Earnings season preview

Financial journalist and commentator on 3AW and Sky Business
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Although we are not yet like the Americans – whose quarterly company earnings reporting seasons seem to merge into a continuous barrage of profit announcements – the Australian market is readying for the February-March reporting season, despite seemingly having just completed the August-September season.

The February-March reporting season covers mostly interim (half-year) reports for the companies that use June 30 as a balance date, but it also features some full-year reports, for the companies that use the calendar year as their financial year.

The interim season will be important as a halfway house in what market-watchers expect to be the first year in three that produces rising earnings across the market (read, the S&P/ASX 200 index). Broker Credit Suisse says the combined earnings per share (EPS) of the ASX 200 fell by 13% over the last two years.

In FY15, according to AMP Capital, market profits fell about 2%, but that was largely due to a 35% slump in resources profits. The rest of the market saw profits rise by about 7.5%, driven in particular by the industrials, building materials, retail and health care stocks. Profits for industrials (excluding financials) rose by 11.5% in FY15, their fourth rise in a row.

Then in FY16, overall earnings fell by about 8%, driven by a 47% slump in resources profits and a 4% fall in bank profits. But AMP Capital says the typical (or median) company reported profit growth of about 4%, and 62% of companies saw their profits rise versus the previous year.

This year – as in the financial year, to June 30 – analysts expect the market to show earnings growth of 8%–11%, as the slump in resources profits reverses, and non-resource stocks also see growth. The mining companies are seeing the fastest rate of earnings forecast upgrades, based on the unexpected windfall of 2016 commodity price rises. In particular, thermal (electricity) coal prices more than doubled last year to more than $US100 a tonne; coking (steelmaking) coal more than tripled in price over the year, to more than US$300 a tonne; and iron ore doubled in price in the second half of 2016, to about $US80 a tonne.

While these levels are not expected to be maintained – and in the case of coal, have come down in the New Year – the effect on resources profits will be influential.

Rio Tinto, for example, which is one of the stocks reporting for the full-year in calendar 2016, is expected on analysts’ consensus to surge strongly back into profitability after a net loss of $1.2 billion ($US866 million) for 2015.

Back then, the company reported full-year underlying profit of $US4.5 billion ($6.35 billion), which was its lowest underlying profit since posting a $US6.3 billion underlying loss in 2009, and abandoned its “progressive” dividend policy, which guaranteed that dividends never fell, altering its dividend policy to trying to return between 40%–60% of underlying earnings over the longer term.

Rio Tinto’s result will be very keenly watched, given that it is the resources rebound that analysts are banking on to generate earnings growth for the market this year.

The company told the market last week that stronger production of iron ore in the December quarter had allowed it to regain some of the lost momentum in the division, which had caused it to cut its full-year production estimates in October – with the surge in the price of iron ore to flow through to higher earnings.

The group’s December quarter production report showed that December quarter production of 85.5 million tonnes of iron ore was up 3% from the prior quarter, enabling Rio Tinto to post 2016 production of 329.5 million tonnes of iron ore, a rise of 6%.

Iron ore prices have posted fresh two-year highs in the spot market this month, of $US83.65 a tonne, with sentiment buoyed by optimism of continued strong demand from China, despite government efforts there to force a number of smaller steel makers out of the market.

Rio Tinto also beat its forecasts for bauxite and coking coal production, while aluminium output jumped 10% in 2016.

Outside resources, broker Citi expects banks, insurance, telecommunications and food retail stocks – all sectors that had earnings falls last financial year – to help the resources stocks with the heavy lifting, returning to EPS growth this year.

Outside the banks, Citi is overweight in energy stocks, materials and consumer discretionary. It remains neutral on consumer staples, financials and technology while underweight in industrials, healthcare, telecoms and utilities.

Margins remain the crux for 2017 earnings growth for the banks: Morgan Stanley analyst Richard Wiles can see a 1% lift in 2017 forecasts for the big four if margins remain flat in 2017, but a 4.5% upgrade in profit forecasts if they can expand profit margins by 5 basis points (0.05 percentage points).

The influence of the big miners and the banks means that the large cap stocks – the S&P/ASX 20 – have seen their earnings contract for the last two financial years, while the smaller companies have been doing well, says George Boubouras, chief investment officer at Contango Asset Management. This year, the market is pricing-in expanding earnings for the larger companies.

As always, it won’t be just the reported profit number that decides how the market reacts to results: it will be (a) how the revenue and profit figures come in compared to company guidance and analysts’ expectations, and (b) whether the outlook statement is optimistic or pessimistic.

What no company can afford is a surprise pre-report profit downgrade, of the kind that Brambles delivered earlier today.

UBS analysts have identified several companies that might disappoint with their financial performance, as well as with their outlook. At risk of delivering such a “double negative” next month are financial markets systems provider GBST (GBT), funeral company InvoCare (IVC), mining services provider Monadelphous (MND) and waste services group TOX Free Solutions (TOX).

Companies UBS sees as likely to deliver a “double positive” include dairy company a2 Milk (A2M), aluminium products group Alumina (ALU), auto accessories and service business AMA Group (AMA), automotive aftermarket parts retailer Bapcor (BAP), fruit and vegetable supplier Costa Group (CGC), waste management group Cleanaway (CWY), task outsourcing marketplace Freelancer (FLN) and newly listed poultry supplier Ingham’s Group (ING).

Here’s what the analysts’ consensus expects for some of the larger full-year reporting stocks in the February season, based on FN Arena’s collation:

Rio Tinto (RIO) (reports in US$)

FY16 EPS change: from –47.5 cents in FY15 to 273.6 US cents
FY16 Dividend per share (DPS) change: –34.6% to 140.6 US cents

Oz Minerals (OZL)

FY16 EPS change: –12.6% to 37.5 cents
FY16 DPS change: –48.5% to 10.3 cents

Westfield (WFD)

FY16 EPS change: –78.6% to 33.3 cents
FY16 DPS change: –14.2% to 29.1 cents

Woodside Petroleum (WPL) (reports in US$)

FY16 EPS change: +3,397% to 104.9 US cents
FY16 DPS change: –22.5% to 84.5 US cents

QBE Insurance Group (QBE) (reports in US$)

FY16 EPS change: +2% to 51.3 US cents
FY16 DPS change: –12.2% to 43.9 US cents

G8 Education (GEM)

FY16 EPS change: +1.8% to 24.3 cents
FY16 DPS change: +1.7% to 24.4 cents

AMP (AMP)

FY16 EPS change: –41.4% to 19.5 cents
FY16 DPS change: +1.1% to 28.3 cents

GPT (GPT)

FY16 EPS change: –39.1% to 28.7 cents
FY16 DPS change: +5.3% to 23.7 cents

IRESS (IRE)

FY16 EPS change: +25.9% to 44.3 cents
FY16 DPS change: +6.3% to 45.4 cents

Sydney Airport (SYD)

FY16 EPS change: +35% to 17.2 cents
FY16 DPS change: +21.6% to 31 cents

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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