PORTFOLIO POINT: The number of earnings downgrades exceeded upgrades by almost three to one in August. Brokers have cut back their earnings forecasts for 2013.
The August reporting season has sent a clear signal investors of more tough times ahead, with an avalanche of corporate profit downgrades for FY 2013 having now ripped through the Australian market.
Numbers tallied at the end of August show FY 2012 earnings growth was (-2%), with FY 2013 earnings estimates having been downgraded by 2% to around 8%.
According to UBS, the earnings backdrop for Australian companies still looks tough on most fronts. “The A$ is still high, commodity prices have come down while resource sector costs are up, credit growth is subdued, housing is weak and capital markets are also subdued,” the broker says. “On the positive side, retail is showing some tentative improvement, as is credit growth, and capex is still strong, albeit momentum is clearly peaking. Cost side efficiencies are also starting to come through after a slow start.”
UBS says that while FY13 downgrades have clearly outnumbered upgrades, share price reactions were evenly distributed, with 25% positive versus 25% negative and 50% neutral – indicating expectations coming into results season were quite subdued. The overall market returned 3% through the month.
Throughout the wider market a note of confidence is returning to many traditional industrial and health care stocks: Sentiment is solid among REITs, Banking stocks are praised for their dividends and core strength though there are concerns our ‘big four’ are simply too big but miners, particularly single commodity miners in the iron ore and coal sector are facing particular difficulty.
Says UBS: “A key trend so far has been the tendency of a number of previously underperforming/value stocks to jump on better-than-feared results. While this is not uncommon in reporting season, we think the extent of this trend is noteworthy given where valuations of many stocks have been driven to over the last six to 12 months. (e.g. Downer, Bradken, Primary Health Care, Australand, Goodman Fielder, Aristocrat Leisure, The Reject Shop). The performance of quality/premium stocks has also been reasonably positive with a number of quality/premium stocks delivering strong results that were well received by the market. (e.g. Resmed, Seek Limited, Carsales.com, Computershare, Ansell and Flexigroup. Wesfarmers, QR National).
Major bank estimates during reporting season were generally upgraded by stockbrokers.
In a report, Credit Suisse said it sees earnings quality as becoming a growing theme as earnings are increasingly supported by declining loan loss provisions (suppressing bad debt charges), rising capitalised expenditure balances and more aggressive use of significant item restructuring charges.
UBS says: “We expect major bank average EPS growth of 2% FY12E, 4% FY13E and 7% FY14E; Revenue growth of 4-5% (lending balance growth of 5% FY12E rising to 8% in outer years
Bad debt charges relatively stable (0.29% FY11, 0.31% FY12E, 0.30% FY13E, 0.28% FY14E); Equity Tier 1 ratios rising from 7.96% FY11 to 8.76% FY14E; ROE moderating from 16.9% FY11 to 15.7% FY14E.”
Winners and Losers
There were winners and losers across all sectors. Winners included pharmaceuticals group (CSL), beverages giant Coca-Cola Amatil (CCL), and manufacturer Breville Group (BGR), however questions have been raised around future earnings upside.
Among the best results of the season were Monadelphous, NRW Holdings (NWH), Skilled Engineering (SKE), QR National (QRN), Ausenco (AAX) and WDS (WDS).
Among the worst results were Fairfax Media (FXJ), Alumina Ltd (AWC), APN News & Media (APN), David Jones (DJS) and St Barbara (SBM). Separately, utility services provider UGL (UGL), gambling stocks Tabcorp (TAH), Echo Entertainment (EGP), building services material manufacturer Boral (BLD), supermarket group Woolworths (WOW) property giant Stockland (SGP) and Telstra (TLS) also disappointed.