All eyes on resources sector in run-up to profit season
With the half-year profit reporting season starting in earnest next week, the usual "confession" period - where companies reveal if they are expecting a fall or an increase in profits - has been benign for local stocks, with few negative surprises.
With the tough global economic conditions of the past six months, analysts say they are simply looking for companies to meet profit expectations.
But they also say investors' expectations have become more conservative, given their experience of the past two years where each year began with expectations of 10 per cent underlying profit growth but ended with expectations of no growth.
This could work in companies' favour this season, particularly if they report better-than-expected profits.
"Similar to the US, what we're looking for is for companies to meet expectations so that the market will be happy," the UBS investment analyst Abby Macnish said. "Obviously there's always going to be some misses but at the moment it's looking quite benign.
"A lot of these companies have really solid balance sheets, they don't need to go to market, so there won't be too many surprises there. We just need them to really consolidate those earnings and start planning for the next few years' growth."
But fund managers have singled out the resources sector as one area of the economy that could still surprise with profit downgrades.
Australia is one of the few advanced economies that has not engaged in unconventional monetary policy. As a result, capital has continued to flow into the Australian dollar, which has prevented miners from getting cost relief, they say.
"On the mining side we're a bit more concerned," the Watermark Funds Management director Justin Braitling said.
"Production numbers have been OK - we've seen that from the iron ore companies - but we're concerned that costs continue to move higher and that there's not been any currency relief even though commodity prices have fallen," he said.
Mr Braitling also said the outlook for industrial companies remained cloudy, but conditions seemed to have stabilised in the past six months.
The currency had been stable for 12 months and the domestic economy had not deteriorated further, with lower interest rates providing some support, he said.
"So the downgrade cycle [for industrial companies] looks to be abating, as those headwinds haven't got any worse. In the last quarter we haven't seen the sort of downgrades we've been seeing over the last couple of years and that's good news for the markets," he said.
"As a consequence, analysts' expectations are set at conservative levels so we would expect the results to be OK."
Frequently Asked Questions about this Article…
Analysts expect the half‑year profit reporting season to be relatively benign, with fewer negative surprises than in past years. Given tough global conditions, investors and analysts are largely looking for companies to meet profit expectations rather than deliver big beats, and the usual "confession" period has been quiet so far.
Fund managers have singled out the resources sector as a potential source of profit downgrades because, although production numbers (for example from iron ore companies) have been acceptable, costs continue to rise and miners haven’t received currency relief. Those cost pressures could squeeze profit margins even if commodity prices fall.
The article notes that capital inflows have kept the Australian dollar relatively strong, meaning miners haven’t benefited from currency relief. That stronger currency can offset any cost advantages from lower commodity prices, keeping costs elevated for local resource companies.
Overall, analysts are not expecting widespread downgrades. Expectations have become more conservative after recent years of downward revisions, so the market is primarily looking for companies to meet those lower expectations. However, pockets of risk remain—particularly in the resources sector.
Abby Macnish said investors should look for companies to meet expectations so the market remains happy. She suggested the reporting season looks quite benign and that while some misses are inevitable, meeting expectations is the main short‑term goal.
Justin Braitling noted that production numbers have been OK—especially for iron ore companies—but he is concerned that costs continue to move higher and that there has not been any currency relief even as commodity prices have fallen. That dynamic increases the risk to resource sector profits.
The outlook for industrial companies was described as still cloudy but stabilised over the past six months. With the currency stable and lower interest rates providing some support, the downgrade cycle for industrial companies appears to be abating, which is seen as positive for markets.
Everyday investors can focus on a few practical signals highlighted in the article: monitor company profit guidance and whether firms meet conservative analyst expectations; watch resource companies closely for cost pressures and currency exposure; and favour companies with solid balance sheets (less need to raise capital). These factors can help you gauge downside risk and where surprises are most likely.
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