GLOBAL growth remains in a malaise and large-cap companies are caught in its sludge. There is no quick fix. There's another week to prepare for our local reporting season, but the US quarterly reporting season is in full swing and gives us a little taste of what our impending six-monthly reporting season will be like.
At the end of last week, just 45 per cent of S&P 500 companies had reported sales above expectations, according to FactSet. This percentage is well below the average of the past four quarters (63 per cent) and is the lowest percentage of companies reporting sales above estimates at this stage of the earnings season since the first quarter of 2009. The blended sales growth rate was 0.7 per cent.
Printer and copier maker Xerox was a classic example. On Friday it revealed that its quarterly operating margin slipped a little as total revenue drifted down 1 per cent year-on-year. "Considering the economic uncertainty, Xerox now expects that revenue from its technology business will continue to be weak, and, as a result, revised its full-year earnings expectations," the earnings announcement conceded.
Even McDonald's felt the need to place the phrase "Economic Headwinds" in the heading for its quarterly profit announcement on Monday. The purveyor of fast food recorded zero growth in sales relative to the same three months in 2011, although it said if currencies had remained stable it would have achieved 5 per cent growth.
Overall, Australian companies are expected to generate marginally negative earnings per share growth for the 2012 financial year, although the aggregate market consensus may be recast in several ways.
If the materials and energy industries are excluded, 2.5 per cent EPS growth is factored in for the rest of the market. But if instead of looking at averages weighted by market capitalisation we looked at the median figures, only 1.5 per cent growth is on the cards for the "typical" non-resources company.
Insurers are key contributors to growth expectations and not because of underlying growth but due to a recovery from a horrendous 2011 in which earnings were decimated by natural disasters.
They are led by QBE Insurance Group, which reports its profits on a calendar year basis and is expected to announce a first-half profit of about $750 million, on the way to a full-year result of just over $1.5 billion compared with only $650 million in 2011. To illustrate the severity of 2011, for that year QBE's risk and catastrophe allowance was 15 per cent of its net earned premiums, while this year it is targeting 10-11 per cent.
The other key industry groups expected to deliver double-digit growth are "Capital Goods" (for that read the engineers and other mining services groups who have benefited from the unprecedented surge in mining investment in Australia) and "Consumer and Professional Services" (the cousins of the engineering sector, typically providing maintenance, installation and business-to-business services).
Growth is expected to be strongest for smaller stocks. The top third of companies by market capitalisation are expected to achieve 6.4 per cent growth, excluding resources stocks, while the middle third are thought to be on track for 7 per cent growth and the smallest third for double-digit growth.
Smaller companies have greater scope for growth in a macro environment where oligopolistic majors must "muddle through". Good small companies are busy penetrating markets, innovating or consolidating.
One of the first results this analyst will be anticipating is that of online travel agent Webjet, which should report on August 9 and is pencilled in by this analyst (who owns shares in Webjet) to achieve 20 per cent net profit growth.
At the big end of town, reporting season will kick off with medical device maker ResMed's results on August 3, followed by toll road operator Transurban Group, construction company Leighton Holdings and hearing-aid leader Cochlear on August 7. It is the Leighton result that will be of most relevance as a guide to the rest of reporting season, given the company's diverse exposure to mining services, non-residential construction and even telecommunications.
Despite the disclosure regime companies operate in these days, there is still scope for surprises.
Engineering group Engenco, which maintains rail wheel-sets and makes rail cars, among other engineering activities, for example, did not warn the market it would fall short of its promise of improved profits in the second half of the financial year until last Friday, 20 days after the June 30 balance date. As a result, it was the worst-performed member of the S&P/ASX Emerging Companies Index last week, diving 38 per cent.
Frequently Asked Questions about this Article…
What is the current global growth outlook and how is it affecting large-cap company earnings?
Global growth is described as being in a malaise, which is weighing on large-cap companies and making earnings progress patchy. The article notes there’s no quick fix and that many big companies are struggling to grow revenue or margins amid weak demand.
What did the recent US quarterly reporting season reveal about sales surprises and blended sales growth?
At the time of the article, just 45% of S&P 500 companies had reported sales above expectations (FactSet), well below the recent four-quarter average of 63% and the weakest start to a season since Q1 2009. The blended sales growth rate was about 0.7%.
How have companies like Xerox and McDonald's illustrated the impact of economic headwinds?
Xerox reported a 1% year‑on‑year fall in total revenue and a slight slip in operating margin, and revised full‑year earnings expectations for its technology business due to weak demand. McDonald’s used the phrase 'Economic Headwinds' in its profit announcement, reporting zero sales growth versus the same three months in 2011 (currency‑adjusted sales would have grown about 5%).
What are the earnings per share (EPS) growth expectations for Australian companies this financial year?
Overall Australian companies were expected to generate marginally negative EPS growth for the 2012 financial year. Excluding materials and energy, aggregate EPS growth of about 2.5% was factored in, while the median 'typical' non‑resources company was expected to see only about 1.5% growth.
Which industry groups and companies are expected to contribute to growth in the Australian market?
Insurers (recovering from the severe 2011 natural‑disaster losses), Capital Goods (engineering and mining services) and Consumer & Professional Services were expected to show stronger growth. QBE Insurance Group was highlighted as a key contributor—expected to report around $750 million first‑half profit and just over $1.5 billion for the full year versus $650 million in 2011.
Are smaller companies expected to outperform larger companies in the current environment?
Yes. Growth was forecast to be strongest among smaller stocks: the largest third (excluding resources) were expected to achieve about 6.4% growth, the middle third about 7%, and the smallest third were pencilled in for double‑digit growth. The article points out smaller firms often have more room to penetrate markets, innovate or consolidate.
Which company results should everyday investors watch early in the Australian reporting season?
Early results to watch included ResMed on August 3, followed by Transurban Group, Leighton Holdings and Cochlear on August 7. Leighton was singled out as especially relevant because of its diverse exposure to mining services, non‑residential construction and telecommunications. Webjet was also noted with its result due August 9 and an analyst‑pencilled 20% net profit growth.
Can companies still surprise investors during reporting season despite disclosure rules?
Yes. The article gives Engenco as an example: it did not warn the market it would miss promised profit improvements until 20 days after the June 30 balance date, and its shares plunged 38%. The piece cautions there remains scope for surprises even under modern disclosure regimes.
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