Reporting season signals market on the move

EVERY results season matters, but this interim reporting season was absolutely crucial.

People on their way into the SPC Ardmona factory in Shepparton.

EVERY results season matters, but the interim reporting season that has filled our business pages over the past fortnight was absolutely crucial to investors because last year’s 20 per cent run-up in the ASX 200 was heavily predicated on the “earnings coming through” - and, by and large, that’s just what has happened.

But behind these numbers there are some important patterns which just about everyone with an interest in the sharemarket should digest.

Understandably, the coverage of the results focused on the surprises - that is, the results that come in higher than we might have expected or, alternatively, the figures that disappointed investors. But what really matters is the cumulative effect the results season will have on the market.

It’s not easy to accurately gauge this effect so soon - there are still weeks to go in terms of results announcements - but noting the ASX 200 has lifted by 4.1 per cent since the start of this month tells you the desired momentum is upon us.

Behind the headlines there are six key aspects of this results season every investor should note:

1. The bellwether stocks came in better than the market expected. If the Australian market is heavily underpinned by two sectors - banks and mining - then those sectors in turn are underpinned by the Commonwealth Bank (CBA), the 10th biggest bank in the world, and BHP Billiton, the world’s biggest miner.

CBA romped home with a 14 per cent lift in profits - better than consensus. Better still, the return on equity at the bank was a handsome 18 per cent. Compare that with the 8 per cent achieved by Bendigo Bank and you get a clear idea why bigger is better in local banking.

BHP, on the other hand, brought in roughly $1bn more than the market was expecting thanks to cost-cutting and a productivity focus.

These two results set the tone for the entire market and they were convincingly positive.

2. Market leaders pushed hard to lift dividends - even without a profit lift.

The “hunt for yield” is the main game for local retail investors and every single major company is now trying to satisfy the trend. Telstra lifted its dividend even though there are distinct concerns whether future earnings will properly justify this move. More dramatically, two key companies lifted dividends at a higher rate than profits - Wesfarmers profits lifted by 9 per cent but the dividend lifted by 10.4 per cent. If you think that is a concern, consider that Suncorp announced a drop in profits of 4.5 per cent but a lift in dividends of 40 per cent.

In summary, blue-chip chief executives realise that dividend yield may override the desire for actual growth in the local market and they are prepared to sign off improved dividends, whether the immediate numbers justify the move or not. That’s all fine if the earnings improve in the months ahead, but if they don’t, companies will be stuck with higher dividend payout ratios and slow growth, a cocktail that will sour quickly if rivals show real earnings growth on the back of investments in the company rather than allocations to dividends.

3. Overall, there were few disappointments across the market. Roughly one in five companies that have reported to date have missed expectations, a reasonably low rate considering we have an economy growing at below trend. Where significant stocks seriously disappointed the market there were often very particular explanations: Coca-Cola Amatil reported an 86 per cent downturn in profits almost entirely due to restructuring costs at the high-profile SPC Ardmona fruit processing facility in Victoria.

Interestingly, the disappointments, when they came, were not common to any one sector, with the possible exceptions of airlines (though those poor numbers were well flagged).

4. The miners beat the gloom. There are, of course, the three big miners - BHP, Rio Tinto and Fortescue - and there is daylight between this group and the other 500 or so mining stocks that dot the market.

However, the big three all came in better than expected and this feeds nicely into the theory that investments in miners are now at what is surely the bottom of the cycle and they will pay handsomely in the longer term.

BHP’s new chief, Andrew Mackenzie, managed to lift underlying profit by 31 per cent. There were weak spots (such as petroleum) but a leaner and meaner BHP is clearly kicking goals. Likewise, Rio, under its new chief Sam Walsh, increased profits by 10 per cent and, usefully, it was not just from iron ore. Rio has, after all, become a one-metal company in terms of profits over the past two years. Profits also emerged at the aluminium division, which had been seen as a lead weight (sorry!) at the miner for some time.

It was, however, the endlessly inventive iron ore operator Fortescue that shot the lights out with a net profit 2.5 times higher than the previous corresponding period. In common with Rio, an element of this profit increase came from reducing debt costs; nonetheless, the miner once again defied doomsayers. What’s more, extending its reputation as a company that always raises its own ambitions, Fortescue followed the better than expected performance with announcements it would take a substantial bet on capacity expansion in the coming months.

5. Consumer stocks outperformed the entire market.

Retailing is a key part of the Australian stockmarket and it is highly cyclic. For the past few years it has been a nightmare, with problems on every front and valuations falling to the point that clear confidence in the sector was shot. Well, that was last year’s news as, remarkably, over the past 12 months consumer discretionary stocks, especially retail, came in with an average total return of 38 per cent - more than triple the wider market’s total return of 10.5 per cent.

Within this dramatic rebound in the retail sector there are companies that, if not quite back from the dead, are back from a very dark place indeed.

Two sterling examples are Country Road and Webjet, which lifted 44 per cent and 26 per cent respectively on the day their results were announced. In both cases the stock price rebounds were underpinned by strong results. There are exceptions here, of course, and plenty of them. Dick Smith did not quite match its promise, and The Reject Shop fell behind expectations. Nevertheless, life has returned to this moribund sector.

6. Even failures got rewarded.

Perhaps this is the most important development of all: even with flat or poor results “Mr Market” is in such a benevolent mood that mediocre top-line results have been ignored as bullish comments from management on the future are taken up with gusto.

Two strong examples here are the building products company Boral and the rail services company Aurizon (previously known as Queensland Rail).

Boral has a new chief executive in Mike Kane and the group is well advanced in a total makeover, but the group actually reported a net loss of $25m for the second year in row. Investors cast this news concerning Boral’s first half aside as imaginations were fired up at the thought of a major building company reforming itself amid a looming home building recovery.

An even stronger example of the phenomenon was the half-year result at Aurizon, which was 40 per cent lower than the corresponding period a year earlier. It was dragged down by one-off impairment charges to the company’s trains and a whopping $50m strategic review.

Never mind. Aurizon chief executive Lance Hockridge said coal haulage volumes were set to improve in the second half and the shares hit a high on the same day.

All in all it’s been a solid reporting season and, though there will no doubt be some negative upsets in the days ahead, the mood is set: good results get rewards, poor results are generally accepted as long as the outlook comments from management are positive. The next part of the cycle demands more input from revenue gains than cost savings, but so far, so good.

James Kirby is managing editor of the Eureka Report. This article is part of the It’s Time series in Eureka Report, focusing on new opportunities for investors this year.

Trial Eureka Report free for 21 days. Register now at www.eurekareport.com.au