Will the momentum continue? – Themes to watch for this reporting season

The February reporting season was the strongest in 20 years, underpinned by record earnings upgrades. But can the momentum continue? With August earnings approaching, Morningstar Head of Equity Research Peter Warnes says the news is likely to be mixed this time around and provides some tips on what to look out for to ride the global recovery.

In a client note in March, Morningstar analysts increased fair value estimates[i] on 34 companies by 5% or more, while trimming just five.

Global recovery supportive but outlook patchy

Morningstar Head of Equity Research Peter Warnes expects a “reasonable reporting season” in August, but cautions investors not to “expect companies to shoot the lights out”. Results will be patchy with some “fairly strong results but not across the board”, with some sectors such as online retail businesses likely to post better results compared with others such as hospitality and travel industries.

A key theme will be the possibility of a global recovery, which he says will bode well for the outlook for many businesses. Findings from the World Bank estimates the global economy is expected to expand by 5.6% in 2021, the fastest post-recession pace in 80 years, led by a robust recovery in the US and China. According to Warnes, the sectors best positioned for this recovery are the energy and resources industries.

Iron ore, oil prices shine light on resources

Warnes described iron ore producers BHP Group (ASX:BHP), Fortescue Metals (ASX:FMG) and Rio Tinto (ASX:RIO) as the “rock stars” in the February reporting season. The combined fully franked dividend delivered by the three big miners was almost $9.85 billion, accounting for nearly 50% of the total dividends of the top 30 companies.  He expects “much of the same” for the remaining year, underpinned by record iron ore prices that are still hovering around the $200 mark and continued demand from China.

A recovery in oil prices will also support the earnings of Oil Search (ASX: OSH), Santos (ASX:STO) and Woodside (ASX:WPL), and for Warnes, if global economies start to grow, “energy will be at the front of the benefiting queue”.

Online retailers set to outperform

Key highlights in the February reporting season included strong results from Coles (ASX:COL) and Woolworths (ASX:WOW). Both reported strong sales growth boosted by significant increases in online shopping. Wesfarmers (ASX:WES) was another standout driven by Bunnings and strongly supported by solid performances from Kmart Group and Officeworks as home offices grew from the work-from-home orders.

Remote working practices also saw home offices ungraded, boosting electronic, office-related and home entertainment equipment sales, providing boom conditions for both JB Hi-Fi (ASX:JBH) and Harvey Norman (ASX:HVN), both of which reported record profitability.

However, with the rollback of fiscal support measures such as JobSeeker and JobKeeper, and delays in the rollout, the latter part of the year could be challenging, he says.

“Profit results for the supermarkets will remain solid, however we are expecting sales growth to slow in the first quarter,” Warnes said.

The online businesses will probably do better than the bricks and mortar, Warnes says adding that people are now more comfortable with online shopping following COVID-19. This will only continue to drive sales through online shopping, he says.

Stocks poised to benefit from local economic recovery

Traditional media business including News Corp (ASX:NWS), Nine Entertainment (ASX:NEC) and Seven West Media (ASX:SWM) are also positioned well from a recovery in the advertising market, according to Warnes. New media including carsales.com (ASX:CAR) will do well off the back of a stronger car sales market while Domain (ASX:DHG) and REA Group (ASX:REA) are both forecast to post solid results amid a robust real estate market. 

Data from Commercial Radio revealed a strong rebound in advertising in the June quarter with television and radio advertising up nearly 60%, and digital advertising up 20%.

This was underpinned by solid business confidence. According to the National Australia Bank’s national business survey, business confidence retreated by three points in May, but remained high at 20 points.

COVID-19 tailwinds

In the industrials space, Warnes highlights ARB Corp (ASX:ARB) to be a standout. ARB fits accessories for four-wheel drive vehicles and is well positioned to benefit from international border closures and a surging local travel.

Results in the health care sector will also remain solid and Warnes expects the continued response to COVID-19 boosting pathology operations of Healius (ASX:HLS) and Sonic Healthcare ASX:SHL). He also expects Ramsay Health Care (ASX:RHC) will post a positive result as surgeries start to pick up.

Juicy dividends in the pipeline? 

With dividend and balance sheets in good shape, Warnes expects dividend payouts to be higher. “It just depends on how aggressive the companies want to get. Corporate debt is pretty well under control and company balance sheets are in pretty good shape,” Warnes said, adding that companies remain reluctant to invest, which could mean higher dividends for shareholders. 

One sector that could be posting higher dividends or buybacks are the banks. Banks have steadily grown their capital following their decision to offload their wealth management businesses over the past five years. Warnes welcomed this decision to “sell off the mistakes they have made in the past 20 years” and now expects buybacks in the pipeline particularly after the pause in dividends back in 2020 as the health pandemic unfolded.

On Morningstar’s numbers, the four major banks are sitting on $34 billion in excess capital. “We think most of it should be returned to shareholders, Warnes said adding that if the excess is used to boost the dividend payout ratio to 100%, and the remainder goes toward buybacks, the majors would trade on fully franked dividend yields of around 6%.

“We think the Commonwealth Bank could kick things off as soon as August with an approximate $5.5 billion off-market buyback,” Warnes said. However, he cautions that the bank's conservatism around loan loss provisioning and dividends during 2020 and 2021 suggests there is a possibility that shareholders may need to wait until 2022. The other major banks report their full-year results in October and November.

Lockdowns for longer a risk to outlook

In late June, New South Wales went into a lockdown in response to the emerging delta variant in COVID-19. At the time of writing, the state was expected to extend the lockdown. While Warnes acknowledges that the lockdown will not impact the reported earnings of companies, if extended, it will have implications for the outlook for businesses if unemployment ticks up and people have less to spend.

However, the growth outlook remains robust, according to Warnes.  He highlights that the 2021-22 Australian federal budget, released in May 2021, forecasts real gross domestic product (GDP) growth, excluding the impact of inflation, to gradually recover to around 2.5% per year over the next two years.

“I do not expect these forecasts to be materially impacted by the latest lockdowns as vaccination rates are increasing and COVID-19 cases remain low. Our expectation is for lockdowns to likely be reversed reasonably quickly.”

[i] The Morningstar Fair Value Estimate tells investors what the long-term intrinsic value of a stock is, helping them see beyond the present market price.