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All eyes on earnings

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James Dunn

It will be a nervous earnings season this year. The way the Australian stockmarket generally rises is that the price/earnings (P/E) ratios of stocks expand, and the improved earnings rise to justify the higher multiples. If the earnings don’t support the higher P/Es, the market comes back down.

In 2013, the first part of that bargain has been supplied: this P/E expansion has taken the S&P/ASX 200 Index’s constituent companies from an average P/E ratio of 12.1 times expected earnings (over the next 12 months) a year ago, to 14.7 times expected earnings going into the reporting season. Given an average multiple for the ASX 200 in the past decade of 14.1 times, that tells you that it’s time for earnings to do their share of the lifting.

Confidence is weak

The problem is that the Australian market is still nervous about potential weakness in China and the US, as well as the softening Australian economy. A rash of profit downgrades from companies – even as recently as last week, witness Oroton and Suncorp – has leached away at sentiment, to the point where confidence in FY 13 results has evaporated.

Earlier this year, analysts’ consensus estimates for earnings growth for the S&P/ASX 200 Index for 2012-13 were running at about 12%, led by the financials and industrials, with the resources stocks acting as a drag on the market, as they did in FY12.

The December 2012 half-year half profit reporting season saw a fall in overall profits of about 9% on the December 2011 half, due mainly to a 35% slump in resources profits. With revenue growth across the market virtually non-existent, it was up to cost control and productivity gains to hold up earnings.

On the other hand, dividend growth was pretty good: 53% of ASX 200 stocks lifted their dividends, against only 22% that cut them – and 40% of companies paid a higher dividend than analysts expected. Also, the closely watched “outlook” statements were considered fairly positive overall.

However, the wave of profit downgrades has disappointed the market, and FY13 earnings are now expected to show a fall, of about 1%. Without resources, the market’s earnings would be up by about 5% – but the resources stocks are going to detract from the overall earnings result. About the best that can be hoped for is a flat outcome.

Aussie dollar reprieve

That may change, with the late improvement in one of the headwinds that was holding back profits for many companies, namely the high Aussie dollar against the US dollar. But the Australian currency only started to come off in mid-May – the fall won’t be enough on its own to boost profits.

Revenue is expected to remain flat in FY13, with revenue growth of less than 2% expected across the ASX 200.

Analysts do expect profit growth in the 2013-14 financial year: at present, the ASX 200 stocks are projected to lift their earnings by about 6% to 9%, excluding the resources stocks. That could be improved by the weaker $A, which has begun to spark upgraded expectations for some of the Australian market’s biggest foreign earners – as well as helping the FY13 downgrades to be not as bad as they could have been.

The companies that benefit most from a lower A$ are those that report their financial results in US$, including BHP Billiton, Rio Tinto, Fortescue Metals Group, CSL, Woodside Petroleum, News Corporation, QBE Insurance, Oil Search, Brambles, Computershare, James Hardie and ResMed. The weaker A$ helps boost their earnings.

Also benefiting from the A$’s slide are companies with significant percentages of their revenue coming from overseas, such as Amcor, CSR, Cochlear, Treasury Wine Estates, ‘New’ News Corporation, 21st Century Fox , Sims Metal Management, Mayne Pharma, Westfield Group, Sonic Healthcare, Henderson Group, Ansell, Adelaide Brighton, GWA, SDI, Navitas, Bega Cheese, Macquarie Atlas Roads, Incitec Pivot and Orica.

Great expectations

But investment bank UBS summed up the market mood late in July when it said it expected surprises to the downside coming out of the August reporting season to out-number positive surprises by a ratio of three to one.

UBS says the standouts could include stocks such as Fairfax and Nufarm, while Brambles, Coca-Cola Amatil, Sonic Healthcare, Computershare and Treasury Wine Estates could lead the disappointments.

Broker Ord Minnett has also looked at stocks that could surprise the consensus – on both the upside and the downside. It says positive surprises could come from the likes of Goodman Group, Ramsay Health Care, Telstra, Westfield Group, Dexus Property Group, Commonwealth Property Office Fund, Iluka Resources, Amcor, Flight Centre, GPT, Sydney Airport, Crown, Federation Centres, CSL, Aurizon, Coca-Cola Amatil and Asciano.

But the broker says stocks that could disappoint include Ansell, Toll Holdings, Computershare, Woolworths, Leighton Holdings, Monadelphous, Wesfarmers, Challenger, Sonic Healthcare, CFS Retail Property Trust, Insurance Australia Group, Tatts Group, Echo Entertainment and Treasury Wine Estates.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Published on: Friday, August 09, 2013

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