3 profit season opportunities

With profit season still in second gear, it’s too soon to draw conclusions about corporate earnings growth and market valuations. But one trend is clear: companies that miss market expectation or issue weaker guidance are being hammered.

Consider Domino’s Pizza Enterprises (DMP). The fast-food giant this week reported 28.8% growth in full-year underlying earnings, below previous guidance. The shares, already firmly in the sights of short-sellers, plunged 19% on the day.

Domino’s has slumped from a 52-week high of $80.69 to as low as $39.50 immediately after its results announcement – a remarkable fall for a stock that could seemingly do no wrong.

A share-price target of $65.62, based on the consensus of 12 broking firms, suggests Domino’s is a bargain buy. But with so much negativity and downward momentum in its share price, best to stand aside for now and avoid “catching a falling knife”.

The profit season also confirms the challenges facing retailers. JB Hi-Fi (JBH) reported a slightly better-than-expected result and reinforced its reputation as one of Australia’s great retailers. Yet, the shares fell 4% because some brokers expected a little more growth.

With Amazon looming on the horizon, JB Hi-Fi was an easy candidate for profit taking. Perhaps fund managers think this is as good as it gets for JB Hi-Fi.

The stock looks undervalued at $24.30, trading on a forecast Price Earnings (PE) multiple of 12.7 times FY18 earnings and with an expected yield of just over 5%, fully franked.

Other retailers were hammered. Baby Bunting Group’s (BBN) solid FY17 result came with a weak update on current trading conditions that raises questions about FY18 guidance. The retailer’s shares tumbled 13% on the result, continuing the heavy falls over 12 months.

Baby Bunting is well run and has an excellent position in an attractive industry. The baby goods industry is fragmented and Baby Bunting can keep growing through store rollouts. But this is one retailer where concerns about Amazon’s arrival look justified; margin pressure on Baby Bunting will intensify as more baby goods are bought online in the next few years.

Nick Scali (NCK) was also whacked after delivering 42.7% growth in FY17 net profit, at the top end of company guidance. The star retailer gave no FY18 guidance because of uncertain trading conditions, and its exposure to the slowing housing cycle has spooked investors.

Like JB Hi-Fi, Nick Scali looks cheap after recent price weakness. At $5.97, the retailer trades on a FY18 PE of about 12 times and is expected to yield 6%. Those valuation metrics are undemanding for a company of its quality. Still, I want to see more evidence that the flat trading conditions in July were an aberration, rather than the start of a trend.

Results that stood out

Here are three stocks that stood out. Some delivered cracking results; others were oversold by a market itching to take profits.

Other stocks that impressed will be covered in later columns for the Switzer Super Report. They include SG Fleet, oOHMedia!, cosmetics group BWX and Aventus Retail Property Fund.

1. CSL (CSL)

Australia’s world-class biopharmaceuticals company can feel a bit like “ground hog” day in the reporting season. Although CSL consistently delivers strong results, the stock tends to get sold off in the earnings season because investors always want a little more.

That’s the price of trading on a trailing PE of 42 times and a forward PE of 30 times, on some broker forecasts. The market expects perfection and CSL provides the next-best thing.

Unlike some other blue chips, CSL does not play the game of lowering market expectations so that it looks a hero when better-than-expected earnings are delivered. The market gets what it’s given: there’s no strategy to “underpromise and overdeliver” to boost the share price.

And so it was with this week’s FY17 result. CSL announced 24% growth in underlying after-tax net profit and 26% in underlying earnings-per-share growth, on a constant-currency basis. The company described the result as “exceptional”.

The market – unfairly in my view – did not see it that way. CSL fell more than 5% to $124.27 after a result that just missed broker expectations. The stock has shed almost $20 since June for no obvious reason.

A consensus price target of $106.25, based on 11 broking forecasts, suggests CSL is still overvalued. The market is too bearish.

Morningstar valued CSL shares at $134 – a view that looks about right.

The quality of CSL’s result suggests several possible catalysts for the next share-price re-rating.

Immunoglobulin sales grew 16% in FY17, extending CSL’s dominant position in the global blood-plasma market. The business has almost 180 blood-plasma collection centres in the United States and Europe and plans to add another 25-30 in FY18.

CSL guided for FY18 after-tax net profit of $1.48-$1.55 billion, from $1.37 billion in FY17 (on a constant-currency basis), continuing a run of consistent profit growth.

Longer term, CSL’s blood-plasma collection network has latent strategic value as demand for plasma products increases. That, no doubt, explains why CSL is opening centres faster than any of its rivals.

CSL acquired a majority stake in Chinese plasma fractionator Ruide and believes there are significant opportunities to expand plasma supply in China.

Chart 1: CSL

Source: ASX

2. Challenger (CGF)

I included Challenger in the Switzer Super Report in October 2015 at $8.10 a share. Challenger rallied to $13.76 in May, then eased to $11.76 amid profit taking. The funds-management group, best known for its annuities, fell 10% after its earnings result this week.

Normalised FY17 net profit of $385 million was slightly below market expectation. A bigger negative was FY18 guidance, about 5% below the market’s pre-result expectation. Challenger also announced a $500 million strategic equity placement to MS Primary.

Brokers revised earnings-per-share-growth targets after the result and the market adjusted to Challenger’s weaker short-term outlook. But beneath the gloom was ongoing strong growth in Challenger’s funds-management inflow and margins.

Challenger is superbly positioned for an ageing population and greater demand for retirement investment products given its dominance in fixed-interest annuities. The company has stolen a march on the big banks in annuity products.

An average share-price target of $12.62, based on a consensus of 15 broking firms, suggests Challenger is undervalued. That target could fall a little as brokers revise Challenger’s earnings growth. Further price weakness would create a long-term buying opportunity.

Chart 2: Challenger

Source: ASX

3. Carsales.com (CAR)

Online marketplace Carsales.com has rallied to $13.36 this year on the back of a solid FY17 result.

Carsales last week reported 8% growth in revenue to $372.1 million for FY17 and 4% growth in net profit to $119.1 million – just ahead of market expectation.

Carsales’ international business stood out. Offshore revenue, small in Carsales’ overall sales, almost doubled to $8.3 million in FY17. The company’s investments in car-advertising websites in Latin America and Asia are starting to provide new growth drivers.

A share-price target of $13.52 from a consensus of 15 broking firms suggests Carsales is almost fully valued. Macquarie’s 12-month price target is $14.

A share-price pullback in Carsales, after stellar gains this year, would not surprise as the market moves on to other earnings results. Carsales would look more interesting closer to $12 and might get there if it fails to break through previous price resistance on its chart.

Longer term, Carsales has much growth ahead as it revs up its international expansion.

Chart 3: Carsales.com

Source: ASX