By Simon Evans
Fund managers are bracing for more profit downgrades amid the steady unravelling of pricing power among some of the sharemarket’s best-known insurance policies against the scourge of inflation.
As cost-of-living pressures on consumers mounted from sharp jumps in household energy bills and borrowing rates, a select group of ASX stocks with a demonstrable ability to pass through the higher cost of doing business were rewarded with impressive valuations.
But some of these are now meeting resistance from customers.
Yarra Capital head of equities Dion Hershan predicts June could be a very difficult month, as executives and their boards realise results are falling short of forecasts.
“Pricing power is fading,” Mr Hershan said.
Over the past four weeks, a string of companies have announced profit warnings across retail, building products, wine and wheat.
Two large car dealership groups, Eagers Automotive and Peter Warren Automotive, grower Graincorp, and building products companies Fletcher Building and James Hardie all marked down their profit outlook.
Baby Bunting, the specialist retailer selling prams and cots, lost 22 per cent of its market value on May 9 alone.
On Friday, automotive and industrial radiators company Adrad joined the list, diving 12 per cent after a warning about weaker profits.
Wine producer Australian Vintage, which is behind the McGuigan brand, was also preparing for a gloomy trading update, but its shares are suspended while it attempts to raise capital.
Mr Hershan said companies needed strong demand and product differentiation to be able to push through real price increases because “the days of lazy prices are probably over”.
Those qualities were increasingly hard to find.
He suspects the looming downgrades will be broad-based: “Rate cuts and inflation trending down simply isn’t happening. Expectations for large parts of the market are too high.”
Barrenjoey chief equity strategist Damien Boey said the Australian economy was slowing, but there was the added complication of pricing power being constrained.
Mr Boey said Reserve Bank of Australia business liaison data suggested this was happening, to the detriment of profit margins.
“I’m most concerned about retailers, banks and builders,” he said.
Wilson Asset Management portfolio manager John Ayoub said it was almost certain more downgrades would arrive.
“It won’t take much top-line pressures to see a margin crunch,” he said.
Not fully priced in
Mr Ayoub said the prospect of any interest rate cuts had been pushed out to 2025, crushing borrowers who were holding out hope for an earlier easing.
“The consumer was hoping for a reprieve, which isn’t coming,” he said. “They will batten down the hatches now. An element is priced in, but never fully.”
Australian shares have drifted 2.6 per cent from this year’s record high.
Kevin Boyle, chief executive of Adrad, observed that over the past few months there had been a deferral or cancellation of projects by some customers.
Mr Boyle said full-year EBITDA would be between $18 million to $19 million for 2023-24, about 6 per cent to 10 per cent below that of 2022-23.
It was symptomatic of a wider slowdown, detected in the company’s national distribution business, where demand had softened, he said.
Weak retail sales data has been reinforced by soft trading updates from several companies.
Morgan Stanley equity strategist Chris Read said figures for March quarter construction work missed expectations significantly.
Activity in home building and renovations fell to a near two-year low as builders struggled to find trades people, the latest official ABS data showed.
Over the first three months of the year, the total value of residential work done fell 1.2 per cent to $19.58 billion on a seasonally adjusted basis, the lowest volume of work completed since the June 2022 quarter.
Fletcher Building, which has the Tradelink plumbing and bathroom supplies business up for sale in Australia, downgraded full-year profit forecasts by 13 per cent on May 13.
Sarah Mann, an analyst at Moelis Australia, said in the automotive sector the supply chain disruptions that had caused serious shortages two years ago were now rapidly unwinding.
“Whilst supply has generally improved across the industry, our channel checks suggest that there are some brands and models that are significantly oversupplied,” she said.
They included Mazda, Volkswagen, Volvo and a raft of Chinese brands. BYD, backed by Warren Buffett, has had a flood of vehicles arrive in Australia.
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