Reporting season half time: Positioning for US rate cuts

The August 2024 reporting season has reached its halfway point, and thus far market earnings growth expectations have shifted slightly lower, with roughly twice as many consensus downgrades than upgrades (from the companies that have reported already).

The ASX 300 is now expected to deliver EPS growth of ~4.5% over the next twelve months, with the lacklustre outlook for resources earnings offset by strong growth expectations for the IT (+30%), Healthcare (+24%), and Consumer Discretionary (+10%) sectors.

More downgrades than upgrades

The market has reacted rationally to results so far this reporting season. Companies with FY24 earnings beats and FY25 guidance upgrades have outperformed this month-to-date on average, while companies that have missed consensus expectations have been punished by investors.

Based on our analysis of major results so far, companies with earnings 'beats' have outperformed the ASX 300 by an average of ~6% this month to date, while ‘misses’ have underperformed the market by ~7%, and companies with ‘in line’ results and guidance have generally market-performed. See figure 2.

In this report, we detail noteworthy results, including Netwealth (ASX: NWL), James Hardie (ASX: JHX), CSL (ASX: CSL) and Commonwealth Bank (ASX: CBA).

Figure 1: ASX 300 earnings expectations have drifted lower this reporting season

Figure 2: Earnings ‘beats’ have generally outperformed, while ‘misses’ have been punished by the market

Figure 3: The majority of GICS sectors have experienced aggregate earnings downgrades this reporting season

Netwealth (ASX: NWL) – Taking profits

In FY24, NWL posted strong EPS growth of +24%, although this was slightly below consensus expectations of +28%. The update has driven minor consensus downgrades to EPS growth forecasts for FY25, primarily due to an increased rate of reinvestment by the business.

While NWL remains a high-quality business with a strong medium-term earnings growth outlook supported by market share gains from incumbent legacy platform providers, after modest downgrades the company’s valuation has become increasingly demanding at a forward PE of ~52x.

Therefore, with limited valuation upside at current levels, we are taking profits from NWL.

Figure 4: NWL has been removed from the portfolio after a period of significant outperformance

James Hardie (ASX: JHX) – Positioning for US rate cuts

JHX was removed from the portfolio in January 2024 (at a share price of ~$57), primarily on valuation grounds and due to near-term consensus earnings risks heading into its 3Q24 result.

Since then, however, the macro outlook has changed dramatically, with US interest rate cuts now highly likely to commence when the Fed meets next month.

Over the last month, we have flagged that we have been actively looking for opportunities to increase our exposure to high-quality global cyclicals to position the portfolio ahead of US interest rate cuts. JHX is one of the companies that we noted was on our ‘watch list’ of potential buying opportunities.

As a building materials manufacturer with significant end-market exposure to US housing (representing ~84% of FY25e group EBIT), JHX will be an early beneficiary of the Fed’s policy easing cycle.

1Q25 update drives modest analyst downgrades

In Q1, JHX posted NPAT growth of +2%, which was 6% ahead of consensus expectations.

JHX also reaffirmed its North American volume guidance of “+/- low single digit %” growth in FY25, although management flagged ongoing US housing market softness, which has resulted in minor consensus downgrades to FY25 consensus forecasts.

Looking through the immediate headwinds, now is an opportune time to invest in JHX to position the portfolio in advance of US interest rate cuts.

Our investment thesis for JHX is based on two key points:

1. Interest rate cuts will support a recovery in US housing construction activity

US housing market activity has fallen significantly since 2022, following successive interest rate hikes and amidst affordability challenges that have weighed on housing construction volumes.

Builder sentiment is weak and new housing starts are currently depressed at four-year lows, which has driven significant downgrades to JHX's consensus North American fibre volumes over FY25-26.

However, with Fed rate cuts likely in September, we expect US housing market sentiment and construction activity to recover, which presents upside risks to JHX’s North American earnings over the medium-term (particularly considering the conservative posture of consensus estimates following downgrades).

An improved macro outlook should also allow JHX’s valuation multiple to re-rate higher, noting the company trades at a meaningful discount to where it traded during the last Fed easing cycle.

In any case, JHX offers attractive value at its current forward PE of 20x considering a consensus EPS CAGR of ~20% between FY26-27 (with risks skewed to the upside).

Figure 5: Interest rate cuts should drive a recovery in US housing starts…

Figure 6: …which creates upside risks for JHX’s North American volumes over the medium-term

Figure 7: JHX trades on a forward PE of ~20x, which is a meaningful discount to where the stock traded during the last policy easing cycle

2. Structural growth tailwinds

Leaving aside the more supportive macro outlook, JHX is also exposed to significant structural tailwinds that have underpinned its two decade-long run of above-system growth, which we expect to continue over the medium and long-term, driven by:

Fibre cement share gains – JHX is the global leader in fibre cement (with ~90% US category share), which is used on the external walls of homes and building facades. Over the last two decades, fibre cement has grown in popularity in the US due to its superior aesthetics and durability, and its lower lifetime cost compared to alternatives like vinyl and timber. Given fibre cement is currently used in 22% of new US housing construction, there is still a long runway for growth over the long-term.

US housing shortage - Since the GFC, the US housing market has been chronically underbuilt, with household formations significantly outpacing new home completions. A significant ‘catch-up’ of new construction activity is needed, which would drive increased demand for building materials, including fibre cement.

Ageing US housing stock - The median US single family home is the oldest it has ever been, at > 40 years old. This is likely to drive growth in repair & remodelling demand (JHX’s focus), as old and deteriorating structures will need to be renovated.

Figure 8: JHX has a strong track record of above-system growth

Figure 9: While JHX has a degree of cyclicality, the business has demonstrated impressive structural growth over the last decade

CSL (ASX: CSL) – Thesis Intact with Margin Recovery on Track

CSL reported NPATA growth of +15% (constant currency) in FY24, which was at the top end of its guidance. FY25 guidance for NPATA growth of 10-13% (constant currency) was slightly below consensus expectations, resulting in minor (low single-digit) downgrades to consensus forecasts.

Notwithstanding downgrades to Vifor, driven by the soft outlook for its iron franchise, our thesis for CSL remains intact – which is centered on the growth of its core Behring segment driven by its ongoing margin recovery.

Pleasingly, in FY24 Behring’s gross margins expanded by +120bps (constant currency), which will continue over the medium-term driven by the roll-out of the Rika donation system (driving a lower plasma costs per litre), along with further growth in volumes and subsequent operating leverage.

In summary, with Behring’s margin trajectory being the key to CSL’s earnings growth outlook, our favourable view towards CSL remains unchanged, despite weakness within its smaller segments. At a forward PE of ~30x, CSL continues to offer growth at a reasonable price given its three-year EPS CAGR of ~14%.

Figure 10: Behring will be the dominant driver of CSL’s earnings growth

Figure 11: Behring’s gross margin recovery is set to continue over the medium-term

CBA (ASX: CBA) – Still Unmoved

CBA’s full-year result was broadly in line with consensus expectations, as its cash NPAT fell -2% in FY24.

There were no major surprises in the result, although the highlight was that NIMs stabilised in 2H24, while expected credit losses held up better than expected despite macro headwinds. Together, these factors underpinned minor consensus EPS upgrades.

With that being said, asset quality is deteriorating, with arrears and troublesome & impaired assets continuing to rise. This indicates that bad debts will increase further over the medium-term.

Everything considered, this was a sound, but largely in-line result from CBA, which has triggered only minor upgrades to consensus forecasts – and no changes to our cautious stance. At a forward PE of 24x, CBA’s valuation remains unattractive considering its (still) lacklustre earnings growth outlook over FY25-FY26. 

Figure 12: CBA’s earnings growth outlook remains uncompelling after minor upgrades

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