As the economy slowly grinds down, the next month or so will give a glimpse into how our publicly listed companies are bearing the brunt of rising input costs, supply chain bottlenecks, labour shortages and recession fears.
- Rising input costs, higher wages and labour shortages are likely to weigh on company results
- Expect reasonable current market conditions to transfer to a bleaker outlook
- Shareholders advised to temper dividend expectations as companies keep cash it the kitty
It is annual profit-reporting season, the time of year when companies on the ASX open their books for all to see just how well, or otherwise, they have been performing.
But the big theme this time is not so much about looking back at the year, but more likely to be all about looking forward, as businesses face increasing costs and uncertainty about the future.
Just like households, in the past six months or so, many businesses have been facing surging input costs and an inability to access adequate supplies, which will weigh on their profit margins.
“Margin degradation, I think, is going to be a huge theme during this reporting season,” RBC Capital’s head of equities Australia, Karen Jorritsma, said.
“I think it’s a case of the market having to get used to margins potentially going backwards for the first time in a long time.”
BetaShares chief economist David Bassanese explained a range of factors are weighing on companies.
“Energy prices have been going up, both gas prices and oil prices, [and that is] helping the energy sector, but [for] other sectors that are consumers of energy, it’s obviously going to hurt them,” Mr Bassanese observed.
“With rising interest rates, the borrowing costs faced by corporations are really going up as well.
“And wages pressures, we haven’t seen a lot of it in the official statistics as yet but, certainly, anecdotally, businesses are talking about labour shortages and rising wage pressures.”
Which could mean a fall in new employment.
“I think, certainly, in the hiring, we may see a pulling back and businesses will continue to rationalise where they can,” Mr Bassanese predicted.
‘Line in the sand’ between now and the future
All of those headwinds will impact company profits, warned UBS equity strategist Richard Schellbach.
“Much the same as last year’s reporting season, a highlight, or rather a low light, will be the inability of companies to maintain profit margins,” Mr Schellbach said.
“When you have input cost pressures, mapping over with a slowdown in revenue, you obviously have difficulty in terms of maintaining profit margins.”
JB Were chief economist Sally Auld said that, as cost pressures continue to rise for both business and consumers, the flow-on impact in coming months could really start to bite.
“I think there are some question marks about the sustainability of consumer demand, just given everything we know that’s going on with rises in interest rates and what’s happened to real incomes growth in the household sector,” she said.
“I think it’ll be a reporting season that really draws a line in the sand between, what is probably going to be a pretty solid six months for earnings growth and, looking forward, what is likely to be a far more difficult and far more uncertain environment for earnings growth.”
The winners and losers
Each reporting season tends to reveal some big wins and big losses and our experts predict the divide may be even larger than usual this year.
“There is very significant divergence between the sectors that have done well — obviously energy would be a big part of that, and the commodity exporters — and sectors that haven’t done so well, such as consumer discretionary, where the markets really started to worry about the resiliency of the household sector,” Ms Auld said.
Mr Schellbach said there was no question where the strongest results would come from.
“The miners and energy stocks, their earnings over the last 12 months are up 100 or 200 per cent, and that is really what has driven the strong profit growth across corporate Australia.
“So, from a pure profit growth point of view, they will no doubt be the winners.
“At the other end of the spectrum, our concerns are focused on stocks exposed to the domestic consumer and also the housing cycle, so that would be retailers and building material companies.”
Maple-Brown Abbott co-portfolio manager Phillip Hudak said the divergence would not just be about sectors.
He said companies that have not been able to pass their cost increases through quickly to their customers would not have strong numbers.
He added that companies that over-earned during the COVID-19 period would be in for some bad news too.
“Some great examples would be many of the retail companies, including the e-commerce players, which may see their revenue and earnings and, on top of that, their higher-than-expected margins that they’ve been able to generate over this period, mean reverting reasonably quickly.”
It’s all about the future
Analysts predict that, while conditions have recently started deteriorating for many businesses, first-half numbers should be enough to see most companies deliver solid results for the 2021-22 financial year.
“Current demand is holding up, although there are significant risks of a slowdown emanating over the next six to 12 months,” Mr Hudak said.
Mr Bassanese agreed this year’s results will mostly be sound.
“In the main, the economy has been strong, consumer spending has been strong and businesses have faced cost pressures, but they’ve been able to pass them on through higher prices.
“So it wouldn’t surprise if the overall earnings results for the half were pretty good.”
It is the 2022-23 financial year outlook to watch out for, with many companies likely to choose not to provide forecasts.
“Forward guidance will be heavily scrutinised by the market,” Ms Jorritsma said.
“Everyone’s going to be looking for any kind of comments from management around whether they anticipate a recession.
“I personally don’t think that CEOs or corporates are going to be in a position to state whether we’re seeing a recession or not, at this point, it’s probably not in their best interest to do that.
“But what they will be talking about is outlook for order books, whether they’re seeing any type of impact on the consumer from what we’re seeing from rates and petrol prices.”
Mr Hudak said the outlook was “cloudy” and that he expected many would keep their cards close to their chests.
“The watch point for investment markets is on those forward-looking outlook statements, but what I do expect is a lower number of companies to provide guidance for FY23.”
He tipped that many would instead opt to give trading updates in the first six to eight weeks of the financial year.
Mr Schellbach expected to see a lot of talk about recession.
“What has become more apparent now are concerns around a slowing economy and the potential for an economic recession both here and offshore,” he said.
“Almost every management team will make specific comments on where they see the Australian domestic economy tracking and also where [they] are seeing the economic environment globally tracking.”
“I think more than we’ve probably seen in recent reporting seasons, the outlooks by many companies will be quite cautious,” Mr Bassanese said.
“We do face a significant increase in interest rates. We face a slowing global economy and our own economy is likely to sort of slow after the post-COVID bounce we’ve been enjoying.
“While the actual earnings may well be OK for the first half of the year, I think the outlook statements may put a bit of a dampener on sentiment.”
All that isn’t great news for shareholders
Companies are likely to keep a little more cash in the kitty to head off the risk of a looming recession.
“Those days of special dividends coming out of the resource sector, for instance, probably are over, when you consider what’s going on with commodity prices and you think about what’s happening with a cost line there,” Ms Jorritsma advised.
“I think the corporates are going to be much more in the business of managing those issues, rather than necessarily paying back to the market.”
Ms Auld has a similar view.
“It probably does make sense to be more conservative than not when it comes to dividend payouts,” she said.
“So, while it’s not our expectation that investors should be preparing for a large reduction in dividend payouts, I think it does make sense just to be a little bit cautious and a little bit conservative around what sort of numbers we can expect.
“One would suspect, if we do go into some sort of global recession over the next six to 12 months, then that would be the sort of environment where I think boards would get pretty conservative in terms of dividend payouts.”