Key Themes from the August Reporting Season

The highly anticipated August 2021 company reporting season for Australian listed companies concluded earlier this week. While certain companies in the travel industry, such as airlines and airports, continue to generate large losses, the month of August showed that large Australian companies are in very good health overall. Indeed, the sum of dividends declared over the last month surpassed the previous all time record set in August 2019!

In this week’s piece, we look at the key themes coming out of the reporting season that finished on Tuesday, along with the best and worst results and the corporate result of the season.

Better than expected

Given the gloomy backdrop of 2020, ongoing uncertainty around COVID-19 and further lock-downs in late 2020, general expectations were cautious going into reporting season. Even companies such as Sonic Healthcare, which had a record year conducting 30 million Covid-19 tests globally, were unwilling to provide earnings guidance. While the profit results in February 2021 were generally quite positive, some of the COVID-19 winners from 2020 were expected to struggle in 2021. The market was also concerned that the economy could face a negative shock as JobKeeper finished at the end of March.

According to UBS, 41% of ASX 200 companies beat their guidance, and over 70% of companies lifted profits compared with the prior comparable period in 2020. Companies beating guidance generally were COVID-19 beneficiaries that saw continued sales momentum (Wesfarmers and CSL) or saw profit margin expansion from improvements in their markets (Amcor and Suncorp). Better than expected corporate profits saw the ASX 200 hit an all-time high of 7628 on the 13th August, an unthinkable situation in March 2020 when the prevailing view was that in 2021 Australia would be in the grip of a deep recession!

Show me the money

The main theme of reporting season was the significant increase in dividends being paid to shareholders. August 2021 saw a record $40 billion in dividends being declared by Australian companies, beating the previous record of $28 billion set in August 2019. This corporate largess is due to a combination of record iron ore prices (BHP, Fortescue and Rio), strong sales from consumers being locked down and being prevented from travelling (Woolworths, JB Hi-Fi and Wesfarmers) as well as much lower-than-expected bad debts (Commonwealth Bank).

In addition to higher dividends, buy-backs were a feature of this reporting season with CBA ($6 billion), NAB ($2.5 billion), Woolworths ($2 billion), ANZ ($1.5 billion) and Telstra ($1.3 billion) announcing measures to reduce their share count and boost future earnings per share. CBA and Woolworths buy-backs will be conducted off-market rather than as direct purchases on the ASX and then cancellations. Here their investors will receive a combination of a tax-efficient capital return and a fully franked dividend which will see excess franking credits transferred from corporate balance sheets into the hands of investors. Furthermore, Wesfarmers announced a $2.3 billion capital return. This wall of money will find its way into the bank accounts of investors over the next two months, which along with companies buying back their shares on market should support the ASX throughout the rest of 2021. NAB shareholders should be less happy, as the bank is now buying back shares on market at around $28, which were issued in May 2020 at $14.15. Sell low and buy high, poor capital management!

Management Choices

Some in the financial press have criticised the levels of dividends being paid to shareholders, saying that it is a sign that management teams are not reinvesting capital in growth projects or making acquisitions that will grow earnings in the future. However, the record of Australian companies successfully making significant investments during times of excess profits is not good. Both Rio Tinto (Alcan 2007 and Riversdale Coal 2010) and BHP (US shale gas 2011) made value destructive acquisitions during previous iron ore booms. Similarly, hardware retailing superstar Wesfarmers foray into the UK hardware market in 2016 resulted in an ignominious retreat two years later. While competition concerns would preclude the big four trading banks from using their excess capital to buy smaller regional banks, their record in using capital to grow in adjacent areas such as wealth management is poor. Similarly, Australia’s banks’ moves to showcase their domestic banking expertise in the UK, USA, and Asia are littered with painful lessons. When management is confronted with the choice of returning capital to shareholders or making an exciting acquisition presented to them by a slick investment banker, we generally prefer to see excess capital going to shareholders, which is what Australian companies have mostly decided to do in 2021.

Mergers and Acquisitions on the Table

Against this background of caution by most Australian companies towards making a major acquisition, August revealed that foreign corporations pension funds are quite happy to pay up for Australian listed companies. Over the month, we saw deals such as NYSE-listed Square’s $39 billion scrip-based deal for AfterPay, Santos’ $21 billion merger offer to Oil Search, a $22.8 billion offer for Sydney Airport and a $5.2 billion bid for Spark Infrastructure. Similar to the quantum of dividends discussed above, these takeovers are likely to support share prices as the proceeds find their way into investors bank accounts in the coming months.

Rising Labour Costs

Despite dire predictions made in early 2020, the combination of stimulus plans, strong corporate profitability and close to zero immigration has seen the unemployment rate fall steadily, with the rate falling below 5% in June for the first time in ten years. Low unemployment is likely to lead to rising wages. In August, major employers such as Woolworths and BHP discussed that higher labour costs are expected to impact profit margins in the future. Similarly, low unemployment levels in the US have increased CSL’s input costs, with the biotherapy company having to pay blood donors more for the blood plasma collections. Also, CSL saw reduced plasma volumes which were attributed to government stimulus cheques stopping donors from turning up at the company’s collection centres in the USA.

Best and Worst

Over the month, the best results were delivered by WiseTech, Suncorp, Domino’s Pizza, James Hardie, and Amcor. Despite the uncertain macroeconomic background, these companies reported strong earnings growth ahead of expectations and an optimistic outlook for 2022.

Looking at the negative side of the ledger, we will ignore travel-related companies such as Qantas, Sydney Airport and Flight Centre as their financial results are due to government-mandated lock-downs rather than poor management decisions. Altium, Magellan, Link Administration and Cochlear reported results that were poorly received by the market. The common themes amongst this group are high price to equity (PE) companies that delivered profit results below expectations, combined with forward profit guidance not consistent with high growth companies.

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 as well as the global pathology testing company Sonic Healthcare. In the most outstanding result of the reporting season, Sonic demonstrated one of the reasons we like the company. Pathology is a volume game, and laboratories have high fixed costs, but profit margins increase when much higher volumes flow through that same lab. Profits were up a staggering +150% to $1.3 billion with 30 million COVID-19 tests performed across 60 global labs. Additionally, Sonic’s base pathology business has grown and is now ahead of pre-pandemic levels. While the company only increased the dividend by 7%, we were pleased to see management use the windfall generated by the pandemic to pay off $1 billion in debt, thus halving the company’s outstanding debt level previously built up to acquire laboratories in the USA and Europe. Building a global network of laboratories has proved to be a prescient move in 2020/21. The next leg in this pandemic story for Sonic is likely to be COVID-19 serology testing (immunity status).

Our take

Overall, we were reasonably pleased with the results from this reporting season for the Atlas Concentrated Australian Equity Portfolio. In general, the companies that we own reported improving profits and indeed, for a number of companies in the portfolio, 2021 delivered record profits that were mainly used to reward shareholders.

The Portfolio returned 29% for the 12 months ending August 2021 which was over 2% above the benchmark. As a long-term investor we are also interested in delivering income to investors, we look closely at 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. 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 across the portfolio, our investors’ dividends will be +50% greater than for the previous period in 2020. This increase demonstrates confidence returning to Australian corporates after the uncertainty brought on by the pandemic. On this measure, we are pleased with how the recent reporting season went.

July Monthly Newsletter

The Atlas High Income Property Fund declined slightly by -0.6% which was an acceptable outcome where lockdowns in Melbourne and Sydney caused the large retail trusts to fall by between -5% and -6% over July.
While lockdowns impact the economy and thus the earnings of property trusts and infrastructure assets, 2020 showed that not
all assets’ owners are uniformly negatively impacted. Indeed, many companies held in the portfolio saw minimal to no impact
on their profits from the lockdowns last year. Consequently, the lockdowns in July 2021 did not result in broad-based panic
selling of real estate assets on the ASX that we saw in February and March last year.

o to Monthly Newsletters for a more detailed discussion of the listed property market and the fund’s strategy going into 2022.

What goes on during Reporting Season?

For equity analysts and fund managers in Australia, Christmas comes twice a year, every February and August, when most Australian listed companies reveal their semi-annual profit results. Companies also guide what growth in profit, revenue, profit margins or dividends that shareholders can expect over the following financial year. Though Covid-19 has seen fewer companies commit to providing guidance given the uncertainty around lockdowns and the dramatic increase in class action lawsuits brought forth by litigation funders keen on profiting from negative deviations in company earnings.
This can be a stressful time for a fund manager. When companies reveal unpleasant surprises, the company’s stock price tends to get sold down hard. Alternatively, it can be enjoyable when the company reports a good result that validates the investment case for originally owning their shares.
In this piece, we will go through how Atlas approaches each day during reporting season and what goes on during a typical day during the earnings season.


Before Reporting Season

In the lead up to reporting season, Atlas reviews all the stocks in the portfolio and considers the key factors and financial metrics that investors will be looking for on results day. We compare our forecasts to the consensus analyst forecasts. What we are trying to do here is to identify which companies are performing ahead of expectations and, more importantly, which companies have the potential to disappoint.

The Spread over the Month

Companies listed on the ASX with a June year-end have until the last day of August to release their financial results; otherwise, they are suspended from trading on September 1st. However, results are not released evenly throughout the month as companies tend to avoid reporting either in the first or last week of the month, preferring the middle weeks. Consequently, there are days when several large companies report on the same day and often at the same time, which often results in the market making swift and not well-considered decisions as to whether the result was either good or bad. Frequently we see a stock trading down on what Atlas considered to be a favourable result, only to see the company’s share price recover the following day after investors have digested the financial reports. The below chart shows the distribution of results during the August reporting season, with the week starting August 16th being the heaviest. Wednesday August 18th, will be challenging for analysts with CSL, Coles, Dominos Pizza, Fletcher Building, Deterra, Santos, Supercheap Auto, Tabcorp, and Vicinity Centres reporting.

On the Day

Generally, companies post their financial results with the ASX around 9 am; this gives investors an hour to digest the facts and figures before trading on the stock exchange begins at 10 am. During this period, we will be combing through the profit and loss, balance sheet and cash flow statements, comparing our forecasts to what the company actually delivered. Also, it is important to compare how a company has performed against their peer group. For example, in isolation, Coles report reporting a slight decline in sales and a steady profit margin could signal a great result if Woolworths and Metcash reported significant decreases in sales and shrinking profit margins.

Company management will then formally present their results to shareholders on a conference call or in-person during the morning, generally between 9 am and midday. These presentations are directed towards the institutional investment community and are effectively closed to the media and public, and can take between one and two hours. The management team gives greater detail on the factors contributing to the profit result and explains any potentially contentious issues. The most informative part is always the question-and-answer session, which allows investors to gauge how confident management is in tackling the most controversial problems coming out of their financial accounts.

Typically, it will only be the sell-side analysts asking management questions, with the large institutional investors saving their questions for behind closed doors. The problem with this is that in addition to writing research, some sell-side analysts want to protect their relationship with the company and keep on its good side for future lucrative investment banking deals. Frustratingly this can sometimes see soft questions being served up for management or avoiding the hard questions when the management has made some mistakes.

After the presentation of the results, we will generally have a quick discussion to see if there have been any fundamental changes to our thoughts and discuss the market reaction. The immediate market reaction can often be misleading, as most of the trading on results day is done by hedge funds or high-frequency traders rather than long-term fundamental investors.

Lunch with the Company??

Before Covid-19, one of the benefits of being a good client of one of the investment banks is the opportunity to have lunch with the company management team, though there have been few of these events since 2019. These events are held in the bank’s boardroom and are fully catered events, though it is rare to see anybody accepting a glass of wine with their steak or fish. Many fine bottles of wine from the cellars of the investment banks get opened, offered around the table by waiters and then returned to the sideboard with one glass poured out.

Whilst this may seem to offer institutional investors an advantage over retail investors, any new insight is rarely gained in these events. This occurs as they are essentially a group meeting of rivals trying to understand what others think about the company. Further, if you know the company well or have a particularly insightful question, an analyst will save that for a one-on-one meeting with the company. Often several large and complicated companies report on the same day, so unless an individual company has had a particularly good or bad result, it is poor time management to spend 1.5 hours over lunch picking through the financial accounts of a company that has performed as expected.

Immediately Afterwards

Over the following week, the company will then organise individual one-hour meetings with their largest institutional shareholders both in Australia and overseas. Before these meetings, it is essential to be well prepared, as this is frequently the best forum to understand whether you should buy more of a company’s stock or completely sell out. During our meetings with the management teams, we will generally seek clarity (on behalf of our investors) on specific issues that we feel weren’t covered to our satisfaction at the formal presentation. While some of these meetings can be quite hostile or very friendly, they are a valuable forum for both parties to give feedback on how our client’s capital has been managed in the past and how that capital should be employed in the future.

I have been in these meetings where management has raised a potential strategy that seemed aggressive and quite alarming. In one case, I left a meeting with management to immediately begin selling down the fund’s position. The company in question was facing both a falling oil price and published decisions of their large listed clients to delay or abandon projects, both public information. These issues were largely glossed over in the earlier analyst call in favour of softball questions to management. A similar flippant response to these concerns was given in our meeting with management, which resulted in the action taken.

After the management meetings and subsequent to reviewing the financial results of a company’s competitors, Atlas is then in a position to determine what changes (if any) are made to our valuation of the company and whether the security’s weight in the portfolio is still appropriate in light of competing investment opportunities.