The Australian full year 2017 reporting season has started badly, with more and more leading companies failing to meet consensus earnings expectations and downgrading forward guidance. This is NOT a good development, which is leading to FY18 consensus earnings estimates being downgraded and also seeing some savage share price falls in response.
The list of disappointments is across a wide variety of industries which suggests that analyst expectations and share price expectations had simply got ahead of reality.
The list of disappointments includes but is not limited to: Rio Tinto (RIO), Suncorp (SUN), AMP (AMP), James Hardie (JHX), Magellan (MFG), REA Group (REA), Crown Resorts (CWN), Mayne Pharma (MYX), JB Hi-FI (JBH), Domino’s Pizza (DMP), Sonic Healthcare (SHL), Sky City Casino (SKY), Westfield Group (WFD), Ansell (ANN), AGL (AGL), Aurizon (AZJ), Santos (STO), Seek (SEK) and Computershare (CPU).
The list of positive surprises is much shorter, with CYB Plc (CYB), IOOF (IOF), GPT (GPT) and Bendigo & Adelaide Bank (BEN) seeing positive earnings revisions and positive share price reactions.
Interestingly, the four positive surprises had “low expectations” in terms of consensus forecasts and share price performance, while almost all the disappointments were high on the analysts love index and had performed strongly into their results.
It’s the old “travel and arrive” theory. These “great expectation” stocks have “travelled” well into their results, but fell apart on “arrival”. It’s vice versa on the low expectation stocks. It also reminds you that if you own high expectation crowded investments, they have to deliver on those baked in expectations and beyond.
The same travel and arrive scenario was seen in certain large cap “great expectation” US equities over the last few weeks, where, for example, high flying technology names like Amazon (AMZN), Alphabet (GOOGL) and Zillow (Z) fell sharply after confirming weaker than consensus earnings that led to consensus downgrades.
AMZN, GOOGL & Z post reporting
As I have repeatedly warned, I think technology stocks in particular are priced for perfection and if you don’t deliver perfection then be prepared to be punished in share price terms.
This week my fund exited its last pure large cap technology stock, the US listed Chinese internet giant JD.COM. Thankfully we sold out before JD delivered Q2 earnings that were less than expectations and saw the share price fall sharply.
My fund has rotated from “growth” to “value”, feeling the MUCH stronger future returns will come from value stocks. We are particularly bullish on banks globally and selected US dollar earners in Australia that have now pulled back to what we consider “value” multiples.
I am absolutely NOT buying the pullback in any “great expectation” stock globally or locally that has disappointed on earnings. They have simply gone for wildly over-priced to over-priced. Leave them alone and focus on stocks with justifiable valuations that are delivering on their earnings outlook.
Between now and year end, I forecast the following:
- The US dollar will bounce from oversold levels and in turn drag the Australian dollar back towards 75usc.
- The Federal Reserve will raise interest rates and also start winding down their balance sheet.
- Global bond yields will rise.
- World economic data will accelerate, led by the USA and Eurozone.
- There will be a rotation in equity markets from growth to value.
- The best performing sectors will be financials, but in particular banks.
- The worst performing sectors will be technology, healthcare and infrastructure.
- The ASX200 will underperform global markets.
It is time to be VERY selective and REDUCE the number of stocks in your portfolio.
What this has meant in the AIM Global High Conviction fund is we have sold all our global technology stocks, we have increased our investments in ING, ABN Amro, UniCredit, Bank of America and CYB PLC (CYB).
We have also increased our investments in ASX listed US dollar earners, but with particular emphasis on Aristocrat (ALL) which is now the largest holding in our fund.
ALL fits every attribute we look for and is now cheap, very cheap in our view. It will deliver more than the now conservative consensus earnings forecasts and deliver total share price returns well beyond the ASX200 and what global markets will deliver.
In a sea of downgrades and disappointments, ALL consensus earnings have risen due to what we think is an excellent acquisition that further increases the percentage of earnings ALL generates offshore and also diversifies its income streams by sector.
The chart below shows ALL CY18 consensus EPS estimates have risen to 101c. The share price has recently fallen but we see no reason why the share price won’t close the gap back up to the EPS line over the year ahead. That would equate to an ALL share price around $24.00.
To quote directly from the well-regarded Wilson’s gaming analyst on ALL…
Aristocrat Leisure has announced an acquisition to bolster the digital business which seems to be sound from a strategic perspective. The deal to purchase Plarium in the digital gaming space for >$500m USD has a number of supporting pillars. Revenue exposure increases materially to the fast-growing digital segment, it expands the digital market opportunity and is unsurprisingly EPS accretive given the use of debt. While we believe the price paid is on the high side we believe the deal makes sense for the long term. We reiterate our BUY call, EPS upgrades of +3% in FY18/19E and TP increases to $25.38 reflecting the impact from Plarium.
Key points Plarium deal adds further digital expertise: Plarium is a free-to-play mobile, social and web-based game developer. Revenues are spread globally with scale in the US and Europe. The games include strategy games, role-playing and casual games. Nine key games are being monetised. Financial performance appears strong: Plarium has posted +55% CAGR revenue since 2012 and 63% EBITDA CAGR. We would also envisage some synergy benefit post acquisition given Aristocrat’s current stronghold in digital. Pleasingly, Plarium’s management have been locked in until 2020 creating stability during the acquisition and integration process.
EPS-accretive deal given funding mix: The deal should be EPS accretive. EPS forecasts increased by +3% for FY18/19E. This deal is being funded from cash and debt ($425m USD seven-year term loan). Aristocrat will be c.1.5x ND/EBITDA pro-forma (as at H1’17A) and hence the BS still has flexibility post the deal. Price paid relatively full but balanced by strategic fit: The deal ticks the box from a strategic perspective – we particularly like the more recurrent nature of the incoming revenues and also further re-pointing the franchise towards digital over land-based gaming. Our analysis does imply the near-term ROIC is around 2.4% beneath the current CoC – albeit balanced by potential synergy mid-term.
Valuation remains undemanding given growth: In our initiation (ALL: Slots cycle still spinning, 4 August) we indicated that Aristocrat had barely re-rated over the past three years. All stock out-performance has been earnings momentum led. At 22x FY18E PER for 17.5% EPS CAGR FY17-19E, we see upside and reiterate our BUY call.
I completely agree with that view and as I said we have used the pullback in ALL to take ALL to our biggest individual holding in the fund.
As I also said, we have bought more CYB PLC (CYB) on the ASX after excellent numbers.
So while I am NOT buying any of the great expectation disappointments globally or locally, and continue to feel the ASX reporting season will disappoint, I am buying ALL and CYB in Australia as they should offer strong total returns over the next 12 months.
Be careful out there people, this is not easy right now and the punishment for the crime, in terms of share prices reacting to earnings disappointments, is very large.
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.