Craig James, Chief Economist; Twitter: @CommSec

Ryan Felsman, Senior Economist; Twitter: @CommSec IMPORTANT INFORMATION AND DISCLAIMER FOR RETAIL CLIENTS The Economic Insights Series provides general market-related commentary on Australian macroeconomic themes that have been selected for coverage by the Commonwealth Securities Limited (CommSec) Chief Economist. Economic Insights are not intended to be investment research reports. This report has been prepared without taking into account your objectives, financial situation or needs. It is not to be construed as a solicitation or an offer to buy or sell any securities or financial instruments, or as a recommendation and/or investment advice. Before acting on the information in this report, you should consider the appropriateness and suitability of the information, having regard to your own objectives, financial situation and needs and, if necessary, seek appropriate professional of financial advice. CommSec believes that the information in this report is correct and any opinions, conclusions or recommendations are reasonably held or made based on information available at the time of its compilation, but no representation or warranty is made as to the accuracy, reliability or completeness of any statements made in this report. Any opinions, conclusions or recommendations set forth in this report are subject to change without notice and may differ or be contrary to the opinions, conclusions or recommendations expressed by any other member of the Commonwealth Bank of Australia group of companies. CommSec is under no obligation to, and does not, update or keep current the information contained in this report. Neither Commonwealth Bank of Australia nor any of its affiliates or subsidiaries accepts liability for loss or damage arising out of the use of all or any part of this report. All material presented in this report, unless specifically indicated otherwise, is under copyright of CommSec. This report is approved and distributed in Australia by Commonwealth Securities Limited ABN 60 067 254 399, a wholly owned but not guaranteed subsidiary of Commonwealth Bank of Australia ABN 48 123 123 124. This report is not directed to, nor intended for distribution to or use by, any person or entity who is a citizen or resident of, or located in, any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or that would subject any entity within the Commonwealth Bank group of companies to any registration or licensing requirement within such jurisdiction.

Economics | August 24, 2020

Earnings Season: Half-time report Corporate Profit Reporting Season Each ‘earnings season’ or ‘profit-reporting season’ CommSec tracks all the earnings results of S&P/ASX

200 companies to obtain a comprehensive picture of the aggregate health of Corporate Australia.

The earnings season has another week to go. But so far, 92 of the ASX200 index group have reported full-year (final) results for the 2019/20 year. A further 18 companies with a December 31 reporting date have issued half-year or interim results.

In the turbulent times, only 75 per cent of companies have reported statutory profits for the year to June. It is the weakest outcome over the decade that we have been tracking interim and final reports with an end-June financial year. Aggregate full-year earnings have fallen by 37 per cent.

Just over 68 per cent of companies issued a dividend. Aggregate dividends are down by 32 per cent.

The Profit Reporting Season Every six months CommSec tracks the earnings of Australia’s largest listed companies. Some analysts track

whether companies have met broker expectations. That tells you little about the financial performance of companies. And unfortunately for many companies only a few brokers ‘cover’ all the stocks.

Other analysts just track the earnings of those companies they ‘cover’ – the companies that they have detailed information on. CommSec includes all ASX 200 companies in its macro (big picture) assessment of the reporting season.

Of the 92 companies to report for the year to June 2020, 69 companies or 75 per cent managed to produce a statutory profit (net profit after tax). The last time a similar low outcome occurred, 82 per cent of companies issued a profit for the 2014/15 year.

Overall, profits were down in the year to June, causing companies to slash or abandon dividend payments and instead hold on to cash.

Clearly it has been the toughest year for some companies in living memory. In 2019 the focus was the US-China trade war and Brexit stalemate. In 2020 it has been the COVID-19 pandemic.

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Economic Insights. Earnings Season: Half-time report

Admittedly a number of companies have prospered in the period. Gold companies have ridden the back of strong demand and record prices for the precious metal (Silver Lake Resource, Saracen Mineral)). Iron ore miners (Fortescue Metals) are riding high with the steel-making ingredient recently hitting 6½-year highs on the back of the strong Chinese industrial recovery and policy stimulus.

Some retailers – especially those with a good on-line presence – have reported higher sales and profits (Nick Scali, Adairs, JB Hi-Fi). Electrical goods and homewares retailers have clearly out-performed. People have been locked down or have continued to work from home and they have been keen to buy goods that enable them to work efficiently at home and be comfortable. This has shown up for several months in strong retail trade data from the Bureau of Statistics.

Services companies – especially those dependent on domestic and global mobility (travel operators) – have experienced the toughest conditions over 2020, especially late in the first quarter and through the June quarter. And the ongoing digitisation and shift to streaming has weighed on media companies, which have underperformed.

The Numbers So to the numbers. And these numbers refer to those companies reporting full-year earnings to June 30, 2020.

Profits

As noted above, 75 per cent of companies have reported statutory profits (net profit after tax) for the year to June. On average over the past decade around 88 per cent of companies have reported a profit rather than a loss. In fact, 92 per cent of the companies that announced interim results for the half year to December 2019 reported a profit.

Of the companies to report a profit for the year to June, 48 per cent managed to lift earnings while 52 per cent recorded a fall in earnings.

In aggregate (summing all the profit results), earnings were down 37 per cent on a year ago. Revenues were up in total by 1.2 per cent, which were matched by a 1.2 per cent lift in expenses.

Dividends

In the six months to December 2019 (interim results), just over 87 per cent of the ASX 200 companies issued a dividend. For the full year to June 2020, 68 per cent of companies have elected to pay a return to shareholders. The average over the past 20 reporting seasons stands at 86 per cent.

Almost 24 per cent of companies lifted dividends; 12 per cent held dividends steady; 55 per cent of companies cut dividends; and 9 per cent of companies that didn’t pay a dividend last time (in February) also didn’t pay a dividend this time.

Of those trimming dividends, 23 per cent or 21 companies that paid a dividend last time won’t be paying a final dividend.

Of the 63 companies paying a dividend, 35 per cent lifted dividends; 17 kept the payout steady; and 48 per cent cut the dividend.

In aggregate, dividends are down 32 per cent on a year ago.

Cash

Profits are down, so companies have elected to trim or not pay a dividend and instead use the cash to shore up stretched balance sheets.

Aggregate cash at hand (cash as at June 30) is up 26 per cent on a year ago (up from $70 billion to $88 billion)

Overall 71 per cent of companies lifted cash levels from a year ago, notably real estate investment trusts (REITS).

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Economic Insights. Earnings Season: Half-time report

Themes Usually each quarter there are a number of themes, covering a range of issues. This reporting season COVID-19

has understandably dominated. Investors have been interested to know:

Are companies able to provide future guidance?

What action have companies taken in response to the crisis? Have they trimmed expenses; slashed capital expenditure; devoted more resources to on-line spending; or perhaps fundamentally re-assessed the business model?

What have companies done on staffing levels, especially companies in receipt of JobKeeper?

What action has been taken on longer-term strategies as opposed to short-term responses?

How has the capital position been managed?

And how have those companies caught up in escalating Australia-China political tensions responded?

Solid retail sales featured over the reporting period, especially on-line sales. Some have benefited from low or lower rents. Retailers to benefit most in the lockdown were in homewares, electrical or have been focussed on delivery. There was a bigger pay-off from companies that already had invested in the on-line presence (sales and distribution). Solid results include those from: ARB, Adairs, JB Hi-Fi, Nick Scali, Coles, Breville, Baby Bunting, Domino’s Pizza, Treasury Wine, Premier Investments, Kogan, Wesfarmers (Bunnings and Officeworks).

While retailers, supermarkets, gold stocks, mining-more-generally, and stay-at-home stocks have out-performed in the COVID environment, energy, tourism, travel-dependent companies and some REITS have been buffeted.

Discussion points A raft of interesting discussion points have come out of earnings season.

Ingenia: The property group noted that requests for rental relief were ‘non-existent’. The company also noted that business was booming for holiday parks.

Abacus: The REIT also downplayed issues of rent, saying that it had collected rent from 90 per cent of office tenants and 98 per cent of self-storage facilities.

Nick Scali: The furniture retailer has forecast a 60 per cent lift in December half-year profit.

Monadelphous: The engineering group painted a positive outlook on the back of new contracts in Australia and Chile.

BHP: Discussion centred on the future for coal including a possible demerger.

ARB: The maker of 4WD equipment has noted record order books. People are keen to take intra-state regional and camping holidays.

Aurizon: The rail freight operator reported minimal disruption from COVID. There was reduced coal demand as Asian factories shut down.

Goodman: Supported by industrial warehouses operation, it beat guidance for the 9th year. Only 10 per cent of its employees were working at head office in Castlereagh Street Sydney.

Gold outperformers: Evolution, Newcrest, Saracen, Silver Lake Resource, Northern Star.

GPT: has reduced operating costs; deferred development projects and non-essential capital expenditure.

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Economic Insights. Earnings Season: Half-time report

Coca-Cola Amatil: cut costs $60 million in the June half-year and plans to cut $80 million in the current December half year.

Retailers vs landlords: Retailers have generally done well but landlords like Scentre Group have been trimming rents and writing down the value of properties.

Market reaction Some brokers maintain estimates for companies on metrics like profits and dividends. So they determine if the

earnings results were ‘good’ or less positive on whether the companies met, beat or missed their forecasts.

In normal times, companies themselves will provide guidance on future results.

But clearly these aren’t normal times. During February and March the majority of companies abandoned previous guidance; some raised extra capital; some cut recurrent and capital spending; and some did all three.

So the best way to determine whether investors were encouraged or discouraged by a company’s profit result was to examine the sharemarket reaction on the immediate days after the report was delivered.

So far 56 per cent of ASX 200 companies that have reported results have seen a lift in their share prices on the day of earnings release with an average gain of 1 per cent and a gain of 1.3 per cent after two days.

What are the implications for interest rates and investors? Australian companies understandably withdrew earnings guidance as the virus crisis unfolded due to the

heightened level of uncertainty. So expectations were set low ahead of the start of earnings season. It was a similar story in both the US and Europe. With the bar set so low, companies safely cleared the lower height.

COVID-19 still dominates the landscape. But investors will likely show lower tolerance from here. Crisis-time responses have been made such as raising capital and cutting or trimming dividends. And some balance sheets and employment levels have been supported by the government’s JobKeeper wage subsidy. But now investors want to know what positive strategies will be followed in the short and longer-term.

There has been discussion of the fact that some companies which received the JobKeeper wage subsidy have reported profits or even higher profits. But any criticism relies on perfect hindsight. At the time that JobKeeper was announced there was significant risk of large scale job losses. The companies supported by JobKeeper – especially profitable companies – are more likely to retain or lift jobs. And that is the whole point of the scheme – saving jobs – and keeping the jobless rate down to hasten economic recovery.

Corporate Australia remains in good shape with strong balance sheets being maintained. But the economic outlook remains very uncertain – especially with the government tapering stimulus. Still, the significant fiscal and monetary policy measures applied provide encouragement together with the success by many states and territories in ‘flattening the curve’. Infrastructure spending will be important in driving economic recovery and will support prospects for industrials, especially engineering and construction materials. The success in keeping the jobless rate down will be important for consumer-focussed companies, especially retailers.

The recovery of the Chinese economy remains encouraging for mining and engineering sectors. Australia is a key global exporter of gold, copper and iron ore, in particular.

CommSec expects the All Ordinaries to be in a range of 6,350-6,750 by end-2020, with the range for the ASX 200 between 6,200-6,600 points. We expect sharemarket returns to be largely flat over 2020 due to supportive monetary and fiscal conditions. While shares remain ‘expensive’ valuation-wise relative to history, clearly these are not normal times. Earnings from financial assets are low. Corporate earnings will remain challenged in the near-term. But much depends on virus containment, finding a vaccine and opening domestic and international borders.

Craig James, Chief Economist, CommSec; Twitter: @CommSec

Ryan Felsman, Senior Economist, CommSec; Twitter: @CommSec