Buoyant reporting season on the way as recovery takes hold Rebecca Urban From: The Australian January 18, 2010 12:00AM
ALMOST a year on from the sharemarket bottoming, Australian investors are about to see the benefits of what is commonly known as the "sweet spot" in financial circles.
Analysts are predicting a solid reporting season for local companies due to the powerful combination of a swifter than expected economic recovery, extensive cost cutting and below-average interest rates throughout 2009.
And going by the surge in equity prices -- the All Ordinaries gained 33 per cent last year in its strongest performance in 16 years -- investors are also optimistic.
Earnings upgrades from companies such as Qantas and the Commonwealth Bank, as well as a strong fourth-quarter production report from miner Rio Tinto ahead of its full-year results in March, have helped cement a widespread belief that the worst of the global financial crisis is over.
The worry now is that expectations might have risen too high.
"It's a concern . . . seeing the market capitalise the growth we're seeing off such a low base."
Investors were reminded about the risk of too much exuberance last Wednesday when mining and engineering contractor WorleyParsons warned that full-year profit would be as much as $40 million lower than expected.
To say that the market was taken by surprise would be an understatement. The company's shares had risen markedly in the preceding month -- despite numerous warnings from analysts that the stock appeared overvalued -- and fell 12 per cent on the day of the profit warning. They have continued to slide.
With a week or so to run until the traditional corporate confession season is over, more profit downgrades will probably follow.
Meanwhile, Australian investors are keeping a close eye on the US, where Alcoa kicked off the profit reporting season last week with a disappointing result.
In Australia, financial results for the six months to December 31 will begin trickling out later this month, with the bulk of reports released next month.
While last reporting season was all about recapitalisation and preserving cash, this year's results -- interim for some companies, full-year for others -- will focus on earnings growth, including the quality and sustainability of the earnings growth. Given that many companies now oversee more conservative balance sheets, thanks to a wave of capital raisings last year, investors will also be listening for guidance on dividends, buybacks and opportunities for mergers and acquisitions.
Matthew Kidman, of Wilson Asset Management, believes that action taken by the government and business when they feared the sky was falling meant the Australian market was poised for a better than expected reporting season. "We had an enormous cost-cutting period a bit over a year ago. No one knew where we were going to end up and Australian companies cut costs dramatically," Kidman says.
Even those companies that were not directly threatened by the economic slowdown took the rare opportunity to trim excess costs. Employees were encouraged to use up annual leave, while some groups cut costs by scaling back employees' working hours and capping pay rises, including those for senior executives.
Kidman points out that it didn't take long to realise Australia had escaped the worst of the crisis. As a result, most companies did not experience the sustained weakened demand for goods and services that many feared.
"When you get that uptick, revenue runs ahead of costs . . . and you've got this sweet spot where margins are greater than anyone anticipated," he says.
Scott Mailer, head of institutional equity sales in Deutsche Bank's Melbourne office, expects that investors will be looking for validation that rising company valuations are justified.
For some sectors, such as mining where share price gains have been against a backdrop of momentum from China and anticipated earnings growth, this will be relatively easy, Mailer says.
But for some sectors, he warns, share price valuations appear high and potentially unsustainable. Good financial results could help buoy the healthcare and utilities sectors, which have lagged the market as a result of their defensive investment nature.
For the discretionary retail sector, the reporting season looks grim. That is despite some recent surprise upgrades from Nick Scali Furniture, GUD Holdings and Speciality Fashion Group.
"Industry feedback suggests that while sales were broadly in line with last year, significant amounts of discounting and promotional activity were needed to achieve these sales," Deutsche Bank notes in a recent sector report.
"Comments such as `if there was nothing in the store on sale, customers walked in and walked straight out' were common. Walking the mall suggests that many stores were on sale from early December and nearly all stores on sale by mid-December.
"Department stores appeared to be . . . discounting earlier, deeper and broader than usual."
Deutsche Bank has tipped perennial over-achiever JB Hi-Fi to buck this trend, along with supermarket operator Woolworths, which also owns Big W, Dan Murphy's and several consumer electronic chains.
Furniture giant Harvey Norman, Billabong International and Pacific Brands Group could be disappointing, the bank says.
Given the extensive cost cutting that took place during 2009, Credit Suisse insists that revenue growth remains the key driver for the achievement of the earnings per share (EPS) growth that the market forecasts for the coming years.
"However, even with the strong rates of revenue growth forecast for 2010, EPS growth is forecast to be weak . . . due to the dilution caused by share issues in 2009," the bank says.
Credit Suisse is also expecting revenue growth to vary depending on the sector. Mining, financial, energy, banking and retail stocks are tipped to record revenue growth in excess of 5 per cent, while healthcare, utilities and basic industries are poised for 3 to 5 per cent growth.
Growth in media, property trusts, gaming, food and beverages, and transport is expected to be below 3 per cent.
"Results are going to look bloody good this time and in June. But if rates keep going up, eventually that's going to bite," Kidman says.
Credit Suisse's Lele agrees. By mid-year, earnings will be "ex-stimulus" he says. "That's not reflected across the market yet."
CNP Price at posting:
27.5¢ Sentiment: Hold Disclosure: Held
