With reporting season just around the corner, I discuss our predictions and identify potential opportunities across various companies, sectors and the broader market.
Setting the scene
Heading into reporting season, companies appear to be generally well-positioned, with a reduction in both the frequency and severity of profit warnings in the lead-up. This suggests the outlook for companies’ full year results is predominantly positive. The number of companies downgrading their profit guidance by 5% or more than the forecast consensus earnings per share (EPS) for FY2017 is around 35% below the decade average.
In addition, this year the so-called ‘confession season’, typically April through May, saw fewer companies issue profit warnings. However, as the financial year drew to a close, there was a marked increase in earnings downgrades announced in June. This has tempered the outlook for the full year reporting season somewhat and prompted investors to question if their expectations of company earnings are too high.
US exposure to create earnings uplift
We believe companies leveraged to the strengthening US economy, such as Computershare (ASX: CPU), Boral (ASX: BLD), Bluescope Steel (ASX: BSL) and Resmed (ASX: RMD), have the potential to deliver solid results. Although this theme is well understood by the market, in our view, companies with exposure to US earnings are still set to outperform the market over the year ahead.
Low Aussie dollar tailwind
A lower Australian dollar has been a welcome development for export-focused businesses, tourism operators and companies deriving a significant proportion of their earnings offshore. Companies currently benefiting from this tailwind and poised to see an increase in profitability include: CSL (ASX: CSL), Qantas (ASX: QAN) and Aristocrat Leisure (ASX: ALL), albeit the latter has an out-of-cycle year end and will not be reporting its results until 30 November.
Mining balance sheets in focus
The market is eagerly awaiting an update from mining companies about potential and prospective capital management initiatives. Following the recent resources downturn, most miners have repaired their balance sheets with the resurgence in commodity prices accelerating this process. While the last few months of the financial year were weak, throughout most of the year, pricing was strong and mining companies are now in a stronger fiscal position with low levels of gearing. For example, it seems likely Fortescue Metals Group (ASX: FMG) will announce it is now very close to positive net cash. Investors are now keen to see how the major miners, such as BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO) and Fortescue Metals, deploy their excess cash, particularly via capital management initiatives such as dividend payments and share buybacks.
Although weaker consumer sentiment may be weighing on discretionary retailers, those in the consumer staples category are virtually immune from this trend and offer investors a defensive play. Of the two major Australian supermarkets, we favour Woolworths (ASX: WOW) with momentum behind the company in the battle for market share. When Woolworths reports like-for-like sales with its profit announcement next month, we expect the company will beat market expectations on sales growth.
The company has made a $1 billion plus investment in price to see it match Coles’ prices and be only marginally higher than Aldi’s. Coupled with other initiatives by CEO Brad Banducci to increase store foot traffic, we expect Woolworths will continue to take market share from Coles for the next two-to-three years.
Retailers surprise on the upside
In recent months, the retail sector has been oversold with the market responding to weaker trading conditions. In combination with these headwinds, listed retailers have also experienced dramatic share price falls as investors respond to the perceived threat of Amazon. In our view, the market has over-reacted to Amazon’s slated arrival given that the risk to retailers is currently neither quantifiable, nor imminent. With the majority of the market taking a negative view of the sector, we believe some retailers could surprise on the upside when they announce their results. While we are cognisant of the longer-term challenges facing retailers, in the short-term we believe there could be some trading opportunities in the sector this reporting season. Stocks to watch include: JB Hi-Fi (ASX: JBH), Harvey Norman (ASX: HVN), Super Retail Group (ASX: SUL) and Nick Scali (ASX: NCK). Of note, the market’s generally negative sentiment towards the sector belies a recent improvement in trading conditions with retail sales increasing in April and May, up 1.0% and 0.6% respectively.
Premium rates to increase
When ASX-listed insurers report their results, we expect a reduction in claim costs allowing them to release reserves as a percentage of premiums at rates ahead of the market’s expectations. For insurers, such as Insurance Australia Group (ASX: IAG) and Suncorp (ASX: SUN), we anticipate this will lead to upgrades to their earnings over the medium term. Already we have seen IAG surprise the market, increasing its profit forecast due to better-than-expected claims costs. For insurance brokers, such as Steadfast Group (ASX: SDF) and Austbrokers (ASX: AUB), there is the potential to beat market consensus when they announce their full year results. Overall, we believe insurers and insurance brokers are well-positioned to benefit from current market conditions and we expect this trend to continue with further earnings upgrades from the sector over the next two-to-three years.
With limited earnings downgrades during confession season, we anticipate a majority of companies will report earnings broadly in line with market expectations. However, with the improving global outlook and a stable domestic economy delivering tailwinds for companies across a broad range of sectors, there is potential for a number of companies to surprise on the upside.
Entities managed by Wilson Asset Management own shares in CPU, BLD, BSL, RMD, CSL, QAN, BHP, RIO, WOW, JBH, HVN, SUL, NCK, IAG, SUN and AUB.