A strong reporting season with weakness in outlook not dampening manager sentiment

Reporting Season Update

Companies were largely able to shrug off the challenges caused by the emergence of the Omicron variant and deliver strong results in the February reporting season. The reporting season continued the trend of the reopening of the economy driving profits higher. Inflationary pressures are starting to permeate through parts of the market but to date these challenges have been relatively well managed.

Broadly positive reporting season results, smaller companies with less pricing power lagged

Reporting season and guidance was generally more positive for larger companies than small companies, which reflects the differing abilities of companies to manage supply chains and pass on rising costs to consumers. However, margins remain under pressure with rising labour costs, input prices, and energy and transport costs. For consumers, inflation, particularly food and energy inflation, is a concern, coupled with limited wages growth which could become a headwind for domestic economic growth.

Despite these challenges, investment managers’ survey by JANA shined through reporting season with portfolio companies beating expectation at a ratio ~2:1, while of the overall market was closer to an even split based off sell side research data.

Resources and Energy expectations for FY 23/24 remain modest

Commodity markets which had been strong have surged again since the outbreak of hostilities in Ukraine, with the commodity prices breaking out and the key iron ore price rallying from its 4Q21 lows to US$158/ton.

In terms of policy, on March 5 Chinese authorities set a GDP target for 2022 of 5.5%. This is the lowest target since 1991 but was at the higher end of market expectations (5% to 5.5%). With the Communist Party’s National Congress scheduled for later in the year, authorities will be looking to deliver economic and social stability.

Managers expect Infrastructure stimulus to be the primary focus in China, boding well for steel demand. On the negative side, the Chinese housing market is still slow and the impact of COVID is tempering the services sector as lockdowns roll through various Chinese cities. Property development is on a downward trend with limited growth after benefiting from stimulus during 2016-2020. Longer term, urbanisation is tapering off and the potential introduction of more property taxes, coupled with falling birth rates are long term negatives. However, in the short term loose monetary policy and easing financing restrictions should benefit steel and iron ore demand.

In terms of earnings expectations from Resources and Energy Sectors, market expectations are for earnings upgrades across both sectors by the sell-side to reflect elevated commodity prices in FY2022. Looking ahead 12 months, the expectation is for commodity and energy prices to remain at elevated levels, therefore FY23 earnings for the two commodity sectors could see further earnings upgrades by the Market.

Financials perform ahead of expectation

Leading into reporting season there was some concern that Major Bank net interest margins (NIMs), the spread between cash deposits and mortgages, would continue to contract because of fierce competition within the sector. Reporting season saw better than expected results and coupled with the expectation of rising interest rates domestically, the outlook for the sector looks more balanced than it had previously.

Market Valuations improving

The ASX 300 index has seen a compression in the P/E forward earnings multiple since the start of the calendar year driven by a combination of improving earnings fundamentals and lower prices.

At present the ASX 300 P/E +1yr is trading at 15.6x and trending towards the 15 yr. average of 14.7x. The earnings recovery which has continued through the February reporting season and is expected to persist, driven in large part by the Resources, Banks and Energy sectors has the potential to compress the multiple further making the index more attractive on a valuation basis.

Sentiment Survey

JANA has undertaken a survey of 20 Australian Equities investment managers to gauge manager sentiment over the next 12 to 24 months. Relative to previous surveys, a much larger number of managers are neutral on the outlook for Australian Equities. 75% of managers now have a neutral view on the outlook for Australian Equities relative to 38% who had a neutral view last quarter.

Sentiment is neutral/slightly positive for Australian Equities over the next 1-2 years with preference given to value over growth-style stocks.

Overall sentiment was broadly positive amongst Australian Equity managers, albeit at much more modest levels than sentiment surveys undertaken in 2021.

Conclusion

Reporting season highlighted the earnings recovery underway albeit under some pressure given the ongoing effects of Omicron and increasing inflationary pressures. Managers surveyed by JANA delivered more earnings beats through reporting season than the overall market. Managers also expect the recovery in value-style to continue relative to growth-style, whilst the general outlook for the market is more neutral relative to late 2021.

The earnings outlook for the Australian equity market remains robust driven in large part by the improving earnings outlook for the Resources, Energy and Financial sectors. Market P/E multiple +1yr has significantly compressed this calendar year and has the potential to sustain that trend given the upbeat earnings outlook for a large cohort of the index leading into calendar year 23.

Sentiment for the market also remains positive and provides support for JANA’s view on the asset class.