Profits season solid but strategists caution on outlook

Corporate Australia may be through the worst of a profits downturn caused by interest rate hikes but strategists have some concerns about the revenue outlook while rates stay high.

Corporate Australia may be through the worst of a profits downturn caused by the rapid rise in interest rates but strategists have some concerns about the revenue outlook while rates stay high.

Investors may share similar concerns.

After rising about 13 per cent from late October to late January, the S&P/ASX 200 index has been unable to make much headway. In the US the S&P 500 has risen an additional 5 per cent after another strong reporting season for tech stocks.

After results from 90 per cent of reporting companies covering about two-thirds of ASX 200 market capitalisation, the number that have beaten consensus estimates by more than 5 per cent has exceeded misses by about 9 per cent, despite some slippage last week as resources disappointed.

Domestic cyclicals and growth stocks have delivered the best results, with a net beat of 24 per cent and positive surprises across sales, margins and dividends. Resources companies weighed last week.

“Domestic cyclicals are the reason why this results season has been better than expected,” says Macquarie’s Australian equity strategist, Matthew Brooks.

“Results look set to finish better than expected driven by strong results from domestic cyclicals and growth – groups that should also benefit from the growth re-acceleration we highlighted over the last month.”

He cautions that if economic growth holds up, central banks may deliver less interest rate cuts than expected this year.

But with the Fed funds rate currently more than 225 basis points above trailing CPI inflation he sees “plenty of scope for the Fed at least to ease off on the hand brake”.

UBS says the February reporting season has been “good from far but far from good”.

A strong showing in terms of the number of beats relative to misses of consensus estimates for December half-year earnings is “misleading given analysts entered the results with unusually low profit expectations”, says UBS equity strategist Richard Schellbach.

For the ASX 200 companies tracked by UBS, 72 have seen their consensus estimates for 2024 financial year earnings per share downgraded after their results, while just 60 have been upgraded.

“Through this period ASX 200 financial year earnings growth has slipped by 0.6 per cent, and now sits at minus 5.5 per cent on-year,” Schellbach says. “A similar negative skew has been seen in the guidance and outlook statements, which have come from company management teams.”

USB equity strategist Richard Schellbach: ‘Companies have been attempting to take out costs at a pace not seen in years.’ Picture: Emma Murray

Cost management has been the main talking point, with most still noting elevated and sticky costs, albeit a third said cost growth had peaked. Earnings calls were filled with cost control discussions.

Builders stood out as a group whose positive results were driven by impressive cost control.

It may not be exactly what the Reserve Bank wants to hear but most companies were still able to pass on costs, as a fully employed economy and significant infrastructure spend from governments meaning that for most businesses end demand remains sufficient, Schellbach says.

“But although this end demand exists, it lacks the buoyancy it had a year ago, and hence companies have been attempting to take out costs at a pace not seen in years,” he says.

“The end result has meant that for around three quarters of the companies that reported, they were able to expand or maintain profit margins.”

Despite the positive skew on results and mixed outlook statements, few companies had anything positive to say about the top line growth environment. Schellbach’s scorecard showed about 60 per cent of companies see their sales trajectory decelerating.

Interestingly, this downbeat story on revenues isn’t due to fear of a domestic recession or a housing consumer crunch.

Instead management teams painted a picture of a customer base which is battling against cost of living pressures and higher rates, and thus has little scope to up their spending.

On top of that, companies continue to point to rising interest expenses.

“At the same time analysts, who usually prefer to focus higher up on the income statement, continued to report material misses below the EBIT (earnings before interest and tax) line due to their own underestimation of interest costs,” Schellbach says.

Labour costs – the biggest headache for businesses in post-Covid Australia – are only slowly receding. Tight job markets were mentioned in 60 per cent of company results.

Morgan Stanley equity strategist Chris Nicol also has concerns about the macroeconomic outlook relative to market pricing for interest rate cuts in the wake of Reserve Bank’s “on-hold” stance.

“The debate now squarely centres on how long this period of assessment will last – and what are the catalysts to see a more meaningful pivot from the RBA,” he says.

“Consensus and market pricing have both landed on a second half of 2024 pivot towards easing, with one to two rate cuts implied by market pricing.

“We think the risks still skew towards a later start to easing.”

Investors have “jumped over” any weakness that may still occur in fiscal 2024 earnings and are now “embracing the possibility” of a broader pro-cyclical domestic earnings outlook in fiscal 2025.

“Critical to this thinking and positioning is that not only will tax cuts start to boost activity but that rate cuts will follow soon after … the data outlook makes this scenario seem less plausible,” Nicol says. “Indeed, what we don’t think is in the price is both an extended hold in interest rate settings and any repricing of potential tightening.”