Big firms fail to match growth of economy

Recently released profit figures confirm that our largest listed companies have not taken full advantage of New Zealand’s buoyant economy. 

Combined net earnings for the nineteen New Zealand registered NZX50 Index companies that have reported for the June 30 ending period increased by only 3.9 per cent, to $2,173 million, compared with the same period twelve months ago.

These nineteen companies reported a 10.6 per cent increase in earnings, from $1,890 million to $2,091 million, twelve months ago.

The three best performing companies, in percentage increase terms, were Property for Industry, which had a net earnings increase of 104.7 per cent, Vital Healthcare’s net profit rose 23.1 per cent and Sky TV’s net profit grew 22.1 per cent.

NZX50 results – mostly underwhelming

The huge increase in Property for Industry’s net earnings was primarily due to the July 1, 2013 merger with Direct Property Fund.

The three worst performing companies were Vector, which reported a 17.0 per cent decline in net profit after tax, SkyCity’s net earnings were down 9.6 per cent while Spark, formerly known as Telecom, announced a 7.7 per cent reduction in adjusted net earnings.

Vector’s earnings downturn was mainly due to regulatory decisions that required it to reduce prices on its energy networks.

Sky City’s performance has been particularly poor as its net earnings have declined for two consecutive years and the company’s 20 cents dividend is well below the 26 cents it paid for the June 2006 year.

The casino operator continues to under perform relative to analysts’ forecasts as follows;

–          After the June 2012 year result analysts had an average June 2013 year forecast of $145.6 million but the company achieved only $136.3 million

–          Following the 2012/13 result the average analyst forecast was $142.8 million for the June 2014 year but the actual outcome was just $123.2 million

–          The average net earnings forecast for the June 2015 year has been cut from $168.7 million following the June 2012 year result to $163.1 million after the 2012/13 year announcement to just $132.0 million at present.

Meanwhile the number of SkyCity executives earning $700,000 or more per annum has jumped from none in 2011 to five in 2012 and eight in 2013.

It will be fascinating to see how many executives were paid $700,000 or more in the June 2014 year as there doesn’t seem to be a close correlation between performance and executive remuneration at SkyCity.

Spark’s headline announcement was that group net profit after tax from continuing operations for the June 2014 year was up 19.6 per cent, from $270 million to $323 million. The company’s investor presentation also highlighted these figures.

However, Spark’s annual report showed that adjusted net profit was $323 million compared with $350 million in the previous year, a 7.7 per cent decline.

This illustrates a major issue faced by investors as our our listed companies are highlighting adjusted or underlying figures and these figures are often spun to give the impression that they are performing better than they are.

But the positive aspect of Telecom’s result was that it managed to beat analyst forecasts struck twelve months ago.

In August 2013, following the June 2013 profit announcement, analysts had an average adjusted forecast net earnings forecast of $327 million for the June 2014 year and the company managed to achieve $350 million. It also announced a full 2013/14 year dividend of 17.0 cents compared with a 16.0 cents a share average forecast twelve months ago.

But SkyCity and Spark weren’t the only negative results, the overall performance of the listed sector has been disappointing in light of New Zealand’s strong GDP growth.

GDP growth was probably between 3.0 per cent and 3.5 per cent in the June 2014 year, compared with 1.8 per cent for the June 2013 year, yet net earnings for the latest period grew by just 3.9 per cent compared with 10.6 per cent for the period ended June 2013.

In addition total dividends grew by only 8.1 per cent in the June 2014 year, a disappointing figure given the buoyant economic conditions. This may indicate that directors have a cautious view of the June 2015 year, a point of view supported by the fairly cautious outlook comments for 2014/15 and the large number of companies unwilling to give any guidance for the year ahead.

Fletcher Building, which is our largest listed company, is a good example of the failure of our companies to live up to expectations.

The building and construction company’s June 2014 year net earnings and dividend forecasts evolved as follows;

–          Broker analysts had average net earnings and dividend forecasts of $691 million and 46 cents respectively for the 2013/14 year following the release of the company’s June 2011 year result

–          These June 2014 year forecasts were slashed to $441 million and 38 cents after the 2011/12 year profit announcement

–          The 2013/14 net profit and dividend forecasts were reduced again to $371 million and 35 cents respectively following the June 2013 year result.

              A point to note is that twelve months ago Fletcher Building was forecasting housing consents of 20,000 in New Zealand, a soft and uncertain Australian market, flat to positive demand in North America, while Europe would remain challenging and China was slowing.

Economic conditions have probably been better than forecast yet Fletcher Building announced net earnings this week of $362 million for the June 2014 year compared with an average $371 million forecast twelve months ago, a $441 million forecast two years ago and an average $691 million for the same June 2014 period three years ago.

In August 2011 one senior analyst was forecasting a $777 million net profit for Fletcher Building for the year ended June 2014. The actual result was less than half this.

Why has Fletcher Building failed to achieve these profit predictions? Is it because these predictions were far too optimistic or the company’s management team is underperforming?

The answer to this question is a combination of both.

Broker forecasts usually have a substantial blue sky element, particularly when they look two or three years forward. These long-term forecasts, which indicate that earnings will continue to rise uninterrupted, are rarely achieved.

However, there are also serious question marks about the performance of Fletcher Building’s senior management team and its ability to deliver. Chief Executive Mark Adamson talked up his abilities in an infamous interview with The Australian late last year but Adamson has yet to prove that his executions are as good as his words.

For example, analysts continue to reduce their Fletcher Building forecasts for the June 2015 year.

Two years ago the average Fletcher Building net profit and dividend forecasts for the 2014/5 year were $549 million and 47 cents a share respectively.

A year ago these predictions had been cut to $457 million and 41 cents and are now $415 million and 39 cents.

The good news is that Sir Ralph Norris was appointed Fletcher Building chairman this week. Sir Ralph has had a stellar management career at ASB, Air New Zealand and CBA in Australia.

However, Fletcher Building is likely to be a huge challenge for him, second only to an ailing Air New Zealand. He will be doing New Zealand investors a huge favour if he can reinvigorate the group’s senior management team and turn the underperforming company around.

Brian Gaynor

Portfolio Manager

Disclosure of interests; Milford Asset Management holds shares in all nineteen companies listed above on behalf of clients.