February and August are two very busy months of the year for Australian investors as most listed companies release their full or half year accounts. It is a great, but somewhat manic period due to the sheer volume of information being released. The information provides timely insights into a company, how they’ve fared over the previous 6 months and how they expect their operating environment and company fortunes to develop over the next half year.
Currently we are in what is mainly a half yearly company reporting period, as most Australian listed companies have a June year-end. Although we are only about a quarter of the way through the current reporting period, some broad trends can be drawn.
To date (15th February), 79 of the top 300 companies have reported (ranked by market cap) and we’ve seen a slight skew to disappointing results. 45 of the 79 results have seen analysts reduce the earnings they’re expecting the company to generate over the next 12 months – this is otherwise known as a downgrade[1]. Volatility remains a stalwart of Australian reporting season and although the average -0.5% share price move on the day of a result doesn’t seem like much, the disparity of returns is very large, ranging from -16% to +23%[2].
One trend that’s been dominating headlines and is starting to impact company earnings is the weaker housing market.
This weakness shouldn’t come as a surprise. Leading into this reporting season three of the eight key listed property developers warned the market about difficult conditions, blaming the Royal Commission, stricter lending standards, proposed labour policies (specifically the abolishment of negative gearing and a reduction in the capital gains tax discount) and the media for a material decline in sentiment and property prices.
Importantly, the three that warned the market are pure residential developers who generate barely any revenue outside of house and land sales to consumers. This highlights the importance of earnings diversity, particularly for property companies that are exposed to market cycles.
Four developers have reported to date with two experiencing whopping earnings declines of -67% and -91% in 1H19 when compared to 1H18 – surprise surprise, these two were pure-play residential developers.
It’s important to note that a weak housing market doesn’t affect residential developers in isolation – the implications across the economy are quite wide-ranging. Construction and certain contracting companies will lose work, housing exposed retailers come under pressure, both of which may lead to lower employment, lower disposable income, and lower discretionary spend. This results in retailers struggling, expanding less, employing less and so on and so forth.
Two other key trends from reporting season are clearly visible:
- The consumer discretionary sector remains very difficult and leading into reporting season, 16 companies within this sector downgraded their earnings expectations, and on average received a -16% daily share price move as their prize.
- Uncertainty around the Royal Commission and its implications on parts of the economy remains. Particularly as it relates to lending and the mortgage broking industry.
In summary, looking at broad sector trends helps ascertain which areas of the market are likely to produce strong or weak returns either over the short or medium term dependant on the expected severity of said trend. However, it is dangerous to paint with a broad brush. Although cyclical or structural headwinds (or tailwinds) may be in force, within each sector it is often possible to find misunderstood and mispriced companies which can deliver good returns. It is therefore important to be aware of these trends, but not blinded by them.