Why reporting season is a cautionary tale so far

A difficult macroeconomic backdrop for listed corporates highlights why portfolio exposures are heavily tilted towards the quality end of the ASX 200.

If it ends as it started, it is likely this reporting season won’t be especially notable in terms of the net “beat vs. miss” ratio. Picture: Gaye Gerard

Reporting season for Australia’s listed sector is capturing the attention of investors and analysts.

Unlike the US, where companies update the market on their earnings each quarter, reporting season only comes around twice a year in Australia. This means there can often be a few more surprises and more market volatility than might be the case elsewhere.

Reporting season can also be a useful source of information for economists and others who track the real economy, as companies provide results for the past six months but also revenue and earnings guidance for the year ahead.

So what have we learnt so far and how might it help us with investment decisions going forward? There are three key points we think worth noting.

First, a broad thematic that has emerged is the cautiousness about the outlook reflected in management commentary.

This may be due to higher than usual uncertainty about the economic outlook and the path for interest rates, or it may be because of industry-specific issues. But regardless, a more cautious outlook has forced analysts to downgrade their earnings per share forecasts for the 2025 fiscal year. This measure is now 5 per cent lower than it was at the beginning of reporting season, a reasonable downgrade.

All else equal, the dynamic of lower earnings poses a challenge for investors, because lower earnings per share estimates mean that investors are now paying a higher multiple for lower earnings. Or in other words, the local equity market has become more expensive, reinforcing the case for investors to consider other asset classes where the risk premium is more attractive.

Second, it is clear that the shift in interest rate expectations through the year – from a broadly held expectation that rates would be lowered in 2024 to an understanding that the RBA is probably on hold for the foreseeable future – has affected corporate earnings. This is perhaps most clear in the listed property sector as higher-for-longer rates have lifted debt costs, but also in the building materials sector, where higher rates have crimped demand for alterations and additions and new housing.

Other sectors have also suffered; parts of the retail complex are still dealing with a subdued consumer, while others are faced with rising bad debts. Higher rates are a mixed blessing for the banking sector; on the one hand banks are reporting a modest rise in non-performing loans, but on the other they are also noting some stabilisation in their net interest margins.

The difficult macroeconomic backdrop for listed corporates at present highlights why it has been important to make sure that equity portfolio exposures are heavily tilted towards the quality component of the ASX 200.

With a higher-for-longer rates outlook, it is important not to have too much exposure to companies with leverage, or to companies with revenues that are highly cyclical. The challenging backdrop also argues for a bias towards management teams that have experience managing through the cycle and for firms that have some ability to protect margins.

Indeed, margin dynamics have been interesting so far in the current reporting season; results so far suggest margin compression is under way.

We think this is a significant but so far not widely discussed dynamic of reporting season. In aggregate, revenue estimates have broadly been in line with expectations, but earnings have disappointed, on net. This discrepancy is largely reconciled by the fact that a rising cost base has forced margin compression.

From an economic perspective, this dynamic is potentially significant. Economic theory tells us that firms generally respond to margin compression by adjusting the variable component of their cost base. In most instances, that is usually their labour force. So it is possible that labour input will come under pressure as firms try to stabilise operating margins. Whether or not this portends a materially higher unemployment rate will depend on whether the adjustment to labour comes via hours worked, or through headcount.

If it is the former, then the labour market adjustment will be modest, and more like that which prevailed in Australia during the global financial crisis. This would underpin the RBA’s attempts to deliver a soft landing. But if it is the latter, we are set for a more dramatic labour market adjustment, which will have consequences for the broader economy and interest rates.

Reporting season will officially finish at the end of the month.

If it ends as it started, it is likely this reporting season won’t be especially notable in terms of the net “beat vs. miss” ratio. But closer inspection of financial metrics and management commentary suggests that the economic backdrop is providing some challenges for Australian corporates at present.

The extent to which this persists will depend in part on the evolution of inflation and interest rates and the resolution of uncertainty around election outcomes in the US and Australia. In the meantime, we remain somewhat wary of a market in which many forward-looking valuation measures are at their highest level in two years despite the fact that the earnings outlook is being revised lower and operating margins are narrowing.

Sally Auld is the chief investment officer at JBWere