Guy Carson
The expectations at this stage are for a strong year in terms of earnings growth. Consensus earnings growth for the market is in double digit territory for the first time since FY11. In fact if expectations are achieved, it will be the first positive year for earnings growth since FY14.
These positive expectations come despite what can only be described as a weak AGM season late last year and the number of downgrades seen through the recent “confession season”. The key driver offsetting the plethora of recent downgrades is the materials sector, where a rebound in commodity prices is set to drive earnings up over 80% following a 42% fall the previous year.
One aspect of the big miners’ reports that will be intriguing to us is how their capital expenditure expectations have changed over the last six months. With the rally in commodity prices, we have seen mining service companies follow suit. In recent years, these services companies have seen their order books shrink as mining work has been cut back. The expectation now is that with the higher commodity prices, capital expenditure budgets will increase and work will start to flow back to the contractors. This work won’t come from expansion of production but more likely through maintenance work that has been delayed in recent times in the name of boosting cashflow. The degree to which the likes BHP and RIO increase their capital expenditure budget for the coming years will help tell us to what degree the recent rally in mining services stocks is justified.
Overall, the direction of the market over the early part of this year will most likely come down to the largest sector, Financials. Within financials, the key driver will be the banks. We have Commonwealth Bank set to report its half year result as well as quarterly updates from the other 3 of the big 4 and the consensus expectations for the sector this year are reasonably low at 2% growth. However given the recent rally in the share prices of the banks (the big 4 are up between 11 and 18% since the US election); we’d suggest that the market is running ahead of the sellside analysts in upgrading future earnings. We are sceptical that these upgrades will occur and we wrote in depth about the challenges facing the banks from the Western Australian and Queensland economies last week (see 2017 Outlook). Typically problems in the housing market take a while to play out however the increase in arrears from WA over the last 12 months suggests we may start to see an impact on the profit numbers soon. With only CBA set to give a detailed half year report in February, we may have to wait until the other three release their results in May to get a full view of how this is playing out.
The other areas within the top 20 companies which are seeing earnings pressures are Consumer Non-Cyclicals and Telcos. The consumer side is dominated by the two large supermarket chains, Woolworths and Coles (owned by Wesfarmers). The supermarkets are facing increased competition from Aldi and Costco combined with the potential entry of Lidl. There seems to be no respite from these pressures in the near term, however Wesfarmers should see a boost to their result from Coal prices over the last six months. The Telco sectors is dominated Telstra, where earnings would be going backwards if not for the reimbursement from the government for the NBN. Telstra, by their own admission, have a $2-3bn earnings hole to fill over the coming year. So whilst investors may still be attracted by the significant yield on their shares, the uncertainty of their longer term earnings plus the increased competition in the sector makes us cautious on the outlook.
When we look at the earnings expectations above, it’s no surprise that the materials sector was far and away the best performer last calendar year with a very strong rally off a low base.
Along with Healthcare, Technology is a sector which has lagged in recent months whilst earnings expectations have been robust. The sector within the Australian market is small and is an eclectic one. A number of companies trade on high multiples with high expectations of future growth. These companies are susceptible to disappointing such as Aconex just last week. Elsewhere, you can find niche companies with strong products and a high degree of recurring earnings. Given their niche offerings, they are typically ignored by larger institutions and hence can offer attractive opportunities.
So whilst the next three weeks will be interesting, there will still be a number of unanswered questions around the direction of the share market and the Australian economy. We will be busy foraging through reports, checking in with the companies we own and looking for potential new investments whilst always keeping in mind that when investing it is the long term that counts and not just the last six months.
Happy Investing,