Reporting season reveals mixed results for Australia’s economy
The 2016 financial year reporting season was mixed for Australian listed companies. While 123 of the 139 reporting companies produced a profit for the year to 30 June, overall aggregate profits fell by a significant 16.8 per cent1.
Those averages do not provide clarity as to the drivers of returns
It is apparent that both the resources and banking sectors were largely responsible for the weaker profit result – of particular note, BHP Billiton reported a $US6.4 billion loss, while profits grew at a modest 3.2 per cent2 once the negative results of the resources sector were excluded. And while overall profit announcements largely met analyst expectations, they did little to impress investors, particularly in light of current market valuations. UBS noted that profit forecasts for the year ending 30 June 2017 were also reduced by 1.7 per cent over the course of reporting season3.
More companies paying dividends is a double-edged sword
As always, dividends remain very much in focus for investors and are clearly a priority for corporates with a record 92.1 per cent of full-year reporting companies electing to pay a dividend. On average, dividends rose by six per cent and the current yield on the market is around 4.2 per cent4. While this initially sounds positive, it is important to consider the costs of continuing to increase dividends when earnings growth is more difficult to attain, and to question whether dividends are coming at the expense of pursuing growth through capital expenditure.
Lack of new investment is a common theme and there were few major expenditure plans proposed by the top 200 companies other than Telstra’s $3 billion investment in its network, AGL Energy’s $300 million on digitising its service offering, and the Star Entertainment Group’s proposed upgrade of its casinos.
Credit Suisse says the market’s payout ratio (the proportion of net profit that is paid out as dividends) was 76 per cent for the financial year5. Historical averages are 60-65 per cent – raising concerns that lack of investment may highlight a challenging economic environment with limited growth to invest in, or more focus by management on short-term incentives.
So what can you learn from these results?
Heightened market valuations (particularly in industrials) suggest that stocks overall appear too expensive, with valuations on the All Ordinaries Index appearing stretched with a price-to-earnings ratio of 17 times (above the long-term average of 15.7). We believe that ‘risk on’ behaviour in this low interest rate environment, rather than company profitability, is driving returns by inflating market valuations. Further domestic interest rate cuts may continue to support valuations, but we believe that investors should be mindful when assessing allocations to equity markets.
We have also seen that large-cap (ASX 20) companies are not invincible and are finding earnings growth difficult in a subdued economic environment. Mining sector woes have been well documented and reflected in profit results, while bank margins came under pressure due to an increase in capital and liquidity requirements as well as bad debts (albeit not alarmingly).
With a significant portion of the ASX 200 concentrated to these sectors, it is very important to ensure that you have a diversified portfolio inclusive of both domestic and international assets. If you have an overweight exposure to Australian shares, it may be a good time to discuss this position with your investment adviser and review your objectives to ensure your portfolio is still in alignment.
This insight contains general financial advice and was prepared without taking into account your objectives, financial situation or needs. Any forward looking statements in this insight are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct. As always, your personal circumstances are critical when considering any financial strategy and seeking professional personal advice is highly recommended.