The recently concluded reporting season in Australia was the best one for at least 4 years. This was a welcome surprise after a long period of disappointment, and was responsible for driving the Australian market up almost 5% in February.

So, what were the key drivers behind the surprise?

First, banks and resource company earnings were resilient. The Banks’ profits benefitted from a continued improvement in bad debts. At the same time, housing finance remains firm, driving top line growth. Steel and Building materials earnings also positively surprised, as the residential housing market continues to improve. As mining investment rolls off, it is comforting to see that construction lead investment is beginning to fill the void.

Second, what this reporting season really highlighted was the ability of companies to preserve and even expand their operating margins, in what is still a subdued revenue environment. This was achieved on the back of management controlling and reducing their costs. While this is unsustainable in the long term, what it does mean is that when the cycle starts to improve and revenues begin to grow again, the operating leverage available to these companies will be significant.

Third, a consequence of this cost reduction is that corporate cash flows were also significantly better, allowing corporates to increase returns to shareholders through higher dividends. The market payout ratio now sits at 76%, up from 73% previously. In the mining space for example, BHP and Rio Tinto held out the promise of more aggressive capital management in the second half of the year. Such promise saw both companies rerate strongly.

In all, the reporting season scored a solid pass mark. More companies either beat or met expectations than expected. While much of this was on the back of better cost control, it does position corporate Australia to take advantage of improving conditions when the economy turns. In the meantime, increasing dividends means that investors are well rewarded in the interim.

Marc Whittaker

Portfolio Manager

Disclaimer:  Milford on behalf of clients has an interest in CBA, ANZ, NAB, Westpac, BHP and Rio Tinto.