A picture of resilience is emerging from Australia’s latest profits reporting season.

Three quarters of the way through the February reporting season, corporate Australia is displaying resilience to macroeconomic headwinds caused by the recent surge in interest rates, The Australian reports

There’s also been a smaller-than-normal fall in the consensus of earnings forecasts in aggregate.

It suggests the corporate profits cycle bottomed out in the December half.

But the relatively muted downturn in profits last year may lessen the potential for a strong rebound.

As of Friday, 146 of 194 reporting companies in the ASX 200 index had reported half-year earnings.

Aggregate earnings were about 6 per cent lower than expected, with the materials, energy, technology and healthcare sectors accounting for most of the disappointment, while the utilities, communications, consumer discretionary, industrials and financials exceeded expectations.

A 1.3 per cent fall in aggregate earnings growth came as contractions in energy, materials, property and consumer staples sector earnings offset growth in utilities, technology, industrials, healthcare, financials, consumer discretionary and communications sector earnings.

There has been a small downgrade of 0.4 per cent in the consensus forecasts for earnings per share in aggregate for the forecast for the year to June, but that’s not as much as the normal reporting season downgrade of 0.7 per cent, according to MST senior analyst Hasan Tevfik.

Including the effect of a weakening exchange rate during the reporting period, the bottom-up consensus forecast for ASX 200 earnings per share has been downgraded just 10 basis points.

“As we look ahead to June 2024 expectations are for ‘less bad’ EPS growth,” Mr Tevfik said.

“Much of the weakness has been in the commodity producers but there has also been a moderation in the pace of industrial sector profits too.

“Expectations suggest there will be an acceleration beginning in the current half and the solid start for the current reporting period helps confirm this.”

But as usual there have been the good, the bad and the ugly of the reporting period.


It’s been good because…

Cost containment by industrials is the main reason why reporting season has been better than normal in terms of the limited amount of downgrades that have occurred.

Operating costs have been guided lower by 43 basis points, giving a $2bn boost to industrial sector earnings before interest, tax, depreciation and amortisation, to $109bn.

Cost improvement has come from slower raw material cost inflation and slower wage inflation.

Dividend upgrades and some big share buybacks have also featured prominently.

Despite the profit downgrade, dividends were revised higher by 0.5 per cent, or $400m, to $93.7bn.

Big dividend increases by BHP, Origin Energy, Santos, CBA and Wesfarmers were partly offset by large downgrades at Fletcher Building, QBE Insurance and IGO.

In addition to $400m of new dividends, Aussie companies have announced $1.2bn of new buybacks.

Financials sector upgrades were also encouraging. The financials sector, which commands 35 per cent of the Aussie earnings base, is the only major sector where upgrades have occurred.

Big banks saw much needed profit upgrades, mostly driven by lower bond yields supporting asset values. Within the financial sector, property trusts saw upgrades, with inflation-based rent increases for Scentre Group and growth in data centres like Goodman Group.


But then, there’s this…

But industrials sector revenue is coming under pressure as companies that benefited from pricing power over the past few reporting periods are no longer finding that’s the case.

Mr Tevfik says sales forecasts have been downgrades of 30 basis points for the ASX 200 industrials, with bigger downgrades for Woolworths on weaker price inflation in food, Seek on weaker volumes, and Orora as its North American revenue weakened in part due to price deflation.

The bigger commodity producers have continued to face cost issues. BHP highlighted wage inflation in Australia. Rio Tinto’s average cost of production in the Pilbara rose to U$21.50 versus U$13.30 in 2018. The company also guided to higher costs in parts, labour and longer haulage distances. South32 is paying more for capex and this will result in a higher future depreciation expense.

As for the “ugly”, there were sizeable downgrades to cashflow estimates for industrials and commodities producers. The industrials downgrades have been a function of higher capex and the commodities downgrades have been mostly due to higher operating costs, Mr Tevfik says.

Industrials have also struggled with interest expenses hitting their profit margins. While guiding to better profit margins, the outlook is flat and interest expenses have been revised up

“The biggest downgrades for the current reporting period seem to be those which have been too slow to adjust to the post Covid world of higher rates, tighter labour markets and changing consumer patterns,” Mr Tevfik said.

“We think it has been a great illustration of management quality, or the lack of it.”


Things got ugly

The biggest single downgrade to June 2024 EPS has been for Sims Limited.

Other stocks at this end of the table include Fletcher Building, Lendlease, Helius and IRESS.

Mr Tevfik maintains that because the ASX 200 profits downturn in 2023 was less severe than was evident in profit downturns of the past, a sharp recovery isn’t on the cards this time.

Where he does see the potential of a V-shaped profits recovery is in small companies.

Small Ordinaries index earnings per share is expected to have fallen 26 per cent during the 12 months to December 2023 – much worse than the 8 per cent fall expected for the top 200.

Current forecasts have Small Ordinaries EPS rising 12 per cent for the 12 months to December 2024.

“A sharper downturn in small company earnings per share is a reason this part of the equity market struggled over the last two years,” Mr Tevfik said.

“A sharper recovery in EPS should be a reason why small caps outperform in 2024.”


This story was originally published by The Australian.