Australia Inc is stuck in the doldrums

Australia Inc is struggling to generate growth and that the momentum that it had been generating from cost cutting and historically low interest rates has faded.

In the dying days of the June-year earnings reporting season it would be an interesting exercise to pull together a profit and loss statement and balance sheet for Australia’s listed companies. Credit Suisse has effectively done that, and it makes for slightly disturbing reading.

While there are still a handful of companies yet to report, the scoresheet as of the end of last week shows Australia Inc is struggling to generate growth and that the momentum that it had been generating from cost cutting and historically low interest rates has faded.

It isn’t just that the companies have underperformed market expectations, which in aggregate they have, but the overall results are unimpressive, at best, even when compared with the prior year’s actual outcomes.

As a group, the companies generated revenue growth of 4.5 per cent compared to 2014-15, which doesn’t appear all that disconcerting in what is a low-growth economic environment.

That revenue growth, however, was outstripped by an increase of 4.7 per cent in the cost of goods sold, which suggests strongly that companies, having been very focused on costs in the post-crisis era, are now struggling to find any new meaningful opportunities.

The impact of that modest squeeze on gross margins cascades through the rest of the numbers, with growth in earnings before interest, tax, depreciation and amortisation of 3.7 per cent, earnings before interest and tax growth of three per cent and after-tax earnings growth of only 2.2 per cent.

Despite the continuing demand from shareholders for income, total dividends paid slipped 1.2 per cent, with the average payout ratio sliding from 77.2 per cent to 74.6 per cent.

In terms of Australia Inc’s balance sheet, equity was 2.5 per cent higher but net debt 8.8 per cent greater, producing an increasing in gearing from 33.4 per cent to 34.7 per cent. That probably reflects the interest companies have in locking in what is historically low-cost debt.

If the results were set against market expectations, reflected in analysts’ consensus expectations, they obviously undershot the targets by meaningful amounts. Revenues, for instance, have come in about 1.1 per cent below expectation and earnings 2.1 per cent below them.

As Credit Suisse noted, the healthcare, insurance, chemicals, telecoms and media sectors were particularly disappointing — miners did surprisingly well, but that is probably due to the low level of expectations that the market held for them.

It’s not Australia Inc is in particularly bad shape, but rather than it is struggling to generate top-line growth and, with the easy gains on costs no longer available, that flows through to the bottom lines.

Interestingly, while Credit Suisse’s number-crunching does show stronger free cash flow generation, it attributes that to reduced capital expenditures by both the industrial and resource sectors.

There’s not as much investment in future revenues and earnings occurring, which is as much a global phenomenon as it is an Australian one.

Companies are risk-averse and, if they have spare cash and balance sheet capacity, are more likely to distribute it to shareholders than invest.

As discussed previously (Top insights from earnings season, August 25), the ASX200 is current trading on a multiple of 18 times historical earnings and at least 16.5 times prospective earnings, which would appear quite stretched and of suspect sustainability given the difficulty the companies have faced in generating growth in 2015-16.

There is nothing in the environment, whether at the global or domestic level, to suggest that there are tailwinds lurking in the background, indeed the general outlook appears, at best, to be quite low levels of growth in a global economy where the growth that is occurring appears quite fragile.

The central banks’ discussions at last week’s central banker gabfest at Jackson Hole in Wyoming tend to underscore how weak the overall outlook is, despite the unprecedented monetary policies central banks have deployed.

In the domestic economy, the delicate balance the Federal Government has in the House of Representatives and the imbalances in the Senate aren’t conducive to any kind of bold economic reform agenda.

The impact of the increasing dysfunction in Canberra in the post-crisis period was initially masked by the massive stimulatory packages the Rudd Government initiated in response to the crisis and then the unexpected and massive effects of a dramatic boom in commodity prices that ended in 2012.

The Reserve Bank’s progressive reductions in official interest rates were and are more about trying to keep a lid on the Australian dollar than stimulating activity, with the boom in housing markets a byproduct with potentially unpleasant consequences rather than an objective.

While the big miners might appear to have found some level of stability, albeit at low levels, the modest outlook for the telecoms and, more particularly, the banks (as demand for credit remains soft and low rates and the rising costs and opportunity costs of regulation continue to squeeze their margins and returns) sets a sombre starting point for the 2016-17 financial year.