Companies’ cost control an encouraging sign: JPMorgan

Improving supply chains and moderating inflationary pressures have helped corporate Australia get through reporting season without significant disappointment.

Improving supply chains and moderating inflationary pressures have helped much of corporate Australia get through the June half-year reporting season without significant disappointment.

The consensus estimate for total earnings per share for the current financial year fell more than usual and there weren’t as many upgrades for dividends-per-share forecasts.

However, an expected fall in the aggregate earnings was mainly due to resources companies coming off “super profits” and expectations of some weakness in banks. Dividend increases are being constrained by normalising payout ratios, as well as caution about the economic outlook. As reporting wraps up this week, the number of companies that have beaten profit estimates has exceeded the number that have missed by a ratio of about five to three.

It comes amid the surprising resilience of the domestic economy after the biggest increase in interest rates in three decades, and the fact that expectations were lowered by profit warnings.

“It’s a case of moderating inflationary and supply chain pressures rather than an outright easing in inflation,” said Jason Steed, managing director and head of Australian research at JPMorgan. “Labour supply has been less of a problem than in recent reporting periods.”

Overall underwhelming guidance led analysts to lower their expectations by more than usual for the current financial year. Downgrades for the 2024 financial year outnumbered upgrade by about two to one.

The consensus estimate for total earnings per share in the next 12 months was revised down by 2.9 per cent in August, making it the biggest downgrade since a 3 per cent drop in August 2020.

But a 3.5 per cent fall in the dollar during reporting season gives a significant positive “translation effect” to earnings from companies reporting in US dollars.

“So I would say in terms of beats and misses, nothing to ­either be of particular concern or to create any optimism,” Mr Steed said. His team’s forecast for the 2024 ­financial year earnings points to a 4.5 per cent fall, whereas before ­reporting began this month the expectation had been for a fall of 2.5 per cent.

But whereas JPMorgan analyst projections point to an overall decline in earnings, only three sectors – energy, materials and ­financials – are expected to go backwards.

Mr Steed said the percentage of companies beating and missing JPMorgan estimates for earnings this reporting season – around one-third for both – was “not out of kilter” with history.

That also applies to the amount of companies that saw negative earnings revisions.

But where the reporting season definitely looked weak versus history was the “very low number of dividend upgrades’’. Whereas JPMorgan analysts normally upgrade their dividend forecasts for more than 30 per cent of companies during reporting season months, it is under 20 per cent now.

Some sectors – like healthcare and materials – bore the brunt of the dividend downgrades. However, in terms of earnings outcomes, the financials sector did better than JPMorgan expected.

The consumer discretionary sector was a surprising standout.

“The part of the market that people were most worried about, because of the mortgage cliff, cost-of-living pressure, it just hasn’t ended up being as disappointing as people expected,” Mr Steed said.

“That’s true both in terms of beats and misses. It’s true on earnings upgrades, and also on dividends.

“So if there’s a standout from a financial outcome perspective, it’s consumer discretionary.”

While it’s partly due to the extent of profit warnings during “confession season”, it’s also due to the fact that the economy has held up better than expected.

“The evidence across the board is that the degree of consumer stress that was expected to manifest itself this season is just not as acute as expected,” Mr Steed said.

Despite signs of consumer stress amid soaring living costs and interest rates, it’s telling that analysts see only a modest decline in profit margins this fiscal year from high levels after Covid.

Mr Steed said that was because many companies were doing a good job of managing their costs.

“For some companies, costs have been a real issue and those stocks have deeply underperformed,” Mr Steed said. “Iress, Coles, Downer, ARB Group, Seek, Domain, South32 – these have seen pretty dramatic earnings declines. So there’s definitely a group that is struggling to deal with costs.”

Some companies, such as Ansell, have struggled with high inventories after the pandemic.

But others such as Healius had disappointing earnings, but better than expected cost control.

AMP, Bendigo, CSL and Magellan shares also benefited from cost control programs.

“I won’t say it’s been a great season in terms of costs, but I haven’t come away thinking costs are really eating away at profits and will be a big factor undermining margins,” Mr Steed said.

And on dividends, Mr Steed does not think companies overall are necessarily hunkering down.

“Companies are experiencing the new world – for the first time in well over a decade – of higher interest rates, so you’re certainly seeing in REITs, for example, a higher cost of debt and management taking a view that they need to probably scale back their dividend payouts,” he said.

“There’s definitely uncertainty out there, but also dividend payout ratios were going up.

“There’s a combined effect of management teams being cautious – even though this results season helps us feel a little less nervous – and you’ve had this quite long drawn out period of higher payout ratios that has to level off.”

Despite the downgrade of aggregate earnings estimates this August, Wilsons equity strategist David Cassidy said many companies saw earnings guidance upgrades due to easing cost pressures, and the insurance and travel sectors enjoyed tailwinds.

“Some companies faced ongoing challenges as labour, rent and debt costs remained high, negatively impacting margins,” he said. “Sectors like manufacturing, media and online-classifieds, and office landlords face near-term earnings challenges due to inventory destocking, subdued ad markets and softer labour market conditions, respectively.”