Reporting season wrap

Reporting season takes its toll. The flood of results, accompanied by management-speak intent on proving Orwell right about everything, especially language as a tool for obfuscation (that's you Scentre), can raise a sense of despair.

One is reminded of a song by The Smiths, the first line of which is "Oh mother, I can feel the soil falling over my head." Well, the soil has fallen and here we are, analysts still breathing, faintly through a straw, anxiety levels returning to extreme. Such is the lot of a value investor in reporting season.

To mark the end of the period, I did what I usually do; smirk a little at their suffering and ask them for notes on the standout themes and results of the last month or so.

Their contributions are below, except for those of James Greenhalgh, who took the advice of another line from the song - "see, the sea wants to take me". JG has already left on his holidays. The rest of us will have to do with a weekend getaway in Gosford.

Whilst a few more results dribble out, from next week normal service resumes, only with a renewed focus on new stocks and opportunities. This includes the promised updates to URW and Scentre, an insurance sector wrap and coverage of Pushpay, Chorus, Pinnacle Investment Management, WiseTech and Audinate. While you wait for that juicy serve, here's the wrap:

1. Major sector themes

Nathan Bell (NB) - Among the retail banks we've long-preferred Commonwealth and Westpac over NAB and ANZ. The former have scale advantages and haven't blown up billions chasing growth overseas.

Still, shareholders are finding out that banks don't make great investments when credit growth is tepid and interest rates are flatlining, issues both beyond management's control. Margins are likely to remain under pressure for a long time. Even maintaining dividends would be impressive in this environment. Given the large premiums at which our banks trade compared to those in the US and Europe, large capital gains in the future would be a big surprise.  

Gaurav Sodhi (GS) - The miners delivered on high expectations. Almost all reported huge free cash flows, strong balance sheets and generous dividends. Apart from iron ore, there isn't even a resources boom to speak of. Much of these earnings are being driven by productivity gains and capital allocation choices.

This, and the results from mining services companies, indicate that exploration and development has been all but neglected. This will probably work to prolong current commodity prices, which don't appear excessive. Still, there are big macro risks on the horizon. External shocks aside, miners might be the new yield stocks, which is something I never thought I'd say. 

Retail was the other standout for me. For all the talk of the inevitable Australian recession, of falling house prices and weak consumer spending, good retailers delivered great outcomes. JB Hi-Fi, Super Retail, Baby Bunting and Lovisa- the best in their respective niches - delivered great results. Even in tough industries one can still find good businesses, if not cheap prices.

There also seemed to be a relief rally in the auto sector. Everything from Bapcor, Carsales.com to Smartgroup and ARB reported reasonable numbers and encouraging outlooks. Perhaps the economy may not be as bad as everyone thinks.

Graham Witcomb (GW) - Despite falling local currencies, Sydney and Auckland Airports suffered traffic declines, primarily due to fewer domestic passengers. Management had no explanation but noted this was a broad industry phenomenon, which should reassure shareholders. But with traffic growth half what it was a few years ago, it's a reminder not to get too carried away with short term predictions and focus on what may happen over a decade.

Rakesh Tummala (RT) - As Nathan notes, falling interest rates, little loan demand, regulation and customer expectations are making life tough for the major banks. CBA was the only one to report, but its result is likely to mirror the sector's. Flat earnings are about the best we can expect for a few years with the risk that credit losses - near historic lows - rise, and dividends fall. I agree with Nathan: income investors need to be aware that present yields may not last.

Mickey Mordech (MM) - Property trusts continue to benefit from a lower cost of debt and higher valuations. In a world assuming lower-for-longer interest rates, there is now a higher value placed on the consistent cash flows they provide. The result is lower yields and higher prices. Collectively, they look expensive but are beating expectations.

Logistics developer and owner Goodman Group sets the pace, trading at a boom-time multiple of almost three times book value. Market darlings like office owners GPT Group, Dexus and Mirvac are not far behind, trading on an average pre-tax yield of under 4%.

Yes, everything is going as well as it can; the outlook for office space is strong; interest rates are falling; occupancy remains high; and supply is tight, although in the coming years it should increase, which should lower growth. For now at least, valuations are rich.

Retail property wasn't so fortunate. Vicinity Centres, Shopping Centres Australasia and Stockland reported lower net tangible assets as lower-quality malls suffered lower valuations. Department stores continue to look weak, despite retail trusts reporting sales growth of around 2%. Stockland suffered a fall in sales per square metre while Scentre Group removed its disclosure of this metric altogether. We'll have more on that next week.

Management teams are all playing the same game, but especially Stockland, which is selling down lower-quality retail properties in favour of more exposure to industrial property. The result is an increasing disparity in valuations as everybody offloads the 'bad' while chasing the 'good'.

The Australian-REIT sector trades at almost 1.6 times net tangible assets - well above the long-term average and is not far from the lofty heights reached prior to the GFC. Risks look elevated, which explains our many Sell recommendations in the sector.

2. Other themes

NB - Even for many high-quality growth stocks, profit growth is fairly modest by historical standards. And yet PERs continue to increase. Paying higher multiples brings future returns forward, so you can't expect the same high future return.

Low interest rates should be seen as a sign of a weak economy and a broken financial system rather than an excuse to pay ever higher stock multiples. This is why we're seeking out companies flying under the radar, where both earnings and valuations can increase despite tepid economic growth.

GS - Who isn't waiting for an Australian recession? With falling house prices, a credit squeeze and depressed consumer spending, I for one thought we were going to get one. That assumption seems misplaced; this reporting season suggests corporate and consumer Australia are doing well enough. 

Still, I wonder what the determination to get interest rates to zero will accomplish. The RBA is one of the world's best central banks but I can't see the case for this approach, although we should pay attention to it. Macroeconomic indicators rarely matter in stock picking; this might be one of those occasions when they deserve more attention.

GW - There's an odd dichotomy between Sydney Airport and the experience of debt agreement administrator and loan provider FSA Group. You would expect domestic passenger growth to slow in a slowing economy, but FSA's result indicates the economy is in reasonable shape. The number of new clients seeking debt agreements fell 21% this year, suggesting a substantial decline in the number of Australians in financial distress.

RT - Investors are happy chasing growing companies that are already expensive. This is now driving the type of companies now listing, including in the evolving buy-now-pay-later market. 

Afterpay has exploded and is making headway in the larger markets of UK and USA. Revenue was up 90% this year to $218m. Even more impressive is an $8bn market capitalisation and a $43m loss. Zip Co offers a similar product and is separately listed. Revenue more than doubled to $83m and it's now valued at over $1bn.

Traditional credit providers are joining in, FlexiGroup included, its share price jumping on the announcement of a change in course. Latitude - a credit card provider - will roll out its equivalent in Harvey Norman stores before an anticipated listing later this year. You can bet the prospectus will highlight its growth opportunities. CBA is getting involved, too, having taken a small stake in Klarna, a Swedish high-flier, that will likely roll-out the product in Australia. 

With interest rates near-zero and the world awash with cheap money, this new sector has low barriers to entry. More competition leads to lower returns, especially in credit. We'll have to wait for that. In the interim, the Goldrush is on. 

MM - The Australian property market has been the subject of intense interest over the last year. Mirvac and Stockland reported lower pre-sales and settlement volumes in 2019; we had hoped the knock-on effects would create some opportunities. With new car sales slumping, we were also hopeful of an opportunity to buy high-quality 4x4 accessories manufacturer ARB Corp. Both failed to materialise. With interest rates down, lending standards loosened and the Liberals regaining power, the property market looks set for another leg up.

3. Winners and losers

NB - I don't like repeatedly mentioning Frontier Digital Ventures as it's so risky but I can't help myself. Revenue growth in its crown jewel Zameen - the Pakistan version of REA Group - grew 120% in local currency. It's early days, but a few more years of growth like this would imply a valuation far beyond the current share price. Which is good because, given the risks, that's where it needs to be.

ResMed's result was fine but hardly deserved the 50% increase in its share price since April. Did the company really add $10bn in value in a few months? This is a great business, but I'd expect long-term returns more in line with the market from here.

GS - The best result for me was Altium. Recently, I've been poring over this high quality (and highly priced) company. It's an amazing operation. Management has promised heady growth which is easy to dismiss as rampant optimism. But market share gains have been astonishing, as are future growth targets. It might be foolish to bet against this business. 

One of the most troubling results came from Amaysim which reported a huge loss of 200,000 customers, ongoing trouble in the mobile business and few levers to pull to change course. The company is even at risk of losing its star status with Optus, on which it depends for favourable network access.

The mobile industry appears to have drastically changed as handset subsidies are abandoned and networks focus on price to capture customers. Worse, shrinking broadband profits have forced networks to compete harder on mobile.

Amaysim has a cost advantage but, as an MVNO, works on skinny margins. The energy business may help but it won't be enough. The most likely outcome from here is a low-priced buyout. We changed course on this former Buy recommendation in July last year and I'm pleased we got out when we did.

GW - Recent Sell Virtus Health and Monash IVF were this season's biggest losers for me. Things started off well enough with an increase in cycle growth over the last few months. Then everything went pear-shaped. Virtus reported a lousy result for its full-service clinics and Monash followed it up by announcing five of its doctors were leaving to form a new competitor. We decided it was time to let the sector go and move on. 

RT- Domestic building materials companies Boral and Adelaide Brighton delivered two poor results. These are capital intensive and cyclical businesses facing the impacts of a housing construction downturn. An infrastructure boom is supposed to support earnings in the coming years but thus far hasn't brought any rewards. We've long steered clear of the sector and I can't see that changing.

MM - Payment solutions provider EML Payments delivered a good result, beating previous guidance with impressive growth across all business lines. The roll out of its gaming solution in the US and Europe continues as does the salary packaging offer in Australia. Growth in gift cards should be strong in light of a full year from the Flex-e-Card acquisition. The virtual account number segment for business-to-business payments is beginning to pick up and a new solution for personal loans providers appears promising. It's early days for this recent Buy recommendation but so far, so good.

Elsewhere, Equity Trustees and United Overseas Australia delivered predictably good results, the former growing earnings by 12% while the latter begins to gush cash as several developments near completion. And ALE Properties is continuing with its rent reviews, which should see higher rental income, a good chunk of debt refinanced at lower rates and non-recurring costs associated with the rent reviews roll-off. Distributable profit should rise meaningfully as a result.

4. Anything else of interest?

NB - The noticeable momentum in share prices created by algorithmic trading strategies acting on the slightest hint of good news is something to watch. When this cycle ends, the increase in market inefficiency they're creating will be manna from heaven for value investors like us. I love beating computers, physically and metaphorically.

GS - Mobile is an industry on the brink with much depending on the TPG/VHA merger outcome. Optus has raised prices substantially in the past few weeks. It would be a surprise to see Telstra do likewise. The NBN is squeezing broadband margins and forcing telcos to find margins elsewhere. If TPG's merger is not approved, VHA may eventually exit the industry, leaving us with another cosy duopoly. I'd revisit our Sell on Telstra depending on the merger outcome. 

GW - CSL produced an outstanding result. All key products are performing better than expected and management is fulfilling a five-year promise to turnaround a failing vaccine business it bought from Novartis. Back then, it was losing $138m a year. Significant cost cutting and product approvals have turned that into a $154m operating profit. The $275m purchase price now looks like a steal. It shows what skillful management can do. If only there were more of it.

RT - AMP surprisingly completed a $650m capital raising at $1.60, a slight discount to the current share price. Investors must be betting on a turnaround but the business seems to be going from bad to worse. We've looked at it a number of times and still can't find a reason to get excited about it.

That's it folks. See you next week.