Consensus Forecasts As A Tool

This story features TREASURY WINE ESTATES LIMITED, and other companies. For more info SHARE ANALYSIS: TWE

In this week's Weekly Insights:

– Consensus Forecasts As A Tool
– Too Early For A Chinese Hurrah
– Australian Profits: Tough, But Not Dire
– Presentation at PhillipCapital in Sydney

By Rudi Filapek-Vandyck, Editor FNArena

Earlier this month, FNArena added a new feature to its service with price charts for individual stocks in Stock Analysis now showing the evolution of consensus EPS forecasts for this financial year and next.

Similar to other, fundamental analysis-based tools and applications that are available on the FNArena website, this new addition still requires a personal assessment from the analyst or the individual investor who wants to integrate this into dynamic investment strategies.

First thing to determine is whether a given stock is trading on earnings growth potential, or on something else. Treasury Wine Estates ((TWE)) shares are trading on high multiples and well above consensus target, but earnings growth (despite a gigantic recovery this year) is not the driver. It's the potential for a corporate suitor to act. Knowing this, there's little use of trying to figure out a link between changes in forecasts and future movements in the share price. One has to accept there's no such thing as one solution for all circumstances in the share market.

Ditto for Ten Network ((TEN)) whose declining share price seems to have triggered attention from private equity. But this also applies to Telstra ((TLS)) for which EPS expectations have been in gradual decline since August last year (see price chart with EPS forecasts below).

Usually, a share price tends to face downward pressure in line with falling profit estimates, but Telstra is inside the present context somewhat of a safe-haven, offering rock solid dividend yield with the prospect of an increased pay-out to 30c and maybe even 31c in the years ahead and this is ensuring solid support for the share price. There is equally little value in trying to figure out a possible connection between EPS estimates and share price potential when the dominant factor is dividend appeal.

Before we move on to the next stock, let's pause for a moment at the Telstra chart above. In the top compartment the greyish shadow in the background shows the evolution of the consensus price target for the stock and it is instantly clear Telstra shares have been trading mostly above target in the year past. Such has been the power of solid dividends in a market dominated by retiring baby boomers (seeking less risk and more security) and persistently low interest rates and relatively low bond yields.

In the bottom compartment, EPS forecasts are shown in yellow for year one (FY14) and in purple for the following year (FY15). As is usually the case, for a relatively solid industrial as is Telstra, the purple line sits at a higher level than the yellow line (indicating continued growth further out), but, as said, both lines have been in gradual decline over the year past, with a mild upswing in recent weeks.

As Telstra's appeal has little correlation with these forecasts and everything to do with the fact that dividends are likely to increase, on top of very slim prospects that Telstra will be forced to cut its dividends, the share price has not only remained at elevated level (above consensus target), but the shares have also gradually ground higher from circa $4.50 last year to $5.40 this month. Even at this week's price of $5.20 Telstra shares are offering nearly 6% in FY15 dividend yield, fully franked. It's but a fair assumption this will continue to dominate the direction for the shares and its general appeal, rather than any minor changes to profits.

There are plenty of stocks around for which earnings forecasts do matter and Australian banks are amongst them. Three of the Big Four in Australia are, similar to Telstra, popular because of solid, reliable dividends, but bank dividends in Australia are more closely linked to profits than is Telstra's dividend at this point, and this makes any changes in forecasts more important.

As clearly shown in the chart below, CommBank ((CBA)) shares have been well-supported by ongoing increases to EPS estimates, both for this year (FY14) and next, and the same goes for Westpac ((WBC)) and for ANZ Bank ((ANZ)). Anyone seeking the answer as to why bank shares haven't sold off this year, despite so many experts calling them "overvalued" and "ripe for a correction" need not look any further. Rising forecasts are more than likely the answer you are looking for, alongside dividend appeal and a general perception of lower risk (rightly or wrongly).

Most bank shares in Australia are trading near consensus target, which means CBA shares -always at a premium- mostly trade above target. The exception is National Australia Bank ((NAB)) and the chart below can serve as the explanation as to why NAB continues to be the sector laggard. Look at the forecasts in the bottom compartment. Observe how, contrary to the other Three, there's no uptrend whatsoever.

National Australia Bank is the laggard because it does not enjoy ongoing upgrades to forecasts. Analysts are doubting a sale of its troubled UK operations is imminent. The above can serve as an explanation to the riddle that must have haunted many an investor throughout the years past: how come, National Australia Bank, with the highest dividend yield, continues to lag the others? A lack of upside momentum in earnings is clearly visible below the price chart above. No need to look any further.

What's the story for the regional banks, I hear you ask? Both Bank of Queensland ((BOQ)) and Bendigo and Adelaide Bank ((BEN)) are also enjoying upward momentum in profit forecasts, but more so for next year (FY15).

There are a number of analysts out there who are currently predicting this positive trend for bank sector profits may well improve further. If their prediction proves accurate, I wouldn't bet on that long anticipated correction in bank share prices to occur anytime soon.

Admittedly, earnings forecasts are not the be and end all in the share market. Sometimes "valuation" -be it excessively high or extremely low- takes over as the dominant factor. In recent weeks share prices of oil producers and explorers have received welcome "stimulus" from a general realisation that supply looks a lot less reliable for crude oil and geopolitical risk is back. The world might be on the verge of a re-appraisal of the many risks to sufficient supply of crude oil and its refined products, and this is being priced in. The same goes for mining stocks. Long before anything shows up in terms of targets and/or profit forecasts, the share price has potentially already moved at the speed of light.

What about the large cap miners, BHP Billiton ((BHP)) and Rio Tinto ((RIO))?

Ironically, consensus forecast for BHP this year has also steadfastily moved higher and higher, indicating BHP remains poised to release a strong profit report in August, to the tune of some 23% above last year's profit result, but for FY15 expectations are pretty much at the same level as where they were last year and this has led to the yellow line crossing purple in February this year. This indicates negative growth for BHP in FY15, an expectation that not only still stands, but at a widening gap too (as this year's forecast kept on creeping higher). On current forecasts, BHP is facing a 5% decline next year.

Could this be responsible for an ongoing lacklustre share price performance? I think so. Note also that BHP dividends are as solid as are the bank's, if not even more solid. So the share price tends to find support whenever forward implied dividend yield, corrected for AUD/USD, reaches 4%. Currently, the shares are sitting at 3.8%.

For Rio Tinto, whose financial year runs until December, there has been more damage to this year's forecasts and it clearly shows in the yellow line below. The negative news is there will be negative growth this year, on latest expectations, but next year should see a positive outcome. Share price weakness has now pushed up Rio's implied forward dividend yield to 3.7% for the year to December, but to 4% on next year's numbers. I think that Rio Tinto shares will follow in the footsteps of BHP Billiton and find increasingly solid support whenever that 4% dividend yield comes into focus. Still a little early for that right now.

What further stands out is that just about every producer of iron ore in the country has seen the yellow line cross over the purple line in months past, indicating profits have peaked and growth will be negative next year, with the exception of Rio Tinto. For Fortescue Metals ((FMG)) this likely implies the present implied rise in dividend payout next year might not happen. Depending on what happens to the price of iron ore from here onwards, analysts are speculating dividends will be cut, if not completely scrapped, to allow further strengthening of the balance sheet by further reducing debt in a much less favourable pricing environment.

As said earlier, it's not all about profit forecasts only.

Sometimes a mismatch can happen between share price and profit forecasts, but investors should not automatically assume this always represents a buying opportunity. The chart for Breville Group ((BGR)) shows shares have come under pressure at a time when earnings estimates have risen. Breville Group shares were trading above target and today the Price Earnings (PE) ratio for this year is still above 21. Clearly, "valuation" has been the prime driver for this stock and investors are probably better off making a distinction between high multiple stocks, such as Breville, and others.

Having said this, with the share price now well below target, and consensus expectations for double-digit profit growth for the company in FY15, it remains an open question as to how long investors will remain wary because of a seemingly high valuation when forecasts for next year are not necessarily going to change (much) in August? Or are they suspecting downside risk on the back of disappointing consumer sentiment in Australia?

A more intriguing mismatch seems to be happening at Automotive Holdings ((AHE)) where this year's profit forecasts remain under downward pressure, and the share price has followed suit, but for next year forecasts keep on rising. Given the forecast of 14.5% growth next year, alongside a double-digit lift in dividends, and the implied yield is now well above 6%, I think it's quite possible the shares are near strong support and probably poised to bounce a lot higher.

Investors should never lose out of sight that "estimates" are just that and they can change dramatically in case of a sudden reversal in sector dynamics or a profit warning issued by management. Also, one look at the bottom part for a stock such as AWE Ltd ((AWE)) instantly shows profit estimates are of little relevance for certain small cap stocks with ever so fluid dynamics.

An industrial company such as Aurizon ((AZJ)), on the other hand, shows how market forecasts have been relatively stable throughout the year, with the share price mostly in a continuous grind higher. Assuming next year's numbers remain where they are, and with an implied 4% yield on offer, it's probably a fair assumption to make Aurizon shares remain poised to rise further in the year ahead, despite what looks like an elevated PE multiple of 20 on this year's estimates.

Paying subscribers can access all of the above, and many more charts with two years of EPS forecasts, via Stock Analysis on the FNArena website.

Too Early For A Chinese Hurrah

There have been plenty of comparisons between current threats in China stemming from too much debt in combination with a struggling property market and the situation in the US pre-GFC, but if there's one easy to observe difference it is that pre-2007 virtually nobody was paying the slightest attention to what was happening in the US and today just about everyone is keeping a close watch on what might be developing in Chinese property markets.

To keep everyone's attention firmly entrenched, the latest data from the National Bureau of Statistics, in China, revealed the average national home price had fallen in May, by 0.2%. The event marks the first negative read since May 2012 when the previous downturn was in full swing. Macquarie analysts note underlying details were noticeably worse in May than in April, so there's probably more bad news ahead on this subject.

In the last down-cycle, national home prices in China fell for eight months from Oct 2011 to May 2012, note Macquarie analysts. Their peers at BA-ML do not think this is more than simply a down-cycle, but they do firmly hold the view the months ahead seem poised to generate more negative news, before things can start improving. Macquarie analysts agree on both fronts: it's simply a cyclical downturn, not a structural change, and there remain plenty of headwinds for the Chinese property markets, regardless of soft government support.

All this translates into: down-side risk still lingers. Or to be more precise (in Macquarie's words): "Beijing's skill in fine-tuning the economy is admirable, but it’s not guaranteed that they will succeed every time". To be continued.

Australian Profits: Tough, But Not Dire

Equity strategists at Citi believe there are likely more corporate profit warnings to hit on share prices and investor sentiment in Australia, with the most plausible culprits to be found in sectors such as media, retailing, engineering, metals and mining while, of course, a stronger Aussie dollar is impacting on exporters. But strategists Tony Brennan and Vivian Jiang see plenty of reasons to stay positive because, among other things, Australian banks may well face upgrades in the months ahead and the end result for profit growth in FY15 is believed to be positive, post all the downgrades and warnings yet to come.

As such, Citi has held on to its year-end target for the ASX200 of 5850. Strategists at Morgan Stanley last week published a target of 5800 for year-end. Including dividends, this implies 2014 is poised to deliver double digit returns in the second half of the year. So far, the first six months have been minimal with average dividends higher than average share price appreciation.

Presentation at PhillipCapital in Sydney

In two weeks, I will be presenting at a Seminar organised by PhillipCapital in Sydney.
Date: Monday 7th July 2014, 6.30pm until 9.30pm (my presentation is 6.30-7.30)
Location: PhillipCapital, Level 9/56 Pitt St, Sydney
Access is free

(This story was written on Monday, 23 June 2014. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website)

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Things might look a lot different today than they have between 2008-2012, but that doesn't mean there are no lessons and conclusions to be drawn for the years ahead. "Making Risk Your Friend. Finding All-Weather Performers", was published in January last year and identifies three categories of stocks that should be part of every long term portfolio; sustainable yield, All-Weather Performers and Sweetspot Stocks.

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