Trump, Brexit, China, political instability and a string of corporate scandals may have created the impression that corporate Australia faces a gloomy 2017. But earnings forecasts for ASX200 companies over the next three years tell a different story.
Interim reporting season officially kicks off next week and strategists are more bullish on the outlook for earnings growth than they have been in years. This sentiment is being driven by a revived resources sector which has bounced back surprisingly quickly on the back of rising commodity prices.
While earnings downgrades from pallet operator Brambles and Village Roadshow earlier in the week were a reminder that even the most robust companies can surprise on the downside, the general mood going into reporting season is upbeat. Biotech company CSL's upgrade on January 19 underpinned a rise in healthcare stocks.
Equity strategists are predicting a return to market earnings growth in the 2017 financial year following two straight years of declines. They also expect earnings growth to remain in positive territory in 2018 and 2019 although history shows forecasts two years out are largely meaningless.
Citi's Tony Brennan notes an acceleration in earnings upgrades over the last two months which now put market EPS growth forecasts at a healthy 17 per cent this financial year. Morgan Stanley has 2017 and 2018 consensus aggregate earnings growth at 11.5 per cent and 7.5 per cent respectively.
But let's not get the cheerleading squad out yet.
Reliance on commodity prices
Most of this earnings growth will come from resources profits, which are coming off a low base. The rest of the market, including banking and industrials, is expected to deliver flat to modest earnings growth.
This sadly reflects Australia's continued reliance on commodity prices to prop up earnings growth. Resources companies, which are in good shape after some heavy cost cutting and an end to big capital projects, account for one-fifth to a quarter of the market's total market capitalisation.
The banks remain solid but earnings and dividend growth has plateaued, increased competition will put the brakes on profit growth at Woolworths and Wesfarmers and even companies exposed to China's consumer market have hit speed bumps as problems at Bellamy's and Blackmore's have exposed.
Citi expects resource companies such as Fortescue Metals, Woodside Petroleum, Origin Energy and Rio Tinto are more likely to beat expectations than those in other sectors. It notes Wesfarmers, Telstra and Tatts has some of the larger stocks that could disappoint.
There are also high expectations around capital returns in the mining sector, which means investors could be disappointed if companies play it safe with excess cash.
External factors are more likely to determine whether the ASX2000 can hit 6000 by the end of the year than local earnings but they will help.
Citi's EPS growth estimates for the market in 2017 were 17.1 per cent this week compared to 6.9 per cent in September, which indicates how much sentiment has shifted in the last six months.
Most promising
The market declined 11 per cent in the 2016 financial year. Resources make up the bulk of this with an 82.7 per cent earnings lift forecast this year. Strip out resources and Citi expects the market to grow at 4.9 per cent. Outside of resources, the most promising sector is food and beverages with EPS growth tipped at 15.1 per cent in the 2017 financial year followed by utilities at 10.9 per cent. Diversified financials is the only sector expected to go backwards with a 0.5 per cent decline in earnings.
What earnings season will highlight is the lack of genuine growth in the ASX200 outside those companies relying on commodity price rises. The energy sector is a potential exception and there will always be the outstanding turnaround stories or rare innovators such as Don Meij's Domino's Pizza. The best investors can hope for is modest earnings growth and that global sentiment does not go backwards under a Trump presidency.
Global volatility means Australian boards continue to take a conservative approach to investment decisions with Asia seen as too risky despite the obvious rewards. This is an era where most companies have stripped out costs and ridden out the post-2007 volatility so the new challenge is finding growth in a low-growth world.
About 150 companies will report results over the next four weeks, peaking in the final fortnight. Resmed was first off the block on Tuesday. Next week is really only a warm up with Navitas reporting on Tuesday and James Hardie on Friday before the majority of companies start reporting the week after.
Tony Boyd is on leave
