The interim profit-reporting season could not have been better timed. After months of being deafened by market “noise”, investors were reminded that earnings are what ultimately matter for valuations. And on that front, things are not as grim as feared.
The earnings season has so far been better than expected. Solid rather than spectacular, but enough to give the uber bears a much-needed reality check. Just over half of results bettered market expectations (up from an average of 44%) on AMP Capital numbers. Company guidance for future earnings was slightly positive.
You can read that two ways: the market had priced in too much bad news and lowered the earnings bar too low; or Corporate Australia is managing through a sluggish period and doing a good job of cutting costs. It’s a bit of both factors.
The market was badly oversold in early February, when hysteria about a Chinese recession, emerging-market crisis, European Union collapse, US slowdown, demand-driven oil-price meltdown, geopolitical tensions and many other overblown factors spooked investors and drove Australian equities briefly into a bear market.
My base case remains that China, while slowing, is managing its transition to a consumption-led economy in difficult conditions; that the US is a long way from recession; and that lower oil prices, driven by excess supply, not plunging demand, will in time boost the global economy. Look at the effect of lower oil prices on Qantas Airways’ bumper recent profit.
The Australian economy, too, is showing more pluck than the bears had hoped. I still expect another interest-rate cut this year, but many developed markets would be happy with our unemployment rate, housing market and remaining monetary-policy ammunition. If only the Federal Government could get its act together with meaningful tax reform.
For all the volatility, the share market continues to work its way through a slow, grinding recovery that will take years to play out. The profit-reporting season confirmed this view: revenue growth is challenged and the earnings outlook is less visible for many companies.
Against that backdrop, I have sought to identify pockets of market strength that are benefiting from tailwinds in the past 12 months for the Switzer Super Report. They are hard to find. Most sectors are struggling with headwinds, such as falling commodity prices (don’t be fooled by the pick-up in prices this week), or tougher regulatory requirements in sectors such as banks.
Rather than focus on individual stocks, I look to the profit-reporting season to confirm favoured trends by assessing results from several companies and joining the dots.
So far, so good. Trends I have been identifying for this Report in the past year are being reflected in higher earnings and share prices, with the occasional exceptions and disappointments.
Here are four trends and what the interim earnings season told us about them. I’ll cover a few more trends in this column’s upcoming installments.
1. Inbound Chinese tourism boom
I explained the tourism megatrend in August 2015 in detail for this report. Sydney Airport, a column favourite, is superbly leveraged to growth in inbound Asian tourism and could deliver low double-digit growth in distributions over the next few years.
Sydney Airport’s (SYD) calendar year (CY) 2015 earnings were slightly below expectation and the upgrade in CY16 distribution guidance means less scope for positive surprises on the distribution front. It’s time to take a few profits in Sydney Airport after such a stellar run, although long-term income investors have good reason to hold on.
The August 2015 column also identified SeaLink Travel Group (SLK), operator of Captain Cook cruise lines in Sydney, as a prime beneficiary of inbound Chinese tourism. Who doesn’t tour Sydney Harbour by boat when on holiday? SeaLink had a cracking profit result, has soared in the past year, and has prospects for further medium-term gains.
After-tax net profit of $4.7 million for the first half of FY15 was 37% of the same period a year earlier. Revenue grew 9% to $57.2 million and SeaLink said it was “well positioned” to improve on its first-half results.
But SeaLink is probably due for a pause or pullback in the next few months after such a strong rally.
Ardent Leisure Group (AAD), also mentioned in that column, has disappointed in the past year. The theme-park operator had a slightly lower-than-expected result. Its gym division, a market concern, showed good gains, but the US family restaurant business, Main Event, was a touch below expectation.
Nevertheless, Ardent is well placed to capitalise on Asian tourism.
Another column favourite, The Star Entertainment Group (SGR), delivered a solid interim result and it looks to have good earnings momentum. The casino operator has its critics, who believe the Crown casino at Barangaroo in Sydney will crush The Star when its opens. That’s still almost four years away; The Star is being successfully revitalised; and a second casino in Darling Harbour could create a vibrant casino precinct.
Moreover, The Star’s expected growth in South East Queensland, through the giant Queen’s Wharf Brisbane Project and the Gold Coast redevelopment project (at the former Jupiters casino), should create a much stronger East Coast integrated resort offering in the coming decade. Few Australian companies will benefit more from an influx of Chinese tourists in the next five years than dominant casino operators.
Mantra Group (MTR) and Village Roadshow (VRL) were others identified for their leverage to growth in inbound Chinese tourism and, in Village’s case, rising Asian demand for entertainment. Both stocks have good medium-term prospects.
Chart 1: Star Entertainment Group
Source: Yahoo!7 Finance
2. New-media stocks
The decline in old-media stocks shows no signs of slowing. Witness Fairfax Media’s results: a solid effort in the circumstances, but ongoing pain for the legacy print assets, and more confirmation that Fairfax’s real estate business, Domain, is the big value driver.
It’s a different story on new-media stocks. This column has identified several in the past 12 months: oOH! Media, APN Outdoor Group (APN), iSentia Group (ISD), 3P Learning (3PL), and smaller outdoor advertising group QMS Media (QMS).
3P has disappointed, down from a 52-week high of $2.85 to $1.32, and with its CEO resigning. The interim profit result met market expectation, but no growth in margins and cash flow being used to support investment crunched the stock. Using more cash to fund investment is a good long-term move, given 3P’s global potential, but not well timed, given the market’s growing scepticism of the company. We’ll stick with it for now – just.
The outdoor advertising stocks were particularly pleasing. oOH Media’s strong interim result justified its high valuation and confirmed its earnings momentum. APN Outdoor Group’s result was well received by the market. QMS had not reported as this column was written.
Outdoor advertising has a promising outlook as more billboards are converted to digital formats, providing higher margins and greater advertising opportunities. The integration of smartphones and outdoor ad technology (at bus shelters, for example) is another opportunity.
oOH and APN Outdoor are not cheap. But it is a case of letting profits run with these stocks as outdoor advertising grows its share of the total advertising pie in the next few years. Be ready to take profits on the slightest hiccup: these stocks are getting close to being priced for perfection, meaning there is little scope for earnings disappointment. Early investors in these stocks might consider taking some profits.
Media-monitoring company iSentia Group has been a cracking performer in the past 12 months. But it fell this week after announcing a solid interim result. Weaker margins in the content marketing business was the main problem, but the sell off could be a buying opportunity for long-term investors, who recognise iSentia’s long-term potential in Asia.
Nevertheless, it is best to stand aside for now. After such a remarkable rally, iSentia was due for a correction on the slightest bad news, and market momentum, for now, is against it. iSentia is not excessively valued given its growth prospects, but will probably be cheaper in the next few months as profit takers move in.
Chart 2: oOH! Media
Source: Yahoo!7 Finance
3. Speciality A-REITs
I have nominated several Australian Real Estate Investment Trusts (A-REITs) in the past year for this report: Westfield Corporation (WFF), Goodman Group (GMG) and GPT Group (GPT) at the large end; and newer specialist A-REITs such as National Storage REIT (NSR), Arena REIT (ARF), Asia Pacific Data Centre Group (AJD) and Galileo Japan Trust (GJT).
The A-REIT sector has plenty of critics, who believe it is overvalued. But A-REIT valuations arguably look more attractive than those in the infrastructure and utilities sectors, and low interest rates and reasonable property demand are solid fundamentals.
Childcare and healthcare investor Arena REIT had a strong interim result. It forecast 9% growth in distributions per security for FY16 – an eye-catching upgrade in this market. Arena has a one-year total shareholder return of 17% (including distribution) and arguably deserves more market recognition, given its recent performance. It remains an A-REIT to watch.
National Storage REIT delivered a slightly better-than-expected interim result and met market forecasts for its guidance. It looks better valued after falling from a 52-week high of $1.75 to $1.52 and is superbly leveraged to the long-term trend of rising urbanisation and city densification, as more people live in apartments and rent storage.
Chart 3: Arena REIT
Source: Yahoo!7 Finance
4. Discretionary retailers
My positive view on select discretionary retailers in January was at odds with a growing chorus of bears about the Australian economy and retail spending growth this year. More than any sector, investing in retail requires a bottom-up company focus and attention to management, rather than relying on top-down themes and forecasts.
I identified three favoured discretionary retailers in that column: Nick Scali (NCK), RCG Corporation (RCG) and Premier Investments (PMV). Furniture retailer Nick Scali delivered yet another strong result and confirmed its reputation as one of the market’s best-run small caps.
Footwear retailer RCG, a star performer over the past 12 months, was yet to report as this column was prepared, and Premier reports its half-year results in March.
Good results from JB Hi-Fi and The Reject Shop also showed there is plenty of life left in the Australian consumer, and scope for further gains in a handful of well-run retailers that also includes Super Retail Group.
Chart 4: Nick Scali
Source: Yahoo!7 Finance
– Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at February 24, 2016.
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.
