Australian companies have underlined their resilience by reporting better than expected numbers in the August earnings season, but a high level of uncertainty ahead means margins—and payouts—could be heading lower.

A combination of intensifying cost pressures, rapidly rising interest rates and softening demand outlook is set to weigh on corporate Australia’s earnings growth over the next six months, analysts say. It will also likely have an impact on the returns shareholders receive.

“We are heading into a weaker FY23 as consumers and corporates tighten their belts, though we are still expecting above trend earnings growth in the high single digits,” Jun Bei Liu, portfolio manager at Tribeca Investment Partners, wrote in Morningstar’s Firstlinks newsletter this week.

Holding up well

That would be a step change from the FY22 earnings performance, where a majority of companies handily met or beat consensus earnings estimates despite challenges that included a COVID-19 rebound, supply chain disruptions and soaring commodities prices.

According to a CommSec review of ASX 200 earnings reports until August 30, aggregate profits jumped 56.3 per cent in the year to June 30, with nearly two-thirds of companies lifting profits over the year.

This seems remarkable given that companies’ books were already reflecting a broad-based increase in costs.

About 86 per cent of companies disclosed higher expenses over the past six months or full year, with the average increase of 21.1 per cent. That compares to a 7.3 per cent cost increase the previous earnings season.

The gains came largely on account of revenue outpacing expenses. CommSec found around 87 per cent of the reporting companies lifted their revenue over the year to June 2022, with an average increase of 34.5 per cent.

“Even though the cost pressure was higher than expected, the revenue has been very strong. We have had some of the best revenue forecasts or upgrades coming through in the last 20 years,” Tribeca’s Jun Bei Liu says.

Headwinds

Indeed, 12-month forward revenue estimates for ASX 200 companies  were upgraded over the earnings month.

But this, and the solid FY22 performance, has not deterred analysts from downgrading forward earnings.

Earnings downgrades have been relatively broad-based, with Wilsons Stockbroking estimating roughly two-thirds of companies saw their consensus FY23 EPS revised downward over the past 30 days.

The market now expects overall earnings to grow 6.5 per cent FY23, down from 20.5 per cent in FY22. Lower margins – on account of higher expected costs – are seen as the main culprit.

David Cassidy, head of investment strategy at Wilsons, says most companies will have to balance passing on higher costs while maintaining volumes as the demand outlook softens amid slowing global economic growth.

“We believe the current dynamic of passing costs onto consumers cannot last forever, and companies may have to change tack before the end of this calendar year. This could lead to margin pressure for many sectors in the ASX 200,” he said in a note.

He expects labour shortages could lead to further cost pressures as companies are forced to increase wages to retain or hire staff. Increasing migration may alleviate some of these challenges, but it is not an immediate solution.

That presents a key risk for a broad range of sectors sectors including mining, tech, supermarkets and banks.

Caution ahead

Historically there has been a close link between dividend payouts and where companies see profit growth heading. The trend is already apparent from the August reporting season.

While more ASX 200 companies reported dividends amid rising profits, aggregate dividends fell 1.7 per cent after lifting in the February reporting season, according to the CommSec report. 

Excluding the impact of strong payouts by resources heavyweights BHP and Rio Tinto, that number would be much weaker.

It likely reflected a 9.8 per cent drop in aggregate cash holdings of companies with banks, insurers and infrastructure firms reporting the most decline. 

“Payout ratios have seemingly peaked and forward payout ratios are still falling as an uncertain outlook makes investors wary of how much capital will be returned to shareholders,” Wilson’s David Cassidy said.

Tribeca’s Jun Bei Liu isn’t expecting a significant pullback in dividends, but says this could vary from sector to sector.

While commodity businesses could see softer payouts amid the downward trajectory in prices and rising capital expenditure over the next 12 months, the banking sector is likely to hold dividends steady despite rising costs and competition.

She is also bullish about consumer-focused stocks such as Woolworths and Wesfarmers given the strong cash flow that these businesses are sitting on.