What to takeaway from company reporting season?

Company reporting season can provide an enormous amount of information to investors, not only about the previous 6 months, but also what lies ahead.

The standout winners were the energy sector which benefitted from higher oil and gas prices not only because of the Ukraine war, but from years of under investment since 2014.  Woodside Energy generated free cash flow of US $2.568bn for the 6 months to June 2022 and forecast that demand from Asia for gas is likely to peak in the mid 2040’s, which suggests that the energy sector may enjoy higher earnings for longer than many would have believed.

David Prescott who is the founder of Lanyon Asset Management said that the common themes coming out of reporting season were inflation, particularly in relation to input costs, lingering COVID 19 issues disrupting supply chains and adding costs, tighter labour markets and a resilient consumer despite the consequences of rising interest rates.

Nathan Bell, the head of research at Intelligent Investor said that the results from reporting season were very stock specific and gave the example of Xero’s results which suffered from slower than expected growth in the UK while fellow tech company Wisetech had a superb result.

Building materials companies Adelaide Brighton and Boral struggled to recoup input cost increases whereas James Hardie and Reece passed on input costs quite easily according to Matt Williams, portfolio manager at Airlie Funds Management.

With inflation likely to remain elevated for some time, investors need to assess to what extent companies can pass on higher costs to their end customers.  Cleanaway reported weaker earnings margins partly due to higher diesel prices, but the report also stated their contracts allow to claw back higher fuel prices, indicating higher costs are likely to be recouped in future reports.

Toll roads showed that they can be beneficiaries of rising inflation as toll revenue is largely linked to inflation.  Atlas Arteria reported record dividends thanks to their interest on debt being fixed for over 5 years, while their income largely is rising with inflation.

Williams said that higher interest rates negatively affected listed property trusts as increased interest costs dampened the outlook for income distributions.  This would appear to be largely factored into share prices of property trusts which have endured a tough first 6 months of the calendar year.  The art form for investors is to understand what expectations about the future have been built into current share prices.

Prescott said that recent interest rate rises did not have a noticeable impact on the earnings of companies reporting at 30th June 2022.  But he added that the outlook statements from various senior managers however portrayed a slightly different story.  Management inability or reluctance to provide formal guidance emphasises the great unknown as to how rising rates will impact future operating profits.

Higher interest rates were yet to have a substantial impact on retailers with JB Hifi and Wesfarmers (Bunnings) reporting good numbers.  Interest rates only began to rise in May this year, so it is too early to understand their impact on consumers.

Williams highlighted QBE as a beneficiary of rising interest rates by increasing investment returns on their fixed interest portfolio.

Bell believes that company profits (particularly from consumer facing companies) will be tested when the nearly 50% of Australian borrowers on fixed rate loans have to refinance in the next 12 – 24 months at far higher rates than they are currently paying.  This is likely to reduce consumers spending power and change spending habits.  Early evidence of this came from the Woolworths result where CEO Brad Banducci said “inflation is beginning to impact all aspects of our customers’ shop and we are seeing a gradual change in customer shopping behaviour. We are seeing some customers trade down from beef into more affordable sources of protein and trade across from fresh vegetables into more affordable frozen and canned offerings.”

Healthcare company CSL is recovering from the effects from COVID lockdowns that reduced plasma collection, and other companies are still reporting COVID costs.  Wesfarmers for example invested $49m into their team to provide paid pandemic leave during lockdowns.  There is potential earnings upside here as the costs of dealing with COVID slowly unwind.

Investors are faced with a complex environment today, but would be well served to read media releases and presentations that companies release during reporting season to provide clues on how to best navigate it.

Each month Mark Draper (GEM Capital) writes for the Australian Financial Review - this article was published on 7th September 2022