After a tumultuous six-month period for equity markets, the Australian fiscal 2019 half-year reporting season again proved to be volatile as 30 per cent of companies experienced a share price move of 5 per cent or more.
During February, 27 per cent of companies in the S&P/ASX 200 reported results ahead of consensus expectations, 40 per cent delivered in-line results and 33 per cent disappointed.
Despite the strong performance in February, with the S&P/ASX 200 Accumulation Index gaining 6.0 per cent, 12-month forward earnings expectations were flat, primarily driven by downgrades across industrial companies.
The strong advance for the overall market was driven by continued expansion in earnings multiples. The S&P/ASX 200 is trading at a price-to-earnings multiple of 15.2 times, near the August 2018 peak of 15.6 times.
The mixed company results reflect the state of the Australian economy and the consumer.
Uncertain about the direction of the economy and facing rising cost pressures and stagnant wage growth, consumers are not spending. The retail sector has particularly struggled, with many of the larger companies in this sector performing poorly over the February reporting season.
Companies with an offshore growth strategy fared better, as Australian investors tried to diversify away from companies exposed to the domestic economy.
Two such companies, City Chic Collective and the a2 Milk Company, bucked sector trends to deliver earnings surprises.
Plus-sized women’s fashion retailer City Chic Collective posted results that exceeded market expectations, with like-for-like store sales growth of 9.6 per cent and earnings before interest, taxes, depreciation and amortisation up 22 per cent. Another bright spot was the 29 per cent growth in online sales, with strong results from Australia, New Zealand and the United States.
We believe City Chic Collective has carved out a strong niche in the plus-sized female apparel market, has managed a successful entrance into the US, and is driving future growth through its online presence and a store roll-out in Australia.
a2 Milk delivered a strong start to the financial year, exceeding expectations with revenue up 41 per cent and net profit after tax up 55.1 per cent. a2 Milk has a strong brand and continues to grow its infant formula market share in Australia and China.
Management continues to invest in the long-term profitability of its business by accelerating its marketing spend to increase brand awareness, expanding into new geographies and developing new products.
We believe the company’s margin guidance of 31 per cent to 32 per cent may prove to be conservative given the company achieved a 35.6 per cent margin in the first half.
Stocks exposed to the housing sector include Stockland Corporation and Lendlease Group and both reported softer results due to slowing residential sales.
These companies have classified their poor results as temporary, claiming improvements will occur in the second half. Both stocks were sold down after their results, with Lendlease and Stockland falling 10.1 per cent and 7.7 per cent in the following days.
Other businesses affected by the slowing housing market were companies exposed to construction activity. In February, Bingo Industries downgraded earnings forecast by 15 per cent to 20 per cent which saw the share price fall 49.1 per cent. In late January, Wagners Holding Company reduced earnings by 8 per cent, citing delays in the start of big projects.
The direction of the Australian equity market over the rest of 2019 will be largely driven by macroeconomic factors as is typical during the latter part of economic cycles.
During these periods, investors must pay significant attention to the Reserve Bank of Australia’s stance on interest rates, how much stimulus the Chinese government injects into its economy, if a trade resolution is reached between the US and China, and whether Jerome Powell and the Federal Reserve maintain a more dovish stance.
We will be following the direction of the Australian economy closely to understand any changes that will affect company earnings as we approach the August 2019 reporting season.
Martin Hickson is a lead portfolio manager with Wilson Asset Management. Listed investment companies managed by Wilson Asset Management were invested in City Chic Collective and a2 Milk.