First-half 2017 earnings season insights

Nicholas Grove | 15/03/2017

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Nicholas Grove: I'm Nick Grove for Morningstar and today I'm joined by Morningstar's Peter Warnes, who is here to give us a breakdown of the recently concluded half-year earnings season.

Peter, thanks for joining us today.

Peter Warnes: Great to be back, Nick.

Grove: Peter, you described this batch of earnings as being solid and generally better than expected, but what were the key drivers of this performance?

Warnes: Nick, I say solid and a little better than expected, that's probably in terms of a total number, in other words, the total profits of corporates. You saw in the December quarter that company profits were up 20.1 per cent in the national accounts. So, that's what I'm talking about. Individually, we did have some disappointments. But look, broadly speaking, the key driver was still cost out. It's very, very difficult in a below-trend economy for companies to get meaningful organic growth. And so, cost out was the driver of a lot of the bottom-line. And that's reflected in low wages growth and sluggish employment. So, it was really the labour part of the equation that was giving the bottom-line a bit of a boost.

Of the 174 companies that reported that we cover 66 we increased earnings per share estimates, forward estimates; 68 we reduced; and 40 remained unchanged. So, that gives you a broad brush of what we thought of the reporting season. Reasonably good. There were a few standouts, but pretty reasonable.

Grove: Peter, were there any companies whose earnings disappointed and which saw a negative market reaction but you think represent some compelling value at this point in time?

Warnes: Nick, of the bigger companies, those that disappointed and were punished were Brambles and it had been to the confessional beforehand, but still what came out and disappointed even with the result and the cancellation of our targets going forward. Telstra, Medibank Private, all missed their targets. Ramsay Health Care was significantly negative on the reaction to the announcement but the results were good. But the CEO succession muddied the water and what have you.

Now, in terms of those four companies, we do see undervaluation, if you like, in Brambles. We think long term it looks attractive, but I don't think there's any need to chase it. I think you've got time on your side. There's going to be a little bit of time before they work out those problems in the US. Telstra similarly--I mean, the whole telecommunications space is very, very competitive. The NBN is unsettling. And so, again, I don't think any rush to being there--all those companies are ex-dividend as well. So, there's no need to go and say I want to buy those because the dividend is there. Medibank Private, look, NIB shot the lights out. Medibank Private is struggling. Again, a lot of churn there and missing targets, but again cost out--it's a cost-out story.

The one that we do like is Ramsay. They've got deep management, a deep management team. They will find the right person to take over from Christopher and this is an opportunity to buy that stock I believe.

The other stock that has no moat and didn't get belted but we like in the media space, which is unusual, because the media space was disappointing generally, is Nine Entertainment. We think it should be looked at. But again, this is a no moat and high uncertainty. So, you got to be a bit careful there. You can't put all in. But it's attractive on a fundamental basis.

Grove: Conversely, Peter, which stocks and which sectors in the market do you think are looking a little bit frothy at the moment?

Warnes: Nick, I mean, we'd obviously continue to say resources and the related mining services sector, because we have got a long-term quite negative view on commodity prices, iron ore, coke and coal, copper. They are the drivers of those big resources companies. And so, our valuations are significantly below the market. And as I say, they are long-term valuations. So, we believe that they are frothy. And mining services obviously have been rubbing shoulders with it and getting a bit of tailwind from what's happening there. The expectation is that the resources companies have got significant free cash flow and they are going to start reinvesting. We are a little bit more sanguine than that and we suspect that there's quite a bit of froth there.

Strange enough, in the engineering and construction space, that's CIMIC, Downer and Lendlease, they will perform pretty well and they were all rewarded with pretty good--their results were well-rewarded by the market. Again, that's kind of more infrastructure and government spending and what have you rather than direct mining investment.

Grove: Finally, Peter, with the world as it is being in unchartered waters politically and with all the market uncertainty, should investors actually listen to some of the day-to-day noise or should they actually just focus on company fundamentals? And do you think it's probably a good idea to let a bit of cash build?

Warnes: $64 question, Nick, isn't it? Look, there's a lot of noise out there. And strangely enough, despite the noise, and we know where a lot of the noise is coming from, a "Trumpet," the thing is that you must continue to watch the fundamentals and look at the future fundamentals, not the past fundamentals. You always invest in the future. And we continue to say you've got to be investing in moat companies and a lower uncertainty around the fair value, the better.

But having said that, with this noise and also with volatility so low, personally, I think you are allowed to take some insurance and take some insurance by letting cash build. I suspect we're going to have a correction in the market in the not-too-distant future. We in Australia might see the banks hold up don't forget three of the big banks which have got March balances, balance dates, are full of dividend--ANZ, NAB and Westpac--and there could be some buying to get that dividend and of course, that's 20 per cent of the market, isn't it? So, personally, yeah, I think let cash build, be a little cautious. These markets are highly valued.

Grove: Peter, thanks very much for your time today.

Warnes: Pleasure, Nick.

This report appeared on 2017 Morningstar Australasia Pty Limited

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