Investor Update - August 2023
The ASX 200 fell 0.7% in August, with the FY23 reporting season delivering a higher incidence of earnings downgrades. For corporate Australia revenues held up well as demand trends were modestly better than expected, however this was more than offset by an increase in finance and wages costs that had a detrimental impact on earnings per share. It also appears to be putting more pressure on Free-Cash-Flow (FCF) as rising operating costs and capex provide the most notable headwind for resource companies.
The FY23 earnings season was particularly harsh for companies that had leveraged balance sheets at ~3x Net Debt/EBITDA, where negative price reactions were most pronounced as the full weight of higher interest costs dragged profits lower. Indeed, we expect that higher finance costs will continue to impact on earnings into FY24 as fixed rate debt rolls off into higher rates.
In an environment where the economy is showing the first tangible signs of slowing and higher operating costs persist it is unsurprising that ASX 200 companies have provided cautious guidance for FY24. The market has clearly entered an earnings downgrade cycle, albeit mildly at this point, with earnings estimates being downgraded by >2% for FY24.
While negative earnings revisions have outweighed positive earnings revisions for this earnings period, it was encouraging to see a handful of companies deliver results ahead of expectations, namely: Brambles, Goodman Group, James Hardie, and Spark NZ.
More broadly, at a sector level, Discretionary Retail, Real Estate and Energy were the strongest performers in August, whilst Utilities, Staples, and Technology underperformed.
At a portfolio level this translated into cyclical companies typically outperforming defensive earning companies. Specifically, Goodman Group, Premier Investments, and James Hardie were notable strong performing stocks. Whereas Ramsay Health Care, Cleanaway Waste Management, and Telstra, weighed on performance.
In our view, the key insights from this reporting season illustrate that companies with strong market shares and conservative balance sheets are enviably better placed to strengthen their value proposition relative to companies with higher debt levels. An aversion to high debt levels has prompted us to divest several names across the portfolios that face the continued headwinds of higher finance costs.