Hard times lingering in results

Battered offshore markets, sluggish local demand and regulatory uncertainty forced management teams to keep a lid on costs and hang on to cash.

With so much hope pinned on a recovery in full-year 2010, the final wash-up was sobering, given most of the earnings gains were recorded against flat or retreating top-line growth.

Even as the mining sector continued to be a bright spot, earnings per share growth, taken as an average of five major broking houses, was just 5.5 per cent, only marginally ahead of private sector GDP growth in the same period of 5 per cent.

But it was a tale of two sectors in that resources stocks grew by 18.4 per cent (0.4 per cent less than expected) while the industrials (ex financial services) retreated 2.4 per cent, but were 1.1 per cent above expectations.

While most companies reported numbers within expectations, the subdued outlook statements and cautious guidance has prompted downgrades to forecast EPS growth this financial year of about four percentage points to around 20 per cent.

UBS chief strategist David Cassidy said the market was already wary that full-year 2011 projections could be a bit optimistic.

"If you look at share price reactions, more stocks rallied on results than were sold off, suggesting the market was braced for some degree of downward revision to forward estimates," he said.

Yet the extent of the weakness in US and European markets coupled with the total lack of confidence on sales growth took many brokers by surprise, leading to the pulling back of growth estimates for full-year 2011.

"I think this reporting season has been tougher than the market had been expecting, especially those companies with North American and European exposure," Perpetual Investments senior portfolio manager Matt Williams said.

Constellation Capital portfolio manager Richard Morris noted that expectations were now shifting to 2012 as being the year for growth recovery.

"There were a few too many V-shaped earnings recoveries that have been pushed out at least another 12 months," he said.

The impact of weaker economic conditions in the US and Europe emerged as a key thematic during the season as companies with mostly a domestic focus or those leveraged to continued demand from China tended to provide better growth prospects.

"Those exposed to earnings from the US and Europe were pretty bearish," Mr Morris said.

"It wasn't so much that the result was poor, more that the outlook statements were very cautious. You saw that with James Hardie, Boral, Billabong and Brambles."

Indeed, outlook statements were kept broad and few companies gave specific guidance, promising more detail at trading updates in the annual meeting season in November.

But Patterson Securities quantitative analyst Kien Trinh noted that guidance for the local economy was "mildly optimistic" with 34 per cent of companies including Pacific Brands, Fairfax, Hills Industries, Adelaide Brighton and GUD Holdings claiming an improved profit trend.

Unsurprisingly, the sector that provided the best uplift during the reporting season with more growth to come this financial year was resources, as a rebound in commodity prices allowed several companies to finish on a strong second half.

"Revenue growth of approximately 9 per cent and good cost control drove earnings before interest, tax, depreciation and amortisation (EBITDA) up by almost 50 per cent for the sector," said Goldman Sachs Asset Management head of Australian equities Dion Hershan.

"It was the only sector to exhibit clear revenue growth.

"We expect these trends to continue into full-year 2011 and market expectations are for more than 50 per cent earnings growth, which is particularly strong against a backdrop of downgrading industrials."

Most fund managers nominated the strong results from BHP Billiton and Rio Tinto as clear standouts for the resources sector while Ausbil Dexia head of Australian equities John Grace said OZ Minerals, Minara and Alumina were also strong performers.

Companies leveraged to increased activity in the resources sector will also make profit gains this year, with Asciano set to benefit from increased coal haulage volumes, while increased mining capital expenditure will boost the revenues of engineering service providers such as Leighton, UGL and Monadelphous.

Outside of resources, sectors that delivered surprise outperformance included the battered listed property trusts, retailers and the media. Goodman Group and Mirvac were among those in the property trust sector which have returned to favour Mr Grace said.

In media, Fairfax and News Corporation provided positive surprises, with the former doing well against expectations especially as it was one of the most heavily shorted stocks going into the results season.

Mr Williams picked News as one of his top three to watch following a well-received annual result where the group exceeded expectations by posting a rise to underlying earnings of 11 per cent to $US4 billion ($4.44bn).

"This stock is priced by US investors and so relative to Australian media companies or other domestic discretionary consumer stocks, its attractively priced," Mr Williams said.

Aviva Investors deputy head of equities Nick Pashias also commented on the situation.

"The reporting season is also giving us some useful insights into general economic trends," he said.

"In Australia, consumer demand seems to be improving, as evidenced by results from Qantas, David Jones and Myer. Other retail related stocks whose results point to better trends in consumer spending include shopping centre operator Westfield, electronic retailer JB Hi-Fi and Coles supermarket owner Wesfarmers."

Woolworths was highlighted by all fund managers as the standout result in its sector and possibly for the season, with a $700 million share buyback on top of delivering a 10 per cent lift in net profit to $2bn, its 11th consecutive year of double-digit profit growth.

Even against such a positive result, Woolworths remained vigilant on cost control, announcing a savings program called Quantum.

Indeed, Mr Hershan said the standout feature of the last reporting season was cost control.

"As we approached this reporting season, there were high hopes that revenue growth would emerge. However, with the exception of the resources sector and some stock specific performances, revenue growth was modest," Mr Hershan said.

Another key highlight of the reporting season was the cash generated by many companies coupled with strong balance sheets.

Mr Cassidy said balance sheets were looking very healthy and that interest coverage was particularly high compared with the last five to 10 years.

"Industrial companies have EBIT interest cover of 10 times and we're forecasting that will rise over the next 12 months," he said.

Australian listed companies excluding banks generated $17.8bn of free-to-invest cashflow in full-year 2010 on Macquarie numbers, which should allow better dividends, acquisition opportunities or even buybacks.

Mr Cassidy said dividend growth during the season was quite flat at about 1 per cent, but that the second half showed improvement. Companies that surprised on the upside for dividends included BHP, Wesfarmers, BlueScope Steel, Newcrest Mining, West Australian Newspapers and Bradken. But Mr Williams was subdued about capital management. "Given we just went through a round of capital raisings and we've just seen companies downgrade expectations, the call for capital management may be premature given the recovery is spluttering along," he said.

Even so, companies across the board had been confident in their own positioning in terms of balance sheet and cost containment, Mr Grace said.

"There should also be a reasonable pick-up in mergers and acquisition activity because companies are in such good shape with good balance sheet strength," he said.

Mr Grace pointed to the recent moves in the market including BHP's $US39bn takeover bid for Potash Corp of Saskatchewan, GrainCorp's merger ambitions with AWB and Harvery Norman's $55m buyout of Clive Peeters.

In the sin bin for results were Telstra, Billabong, Computershare, James Hardie, Worley Parsons and Primary Health Care.

Telstra's warning that earnings could fall by more than $1bn this year shocked investors, who slashed the group's share price by 10 per cent on the day of its results.

Regulatory uncertainty tied to the election did not help, but it was concern over a turnaround strategy that disappointed investors.

"When you look at the five-year transformation plan where Telstra spent about $20bn in capex in that time, patient investors did not see the payoff," Mr Williams said.

"There was seemingly no net benefit from the capex that allows it to invest in the business, that is, invest in price and maintain current levels of profitability."

Telstra, which arguably operates in a non-discretionary market, reported an annual profit loss of 4.7 per cent against falling revenues of 2.2 per cent.

Bell Potter head of research Peter Quinton notes that the overall market is trading on a price-earnings ratio of 11.7 times, well under the norm of 14.4 times.

"In effect the market is telling us that investors don't believe the (current targets) will be achieved and they are factoring in further downgrades," Mr Quinton said.

Corporate Australia may have returned to earnings growth this season, but few in the market will say we are out of the woods.