ASX reporting season: Margins, misses, and market opportunities

Quin: 

Welcome to First Sentier Investors Curious Podcast. I'm Quinn Smith, Head of Distribution for Australia and New Zealand. In today's episode, we're going to be unpacking August reporting season, the most volatile reporting season on record.  

This podcast is general information and for an Australian audience only. It isn’t advice. It doesn't take into account anyone's investment objectives, situation or needs. 

Funds referred to in this podcast are issued by either The Trust Company (RE Services) Limited or Colonial First State Investments Limited. Product disclosure statements and target market determinations are available on the First Sentier website and should be considered before deciding whether to invest in the Funds. 

Quin: 

With me today is Christian Guerra, Head of Research for the Australian Equities Growth Team, and David Wilson, Deputy Head of the Team and Portfolio Manager for one of the longest running Australian Geared Equity Strategies. Welcome, Christian and David.  

David & Christian: 

Thank you. Quin. 

Quin: 

If I had to give you one word to describe the past reporting season, what would it be? 

David: 

For me, Quin, it would be exaggerated because for very sort of small misses or small beats, just tiny inflexions of news, you've got dramatic share price movements, which I actually think, as I said, were exaggerated and we definitely saw that right through reporting season.  

Quin: 

And Christian? 

Christian:

And Quin, for me, the word would be encouraging. So you're actually both right in terms of, we saw some incredible and quite outsized moves during the month of August. In fact, almost 50% of stocks moved more than 5% on result day, which is pretty much a record, but I'm using that word encouraging simply because we had overall earnings beat expectations and dividends beat expectations. And more importantly, moreover, I would say that stocks that actually delivered quality results were rewarded. 

Quin: 

Christian, you used encouraging. Let's unpack that. Why don’t we go a bit deeper into? What do you mean by encouraging? 

Christian: 

Sure. So we saw a net beat of around 11% in the reporting season, which was quite a good result. And around one third of companies actually beat expectations. Now, what was really interesting was that the beats were driven by better margins, and for the first time in about three years, margins stabilised, which probably reflects the fact that cost pressures in the economy are probably moderating a little bit, but companies can obviously continue to focus on their cost basis and manage their cost basis really well.  

The other thing that we thought was really pleasing was that dividends actually beat expectations by about 15%, and that was a combination of both stronger earnings as well as modestly higher payout ratios. We also saw special dividends from the likes of JB HiFi, Wesfarmers and Qantas. Now having said that, I did use the word encouraging. We probably just need to temper our enthusiasm a little bit, and I say that for two key reasons. Firstly, we actually saw more companies than usual missed revenue forecasts, and it's actually the worst results since COVID in terms of company's missing on revenue. And as a result of that, analysts actually cut their forward revenue projections. And secondly, despite the fact margins were better, overall, earnings came down simply because the weight of those revenue downgrades. 

Quin: 

Interesting. Thank you for sharing. David. You used Exaggerated. Let's unpack that one now. 

David: 

Well, I think as an active manager, Quinn, it's actually upon us. It's actually an opportunity, in fact for us to take advantage of those exaggerated share price movements that if a stock that we like and you saw an exaggerated move upwards and beyond the valuation where we think exists in the stock, then it's upon us to actually sell that stock or reduce our position. And just as importantly, if we think that market's overreacted on the downside and through this reporting season, you get the usual sort of comments, oh, it's caused by quant funds or it's caused by hedge funds, whatever it may be. But if you see those exaggerated downside movements in stock prices, again as active managers, it's upon us to actually take advantage of those situations. 

Quin: 

Let's talk about some of those glamour stocks that potentially didn't fare so well in the reporting season. Is there any that come to mind?  

David: 

There was a lot of press commentary on this, and they did have exaggerated movements. So you're talking stocks like CSL, you're talking Sonic, you're talking WiseTech, you're talking James Hardie, and you're talking Woolworths just to name a few. And to be honest, most of those, there were good reasons why those, you saw those share price movements in that period.  

So you saw CSL, basically they said to the market that they met expectations, but in fact, then they stepped back from their margin guidance and they stepped back from their revenue growth and the market really didn't get on board with their Seqirus demerger as well. In fact, they saw that as potentially sort of bad news as well. So that I think was fully deserved.  

Woolworths, again, struggled on margin, struggled to compete with Coles and the likes of Aldi as well. And so the market marked that stock down as well. I thought that was perfectly deserved.  

Another stock, James Hardy, again, the market earlier on the year was obviously very, very, disaffected is probably the best word I could use, disaffected with the Aztec acquisition, and then they followed that up with a profit downgrade and the market was really rightly concerned about that.  

And the final one to mention is WiseTech, where it did miss its number slightly in our view. I think it's more just a delay in the earnings coming through. We've got a good strategy around E2open and certainly the rollout of CargoWise was delayed and it's been delayed probably into the second half of this financial year. But to our mind, that still represents an opportunity for us and our investors. 

Quin: 

Thanks very much. Can I move the conversation maybe into a couple of sectors? Christian, how did the banks go? 

Christian: 

Yeah, thank you, Quin. So yeah, I'll talk about the banks and the insurers as well, but I'll start with the banks. And really what we saw was really solid results in an operating environment that really can't get much better for the banks. So you've got credit growth, we call it 6 to 7%. You've got margin headwinds that are abating. In fact, margins actually went up for a couple of the banks in the period. Capital levels are very healthy, which is obviously important for dividends, and we're really not seeing anything in the way of material credit quality concerns. So good results. I mean, we did see there are some headwinds on costs. So the banks are struggling a little bit with their labour costs and also their third party vendor costs, but clearly when you've got a stronger revenue line, it can make up for a lot of bills on the cost line. 

Now we'd say the banks are certainly priced for it, but I think we need to acknowledge that they actually did deliver pretty solid results. And then turning across to the insurers, I'd say that both Suncorp and IAG delivered credible results. There was a bit of capital management, the outlook was pretty solid as well. So we thought they were, again, both pretty commendable in terms of what they delivered.  

QBE I mean, they are seeing a bit of softening in the premium rate cycle, but they're seeing really good volume growth. Again, that was a pretty decent result. And then I guess while we're talking about the insurers, we should mention the insurance brokers, which is a space we're focused on in the past where again, that premium rate sort of normalisation cycle is happening. But we'd argue that's more of a normalisation in the cycle and there's still delivering mid single digit highest single digit EPS growth that's quite often augmented by mergers and acquisitions and bolt-on opportunities. Overall, I think it's a space where they continue to deliver.  

Quin: 

Thanks, Christian. David, do you have anything to add on the banks? 

David: 

Yeah, I think the banks are really topical, Quin because you get a lot of emotion around them. People are saying they're the most expensive banks on the planet, maybe the universe, and it doesn't really concern us too much. I think that they're pretty solid investment propositions, fully frank Dividend yields, ROEs are solid, they're well capitalised. There's no sign of mortgage stress. And so whilst credit growth is around, call it 7%, I don't think they're the world's most exciting stocks. But I think the emotion, it gets a bit odd with the banks and I think they're actually pretty solid places to invest at the moment. 

Quin: 

Moving on from maybe moving on from banks and insurers into other sectors, is there anything that really surprised on the upside? 

Christian: 

Yeah, Quin, I might start there and I might start with a couple of industrials, so I'll kick it off with Brambles, which is a company we've talked about in the past. Again, they delivered a very, very solid result. So their top line's growing, call it mid single digits, they just did 10% EBIT growth the last several years under the new management team, one of the hallmarks has been, they've done a great job on asset control, which is the underlying pallet. So essentially they're losing less pallets, which has been an affliction. This company has suffered from many times in the past. And so therefore their cashflow was very strong and they're still delivering a return on capital of, call it 20%, which is very, very solid in anyone's language. So we thought brand delivered a pretty good result.  

The other one in the industrial space is Qantas, where they're benefiting from strong demand for travel as well as what I'd call a pretty stable operating environment where you've got competition is rational, the oil prices behaving itself, there's not a lot of issues in the rest of their cost base. 

And quite remarkably, they're also seeing some small benefits from their investment in their fleet. So the newer plane, the newer aircraft, the new planes that they're receiving are driving small benefits in terms of both cost and revenue.  

And then I also might talk about a couple of healthcare names where I'll start with ResMed, where again, quite a phenomenal result. So their top ones growing caught 10%, they're delivering EBIT growth of 20%, margins are improving. And pretty simply they're seeing really strong diagnostic volumes plus new product launches driving really strong top line growth. And they're also ensuring they benefit at the earnings line via very strong operating leverage. So we thought Resid was a great result.  

And then the other one, again, which we've talked about in the past, is Pro Medicus where, I mean, this company just continues to deliver 30% top line growth, 40% growth in EBIT. Their sort of industry leading solution is continuing to drive contract wins. And what's most interesting is those contract wins are becoming larger and more frequent.  

Quin: 

Any surprises on your side, David? 

David: 

I'd throw in a stock like Origin. It's a stock that a couple of our funds now actually hold, and the stock just continues to modestly surprise on the upside. This is at a time where APLNG in Queensland is actually starting to actually, the assets are sliding to deteriorate, but the energy markets is actually very well placed from the disruption that we're seeing in the energy markets. So they're doing well there. Plus also their investment in Kraken and Octopus in the UK continues to surprise amazingly on the upside, it's sort of Origin, almost the hidden tech stock. But so yeah, that's very much a stock that's surprise through reporting season. 

Quin: 

So, there's a couple of surprises there. It has been the most volatile reporting season in history is volatility here to stay? 

David: 

My sense of it, it probably is because of just the changing structure in the market where you've got more index funds, you've got more quant funds, you've got the presence of hedge funds, and so therefore a little less of the traditional long only investors like ourselves. But therein lies the opportunity. I mean, you've got this distorted, exaggerated market, whatever you want to term it, but the fact is that that creates opportunities for people like ourselves to take advantage of. 

Quin: 

Christian, what's your thoughts on the volatility, here to stay? 

Christian: 

Look, I think so, and I only say that because I feel like every time we catch up and discuss reporting season, we say it was the most volatile ever. So the trend is only going one way. There's no reason to suggest that trend is going to change anytime soon. And I guess what I'd say most importantly is that's where a large, strong, well-resourced, experienced research team comes to Its for. So it's something we pride ourselves on. We crunch the numbers when the results come out, we get to the bottom of the results, we look at the quality leading indicators that we basically search for in results, and we can make a call pretty quickly to the portfolio managers as to whether the result is good, bad, or indifferent, regardless of what the share price has done. 

Quin: 

Thank you, David and Christian. They'll be back with future reporting season updates, so please don't forget to subscribe to the Curious Podcast.