Insights

Insights from the Reporting Season Wrap

Dive into the latest edition of The Month Ahead as we dissect the insights gleaned from the recent reporting season. Amidst the influx of information, we've identified three standout companies that emerged with promising investment prospects from their biannual earnings reports in February. Discover why Australia’s leading lottery operator, The Lottery Corporation, along with salary packager Smartgroup, and essential services provider Ventia deserve your attention as potential investment opportunities.

Smartgroup

If you haven’t heard much about the Government’s Electric Car Discount Policy which was introduced in November 2022, it has started to gain early traction and you’re likely to hear more as the number of electric vehicles (EVs) purchased in Australia increases. In Australia, EV sales made up ~3% of total vehicle sales in 2022 and this is set to rise, as it has in many other countries, on the back of policy-led demand. On part of the policy will allow many employees to take up EV ownership via salary-sacrifice (a novated lease) in a tax advantaged manner (this is not tax advice) to lower the cost of an EV versus a traditional vehicle.

One segment of the market which is set to directly benefit from the policy and the evolving focus on sustainability is the fleet managers and salary packaging businesses. Smartgroup (SIQ) operates in the segment as one of the two largest salary packers in Australia (alongside McMillan Shakespeare). Smartgroup has faced several pressures in recent years which have seen earnings fall from highs set in 2019. Pressures have included COVID-19 disruption, supply issues, wage inflation and heightened competitive activity (including a large contract loss). Despite this, Smartgroup has delivered solid profitability and the strength of the balance sheet has allowed special dividends in recent years (Smartgroup announced that there will be a special and ordinary dividend payment at the time of writing). Whilst some pressure remain, stronger EV demand should flow directly into the uptake of novated leasing; SIQ’s core offering and revenue driver. The stock has had a reasonable share price run of late and trading back broadly in-line with its average multiple however earnings now have a tailwind. As with all small/mid-cap companies, risks around execution exist.

In its recent result release, Smartgroup stated ‘there has been a significant uptick in EV demand since the introduction of the Electric Car Discount Policy in November 2022, with an increase of c.270% in novated leasing quotes for EVs in Q4 2022 compared to average EV quotes in Q1 to Q3 2022. The legislative change makes leasing of electric vehicles more appealing, and we have seen strong interest from all segments, particularly from our government and corporate clients, presenting a significant opportunity for Smartgroup.'

The Lottery Corporation

Last year's demerger of Tabcorp resulted in the spin-off of a powerful lotteries and Keno business into a separately listed vehicle called The Lottery Corporation (TLC). The business has long been one of the highest performing lottery companies in the world. This is the fact that was underlined by an impressive first half earnings result last month that saw EBITDA rise by 16% to more than $400m. The excitement generated by a $160m Powerball jackpot during the period was a huge positive for customer demand.

The Lottery Corporation has long dated and exclusive licences to operate lotteries all over Australia (except for Western Australia). Lottery ticket sales are resilient to cyclicality and there is even some evidence that demand may even increase in an economic downturn. As The Lottery Corporation’s CEO commented last month 'history says demand for our products is quite resilient and relatively inelastic compared to other consumer products (and) we're not seeing anything in recent trading that fundamentally changes that view.' The Lottery Corporation’s cash flows are steady and predictable and there is a low ongoing need for capital. These characteristics mean we expect The Lottery Corporation to be able to continue pay a fully franked ordinary dividend at a very high payout ratio, while still paying down debt steadily. This may create the opportunity for future capital management over and above the special dividend declared last month.

We have an ADD rating on The Lottery Corporation and a $5.60 target price, which has already increased by 20c since we initiated coverage last year.

Ventia

Ventia (VNT) is one the largest providers of essential services in Australia and New Zealand. It ensures infrastructure assets function safely and efficiently throughout their lifecycle by offering the full range of operations and maintenance services, as well as facilities management, environmental services and minor capital works. Ventia works predominately with the government (77% of revenue). It has an average contract tenure of 5.4 years and direct inflation passthrough in most contracts. The industry grows at 6-7% p.a., with Ventia growing 7-10% through industry growth and contract expansion. Margins should remain stable, potentially delivering dividend growth of high single digits. The stock has a current dividend yield of nearly 7% growing at mid-single digits and trades on an undemanding forward price/earnings ratio of 10-11x.

In the recent result, Ventia’s CEO Dean Banks said: ‘Ventia’s Board and Management anticipate continued stable and considered growth. We expect revenue and earnings momentum will remain as the demand for essential services, underpinned by recent record infrastructure spend continues. Ventia’s business fundamentals and differentiated strategy provides a strong business outlook. This gives us confidence to today announce our 2023 guidance range for NPATA growth of 7-10% compared to FY22 pro forma NPATA.'

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Dalrymple Bay (ASX:DBI)

The FY22 result delivered the substantial earnings growth we were expecting following finalisation of Terminal Infrastructure Charge (TIC) negotiations in 2H22. DPS guidance had already been provided and was unchanged (albeit the growth outlook was not reaffirmed).

Add retained, given forward cash yield of mid-8% and c.6% price growth potential.

TPG Telecom Limited (ASX:TPG)

TPG FY22 result was, pleasingly, inline with expectations. Revenue was up 1.5% YoY and Underlying EBITDA was up ~4% YoY to $1,793m.

TPG delivery subscriber, ARPU and EBITDA growth. We retain our Add recommendation.

Stanmore Resources (ASX:SMR)

Key CY22 financials easily beat our expectations on higher PCI price realisations. We now forecast SMR to reach a net cash position during the 1H23.

SMR enjoys clear M&A advantages in the Bowen Basin and we think positioning for possible acquisitions will far out-rank dividends through 2023.

Bega Cheese (ASX:BGA)

As expected, BGA's 1H23 result was weak with NPAT down 74%. Margins were materially impacted by higher milk and other inflationary costs and the lag impact of implementing price rises.

While we continue to have concerns about the dairy industry, we think BGA is now through the worst of it. We rate BGA's new management highly and expect them to deliver improved returns over the coming years. We upgrade to an Add rating.

Airtasker Limited (ASX:ART)

ART released its 1H23 result. While most metrics were pre-released, GMV growth of +58% on pcp (to ~A$132m) and revenue growth of +57% on pcp (to ~A$22m) was a resilient performance from the local services marketplace, in our view.

Whilst some softness was seen at top-of-funnel demand (posted tasks) as consumer confidence remains subdued on macro uncertainty, we note supply side normalisation (labour) has begun and assisted completion rates and helped underpin ART's GMV growth.

Waypoint REIT (ASX:WPR)

WPR's FY result was in line with guidance with the focus in 2022 on non-core asset sales; capital management initiatives (buy-back completed); and balance sheet (hedging +90%).

CY23 distributable EPS guidance to be in line with CY22 which equates to a distribution yield of +6%. We retain an Add rating.

Ai-Media (ASX:AIM)

AIM's 1H23 result was broadly in-line with our expectations. The company booked revenue of $29.7m for the year.

More importantly, AIM's gross profit dollars increased YoY and HoH. We calculate that gross profit for SaaS (and other) was ~53% of total growth profit. Since its nearly double the margin of legacy and growing much faster this means AIM has cleared the critical inflect point in its transition to a SaaS business.

Growing profits gets much easier from here. Add recommendation retained.

Kina Securities Ltd (ASX:KSL)

KSL's FY22 Underlying NPAT (PGK106m) was +10% on the pcp and in-line with MorgansE. Overall, we saw this as a broadly solid FY22 result, with bad debts well contained and KSL delivering an impressive ~18% FY22 ROE.

KSL continues to deliver solid underlying profit growth, and trading on ~6x FY23F earnings and a >10% dividend yield, we see the stock as too cheap. Add maintained.

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Coles Group (ASX:COL)

COL's 1H23 EBIT was above our forecast but was driven by lower-than-expected D&A. At the EBTDA level, the result was broadly in line with our expectation.

We make minimal changes to FY23-25F group underlying EBIT with upgrades to Supermarkets offset by downgrades to Liquor and the removal of Express.

We maintain our Add rating.

Seek Limited (ASX:SEK)

It was broadly a positive result, in our view, however job ad volume growth moderating in 2H23 (particularly ANZ), whilst not unexpected, looks to be a factor in guidance being set at the lower end of previously flagged ranges.

We adjust our FY23F-FY25F EPS by -5%-+1% factoring in the revised guidance, lower topline estimates across our forecast period on additional conservatism and improved EBITDA margins in SEEK Asia. Add maintained.

HUB24 Ltd (ASX:HUB)

HUB reported above expectations.

HUB looks to be delivering 'cleaner' financials; the product offering is industry leading (along with NWL); and the runway to secure more clients looks intact. Whilst upside to our valuation is reasonably low, the potential for larger 'transitions' wins is a realistic catalyst within CY23. Add maintained.

Monash IVF Group Ltd (ASX:MVH)

MVF posted a solid 1H23 result of underlying NPAT of A$12.6m which was slightly ahead of guidance. Despite industry volumes declining in the half, MVF continues to gain market share in its key markets through both organic growth and through acquisitions.

We have made minor changes to our forecasts, adjusting our cost base down slightly. We maintain our Add recommendation.

Peter Warren (ASX:PWR)

PWR's 1H23 result was broadly in-line, however showed the impact of higher opex flowing through.

PWR is trading on ~11x our assumed more 'normalised' conditions (FY24/25). Industry consolidation will continue - we expect PWR to be a participant which adds to structural earnings capacity. Adding Toyota is a potential s-term catalyst.

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Endeavour (ASX:EDV)

EDV's 1H23 result was comfortably ahead of expectations with Retail margin performance the key standout.

In our view, the result highlighted management's ability to control costs despite inflationary pressures. While the regulatory environment remains uncertain, on balance, we think the risks lie to the upside with the underlying business performing well. We upgrade our rating to Add (from Hold).

Aurizon (ASX:AZJ)

1H23 earnings (EBITDA -7% on pcp, EPS -34%), cashflow, and DPS (-33% on pcp) were below expectations, and FY23 EBITDA guidance was downgraded 4%.

Implies both attractive valuation metrics and a share price rebound as the market digests the one-offs affecting FY23. We think there is both potential price upside and reasonable yield at the current share price (more attractive looking into FY25F). Upgrade to Add (from Hold).

JB Hi-Fi (ASX:JBH)

The 1H23 result was in line with JB Hi-Fi’s January preannouncement. We have made no major changes to our estimates, increasing our FY23 EPS forecast by 1.6% and reducing our FY24F EPS forecast by 2.5%.

We retain an Add rating.

Beach Energy (ASX:BPT)

BPT delivered a soft 1H23 result, down 10% on pcp, driven by cost increases and production declines. Guidance for FY23 has been downgraded with production reduced by 7% and field operating costs up by 12%.

FY24 production guidance to be provided at the full year result but management clarified that legacy aspirational targets are no longer relevant.

We retain our Add rating.

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Our best ideas are those that we think offer the highest risk-adjusted returns over a 12-month timeframe supported by a higher-than-average level of confidence. They are our most preferred sector exposures.

New additions this month: CSL Limited (ASX:CSL), Qantas (ASX:QAN), Mineral Resources (ASX:MIN) and Megaport (ASX:MP1).

Removals: BHP Group (ASX:BHP), AGL Energy (ASX:AGL), Incitec Pivot (ASX:IPL), Healius (ASX:HLS) and IDP Education (ASX:IEL).

Large cap best ideas

Commonwealth Bank (ASX:CBA)

The second largest stock on the ASX by market capitalisation. We view CBA as the highest quality bank and a core portfolio holding for the long term, but the trade-off is it is the most expensive on key valuation metrics (including the lowest dividend yield). Amongst the major banks, CBA has the highest return on equity, lowest cost of equity (reflecting asset and funding mix), and strongest technology. It is currently benefitting from the sugar hit of both the rising rate environment and relatively benign credit environment.

Westpac Banking Corp (ASX:WBC)

We view WBC as having the greatest potential for return on equity improvement amongst the major banks if its business transformation initiatives prove successful. The sources of this improvement include improved loan origination and processing capability, cost reductions (including from divestments and cost-out), rapid leverage to higher rates environment, and reduced regulatory credit risk intensity of non-home loan book. Yield including franking is attractive for income-oriented investors, while the ROE improvement should deliver share price growth.

Wesfarmers (ASX:WES)

WES possesses one of the highest quality retail portfolios in Australia with strong brands including Bunnings, Kmart and Officeworks. The company is run by a highly regarded management team and the balance sheet is healthy. We believe WES’s businesses, which have a strong focus on value, remain well-placed for growth despite softening macro-economic conditions.

CSL Limited (ASX:CSL) - New Addition

A key portfolio holding and key sector pick, we believe CSL is poised to break-out this year, a COVID exit trade, offering double-digit recovery in earnings growth as plasma collections increase, new products get approved and influenza vaccine uptake increases around ongoing concerns about respiratory viruses, with shares offering good value trading around its long term forward multiple of 31.5x.

Treasury Wine Estates (ASX:TWE)

TWE owns much loved iconic wine brands, the jewel in the crown being Penfolds. We rate its management team highly. The foundations are now in place for TWE to deliver strong earnings growth from the 2H22 over the next few years. Trading at a material discount to our valuation and other luxury brand owners, TWE is a key pick for us.

ResMed Inc (ASX:RMD)

While we expect the next few quarters to be volatile as COVID-related demand for ventilators continues to slow and core sleep apnoea volumes gradually lift, nothing changes our medium/longer term view that the company remains well-placed as it builds a unique, patient-centric, connected-care digital platform that addresses the main pinch points across the healthcare value chain.

Santos (ASX:STO)

The resilience of STO's growth profile and diversified earnings base see it well placed to outperform against the backdrop of a broader sector recovery. While pre-FEED, we see Dorado as likely to provide attractive growth for STO, while its recent acquisition increasing its stake in Darwin LNG has increased our confidence in Barossa's development. PNG growth meanwhile remains a riskier proposition, with the government adamant it will keep a larger share of economic rents while operator Exxon has significantly deferred growth plans across its global portfolio.

Macquarie Group (ASX:MQG)

We continue to like MQG’s exposure to long-term structural growth areas such as infrastructure and renewables. The company also stands to benefit from recent market volatility through its trading businesses, while it continues to gain market share in Australian mortgages.

QBE Insurance Group (ASX:QBE)

With strong rate increases still flowing through QBE's insurance book, and further cost-out benefits to come, we expect QBE's earnings profile to improve strongly over the next few years. The stock also has a robust balance sheet and remains relatively inexpensive overall trading on 9x FY23F PE.

Transurban (ASX:TCL)

TCL owns a pure play portfolio of toll road concession assets located in Melbourne, Sydney, Brisbane, and North America. This provides exposure to regional population and employment growth and urbanisation. Given very high EBITDA margins, earnings are driven by traffic growth (with recovery from COVID) and toll escalation (roughly 70% by at least CPI and approximately one-quarter at a fixed c.4.25% pa). We think TCL will continue to be attractive to investors given its market cap weighting (important for passive index tracking flows), the high quality of its assets, management team, balance sheet, and growth prospects.

Telstra (ASX:TLS)

After a major turnaround, TLS has emerged in good shape with strong earnings momentum and a strong balance sheet. In late CY22 shareholders vote on Telstra's legal restructure, which opens the door for value to be released. TLS currently trades on ~7x EV/EBITDA. However some of TLS’s high quality long life assets like InfraCo are worth substantially more, in our view. We don’t think this is in the price so see it as value generating for TLS shareholders. This, free option, combined with likely reputational damage to its closest peer, following a major cybersecurity incident, means TLS looks well placed for the year ahead.

Qantas Airways (ASX:QAN) - New Addition

QAN is now our preferred pick out of our travel stocks under coverage given it has the most near-term earnings momentum. Looking across travel companies globally, airlines are now in the sweet spot given demand is massively exceeding supply. QAN is trading at a material discount compared to pre-COVID multiples, despite having structurally higher earnings, a much stronger balance sheet, a better domestic market position, a higher returning International business and more diversification (stronger Loyalty/Freight earnings). The strong pent-up demand to travel post-COVID should result in a healthy demand environment for some time, underpinning further EBITDA growth over FY24/25. QAN’s balance sheet strength positions it extremely well for its upcoming EBIT accretive fleet reinvestment and further capital management initiatives (forecasting a A$400m on-market share buyback to be announced at 1H23 result). There is also likely upside to our forecasts and consensus if QAN achieves its FY24 strategic targets.

Aristocrat Leisure (ASX:ALL)

We have three key reasons for being positive on ALL. They are: (1) long-term organic growth potential. ALL is better capitalised than many of its competitors and has what we regard as a strong platform to continue investment in design and development in both its land-based gaming and digital businesses; (2) strong cash conversion and ROCE. ALL is a capital-light business despite its ongoing investment in Gaming Operations capex and working capital. It has a high level of cash conversion and ROCE and (3) strong platform for investment. ALL has funding capacity for organic and inorganic investment in online RMG, even after the recent buyback. Its current available liquidity is $3.8bn.

South32 (ASX:S32)

S32 has transformed its portfolio by divesting South African thermal coal and acquiring an interest in Chile copper, substantially boosting group earnings quality, as well as S32's risk and ESG profile. Unlike its peers amongst ASX-listed large-cap miners, S32 is not exposed to iron ore. Instead offering a highly diversified portfolio of base metals and metallurgical coal (with most of these metals enjoying solid price strength). We see attractive long-term value potential in S32 from de-risking of its growth portfolio, the potential for further portfolio changes, and an earnings-linked dividend policy

Seek (ASX:SEK)

Of the classifieds players, we continue to see SEEK as the one with the most relative upside, a view that’s based on the sustained listings growth we’ve seen over the period. The tailwinds that have driven elevated job ads (~210k currently, broadly flat on the robust pcp) and strong FY22 result appear to still remain in place, i.e. subdued migration, candidate scarcity and the drive for greater employee flexibility. With businesses looking to grow headcount in the coming months and job mobility at historically high levels according to the RBA, we see these favourable operating conditions driving increased reliance on SEEK’s products.

Xero (ASX:XRO)

XRO is a high quality cash generative business with impressive customer advocacy and duration. Over the last 12 months rising interest rates and competition have made things harder for Xero. However, we see the current short-term weakness as a rare opportunity to buy a high quality global growth company at a discount to the life time value of its current customer base.

Morgans clients can download our full list of Best Ideas, including our mid-cap and small-cap key stock picks.

• As attention turns to the February first half reporting season, earnings estimates continue to defy expectations of an imminent slowdown. However, fears that they will materially decelerate in 2H23 will temper sentiment when anticipated headwinds from rising interest rates hits home.
• Quantity and quality of earnings will come into focus as the macro takes a back seat to company fundamentals. Key themes to watch include FY23 earnings trends, cyclical signposts (consumer demand, industrial margins), China restart short selling and positioning in resources.
• Morgans analysts preview the results for 145 stocks under coverage that report in February and call out likely surprise and disappoint candidates from page 14.
• Key tactical trades (page 3) include Qantas (ASX:QAN), Megaport (ASX:MP1), Lovisa (ASX:LOV), Coles (ASX:COL) and HomeCo Daily Needs REIT (ASX:HDN).

No imminent slowdown

As attention turns to the February first half reporting season, earnings estimates continue to defy expectations of an imminent slowdown. ASX 200 earnings remain resilient despite deep cuts to estimates in other developed markets.

We point to the lack of guidance, frequency of trading updates and less acute inflation as reasons why forecasts have held up against the negative sentiment.

Headline estimates point to ASX Industrials growing 5.5% EPS in FY23 before tracking sideways in FY24-25. While growth looks subdued, corporate performance divergence will provide investors with opportunities. The broad valuation de-rating in 2022 will also give some further shelter.

With renewed focus on fundamentals, identifying companies that are less prone to earnings erosion will be key. These include companies that have a growing earnings profile, strong cash flow profiles and are trading at reasonable valuations.

Our preferred exposures include Qantas (ASX:QAN), Telstra Group (ASX:TLS), QBE Insurance Group (ASX:QBE), Treasury Wine Estate (ASX:TWE), and Corporate Travel Management (ASX:CTD).

Consumer and commodities – playing the cycle

The long-anticipated consumer slowdown so far has been more gentle than the market feared. We expect 1H retail results overall to be reasonable, but investors will be ever-cautious on the 12-month outlook.

However, we don’t see a ‘cliff’s edge’ for retail with the pace of decline potentially less pronounced than analysts are forecasting. The current balance of market expectations supports price strength in the more resilient retailers, especially those capable of growing market share (JBH, BLX, and UNI).

Dramatically improved sentiment – fueled by China re-opening – has arguably pushed the resources sector slightly ahead of fundamentals. While the medium-term outlook is compelling, we expect a bumpy ride in 2023 and prefer to stick with key producers South32 (ASX:S32), Mineral Resources (ASX:MIN), Santos (ASX:STO), and Karoon Energy (ASX:KAR).

Volatility bound – decoding the short interest signals

As the ASX 200 closes in on its 2022 high, short interest has been accumulating. We think illiquidity and uncertain trading conditions have brought short positions sharply into focus.

We’ve argued that earnings will attract greater focus this season as macro concerns affecting equities have eased in recent weeks.

We think conditions are ripe for volatility in and around the results with average days-to-cover increasing and significant crowding in individual stocks.

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.