Reporting Season: what to expect

01 February 2024
By Derek Bilney

Too hard, too soon: have markets got ahead of themselves?

As another reporting season kicks off in February, Portfolio Manager Derek Bilney shares six key themes to watch, which will be critical in determining if markets have run too hard, too soon and got ahead of themselves.

• Markets re-rated strongly in late 2023 driving valuations to elevated levels leaving them susceptible to any earnings weakness.
• Profit results likely to be mildly disappointing vs current consensus, but we expect the market will be focused on any outlook commentary provided.
• Key themes to watch this reporting season: leverage and interest costs; labour costs; property revaluations; consumer spending; mortgage stress / credit quality and resilience of dividends.
• Despite the risk of some short term volatility, Australian equity markets are still expected to deliver moderate returns in 2024.

Equity markets were up strongly in the final months of 2023 as bond yields tumbled. The release of the US Federal Reserve “dot plot” forecasting multiple interest rate cuts in 2024 was the key driver, as well as generally defensive positioning by investors.

This was the perfect excuse for a so-called ‘Santa rally’. However, share price gains were not matched by a change in earnings expectations, leaving valuation multiples somewhat elevated relative to history, as shown in Figure 1.

Figure 1: S&P/ASX300 - Forward 12mth Price/Earnings Ratio

Source: Factset.

After a strong post-COVID rebound in earnings, driven by banks and resource companies, earnings expectations have generally trended downwards on fears of a slowing economy (refer Figure 2). Buoyant population growth, robust domestic employment, and strong financial buffers, have buttressed corporate earnings to this point; however, these supporting factors are beginning to wane.

Figure 2: Earnings consensus earnings estimates – gently trending downwards

Source: Factset.

Although earnings expectations are moderate, there is a risk that results will still mildly disappoint. However, as always, the key will be the earnings outlook statement and the extent to which companies are finally seeing the impact of tightening financial conditions and higher costs on earnings.

A disappointing reporting season may see some short-term pullback in share prices, but overall, we believe that the Australian equity market should deliver moderate positive returns in 2024.

Reporting Season February 2024: key themes to watch

We expect the following themes to emerge from reporting season:

1. Leverage: Interest costs and gearing levels

Interest costs surprised on the upside at the August 2023 reporting season with a lack of transparency on the specifics of corporate debt (hedging levels, mix of fixed/variable rate debt, tenor of debt) leaving analysts somewhat in the dark. There should be less surprise this time around. Companies with higher debt burdens will also be monitored to assess if equity raisings are required. In our view, companies benefitting from higher interest rates should report solid results.

Examples of some companies which might be impacted by these themes include REITs, Dominos Pizza (DMP), Ramsay Healthcare (RHC), Insurers, Funds Management Platforms (HUB24 (HUB), Netwealth (NWL), Computershare (CPU)).

2. Labour costs and availability

The lagged impact of rising wages will impact those companies with a higher proportion of wage expenses – typically service-based companies. Higher award-based salaries and re-negotiated enterprise bargaining agreements (EBAs) may potentially drive higher wage bills and lower margins. Labour shortages in WA may again impact mining services and resources companies.

Examples of some companies which might be impacted by these themes include Downer EDI (DOW), Worley (WOR), Collins Foods (CKF), Flight Centre (FLT), Qantas (QAN), mining services, resources, service-based companies.

3. Property valuations

REITs outperformed in the final months of 2023 on the back of falling bond yields. However, many REITs continue to trade at a significant discount to book value, highlighting market concerns on valuations due to a lack of asset trades. Office property remains in focus as the working from home thematic endures, albeit with increasing pressure from employers to ‘encourage’ employees back into offices more regularly.

Examples of some companies which might be impacted by these themes include Dexus (DXS), LendLease (LLC), Charter Hall Group (CHC), Centuria Office (COF).

4. Consumer spending

Results from the retail, travel and leisure segments will provide insights into the state of household spending. With unemployment levels remaining low and house prices buoyant, it is expected that results will remain robust, albeit the focus will be on the outlook statement and any comments on current trading activity. Will Australians come back from their summer holidays and tighten the purse strings?

Examples of some companies which might be impacted by these themes include JB Hi-Fi (JBH), Wesfarmers (WES), Qantas (QAN), Flight Centre (FLT), Harvey Norman (HVN), Eagers Automotive (APE), Nick Scali (NCK).

5. Mortgage stress and credit quality

Commonwealth Bank is the only major bank to release half year results (the other majors will provide quarterly updates). The market will be closely monitoring for any signs of credit stress in lending books (mortgages, credit cards, business loans). With employment remaining robust, expectations are that bad debts will remain at low levels.

Examples of some companies which might be impacted by these themes include Commonwealth Bank (CBA), Helia (HLI), Judo Capital (JDO), AGL, emerging fintechs.

6. Dividends

With profits expected to broadly hold up, dividend payouts should also be robust. Special dividends are less likely in the absence of windfall gains. Iron ore prices have been higher than most expected which has the potential to lead to healthy dividends from the big miners, albeit not at levels seen for 2-3 years when iron ore prices hit USD $220.

Examples of some companies which might be impacted by these themes include BHP (BHP), Rio Tinto (RIO), Commonwealth Bank (CBA), Telstra (TLS), insurers.

Investment implications

Higher interest rates operate with a lag to slow economic demand. Markets understand this but have generally been surprised at the resilience of corporate profitability to this point. The upcoming reporting season should see this resilience broadly continue, although it is expected to get increasingly tougher as 2024 progresses.

Reporting Season tends to be a period when the market re-focuses on companies with solid investment fundamentals including good quality earnings, cashflow generation, reasonable valuations and positive earnings sentiment.

Our investment process strives to identify companies with these characteristics in the context of a diversified portfolio of investment exposures.