Words on Reporting Season

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Introduction

Welcome to Words on Wealth, a podcast by Evans and Partners that unpacks the key trends and opportunities shaping markets, the economy and your financial well-being. Join us as we make sense of the issues that matter most to you.

David Hay

Welcome to this week’s edition of Words on Wealth. My name’s David Hay, Senior Investment Advisor here at Evans & Partners. And today I’ll be joined by Robin Young, Executive Director within our research team. We’ve just completed the reporting season for companies on the ASX here in Australia. Today we will cover off some of the key takeouts from this period of time. We’ve had sectors that have performed well post-reporting. We’ve had some that have struggled. So today we’ll take a deep dive into the various sectors and companies and talk about what our key takeouts were. We’ve got plenty to cover with Robin, so let’s get into it.

David Hay

Robin, thanks for joining us today. Welcome, good to see you.

Robin Young

G’day, David, how you doing?

David Hay

Well, my first podcast here, so please go easy. Robin, domestic company reporting season for the first half of this financial year has just been completed. At a top level, what were your key two or three takeouts?

Robin Young

I think from a top down level, we started the year with the market at quite a high valuation level. If we’re about the price earnings ratio relative to history, if we’re about the dividend yield relative to history. And it probably wasn’t a reporting season that justified those kind of expectations, I would say. If I look back at this one relative to the last couple, probably a little bit less positive momentum. If I’m just looking at the stocks that we cover here at E&P, you know, the results, there was slightly more above than below. I’m probably a lot more in line with expectations, I guess. I think looking back at last two reporting seasons, there’d probably been little bit more positive surprise. Then when I looked at the sort of changes in valuation subsequently, again quite balanced between upgrades and downgrades. think looking back we’ve probably been seeing more upgrades to valuations, tilt in that direction. And then lastly not really a lot changing on the recommendation front. We had sort of three downgrades, three upgrades there, four upgrades there sorry. So it was know it was fine but I think we needed more.

David Hay

Yep so is it one of those reporting seasons Robin where if you beat expectations the share price stayed where it was. If you met or disappointed share prices moved based on that, like that historical notion of the market not being shaped, being fully priced and priced to perfection.

Robin Young

Yeah, I think certainly you had a lot of stocks, know, I think the technology sector is a great example of this. I mean, was down 12% in February, it’s down about 13% year to date as we’re recording this, but obviously had a massive 2024. And so you’re coming in at a premium price earnings ratio multiple and so obviously a lot of expectations and if you just came in in line with expectations for your first half 25 result and then also didn’t really change your guidance and people probably looking for more and yeah it’s got you know been a profit taking I think where that was the case and you know tend to be the ones with the surprises to the upside existed would have been those where people already kind of feared the worst they’ve been underperforming going in. And so in that case, if you kind of met expectations, then there was a relief for us.

David Hay

And how about those companies that maybe had a fair result for the first half and promised a good result for the second? Were they given the benefit of the doubt or is the jury still out there generally?

Robin Young

I think as a rule, there’s not a lot of patients around with the market at these levels. We call it the second half club, I think when you’ve got a big kind of skew to the second half in terms of what’s going to deliver your result. And sometimes that’s just seasonal mission of your business. I think one example, you can look at Flight Center, that probably missed on the first half result because the super overriding commissions didn’t come in from the airlines. There wasn’t really any change to the full year expectations, but just that larger second half skewed to the result than normal just means that people took some money off the table and are bit more cautious, given that if suddenly 70 % of your full year money is coming in the second half, it’s probably not surprising that people want to take a bit of a risk off.

David Hay

Yeah, I understand. Let’s have a look at the sectors or some of the sectors if you like. I suppose the two key sectors in our market are financials with the banks and the mining sector. Let’s start with the banks. We have Commonwealth Bank, which has their half yearly result announced. The other three major banks have a trading update if you like. So let’s focus on Commonwealth Bank. Was there a key read you were looking for in a take out here?

Robin Young

So the Commonwealth Bank result, it was a very solid result. It was in line with expectations basically within a percent of what the market was looking for in terms of the earnings and the dividends. But you could argue obviously there’d been a very strong run up in the share price over the past 12 months so did it necessarily provide the positive upside surprise to justify that. Ultimately the stock’s up about 1% in February, it’s down about 3% now year to date. So it does seem that it wasn’t necessarily enough to carry on the positive momentum. mean clearly the management messaging around the result was that they made a choice to invest and to continue to strengthen their franchise and from the long term perspective that’s absolutely what they should be doing. Whether that’s a choice or an obligation is an interesting question. Expenses were up 6% half on half and investment was up about 11%. So, you know, they clearly continue to invest to build their advantage and that’s impressive and that’s what you want to see. And you know, that was clearly strong coming through the result. But the one thing we’ve got to bear in mind here is, you know, the growth of the underlying business, you know, if you take out before they start providing for bad debts, you know, it was up 1.1% year on year pre-provision profit and it’s not that much different from what it was in 2017. I encourage everyone to go back and look at what the comeback shares were trading at in 2017 relative to what they are today. And you’d be surprised if the profit was only at 1% if you look to that share price chart. And then the other thing clearly coming through in that comeback result, I think this is a little bit different maybe with someone like NAB, bad debts have been surprising on the upside for the last 12 to 18 months. And that’s in terms of the provisions the banks take to account for the expected bad debts on their books. Now sort of post COVID, obviously a lot of money thrown around to support businesses and support households. So as a rule for the economic cycle, what we’re seeing is that they’re not having to as many bad debt charges expected. And that’s a positive boost to them, bottom line performance of the banks. At some point, that will normalize. To what extent it will normalize to what we’ve seen over the last 20 years, not clear. I think banks are probably better at underwriting risk than they were. But nonetheless, that has been a positive surprise. In the case of NAB, it wasn’t, and that’s why they’ve sold off more. NAB’s clearly been the underperformer.

David Hay

Before we jump on the net interest margin for Commonwealth Bank, that’s another area I know analysts look at closely. Were they able to hold that net interest margin or did that slip a bit with competition with deposits?

Robin Young

No, they held up pretty well and then they invested further in the business so they probably, I think, suppressed the true margin they could have generated. And bearing in mind where we are on the electrical cycle, that was probably quite a smart choice. So was not a great time for Combank to be blowing the doors off on the result. So the market was pretty comfortable with what they were doing on the margin front. And the other side of that, obviously, was someone at Bendigo Bank, which was sold off really heavily at about 19% in February. And that’s because they grew more than expected, which was good, but it came at the expense of margin returns. And that’s why the share price was heavily dealt with.

David Hay

Coming back to NAB, their trading update, if you like, I’ll say slight, you can define it, was slight, but a slight deterioration in their bad debt outlook. Is that not surprising given they have a different mix of lending, i.e. more to small business, where anecdotally that’s where some of the stress is being experienced?

Robin Young

Yeah, certainly they do have a much higher mix of business banking within their portfolio, less reliance on mortgages, certainly than someone like Westpac or Commonwealth Bank. So yeah, they should probably be feeling that a little bit more, but it was noticeably different relative to everyone else who’s probably been benefiting from that. within that, the volume metrics and the margin metrics, they were fine. They seemed to be on track with what people are looking for, for the first half. But I think people are sort taking that there’s a lot more competition coming through in business banking because returns still appear to be relatively good there, whereas in mortgages and under pressure. So everyone’s kind of coming for the crown jewels, I think, a bit with that. Comeback’s done a fantastic job and now Westpac ends it trying to catch up. And so if NAB isn’t shooting the lights out there, think that’s going to be somewhere where shareholders have questions. And obviously the new news yesterday was that they’ve replaced the head of the business bank with someone from the Bank of Montreal who’s closer to the new CEO. It quite an interesting move, I think, in the scheme of things and one that people will be keeping an eye on.

David Hay

Better keep moving but key tag out there Robin is investors should be just keeping an on their bank exposure and portfolios and the news flow that ensues. The mining sector. I suppose my key question, we starting a cycle of reinvestment for the big miners, BHP and Rio, to have another super cycle in five to seven years time? Is that where we’re at?

Robin Young

Yeah, I think this is a really interesting point to try and break away from the mining sector in terms of what happens in commodity prices this month, this quarter, and actually where they sit on that sort five to seven year view. And our kind of clear view is that we’re in a period of higher capital intensity, which means that there’s not the same room for big dividend surprises because one of the things we’ve got obviously we’re going to meet the challenges of the energy transition that’s incredibly materials intensive, means lots of steel, aluminium, copper etc etc and these guys have got to develop the supply to match this growth and demand that is expected over the medium to long term. So we’re definitely seeing capex budgets moving up across the miners. You know in case of Rio from something like 6 billion a few years back to sort of 9 to 10 billion now and so that means we’re going to get less special dividends we’re going to get less buybacks as a result because they’re doing what they should be doing which is building mining projects. What you’ve got to accept on the other side of that as a shareholder is that you know developing mines, building projects etc etc involves risks you know. Spending too much money, taking too long doing it. So it’s not as comfortable as just sitting there getting excess dividends back. And you look to the early part of this decade, they’ve made some mistakes in the middle of last decade. They were being nice to shareholders to try and buy back trust. Well, now we’ve got this opportunity in front of us for the energy transition. And clearly what we’ve got is a situation developing in a few minerals, particularly copper, I would say, where the expected demand grows as well in excess of where we think the supply is coming from. So in the long term, that’s where, know, always going to be careful throwing out the super cycle word, but is there an opportunity for existing resource holders with long life, low cost assets to start to get higher profitability looking out? I mean yes, definitely. You know, things like Escondida, the big copper mine that BHP and Rio have got, that should be well set up for the next 10, 15 years. And, you know, there’s great opportunities for BHP in South Australia. And, you know, the Mongolian mine, Oia Talgo that Rio has is going through a big expansion phase. It’s going to be the fourth biggest copper mine in the world. That’s going to be a very strong cash flow driver at the back half of this decade. So the medium term story is still interesting. I mean know that people’s timelines around energy transition may be a bit more fluid given geopolitics in the world. But we’re still broadly moving in that direction I think and I still think there’s a strong opportunity for the people owning the good assets which in our case is BHP and Rio to make some good profits in medium term.

David Hay

And is it a matter of both companies having a core iron ore exposure and BHP looking for potash to be the future and Rio looking for lithium to be the future or is that too simplistic Robin?

Robin Young

I think lithium starts to add to Rio also 2030 plus. And it ends up being sort of 10% ish of the business. I mean, let’s not hide from the fact that BHP and Rio, the majority of their earnings will always be driven by iron ore. And I guess some of the upside surprise that we’ve seen in that business over the last five years, you know, that market’s going to gradually come closer towards balance. And so you might not necessarily see some of the super normal profits that we’ve had from that business, but it’s still a sensational business with fantastic return on invested capital. And yes, you have to invest in sustained volumes, but it’s still going to be in the realms of large industrial businesses in terms of generating return on capital, generating free cash flow, one of the better things we can have client money in.

David Hay

good. We’ll get on to the tech. I mean, it’s just a question. take it on notice if you like and maybe it’s too early to answer. A lot being talked around tariffs by the US at the moment. Are either BHP and Rio going to have a direct effect in your view at this early stage from what we know or? But iron ore for instance is not steel, it’s the product that goes into steel. We’ve got to evolve our thinking there, Robin.

Robin Young

Yeah, what we know a bit is the really hard bit there. It’s bit of pin the tail on the donkey.

David Hay

Good analogy.

Robin Young

Things change every hour, every day to some degree. I think it’s the second order effect of it all, the real kind of known unknown, I suppose. And yeah, the one clear area is obviously, say, in the aluminium industry, where someone like Rio has got a lot of operations in Canada that supply people in the US. Ultimately a lot of that volume will get redirected into European markets and what we’ll have instead of aluminium going from Canada to US, that aluminium will go to Europe and the US will be importing from lower tariff places like India and the Middle East. So we’ve just added lot of freight and cost but not necessarily made a lot of sense. The big kind of local winner I’d say is probably Blue Scope, because they have a big steel operation in the US called North Star, I think it is in Ohio, that’ll do well. What you can see is obviously the US prices increasing, given the sort of scarcity value there. The US is a massive net importer of aluminium, for example, where you can see the Midwest premium prices going up. They’re not going to be replacing aluminium production in the US anytime soon.

David Hay

Probably a bit early Robin, it’s topical. it’s worth a comment.

Robin Young

It’s such a moving feast and I think, you know, really hard to make concrete judgments on given how much it changes.

David Hay

Not expecting that. Tech, you wanted to touch on, did we see some profit taking there? And is that a result of reporting season or some of the changes we’re seeing globally in the last six weeks or so?

Robin Young

Yeah, I think certainly initially that, you know, the news out of China on deep seek is just adding more questions to what the path is in AI and how that all develops. so, you know, greater uncertainty isn’t ideal when you’re already trading at quite high multiples. And obviously near term profits aren’t really the drivers of valuation in the sector. It’s where you think these businesses will be in five to 10 years that matters. So it does lead to a lot of volatility in the near term at least. We think of some of the core business franchises. Something like Next DC can be incredibly lumpy. People are looking for contract announcements that weren’t any, therefore the share price result was seen as a of a non-event. Something like Block that’s got some issues in the near term around consumption figures in the US because of a very strong and extreme weather in the US in January. So that’s kind of meant the first quarter guidance wasn’t as high as people were looking for. So that’s caused a few nerves. you know, when you’re high multiple like long growth company, this is kind of no room for error short term things. You know, I don’t think, you know, some of longer term structural drivers are all broadly still intact. And, you know, I think the more the market looks to the deep seek thing the more they realize it just means that you know kind of underpins the base case for compute power and the need for data sensors etc etc and but you know when you’ve had a really strong run-up and there’s not really any room for forgiveness if things aren’t continued to have huge positive momentum.

David Hay

Either from an earnings or announcement point of view. Conscious we’ve sort of concentrated on three sectors and also conscious of time. The industrials part of the market like you know, the Woolworths the Wesfarmers, the Telstra’s, etc. Any sort of brush comment across the bigger industrial names that was a key takeout from reporting season? Dividends seemed to be in line for the first half. Probably earnings weren’t spectacular. Were they solid? Is that fair?

Robin Young

I think it was a good result from Telstra. Clearly the $750 million buyback was a surprise. The tracking on the top end of guidance and certainly I think people are starting to look at to what extent dividends can continue and to maybe grow a bit faster than the current trajectory. And so that kind of mobile oligopoly thesis seems to be playing out. Yeah, in terms of Woolworths, think clearly some issues around the strikes that happened in Victoria at the end of last year have mucked up the numbers a bit. And does seem to be that Coles is probably executing a little bit better as well in terms of what we’re seeing at sales growth numbers that the two put out. So maybe jury out a little bit there. Clearly some execution challenges worse than the result. But by and large, think if we’re talking about the consumer stable kind of companies, I think Tesla was probably the standard.

David Hay

Probably finish off with those that probably we thought were good key takeouts, positive key takeouts from reporting season and those that had share prices disappointed and perhaps result disappointed. Let’s start with those you mentioned, Telstra, that’s probably in the, if you like, the winners or the more positive category. Others, names that were sort of standouts from your point of view?

Robin Young

Well, the best stock in the ASX200 has been A2 Milk, and that’s about 53% year to date. The results had consensus expectations, they lifted the guidance. Dividends are back, talking about capital management going forward, it was a very strong result from them and has been rewarded by the market. Blue Scope, we mentioned that before, another strong result, extended their buyback, a series of growth initiatives and quantified them, which the market liked. Some of that Brambles, again, they’ve continued to deliver on what the business should be doing, raising prices, better productivity, better cash flow, so the market likes that. Those ones where you’ve slightly exceeded expectations, registered gradients, increased confidence, they’ve been the stocks that done well.

David Hay

Yep, okay. And I suppose Robin, finishing up, those that perhaps disappointed the market and largely the share price reflects that with a drop in share price, so maybe two three of those names, and I presume they’re worth considering on a long-term view if the share price has been weak because of earnings disappointment in the short term.

Robin Young

Yeah, so the one that got taken out most severely during February was Viva Energy. They obviously bought a business called On The Run. They’re changing all the sort of Shell stations across to that brand. On The Run’s been an incredibly successful business in South Australia for a long period of time, but that rollout’s taking longer than they expected. The fiscal year 24 result was weaker than people thought, and the guidance for this year was probably about 25% below what people had in mind. So, you know, certainly people want to see some delivery there and convenience retail in their sense they have quite a high leverage to the tobacco space and that’s obviously had some pressures. Block we talked a little bit about from the tech perspective that weakness in the first quarter and quite severe reaction there and down 30% and you know you can look at some of underlying drivers there they do seem to be continuing in terms of the take up of Cash App in the US the growth of Square globally and investors quite nervous about the first quarter numbers and then some of the sort of longer term healthcare names and they have been under pressure and you know results were and you know for a couple of smaller reasons maybe not quite as good as expected you know something like Cochlear the services line was a little weaker and no change to the longer term growth aspirations but just you know earnings coming down three or four percent and you know when you’re on a high price earnings multiple there’s not really a lot of room for disappointment.

David Hay

Do you throw CSL in there?

Robin Young

Yeah CSL is the same thing. you know the sequars business which is the vaccines business that was a slightly weaker result and that was really driven by lower levels of vaccinations in the US there’d be a price competition in that space you know the underlying core business was entirely in line and longer term factors seem to be still strong there. But you know, I think one of the key themes as you mentioned at the start, if you were on, the market was on a high valuation multiple, if you were as a stock or even higher than the market, then you needed to do more than just meet the expectation. And if you missed, then disappointment was gonna be there.

David Hay

Yep. I think I’ve squeezed the lemon enough today, Robin. Thank you for your insight, thanks for your overview, and no doubt any of the names that we’ve chatted about today, people need to, investors if you like, listeners need to speak to their own advisor to get some further detail there. So Robin, thanks for your time.

Robin Young

Thanks, David.

David Hay

And thanks to all the listeners. We’ll see you again soon.

Disclaimer

This podcast was prepared by Evans and Partners Proprietary Limited AFSL number 318075. Any advice is general advice only and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Where this presentation refers to a particular financial product, you should obtain a copy of the relevant PDS, TMD or offer document before making any investment decisions. Past investment performance is not a reliable indicator of future investment performance. Directors, employees and officers at Evans & Partners and its related entities may have holdings in securities listed. Any taxation information is general and should only be used as a guide.