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We have just experienced one of the stronger reporting periods in the past 20 years with corporate earnings upgraded in the low single digits, compared with most reporting periods which are dominated by downgrades. The strength was supported by exceptional upgrades in the commodity and financial sectors, offset by smaller downgrades in industrials.
Most corporates have enjoyed big revenue upgrades, but this has been offset in some cases by a big escalation in costs. EBITDA margin forecasts have declined marginally across the board and wages appear to be the one cost that is harder to offset or pass through.
However, corporates are sitting on what is probably their strongest balance sheets in 20 years and over $6 billion in buyback, special dividends and capital returns has been announced so far.
Despite the strength across corporate earnings, the ASX200 is only up 2.5% (to 24 February) following a weak January where the index fell 6.4%. There are two reasons for this muted index performance. Equity markets continue to adjust to higher interest rate expectations due to the inflation surge in the US market, plus the escalation in geopolitical tension is causing investors to seek a capital preservation mode.
The 2022 earnings expectations across ASX200 sectors have been on a gradual upward shift since last reporting season in September 2021. Expectations for the Energy sector have been revised upwards the most (up 15%), buoyed by oil and gas prices remaining on a steady climb. The Real Estate sector is also bouncing back with better-than-expected rental receipts and expectations that traffic and activity will grow in 2022 as COVID restrictions ease.
The valuation reset due to rising interest rates is impacting the IT sector the most. As a group the sector is down 7.2% in February and down 24.3% so far in 2022 (to 24 February). The underlying strength in the economy is being highlighted by the fact that retail sectors continue to perform well.
Some of the stronger results for the Tribeca Alpha Plus Fund from this reporting season came from Seek, Treasury Wine and A2 Milk.
Australia and New Zealand provided the highlight of Seek’s first half result. Revenue grew 72% over the period driven by record volumes that were up 49%. Yield growth was boosted by a greater portion of advertisements coming from higher-priced small and medium sized enterprises (SMEs) and SMEs accounted for 39% of job ads, up from 25% in FY20. A number of these SME customers are using Seek for the first time and we expect these new customers to be retained.
This was a better-than-expected result and the continued strength of job advertisements in January saw management upgrade full year guidance. Strong revenue growth enabled investment and margin expansion and EBITDA margins expanded 7% to 66%.
During the half Seek completed the rollout of its new contract pricing model. While the current market tightness is constraining its ability to raise pricing on its new contracts, we expect Seek’s new dynamic pricing model will drive higher yields over the medium term.
Seek’s share of placements in Australia grew to 34% further cementing its leadership position.
SEK trades on 35x FY23 PE with double digit EPS growth over the next three years. This is the cheapest level it has traded in many years.
Treasury Wine Estates delivered a strong result beating consensus expectations. Its price was up over 11% on results day, after being sold off earlier on fears of large misses and accompanying broker downgrades.
Post the China wine tariff implementation, the company showed a strong ability to reallocate a significant amount of the volume which it formerly exported to the key market of China, specifically luxury wine in the company’s ‘Penfolds’ portfolio. Penfold’s EBIT outside of Mainland China was up 32.1% on the previous half, and Penfolds net revenue in Asia ex-China was up 119% supported by strong inventory run down depletions led by Malaysia, Singapore, Thailand and Hong Kong.
The company provided earnings visibility for the full year by announcing that it expects trading conditions to remain consistent in 2H and loosely guided EBIT for the Penfolds segment by noting that it will be skewed 1-2% in 1H.
TWE is expected to put in double digit earnings growth - with sub-market valuation for the next 12 months. This makes it very attractive against other lower growth and defensive businesses.
The A2 Milk Company beat consensus revenue expectations by 8% at the top line, with EBITDA of 23 per cent against the consensus view. The result was supported by strong performance in China and other Asian markets with an EBITDA that was 47% above consensus and driven by better-than-expected sales and margins. Operating cash flow was positive, driven by higher earnings and better payables management, which bodes well for the balance sheet which remains robust. The company now has a cash position of $667 million.
The company continued to gain share in the Australian liquid milk market, slightly up at 12.4% (against 12.2% in the previous half). Price increases were a consistent theme throughout the investor presentation, with the company noting price increases were to be implemented across all customers in 2Q22 and specifically mentioning an 11% price increase in USA which would be effective in 4Q22.
The company noted its outlook was improving and despite continued investments into its brand, its earnings continue to track above expectations.
Like Treasury wine, A2M represents a rare opportunity for investors to buy into high quality brands at discounted prices as earnings going through transition. We believe we have seen worst.
Some of the stronger results for Redpoint Investment Management from this reporting season came from Woodside Petroleum, Bendigo Bank and JB Hi-Fi.
Woodside is set to become much larger in the first half of 2022 as it merges in BHP’s petroleum assets. A larger asset base will enable the company to better support the capital expenditure requirements of maintaining its oil and gas production as the world moves to less carbon intensive energy sources.
The company’s annual report on February 17 provided both an earnings and dividend surprise. The company realised the highest average price in over 5 years for its oil and gas which boosted revenues by 93% to almost $7 billion. Production costs were only slightly higher (year on year) which highlights the potential for commodity-based firms to benefit in a higher inflation environment where revenue growth can exceed their cost growth.
While the company has committed to reducing its Scope 1 and Scope 2 emissions there is more work to be done. The real emissions impact for a company like Woodside is in Scope 3: when its customers consume their oil and gas. Woodside has committed $5 billion (once the BHP petroleum assets are acquired) to new energy products and lower carbon services but details remain scant. Further detail on these initiatives is critical to better assess the medium to longer term prospects for the soon to be larger Woodside.
While all eyes are generally on Australia’s largest four banks, Bendigo Bank delivered a solid result showcasing the strength in its residential mortgage business. Half year profit of $321.3 million beat expectations, but the interim dividend of 26.5 cents, while higher than last year, remains below the 35 cents dividends paid twice a year in 2018 and 2019.
A key area to watch for investors is the company’s stated transformation plans between now and 2024. It’s proposed simplification of the brands and banks systems, along with efficiencies and automation, are critical to enabling ongoing growth and expanding profitability. The bank also remains well placed to see an improvement in its net interest margin as and when the RBA moves to increase interest rates in Australia later in 2022 and 2023.
JB Hi-Fi has been a strong beneficiary of the pandemic’s imposed lockdowns with sales doubling from pre-COVID levels as customers changed their spending habits from leisure to home entertainment and improvements (The Good Guys is a business division of JB Hi-Fi).
Rising from its March 2020 low of $23.50, JB Hi-Fi has range traded between $45 and $55 over the past two years. JB Hi-Fi pre-announced their results in January so there were no material surprises in February, apart from a strong sales update for the January period.
Profits in the first half of financial year 2022 were $288 million, down 9.4% from a year earlier, but this was largely expected as the aforementioned benefits taper off. Sales and profits remain well above levels seen two years ago.
The company also announced an off-market share buyback worth $250 million, roughly 4% of outstanding shares. This will be valuable to all shareholders by reducing the number of shares from which earnings are distributed but will specifically be of benefit to low and zero tax rate payers who can take advantage of the franking credits that are distributed as part of the buyback. We estimate that non-tax paying shareholders will be able to realise a 20% premium to the current share price by selling their shares back to the company.
The company announced an interim dividend of $1.63 per share, down from $1.80 in 2021. The company trades at an attractive cash yield of 5.5% (including an expected $1 per share final dividend in August) and almost 8% including the value of the franking credit.
The main risk for JB HiFi is that higher interest rates reduce consumer confidence housing activity and higher mortgage payments reduce disposable income for discretionary spending. The impact of inflationary pressures remains evident but, again the company remains well placed noting that it will pass on the higher price of goods from its suppliers. The company refused to give guidance for the rest of the year due to uncertainty arising from COVID-19 but noted continued strong customer demand.
JB Hi Fi is one of our preferred retailers. It is a high-quality business, with a robust business model, attributed to its well-established branding and omni channel offering (bricks and mortar store and established online retail channel which is now 23% of sales), strong cashflow, return on equity and a sound net cash balance sheet. JB Hi-Fi also offers good value at current levels, trading at 12x next year’s earnings.
First published on the Firstlinks Newsletter. A free subscription for nabtrade clients is available here.
Jun Bei Liu is Lead Portfolio Manager at Tribeca Investment Partners and Max Cappetta is a Portfolio Manager and CEO at Redpoint Investment Management. Analysis as at 02 March 2022. This information has been provided by Firstlinks, a publication of Morningstar Australasia (ABN: 95 090 665 544, AFSL 240892), for WealthHub Securities Ltd ABN 83 089 718 249 AFSL No. 230704 (WealthHub Securities, we), a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited ABN 12 004 044 937 AFSL 230686 (NAB). Whilst all reasonable care has been taken by WealthHub Securities in reviewing this material, this content does not represent the view or opinions of WealthHub Securities. Any statements as to past performance do not represent future performance. Any advice contained in the Information has been prepared by WealthHub Securities without taking into account your objectives, financial situation or needs. Before acting on any such advice, we recommend that you consider whether it is appropriate for your circumstances.