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Australian reporting season — the devil is in the detail

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Australian reporting season — the devil is in the detail.

Larry Williams:
Manuel Australian companies concluded their reporting season last week — they appeared to do well, how did it go for them in your view?

Manuel Greenland:
I think the numbers indicate that it went well as the number of companies beating profit expectations well exceeded those disappointing. We saw a little less than half the market beat the consensus earnings, compared to about a third that missed what analysts had expected. From a sector point of view Financials and Industrials did better than Resources companies, which you'd expect given the pressure we've seen on commodity prices.

Larry Williams:
Well that's positive — so you'd conclude that Aussie companies are generally doing better than expected?

Manuel Greenland:
Yes and no — while significantly more companies beat rather than missed profit expectations, the margin of beats looking at sales revenue expectations was much lower. So the inference is that companies showed better than expected profitability by cutting costs rather than by growing sales. While cost cutting is good in as far as it makes companies leaner and more efficient, there is a limit to how much companies can cut costs before they negatively affect their ability to business — essentially you can cut only so much fat before you start cutting muscle. It is starting to look like Aussie industrial and financial companies may have reached this limit now meaning that further earnings growth really does rely either on the companies themselves finding ways to grow sales, or demand in the general economy coming to the rescue.  

Larry Williams:
So without some demand growth then the outlook is bleaker?

Manuel Greenland:
I think that is right for the average company yes. Two significant trends we've noticed talking to Aussie companies are firstly that there are early signals that profit margins are contracting. So the companies are saying "look we've supported profitability by cutting costs, but we can't cut costs anymore and our sales revenues are under pressure". So although this result was still strong from a profitability point of view, we would not be very surprised to see some pressure on profit margins over the next while. The second very obvious trend through the results was companies downgrading their full year guidance — so saying "we've done well for the first half, but expect us to do a little less well in the second half" — again indicating that in the main management is feeling like they have done everything they can and need demand to return.

Larry Williams:
So the economy is not in great shape and companies need demand to come back — how do you invest in that environment?

Manuel Greenland:
Look it's never easy, I can talk to how we view it and how we invest. Firstly we want to be invested in companies that have true sustainable competitive advantages so that even if the general pot of available earnings is under pressure, truly strong companies can increase their share of that pot because they are more competitive. Secondly we want to be invested in companies exposed to niches that are still growing, so that they do enjoy the benefit of growth markets even if the general economy is having a hard time. Finally we have consciously moved away from companies that are dependent on a single product or distribution channel to drive sales, and invested more in companies that face a wider sales opportunity set and are better diversified. Our portfolio enjoyed a higher proportion of positive surprises than the market average through the result, so this approach is working well for us so far.

 

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