Good investors constantly ‘take the temperature’ of the economy, and companies, in order to make decisions. Company reporting season offers investors a smorgasbord of information, but investors need to assess what information is useful.
This reporting season draws to a close at the end of August and is expected to feature broad themes according to Hugh Dive, Portfolio Manager at Atlas Funds Management. These include 1) effect of higher interest costs on earnings 2) impact of inflation on operating costs 3) lower Australian dollar and 4) slowing consumer demand as a result of higher interest rates.
Every sector needs to be looked at differently, so some of Australia’s leading fund managers share their views on what investors should be looking for from this reporting season.
The banking sector is probably one of the most widely owned in Australia, but Nathan Bell, Portfolio Manager at Intelligent Investor, highlights that most banks have produced next to no capital gains over the past two decades despite the largest credit and housing boom in history. He expects investors will suffer more of the same over the next decade as net interest margins are not going back to the high levels of years ago. CBA’s result showed lower net interest margin as a result of higher funding costs, depositors switching banks for higher deposit rates, which are offsetting the benefits from higher mortgage rates. While Bell expects bad debts to remain low, margin pressure and relatively high valuations doesn’t augur well for future returns.
Dan Moore, Portfolio Manager at Investors Mutual says that investors in discretionary retailers should pay attention to the level of inventories as this will highlight the outlook for margins. High inventories is negative for margins. Dive believes that the sales results for the first 4 weeks of July, which is announced when companies report, is a key indicator of future sales activity.
For supermarkets Moore is focussing on signs of consumers ‘trading down’ and switching to own label products which can protect margins. Dive will be watching for wages pressure and goods inflation and whether these higher costs can be passed onto consumers. An increase in a supermarkets net margin implies that higher costs have been passed on successfully to consumers.
Bell says that the ferocious competition in the Telco sector has recently been replaced with more sensible and higher pricing. Average revenue per user (ARPU) is the key metric he is looking for to determine whether consumers are accepting price increases. Given Telco’s low margins, small movements in ARPU can have a huge bearing on profits and dividends. Telstra recently announced ARPU increased by 5.4% and profits grew by 13%. The 3 major telco’s have all increased their prices in recent times which should flow through to their financial statements this reporting season. Moore also looks at customer growth relative to peers to highlight whether consumers are trading down to budget carriers.
The important aspects for the property sector according to Moore are the re-leasing spreads, which is defined as the difference between the new rent and the prior expiring rent. Positive spreads indicate future rental growth and vice versa. Industrial spreads are likely to be positive while office spreads remain under pressure. Dive says that another focus will be on valuations and expects falls in shopping centres and office trusts with minimal movements in industrial. The cap rate used to determine valuation is key, (higher cap rate results in lower valuation) so investors should make sure the cap rate used is appropriate.
Bell thinks that profit results from iron ore miners will play second fiddle to expectations for the iron ore price. Supply is expected to increase over the next couple of years, plus China’s lower focus on fixed investment bodes poorly for Australia’s iron ore miners given their current high valuations.
Markets are forward looking by nature. Profit reports that on the surface appear poor, but result in the share price rising, suggests the market was factoring in a worse scenario than what was delivered. Investors should be alert to these situations as they can suggest an inflection point for company earnings and result in a profitable trade.
Profit reporting seasons presents investors with sign posts of what may lie ahead, but knowing which signs are important is key.
Mark Draper writes monthly for the Australian Financial Review - this article was published on 23rd August 2023