By David Rogers
Heightened uncertainty about the macroeconomic outlook has stoked a slightly bigger than usual downgrade of expectations for Australian corporate profits this reporting season, amid industry cost pressures and commodity price volatility.
The bourse has almost fully recovered from a US growth scare at the start of August that saw a huge two-day fall in share prices amid a global stock sell-off.
However, Australian corporate earnings forecasts are being reined in as costs rise for industrials companies and commodity producers face weaker revenue.
Financials have been a standout, in part because sustained high interest rates are supporting net interest margins and buoyant property and jobs markets have curbed bad debt provisions. US interest rate cuts are widely expected from next month, but Australia’s sticky inflation and Reserve Bank guidance that domestic interest rates may be on hold for an “extended period” add to uncertainty about the corporate earnings outlook globally due to US political uncertainty, weak growth in China and geopolitical risks from wars in Ukraine and the Middle East.
“The tone among CEOs is cautious,” said WAM Leaders lead portfolio manager Matthew Haupt.
“No one’s really investing ahead of the curve – you have pockets like AI – but the theme is just a degree of conservatism and caution on the part of companies.”
After reports from about two-thirds of the top 200 companies in the past three weeks, analysts have trimmed their forecasts for total earnings per share in the 2025 financial year by 0.9 per cent, compared to an average downgrade of 0.7 per cent during reporting seasons, according to MST Marquee.
Commodity sector earnings have fallen 1.8 per cent versus a “normal” downgrade of 1.2 per cent for the sector during the reporting season months.
Industrial companies in the ASX 200 index, excluding financials and commodities producers, have been downgraded by 1.2 per cent, versus 1 per cent normally.
“There’s a hole in the Aussie profits bucket,” said MST senior analyst Hasan Tevfik.
“In fact there are two holes, and our analysis of profit and loss statements suggests they are operating costs for the industrials and revenue concerns for the commodity producers.”
Industrial companies look to be enduring “negative jaws” in costs compared with expenses.
Their guidance points to a small rise in operating costs and a small fall in revenues.
A large proportion of this increase in operating expenses has been due to labour costs.
REA Group highlighted an increase in bonus payments pushing up its wages bill, and it also increased its headcount for strategic investments while rival Domain Holdings forecast higher labour costs driven by wages and headcount increases.
Origin Energy had $50m of extra labour costs, partly associated with an increase in temporary resources because of the migration to its Kraken customer service system.
Aurizon Holdings endured higher maintenance costs, largely due to wage inflation.
But Mr Tevfik said it was not just labour costs lifting operating expenses for corporate Australia.
JB Hi-Fi’s cost of doing business rose 5.5 per cent despite its “disciplined cost control”.
Still, the electronics retailer reported FY24 group pre-tax earnings 5 per cent above expectations and its trading update showed improved momentum despite the cost of living crisis.
Nick Scali highlighted more expensive freight rates to Europe and Britain while James Hardie Industries noted higher freight rates, as well as unfavourable cement and labour costs.
Despite its stretched valuation, CBA’s earnings met expectations and its results showed “very solid execution in managing volume growth and asset and liability pricing”, according to Citi.
“This provides support to core earnings expectations, and our analyst expects the market will likely be revising net interest margins higher,” said Citi equity strategist Liz Dinh.
The other main squeeze on profits has been falling commodity revenues.
China’s property slump has spawned a glut of steel, which led iron ore prices to fall as much as 36 per cent, from an 18-month high of $US143.50 a tonne in January to a 21-month low of $US91.45 this week. China’s weak economy has also contributed to an ongoing collapse in lithium prices.
“The weakness in China remains the central concern here,” Mr Tevfik said.
Rio Tinto said steel demand from the Chinese property sector was now down by as much as 30 per cent from its 2020 peak.
BlueScope Steel said soft steel demand in China had hurt its local business and bigger steel exports from China appeared to be hitting its North American revenues. But despite a median downgrade of 7 per cent for earnings per share for the companies that have been downgraded, those companies have only underperformed the market by an average of 1.3 per cent.
“Investors are not really penalising losers and rewarding winners well,” Mr Tevfik said.
“They could be looking beyond the valley in Aussie profits and potentially focusing on the upcoming recovery.”
The reporting season has given hope of an earnings recovery linked to an improving demand outlook, even as sustained high interest rates are having mixed impacts.
The consensus among analysts is that corporate profits are bottoming out.
Total profit growth is expected to fall 3 per cent for FY24 before rising 2.6 per cent in FY25 and 4.4 per cent in FY26.
Total dividends are set to fall 2.3 per cent in FY25 due to a 12.8 per cent fall in commodity-sector dividends and a 2.6 per cent fall in bank dividends.
Dividends outside banks and resources are expected to rise 6.8 per cent, according to Citi.
But Mr Haupt sees considerable uncertainty and stretched valuations.
As a year ago the global business cycle was expected to weaken but it proved stronger than expected.
The JPMorgan global manufacturing PMI rose from a “contractionary” level of 48.6 in July 2023, hitting an “expansionary” two-year high of 51.0 in July 2024, but has since fallen to 49.7.
“Our feedback is that everyone (corporates) is holding off on investing in the US before the election outcome – you don’t want to sink a lot of capital in if the environment is going to change,” Haupt said.
“The US jobs market is definitely cooling – it’s just a question of whether it falls off a cliff.
“There is enough to warrant a degree of caution.
“The odds of recession are still low but the data are increasing that probability. No one really knows but everyone’s wary.”
Many companies were battling cost inflation as wage inflation has been relatively sticky while selling price inflation was cooling.
“There is a bit of a margin squeeze under way at the moment,” he said.
“Domestically, it’s more a case of consumer spending. We’ve got the tax cuts, but the RBA is still trying to fight off inflation, so the RBA commentary has sort of subdued the consumer a bit.
“A soft landing is baked into share prices already, so it’s hard to see huge upside from here.”
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