The importance of earnings season for active investors cannot be overstated. Some 70 per cent of active fund managers’ value is added during the semi-annual reporting season, with stocks rerated in light of their earnings reports and outlook statements.
The February 2018 reporting season has proven particularly important because it has given investors a chance to look through the recent market noise and take a closer look at the fundamentals that drive individual companies’ performance.
The good news is that, overall, Australian companies performed slightly better than expected. Earnings per share (EPS) forecasts for the full year across the market rose to 7 per cent, having been upgraded marginally in February.
What is clear from the latest reporting season is that Australia’s improved economic performance is translating to increased earnings that are being reinvested and returned to shareholders in the form of higher dividend payout ratios.
A number of leading companies posted strong results, including television network owner Nine Entertainment and electronic software company Altium. Companies trading on high price-to-earnings (PE) multiples, such as a2 Milk Company, telco Next DC, global biotech company CSL and Corporate Travel Management, were the best performers with investors pushing their shares significantly
Nine Entertainment Group delivered one of the best results, beating analysts’ forecasts and upgrading its outlook for earnings before interest, tax and depreciation (EBITDA) for the second time in three months to about $260 million for the financial year. The company continues to benefit from its recent ratings momentum through hit shows such as Married at First Sight. The market will be watching Nine navigate the renegotiations of the cricket rights with interest over the coming months.
Nine has previously stated that it will broadcast cricket matches only when the return on invested capital is accretive for shareholders. Recent media speculation has pointed to the possibility of Nine and News Corp lodging a joint bid for the broadcasting rights that could include the Big Bash League. We believe Nine will continue to grow its earnings in 2018-19 and 2019-20.
Shares in a2 Milk Company jumped 58 per cent to a record high of $13.78 in the two days following its results announcement after the milk bottler signed a supply deal with global dairy giant Fonterra and announced a 150 per cent surge in half-year net profits. A2 has been the best performing stock on the ASX in recent years. Just five years ago, the share price was 50¢ compared with the price at the time of writing of $12.11, a 2300 per cent gain. Investors’ focus over the coming years will centre on the company’s ability to penetrate further channels into the Chinese market.
But earnings season also highlighted some challenges with poor results from the likes of regional bank and insurance group Suncorp and childcare centre operator G8 Education. Telecommunications company Vocus missed interim earnings expectations, positing a downgrade of full-year underlying EBITDA guidance to $365 million-$380 million, from $370-$390 million, citing higher-than-expected subscriber acquisition costs. It also said it would hold off paying its half-year dividend. Chief executive Geoff Horth resigned.
Several companies, including iSelect and Southern Cross Media, joined the infamous “second half club” relying on larger than normal earnings for the remainder of the year to meet earnings expectations on the street. These companies potentially carry the risk that earnings do not rise to meet full-year guidance.
The downside of improved economic conditions – higher costs – surfaced as an issue in results and outlook statements. Miner South32, packaging group Orora, and gaming company Star Entertainment Group all pointed to higher electricity prices as a headwind. In particular, many companies are struggling to pass on electricity cost increases and are suffering margin contraction, notably mining services firms. As investors we focus on the factors that can influence this large input cost, identifying individual companies’ level of exposure and their ability to pass on power price increases.
While the recent reporting season highlights the health of corporate Australia, the direction of the equity market over the short-to-medium term is uncertain.
The US equity bull market will soon pass the nine-year mark and is showing its age. A patter of rising prices and record low volatility was interrupted last month as strong US wage figures brought forward expectations of interest rate rises, placing downward pressure on equities.
We expect volatility will increase as the global economy improves and central banks normalise interest rates, forcing PE ratios into a state of flux. But a turbulent market presents many opportunities for active investors focused on company fundamentals.
Listed investment companies managed by Wilson Asset Management invest in Nine Entertainment, Altium, CSL, Corporate Travel Management, Star Entertainment Group and Southern Cross Media.