Harbour Asset Management crew Andrew Bascand, Shane Solly and Craig Stent mull over the latest round of Australasian corporate profit reports and where NZ and Australia equity markets may go next.
At an aggregate level the latest earnings round for both New Zealand and Australia provided little movement in prospective earnings. The profit reporting season effectively earned a ‘pass’ mark. Analysts had largely factored in earnings outcomes. The surprises largely came in terms of dividend announcements and the earnings leverage Australian companies achieved in the absence of sales growth.
Economic trends differ significantly between New Zealand and Australia – the Australian economic cycle lags well behind. This is playing out in the detail of corporate earnings announcements. In February the majority of companies in New Zealand and Australia provided financial reports or updates to performance. The key trend differences observed were:
- sales growth in New Zealand was a healthy 4.9% in the last half of 2014 compared with only 1.0% in Australia for the non-resource sector,
- bottom line earnings growth was a similar 4.8% in New Zealand but accelerated to 9.0% (ex-resources) in Australia.
- dividend growth in New Zealand was 10.4% and was still a healthy 7.1% in Australia (ex-resources). Including resources Australian dividend growth was 7.9%.
The earnings differences show the operational leverage in the Australian corporate sector, as a result of extensive efficiency drives in a tighter economy and a greater focus on dividend growth rather than re-investment at this stage of the cycle.
The New Zealand economy continued with a broadly consistent path in February driven by the same factors of residential construction and migration, with the drought induced slowdown in agricultural production perhaps one of the few key negative influences. Like many economies globally, the fall in inflation expectations is possibly the only other remarkable change. The Reserve Bank of New Zealand held interest rates steady.
In Australia the Reserve Bank of Australia cut interest rates to 2.25% – the first interest rate move since August 2013. The move in Australia came against a backdrop of mixed economic data which at the margin may have been a little weaker than expected, especially with respect to capital expenditure. In our opinion Australian data still is not as weak as the media and market commentators portray in headlines. For instance in 2014 real GDP growth was still a healthy 2.5%. The astonishing thing is that Australian non-resource companies managed to generate 9% earnings growth.
Because the Australian equity market has a large proportion of global facing companies this stronger earnings growth for Australian stocks also reflects global growth influences which continue to be more positive, with US employment growth and European economic growth surprising slightly on the upside. The tail wind of a weaker Australian dollar is also assisting many companies.
While a good pass mark can be given for the earnings season in both Australia and New Zealand, both markets ran strongly. Most of the gain in the equity markets in the last 2 months has reflected a valuation expansion. That valuation expansion is seen in the number of sell ratings now placed on companies by stock broking analyst’s increase on both sides of the Tasman to a decade high of 23%.
Figure 1. Australian market sell ratings at highs
Source: Deutsche Bank
Taking a more detailed look, Australian earnings results were in line to slightly better than expectations (26% of companies beat earnings estimates while 17% missed earnings estimated).
Aggregate revisions to 2015 earnings resulted in very mild downgrades for Australia (about -0.5% in aggregate), 16% of stocks had upgrades by more than 2%, but 20% had downgrades of more than 2%. Company guidance was more balanced with 12% positive and 13% negative.
Overall however Australian market EPS growth (excluding the resource sector) is still set for about 9% growth in 2015, this follows similar out-turn for 2014. Overall earnings for Australia (including resources) are expected to be flat in 2015 – the resource sector has a -29% expected forecast profit slump in 2015 (this too is little changed from a month earlier).
The key themes of cost out and positive dividend surprises are worth drawing out further.
First, companies’ efforts to drive efficiencies and take out excess cost continue. BHP and RIO have led the cost drives with upgrades to margin forecasts for the large resource companies despite difficult commodity markets. Amongst Australian industrials efficiency programs are easy to identify for 15 of the larger non-resource companies as driving significant margin growth on a weak sales environment. More than half of the Australian larger companies are expected to increase margins again in 2015.
Figure 2. Australian companies are delivering on underlying earnings growth
Source : Deutschebank. Excludes financials
The Australian market has made a strong start to 2015 – more to do with lower interest rates and the RBA interest rate surprise.
Australasian markets have now moved to a price earnings ratio of 16 times in Australia and 20 times in NZ – both markets are looking fully valued, obviously NZ more than Australia.
Second, dividend growth for the Australian market was 7.9%, with the pay-out ratio rising. Over 17% of companies positively surprised on dividends, with only 7% disappointing. Many companies announced additional capital management.
Amongst the largest sectors trading updates for the banks were benign with current trends largely confirmed. Cyclicals (transport, media, and listed retailers) and small capitalisation domestically focussed companies showed lower earnings momentum than globally facing companies. Revisions for small cap stocks were negative and on average small caps also had a dearth of dividend or capital management surprises. The exception was housing exposed companies which reported strong demand and retail REITs that noted that specialty retail demand growth has edged up.
In New Zealand dividend growth was very healthy in 2014 with a 19% lift for the overall market in dividends, led by dividend upgrades for the electricity generator/retailers (gentailers). Overall however, pay-out ratios for New Zealand stocks are becoming stretched. The prospect for further NZ dividend growth out-pacing earnings growth is limited. As we look forward dividend growth expectations are shifting down a gear for New Zealand stocks. For instance after a 10.5% growth rate in 2014, dividend growth in 2015 and 2016 is expected to slow to about 5% per annum – still healthy but a clear slowdown.
The Australian market may offer better dividend growth prospects with earnings growth prospects and a lower pay-out earnings ratios than the New Zealand market. Australian market dividend per share growth is expected to be about 6% in both 2015 and 2016.
Figure 3. Dividend growth over 5 years has been stronger in New Zealand than Australia – this might be changing
Outlook – Convergence
Equity markets may continue to react more to interest rates and dividend announcements than earnings. However, in February there were signs that this trend is changing with some of the larger New Zealand yield stocks under-performing the broader New Zealand market. Perhaps this under-performance could reflect the turning point in long bond yields – after hitting a generational low of 3.13% in early February, NZ 10 year government bond yields have risen to 3.37% in early March.
While interest rates are likely to stay low by historic standards, and continue to drive investors to invest in quality securities that provide some yield enhancement over low Government bond yields, it may be that the pricing of such securities now reflects the weight of money that has been unleashed by easy global monetary policy settings.
Going forward we expect a reversion in return outcomes across equity sectors with quality non-defensives increasingly sought out by investors, and ‘expensive defensives’ giving back some of the last twelve months relative outperformance.
Harbour Asset Management’s research is available on their website, see: www.harbourasset.co.nz
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 Data from Forsyth Barr for NZ and UBS for Australia
 For the median New Zealand and Australian companies sales growth was a healthier 7.5% and 5.3%, respectively in 2014.
 Adjusts for the reintroduction of a dividend by Auckland Airport
 In a 25 February, 2015 note Deutsche Bank identify 12 major programs in the non-resource listed large companies.