Earnings season: On the road back

Corporate profit reporting season

• Each ‘earnings season’ or ‘profit-reporting season’ CommSec tracks all the earnings results of S&P/ASX 200 companies to obtain a comprehensive picture of the aggregate health of Corporate Australia.
• In total, 141 companies of the ASX200 index group reported half-year (interim) results for the 2020/21 year. A further 31 companies with a December 31 reporting date have issued full-year or final results. The other ASX 200 companies have different balance dates.
• Despite the turbulent times, 86 per cent of companies reported statutory profits for the six months to December. But aggregate interim earnings fell by 17 per cent.
• Dividends are returning. Just under 79 per cent of companies issued a dividend (long-term average 86 per cent). Aggregate dividends are actually up by 5 per cent on a year ago.
• The big trend has been the lift in cash holdings. Aggregate cash holdings are up by over 50 per cent to $124 billion. And 70 per cent of companies have lifted cash holdings over the past year. Add in the companies reporting full year results and cash holdings stand at $166 billion.

The profit reporting season

• Every six months CommSec tracks the earnings of Australia’s largest listed companies. Some analysts track whether companies have met broker expectations. That tells you little about the financial performance of companies. And unfortunately for many companies only a few brokers ‘cover’ all the stocks.
• Other analysts just track the earnings of those companies they ‘cover’ – the companies that they have detailed information on. CommSec includes all ASX 200 companies in its macro (big picture) assessment of the reporting season.
• For some companies it has been the toughest year in living memory. Notably companies most negatively affected have been those dependent on people mobility. Especially global mobility – companies dependent on foreign travel such as airlines and booking companies. Local lockdowns and the closure of foreign borders have buffeted services like hospitality, accommodation, arts & recreation and gaming operators as well as commercial and retail property businesses and toll road operators.
• Energy companies were hit over 2020 by lower – often government administered – prices and demand although 2021 is looking to be a better year.
• For others like retailers, conditions have been arguably the best since the recovery period of the previous economic ‘emergency’ – the global financial crisis.
• And then there are the miners, supported by favourable commodity prices and demand, although experiencing the headwinds of a firmer Australian dollar. It is worth pointing out those Aussie dollar headwinds for companies with a significant foreign presence.

The numbers

• So to the numbers. And these numbers refer to those companies reporting half-year earnings to December 31, 2020.

Profits

• Of the 141 companies from the ASX 200 group that reported for the six months to December 2020, 121 companies or 86 per cent managed to produce a statutory profit (net profit after tax). This proportion is well up on the 75 per cent of companies reporting statutory profits (net profit after tax) for the year to June.
• Over the past decade, on average around 88 per cent of companies have reported a profit rather than a loss.
• Of the companies to report a profit for the half-year to December, 60 per cent managed to lift earnings while 40 per cent recorded a fall in earnings.
• In aggregate (summing all the profit results), earnings are down 17 per cent on a year ago. Revenues fell in total by just 0.9 per cent, short of the 0.1 per cent aggregate lift in expenses.

Dividends

• In the six months to December 2020, 111 companies (79 per cent) elected to pay a dividend. If we go back to the full year to June 2020, only 68 per cent of companies elected to pay a return to shareholders. The average over the past 20 reporting seasons stands at 86 per cent. So dividends are returning, but there is still some way to go.
• Almost 35 per cent of companies lifted dividends; 14 per cent held dividends steady; 30 per cent of companies cut dividends; and 21 per cent of companies elected not to pay a dividend.
• Of the 30 companies not paying a dividend, 21 similarly elected not to pay a dividend six months ago.
• Of the 72 companies paying a dividend, 44 per cent lifted dividends; 18 kept the payout steady; and 38 per cent of companies cut the dividend.
• In aggregate, dividends were up 4 per cent on a year ago.

Cash

• In the full-year earnings season six months ago, companies elected to trim or not pay a dividend and instead use the cash to shore up stretched balance sheets.
• Companies are paying dividends again, but they remain wary, choosing to hold more cash.
• Aggregate cash at hand (cash as at December 31) was up over 50 per cent on a year ago (up from $82 billion to $124 billion). Add in the companies reporting for the year to December and cash holdings stand at $166 billion.
• Overall 70 per cent of companies lifted cash levels from a year ago, notably retailers and banks.

Themes

• Usually each quarter there are a number of themes, covering a range of issues. This reporting season – just like the last – Covid-19 has understandably dominated.
• Investors are clearly more sympathetic with any lack of earnings guidance provided. Investors have seen how quickly conditions can change. But certainly investors are interested in the initiatives and strategies that companies have chosen – and those that are planned.
• Six and twelve months ago there was a focus on strengthening the capital position. But now with those positions shored up, the question is ‘what’s next?’ and ‘what is the best use of the huge cash stockpiles?’
•  There is a big focus on supply chains – especially global supply chains. Not only the response to Covid-19 but also those companies affected by the trade restrictions applied by China. Have diversification efforts begun, and how successful have they been?
• There are the inevitable questions on staffing levels, especially companies in receipt of JobKeeper. Some companies have decided to repay JobKeeper payments to the Government but others are torn on the issue – arguing that they ‘protected’ jobs.
• Just like six months ago, solid retail sales have featured over the reporting period, especially on-line sales. Some continue to benefit from low or lower rents. Retailers benefiting most are in homewares, electrical or those focussed on delivery. There was a bigger pay-off from companies that already had invested in the on-line presence (sales and distribution).
• While retailers, supermarkets, gold, mining-more-generally, and stay-at-home stocks have out-performed in the COVID environment, energy, tourism, travel-dependent companies and some REITS have been buffeted. It’s been an uneven economic downturn and recovery.

Selected observations & notations

• Rio Tinto: Iron ore unit costs to rise from US$15.40/tonne to US$17.70 in 2021.
• Domino’s Pizza Enterprises: Intends to accelerate expansion.
• Ingenia Communities: will repay $1.7 million of $5.1 million JobKeeper payment. Surging revenues from holiday parks.
• Adairs: Returned $6.1 million JobKeeper payment. Lifted gross margins from 61.1 per cent to 66.1 per cent.
• Breville: Cut dividend as part of strategy to reduce payout ratio to 40 per cent.
• ARB Corp: Won’t repay $9.8 million in JobKeeper.
• BHP: Optimistic on global economic recovery and prospects for commodity prices.
• SCA Property: It will take two years for earnings to reach pre-Covid levels.
• Aurizon: Expansion into ports and trucks to complete supply chain.
• Mineral Resources: Record iron ore sales and profits. Sharp lift in dividend.
• Cimic: Back in profit but actual and projected profits miss analyst forecasts. Delays in big roads projects.
• Dexus: Will continue to expand flexible space offering.
• James Hardie: Strong demand for fibre cement for renovations.
• Boral: Hurt by slump in apartment projects.
• Altium: To use excess cash for acquisitions.
• Telstra: Aim for mid-to-high single digit growth in earnings.
• Downer: Plan capital return; buyback or special dividend.
• Graincorp: Has diversified sales from 30 countries to 50 countries
• GPT: Plans to lift share of industrials from 20 per cent to 30 per cent.
• Seven West: Sharp focus on operating costs.
• CQR: Record leasing deals at higher rents.
• Cochlear: Will repay $24.6 million in JobKeeper payments.
• Shaver Shop: “is in strongest shape it has ever been in.”
• Coles: Expressed concern about absence of population growth to drive sales.
• McGrath: First dividend since 2017; raised prospects of acquisitions.
• BlueScope Steel: strongest orders in a decade; net profit up 78 per cent.
• NIB Health: 16,000 more members; expects final dividend to lift to pre-Covid levels.
• oOh!media: Advertising market fell 15 per cent in 2020.
• CSL: Challenges ahead with fewer plasma donations.
• Wesfarmers: Maintaining a strong balance sheet is prudent.
• Fortescue: Up to 10 per cent of capital may be used in clean energy ventures.
• Harvey Norman: Latest profit result described as “off the map”.
• Beacon Lighting: Higher home prices to lift sales; profit margins doubled over the year.
• Abacus Property: Swing to self-storage – strong trading conditions.
• Woolworths: Focus on digital sales; absence of foreign students impacting sales.
• AP Eagers: Won’t repay $130 million JobKeeper that helped save 2,000 staff.
• Adbri: will be aggressive bidder for infrastructure project work.

Market reaction

• Some brokers maintain estimates for companies on metrics like profits and dividends. So they determine if the earnings results were ‘good’ or less positive on whether the companies met, beat or missed their forecasts.
• In normal times, companies themselves will provide guidance on future results.
• But clearly these aren’t normal times. Companies remain reluctant to provide guidance and are holding larger-than-normal cash balances.
• So the best way to determine whether investors are encouraged or discouraged by a company’s profit result is to examine the sharemarket reaction on the immediate days after the report was delivered.
• Overall, almost 57 per cent of ASX 200 companies that reported results saw a lift in their share price on the day of earnings release with an average gain of 0.3 per cent and a loss of 0.1 per cent after two days.

What are the implications for investors?

• If one thing is clear in the Covid-19 environment, companies need to be agile. When the crisis hit, the priority was on shoring up the capital base, especially by equity raisings, as well as some debt. And those companies that acted quickly and decisively were successful. Then it was a case of having a plan on lockdowns – especially the situation on staffing and trying to fulfil customer sales and orders.
• Certainly the retailers that either had a good online presence to begin with, or were quick to put plans in place, have been hugely successful.
• We now move into a new phase. The economic recovery has been swifter than expected. Vaccines are being rolled out in Australia as they are across the globe. That may mean that domestic lockdowns become a thing of the past. Corporate Australia is in solid shape with strong balance sheets being maintained.
• So should the extra cash held by companies be used for capital spending, mergers/acquisitions or should it be returned to investors? As always the answer will vary across companies and sectors. But investors will be carefully assessing the decisions made. Companies will also need to determine when earnings guidance is reinstated. Again it will reflect on company management and strategy and the direction that companies are taking.
• Of course this is still early days. Mutant strains of the virus could be less responsive to vaccines, putting us back to square one. And the foreign borders are still closed.
• There is still plenty of stimulus and support being applied to the economy. And that won’t be removed too quickly, especially if the Reserve Bank has any say in the matter. The Reserve Bank is adhering to the view that low cash rates will be maintained for three years. Some businesses are sceptical, given that input costs are rising and job shortages are appearing. And the imminent tapering of JobKeeper payments poses a test to the most virus-affected firms and industries.
• Infrastructure spending will be important in driving economic recovery and will support prospects for industrials, especially engineering and construction materials. The success in keeping the jobless rate down will be important for consumer-focussed companies, especially retailers.
• Spending on infrastructure, super-low interest rates and a home-building boom spurred on by HomeBuilder (and state-based schemes) will provide the economy with momentum over 2021. Then there is the external factor – China and other countries driving growth in their economies through infrastructure spending. The Biden Administration has made infrastructure a priority policy with a focus on renewables. That means more demand for Australian resources.
• The recovery of the Chinese economy remains encouraging for mining and engineering sectors. The iron ore price is near 9-year highs. Copper is near 9½-year highs. Oil prices are near 13-month highs.
• The main challenges for the resource sector are a firmer Australian dollar and the global production delays caused by shortages of labour, parts and shipping containers. Firms are already reporting skilled labour shortages in the building industry and border closures present challenges to agricultural harvesters reliant on temporary overseas workers.
• CommSec expects the All Ordinaries to be in a range of 7,200-7,600 by end-2020, with the range for the ASX 200 between 7,000-7,400 points. The hard part is in determining whether equities have become – or are becoming – too expensive. While less of a challenge with ‘normal’ interest rates, it is harder to resolve the ‘cheap/dear; debate with near zero rates. The ‘chase for yield’ is supportive of risk assets, but rising real interest rates – as inflationary expectations mount – present the biggest near term challenge to interest rate sensitive sectors of the sharemarket.
• Maintenance of fiscal and monetary stimulus will continue to support prospects for Australian companies. But governments would like to see a transition from government support to a business-led recovery. Improving business conditions bode well for hiring intentions and business investment. And the domestic vaccine roll-out will also be fundamentally important to future prospects as will be how overseas countries transition out of lockdown.
• Issues to watch in coming months include lifting market interest rates; migration (opening up of the borders); rising cost or inflationary pressures; difficulty of accessing stock and labour; the ‘green’ agenda of the new US President; risk of policy errors will the roll-back of stimulus; the rising Australian dollar; and the trade relationship with China.