Should you catch any of these falling knives?
We’re in reporting season – half-year to December 31 for most companies, but full-year results for those which use the calendar year as their financial year – and that can only mean one thing: “confession season” is ending.
Just as there are two reporting seasons – February and August – there are two confession seasons, one in December-January and the main one, April-June (early confessions come after companies see their results for the March quarter.) If the companies realise that they are unlikely to meet their own “guidance” for expected profits – often expressed as a range – or the market’s expectations, based on analysts’ current consensus estimates – they tell the market about it.
And depending on what the market was expecting, these revisions to outlook can have a severe impact on share prices.
For example, on Tuesday night, Treasury Wine Estates sprung a surprise on the ASX, bringing out a weaker-than-expected first-half result, and downgrading its full-year forecasts, on the back of a downturn in its US business. Treasury says a flood of cheap wine that has entered the US wine market and cut into margins might take two years to reverse: in response, the share price fell more than 25%. (Treasury shares had already fallen by close to 6% on Tuesday, largely seen in the market as being driven by concerns as to what the coronavirus outbreak in China might do to consumer spending in the company’s most profitable market.)
Such a brutal fall in the share price is a kick in the stomach to shareholders: I should know, as I had TWE as one of my five top tips for 2020, in December, at $17.09 – it is now trading at $12.50. (Although, I did pose the caveat that “the US market is the company’s largest by revenue, and the competition there is intense: lifting sales in the US will be more crucial over the next few years than increasing success in China.”) Nevertheless, such blind-siding hurts.
Earlier in January, online retail and services specialist Kogan.com released a surprisingly disappointing first-half trading update. Kogan’s gross sales and gross profit grew 16% and 9%, respectively, in the first half compared to 12 months ago, but gross profit growth slowed from 28% at the end of September quarter. The company’s operating costs fell during the period, meaning that the net profit could still grow, but the market was not impressed, and KGN stock fell more than 22% on the day of the announcement (20 January), and is now almost 32% lower than where it was on 19 January.
On the same day as Kogan released its upgrade, private health insurer NIB (NHF) updated its outlook for FY20. An increase in claims expenses means NIB now expects its underlying operating profit (UOP) to be about $170 million in FY20, down from previous guidance of at least $200 million. NHF stock fell by 12.7% on the day: since the downgrade, further price slides have taken its fall to 17.4%.
20 January also saw Super Retail (SUL) – owner of the Rebel Sport, Super Amart, BCF, Macpac and Super Cheap Auto brands – release a trading update stating that the bushfires and sustained drought conditions had impacted December trading. While the market only marked SUL down by 1.8% on the news, the stock has been singled out as one of the ASX-listed stocks most exposed to the bushfires, through its “outdoor” category, namely BCF and Macpac. Since the trading update, increased nervousness around the bushfire impact has stripped more than 11% from the SUL share price.
On 22 January, engineering and construction giant Downer (DOW) cut its profit guidance for FY20 to $300 million, from the previous figure of $365 million, representing a 12% fall in the forecast, and thus an effective 19% decline in full-year earnings if borne out. The major problem was the Engineering, Construction, and Maintenance (EC&M) business, as Downer deals with ongoing difficulties at the company’s renewable energy and mining projects. Downer faces the double-whammy of escalating cost to complete construction projects currently in progress, but a smaller pipeline of new projects. DOW stock slumped 18% on the day of the announcement and has extended that fall to 19.6%.
One day after Downer’s mea culpa, construction and contracting group, CIMIC (the former Leighton Holdings) told the market that a review of its businesses would see it take a $1.8 billion post-tax write-down on the value of Middle Eastern group BIC Contracting, in which CIMIC holds a 45% non-controlling interest. Investors took more than 20% off the CIM share price, and the stock is still down 19.9% from where it had been trading.
There are always reasons for downgrades, whether company-specific or more general in terms of market and economic factors; and given the effect of the bushfires (and now, potentially, floods in northern Australia) on consumer spending; and also the rapidly broadening impact of the coronavirus epidemic emanating from China, on which news changes daily, there are likely to be more.
ASX stocks exposed to travel have been hit in share price terms.
- Qantas Airways (QAN): down by 11%
- Sydney Airport (SYD): down by 7%
- Corporate Travel Management (CTD): down by almost 15%.
- Webjet (WEB): trading 10% lower
- Flight Centre (FLT): down by 10.6%
After a strong start to the year, A2 Milk – which sells into China – has lost 3% in three days, while Crown Resorts is down 8%.
Of the big bulk-commodity suppliers that would be affected by a Chinese economic slowdown, BHP is down 4.4%, Rio Tinto is 6.4% weaker, and Fortescue Metals has lost 9%.
But none of these companies has released an announcement specifically referencing coronavirus – it is too uncertain and fast-moving a situation. However, it could certainly affect full-year earnings if it worsens, and widens.
So, should an investor try to catch any of these falling knives?
Take Downer (DOW) for example. Stock Doctor/Thomson Reuters has an analysts’ consensus valuation of $7.79, while FN Arena has $7.89. The stock is offering, at the current price of around $7.26, a consensus forecast FY21 yield 4.4%, grossed-up to 5.3%. Broker Ord Minnett – which updated its recommendation on January 28 – has a target price on the stock of $8.90, more than 22% north of the current price.
CIMIC is a similar case. Stock Doctor/Thomson Reuters shows a consensus valuation on CIM of $33.75, compared to the current price of $28.99; FN Arena’s consensus valuation is even higher, at $34.475. CIMIC’s FY December 2020 forecast yield is 5.3% fully franked, equating to a grossed-up yield of 7.6%.
Post-downgrade, Kogan is trading at $5.38. Despite the downgrade, Stock Doctor/Thomson Reuters says analysts’ consensus values the stock at $6.94; FN Arena puts it at $6.83 (with Credit Suisse the most bullish broker, at $7.37). If those consensus valuations are reached from here, the potential upside is in the range of 27%–28% – and there is a forecast FY21 yield of 3.9% fully franked to go with that, equivalent to a grossed-up yield of 5.6%.
Investing after downgrades – or lowering your average entry cost by buying more – can be a lucrative pastime, but it also requires a redoubling of “doing your homework,” to make sure that your original investing case has not been harmed too much.
And on that note, it is too early to say that for Treasury Wine Estates, on which the first brokers to respond have significantly cooled expectations – despite price targets that look attractive from where it ended up on Wednesday.