Yarra Capital Management’s Dion Hershan takes positivity from a negative reporting season

An easing of price pressures and some exaggerated share price weakness during reporting season leads Yarra Capital to be more positive on consumer-facing sectors and quality industrials.

Yarra Capital Management executive chairman Dion Hershan. Picture: David Geraghty

Dion Hershan has a more constructive take on the August reporting season.

While earnings estimates for the 2024 financial year fell sharply thanks to underwhelming guidance from corporate Australia, the Australian equities boss at Yarra Capital Management sees easing price pressures lessening upside risks for interest rates and downside risks for domestic demand.

In his view this will lead to rate cuts next year – yet the money market still sees some chance of another rate rise in the next six months and only a small chance of a rate cut in the next 18 months.

Some sectors may face more difficult conditions, with narrowing net interest margins potentially an issue for banks, and iron ore miners in the firing line if the iron ore price drops below $100 a tonne amid a lack of large-scale stimulus from China in response to disappointing growth this year.

But an easing of price pressures and some exaggerated share price weakness during reporting season leads Yarra Capital to be more positive on consumer-facing sectors and quality industrials.

“It was our expectation that there would be some extraordinary anxiety heading into reporting season and that investors would be prone to overreact,” Mr Hershan said. “There has been some evidence of that, but like the economy it has been more mixed rather than universally negative.”

Australia’s ASX 200 rose 0.7 per cent to a two-week high of 7210.5 points on Tuesday as China’s sharemarket continued to rebound, amid hopes that policymakers would unveil a comprehensive plan to support the economy via fiscal and monetary policy stimulus.

The ASX 200 is down 2.7 per cent so far this month after recovering from a low of 7090.

As is usually the case with corporate reporting, downgrades during “confession season” in the lead-up to August meant there were many more “beats” than “misses” of consensus estimates.

But weak guidance led analysts to lower their expectations by more than usual.

Downgrades for financial 2024 profits beat upgrades by two to one and the consensus estimate for aggregate earnings fell to minus 5.7 per cent from minus 0.8 per cent a month ago.

Still, Mr Hershan says the earnings season hasn’t confirmed fears of a “consumer recession”.

So far there hasn’t been much evidence of China’s downturn hitting resources-sector earnings, corporate balance sheets haven’t been ravaged by inflation (although costs are clearly an issue) and there hasn’t been much in the way of “unduly cautious” macroeconomic guidance.

“There were some signs and anecdotes of those pressures, but it wasn’t broad based,” Mr Hershan said. “The economy has been a lot more resilient than many people would have anticipated.”

The expected fall in earnings of close to 6 per cent for the year ahead is mainly due to the fact that the resources sector is coming off unusually strong earnings. Banking sector earnings are expected to be modestly down, and industrials and insurers are expected to see moderate earnings growth.

But perhaps the most important takeaway from the reporting season is that inflation is coming down. “This is the key to unlocking possible interest rate cuts in 2024,” Mr Hershan said. Whereas 12 months ago there were large price increases from supermarkets, and general merchandise and apparel companies, that pressure is “genuinely subsiding”, with supermarkets reporting negative volume growth for groceries and big shifts to cheaper private-label goods.

“They were pushing through price increases, but there were consequences, and most companies are no longer doing that,” Mr Hershan said. “You also saw Coles, Woolies and Domino’s Pizza, saying they will basically protect the consumer by not doing large price increases.”

There have also been signs of disinflation in input costs – including raw materials and freight – in reports from companies such as James Hardie, Reliance Worldwide and Amcor. “Input costs are trending down, which means there’s less pressure to increase prices,” Mr Hershan said.

A third reason why he thinks inflation will continue to fall rapidly is that there have been signs of easing pressure in the labour market, even though the unemployment rate remained near 50-year lows, with high levels of immigration already “loosening up” the labour market.

A fourth reason why he sees inflation moderating further is the curtailment of some large capital expenditure programs by state governments, mining companies and property trusts.

“All these things are taking heat out of the economy, which is what the RBA aims to do, and if inflation trends down, it will be a big relief for the Australian consumer and corporate Australia,” Mr Hershan said. At the same time, he doesn’t see a big downturn in consumer demand ahead.

In his view “this is actually a ­really good time to be looking at quality retailers”.

His fund has been “quite a large buyer” of retail shopping malls with solid balance sheets, attractive yields and discounts to their net asset backing. But he sees office REITs remaining challenged.

The plunge in ResMed shares was “probably the single biggest over-reaction from the reporting season”.

“For a stock to fall 20 per cent on the basis of slight disappointment on gross margins for one quarter felt like a massively outsized reaction,” Mr Hershan said.

“They had 23 per cent revenue growth, a slight drop in gross margins when people expected a slight increase, and they invested heavily in sales, marketing, product development, which, frankly, we think is a good lead indicator. We thought investors would overreact to some results and I’d say that’s happening. So we certainly have stepped in to capitalise on that.”

He also says JB Hi-Fi produced a “really strong result given the circumstances”.

“What’s pretty clear is that the category traded very strongly during Covid, and that is starting to fade but they’re obviously taking a ton of market share, and they’re holding up extremely well.”

But with S&P/ASX 200 now trading around its long-term average valuation of about 15 times next 12 month earnings, and term deposits offering a risk-free yield above the gross dividend yield on the S&P/ASX 200, “where you want to invest is where you see capital appreciation”, he said.