That's a wrap: August 2018 reporting season

Market insights

September 2018

As reporting season comes to an end, we look back at how the Australian equity market performed: dissecting the key themes that emerged and evaluating how this may impact markets going forward.

Overall, a solid reporting season helped drive the S&P/ASX 300 Accumulation Index to gains of 1.4% during the month. However, as always there were hits and misses aplenty, many of which were met with explosive price moves. Unsurprisingly, the difference between the best and worst performing companies was particularly high towards the end of the month, when small-cap names traditionally tend to release results.

The five pivotal trends we saw materialise in the recent reporting season, and which are highlighted in this insight are:

  1. The reappearance of cost inflation
  2. The resilience of consumers and retailers
  3. Capital management policies
  4. Corporate activity
  5. Small-cap tech performance


Cost inflation

Input cost pressures stemming from labour (primarily from the increases in the Australian minimum wage), energy, raw materials and transport costs were felt across multiple industries, with energy and materials the hardest hit, as shown in Chart 1.

Price takers such as packaging company Pact Group (PHG, -21.7%) in particular struggled to maintain margins in the tighter operating conditions, while plumbing manufacturer Reliance Worldwide (RWC, -10.8%) retraced some of its recent gains, as the anticipation of cost pressures contributed to a slightly weaker than expected guidance statement.

By contrast, price makers or companies that were able to pass costs through to their customers were rewarded by the market, as demonstrated by Brambles (BXB, +11.0%).

Should inflationary pressures become more pronounced or real wage growth show signs of revival, this distinction between price takers and price makers will be instrumental to future earnings potential. These early signs of rising input costs may signal an evolution of the market from the stagnant low inflation/low interest rate environment which has defined markets for the past decade.

Chart 1 – Reporting Season beats and misses by sector

Source: Macquarie


Consumers and retailers

A key turnaround story this reporting season was the resilience of consumer-focussed companies, with a host of consumer discretionary names delivering strong (relative) results, despite ongoing challenging operating conditions.

A standout was Webjet (WEB, +27.3%) which beat profit expectations by approximately 12% and reaffirmed bullish FY19 guidance. Others such as Nick Scali (NCK, +9.2%) and Breville Group (BRG, +26.3%) returned generally in line results which the market took positively given the tough environment.

Two of the market’s most heavily shorted stocks, JB Hi-Fi (JBH, +12.7%) and Dominos (DMP, +9.3%) posted strong returns, albeit assisted by short-covering. In the case of Dominos, this was despite doubts on the quality of the result, and a lowered guidance. In the end, the potential for strong overseas growth was enough to override other concerns – an underlying theme of the month.

Ultimately, the outperformance of the sector can be attributed to low investor expectations paired with better-than-feared company results, rather than a resurgence in consumer confidence. Solid employment numbers remain supportive, but worsening house prices, and out-of-cycle mortgage rate rises will likely affect confidence going forward.


Capital management

Capital management was front and centre this reporting season, with many companies opting to return capital to investors.

The announcement of special dividends pleased the market, aiding the performance of stocks such as Telstra (TLS, +13.0%) and Suncorp (SUN, +6.8%), while Magellan Financial Group (MFG, +17.3%) elected to increase its payout ratio.

Buybacks were also a popular form of capital management with the likes of Crown, Qantas and BlueScope Steel and others announcing plans to repurchase shares.

As per usual, those neglecting to pay or reducing dividends were heavily punished, such as Origin Energy (ORG, -18.6%). Resource heavyweights Rio Tinto and BHP Billiton are expected to distribute significant cash in the coming year.


Corporate activity

There was also a surge in corporate activity during the month.

Major deals included Nine Entertainment acquiring Fairfax, Amcor acquiring US-based Bemis, and most recently TPG Telecom and Vodafone Hutchinson Australia announcing an agreement to a merger of equals, rocketing TPG up +50.0% by month end. Bingo Industries (BIN, +20.2%) and Northern Star Resources (NST, -3.3%) both announced major acquisitions that were well received by the market.

With balance sheets generally healthy and borrowing costs still relatively low, the environment remains supportive of M&A activity, notwithstanding the fact many segments of the market are currently priced at relatively high levels. On the flipside, a falling Australian dollar may increase the appeal of well-run Australian companies to foreign acquirers.


Small-cap tech companies

Lastly, as displayed in Chart 2, the clear winner from this reporting season was the Information Technology sector, as numerous earnings beats, the highest across all sectors, translated into explosive daily moves.

High profile small-cap tech stocks led the gains with impressive results from Wisetech (WTC, +40.1%), Altium (ALU, +37.4%) and Infomedia (IFM, +36.8%). The performance of these high growth names was likely aided by strong market support for high price-to-earnings (PE) names in general throughout this reporting season.

On a cautionary note, the expansion in the PE multiple of many of these names far outstripped the change in underlying earnings. For many names in this sector, the focus remains on top line growth rather than profits.

Chart 2 – Return profile of ASX200 Information Technology Sector

Source: Macquarie


Summary

The August reporting season saw the emergence of some interesting themes in the Australian equity market. The persistence and endurance of these trends will be significant in determining potential active returns of stocks, sectors and factors going forward.

At Macquarie Systematic Investments, we believe that domestic economic conditions remain supportive and the Australian equity market continues to offer opportunities for investors, noting an increasing divergence in valuation between segments of the market.

Learn more about our capabilities in Australian equities.

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