Market to feast on every crumb in reporting season
Since last earnings season, the All Ordinaries Index has climbed 15 per cent. Back then, sentiment was grim, with most analysts sharpening their pencils to downgrade earnings. Companies only needed to hit guidance to trigger relief rallies in their share prices. Within the space of six months, expectations have become grander and companies will need to beat estimates and the outlook commentary will have to have a silver lining. Companies that miss their numbers could be punished.
Since Christmas a string of companies have announced strong earnings revisions prior to reporting their numbers. These include retailer Specialty Fashion, car dealer AP Eagers, engineering outfit E&A Limited, and debt collector Collection House. All have had strong share price performance before and after the updates.
E&L Ltd
WE WROTE about E&L in November when it announced its September quarter update. The stock had become friendless, but rising earnings together with a hefty dividend yield got some people excited. At the time the company was trading around 32¢. If you annualised the first-quarter net profit of $1.6 million, the company was trading on a modest price to earnings (PE) ratio of 5.6 times and a dividend yield of about 12 per cent. At the time we said the stock had the ability to jump to 45¢. E&L's share price has eclipsed that target and now trades at 54¢.
Last week, the company announced its second quarter was an improvement on the first-quarter net profit of $1.6 million. If we assume E&L can deliver a net profit of $2 million for the second quarter, then it is on track to hit a full-year profit of $7.2 million, placing it on a PE ratio of eight times and a dividend yield of 8 per cent.
If the commentary at the half-year result next week confirms the earnings momentum, it is feasible the stock can trade 20 per cent higher to 65¢ a share as its dividend payment gets closer.
Devine Ltd
THE Queensland-based property group has been charging higher in recent weeks. There have been reports that the south-east Queensland housing market has started to pick up after a four-year lull. Devine's shares have gained a remarkable 60 per cent since early November. Despite this spurt, Devine continues to trade at less than half its asset backing of just shy of $2 a share. Given the high debt levels and the prospects of a capital raising, it is unlikely the stock can trade at asset backing. But the share price should climb if the property market continues to improve.
In November, the company delivered a disappointing net-profit forecast of just $10 million for the 2013 financial year. Shareholders will be hoping chief executive David Keir will indicate that interest rate cuts are having an effect and the outlook is improving. Such comments would propel the share price towards $1.40. Sombre commentary would be a setback for the rallying stock.
Sydney Airport
A DECISION by the Tax Office to release a position paper questioning the tax deductibility of the airport's redeemable preference shares has led to a fall in the stock from $3.61 at Christmas to $3.04 on January 18. Since then the shares have recovered to be trading around $3.15. Sydney Airport, riding on a strong yield, had been a star performer until December, outperforming the ASX/S&P 200 Index by about 25 per cent in 2012.
The lion's share of the selling since Christmas has come from offshore investors who are concerned the bigger tax bill will result in a reduced distribution - currently around 7 per cent.
The Tax Office has only targeted $900 million of a possible $3.1 billion RPS and there are fears the view will extend to the whole amount, further reducing the after-tax income. While foreign investors are upset, the extra tax paid would increase franking levels, inducing local shareholders onto the register.
If the ATO wins the day, the company always has the ability to restructure its capital.
The Age takes no responsibility for stock tips.
matthewjkidman@gmail.com
Frequently Asked Questions about this Article…
Reporting season is when companies publish their earnings and outlooks, and it's a fertile time for trading because stocks that beat consensus forecasts and give upbeat outlooks often outperform in the short term, while companies that miss numbers or give negative guidance can be punished by the market.
Share prices react strongly to earnings surprises and management commentary: beating estimates and providing a positive outlook tends to trigger relief rallies, whereas missing forecasts or casting doubt on future earnings usually leads to underperformance — expectations are higher now than six months ago, so companies often need to exceed estimates and offer a silver lining to avoid a sell-off.
The article highlights Specialty Fashion, AP Eagers (car dealer), E&A Limited (E&L) and Collection House as examples of companies that issued strong earnings revisions before reporting. Investors should notice pre-reporting upgrades because these revisions often boost share-price performance both before and after the results are released.
E&L Ltd moved from around 32¢ to 54¢ after rising earnings and an attractive dividend yield drew attention. The article notes an annualised first-quarter net profit of $1.6m implied a PE of about 5.6 and a ~12% dividend yield; with a stronger second quarter (assumed $2m), E&L could be on track for a $7.2m full-year profit (PE ~8 and ~8% dividend yield). If the half-year commentary confirms momentum, the stock could potentially trade higher as the dividend payment approaches.
Investors should look for management commentary from CEO David Keir on whether interest-rate cuts are stimulating the southeast Queensland housing market — positive comments could push the share price higher toward about $1.40. Key risks include Devine's high debt levels, a disappointing $10m net-profit forecast for the 2013 financial year, and the possibility of a capital raising, which could limit how high the stock can climb despite recent gains.
Sydney Airport's shares fell after the Tax Office released a position paper questioning the tax deductibility of the airport's redeemable preference shares (RPS). The ATO has targeted about $900m of a possible $3.1b RPS, creating fears of a reduced distribution (around a 7% yield previously). If the ATO's view is applied more broadly it could lower after-tax income, prompting offshore selling, though higher tax payments could increase franking levels and attract local investors; the company could also restructure its capital if needed.
PE ratios and dividend yields are useful screening tools: low PE and high dividend yield can indicate a value or income opportunity (as seen with E&L's earlier metrics), but investors should check sustainability — watch earnings momentum, management commentary, balance-sheet risks like high debt, and any tax or capital structure issues that could affect future payouts.
During reporting season, focus on companies that beat consensus and give positive outlooks, but be cautious of elevated expectations — stocks that miss can be punished. Monitor pre-reporting earnings revisions, read management commentary for guidance on future momentum, watch balance-sheet items (debt, potential capital raisings) and tax issues that can affect dividends, and remember to balance short-term trading with a view on fundamental sustainability.
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