Rudi’s View: August Results; Anticipation & Trepidation

This story features FORTESCUE LIMITED, and other companies. For more info SHARE ANALYSIS: FMG

In this week's Weekly Insights:

-August Results: Anticipation & Trepidation
-Predicting The Next Index Changes
-Conviction Calls
-Research To Download
-FNArena Talks

By Rudi Filapek-Vandyck, Editor FNArena

August Results: Anticipation & Trepidation

Prima facie, Australian shareholders have plenty of reasons to feel excited ahead of the upcoming August results season.

Most companies have recovered more quickly than forecast from last year's lockdowns and pandemic, and profits and dividends are in a strong uptrend with Macquarie analysts observing consensus forecasts in Australia are now in their 11th consecutive month of upgrades, and expectations are building there's more of the same on the horizon.

February was on most market analysts' assessment one of the best local results seasons ever. Corporate Australia not only delivered strong recoveries in profits and dividends, but -uncharacteristically for Australia- it also handsomely beat analysts' forecasts, even though they had been lifting for multiple months already.

On FNArena data, the percentages of earnings "beats" over the past three reporting seasons (before, during and after February) have been at 49%, 47% and 55%, respectively; well above the circa 33% average we measured over the twenty seasons prior.

According to stockbroker Morgans, corporate Australia is currently experiencing one of its strongest upgrade cycles since late 2004. Over the past three months, upgrades have outnumbered downgrades by two-to-one with both miners and energy companies enjoying the strongest momentum.

Recent corporate market updates have equally contributed further, as did Cimic Group's ((CIM)) interim results release last week. It wasn't exactly a shoot-the-lights-out performance from the former Leighton Holdings, but it was good enough for slightly increased forecasts, a small bump up to analysts' valuations (already well above the share price) and the share price has risen slightly too.

For a company that hasn't exactly been kind to its shareholders over the past two years, it most have felt like a welcome relief for many, and a possible early indicator of the turnaround stories that August might present.

One minor disappointment, ironically, would have come from numerous mining companies not meeting production forecasts or failing to contain costs, including BHP Group and Rio Tinto, but the sector continues to enjoy stronger-than-expected prices for its products, which offers plenty of compensation, plus some.

When resources analysts put today's spot prices into their modeling, they see share prices trading on double digit percentages in free cash flow, which then feeds into questions such as: how high exactly might dividends be next year?, but also: how long before those share prices start pricing it in?

It is for this exact reason, I believe, that share prices have remained remarkably resilient over the weeks past, even as governments globally encountered set-backs in their quest to quell the pandemic, including 60% of Australians back in lockdown, and with the climate causing chaos and havoc in parts of Europe and Asia.

Corporate profits are recovering rapidly. Forecasts keep rising, while expectations for the years ahead remain positive. Dividends are coming back, and growing. There's potential for bonus payouts, for buybacks, and for M&A.

Only a few weeks out from August, it would take a lot of negative news to convince investors they'll be better off selling shares in, say, Fortescue Metals ((FMG)) and Mineral Resources ((MIN)), but equally in REA Group ((REA)), Telstra ((TLS)) and Charter Hall ((CHC)).

Clearly, it hasn't happened, and I'd wager this is because the same positive prospects are currently supporting optimism in Europe and the US, where corporate performances are equally surprising to the upside.

That said, there is always the possibility this positive undercurrent might turn or exhaust itself and investors will thus be on the lookout for clues both here and overseas: are business leaders confident enough? What are the effects of transitory inflation on profit margins? Is the consumer prepared to spend more from savings? Are governments able to navigate their way out of this? Did anyone mention central banks and less stimulus?

There is always the dreaded elephant behind the curtains: what will bond yields do in the months ahead?

Not to be dismissed: investors are reminded corporate performances are always judged against forecasts and expectations. While multiple signals point towards ongoing potential for positive surprises, it remains yet to be seen whether corporate Australia can maintain the exceptionally high percentages of "beats" we all have experienced post August last year.

I am inclined to think the numbers of "Beats" and "Misses" will look a lot more "normal" by the beginning of September and this by default means there is potential for a lot more portfolio damage even without macro-influences and left field occurrences.

Analysts are starting to preview and re-assess their forecasts and assumptions, and I expect a lot more to be released over the two weeks ahead (early August is quiet in the season). Next week will thus dig deeper into anticipated beats and misses.

This week we preview with three themes that seem poised to feature prominently in reporting season, and beyond.

Theme 1: Cost Inflation And Margin Pressure

It has the potential to become one of the defining features of the August results season: how much does transitory inflation impact on companies' profit margins, including through rising wages?

Sectors that have investors' attention: retailers and mining services providers.

Stockbroker Morgans has selected a number of companies with a question mark about their margins: Super Retail ((SUL)), JB Hi-Fi ((JBH)), Jumbo Interactive ((JIN)), Reliance Worldwide ((RWC)), GUD Holdings ((GUD)), and Accent Group ((AX1)).

On the other hand, the broker also believes investors might currently be underestimating the potential for margin expansion at: Afterpay ((APT)), Orora ((ORA)), Link Administration ((LNK)), Ramsay Health Care ((RHC)), Chorus ((CNU)), Tabcorp Holdings ((TAH)), Domain Holdings ((DHG)), Amcor ((AMC)), and IDP Education ((IEL)).

Theme 2: M&A Is Back!

With Sydney Airport and Oil Search firmly in play, both investors and analysts are starting to look for who could be next?

JP Morgan has identified the most likely candidates among the large REITs in GPT (GPT)), Dexus ((DXS)), and Lendlease ((LLC)). There is, as per always, seemingly more potential among the smaller cap players in the sector: National Storage REIT ((NSR)), Abacus Property ((ABP)), Irongate Group ((IAP)), Hotel Property Investments ((HPI)), and Waypoint REIT ((WPR)).

Morgans has identified no fewer than 35 potential M&A opportunities for investors:

-Acrow Formwork and Construction Services ((ACF))
-Aerometrex ((AMX))
-Earlypay ((EPY))
-Cooper Energy ((COE))
-Karoon Energy ((KAR))
-a2 Milk ((A2M))
-GrainCorp ((GNC))
-Treasury Wine Estates ((TWE))
-United Malt Group ((UMG))
-Tabcorp Holdings
-Japara Healthcare ((JHC))
-Mach7 Technologies ((M7T))
-Regis Healthcare ((REG))
-Volpara Health Technologies ((VHT))
-Blackmores ((BKL))
-Dalrymple Bay Infrastructure ((DBI))
-Silk Logistics Holdings ((SLH))
-Nufarm ((NUF))
-iCar Asia ((ICQ))
-Iress ((IRE))
-Praemium ((PPS))
-National Storage REIT
-Bapcor ((BAP))
-Baby Bunting ((BBN))
-MyDeal.com.au ((MYD))
-Redbubble ((RBL))
-The Reject Shop ((TRS))
-Data#3 ((DTL))
-LiveHire ((LVH))
-NextDC ((NXT))
-Over The Wire Holdings ((OTW))
-Superloop ((SLC)
-Qube Holdings ((QUB))
-APA Group ((APA))
-Spark Infrastructure ((SKI))

Theme 3: Dividend Super Cycle

On Morgans' data, the percentage of ASX-listed companies who paid out a dividend in February rose to 57%, from 53% in August. Market forecasts for earnings and dividends have risen by approximately 14% since then, which pulls back total dividends domestically to equal the total payout from 2019.

What has improved is the average payout ratio: circa 70.5% now versus 75% two years ago, leaving businesses with more to invest for the future.

No surprises here when all and sundry are once again looking at the banking sector to reinstate dividends and add additional payouts and share buybacks on top due to excess liquidity. ANZ Bank ((ANZ)) already surprised early this month, will CommBank ((CBA)) follow suit next month?

No surprise, also, many eyes are staring at BHP Group, Rio Tinto, Fortescue Metals and other iron ore producers for positive surprise potential on excess cash and little appetite to spend it on operations and/or M&A.

Insurers could surprise too. And Ampol ((ALD)) is everybody's favourite this year to splash out on extra shareholder benefits.

As per standard practice, FNArena will be paying close attention over the coming six weeks. Our dedicated year-around Corporate Results Monitor is empty, but won't be for long:

https://www.fnarena.com/index.php/reporting_season/

(There is an archive to research past reporting seasons for paying subscribers)

Predicting The Next Index Changes

Better early than late seems to be the motto at Wilsons as quant analyst Angus Stains has already published his predictions for the next update on Australian share indices. Index manager Standard & Poor's is expected to update on the composition of Australia's leading indices on September 3, with any changes only taking place on September 17th, after the market close.

Starting from the top, Wilsons is not expecting any change to the current ASX20, but since the ASX50 now has 51 constituents (Woolworths ((WOW)) and Endeavour Group ((EDV)), at least one change is to be announced. Wilsons sees potential for multiple changes.

Most likely to be dropped are a2 Milk ((A2M)) and AGL Energy ((AGL)), with Ampol ((ALD)) seen as a possible drop-out too. In their place, Seek ((SEK)) and BlueScope Steel ((BSL)) are seen as likely candidates to join. Were S&P to also remove Aurizon Holdings ((AZJ)) and Origin Energy ((ORG)), then ResMed ((RMD)) and Mineral Resources ((MIN)) seem best placed.

The ASX100 is expected to see fewer changes with only Beach Energy ((BPT)) identified as a likely drop-out, and no one to be added (because of Woolworths-Endeavour). Wilsons thinks it is possible Link Administration ((LNK)) might be dropped too. In that case, Steadfast Group ((SDF)) seems most likely for inclusion.

Traditionally, changes in the ASX200 tend to have more noticeable impact on share prices, as funds managers literally jump off and on board in case of exclusions and additions. Here, Wilsons sees Nuix ((NXL)), NRW Holdings ((NWH)), G8 Education ((GEM)) and Westgold Resources ((WGX)) all losing their membership in September. S&P could also decide to drop Spark New Zealand ((SPK)).

Most likely candidates to fill in the newly vacant spots have been identified as Pinnacle Investment Management ((PNI)), SeaLink Travel Group ((SLK)), De Grey Mining ((DEG)), Event Hospitality & Entertainment ((EVT)) and, at a lesser chance, Piedmont Lithium ((PLL)).

As is traditionally the case, there might be more changes coming up for the ASX300, but because of tie-ups such as between Orocobre and Galaxy Resources, the September reshuffling should see noticeably more inclusions than removals.

Have been identified as most likely to be added in September are: Paladin Energy ((PDN)), Imugene ((IMU)), Liontown Resources ((LTR)), Betmakers Technology ((BET)), Novonix ((NVX)), Johns Lyng Group ((JLG)), Strike Energy ((STX)), Australian Strategic Materials ((ASM)), Dubber Corp ((DUB)), and HomeCo Daily Needs REIT ((HDN)).

The six candidates who might find themselves friendless, at least immediately after the announcement, are Bubs Australia ((BUB)), Synlait Milk ((SM1)), Integrated Research ((IRI)), Maca Ltd ((MLD)), Medical Developments ((MVP)), and Humm Group ((HUM)).

Wilsons sees an outside change that SSR Mining ((SSR)) too might be dropped from the ASX300, in which case Syrah Resources ((SYR)) is expected to make a come-back.

Conviction Calls

Morgan Stanley's Australia Macro+ Focus List (read: stocks most positively viewed with extra conviction at this particular point in time) currently consists of the following ten inclusions:

-Ansell ((ANN))
-APA Group ((APA))
-BlueScope Steel ((BSL))
-Downer EDI ((DOW))
-Qantas Airways ((QAN))
-QBE Insurance ((QBE))
-REA Group ((REA))
-Scentre Group ((SCG))
-Telstra Corp ((TLS))
-Westpac ((WBC))

****

A collective effort among Macquarie analysts has identified 16 investment ideas ahead of the August reporting season; 14 positive ideas with Domino's Pizza ((DMP)) and Suncorp ((SUN)) as the two negative outliers.

Returning to the positive "Best Analyst Ideas"; Amcor ((AMC)), Brambles ((BXB)), Coles ((COL)), Transurban ((TCL)) among defensives, Afterpay ((APT)), Charter Hall ((CHC)), ResMed ((RMD)) and Seek ((SEK)) among the local growth stocks. Favourite ideas for capital return: Ampol ((ALD)), BHP Group ((BHP)), Deterra Royalties ((DRR)) and Fortescue Metals ((FMG)).

Plus two cyclical ideas to round up the list: Eagers Automotive ((APE)) and BlueScope Steel.

****

Last week's update on stockbroker Morgans Model Portfolio certainly provided some eye brow-raising suggestions such as that the Core Model Portfolio is holding on to its shares in Sydney Airport ((SYD)) in anticipation of a higher offer to shareholders.

Portfolio managers also decided to top up their ownership in Woolworths-spinoff Endeavour Group, while switching into Santos ((STO)) and out of Woodside Petroleum ((WPL)) and slightly trimming the position in Brickworks ((BKW)).

Morgans' Growth Model Portfolio waved good bye to outperformer Collins Foods ((CKF)) and initiated a new position in TechnologyOne ((TNE)) instead, welcoming the latest addition as "a great steady earnings compounder well suited to the Growth portfolio".

Research To Download

RaaS on Millennium Services Group ((MIL)):

https://www.fnarena.com/downloadfile.php?p=w&n=C5145AAE-03C8-390B-8CC1397EABE7CF0F

RaaS on Pureprofile ((PPL)):

https://www.fnarena.com/downloadfile.php?p=w&n=C51BD975-AECD-FD1C-EE90F53D2356E110

FNArena Talks

Last week, I presented to the SMSF Discussion Group at CPA Australia and a video titled July 2021 – The Big Picture (55 minutes) is available via FNArena Talks on the website:

https://www.fnarena.com/index.php/fnarena-talks/2021/07/24/july-2021-the-big-picture/

The presentation slides can be downloaded via Special Reports. Paying subscribers can use the drop down menu starting from ANALYSIS & DATA on the black belt running across the top of the website, under our logo.

(This story was written on Monday 26th July, 2021. 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).

****

BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

Subscriptions cost $450 (incl GST) for twelve months or $250 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index.php/sign-up/

Click to view our Glossary of Financial Terms