In this video, Dan Moradi, Portfolio Manager for Listed Products, provides an update on the Australian equity market following a very interesting reporting season and takes an in-depth look at how various sectors and companies performed.
The February reporting season results were better than initially expected, particularly if we look at the middle of last year when earnings expectations were experiencing significant downgrades in the midst of the COVID-19 related lockdowns. Since then, the downturn has not been as severe as expected, and we’ve seen estimates for FY21 being upgraded, indicating relatively strong balance sheets across the market and to some extent, improved confidence of corporate boards in setting up payout dividend ratios.
Overall, we seem to be turning a corner with the majority of the companies expected to return to growth over FY21 and 22. Although despite these earnings rebound, some companies aren’t out of the woods yet.
I hope everyone is safe and well. Today I’ll be providing an update on the Australian equity markets following a very interesting profit reporting season, which was much better than initial expectations, particularly if we look at the middle of last year when earnings expectations were experiencing significant downgrades in the midst of the COVID related lockdowns around the globe. Obviously, since then the downturn has not been as severe as expected, and we’ve seen estimates for FY21 getting upgraded, particularly over the latter part of 2020 and heading into the reporting season this year. At the market level, overall EPS for 2021 grew by around 5% over the month of the upgrades while the dividend expectations grew by around 10%. However, despite the upgrades, market gains during the month were modest as the positive conditions were most likely priced into the lead-up of the reporting season. At the sector level, this was really driven by upgrades within the financials and resources sectors, while the technology and industrials saw the largest EPS downgrades. Aside from the more upbeat outlook statements dividends surprised to the upside, indicating relatively strong balance sheets across the market and to some extent, improving the confidence of boards in setting up their dividend payout ratios. Once again, this was driven by the banks and resources which saw dividend expectations upgraded by 12% to 15%, obviously driven by high commodity prices within the resources and the removal of the restrictions on banks. At the stock level, within the ASX200 universe we had the likes of James Hardie, Seek, Cochlear, and Commonwealth Bank reports stronger than expected performances, whilst Challenger, Ampol, Center Group, and Appen delivered relatively weaker results.
In terms of the themes that we saw, unsurprisingly COVID-19 and its impact on the corporate sector as a whole was the main discussion point again during the reporting season. However, there was a much more improved tone in the company’s communications to the market in comparison to what we saw in August last year. In absolute terms, the pandemic has had and continues to have a material impact both positive and negative on various segments of the market, the extent to which still remains unclear. Companies within the retail, e-commerce, technology, and metals and mining sectors have benefited greatly from the shifting consumer behavior experienced over the past year. While obviously the supply chain disruptions and the potential inflationary impacts of the pandemic have been a positive tailwind for commodities and the metals and mining sector as a whole. On the other side of the spectrum, the tourism, infrastructure, retail landlords, insurance, bank, and the energy sectors took the brunt of the earnings in FY20. But all seem to be turning the corner with the majority of the companies expected to return to growth over FY21 and FY22. But despite these earnings rebound, some of these companies are not really out of the woods yet. And it may take a few years for conditions to normalise. And this is likely to be reflected in a high degree of ongoing volatility for these companies.
Some of the other key themes that we saw during the reporting season was the ongoing impact of COVID-19 on supply chains, which as an example is impacting inventories in a number of sectors and this is likely to have an inflationary impact on these companies and sectors until these issues are resolved. We’ve also seen a significant move in bond yields. So with the 10-year bond yields almost doubling since December. Whilst this doesn’t have an immediate impact on company earnings, the market is really reassessing the sustainability of rising bond yields and its impact on the valuation of the high-duration growth companies like technology and healthcare businesses and also the lower Beta defensive companies in infrastructure and staple sectors. This concern has been a major driver of the underperformance of these sectors since December last year and probably going to continue in the short term.
Lastly, the strength of the companies in the resources sector was another theme evident during the reporting season. The strengthened commodity prices and the very strong balance sheet in the sector. So the likes of BHP, Rio, Tinto, and Fortescue all beat dividend expectations. This trend does look like it can continue over the short term, obviously subject to the underlying commodity price movements, but we do see upside risk to earnings within the resources segment with the attractive yields on offer, probably set to continue over 2021.
Looking ahead, at this stage consensus estimates are expecting a 33% rebound in earnings in FY21 as a whole, and this has improved from around 10% after the August reporting season last year. Now if this was to eventuate this means that the market earnings have gone back to pre COVID levels, which is a remarkable development and one of the sharpest earnings recoveries in history. From a dividend perspective, the pace of the recovery has improved, but expectations so far in play will take a slightly longer period to return to pre-COVID levels. But I think there is an upside risk to that scenario, particularly if the worst of COVID is already behind this and commodity prices remain strong. So this does imply that from a valuation perspective, the market is currently trading at a PE ratio of around 18 times with a dividend yield of 3.8%. And I’d say both would be expected to improve in 2022. In terms of what’s in store for the rest of the year, obviously, the path of the pandemic will play a large part in the outcome, but the momentum has definitely turned positive. On the earnings front, consumer confidence remains solid. The tapering of the government stimulus at the end of March this year will provide further insight into the shape of the recovery. And the RBA stance on being on hold until 2024 is still a very positive tailwind for risk assets. In terms of risks, this is a very uneven recession and recovery and over a very short period of time, the after-effects of such could result in some unintended consequences which can potentially result in periods of elevated volatility potentially over the remainder of the year. Thank you
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