Rudi’s View: Hits & Misses From Reporting Season February 2016

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

(This story was originally published exclusively for paying subscribers at FNArena on March 3. It is now being re-published to make it available to a wider audience).

By Rudi Filapek-Vandyck, Editor FNArena

Local reporting season throughout February 2016 has been dubbed "not as bad as feared" and most strategists and market watchers seem to agree on this conclusion, but what does it mean exactly?

Does it mean the end balance is positive (e.i. the reporting season was "good") or is it merely a case of it could have been a lot worse, thank heavens it proved not to be?

To create a framework of historical references, I have lined up basic calculations from FNArena's Reporting Season Monitors which have been compiled, updated and published since August 2013. As such, we have a total of five prior reporting seasons to compare with.

August 2013

Upgrades: 61
Downgrades: 86
Average price target increase: 2.2%

Beats: 24%
Misses: 19%

February 2014

Upgrades: 64
Downgrades: 74
Average price target increase: 4.0%

Beats: 30%
Misses: 22%

August 2014

Upgrades: 55
Downgrades: 90
Average price target increase: 2.1%

Beats: 30%
Misses: 26%

February 2015

Upgrades: 38
Downgrades: 118
Average price target increase: 5.57%

Beats: 35%
Misses: 26%

August 2015

Upgrades: 116
Downgrades: 40
Average price target increase: 1.24%

Beats: 30%
Misses: 20%

February 2016

Upgrades: 70
Downgrades: 70
Average price target increase: 1.44%

Beats: 37%
Misses: 21%

Historical Framework

A few observations:

– Counter-intuitively, perhaps, but a good reporting season sees analysts issuing more ratings downgrades than upgrades
– Most reporting seasons generate more downgrades than upgrades
– A reporting season with low expectations sees more companies beating analysts' forecasts
– Every reporting season delivers a net increase to the average price target for stocks; February tends to generate higher increases than August

Within this historical context we observe:

– The average increase in consensus price target has been the lowest out of the six reporting seasons, much lower than prior February precedents
– This season saw the highest percentage of companies issuing better-than-expected results (37%)
– Against the background of low expectations, the number of "misses" was still relatively high, in particular taking into account a number of companies pre-warned. Thus the actual percentage is higher than the registered 21%

Details

What is not obvious from these numbers is that many of the upside surprises had low quality foundations such as unexpected tax benefits, underestimated currency impacts, less interest expenses and further reductions in spending. In addition, many of the misses this season were due to higher-than-expected costs. The latter may suggest a number of companies is running out of options to further cut operational costs, even though there is, in several cases, also an element of accelerated investments (under pressure from competition?).

Good old fashioned revenue growth in combination with rising margin, higher profits and healthy cash flows remains a rather rare occurrence. But companies continue to do their utmost to pamper their shareholders through higher dividends, share buybacks and special distributions. Total dividend payout declined in February, but this was entirely a resources companies story. Many companies under pressure still raised dividends or announced a share buyback.

The negative take-away from this is that companies put short term shareholders' interests first, no matter what. This might imply that if current pressures persist, companies might reduce spending further in order to continue keeping shareholders happy.

In terms of profits, the Australian share market remains in a negative trend with average earnings per share (EPS) declining further throughout February. FY16 is now en route to again show negative growth (-10%); for the second year in a row. The good news is, remove resources from the calculation, and "underlying" EPS growth for FY16 is circa 4%. In the bigger scheme of things, this isn't so bad. Banks will be struggling to match that.

Top 20

Worth highlighting is that Australia's Top 20 -Blue Chips if you like to call them that- are still contributing negatively to all of the above.  For example, CommBank ((CBA)), having reported a not as bad as feared interim report, still saw its consensus price target decline to $78.20 from $80.89. The situation is worse for Bendigo & Adelaide Bank ((BEN)), the other bank that also released interim financials this season, with forecasts plunging post the event, causing a much steeper fall in price targets. Bendalaide's share price suffered in spectacular fashion, falling below $8.50 from $11.

The twist in this story lies in the fact that both share prices of CBA and BEN are trading well below downward revised price targets. A situation that applies to virtually all "blue chips" in Australia, including all Big Four Banks, BHP Billiton ((BHP)) and Rio Tinto ((RIO)), but not Wesfarmers ((WES)), Woodside Petroleum ((WPL)), CSL ((CSL)) or Ramsay Health Care ((RHC)).

Sectors

In terms of specific sectors and categories, domestic oriented companies, such as housing related and numerous consumer oriented stocks, in general managed to beat market expectations. This supports the view of an Australian economy which is proving more resilient than its detractors believed it to be. A suspicion that has since been confirmed by a surprisingly good Q4 GDP read released on Wednesday this week. Company reports that contributed to the overall picture of domestic resilience include Adelaide Brighton ((ABC)), Boral ((BLD)),Star Entertainment Group ((SGR)), Harvey Norman ((HVN)) and Stockland ((SGP)).

Having said that, consumer related stocks once again provided both strength and disappointments, beats and misses, in a sector that generated big moves in share prices either way. This has been a continuation from previous reporting seasons, but the names are not always the same or in the same basket. The Reject Shop ((TRS)) this time surprised in a positive manner, while RCG Corp ((RCG) and JB Hi-Fi ((JBH)) continued their upward momentum. Newcomer Baby Bunting ((BBN)) started life as a public entity with a bang.

On the other hand, Super Retail ((SUL)) released a shocker as weakness in its leisure division was exposed. Lovisa ((LOV)) delivered another shock. Wesfarmers ((WES)) disappointed too, while Woolworths' ((WOW)) report suggests a lot more weakness should be expected, though its share price regained upward momentum on the news a new CEO had finally been announced. Crown Resorts ((CWN)) also surprised to the downside, as did Surfstitch ((SRF)), Billabong ((BBG)), and others.

Analysts at Morgan Stanley predict margins for consumer related stocks have now peaked, in a general sense, which shall make for an interesting build-up to the August reporting season. Investors should also note a number of retailers will report their results out-of-season in the weeks ahead.

Stocks with international exposure mostly released better-than-expected results and this includes popular high PE names such as Domino's Pizza ((DMP)), Treasury Wine Estates ((TWE)), Ramsay Health Care ((RHC)), ResMed ((RMD)), Cochlear ((COH)), Amcor ((AMC)), Orora ((ORA)), Brambles ((BXB)), et cetera. Ansell ((ANN) had opened with a nasty profit warning, but it turned out the company's growth problems were company-specific.

This observation seems to vindicate my own strategy this season as outlaid in Bear Market Diaries – Episode 3.

Healthcare as a sector delivered a much more mixed performance (than usual) with many small caps in particular missing expectations. Primary Healthcare ((PRY)) experienced a big jump in share price, but this happened after yet another profit warning with share price sell-down had occurred prior. Sonic Healthcare ((SHL)) also missed expectations. So did Estia Health ((EHE)) whose CEO stood out this reporting season by being genuinely surprised investors put so much focus on whether prospectus estimates are being met or not (Yes, I have some serious questions about this too).

Other stand-out events include a whopper profit from Qantas ((QAN)) and the absence of yet another disappointment from QBE Insurance ((QBE)). The self-destruction at Slater & Gordon ((SGH)) continued unabated.

High PE Stocks

Companies whose financial reports forced noticeable increases in price targets include AGL Energy ((AGL)), APN Outdoor ((APO)), ARB Corp ((ARB)), Aveo Group ((AOG)), BlueScope Steel ((BSL)), Brambles ((BXB)), Capilano Honey ((CZZ)), Cochlear, CSL, Domino's Pizza, Greencross ((GXL)), JB Hi-Fi, Newcrest Mining ((NCM)), Reece Australia ((REH)), The Reject Shop, Seek ((SEK)), Silver Chef ((SIV)), Stockland ((SGP)) and TFS Corp ((TFC)).

The dilemma for investors is many of these outperformers are already trading near or above consensus price targets which may limit further upside while many shares in companies that disappointed and suffered cuts in forecasts and price targets are still trading well below consensus targets. The Big Four Banks come to mind, as well as BHP Billiton, Rio Tinto, Woolworths and many mining stocks (not necessarily energy companies).

Spectacular Misses

Also remarkable were numerous spectacular misses among small cap technology stocks & telecom services providers. SMS Management and Technology ((SMX)), Urbanise ((URB)), Tomizone ((TOM)), BigAir ((BGL)), Rubik Financial ((RFL)), 3P Learning ((3PL)), Amaysim Australia ((AYS)), Infomedia ((IFM)), Reckon ((RKN)) and Speedcast International ((SDA)); all suffered large, if not spectacular share price losses.

The same can be observed for some small cap high PE stocks whose financial performance not quite met elevated market expectations, including IPH Ltd ((IPH)), Bellamy's ((BAL)), Bega Cheese ((BGA)) and iSentia ((ISD)). The latter in particular suffered premium de-rating post result.

Outlook

In terms of growth beyond FY16, current forecasts are for a major jump in profits for miners and energy companies, assuming a parallel jump in commodity prices in the year ahead. The longer such a sustainable bounce doesn't occur, the greater the chances these sectors will remain in downgrade mode for longer. Analysts are currently projecting double-digit growth for both FY17 and FY18, but if the trend for the past two years is anything to go by, these forecasts could well be negative by February next year.

This is the question mark that continues to haunt investors: how much of the downtrend is going to become visible in the next reporting season(s)?

Deutsche Bank sees further potential for rising margins for building materials, packaging, transport, retail, utilities, gaming and IT, but margins appear to be headed down for contractors, food retailers, mining, healthcare and telcos.

In terms of a defining theme, this was the reporting season when the downturn for energy and industrial commodities really hit home. While broadly anticipated, dividend cuts, impairments and operational losses in many cases still took analysts and investors by surprise.

Overall, companies retained a cautious streak when issuing guidance, but there has been a slight bias towards more upside/positive outlooks. Also, Australian shares usually outperform their international peers during reporting season. In February they underperformed. Volatility spiked considerably with Deutsche Bank analysts reporting on their measurement share price volatility in February hit a new four year high.

Strategists at CLSA observed 35% of companies reporting saw their share price respond by at least 5% on the day (either direction). The last time we saw such a high number of stocks reacting +/- 5% on the day of results was FY08, but nobody likes to be reminded of that comparison, of course.

All in all, average Price-Earnings ratio for the ASX200 is not too far off from its long term average of 14.5x; that is, if we focus on FY17. Taking cue from FY16, the market's PE sits above 16x, which is well above the long term average. This while the Top 20 is struggling for growth and analysts' forecasts for FY17 and FY18 are potentially to come under pressure in the months ahead, especially if commodity prices do not improve sustainably.

See also FNArena's Reporting Season Monitor February 2016

(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.)  

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