When corporate Australia reported an average 20 per cent lift in earnings last financial year, darker clouds were already gathering. It has since become clear severe headwinds that emerged in the six months to December 2014 will result in a far less robust set of half-year profit reports in many sectors.
Corporate earnings season kicks off on Monday morning, when retailer JB Hi-Fi reports results for the first half.
A handful of themes are likely to dominate the results and outlook commentary from company executives this season, and forward guidance may be harder to come by.
A volatile backdrop
The extreme turbulence in financial markets over the past few months will start to filter through. The Australian dollar dropped sharply over the second half of 2014 as the economic outlook dimmed. The dollar started July at US95c and ended December at US81.7c.
Losses have accelerated, with the dollar hitting a five-and-a-half year low below US78c on Friday as rate cut chatter reached fever pitch.
Exporters are finally feeling some relief after two years of jawboning by Reserve Bank officials that the high currency was out of whack with economic fundamentals.
The currency should be a bright spot for Treasury Wine Estates, which fended off two private equity approaches last year and described the year as a “reset” one for the group as Michael Clarke proceeds with his strategy of lowering costs and lifting marketing spend. Earnings from its exports will get a lift, and there will be a translation benefit from earnings in the US business for the first time in years.
Health care business like ResMed and Sonic Healthcare, which have a large amount of foreign earnings, will also benefit from the sliding dollar. However, the unexpected 25 per cent appreciation in the Swiss franc this month may hurt both CSL and Cochlear in the next half, since both have operations in Switzerland.
Over the longer term, the weaker Aussie will also provide a windfall for the funding requirements of the big four banks, since they will be able to issue less debt in offshore markets to meet current A$ maturities. Analysts at JP Morgan say US dollar denominated issuance, which accounts for about 35 per cent of total debt issuance, will be a key beneficiary. Increased volatility might also give a boost to the banks’ trading incomes, but that could go either way. It certainly has helped Macquarie.
Oil price bites
The halving of the oil price is already having widespread and predictable impacts across the resources and energy sectors. Woodside Petroleum and Santos have warned of write-downs and budget cuts even as production surges, while the largest miners BHP Billiton and Rio Tinto are cutting capital expenditure and revaluing some mines. Any change in dividends will be closely monitored, and the crash in oil and iron ore has dimmed hopes for capital management at BHP. Rio has promised “materially increased” returns to shareholders, partly funded by revenue from extra sales.
But there are positives for consumers of oil. Fortescue revealed this week fuel and energy costs make up about 12 per cent of C1 costs and the fall in oil helped to trim costs by about US26c a tonne in the December quarter. Combined with the falling dollar, the slide in oil will help offset the impact of iron ore.
For Qantas, the collapse in fuel costs is a gift that will keep on giving. In a highly cyclical industry, the wheel has finally turned in the airlines’ favour and the corresponding slide in jet fuel costs is estimated to add billions to profitability across the industry.
UBS estimates Qantas will report an underlying pre-tax profit of $1 billion for the year, with most of the benefit of falling oil in the second half. The airline estimates a boost of around $30m from oil in the first half, and reluctantly dropped its fuel surcharge this week but adjusted prices so that consumers would be no better off and the profits would flow through to the bottom line.
Caution in the boardroom
Gloomy business and consumer sentiment and the collapse of commodities prices have produced an abundance of caution in corporate boardrooms around the country and made companies reluctant to grow by acquisition or invest in their own businesses.
This has been manifested in a growing pile of cash on balance sheets, which can be alternately viewed as justifiable prudence against future uncertainty or a wasted opportunity. Companies will be closely scrutinised for plans to either reinvest or return cash to shareholders.
A survey of chief financial officers by Deloitte this week showed boardrooms caught in a crisis of confidence when it comes to the business environment and willingness to take on risk. Only 6 per cent felt confident about the financial prospects of their company, while 85 per cent believed current levels of uncertainty will last another year.
As the banks have found, despite the abundance of cheap debt available, companies are reluctant to borrow due to low confidence levels and most expect their own gearing to fall.
Businesses always need to balance growth and risk, but the pendulum for now appears to have swung firmly away from anything remotely resembling risk. Don’t expect reporting season to alter the mood.