8/2/2019 Olivers Insights the Australian Share Market and Profits

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EDITION 8 7 MARCH 2012

Shane Oliver, Head of Investment Strategy& Chief Economist

This is the worst earnings results since February 2009, during theglobal financial crisis (GFC). Reflecting this, results were greetedcautiously with 52% of company share prices underperformingthe market on the day results were released. While outlookstatements have improved slightly from the last reporting season,the net balance of positive statements remains relatively low.

Outlook statements have become slightly more favourable

Source: AMP Capital

Reflecting the lacklustre reporting season, analyst revisionsto earnings expectations have been generally negative. Thenext chart shows that the number of Australian companiesseeing their earnings forecasts being revised down by analysts,has continued to outweigh the number of companies seeingupgrades. Additionally, the pace of downgrades has been farmore intense than the last couple of years, which partly explainsthe relative underperformance of Australian shares. However, the

good news is that the pace of downwards revisions is slowing,as is the case globally. In fact, based on weekly trends, we believeglobal earnings revisions are likely to turn into net upgrades soon.

Downwards earnings revisions have been more intense in

Australia, but have started to slow globally

Source: Thomson Financial, AMP Capital

The 2011/2012 financial year consensus earnings expectationshave been revised down to 3%, from 7% in late January 2012 andfrom 14% a year ago. The downgrades have been concentrated toresource, insurance, media and other financials sectors.

Key themesSeveral key themes have become apparent. Firstly, earningsgrowth was non-existent through 2011. Aggregate earnings havebeen effectively flat or slightly lower compared to the December2010 half-year results.

Secondly, the weakness in earnings was broadly based acrossall major sectors with resource profits down slightly, non-bank

industrials flat and banks slightly up. A similar message is apparentfrom the Australian Bureau of Statistics with their measure ofprofits up just 2.7% compared to a year ago which were up 20%.

Thirdly, the weakness in profits reflects a combination of factorswith the main ones being weak domestic demand, the strong A$and commodity price softness during the second half of last year.

OliversInsights

Key points> The December half-year reporting season was lacklustre,

with fairly flat profits.

> Profit growth is likely to pick-up in the coming year but still

lag consensus expectations for double digit growth.

> Australian shares are likely to rise over the year ahead asvaluations are attractive and global shares are likely to rise,

although we expect Australian shares to remain a relative

underperformer for a while yet.

IntroductionThere were plenty of nerves around leading into Februarywith announcements of December 2011 half-year reportingin Australia. Domestic demand has been weak, the strongAustralian dollar (A$) is bearing down on trade-exposed sectorsand resource sector profits were coming off a high base withcommodity prices falling in the second half of 2011. The results

were pretty much as expected, in a word: lacklustre.

Reporting season wrap upIn good news, most companies saw profit growth over the last

year, with 68% of companies reporting a profit increase.

Australian company profits relative to a year ago

Source: AMP Capital

Against this, only 31% of results announced beat expectations,down from the 37% of companies that beat expectations for theJune 2011 half-year results and well below the norm of 45%.

Australian profit results relative to market expectations

Source: AMP Capital

The Australian sharemarket and profits

0102030405060708090

100

Feb 07 Aug 07 Feb 08 Aug 08 Feb 09 Aug 09 Feb 10 Aug 10 Feb 11 Aug 11 Feb 12

Reporting season

down

up

Percentage of company profit results

79 89 67

21 11 33 27

73 50

50

42

58 41

59 70

30

67

33

67

33

68

32

(%)

0

102030405060708090

100

Feb05

Aug05

Feb06

Aug06

Feb07

Aug07

Feb08

Aug08

Feb09

Aug09

Feb10

Aug10

Feb11

Aug11

Feb12

Reporting season

In line

Below

Above

Percentage of results

64 58 49 49

11 1827 39

25 24 24 12

47

36

17

44

39

17

38

29

33

27

43

30

27

37

36

44

38

18

49

29

22

38

39

23

37

31

32

37

36

27

31

46

23

(%)

-80-60-40-20

020406080

Aug 08 Feb 09 Aug 09 Feb 10 Aug 10 Feb 11 Aug 11 Feb 12

Reporting season

Net balance of positi ve le ss negative outlook statements

(%)

-80-60-40-20

020406080

00 01 02 03 04 05 06 07 08 09 10 11 12

Net, percentage consensus earnings revisions up versus down

World

Australia

Net positive revisions

Net negativerevisions

(%)

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Contact usIf you would like to know more about how AMP Capital can help you, please visit ampcapital.com.au, or contact one of the following:

Financial Advisers Your Business DevelopmentManager or call 1300 139 267

Personal Investors Your Financial Adviser or callus on 1800 188 013

Wholesale Investors AMP Capitals Client ServicesTeam on 1800 658 404

Important note: While every care has been taken in the preparation of this document,AMP Capital Investors Limited (ABN 59 001 777 591) (AFSL 232497) makes no

representation or warranty as to the accuracy or completeness of any statement in itincluding, without limitation, any forecasts. Past performance is not a reliable indicator

of future performance. This document has been prepared for the purpose of providinggeneral information, without taking account of any particular investors objectives,financial situation or needs. An investor should, before making any investmentdecisions, consider the appropriateness of the information in this document, andseek professional advice, having regard to the investors objectives, financial situation

and needs. This document is solely for the use of the party to whom it is provided. OI_070312

Non-bank industrials have been hit by a combination of weakdomestic demand, sticky cost bases which partly reflect the 2010surge in workforces and the strong A$ bearing down on tradeexposed sectors. Additionally, industrial sector profits have beendoing it tough since before the GFC.

Non-banks industrials earnings per share growth

Source: Deutsche Bank

Banks have seen profit growth slow to a crawl on the back of softcredit growth, pressure on bank margins from higher fundingcosts and disappointing trading income.

Resources have seen profits stall, partly reflecting the high baseof 2010 but also a fall back in commodity prices during thesecond half of 2011 as well as increased costs associated withbooming mining investments.

Of course there have been some pockets of strength, such as

within mining services companies, which have benefitted fromthe surge in mining related investment as well as within healthcare stocks, among high quality franchises such as CSL, Cochlearand Resmed. The overall softness in profits is a confirmation ofthe broader weakness in much of the Australian economy.

OutlookConsensus earnings expectations are for 12.6% earnings growthin 2012/2013 financial year.

Australian share market earnings per share growth

Source: UBS

Profit growth is likely to pick up over the next financial year. Theresources sector, in particular, is likely to benefit from an ongoingglobal recovery, modestly higher commodity prices and a risein production. Industrials are likely to benefit from corporaterestructuring, further falls in interest rates and an eventual pick-up in domestic demand, which should result in some marginexpansion. Consensus expectations for margins are also more

realistic than they were six to 12 months ago; however, profitgrowth is still unlikely to meet current consensus expectationsfor the 2012/2013 financial year. We estimate an outcome ofaround 7% growth more likely, attributed to the likelihood that

domestic demand will remain constrained and the A$ willremain strong.

Where does this leave Australian shares?A further downgrade in expected earnings growth is likely duringthe year ahead. The Australian share market is trading on aforward price to earnings (PE) ratio of 11.5 times. This is downsubstantially from 12.9 times a year ago. Even if the year aheadearnings expectations are downgraded by a further 5%, thiswould still leave room for circa 8% capital growth if the marketwere to rise to a forward PE ratio of 13 times. This level is below

the markets 15 year average PE ratio of 14.5 times, but may beappropriate for the more volatile environment we are in.

Another positive is that with corporate cash holdings at recordlevels and low gearing, there is plenty of scope for furtherincreases in dividends, buybacks and other corporate activitygoing forward.

Australian corporate sector gearing is benign and cash holdings

are at record levels

Source: RBA, AMP Capital

Notwithstanding the risk of a short-term correction, further gainsin global shares on the back of attractive valuations, continuingglobal recovery, easy monetary conditions and decreasing risk ofa European melt-down are likely to help pull up the local sharemarket over the coming year.

For the time being, the Australian share market is likely to remaina relative underperformer. Since late 2009, Australian shareshave underperformed their global counterparts, thanks to acombination of tougher domestic monetary conditions whichhas constrained domestic demand and limited the flow of fundsinto shares. Additionally, the strong A$ and worries about a hardlanding in China have adversely impacted markets.

Fears of a Chinese hard landing are likely to recede further.However, there is unlikely to be much relief in terms of the strongA$ (barring another GFC-like event, which would obviously bebad news) and monetary conditions in Australia are unlikely toease much, relative to the US and Europe. This suggests thatAustralian shares could rise further this year, but continue to lagglobal shares for a while yet.

Dr Shane OliverHead of Investment Strategy and Chief EconomistAMP Capital Investors

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1988 1992 1996 2000 2004 2008 2012

Financial years, percentage change Consensusforecasts

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1991 1995 1999 2003 2007 2011

Financial years, percentage change Consensusforecasts

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88 90 92 94 96 98 00 02 04 06 08 104

68

10

12

14

16

18

Bank deposits relative toliabilities (RHS)

Debt relative toequity (LHS)

Private non-financial corporate sector

(%)