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AUSTRALIA’S economic cycle has gone on longer than expected – and it shows in the recently ended ASX earnings season.
Somewhat surprisingly, most parts of the economy are still in reasonably good shape despite a string of interest rate rises.
The strong jobs market is a factor, helping prop up consumer spending.
“But the expectation is that higher interest rates will likely hurt earnings in the rest of the financial year,” says Brenton Saunders, who manages Pendal MidCap Fund.
“Across the market as a whole, revenue beats were pretty widespread even though many companies missed earnings forecasts at the bottom line,” says Saunders.
“Revenue beats were much higher than profit beats.
“We saw profit margins reduce and that relates to higher costs.
“In many cases, despite high product price increases, costs increased at a faster rate resulting in margin pressure.”
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Revenue beats came in at 25 per cent versus misses of 17 per cent, according to Barrenjoey research. In contrast, the research shows earnings per share (EPS) misses of 38 per cent and beats of 35 per cent. The EPS misses are elevated by historic standards.
“We saw profit margins reduce and that relates to higher costs,” Saunders says.
“In many cases, despite high product price increases, costs increased at a faster rate resulting in margin pressure,” Saunders says.
Earnings season also demonstrated that companies have significantly higher interest costs as a result of the rates increases — which consensus forecasts underestimated in many cases, Saunders says.
That has also contributed to bottom-line misses.
“Companies have different mixes of fixed and floating interest rate exposure and that’s difficult for the market to model.”
In terms of individual sectors, it was a “mixed bag”, Saunders says.
Here’s a quick sector snapshot:
Profits in the resources sector were weaker for the December half, with a few exceptions such as lithium, nickel and coal.
Other commodity prices were lower, year-on-year in the final six months of 2022 driving profits lower.
“Similar to a number of sectors, the main negative for resources companies was costs.
“Unit cost guidance from the vast majority of companies has gone up and for a number of companies that’s resulted in a downgrade of earnings expectations.”
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“In resources we also saw some lower dividend outcomes after the bumper payouts last year.
“That’s because profits weren’t quite as good as they were a year back, and increased capital expenditure as new capacity is built.”
The banks – half year from Commonwealth Bank, Bendigo and Macquarie Group, and quarterlies from National Australia Bank, Westpac and ANZ – reported strong net interest margins.
“The main negative across the banks is competition, especially in the home-lending and term-deposit markets, as fixed rate mortgages roll-off.
That is putting pressure on earnings forecasts.
“Cyclically we are close to peak interest rates and alongside higher competition means the banks are close to, or at peak net interest margins which many of the banks alluded to.”
It’s a similar story with many consumer discretionary stocks.
Interim profits were mostly strong, though the current half year looks softer as the impacts of higher interest rates dampens spending.
“It’s been a case of stronger for longer for consumer discretionary though it wasn’t quite as ubiquitous across discretionary retail companies, compared to the June 2022 half.”
Building and construction was mixed, Saunders says, with surprises on the up and downsides, in part depending on where the bulk of business was undertaken – locally, in the US or in Europe.
Consumer staple stocks reported strong results with Woolworths being the stand-out, in part thanks to higher goods inflation.
But costs also compared well to last year’s COVID impacted costs, which meant some margin expansion.
Technology was relatively strong, Saunders says.
“Many of the tech and growth companies rolled out some kind of cost reduction program with a bigger focus on cashflow which the market took well.”
Healthcare stocks results were mixed in part because of comparisons to the previous, COVID-impacted half year, Saunders says.
That worked against some companies, and advantaged others.
Finally, stocks in the real estate investment trust (REIT) sector broadly announced lower-than-expected-revaluations.
“The weakest part of the property sector is office while industrial is strong, and so too some niche areas like storage and convenience.
“The second half of this financial year is likely to see property revaluations increase putting some incremental pressure on REIT balance sheets. ”
Brenton is a portfolio manager with Pendal’s Australian equities team. He co-manages Pendal MidCap Fund and our natural resources portfolio, drawing on more than 25 years of expertise in resources, derivatives, investment banking and private equity. He is a member of the CFA Institute.
Pendal MidCap Fund features 40-60 Australian midcap shares. The fund leverages insights and experience gained from Pendal’s access to senior executives and directors at ASX-listed companies. Pendal operates one of Australia’s biggest Aussie equities teams under the experienced leadership of Crispin Murray.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Find out more about Pendal MidCap Fund here
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