With reporting season upon us, companies could be forced to cut expenditure as profit growth is expected to slow.
Many Australian corporates are in for a difficult earnings season come August, with subdued consumer spending and sentiment weighing on earnings, says Dermot Ryan, a fund manager at AMP’s Australian Equities team. “We’ve seen some pretty challenged conditions across a lot of domestic focus sectors for the past few months despite the fact the market is rallying very high. Profits, and the expectations of profits, across the market outside of the export and resources sectors have actually been quite low.”
Commenting in mid-June, Ryan noted the market had received a “bump” thanks to the surprise election win by the Coalition, with expectations there would be more stimulus from tax cuts and lower interest rates would help domestic-focused stocks. Nonetheless, analysts are pessimistic about profit growth, forecasting just two per cent earnings-per-share (EPS) growth in the 12 months to June this year, according to IBES market consensus numbers.
Ryan points out that what profit growth there is has largely been driven by the resources sector, helped by strong commodity prices and a lower Australian dollar. “What we’re seeing in the general economy is banking profits are probably going to be negative and earnings per share growth would be maybe flat to potentially slightly down over the next year.
We’re also seeing that industrials and domestic-related sectors had, in aggregate, a pretty challenged couple of months.”
Greg Smith, head of research at equity research house Fat Prophets, says stronger resources prices such as a doubling of the iron ore price to around US$120 a tonne from a year ago, will also support profits in sectors related to resources, such as mining services. Qantas is considering moving more aircraft to the West Australian fly-in, fly-out services, CEO Alan Joyce said in June, adding he expected mining to remain strong for the next few years.
However, Smith says he believes the sector won’t improve much more. “I’m not sure things are going to get much better going forward — and this might even be the peak earnings season for a lot of those companies. It’s hard to see iron ore going higher.”
Despite softer earnings overall, Smith says the “vibe will be generally positive” thanks to a boost in confidence from the Reserve Bank of Australia rate cut. Speaking in June, he said he expected the construction and building sector to be weak thanks to the decline in property prices. However, he added that property prices appear to be bottoming out with auction results picking up in Sydney and Melbourne, particularly now investors will be able to continue negatively gearing property following the re-election of the Morrison government.
Giselle Roux, chief investment officer at wealth management advisory firm Escala Partners, says there are unlikely to be earnings surprises from major companies because they usually flag any results the investment community isn’t expecting ahead of the earnings season. “The big companies are very attuned to letting the market know, prior to the results, what they should expect. Therefore, there are generally far fewer surprises in those ones. Most of the surprise or market reaction comes from the mid to smaller end.”
On the home front
Various domestic-focused companies have cut their profit forecasts and blamed weak consumer spending. Casino giant Star Entertainment Group cut its operating profit (EBITDA) forecast by three per cent thanks to the continued decline in revenue from super-rich VIPs, alongside weaker domestic growth. Flight Centre slashed its pre-tax underlying profit guidance for the 12 months ending June 30 to $335m–$360m, down from the $390m–$420m range it flagged in October, blaming a “flat consumer market”. Managing director Graham Turner said Australians are not booking as many overseas holidays while the economic outlook remains uncertain — and that falling house prices are weighing on consumers’ minds.
Lighting retailer Beacon also cited falling house prices as impacting on its earnings, with EBITDA for the March quarter down 11.6 per cent. Car dealership Automotive Holdings Group has warned profits for 2018–19 will be weaker than expected because of a downturn in new car sales.
While many of the biggest profit downgrades will have already been flagged to the market before the earnings season gets underway, Ryan says the market will be looking at to what extent any “new-found hope” from the election results have spilled over into profits.
“Management outlooks for profit guidance for the next financial year will be very important come August because we’ve had a very big rally at this point and if those profit numbers are weak and/or if the outlook statements don’t point to at least stable or improving profit outlook, then the valuations of some of these stocks will come under downward pressure.”
Ryan will be looking to see how much companies are investing for growth — and how much cash they are returning to shareholders. “Companies and boards in particular should always be looking for good growth options,” he says. “How you manage your balance sheet and cash at hand is really important and very important for driving long-term growth. Companies are investing in cost efficiencies and investing for growth where they can.”
The cost cuts also mean companies have abundant free cashflow, which supports dividend growth and buybacks. Record amounts of franking credits have been distributed to shareholders in the past eight months and Ryan expects that trend to increase in the next financial year.
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