Profits, Dividends and Disappointments

Capital management was again prevalent in the recent reporting season and was understandably popular with investors, especially following significant falls in term deposit rates over the past year. Qantas, AGL Energy, Aurizon, Amcor, Link Adminand Brambles announced new share buy-back plans. Special dividends were announced by the ASX, Suncorp, BHP, Coles and Medibank Private. Several companies also increased their dividend by a greater rate than their earnings per share, thus increasing their payout ratio.

While rising dividends play to the “search for yield” investment theme and provide a short-term boost to share prices, in the longer-term companies do need to retain cash to reinvest in their operations to grow earnings in the future without adding to debt. Across the industrial companies, the dividend payout ratio remains high and is now approaching 80%.

Going into the August results season, we were concerned that company results would show a dramatic pull-back in retail sales due to falling house prices and political uncertainty. The financial results for large listed retail property trusts such as Scentre group give a good insight into consumer spending. Across Scentre’s portfolio of 41 shopping centres and 11,500 retailers, sales were up +1.3%. Weakness in department stores was offset by sales growth in food, personal services, supermarkets, and even fashion. Elsewhere in retail JB Hi-Fi saw sales grow +3.5% as consumers opened their wallets to buy phones, gaming consoles and Fitbits; similarly, Tabcorp showed the continued willingness of Australians to bet on horses and play lotteries. Coles and Woolworths both showed approximately 3% sales growth in supermarkets and liquor.

The areas where consumer spending was weaker than expected included domestic travel, with Flight Centre reporting a decline in Australian leisure travel – though this could be attributed to weakness in the Australian dollar over 2019 which has reduced the attractiveness of foreign travel. Coca-Cola also saw declining volumes which may be due to overall diminishing consumer appetites for carbonated soft drinks.

While most of the market looks to own stocks that will report a good result and increase their dividends, some fund managers look to capitalise on bad profit results by short selling the shares of companies whose share price they expect to fall after disappointing the market. The below table looks at the ten most shorted stocks from the ASX 200 as of the end of July 2019, ranked by the percentage of their share registry that has been sold short.

Of the ten most shorted stocks at the end of July 2019, only one stock – A2M Milk – has been profitable for the short-sellers. The two largest short positions – Domino’s Pizzaand JB Hi-Fi – would have been painful for those shorting these stocks as their prices have rallied over August. Domino’s Pizza delivered a result that was around market expectations, with sales in Japan and Europe offsetting weakness in Australia. Domino’s share price has rallied since the result after management gave a positive outlook for 2020, telling the market that sales were up close to 5% over the first seven trading weeks of the new financial year. 

When a fund manager has short sold a stock, the last thing that they would want to see on results day is a headline saying that the short-sold company has delivered net profits above their guidance, which is what JB Hi-Fi did last week. JB Hi-FI confirmed our view that the company is a world-class electrical retailer growing sales and profits against a challenging consumer backdrop.

The miners (mainly the iron ore producers) reported strong profit growth in August driven by elevated commodity prices. Iron ore went from US$71/per tonne at the start of 2019 to peak at US$125/tonne at the end of June due to the failure of a tailings dam in Brazil that killed 248 people. This accident resulted in the miner Vale shutting down 40 million tonnes of iron ore production, tightening up the global market for iron ore.

Rio Tinto, BHP and Fortescue all reported solid growth and increased dividends, but this was overshadowed by the 30% fall in the iron ore price since the end of the 2019 financial year. Looking ahead, planned mine expansions (and resultant increased supply), the impact of trade tensions between China and the US, as well as a moderating Chinese demand should see the price of iron ore continue to drift downwards.

On the conference calls to investors, management teams from the mining companies promised to maintain capital discipline, increase returns to shareholders, and pay down debt; all sound strategies given the weakening of commodity prices since June. What concerned us was the evidence of rising costs apparent in the results of BHP and Rio Tinto. In 2020, the mining companies could face costs moving higher (particularly labour) at a time when commodity prices are weakening and Chinese demand likely to be diminished by trade wars with the USA.

Over the month the best results were delivered by Lend Lease (+20%), Afterpay(+16%), Wisetech (+15%) and Beach Energy (+14%). Lend Lease’s share price was stronger after management did not reveal any further nasty surprises in their troubled engineering division and showed that the residential development business was performing strongly. Favoured tech stocks Afterpay and Wisetech gained in August after giving outlook statements that were ahead of already optimistic market assessments.

On the negative side of the ledger Iluka Resources (-26%), Worley Parsons (-22%), A2 Milk (-21%) and Orora (-18%) all reported disappointing results compared with other companies. The common themes amongst this group were the profit results coming in below expectations combined with bearish management commentary for the coming year, mainly due to higher costs.