Earnings wrap: how did the wide-moat stocks perform?

Morningstar's wide moat stocks didn't shoot the lights out this earnings season, but they at least did well enough to defy global volatility and roundly meet expectations.

A substantial jump in retail spending helped Auckland International Airport (ASX: AIA) offset slowing growth in international traffic, while Wesfarmers (ASX: WES) was rescued by its powerhouse hardware chain Bunnings. As for the ASX (ASX: ASX), Australia’s primary securities exchange, it stood out by offering shareholders a special dividend.

Despite several strong results this season, near-term outlooks are broadly subdued. None of the wide-moat companies have four- or five-star ratings and some screen as significantly overvalued. The ASX, for instance, trades at a 50 per cent premium. Bionic implant maker Cochlear is trading at a 60 per cent premium.

Membershup of the wide-moat club – which comprises the big four banks, ASX, Cochlear, Wesfarmers, funeral home company InvoCare, pallet maker Brambles, Iluka Resources and toll road operator Transurban – held strong this reason. Analysts believe these companies have retained their sustainable competitive advantage and display qualities that allow them to fend off competition and generate excess returns for the next 20 years.

We've used Morningstar's Stock Screener to focus on eight of the wide-moat names that released full or half-year results this reporting season. In this article, we look at AIA, ASX and Wesfarmers.

Source: Morningstar Premium

To learn more about Morningstar's moat ratings and the characteristics that analysts look for when deciding whether a company has built a wide moat, Lex Hall's two-part article ' Morningstar's eleven: How to spot a wide-moat stock' is only a click away. 

AIA: jump in retail spending offsets slowing international traffic

A substantial jump in retail spending helped offset Auckland International Airport slowing growth in international traffic. New Zealand's largest airport delivered an underlying net profit after tax up 4.4 per cent to $274.7 million.

But while Morningstar analyst Adam Fleck remains positive on the firm's long-term growth profile, he believes fiscal 2020 looks "challenged", owing to a slowing global economy, lower near-term passenger fees, and heightened capital spending requirements.

Revenue from retail spending leapt 18.5 per cent on the back of 32 new stores, rising duty free spending, and the airport participating in a greater share of retailers' strong sales growth. On a per-international-passenger basis, retail revenue climbed 15 per cent.

However, AIA saw its international traffic growth slow in fiscal 2019, owing to economic challenges in China, more muted airline capacity additions, and lower growth in airport passenger numbers.

Chinese travellers, the largest nationality travelling through Auckland Airport outside of New Zealanders and Australians, fell nearly 9 per cent in the fiscal year, versus a strong 11 per cent positive rate in fiscal 2018. Declines accelerated through the year.

Ahead, Fleck says AIA will have to contend with declining per-passenger fees in fiscal 2020 as a reduced pricing scheme kicks off with airlines following last year’s Commerce Commission review. It will also face a more muted passenger outlook and slowing retail spending, he says.

"Although New Zealand remains a strong tourism choice for a rising global middle class, we now see lower near-term passenger growth given slower airline capacity additions and soft global economic conditions," he says.

"While outbound New Zealanders’ travel, and potential new routes to North America, will likely support positive near-term gains, we now forecast a 2.8 per cent average annual growth rate in international passenger movements through fiscal 2023, down from 4 per cent previously."

Offsetting the firm’s near-term challenges, Fleck believes per-passenger should rebound starting in fiscal 2023 when the next round of five-year pricing agreements with airlines starts.

ASX: shareholders handed special dividend

Wide-moat rated ASX reported a strong fiscal 2020 result, with underlying net profit after tax up 8 per cent. Profit was boosted by an increase in client margins, owing to increased trading activity, and an increase in yields in the first half the fiscal year.

The company also announced a $1.29 fully franked special dividend following the sale of the IRESS shareholding, which Morningstar analyst Gareth James foreshadowed in his note on 26 February.

Management highlighted the 57 per cent increase in technology companies and 54 per cent increase in foreign companies.

James has increased his fair value by 10 per cent to $57 due to the time-value-of-money effect on his financial model and higher earnings forecasts. However, at the current market price of $85.18, he continues to believe ASX is overvalued.

"The share price has performed well in recent years and is up 26 per cent over the past year alone, far outperforming the 4 per cent rise in the S&P/ASX 200 index," he says.

"However, we don’t believe share price growth has been supported by an improvement in the earnings growth outlook. For example, the one-year forward price/earnings, or PE, ratio has expanded from below 18 five years ago to around 33 currently despite expectations of mid-single-digit annual earnings growth."

James owes ASX's share price strength to the global yield compression theme that has accelerated in recent months.

Ahead, James is sceptical about the potential success of the ASX's technology and foreign company strategy and only forecast a compound annual growth rate in the number of listed companies on the ASX of 0.5 per cent over the next decade.

"From a global perspective, Australia isn’t a large source of technology stocks – which means it won’t be easy to make the ASX a global destination for technology listings," he says.

"We’re also concerned that ASX will tend to attract companies that can’t list elsewhere and may lose higher quality initial public offerings to overseas exchanges."

Wesfarmers: Bunnings to the rescue

Wesfarmers’ fiscal 2019 result offered no big surprises. Reported earnings per share of $4.87 per share was in line with Morningstar analyst Johannes Faul's $4.84 estimate.

Total dividends of $1.78 per share were higher than Faul had forecast, but he expects the payout ratio on underlying earnings per share to revert to 85 per cent now that Coles is demerged and Wesfarmers only has a remaining 15 per cent stake in the grocer.

Earnings before interest and tax from continued operations of $2.8 billion was only 0.3 per cent ahead of Faul's estimate.

In the Bunnings segment, like-for-like sales grew by 3.9 per cent in a downbeat housing market –displaying some resilience in its product range – but still down from the 8.9 per cent in fiscal 2018.

In contrast, Kmart Group, Wesfarmers’ second largest business, struggled to increase sales and saw profits crumble.

Slightly lower contributions from retailers Bunnings, Kmart Group and Officeworks, were offset by a stronger result from the industrials segment. However, none of the variances was material enough for Faul to amend his long-term theses on the respective segments.

The outlook for Bunnings’ fortunes is perhaps where Faul differs with the stock market.
"The hardware retailer contributed almost 57 per cent to group earnings in fiscal 2019 and we expect it to remain the dominant business, singlehandedly underpinning our wide-moat rating," he says.

"Bunnings dominates Australian hardware retailing and we forecast it to take market share as it expands its commercial customer base and product range in the underpenetrated categories such as flooring, window furnishings, kitchen, and bathroom. 

"Nevertheless, current share prices imply too much upside to Bunning’s operating margins."
Wesfarmers’ earnings before interest and tax margins would need to widen by 6 percentage points to 18 per cent for Faul to increase his fair value to $39 – or where the company's stock price sits around today.

Faul forecasts a gradual increase in EBIT margins driven by operating leverage, offset by growth in the commercial and online channels, which he says are likely to dilute profit margins earned on sales from brick-and-mortar sales to retail customers.

"We forecast EBIT margins to increase to 12.6 per cent by 2029, from an estimated 12.1 per cent in fiscal 2020. In fiscal 2019, Bunnings’ EBIT margins were flat at 12 per cent, despite 5.0 per cent total sales growth, after adjusting for volatile contributions from property developments," he says.