Earnings season outlook – pressure to perform

Financial journalist
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The summer holidays are a distant memory for those in the investment business, as the February reporting season moves into full swing this week.

Most companies will report their results for the half-year to December 31, 2013, but there is an influential minority that uses the calendar year as their financial year. This group includes resources heavyweights Rio Tinto (RIO), Woodside Petroleum (WPL), Santos (STO), OZ Minerals (OZL), and OilSearch (OSH), as well as Leighton (LEI), QBE Insurance (QBE), AMP, GPT, Caltex Australia (CTX), Australand Property Group (ALZ), Coca-Cola Amatil (CCL), APN News & Media (APN), Adelaide Brighton (ABC), Spark Infrastructure Group (SKI), InvoCare (IVC) and Sydney Airport (SYD).

This week sees some of the market’s heavyweights sliding in to the confessional booth. On Wednesday, Commonwealth Bank (CBA) reports its half-year result: broker UBS expects an interim net profit of just over $4.2 billion, compared to $3.8 billion a year ago, and lift its interim dividend by 16 cents to $1.80.

On Thursday, it’s the turn of Telstra (TLS), whose interim net profit is expected by the UBS analysts to come in at about $1.79 billion, up about 12% on the $1.6 billion earned a year ago, and maintain the dividend for the half at 14 cents.

Thursday will also see Rio Tinto’s full-year result: last year, the mining giant posted the first net loss in its history – of $US2.99 billion ($A2.9 billion) – dragged down by write-downs in its aluminium and Mozambique coal assets. This year, UBS expects Rio to deliver underlying 2013 earnings of about $US9.8 billion ($11.1 billion).

Investors are hoping to see sound profit growth from the interim reporting season, to justify the high price/earnings (P/E) ratio expectations.

P/E expansion – effectively, the market being prepared to pay more for expected earnings – has driven a large chunk of the Australian market’s performance in recent years. The estimated forward P/E for the S&P/ASX 200 surged by 23% in 2012, and rose by 14% last year. Also pushing share prices higher has been the element of money flowing out of low-returning cash and bonds in search of higher yields in share dividends, and capital growth on top.

The pressure is on

The prospective P/E for the S&P/ASX 200 Index is currently about 14.1 – 14.2 times earnings, significantly higher than its five-year average of about 13.4 –13.6 times. This P/E expansion is more pronounced in some areas of the market: State Street Global Advisors, for example, reckons the forward P/Es for the market sectors leveraged to the domestic consumer – banks, media, retail and consumer services – are trading about 20–30% above normal longer-term levels.

Quite simply, companies are under pressure to deliver earnings growth to justify their mostly elevated P/E ratings.

For the financial year, analysts’ consensus expectations are for about 14% earnings growth across the S&P/ASX 200, led by about 35% growth in resources profits, on the back of the lower Australian dollar and reduced capital spending requirements, and 8% growth for industrials. (The most optimistic projections expect resources stocks’ profit growth to be 50% plus for FY 14!) The interim season will go a long way toward strengthening the case that this could be achieved – or not.

What the market does have in its favour are the benefits of the lower Australian dollar for miners and others with overseas earnings, and strengthening consumer spending for those with a domestic focus.

Over the last few reporting seasons, investors have seen plenty of focus from companies on cost control, which has been admirable, but companies can’t cut their way to growth. The market really needs to see concrete signs of top-line (revenue) improvement.

Spending again

According to broker CommSec, Australian retail spending clocked in at $264.2 billion in 2013, up 3.2 %, and the strongest calendar-year growth in four years. Real spending rose 0.9% in the December quarter after a 0.8% rise in the September quarter – the best back-to-back gains in 18 months. That will help stocks exposed to domestic spending, as will the prevailing low-interest-rate environment.

With some results already in, this trend is evident. For example, speciality home appliance retailer JB Hi-FI (JBH) reported a strong set of numbers, with sales up 6.8% for the December half-year to $1.94 billion and net profit up 10% to $90.3 million, and a 5 cent (10%) lift in the dividend, to 55 cents.

Fashion retailer Country Road (CTY), which is also at the mercy of consumers’ willingness to part with their cash, saw its first-half profit surge to an all-time high, up 72% to $38 million, on the back of a 27% lift in revenue, to $424.6 million. While Country Road did not give official guidance for the full-year, it did flag “improved results” for the remainder of the year.

Debt collections business Credit Corp (CCP) delivered results ahead of previous guidance, with revenue up 25% to $84.1 million, and underlying net profit up 12% to $14.6 million: even better, the company upgraded expectations for the full year. Breathing-products medical device maker ResMed (RMD) disappointed analysts with weak revenue growth, but the company maintained both its margins and its confidence in its full-year earnings guidance.

Companies forecast to surprise on the upside by broker UBS

  • CSL (CSL) Feb 12
  • Ansell (ANN) Feb 17
  • Sonic Health Care (SHL) Feb 18
  • Arrium (ARI) Feb 18
  • GWA Group (GWA) Feb 18.
  • Fairfax Media (FXJ) Feb 19
  • Fletcher Building (FBU) Feb 19
  • Ramsay Health Care (RHC) Feb 25
  • Henderson Group (HGG) Feb 26

Companies forecast to surprise on the downside by broker UBS

  • Leighton Holdings (LEI) Feb 19
  • Cochlear (COH) Feb 11
  • Carsales.com (CRZ) Feb 12
  • UGL (UGL) Feb 17
  • Asciano (AIO) Feb 18
  • Cardno (CDD) Feb 18
  • Coca-Cola Amatil (CCL) Feb 18
  • Suncorp Group (SUN) Feb 19
  • Insurance Australia Group (IAG) Feb 19
  • AMP (AMP) Feb 20
  • Trade Me Group (TME) Feb 19
  • Treasury Wine Estates (TWE) Feb 20
  • Monadelphous Group (MND) Feb 20
  • Wotif.com Holdings (WTF) Feb 26
  • Worley Parsons (WOR) Feb 26

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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