Wild ride in FY17 and more to come - part 1

Glenn Freeman | 12/09/2017

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Glenn Freeman: I'm Glenn Freeman for Morningstar and I'm joined today by Peter Warnes, head of equities research for Morningstar Australasia.

Peter, thanks for joining us today.

Peter Warnes: As always, Glenn, it's always good to be here.

Freeman: Peter, now that we are at the end of earnings season for fiscal '17, what would you highlight as the overarching theme this year? So, for last year, we had cost out was the theme. Does that still hold for this year and what do you see for fiscal '18?

Warnes: Glenn, I think, cost out did drive a lot of the performance for the industrial space this year. The commodity prices obviously drove the resources space and cost out was evident there as well. But cost out did deliver again this year. The revenue line was hard to get growth in and with low inflation that's obviously dominating that influence. And overall, the economy is still below trend. Total demand is still struggling a little bit. And so, therefore, it was a focus on costs again.

Freeman: And Peter, what do you read into these results for fiscal 2018 and beyond?

Warnes: Glenn, last year we talked about cost out and how that could impact the reporting season. Going forward now there has been a lot of emphasis on the intentions of companies to start investing in capital expenditure is number one on the list there. Is the business community starting to get more confident and starting to invest? And those intentions certainly were played up in a number of the conferences that were held during the season.

Now, I'm a little bit skeptical about just what will happen there, because part of the cost that we've had for the last couple of years, I believe, has been a little bit more cutting of also capital expenditure or maintenance CapEx, in other words, stay-in-business CapEx. In fact, the numbers we pulled out would show the depreciation from last year to this year hasn't changed very much and the asset base has certainly increased. So, you'd ask yourself why is that happening.

So, what I'm saying is that what I think the regular – or the ASX should do is make it compulsory for companies to break down their CapEx intentions into stay-in-business CapEx and growth CapEx. And that will give you a better idea as to whether they are putting the foot to the floor in terms of growth or whether they are just maintaining the asset base.

Freeman: Now, looking at these company results, which sectors will appeal to investors for fiscal 2018 in your view?

Warnes: Well, I mean, the overall reporting season was disappointing. If you took out the resources companies and those basically exposed to iron ore, so that's BHP, Rio and Fortescue, those three companies contributed or represented nearly 24 per cent of all the companies' profits that are under Morningstar coverage. The total profit of that coverage was 78.3 billion and those three companies represented 24% of it. Now, if you took those away, then the rest of it was pretty ordinary. I mean, low-single-digit growth across the board and the market was looking for better than that. And that's why you had the indices, the S&P/ASX 200, went nowhere in August. And so, that meant that the companies didn't exceed expectations in a general sense.

You had insurance companies, they got the trifecta for disappoints. QBE, IAG and Suncorp, all fell by over 5 per cent within 24 hours of their announcement. You had healthcare – strangely enough there was a couple of disappointments within that group which have been very, very resilient over many, many years. And so, Ramsay, Healthscope and ResMed, all are little bit disappointing in terms of the reaction of the market to the results and to the commentary around it.

You had Telstra and Vocus giving a wipeout to the telco space. They are major companies and there were very few major companies that actually surprised positively. (Indiscernible) was one Origin Energy was the second one. But there were few and far between. And so, overall, the big companies did very, very little and then there were some good surprises in the medium-sized stocks. You had companies like Super Retail, and Bendigo and Adelaide Bank, Breville, companies like that that surprised positively. And then Domino's hit it out of the park on the negative side. And there were quite a few companies that did report negatively.

So, going forward, the sectors – look, the demographic is still aging population. And if you've got some situations like a Ramsay that's been – has pulled back, that's starting to look very attractive as far as we are concerned. We have no problem with the ResMed. There's still a question mark, if you like, over Healthscope. There is some value starting to throw in some of the smaller retailers, not the bigger retailers. The consumer is still gun-shy. He has got a lot of expenses that's hitting disposable income. And so, he is still gun-shy.

The banks have come back but they are still all in the hole zone. In the other financial space, we don't mind MYOB and in the technology space TechnologyOne. They have come back and they are starting to look reasonable value. But overall, I still think that this market is still going to start looking for direction. This is not a sheer win. I'm still quite negative on the market thinking there is a pullback – the U.S. market will pull back and we will come back with it.

This report appeared on www.morningstar.com.au 2017 Morningstar Australasia Pty Limited

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