Insights

February marks a pivotal time for investors as ASX-listed companies unveil their half-yearly results. At Morgans, we're thrilled to present our comprehensive Reporting Season Playbook in this edition of The Month Ahead. Bursting with forecasts, company previews, and expert investment insights, our playbook equips you with the tools needed to navigate the upcoming weeks with confidence. Delve into our series of insightful videos where our analysts uncover the stocks poised to surprise investors, both positively and negatively, along with the key emerging themes shaping the market landscape. Stay informed as the results unfold and make informed investment decisions with Morgans by your side.

Technology, Media and Telecommunications Preview

With Nick Harris, Steven Sassine, James Filius and Leo Partridge.

Financials Preview

With Nathan Lead, Richard Coles and Scott Murdoch.

Healthcare Preview

With Scott Power, Iain Wilkie and Emily Porter.

Resources Preview

With Adrian Prendergast, Tom Sartor and Chris Brown.

Consumer Discretionary Preview

With Alexander Mees, Head of Research.

Travel & Tourism Preview

With Belinda Moore and Billy Boulton.

Consumer Staples Preview

With Alex Lu and Belinda Moore.

Morgans clients receive exclusive insights such as access to the latest stock and sector coverage featured in the Month Ahead. Contact us today to begin your journey with Morgans.

Morgans Chief Economist Michael Knox says that Federal Reserve rate cuts later this year will be shaded by a major program of quantitative tightening.

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Morgans Chief Economist Michael Knox walks us through his model for the US Economy using the Chicago National Activity Indicator, which explains 78% of YoY growth in US GDP.

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• Earnings trends remain remarkably stable despite widespread expectations of an impending earnings slowdown. While the 9% rally in the ASX200 and subdued outlook statements might temper some good results, we still see potential upside surprises in February.
• Quantity and quality of earnings will come into focus as the macro takes a back seat to company fundamentals. Key themes to watch include: the risk of hiding in defensives, small-cap/cyclical rotation, focus on cashflow and operating leverage, short selling signals and revisiting REITs.
• Morgans analysts preview the results for 150 stocks under coverage that report in February and call out likely surprise and disappoint candidates from page 10.
• Key tactical trades (page 3) include CSL, ResMed, A2 Milk, Domino’s Pizza, Tyro and Megaport, among many others.

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We reset our strategy following the 9% run since November

We update our strategy heading into February. First on the back of the late surge in 2023, we advocate being opportunistic on pullbacks.

Second, given the ongoing macro concern, we do not think the “focus on fundamental” regime is over - anything other than a path back to historically low rates and plentiful liquidity is likely to keep investors on the hunt for near-term cash and earnings generation. And last, cyclicals typically find valuation support as interest rates come down, providing an attractive alternative to growth and defensives.

Rising rates, recessionary fears and weak investor sentiment provided plenty of reasons for investors to hide in defensives in 2023. However, as conviction around a cyclical peak in interest rates firmed, a rotation to growth and cyclicals ensued late in the year with defensives all underperforming the ASX200.

We continue to favour a rotation away from defensives (telco, staples) as earnings growth broadens across the market.

Look below the surface – solid earnings growth on offer

We see the S&P/ASX 200 index rangebound in 2024. FY24 EPS is forecast to decline 5% before rebounding 5% in FY25, leaving the heavy lifting down to P/E multiple expansion, but at 16x vs the 14.5x 20-year historical average, there is limited scope for further expansion barring a sharp retreat in interest rates.

While we do not expect the index to do much at the headline level, high-level numbers conceal significant variation across sectors. Cyclicals including consumer and commercial services, media, retail and capital goods offer mid-to-high EPS growth into FY24 at lower relative valuations.

Cyclical stocks that look interesting include Acrow, GQG Partners, Alliance Aviation, Baby Bunting and Santos.

Small-caps continue to look constructive

Small-caps have historically bounced hardest upon confirmation of a flattening-out in the rates cycle. Several ingredients remain in place supporting a rebound in this space (rates, trading/fundamentals, sentiment/positioning).

We think the tide is turning for small-caps, and now is an opportune time to build exposure to forgotten small-caps including Helloworld, Credit Corp, IPH Limited, Clinuvel, Veem, Vulcan Steel and DGL Group.

Time to rethink REITs

REITs was the best performing sub-sector of the ASX200 in late 2023 on broadening views that the rates cycle in major economies has likely peaked and that material rate cuts are possible in 2024.

While we still see some earnings risk in Retail and Office that could weigh on the sector and valuations on the balance sheets that could fall in 2024, the downside looks more than priced in when we look at discounts to NTA of 20-40%.

We also expect strong balance sheets to help buffer any falls in book values. Our preferred A-REITs are Goodman Group, Qualitas, HomeCo Daily Needs REIT and Dexus Industria REIT.

Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.

Fixed interest securities offer investors investment income and portfolio diversification and come in many forms.

ASX-listed Corporate and Bank issued securities offer investors the benefit of higher returns than investments such as Government bonds or bank deposits while providing liquidity liquidity via the ASX platform, however they also carry a higher level of risk.

The income paid will be based on either a fixed or floating rate. Investors should understand the three primary sources of risk which are the credit quality of the issuer, interest rate exposure and the specific structural features of a security.

Main characteristics

• face value – is the price at which the security is issued and the amount payable to the investor at maturity/redemption by the issuer
• distribution/dividend/coupon – the income stream payable to investors either quarterly or semi-annually
• maturity/redemption – the date at which holders will be repaid the face value of the security in cash
• conversion – the date when a preference share or other convertible security will convert into ordinary shares in the issuer (assuming the required conversion conditions are met)

Why invest in fixed interest securities?

Fixed interest securities are generally suited to investors seeking income; however where a security trades at a discount to face value, some capital growth over time can also be expected as the security moves back to its face value at maturity. Conversely, where a security is purchased at price above its face value, only the face value will be repaid at redemption.

Investors seeking portfolio diversification should also consider ASX listed Exchange-traded Government Bonds which, while generally paying lower levels of income than bank and corporate securities, carry a lower level of credit risk. This is because all interest payments and the repayment of the bond's face value are guaranteed by the Government. Government bonds also provide significant portfolio diversification benefits. This is because in times of economic stress where shares and other higher risk asset classes might be expected to fall in price, Government bond prices generally rise.

It is very important to read and clearly understand the security issue terms as the securities in this sector vary greatly. Some general advantages and risks associated with investing in fixed interest securities are outlined below:

General features

• known return profile with distributions / dividends / coupons being either fixed or floating in nature
• yields are higher than government bonds and bank deposits
• returns are more predictable than ordinary share dividends, and in the event that they are not paid on these instruments, companies are generally unable to make payments to ordinary shareholders
• franking is often a component of investor returns for preference shares
• issuers are generally known and trusted names
• ASX listing provides liquidity
• price volatility is generally lower than the underlying ordinary share of the issuer

General risks

• preference share / capital note distributions are are subject to the issuer having sufficient distributable profits to make the payment and in many cases are discretionary
• subordinated note coupon payments may be deferred in certain circumstances
• investors are exposed to interest rate risk and market price risk
• returns to the investor upon conversion or preceding conversion may be affected by movements in the underlying ordinary share price
• in the event that the issuer is wound up, investors may receive less than the security's face value if there are insufficient funds following the repayment of higher ranking creditors
• securities issued by the APRA regulated entities i.e. banks & insurers, may in certain extreme circumstances be converted to equity or written-off resulting in financial loss.

Capital Structure

The size and depth of the listed security market has grown over the past few years, from one which consisted largely of hybrid securities to one which now provides investors with access to a range of instruments across the capital structure (with the exception of covered bonds issued by financial institutions).

Senior Secured Debt

If a company is declared bankrupt or enters liquidation, senior secured debt holders are the first to get their money back and most likely 100% of the principal invested. This is because this class of investor or lender has direct and definable security or legal charge over specific assets of the company e.g. mortgage/lien over real property or other assets.

Senior Unsecured Debt

As we move down the capital structure the probability of receiving all of the money invested decreases in the event of a company's failure. The expected level of recovery will vary depending on the initial financial strength of the company but senior unsecured creditors have the first access to the proceeds in the event of liquidation (behind any secured lenders). Most corporate debt is issued on an unsecured basis.

Subordinated Debt

This is another notch down in the capital structure and while still debt with a defined maturity date and interest payment obligations, in the event of wind up, the interests of the subordinated-debt holders will rank behind the senior debt holders (both secured and unsecured). Companies also issue subordinated debt as in many instances rating agencies look favourably on these instruments and provide them with "equity credit".

Capital Notes / Preference Shares

Capital Notes and Preference Shares, often referred to as Hybrids, pay dividends which rank ahead of the payment to ordinary shareholders. These securities follow the sequential nature of risk, just as subordinated debt is subordinate to other forms of debt; hybrids are subordinate to all forms of debt, but generally rank ahead of ordinary equity in the event of a wind-up.

Ordinary Equity

Finally, ordinary equity sits at the bottom of the capital structure. If things turn sour, this is the first call on capital or funding to wear the pain. This arises from the fact that there is no obligation to repay equity or provide any income stream, so companies are breaking no agreements or laws by losing shareholder value or not paying dividends. There are risks associated with moving down the capital structure from senior secured debt to ordinary equity which include:

• a reduction in the security of cashflows
• no recourse against an issuer should payments not be made or capital is put at risk;
• liquidity in the instrument may decrease particularly in times of financial stress
• ranking or priority of claim in the event of the issuer being wound up

Types of listed fixed interest securities

While the major details of fixed interest securities have been outlined above including, the features and risks of investing in this asset class, it is important to understand the differences between the various types of securities on issue.

Download the PDF to learn about the types of securities available, including:

• debt securities
• convertible preference shares
• convertible notes
• reset preference shares
• income securities
• step-up preference shares

This document also has more information on the risks and factors impacting fixed interest securities.

Key terms and their meanings

There are a number of terms used in the fixed interest market which may be unfamiliar to many investors. These are explained below:

• Current price – most recent security price as at the date of publication
• Price target – may be set at a discount or premium to the Morgans assessed fair value depending on a variety of factors
• Cash running yield – is calculated as the cash distribution payable to holders (based on the security’s issue margin plus the one year swap rate) divided by the last traded price of the security
• Gross running yield – is calculated as the cash distribution payable to holders (based on the security’s issue margin plus the one year swap rate) plus franking credits (if applicable) divided by the last traded price of the security
• Yield to maturity/call (YTM/YTC) – investor's expected return having paid the published current price and assuming all distribution payments are made through to conversion. In addition, the calculation assumes investors realise the face value of the security and fully utilise any franking benefits. Income forecast for the calculation of the YTM/YTC is calculated using the interest rate swap curve
• Trading margin – the YTM/YTC minus the relevant swap rate and shows the return premium required by investors to purchase the security rather than investing in bank bills. The relevant swap rate is determined by looking at the maturity/conversion date of the security and matching that to a comparable level along the interest rate swap curve. i.e. if a security has a YTM/YTC of 7.00% and four years to maturity, this would be benchmarked to the four year swap rate (e.g. 4.00%); subtracting this from the YTM/YTC gives a trading margin of 3.00%.
• Accrued distribution – the income accrued to date in the current dividend or distribution period
• Swap rate – this is a benchmark yield that is determined on a daily basis by a panel of banks across a range of terms and provides a benchmark from which a range of financial instruments and transactions are priced

The Australian Bureau of Statistics (ABS) has reported that seasonally adjusted retail sales were $36.5 billion in November 2023, the highest monthly sales number ever reported. This was 2.0% higher than in October 2023 and 2.2% higher than in November 2022. Due to the timing of Black Friday Cyber Monday (BFCM) and the lead-in to Christmas, November is seasonally the biggest sales month of the year. Retailers started their BFCM discounts early in 2023 and ran them for longer, offering even bigger deals than we’ve seen in previous sales periods. This means it is likely some discretionary expenditure was deferred from October to November. We also anticipate that, when they are released on 30 January, the December 2023 sales figures will show a pull forward of sales into November from that month. The strongest performers were Household Goods (especially Electricals and Electronics) and Department Stores.
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November 2023 sales up +2.0% month-on-month
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Retail sales in November 2023 were up 2.0% on a weak October (which itself saw sales down 0.4% on the previous month). BFCM was clearly a success, and so much so that it appears consumers deferred discretionary expenditure they might otherwise have made in October.

Online sales penetration spiked in November, up to 12.7% from an average of 10.6% for the 10 months of 2023 beforehand and 10 bps higher than the 12.6% reported in November 2022. Online sales totalled $4.92 billion, also a new monthly record.

Electrical and Electronic Goods (within the Household Goods category) were the clear standout, with sales in November 14.4% above October. This may be good news for JB Hi-Fi (JBH). Furniture (+9.7%) was also strong, which could be positive for Adairs (ADH), Nick Scali (NCK) and Temple & Webster (TPW).

All major categories of retail sales were in growth on a month-on-month basis, along with almost all sub-categories, with the exception of Hardware (down 0.9%), Takeaway Food (down 0.2%), and Newspapers and Books (down 0.2%).

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November 2023 sales up +2.2% year-on-year

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Clothing and Footwear sales were flat year-on-year (-0.1% to be precise), but all other major categories reported sales that were higher than in November 2022. Eating Out (+4.4%) was up the most, reflecting the effects of food inflation.

Pharmaceuticals and Toiletries were up 8.6% and Electrical and Electronic Goods were up 3.9%. Moving in the other direction were Newspapers and Books (down 10.8% year-on-year) and Footwear (down 3.7%).

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