Reporting season in review – a small companies perspective
Leading into reporting season this year, it felt more critical than usual from an investor’s perspective. This was driven mainly by the ever-changing macro backdrop which at this point in time could be argued is driving share prices more so than company fundamentals.
The second key point to consider is the operating period over which reporting season resides. The full year reporting season carries two key periods, firstly it allows you to draw conclusions around the trading period from January to June, and then assess the financial year in its entirety.
Reporting season, based on data from UBS was a success. Company beats outnumbered misses by a ratio of three to two. When we take a moment to reflect upon this, we want to consider the comment above around the operating period.
Inflation and interest rates are a worry for investors
If we look at investor concerns, they ultimately focus on inflation, and the subsequent interest rate policy that we will see from central banks and what damage this will do to the consumer and ultimately demand. It is important to note the Reserve Bank of Australia didn’t start increasing interest rates until May 2022. When you consider the transmission time for interest rate increases it is highly unlikely that any of the current increases have been captured in any of the data from reporting season.
Investor sentiment in relation to this backdrop was the signpost for the assessment of every company’s results. It was this perspective from which investors rewarded the winners and punished those who disappointed during reporting season.
If we saw one key characteristic prevail during reporting season it was any company that could show top line resilience. Those with the ability to pass on its costs (i.e. pricing power, and a strong business model), and ability to demonstrate they could maintain its margins, during what is perceived to have been a potentially charging period was ultimately rewarded by the market.
Why Lovisa demonstrates growth
In the Montgomery Small Companies Fund’s portfolio an example of a business that was able to demonstrate growth, maintain margin, and navigate an ever increasingly challenging environment for its sector was Lovisa Holdings Limited (ASX:LOV). The market has warmed to their new CEO, the company has proven its growth strategy to be resilient, and its core demographic are less sensitive to the above macro trends. We have seen the stock outperformed the market by over 65 per cent in the last three months including August.
IDP Education is seeing a recovery in student placement
We also saw similar characteristics in IDP Education (ASX:IEL), they posted above consensus NPATA growth at 8 per cent beating broker expectations of 5 per cent. IDP continue to see a solid recovery in student placement, with one particular highlight being strong momentum in the second half here in Australia. Even with the looming economic backdrop; when you consider the decision of where your children will study particularly when abroad, this is made many years in advance of it taking place, it is well budgeted for and less economically sensitive. This base characteristic of parents providing higher education for their children is a key strength to the resilience of this business and one of its quality attributes.
IDP has outperformed the market by 23 per cent over the last quarter and continues to be a meaningful position in our portfolio.
Why more companies are deploying capital into buybacks of their stock
The other dynamic that was met with great reward, was that of share buybacks. Many companies have entered this period with what we would considered to be strong balance sheets. They have been built off the back of very accommodative trading conditions, coupled with the hangover of many being fortified during the COVID period.
As a result, companies are prepared to utilise these balance sheets, and deploy their capital into buybacks of their stock. Ultimately investors have rewarded this, as they are happy to see the cash in their hands rather than potentially at risk in the market. We believe this has also built a floor into some of the company’s share prices. Notably we saw buybacks from oOh!media Limited (ASX:OML), CSR Limited (ASX:CSR), G8 Education Limited (ASX:GEM), and Iress Limited (ASX:IRE).
Companies missing expectations during reporting season
For companies that missed during reporting season, the market was appropriately harsh in its response and the result was quickly reflected in their share price. Having said that, we did see instances where we would argue a company’s results were within a very reasonable variance from the markets expectation, but where the underlying details of the report were not in line with the markets desire, then the stock in some cases we believe was unduly punished.
We saw this in particular with businesses that continued to reinvest in themselves. At times this reinvestment is fundamental to their long-term growth but comes with some short-term expenses or balance sheet changes. Ultimately this was seen as a negative by the market and reflected in the share price. We saw an example of this in the result from Aussie Broadband Limited (ASX:ABB).
Strong mergers and acquisitions activity
With results overshadowed by the macro, one final thematic we saw through reporting season which is worthy of mention was the emergence of strong mergers and acquisitions activity. There were a number of very cashed up private equity firms circling the market and looking to take advantage of much weaker conditions. At this point in time if you are a growth company, ‘growth’ is a dirty word, investors are not keen to own growth companies in a rising rate environment and as a result this has been the area where we have seen the largest drawdown and share price weakness (over the last 6-8 months not just reporting season).
Being the opportunistic investors that they are, private equity companies have taken advantage of this investor sentiment and we’ve seen several bids come to market in the last few weeks. The following companies have to date been the target of some of this activity: Infinity Lithium Corporation Limited (ASX:INF), Nearmap Limited (ASX:NEA), Nitro Software Limited (ASX:NTO), and most recently Tyro Payments Limited (ASX:TYR).
The size and acceleration of this dynamic has come as somewhat of a surprise. Having said that if the outlook does not turn out to be as poor as some investors expect, then this type of activity in time may be proven to be quite opportunistic.
The outlook for companies
The final piece in any reporting season comes via the outlook statements for companies. As one would expect given the uncertainty and ever-changing backdrop at a macro level, many companies are hesitant to provide any significant detail in their outlook statements.
The challenge for us as fundamental bottom-up investors, is to sift through what little detail they do provide and marry that with our own work. We then utilise this information to ensure we have the right shape to our portfolio, and it consists of the best names for the environment we see ahead.
All in all, reporting season was a strong month for our portfolio, we had more beats then misses. For our portfolio we saw particular strength in the resource sector and benefited from our positions in battery material feedstock as well as Energy exposure. As has been the theme our detractors generally had more of a growth flavour to them, or are investing in their growth, which is not a theme currently favoured by the market.
We will continue to remain active in managing the portfolio and expect volatility to increase further as speculation around inflation and interest rates continues, coupled with the uncertainty flowing from the conflict in Ukraine. Ultimately by maintaining a position in quality companies who have a strong influence over their destiny, our portfolio should demonstrate earnings resilience in the period ahead.
The Montgomery Small Companies Fund owns shares in Lovisa, IDP Education, Aussie Broadband, G8 Education. This article was prepared 26 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 these companies you should seek financial advice.