Harbour commentary: Few surprises in Earnings Season

Reporting season results have been in line with expectations in Australia and New Zealand, boosting both share markets, but resource companies are starting to suffer from falling prices.

Friday, September 14th 2012, 2:22PM

by Harbour Asset Management

• Global markets continued their momentum in August with key global indices finishing in positive territory despite numerous headwinds throughout the month. Global equities rose by 2.5% in US dollar terms in the month. The New Zealand equity market posted another solid month with a balanced result season finishing the month up 3.4%, once again leading most developed markets.
• In August we saw the reversal of the recent outperformance of the more defensive stocks. Telecom for instance had a result which was in line with expectations however the outlook from the company disappointed the market. In contrast results or AGM updates from the likes of Air NZ, Nuplex, Fisher and Paykel Appliances and Healthcare generally provided more upbeat tones.
• The reporting season was largely in line with market expectations. The relatively positive results supported the performance of the local market, partially a case of the worst case outcomes not being realised.
• Economic data in Australia continued to be mixed. Employment improved and retail sales were better than market expectations, positively impacted by the recent one off government handouts for carbon and children educational payments.
• One of the bigger moves in the month was iron ore prices which fell 24% contributing to the underperformance of the Australian resource sector. Softer PMI data in China, falling steel prices triggering cuts in production all contributed to the weaker prices.
• The Australian equity market rose 1.1% in New Zealand dollars – led by healthcare, IT and consumer staples, while resources lagged.

Reporting Season Delivers a Cautious Outlook
Australia's reporting season delivered results close to expectations, providing a cautious outlook particularly from the resource sector. The fact that actual earnings for both industrials and banks were in line provided a relief rally in many stocks.
The NZ reporting season was also broadly in line with market expectations. Of the 27 companies that reported 15 were in line, while 6 were above and 6 were below analyst forecasts . Outlook comments were cautiously optimistic with signs of domestic NZ improving with remarks from transport companies that volumes have been reasonable and improving. The Canterbury rebuild has been slow and companies with direct exposure have had a difficult time over the last 12 months, however there are signs that the rebuild work levels are increasing.
Firms have had and continue to have a strong focus on cost control and are also benefitting from the current low interest rate settings. The two largest stocks Fletcher Building and Telecom have both signalled areas of cost improvement following the appointment of new CEOs.
In both markets there continues however to be broad base adjustments to FY13 earnings growth with estimates lowered to approximately 6% growth from 14% forecast at the beginning of the year. Downgrades in Australia continue to be driven by the resources, materials and consumer discretionary. Earnings growth forecasts have been re-set to more reasonable levels, and more consistent with top down growth forecasts.
A key theme in both markets was the trend towards the payment of higher dividends. In New Zealand Freightways, Sky City, Fletcher Building, Sky TV, plus several others reported dividends higher than market expectations. In Australia there were also several examples including Lend Lease, IAG and Resmed. This may be a continuing theme with corporate balance sheets generally remaining conservative, earnings momentum stabilising and payout ratios being at sustainable levels.
In terms of specific company results, quality stocks that delivered were well rewarded in the results season. CSL delivered a solid result at the higher end of market expectations and guided to FY13 growth of 12%. Additionally the company announced a $900m buyback of shares which was taken positively by the market. Seek, Lend Lease and Wesfarmers also provided solid earnings results.
The Telecom result highlighted some of the key concerns we had about the company for some time. As we discussed in our recent Harbour Navigator , our investment process for our equity growth funds focuses on the potential of companies to grow profits and invest to expand valuation through time. For the last few months we have had the view that Telecom was being priced on current yield and that the stock had become relatively expensive.
Our investment thesis has been that Telecom faces significant industry challenges to maintain both profit and dividend payouts. The result was fairly much in-line with market expectations however the market reacted very negatively to commentary regarding the competitive Telco market place, pricing pressures and the likelihood that future profits may be lower than those of today.
Whilst we rate the Telecom management and the new CEO, the share price volatility in the month serve to remind investors that the Telco industry in New Zealand faces significant challenges from both device manufacturers like Apple and Samsung and new industry players who will offer competitive mobile and broadband plans.

Outlook
With the recent rally in markets and risk assets outperforming, expectations by the market for policy action by central banks has risen. September will be a key month for markets with various European events around Greece, ECB governing council, and decisions to be made around the ESM by the Germans. Mid September may also provide further colour on the much talked about QE3 from the Fed. The likelihood of China policy response is also rising as the economic data continues to disappoint.
Despite the weakening Euro zone growth and softness in China, the prospect of near term easing in monetary policy by central banks is likely to provide support to markets. Locally whilst domestic data remains mixed, the general theme of a moderate recovery in the NZ economy continues.
The earnings results has affirmed out key overweight positions with the portfolio continuing to be tilted towards companies with expectations of earnings growth, positive earnings momentum and rated by the Harbour analysts. We continue to not hold any resource exposed companies and have little exposure to companies with earnings from European operations.

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