Rudi Interviewed: Is August Too Early?

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It has become the 'unofficial' tradition in recent years: an interview with Livewire Markets ahead of yet another corporate reporting season in Australia.

This a sub-edited transcript from the pre-August results season interview that took place on August 5. 

By Rudi Filapek-Vandyck

It has become the ‘unofficial’ tradition in recent years: an interview with Livewire Markets ahead of yet another corporate reporting season in Australia.

Below is a sub-edited transcript from the pre-August results season interview that took place on August 5. The video is available on Livewire and on YouTube.

James Marley: Welcome to the Rules of Investing, Podcast that gets inside the minds of leading investors, economists and industry experts, brought to you by Livewire.

My name is James Marley. I’m going to be your host today. With reporting season on the ASX about to kick into full swing, my guest today is someone that has crunched the data on more results and the reactions from the market than just about anyone else.

Rudi Filapek-Vandyck, Editor of research website FNArena and popular contributor to Livewire, is with me to help you get match fit and in the zone for the upcoming reporting season.

From the big picture on current valuations, the impacts of AI and the stocks to watch in August, this is going to be a cracking session.

Now, remember, if you’re not subscribed to the Rules of Investment podcast, you can find it in all the major podcasting platforms, or you can sign up to Livewire Markets.

It’s free. It’s easy to register, and we’d love to have you on board. Now with that, I’d like to extend a very warm welcome to Rudi for our regular reporting season preview.

Rudi, great to have you online, and thanks so much for your time.

Rudi Filapek-Vandyck: My pleasure. The sound you’re hearing is the rain coming down in Sydney on the moment this interview starts.

They’re saying in investing timing is important. Apparently, with recording, it’s equally as important.

James: I thought it was a sign that we’re about to get rained down with a deluge of information on reporting season, and you’re going to be our little safe harbour to help us get through it?

Rudi: I will definitely do my best, but after such an intro, half my work has already been done!

Valuations Are High, What Gives?

James: Well, we were having a chat about what will we talk about today? And you sent through a few points. One starting point are valuations. Are they high? Are they stretched? It’s topical for investors. Difficult one to answer.

I’m going to draw attention to an article that my colleague Kerry Sun put together recently, which effectively told people to stop calling markets expensive. They’re at all-time highs but the crux of the article is, drawing from UBS research, the market has evolved. Companies have gotten better.

Therefore, we need to think about market valuations in a different light. So Rudi, does that mean we need to get used to paying higher multiples, should we be more comfortable with higher valuations?

Rudi: I think the answer is yes, under certain circumstances, not always, but we definitely need to stop calling the market overvalued simply because the valuation multiples are higher than what we are used to.

It is being said that generals always fight the last war. I’ve come to the conclusion that most investors invest in yesterday’s market, and they need to invest in tomorrow’s market, of course, because it’s all about looking forward.

 I can’t emphasise enough how happy and how glad I am that stories like that and analyses like that are being published, not just by me, but by others as well.

Because I do think a whole change still needs to take place in the psyche of investors. Australia being a typical value-oriented market for such a long time, investors are constantly thinking that something trading on a PE of six or nine is, by default, a better long-term investment than something that’s trading on 96 times.

We clearly saw over the past 15 years or so that’s no longer true. In addition to all the arguments mentioned –and I completely subscribe to those arguments– I do think there’s also a very simple, easier way to understand the metrics for today’s market.

We still reason in averages. We judge the market by the average PE ratio for the ASX200 and we judge the environment for corporate Australia by the average EPS growth forecast.

In both cases, the market is so polarised these days, and it has been for such a long time. The market has at least been polarised ever since covid hit. That’s 2020, five years ago now.

On my analysis, the polarisation is quite extreme in today’s market. What that means also is those averages we are used to watch, the PE ratios and the average EPS forecast, you can’t take them at face value anymore.

A big part of the reason why the PE ratio looks this high for the Australian market is because we have 11% –Commbank ((CBA))– of the index probably trading at the highest valuation any of us has seen in our lifetime.

At 11% of the index, of course, it’s going to have a big influence on the average PE ratio, and that’s one of the reasons why the PE ratio is that high.

The bigger question, I think, is should the market sell off because CBA is trading at an all-time high?

I know sentiment is important, but I would argue it doesn’t need to. The other element is resources remain a very important input in Australia.

They are the second biggest index weight, and they too have an outsized impact on all the averages we can calculate for the index.

So I would often smile when the next person is calling for the bubble to burst.

I don’t think there’s a bubble. I think it’s way too early to say there’s a bubble. Are valuations high? Yes, they are, but there are particular reasons why that potentially can be justified.

 I’m sure we’ll talk about it over the next however long this interview takes.

Why Is Corporate Australia Not Growing Earnings?

James: One of the things you mentioned there was earnings. And we get told, as investors, over time, where earnings go so too will share prices.

Same note from UBS, or a more recent note perhaps, pointed out we’re about to get the second consecutive year of negative earnings growth for the ASX.

Now, to your point, that’s on average, but we’ve got all-time highs being hit at the time when earnings are weak. So, what gives?

Rudi: Again, yes, you’re right at face value. We are at an all-time high, with a PE ratio we very seldom see, on average, and August will mark the third consecutive year of negative EPS growth on average for the local market.

So you would think it’s all about multiple expansion; there’s no earnings growth here.

But that’s not true when you look below the surface. Below the surface, the two largest components of the index locally, banks and resources, are weighing negatively on the average.

The banks are positive for this year, but it’s not much, and the resources –again– negative, both the mining companies and energy companies.

If you strip those out, you see the growth forecast for corporate Australia outside of those two sectors, is actually not that bad at all.

It’s more in the mid to high single digits EPS growth. Long term the average in Australia is 5% EPS growth per year.

If the forecast now is six or seven or eight, that means there are large parts of the Australian economy that are performing above average.

Coming back to the polarisation that I touched upon earlier, what you will find in sectors is that one company has performed and the other one hasn’t. If you want to drill down to it, it’s usually that one company has performed operationally and the other one hasn’t.

So, earnings do count, not only in August, but also for the in between seasons.

August Too Early?

James: Banks, it’s going to be hard for them to meaningfully move their earnings. They’re flat-ish type businesses and have been for a long time. Resources, highly cyclical. Can you see a turnaround story in that earnings outlook? People have been waiting for that broader earnings picture to move into positive territory again. Are we going to see it this August?

Rudi: Its going to be interesting. My view in advance, I think the question that will come to the fore for August is: is it not too early still?

That will be the question that will be asked for a lot of things. We’ve now had at least three years of large caps on average outperforming small caps. Is that going to reverse?

I think the question will be: is it not too early for that?

We have subdued consumer spending. We have profit warnings from consumer spending-related companies in Australia. Is that going to turn around in August?

I think the question will be: isn’t it too early yet for that?

I also think the whole revival of the resources sector is most likely too early.

Are we going to see a big improvement in earnings forecasts? I think it’s too early in August; the RBA has been very reluctant in helping out, Trump tariffs, it hasn’t all helped.

I think maybe a more logical time will be February next year, instead of August this year, which clearly will pose some challenges for investors.

You can also expand that to other sectors and to other themes. Are we going to see a broadening out of the advantages, the benefits, the applications of AI across corporate Australia?

Probably a little bit too early to see concrete results of that. If you take the broad view this whole AI theme at some stage will stumble and at least have a pause, but that too, I think, will be too early for August. I think that will continue.

So, I think the challenges are lining up, and I know the usual reflex of investors is trying to figure out which companies haven’t performed yet — they might perform in August.

I think the danger is they will say goodbye too early to companies that have performed and that still have a lot of firepower to continue performing.

If you look, for example, at the three corporate results just prior to this interview, Champion Iron ((CIA)) and Rio Tinto ((RIO)), two commodities companies, two iron ore producers, two disappointments.

Both share prices went down. Both share prices have not performed over the year past.

We also had ResMed ((RMD)) reaching an all-time high, and it comes out with a result better than expected. Share price up.

I think there’s a lesson here for investors. Don’t say too early to companies that have performed that this is the end of the road, and don’t think too easily that those who are lagging that their time has come to perform now.

August might just be too early for that.

How To Deal With Volatility?

James: Interesting. From the US perspective, we also saw some of the big tech companies match up. Microsoft performing really, really well. We had the IPO of Figma, which was just stratospheric in terms of returns.

It connects to that theme around AI and some of that tech momentum you’ve talked about.

Volatility. It’s been a big part of prior Australian reporting seasons and it has been evident in the US.

Do you think that that’s going to be a feature again, and how do you deal with it? Any tips for investors on how to take advantage of it?

Rudi: My personal position is probably the best starting point. The portfolio I manage currently has 10% in cash. It was a bit more, but we did apply for extra shares in Xero ((XRO)) recently.

So, we have 10% in cash and, at this point in time, no intention of doing anything with it because I worry a little bit we might need it in in August or in September, because it might well get that volatile.

If it happens in the right stocks, then we’ll be buying and that’s basically the attitude you need to have as an investor.

What worries me a little bit in that regard, and that’s backed up by research done by the likes of UBS, and I believe Morgan Stanley did something similar as well, is the average volatility in the last two seasons has picked up dramatically, like: really significantly.

That basically means if, somehow, releases do not quite meet expectations, the punishment can be extraordinary.

That is obviously devastating if you’re holding the wrong stocks for the wrong reasons, and you have no confidence in them because there are your losses, even if you don’t take them.

But for the right stocks, if you are confident it’s a temporary setback and the long-term story remains intact, the obvious observation to make, of course, that it’s an opportunity.

I am often being asked, which ones do you think will fail, and which ones are your favourites?

I’ve been doing this for such a long time, and I’ve stopped predicting, because you simply don’t know.

In a very simplistic proposition: I’m still a long-term shareholder in ResMed. The shares are now up 100% in two years.

I have no intention of saying goodbye to them. The shares rallied very strongly over the past month into this result, and that normally can make you a little bit worried, because who tells you that that will not lead to a disappointment on the day?

In this case, it hasn’t, but there’s no guarantees when you put all the elements together. Whether that matters in the immediate term is very much dependent on why you own your stocks, what’s your horizon, what does your portfolio look like?

And probably the most important thing is: how large is your confidence in that whatever happens in August does not necessarily reflect on the year ahead or the two years ahead?

Is August Key For CSL?

James: Let’s dive into a couple of important results and key results for people to keep an eye on. I’ve picked CSL ((CSL)). I know it’s a company you followed for a few years.

We had a number of commentators and fund managers on Livewire saying this result really matters for CSL. Investors have been patient. The stock’s been trading sideways for an extended period.

It’s time for management to deliver on some of the promises around better margins and growth. What’s your take on the outlook for CSL?

Rudi: I’m not so sure whether that’s true. I think those people might be expecting too much.

The reason why is we still have Trump in the White House and I do know Trump goes after healthcare costs in the US and is targeting Big Pharma.

How much of that will also impact on CSL, or will it exclude CSL, etc, etc?

The share price hasn’t performed post covid. What people forget and it’s easy to ignore, is this company’s growing at double digits.

Underneath the share price is a company that grows at double digits. It did that last year, and it has guided to do that this year, and it probably will equally guide to do that next year.

There’s only so much the company can control. On one end, you’re right. There is a lot of insecurity if you are inside the CSL bunker and there are signs I’ve noticed over the year that they’re definitely feeling the pressure.

They definitely feel like they need to do something, because shareholders, clearly, they’re not sitting there to have a share price that doesn’t move.

But in the same respect, I am very cognisant of the fact it’s not all in their power. They would love to be in a position like ResMed is, where they can just have solid sales and an increased margin.

Similar as with BHP Group ((BHP)), where they had to increase capex and postpone the second expansion project in Canada with Jansen potash, the disappointment from CSL was that the return to the pre-covid profit margin has been delayed — twice.

From that perspective, they probably need to come out and say we’re on track now and not delaying by another 12 months.

That would definitely be a big disappointment. If they read the room correctly, that’s exactly what they shouldn’t do in August.

Again, we will have to see. If it wasn’t for the whole anti-vax movement in the US that is now in charge of the government, I would not be that negative about CSL. I’m not negative now, but I am cognisant of the fact they have no control over certain things that can have a big impact still on market sentiment, at the very least.

What I do notice is that in July, both ResMed and CSL share prices have rallied quite strongly. Clearly, the market, for some reason, felt more comfortable in owning those shares after June than before and why exactly that is, I don’t know.

All I know is Trump hasn’t changed his views. But maybe, maybe there’s more confidence out there that whatever comes out of CSL operationally will not be bottom of the barrel.

Corporate Results In Focus

James: Rudi, gives us a couple of stocks that you’ve got your little Rudi microscope on for reporting season; that you think could be interesting to keep an eye on?

Rudi: I’m still very much into AI mode. I still believe the scepticism that has descended upon the Australian share market will be proven misplaced.

You’ll find that all those stocks that last year could do no wrong because they had an AI label attached to them, the whole atmosphere around them has changed this year.

I’ll definitely be on the lookout and not just the likes of Goodman Group ((GMG)), NextDC ((NXT)), Macquarie Technology ((MAQ)), Infratil ((IFT)), and others, but also the technology companies like WiseTech Global ((WTC)) that will be applying AI fully through its operations.

The AI discussion in the US is much livelier than it is in Australia. In the US, those who are convinced that AI will have a profound influence on the economy over the years ahead, they are toying with the idea that companies will be successful.

These companies can be in finance. They can be in the insurance sector. They don’t necessarily have to be one of the big tech companies.

If companies are successful in applying AI, their revenue will go up and their margins will increase. If you have the combination of those two, then whatever is priced in today will not look expensive in two or three years’ time.

This is something investors in Australia should consider as well. Again, I think it will be too early in August, but companies will talk a lot more about AI, I’m sure.

That will include the likes of CBA. In recent times, even companies like Imdex ((IMD)) are now moving into SaaS and AI.

You will hear it from Pro Medicus ((PME)). You will hear it from WiseTech. You’ll also hear it from Scentre Group ((SCG)), and from Myer ((MYR)), and from Temple and Webster ((TPW)).

While August will be a season with a lot of talk about AI, we won’t see that much in terms of extra revenue and profit increases.

That might come, at your earliest, probably in February next year, maybe August next year.

AI Front Runners In Australia

James: Do you have a couple of front runners on the AI front? You’ve talked about the data centres; I know you’re a fan there.

You’ve listed a cluster of stocks from bricks and mortar retailers, through to the biggest bank, through to a mining services software provider. Are there a couple on the top of your list where you think they could be on the front?

Rudi: I think there’s a time and timing for everything. I’m still into the data centres, because that is still a very straightforward way of playing this mega trend.

At this point in time, the most obvious other companies are companies in which we already are a shareholder anyway.

So you talk about TechnologyOne ((TNE)), you talk about Xero ((XRO)), you talk about WiseTech Global; they already are working with AI.

It’ll go through the databases. It’ll go through their client bases. Given their business models, they will stand to benefit.

Also quite straightforward: the margins will probably increase, the cost will go down.

These are the obvious ones to watch this reporting season. (Note: TechOne and Xero don’t report in August, WiseTech Global does).

In the next phase, we will start talking about AI being used in finance;  insurance companies, banks, probably also in other finance services providers.

The telecommunication companies will start using it. We can position for that right now, but it is still early days.

As I said earlier, BHP is big on AI, but it won’t move the dial there, unless we see the copper boom coming to the surface, or potash, or iron ore staying resilient for longer.

Because, at the end of the day BHP can apply AI as much as it likes, if those commodity prices don’t move, the share price won’t move either.

Three Bonus Questions

James: Rudi, we usually have three regular questions, but I’m going to call them irregular questions this time around, because I’ve tweaked them for you, ahead of reporting season.

They’re meant to be short, sharp, a little bit of fun. So why don’t we get stuck into those?

You’ve analysed 1000s of broker reports, maybe tens of 1000s, possibly hundreds of 1000s, over the last two decades. If you had to pinpoint one aspect the most valuable part of that research, what is it? And how can investors use it?

Rudi: Probably in the way I use it. It helps you understand what makes a company tick.

For someone like myself, that is more important than someone putting a Sell or Hold or Buy rating on the company and coming up with a price target or valuation.

What has helped me massively over the past 20 years that I’ve been doing this, and longer, is having access to such reports.

If I come across a company and I have no idea what it does, I can, obviously, download an annual report or something, but having access to broker research that goes through the whole company from A to Z and back — you don’t have to agree with everything–  it helps you understand what is important, this market, that product, etc, etc.

As I always like to say, Warren Buffett said you want to invest in a company that sooner or later can be run by an idiot.

But you have to understand it, to identify that particular company.

James: Normally, we ask people what they think are investors getting wrong about the market. Which company do you think investors are underestimating the most in the market right now?

Rudi: That’s an easy one: NextDC. Recently I had, again, a long conversation with investors, and I can’t get around the impression that people really can’t get their head around how the data centres sector actually works, and why the world needs companies like NextDC.

Maybe this is something I underestimated over the past decade, that I was quite lucky to have access to industry reports, to broker reports that explain how the industry works, why we need NextDC, why there is a mega trend, and all of that.

I’ve noticed that, clearly, for a whole bunch of other people, it’s very difficult to get their head around.

Not making it any easier: this is a company that doesn’t make a profit.

James: Rudi, last question, it’s been about 15 months or so, maybe a little longer, since you were last on the Rules of Investing. You were asked by Ally if you could only own one stock for the next five years, what would it be?

You’re a bit cheeky. You picked three stocks. Those stocks were Goodman Group, NextDC and CSL. Are you happy to stick with those stocks for the remaining three and a half years? Did you want to substitute one instead?

Rudi: No. If you’d want to substitute one, it would probably be CSL, simply because of the risk factor.

But I still believe that CSL is a quality company. It’ll get things right as far as what they can control.

Actually, we now are making a circle to where we started this conversation today.

People have to stop looking at Goodman Group as a property developer. They have to stop looking at NextDC as a capital-intensive business.

What they do have to understand is that we are most likely revisiting the 1920s and in the 1920s, at the beginning of the wave upwards, at the beginning of societal change, at the beginning of the mega trend, the last thing you worry about is that you can overpay.

Because those share prices will be carried by the mega trend. It’s called a mega trend for a reason. CSL will use AI as well.

James: if you were to switch out of CSL, is it ResMed you’d pop in instead?

Rudi: I might pick ResMed, yes, for obvious reasons. ResMed, also in the portfolio, has –sort of– taken the mantle from CSL.

James: Rudi, talking of mega trends, that was a mega interview ahead of reporting season. Always great to catch up. I really appreciate your time and putting your hard hat on. Best of luck for August.

Rudi: Thank you. And don’t fight the last war!

James: Very good. Ladies and gentlemen, I hope you enjoyed that episode of the Rules of Investing. A special one with Rudi Filapek-Vandyck ahead of the August reporting season.

Remember, if you enjoyed that video or the podcast, make sure you subscribe to our channels on YouTube or on Apple and all the major podcasting platforms.

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