Economic Update, Sept 2020 – Reporting Season Wrap

Overall the FY2020 reporting season was better than expected. The dire predictions in the early days of the pandemic proved too bearish.  That said it was the toughest reporting season in over a decade and for some companies in the sectors most impacted by the pandemic, the harshest in living memory.

Top line numbers were as follows –

• Full year earnings for the ASX 200 were down by 38% on 2019
• The proportion of ASX 200 companies actually producing a profit fell to 75% versus the long term average of 88%
• Of the 75% of companies reporting a profit, over half reported a fall in earnings year on year.
• Dividends were slashed and in some cases suspended as companies focussed on shoring up their balance sheets and preserving cash.
• 20% of companies cancelled their final dividend.
• Of the companies paying a dividend, 33% increased dividends, 17% were unchanged and 50% cut their dividend.
• In aggregate dividends fell by 38%.
• Energy was the worst performing sector with earnings per share (eps) down around 40% and dividends per share (dps) down by 45% followed by financials with eps down 27% and dps by over 30% and Industrials with eps and dps both down by around 25%.
• The best performing sector was Healthcare with eps growth of about 16% and dps growth of around 6%, followed by Metal and Mining with eps growth above 10% although dps fell after the very strong payout ratios and dividend yeilds from BHP and Rio in FY2019. Aside from Healthcare the only other sectors to deliver positive dividend per share growth were Consumer Staples and Information Technology up about 9% and 5% respectively
• Very few companies provided guidance citing the very uncertain economic outlook.

One  key observation was the divergence in performance across sectors and industries due specifically to the impact of COVID-19. Stay-at-home stocks in the discretionary and staple retail sectors and related e-commerce have outperformed along with resources, particularly iron ore and gold, and healthcare in the COVID environment. Sectors and stocks most impacted by the lock down include travel and tourism, energy and shopping centre REITS.

There are a number of reasons why overall the reporting season was better than expected albeit off somewhat low expectations.  Firstly there is the  massive government stimulus programs which in relative terms have been larger than most other economies.  This along with early withdrawals from superannuation have kept consumers spending.  With consumers quarantined and working from home and unable to spend on entertainment and recreation this had a positive impact on the consumer staples and consumer discretionary sectors of our market.  At the stock level key beneficiaries included JB Hifi, Wesfarmers (Bunnings and Officeworks), Coles and Woolworths and Harvery Norman. The shut down also accelerated the shift to online shopping benefitting a new breed of online only retailers such as Kogan and Temple and Webster (furniture).  

The second reason for the better than anticipated reported season was the continued strength of the resources sector. While not unexpected, China has reached for the same Global Financial Crisis play book of infrastructure and related steel intensive government stimulus in response to the coronavirus induced global recession.  This has driven iron ore deamnd and prices higher and underpinned the very strong cash flows and profits of our  major miners BHP, RIO and Fortescue.  The Gold sector also performed well buoyed by its safe haven status, rising uncertainty and very low interest rates.

Another positive for our market was the performance of our health sector. As noted earlier it was the only sector to deliver both positive earnings per share and dividends per share growth.  The Health sector now accounts for 7% of our market and continues to offer excellent growth and defensive characteristics.  Standouts included respiratory device manufacturers ResMed and Fisher and Paykel Healthcare, both direct beneficiaries of the pandemic. CSL, Sonic and Ramsay Health Care also exceeded analyst expectations.  CSL and RMD are portfolio stocks. Both companies reported very strong results for the year to June. CSL was one of very few companies to provide positive guidance for 2021.  RMD guided to softer growth in 2021 after an overtrend 2020 and we have taken some profit from RMD and added to CSL. Both remain high conviction stocks in the portfolio.

Another factor contributing to the better performance of the ASX 200/big business  was the relative impact of the pandemic on big business versus small and medium sized businesses (SME’s). The sectors hardest hit by the shut down include cafes and retaurants, hotels and clubs, accommodation, the arts, entertainment and travel and tourism operators. These sectors and industries are dominated by SMEs. With the exception of travel and travel related stocks such as Sydney and Auckland Airport, Flight Centre, Corporate Travel and Webjet these major industry sectors are not well represented in the listed market.

The banking sector remains under pressure.  CBA is the only one of the big four banks with a June year end date but the other major banks released quarterly updates. Still recovering from the fall out from the Royal Commission the banks are now faced with rising provisions and bad debts due to a deteriorating property market (particularly apartments) mortgage and business loan deferrals and other customer support initiatives.  Dividends have been slashed. Net Interest Margins continue to fall. As we have noted in previous updates, we believe the challenges facing the banks are structural not cyclical and that the big four retail banks will continue to decline as a share of our market.  Faster and more nimble fintechs continue to emerge attacking key banking revenue streams across mortgages, payments and credit cards.

This reporting season has also been a wake-up call to many businesses across all sectors who have not responded fast enough to the changing modus operandi of the digital age. The shutdown has accelerated the structural shifts already underway in the economy driven by digitisation enabling and accelerating major changes in how and when we shop, work, entertain and access a broad range of goods and services. The direct beneficiary is the Information Technology sector but the impact of cloud computing, work-based collaboration tools, Software as a Service etc is ubiquitous across many sectors and industries.  

Not surprisingly, the Information Technology sector both domestically and internationally continues to outperform. In the USA the technology index, the NASDAQ is now 18 percent above its March lows and in our view heading into bubble territory.  This is not to say we do not believe the above-mentioned trends have a long way to go, only that the price people are now prepared to pay for these future earnings looks stretched. Domestically we have seen the strong performance of digitally/e-commerce enabled traditional retailers such as JB Hi-Fi and Wesfarmers along with pure play online retailers such as Kogan.  The acceleration in e-commerce has seen short term finance providers emerge in a new form now known as the Buy Now Pay Later space (BNPL).  Australia has been a pioneer in this sector with five key players listed on our market alone including Afterpay, Zip Co, Sezzle, Splitit and Openpay with more entrants on the horizon.  We have chosen not to participate in the online retail or the BNPL space to date.  In the online retail space, most of the larger listed players are still domestically focussed and through our eyes any retailer and especially online retailers need to be global.  In the BNPL space apart from nonsensical valuations for the likes of players like Afterpay we again have reservations about the strength of the business model and the ability to develop sustainable competitive advantage in what is rapidly becoming a very crowded space. 

Our preference generally in any sector is for companies that have and are building competitive advantage on a global scale. In the March market sell down we initiated a position in Reece Ltd. Reece is Australia’s largest wholesaler/retailer of plumbing supplies and in 2018 made a major acquisition of plumbing supply chain Morsco in the USA. The company reported very well with sales of its US operations up 7% and well above market. Reece, we believe is also the industry leader in the digital transformation of its business.

Markets continue to hold up well despite the uncertainty around the severity of the coronavirus induced recession domestically and internationally.  The disconnect between the markets and the underlying economy and earnings remains a little too wide for comfort. That said, as I write the NASDAQ has fallen by 11 per cent over the last three trading sessions so this could be the start of a correction.  Should this flow through to our market we will use the opportunity to increase our exposure to several high-quality companies on our watch list in several sectors including; Information Technology, Health Care, Industrials and Resources.

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