Reporting Season August 2014: The Verdict

This story features WOOLWORTHS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WOW

In this week's Weekly Insights:

– Reporting Season August 2014: The Verdict
– China Stimulus
– Lower For Longer Remains The Mantra
– Buy Backs Rule
– Rudi On TV: The Week Ahead
– Rudi In Brisbane This Week

Reporting Season August 2014: The Verdict

By Rudi Filapek-Vandyck, Editor FNArena

FNArena celebrated its twelfth anniversary earlier this year. I guess I have been watching stockbroking analysts and corporate results in Australia for a while. Yet, I cannot remember one previous occasion when views and opinions were as divided as they seem this year post the FY14 August reporting season.

One would think it's a fairly straightforward concept. We have share prices and expectations, often in close correlation with each other. Companies release financial results and provide some guidance. Share prices adjust. Analysts revise their expectations. The net balance between these events provides us with a fairly basic overview of how it actually went. Bad. Good. Or somewhere in between.

This year, however, it is as if market analysts and commentators have been watching different reporting seasons altogether and their views are as wide and varied as I've witnessed over the past decade or so.

Before I attempt to put some perspective on things, let's clear the air on one persistent misconception:

Part of the Kommentariat continues to refer to "low expectations" going into this reporting season. There may have been a lot of questions and scepticism on the basis of low momentum and patchy confidence in Australia, but expectations, as expressed in market consensus for earnings per share growth, had not been as high as this year since 2007.

This makes a lot of sense once we take a few seconds to absorb this information. There has been virtually no EPS growth for the ASX200 on a net basis in previous years, which can function as a major factor as to why the Australian index was left behind by Wall Street during those years. Also, with the share market hovering at six year high levels, and on above average market PE, expectations had to be higher than in previous years to justify current prices.

The good news from this year's August reporting season is thus that expectations have been largely met and in many cases exceeded, while real disasters were left to a few only, which means there's no need for a sell-off or otherwise re-adjustment to lower multiples and share prices. Australian companies have provided enough justification for the level at which their share prices are trading. But there has been very little to significantly enhance further upside potential. At least among the larger caps, which does raise questions about  sustainable further upside potential for the ASX200.

(I noticed UBS' end-of-year target is around present level. No surprise, UBS is being quoted in newspapers as saying the index is likely to proceed sideways for the remainder of the calendar year).

We're still crunching numbers here at FNArena (as I am sure they're doing the same thing elsewhere) but it is well possible the end verdict could be for double digit growth in FY14, on average, for the ASX200. If not, it'll turn out in high single digits. To put this in perspective: this just about doubles all growth recorded in Australia since 2009.

Expectations for FY15 are for yet another year of robust growth, probably high single digits. So not only has corporate Australia just put in its best effort since 2007, market expectations are for a repeat this year. Low expectations? Think again.

The first thing to keep in mind when assessing these expectations is that the composition of growth is about to change dramatically. FY14 numbers still saw hefty growth numbers from (some) iron ore producers. This is no longer assumed to be the case in the year ahead. Instead, large oil and gas companies are anticipated to start contributing as large LNG projects approach completion and capex programs expire.

Banks and other financials are expected to continue growing, but at a more sedate pace. If current consensus is correct, it'll be the industrials space that will carry the main load this year. Starting with cyclicals that benefit from momentum in housing markets and exporters that can tap into growth in the US and in developing economies.

Overshadowing all of this, remains the fact a lot of the growth reported in August was the result of cost out programs, of reductions in spending and on the back of low interest rates. This is why some are talking "low quality" and "unsustainable". In simple terms, top line growth was in most cases lower than growth in profits and dividend increases were in most cases larger than both (even though the pay out ratio declined somewhat).

According to the pessimists, this is not a good sign. According to the optimists, this simply shows corporate Australia is gaining in confidence, has plenty of cash and undergeared balance sheets and is not afraid to reward shareholders while better times lay ahead.

We gotta give it to both camps: there's more than just a grain of truth in both assessments.

In terms of company performances vis-a-vis expectations, on FNArena's assessment, around 30% of reports proved a beat, while 26% missed. These numbers are not that unusual. Consider that in February 30% beat but only 22% missed. In August last year, for a total result of a slight negative EPS performance for the ASX200 overall, 24.5% beat and less than 19% missed.

Again: the key difference this time around was that expectations were much higher. And they have remained relatively high for the year ahead.

Two observations are worth paying attention to:

1. The number of negative changes in broker ratings has been noticeably higher this season than it has been in the past. Thus far, at FNArena we registered 90 downgrades and 55 upgrades. In February the corresponding numbers were 74 and 64. In August last year, the numbers were 86 and 61. No doubt, both the rise in downgrades as well as the decline in upgrades are both a reflection of share prices being perceived at fully valued levels.

2. The lift in valuations and broker price targets has proved rather benign, in particular for large caps. Updates by banks no longer automatically raised targets in August. Any net increase in the consensus target for BHP Billiton hardly registered, despite slight increases to profit forecasts. All in all, on FNArena's calculation, the average target increase during the month was 2.15% compared with more than 5% in February and an equal 2.15% in August last year.

I would not be projecting a surge to 6000 anytime soon and if it does happen quickly, I would be very concerned about what comes next.

The individual result that probably best illustrates the August reporting season, in my view, is that of Woolworths ((WOW)). Strictly taken, the company reported growth in line with its own guidance, albeit at the lower end of it and after delaying the path to profitability for its troubled Masters franchise.

This is an extract from CIMB's response on Monday:

"While the FY14 result hit expectations on most levels, we came away feeling a little empty. The company appears to have pulled the price lever in 4Q14 to meet earnings targets, DPS growth was behind EPS growth, capex is forecast to increase notably in FY15 and changes have been proposed to reduce disclosure in the core supermarket operation. While none of the above are likely to result in an abrupt reduction in PE rating, we don’t see any upside potential at this point. Our earnings forecasts remain largely unchanged, as does our target price of $35.60. We retain our Hold rating. Forecast growth in FY16 and beyond becomes dependent on an improvement in Masters. This remains the greatest risk to our recommendation."

Woolworths only received one recommendation downgrade but its share price has remained under pressure as both analysts and investors ask the question: even assuming no significant de-rating is afoot, how much upside potential is left for a non-inspiring story that is trading on a PE of 17.5 while offering a dividend yield of 4.1% (fully franked) and with tepid growth prospects, and only if they don't allow Masters to inflict more damage?

Woolworths does still have the support of other analysts with ongoing optimistic skew, but even UBS (Buy, target $39.20) acknowledges the pressure is on for Woolworths as the competition in Coles, Aldi and Costco is making its presence felt. UBS is banking on the company's inherent strength to continue defying the sceptics and the pessimists.

Woolworths' story is essentially the same one as for the major banks, most other financials and for those industrials companies that have continued performing in FY14, just like they did in prior years, but whose share price valuation today is a direct reflection of this robust performance. Think REA Group ((REA)). Think Amcor ((AMC)). Think Commonwealth Bank ((CBA)). Think Ramsay Healthcare ((RHC)) and Domino's Pizza ((DMP)).

On the other hand, pleasant surprises that weren't necessarily priced in already came from the likes of Caltex ((CTX)), CSG Group ((CSV)), Dick Smith ((DSH)), Echo Entertainment ((EGP)), M2 Telecom ((MTU)) ands McMillan Shakespeare ((MMS)), among others.

Many of recent IPOs also set up a positive track record: 3P Learning ((3PL)), Asaleo Care ((AHY)), Cover-More ((CVO)), iSentia ((ISD)), Nine Entertainment ((NEC)), Veda Group ((VED)), and others.

A selection of former disaster stories finally started to outperform weak expectations, including APN News & Media ((APN)), Cabcharge ((CAB)), Fairfax Media ((FXJ)) and Toll Holdings ((TOL)).

Last but not least, as in every other reporting season, we also witnessed some companies losing their halo, including Aurizon ((AZJ)), Breville Group ((BRG)), Coca-Cola Amatil ((CCL)), Computershare ((CPU)), JB Hi-Fi ((JBH)), QBE Insurance ((QBE)) and Tatts ((TTS)).

All in all, it would appear that "growth" has finally announced itself for corporate Australia (it only has taken six years to arrive), but in many cases that was as expected and thus priced in, while there's enough doubt left to not get overly excited about FY15-FY16 just yet.

China Stimulus

Anyone else noticed how Chinese data have carved out a familiar pattern over the past three years?

First the authorities try to reign in too much liquidity and misallocation of funds, and to re-direct the economy away from excessive spending on infrastructure. Next thing we know economic data and indicators start decelerating and demand for natural resources slows. Then over the hill comes the cavalry, liquidity increases, new infrastructure spending comes to the rescue and the government's growth target is secure for yet another year.

This year is the third in a row that has seen the same script being played out. Only this year, it appears, more stimulus is needed since recent indications are Chinese growth is again losing momentum this quarter. The two PMI surveys released on Monday suggested as much. So why isn't Chinese stimulus working as it has done in previous years? Is this yet more evidence that the wonder-formula of unbridled spending is approaching its limits?

I wouldn't reach for guaranteed doom and gloom blue prints just yet, but it is probably a fair assumption the difference this year is that the property sector is in a funk, which also explains why copper has failed to get any traction this year and why iron ore is below US$90/t instead of above US$100/t. Given the experience of previous years, and Beijing's determination to save face and reputations, more liquidity and more stimulus should be around the corner. That's exactly what the army of China watchers and economists with special interest in the country are expecting too.

This year also sees one alternative index to measure China's economic strength lose its lustre, if not relevance altogether. Macquarie analysts organised a burial for the Li Keqiang Index last week, arguing all three sub-components (power consumption, rail freight and bank loans) are losing their significance in the transforming Chinese economy, and thus the index is becoming less relevant. The LKQ has been a popular indicator among media and investors in tracking China’s economy in years past. [Three seconds silence please].

Lower For Longer Remains The Mantra

I made a specific mention of this in last week's Weekly Insights, but still think this is important enough to warrant another moment in the limelight: anyone who wonders what the real reason has been for another rally upwards in US equities need not look further than moderating interest rate expectations among global funds managers and professional investors. In other words: the Federal Reserve will still start raising interest rates sometime in 2015, but the pace of Fed Funds hikes is likely to remain glacial, so it won't interrupt, or damage, the present bull market in US equities.

Last week I referred to CBA's revised blue print for Fed rate hikes. This week I have the opportunity to add some of Gerard Minack's comments on the matter:

"Rate markets in the US have pushed out the prospect of Fed tightening despite this better forward-looking data. Better growth and delayed tightening: equities have been able to eat their cake and have it too, at least in the US.

"This splendid mix will, in my view, likely change in coming months. Solid growth, if it arrives, will surely bring forward market expectations for Fed tightening. This prospective change will likely bring to an end the PE-driven expansion in equities, at least in the developed markets."

Buy Backs Rule

I've labeled it the Americanisation of the Australian share market. Economic momentum might be patchy, and the Aussie dollar still very much too high. No real help can be expected from Canberra and top line growth is still a demanding target. But none of this stops boards rewarding shareholders, just like the corporate peers have done on Wall Street in years past. Remember GDP growth in the world's largest economy has averaged a paltry 2% in the post-GFC era, but anyone would be hard pressed to find any evidence for this in US equity markets.

So this year we saw spin-offs, mergers, privatisations, special dividends, more dividends and… share buy backs. International research suggests a strong causation between companies who buy in their own capital and share price outperformance. At the very least, share buy backs provide support to the downside in case of a defensive policy.

Here at FNArena, we've put together a list of companies that have announced buy backs, but my gut feel tells me this is something best done in cooperation with our database of readers and subscribers. So if you know of any more companies, do tell us and we'll investigate and add them to the list.

Companies who've announced a buy back:

Ansell ((ANN))
CSL ((CSL))
Helloworld ((HLO))
Karoon Gas ((KAR))
Telstra ((TLS))

Companies believed to potentially announce buy backs in the not too distant future:

Aurizon ((AZJ))
BHP Billiton ((BHP))
GWA Group ((GWA))
Rio Tinto ((RIO))

Our address, as per usual, is info@fnarena.com

Rudi On TV: The Week Ahead

On request from readers and subscribers, from now onwards this Weekly Insights story will carry my scheduled TV appearances for the seven days ahead:

– Monday – Sky Business – circa 11.20am (Broker Calls)

Rudi In Brisbane This Week

On Wednesday, September 3, I will be presenting in Brisbane twice. First at 2.45pm on invitation of the Australian Investors' Association (AIA) and later in the evening on behalf of the Australian Technical Analysts Association (ATAA)).

The first presentation at 2.45pm:

Venue: Bronco Leagues Club, Fulcher Rd Red Hill
Two speakers: One at 1.30pm for one hour and I am at 2.45pm for an hour.

The second presentation runs from 6.30-7.30pm and continues from 7.45-9pm.

Venue: Fitzy’s Tavern at Loganholme

(This story was written on Monday, 01 September 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.

This eBooklet is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to info@fnarena.com

For paying subscribers only: we have an excel sheet overview with share price as at the end of August available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms