Rudi’s View: August Bonanza, But What’s Next?

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

In this week's Weekly Insights:

-August Bonanza, But What's Next?
-Conviction Calls
-Research To Download

By Rudi Filapek-Vandyck, Editor FNArena

August Bonanza, But What's Next?

The upcoming August corporate reporting season should offer plenty of positives for Australian shareholders.

With both banks and large cap mining companies swimming in cash, there should be plenty of additional rewards on top of a strong recovery in post-2020 dividends. Both ANZ Bank and National Australia Bank have already indicated as much and Rio Tinto's larger-than-usual payout, including a bonus dividend, is equally but the first sign of what is likely to follow over the coming four weeks.

But the benefits that await from August stretch much wider; the quicker than anticipated economic recovery has fueled a much quicker than forecast recovery in corporate profits and balance sheets, and thus Australia awaits an even greater recovery in dividends across the board.

But wait, there is more, a lot more. Asset sales are providing the proverbial cherry on the cake with REITs and companies including Waypoint REIT, Telstra and Insurance Australia Group selling off parts of the business with the intention of (at least partially) passing on the proceeds to shareholders.

And, would you believe it, there is more, still. Increased confidence in that the world will overcome the challenges provided by covid, has interest in pursuing mergers & acquisitions spiking noticeably on the ASX. The latest such announcement came from Afterpay on Monday morning, informing investors its board had agreed to a full take-over by US-listed Square.

We already knew about suitors for Sydney Airport, Oil Search, Japara Healthcare, Spark Infrastructure, iCar Asia, and Iress among mid and larger cap names, but chances for the next suitor to announce itself for an ASX-listed target are improving by the day, or so it seems.

Can Treasury Wine Estates be next? Or Challenger or Praemium, maybe? How about Aerometrex, Bapcor or NextDC? Is Altium now fully off the hook? (See also last week's Weekly Insights for a list of potential targets).

Corporate Profits

In terms of corporate profits, the general expectation is that profits in aggregate are back to where they were pre-pandemic, though this won't be the case for every company individually, of course. Strong underlying support is provided by continuous upgrades to market forecasts which have now been rising for eleven months uninterrupted.

On average, earnings per share for the financial year that ended on June 30 are expected to have risen by circa 26%; this percentage is projected to rise to 45% for the year to December 31st, but for FY22 ending in June next year projected growth sits around 10% and by December 2022 it is close to zero.

One year ago, the average EPS in Australia fell by -19.3%. At the start of 2021, the forecast was for 8% EPS growth in FY21 (showing just how strong those upgrades have been since, carried by resources and financials).

What Comes Next?

The numbers above show the challenge for the Australian share market beyond August: how much growth is left beyond the initial V-shaped recovery?

The answer to that question might prove all-important because share markets are not cheaply priced. The local market's average Price Earnings (PE) ratio is still around 20x if current forecasts for the year to June 30 prove correct. But share markets are forward looking and that PE ratio falls to 17x-something by year-end and will shrink further by June next year if/when current growth forecasts improve further.

But can they?

The question will remain on investors' mind as countries struggle to vaccine populations and contain the virus, central bankers are looking for signs to start reducing liquidity and monetary stimulus, and bond yields might not stay at current depressed levels forever and always.

It would be a big ask for domestic companies to provide all the necessary answers in August, quite unrealistic to be frank about it, but share buybacks, bonus dividends and an explosion in M&A announcements at the very least show there is a lot of (quiet) confidence on display.

And confidence, as every economist and central banker will assure us, is extremely important for financial markets and economies alike. Investors will be hoping inflation will prove transitory and governments will figure out how to deal with the virus, as with climate change.

Bottom line: the outlook for equities won't be solely determined by profits and dividends, but for the four weeks ahead they are nearly all that matters, with the general framework set for a genuine cash splash bonanza on the ASX. Incidentally, data accumulator FactSet reports the second quarter in the US is generating the best outcomes on multiple metrics since FactSet started its US corporate data series in 2008.

US share markets are in a similar position as the ASX: not cheap, but with strong underlying support, and with multiple serious question marks ahead, though few will question the resilience of the mega-trends in the background.

Dividends In Strong Up-Trend

When it comes to specific sectors and individual companies, the key difference between Australia and the US cannot possibly be more accurately illustrated as through Rio Tinto's ((RIO)) super-dividend announcement last week.

As the shares are essentially trading on a double digit yield percentage, because the market doubts iron ore priced above US$200/tonne is sustainable, Rio Tinto's half-yearly payout amounts to a 5%-plus cash distribution; or what shareholders pre-pandemic came to expect from their beloved banks is now being paid out over six months only, with more to follow.

The yield on Fortescue Metals' ((FMG)) dividend in August should be even higher, while a more diversified BHP Group ((BHP)) should still pay out more than each of the banks this year.

Sure, there is every chance this year marks the peak in payouts for these companies, but it remains an open question how long iron ore prices keep feeding into excess capital and exactly how quickly the transformation to a more normal payout will ensue for the sector.

Other candidates to surprise with their dividends in August include Deterra Royalties ((DRR)), Iluka Resources ((ILU)), OZ Minerals ((OZL)), QBE Insurance ((QBE)) and Santos ((STO)).

As the likes of JP Morgan will remind their clients over the weeks ahead: Australia is only at the start of a Super Cycle in Dividends that goes well beyond this year's extraordinary payouts from iron ore producers.

As per usual, Australian investors should not allow themselves to be blinded by high yields only, as history shows superior investment returns are achieved through combining yield with growth.

In Focus: Margins

History also shows the better investment returns come from owning companies whose profit margins are on the rise. It is for this reason that investors remain uncertain about what the year(s) ahead might look like, even if the economic recovery continues unabated. Rising costs, already showing up in "transitory inflation", can play havoc and become a major impediment for companies unable to pass on or contain costs.

A recent analysis by Wilsons suggests an extra complicating matter might present itself as covid might lift or lower margins for certain sectors, with potential consequences for how investors value companies in these sectors.

Wilsons' analysis suggests margins might now be lower-for-longer for industrials and consumer staples, while there appears to be a bias for higher margins in sectors information technology and materials.

An interesting role in this context might be reserved for the Australian dollar. Earlier forecasts had AUD/USD at 0.80c if not 0.85c but instead the cross seems to have settled below 74c and more iron ore weakness and a dovish RBA could well push it closer to 70c.

Morgan Stanley pointed out recently some 27% of the ASX ex-resources is made up of foreign growers who should all benefit from a weaker domestic currency. Think Amcor, ResMed, Cochlear and Aristocrat Leisure, but also Ansell, Pro Medicus and QBE Insurance.

Nominations: Winners & Losers

As happens for every season, analysts pick their potential winners and losers ahead of the real event. This year, those lists are more extensive than usual. The overall bias is unmistakably for more upside surprises relative to negative disappointments. Apart from all of the above, maybe the big hint lays with the so-called confession season that precedes each February and August in Australia; it has virtually gone quiet.

When was the last time a big profit warning shocked the market? Not so long ago the likes of Canaccord Genuity kept an overview of profit warnings and that list would swell to above 100 companies. But that was pre-pandemic. Post-pandemic we have a different dynamic, as also illustrated by the statistics that coloured the past three reporting seasons: before, during and after February. (see archive for the FNArena Corporate Results Monitor on the website).

On my observations, not backed up by any firm statistical analysis, most incorrect predictions usually involve analysts fearing the worst. Companies tend to find a way to smooth things out, or to combine disaster with a positive twist (extra dividend, restructuring, asset sales, lay offs, etc).

Hence, for what it's worth, companies that tend to get mentioned in a negative sense ahead of their August reports ("downside risks") include:

-AMA Group ((AMA))
-Boral ((BLD))
-Domain Holdings ((DHG))
-Elmo Software ((ELO))
-Flight Centre ((FLT))
-InvoCare ((IVC))
-PolyNovo ((PNV))
-REA Group ((REA))

Companies perceived to have a predilection for upside surprise in August:

-Adore Beauty ((ABY))
-Audinate Group ((AD8))
-ARB Corp ((ARB))
-Breville Group ((BRG))
-Computershare ((CPU))
-Downer EDI ((DOW))
-IDP Education ((IEL))
-Integral Diagnostics ((IDX))
-NextDC ((NXT))
-NRW Holdings ((NWH))
-Ridley Corp ((RIC))
-Resimac Group ((RMC))
-Seven Group ((SVW))
-South32 ((S32))
-Universal Store Holdings ((UNI))
-Whitehaven Coal ((WHC))

There is always a list that attracts both cons and pros. It would not be fair to mention them in either of the above lists:

-CSL ((CSL)
-EML Payments ((EML))
-Lendlease ((LLC))
-ResMed ((RMD))
-Super Retail Group ((SUL))
-Seek ((SEK))

Candidates for fresh capital management announcements:

-Ampol ((ALD))
-BHP Group
-CommBank ((CBA))
-Fortescue Metals
-South32
-Telstra ((TLS))
-Woolworths ((WOW))

Lastly, a company that happens to disappoint in results season is not by definition not worth buying or holding on to, just like not every winner in the season is an excellent longer term investment. Every reporting season builds a narrative and there will always be fresh insights and conclusions that can prove vital later on.

Investors can follow August's progress via the dedicated FNArena Corporate Results Monitor (soon with daily updates):

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

See also last week's "August Results: Anticipation & Trepidation" https://www.fnarena.com/index.php/2021/07/29/rudis-view-august-results-anticipation-trepidation/

Conviction Calls

Stockbroker Morgans has updated its Best Ideas pre-August reporting season.

This has led to the inclusion of five new names: Treasury Wine Estates ((TWE)), Transurban ((TCL)), AusNet Services ((AST)), Tabcorp Holdings ((TAH)), and Hotel Property Investments ((HPI)).

In the stockbroker's own words, Best Ideas are those that come with the highest risk-adjusted returns over a 12-month horizon, supported by above-average confidence.

Research To Download

IIR on Milton Corp ((MLT)):

https://www.fnarena.com/downloadfile.php?p=w&n=2EE0D401-AF36-9419-5E49A99B4A92281F

IIR on Pengana International ((PIA)):

https://www.fnarena.com/downloadfile.php?p=w&n=2EE7F7FF-F158-8AD4-0B5F6CD40B590BE1

IIR on Wam Alternative Assets ((WMA)):

https://www.fnarena.com/downloadfile.php?p=w&n=2EF36BF8-0337-9FB2-056323B8348019C3

(This story was written on Monday 2nd August, 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).

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