Earnings Season Opportunities…Not Where You Think
Wednesday, 19 August 2020
By Greg Canavan
We’re slap bang in the middle of week three of annual profit reporting season.
As such, I thought I’d have a look at a few of the key results so far, to see if it provides some clues on how the Aussie economy is coping. Not necessarily with COVID, but with the absurd overreaction to it by our ruling classes.
Victoria is still only halfway through its hard lockdown. It’s a terrible policy mistake resulting from a near-criminal level of negligence in letting the virus get out of control in the first place.
But I digress…
So, how is corporate Australia faring?
Before looking at the numbers, keep in mind that the important thing to note is the share price reaction to the result, not necessarily the result itself. That tells you whether the market had already priced it in or not.
With that in mind, have a look at the ASX 200 Index and the Small Ords Index. The red line marks the start of reporting season. Based on the evidence so far, it looks like the rebound rally from the March lows into the June peak priced in much of the FY20 profit picture.
The Small Ords have just managed to exceed the June peak, while the large-caps continue to move sideways.
The banks have all reported results for the year or quarter. CBA saw cash profit drop 11%, while Bendigo Bank’s profit plunged 27%.
NAB reported a 7% earnings decline in the third quarter (ending 30 June), following a 51% decline in the first half.
Westpac reported a weaker than expected third quarter profit result, thanks largely to an increase in bad debt provisions. It also cancelled its final dividend.
And today, ANZ announced a solid $1.5 billion cash profit in the third quarter (compared to a first half profit of $1.4 billion). It also announced a 25-cent interim dividend, down from 80 cents last year, but still better than no dividend at all.
What made the result even better was the fact that ANZ took an additional $500 million bad debts provision in the quarter.
The market responded positively, with ANZ’s share price up 3% in trading so far.
Up until today, bank stocks had all moved lower following the other results. While the sector looks like good value at these levels, the mixed reaction suggests a lot of uncertainty about the pace of recovery.
As good as it gets for miners?
Moving onto the big miners, BHP and RIO. While their results were strong; the muted share price reactions suggest the good news is largely priced in.
The companies are effectively a play on China and iron ore.
Iron ore prices are very strong right now.
Yep, both BHP and RIO declared lower dividends this reporting season compared to last year. Is this perhaps an acknowledge from management that these price levels are unsustainable?
RIO’s share price has retreated since its announcement, while BHP’s declined slightly yesterday. No big deal, but just the market saying all the good news is in the price for now.
On the topic of dividends, the Financial Review writes that of the 81 companies to report results so far and paid a dividend last year, 15 have scrapped it this year.
Furthermore, 26% of companies have increased dividends, while 66% have reduced their payouts.
That makes sense. A mandatory shutdown of a functioning economic system is going to come at a cost.
But thanks to plenty of government largesse, many stocks are thriving.
Especially in the retail space.
Retailers enjoying handouts
JB Hi-Fi reported a 33% increase in underlying profit for FY20. Online retailer Kogan.com posted a 56% year-on-year increase.
Meanwhile, Premier Investments (owner of Smiggle, among other brands), Adairs (homewares), and Nick Scali (furniture) all increased dividends while receiving JobKeeper support programs. Nice work if you can get it.
As you can see in the chart of the discretionary retailers below, they’ve continued to move higher since the start of reporting season (vertical red line). The question for them is how they will go when the government support tap turns off, the economy fully opens, and consumers have other spending alternatives.
Tough environment for telcos
Telstra’s result (a near 15% decline in net profit) reflects COVID-related cost increases as well as a difficult market structure for telcos. That is, the high wholesale prices charged by the NBN cannot be passed on by the retail providers, meaning their broadband margins are almost non-existent.
Telstra also lowered its future return on capital target, which the market didn’t like. Telco land is tough enough with an uneconomic NBN setting wholesale prices. Throw in a low-growth future and there’s not much to get excited about.
Property trusts for the contrarians?
One area that is looking interesting for the contrarians is property trusts. Many of the larger trusts have reported results, and they have been predictably terrible. Lots of asset write-downs.
But the massive decline in March more than factored all of that in. Since reporting season kicked off, the sector has moved marginally higher. That’s a positive. It’s still early days, but this could be a sector worth keeping an eye on for both income and capital growth opportunities.
Small-caps for the punters!
Finally, let’s take a look at the small-cap space, the Small Ordinaries Index.
As you can see below, it’s moved higher since reporting season kicked off. Whether this is due to fundamentals or speculative fervor, I don’t know. But as you can see, the index is right up against support/resistance. If it can break through there, a quick rally to the old highs is in prospect.
[At lunch time today, the small-cap index was down slightly, compared to a big rally in the ASX 200. You can thank the banks for that.]
For the speculators, the ‘why’ doesn’t really matter. But given the poor economic conditions and outlook, and the muted response to many blue chips’ results over the past few weeks, it suggests this rally is running more on the fumes of hope, rather than on ‘fundamentals’.
And it helps that many small-caps don’t have earnings or are very early on in their growth path. So, it allows the market to use its imagination when it comes to share price projections.
I saw a tweet yesterday that said from 6 April to 12 June, 255 ASX companies doubled in price. 80% of those companies had negative earnings, while the other 20% had an average P/E of 55 times!
Having said that, this is EXACTLY the type of market you need if you want to make money QUICKLY.
It’s not my type of market. I see too much risk and uncertainty. But that doesn’t mean there’s not plenty of opportunities.
As I showed you in Monday’s essay, Ryan Dinse’s Small-Cap Momentum Alert is firing off trades left, right, and centre. His momentum indicator is working overtime.
As long as you manage your risk (as Ryan does), which is always notably high for small-caps, this can indeed be a very lucrative time to speculate.
But do so with your eyes wide open.
Ask yourself, what is my downside risk?
How much of my portfolio am I prepared to punt?
What is my worst-case scenario if the market turns against me?
Tick those boxes, and away you go!
By the way, if you’ve yet to see what Ryan’s small-cap service is all about, you can check it out here.