Three things we’ve learnt from AGM season
With annual general meeting (AGM) season underway, we’re starting to see some interesting trends. One is that, overall, results have been better than expected. Another is that, in Australia, margins are coming under pressure as inflation starts to bite. And a third is that the retail sector is experiencing a subdued start to FY22 – perhaps because many of us satiated our shopping urges during the COVID-19 lockdowns.
With excellent progress on vaccinations, the economy is now opening up during the AGM season. Understandably investors want to see activity recovering and are seeking confirmation from their CEOs.
Thanks to COVID-19 and the hyper-dynamic nature of consumer spending and business investment, the 2021 AGM season has also become a mini-reporting season. Meanwhile, rising US 10-year Treasury Yields – from around 1.00 per cent in January to 1.55 per cent today – should be prompting higher volatility. But that isn’t happening. In fact the VIX remains near its lowest levels since the COVID-19 pandemic emerged. We think this might reasonably be attributed to relatively robust earnings.
Observation #1 – Results are looking pretty good so far
It’s the busiest third quarter earnings week currently in the US and companies representing nearly half of the S&P 500’s total market capitalisation are reporting.
So far 192 (58 per cent of total market capitalisation) S&P500 companies have reported their third quarter results 3Q results. Sixty-three per cent of those companies have beaten consensus by more than one standard deviation, according to Goldman Sachs, which is higher than the 46 per cent historical average. Only eight per cent have missed consensus estimates by more than one standard deviation, which again, is significantly lower than the historical average of 14 per cent.
In other words, third quarter US results have been much better than expected and this is helping to more than offset the negative influence of rising bond rates.
But it’s not all beer and skittles. Australia’s AGM season is reflecting one of the trends also emerging during the US third quarter reporting season.
Companies beating estimates are outperforming the market by a bit. However, companies that miss estimates underperform by a lot, hence the need for AGM season to provide clarity.
Again, according to Goldman Sachs, US firms that beat earnings estimates by at least one standard deviation have only outperformed the S&P 500 by 96 basis points in the trading session directly after reporting (vs historical average of +102 basis points of outperformance). Companies however that miss earnings estimates by at least one standard deviation have underperformed the S&P 500 by nearly 300 basis points, which is worse than historical average of -211 basis points of underperformance.
We’ve seen a similar trend in Australia. This week metal detection company Codan merely reaffirmed guidance that FY22 would be flat on the previous year. This is a solid result considering the massive bump in sales Codan enjoyed last year as a result of pandemic related lockdowns. Analysts however have seen the company previously under-promise and over-deliver but this time the company implied they aren’t playing this game. Consequently, analysts are now downgrading their forecasts for FY22 by about five per cent. Nevertheless, Codan’s share price fell nearly 20 per cent yesterday, confirming the trends observed in the US. The need for clarity and the state of nervousness there, is also endemic here.
In another example, Flight Centre used its AGM last week (Wednesday 20 October) to paint a rosy outlook, remembering overseas travel for the vaccinated was originally slated for mid-22, Australians are now preparing to resume quarantine-free international travel imminently.
But Flight Centre merely reiterated expectations of break-even later this financial year, while surpassing pre-COVID bookings by 2024. Even with materially lower costs, the market was disappointed. Disappointment is, as we’ve discussed, treated harshly in present conditions. And since the AGM, FLT shares are down 13 per cent.
Observation #2 – Margins are under pressure
You might recall, last year during reporting season, investors were largely willing to look through the negative impacts of the COVID-19 lockdowns. That tolerance appears to have evaporated. And at the August results only 16 per cent of Australian companies had provided quantitative guidance with most erring on the side of caution when offering outlook commentary.
Investors are particularly concerned with margins.
The impact of cost inflation and shortages, and the ability of companies to pass on cost increases even as global growth slows will determine whether margins are lower their orbit. Where they settle will play a big part in the outcome for individual company share prices.
Margins expanded impressively over the last eighteen months but are now under pressure. According to autoparts distributor Bapcor, supply chain challenges are yet to abate.
Meanwhile, promotional activity and associated price discounting is intense.
Once again, investors are hopeful that while margins will contract, they will settle above pre-COVID-19 levels.
Observation #3 – Retail sales
Based on last year’s ‘false start’ reopening and the experience of a pent-up surge in sales, retailers are hopeful of a similar experience, especially given reopening coincides with the Black Friday and Christmas seasonal sales surges. This Christmas is currently expected to be a bumper or even record year, timed, as it is, with the end of extended lockdowns.
You might recall however we have posited the idea of the “Economics of Enough.” Consumers have simply purchased so much stuff during the last lockdown and committed to other projects to such an extent, they simply have enough. Consequently, there’s a risk this year’s surge may not be as broadly based as is currently expected.
We are not surprised the retail sector is reporting a subdued start to FY22, and we’ll soon discover how retailers fare emerging from lockdown and entering Christmas.
Median year-to-date total sales growth Year-on-Year is reported to be down 10 per cent, and down 9 per cent on a like-for-like (LFL) basis. And that’s before travel resumes in earnest, which of course will redirect spending away from goods, including online.
The one possible saving grace is the absolutely massive amount of savings amassed. Some surveys suggest consumers will spend on travel without crimping their Christmas retail plans.
Pleasingly, FY22 year-to-date (YTD) median total sales growth remains 23 per cent above two years ago, suggesting sales might remain above pre-COVID-19 levels in some segments of the retail sector.
Super Retail Group may be one example with the company noting, “In FY22 year to date, we have maintained steady trading momentum in non-COVID impacted regions and we are confident that we will see a rebound in sales as lockdowns end and stores re-open. As COVID-19 restrictions ease, we are looking forward to helping our customers celebrate by providing them with all of the products they need to resume travelling, playing sport and enjoying the great outdoors.”
Adding, “With a strong inventory position [we] should be well placed to take advantage of the expected uplift in consumer demand in the auto, leisure and outdoor categories over the summer holiday period.”
Super Retail Group recently reported YTD group sales down 12 per cent Year-on-Year but up 10 per cent versus two years ago.
Elsewhere, Adairs recently reported YTD group sales down 8.5 per cent Year-on-Year but up nearly 15 per cent versus two years ago.
Whether this is enough to assuage nervous investors, or whether the requirement for more is the only thing that can support prices more broadly, will be revealed soon enough.
The Montgomery Funds owns shares in Codan and Adairs and the Montgomery Small Companies Fund owns shares in Flight Centre, Super Retail Group and Adairs. This article was prepared 28 October 2021 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.