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“Things are never as good as they seem or as bad as they seem“
Legendary investor Sir John Templeton

Last week the ABS (Australian Bureau of Statistics) released the Australian unemployment rate for February 2021, which surprised the market, coming in at 5.8% with 88,700 new jobs added since January. This positive news caused us to reflect on where we were a mere 12 months ago and the journey that the economy and equity markets have made from the depths of despair prevailing on this day twelve months ago;  23rd March 2020.

Panic Stations March 2020

Twelve months ago, today, the ASX 200 fell -5.6% to 4546 with $11 billion worth of shares traded, making this day one of the top 20 busiest days in ASX history. The Australian dollar had crashed to an 18-year low of 57c, oil was at US$22 a barrel, and earlier on in the week, the RBA announced an emergency 25 point cut to interest rates. More alarming for investors were headlines predicting a severe recession with many businesses going into receivership and unemployment to reach levels last seen in the early 1990s or the 1930s. In the USA, a Federal Reserve Governor predicted that the US unemployment rate would hit 30% due to shutdowns to contain the virus and the US Congress failed to pass a $1 trillion Covid-19 aid plan.

Questions were being asked about whether commercial real estate and infrastructure would become stranded assets, as Covid-19 was likely to permanently change human behaviour, negating the need for offices, shopping centres and toll roads.

How the crash was different

The crash in March 2020 differed from previous market crashes of 2000 and 2008/09 in that virtually the entire ASX was sold down heavily, even companies that were expected to do well during Covid-19 shut-ins. Atlas viewed that this selling pattern occurred due to the increasing influence of index funds and geared index funds on the stock market. When these funds received redemption, the manager mechanically sells shares in every company in the ASX 200 following its index weight. This saw sharp falls in the share prices in March 2020, even for companies such as JB Hi-Fi, Wesfarmers, Sonic Healthcare and Amcor that were likely beneficiaries from lock-downs and increased testing. Indeed, on this day 12 months ago, JB Hi-Fi revealed that March quarter sales had surged by +9%; nevertheless, their share price fell -11% to $24.61 on market capitulation.

The Banks

The banks were viewed as the canary in the coal mine and were expected to wear heavy loan losses from rising bad debts. For the following year, Westpac forecasted an 8% contraction in GDP, unemployment at close to 9% and house prices to fall 20% by the end of 2021. Consequently, bank shareholders felt the heat as dividends were either cancelled or suspended. While ANZ, Westpac and NAB cut their dividends during the Great Depression, both World Wars, the 1991 recession, and the GFC; one had to look back to the banking crisis of the 1890s to see the last time that major banks declined to pay dividends to shareholders, as was done in early 2020.

The path back March 2021

While it would be premature to declare victory over Covid-19, none of the doomsday predictions made twelve months ago has come to fruition, and any decision made in March 2020 to panic and liquidate equity portfolios would have been a poor one for investors. Indeed, 23rd March 2020 marked the bottom for equity markets globally.

Previous downturns such as 1982/83, 1992 and 2009 were quite different from what we saw in 2020. While in 2020, unemployment spiked and the stock market crashed in March and April, the levels of fiscal stimulus are much more significant. The Rudd Government’s $42 billion stimulus packages from 2008/09 were dwarfed by the $257 billion in direct Covid-19 related support measures. Moreover, Australia has seen very low to no community transmission of Covid-19, which has allowed the economy to function with fewer impediments than experienced in Europe and North America.

The recently completed February 2021 reporting season has seen companies outperform expectations on revenue, earnings and dividends. Earnings upgrades came from banks (with fewer bad debts) and resources (higher commodity prices). Dividends were the highlight of the reporting season, with many companies increasing payouts to shareholders, potentially recognising that dividends were cut too hard in 2020. Currently, the ASX 200 is a mere 5% below the highs set in February 2020, unemployment has declined from a peak of 7.5% in July 2020 to 5.8%, and retail sales are above pre-Covid 19 levels.

Finally, as following house prices is the one sport that unites all Australians, far from falling 20%, the most recent CoreLogic RP house price index showed that house prices were up +3% over the past year led by Sydney and Brisbane. Stable to rising house prices have seen bad debts for the banks significantly below expectations and seen rising capital ratios. This paves the way for higher dividends throughout 2021 and even bank share buy-backs, a scenario unthinkable a mere 12 months ago!

Our Take

I have had the “fortunate” experience of having observed three major crashes; March 2020, the GFC in 2007-08 and the Tech wreck in North America in 2001 from the front lines.During these dark periods, the portfolios were populated with companies paying dividends from stable recurring earnings such as TransCanada Pipelines and Amcor, with no exposure to companies reliant on the previous frothy market conditions Pets.com, Nortel, Babcock & Brown or Allco Finance.

What I learned from these experiences is that a portfolio constructed in a conservative manner populated by companies paying stable dividends with low gearing will bounce back from the blackest nights of doom and gloom. Additionally, as markets are driven by human emotions, at the period of maximum despair (March 2020), many investors make irrational decisions based on the view that share prices now only go down. Panic conditions on share markets can result in profitable investment opportunities for those that can avoid the noise. However, it is much easier to make this statement with the benefit of hindsight after the doomsday scenarios for the economy and corporate profits have not eventuated.

• February proved to be a very eventful month initially dominated by Australian corporate earnings, which were much better than expected and revealed that corporate Australia is recovering from Covid-19 must faster than expected. In the second half of the month, the main focus was on rising bond yields and what this means for stocks rather than corporate earnings.
• The Atlas High Income Property Fund gained by +0.74% in February, a pleasing result ahead of both the benchmark and the wider Listed Property sector that declined almost -3%. The February reporting season held few surprises for the companies we own, as rent-collecting trusts offer greater earnings visibility, whereas trusts with development earnings can be volatile.
• Overall, we were pleased with the companies’ financial results that we own in the Fund. The common themes were profits recovering, rents being collected, and the outlook for 2022 looking much clearer.  Unlike going into the GFC, the listed property sector faced no debt issues in 2020 as the industry had low gearing, faces low interest costs and most importantly, a spread of debt maturities.

Go to Monthly Newsletters for a more detailed discussion of the listed property market and the fund’s strategy going into 2021.

Sonic’s boom due to COVID-19 tests, but how long will it last?

“The next leg in this pandemic story for Sonic is likely to be COVID-19 serology testing (immunity status),” Mr Dive said. “Since I started covering stocks as a young analyst in the late 1990s, I have never seen a result like this from a large cap stock.”

The February 2021 company reporting season that concluded on Friday and was one of the more interesting over the past decade, coming as it does after the doom and gloom of the February and August 2020 results seasons. Aside from a few companies such as JB Hi-Fi and Sonic Healthcare that were forced by ASIC and the ASX’s continuous disclosure laws to give market updates (due to unprecedented demand for electrical goods and COVID-19 tests), most companies had given the market very little profit guidance going into the February season.

In this week’s piece we are going to look at the key themes coming out of the reporting season that finished on Friday.  Click here for an interview on Reporting Season in Finer Market Points

Better than expected

Given the gloomy backdrop of 2020, ongoing uncertainty around COVID-19 and further lockdowns in late 2020, general expectations were cautious going into reporting season.  The market expected little in the way of positive sentiment from management teams outside the COVID-19 winners and the miners.

February 2020 has generally seen companies outperform expectations on revenue, earnings and dividends. Earnings upgrades came from banks (with fewer bad debts) and resources (higher commodity prices). Dividends were the highlight of the reporting season with many companies increasing payouts to shareholders, potentially in recognition that dividends were cut too hard in 2020.

On the negative side of the ledger the rising Australian dollar hurt the translation of profits earned by companies in US dollars such as CSL, Macquarie Bank, BHP and Sonic Healthcare.

Show me the money

During times of uncertainty such as those seen in 2020, the first move a company’s board will make is to either cut or reduce dividends paid to shareholders with the aim of conserving cash. This move is preferable both to a dramatic reduction of their workforce – which crystalises significant redundancy costs – and to raising equity, which dilutes that of current shareholders. 

2020 saw significant dividend cuts from most ASX listed companies. However, the main feature of the February reporting season has been companies significantly increasing dividends or resuming dividend payments that were previously suspended.

We see that dividends are a better measure of management’s and the board’s opinions of a company’s health: a company is unlikely to raise dividends if business conditions are worsening. Furthermore, while earnings per share can be restated at a later day due to “accounting opinions,” once dividends are paid, they cannot be retrieved.

Commonwealth Bank’s result is always one of the most closely scrutinised – not only because it is Australia’s largest company, but with 15 million customers, the health of CBA often mirrors the health of Australia. With this in mind it was pleasing to see CBA lift its dividend from $0.98 to $1.50 per share.

Covid-19 Stars Fading

One of the more interesting results has been Coles that was off significantly post the result, despite reporting a 14.5% gain in profits. The fall in Coles’ share price was mainly due to management’s warning about sales growth of only +3% in January. They indicated that investors should expect a sales decline in the second half of 2021, as Coles’ future earnings will not compare favourably to those from last year, which benefited from panic buying behaviour exhibited prior to lockdowns.

Coles’ result sent a tremor through the retail sector. The impact was felt even in companies such as JB Hi-Fi who reported a very impressive 86% growth in profit for the half, and saw strong sales momentum continue into January. Conversely, we have seen a recovery in some of the losers from COVID-19 based on signs that the worst may be behind them: for example, Tabcorp, Sydney Airport and IDP education.

Government Handouts

Cash flows from the government have been a significant feature of the February results season, both directly via JobKeeper payments and indirectly due to the impact that these payments have had on consumers ability to pay for goods and services. Obviously, the direct payments are more tangible. Understandably, however, the impact was not highlighted by management when they presented their results, given the increasing community backlash against the payment.

Harvey Norman’s result attracted a large amount of commentary in the press after reporting a record profit on the back of strong online sales, maximising JobKeeper subsidies, and rent waivers. However, many other companies have also benefited from stimulus plans without receiving the same level attention.

Over the past month Crown, Sydney Airport, Qantas, Vicinity and Aristocrat all received employment support measures. Amusingly one company proudly announced that they had not accepted a single dollar of JobKeeper payments, while simultaneously revealing a 27% increase in profits. We are not sure how this company could have been eligible for this support program. In February Domino’s Pizza, Nick Scali, CIMIC and Cochlear all announced that they would repay previously received JobKeeper subsidies

Best and Worst

Over the month, the best results were delivered by JB Hi-Fi, Nine Entertainment, Bendigo Bank, Amcor and CSL. Each of these companies reported strong earnings growth against the gloomy macroeconomic background. 

On the negative side of the ledger, it is harder to find candidates as low expectations create an easy hurdle for most companies to jump over. AMP, Challenger and Crown, however, all delivered results below expectations. The common themes amongst this group were the profit results coming in below expectations, combined with bearish management commentary for the coming year, mainly due to the inability to reduce costs in line with revenue falls.

While Treasury Wine’s share price has rallied in February, it is hard to make the case that this maker of high-quality wines has turned the corner. TWE’s profits were down -24% as the impacts of punitive Chinese tariffs (> 200%) begin to bite on sales of Penfolds, a mainstay of banquets from Harbin to Chengdu. China was previously a large, growing and profitable market for Treasury and accounted for over 40% of company profits in FY19. Such a market is not easily replaced, and the loss is due to no fault of company management.

Result of the Season

While some companies have done well out of the COVID-19 pandemic, it is difficult to think of a company that has flourished well as global pathology testing company Sonic Healthcare. In the outstanding result of the reporting season, Sonic demonstrated one of the reasons why we like the company: pathology is a volume game, laboratories have high fixed costs, but as much higher volumes flow through the same lab, profit margins increase. Profits were up a staggering +166% with 18 million COVID-19 tests performed across 60 global labs. While volumes have been falling in Australia, they are still at record levels in Europe and the USA. The next leg in this pandemic story for Sonic is likely to be COVID-19 serology testing (immunity status). Since I started covering stocks as a young analyst in the late 1990s, I have never seen a result like this from a large cap stock.

Our take

Overall, we were reasonably pleased with the results from this reporting season for the Core Australian Equity Portfolio. As the Atlas High Income Property Fund focuses on owning conservative Trusts that are rent collectors, reporting season offers few surprises – especially as most of the Trusts we own pre-announced the distributions several months ago in December.   

As a long-term investor interested in delivering income in the portfolio to investors, something we look at closely is the dividends paid out by the companies that we own and whether or not they are growing. We look to “weigh” the dividends that our investors will receive, as our view is that talk and guidance from management are often cheap, but actually paying out higher dividends is a far better indicator that a business is performing well. Using a weighted average, the dividends that our investors will receive will be +30% greater than for the previous six months, demonstrating confidence returning to Australian corporates after the uncertainty brought on by the pandemic. On this measure, we are fairly satisfied with how the recent reporting season went.

As Mayfair 101 investors can attest, there is no point chasing higher rates of income if it is not sustainable or results in capital destruction.

Here are four key qualities that investors can look for when researching a company, infrastructure or property trust in order to assess the sustainability of income.

Dividend payout ratio: Hugh Dive, portfolio manager at Atlas Funds Management, says that generally anything above 80 per cent suggests the current level of the dividend may not survive the inevitable variability in profits from the economic cycle. Though this can be industry-specific, a regulated electricity utility such as Spark Infrastructure can handle a higher payout ratio due to greater certainty of earnings than a mining company such as Alumina. Spark Infrastructure offers investors an income yield of around 6.3 per cent based on the current share price.

How to chase higher income without blowing up capital

SCA Property, a listed property trust with exposure to non-discretionary retail via 91 suburban shopping centres anchored by long leases to major supermarkets with low gearing, is an excellent example of an investment displaying these characteristics, says Dive.