Feature Stories | Mar 09 2023
Download related file: FNArena_Reporting_Season_Monitor_Feb_2023
The February result season broke FNArena’s record for the most number of earnings misses to earnings beats. What can we now look forward to?
-February verdict: misses outweigh beats
-Inflation lingers
-Banks, resources past peak
-Two-speed economy ahead?
By Greg Peel
With the February result season now complete in 2023, the FNArena Corporate Result Monitor, which has been building throughout the month, is now complete and published in its final form.
Guide
The table contains ratings and consensus target price changes along with brief summaries of the collective responses from FNArena database brokers for each individual corporate result, and an assessment of “beats” and “misses”. Australian corporate results tend to focus on the profit line, with all its inherent potential for accounting vagaries, tax changes, asset write-downs and other “one-off” impacts. FNArena has focused mostly on underlying earnings results (more in line with Wall Street practice) as a more valuable indicator of whether or not a company has outperformed or underperformed broker expectations. There is also a level of “quality” assessment here rather than simple blind “quantity”.
The Monitor summarises results from 345 major listed companies. By FNArena’s assessment, 101 companies beat expectations and 113 missed expectations, for a percentage ratio of 29/33 or 0.9 beats to misses. The aggregate of all resultant target price changes came in at a net -0.3% reduction. In response to results, brokers made 53 ratings upgrades and 46 ratings downgrades.
The first FNArena Corporate Result Monitor was published in the August season of 2013. See table:
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A Record
Only once before in the history of FNArena’s Monitor have beats failed to exceed misses, largely because it is in a company’s interest to set guidance low and beat it, rather than the other way around. Equally, it is in stock analysts’ interest to be conservative with forecasts, as being wrong to the downside is more easily forgiven than being wrong to the upside.
In August 2019, 24% of results beat expectations and 25% missed. On two occasions since August 2013 the percentages have been equal.
In February this year, 29% of results beat and 33% missed. If we pick that metric alone, it was the worst result season since our records began. The average is 33% beats to 24% misses.
But there are other metrics. The average of broker ratings upgrades following results to downgrades is 59 to 69, meaning on average more downgrades follow than upgrades. This February season saw 54 upgrades and 43 downgrades – not a record, but one of the more positive outcomes compared to history.
We do need to put that in context nevertheless.
Over the month of February, the ASX200 fell -2.9%. That’s the first negative move across a result season since 2020’s covid crash. There are two reasons the index would move, up or down, over a season – one micro, one macro.
Note that while we use the ASX200 as a benchmark, this season’s monitor reported on results from 345 companies covered by FNArena database brokers, extending to the ASX300 and on to the All-Ords (500). Not all ASX200 companies report on a June-December cycle, including three major banks, all chemical/ag companies, some tech companies and various retailers.
Micro moves refer to individual share price moves in response to result releases, which collectively will move the index all things being equal. However, the macro overlay is always more influential, and the month of February was highlighted by hawkish central bank commentary and strong US jobs and inflation data, which specifically sent global bond yields surging.
Earnings forecasts for most companies are based on a discounted cash flow model with the discount rate being the “risk-free rate” – typically the ten-year government bond rate. Increase that rate and earnings forecasts into the future automatically reduce.
The impact of a net-negative macro overlay during February was to make it tougher for companies beating expectations to rally on the day, and to lead investors to throw companies missing on the day to the wolves. Which brings us back to the “positive” outcome on broker upgrades versus downgrades.
A lot of those were based on “share price response too severe”, and a lot were from Sell to Hold as well as from Hold to Buy.
Thus not as “positive” as face value would suggest.
Looking Back
This is an excerpt from the August 2022 result season Wrap:
“Back in the February [2022], noting results reflected the half to end-December, results were heavily impacted by what was the overlaying theme of the season – supply constraints, rising costs, covid lockdowns during the delta wave and closed state and federal borders, with WA’s lingering border lockdown proving particularly impactful on the mining and energy sectors.
But in the half to end-June, lockdowns were being lifted, borders were reopening, and consensus suggested supply constraints would begin to ease, labour shortages would fade, and inflation would begin to subside. Managements were able to take a more optimistic view of the half ahead.
But no. Omicron appeared, shifting the labour shortage issue to one of covid absenteeism rather than covid lockdowns, as workers succumbed to the virus and had to isolate for seven days.
Any meaningful easing of supply constraints was scuppered by China going back in widespread lockdowns.
Any meaningful easing of inflation pressures was scuppered by Russia invading Ukraine.
And to top it all off, Australia suffered devastating, and repeated, flooding, as the east coast in general copped greater than average rainfall.”
So what changed in the ensuing six months?
Well, realistically, nothing. For starters, China did not come out of lockdown until early this year, post the December half reporting period. Supply constraints continued, as did constrained demand in China for Australian exports.
We don’t much talk about covid anymore, but it’s still with us. We just pretend it isn’t. If there has been any meaningful easing of the labour shortage issue, it certainly was not apparent in the resource sectors. Many a miner/driller this season bemoaned ongoing shortages and subsequent higher wage costs.
Inflation begin to subside? I don’t think so. Very few management updates did not include ongoing high inflation as being the biggest impediment to margins, and thus earnings.
We have now entered the second year of the war in Ukraine.
Parts of Australia are still flooded to this day, particularly the Northern Territory, and if we extend our consideration to across the Tasman…
The only saving grace is that La Nina does seem to have now departed. Prepare for drought.
Looking Forward
Just as important as last period’s earnings results, and arguably more important, is guidance provided with those results as to the next period’s performance. Since the covid era began, a feature of each result season has been a total lack of guidance – when covid first hit and no one really had any idea – or guidance provided with a clear “uncertainty” caveat, as new covid waves kept appearing.
This season’s guidance featured very little mention of covid at all, other from those companies directly (negatively) impacted by the end of covid, such as those which thrived on covid testing and ventilator sales. Inflation and labour shortages were the major issues, adding up to higher costs, but once again managements were happy to assume these costs would subside in the period ahead.
Hence, while many a company missed on earnings during the period, they did not downgrade next period’s guidance as a result, assuming they can catch up in the ensuing period. This led to a large number of companies relying on an earnings “skew” to the next period, far more so than those which typically work on seasonal skews.
Past covid-impacted seasons had left brokers suggesting cautious guidance from managements likely errs on the conservative side. Not so this season. This season many a company issued what brokers believed to be “ambitious” guidance.
Another cost that we can link back to inflation is the cost of money. Economists constantly remind us interest rate increases have a “lagged” effect on the economy. One reason for this is that companies mostly finance their businesses via fixed rate loans. Only when those loans mature does the company then cop a higher cost of financing.
Then there’s households. Any taxi driver can warn you of the upcoming fixed mortgage “cliff”.
This week the RBA hinted that, maybe, a pause in rate hikes is not far away. Unfortunately, the Fed then turned around and hinted at the exact opposite. Either way, interest hikes are not about to turn into interest rate cuts anytime soon. If we do see interest rate cuts, it will only be because the economy is heading into a nosedive.
A bit of a lose-lose on the cost of money front.
The Peak
Australia’s banks have been enjoying a dream run of net interest margin (thus earnings) expansion as a result of the RBA’s rapid interest raises, by immediately passing on the increase to borrowers and being very tardy in affording the same to depositors. At the same time, households have been able to absorb additional mortgage costs with covid-era savings, mortgage “buffers” and fixed-rate mortgages. Hence, bad debts have to date been minimal.
All analysts agree this dream run is now over. As the RBA moves to pause, competition in deposit rates will intensify, reducing margins. As household savings are tapped out, mortgage buffers are caught up with and the fixed rate loans on around 40% of mortgages mature and roll-off into much higher rates, bad debts will surely kick in.
Analysts agree the banks have now seen their “peak”.
While the war in Ukraine rages on, the initial impact on commodity prices, particularly energy prices, has subsided. We can put this down to a warmer than usual European winter and a swift response to secure alternative sources other than from Russia.
Commodity prices also fell due to China being locked down, so the reopening should imply a return of Chinese demand. At the same time, the Fed has indicated a recession in the US may be the price one has to pay to tame inflation, for to not tame inflation would only make matters worse.
Either way, 2022 brought about a bonanza for Australia’s resource companies, particularly in LNG and thermal coal but also iron ore, base and other metals and minerals, grains and other foodstuffs. Inflation also elevated costs, but the end result was excess cash flow leading to excess dividend payments.
Before the February result season started, analysts were warning the dividend spree to come would be the last. Commodity prices have come down, cost inflation remains, and resource companies are now turning to funding new growth projects.
We have just enjoyed a record season for grain harvests and fibre production. That was thanks to La Nina.
Analysts agree elevated dividends have now seen their “peak”.
Wherever we look, 2022 is history.
The Outlook
The RBA has this week hinted it is close to pausing its rate hikes to allow the lagged effect of rate hikes to date to catch up, with Australian households already feeling the pinch.
Consensus suggests we’ll get another hike in April. Thereafter, any further hike, or a pause, will likely be dependent on the March quarter CPI and PPI reports. At the moment, consensus suggests a peak rate of 4.10%, implying two more hikes. But again, it will depend on inflation data, and also March and April jobs numbers.
While a pause would be positive for the stock market, the reasons for the pause – waiting to see how bad things will get – is implicitly not.
Meanwhile, the Fed is going the other way.
Late last year, as US inflation numbers started to tick down, Wall Street was assuming a peak Fed rate of under 5%. As economic data remained resilient, that assumption moved gradually upward, to 5.50%. Last month’s hotter than expected jobs and inflation data moved the dial to 5.75%, but since the Fed’s announced determination this week to go higher, faster and for longer, depending on the data, there is a quiet shift to 6%-plus expectations.
Any rate relief on the home front may still be overridden by weakness on Wall Street, if that is to be the outcome.
Alongside peak margins for banks and peak dividends from the resource sectors having now passed, analysts are most wary about the impact of rate hikes to date on the Australian consumer. If we all stop spending on discretionary items, and become frugal with regard staple necessities, the impact will be notable on the economy (GDP).
Another point to note is that if the RBA pauses but the Fed pushes on, the result will be a lower-still Aussie dollar – good for exports, but the opposite for imports. Given most of what Australians consume at a discretionary level comes from overseas, prices will rise and demand will fall, if it hasn’t already.
Consensus predicts the Australian economy will not fall into recession. But the Australian economy is measured only by one thing – GDP. As long as we continue to export rocks and gas at good prices, we should be okay, even if consumer spending crashes.
Of course, we need those commodity prices to remain solid, and that will depend to a large extent on China, and also on the war. If we assume the war will drag on, then China’s post-reopening economic growth, and subsequent demand, will be the swing factor.
Two-Speed
We recall that while the Australian economy posted a multi-decade run of positive GDP growth, brought to an end in 2020 by covid (but only just), back in the early twenty-teens there was much talk of a “two-speed economy”. The miners and oil & gas companies were doing their bit to maintain positive GDP growth, thanks to solid commodity prices, but everyone else was struggling.
Everyone else was in recession. It may not have been official, but a recession is as much a state of mind as it is a number, and if it feels like a recession, it is.
Welcome to 2023.
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FNArena's Results Monitor will soon shift to monitoring results released after February and before August:
https://www.fnarena.com/index.php/reporting_season/
Paid subscribers have access to insights and data for each season since August 2013.
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