What To Expect This Reporting Season

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Despite heightened market uncertainty due to the recent round of lockdowns, brokers expect strong earnings growth to underpin market performance during the August reporting season.

-Time to pounce on cyclicals harshly treated amid broader volatility
-Credit Suisse expects spending to revert to ‘reopening’ activities throughout 2022
-Citi believes Sydney lockdown could derail the banks’ capital return plans
-Undervalued non-banks are seen as a better way to play the housing market

By Mark Story

The market is witnessing one of the strongest upgrade cycles since November 2004, and across the ASX200 over the past three months analyst rating upgrades have topped downgrades by two-to-one. Unsurprisingly, investors have been primed to expect the positive momentum, which has driven the market up 6.8% since the February reporting season, to continue well into August’s upcoming reporting season.

Despite current caution and uncertainty around lockdowns, which may potentially hold some upgrades back, brokers are generally expectant of upward revisions to 2021-22 EPS expectations throughout August.

With clarity returning to the earnings outlook and a historically low cost of capital, Morgans sees the prospect of a further pick-up in M&A activity into FY22. While buying companies purely for M&A is a fraught strategy, the broker thinks it can offer some downside protection for embattled names or help peers realise value in out-of-favour sectors.

Morgans Research team identifies 35 opportunities that shape up as takeover targets, including five from different sectors: Karoon Energy ((KAR)), Treasury Wine Estate ((TWE)), Japara Healthcare ((JHC)), Tabcorp Holdings ((TAH)) and NextDC ((NXT)).

Overall, Morgans suggests investors prepare to pounce on cyclicals – notably banks/financials, resources, energy — which may be harshly treated amid broader volatility, yet which are leveraged to ongoing economic reflation. The broker also sees opportunities in ‘covid exit’ stocks in travel, transport, and infrastructure and in (high PE) growth stocks vulnerable to an overdue market pullback.

Preferred stocks that Morgans considers worth watching on weakness during reporting season include BHP Group ((BHP)), Santos ((STO)), OZ Minerals ((OZL), Reliance Worldwide ((RWC)), NextDC ((NXT)), Hub24, ((HUB)), Technology One ((TNE)), Lovisa ((LOV)), Universal Store Holdings ((UNI)), Alliance Aviation ((AQZ)), and Acrow Formwork ((ACF)).

Within Morgans reporting season playbook, the broker has identified TPG Telecom ((TPG)), and Dalrymple Bay Infrstructure ((DBI)) as offering compelling value, but also flags ResMed ((RMD)), Ramsay Healthcare ((RHC)), and Hub24 as having covid/cyclical earnings risk.

Despite near-term disruption, Credit Suisse expects spending to start reverting to ‘reopening’ activities throughout 2022 and assumes a return to trend growth by the end of FY23. As a result, the broker believes the market under-rates the sustainability of Super Retail Group’s ((SUL)) market positions in auto accessories and sport and it is improving its leisure businesses.

Similarly, given the competitive position of GUD Holding’s ((GUD)) key auto brands, the broker believes the company is also better placed than most to deal with near-term headwinds and potentially take share.

Industrials

With ASX200 Industrials upgrades continuing to gather pace over the past month, while forecast uncertainty has been falling, Morgans suspects company earnings are shaping up positively over the next 12 months. And with valuations well off the recent highs, the broker thinks this leaves some scope for further upside at the August results.

Morgans believes a broader distribution of growth across the market – with 40% of ASX200 industrials set to report 20%-plus earnings growth – reinforces the broker’s view that strong earnings growth will underpin market performance.

Despite persistent lockdowns, UBS expects strength in Australian housing demand to continue and forecasts 220,000 starts in 2021. The broker’s top picks for the sector are James Hardie ((JHX)), CSR ((CSR), and Reliance Worldwide.

Based on conservative cost inflation assumptions, the broker expects James Hardie to start the year with an upgrade to FY22 net profit guidance.

Diversified financials

When looking at diversified financials, Credit Suisse identifies Link Administration ((LNK)), IOOF Holdings ((IFL)), and Platinum Asset Management ((PTM)) as likely to report results with upside surprise risk.

While Link has completed the listing of Pexa, the stock is yet to re-rate. As a result, the broker sees scope for a more optimistic outlook statement given emerging tailwinds and potential for the announcement of a $100-150m buyback as Link deploys Pexa proceeds.

While Computershare ((CPU)) could also surprise on the upside, the broker suspects the company’s FY22 earnings growth guidance could underwhelm. Given activity levels are known, earnings risk on ASX’s ((ASX)) FY21 result is minimal, but Credit Suisse suspects commentary on the outlook could be cautious with scope to disappoint on cost and capex guidance.

Driven by a full period of earnings from the Barrow Hanley and Trillium acquisitions, despite capturing higher cost guidance, Jarden expects strong results for Perpetual Ltd ((PPT)).

Ahead of FY21 results, Goldman Sachs remains Neutral ratings on Platinum, Challenger ((CGF)), and Perpetual following minor earnings changes.

Insurers

Credit Suisse sees more upside and limited downside risk for the sector going into the August reporting season and favours QBE Insurance ((QBE)) due to strong revenue and margin growth as higher rates earn through. The broker has suggested Suncorp Group ((SUN)) could also deliver upside if capital management and bank provision reversals exceed expectations, and this proved to be the case at yesterday's result release.

Credit Suisse also expects to see value in Insurance Group Australia ((IAG)) over the coming year, and notes there are no obvious short-term catalysts.

While Jarden expects general insurers’ underlying insurance trading ratio (ITR) margin to track sideways, the broker believes the private health insurers are well-positioned to post strong June 2021 results.

Due to covid-related tailwinds continuing to support stronger policy growth and lower claims activity, the broker expects strong second half FY21 results from Medibank Private ((MPL)) and nib Holdings ((NHF)), underpinned by benign claims outcomes.

While there is limited room for a further upside surprise, with the market already expecting a beat at FY21, Credit Suisse flags potential risk on how nib Holdings is managing international and travel costs.

Banks

After six months of successful covid recovery, Citi believes the latest Sydney lockdown has the potential to derail the sector’s capital return plans to drive future earnings growth.

Citi still expects CommBank ((CBA)) to lead the sector with $5bn off-market buybacks announced at the upcoming FY21 results. But given the politics at play, the broker reminds investors more modest $2bn on-market buybacks from CommBank is a scenario that cannot be ignored.

More broadly for banks, Citi expects this reporting season to highlight improving revenue growth driven by stronger mortgage volumes, well-managed costs, and strong asset quality. Overall, Westpac ((WBC)) remains Citi’s top pick, with greater leverage to capital management, divestments, and cost-outs to provide stock-specific valuation support within a soggy rate environment.

While Morgans also believes the capital management potential for Westpac looks as strong as for Commbank – with special dividends and buybacks on the cards — ANZ Bank ((ANZ)) remains the broker’s preferred bank with the stock launching a buy-back mid-July.

Beyond the majors, Citi believes Bendigo & Adelaide Bank ((BEN)) is well placed to grow revenues due to its consistent above system housing growth. Driven by higher average interest-earning asset growth, the broker is forecasting 5.5% year-on-year revenue growth, 1.1% above consensus, driven by strong 12.5% housing loan growth.

However, the broker rates Bendigo high risk given the coinciding of significant operational risk from the transformation agenda, the economic impact from covid, and risks around the growth strategy currently in place.

Non-banks

Credit Suisse believes non-banks are likely to generate lower growth over the next two years relative to strong recent performance and suspects current covid lockdowns introduce potential short-term downside risk. However, the broker continues to identify earnings drivers for both Liberty Financial Group ((LFG)) and Peppermoney ((PPM)) for FY22-23.

Based on undemanding valuations and a positive investment outlook, the broker maintains an Outperform rating on both stocks.

Having concluded FY22 will be another year dominated by strong property market conditions, Citi expects Australian Finance Group ((AFG)) and Liberty Financial to benefit from continued strong mortgage commitment growth, funding cost tailwinds, and secured finance growth.

Citi believes both stocks are attractive ways to play the housing market, with better growth prospects than the banks, yet trading on a -20% discount.

Media sector

Drilling down into the ad market sector, Credit Suisse expects a recovery to be evident in the June half FY21 numbers. The broker had mostly seen upside risk to earnings in the upcoming results, suggesting REA Group ((REA)) and Domain Holdings Group ((DHG)) would clearly benefit from property listings strength, although last week's REA result did somewhat disappoint.

The only traditional media stock for which Credit Suisse sees downside risk to near-term earnings is oOh!Media ((OML)), with the out-of-home sector likely to be most impacted by stay-at-home restrictions, especially in Sydney.

Given extensive cost programs in fourth quarter FY20 to offset volume and ad market headwinds, Goldman Sachs believes sustainability of these savings into FY21 will be a key focus.

Resources

While a bullish commodities outlook is supported by rebounding demand, supply constraints, and financial forces – including US$ deflation and inflation hedging – Morgans believes this broad consensus view leaves sector sentiment vulnerable to overheating.

With current volatility generating opportunities on weakness, the stocks at the top of Morgans watchlist are BHP Group, Santos, OZ Minerals, Whitehaven Coal ((WHC)), and Ramelius Resources ((RMS)).

Morgans believes upside in the earnings outlook provides scope for boards to again surprise in dividends released, albeit off a higher expectations base and pending confidence into FY22.

Dividends

While the average 12-month yield fell below 4% as companies chose to preserve capital during pandemic-driven uncertainty, Morgans thinks FY22 will usher in a period of strong total returns for dividend investors. Overall, key market stalwarts highlighted by the broker are resources (6.1%), banks (4.5% + buybacks), and insurers (4.5%).

Morgans expects the major miners’ capital discipline and returns focus to offer scope to again surprise on payouts in August. Two other sectors the broker also thinks could offer the highest yield upside include REITS and Staples.

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