What to watch this reporting season

Well, that didn't last long did it? The holidays are officially over and market commentary has quickly returned to the worrywart staples – are stocks expensive, will inflation break out and interest rates rise as a result?

It's true that, as senior analyst James Greenhalgh says, 'high quality companies are more premium-priced than ever' and the threat of rising rates could hit these stocks hard. But it's also true that, for the first time in a decade, global growth is reasonably strong and co-ordinated. This is the tension that hovers over this reporting season.

For shareholders in Australian companies with US earnings – think Computershare, Cochlear, ResMed, Ansell and Macquarie Group – there's an extra complication: the impact of a lower US corporate tax rate and new regime on local earnings. These are the reasons why we asked the analytical team for their thoughts on the season ahead; what stocks are most on their mind; what metrics to watch out for; and what opportunities might emerge.

James Carlisle, research director

The banks continue to bumble along with record low bad debts but little in the way of growth. There are, though, points of difference, particularly in net operating income growth. Commonwealth Bank sits at the top of the pile, ANZ Bank at the bottom. We'll be watching this number closely in the half-year report for CBA and the quarterly reports of the others. Also significant will be the measure's composition. NAB's, for example, was boosted by trading income last year.

The banks are also responding to the low-growth environment differently. ANZ and NAB are aggressively cutting costs while Westpac and CBA continue to invest (as we prefer). It will be interesting to watch the costs line.

With the banks well on the way to meeting APRA's new capital targets, we'll also be looking for clues on capital management and dividends. ANZ announced a $1.5bn share buyback starting this month (January), so it will be interesting to hear how that's going.

NAB is likely to maintain its dividend at above its target payout ratio of 70–75%, while Westpac may start growing its dividend again. CBA is also likely to continue its steady dividend growth. Commentary around this issue will be worth watching, although we're less interested in the dividend per se than the long-term cash earnings growth that might support it. Capital management can be instructive, too, in terms of overall strategy. You don't want a business paying out dividends the business can't support long term.

CBA revealed its money-laundering problems at the beginning of the latest half so we'll also be looking for updates on the fallout, not least the search for a new chief executive to replace Ian Narev by the end of the 2018 financial year.

As ever, the key for fund managers is funds under management, and the flows that support them. They report this monthly or quarterly, ahead of the formal results, so there generally aren't many surprises. Over the past year or so, though, Perpetual's private wealth management business has been compensating for a weak performance from funds management. We'll be looking to see if that continues and watching for news on the replacement for CEO Geoff Lloyd, who retires in June.

IOOF has been enjoying strong flows into its advice business lately. We'll be looking to see if platform margins are still improving after the first half weakness in the 2017 financial year. Just as important will be the progress of the acquisition of ANZ's wealth business, especially the synergies management expects to extract. Chief executive Chris Kelaher has a great record in this area and we're keen to hear how it's going.

Shares in Platinum Asset Management have almost doubled since June last year with a sharp improvement in fund performance leading to an even sharper turnabout in fund flows. With the stock hovering slightly above our Sell price of $8, we'll be watching the commentary from managing director Kerr Neilson closely.

Computershare is another stock that's risen sharply over the past year, although in this case we downgraded to Sell in the run up to Christmas. The reason is that investors have been anticipating an increase in interest rates, which would boost the margin income the company earns on its client cash balances. Earnings guidance has also been upgraded, partly based on an improvement in corporate activity. This is an important component of the hoped-for improvement in margin income. We'll also be watching for comments on how the company is progressing with its UK mortgage business, to replace falling profits from its UKAR business as they start to decline after 2020.

Gaurav Sodhi, deputy research director

In mining and energy, investors used to demand growth. Now they want cash. As a result, capital expenditure levels have fallen enormously over the past few years. It will be fascinating to see whether the flood of free cash flow generated by miners will reverse that.

I'll also be watching unit costs, a cyclical metric that has trended down for years. I expect costs to start rising again, with South32, which has cut perhaps the deepest and maybe too far, particularly at risk of higher operating costs. This was one of the reasons we decided to lock in a nice return when we suggested members sell out of this prime buy recommendation in November last year.

In telcos, where the political costs of the NBN keep rising, we might see some regulatory changes. I'll be keeping an eye out for management commentary on this issue, especially how the big players (Telstra, TPG Telecom and Vocus Communications) are likely to adjust to it. At the last result, Telstra devoted a whole slide to how it was fighting TPG. This time it might have more to say about competing with them in mobile.

Fleetwood, which I have been thinking about a lot recently, deserves special mention, too. It seems clear that the caravan division, having recently downgraded results, needs to be sold off. I'm interested to hear about the revised divestment plans for this business.

As for general economic themes, I usually say 'bah humbug' to them. This is the worst way to invest. But just as persistently low interest rates have been a big deal, we must also acknowledge the reverse. It might be worth thinking about how higher interest rates could impact potential investments. For example, I would demand a higher margin of safety before re-entering businesses like Spark Infrastructure, APA Group and Transurban.

I'm also going to keep a particular eye on boring businesses. A bull market is raging and, in those circumstances, investors tend to chase the new and exciting over the dull and dependable. Anything with static revenue but potentially higher margins, or turnaround situations or boring industries is on my radar.

James Greenhalgh, senior analyst

The first thing I'll be looking for is a certain reluctance on the part of management to offer earnings guidance. This isn't necessarily a bad thing. Companies like Flight Centre and Navitas were caught missing their guidance numbers last year so more circumspection this time around wouldn't be a surprise.

Most of the stocks I cover are high quality with few management issues, but this can lead to some releasing the bare minimum of information to the market. That might be fine when things are going well but clamming up doesn't help when there's a hiccup. In this case less is not more; more is more and I'd like to see more of it.

On to a few sector comments. At the grocery retailers there's a general expectation that Woolworths' margins will expand as its same-store sales growth continues at Coles's expense. Talk about short memories. This is what got Woolworths into trouble a few years back. On the other side of the street, we're expecting margins at Wesfarmers' Coles business to continue weakening, although the worst of it should be over. If either company talks about margins expanding in this climate, I'd respectfully suggest management is focusing on the wrong thing.

Among the online classifieds companies, revenue growth is the metric to watch. At many companies, including Seek, REA Group and Carsales.com, we're actually expecting an acceleration in revenue growth from last year. The composition will be interesting to watch because there's a cyclical element for some (such as Seek's domestic business). But any shortfall in revenue growth compared to market expectations could be an issue. Share prices in the sector have been strong in anticipation of this higher growth. Without it they might struggle.

Trade Me, the only remaining Buy recommendation on my coverage list, will be one of the few to report revenue growth weaker than in 2017. This won't be a surprise and is not a worry in any one year. However, it could be worse than market expectations. This will depend on how much Facebook Marketplace has affected Trade Me's market share and whether the drawn-out New Zealand election had a prolonged effect on property listings.

One of the metrics to watch as an indicator of long-term health is the growth of premium advertisement revenue in Trade Me's classified businesses. This has been growing strongly recently and it's a key part of our investment thesis, although still small in the scheme of things. There will also be higher cost growth, as management flagged at Trade Me's 2017 results. I still expect profit growth in 2018, although at a subdued rate.

Another result I'll be watching closely is Navitas, which was a Buy for most of the first half of last year. It's a bit early to get my hopes up but evidence of a rise in future enrolment growth in the UK and North America would be wonderful for members that bought into this recommendation.

Graham Witcomb, senior analyst

Australia's healthcare system, as with others around the world, is undergoing a structural shift. Smaller players are merging or being left behind as the world moves to a ‘big payer, big provider' model dominated by governments, private insurers and hospital and pathology oligopolies.

As healthcare budgets strain, negotiating prices and rates for services are increasingly cut-throat, with lots of concentrated power on both sides of the table. Whether it be Ramsay Health Care, Sonic Healthcare, Virtus Health or Cochlear, we will be watching gross and operating margins and returns on capital closely. Sustained changes in any of these numbers could suggest shifts in the competitive landscape or declines in negotiating power.

Virtus Health's result is the one I am most interested in. As explained in Is the IVF market splitting in two?, the industry is at an inflection point. Our analysis suggests that the budget IVF business model isn't all it's cracked up to be but uncertainty around it has left premium providers unnecessarily shunned. It's a baby and bathwater story.

We were too early to upgrade the IVF stocks a couple of years ago but if our long-term thesis is correct, we should see margins holding up and cycle number growth in the low single digits. IVF is a highly cyclical industry, though, so this one result doesn't carry much weight, although it will help to paint a bigger picture. Both Monash IVF and Virtus remain on our slender Buy List.

The US dollar has weakened significantly over the past year, which makes US-made goods and services more competitive on the world stage. However, it also makes earnings from the US worth less in Aussie dollar terms. Companies with significant US earnings, such as Cochlear and SomnoMed, had foreign exchange movements as a headwind this year. Members should focus on the ‘constant currency' numbers to see how the underlying businesses are performing.

Jon Mills, senior analyst

For the first time since the GFC, most major economies are growing in lockstep at a time when major central banks – led by the Federal Reserve – are reducing their purchases of government and non-government bonds. This has helped keep interest rates artificially low in recent years (with flow-on effects to interest-rate sensitive stocks like property trusts, infrastructure and ‘growth stocks'). Will inflation pick up as economies grow faster and unemployment falls? And if so, will central banks' reduced purchases or even net sales drive up interest rates faster than the consensus thinks?

These are the big questions markets face right now, and no-one really knows the answers, which is why it's best to focus on stocks and sectors, where the value of analysis is more tangible.

Big office property trusts, including Dexus and Investa, have been experiencing dramatic increases in effective rents (face rents less incentives) in Sydney. Minimal construction, Sydney's Metro project and the conversion of offices to residential properties have limited supply.

The retail trusts have bigger issues. Scentre Group and Vicinity Centres have Amazon to worry about, which is why they're pursuing a strategy of ditching lower-quality malls and upgrading their higher quality regional and super-regional malls to minimise Amazon's impact. The aim is to increase ‘experiential' retailing – more dining, drinking, health and entertainment – which can't be replicated online. Is it working? It may be too early to tell but one metric to keep your eye on is 'leasing spreads' – the increase (or decrease) in rents paid by tenants on new leases compared to previous leases. This is the canary-in-the-coal-mine metric for these businesses, whether the new tenants replacing the old are signing up at higher or lower rents.

As for the casino stocks – Crown Resorts and The Star Entertainment Group – their AGM updates revealed that VIPs had started to return. I'll be looking for evidence that this is continuing. Both are also heavily affected by economic growth, especially wages growth, so improvements (or lack thereof) in main gaming floor revenue will also be worth watching. Crown has been simplifying its business since John Alexander took charge and I'll be interested to see whether the company's Melbourne and Perth casinos are becoming more profitable.

Ainsworth has been 'confident' of improved results since we upgraded it to Buy three years ago. Results have indeed improved in North and Latin America, but Australia has deteriorated significantly. I'd like to see management acknowledge this and strike the word 'confident' from future commentary. Drives me mad, as does the mention of successful games in The Americas but not in Australia (because they are few and far between). Any mention of a successful local game – such as the recently released Pacman Wild or Firepower games – would be indicative of improved market share in Australia.

Alex Hughes, senior analyst

In a macro sense, I'm most interested in inflation and the property market. Everyone's talking about inflation again so it will be interesting to see if managers are seeing or expecting a ‘cost push' in their businesses. This will give a read-through into interest rates.

The outlook for property will be fascinating given the industry is a large employer and the average Australian carries unprecedented levels of personal debt. Its direction will influence economic growth significantly. I'm looking forward to what the banks, developers, retailers and REITs have to say about these issues.

As far as the stocks I cover are concerned, the important aspect of the upcoming result of Adacel Technologies – a Buy recommendation from mid-last year – will be management discussion around the competitive landscape. Adacel has a near-monopoly in US training centres, and is valued as such. But competitor (UFA Inc) recently displaced it in one training school and the company has also lost an FAA field support contract (which directors, coincidentally I'm sure, sold shares before announcing). These could be isolated events or part of an emerging trend. I'll be looking for commentary around this issue in particular.

RPMGlobal is another one to watch, having recently changed its revenue model from upfront licence fees to recurring monthly payments. This is the first step off a short-term revenue cliff in the pursuit of an improved business model. It's counterintuitive but the better the company is doing the worse their software results will look. It's possible that misinformed investors will react foolishly to this in the short term, creating an opportunity for us to buy in. I've been following this stock for a while and am hoping we'll finally get a chance to buy at an attractive price.

Note: The Intelligent Investor Equity Growth Portfolio owns shares in Ansell, Macquarie Group, Perpetual, IOOF, TPG Telecom, Fleetwood, Flight Centre, Navitas, Seek, Carsales, Trade Me, Virtus Health, Monash IVF and Crown Resorts. The Intelligent Investor Equity Income Fund owns shares in Ansell, Macquarie Group, CBA, Westpac, Perpetual, IOOF, Flight Centre, Navitas, Woolworths, Seek, Carsales, Trade Me, Virtus Health, Monash IVF and Crown Resorts. The InvestSMART Australian Small Companies Fund owns shares in Trade Me, Virtus Health, Monash IVF, Adacel and RPMGlobal.

Disclosure: Staff members own many of the stocks mentioned personally and through investments in Intelligent Investor and InvestSMART funds.