Profit outlook worsens as rising costs hit home

Corporate Australia’s inability to manage rising costs in a better-than-expected demand environment isn’t helping matters.

MST senior analyst Hasan Tevfik.

August is shaping up as a fairly weak month for equities, not helped by corporate Australia’s inability to manage rising costs in a better than expected demand environment.

Profit margins are under pressure and outlook statements have reinforced expectations of a challenging December half after the most aggressive interest rate hikes in three decades.

“Policymakers have done what they were supposed to and delivered a soft economic landing,” says MST senior analyst Hasan Tevfik. “So revenue has been better than expected but companies haven’t been able to deal with extra cost issues associated with that revenue.”

After rising 2.9 per cent in a typically strong July, the ASX 200 has fallen 4 per cent so far in August, on track for its worst month since a 7.3 per cent fall last ­September.

Friday’s speech by Fed chair Jerome Powell at the Jackson Hole economic policy symposium will be closely watched after his hawkish comments last August sparked a sell-off in equities as bond yields soared.

In local currency terms, the ASX 200 has outperformed offshore markets this month. However, it has underperformed in US dollar terms, as the Australian dollar has fallen about 4.6 per cent amid heightened concern about China’s economic outlook.

Mr Tevfik says companies had “turned a pretty good macro situation into something worse for the shareholders”, when they “should have seen these issues coming through the pipe”.

“These are issues that were quite obvious. They haven’t done enough to deal with wage inflation – an obvious issue; where were the productivity increases to offset this?”

He calls out Ramsay Health Care as an example of a company “doing nothing” to deal with its struggling overseas businesses dragging on its share price ­valuation.

“I’m going to blame it on management a bit,” Mr Tevfik said. “There should have been productivity improvements elsewhere to offset increases in wage inflation and raw material costs.”

He says many Australian companies have fallen behind their US peers in this regard.

The upshot is that profit margins did worse than expected in the June half.

“This is all about the outlook for profit margins getting worse,” Mr Tevfik says.

Broadly speaking, the profit margin for commodity producers has been falling from peak levels, while margins for industrial companies have been recovering from trough levels.

Mr Tevfik says the concerning aspect of the June reporting season is that commodity producer margins are coming down faster than previously thought, and those of industrial companies are recovering slower than thought. “There’s still a recovery there, but it has slowed. It comes out to management not being able to deal with the competition.”

With the reporting season about 85 per cent complete, the June half has been a bit better than feared in terms of the number of companies beating consensus estimates for profits.

“Upside and downside surprises have been neck and neck with about 36 per cent surprising on the upside, which is below the norm of 43 per cent, and 37 per cent surprising on the downside, which is more than the norm of 26 per cent,” said AMP’s head of investment strategy and chief economist, Shane Oliver.

While 58 per cent of companies have seen earnings rise on a year ago, that’s below a norm of 63 per cent. Only 43 per cent have increased their dividends on a year ago, versus a norm of 58 per cent.

“It’s been a bit better than feared but expectations are still getting revised down on the back of cautious corporate guidance,” Oliver says.

He concurs that cost pressures remain a challenge although he sees signs they are easing.

Building material companies are still benefiting from strong activity although some have warned of a slowdown.

Insurers have seen margin improvement at the expense of their customers who have been slugged with big premium increases.

Home borrowers are keeping up their payments, but rate hikes have yet to fully flow through.

And corporate guidance has been cautious, with retailers warning of tougher conditions, with better-off customers turning to discount stores like Big W and Kmart for ­bargains.

“Partly reflecting the cautious outlook, consensus earnings expectations have been revised down since the reporting season started,” Oliver says.

The consensus is now for a 1.8 per cent rise in earnings for the fiscal 2022-23 year just ended. That represents a downgrade of 70 basis points from a 2.5 per cent rise forecast at the end of July.

The consensus estimate for the 2023-24 financial year has been lowered to minus 5.4 per cent, down from minus 0.8 per cent.

“It’s too early to conclude that the correction in shares is over,” Oliver says.

The good news is that the expected fall in profits in the year to December may be as bad as it gets, assuming that interest rates have peaked and the macro-economic outlook doesn’t worsen.

“The year-on-year change in aggregate profit for the current half year is going to minus 5 per cent, and that should be the trough in earnings,” says Mr Tevfik.

“The year-on-year profit growth outlook to June 2023 should be minus 3 per cent, so there are early signs of ‘less bad’. The trough is coming but it will be shallower it could have been.”