Corporate Australia adjusts to new realities

Corporate Profit Season

• Each ‘earnings season’ or ‘profit-reporting season’ CommSec tracks all the earnings results of ASX 200 companies to obtain a comprehensive picture of the aggregate health of Corporate Australia.
• The good news is that Corporate Australia has delivered for shareholders with earnings up in response to an improving economy. CommSec has assessed the results of the 136 companies that have reported half-year (HY) or interim earnings (results for the six months to December 2015) and the 27 companies that reported full-year results for the year to December 2015.
• Almost 90 per cent of those reporting half-year earnings (HY companies) reported a profit – near record levels.
• And 69 per cent of the HY companies improved their profit results – the highest result in the 12 profit reporting seasons we have covered.
• A record 91.2 per cent of companies issued a dividend and almost 77 per cent of HY companies lifted or maintained dividends.
• Cash holdings of all the ASX 200 companies that reported earnings remain healthy but fell by around 4 per cent over the year to $96 billion.

Corporate Australia delivers

• Six months ago, when we reviewed the full-year ‘earnings season’ (results for the twelve months to June) we concluded: “This earnings season has been totally unremarkable.” In justifying this we noted that “Profits didn’t soar nor slump. Same for dividends and same for cash levels. But that is entirely understandable when you consider the unremarkable performance of the Australian economy over the past year.”
• But we highlighted a ray of hope for the future earnings results of listed companies: “Over the past six months, consumer spending has been above average and housing activity has been strong. Also late in that first half of 2015, operating conditions, confidence and spending all improved in the business sector. The Aussie dollar has also come down, improving the outlook for globally-focussed companies.”
• In short, the economy started to improve in the first half of 2015. The good news is that the economy continued to improve in the second half of 2015. In turn, Corporate Australia has delivered with solid results in the latest earnings season.
• Really the only way that you can properly assess how Corporate Australia as a whole performed in the past six months is to put all the results together. The good and not so good. And indeed that is what we have done.
• Understandably resources companies have recorded results that they hope prove more the exception than the rule when looking ahead to the future.
• But domestic-focussed companies have borne the fruit of the improved operating environment in the last six months of 2015. It was an environment of lower interest rates and a lower Australian dollar. And oil prices continue to ease but there was more focus on the positives for consumers and businesses in terms of lower costs and increased spending power.
• In recent months the focus has been more on what lower oil prices mean for the financial health of producers and therefore the risks for their financiers – the contagion risk.
• Now while the results of HY companies have been good, that doesn’t mean that management of companies has been exultant. Far from the case. Revenues are still hard to come by although the cost environment has been benign, leading to satisfying bottom-line results.

Key theme: the new realities

• As we noted above, we described the last reporting season as “unremarkable”. And for the simple reason that the season was devoid of themes. We noted last time that companies had not generally been slashing costs; but there were the difficulties for resource companies; the benefits of the housing boom for others; some companies identified significant “impairment charges” or write-downs and provisions; and there were some “turnaround” stories.
• So there was a mixture of influences. Of course some earnings seasons are like that – the prior reporting season was similarly ‘unremarkable”. But usually there is a theme or common thread to the results.
• But this season there has been a key theme apparent in the results. Companies are adjusting to the new realities. One reality is that the resources boom is indeed over. A raft of resource companies reported statutory losses – BHP Billiton, Rio Tinto, South32, Santos, Beach Energy – just to name a few.
• And the new reality means lower prices and the need to trim costs – not just as a one-time effort but on an on-going basis. It means a re-assessment of strategy, including dividends, capital spending, acquisitions and determining the value of some sections of the business.
• Some companies have been forced to go down that track earlier, and not just in the resources sector. But these companies have seen the value of a fundamental assessment of operations and strategy. Companies like BlueScope Steel, Qantas, Brambles and Treasury Wine Estates.
• All companies realise that the world has fundamentally changed. It is a low inflation and therefore low cost environment. It is increasingly tough to generate revenue. In large part this reflects globalisation – the increasing realisation that competition is global. More and more industries are experiencing this. Then there is the on-going theme of “disruption” – largely driven by technological change but innovation more broadly. Cabcharge and APN Outdoor Group are two companies to experience the negatives and the positives of disruption.
• And there is the reality that, in a world where companies find it harder to grow or maintain a sense of ‘leadership’ in their industry sector, dividends are increasingly important. A record proportion of companies have issued a dividend – more than 90 per cent of all companies. Rewind four years ago and less than 80 per cent of companies chose to issue a dividend.
• Some have criticised companies for a seemingly blinkered view of issuing dividends at all costs. And indeed some companies have re-assessed their policies or strategies.
• But there is competition for shareholder affections and it is a global competition. And it is a low inflation environment and one where the ‘speed limit’ of the economy may have ratcheted down from 3.25 per cent to 2.5 per cent. And a world of more modest growth where China is switching from industrial-led growth to consumer-led growth.

The 2015/16 interim profit reporting season (six months to December 2015)

• The only way to assess whether the recent profit-reporting season has been a success or failure is to add up the numbers. And that’s what we’ve done. It’s certainly not a case of comparing results to the expectations of analysts due to continuous disclosure and because companies are routinely successful in managing expectations. And the expectations of analysts are really only there to provide a reference point for the short-term investment direction of individual companies.
• Instead investors want to know how Corporate Australia is fairing more broadly. And you can only know that by aggregating and dissecting the key metrics of all the companies.
• So to the numbers. CommSec has assessed the results of 136 companies from the ASX 200 index that reported earnings for the six months to December 2015.
• In aggregate, revenue grew by 0.2 per cent to $281.4 billion while expenses grew by 6.1 per cent to $242.4 billion, leading to a 46.6 per cent fall in net profit to $13.5 billion (in the full-year earnings to June 2015, profit fell by 31.9 per cent).
• But as noted, there have been a raft of resource companies declaring statutory losses for the half year, notably BHP Billiton. If we just strip out BHP Billiton, we estimate that underlying aggregate revenues rose by 3.8 per cent, expenses rose by 4.5 per cent and aggregate profits fell by 6.4 per cent. (If South32 was also removed from the sample, aggregate profits were up 2.1 per cent.) In addition we should note the $2.2 billion turnaround from Woolworths (from profit to loss) reflecting the Masters write-down. If the Woolworths result is similarly not seen as reflective of the environment, aggregate profits of listed companies would actually be up 13.4 per cent.
• Highlighting the good underlying position of the reporting season, 122 of 136 companies (89.7 per cent) reported a statutory profit – almost a record result. Of all companies, 69.3 per cent of companies lifted profits – a record result and above the 60.8 per cent average. And of those companies issuing a profit, 76.4 per cent actually lifted earnings – a remarkable result.
• In the last earnings season (six months to December) cash levels fell by 10.1 per cent. In the latest results, cash holdings were up by 5.2 per cent. But 71 companies lifted cash levels and 65 cut cash levels on a year ago. So the performance was more mixed. Note that BHP Billiton reported cash holdings up 73 per cent to $10.6 billion.
• If you put all companies together (163 companies) total cash earnings were $96.6 billion, down 4.1 per cent and the third straight decline from record highs.
• As noted above, a record 91.2 per cent of companies elected to issue a dividend (average 85 per cent over 12 reporting seasons). Dividends rose in aggregate by 7.5 per cent (up 9.8 per cent excluding BHP Billiton). Of all companies, a record 62.8 per cent lifted dividends, 14.6 per cent cut, 13.9 per cent didn’t change dividends and 8.8 per cent chose not to pay a dividend. Of all companies issuing a dividend, 84 per cent lifted or maintained dividends.

The full-year 2015 profit results (twelve months to December 2015)

• So how did the companies reporting full-year 2015 results fare? As is always the case this is a much smaller sample, just 27 of the ASX 200 companies reported annual profits for year to December 2015. In aggregate, profits totalled $6.2 billion, down 67.2 per cent on a year earlier (excluding Rio Tinto, Woodside Petroleum and Scentre Group, down 3.6 per cent). In total, 82 per cent of companies made a profit.
• Excluding outliers, aggregate sales in the twelve months to December fell by 10.5 per cent while the cost of sales or expenses fell by 14.8 per cent. Earnings per share actually rose by 40 per cent, dividends rose by 14.3 per cent and cash holdings rose by 18.5 per cent to $12.0 billion (of all companies, cash fell by 18.4 per cent. All but one company provided a dividend

Outlook

• All global sharemarkets have been hit by concerns about falling oil prices, the impact on the financial health of producers and the knock on effects to banks and other financiers. Then there have been the worries about the Chinese economy and the uncertainty over whether the US Federal Reserve will lift interest rates this year.
• Total returns on the Australian sharemarket – as measured by the All Ordinaries Accumulation index (XAOAI, dividends plus share price changes) – hit record highs on April 27 at 51,568 points. On February 26 2016, the XAOAI was almost 14 per cent down from record highs. Currently total returns on Australian shares are down 12 per cent on the year.
• If the Australian sharemarket was assessed on domestic factors alone it would be higher than current levels. Because it is clear that Australian company balance sheets are generally in strong shape. The majority of companies are making money and lifting dividends. Low interest rates have led to lower borrowing costs. The lower oil price has reduced freight and other transportation costs. The lower Australian dollar has boosted the competitiveness of Australian companies. Annual growth of consumer spending is above long-term averages. Housing construction and record tourism are buoying economic momentum.
• The preference of companies to issue dividends – and indeed maintain or lift dividends – will remain in focus. It is important for companies to strike a balance. Companies must be competitive in attracting shareholder dollars. But to generate higher future dividends and lift share prices, companies can’t neglect investment and acquisition opportunities. It is a matter of determining the ‘right’ return on investment and this isn’t a purely mathematical question.
• The Aussie sharemarket is reasonably valued at present with a price-earnings ratio sitting at 15, below the long-term average of 15.7. Current earnings results are supportive for the sharemarket and with the economy in good shape, share prices have scope to track profits higher. We currently expect the All Ordinaries to stand at 5,200-5,400 points by mid-2016 (ASX 200 probably 50 points lower) with the index lifting to 5,500-5,700 by end 2016.
• As noted above, companies are choosing to pay dividends, with most lifting or maintaining dividends. The current dividend yield of 4.89 per cent is the highest since the global financial crisis (June 2009). Excluding that period, dividends are the highest in 24½ years (since June 1991).
• As always, the focus of investors should be on total returns from shares, not just share prices. Global factors may act to constrain domestic share prices, but fundamentally companies are in good shape, making money and issuing dividends.