The results of the Australian reporting season reveal a number of upgrade and downgrade themes for listed companies’ earnings.
Major Upgrade Themes
Cost disinflation and cost-outs an earnings tailwind for some
Some of the largest earnings upgrades this reporting season have been on the back of easing cost pressures.
James Hardie’s (JHX) (Focus Portfolio 3%) stellar Q1 earnings and Q2 upgrades were driven in part by the disinflation of freight and raw material costs over the year (compared to an elevated base year), which, in combination with price/mix gains, has helped to offset macro-driven volume softness.
A raft of companies also received earnings upgrades after they announced cost-out programmes aimed at improving their profitability, including AMP, Qantas, Orora, Qube.
Sector tailwinds
A number of sectors are still in upgrade mode on the back of favourable sector-specific trends.
Insurance – general insurers and insurance brokers, like IAG (Focus Portfolio 3%), Suncorp and Steadfast, have continued to benefit from improving profitability trends driven by continued momentum in the insurance premium rate cycle.
Travel – the ongoing post-covid recovery is continuing to drive upgrades to consensus forward earnings estimates for Qantas, although we are increasingly of the view that the market is ‘looking through’ current strength to more normalized earnings.
| Company | Ticker | FY24 EPS revisions - last 30 days | Primary driver | ISG comment |
| Top 10 upgrades | ||||
| James Hardie | JHX | 17% | Cost/margin tailwinds | JHX's 1Q24 result and Q2 guidance was a strong beat to consensus, driven by a combination of better than expected North American volumes, cost disinflation across freight and raw materials, and price/mix gains. |
| AMP | AMP | 8% | Cost/margin tailwinds | The highlight of AMP’s 1H24 result was details provided on the company’s latest cost-out programme, which targets $120m of annualized cost savings by FY25. |
| Qantas Airways | QAN | 5% | Travel tailwinds | FY23 results were in line with consensus and guidance, while the $500m buyback was more than anticipated should be accretive to FY24 EPS. The FY24 outlook points to a continuation in the travel recovery, >$300m of cost and revenue transformation initiatives, and higher CAPEX reflecting investment in fleet renewal. |
| Cochlear | COH | 3% | Strong execution | COH’s FY23 earnings were broadly in line, while FY24 guidance was well ahead of expectations on the back of strong momentum with increased referrals from hearing aid channels and direct-to-consumer marketing. |
| Carsales | CAR | 3% | Strong execution | CAR’s FY23 was a strong earnings beat, while FY24 guidance is looking for ‘very strong revenue and earnings growth’ on the back of strong growth from international operations and an acceleration in Trader Interactive’s growth in the first half under CAR’s ownership. |
| Orora | ORA | 3% | Cost/margin tailwinds | Solid FY23 earnings, which beat expectations, while FY24 outlook for ‘earnings to be higher’ was better than consensus and will be driven by margin accretion from profitability programs/cost management, cost disinflation for some commodities, and pricing discipline. |
| Qube | QUB | 2% | Cost/margin tailwinds | FY23 EPS beat expectations, while FY24 outlook comments guided to continued growth on the back of stable (high) volumes across most markets and margin benefits from improving labour availability and cost/productivity initiatives implemented in FY23. |
| Suncorp | SUN | 2% | Premium cycle | SUN’s FY23 result was largely in line with a strong insurance result offset by softer bank earnings. In FY24, insurance margins are expected to improve to 10-12% driven by repricing benefits from higher premiums which should offset a higher CAT budget and higher reinsurance costs. |
| Steadfast | SDF | 2% | Premium cycle | FY23 earnings hit the top end of guidance, while FY24 guidance was better than expected as momentum remains positive in the insurance premium rate cycle. |
| Worley | WOR | 2% | Cost/margin tailwinds | WOR’s FY23 earnings were broadly in line, but FY24 EBITA guidance was upgraded for the third consecutive time in 6 months driven by higher value work in its factored sales pipeline and backlog as contract wins are increasingly being seen in higher margin sustainability-related work. |
Source: Refinitiv, Wilsons.
Major Downgrade Themes
Stickier cost items continue to weigh on some companies’ margins
While some businesses have benefited from cost disinflation this reporting season, a range of key costs items (namely labour, rents, and debt costs) have proved sticky and continue to act as a headwind for labour intensive industries, businesses with significant occupancy costs (e.g. retailers), and indebted businesses, in particular.
Ramsay Healthcare and Endeavor Group both received earnings downgrades this reporting season as their outlook is being hampered by higher-than-expected interest costs. Coles also underwhelmed consensus expectations due to a higher cost of doing business driven by higher wages, rents, and a tick up in theft.
Meanwhile, both Wisetech and Seek’s earnings guidance has been weighed down by the near-term margin dilution associated with recent merger and acquisition (M&A) activity and investment into growth initiatives.
Sector headwinds
Several sectors are facing cyclical headwinds that have weighed on near-term earnings expectations.
Manufacturers – both Ansell and Amcor have been impacted by inventory destocking from their customers, which follows a period where customers accumulated stock amidst covid-related supply chain dislocations. Both companies have highlighted that despite the destocking headwind in FY23, end-user demand has still remained relatively resilient, while destocking trends are expected to stabilise/ease by the second half of FY24.
Media / Online Classifieds – the softer macro environment has translated to a subdued ad market backdrop, which has driven earnings misses for companies like Nine Entertainment and Seek.
Office landlords – A-REITs with significant office market exposures like Dexus and Growthpoint Properties and have faced both cyclical (i.e. labour market conditions, higher cap rates) and structural headwinds (from work-from-home), which we expect to weigh on asset valuations and operating metrics through FY24.
| Company | Ticker | FY24 EPS revisions - last 30 days | Primary driver | Comment |
| Top 10 downgrades | ||||
| Ramsay Health Care | RHC | -26% | Cost/margin headwinds | FY24 guidance was a significant miss to consensus, with management indicating that the company’s earnings recovery would be hindered by cost inflation, rising operating expenses in digital and data, higher reimbursements, and higher interest expenses. |
| Ansell | ANN | -13% | Customer destocking | Key FY23 line items and FY24 guidance were pre-released, although the result highlighted that (despite strong end user demand) inventory destocking within the healthcare segment is expected to continue in 1H24 before stabilizing in the second half. |
| WiseTech Global | WTC | -13% | Cost/margin headwinds | WTC’s FY23 result missed expectations due to higher than anticipated R&D spend in the second half, which is expected to step up further in FY24 according to company guidance as investment is pulled forward into recent acquisitions. Margins are not expected to reach 50% by FY26 due to the near-term margin dilution of recent acquisitions, albeit this was well telegraphed by management prior to the result. |
| Seek | SEK | -11% | Cost/margin headwinds | SEK’s FY23 was a slight miss to consensus, but the biggest disappointment for the street was the company’s FY24 guidance which implies flat revenue growth (in line with consensus) and a worse than expected decline in earnings driven by elevated costs growth from growth initiatives despite a less supportive cyclical backdrop from the employment cycle. |
| Nine Entertainment | NEC | -10% | Macro headwinds | The 2H23 result was a slight miss on EBITDA due to weaker Digital and Publishing earnings, while the company guided to weak 2H23 momentum continuing through FY24 as the ad market remains subdued which is reflective of the macro backdrop. |
| A2 Milk | A2M | -9% | Sector headwinds | A2M’s FY23 result was broadly in line with expectations, while guidance for low single-digit revenue growth in FY24 disappointed as the company faces cyclical headwinds from a declining China Infant Milk Formula market which is being driven by a subdued birth rate and evidence of deferred pregnancies during Covid restrictions. |
| Dexus | DXS | -9% | Valuation headwinds | FY23 results were largely in line, but FY24 distribution guidance was lower than expected due to softer trading profits (i.e. asset sales). The outlook for office buildings remains challenged with management suggesting it is ‘halfway through a challenging two-year period’ with further downward pressure on asset valuations expected. |
| Coles Group | COL | -8% | Cost/margin headwinds | FY23 sales were above the street, but earnings undershot consensus expectations driven by weaker than expected supermarket margin due to cost of doing business headwinds from higher wages, rent, theft, and operating expenses related to automated fulfillment centres (i.e. Witron & Ocado). No headline quantitative guidance was provided, but cost headwinds are expected to remain a feature of FY24. |
| Endeavour Group | EDV | -7% | Cost/margin headwinds | EDV’s FY23 result missed expectations at the EBIT and NPAT line driven by lower Q4 revenues with the retail segment reverting to negative like-for-like sales growth while hotel sales only grew modestly. FY24 interest cost guidance was materially higher than consensus expectations, driving earnings downgrades despite otherwise solid cost management and the new optimisation programme Endeavour GO. |
| Sonic Healthcare Ltd | SHL | -7% | Cost/margin headwinds | FY23 EBITDA fell -40% and was -5% below consensus expectations due to higher than expected operating expenses driven by labour costs, while the tailwind from covid-related earnings has also diminished. The FY24 guidance range points to ~0-5% EBITDA growth, which was below consensus at the mid-point. |
Source: Refinitiv, Wilsons.
Unpackaging Amcor’s Value: Adding at 3%
We have screened the ASX for other stocks that could provide cost disinflation upside over the medium-term, and Amcor (AMC) is a standout. We have added AMC to the Focus Portfolio at 3%.
Significant upside over the next 12-24 months
We believe AMC can materially outperform the benchmark over the next 12-24 months. The key to our investment thesis is:
- Worst is behind us: The abatement of headwinds - global destocking and elevated costs - which have knocked earnings forecasts and investor confidence.
- Upgrades: We expect earnings to recover quicker than expected as these two headwinds subside.
- Attractive valuation: AMC looks cheap and we expect a rerate as these headwinds subside.
AMC Overview: Resilient End Market, Global Reach
Amcor boasts a commanding position within the global packaging solutions sector. The company operates in 43 countries with 220 locations from the US to emerging markets (EMs). 95% of sales are to consumer end markets and major customers include global titans Unilever, Nestle, Proctor and Gamble, J+J and Coca-Cola.
The end-use sector mix is largely defensive in nature. A large portion of sales (FY22) are focused on food (43%), beverage (26%) and healthcare (13%), acknowledged for steady and steadfast demand, usually offering stability even amid broader economic fluctuations.
Returns we Expect over the Cycle
We expect AMC to generate a total shareholder return of 10-15% over the cycle. This is driven by 3 key areas. First, is capital expenditure reinvested into the business such as R+D spend or expanding capacity, this grows earnings organically. Second, through buy-backs or M&A activity. AMC has invested over $5bn on acquisitions and buy-backs since 2010. Third, dividends. AMC has consistently paid a 4-5% dividend yield over the last decade. All this together provides a total return that is historically higher than the index.
Deciphering the Destocking
AMC’s volumes and margins have suffered due to global destocking. The US in particular has seen significant destocking since last year. In 2022, retailers (including food and beverage retailers) built up a level of inventory that soon became unsustainable, due to:
- Supply Chain Challenges: Persistent supply chain dislocations resulting from the pandemic triggered a change in retailer buying patterns. Retailers ordered products earlier to ensure they had enough during busy seasons and even ordered more to prepare them for potential disruptions.
- Shift to "Just-in-Case": US food retailers shifted from ordering only what's needed (just-in-time) to ordering more to be safe (just-in-case).
- Cost of living impact: As interest rates and inflation increased, consumers tightened their spending.
- Inventory Mismatch: With consumers buying less and retailers ordering more, the balance between what was in stock and what was wanted shifted. This resulted in excess inventory that needed to be adjusted.
Destocking adversely impacted Amcor operations via:
- Lower Volumes: Destocking has reduced order volumes for AMC's packaging products in recent reports.
- Price Pressures: In a destocking environment, customers might exert pressure on suppliers like Amcor to reduce prices or offer discounts.
- Difficulty Passing on Cost Increases: AMC faced higher costs in its supply chain, such as higher raw material, production costs or freight. Subsequently, the company has
found it challenging to pass these increases onto customers in an environment of soft demand, which has crimped margins.
Destocking risk moderating
We are now seeing evidence that the destocking cycle is easing. US data on food and beverage inventory levels provide evidence of a slowdown and return to trend growth. Furthermore, food and beverage sales data have started to turn positive as the US consumer proves resilient in the face of higher interest rates.
Major retailers are getting more positive on their inventory levels. Walmart (>50% of US revenue is from grocery sales) discussed in its recent results how it “made good progress” in reducing inventory levels and is more focused on reducing exposure where it is seeing declining sales such as electronics and home goods. Costco also recently discussed its destocking over the past 6 months, but like Walmart, was a lot more comfortable with its inventory levels in June.
AMC is now more positive on destocking. Management discussed in the recent result that they expect destocking will abate and be largely behind us by the end of this calendar year.
We expect this destocking was a one-off for AMC after an unusual inventory cycle over the pandemic. AMC’s end consumer has proven to be resilient.Once destocking is complete, we should see a quick return to volume growth. Operating leverage will drive results as volumes improve.
We expect a more rational cycle over the medium term. In a more rational cycle, AMC should be able to pass on more costs to customers and volumes should grow at normal levels.
Downside Risk to Costs, Upside Risk to Margins
In a period of lower volumes, AMC's higher costs could not be fully passed along to their customers, and margins contracted as a result.
Costs can fall quickly, as we saw with James Hardie (JHX) in their recent result. AMC’s cost profile is very similar to JHX. Like JHX, AMC’s freight and raw material costs could decrease within the next few quarters, providing an upside risk to
FY24 earnings.
AMC, like JHX, has been increasing prices over the past year, but costs swung margins the wrong way. A period of lower costs and elevated prices could lead to a significant beat to earnings expectations via margin expansion.
Margins in consensus look too low when you consider the risk of cost disinflation and the end of destocking. A 1 percentage point increase in FY24 net income margins would lead to a ~9% increase in earnings (keeping revenue constant). We think the risk to margins is to the upside, with FY24 representing a low point in margins.
Attractive Valuation
Amcor's valuation is attractive. Trading at approximately 13.7x on a 12-month forward price to earnings (PE) basis, the stock is trading below its 5-year (15.4x) and 10-year average (16.6x). At 13.7x with an expected earnings annual growth of 7% from 2024-2027, AMC’s PE has upside risk, in our view.
The current discount to the five-year average PE suggests the market is factoring in an expected earnings downgrade of approximately 11.5%. We believe downside risk to earnings is now minimal. Significant deterioration in volumes and earnings seems a low-probability outcome.
Dividend also looks attractive at 5% (12mth fwd). This is at the top of the range for AMC and above its historical 10 year average of 4.4%.
Against other defensives, AMC represents good value from a growth to valuation perspective, with upside risk to valuation and growth.
Removing NextDC (NXT) -2%
After a strong run of performance, we are removing NXT from the portfolio.
Our positive fundamental view of the underlying business remains unchanged, with NXT being a beneficiary of the structural growth in cloud computing as well as incremental Generative AI-related tailwinds, although the valuation is now relatively full in our view, with the company now trading at a 12-month forward EV/EBITDA of ~36x (compared to ~25x when we first introduced it into the portfolio in September 2022).
NXT’s full year result also included much higher than expected CAPEX guidance for FY24, at $850-900m vs consensus of $473m, as the business looks to ramp up investment ahead of demand.
This could weigh on sentiment towards the company given the near-term impact to free cash flows, notwithstanding the long-term return on investment (ROI) potential from growth CAPEX.
Finally, in the last ~5 months, NXT has announced material contract wins in both NSW, and more recently in VIC, meaning the key near-term catalysts we were anticipating have now played out. Therefore, in summary we see now as an opportune time to take profits from NXT by removing it from the portfolio.
Removing Cleanaway Waste Management (CWY) -2%
We have also removed CWY from the portfolio.
Since adding CWY to the portfolio, our investment has not played out in line with our expectations on several fronts:
- Lack of bolt-on acquisitions – it has been more than a year since CWY’s acquisition of Godolphin Resources (GRL) in August 2022, when CWY raised a total of $350m, which included $175m of additional ‘balance sheet capacity’ to be used in part for future growth projects. In this context, it has been disappointing that CWY has not announced any further value accretive bolt-on acquisitions since the GRL deal.
- Slower than expected earnings recovery – while CWY’s earnings recovery is still ongoing, it has been slower than expected. The business did not provide any headline guidance for FY24, and aspirational guidance for EBIT of >$450m by FY26 is broadly in line with consensus expectations, thus failing to deliver a meaningful upgrade to the street’s medium-term expectations as we had been anticipating.
- CAPEX higher than expected – CWY’s FY24 CAPEX guidance, at $430-450m, was materially higher than we had anticipated and was ~30% higher than consensus estimates at the mid-point, which will weigh on the free cash flow line and balance sheet for the near-term at least.
Therefore, with no significant visible catalysts on the horizon and disappointing execution to date, we view now as a good time to remove CWY from the portfolio and ‘recycle’ the proceeds into more attractive opportunities.
Adding to Xero (XRO) +1%
XRO stands out to us as one of the most impressive tech stocks on the market. In our view, the market appears conservative on XRO’s free cash flow (FCF) over the medium term. New management has impressed us so far, with a more balanced approach to growth and profitability.
We think XRO has a number of levers for growth over the next 12-24 months:
- Price - We think XRO can raise prices as the offering keeps improving. The market looks too conservative on pricing.
- Cost - As XRO builds more scale, we think there will be scope for the business to wind back its high rate of investment into marketing and product development (currently representing >80% of OPEX and ~70% of revenues) in line with other more mature software businesses (where total OPEX typically represents ~50% of revenues). This is underappreciated by the market.
- Subscribers - There remains a very significant runway for growth offshore, particularly in the UK and US. These countries have total addressable markets of 5.5 million and 34.5 million subscribers, while XRO’s penetration remains relatively low at ~16% and ~1%, respectively.
Written by
Rob Crookston, Equity Strategist
Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.
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