Once again, during August, the Redwood investment team rose daily for a constant diet of early-morning conference calls with many of our country's senior management teams. Reporting season was upon us once more. The month remains an important part of the Investment Committee's calendar, as it allows us to conduct an important health check over the stocks that make up a considerable portion of our clients' portfolios.
Many will recall 12 months ago our comments around elevated equity valuations. At that time, we advocated realising some profits and holding slightly higher levels of cash, while not losing sight of our longer-term objectives. While share price performance over the last 12 months may appear somewhat lacklustre, the underlying earnings for many of these companies continues to grow in line with our expectations. Total shareholder returns over the last 12 months reflect this higher starting point.
The August 2017 reporting season highlighted the following key themes:
- Revenue growth remains limited (outside the major resource companies, which are benefiting from elevated commodity prices), owing to Australia's below-average economic growth, company-specific items and currency headwinds;
- Cost reduction programs have largely run their course, following two to three years of stringent focus on expenses. Furthermore, materially higher electricity prices on the east coast were consistently nominated as a headwind for this year's (2018 financial year) profits;
- Innovation is on everyone's mind in a world of potential technology-led disruption. A consistent example was the threat of Amazon/online in both investor and company management psyche, particularly for retailers and shopping centre landlords;
- A number of businesses continue to assess avenues to strategically 'trim down', as they look to focus on their core strengths and improve returns. BHP finally announced its long-overdue intention to exit its disastrous foray into US shale oil/gas assets, while Brambles is looking for a buyer for its low-returning pallet recycling division;
- Businesses which delivered results above expectations were typically those not influenced by economic activity;
- Companies which missed expectations saw their share prices punished; and
- While the elevated Australian dollar was a headwind for many companies this year, over the medium to longer-term, a lower dollar will conversely be a significant benefit.
At a high level, domestic earnings trends remain less convincing than those prevailing globally. Earnings growth for the 2017 financial year was an impressive 17%, however, removing commodity price-boosted resource companies, the rest of the market generated less-impressive 6% growth. Further, management guidance for the 2018 financial year implies a similarly modest profit growth forecast of 5% (excluding resources). While still growing, higher earnings growth may be required to justify valuations, in some stocks.
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