A change of leadership for the ASX

It's been another fun reporting season - waterboarded with information, as always. But what really matters isn’t the past six months; it's what the numbers tell us about the future.

This time around, we saw something different - a shift in tone from management teams. Unlike previous reporting seasons where outlook statements were scarce, this time, more companies showed confidence, jumping on the rate cut bandwagon and backing an improving Australian consumer.

That’s always a concern. When everyone agrees on the macro, it’s usually time to start questioning the consensus. What we focus on instead is pricing power. Over the next 12 months, pricing power will separate the winners from the losers, especially now that the easy price rises of the high-inflation era are behind us.

These are five trends that caught our attention from the large cap companies on the ASX.

1. Early signs of market leadership change – Since late 2023, four sectors have led the market higher: technology, major banks, consumer discretionary, and property. February’s results showed steam coming out of these sectors, particularly tech, which underperformed despite solid earnings. That suggests investors are reassessing valuation multiples.
2. Banks losing earnings momentum – While the major banks broadly tracked the market, earnings revisions for two of the big four turned negative. With rate cuts ahead, pressure on net interest margins will likely weigh on earnings.
3. Retailers feeling margin pressure – Consumer discretionary names have led for over a year, but now sales are holding up only because of discounting. That’s a clear sign of fatigue in consumer spending.
4. Cost control driving earnings beats – Many of the positive surprises this season weren’t from strong revenue growth but from lower costs. Some companies, like Nine Entertainment, are undergoing structural cost resets, while others, like Seek and APA, are reaping benefits from prior IT investments.
5. Opportunities emerging as high-flyers come back to earth – As overvalued parts of the market correct, fundamental investors are set to benefit. Stocks like QBE, for example, remain cheap relative to global peers, with a clear path to earnings growth.

The big takeaway?

The leadership baton is shifting. With stretched valuation multiples and momentum fading in key sectors, this could be a protracted process. But for investors who avoided the overpriced names, the coming months should throw up plenty of opportunities.

I discuss these themes in more detail in the video below.

Edited transcript

It's been another fun reporting season waterboarded with information. Interesting thing about reporting season is we look at lots of data, but it's mainly backward looking. We only care about, it's only relevant in terms of what it tells us about the future. It's nice to beat your first half earnings numbers, but it's more about what's going to happen with the full year and the go forward numbers.

I think this reporting season was interesting because there's a bit of a change of tone from management teams. If you go back to, you know, reporting seasons of the of the recent past, people would present their last six weeks numbers as their only insight into what the period ahead might be able to deliver.

This time we saw more people being confident to give a bit more of a positive outlook statement, jumping on the rate cut bandwagon to, you know, show confidence in an improving Australian consumer.

It's always a worry when everyone agrees on the macro outlook. So we'll watch it carefully, but what's important for us not knowing what the macro will bring, is to look for companies that have pricing power.

So I think the pricing power of franchises over the next 12 months is going to be much more important than it was over the last two or three years where, you know, price rises were pretty easy to take in that higher inflation environment.

Australia's fund managers are just coming up for air after what's been a very busy reporting season. It's fair to say they're coming up with their heads spinning after what's been the most volatile reporting season in memory. There was a heap of outsized share price reactions to relatively immaterial news, which was a real difference to reporting seasons of the recent past. 

Putting volatility aside, I think the most important thing that came out of this reporting season was what appears to be early signs of a change in leadership in the market. And what I mean by that is since November 2023, we've really had four sectors driving the market higher. It's been the growth stocks, the major banks, the consumer discretionary names and the property sector. And in February what we saw was the steam coming out of those sectors in terms of the growth cohort.

We saw tech stocks underperforming the market quite materially. That's that sector was down by about 10%. That weakness comes despite still printing pretty good earnings results and certainly meeting or exceeding expectations. So that underperformance relative to pretty good earnings outcomes suggest that investors are reconsidering the valuation multiples in that space. Very high valuations require high levels of confidence in the longevity and sustainability of a business model and growth prospects.

And perhaps with Deep Seek coming out of the blue in January, investors are starting to become aware that the technology space is the fastest evolving space in any market segment and reassessing the competitive landscape in that area.

In regards to the major banks, whilst they performed roughly in line with the market, we did see some some signs that the momentum in earnings revisions is cracking two of the four major banks earnings downgrades during the month.

It's really been that quantitative factor that's driven the banks last year with positive earnings revisions and that's coming to an end particularly with in now into a rate cutting cycle which puts pressure on their net interest margins and should see a headwind for major bank earnings.

In regards to the consumer discretionary space, again a leader for the last sort of 14 months. In this result, we did see the discretionary retailers largely hit their sales numbers, but those sales numbers came with weaker gross margins. It appears to us that those gross margins were weak because the the retailers are having to discount to maintain sales and it's probably not surprising that we're starting to see a bit of fatigue in consumer spending.

So overall, with three of those four sectors that have been driving the market now looking at a little more tenuous, we're starting to see the steam come out and it's most likely that we're in the early stages of changing leadership in the market.

So with the momentum coming out of these sectors that have been leading the market higher at the same time as evaluation multiples are still relatively elevated, this could go on for a protracted. It's really positive for fundamental investors who have avoided these overpriced parts of the market. But as they correct, it's going to throw up a lot of opportunities that we're going to be able to take advantage of.

This reporting season saw more misses than beats in terms of the results. What was interesting is that the beats came not necessarily from high revenues, but from lower costs. So the beat was on margins. That was interesting because what we've seen is, you know, partly that's driven by inflation on both sides. 

The other thing that's been happening is we've seen some management teams being more aggressive on cost and that's coming coming about because of two reasons. Either you've got some structural change in your cost base that you that you're making to set yourself up for the revenue environment, something like a Nine Entertainment (ASX: NEC) is in that basket.

And then there's other companies who are benefiting from an IT investment they've made over the last two or three years. We saw that in companies like Seek (ASX: SEK) and APA Group (ASX: APA).

APA is an interesting example. The stock did really well during reporting season. The technical reason for that is that everyone was shorting the stock into the results expecting a capital raising. Now the CEO, Adam Watson quashed that idea pretty definitively and we saw the share price do better.

It's interesting how it's changed sentiment towards the stock. The stock should have gone up late last year when they got a positive regulatory outcome on some of their assets, but it didn't because of these fears were around in the market about the balance sheet. Now we come to the point where people see it for what it is, which is a stock that's very cheap on an 8% dividend yield with tailwinds on costs as they take costs out of the business.

The other thing is that the business has seen more positively because it's exposure to gas and gas as a solution to the energy transition is appreciated and seen as a positive rather than a negative.

Now a stock in the portfolio we're still really excited about. It's done well for us over the last few years, but we still see much more upside in his QBE Insurance (ASX: QBE). It's done really well on the back of the business rationalisation that Andrew Horton started in 2001, in which they're either walking away from business, it's unprofitable or repricing it to get an economic return.

In addition to that, they've identified a number of areas for potential growth for them that'll take a couple of years to manifest. But there's significant upside to earnings from that. And at the same time, they're still trading at a discount to their global peer group.

With continued delivery of consistent results, we think that gap can narrow and the company can deliver significant outperformance in the next two years. 

The big M&A story of this reporting season was the CoStar bid for Domain (ASX: DHG). Lots of focus on what does that mean for the profitability of REA Group (ASX: REA).

We know the CoStar model very well. We've met with the company and done a lot of work on it over the last couple of years. We can see a situation where it could, you know, really be quite successful with what it does with Domain without it necessarily being hugely negative for Rea.

But the issue here is about valuation. So what it's really highlighted, you know CoStar are going to go and buy Domain rather than build in Australia. The reason that opportunity came about is because you had a number two player, a solid \#2 player that was trading at a 13 times EV EBITDA multiple, whilst you know the market leader traded at 33 times EV EBITDA.

Now both those numbers are wrong and so you never know what the catalyst is going to be for the market to be more rational in the way that it values things, but that's what's happened in this case.

Coles (ASX: COL) has been a consistent contributor to the portfolio for a number of years. The management team there has continued to execute extraordinarily well and their sales trends have been really positive as a result and they continue to take share from Woolworths. In addition to that, they've made significant investments in automation over the last three years. That's starting to to come to the fore now and starting to bear fruit. That will come in the form of efficiencies and cost savings, which they can reinvest in price and drive further out performance. We still see a lot of upside in Coles despite the fact that it's had a very good run so far. 

So the outlook for dividends in Australia is still really strong. We saw Qantas reinstate its dividend after a 5 year hiatus. We've seen strong cash flows across the market. So the breadth of opportunities for dividends is still there.

What we have noticed, and we've been calling this out for the last few halves is more of a rebalancing in the market as people have opportunities to invest for growth and balance that out.

Managed Fund

Tyndall Australian Share Income Fund

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