Despite a higher dollar and tough business conditions, many Australian blue chips delivered solid earnings and higher dividends. Colonial First State’s Raaz Bhuyan takes a looks at highs and lows of the 2012 reporting season.
The 2012 earnings season, which typically occurs in September and October each year, played out in a landscape of difficult conditions for local business. The Australian dollar stayed relentlessly high, while consumer confidence remained weak. Added to that, the strength of capital spending in the resources sector forced the Reserve Bank to keep a tight hold on the purse strings.
But while conditions were tough, there were some stand-out results in 2012. The healthcare sector in particular had a positive reporting season, with earnings up markedly despite the strong Australian dollar.
The big four banks delivered positive results in 2012, with the Commonwealth Bank reporting solid earnings, and the NAB and ANZ giving positive trading updates. All four banks appeared relaxed despite a difficult domestic operating environment.
The Commonwealth Bank surprised the market by paying a higher dividend and signalling a higher dividend payout ratio in the future.
Given the high, fully franked yields and low-but-steady earnings outlook, the banks have traded like defensives and significantly outperformed in recent months.
Telstra meets expectations
Telstra reported a result in line with estimates and provided guidance for low single-digit revenue and operating profit growth in 2013.
Looking ahead, the company’s earnings growth will be driven mainly by the mobile business and NBN Company payments, as part of the agreement with the Australian Government. However, based on our analysis of the Australian mobile industry, we believe Telstra’s mobile profitability could be hurt by a competitive response from Optus or Vodafone in the future.
The resources sector — the powerhouse of the Australian economy— struggled in 2012. In the second half of the year, earnings fell by over 20% as increasing costs and a high Australian dollar squeezed margins.
Since June, the price of iron ore has fallen considerably, compounding issues and leading to speculation over the end of the mining boom.
But the news isn’t all bad for the big miners. As the lowest-cost producer of iron ore in the world, Rio Tinto is making significant operating profit even at current prices. And based on our estimate of the marginal cost of production in China, we expect iron ore price to revert to around $110 per tonne reasonably soon. With productivity improvements likely to increase iron ore production by over 20% by 2014, we expect profits to multiply off a lower base.
Having said that, we expect the 2013 earnings outlook for resources to be softer. Mining companies can no longer use commodity prices to generate profit. Instead, they will need to improve productivity — something which could have an adverse effect on the mining services sector and other suppliers.
Outside of the insurance sector, few companies believe that 2013 will be any easier.
With the mining investment boom now predicted to be past its peak, as more capital projects are being deferred, the Reserve Bank should have greater freedom to continue interest rates cuts and help rebalance the economy. However, the main concern now is that, if the Government continues to cut spending to reach its budget surplus targets, housing, retail and media companies will continue to be held back.
Stand-out stocks of 2012
Plasma products company. CSL has generated around 25% compound average earnings growth in their core business over the last six years. After acquiring cheap complementary assets from competitors during a cyclical downturn in the global plasma industry, CSL’s global market share went from 25% in 2006 to 35% in 2012. The company has steadily improved profit margins and return on capital during this time.
Since taking over supermarket giant Coles, Wesfarmers has improved its operating profit by 60%. Coles can now roll out more stores and we expect its earnings will continue to grow. While Woolworths has also done well, we believe that the roll-out of their Masters hardware stores will constrain their ability to aggressively compete with Coles.
Suncorp and IAG
Big insurers Suncorp and IAG reported good underlying results in their insurance divisions. After having their earnings decimated by floods and earthquakes in recent years, both insurers increased premiums in home and motor insurance, improving their earnings outlook.
Raaz Bhuyan is a Senior Portfolio Manager from the Colonial First State’s Australian Equities Growth team.
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This document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at 7 November 2012. This document is not advice and provides information only. It does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement available from the product issuer carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision. Copyright © 2012 Colonial First State Investments Limited.
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