Key observations

•    Australian companies just reported half-year results, a slightly disappointing season relative to expectations, with earnings falling -2.2% in nominal terms in HY23 compared to HY22, due to a combination of factors including lower commodity prices, higher interest rates and inflationary pressures impacting cost growth.

•    At the close of HY23, consensus expectations for earnings growth were +5.0% for FY23 and +3.0% for FY24 (S&P/ASX 200).

•    There were positive EPS revisions for 10 sectors, and 21 sectors experiencing negative EPS revisions for FY23 for the S&P/ASX 200.

•    The Australian economy continues to slow in response to rapid rate rises and stubborn inflation globally. While Ausbil’s view is that Australia will avoid recession, there has still been some derating in market earnings with slowing demand.

•    Ausbil believes we are entering a period of stabilisation where we expect rates to peak and hold for some time while the economy adjusts to the recent tightening cycle. We believe earnings growth will be harder to come by than in FY21 and FY22.

•    Looking ahead, we like critical metals and commodities for the long rotation from fossil fuels to renewables in the great decarbonisation and the electrification-of-things. We also think that the beneficiaries of elevated inflation are expected to perform in 2023. However, the emphasis on those that benefit in a rising rate environment is starting to shift towards the beneficiaries of stabilisation and peaking rates.

Context

HY23 reporting season comes after an extraordinary period where interest rates have risen rapidly to curtail high inflation, the result of huge stimulation during the pandemic, and compounded by a commodity shock with Russia’s invasion of Ukraine. The economy has been resilient, operating near full employment, but with the cash rate rising from 0.10% in April 2022 to 3.35% in February 2023, it is slowing down as expected. While Ausbil’s view is that Australia will avoid recession, there has still been some derating in market earnings with slowing demand.

Earnings

We are seeing evidence of inflation and slowdown in the outlook statements and guidance for companies for FY23, though not all are negatively impacted by current conditions. Cost pressures have seen a number of companies miss on expectations across sectors, and there remains some caution in outlook statements given the unknown path for interest rates and inflation.

Across the reporting season, EPS revisions for the market have turned negative for FY23 and FY24, and the growth outlook, while positive has softened. Across the month of February, EPS revisions stood at -2.0% for the S&P/ASX 200, with positive EPS revisions for 10 sectors, with 21 sectors experiencing negative EPS revisions for FY23. EPS revisions for FY24 amounted to -1.1%, with 11 sectors experiencing positive EPS revisions, while 20 sectors saw EPS downgraded.

At the close of HY23 reporting season, consensus is expecting full FY23 EPS growth of +5.0% (21 sectors with EPS growth and 10 sectors with EPS declines), and +3.0% for FY24 (25 sectors with EPS growth and 6 sectors with EPS declines) for the S&P/ASX 200. The shift in the outlook for earnings this reporting season is illustrated in Chart 1.


Chart 1: Shift in FY23 earnings outlook by sector


Source: Ausbil, Visible Alpha at end February 2023.
 
Company outlook statements

We are seeing ongoing caution around outlook statements and wider guidance ranges. We see this as largely being related to the unknowns around energy, where the current tightening cycle will end, unknowns around how the consumer is coping with tighter conditions, and the risk of central banks pushing too far on policy.

Dividends and capital management

In our universe overall, dividends were slightly below expectations, and buybacks were as expected, though at current prices the dividend yield outlook for FY23 is 4.3% (S&P/ASX 200). This is ascribed to a mix of inflation, rates and other margin pressure, and general market uncertainty. We are also seeing some of the difference in dividends from expectations being reinvested into capex. Overall, the reporting season has shown the resilience and health of Australia’s corporate balance sheets even with the raft of pressures they are facing on inflation and costs.

Environment, Social and Governance (ESG) this reporting season.

This reporting season saw increased ESG disclosure by companies, continuing the trend from 2022. Key themes in corporate presentations were climate change, health and safety, and cyber security.

On climate change, the majority of ASX 200 companies by market cap have committed to net zero targets and/or carbon neutrality by 2050. Going forward, the focus will be on scrutinising the credibility of those commitments and there will be greater expectations by investors on milestone targets and ideally, links between climate change goals and executive remuneration. This, as well as potential impacts from the Safeguard Mechanism have been the focus in many of our corporate engagements to date in 2023.

On safety, disappointingly we saw another period of fatalities in the mining sector. However, we were encouraged by a number of companies across other high-risk industries where there have been safety issues in the past but where performance has turned around. With workplace reforms to take effect in June, we assess the risk of industrial action and wage inflation, but as part of that we also assess safety trends and general staff engagement. With respect to staff engagement, Ausbil assesses companies ahead of the reporting season by drawing information from independent staff reviews on Glassdoor. The interim reporting season shows that the company- specific trends we saw in Glassdoor ahead of the reporting season are very similar to what was reported.

Another area where we have engaged extensively in the past is on labour rights in global supply chains; we believe the re-opening of borders and resumption of cross-border migration have heightened the risk, both in Southeast Asia and in Australia. We have also engaged with companies on their preparedness for an economic downturn, such as financial hardship policies and how they tackle the increased prevalence of financial scammers. Biodiversity will also be a focus area in years to come and from our engagements we know that some companies have done initial work in this area, mainly in mapping risks and opportunities.


 
Equity outlook

We believe inflation is in a peaking phase in response to the stringent central bank tightening program. Whilst we expect some further small upward adjustments to interest rates, our view is that we are fast approaching the terminal rate for this cycle, where it will hold for an extended period as the RBA assesses the economic impact. The economy is slowing, and we see economic growth below trend in 2023 and into 2024. In this environment, we believe earnings growth will be harder to find.

Compared to the stellar earnings growth of 22% in FY22 and 30% in FY21 in the pandemic rebound, we see positive but more muted growth for FY23. There is room for some upward surprise in certain sectors as Australia’s economy remains relatively resilient and is operating near full employment.

We remain focused on the key thematics that are driving the long- term earnings growth, particularly where imbalances see demand exceeding supply on a fundamental basis for some time.

We like critical metals and commodities for the long rotation from fossil fuels to renewables in the great decarbonisation, and the electrification-of-things, with the steady switch from combustion and fossil fuel power to renewable electricity generation. Service companies associated with the cap-ex investment needed for this energy transition are also attractive. With China re-emerging from its intense COVID issues, we see upside in commodity prices as demand returns across calendar 2023.

The beneficiaries of elevated inflation are expected to perform in 2023, but the emphasis on those that perform well in a rising rate environment is starting to shift towards those that will benefit with stabilisation and peaking rates. Quality REITs, some quality leaders in technology, and some exposures in building products are helping to bridge the shift from the inflation beneficiaries that outperformed in 2022.

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