THE glass half-empty view of the June 30 profit season that is about to begin is that our 200 biggest companies will report combined earnings that are below those they posted five years ago, before the financial crisis erupted.
The glass half-full view is that the markets know what is coming. Analyst estimates of earnings for the companies in the S&P/ASX 200 Index have been wound back steadily for nine months, to a point where a merely lousy profit season should be a non-event.
A year ago, the consensus view was that the companies that make up the index would collectively earn $391 a share in the financial year that is now drawing to a close. That outlook held for a couple more months company analysts are notoriously optimistic but then Europe's sovereign debt crisis flared, and signs of a bigger than expected slowdown in China began to appear.
Beijing had induced an economic slowdown to tame inflation at the same time as Europe's mess, and lethargic growth in the US was undermining exports to the West.
Global growth estimates and commodity prices fell as awareness of this spread, and in this country, fears that the eastern states were hitting the wall grew as the Reserve Bank held rates up: it held its cash rate at 4.75 per cent for a year until it cut by a quarter of percentage point in November last year, on its way down to 3.5 per cent.
Expected aggregate earnings for the ASX 200 index had been cut by 7.5 per cent by the end of last year, and they have been lowered by another 7.5 per since then. The ASX 200 index is also down, by about 10 per cent for the year, but the erosion of confidence in earnings is another facet.
One of the key measures of the value the market offers investors is the price/earnings ratio, or P/E. It measures how much investors are prepared to pay for earnings, and it has actually risen in the June half, from 10.3 times expected earnings over the next 12 months to 10.7 times. This increase is a product of weaker earnings estimates however, not a sign of rising core values or improving confidence. The measure is based on expected earnings, and they have also been wound back, by 7.5 per cent in the December half, and by another 6.5 per cent in the June half.
Analysts are, as I said, optimists. Economists in the same firms are invariably more cautious. For that reason alone we have to see the profits before deciding whether the current forecasts are correct. They are closer to the mark than they were six months ago, however, and well below average, here and overseas.
Wall Street's S&P 500 index is trading above Australia's 10.7 times earnings multiple at 12.1 times expected earnings in the next year, compared with 12.4 times a year ago. The MSCI global index of stocks, a reasonable proxy for markets as a whole, is trading closer to Australia, at 10.4 times expected earnings, down from 11 times earnings a year ago. All are nominally cheap: here in Australia for example the long-term average is about 14 times expected earnings. The average since the global crisis erupted is about 13 times.
Profit downgrades have been uneven in the Australian sharemarket. Estimates of bank earnings have only been nibbled in the last three months, and downgrades of consumer-facing companies including retailers have slowed. In both cases the medicine had already been taken.
The big cuts in the June quarter have been in the resources sector, where commodity price falls are being magnified in $A terms by the Australian dollar's failure to follow commodity prices down.
Gold is almost 11 per cent below its 2012 high, oil is down 11 per cent, aluminium is almost 13 per cent down, copper is 7.7 per cent lower, nickel is 20 per cent below its year high, iron ore is down 9.4 per cent and thermal coal is down 25 per cent.
Our dollar, meanwhile, began the year at $US1.02 and is less than one US cent lower today, as global investors chase triple A-rated Australian government bonds, and lock in Australia's still-attractive fixed interest yields.
I don't think there's any relief in sight. The dollar will continue to be propped because it's a safe place in a troubled world, and because Australian yields are still relatively high by global standards. Commodity prices will be weakish until Europe and China's trajectories are known, at least, and consumer demand and corporate activity will be subdued until we know where Europe and China are headed.
Companies will say conditions are tough, and they will be loath to give guidance. They will be talking a lot about cutting costs, and reconstructions including the one Rupert Murdoch's News Corp is announcing today will be in vogue.
The analysts do, however, seem better prepared than usual: the June-year profit season will be a shocker, but it really shouldn't be a surprise.
mmaiden@theage.com.au
Frequently Asked Questions about this Article…
What should everyday investors expect from the upcoming ASX 200 profit season?
The article says the June 30 profit season is likely to be weak — analysts have steadily cut earnings forecasts for S&P/ASX 200 companies, so a poor profit season should be no surprise. Consensus estimates were trimmed over the past year and investors can expect companies to report lower aggregate earnings than five years ago in some cases.
Why have analyst earnings forecasts for ASX 200 companies been lowered?
Forecasts were trimmed because of a weaker global outlook: Europe’s sovereign debt worries, a China slowdown, and softer US demand. Those factors pushed down global growth expectations and commodity prices, prompting analysts to reduce earnings estimates for ASX 200 firms over the past nine to twelve months.
How have profit downgrades differed across sectors, and which sectors are most affected?
Downgrades have been uneven. The resources sector has seen the biggest cuts because falling commodity prices — magnified in A$ terms by the Australian dollar not falling as much — hit commodity producers hardest. Bank earnings have only been nudged down recently, and downgrades for consumer-facing companies, including retailers, have slowed because many had already been adjusted earlier.
What do changes in the market price/earnings (P/E) ratio mean for investors right now?
The ASX’s forward P/E rose from about 10.3 to 10.7 times expected earnings in the June half — but that increase reflects weaker expected earnings, not stronger prices. In other words, P/E increases here are driven by earnings being cut, so investors should be cautious about reading that as a sign of improving market value.
How have commodity price moves and the Australian dollar affected Australian company profits?
Commodity prices have fallen (examples cited include gold ~11% below its 2012 high, oil down ~11%, aluminium ~13% down, copper ~7.7%, nickel ~20%, iron ore ~9.4%, thermal coal ~25%). Because the Australian dollar hasn’t fallen in line with those commodity drops (it began the year near US$1.02 and is only marginally lower), resource companies feel the hit more severely in A$ terms, squeezing profits.
What role do global issues like Europe and China play in local corporate earnings?
Europe’s debt problems and signs of a slowdown in China have reduced global growth forecasts and demand for commodities and exports. The article stresses that commodity prices and consumer demand will stay subdued until the trajectories of Europe and China become clearer, which will continue to weigh on corporate activity and earnings in Australia.
How are companies likely to respond during this tough profit season, and what should investors listen for?
Companies will probably describe conditions as tough, be reluctant to give firm guidance, and emphasise cost-cutting and restructurings — the article specifically mentions restructures like the one News Corp announced. Investors should listen for realistic profit guidance, details of cost cuts or restructurings, and any changes to dividend or capital allocation plans.
Is the Australian market cheap compared with history and other markets right now?
By the numbers in the article, Australia’s forward P/E of about 10.7 is below long-term averages (roughly 14 times expected earnings historically, and about 13 times since the global crisis). Comparatively, the S&P 500 trades around 12.1 times forward earnings and the MSCI global index near 10.4. That suggests valuations are nominally cheap, but weaker earnings forecasts are a key reason for the low multiples.
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