Rudi’s View: Mate, Where Have The Profits Gone?

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In this week’s Weekly Insights:

-Mate, Where Have The Profits Gone?
-All-Weather Model Portfolio

By Rudi Filapek-Vandyck, Editor

Mate, Where Have The Profits Gone?

It’s not something that becomes obvious from watching the local share market retreat after climbing to a new all-time record high in September, but profits for corporate Australia are almost literally melting away post the August results season.

That results season, as reported at the time, was one of the worst over the decade past with many more ‘misses’ than ‘beats’, specifically through management teams providing more sober outlook statements than analysts and investors had positioned for.

Following a not so fantastic FY23, FY24 saw the average EPS for the ASX200 slump by -5.2%, but at least the following year would see a return to growth with consensus projecting 4% for FY25, followed up with 5.9% growth in FY26.

Two months later, and the outlook for Australian profits has dramatically changed with the consensus growth forecast sinking below 1% (at 0.8%) and continuing to trend negatively. Won’t be long and Australia will be challenged to stay above zero yet again this year.

Over at Macquarie, the numbers look a lot worse with this broker projecting -4.9% for the year ahead with both the banks and large cap resources (mining and energy) expected to drag the market’s average deep in the negative.

It’s not so much about analysts growing more sceptical about the future; what we are experiencing is companies failing to deliver on already pared-back expectations, and so forcing those analysts to shave off yet another slice from forward projections.

The weeks past have provided plenty of examples; from BlueScope Steel ((BSL)) and Macquarie Group ((MQG)), to Metcash ((MTS)) and Woolworths ((WOW)), to smaller caps OFX Group ((OFX)), Cettire ((CTT)), Immutep ((IMU)), and numerous others.

Not all share market updates are by definition negative, as also proven by Westpac ((WBC)) on Monday morning and by Bank of Queensland ((BOQ)) earlier, but it’s plain impossible to ignore the balance is heavily skewed in favour of more downgrades.

So how come the share market is still within reach of its all-time high, with the ASX200 trading on a seldom witnessed 18x multiple for next year’s dwindling profits and only offering on average 3.6% in dividend yield, against a long-term average of 4.5%?

Should we worry about much lower share prices ahead, in line with rapidly weakening profits?

The Cavalry Is Coming

It’s a sentiment-driven market, according to analysts at Macquarie. But I think part of the mystery, if there is one, can be located in market forecasts for FY26, currently projecting average EPS growth of 7.9%.

That number implies forward-looking investors remain confident of better times ahead, regardless of hiccups and disappointments in the short term.

Australia has been lagging the US in its post-covid recovery, also because the strong innovation drive behind companies in US healthcare and technology only applies locally through second or third derivatives, plus a still hawkish RBA stands out in a world of cash rate cutting central banks elsewhere.

Starting from behind, the Australian economy is expected to play catch-up over the year ahead, as can be seen from Bloomberg forecasts in the graphic below:

If current projections prove correct, inflation is on trend towards 2% (blue line) and GDP growth (grey towers) has seen its low for the time being and should double by this time next year. Somewhere in between the RBA is expected to join other central banks with lowering its cash rate.

Increasingly, economic signals are underpinning such projections.

From a recent update by Oxford Economics:

“Oxford Economics’ Industrial Cycle Index for the advanced economies improved to -0.2 in the most recent data from August, compared to -2.7 in the previous month, signalling we are at the bottom of the cycle and gradually moving into expansion.”

But also:

“Our projection of a bottoming in the third quarter of 2024 is coming to pass, but the recovery will be halting in its early stages. Cyclical momentum is not expected to improve dramatically for the rest of 2024, and it will not be until the second half of 2025 that the full impact of monetary easing will begin to be felt.”

Meanwhile, last week’s retail sales data for the September quarter locally revealed the strongest pace of growth since Q2 of 2022, leading economists at ANZ Bank to declare “retail sales data suggests household spending has past the low point for this cycle”.

Retail volumes per person in Australia have declined for nine consecutive quarters but last week’s update revealed a decline of only -0.1% compared with -0.9% in Q2.

Concludes ANZ Bank: “It appears the combined impact of cost-of-living relief, moderating inflation and tax cuts is flowing through to a modest pickup in aggregate spending.”

But also: “Our ANZ-Roy Morgan Australian Consumer Confidence measure continues to trend upwards, albeit at a gradual pace. That in turn suggests an elongated recovery in spending growth from here.”

The economists do anticipate to see strong spending around key retail events like Black Friday and Boxing Day sales.

Colleagues at Westpac have come to the same conclusion: it looks like the bottom is in for consumer spending in Australia, but the recovery won’t be sharp, or rapid, and probably not move in a straight line either:

“Despite some more promising signs, the consumer recovery still has a long way to go.”

Snakes & Ladders

The message for investors seems unambiguous: better times are forthcoming, but that won’t stop companies from struggling in the here and now.

The combination of these opposing factors does provide context behind what is happening in the share market post the peak in September optimism.

Money is yet again flowing out of smaller cap companies as the risk to own the next major disappointment in this segment is many times over larger than through owning larger cap blue chips.

This remains the case even if the likes of Macquarie Group ((MQG)), Brambles ((BXB)), Woolworths and BlueScope Steel are equally guilty of not living up to expectations.

BlueScope Steel’s profit warning implied analysts’ forecasts were too high by some -25%, but the share price didn’t fall nearly as much in the days after the announcement and already the buyers have returned. It is FNArena’s observation the average price target for the stock has actually risen, not weakened, since.

As many a small cap afficionado might be wondering: what kind of extraterrestrial large cap voodoo magic is being applied here?

The following update on the local steel sector by RBC Capital on the weekend is likely to provide some answers:

“We believe FY1H25 represents the low point in the current steel market cycle, and as such presents opportunities for investors with through-the-cycle investment horizons.

“For Sims (SGM, PT $14.50) we are Sector Perform, Speculative Risk given our view that seaborne demand for ferrous scrap is likely to remain extremely challenged while Chinese exports remain high.”

A similar observation can be made for Macquarie Group whose consensus target has equally slightly increased post disappointment, though an extended share buyback will be part of its share price support (as also applies for Westpac).

There is, however, no uniformity, let alone any certainty as to how the market will respond to the next operational disappointment. Amcor’s quarterly update, for example, seems to have elicited a much harsher punishment than what would have been expected, having delivered a broadly in-line performance with signals of improvement.

Maybe the fact the share price was trading well above FNArena’s consensus price target before the market update gives us the explanation?

Investors are equally witnessing a notable difference in treatment of misbehaving founders of long lasting success stories at WiseTech Global ((WTC)) and Mineral Resources ((MIN)).

The public humiliation of Richard White has ended, at least for now, but him shifting to a consultancy role, on the same pay and with direct reporting obligation to the board, has clearly appeased shareholders and others.

At $122, and carried by a positive trajectory, shares in Australia’s most successful tech story when measured by market cap are not only well off the below-$100 sell off low, the share price is also back above FNArena’s consensus target of $118.78 and less than -10% off the recent all-time high.

Things look a whole lot differently for Chris Ellison and MinRes. For starters, the alleged misdemeanours are far more malicious with the board having concluded Ellison enriched himself while shortchanging the company and its shareholders.

But a founder/CEO is not equal to any other business leader, of course, and Monday’s announcement suggests he has been given 18 months to officially step down from his position. While this must be a relief for anxious shareholders in the short term, I think a permanent discount to valuation seems but the logical outcome.

This won’t stop the share price from recovering -the shares are down -47% in 2024- but it will keep a lid on the potential recovery. Contrary to WiseTech, MinRes is still hampered by its balance sheet, though the recent deal with Gina Rinehart has arrived timely, and its core operations and markets are facing severe cyclical challenges.

Look no further than Newmont Corp, or Iluka Resources ((ILU)), or Paladin Energy ((PDN)), or even Champion Iron ((CIA)) to back up that statement.

All in all, it is easy to see the positive in how the cycle is turning to the benefit of Australian companies, but short-term pressures are quickly turning the Australian share market into a field full of landmines that can not always be confidently avoided.

The big challenge for investors remains to distinguish which companies are less likely to disappoint in a major fashion and, in case they do, which ones are worth holding on to and maybe increase exposure to?

As I stated in a recent conversation with a stockbroker who advised his clients to secure profits from stocks that have performed well thus far in 2024: those are not by definition the holdings one should be concerned about.

Earnings certainty and confirmation will most likely trump the uncertainty from profit warnings and disappointments elsewhere. Something that might again exert itself when solid performers such as Xero ((XRO)), TechOne and Aristocrat Leisure ((ALL)) report their financials in the coming weeks.

Goes without saying, all of the above has been written ahead of this week’s US presidential election of which the outcome and ramifications at this stage remain anybody’s guess.

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A few things to note:

-FNArena reports weekly on what’s happening with analysts’ forecasts and valuations:

https://fnarena.com/index.php/2024/11/04/weekly-ratings-targets-forecast-changes-01-11-24/

-FNArena reports daily on analysts’ updates and revisions for ASX-listed companies:

https://fnarena.com/index.php/financial-news/australian-broker-call/

-The website has a dedicated section to my personal research into All-Weather Companies and various curated lists on Quality Growth, etc:

https://fnarena.com/index.php/analysis-data/all-weather-stocks/

-The website also keeps a tab on corporate results, including an archive dating back to August 2013:

https://fnarena.com/index.php/reporting_season/

The FNArena Corporate Results Monitor will play catch-up this week.

All-Weather Model Portfolio

The FNArena/Vested Equities All-Weather Model Portfolio managed to slightly outperform the broader market at face value in a subdued October month, but underperformed once dividends had been included.

Not that we pay much attention to such short term considerations, in particular not when the twelve months’ return has accumulated to more than 33%, of which only 2% came from dividends.

Strong contributors in recent months have been Hub24 ((HUB)), REA Group ((REA)), ResMed ((RMD)) and TechnologyOne ((TNE)) while disappointments from Audinate Group ((AD8)), Steadfast Group ((SDF)) and Woolworths ((WOW)) erased some of the gains booked.

Readers should note both Audinate Group and Steadfast Group are no longer included in the Portfolio which has increased cash holdings to circa 8.5% ahead of the US presidential election.

Another observation to make is the Portfolio prefers to have exposure to gold through an ETF, rather than also taking on board specific company risks via shares in gold miners and/or explorers. Watching Newmont Corp ((NEM)) shares receiving capital punishment after releasing yet another disappointing quarterly update, among others, is certainly taken as vindication of our lower risk strategy.

FY24 review for the All-Weather Model Portfolio:
https://www.fnarena.com/index.php/download-article/?n=DE2A4552-E2C7-4DC7-0A896CE5CF68ACD8

Prior years:

FY23: https://www.fnarena.com/index.php/download-article/?n=DFC11150-CB36-C777-1AA3EDA640E2F5BF

FY22: https://www.fnarena.com/index.php/download-article/?n=DFE7241B-9CD8-61F1-1602C581A8E539C4

FY21: https://www.fnarena.com/index.php/download-article/?n=DFF82691-E53E-3CF5-17A2337D72CDB54F

Video: Why FNArena & All-Weather Stocks

I’ve used my participation to the InvestmentMarkets’ conference in July to explain how/why FNArena started & what investors get out of it, including research in All-Weathers and Gen.Ai

The video: https://bit.ly/3A1pLuz

Model Portfolios, Best Buys & Conviction Calls

This section appears from now on every Thursday morning in a separate update on the website. See Rudi’s Views for the archive going back to 2006 (not a typo).

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (21 since 2006); examples below.

(This story was written on Monday, 4th November, 2024. 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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