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Cloudy, with a chance of profit

Higher dividends and more share buybacks suggest the market environment is not as dire as some chief executives would have you believe though it is still not ideal, writes David Potts.

Higher dividends and more share buybacks suggest the market environment is not as dire as some chief executives would have you believe though it is still not ideal, writes David Potts.

In case you hadn't heard, this year will be challenging. Just about every captain of industry says so, after all.

Well, that should give them something to do. But if only they had set themselves the challenge of not saying "challenging" and been more forthcoming, shareholders would have a better idea from the profit-reporting season of how their company is faring.

I never thought I'd say this but I miss their being "cautiously optimistic", non sequitur that it was. Worse, one of the best results was from, wouldn't you know, Challenger. Sigh.

Still, as far as I can tell, challenging is only one degree below cautiously optimistic. And judging by the way the market has savaged stocks where the chief executive didn't comment on the outlook, it was better than nothing.

Billabong, for example, suffered a 26 per cent wipe-out in one day and has more or less been on a downward spiral since, not that its drop in profit was any help. Yet if CEOs were really challenged, they wouldn't be lifting dividends or embarking on share buybacks, both features of the latest reporting season.

In fact, analysts are predicting earnings-a-share will grow faster this financial year than in 2010-11. That's right. For all the financial gloom and market volatility, they're saying things will get better, not worse. But then, they can always lower their estimates and probably will.

Although profits of the top 200 might have soared 32 per cent, take out BHP Billiton and they were up just 9.3 per cent, according to the chief economist at CommSec, Craig James.

Then again, as he points out, take out two of the worst performers, BlueScope Steel and Leighton, and profits would have been up 17.3 per cent.

"Where do you stop in that process?" he asks.

Perhaps it's better to start with BHP Billiton, indisputably a stunning result. Its profit jumped more than 80 per cent to just over $22 billion. Despite having another $12 billion of cash to play around with, it proved the exception to the rule of cashed-up companies in not buying back some of its shares, though it did last year.

Yes, it had challenges, too, but at least "we remain positive on the longer-term outlook for the global economy", BHP told the market.

The wonder is its share price, hovering under $40, is well off its peak despite the greatest mineral boom Australia has ever known.

It is trading at just 10 times its earnings, which is about 40 per cent below its norm of the past 10 years.

And did I mention the record profit, dividend, and fewer shares on issue?

"I don't normally advocate buying a stock and holding it forever but this could be one to save for the grandchild," the CEO of Lincoln Indicators, Elio d'Amato, says.

As the biggest profit earner it sure must be glad it shed the worst loss maker, BlueScope Steel, a decade ago.

While its result shows how the mining sector is rocketing along, anything that depends on household spending is doing it tough.

A worry of the reporting season is that there were more "negative surprises", as analysts call them, than positive ones, though it's close with the ratio at about 55 per cent to 45 per cent.

"Positive and negative outlook statements have been roughly matched, which is well down from the last four reporting seasons, which have seen more positive than negative outlooks," the head of investment strategy and chief economist at AMP Capital Investors, Shane Oliver, says.

While overall profit growth has been about 10 per cent, he says analysts' expectations of 13 per cent growth this year are "too high".

Not that this has stopped them slashing their forecasts for the sharemarket index by the end of the year by about 500 points, with the consensus seeming to be an ASX200 at about 4500.

"With a lower-growth scenario we could see some pull-back. It'll weigh on share prices," the chief market strategist for CMC Markets, Michael McCarthy, says.

CMC predicts the market will "range trade"

at about 4500 for the next year. It was 4243

on Friday.

In any case, bit by bit analysts have been revising down their forecasts of earnings a share for 2011-12. The trouble is, they look at specific companies and so can miss the big picture, as the GFC showed.

That big picture, unfortunately, isn't looking so good for profits.

A good indicator is the banks. The only one to report was the Commonwealth, which suggested slowing growth and, incidentally, was exceptionally generous with its dividend.

Thanks to the fact that their share prices have been marked down, bank stocks bought today are returning almost double digits from dividends alone after the 30 per cent tax credit from franking.

You can just about hang your hat on this since the banks are especially loath to cut a dividend. The CBA wouldn't be lifting its this year, and the others are bound to follow suit, if it thought there was even the slightest possibility of that.

But don't forget the banks were the first to say things are challenging. While you could hardly call it suffering, they're victims of the slow growth in mortgages and other credit as the nation saves more.

That would seem to rule out any gains in their share price for some time so the dividends might be all you get.

By the way, among the other big dividend payers, or rather those offering huge income yields partly because their prices are depressed, the standouts are GUD, GWA, Perpetual, Seven West Media and Telstra.

Australia's uncharacteristic urge to save is also hitting retailers, builders and building suppliers.

"The outlook is for more of the same," the chief investment officer of Clime Investment Management, John Abernethy, says.

"Consumer sentiment is poor, there's a high savings ratio and the Reserve Bank is on the sidelines. There's nothing to change it," he says.

And we all know retailers are suffering because they keep telling us. Or are they? Some of the niche ones produced extraordinary results.

Net profit of the Super Retail Group, which owns the Super Cheap Auto Group warehouses, jumped 46 per cent. It also lifted its dividend for the year by 35 per cent.

Another was the owner of the Athlete's Foot chain, RCG, which recorded a 30 per cent rise in what's supposed to be a retail recession.

Then there was ARB Corporation, which makes and sells accessories for four-wheel-drives, lifting profit by 16 per cent.

But among the retail giants, d'Amato says Wesfarmers is the pick, though not because it owns Coles.

"It has the more exciting future outlook, especially its coal assets. There's merger and acquisition in the coal sector. Wesfarmers is probably worth more as two separate identities," he says.

Not that Woolworths can be written off. Although it's a "shocker" in the table, that's because its result was lower than expected. The profit climbed 5 per cent, its lowest in years.

Oh, and it could be a bit worse this year as it builds its Masters hardware stores to take on Wesfarmers' Bunnings.

The health sector did well despite the stronger dollar, even though the bigger companies have offshore earnings.

That the standouts were Cochlear and CSL is hardly a surprise.

Speaking of surprises, even Telstra delivered in its own way. For once, its result was a bit better than it had promised.

Never mind that the profit fell.

"There's a mismatch there," d'Amato says. "Its earnings per share are 26 cents but the dividend is 28 cents so it must be dipping in its reserves."

Anyway, for the most part it was a better-than-average reporting season for shareholders.

All that was missing were more reassuring comments about the future but then that's forecasting, which you need to take with a pinch of salt.

Two-thirds of those reporting full-year results had higher profits.

So where to from here?

"Everybody looks at the outlook statements but when the dust settles is when savvy investors can pick up a bargain," d'Amato says.

A starting point might be companies that are buying back some of their own shares.

This is a barely disguised tax rort for shareholders because the price is mostly comprised of franking credits with their 30 per cent tax break.

And if you don't sell your shares you come out ahead as well. Probably even better over time because there are fewer shares for the profits and dividends to be spread around.

Notable buybacks announced or planned for included Amcor, Ansell, Crown, Dexus, Foster's, GPT, Hills Holdings, Investa Office Fund, iiNet, Mirvac, News Corporation, OZ Minerals, Pacific Brands, Perpetual and Stockland.

Stunners

ARB Corporation

Atlas Iron

BHP Billiton

Blackmores

Challenger

Domino's Pizza

Fortescue Metals

Miclyn Express Offshore

Newcrest

Rio Tinto (half year)

Shockers

Aristocrat

BlueScope Steel

Goodman Fielder

Hills Industries

Leighton Holdings

Qantas

QBE

Transfield Services

Transpacific Industries

Woolworths

Deciphering the data

PROFIT reports have a lot of figures but finding the facts can be harder.

They'll tell you everything about the past year or six months but what you need is a feel for how the company is really going.

So where to start?

Don't say the profit (or loss, as the case may be) because that's a moveable feast, depending on whether it is before or after tax, for starters.

Take Billabong, for example. It wasn't until two-thirds of the way through the chief executive's summary that the tax breaks that boosted what analysts said was a poor result anyway were mentioned.

Even then, it was only in the context that this financial year would be tougher because the one-off tax breaks would disappear.

Billabong is not alone. Often there's a one-off tax break from an earlier writeoff or a special provision that won't happen again.

Either way, the reported net profit might have more to do with a tax adjustment than the business.

In Billabong's case, the tax bill was down 85 per cent, with the result that it paid a rate of just 7 per cent.

Certainly, you need to take out one-offs, such as an asset sale, revaluations or redundancy payments, to see the underlying profit.

Some companies go further and emphasise the pretax, pre-abnormals, pre-interest, pre-depreciation, pre-amortisation earnings, or EBITDA. That doesn't leave much.

It's so sanitised you might wonder what you're getting probably a company with big debts that spends a lot.

Still, earnings before interest (EBIT) usually features prominently in profit announcements because it shows how much cash the company is making, or at least would be, if it weren't for pesky interest payments on the debt.

That's why it's often called the operating profit, even though without the borrowings the company wouldn't be, well, operating. For their part, analysts head straight for the cash-flow statement because it shows how much came in, what was done with it and where the company finished up.

The aim is to have more money sloshing around in the company coffers at the end of the year than at the start, preferably from the business rather than asset sales and the like.

But even here are traps. Managers can manipulate working capital by slowing down payments to creditors or speeding up collections from debtors.

"They can only do it for one year, though," says John Abernethy, the chief investment officer of Clime Investment Management, which runs the top-performing Australian Value Fund. "That's why we watch it over two or three years.

"You want operating cash flow to be stronger than the reported after-tax profit."

Then there's the small print, known as the "notes to the report", which are at the back of the releases to the ASX and later in the annual report.

They were once just footnotes but nowadays are entire chapters.

In fact, notes to the report probably reveal most about the company.

Yet, perhaps the most telling figure for shareholders isn't even given, though it's not hard to get from the rest of the report.

That's the return on equity, calculated by taking the after-tax profit and dividing it by the shareholders' equity (also called net assets). Anything more than 15 per cent is a good result. Even better if it keeps rising.

BHP Billiton is close to 40 per cent but, then, that's what a commodity price boom can do for you.


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