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Jun Bei Liu: Key themes to shape the coming reporting season

For an active investor, there is nothing more exciting than reporting season. It is a time when fundamental research is rewarded with strong company results and, hopefully, a rise in the share price (or fall if it is a short position).

This is especially true for the coming results season. Many investors have suffered from a volatile macro backdrop with elevated uncertainty meaning many stocks have drifted away from long-term fundamental value.

We see a number of dominant themes playing out in the upcoming reporting season that are likely to provide a great barometer for the health of corporate Australia, as well as a deep cross-sectional view of the national economy.

 

What consumer slow down?

Consumer-facing companies will be closely scrutinised this season. It’s likely many of them will report very strong results and trading updates. So far, we have heard from leading retailers, such as JB Hi-Fi, upgrading earnings and beating consensus expectations by more than 10 per cent.

Homeware retailers, such as Harvey Norman, will report solid numbers. But will that matter? FY22 results are now firmly in the rearview mirror, interest rates have already risen dramatically and have much further to go with another half-percentage point rise expected to come at the RBA’s meeting next Tuesday.

Consumers are already feeling the pinch with food prices rising in the high single digits, energy price inflation hitting double digits, and many also facing the rollover of fixed home loans into more expensive rates in the next six to 12 months.

It is hard to see how consumers can continue with the high levels of spending of the past two years. With international borders now open, and services and entertainment returning to normal, consumers will have other things to with their dollars than buy another TV or sofa – particularly when house prices are also in rapid decline.

This may well be the retailers' last hurrah before we enter into a tougher environment, and this Christmas is looking increasingly like it will be a particularly hard one for retailers.

Rising costs, particularly labour costs, have been increasing for the better part of 18 months, thanks to supply chain disruptions and Moscow’s war on Ukraine. This reporting season we will see some of the worst impacts and possibly the beginning of a sharp rise in wages already witnessed in broad macro measures and bargaining agreements.

Margins will come under further pressure as wage growth is often difficult to offset, particularly when it is rising rapidly and when final demand is also slowing (which we have rising interest rates to thank for).

We expect labour-intensive businesses – such mining services and builders – to continue to point to a tough outlook ahead as skill shortages compound the need for employers to also help address rising living costs.

It’s not all doom and gloom, however. Over the next six months we should see sequential improvement in some areas of costs as raw materials come off their highs and supply chain bottlenecks ease. In addition, companies are running lean with a decade-long focus on cost control, and a quick decline in broad inflation pressures will help alleviate the need for long-dated wage increases.

 

Buybacks and special dividends

Corporate Australia is in excellent shape in terms of balance sheet strength, with many companies reaching almost debt-free levels and with a limited need to tap capital markets given the influx of raisings that occurred throughout the pandemic.

We anticipate increasing special dividends and buybacks this reporting season. Diversified mining companies such as BHP are poised to announce large buybacks as are banks such as CBA, and oil companies such as Woodside.

In fact, this reporting season might just be the best season yet for dividends and capital repayments. One caveat is mergers and acquisitions: with the growth outlook slowing, many companies will struggle with cost pressures and a slowing top line. We will see more businesses looking to buy growth, and this reporting season will give a hint as to which companies are already moving down the acquisition track.

 

Growth companies are growing slower

The 2022 bear market in growth stocks has been brutal.

Bear markets tend to have two phases. The first is a contraction in valuations and the second is when earnings growth begins to slow and/or contract. The equity market correction started with a significant de-rating in growth stocks as bond yields spiked higher.

The second phase, when earnings growth slows, is yet to be seen in most growth stocks if not for the broader market including many value stocks that have a higher cyclical element.

We think trailing results will be solid, but the outlook is weakening, and broad macro uncertainty will mean companies are cautious in their guidance given the market is unforgiving to disappointments.

But many of these concerns are short-term and stocks are trading at significantly cheaper levels already. The next few months will be difficult to navigate, and it will be important to sort out the “noise” from what really matters.

Companies with strong fundamentals will still shine and for investors who can look through the noise, there will be great opportunities to set up portfolios of quality names that offer strong long-term value.

 

Disclaimer: This material has been prepared by Australian Financial Review, published on 31 July 2022. HM1 is not responsible for the content of linked websites or content prepared by third party. The inclusion of these links and third-party content does not in any way imply any form of endorsement by HM1 of the products or services provided by persons or organisations who are responsible for the linked websites and third-party content. This information is for general information only and does not consider the objectives, financial situation or needs of any person. Before making an investment decision, you should read the relevant disclosure document (if appropriate) and seek professional advice to determine whether the investment and information is suitable for you.

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