A Montgomery reporting season preview

With reporting season about to commence amid the bush fires and coronavirus, the environment is ripe for more positive and negative surprises than we have seen in some time.

Meanwhile the ASX 200 industrial index, excluding financials, is trading on a record PE of 28.5 times. With valuations generally stretched the potential impact on prices from profit and outlook surprises could have a greater impact on investors’ portfolios than at any time since the GFC.

Here’s what we can say broadly about retail.

The raw national figures reveal a soft Australian retail sector. December retail sales grew at 0.5 per cent, or 2.4 per cent annualised, and while this has been portrayed as solid, it is in fact a decline on November’s 3.4 per cent and October’s 2.7 per cent. NSW was responsible for most of the decline falling from an annualised 1.9 per cent in November to 0.6 per cent in December.

Importantly, non-discretionary food drives 30 per cent of retail sales and in November food rose 3.8 per cent annualised however in December growth slumped to 2 per cent annualised.
We also know that annual retail sales volume growth went negative in the September quarter for the first time since the 1991 recession. In December growth improved marginally to zero growth annualised.

Finally, annualised personal credit growth is deeply negative reflecting our forecast credit contraction with consumers paying down credit cards on a net basis.

We expect soft results from retailers generally and a cautious outlook from small cap retail sector based on continued challenging conditions in the domestic economy.

Despite additional stimulus in tax cuts and rate cuts, plus recently improved capital city house prices which is a big driver of consumer sentiment, the banks have confirmed that households have chosen to pay down mortgages and credit cards rather than spend in the shops.

Although online sales were reportedly very strong in November (Black Friday/Cyber Monday), much of this represents a pull forward in sales from December rather than incremental dollars spent – this was just confirmed in the December retail stats which saw December down 0.5 per cent.

The shut-down of activity in China could affect retailers from a stock perspective. Those businesses with fast inventory turnover could potentially run low on stock, impacting revenue, if they are unable to source from alternatives to China.

Bushfires were also a factor throughout December and January.

Much of this caution has already been expressed – in January we have seen downgrades from a host of retailers.

Retailers downgrading

Super Retail Group (ASX:SUL),

Mosaic Brands (ASX:MOZ – formerly Noni-B),

Beacon Lighting (ASX:BLX),

PAS Group (ASX:PGR), and

Kogan.com (ASX:KGN).

Some retailers are doing well. Temple & Webster (ASX:TPW) just reported 50 per cent growth in sales while Nick Scali (ASX:NCK) saw a better 2Q (although Jan is down year over year).

Our small cap team, running the Montgomery Small Companies Fund, prefer Adairs (ASX:ADH), City Chic (ASX:CCX) and Premier (ASX:PMV).

The outlook for miners

Remember profits are backward-looking, the upcoming reporting season for miners should generally be positive for the December half. The six months to December 2019 coincided, for example, with a period of relative strength in iron ore. The strong expected earnings should help major miners BHP, RIO and Fortescue continue with close-to-record dividends as they are based on a payout ratio to net profit.

The outlook however is not as rosy, as resources companies face uncertainty around the level of slowdown in China as a result of Coronavirus. For example, China is by far the dominant consumer of iron ore at over 70 per cent of global supply, so any slowdown can have a significantly negative impact on short- and medium-term prices.

Reporting season technology

In technology, especially small cap technology, it’s all about growth and demonstrating the potential for future earnings scale. Reporting season is viewed closely for validation of growth forecasts.

Market valuations for Technology companies have strengthened, particularly in areas where structural global growth is evident such as in payments, cloud and AI toolsets.

US earnings season for mega cap technology companies such as Microsoft (NASDAQ:MSFT), Alphabet (NASDAQ:GOOG) and Amazon (NASDAQ:AMZN) as well as others in the tech ‘food chain’ have demonstrated continued strong growth and we expect those trends to also be experienced by companies here in Australia, including NextDC (ASX:NXT), Appen (ASX:APX), Megaport (ASX:MP1) and EML Payments (ASX:EML).

Locally, we expect further evidence that fintechs are growing fast at the expense of the big banks, and taking advantage of demand for perosnal and business finance where the big banks are withdrawing. Additionally, we expect to see continued growth where innovation is disrupting traditional or conventional revenue models, think Buy-Now-Pay-Later.

Keep in mind, in technology investors have been willing to trade losses and lower profits today for faster growth. Stocks that deliver the former without the latter will get punished (ASX:NEA), whilst faster growth will be cheered (ASX:BTH).

In healthcare technology valuations are white hot, reporting season may remind investors how far some of these stocks are from becoming financially self-sustaining and how insignificant the revenue pool is relative to market capitalisations and we are very cautious in this area of the market and companies such as Polynovo (ASX:PNV), Pro-Medicus (ASX:PME) or Volpara (ASX:VHT) 

The Banks

The Commonwealth Bank of Australia (ASX:CBA) and Bendigo and Adelaide Banks (ASX:BEN) report their half yearly results, while Westpac (ASC:WBC), Australia and New Zealand Banking Group (ASX:ANZ) and NAB release quarterly numbers and/or pillar III statements. We don’t expect many big surprises, with underlying conditions remaining tough. The one area of possible surprise (either positive or negative) would be in the area of capital management by CBA.

With national household credit growth, as measured by housing credit growth and personal credit growth is declining, the reporting season for the banks is likely to show increasing pressure on revenue growth and declining net interest margins.

Costs will continue to grow as increases in compliance and regulatory costs more than offset efficiency savings in the core operating cost base. Delinquencies have been increasing slowly for a while despite bad debt provisions remaining stubbornly at cyclical lows. Bad debt provisions should present a headwind to profit growth.

The outlook is expected to remain subdued despite some signs of improving loan book growth, as net interest margins and fee revenue growth are likely to remain under pressure.

CBA could announce capital management following the sale of Colonial and its Life Insurance business and resulting increase in its CET1 capital ratio. The share price is implying a reasonably high probability of this occurring. If it doesn’t and the company does not make any statements about future capital management intentions, the share price reaction is likely to be negative.

The Montgomery Small Companies Fund own shares in EML Payments and NextDC. The Montgomery Fund owns shares in Westpac and the Montgomery Global Fund and Montaka owns shares in Microsoft and Alphabet. This article was prepared 07 February with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade any of these companies you should seek financial advice.

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