Corporate Australia's COVID test results: infected or recovering?

Articles 3/09/2020
Corporate Australia's COVID test results: infected or recovering?

We have just experienced the Australian corporate sector's most telling reporting season in a decade. Few companies (about one third) were willing to provide profit guidance for the year. Those guiding for profit growth were even rarer. A few truly resilient businesses with a high degree of certainty in their outlooks, were able to provide a clear outlook for growth.

In the main, companies in Redwood's portfolios fared well reflecting the quality of those businesses. The broader market's average earnings were down about 20% over the last twelve months. Perhaps more disappointing is that earnings are currently expected to rebound by only 8% over the financial year ahead. Interestingly, companies with primarily domestically-focused businesses are still expected to deliver negative earnings growth over the year ahead. While Australia may be leading the pack in the health fight, from here greater earnings growth is expected to be generated offshore.

Commensurate with the reduction in earnings, dividends for the June half were similarly impacted with Macquarie Equities noting almost two thirds of their stock coverage either cut or suspended shareholder distributions. While many businesses noted improved trading conditions over July and August as restrictions eased, we expect dividends to remain under a degree of pressure as markets grapple with the uncertainty of a progressive reduction in stimulus while a vaccine remains a 'work in progress'.

Redwood's portfolios owned a number of businesses that guided to earnings growth including consumer product packager Amcor, pallet provider Brambles and blood product and flu vaccine manufacturer CSL. None of these businesses were beneficiaries of COVID-related stimulus and all three are globally-focussed.

A number of discretionary retailers (such as JB Hi-Fi, Kogan and Harvey Norman) reported strong numbers. With domestic consumers remaining technically employed and enjoying the cashflow boost of JobKeeper and early access to super it's understandable but we expect it unlikely to be sustainable.

Redwood portfolio beneficiaries from the strong domestic consumer included Wesfarmers (particularly Bunnings and Officeworks) driven by home office investments along with consumers having extra time at home to complete those long-overdue DIY projects. Automotive part wholesaler and retailer Bapcor and four-wheel drive accessory manufacturer ARB also saw a temporary spike in sales from the increased prevalence of local holidays, while overseas travel remains off the cards.  Management from all these companies delivered a consistent warning: this momentum will not last and is likely to taper as stimulus and restrictions are withdrawn. However, we remain positive on their respective longer-term outlooks.

Yet not all retailers (or businesses exposed to retailing) benefitted. Domestic shopping centres experienced devaluations in the range of 10 to 15% driven by lower rent collections.

In contrast office and industrial property owners such as Dexus continued collecting rent, largely unaffected by the pandemic. We continue to believe high quality property owners will be well positioned to offer attractive and flexible corporate environments and supply chain facilities for the accelerating penetration of e-commerce.

Residential property developers such as Stockland, benefitting from significant State and Federal government stimulus (refer below), have had buyers snapping up new developments almost as quickly as they can be released to market.

The major miners, buoyed by high iron ore prices, delivered strong results enabling them to further reduce debt to below-target levels, allowing for solid dividends to shareholders. While iron ore continues to trade at historically high levels, we remain wary of the potential for previously-disrupted Brazilian supply to return to the market over the coming year.

In general, our Australian equity portfolio saw a particularly welcome set of results. While we intend to retain exposure to this select group of resilient businesses, it remains appropriate to manage risk and weightings when opportunities arise. Furthermore, looking forward, we have a preference in allocating incremental capital into offshore equity markets. We expect the impact of Victoria's second lockdown may take the shine off near-term results while Australia's trade relationship with China continues to deteriorate affecting some major export industries.  Above all else, local equity valuations continue to trade at a marked premium to their offshore counterparts.

In this uncertain environment we remain cautious and are tactically underweight growth investments. Our portfolios hold high quality businesses whilst maintaining liquidity through strong cash positions. Should markets forge ahead we remain comfortable missing out on some of the upside in pursuit of protecting clients' capital.

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