August reporting season wrap
In the wash-up of the FY22 reporting season a significant amount of focus has been directed to the proportion of companies that beat, met or missed expectations. Roughly 30 per cent of companies beat analyst forecasts, slightly more than 41 per cent were in line with estimates, and the remaining 29-odd per cent missed estimates.
I always find these numbers curious if only because I haven’t worked out if the misses were the company’s fault, or the analyst’s fault for being wrong. This year the numbers are also curious because this year’s reporting season was heavily ‘pre-reported’. The conclusion I reach is that analysts were simply too bearish going into results season.
Recalling the recessionary fears and tapering that spurred the market dive into June, investors rotated into defensive sectors such as consumer staples. With the fears of recession subsequently seen as overplayed, a move back into cyclicals occurred and the result was the share price of the median ‘beat’ outperformed the median ‘miss’ by a relatively large amount. According to UBS, that number was 2.8 per cent, again skewed by rotation upon macroeconomic drivers.
And although slightly more companies beat estimates than missed, analysts nevertheless did become more depressed by the weakening domestic and global economies, which was reflected in reduced estimates for 2023 and 2024.
Macro-economic drivers in the short-term
Indeed, it appears macro-economic drivers are taking precedence in the short-term. This might be reflected in the observation the 2022 reporting season didn’t appear to help the Australian market outperform its major global peers significantly in August.
Amid the renewed hawkishness of the U.S. Federal Reserve, and a post-peak economy, the S&P 500 rose 4.48 per cent in August and the MSCI World Ex Australia rose 0.3% is USD terms. The ASX200 rose just 0.6%.
Australia’s earnings cycles are extended affairs, so the commencement of declining earnings estimates represents the beginning of a pattern. In other words, the optimistic interpretations of reporting season by some commentators ignores the more relevant fact the market casts its shadow before it and future earnings are expected to be lower.
Australian average annual earnings growth
According to UBS, over the past 20 years, the average annual earnings growth delivered by Australian companies has been 5.5 per cent. With our thesis about ‘sticky’ supply chain bottlenecks keeping input prices elevated, with labour supply issues unlikely to be alleviated by cheap airfares anytime soon, and with interest rates likely to continue rising, it might be wishful to believe annual earnings growth will meet UBS’s calculated average in the next twelve months.
The big headwinds companies had to navigate during the year were well known. Ongoing after-effects of COVID-19, including sticky or persistent supply chain bottlenecks, labour shortages and the impact on wage costs, inflation and its impact on discretionary spending, rising interest rates, more agressive geopolitical sabre rattling and extreme weather all variously impacted business during the 2022. Indeed, this list of trials was perfectly summarised by Mirvac’s CEO, Susan Lloyd-Hurwitz, who noted “FY22 presented a more challenging operating environment…the ongoing impacts of COVID-19, supply chain issues, labour shortages, rising inflation and interest rates, geopolitical tension, and extreme wet weather, particularly across the east coast of Australia.”
Turning to specific companies
One of our current favourite long-term structural growers is Megaport (ASX:MP1) and its response to the supply-chain challenges was to purchase additional equipment and licenses to alleviate the impact of delays from its vital equipment suppliers. WiseTech Global (ASX:WTC) noted “persistent supply chain constraints, inflationary pressures and COVID-related business disruption.”
Technology companies weren’t the only businesses responding to the supply chain challenges. Retailer Super Retail Group (ASX:SUL) made a tactical decision to invest in inventory in response to the disrupted global supply chain. They weren’t the only retailer doing so. Crowd favourite Lovisa (ASX:LOV), as well as City Chic (ASX:CCX), Breville (ASX:BRG) and Nick Scali (ASX:NCK), all increased inventory levels materially.
Meanwhile, the tail end of COVID-19 is now, hopefully, with us but many companies noted the serious impacts the pandemic had on their businesses. Coles (ASX:COL), Woolworths (ASX:WOW), Wesfarmers (ASX:WES) and Ramsay Health (ASX:RHC) all mentioned higher absenteeism levels and sick leave, and the effects of the same on Qantas (ASX:QAN) is well known to anyone who has been at a major Australian airport in the last six months.
COVID continues to cause issues for businesses seeking to hire people. Expensive airfares, backed up visa applications and resentment held by now-departed foreign visa holders who didn’t qualify for Jobkeeper all continue to limit the number of workers in Australia, in turn causing rising salary costs for businesses. SEEK (ASX:SEK) noted job ad volumes hit a record high of approximately 325,000 in March, Corporate Travel Management (ASX:CTD) observed unprecedented resourcing shortfalls in the travel industry, Coles said “We need more skilled and unskilled people to do all the jobs that need doing at the moment; otherwise it will drive further inflation”, and Ramsay Healthcare (ASX:RHC) said it will hire 800 graduate nurses as part of a cadetship program. Staff shortages appear to most acute in Food Production, Retail, Transport and Education.
A conga line of companies mentioned inflation. Indeed, rising input cost pressures was one of the most dominant themes in corporate commentary, and across all sectors. Computershare (ASX:CPU) noted costs are expected to rise in FY23 with margin income driving strong earnings growth. KFC owner Collins Food (ASX:CKF) will increase menu prices by 1-2 per cent for the third time, Coles’s results reflected an inability to leverage food inflation, while Woolworths (ASX:WOW) noted customers trading down and substituting cheaper mince varieties. (That latter trend might not last with growing overseas demand for Australian beef reducing supplies). Despite the pressures plenty of companies demonstrated an ability to pass on higher costs and therefore maintain margins. This can be attributed to relatively buoyant demand, which of course may now begin to wane.
Outlook for FY23
Returning to the earnings outlook for FY23, and cuts to FY23 earnings accelerated during reporting season. According to trading updates for the first few weeks of the new financial year, consumers might still be spending but rising interest rates will inevitably crimp demand. Likewise, while builders noted continued strong demand and a solid pipeline, the severe and rapid declines in borrower commitments will lead to declines in new builds as well as renovation demand.
Investors can now leave the 2022 financial year behind but the work to properly analyse and model the results, and the implications for the future, is only just beginning. Meanwhile, as the news flow quietens down, the direction for companies will again be influenced by macro-economic and financial events overseas, including U.S. Monetary policy and global liquidity events.
The Montgomery Funds own shares in Megaport (ASX:MP1), Lovisa (ASX:LOV), Corporate Travel Management (ASX:CTD), Breville (ASX:BRG), Woolworths (ASX:WOW), Ramsay Health (ASX:RHC), Computershare (ASX:CPU) and Wesfarmers (ASX:WES). This article was prepared 2 September 2022 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade any of these companies you should seek financial advice.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
