Hugh Dive, Head of Listed Securities

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Tales from the Trenches - Reporting season themes

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During the months of February and August the majority of Australian listed companies reveal their profit results and generally provide guidance as to how they expect their businesses to perform in the upcoming year. Whilst we regularly meet with companies between reporting periods to gauge how their businesses are performing, during semi-annual reporting season companies fully open up their car bonnets to let investors have a detailed look at the company's financials. Until this happens, investors don't know for certain whether they are going to find burning oil and hissing snakes or see that the company's growth engine is running to expectations.

Today marks the final day of the August 2014 reporting season and Woolworths, along with the rats and mice of the index, present their profit results. In this piece we are going to run through the key themes that have emerged over the last four weeks.

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Few large earnings surprises

In aggregate August has been a fairly benign reporting season and was generally better than expected due to strong earnings growth from the banks (ANZ and Commonwealth) and miners (BHP and Rio Tinto), offsetting weakness in the industrials sectors. Overall we have seen approximately 13% growth in earnings over the 2014 financial year, though a large amount of this is due to the resource companies. Excluding resources, earnings per share from Australian companies in aggregate climbed by 7% over the past year.

Give me my money back!

Capital management was a feature of the recent reporting season and was understandably popular with investors. Telstra and CSL announced new share buy-back plans and Suncorp and Wesfarmers provided special dividends. Across the industrial companies the dividend payout ratio is very high and is now approaching 80%. Whilst increasing dividends plays to the "search for yield" investment theme and currently boosts share prices, in the longer term companies do need to retain cash to reinvest in their operations in order to grow earnings in the future. Over the last six months BHP gave investors strong indications that they should expect a capital return; unfortunately BHP surprised the market and in particular their English shareholders with news that they are looking at demerging their aluminium, Columbian nickel, manganese, silver, Illawarra and South African coal assets into a new Australian-listed company. The disappointment at the lack of capital management overshadowed what was a positive underlying result (profits +10% and dividends +4%).

Cost cutting all around

In the absence of revenue growth, Australian companies are clearly holding onto their wallets and delaying or halting significant investment spending. The large diversified miners were again very vocal about their focus on shareholder returns and reducing capital expenditure, with Rio Tinto and Woodside being the most aggressive cost cutters. Amongst the retailers JB Hi-Fi attempted to offset the earnings impact of falling electronic tablet sales with cost cutting across the business, though ultimately this was insufficient, as investors turned sour on this growth stock.

Gearing and the cost of debt continues to fall

As a consequence of corporates cutting back on large capital expenditure, yet still delivering strong earnings, we have seen an expansion in free cash flow and a reduction in net debt. Woodside Petroleum not only increased their AUD dividend by 28%, but also reduced their debt by 72% to leave the company only geared at only 4%! Similarly both BHP and Rio Tinto paid down $2 billion in debt over the half.

The de-gearing we have seen amongst corporate Australia sets the scene for this excess capital to be used in either a spate of acquisitions or returned to shareholders in the near future. From meetings with management teams over the past few weeks, capital management appears to be the preferred course of action.

Additionally companies are paying much less for the debt they have in the past, primarily by accessing the offshore debt markets. For example in the last six months Sonic Health placed some debt for 10 years at 2.8% and property trust SCA Property Group placed 14 year bonds in the US for 4.4%. Falling debt costs has delivered profit growth in an environment where revenue growth has been hard to achieve.

Best and worst results

Over the month the best results were delivered by Caltex, Amcor, Woodside, CSL and Rio Tinto. The common theme amongst these companies was a solid control of costs and that the profit result was not reliant on an improvement in the domestic Australian economy. The portfolio's bête noire QBE and also Qantas performed well in August, after reporting results better than expectations and providing indications as to an improving future.

On the negative side of the ledger Transpacific, James Hardie, JB-HiFi, BlueScope Steel and Leighton all reported disappointing compared with other companies. The common theme amongst this group was high price to earnings rated companies not delivering on high expectations.

Overall, the August 2014 reporting season was a good one for the Core Equity Portfolio. Investors have benefited from the strong results from some of our largest overweight positions and no significant unpleasant surprises. On the capital front we would have preferred to have received some concrete plans from BHP and Woodside as to their capital management intentions, but the robust financial positions of both companies point to a timing lag, rather than a cessation of a significant share buy-back.

Disclaimer
This article has been prepared by Philo Capital Advisers Pty Ltd ABN 70 119 185 974 AFSL 301808 (Philo) and contains general investment advice only. The information in this article does not take account of your objectives, financial situation or needs or those of your client. Before acting on this information readers should consider whether it is appropriate to their situation. We recommend obtaining financial, legal and taxation advice before making any financial investment decision. To the extent permitted by law, neither Philo nor any of its related entities accepts any responsibility for errors or misstatements of any nature, irrespective of how these may arise, nor will it be liable for any loss or damage suffered as a result of any reliance on the information included in this article. The information in this article is based on information obtained from sources believed to be reliable and accurate at the time of publication but we do not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. Past performance is not a reliable indicator of future performance. Any forecasts included in this article are predictive in character and may be affected by incorrect assumptions or by known or unknown risks and uncertainties. Nothing in this article shall be construed as a solicitation to make a financial investment.


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Hugh Dive, Head of Listed Securities


Prior to joining Philo, Hugh was Head of Basic Materials Group Investment Research; covering the chemicals, building materials and steel sectors. In the 2011 Reuters StarMine Equity Analyst Awards, he was rated 5th overall in Australia for stock picking and first in the Diversified Industrials and Chemicals sectors. Hugh has extensive portfolio management experience gained at Investors Mutual, with a successful track record managing both small and large cap value funds. In 2009, one of the funds he helped manage, the IML Future Leaders Fund, won the AFR Smart Investor Award for the best Australian small cap fund.


Hugh started in funds management with CC&L Investment Management in Vancouver; Canada’s largest independent fund manager with C$37B under management. At CC&L he focused on asset allocation and then Canadian equity analysis. Hugh holds bachelor’s degrees in both Economics and Law from Sydney University and the University of British Columbia, Canadian Securities Course (Honours) and is a CFA charter holder.

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