There is little doubt the past year has been a wonderful time to be an equity investor, with strong company results and very strong markets.
The 2021 company reporting season that has just ended underlined just how well equity investors are doing.
There was approximately $90 billion in buybacks, dividends and takeovers that have been distributed to shareholders during reporting season 2021, representing an extraordinary 5% of Australia’s gross domestic product1.
It is an enormous contrast to where we were just a year ago and the market has recognised the change, driving a 67% rally in share prices from the lows of 2020. This remarkable performance has been one of the fastest ever recoveries from a downturn taking just over a year to get back to pre-COVID earnings levels and setting new record highs for the ASX 2002.
But underlying the headlines are range of different outcomes. In fact, just two of the 10 sectors that make up the Australian market were responsible for the bulk of the earnings growth – miners and banks. These two sectors were the largest contributors to the outsized dividend returns investors enjoyed this August.
Sectors like utilities, telecommunications and industrials are lagging, as are travel stocks whose earnings are well below pre-COVID levels. These sectors have been impacted by COVID restrictions and have taken longer to recover.
This patchy performance underlying the averages indicates that the market is expected to be ripe for a stock-picking approach.
At the top end of the market, in our opinion the buybacks and dividends were the product of very strong balance sheets and cashflows, particularly among the iron ore majors and the financials. Banks are also enjoying the tailwind of government funding support, low unemployment and a strong home lending market.
Among the banks – whose reporting season is yet to come but where some buybacks have already been announced, like CBA’s $6 billion off-market buyback3 – capital raisings taken last year as prudent insurance against the risk of a COVID-19 downturn that never materialised are now being returned to shareholders.
In retail, we saw a perfect example of returning capital to shareholders in Metcash, who in July did a $175 million buyback4, just 15 months after doing a $300 million capital raising in part to make a hardware acquisition of total tools5.
Among the miners, soaring prices for iron ore means the commodity is trading around 10 times its production costs6, effectively delivering the kinds of earnings margins more often seen among luxury goods makers.
Meanwhile, the shift towards decarbonisation has put a rocket under demand for the commodities needed for battery technology like lithium and nickel, further boosting the mining sector.
So, what does the future look like?
Upgrades in earnings forecasts outpaced downgrades in the lead up to the reporting season. Interestingly, this year’s share market reaction to earnings revisions has not tracked its normal pattern. Usually, companies whose results trigger positive earnings revisions usually see a positive share price reaction, while those with negative revisions see shares fall.
This year, share market reaction to earnings revisions has been less predictable. Part of this is due to the high level of macro-economic moves in the background, such as how investors are thinking about future inflation and interest rates and the speed of withdrawal of stimulus by central banks and governments.
Inflation is probably the biggest macro theme showing up in reporting season in our opinion.
Data from the US Bureau of Labour Statistics shows that much of the inflation showing up in current figures is transitory and driven by the re-opening of the economy and people switching their spending towards travel. This has driven double digit year on year rises in the price of airline fares, hotels and used cars7. Similar patterns are expected to show in Australia’s inflation when the current round of government COVID restrictions eventually ends. A welcome arrival of freedom, no doubt. We believe this will be a positive for companies exposed to the reopening trade, like travel agents, but a potential headwind for others.
Not all inflation is related to consumer spending. Higher shipping prices are the result of a lack of shipping containers and are posing a problem for companies exposed to international trade8.
The trick for investors is to focus on quality companies that can lift their prices in the face of inflationary headwinds. For example, companies supplying households with hardware and building materials have been able to maintain supply lines and lift their prices due to higher demand for home renovations over the past year. Similarly, supermarkets have been able to reduce promotional activity, allowing them to lift their prices and expand their margins. But some companies that have less ability to set prices might face a squeeze on margins going forward.
Labour costs are also an inflation risk.
The mining sector has struggled with the closure of international and state borders. On the other hand, there has also been a lift in labour demand in areas like retail and food where check-in and delivery staff are needed under government COVID rules.
Still, there are reasons to be cheerful. Labour pressures appear to be easing in Western Australia and are expected to ease further as borders open. Globally, the post-COVID re-opening is well underway, notwithstanding Australia’s latest round of lockdown and border closures. US air passenger numbers have recovered back to 75-80% of 2019 levels, and European flight capacity is in the 60-70% range9. Australia’s rapid vaccination rollout is likely to see a similar scenario play out here and the participation rates and speed of rollout have been encouraging.
Re-opening opportunities for investors will play out differently sector by sector.
The travel sector will clearly be a beneficiary. IATA data says 57% of travellers plan to take off within two months of COVID-19 being brought under control10. However, non-travel sectors are also expected to benefit with the food and beverage sector likely to enjoy a rapid recovery as people return to dining out once restrictions ease.
The outlook for retail is expected to be mixed as the winners from COVID slow a little, especially where they have been slow to develop an online offering.
As always with COVID-19, investors need to stay flexible and take your opportunities when they come. However, with that massive $90 billion received by shareholders, it’s certainly been a good start to the year and shows our Aussie companies are in good health and have strong balance sheets to get them through to the other side of the lockdown and the expectant promised land of freedom and big-spending largesse.
1. https://www.afr.com/markets/equity-markets/historic-earnings-season-rains-86b-cash-20210827-p58mf3.
2. Australian Stock Exchange
3. https://www.commbank.com.au/about-us/investors/cba-off-market-buy-back.html
4. https://www.afr.com/companies/retail/metcash-launches-175m-buy-back-as-profits-soar-20210627-p584pb
5. https://www.afr.com/companies/retail/metcash-eyes-bolt-on-acquisitions-after-raising-330m-20200420-p54lc7
6. BHP, Rio Tinto and Fortescue company accounts
7. https://www.abc.net.au/news/2021-07-01/car-shortages-new-and-used-vehicle-prices-increase-waiting-times/100256070
8. https://www.reuters.com/business/china-us-container-shipping-rates-sail-past-20000-record-2021-08-05/
9. https://www.eurocontrol.int/sites/default/files/2021-07/covid19-eurocontrol-comprehensive-air-traffic-assessment-22072021.pdf
10. https://www.iata.org/en/pressroom/pr/2021-03-09-01/
Author: Dermot Ryan, Co-Portfolio Manager (Income) Sydney, Australia
Source: AMP Capital 24 August 2021
Reproduced with the permission of the AMP Capital. This article was originally published at AMP Capital
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