Reporting season always gives us the good, the bad and the ugly – and situations that are not as clear-cut. Often the market reacts poorly to a result for reasons that can appear, on further examination, to be capricious.
This is where long-term value-oriented investors occasionally get the bonus of a price fall opening a window for them to get into (or back into) a stock that had run away from their parameters.
Here are three situations from the recent reporting season that fit this description, for contrarian investors unwilling to share the market’s immediate reaction to a “disappointing” result.
BWX (BWX)
Market capitalisation: $624 million
Forecast FY18 yield: 1.8%, fully franked
Analysts’ consensus target price: $5.90
Body, hair and skincare company BWX came into reporting season on a high – in fact, it was a market darling. Having listed in November 2015 at $1.50 a share in a heavily over-subscribed float, BWX was trading at $7.34. That positioned the stock on a forward (FY18) expected price/earnings ratio (P/E) of 32 times earnings and an historical (FY17) P/E of 45 times earnings. That made it the kind of high-multiple stock that couldn’t afford a slip-up.
Unfortunately, while revenue for the December 2017 half-year surged 79%, to $67 million, BWX reported net profit down 34%, to $5.4 million. The company gave EBITDA (earnings before interest, tax, depreciation and amortisation) guidance in the range of $42 million–$46 million for FY18, which would represent an increase of between 60%–74% on FY17. That sounds impressive – but investors were expecting higher guidance.
The market seemed not to like BWX talking of a $6.5 million hit to revenue in FY18 as a result of its decision to “discontinue third party brand representation” – which is actually a good thing, because it means the company is concentrating its resources on its own brands, which generate higher returns. (BWX owns, produces and distributes the skincare brands Sukin, DermaSukin, Uspa, Renew Skincare and Life Basics, and the hair products brand Edward Beale.) The market also did not like the fact that BWX’s gross profit margin (the percentage of profit made from each dollar of sales before business-related expenses) fell from about 65% to less than 60%. The half-year result was also affected by the acquisitions of North American natural beauty businesses Andalou, Mineral Fusions and Nourished Life – but these improve the company’s international growth prospects in the longer term.
None of that mattered to the market when it stripped 31% from BWX’s valuation in the wake of the interim result. That took the share price back to where it was 18 months ago, and lowered the forward P/E to 22 times earnings (FY18) and 16 times earnings (FY19). All of a sudden, BWX became a lot more attractive in valuation terms, to investors taking the longer-term view. The dividend is not yet an alluring factor – the yield is estimated at 2.5%, fully franked, in FY19 – but BWX still has a strong growth story, for which you’re now asked to pay a lot less than was the case before reporting season.
JB Hi-Fi (JBH)
Market capitalisation: $3 billion
Forecast FY18 yield: 5.2%, fully franked
Analysts’ consensus target price: $27.28
Electronics retailer JB Hi-Fi brought out a first-half result that looked pretty good: underlying net profit rose by 21% to $151.7 million, on sales that jumped 41% to $3.69 billion. Same-store sales surged by 9.7% in the December quarter, after growing by 4.9% in the September quarter. JB Hi-Fi lifted its interim fully-franked dividend from 72 cents a year ago to 86 cents. The company lifted its full-year sales guidance by $50 million to $6.85 billion, compared with $5.6 billion in 2017, but said it expected underlying net profit to rise by 13.1%–15.5%, to $235 million–$240 million.
And there’s the problem. The revised profit guidance fell short of consensus forecasts, of about $242 million. That explains why JB Hi-Fi fell by 8% on its result, and by 12% from where it had entered reporting season.
Another reason for the market reaction was that despite the 9.7% lift in same-store sales in the crucial December quarter, margins did not budge. And with profits projected to grow slower than sales, margins look to be coming under further pressure.
The market also hoped that JB Hi-Fi would upgrade the synergy benefits it expects from integrating The Good Guys, which it bought in September 2016. While The Good Guys is performing well, the synergy benefits are still expected to be in JB Hi-Fi’s original $15 million–$20 million forecast range – albeit at the top of that range. But there was no boost to this.
Taken together, the market treated the JB Hi-Fi outlook as a pseudo-downgrade, and marked the stock down.
Again, this opens up more attractive value to the longer-term investor. JB Hi-Fi’s expected fully franked dividends are also alluring, at consensus (Thomson Reuters) 5.2% for FY18 and 5.5% for FY19. There remains lingering concern about the effect that Amazon’s entry to Australia will have on JB Hi-Fi, but the company is investing to protect its market position, while being deliberately conservative with its guidance – in particular, with respect to The Good Guys – which should enable it to impress over the next few reporting periods.
Nanosonics (NAN)
Market capitalisation: $806 million
Forecast FY18 yield: n/a
Analysts’ consensus target price: $2.89
Nanosonics is an emerging global medical technology star. Its world-first trophon disinfection technology is a major breakthrough for medical devices that cannot be sterilised by conventional means because of heat sensitivity. Before trophon, ultrasound probes were disinfected with corrosive chemicals that were only about 80% efficient. Trophon is a ‘biocide’ technology that is more efficient and environmentally friendly.
The technology is based around very fine, vapourised droplets of concentrated hydrogen peroxide, which kill microorganisms on surfaces: there is no hazardous waste to dispose of afterwards as the only by-products are oxygen and water. The technology is more cost-effective than its nearest competitors – which, in any case, are not as “clean” – and stands every chance of being accepted as the global standard of care.
However, Nanosonics is making the transition from having developed a world-beating technology to rolling it out around the world – and the commercial aspects of that were behind an interim result that disappointed the stock market. Revenue was down 4% to $30 million, gross profit was up 3% to $3.7 million and net profit fell by 48%, to $2.2 million. The lower sales figure was explained by the build-up of inventory (of units, consumables and accessories) at Nanosonics’ North American distribution partner, GE Healthcare: this can be seen mainly as a timing issue. But for Nanosonics, a more important number is the installed base of trophon units: in North America, the installed base increased by 1,700 units during the half, to 14,100 units. Globally, the installed base is now 16,000 units.
Nevertheless, the shares fell 14% on the back of the result.
There was no financial guidance provided, but Nanosonics expects continued growth in its installed base in North America, saying that the second half of FY18 should show the same growth as the first half. The installed base in the other territories where it sells trophon – Australia/New Zealand, the United Kingdom, Europe, Singapore, Hong Kong, South Korea, Japan – should also grow. Nanosonics’ strategy is both to expand trophon use in existing markets and to enter new markets. Beyond FY18, the company says shareholders can expect the introduction of new products – including the second generation of trophon, as well as “one or more new infection prevention solutions” in FY20, subject to regulatory approvals.
Because of the poor reaction to the interim result, this growth story got a lot cheaper for investors prepared to look beyond the current financial year.
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