Australian Equities: How to identify the next wave of share market outperformers
It’s been a volatile year for Australian shares. Our Australian Equities team share their views on the themes that will matter for the share market in the coming months and how they are identifying the stocks likely to outperform.
The performance of the Australian share market has been volatile in 2016, with continued jitters over Chinese growth and their next currency move in one corner, and a question mark around the US Federal Reserve raising rates further in the other. These fears were compounded by a bounce in oil prices as members of the global oil body, the Organisation of Petroleum Exporting Countries (OPEC) agreed to slow production.
Back home, there are three key structural developments in the share market that will have the greatest implications for investors:
- The era of abundant liquidity has come to an end – following a prolonged period of policymakers supplying cheap debt to fuel corporate growth, companies are now finding it harder to access cheap funding both domestically and globally. We are seeing emerging markets and major oil exporting economies withdraw money from global equities, exacerbating volatility in markets worldwide. The focus of investors has moved from absolute yield to the sustainability and future growth potential of this yield.
- The economic cycle has become more muted – the returns outlook for Australian shares is lower and few companies are benefiting from strong cyclical tail winds. Companies continue to focus on maximising capital return to shareholders, reflecting both a relative absence of growth opportunities in the Australian economy and the understanding that investors crave yield in an environment of low rates and compressed bond yields.
- Disruptive forces are changing the outlook for returns across a range of industries – Understanding industry structures and potential changes to theme is key, and in such an environment, management actions are more critical than ever in determining returns. A great example of this is the supermarket industry, where the success of low-cost retailer Aldi has lured market share away from Woolworths and Coles. The incumbents have been forced to spend more money on store expansion, differentiation and customer experience to maintain their growth – while at the same time they are forced to reduce their profit margins – degrading profitability and growth potential.
Which companies are outperforming in this environment?
There are always lessons an investor can learn from reporting season. During the recent reporting season in February, we saw the ASX 200 companies with the largest downward revisions to earnings forecasts actually outperform.
The market was not expecting too much. Expectations for S&P/ASX 200 earnings per share growth were downgraded by -1.2%, to -6.0% for financial year 2016. This negative outlook is driven primarily by resources, as weak commodity prices are expected to see earnings decline by -59%. The recovery in the resource sector is unlikely to be sustainable as it is yet to address its chronic oversupply. Likewise, better economic data in the US is reviving expectations of further rate hikes this year, which could see the defensive yield stocks give back some of their recent gains.
The financials are expected to grow earnings around 3%, with greater capital requirements and curtailed lending weighing on the banks. Expectations for industrials are a touch above 1%.
While macro concerns have dominated market performance over the year, we believe the risk of another major economic downturn is limited and that stock-specific factors will ultimately prevail and drive returns. Aggregate valuations remain in-line with long term averages and the market’s yield remains supportive, particularly given the large amount of cash on the markets side lines.
Where should an investor look next?
We are focusing on factors that can change earnings outcome, whether it be a change to industry structure, cyclical trends or business innovation. We also look out for companies demonstrating disciplined capital allocation or embarking on a ‘self-help’ journey.
An example of a stock we hold in our portfolios is Amcor, which provides packaging products across industries such as food, beverage and health care. Amcor was one of the few offshore-earners to provide the market with a positive surprise in reporting season, growing underlying profit and earnings per share by 6.6% and 10.2% respectively.
The strong US dollar continues to remain a headwind for returns from the non-US parts of its business. However the market concerns around its emerging markets exposure failed to materialise as volumes were supported by recent acquisitions.
Amcor’s management has a credible and transparent strategy to deliver shareholder return via organic growth, acquisition and capital management. This result provides more evidence of its ability to deliver on this plan.
BT Investment Management has one of the largest equities teams in Australia covering every stock on the ASX 300. For more information click here.