Big Upside Surprises

This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO

In this week’s Weekly Insights:

– Big Upside Surprises
– Correction, Correction, Where Art Thou?
– Surprise Revelation From Ardent Leisure
– Radar On Buy-Backs
– Rudi On TV
– Rudi On Tour

Big Upside Surprises

By Rudi Filapek-Vandyck, Editor FNArena

What started off like a surprisingly good reporting season has since lost a bit of its glamour, but nothing to get overly discouraged about.

Company profits are still beating expectations on more occasions than they disappoint, and so there seems plenty of justification around for as to why share prices have booked double digit returns since December.

On FNArena’s assessment, more upward adjustments to targets and forecasts are being made than negative revisions and this in particular is the case when we ignore resources stocks and mining services providers.

At face value, it appears average forecast for growth in earnings per share (EPS) for the current financial year might struggle to stay in positive territory post this reporting season, the average itself is no longer representative as it is heavily weighed down by resources stocks.

For example. while Rio Tinto ((RIO)) may well have delivered one of the stand-out positive surprises thus far this month, market consensus still predicts this year’s EPS will decline by 20%. For BHP Billiton ((BHP)), the decline for the year until June 30 is predicted to be twice that large. For Fortescue Metals ((FMG)), this year’s decline is expected to be twice as large as BHP’s, to be followed by a further decline of 51% in FY16.

Let’s not even mention mining services providers.

Industrials Are Stealing The Show

On the positive side, industrials companies are clearly stealing the show, reporting better than expected earnings, lifting dividends, announcing buy-backs and special dividends and understandably attracting most of the market’s attention.

Each reporting season has its stand-out winners and losers, with big share price movements in each direction, but it would appear this reporting season has generated more eye-catching surprises to the upside.

Hands up who thought the Domino’s Pizza ((DMP)) share price had yet another 41% in it? Flexigroup ((FXL)) is up by more than 30% over the past thirty days. Recently listed iSentia ((ISD)) is not far behind.

I don’t think I can remember a reporting season when a 25% gain for AMP ((AMP)) shares was not enough to make it inside the top ten.

Here’s the Top Ten share price gainers so far as compiled by The Intelligent Investor: Toll Holdings ((TOL)), Domino’s Pizza, Mayne Pharma ((MYX)), Australian Pharmaceutical ((API)), Flexigroup, Crown Resorts ((CWN)), Nufarm ((NUF)), Myer ((MYR)), iProperty ((IPP)) and iSentia.

The Bottom Ten according to the same source consists of Kathmandu ((KMD)), Acrux ((ACR)), iiNet ((IIN)), GWA Holdings ((GWA)), Prana Biotech ((PBT)), Southern Cross Media ((SXL)), Ardent Leisure ((AAD)), NewSat ((NWT)), Programmed Maintenance ((PRG)) and Navitas ((NVT)).

GDP Growth Does Not Equal Profits

In more general terms, and worth repeating in my view, is that rather weak economic momentum (see RBA rate cut and federal government budget) does not stop industrial companies from putting in a strong performance.

Well, certain industrial companies. Think Telstra ((TLS)), and Domino’s Pizza of course, and Greencross ((GXL)), and Sirtex Medical ((SRX)), and Amcor ((AMC)), and Slater and Gordon ((SGH)).

Weak economic momentum does create a lot of problems for those who operate under more precarious conditions, such as mining services providers, and insurers (for whom the cycle has turned and competition is starting to bite), IT services and advertising who need higher business confidence, and retailers for whom consumer income and confidence both need to rise, and quickly.

There is still a large number of companies yet to report this week, so too soon to draw any definitive conclusions, but many of the solid outperformers from the past years have simply added yet another solid report this month.

Many of whom are on my personal radar as they are part of my selection of All-Weather Performers^(*). I intend to conduct a more detailed analysis once we’ve seen the last of the reporting tsunami, which should be this Friday. So far, the signals look good.

Amongst the companies that proved a clear “winner” so far this season are Ansell ((ANN)), Amcor, Domino’s Pizza, Greencross, Regis Healthcare ((REG)), Silverchef ((SIV)), Slater and Gordon, Sirtex Medical, Flexigroup and iSentia.

Amongst the “losers” we find Insurance Australia Group ((IAG)), Leighton Holdings ((LEI)), Seek ((SEK)), Ardent Leisure and iiNet ((IIN)), plus a whole bunch of mining services providers.

With regard to IAG, Ardent Leisure and iiNet, I see yet more evidence as to why competition dynamics are more important than the overall state of the economy.

Yet more proof as to why the direct correlation between economic growth and share price performance remains a wobbly correlation, at best.

Analysts Good In Predicting Disappointments

Allow me to take a side-step and refer to the list of candidates for potential disappointment this reporting season as included in my Weekly Insights from February 9.

Looking back, it would appear the hit rate of that list has been extremely high. It even mentioned CSL. To save you all the effort of going back and trying to decipher who’s up next, here are the remaining candidates for disappointment who have as yet not reported: BHP Billiton, PAS Group ((PGR)), QBE Insurance ((QBE)), Treasury Wine Estates ((TWE)) and Woolworths ((WOW)).

Note: a high accuracy rate thus far presents absolutely no guarantees for the remaining reports ahead. Second note: is it just my perception or are second and third tier players in the telecom sector losing (some of) their mojo?

Other notable disappointments have been delivered by BlueScope Steel ((BSL)), Platinum Asset Management ((PTM)), STW Communications ((SGN)) and Transpacific Industries ((TPI)). The first public release by Medibank Private ((MPL)) proved rather underwhelming because people are revolting against higher fees, seeking out cheaper options instead.

While CommBank ((CBA)) again delivered more than what just about everyone dared to ask for, there’s a growing number of analysts who believe the signs of a downtrend for banking are starting to emerge. Not that anyone is paying attention just yet.

Citi is carrying a Sell rating for all Major Four. Morgan Stanley is suggesting Westpac ((WBC)) might have to “review” its dividend policy come FY16. That’s broker lingo for the board might actually decide to no longer increase its dividends for shareholders that year (imagine the shock waves that will cause).

Lastly, REA Group ((REA)) still managed to deliver a positive surprise, but not so for carsales.com.au ((CRZ)) and certainly not for Seek. As a result, overall investor sentiment seems to have turned lukewarm towards the Big Three of online consumer spending in Australia.

^(*) For more on All-Weather Performers, see further below.

Correction, Correction, Where Art Thou?

After barely managing a positive close in 2014 and what initially looked like a shaky start of 2015, the local share market has now posted five positive weeks in a row. According to my feedback, stockbrokers and other advisors have been telling clients to take some money off the table or otherwise add some portfolio protection as, surely, the whole construction must come down any moment now.

A bit like waiting for Godot, if you ask me.

On my observation, the popular, “over-priced” yield stocks such as Telstra ((TLS)) and CommBank ((CBA)) continue to enjoy solid buying support. While the steam has now evaporated from the previous strong share price rally, share prices remain near all-time highs and if there is a brief deflation taking place, buying support is usually not far away.

Observe how both share prices, and many others, remain near peak-levels (don’t forget also CBA has paid out its final dividend).

What makes the performance even more impressive is that during the period, on assessment of Credit Suisse, global risk appetite made a new low since late 2012. We are now witnessing a bounce back.

Now, we all know investors can be a fickle lot, and certainly sentiment can turn on a dime, mostly when not expected, but with the next RBA rate cut still on the menu, local reporting season not surprising to the downside and profits elsewhere, including in the US, holding up well, it appears this market requires some kind of a bazooka to get things really going to the downside.

Good luck with locating that one.

In the meantime, worry less and maybe ask yourself the question: if your portfolio does not include star performers like Domino’s Pizza ((DMP)), Slater & Gordon ((SGH)), Greencross ((GXL)) and Pact Holdings ((PGH)), then why?

Surprise Revelation From Ardent Leisure

Ardent Leisure ((AAD)), formerly of the Macquarie Group stable, had clawed its way back onto investors radar prior to the February reporting season. This come-back also involved a sharp re-rating from a somewhat largely ignored yield play, without franking, to a solid and defensive growth stock on the back of its successful family entertainment Main Event formula, which is being rolled out in the south of the USA.

FNArena has been without discussion supportive of the transformation, regularly reporting from the early days of the re-awakening, when the stock was trading around $1 and offering yields as high as 11%. Now imagine the share price was trading as high as $3.47 in late October 2014. From that moment onwards the share price started to head south, with the investor community beginning to realise that, with a high concentration of Main Event centres in oil state Texas, Ardent Leisure’s growth might take a hit because of the faltering oil price.

Within this context, the company’s financial report this month contained two major surprises. The first was that no impact whatsoever had been felt from lower oil prices. The second was that while the world was carefully watching Main Event in Texas, the company’s gym business fell apart because of reinvigorated competition from smaller 24/7 operators.

The latter was a genuine and nasty surprise and has not been taken lightly by both analysts and investors. The Gym business was supposed to be part of the backbone of the Australian operations; solid, reliable and resilient. Now it appeared gyms are more of a straw hut rather than a brick-and-mortar fortress.

The change of perception has made Ardent Leisure already one of the stand-out disappointments this reporting season. Given the genuine shock delivered, it very much remains an open question whether positive momentum can genuinely return before August and only on the premise that management by then can provide it has successfully turned around the rapidly deteriorating gym operations.

Such are the disadvantages of having enjoyed a re-rating into a defensive growth stock, once shareholders start questioning the solidity of the re-rating, heavy share price falls follow.

No doubt, and irrespective of the 20% share price fall since December, investors are now toying with questions such as: don’t profit warnings usually come in three? What if gyms are fixed but then Texas slows down on a delayed fall-out from the oil price carnage?

At face value, it appears further downside should remain limited with the forward implied dividend yield now close to 6%. But this, of course, still remains on the premise that no further disappointment shall be announced from here onwards.

Only stick with the shares if you feel comfortable with the risks involved. Ardent Leisure shares are now going to be out of favour for a while, regardless of another RBA rate cut. I very much doubt whether the shares will participate into further upside for the share market overall.

Radar On Buy-Backs

Not every share buy-back is the same. That much I am willing to concede. At times, when a company is in trouble and no reliable growth prospects seem on the horizon, buying back own shares merely limits further downside. In most cases, however, market outperformance is the ultimate consequence.

CEOs in the US know it. Just about every quant analyst who has done the data analysis knows it too. Share buy-backs are beneficial for performance.

Last year I ran a regular update on local share buy-backs in this weekly story, with some participation from subscribers and readers; thank you for your assistance.

Some readers, however, complained that I should focus on whether buying back own shares was actually the right thing to do. The suggestion here was that if a company bought its own shares at too high a price, an opportunity was being wasted and there should be no outperformance, but the opposite instead.

While I can sympathise with such view, and it certainly seems to make a lot of sense -within an academic context- I actually find there’s very little evidence supporting such good/bad buy-back assessments.

Sure, if iron ore prices collapse tomorrow, it won’t stop shares in Rio Tinto ((RIO)) from falling, even those shares look relatively undervalued and the board is thus doing the right thing, seemingly.

But companies including Telstra ((TLS)), CSL ((CSL)) and Amcor ((AMC)) have been buying in own shares for years now, and in each of these cases it can be argued there’s no undervaluation and those companies are buying in at too high prices. It has not stopped each of them significantly outperforming the broader market.

So what’s all this fuss about companies should only buy in when their share prices are cheap and undervalued? Isn’t the irony that if a company is in good shape, and has plenty of excess cash, its share price by definition won’t be undervalued? Happy to start up a discussion about this. All contributions welcome at info@fnarena.com

In the meantime, here’s my starting overview of share buy-backs in 2015 (all contributions, corrections and additions, welcome at the above email address):

– Amcor
– Fairfax ((FXJ))
– Rio Tinto

Rudi On TV

– on Wednesday, Sky Business, 5.30-6pm, Market Moves
– same Wednesday, hosting Your Money, Your Call, 8-9pm
– on Thursday, Switzer TV, between 7-8pm

Rudi On Tour

I have accepted invitations to present:

– Wednesday, 11 March to members of Chatswood section of AIA, in Chatswood (evening)
– August 2-5, AIA National Conference, Surfers Paradise Marriott Resort and Spa, Queensland

(This story was written on Monday, 23 February 2015. 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

Odd as it may seem, but today’s share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.

The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.

Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, 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 January available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms