Expectations for the upcoming reporting season are the highest they have been in three years. In our experience, heightened expectations often lead to disappointments. This is particularly the case for industrials with global operations which in the last 6 months have had to contend with the impact of Brexit and the US elections. Given the market’s propensity to punish poor-performers, we believe this reporting season will be more about avoiding the losers than picking the winners.
H1 Reporting Season:
The semi-annual ASX reporting season inevitably presents surprises, disappointments and opportunities. Investors, analysts and shareholders will have their own expectations regarding the results to be reported, and companies will either beat, miss or fall in line with these expectations. Reporting for the half year ended 31st December 2016 started last week and runs through until the end of February, with the potential for more surprises, disappointments and volatility than usual
Heightened expectation:
According to Factset consensus earnings estimates, earnings growth for the S&P/ASX200 is forecast to be 12% in FY17, which represents a turnaround in expectations from the last two years which have seen negative earnings growth reported. Much of this year’s expected earnings growth is concentrated in the resources sector, where a rebound in commodity prices is forecast to drive significant profit growth (greater than 50%) for the sector. For the balance of the market (largely industrials) the results and outlook may not be as bright as many expect. In our experience, heightened expectations often lead to disappointments.
Challenging macro conditions:
The six months to 31 December 2016 saw two large political events play out – the Brexit vote and the US election. These events have impacted sentiment and business decisions in two of the major developed global economies, and have resulted in exchange rate and general market volatility. Growing global companies are particularly exposed to these dynamics, with two ASX listed mid-cap companies Servcorp (ASX:SRV) and Aconex (ASX:ACX) recently substantially downgrading their profit expectation in part due to this global macro uncertainty. This followed Brambles (ASX:BXB) downgrading expectations on the back of operational weakness in America. The fact that both SRV and ACX downgraded their forecasts after having just provided more positive guidance in late 2016 illustrates the difficulty in forecasting earnings for global businesses with many moving parts, and also perhaps suggests a degree of management over-confidence/naivety in their previous forecasting.
In addition to the issues in Europe and the United States, China continues to present challenges as the well publicised Bellamy’s (ASX:BAL) downgrade highlighted.
Closer to home, challenging retail conditions have seen downgrades to date from large national retailers, Oroton (ORL) Shavershop (SSG) and Adairs (ADH). The market is unforgiving in relation to any such downgrades, particularly against a backdrop of general rotation away from small caps into large caps, and a de-rating of stocks on high multiples. The real challenge for investors during the upcoming reporting season is to avoid exposure to such downgrades and guidance misses.
Portfolio weighted towards domestic businesses with momentum:
Our own smaller companies portfolio is weighted (60%) to Australian businesses with Australian customers. These companies, for the most part, have limited exposure to most of the global issues at play and fewer ‘moving parts’. Generally, these are also businesses that are coming off a strong first half of calendar 2016, and have provided positive updates at their recent annual general meetings (AGMs).
Portfolio examples include:
- Debt collector Pioneer Credit Limited (ASX:PNC) advised at its AGM that it was excited about the way in which FY17 had commenced, and that another year of high quality growth was underway. At its AGM, PNC reiterated its guidance for the full year of statutory NPAT of at least $10.5m. Since its AGM PNC has advised of further portfolio purchases and executed an increased debt facility.
- Paragon Care Limited (ASX:PGC), a leading provider of consumables and equipment to hospitals and aged care facilities, advised at its AGM that it had enjoyed a strong start to FY17. Strong growth was being delivered across key financial metrics. In the first quarter of FY17, the company’s EBITDA on a like for like basis was up 12% over the prior corresponding quarter. PGC reaffirmed expectations of strong earnings growth for FY17, with FY17 being the first full year of earnings capture from it 2015 acquisitions.
- Investment company Joyce Corporation Limited (ASX:JYC) noted at its AGM a strong start to the year, maintaining a relatively high rate of revenue growth for the first quarter. Total written sales across the JYC businesses (including franchisee sales), is expected to be within the range of $180m- $200m in FY17. “At this early stage it appears to be tracking toward the higher end of this range.” This represents an upgrade on the previously advised level of $170m. In FY17, JYC will benefit from the earnings contribution from its recently acquired Lloyds business, and (from January 2017) rental savings when it moves into its new wholly owned property. We expect its FY17 NPAT to exceed $3m (FY16: $1.9m; +58%). The company continues to hold a large cash balance and property assets, and is currently offering a 7%+ fully franked dividend yield.
- Property fund manager, and property management company, Blackwall Limited (ASX:BWF) announced the completion of a number of capital raisings and other transactions across the funds it manages during the second half of 2016, which will provide BWF with additional fees, and increase its funds under management into 2017. BWF also continued the roll-out of its shared work space business ‘Wotso’ during the period, noting at its AGM that its annualized turnover had more than doubled to $5.5m since June 2015.
Lower expectations for global businesses:
Two businesses in our portfolio with significant global operations are SDI Limited (ASX:SDI) and Gale Pacific (ASX:GAP) – both of which have been adversely impacted by global macro events.
Global dental products manufacturer SDI Limited (ASX:SDI) recently advised that not-withstanding good sales growth, it is on track to report a lower first half profit than the previous year. A reason for the disappointing fall in profit was surprisingly strong sales growth in the UK (+18% on PCP) resulting in relatively lower gross margins due to the weakness of the pound.
Outdoor shade cloth manufacturer GAP noted at its AGM that in America it has seen weaker market conditions due to lower consumer confidence. GAP are guiding for a ‘modest’ increase in revenue and profitability in the first half.
With limited expectations around current earnings, the outlook provided here for both SDI and GAP is likely to be of more interest to the market.
Conclusion:
Given the market’s propensity to punish poor-performers, even more so than usual, this reporting season will be more about avoiding the losers than picking the winners. Accordingly, we continue to focus on the downside potential of stocks, and are focused on investing in companies that trade on undemanding multiples and where expectations are low.
Happy Investing,
