Hits and misses: An ASX form guide

PORTFOLIO POINT: Which companies will surprise on the upside and downside. We canvass the experts.

If you know bad news is coming, how do you react when it finally arrives? Could it be that the anticipation is the worst part, and that we respond with relief instead of more sadness once the bad news we were expecting announces itself?

While the Australian sharemarket remains mired by international, macro-economic and sovereign uncertainties, there seems to be a near-universal agreement the upcoming local reporting season will turn into a slaughter-fest.

The list of culprits behind these cuts is long, but well-known, ranging from wet weather and natural disasters to a strong currency, dismal consumer spending, lack of any political leadership in Canberra, to the pending introduction of the carbon tax, a moribund housing market, disappointing growth in developed economies, accelerating labour costs, delayed business spending and sovereign debt uncertainties '¦

Making matters worse than the previous reporting season is that economic circumstances overall have deteriorated considerably since then, with the domestic economy slowing noticeably in the June quarter.

But it's not as though investors didn't see any of the above coming. Which is why not everyone is convinced that the August reporting season, which begins in earnest next week, is poised to push the Australian sharemarket to lower levels.

Over the past few weeks analysts, strategists and quant experts have been busy trying to line up names they believe are likely to disappoint (most companies) while trying to pick the few companies that remain poised to surprise to the upside. Below is an overview of that research that you may like to consider over the weekend.

Investors should keep in mind that no matter how much research is done, there is no such thing as a watertight conclusion. The fact that both David Jones (DJS) and Premier Investments (PMV) had been lined up as "looking pretty safe" prior to their respective profit warnings might serve as a reminder within this context. As everyone seems convinced the upcoming reporting season will be a bleak experience in Australia, with downgrades anticipated to significantly outnumber upgrades, I have only focused on the more extreme expectations, and more specifically on those candidates believed to have upside surprise potential.

Goldman Sachs is of the view that only a relatively small group of companies has the potential to deliver results that might clearly beat market expectations. Its list of potential candidates includes Aditya Birla (ABY), ARB Holdings (ARP), Austbrokers (AUB), Challenger Diversified Property Group (CDI), Charter Hall (CHC), Domino's Pizzas (DMP), Flexigroup (FXL), Graincorp (GNC), Iress (IRE), Kathmandu (KMD), Sedgman (SDM) and Sigma Pharmaceuticals (SIP).

Over at Citi, the team of quant analysts has once again relied on their in-house developed model, which this year has been tweaked further, even though their reliability and accuracy in the past has been pretty high. Citi's quant team selection of companies likely to surprise to the upside this season includes Navitas (NVT), Telstra (TLS), Ansell (ANN), Brambles (BXB), Charter Hall Office (CQO), Carsales.com (CRZ), Mermaid Marine (MRM), Flight Centre (FLT), Monadelphous (MND), Ausdrill (ASL) and NRW Holdings (NWH).

Investors should note the Citi model throws up more likely surprises from the major banks, BHP Billiton (BHP), lots of property developers and trusts, gaming stocks as well as Fleetwood (FWD), Woolworths (WOW), Lend Lease (LLC) and others, but the above-mentioned names come with a higher probability (according to the model).

Quant colleagues at RBS have done a similar exercise, but they only came up with a few upside surprise candidates: Sims Group (SGM), CSR (CSR), Aristocrat (ALL), Coca-Cola Amatil (CCL) and Carsales.com (CRZ). Similar to other surveys, RBS quant predicts there will be many more disappointments than positive surprises.

Market strategists at Citi agree. Their selection of stocks likely to surprise only includes AGL Energy (AGK), Ansell (ANN) and "some office REITs". Probably not unimportant, Citi strategists also point out that while resources stocks are also expected to suffer from downgrades this season, the overall risks for the sector remain "modest" overall. Most resources companies are believed to suffer from the strong Australian dollar, ongoing impacts from wet weather disruptions earlier in the year and from rising labour and operational costs.

All this means the list of stocks likely to miss forecasts and to suffer from downgrades will be a very long one this season. Most at risk, suggest Citi strategists, are the more cyclical industrial stocks for which significant earning recoveries continue to be expected. Think Boral (BLD), James Hardie (JHX), Aristocrat (ALL), Fairfax (FXJ), Harvey Norman (HVN), Billabong (BBG) and many others.

Goldman Sachs' list for potential disappointers contains many similar names, plus companies such as Asciano (AIO), Downer EDI (DOW), Foster's (FGL), Primary Health Care (PRY), Toll Holdings (TOL) and Wesfarmers (WES).

Quant analysts at RBS focused on other parts of the market and ended up selecting CSL (CSL), Southern Cross Media (SXL), CommBank (CBA), Cochlear (COH) and Kingsgate Consolidated (KCN) as companies that can potentially disappoint.

Citi's quant model throws up many more candidates, but the following (extensive list) comes with the tag "very negative", indicating the quant model believes chances are very much in favour of disappointment this season: Seven West Media (SVW), Leighton Holdings (LEI), Primary Health Care (PRY), ASX (ASX), Downer EDI (DOW), Gunns (GNS), The Reject Shop (TRS), Billabong (BBG), Coalspur Mines (CPL), DUET Group (DUE), BlueScope Steel (BSL), Charter Hall (CHC), Foster's (FGL), Kagara (KZL), Origin Energy (ORG), Western Areas (WSA), Asciano (AIO), AWE (AWE), Pacific Brands (PBG), Qantas (QAN), Suncorp (SUN), Abacus Property Group (ABP), Insurance Australia Group (IAG), Toll Holdings (TOL), Transpacific Industries (TPI), Virgin Blue Holdings (VBA), Cabcharge (CAB) and Panoramic Resources (PAN).

As said earlier, facing downgrades to earnings forecasts is not the only factor that will impact on investment returns for the year ahead. The severity of these cuts will be equally important, as well as the low/high valuation that is currently priced in.

Taking a leaf from the same book, market strategists at UBS recently took a different approach. They tried to take into account what is coming then determine which stocks are likely undervalued and which ones overvalued. The first group (undervalued) contains names such as Santos (STO), Billabong (BBG), Perpetual (PPT), Boart Longyear (BLY), JB H-Fi (JBH), Sims Group (SGM), Woodside Petroleum (WPL), ASX (ASX), Boral (BLD), OZ Minerals (OZL), Stockland (SGP), Incitec Pivot (IPL), Oil Search (OSH), BHP Billiton (BHP), Wesfarmers (WES), Bendigo & Adelaide Bank (BEN), Lend Lease (LLC), Westpac (WBC) and Cochlear (COH).

On the other side (overvalued), we find names including Foster's (FGL), ResMed (RMD), Ansell (ANN), Downer EDI (DOW), Transfield Services (TSE), Newcrest Mining (NCM), Goodman Fielder (GFF), News Corp (NWS), AMP (AMP), Qantas (QAN), AGL Energy (AGK), QBE Insurance (QBE) and Primary Health Care (PRY).

All will be revealed over the next few weeks.

Rudi Filapek-Vandyck is editor of FN Arena, an online news and analysis service.