The upcoming Australian reporting season could be a key catalyst for broader market downgrades.
This follows a series of downgrades in recent months, indicating challenging times ahead. The prevailing market sentiment remains downbeat, which we believe is justifiable given the current economic headwinds.
One of the major concerns lies in the softening of demand within cyclical sectors. The economy still faces several headwinds including high interest rates, elevated inflation, and mounting cost of living pressures. We expect to see evidence of a significant downward shift in consumer behaviour in this reporting season. As a result, we have adopted an underweight position on domestic cyclicals going into this reporting season.
With that being said, in spite of the challenges associated with a softening macro backdrop, there are still pockets of resilience where we see potential upside this reporting season.
We remain positive towards high quality infrastructure, real estate, and data centre owners, as well as telcos, healthcare, and lotteries; which should be relatively sheltered from broader market downgrades.
Our positioning within these sectors is focused on market leaders in attractive industry structures that benefit from highly predictable/acyclical customer demand profiles, recurring/contracted revenues, inflation-protected cash flows, and significant structural growth tailwinds.
Domestic Cyclical: Consumer Wave Wipeout
The retail sector in particular seem to be most at-risk during reporting season. The key macro factors driving our caution include:
- The impact of interest rates on consumer spending often work with a lag, and now appear to be hitting households.
- Consumers continue to recalibrate spending back to services after a surge in good spending during COVID.
- Large-cap retailers have, until recently, sidestepped meaningful earnings downgrades. This might start to change during reporting season.
What we are looking for?
- Evidence of a softening consumer leading to weaker-than-expected sales and margin erosion instigated by heightened discounting could be the catalyst for substantial downgrades.
- Inventory levels also warrant close attention. High inventories might signal further discounting over the next 6-12 months, potentially squeezing margins further and exacerbating analyst downgrades.
- Trading updates will be a significant focus for the market. We anticipate soft updates for July and August.
What could support the sector?
- Current valuations factor in some of this anticipated softening. However, sector-wide downgrades should be a significant headwind for sector performance.
- There is a risk the market might opt to look through poor results. As a Goldilocks scenario of steady growth with falling inflation and interest rates over the next 12 months becomes more conceivable, investors may remain optimistic rather than focus on any near-term weakness.
Global Earners: Upside Surprise?
Stocks exposed to the US and China’s economy seem to be at less risk this reporting season relative to domestic cyclicals.
US exposed company guidance may be more upbeat than expected. Recent macro data in the US has ignited hopes of a soft landing and suggests that the US Federal Reserve may pause raising rates as inflation is off its highs.
US economic growth data has surprised the consensus to the upside so far this year, continuing to expand at around trend pace and defying widespread predictions for a mid-year slump into recession.
A key stock for the portfolio with US exposure is James Hardie (JHX). It is crucial for JHX to meet guidance, having surprised the market in the previous quarter. Another successful performance could indicate the end of its downgrade cycle as the US macro has bottomed. We seek positive forward guidance from JHX, signaling a more promising FY24 outlook.
China reopening may still provide (unexpected) earnings tailwinds. While the reopening has not gone to plan, stocks like IDP Education (IEL) should see an incrementally better earnings outlook than last year.
We think post lockdown reopening will be bumpy (like it was for many countries in the world), but we do think that the Chinese economy/consumer could be a key driver of earnings for stocks like IEL.
IDP Education should have benefitted from China's reopening as students consider international options again. We expect this reporting season to provide evidence of a rise in enrollments driving earnings upgrades. Positive outlook statements are also anticipated, reflecting confidence in international students returning to the market.
Travel Rally Over or Still Flying
We have seen a positive update from Flight Centre (FLT) last week. FLT upgraded its FY23 EBITDA guidance by +7% at the mid-point to $295-305m. Management said it expects leisure travellers to continue to prioritise holidays and experiences over other areas of discretionary spending.
In terms of earnings, we expect another strong reporting period for travel-exposed companies. However, management outlooks will be key in supporting the rally as investors weigh up the longevity of favourable operating conditions against mounting cost of living pressures and a softening consumer backdrop.
We are cautious that the market may start to ‘look through’ / discount the near-term fundamentals for companies that are on the brink of ‘over-earning’, and instead capitalise on longer-term sustainable earnings capacity.
We exited from our position in Qantas (QAN) at the start of June on the view that the airline’s earnings upgrade cycle was drawing to a close and given a looming $12bn CAPEX bill over FY24-FY28.
Banks: Competition Cooling or Still Simmering
Commonwealth Banks’s (CBA) report in August will give us a barometer of the performance of the other big 4 banks. The competition for home loans and deposits has been notably intense. However, there are indications that this competition may be starting to cool.
A sustained period of heightened competition for loans and deposits has put downward pressure on NIMs. We expect consensus to be too optimistic on NIMs, with competition still intense enough to be a headwind.
With such uncertainty in the micro and the macro, we are still cautious the banks going into this reporting season.
We still believe CBA is priced for perfection. With a lofty valuation, any negative aspect of the result could be detrimental to CBA in its result on 9 August. CBA still sits on an elevated premium compared to the other big 4 banks. Outside of March 2020, the disparity between the price to book of CBA vs the other big 4 has never been larger.
We have preference to the other big 4 banks (NAB, Westpac (WBC), ANZ) on valuation grounds.
Preference for Earnings Resilience
In the face of cyclical weakness, we think exposure to resilient stocks/sectors is imperative going into this reporting season.
Our resilient stocks
We expect resilient results from companies with:
- Predictable customer demand
- Recurring or contracted revenues
- Inflation-pass throughs or pricing power
- Significant structural growth drivers
Focus Portfolio holdings that fit the bill include:
APA Group (APA)
As an owner of monopoly pipeline assets with ~90% of contracts being take-or-pay/regulated in nature with CPI indexation, there is relatively limited earnings risk for APA this reporting season. We are looking for more colour on the medium-term growth outlook, which we expect will be driven by incremental demand for pipeline infrastructure in the tight East Coast (i.e. East Coast Grid Expansion) and West Coast gas markets (i.e. Northern Goldfields Interconnect), as well as an extensive pipeline of electricity transmission projects where APA is shortlisted.
Healthco Healthcare and Wellness REIT (HCW)
After reaffirming its FY23 FFO and DPU guidance of 8.0c and 6.9c respectively in June, we are confident HCW will meet, if not beat, its full year guidance this reporting season. The A-REIT offers a high degree of earnings visibility supported by the acyclical demand for healthcare/social infrastructure assets, its long-dated leases (WALE of 16 years), very high occupancy levels, tenant cost pass throughs, and majority CPI-linked leases. We will be looking for further colour on the delivery of HCW’s ~$1.0bn accretive development pipeline, which will be a key medium-term driver of its earnings and distributions. The balance sheet will also be a point of investor focus and we will be looking for updates on the progress of its $75m in planned asset sales, and the extent of portfolio revaluations (to reflect higher capitalisation rates) to gain comfort in HCW’s look-through gearing.
NextDC (NXT)
The data centre owner has met or beaten its guidance at every yearly report over the past 7 financial years, and we expect its FY23 update to be no different given NXT benefits from a high degree of medium-term earnings visibility from its recurring, long-term contract structure. Recent customer wins have exceeded expectations demonstrating to the market that investment in its assets has been grounded in genuine visibility into future demand by its world-leading, global technology clients. In April, NXT reported that its Contracted Utilisation had increased +43% from 84MWs in 1H23 to 120MWs, with its S3 asset in Sydney being the main beneficiary. In the FY23 result we will be looking for continued momentum in new customer wins – particularly in its M3 asset in Melbourne, where we see the most possible near-term upside (from a Contracted Utilisation perspective).
ResMed (RMD)
Currently operating as an effective monopoly player in the global CPAP market with #2 global player Philips sidelined due to a product recall, we expect RMD to report a strong set of numbers reflecting market share gains as it fulfils previously unsatisfied CPAP demand (noting AS10 device supply is now unconstrained). While short-term gross margin impacts from mix (i.e. market share gains in the lower margin US market) and elevated component costs (associated with ‘paying up’ for supply security) may linger in this report, we encourage investors not to miss the wood for the trees - with RMD positioned to permanently strengthen its #1 global market position.
The Lottery Corporation (TLC)
Despite being classified as a discretionary expenditure item, lottery sales have historically been highly resilient through past economic cycles, albeit with the potential for some short-term variability based on the luck of the ‘jackpot cycle’ which has been the case in FY23. We are comfortable heading into the FY23 result, and more importantly into FY24, with TLC being well-placed compared to most other consumer-facing companies. We see potential earnings upside at the FY23 result from growth in digital penetration (which is 3x higher margin) and increases to ticket prices (i.e. Powerball prices increased in May 2023).
Telstra (TLS)
The domestic mobile market is the most rational it has been in years, which is allowing TLS to raise its plan prices annually in line with CPI (without losing market share). We expect a degree of ‘tactic collusion’ to continue over the medium-term as Australian telcos return their focus to profitability amidst significant 5G investments. While ‘trade-down’ impacts are possible, mobile connectivity is largely non-discretionary which should see demand hold up well in a consumer slowdown, while returning migration presents an offsetting tailwind to net adds. Plus, we note infrastructure assets underpin ~25% of TLS’s earnings, providing annuity-like contracted cash flows with explicit CPI indexation. All in all, the attractive mobile backdrop, combined with TLS’s ongoing T25 cost out program, and the defensive nature of its infrastructure-based earnings makes us confident heading into the FY23 result. We will be looking for further colour from management on the proposed InfraCo Fixed monetisation which we see as a key catalyst over the medium-term.
| Company Name | Ticker | Sector | Report type | Estimated report date |
12mth fwd PE | 3 month total return | 3 month EPS revisions (12 mth fwd) |
| Industrials | |||||||
| Macquarie Group | MQG | Financials | AGM - Q1 Update | 27/7/2023 | 15.6 | 2% | 0% |
| Pinnacle Investment Management | PNI | Financials | Full year | 2/8/2023 | 24.0 | 27% | 3% |
| Resmed | RMD | Healthcare | Full year | 3/8/2033 | 29.2 | -3% | 3% |
| James Hardie Industries | JHX | Materials | Quarterly | 8/8/2023 | 21.6 | 20% | 7% |
| CSL | CSL | Healthcare | Full year | 15/8/2023 | 28.3 | -11% | -4% |
| Healthco Healthcare and Wellness REIT | HCW | Real Estate | Full year | 15/8/2023 | 17.8 | 8% | 3% |
| National Australia Bank | NAB | Financials | Q3 Trading Update | 15/8/2023 | 12.4 | 0% | -9% |
| Netwealth Group | NWL | Financials | Full year | 16/8/2023 | 40.9 | 11% | 6% |
| Telix Pharmaceuticals | TLX | Healthcare | Half year | 16/8/2023 | 40.8 | 4% | 98% |
| Telstra Group | TLS | Communication Services | Full year | 17/8/2023 | 23.5 | -1% | 1% |
| ANZ Group | ANZ | Financials | Q3 Trading Update | 17/8/2023 | 11.0 | 7% | -4% |
| Goodman Group | GMG | Real Estate | Full year | 17/8/2023 | 19.9 | 8% | 2% |
| Insurance Australia Group | IAG | Financials | Full year | 21/8/2023 | 16.0 | 18% | 9% |
| Westpac Banking Corporation | WBC | Financials | Q3 Trading Update | 21/8/2023 | 11.2 | 2% | -7% |
| Lottery Corporation | TLC | Consumer Discretionary | Full year | 23/8/2023 | 27.5 | 2% | 4% |
| IDP Education | IEL | Consumer Discretionary | Full year | 23/8/2023 | 34.3 | -19% | -4% |
| Worley | WOR | Industrials | Full year | 23/8/2023 | 22.3 | 9% | 6% |
| APA Group | APA | Utilities | Full year | 23/8/2023 | 30.0 | -4% | 1% |
| Cleanaway Waste Management | CWY | Industrials | Full year | 24/8/2023 | 30.4 | 10% | 4% |
| NextDC | NXT | Information Technology | Full year | 27/8/2023 | na | 11% | 4% |
| Resources | |||||||
| Lynas Rare Earths | LYC | Materials | Full year | 31/7/2023 | 17.2 | -2% | 21% |
| Evolution Mining | EVN | Materials | Full year | 16/8/2023 | 12.8 | 3% | 10% |
| Allkem | AKE | Materials | Full year | 18/8/2023 | 10.6 | 36% | 3% |
| BHP Group | BHP | Materials | Full year | 21/8/2023 | 11.7 | 0% | -10% |
| Woodside Energy Group | WDS | Energy | Half year | 22/8/2023 | 13.2 | 8% | -12% |
| South32 | S32 | Materials | Full year | 24/8/2023 | 10.9 | -14% | -24% |
| Mineral Resources | MIN | Materials | Full year | 29/8/2023 | 11.0 | -11% | -42% |
Data as at 25/7/2023. Source: Refinitiv, Wilsons.
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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