EDITED TRANSCRIPT
What were the key takeaways from this reporting season? And what surprised you the most?
Paul Taylor: We saw a continuation of a lot of the trends that we've seen for a while: the consumers hung in there a little bit better than expected, the technology sector still remain pretty good, financial services were average, and the weaker areas were in the resources, energy, healthcare, and media sectors.
Nuances were seen more at a company level. It was interesting to see companies who implemented self-help programs be able to separate themselves from the pack.
Some companies are very dependent upon the market and there's not much they can do about it. Self-help programs are what a company can do to turn things around in a period using tools in its control.
We saw this with stocks like Suncorp which sold off a lot of its business to simplify to general insurance. Thanks to this simplification program, it’s now been able to release the capital. Another was Downer which had experiences many issues with bad contracts. It focussed on cutting back to only good contracts going forward.
Casey McLean: Overall, there was probably more beats than misses in results and earnings were cut across the market, so it's the size of those misses were well and truly outweighing the beats. A lot of those cuts were coming in the resource-orientated sectors Paul mentioned.
One of the biggest transvenous in the market is the cuts that we saw in dividends. There was quite a lot of companies that either cut their dividend or downgraded it or missed expectations on what their dividend would be. In those cases, the market really voted with it and sold those companies down heavily.
On the flip side, there was quite a few companies that delivered surprises in terms of announcing buybacks. So, we think it's bifurcated and across the market the return of capital shareholders was a bit lower than expectations.
Overall, it was really that difference between companies trying to optimise their balance sheet and with capital expenditure budgets higher than expected, retaining a bit more cash by cutting the dividend as well.
James Abela: The winners market leaders are those companies winning share and continuing to grow really well, names like REA, Wisetech, Car Group, Life360, Hub, Netwealth, Charter Hall, and Fisher and Paykel. All these companies are strong, high-quality businesses which delivered very good results. They were rewarded quite handsomely because growth, certainty and confidence are really what's scarce in the market.
What was a surprise was the dispersion in performance was quite high. Names like JB Hi-Fi and Temple & Webster in the consumer sector which was a known risk factor for the market were okay, but Harvey Norman was weak. Similarly, Seven Group did quite well, but then Johns Lyng did quite poorly. So, it was clear that where there's a bit more competition, management abilities do show through to the outcomes in the stocks.
We saw some of the stocks that met expectations fall in value in terms of their share price, while others that missed actually did okay in terms of how the market reacted to their share price. How does this work and why did this happen?
PT: That's a reflection of the valuation and I would say that's the exception rather than the rule. Most of the time stock outlook statements were a bit more cautious, which led to the downgrades for financial year 2025.
Take Wesfarmers for example who just beat expectations and came out positive but still fell off a little bit - this reflects the high valuation.
When something's going along the bottom and it has a bad result, I think it probably also reflects the fact that maybe the shareholding has changed through time as well. When a stock is really struggling, long-term investors tend to see through the noise and expect a long-term to see the turnaround. So, when it does disappoint, it doesn't really go down. When this happens, it's a bullish signal. Contrarily, if it has a good result and it goes down, that's a bearish signal.
Overall, it's just indicating maybe we're at value for those companies, but I would highlight there an exception rather than the rule - that we're seeing valuations either stretched or at a bottom.
Technology is one of the ways for the world and us as consumers, to get productivity up, which is why technology across the board has been strong.
Consumers, for some time now, have been a focal point thanks to factors including multiple rate hikes and cost of living pressures. The question everyone has been asking is whether the consumer would fall off a cliff and would we see a spending pullback?
Do you think the consumer is still resilient or is there a bit more nuance to it?
CM: I think nuance is the key here. There are segments of the market and consumer that is very weak and falling off the cliff and it's probably the younger cohort, whereas the older cohort who are more likely to be cashed up are benefiting from higher interest rates are doing better. We’re seeing this within retailer sub-categories: the better retailers are those who are managing stores more efficiently with rollout, growth, and inventory.
But one of the things I questioned coming out of reporting season was what products are actually discretionary and what are staples. So, JB Hi-Fi did really well; are iPhone's a staple and not a discretionary? Similarly, quick service restaurants and fast-food companies have done poorly: is takeaway food actually discretionary?
It’s certainly debatable. This again relates to the age cohorts within the consumer as well.
What's clear across all categories and all age groups is that there is some trading down within the consumer basket and system. Some good examples include service stations where independent fuel retailers are doing better because they're the ones that are a few cents cheaper per litre.
Endeavor Group is talking about in their pubs: people are drinking beer as it’s cheaper, and even within beer they're buying jugs rather than schooners since you are getting a few millilitres more for a lower cost.
Carsales are talking about how new car sales are doing quite badly but used cars are doing much better, so people are trading down there as well. I don't think that's a trend that's going to go away anytime soon.
PT: We saw that in the insurance companies as well which I thought was interesting. They were saying more of their customers are increasing their excess to keep premium rates down, which I think is actually pretty sensible thing to do for the consumer, and for the insurance company as well. People are pulling any lever they can to try to lower cost.
Is this prevalent more this reporting season, or is that a trend that's been happening for some time?
CM: I think it's been bubbling away for a while, but it seems to be more pronounced in this reporting season. The flip side of it is that the next move in interest rates is likely down and we just had tax cuts come through in July. What's pretty clear is that the excess saving for some of these consumers has been eroded already and now they don't have that buffer, and the ones that do, those older cohorts, they're already spending up.
The other area that's interesting is the broader topic of inflation but from a company perspective, input costs etc. This theme has been playing out over some time: the cost of labour, productivity of that labour market. From an Australian and company perspective, what were some of the observations?
JA: Firstly, a lot of companies just put prices up to try to protect the actual cost of everything. This includes input costs, labour costs, cost of debt, and inflation, and it's all those categories at the same time. A lot of companies put up prices to maintain margins and usually in Australia, you get two or three of those factors plus a currency move, and the market's worried about margin compression, which just didn't happen in this cycle. Nearly all companies in most industries have the ability over pricing.
Secondly, one strong theme I am seeing in the Australian small to mid-cap market is technology. Whether it's education technology, financial technology, financial services technology, software technology, consumer technology, or health technology, all are trying to boost productivity. Technology is one of the ways for the world and us as consumers, to get productivity up, which is why technology across the board has been strong. I think that's one of the ways we're going to fight inflation and productivity.
PT: We’ve seen this with Wisetech. There are so much extra costs within freight forwarders and its product Cargo Wise has helped take a lot of those costs down. Too, the freight forwarders want to share gains so it’s a win-win for everyone.
JA: Software tools help productivity enormously. It affects the whole system because if every unit of every contributor into an ecosystem can be more productive, it brings the cost down. We’ve seen the same thing happen with Promedicus, REA Group, Car Group, Netwealth, and Hub - so this thematic was prevalent.
On the flip side, are valuations stretched? Are they priced for perfection?
JA: Valuations are getting up there. I've done the analysis on the ASX 300 and 25% of the universe i.e., 60 out of 250 stocks are over 35 times P/E - double the Index. That's an unusual environment where there's so many stocks on expensive valuations. You've got to think stock by stock individually and their growth, outlook, sustainability etc.
But we are in an environment where a lot of things are priced for high expectations, so it’s best to be careful to avoid stock disappointment, too in the technology universe which has more re-sellers, low pricing power, or they're on contracts, and the P/E multiples have come off substantially.
Overall, you need to be careful and very aware of valuations in this market. It's probably getting a bit more volatile because the momentum has been quite strong.
What are we seeing in the resources sector?
CM: It seems to me that labour costs just generally across the Australian economy are going up, we've entrenched four-five percent growth now. When federal politicians are giving themselves that sort of pay raise, we ought to expect that to flow through to the rest of the economy which is what's happening.
That's not normally a problem if it's a company and an increase in productivity, but that's been totally absent across the whole economy, particularly so in the mining sector where companies like BHP are even talking about productivity going backwards. There are risks that unionisation of the labour in resources in particular, with change in regulations, could entrench that even further and continue to be a headwind on margins.
It's not just the resources sector, it's any labour-intensive business. If you don't have that pricing power, as James mentioned with technology for example, you're going to have some pressure on your margins going forward.
PT: The one little really interesting a side effect is that miners are also talking about is a potential change in the cost of production which means the cost curve is important in the industry because that sets the marginal cost of production. This means the commodity will go up or down around that marginal cost of production. For example, if we need 100 units, and if the cheapest is mined at is $20 and 20 units are mined there, another 30, you're mined at $30. If the 100th unit is mined at $100, that's the marginal cost of production.
What the miners are also arguing now, and this came through in the iron ore statement, is that if you said to me, iron ore was $100 a tonne, I would have said actually at $100 a tonne, you’d assume China must be pretty good environment, but this is not the case.
Fundamentally, the structural issues that are happening with the cost of production means that that marginal cost has gone up as well. BHP and Rio Tinto said that's moved up to $80-$100 a tonne. I think that's a really interesting consequence of some of these structural issues as well.
So, whilst we're seeing inflation come down, there's still some pockets of stickiness driving some of those issues in terms of import costs.
CM: I think the labour availability across the economy has got much better. It's not that hard to hire, but the price of that labour is still going up. At the moment there's still a lot of companies in all sectors hoarding labour as well and you can see this in economic statistics. The hours worked have come down but they're still holding onto that labour because they're so scarred from what happened during Covid where people were laid off and then couldn't be re-hired. So you need activity to increase to not see the unemployment rate rise.
PT: If we bring that back to the mining sector again, the movement or the commodity private (nickel and lithium) have come down a long way and we've actually seen some closures. These mine closures in lithium nickel are helping with what Casey's talking about, which is a little bit more labour availability.
Coles is very much at the pointy end of the consumer. What are some of the observations on the stock from the recent reporting season?
PT: Due to the trading down effect mentioned, which can be to private label/white label, tends to benefit the supermarkets. Margins are a little bit higher; it'll be lower price but potentially a higher margin and they go they go through a strategy of a range of products at different levels for consumers.
Take for instance the loyalty programs, people want those savings wherever they can get them. So, it's trading down. It's using discounts and savings.
But what really differentiated Coles was much more of focus on their cost of doing business. If you look back to a couple of reporting seasons ago, Coles had a difficult few because of what they call shrinkage or theft, which significantly spiked. Coles, like Woolworths and most supermarkets around the world, have moved more towards an automated self-checkout program which led to a spike in shrinkage. Woolworths had moved ahead by putting technology in place to stop that.
Now, Coles have put that in place. They took significant reduction in goods that were stolen within their stores and placed a big focus on the cost of doing business and overall efficiencies. It's what company in this higher cost environment have got to focus on. That did differentiate them in the reporting season.
Furthermore, Coles is under a challenge from the cost-of-living issues. When they can reduce costs and improve efficiency, they can obviously share that in the pricing structure of the product, as well as what gets returned to shareholders. So that's, once again, a better outcome and probably a win-win for both consumers and shareholders.
Before Covid, things changed a little bit. A lot of people would do a double shop because they were focussed on cost. So, they might start at Aldi for a very specific item but then with items they couldn’t get there, they may go to Woolworths or Coles - i.e., multiple shopping. This stopped during Covid because people didn't want a multiple shop. This is now heading back to pre-Covid where people are preparing to multiple shop again.
Because Aldi is a 100% private label, Woolworths and Coles too are endeavouring to make sure they have a good private label offering that is competitive, or better than, Aldi. We’re seeing Coles trying to attack at both levels.
CM: The other thing that's interesting is that Aldi don't do any online or home delivery in any market in the world. Coles just last week launched its Ocado customer fulfilment centre for their online deliveries which could be a game changer for its online ordering as well as the speed of delivery etc. It will be interesting to see how that rolls out and the success of that product.
It's a structural differentiator as well because online shopping is gaining share of supermarket spend. Aldi don't have that. Now Coles have this new system that they're implementing.
Can you give some observations on Car Group and Judo bank?
CM: Both performed pretty well in the reporting period.
Car Group are a high-quality company, they’re the dominant marketplace for used cars, or car retailing in general in Australia, and the Australian market is performing well. They're getting price rises with their new pricing systems and new ways of selling cars like instant offer.
But it's really becoming an international story, which is why Carsales rebranded to Car Group; it's not just carsales.com.au now, it's WebMotors in Brazil, Trader Interactive in the US, and Encar in Korea. It's really the US and Brazil that are the key growth drivers for going forward. They're much bigger markets than Australia (2-4 times larger). In the US alone they're focusing on RVs, trucks, power sports. They're like a smaller niche, but still a much bigger market there as well.
Car Group bought SN Car in Korea about a decade ago. They were the second player in the market at the time and now, they're a distant first. It's been very successful. Web motors and trader interactive are newer. They've just increased to 70% ownership in Web Motors 18 months ago or so. The Trader Interactive acquisition was more recent as well.
Whilst there's risks around it, the strategy is to hone its skills and IP in Australia and then export into the US and Brazil over a longer period. As this happens, the price increases and better returns occur. It shows the pricing power the business has in these various markets as well. Additionally, they're not super competitive markets. If they entered cars in the US rather than their niche in RVs and trucks etc., it would be more of a concern because there is dominant competitors in that market.
Judo bank is maybe a brand that not everyone is familiar with.
It’s classified as a challenger bank or neo bank that services the niche SME segment of the market. This is a relationship driven market; you need to have bankers on the ground talking to the businesses you know to understand what their needs are constantly.
They've been able to execute that strategy successfully they've grown their loan book to over $10 billion now and profitability is starting to improve as well, delivering decent results and maintaining their long-term guidance, what they call their at-scale metrics, where they can get to low to mid-teens ROE. It looks like they are on track there and continuing to gain share and managing the business quite well.
The business banking segment is probably the new source of competition for the majors. They are pivoting from mortgages to business. Most of them are competing a few segments higher in the market, bigger loan sizes, bigger companies, the more mid-market or even institutional as well. Judo still has less than 1 percent market share now and are able to grow without becoming a huge red flag to the majors, and not too competitive as well.
Valuation is still where your caution should come in. If you're getting too valuation agnostic in a market that's getting more cautious, I think you could be facing a bit of risk.
In the small to mid-cap part of the market, two stocks that are certainly interesting are Promedicus and Fisher and Paykel - can you talk through them post this reporting season?
JA: Both stocks delivered good results. The three things we look at to find future leaders is viability - that is the return profile, sustainability, duration, and credibility with accounts and management. Both stocks ticked all the boxes many years ago. We’ve held them for a number of years. They're both very trusted brands and it's a very trust-driven sector because it's in the medical industry and so it can be life critical (Fisher & Paykel dealing with oxygen and ProMedicus dealing with imaging). Both stocks are doing something different.
They're both investing in R&D which leads to very high returns because they've invested in R&D over many, many years and had leadership in the industry. As industry leaders delivering good results in a market that's very competitive, it pays off to do something that's very different.
The two questions are constantly on those stocks are around valuation and growth. Promedicus on a very high P/E and Fisher and Paykel is also quite high, yet they just keep on delivering and keep on winning share. Promedicus is going into the US and has continued to win contracts and Fisher and Paykel went through Covid and had upgrade after upgrade, then went through a downgrade after Covid, now it's just gone back to organic growth.
Valuation is interesting because things can remain expensive for a long time, which it has been for both stocks.
Taking into account the learnings from this reporting season, what is the outlook for the next 12 months?
CM: I think growth is slowing and volatility in markets is increasing. We've seen this just this last month as well with the start of August. There have been some wild swings and market quickly regained it and that's as a result of high volatility, which I think is here for a while.
Looking ahead, I am slightly more cautious and more wary of the higher beta names now that have done very well. Some of them are those higher valuation stocks that we've talked about today. But overall - more cautious and looking to more lower volatility stocks.
PT: I think if you look at 2025, we've got low single-digit earnings growth and the market's on about 17x, so it's not super expensive, but maybe just that little bit expensive.
JA: I'd agree with being a little bit more cautious, especially on valuations. Valuations are getting up there, as I mentioned so you've got to be careful. We tend to buy more defensive and more value stocks, the wonderful in-betweeners. They're not in the cold value trap environment, but they're not the really high P/E, high-growth, high-quality names. So, something in between is worth looking at.
Overall, I think things look all right. It's hanging towards high single-digit growth in the small and mid-caps. Valuation is still where your caution should come in. If you're getting too valuation agnostic in a market that's getting more cautious, I think you could be facing a bit of risk. As long as you're aware of that, I think it's fine. Best to be careful of expectations that have got quite high in the market.
