There was a lot to like about the February reporting season. By our estimates, over 30 per cent of large caps beat the market’s expectations, and unlike previous seasons, estimates held firm rather than falling away into results. Downgrades and significant misses were largely a non-event and overall management commentary reflected the most buoyant conditions we’ve seen for a while.
The market correction in early February saw the market multiple trade as low as 15.2x and doubtless made it easier for companies to meet investor expectations. On the whole, the large caps (ASX50) were the star performers with 30pc beating consensus expectations and only 9pc missing. Small and Mid-caps saw more varied results (25pc beating, 19pc missing), which is no surprise given the strong price run-up into the start of the year.
Modest profit growth (again) in 2018
Expectations for financial year 2018 corporate profit growth (ex-Resources) were revised 0.5pc higher over the course of reporting season to 6.0pc, or 10.3pc if we exclude banks and financials. Large cap results were robust, but their sluggish earnings growth is also dragging on the market. ASX50 Industrials are growing earnings at only 4.2pc versus smaller-caps at 10.6pc. We’ve been highlighting better opportunities outside of the traditional large cap stalwarts for some time now.
Investment strategy remains cautious
The valuations investors are paying for earnings remain elevated by historical standards, and we caution investors from expecting higher-than-average returns. Current earnings growth sits well below the long-term average (~9-10pc), reflecting below-trend economic growth, while valuations (XJI on ~16x forward) appear to be pricing in earnings acceleration that is yet to be delivered.
Some themes we believe will set the tone for 2018
Management gives the green light on the economy – The robust business surveys were reflected in the mostly upbeat tone across the results. While results were good, it wasn’t hitch-free. The Retail and Telco sectors continue to struggle against structural change and higher payouts continue to be the modus operandi; nonetheless, the economy remains on much firmer footing than it has for some time.
Large caps catch a bid – The investment playbook for the Goldilocks environment of growth without inflation was to buy growth. Since October the MSCI Growth index has outperformed the Value index by 3pc and even more pronounced was the out-performance of small caps over large caps (+8pc).
Offshore growth surprises on the upside – Global growth and favourable changes to the US tax code continue to be a strong source of upside for stocks with exposure to the recovery in US and Europe. The median EPS revision for the Morgans basket of offshore earners was 2.4pc and a 1.8pc price reaction since the result.
Investors still hung up on high PE growth – The large valuation divergence between high PE and low PE stocks closed marginally, we think this is unlikely to be sustained in the context of stronger growth and rising inflation. We think expensive growth will under-perform GARP and value over the short term.
The infrastructure opportunity – The trend remains positive for infrastructure activity in key urban markets. Macromonitor estimates that nearly $16 billion pa will be spent on transport projects alone over the next three years and peak in 2020. Results from DOW, ABC CIM and SVW highlight the magnitude of the upcoming pipeline.
The Resource cycle is maturing – Resources and energy companies largely delivered as expected in February, with higher earnings flowing through into higher dividends and capital management initiatives. Two emerging themes stood out to us though around the return of cost inflation and notable growth via M&A rhetoric and or activity.
- Boh Burima, Financial Adviser | Authorised Representative: 000341081. Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410