Rudi’s View: Coming Soon, The August Reporting Season

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In this week's Weekly Insights:

-Coming Soon: The August Reporting Season
-A Deeply Frustrated Fund Manager

Coming Soon: The August Reporting Season

By Rudi Filapek-Vandyck, Editor FNArena

On many accounts, the August reporting season about to be unleashed upon investors in Australia will mark a new low post-GFC, which ended 11 years ago.

This does not by default imply the Australian share market is ready for a big sell-off in the weeks to come.

Investors are being reminded markets do not compare in absolute numbers or values. It’s all about matching what is forecast, what is priced in and what can ultimately be achieved.

Reporting seasons are mostly about changes to forecasts (and perceptions) rather than what companies have achieved.

Within this framework it remains an open question as to what conclusions exactly can be drawn from company financials and updates when macro developments remain all-important, and unpredictability of events and outcomes high.

We are less than 3.5 months away from the US presidential election, to name but one of the obvious obstacles to make far reaching predictions with any sense of conviction.

Companies will be reluctant to provide concrete guidance, but those who can/do will be rewarded for it.

Analysis of the five months since the pandemic spread teaches us that concrete guidance will be rewarded with share price outperformance.

Makes a lot of sense, if you think about it, as long as that guidance doesn’t need to be withdrawn later.

Bad news is not necessarily the equivalent of a fatal blow, as also shown by energy producers and shopping mall owners pre-season. Large write-downs of assets had investors merely shrugging their shoulders: tell us something new!

We saw those write-downs coming from many miles away.

Investors are definitely looking forward, in many cases to FY22 which is not one but two years away, which means high tolerance for bad news in the short term, as long as it doesn’t impact on FY22 estimates and derived valuations.

(This also shows, once again, why the macro picture remains the all-important denominator).

There is some anticipation that boards and management teams will grab the opportunity to clean balance sheets and get rid of a lot more baggage than otherwise would have been the case.

Again, this means: even more bad news will be thrown into the open.

Earnings estimates, on average, have been reduced by -15% and dividend cuts will be larger still, double the cuts in profits on some forecasts, which will make 2020 the worst year for income seekers in a long while.

Equally noteworthy: most forecasts assume no growth, on average, in FY21. A lot of weight is thus placed on recovery prospects by FY22.

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Wat sets this year apart from past references is that the global pandemic created beneficiaries in the form of medical tests, ventilators, sanitisers, home entertainment and online shopping.

There were no obvious beneficiaries around when the Nasdaq bubble burst or when Lehman Bros went bankrupt.

Hence, more so than ever, this year’s August reporting season comes at a time of extreme share market divergence – winners versus losers.

Whereas the losers might be enticed to spill the beans, throw out the kitchen sink, clean all the cupboards and create a springboard for future recovery and growth, no such leniency will be granted to companies whose share prices are trading near the all-time high.

Assessments will be made on a case-by-case basis.

None of this means losers won’t be punished or winners cannot positively surprise. If past reporting seasons can be our guide, day-to-day volatility might spike a few extra notches.

There is always room for disappointment and surprise.

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Potential strong performances will be delivered by producers of iron ore and retailers enjoying the spoils from government stimulus programs JobKeeper and JobSeeker. In both cases investors will be wondering: how sustainable is this?

Dividends from mining companies are expected to make up one third of total payouts, also because banks probably won’t be paying anything.

Some analysts are forecasting a big revival for banking profits in 2021. Some are forecasting a large fall in profits for mining companies next year.

These questions will not be resolved in August.

Sectors that on current forecasts are looking towards two subsequent years of pain are transport, insurance, diversified financials, and infrastructure.

Cash flows and balance sheets will be in constant focus, as will be “dividend certainty”.

More write-downs and revaluations are expected, as well as additional capital raisings.

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Meanwhile, it’s probably still OK to talk about consensus forecasts and average reductions, but underneath the bonnet the divergences are as wide as during the GFC – expect large resets either way.

Some analysts are grabbing the opportunity and reiterating their conviction in forecasts that are well out of synch with consensus.

Wilsons, on Tuesday, nominated ARB Corp ((ARB)), a2 Milk ((A2M)), Nick Scali ((NCK)), SomnoMed ((SOM)), Bravura Solutions ((BVS)), NRW Holdings ((NWH)), and Perenti Global ((PRN)).

Other companies for which simply achieving guidance would imply a significant upward adjustment for market consensus include AMA Group ((AMA)), AP Eagers ((APE)), Costa Group ((CGC)), Whitehaven Coal ((WHC)), New Hope Corp ((NHC)) and Monadelphous ((MND)).

Wilsons sees downside risk for GUD Holdings ((GUD)), Ramsay Health Care ((RHC)) and Nanosonics ((NAN)).

Goldman Sachs likes QBE Insurance ((QBE)), Suncorp ((SUN)), Computershare ((CPU)), Pendal Group ((PDL)) among non-bank financials, while investors are advised to sell ASX ((ASX)), Platinum Asset Management ((PTM)) and Medibank Private ((MPL)).

Stockbroker Morgans believes domestic cyclicals need to deliver better-than-expected results plus confirmation of an improving outlook for the ASX200 to be able to break out of its current narrow range.

Tech stocks may find beating forecasts is difficult given high expectations, but resources companies, in particular those exposed to iron ore and copper, might be able to surprise both on profits and dividends.

Candidates for a potential positive surprise include a2 Milk, AP Eagers, AGL Energy ((AGL)), Superloop ((SLC)), Afterpay, Amcor ((AMC)), and Domino’s Pizza ((DMP)).

Morgans sees Telstra ((TLS)) potentially surprising through capital management.

Nominated for possible disappointment are Ramsay Health Care ((RHC)), Link Administration ((LNK)), Orora ((ORA)), Qube Holdings ((QUB)), Coca-Cola Amatil ((CCL)), and Woodside Petroleum ((WPL)).

Morgans also suggests both CSL ((CSL)) and Cochlear ((COH)) look vulnerable for a valuation de-rating.

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Finally, while expectations are low -admittedly for good reason- average valuations look sky-high, which usually provides the ideal scenario for lots of volatility to kick in.

I wrote a story earlier in the month why valuations are probably not as much out of order as many are arguing, see further below.

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I leave the closing statement to Morgan Stanley:

“Despite investor feedback that earnings 'don’t matter' amid the Covid-19 crisis, we think FY20 earnings are important. In a world where guidance has been withdrawn, earnings estimates are stale and earnings dispersion is very wide, the looming refresh will provide much-needed context and depth to what have typically been updates that have been narrow in focus and scant on detail. Cash flows, margins, capex and balance sheets can now come back to base.”

Read also: Rudi's View: Forecasts, Not Valuations https://www.fnarena.com/index.php/2020/07/23/forecasts-not-valuations/

A Deeply Frustrated Fund Manager

Auscap Asset Management was established more than eight years ago, but the hefty relative outperformance from the early years has been replaced by notable stasis.

Principal and portfolio manager Tim Carleton, in a webinar with investors this week, made no bones about it: the past two years have been “frustrating”.

Auscap does not regard itself a typical “value” investor, even though a number of its favourite positions can definitely be labeled part of the value side of today’s share market, including Unibail-Rodamco-Westfield ((URW)), Westpac ((WBC)) and Virgin Money UK ((VUK)).

Recent underperformance is being explained through investors highly valuing specific companies and sectors that are popular and hot, while other sectors and companies that are equally achieving growth are simply not being rewarded for their effort.

Auscap went into the February-March sell-down with a 30% portfolio weighting for REITs and has been severely punished for it, but Carleton sticks to his conviction on the sector.

Once the worst of the pandemic is behind us, investors will be looking for yield and income with even more urgency, is his prediction, and thus the return of investors’ attention, and money flows, for undervalued, quality REITs seems but a matter of time.

And patience, if you are an investor in the Auscap fund.

Apart from UR-Westfield, Auscap managers also like Aventus Group ((AVN)), Home Consortium ((HMC)) and GDI property Group ((GDI)); the latter for exposure to offices in Perth.

Always difficult to predict when share prices will deflate for the popular growth stocks in today’s market, including a number of quality businesses Auscap would like to own, just not at current prices.

To prove his point that investors are rather selective in their preferences rather than choosing “growth” over “value” in absolute terms, Carleton compared a number of stocks against each other, each time questioning the relative valuation gap between the stocks chosen.

Auscap prefers Nick Scali ((NCK)) instead of Temple & Webster ((TPW)), UR-Westfield rather than Afterpay ((APT)), Mineral Resources ((MIN)) versus ALS Ltd ((ALQ)), Carsales ((CAR)) more than Altium ((ALU)), and Macquarie Group ((MQG)) above US-listed Atlassian.

One prime example of the share market not necessarily appreciating the quality and growth on offer comes in the form of retailer JB Hi-Fi ((JBH)) whose shares have succumbed to multiple sell-offs over the years but shareholders, including Auscap, have still enjoyed an average annual return of 23%.

According to Auscap’s latest communication with investors, the fund’s Top Ten investments are made up of AP Eagers ((APE)), Aventus Group, GDI property Group, Macquarie Group, Mineral Resources, Nick Scali, Super Retail Group ((SUL)), UR-Westfield, Virgin Money UK, and Westpac.

Last week, portfolio managers at Bell Asset Management declared the 2020 sweet spot for investors is likely amongst small and midcap stocks internationally (market cap minimum $1bn) where valuations are still reasonable and leverage to the post-pandemic recovery high.

(This story was written on Monday 28th July, 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website).

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via the direct messaging system on the website).

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