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Reporting season - how are companies faring against economic headwinds?

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During July, 43 companies announced profit downgrades. So, what can we expect when the full reporting season gets underway?

August sees the beginning of Australia’s reporting season - often referred to as “confession season” - putting investors on their toes with an onslaught of earnings reports from publicly listed companies. During July, 43 companies announced profit downgrades far outweighing the 15 reporting upgrades of the ASX’s 200 publicly listed companies. So, what can we expect when the full reporting season gets underway?

Although recent commodity price buoyancy is expected to drive a better than expected result for the mining sector, on the flip side, consumer stocks are expected to suffer from subdued consumer spending as pressure mounts on household budgets. Overall, the earnings results are expected to provide a very good insight for investors and policy makers into the impact of the various economic headwinds on business conditions.

The start of the season for the ASX-200 has been slow and somewhat disappointing with six companies falling short of expectations and only one outperforming across the first three days of August. The first week of August saw 15 companies report earnings, including Rio Tinto, Crown Resorts, Suncorp and Tabcorp. Some of the emerging themes included increased pressure from the strong Australian dollar on companies with US dollar denominated revenue streams, weak consumer spending hurting retailers, rising electricity costs impacting not just households but also businesses’ bottom lines, and a continued focus on future cost reductions.

What’s happening in the resources sector

Low commodity prices through 2016 put pressure on the miners’ earnings, but a price rebound in late 2016 and early 2017 is expected to materialise into a profit rebound for some miners. However, this may not be enough to spur a new wave of investment in the sector, which has been decreasing over recent years following the height of the mining boom in 2011.

Rio Tinto (ASX: RIO) for example, announced strong earnings of $4.95 billion for the half year and, given the low interest rate environment, shareholders were pleased to hear they will be paid an all-time record interim dividend1. The dividend equates to just over A$1.37 per share and will be fully franked. Rio produces more iron ore than any other Australian miner, and while the rally in the price of iron ore provided a real benefit, it may similarly be to their detriment should it move the other way.

Through the mining boom of the 2000s, significant amounts of capital investment flooded the mining sector, leading supply to catch up with seemingly insatiable demand. Although we have seen commodity prices strengthen in recent times, we believe this may be unsustainable in the medium- to long-term despite sustained demand from countries like China. As supply continues to come online and competing technologies – renewable sources of energy, for example – become more affordable and available, commodity prices could face increased pressure, squeezing resource companies’ margins.

In our view, the long-term equilibrium pricing for many commodities may be below their current levels.

More broadly in Australia

Although this reporting season is set to be more positive than the last, our short- to medium-term outlook for Australian equities remains cautious. Valuations remain strongly influenced by sentiment abroad, particularly China, and overall, the Australian economy remains susceptible to external shocks.

In its monthly meeting, the Reserve Bank of Australia kept interest rates on hold for the 11th straight month– still not seeing room to move. They cited confidence in our economic recovery, though the resurgent Australian dollar, high housing prices, and China’s economic policies were noted as potential headwinds for our economy. These remain concerns we consider when investing, and give reason for our continued caution on domestic equities.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct. Past performance is not a reliable indicator of future performance.

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Reporting season - how are companies faring against economic headwinds?
madison kennedy  x
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