AUSTRALIAN corporate earnings are ahead of expectations halfway through the reporting season.
But there are early signs that companies are starting to bunker down amid uncertainty about interest rates and wages growth, says Pendal portfolio manager Jim Taylor.
About a third of companies exceeded market consensus for their June 30 numbers — while 18 per cent missed the consensus number, he says.
Bottom-line earnings and free cash flow have been pleasing. But dividends and buy-backs have disappointed — indicating managers are taking a conservative view on the economic outlook.
Earnings forecast downgrades are also accelerating as interest rates rise and commodity prices ease.
“The bottom line is the results for these six months have come in there or thereabouts,” says Taylor.
“But the outlook commentary from the companies indicates some very significant uncertainty about the economic environment and what interest rates are doing,”
“Boards are taking quite a conservative view on what the next year sort of looks like and have taken the opportunity to temper some expectations in the out years and preserve some balance sheet capacity and cash.”
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ASX shares have lifted about 10 per cent from their June lows through earnings season as some of the more dire concerns that sent markets lower in the first six months of 2022 failed to materialise.
“The reporting season is always a concertinaed period of intense information overload, but the market is getting quicker and quicker at sifting through the information,” says Taylor.
Three themes are weighing on the outlook, says Taylor:
“One of the key questions we’re trying to get answers for is how the consumer demand environment will fare heading into Christmas,” he says.
“That’s going to be vital. There are a few questions marks over the amount of inventory the retailers are taking into that environment.
“If you get a rapid slow-down in consumer demand, we’re going to see inventory problems, but there’s nothing that’s really come from this reporting season which would suggest that that’s highly likely.”
The trajectory for interest rates is also a key factor for markets, particularly how much benefit from higher rates accrues to the financial sector.
“We’ve had a few companies that have tried to temper expectations, stressing that the benefit of rate rises is nuanced. There are competitive forces. There’s the way their hedges are structured. And there’s a desire to spend some of the windfall from higher rates on maintaining market share.
“That’s something the market is very focused on.”
The third issue investors should watch out for is the state of the labour market and wages. Recent data shows wage growth at a 10 year high in Australia, but Taylor says availability of workers is a more pressing issue for local companies.
“It’s not so much the cost of labour but the access to labour and the rate at which sick leave is occurring.
“We’ve seen a couple of the building material companies come out and flag weather and access to labour as a key issue that they’re very focused on towards the back end of this year.”
Australian stocks still look well placed despite some rising concerns from boards and earnings downgrades, Taylor says.
With high exposure to resource companies and financials, the ASX is less sensitive to higher interest rates than other developed markets.
“The absolute level of commodity prices is still very healthy.
“There’s still going to be excellent margins generated and excellent levels of free cash flow and resulting dividends.
“And Australia just doesn’t have this significant weighting to high growth and tech that some of the other markets do.
“As a result of that, we’ve got a much lower level of sensitivity to what interest rates are doing.”
Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.
Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.
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