Reporting Season Commentary
One of the major effects in this reporting season has been the Central bank activity over the years through QE and its effect upon interest rates. Low-interest rates are one of the reasons for investors to buy equities but, rates have also affected how companies are performing. Banks and AREITS are taking advantage of the low-interest rates at present.
Market commentators are calling our current rally the “TINA” rally because it describes investors who think that “There Is No Alternative” to the stable, high PE stocks that are seen to be safe havens in this low-interest rate environment. However, many of them are expensive and unlikely to perform and investors need to look for value.
This reporting season we saw the ASX down 1.6% after dividends as well as concerns over a US rate rise. The expectations were for reasonable to low results but still 36% of companies missed the consensus EPS numbers. Only 28% managed to beat EPS consensus expectations. The stand-out performers were Amcor, Blue Scope, Computershare, EDI Downer and JB-HiFi whilst Estia, Newcrest, Origin and CSL missed their marks. Many of the low PE stocks outperformed the higher PE so-called ‘blue-chip’ stocks indicating that investors are looking outside of the Top 50 for value and yield.
Another feature of the recent reporting season is the lack of guidance on future earnings. Only 19% of companies provided an outlook statement which, to me, implies some caution regarding the economy and the companies’ abilities to perform in it. Interestingly, companies that announced a buy-back saw their share prices’ slump.
Many companies announced buy-backs, presumably because there was no value to be found in mergers or acquisitions. The companies undertaking buy-backs include: Ansell, Caltex, Computershare,CSL, IAG,James Hardie, Qantas, Rio and Telstra.
The Banks reported in-line with expectations in general but the insurance stocks were disappointing due to low-interest rates, policy lapses and higher claims. The Building Materials stocks posted strong results and I expect that they will continue to perform well with the focus of infrastructure development. However, to be a successful investor now, you cannot simply select any stock, you have to look at each company to ascertain if there is value and at what risk; a classic ‘stock picker’ market!
The major retailers, Woolworths and Wesfarmers have seen their margins fall and are restructuring their businesses in order to focus on growth opportunities. They are exiting poorly performing assets and reigning in debt. The result is a fall in dividends as evidenced in Flight Centre. JB Hi-Fi has benefitted from the closure of Dick Smith stores to become the premier electronics ‘bricks and mortar’ retailer but online store Kogan (with the Dick Smith label) will start to impact sales.
In the Resources space, commodity price weakness and cost reduction were the features of the period. Many of the miners saw their profits negatively impacted by impairment charges. However, cash flows (largely from increased production) improved and allowed them to repair their balance sheets. BHP and RIO are notable examples. A positive spin-off to higher production was a rising demand for mining services. They generated higher cash flows and posted good results.
The outlook for the short-to-medium term will depend largely on the Central Banks and interest rate policy.
Various initiatives, such as Quantitative Easing, were introduced to deal with the GFC and created central banks with sizeable balance sheets which drove long-term yields down. As a result, the financial system now has an elevated exposure to government bond yield risk. Reversing the monetary policies could result in greater uncertainty in the markets. Investors will need to be wary of bond proxy investments such as AREITs, Infrastructure companies and Hybrids which will react sharply to changes in interest rate and conditions in the bond market. Companies must reduce their debt profile and ensure that they can manage it in this low-growth environment.
Domestic cyclicals offer some value as they return to favour and Building Materials companies Boral (BLD) and James Hardie (JXH) are candidates. The banks also offer some value even after considering bad and doubtful debts and increasing capital requirements. However, they do need to focus on cost reduction and many analysts favour ANZ an NAB because they are selling off non-core assets and reducing costs. However, my focus is on debt and CET1 ratios. Banks are having to provide higher levels of capital to ensure liquidity in the case of a credit crunch so I prefer the banks that are lowering their payout ratios and have a higher CET1 ration. Hence I prefer CBA despite it being more expensive than the other majors.
As I mentioned earlier, the property trusts (A-REITs) are performing well in a long-term low- interest rate environment. They have borrowed to build or buy assets. But now they are positioning for a change and we have seen floats being offered. Crown is proposing to spin-off most of its Australian hotels. There have also been asset sales from Mirvac and Stockland. These managers are to be applauded because they will have good quality assets and low debt when interest rates start to move upward. Exercise caution with new AREITS, avoid those that contain underperforming assets and high debt
QBE and IAG will continue to operate in highly competitive markets bearing the brunt of pricing pressure. Their investment portfolios will only provide modest returns so there is not much value to be found in the general insurance patch.
The Telco giants (Telstra TPG and Vocus) appear to be consolidating their businesses as growth slows.
This reporting season saw many of the large caps stocks underperform and their valuations remain stretched. Therefore, fund managers and private investors are looking elsewhere for both yield and growth. The key to future dividends is consistent or growing cash flows so banks will return to favour.
If you need help contact Gail Gadd who will be able to review you portfolio so that delivers the returns you are looking for.