With a period of volatility in global markets over August, it was timely for Australian-listed companies to report their financial results to 30 June. This brought a welcome focus to underlying fundamentals, with our domestic equity investments delivering a broadly solid set of results while affording us a great opportunity to assess the medium to longer-term prospects, which we continue to believe are sound.
More broadly, while operating through tough conditions Australian companies still made profits. While there were slightly more profit misses than hits, expectations leading in meant the reactions were more balanced with reporting day price movements of companies seeing the number of 'ups' match the 'downs'.
Heading into August, result expectations were quite subdued with Earnings Per Share (EPS) growth for the broader S&P/ASX 200 expected to be only 2% for the completed 2019 financial year. However, more importantly (and in stark contrast to the somewhat difficult macro environment) market expectations were for an optimistic 10% growth in EPS for the coming 2020 financial year.
Consequently, investor focus was clearly going to centre on management commentary and guidance. The resulting tone from management was unambiguously cautious with many navigating tough operating environments characterised by:
- A softening housing construction market, notwithstanding a recent recovery in prices for existing homes on the east coast
- Weakening global trade activity and commensurately subdued business confidence
- Continuing regulatory scrutiny, particularly for the domestic banking sector; and
- Poor domestic consumer confidence
Record high share market prices and relatively soft earnings growth expectations meant the market was comfortable with higher valuations (refer to the chart below), as long as earnings were delivered.
Companies that disappointed the market saw their share prices punished - just ask fruit and vegetable grower Costa Group and poultry processor Ingham's, who were down 16% and 17% respectively on the days of announcing their results! In addition, the market had held overly pessimistic expectations for some companies held in Redwood portfolios. However, upon delivery of their results many saw solid rebounds, such as auto parts supplier Bapcor (+7% on the day) and plumbing products manufacturer Reliance Worldwide (+16% over the 3 days following its result). This contributed to some of the volatility through the month.
As we foreshadowed six months ago, housing construction data was pointing towards a softer environment for FY2020. However, following the Coalition's Federal election victory and two RBA rate cuts (with potentially more to come), the outlook for FY2021 and beyond is appearing better. Stockland, who was down 7% on the day of its result but finished 5% above its pre-result level by month's end, reported a result indicative of this view: while profit growth will be negligible in 2020, the seeds have been sown for an improved result in the following year. In addition, Wesfarmers-owned Bunnings continued to illustrate why it is one of Australia's best retail businesses, recording both revenue and profit growth despite the softer housing conditions.
In the context of softer global activity, defensive business models again came to the fore:
- Leading global blood plasma fractionator CSL (+10% since its result) delivered another result ahead of guidance with its outlook for FY2020 appearing conservative. With competitors remaining capacity constrained, we expect the company to continue taking share in the market for these life-saving products;
- Global pathology operator Sonic Healthcare (+6% since its result) again demonstrated the benefits of having a well-diversified portfolio of businesses across Australia, the US, Germany and the UK as well as the further opportunities from acquisitions, increased screening for chronic illnesses and future contracts;
- National logistics, storage operator and stevedore Qube Holdings (+5% since its result) highlighted the strength of its assets, delivering earnings growth despite an east coast drought (weaker grain volumes), lower new car sales (weaker car imports) and more subdued trade activity. More importantly, management confirmed the first freight train is due imminently at its newly-developed "inland port" at Moorebank in western Sydney. This an asset of national importance to the operation of Australia's import/export supply chain.
Reporting season also provides us opportunities to reassess those companies on our watchlist to review how they are progressing and whether we are happy to start building an exposure. One example is Worley: a global diversified industrials business that provides expertise in engineering, procurement and construction through a range of consulting and advisory services to the oil & gas, mining, chemicals and infrastructure sectors. The Worley business was transformed with the recent acquisition of Jacobs Engineering Group that diversified the company's revenue streams away from just oil and gas and towards more defensive services. In time, we believe the market will recognise this and the recent result confirmed the integration was tracking in line with expectation.
Given the prevailing valuations in the market and a number of macro uncertainties on the near-term horizon, we continue to take a defensive stance to portfolio management. We remain comfortable holding underweight allocations to growth assets and are managing our cash and fixed income holdings with the priority of protecting capital. While we recognise this may impact near-term returns, we feel it far more prudent to ensure we're well positioned heading into any further step-up in volatility.