Earnings season insights
The slowing economy shows in FY23 results; guidance for FY24 soft.
The Morningstar Earnings Season Insights report is available to Morningstar Investor subscribers. For non-subscribers a free trial is available to access the report. The following is an excerpt from the report.
The FY23 reporting season provided an insight as to how Australian companies weathered the deteriorating economic environment. GDP growth in both the September and December quarters of 2022 was 0.6%, slowing meaningfully in the March quarter to 0.2%, with little change likely in the June quarter. On a per capita basis the reading was negative 0.2% in the March quarter.
Since 3 May 2022, the Reserve Bank (RBA) has raised the official cash rate by 400-basis points (4.0%) and the economy is still digesting the aggressive tightening medicine and is spluttering. The September and December quarter GDP data could set up a technical recession. On a per capita basis a technical recession cannot be avoided.
Under the circumstances, the reporting season was reasonable, as analysts had been downgrading estimates for FY23 after the 1H23 reports were released in February. The disappointments came from FY24 guidance, which sent the analytical brigade back to their spread sheets resulting in further downgrades.
Inflation and interest rates dominated FY23, both impacting corporate operating costs across wages, input costs and interest expense. They will also influence FY24 as interest rates are not expected to be cut until well in to 2024 and increases in wages effective in July are yet to flow into operating costs. Core inflation is likely to remain above 4% for some time. Energy prices are not coming down and the strong rebound in global oil prices in July and August are yet to be felt at the bowser. Westpac’s chief economist Bill Evans expects rates to remain on hold until the September quarter of 2024, when the first cut of 25-basis points will be made.
Recall, the Reserve Bank’s (RBA) August Statement on Monetary Policy (SoMP) was significant on two fronts. Firstly, the GDP growth forecast for 2023 was downgraded from a previously subdued 1.2% to 0.9% and from 1.7% to 1.6% in 2024. Secondly, the inflation forecast for 2023 was trimmed from 4.5% to 4.25% and for the first time has a year end 2025 forecast of 2.75%, still above the midpoint of the long-term target of 2%-3%.
The Board is betting weakening demand, as evidenced in the lower GDP forecasts, will drag inflation lower, but still not near the low point of the targeted range, before economic growth is forecast to rebound.
While goods inflation has slowed, services inflation remains strong. The trimming of the 2023 CPI forecast exposes the board to a rogue September quarter print to be released on 25 October. Unemployment is forecast to rise from the current 3.5% to 4.0% in December 2023, 4.25% in June 2024 and 4.5% by December 2024. These forecasts are unchanged from the May SoMP.
The assumed official cash rate implicit in the SoMP forecasts is 4.25%, against the current rate of 4.10% and up from 3.75% in May. Interestingly, cash rate expectations have risen since May.
Favourable conditions for the banks appear to have peaked. Net interest margins are likely to come under pressure from a rise in competitive intensity in the mortgage loan market, declining credit demand, and depositors becoming more aggressive on where funds are parked. Wholesale money is becoming increasingly expensive. Impairments will rise, although banks are well provisioned.
Household consumption remains under pressure as we work through the mortgage cliff. The savings ratio was at 3.7% in the March quarter, having fallen on six consecutive quarters from 19.4% in the September quarter of 2021. This slide has supported consumption over the past 18 months but is now exhausted. The labour market is starting to soften, and unemployment is almost certain to rise above 4% in 2024. Household disposable income is under pressure and its growth turned negative a few months ago. Discretionary spending, excluding by the band of well off and debt-free, is in decline and the journey is far from over. The main driver of GDP growth is spluttering.
The RBA’s Financial Aggregates for July show total credit growth has slowed from 9.5% for the year ended October 2022 to 5.3%. Housing credit growth down from 7.2% to 4.5%, with business down from 15% to 7.6%.
The environment remains challenging and geopolitical tensions remain elevated. China’s economic problems are another issue for the Australian economy to absorb. Excess liquidity is still being withdrawn from the financial system with the repayment of the first tranche of the Term Funding Facility approaching. The RBA’s balance remains bloated.