Note: This information is provided by Ausbil Investment Management Limited, an Australian-based investment manager.
Key Observations of Reporting Season
FY22 reporting season comes after a period of extraordinary events. The invasion of Ukraine by Russia towards the end of the HY22 reporting season in February had a profound effect on the economy. While strong economic growth in 2021, and into 2022 was expected to put upward pressure on prices, not many were prepared for the energy shock from Russia’s military action to drive prices so high so fast.
Across the second half of FY22, this precipitated a major turning point in monetary policy, with rates moving rapidly from emergency levels in Australia of 0.10% to 1.85% by the end of reporting season in just over 3-months, with more rate rises expected.
Key issues facing companies this reporting season
With this context in mind, Ausbil has been looking at the impact of inflation on the sector and company performance since early 2021 when we took a deep dive into the impact inflation might have as the economy surged beyond COVID.
Some of the things we have been looking at are general price pressures on income statements, signs of wage pressure, whether companies can pass inflation impacts to their end clients, and also some of the recent price distortions exacerbated by the commodity price shock precipitated by the invasion of Ukraine.
Earnings and the economy
The Australian economy has been markedly resilient to date. However, the Ukraine invasion has triggered an energy and food inflation shock in the context of the aggressive front-loading of global and domestic interest rate rises. In response, economic activity is slowing. Although we expect economic growth to undershoot the trend for 2023, we do not see Australia entering a recession. We are seeing the economy’s resilience reflected in earnings for FY22, but some uncertainty is likely in FY23.
Of course, this is sector relevant, for example, sectors like banking, general insurance, resources and energy are expected to perform well in the prevailing inflationary environment. There are also quality leaders in the marketplace that tend to perform across the cycle and which can provide some hedging benefits against a slowing economy. Sectors like real estate, consumer discretionary, construction and others that are sensitive to the economy are expected to underperform.
We are seeing evidence of inflation and slowdown in the outlook statements and guidance for companies for FY23, though not all are negatively impacted by current conditions. FY22 had largely run before the invasion of Ukraine in late February, and while high inflation in the last two-quarters of FY22 impacted results, it did not throw companies off course.
Overall, in the weeks of reporting season, we have had, the bear views on the FY23 outlook seeing a significant downgrade in earnings have not come to fruition. Rather, we are seeing earnings holding up even with the current inflation, interest rate and market pressures. From an earnings perspective, given the inflationary environment, we are in, resources energy and general insurers as part of diversified financials have outperformed.
Sectors that are underperforming on earnings include manufacturers in consumer discretionary, health care and other sectors. Construction materials and real estate companies leveraged to residential property have also underperformed.
Dividends and capital management
In our universe overall, at this stage of reporting season, dividends were slightly below expectations, and buybacks were as expected. This is ascribed to a mix of inflation, rates and other margin pressure, and general market uncertainty. We are also seeing some of the difference in dividends from expectations being reinvested into CAPEX. Overall, the reporting season has shown the resilience and health of Australia’s corporate balance sheets even with the raft of pressures they are facing.
Company outlook statements
We are seeing caution around outlook statements, wider guidance ranges and words like ‘volatility’ and ‘uncertainty’. We see this as largely being related to the unknowns around energy, the pace of monetary tightening, and the great unknown about where central banks will settle concerning the cash rate. Until we feel we are closer to a terminal rate and inflation normalises, companies will be shy about sharing clear measurable outlooks.
The Australian economy has been markedly resilient to date. While the economy is slowing, Ausbil’s view is that Australia will avoid recession.
For FY23, with higher inflation sectors like materials (metals and mining), financials (banks and general insurers), and select energy and quality leaders businesses that perform across the cycle are expected to generate positive earnings growth.
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