Returning capital to shareholders a worrying trend
Jamie Nicol
A difficult six months in a number of sectors has led to mixed reporting of Australian listed companies, says Jamie Nicol, CIO, Dalton Nicol Reid.
“Our research shows that 36% of Australian listed companies beat market expectations and 23% of the companies missed market expectation in the current reporting season,” he said.
“It’s important to note that there is a small downgrade of around 0.8% forecast for 2015,” he said. “Already around 28% of companies have been upgraded for 2015, and 27% downgraded.
Mr Nicol said that it has been difficult to forecast in the current economic climate.
“Offshore markets were impacted by the volatility of the weather, and domestic companies were hit by the federal budget which caused a drop in consumer confidence.”
“While analysts are reluctant to project the difficult trends to continue, they are also reluctant to forecast a large bounce,” he said. “In a number of our holdings we see analyst’s forecasts as being quite conservative and have been adding to these positions.”
“The underlying backdrop of low yields does make companies returning capital to shareholders seem appealing in the near term, however we are concerned that this strategy is somewhat short sighted.
“We are already seeing a trend where companies with buy-backs (even if small) and special dividends were rewarded – such as Suncorp, Telstra.
“High quality businesses should be able to reinvest capital to generate even greater future returns for shareholder,” he said. “We see the trend of returning capital as somewhat counterintuitive given the current low cost of debt and equity.”
“We are concerned that while the market continues to reward near term yield over longer term growth, most company Boards will be reluctant to invest in future opportunities preferring the short term impact of returning capital.
“So we are actively seeking quality companies where Boards are prepared to reinvest in the business to generate future returns rather than taking the short term ‘sugar hit’ of returning capital – such as Aurizon & Origin Energy. “
“With top line revenue growth remaining scarce, companies with strong business models that demonstrated sustainable growth are being justifiably rewarded (eg Veda Advantage, Iress & Domino’s Pizza).
“A generally sluggish economic backdrop means companies that can generate maintainable growth are likely to continue to be rewarded by the market and we continue to investigate opportunities in this area.
Mr Nicol was optimistic about the continued expansion of domestic housing activity which has continued to expand. “Housing is now settling at a much healthier level of activity following several years of anaemic growth post GFC,” he said. “We have a solid exposure to this area and expect underlying demographics and historical underbuilding to drive returns for quality companies exposed to this sector.”
But Mr Nicol said that mining activity continued to slide with the capex peak on existing projects having passed, and new projects still struggling to get approval.
“The focus has turned to non-residential construction activity to fill the void, but despite much talk at both federal and state government levels, the long lead times and political nature of these projects means real activity is still some way off,” he said. ‘We remain optimistic that the activity levels will eventually pick up in the area and see opportunities for companies such as Lend Lease to participate.”
