Results season suggests worst may be behind us

During the first six months of the current financial year growth slowed but the good news from reporting season is that Australian companies look like they have adjusted well to their challenges.

Analysts have barely altered their expectations for company profits this year.

February is always a keenly awaited month for observers of the Australian equity market, because it features reporting season.

In this biannual event, Australian listed corporates release their first-half profit numbers for the current financial year. It is usually viewed as an important signpost for equity investors – in large part because it often brings its fair share of surprises, both positive and negative.

So how are Australian companies faring so far? Before we get to the results, let’s start with the backdrop.

On most measures, the first six months of the current financial year – July through to December – saw growth slow.

Gross domestic product (GDP) for the three months to September was softer than expected, and most of the data we now have in hand for the fourth quarter of calendar 2023 suggest another three months where GDP growth is likely to annualise around 1.5 per cent.

A further 25 basis point rate hike from the RBA in November would have also had a dampening impact on consumer sentiment as the first half of the financial year drew to a close.

In addition, many cost pressures for Australian businesses remain elevated; wages growth is tracking a 4.2 per cent annual rate as of December 2023, and costs associated with other inputs, such as insurance and energy, remain significant.

So one could be forgiven for thinking that Australian corporates faced a challenging mix in the first half of this financial year – softer revenue growth as the economy slowed, in addition to a still rising cost base.

And for those importing and exposed to currency fluctuations, there was little joy from the Australian dollar, which averaged a touch above US65c for the first six months of the financial year.

The good news from reporting season is that Australian companies look like they have adjusted well to a more challenging economic environment.

From a top-down perspective, this reflects sound management and perhaps a renewed willingness to more proactively adjust to different environments after the pandemic experience. And in the spirit of controlling those things you can control, reporting season thus far shows us that cost management has been disciplined.

This has meant that even in an environment of decelerating top-line revenue growth, firms have largely preserved margins.

Consequently, analysts have barely altered their expectations for profit growth for the current financial year.

Indeed, if we take the economists’ consensus as a starting point, Australian corporates need only endure one more half-year of soft economic growth before GDP growth should start to accelerate.

The consensus forecast expects annualised growth rates of both consumer spending and GDP to trough in the final quarter of the current financial year, before improving in the first half of the 2025 financial year.

So it is possible that the current financial year will be the most challenging operating environment, with better growth on the horizon. Indeed, commentary from corporate executives through reporting season also reflects a sense that the worst may be behind them, with a more upbeat tone to guidance and outlook statements.

Of course, this forecast for a more supportive economy for earnings relies on an environment of stable or lower interest rates, lower inflation and a very modest rise in the unemployment rate.

Should any or all of these not hold true, then the outlook for the economy may not be as favourable for corporate earnings as the market and corporate executives expect.

At an index level, the broader market has traded sideways in February, suggesting that on net, there hasn’t been enough of a surprise one way or the other to challenge current valuations or the outlook for future earnings.

Perhaps this is a little surprising given analysts’ low expectations coming into reporting season, and also given the market’s enthusiasm to “look through” to better times. But with the ASX200 sitting just below all-time highs and the one-year forward multiple already one standard deviation above its long run average, perhaps a lot of good news is already in the price.

Against this backdrop, larger and more numerous upside surprises are required of corporate results to deliver further index appreciation.

Sally Auld is the chief investment officer at JBWere