Looking beyond the Macro: The Reporting Season in Review

Global equity markets have started this year in a truly volatile fashion. A range of factors have impacted  investor sentiment including concerns over Chinese growth, commodity price deflation and a continuation of the extraordinary monetary policies that have defined life in the post-GFC era. This past month local stocks have had the chance to step out from under the macro cloud and provide insights into how their businesses are performing by releasing their profit results. This is also an important time for company executives to educate investors on the opportunities and challenges their businesses face going forward.

Throughout last year, local analysts revised their company earnings forecasts lower on account of concerns around domestic economic growth and the uncertainty being created by the volatility in offshore markets. Despite this negative momentum, the verdict across New Zealand and Australia on the past months reporting season is that overall results were better than had been expected. It is hard to draw sector based conclusions on the New Zealand market given its lack of size, but we can identify some important trends from Australia. This is a market which has significantly underperformed the NZX over the past 5-years but encouragingly current earnings momentum looks to have held up reasonably well, especially across the Industrial sectors. In fact, despite some of the nervousness that existed across the market going into February, the number of stocks that required an upgrade to forecast earnings during the past month ended up being high relative to history.

Understanding key sector drivers is an important part of our process and we watch carefully to see which areas of the listed market are performing better than others and reporting season provides us with useful insights here. Despite the many bearish views circulating the market about the performance and risks of the Australian and New Zealand economies, strong results were delivered by those businesses whose operating outcomes are influenced by the domestic cycle. Included within this group were stocks exposed to Housing, Consumption and Media as many of these businesses are currently enjoying solid demand for their products and services. This is particulary encouraging because one important characteristic of the recent bull-market in equities has been the requirement of cost management to cover for a lack of top-line sales growth. Despite this we saw many of these businesses posting like-for-like sales growth in the 5% range over the last month. An exception to this rule remains those businesses whose operating experiences are tied to commodities and mining which continue to suffer from commodity oversupply and price deflation.

The other very important sector to mention is of course Banking. This is the largest sector in the ASX200, making up over 30% of the index weight. Although reported results were broadly in-line with market expectations the “Big Four” stocks (ANZ, CBA, NAB and WBC) were all notably weaker during the month after investors became concerned over a lack of growth opportunities, ongoing risks to capital and their leverage to any degredation in credit quality across New Zealand and Australia.

When all sectors are considered the Australian market is still on track to record its second consecutive year of negative earnings growth but that is largely due to the Resource stocks. If we remove them from consideration then the market is expected to achieve mid-single digit growth in FY16. Although these assumptions will undoubtedly face some negative revisions during the next few months, as recent trends would suggest, the platform for corporate earnings remains acceptable.

In summary there were some interesting trends evident during the reporting season with many companies on both sides of the Tasman enjoying acceptable revenue growth while also achieving margin expansion through effective cost management. The combination of these two value drivers should ensure that despite volatile equity markets, the environment for equity investors remains productive.

On a final note, we wanted to highlight again the recent introduction of the Devon Diversified Income Fund. This strategy has been designed to offer our clients a conservatively managed solution for achieving a better-than-bank return with their savings. The frustration that many of us have with the low rates of return available on bank deposits is addressed with this Fund by principally investing across a portfolio of New Zealand Fixed Interest and high yielding Australasian shares.

Slade Robertson - Portfolio Manager

February 2016