Going into the August reporting season, the market has softened earnings expectations for companies. Declining commodity prices, a higher dollar than many had expected and a budget related decrease in consumer spending and sentiment were all drivers of the weaker forecasts.
One bright spot in the economy however was the recovery in house prices and construction, which finally began to ramp up in the second half.
Similar to first half we expect to see only minor top line improvement in many companies, with the majority of the heavy lifting in relation to earnings improvements coming from internal cost outs and efficiency programs. Given the share market highs, prices will be highly vulnerable to any earnings misses but this will largely revolve around 2015 expectations with most companies already guided to 2014 results. Companies that demonstrate revenue growth will be rewarded given the scarcity.
A key focus for Dalton Nicol Reid this reporting season will be assessing the outlook for the market to hit the 2015 growth forecast. The market is currently anticipating 8% growth.
We do expect a pick up in company margins for those companies that see growth return to their top-line and beginning to benefit from their cost cutting and efficiency programs of prior periods. Many companies have also been de-gearing and the combination of healthier balance sheets, low interest rates and scarcity of top line growth could lead to a pick-up in M&A.
Given this backdrop we are looking for a select set of investment characteristics. Valuations have now normalised and our focus will be on earnings which we believe will drive returns going forward. Therefore our reporting season watch list includes:
– Companies demonstrating a diversified or deeper pool of growth opportunities given patchy domestic recovery, in particular those with offshore exposure where growth appears stronger.
– Companies which are driving earnings through cost cutting and efficiency programs leading to future margin expansion when top-line growth comes back.
– Companies demonstrating strong cash flow generation reducing leverage. This supports M&A growth going forward especially with low interest rates or potential capital management.
– Good companies with strong business models operating in cyclical/consumer sectors being dragged down by weak sentiment. To what extent have they withstood recent consumer related weakness and have activity levels improved?
– Emerging growth stories or newly listed stocks delivering solid results which are not well understood by the market yet. Are they meeting prospectus expectations?
– We are looking to see if capital management begins in resource companies and likelihood of any divestments.
– Any green shoots among mining service companies?
– Any signs of deterioration in bad debts among the banks and any signs of increased competition?
– De-rated high PE stocks – are the earnings meeting the expectations implied by lofty multiples?
