An end to the earnings drought
FY17 reporting season kicks off in earnest mid-August and according to the latest IBES consensus earnings estimates, EPS growth for the S&P/ASX200 is forecast at 13% in FY17, slightly down from 13.6% at the end of 1H17. Pleasingly this would still mark the end of the earnings recession after two straight years of contraction. We are confident that the improvement in the economic outlook will translate to earnings over the next 12-18 months so long as the positive conditions are reflected elsewhere (outside of Resources). With this in mind, we think outlook commentary and how management chooses to deploy capital may be as important as reported numbers.
The growth versus value conundrum
The prospect of policy gridlock in the US and low levels of global wage inflation have again resurfaced dis-inflationary fears. This has prompted investors to seek safety in the quality and yield trades that have been so profitable for many over the past two years. Valuations therefore remain extended and the divergence between 'growth' and 'value' stocks has again widened. High valuations make for high expectations. We are wary of high PE stocks with even the slightest earnings risk (CSL, DMP, COH) – as demonstrated through the May 'confession' season, stocks that miss the mark continue to underperform. The PE divergence also presents opportunities in overlooked areas of the market where we see earnings upside potential (LOV, JBH, CLH).
Turning 'soft' data into earnings
While a lot has been said of the weak growth in the Australian economy in Q1 2017, forward-looking indicators of business activity continue to indicate broad expansion in activity. After a prolonged period of cost-out and consolidation, it is encouraging to see a sustained pick-up in business conditions and sentiment which we expect to translate into an improvement in earnings. The translation of improving 'soft' survey data into earnings growth is necessary to support the high valuations commanded by the market. Falling payout ratios suggest that, perhaps, corporate Australia is finally ready to revive capital expenditure and investment in growth.
Morgans surprise or disappoint candidates
We highlight our key candidates that may surprise or disappoint during the upcoming August results season:
- Potential earnings surprises – Amcor (AMC), Reliance Worldwide (RWC), JB HiFi (JBH), Lovisa (LOV), Webjet (WEB), ResMed (RMD), Bapcor (BAP)
- Likely to see positive outlook statements – Ramsay Healthcare (RHC), Healthscope (HSO), Collection House (CLH), Sirtex (SRX), EBOS (EBO)
- Potential for positive capital management – BHP (BHP) and Rio Tinto (RIO)
- Potential earnings disappointments – Coca-Cola Amatil (CCA), Blackmores (BKL), Pact Group (PGH), Admedus (AHZ)
- Possible soft outlook – Telstra (TLS), TPG Telecom (TPM), Cedar Woods (CWP), Mantra (MTR)
- Vulnerable high PE stocks – Ansell (ANS), CSL (CSL), Cochlear (COH), Domino's (DMP)
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