What companies will surprise this earnings season?

Financial journalist and commentator on 3AW and Sky Business
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Key points

  • UBS expects flat earnings growth across the market, at 0.8% on consensus estimates, but that figure is 9% if the resources stocks are stripped out.
  • On a median basis (eliminating market-capitalisation impacts) UBS expects the “typical” stock to post earnings growth of 6.5% in FY15.
  • Potential positive surprise candidates are engineering and infrastructure group Downer, casino operator Echo Entertainment, retailer Harvey Norman, building materials company James Hardie real estate business Mirvac Group and Qantas.

It’s that time of year again on the stock market: the FY15 earnings season is about to kick off, in which companies report their profit results for the year ended June 30 (or the half-year, in the case of those companies that use the calendar year as their financial year.)

It is not a full reporting slate, because three of the big four banks (Westpac, ANZ and NAB) do not rule off their books until September 30, but the August profit reporting season shows how the bulk of the market is travelling in terms of revenue, costs and profit – and also reveals how optimistic (or pessimistic) the companies are about the year ahead, in their outlook statements.

A recap

Last year, amid nervousness associated with the falling iron ore price and the jolt to consumer confidence associated with the May 2014 Budget, the full-year FY14 reporting season delivered solid earnings results, without being spectacular.

According to Shane Oliver, head of investment strategy and chief economist at AMP Capital, average earnings growth for FY14 came in at about 12% across the S&P/ASX 200, with resources stocks showing strong profit growth of 25% (after a 19% profit slump in FY13), bank stocks generating 9% profit growth and the industrial stocks managing 4% growth, with cost-cutting making up for weak revenue growth.

54% of companies beat market expectations, which was the best result for nine years. 68% of companies lifted profits from the previous year (compared to a ‘norm’ of 66%), while 65% of companies boosted their dividends. Dividends grew by 7%, after 11% growth in FY13.

Earlier this year, the December 2014 half-year result figures were again better than had been feared, says Oliver. 55% of December half profit results beat expectations against a norm of 45%, 66% saw profits rise from a year ago, 52% saw their share price outperform the day results were released, and 62% increased dividends.

At the time, Oliver projected solid profit growth for the banks in FY15, of about 8%, and a better performance from the industrials, at about 10% profit growth. But he expected a slump of about 25% in resources profits on the back of lower commodity prices. Overall, he expected sluggish revenue growth, at about 2%.

Resources are a drag

Investment bank UBS agrees that the resources stocks will drag down market earnings growth this full-year season, despite an improved performance from the industrials, which will benefit from the weaker A$. UBS expects flat earnings growth across the market, at 0.8% on consensus estimates, but that figure is 9% if the resources stocks are stripped out. Excluding resources and financials, industrials’ profit growth is expected to grow by 13%, boosted by the fall in the A$.

In good news for yield-oriented investors, FY15 dividend growth (excluding resources) is expected to be about 7%, slightly below earnings growth. The expected FY16 dividend yield for the market stands at 4.7%.

In the “confession season” lead-up to full-year reporting season – when companies situations are turning for the worse prepare the market for bad news by lowering their earnings “guidance” – UBS says downgrades have been most prevalent in the resources sector. The investment banks says FY15 consensus earnings estimates for the market are about 2% lower than six months ago – and 6.6% lower than 12 months ago – dragged down by resources. Outside the resources stocks, estimate revisions have been much more benign, and have actually edged higher recently, helped by the fall in the A$.

On a median basis (eliminating market-capitalisation impacts) UBS expects the “typical” stock to post earnings growth of 6.5% in FY15. While the resources sector will be the main handicap for earnings growth this year, UBS expects the bank sector to be lead in the market’s saddlebags in FY16.

This year’s themes

UBS says the main themes for reporting season are likely to include:

  1. Sluggish top-line revenue growth, versus companies’ ongoing efforts to cut costs out of their businesses;
  2. Evidence of tougher competitive conditions in key sectors, for example Consumer Staples, where the supermarket giants are slugging it out, and general insurance, where underlying margins appear to be peaking;
  3. Profit tailwinds from the strong housing sector; and
  4. A first look at how the banking sector responds to higher regulatory capital requirements.

Among the large-cap stocks, UBS says potential positive surprise candidates are engineering and infrastructure group Downer, casino operator Echo Entertainment, retailer Harvey Norman, building materials company James Hardie (which does three-quarters of its business outside Australia), real estate business Mirvac Group and Qantas.

Conversely, potential large-cap negative surprise candidates include: global supply-chain logistics leader Brambles, beverage giant Coca Cola Amatil, online real estate player REA Group, employment website operator Seek, insurance and banking group Suncorp and retail-oriented conglomerate Wesfarmers, owner of Coles, Bunnings, Kmart and Target.

Companies that did not come out confession season well – that is, they downgraded earnings expectations – include Woolworths, Bega Cheese, Flight Centre, Cardno, Greencross, Metcash, Monash IVF, Oroton, Primary Health Care, Super Retail Group, Virtus Health, Sonic Healthcare and South32.

But there were also some companies that gave more upbeat guidance than expected, for example Woodside Petroleum, Oil Search, building materials supplier Boral, apparel group Pacific Brands, Fisher & Paykel Healthcare, retailer JB Hi-Fi, health insurer NIB and fuel marketer Caltex Australia.

As always, companies that disappoint the market – especially with a poor result that has not been foreshadowed – stand to suffer large share price falls.

In that light, an interesting backdrop about the imminent reporting season is that Australian Securities and Investments Commission (ASIC) data shows that 30% of ASX-listed companies have experienced an increase in the number of their shares being “shorted” (that is, short-sold) over the past month. (Professional investors such as hedge funds short-sell stocks if they expect their prices to fall.)

Broking firm Morgans reckons the total value of short positions ahead of the August profit season has hit $22.9 billion, an increase of more than 50% above the same period in 2014 and 2013. Clearly there are some smart investors expecting some share price carnage this reporting season.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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