Rudi’s View: More Beats Than Misses

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In this week's Weekly Insights:

-More Beats Than Misses
-(Other) Expert Voices

By Rudi Filapek-Vandyck, Editor FNArena

More Beats Than Misses

As I write this week's Weekly Insights on Monday, the FNArena Corporate Results Monitor shows the financial results from 120 ASX-listed companies have been reported and reviewed thus far. By the beginning of March, next week, this number will have risen to just under 350.

It is dangerous to draw conclusions when we only have a little more than one third of data available, and history suggests many more misses will be coming out of the woodwork during the final days of the season, but some of the early trends that are appearing are worth paying attention to.

First up, while circa two-thirds of company results are still absent from the Monitor, those companies that have already reported represent more than two-thirds of the ASX's total market capitalisation. Let's not forget the re-unified BHP Group ((BHP)) has an index weighting of 10%-11% these days.

Early observations

Corporate Australia is displaying a lot more resilience than it's generally been given credit for. Despite broad discomfort with how companies might be performing amidst numerous challenges, including covid-impacts and inflationary pressures, the general impression after three weeks of public admissions is that companies are prepared and coping better than expected.

This is important as corporate results are all about market expectations beforehand and after the release of detailed financials. So far, earnings forecasts have -on balance- regained upward momentum, which is quite rare. Reporting seasons usually reduce earnings forecasts in a broad, general sense. February 2022's exception thus far is both a reflection of corporate resilience and analysts having built in too much caution in their estimates.

Putting things in perspective: FY22 market consensus has EPS growth at circa 13%, while for FY23 that number is only 3%. Things can change dramatically for energy and materials producers as most spot prices are above analysts forecasts, in some cases: well-above forecasts.

We can but wonder what the daily price action would have looked like if not for macro-influences exerted by rising bond yields, inflation data surprising on the upside, and investors opting for a risk-off attitude, with general caution heightened by the prospect of military escalation between Russia and the West.

Lower share prices in a general sense also means the average Price-Earnings (PE) multiple for the Australian share market is now below 17x from above 20x in early 2020. Again, one needs to take into account that doubling the weight of BHP, trading on a FY22 currency-adjusted PE below 10x, in itself has made a big impact on the general calculation for the market as a whole.

The debate about share market valuation is not going to die anytime soon!

Historical analysis by Morgan Stanley suggests February is the season when corporate Australia is most likely to beat market forecasts. February last year saw more than 50% of companies beating EPS forecasts, on Morgan Stanley's assessment, and before that February 2017 also generated EPS beats well-above average.

Thus far this month, the percentage of EPS "beats" is running above 50%, but the number is more impressive at the top line as more companies to date have reported better revenues than those who've met forecasts. It's similar when looking at declared dividends.

On FNArena's holistic assessment, as at Monday morning, 52.5% of reporting companies delivered a "beat" (63 companies) while 30.8% reported in-line (37 companies) and only 20 companies (16.7%) missed the mark. Our own numbers confirm Morgan Stanley's observation with February 2021 the best results season to date (post the Monitor's introduction in 2013), ending with 47% beats and only 13% misses.

The sole reporting season that managed to record total beats above 50%, on FNArena's account, has been the season in between August last year and this February. But that's a tally of 49 companies only, and many have a specific, non-representative natured business compared with the rest of the ASX.

The overwhelmingly positive numbers on profits, sales and dividends -what most investors pay attention to- are somewhat being tempered by many companies reporting weaker free cash flow numbers, points out Macquarie. On the broker's analysis, misses on free cash flow are coming predominantly from large industrial companies and from the resources sector.

Macquarie draws a direct correlation with margin pressures and shrinking capex intentions, while also fewer buybacks and special dividends have been announced to date. The positive trend in profit forecasts is directly connected with large cap resources companies, explains Macquarie, with each of Woodside Petroleum ((WPL)), Evolution Mining ((EVN), BHP Group, Newcrest Mining ((NCM)) and Santos ((STO)) suggesting their pricing power and operational resilience is greater than for smaller cap peers.

Market responses are a lot more difficult to read this month, as macro plays a dominant role on most trading days, but Macquarie is still confident enough to posit that companies beating on cash flow and/or dividends are more likely to see their shares outperform, while others lag.

Analysts at UBS already spotted enough evidence to conclude inflation bottlenecks are starting to ease. This fits in nicely with Macquarie strategists' view that "The growth cycle is still slowing, so stay low risk. As noted [previously], we still think we are close to the end of the yield spike as focus may soon shift to weaker growth."

The First 120 Results

Macro-impacts or not, investor preferences lay with share market laggards that are, at best, fairly valued with low expectations to beat (or at the very least: not to miss dramatically).

Best share price performances over the past three weeks have thus come from the likes of NRW Holdings ((NWH)), Treasury Wine Estates ((TWE)), Sims ((SGM)), Vicinity Centres ((VCX)), Challenger ((CGF)), Pact Group Holdings ((PGH)), Nearmap ((NEA)) and Magellan Financial Group ((MFG)).

If we take the same thematic a little broader, we can also include CSL ((CSL)), Seek ((SEK)) and JB Hi-Fi ((JBH)) – historically solid performers whose potential performance this time around had been clouded by lots of questions and doubt beforehand.

And, as expected given the general set-up and jittery investor nerves, the market is in absolutely no mood to take prisoners in case of disappointment. See double-digit punishments for Super Retail ((SUL)), for Mineral Resources ((MIN)) and for Netwealth Group ((NWL)), and equally harsh treatments for Wesfarmers ((WES)), for Telstra ((TLS)), for Cimic Group ((CIM)), for Domain Holdings ((DHG)), for EML Payments ((EML)), and numerous others.

Companies having suffered noticeably large downgrades to forecasts include Ansell ((ANN)), Star Entertainment ((SGR)), GPT Group ((GPT)), Origin Energy ((ORG)), and Wesfarmers ((WES)).

Equally important, as successful investing is all about looking forward and distinguishing short-term noise from longer-term fundamentals and growth prospects, this reporting season is building a list of companies whose share price would have been richly rewarded if only general sentiment and focus had not been so strictly on rising bond yields.

Companies that deserve to be included on that list are Baby Bunting ((BBN)), Breville Group ((BRG)), Centuria Industrial REIT ((CIP)), Goodman Group ((GMG)), IDP Education ((IEL)), Pro Medicus ((PME)), REA Group ((REA)), ReadyTech Holdings ((RDY)), Seek, and Temple & Webster ((TPW)).

Due to the many factors impacting this year, and the unforgiving attitude in case of a misstep, it's inevitable a well-diversified investment portfolio will be hit by large sell-offs throughout this season. There is only so much that can be forecast and anticipated.

For investors, the task at hand is to assess whether investment theses remain intact, irrespective of share price action, and when and where cash on the sidelines should be re-allocated for the maximum, longer-term return.

Latest Update

By the time I am ready to wrap up this week's assessment, later on Monday, the numbers for FNArena's Corporate Results Monitor have changed, though not in a dramatic way.

The total tally of companies has now risen to 131, of which 69 (52.7%) have beaten, 40 (30.5%) have met and 22 (16.8%) have missed forecasts.

One of the stand-out developments this season is that the unusually large number in beats, and the positive trend in earnings and dividends have not been met with further increases in valuations and price targets. As things stand on Monday afternoon, it looks like February this year will not generate much in terms of additional upside.

Thus far, only two reporting seasons have ended with a net negative aggregate balance for price targets; February 2019 and March-July 2020. As we are all aware by now, it's an extremely bifurcated market that's hiding behind those data.

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FNArena's daily updated Corporate Results Monitor: https://www.fnarena.com/index.php/reporting_season/

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Weekly Insights last week:

https://www.fnarena.com/index.php/2022/02/17/rudis-view-2022-the-big-adjustment/

The prior week's Weekly Insights:

https://www.fnarena.com/index.php/2022/02/10/rudis-view-february-results-macro-traps-and-opportunities/

The week before:

https://www.fnarena.com/index.php/2022/02/03/rudis-view-february-looks-tricky/

The week before that:

https://www.fnarena.com/index.php/2022/01/27/rudis-view-risks-to-consider/

My latest on All-Weather Stocks:

https://www.fnarena.com/index.php/2022/01/20/rudis-view-all-weather-stocks-some-answers/

(Other) Expert Voices

When reading mainstream media, and listening to most market commentators, the false impression can befall upon investors there's only one way forward from here and that is via persistently elevated inflation and a behind-the-curve central bank in the USA that needs to start ramping up a whole new hiking cycle that will take the US cash rate, and government bond yields, back to levels that will turn out being punitive for mortgagors and pricey asset values.

There are still plenty of alternative scenarios possible, if not probable, and plenty of experts voices that will highlight those, if only we'd cared to listen.

On inflation, fixed interest specialists at Western Asset:

"We maintain the view that global inflation will return toward pre- COVID-19 rates sometime soon, as pipeline pressures begin to ease"

"Inflation overshoots have proven more persistent than anticipated, and remain challenging for policymakers globally. However, we expect that the impact of leading inflationary components will ease meaningfully through the course of 2022."

On the Value versus Tech & Growth debate, US equity strategists at Citi:

"S&P 500 Value is set to “outgrow” Growth in ’22. This mostly reflects its leverage to cyclical recovery beneficiaries. That changes looking ahead to ’23. Should Fed rate hikes materially cool off broader economic activity, we suspect that Value’s earnings growth expectations will be more at risk vis a vis Growth."

On the share market dynamics for the remainder of 2022, David Bassenese, chief economist BetaShares:

"…this first stage valuation-driven equity correction seems likely to last for as long as long-term bond yields are pushing higher – with the former likely to level out only once markets are convinced the worst in terms of Fed tightening is already priced in. Of course, all this assumes Fed tightening won’t be allowed to crush the economy or earnings – which in turns depends on how quickly currently hot wage and price pressures subside.

"If inflation pressures persist, and wage growth remains red hot, the Fed may have no other choice but to significantly slow the economy, which could see a second stage earnings-driven equity decline even if bonds yields stop rising."

On why gold has all of sudden rediscovered upward momentum, ANZ Bank:

"The inverse correlation between gold and the US 10y yield has broken down as intensifying geopolitical tension is boosting safe haven demand. A weaker US dollar is providing support, while higher inflation is negating downside risk of aggressive rate hikes."

(This story was written on Monday 21st February, 2022. 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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