Lessons from reporting season

Investors should focus on improving conditions for retailers, the effects of cost-cutting programs and the capital management initiatives announced.

Summary: With the February reporting season virtually complete, we highlight three observations for the period: Some cost-reduction programs are driving visible improvements in earnings (while some are having mixed success), an improved outlook for retail stocks – with more consumer stocks reporting excellent results in the past week – and the various capital management initiatives announced.

Key take-out: While BHP and Rio Tinto drew most of the attention for announcing cost-out initiatives, a number of other companies have revealed how theirs have progressed since last year. This is important, because share prices seem to fully discount success of these programs early on. 

Key beneficiaries: General investors. Category: Economics and investment strategy

Reporting season, where companies report their earnings for the six months to December 2014, is now largely complete. 

Over this week and last we thought it worth highlighting our key observations as we work through many of these earnings releases, attend analyst briefings and speak with company management teams.

In last week’s edition we highlighted the emerging theme of improving outlooks for retailers (see Retail stocks rise again) based on a number of half-year reports in the sector.

This trend is very much continuing, with more retailers issuing positive updates since then. As well as taking a look at new results from consumer stocks, this week we focus on how companies’ strategies to reduce costs are progressing and the various capital management initiatives that have been announced.

Cost-reduction programs

2014 was peppered with companies announcing cost reduction initiatives across their businesses.

There is no doubt that improving the capital efficiency of a business is a good thing for shareholders. Some programs appear to have been highly successful, driving earnings growth and margin improvement.

However, with share prices discounting the full benefit of these initiatives on announcement (as opposed to delivery), it is certainly worth keeping an eye on how the programs are progressing. Below we take a look at a couple of examples.

Building and construction materials business Boral is undertaking a significant cost-restructuring program across much of its portfolio. The group lifted cost-out targets from $150 million to $188m. Of this amount, $130m was already achieved in FY14.  It is important to put these cost-out initiatives in context, given in FY14 the group delivered pre-tax profit of $210m, which is only $80m greater than the cost reductions Boral claimed to have achieved in that year. Clearly, some of the cost-out story is being absorbed by inflationary pressures elsewhere in the business.

The Australian-listed packaging company Orora has previously announced a $93m cost-out program. In an industry where top-line revenue growth or industry consolidation opportunities are limited this is a key reason for anyone to own the stock.

The major component is the cost out program is a $50m cost-saving target related to a new recycled paper mill in Botany, NSW. The plant was finished in 2013 and so far has delivered cost savings of $14.2m. Management remain confident of delivering a cumulative $20m in 2015 with the balance to be delivered over the next two to three years. Time will tell.

BHP and Rio Tinto have each announced meaningful cost rationalisation initiatives. While both appear to be delivering, clearly what are driving earnings for both of these businesses are commodity prices, which haven’t been moving in favour of either company.

Cost-out initiatives, particularly when they are large, always beg a few questions to be asked.

  1. Are they so big that they constrain the company’s ability to generate revenue?
  2. Will the cost reduction hit the bottom line or are they offsetting inflation within the broader business?
  3. Are they actually going to be achieved?

Success and failure of these programs should be tracked over time, particularly considering share prices seem to fully discount success early on.

More retailers report positive trading updates

While there may be some debate about the impacts interest rates, petrol prices and asset values should have on the consumer, consumer-related businesses have clearly been seeing some benefit.

While first-half FY15 results showed signs of improvement, one clear observation from reporting season is that trading updates for January and February were universally positive. 

This is interesting to us as consumer and retail stocks are offering undemanding valuations, decent dividend yields and the prospect of above average earnings-per-share (EPS) growth in the coming years.

This theme continued to emerge this week with the following consumer companies releasing first-half results:

  • Harvey Norman (HVN). The company reported Australian revenue and like-for-like sales growth of 2.8 per cent. January trading in Australia saw 8.8% increase in sales on a comparable basis.
  • Fantastic Holdings (FAN). It saw revenue growth, and like-for-like sales growth of 8.7 per cent. LFL sales were up 9.2 per cent to February 8 so far in 2015.
  • Specialty Fashion Group (SFH). The clothing retailer delivered like-for-like sales growth (excluding the recently acquired Rivers) of 5.7 per cent. See Specialty Fashion drowning in Rivers for our take on the stock.

As we discussed last week, stocks exposed to this theme that appear to screen favourably to us include Dick Smith (DSH), Sky City (SKC), Crown (CWN) and on any pull back Beacon Lighting (BLX).

Capital management initiatives

Capital management is once again a meaningful theme of the interim reporting season. We outline a number of initiatives below:

  • Nine Entertainment (NEC): A $150m on-market buy-back
  • Amcor (AMC): $500m share buy-back
  • Genworth Mortgage Insurance Australia (GMA): Second-half dividend of 13.1 cents for 2014 as well as a special dividend of 11.5 cents.
  • Fantastic Holdings (FAN): A 6 cents dividend and a 4 cents special dividend.
  • Platinum Asset Management (PTM): A 17 cents dividend plus 10 cents special dividend.
  • Cover-More (CVO): A 3.2 cents dividend plus a special dividend of 1.8 cents.
  • Fairfax Media (FXJ): An on-market buyback of up to 121m shares over the next 12 months.