Rudi's View | Aug 25 2022
This story features REDBUBBLE LIMITED, and other companies. For more info SHARE ANALYSIS: RBL
In this week's Weekly Insights:
-August Delivering More Downgrades And Misses
-The Real McCoy Rally?
August Delivering More Downgrades And Misses
By Rudi Filapek-Vandyck, Editor FNArena
As far as price action goes, any company that disappoints this season is likely to see its share price drop for more than one day, even if that initial punishment on the day looks like a genuine shellacking.
Think Redbubble ((RBL)), down nearly -40% over the four days following its FY22 update, but also Blackmores ((BKL)), Codan ((CDA)), Inghams Group ((ING)), the ASX ((ASX)), Appen ((APX)), Pact Group ((PGH)), Australian Clinical Labs ((ACL)), TPG Telecom ((TPG)), and numerous others.
That's the 'normal' part of the August reporting season thus far. Thou shalt not disappoint remains an all-important condition in any reporting season.
But we also have two notable exceptions this month, and they are worth highlighting.
First category: share prices that had been sold down too far, irrespective of further disappointing news.
Second category: excellent performances that won't be rewarded post the initial on-the-day rally, because the market doesn't believe it is representative of what earnings might look like when tougher times arrive next year.
Plenty of examples fit in to category two and most have one or two things in common: they are either retailers (dependent on consumer spending) and/or exposed to the local housing cycle. JB Hi-Fi ((JBH)), Super Retail ((SUL)) and Stockland Group ((SGP)) are a few examples that come to mind.
Share price action post recent disappointing market updates suggests a lot of negative news had already been accounted for in prices for Auckland International Airport ((AIA)), BlueScope Steel ((BSL)), Challenger ((CGF)), Fisher and Paykel Healthcare ((FPH)), and GUD Holdings ((GUD)).
James Hardie ((JHX)) did issue a profit warning, but every analyst covering the company had already anticipated it.
Larger-sized companies are usually more resilient than small-caps and the first three weeks have delivered some notable heavy punishments for Redbubble and the like, confirming the thesis. Even though, it has to be noted, Adbri ((ABC)) shares are down -17% on the day of this company missing market expectations.
Even more important, potentially, is the fact that outperforming market forecasts with June-half performance and forward guidance is proving a bridge too far for most ASX-listed companies.
Having judged 120 corporate releases as at Monday, August 22nd, the FNArena Corporate Monitor is witnessing an ever widening gap between "misses" and "beats", currently at 32.5% (39) versus 25% (30).
Given the exceptionally high percentage in Buy ratings at the start of this season, it should not surprise downgrades are significantly outnumbering upgrades; 42 against 12 on Monday, while price targets are either falling or not adding much. Virtually every market update is followed-up with reduced forecasts for the year ahead.
With around two-third of companies yet to report, investors might want to keep their fingers crossed there is improvement on the horizon.
Against the background of more "misses" than "beats" and analysts cutting forecasts for FY23, Ord Minnett head of private client research, Simon Kent-Jones has observed how companies that are able to provide shareholders with a positive outlook are being rewarded through a favourable share price response.
Kent-Jones refers to Brambles ((BXB)), Medibank Private ((MPL)) and Treasury Wine Estates ((TWE)) but equally to positive dividend announcements made by the likes of BHP Group ((BHP)) and Telstra ((TLS)).
On the broker's assessment, all these share prices have outperformed the broader market thus far in August.
Over at UBS, strategist Richard Schellbach and analyst Akash Biradar, also zoom in on the positives so far, and this includes corporate Australia overwhelmingly posting robust, resilient financial performances this month, on average outperforming analysts' forecasts.
The flipside is, of course, that most of the disappointments do not come through FY22 financials, but via cautious, if not absent, forward indicators and guidance.
The UBS duo does concede this picture of relatively robust operational financials might yet be put to the test in the final stage of this season when more domestic and consumer related companies release market updates.
Meanwhile, there is no escaping, earnings forecasts are falling, and they are falling rather universally for FY23. UBS suspects this process might accelerate throughout the final week.
The sector with most positive surprises, on UBS's observation, is thus far the insurance sector with forward-looking estimates carried higher on projected benefits from higher interest rates. Maybe it should then not come as a surprise that victims of higher interest rates, the local REITs, have thus far been most underwhelming.
The culprit for that sector is debt. With higher interest rates, the heavier burden to service debt is seriously eating into growth prospects for many a local REIT.
But, as UBS points out, resources companies are receiving most of the downgrades for earnings estimates in the year ahead as analysts' focus remains firmly on the tougher economic outlook ahead.
In general terms, UBS is not too unhappy with the local share market set-up, noting the forward-oriented price earnings (PE) ratio for the ASX200 was below 14x pre-August. This is below the long-term average of 14.5x and certainly a lot lower than the 17x-20x multiples seen prior to preceding reporting seasons in recent years.
Equally important: the ongoing cuts to forecasts have not stopped share prices from putting in a strong performance since mid-June. UBS observes the ASX200 has gained some 8% over the last month, with the index rallying 10% since bottoming in June.
With history showing Australian equities tend to hold on to their gains during the after-season, UBS is hopeful 2022 will finish on a positive note:
"The markets rally since mid June has provided equities with more positive momentum than has been the case leading into recent reporting season.
"The continuation of this rally over the last fortnight, has matched the favourable reaction which we have become familiar with over recent years.
"Furthermore, with the exception of the COVID shocks of March 2020, Australian equities have tended to hold onto these gains over subsequent months."
As reported in earlier editions, Macquarie strategists are a lot less optimistic than is UBS. They highlight the fact that, so far, dividends tend to "miss" expectations, while the average guidance communicated looks rather "soft".
Up until Friday, notes Macquarie, analysts are issuing twice as many downgrades to FY23 forecasts than upgrades. Among the positives is that free cash flows tend to surprise positively, especially from resources companies. (This contrasts with the dividend disappointments, suggesting boards are cautious).
Macquarie also notes there are fewer share buybacks being announced, which is yet another disappointment.
There haven't been too many examples of companies issuing guidance that well-exceeds market expectations, but Macquarie mentions Brambles and ReadyTech Holdings ((RDY)) as two examples.
Macquarie counted only three companies that beat with their FY22 performance and experienced upgrades to FY23 forecasts last week: Medibank Private ((MPL)), Temple & Webster ((TPW)), and Qualitas ((QAL)).
This broker's overall market assessment reads a lot different from UBS's:
"We still think it is hard to make a bull case for stocks when valuations are already high, we are early in an earnings downgrade cycle and the Fed/RBA are likely to tighten further to slow inflation."
Macquarie's forecasts are positioned below consensus for Woolworths ((WOW)), Reece ((REH)), Nine Entertainment ((NEC)) and Fortescue Metals ((FMG)) suggesting, if Macquarie is correct, heightened risk for result disappointment.
Macquarie is also keeping a close watch on inventories with most companies having reported to date showing higher-than-expected inventories. While the official explanation is usually in reference to preparation for supply chain bottlenecks, Macquarie nevertheless points out this can be an earnings risk as the cycle slows.
Macquarie's aggregate FY23 EPS forecast for the ASX200 is falling, but at 11.8% the strategists believe it remains too high for a US recession scenario next year. The FY23 EPS growth forecast for Small Industrials is now slightly negative.
Equity strategists at JP Morgan, Jason Steed and Emily Macpherson, summarise the running August season as: Cost, Capex and Conjecture. The latter refers to companies issuing guidance (or not).
Rising costs and the ability to keep a lid on input inflation is dividing corporate Australia in August, suggests JP Morgan, with the likes of ASX, Domain Holdings Australia ((DGH)) and Transurban in the not-coping-well basket and the likes of BHP, Brambles, REA Group ((REA)) and Treasury Wine Estates proving they are better suited in the present environment.
Equally notable is that several companies are ramping up capital expenditure (capex), but it's not always well-received.
JP Morgan points out higher capex guidance by BHP, Brambles and Sims ((SGM)) was well-received by investors. More importantly: JP Morgan finds there has been a trend of rising capex in recent years, and while moderating, this trend is expected to remain at elevated level in Australia.
Underlying, both strategists acknowledge, it's not shaping up as an exceptionally great season, but trends might simply be reverting back to pre-covid averages.
Irrespective, only 17% of reporters by the end of last week had enjoyed upgrades to forecasts by JP Morgan analysts, and this is well-below historical trends, as well as well-below the 43% that is seeing downgrades.
Some of the notable "beats" to forecasts have been, on JP Morgan's assessment, Brambles, Domain Holdings, Insurance Australia Group ((IAG)), Medibank Private, REA Group, Suncorp Group ((SUN)) and Telstra.
At face value, analysts at JP Morgan seem a lot less active than their peers at, say, Macquarie with aggregate bottom-up EPS forecast for FY23 currently sitting at 3.9%, down from 4.1% pre-season.
One additional observation to highlight is that companies that should benefit from improving market dynamics post-covid continue to enjoy market support, even as those companies are tempering analysts' expectations. Witness, for example, the CSL share price, or Cochlear's ((COH)) in recent days.
In terms of absolute stand-outs, the picking thus far has been extremely slim. Audinate Group ((AD8)) would be one logical nomination on the positive side with just about everyone in awe of how well management at this little technology gem has managed the operational headwinds.
Another logical nomination is Pro Medicus ((PME)), though its existence alone triggers heavy-handed debates on social media about "valuation" and what might already be priced-in.
Among the large caps, both BHP and Telstra rank highly on analysts' nominations, with both surprising positively with dividends.
Brambles and Carsales ((CAR)) are worth mentioning too, but macro-considerations are ever-present, which means positive performances from companies including Corporate Travel Management ((CTD)), Super Retail and Seek are not receiving the rewards they would otherwise enjoy under different circumstances.
This year's tougher environment is preventing many of your typical strugglers to put in a come-back performance, with the likes of AGL Energy ((AGL)), Appen, Aurizon Holdings, Inghams Group, GWA Group ((GWA)), Magellan Financial, and Pact Group once again proving successfully turning around under difficult conditions is mostly wishful thinking.
FNArena's Corporate Results Monitor is updated daily: https://www.fnarena.com/index.php/reporting_season/
Recent Weekly Insights:
The Real McCoy Rally?
Said strategists at Citi late on Friday Australian time:
"Relative to the apparently more sunny view in financial markets, we remain concerned about the possibility of further storms ahead.
"While our baseline (modal) forecast sees the global economy narrowly avoiding recession, we judge that the risks are skewed heavily to the downside.
"These include a sharper-than-projected downturn in the euro area, a failure of the Chinese authorities to provide sufficient stimulus, and a more-rapid softening in U.S. consumer spending and labor market conditions.
"Accordingly, we reaffirm our 50% global recession call—and underscore that global recession is a clear and present danger."
But any optimist would still conclude: 50% chance of a global recession means there is a 50% chance there will not be a global recession.
And that is the view adopted by Wilsons which then leads to the view the global rally in equities off the June lows does not by default have to be an ordinary bear market rally.
It is possible, says Wilsons, that this was it, as far as the 2022 bear market is concerned, and we can all relax and look forward to the next bull market climbing the wall of worries.
Is it really that simple?
Of course not. And Wilsons would not necessarily deny Citi's assessment. It's simply a case of glass half full or half empty – and both views are equally valid when the odds for a more prolonged bear market are in the hands of a coin-flip.
What are the necessary conditions that would make this rally more than just a bear market phenomenon?
Inflation, says Wilsons. At its core, it all comes down to how sticky is inflation at this year's elevated highs.
Wilsons' in-house view is that inflation next year, in 2023, will drop sharply and this will create a fundamentally different dynamic for financial assets.
But in the run-up to 2023, it won't be long before central bankers can start to relax, and this means government bond yields can settle, and this provides breathing space for equities.
The combination of all of the above is the US, and the world at large, can escape economic recession next year. This means corporate earnings can remain relatively resilient. And this translates into less downside for equity prices.
The flipside is there is less upside, because markets have already recovered a lot from earlier weakness and equity valuations have never genuinely become 'cheap' this year.
The latter is being referred to elsewhere as a reason why this couldn't possibly be the end of this year's bear market, but a pragmatic Wilsons is of the view that cheap valuations are not by default the end result of every bear market.
It won't be this time around if, as today's optimists believe is the case, the 2022 bear market ended in June, at the same time as global bond yields peaked.
(This story was written on Monday 22nd August, 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).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer 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: firstname.lastname@example.org or via the direct messaging system on the website).
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