Rudi’s View: Awaiting The August Verdict

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In this week's Weekly Insights:

-Awaiting The August Verdict
-Conviction Calls and Best Ideas

By Rudi Filapek-Vandyck, Editor

Awaiting The August Verdict

It's by no means a perfect relationship, but earnings forecasts in Australia are tumbling in seldom witnessed fashion while key indices are threatening to set new highs for the year.

If investors are looking for a genuine reason to be worried, the gap that is opening up between these two might just be the appropriate concern.

But it is and remains a heavily polarised share market and thus general averages only tell half of the story, at best.

At face value, corporate profits in Australia have proved more vulnerable than in overseas markets, Europe and the USA included, and the prospects for the year ahead suggest the pressure is on with the aggregate EPS forecast for the ASX200 now firmly in negative territory for FY24.

One look into the finer details, however, quickly reveals this negative outlook is closely correlated with the local share markets' heavy weighting towards resources companies and banks. This does not erase the fact that things are getting tougher for many companies in many industries.

The general mood among local share market forecasters ahead of the August season is cautious, also because overseas companies that manage to beat forecasts are not necessarily rewarded with a higher share price.

Analysts at Macquarie believe a close relationship seems to be forming as to how share prices perform ahead of each financial report; did the share price rally in advance? A weakening should be expected post release. Did the share price lag ahead of the release? The odds are in favour of a share price rally post event, even if the result itself is a "miss".

The upcoming August reporting season will also mark a trend reversal in local dividends as super payouts from the iron ore producers in years past are normalising. See also the significantly lower payout from Rio Tinto ((RIO)) last week.

Bank dividends remain poised for strong increases this year, but then expected to largely remain unchanged in FY24.

On Citi's projections, total dividends paid out to Australian shareholders are likely to contract by some -6% in FY23, and again by a similar percentage in FY24.

Dividends from the resources sector are projected to shrink by -25% and -22.6% respectively for both years, with dividends expected to fall more than earnings due to lower payout ratios.

Optimism Trumps Fear

Back in February, corporate results in Australia proved a reality check for a market that had put in a fierce rally off the September-October lows, but five months later the broader dynamic is changing.

The Q2 reporting season in the US has been strengthening the overall impression that things are starting to improve and that before long companies and investors can start looking forward to growth in profits and sales again.

It is for this reason market strategists at Citi have turned more positive on the outlook for the S&P500 in the year ahead. Citi last week upwardly revised its targets for this leading index to 4600 by year-end and to 5000 for mid-next year.

The implication, explain Scott Chronert & co, is that any pullbacks can now be bought for an earnings growth acceleration call in 2024.

The team of strategists at Macquarie (bearish on Australia) broadly concurs, suggesting profit margins in the US are holding up better-than-expected, while inventories no longer seem the problem they once were.

All in all, earnings forecasts are no longer downgraded in the same fashion as they have been in recent quarterly reporting seasons in the US and this is feeding into generally broadening market optimism.

Divergence Dominates ASX Prospects

In Australia, the outlook appears a lot more challenging, as also indicated by analysts at Wilsons whose research update laid bare the extreme divergence in growth prospects for Australia's largest companies.

Zooming in on the local Top20 for the three financial years of FY23-24-25 immediately highlights the meagre, if not negative forecast trajectories for ASX-heavyweights including BHP Group ((BHP)), Fortescue Metals ((FMG)), Rio Tinto, Santos ((STO)), Woodside Petroleum ((WPL)) and all four of the major banks.

It goes without saying, share prices in commodity companies remain leveraged to any changes impacting on sector dynamics. Share prices have surged recently on speculation of more stimulus from the Chinese government to pull that economy out of its moribund state.

Wilsons' research also revealed which large cap companies in Australia look set to rise above the cornfield when all others will be struggling to keep the EPS growth pace positive:

-Aristocrat Leisure ((ALL))
-CSL ((CSL))
-Goodman Group ((GMG))
-Newcrest Mining ((NCM))
-Telstra ((TLS))
-Woolworths ((WOW))

Wilsons retains a mildly positive outlook for the Australian share market, also noting the median EPS growth forecast for the ASX100 ex-resources and banks is 10% for the year ahead, following on from a predicted 5% growth pace in FY23.

As said: the broad, generalised numbers for the ASX only tell half of the story, if that.

A recent survey among sector analysts at Morgan Stanley signals cost pressures are seen worsening for 35% of reporting companies in August, with pressures improving for circa 8% of companies.

Most analysts expect market forecasts to fall further as the August season unfolds.

Forecasting Beats & Misses: Goldman Sachs

Ahead of every reporting season, analysts and strategists put in their best effort to identify which companies most likely might surprise in a positive manner, and which companies seem poised for that nasty, negative disappointment.

Such forecasts are not always 100% accurate as companies sometimes still have offsetting levers at their disposal, while other times share prices have already been marked down allowing upside to be triggered by even the slightest hint of optimism.

Equally important: a falling share price need not always be negative news as it allows investors to get on board of companies they might have previously deemed too expensively priced. Existing shareholders can buy more exposure at a lower price.

Small cap analysts at Goldman Sachs have their eyes set on margins and balance sheets, suspecting earnings risks stem from higher inflation, wages in particular, and from higher interest rates.

It is this focus that keeps the team cautious on small cap companies such as Dicker Data ((DDR)), Maas Group Holdings ((MGH)), Inghams Group ((ING)) and Ingenia Communities Group ((INA)).

For potential positive surprises, the team is looking at Data#3 ((DTL)), Life360 ((360)) and Fineos Corp ((FCL)).

Goldman Sachs' small cap favourites leading into August are (ranked in order of preference):

-Macquarie Technology Group ((MAQ))
-Lifestyle Communities ((LIC))
-Data#3
-Life360

Macquarie

Those aforementioned (bearish) strategists at Macquarie favour ResMed ((RMD)) over Credit Corp ((CCP)) this week, and Boral ((BLD)) and Computershare ((CPU)) next week over CommBank ((CBA)) and Charter Hall Long WALE REIT ((CLW)).

Macquarie also makes it a habit to highlight where its own projections are opposite market consensus, thus suspecting potential for upgrades following market updates from Allkem ((AKE)), Lynas Rare Earths ((LYC)) and IGO Ltd ((IGO)).

On the same basis, downgrade risks are seen for Northern Star Resources ((NST)), Woodside Energy, Santos, IDP Education ((IEL)), Reece ((REH)), and Mirvac Group ((MGR)).

As reported in prior editions, Macquarie sees plenty of reasons to stay cautious towards the Australian share market and reminds investors August and September can be quite volatile.

Citi

Quant analysts at Citi have nominated the following companies for a positive surprise in August, with High Conviction:

-Abacus Property Group ((ABP))
-Autosports Group ((ASG))
-Carsales ((CAR))
-Domain Holdings Australia ((DGH))

In contrast, the following have been marked as High Conviction Sell-rated disappointers:

-Alumina Ltd ((AWC))
-BWP Trust ((BWP))
-Liontown Resources ((LTR))

In what can be interpreted as a positive signal, Citi's sector analysts are expecting a relatively balanced outcome between positive and negative surprises this season, though this in itself marks a negative trend given the balance favoured the positive ahead of the February season.

Citi sees higher costs as the key factor dominating results and forecasts this month, though investors will also be curious whether macro conditions are impacting on a company's top line, suggests the quant team.

One of the sectors that is expected to continue suffering from inflation pressures (higher costs) is healthcare with companies that are not enjoying strong top line growth likely to continue exhibiting margin pressure. Citi is keeping a close watch on the likes of Australian Clinical Labs ((ACL)), Healius ((HLS)), Integral Diagnostics ((IDX)), and Ramsay Health Care ((RHC)).

Also: Citi expects the relative underperformance of the Australian market to continue, sticking with a mid-2024 target for the ASX200 of no more than 7400. This is despite the US market looking more "expensive" and the Australian market merely trading around its 15-year median PE ratio of circa 15x.

Other companies poised for outperformance, on Citi's quant research, include Altium ((ALU)), REA Group ((REA)) and Zip Co ((ZIP)) while alarm bells are reported ringing for the likes of Lendlease ((LLC)), Lynas Rare Earths, and Region Group ((RGN)).

UBS

The most intensive research exercise ahead of August appears to come from the team of small cap analysts at UBS. Here we focus only on the most important calls made.

UBS expects to see a double negative, in the form of a disappointing earnings miss and a disappointing outlook, from the following small and midcap companies:

-Adore Beauty Group ((ABY))
-AMA Group ((AMA))
-Dicker Data
-IPH Ltd
-MA Financial Group ((MAF))
-Servcorp ((SRV))

A double positive is anticipated from:

-Audinate Group ((AD8))
-Autosports Group
-Corporate Travel Management
-Hansen Technologies ((HSN))
-Infomedia ((IFM))
-Ridley Corp ((RIC))
-SiteMinder ((SDR))
-Temple & Webster ((TPW))

Ignoring all of the above, UBS's favourites for the year ahead are:

-Autosports Group
-Breville Group
-Corporate Travel Management
-GUD Holdings
-Hansen Technologies
-NextDC
-NRW Holdings ((NWH))
-Ridley Corp
-Webjet ((WEB))

****

One sector for which a much stronger FY24 could be in waiting are engineers and contractors, while operational momentum for general insurers remains strong, which should equally rub off positively for the insurance brokers.

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FNArena will start updating its Corporate Results Monitor this week: https://www.fnarena.com/index.php/reporting_season/

For more reading on the upcoming August results season:

–https://www.fnarena.com/index.php/2023/07/26/rudis-view-arb-corporate-travel-goodman-group-nextdc-orora-worley-xero/

–https://www.fnarena.com/index.php/2023/07/19/rudis-view-low-expectations-not-low-enough/

Conviction Calls and Best Ideas

As has become a local tradition in years gone past, Morgan Stanley has once again communicated its small cap results convictions and this time around, ahead of the August season, the nominees are:

-Audinate Group
-Breville Group
-Corporate Travel
-IPH Ltd
-Life360
-McMillan Shakespeare ((MMS))

All have been nominated from a positive angle.

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Citi's healthcare favourites are CSL, ResMed, and Sonic Healthcare ((SHL)).

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Wilsons yet again expressed its preference for resilient businesses that can show off their earnings resilience and a recent update highlighted the following candidates:

-APA Group ((APA))
-HealthCo Healthcare and Wellness REIT ((HCW))
-The Lottery Corp ((TLC))
-Telstra
-NextDC ((NXT))
-ResMed

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Following share price weakness, Goldman Sachs has added Endeavour Holdings ((EDV)) to its selected list of Conviction Buys in Austalia and New Zealand.

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(This story was written on Monday, 31th July, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday 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: contact us via the direct messaging system on the website).

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