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Profits growing, but for how long?

Nicki Bourlioufas  |  16 Oct 2017Text size  Decrease  Increase  |  
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Subdued wages growth is helping to buoy company profits, but low inflation also suggests the economy is struggling and this will keep a cap on future earnings and profit growth, analysts say.


Peter Warnes, head of equities research at Morningstar, says low wages growth is good for company earnings and profits initially "because in most cases, wages and salaries are the biggest expenses companies have."

Dr Shane Oliver, AMP Capital's head of investment strategy and chief economist, agrees and says industries that benefit most will be those that have relatively high wages costs and relatively solid demand that is not affected by weak household income growth.

"This would include the health and education sectors, tourism that mainly depends on foreign tourists, and parts of manufacturing. The retail sector has a high wages bill but its revenue growth is being hit by the combination of constrained consumer spending, thanks to weak wages growth and intense competition," says Oliver.

According to official data from the Australian Bureau of Statistics, the trend estimate for company gross operating profits across all sectors rose 3.2 per cent in the June 2017 quarter to be up 31 per cent from a year earlier. Wages growth was rose 1.2 per cent but just 1.6 per cent from a year earlier.

Over the longer term, however, Oliver says poor wages growth reflects low economic growth and will constrain consumer spending and company profits.

"Low wages growth is initially good for company profitability because it helps contain a key driver of corporate costs. But it can also act as a constraint on profitability to the extent that it limits consumer spending and hence revenue growth for corporates."

Morningstar's Warnes adds that because prices aren't growing much and sales volumes are under pressure, total demand is under pressure. "That's why gross domestic product (GDP) growth is below trend. If you aren't getting much price growth or volume growth, the result is that GDP growth is low, which is what is happening in the Australian economy."

"For the eight months of 2017 that retail sales have been reported, there have been just two months where retail sales were positive; the other six months, sales were down year on year," says Warnes.

A big fall in the household savings ratio to its lowest in nine years at just 4.6 per cent also indicates people are using their savings to fund their consumption rather than income. As Australians run out of savings, growth in household demand, which makes up 55 per cent to 60 per cent of GDP, will slow, says Warnes.

"The reduction in the savings ratio has been helping to fund retail sales and consumption. But if you run out of savings, households can't keep on spending and that's what's happening in the Australian economy, and even before interest rates rise. The Reserve Bank knows that if it raises interest rates, then it will have a recession on its hands," says Warnes.

"Energy costs, insurance of all forms, childcare and education expenses, they are all rising at an annual rate of three, four or five times the inflation rate, therefore household consumption is subdued."

Nor does Warnes expect improvement. "There's still a lot of spare capacity out there so wages growth is likely to remain low. People are being very careful and they are very wary of losing their jobs, so they aren't asking for wage rises."

As a result, Warnes expects profit and earnings growth to slow. "If you take out the three big miners, BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO), and Fortescue (ASX: FMG), the rest of the companies out there reported earnings growth of about 5 per cent. I think it will be less going forward as I don't think things are getting any better."

According to Oliver, the recent reporting season reflected a strong rebound in resources profits as commodity prices rebounded.

"Overall profits rose around 18 per cent, as resources profits rose around 124 per cent. Non-resources profits rose around 6 per cent, reflecting moderate underlying growth in the economy and helped by constrained wages growth," Oliver says.

"Profit growth in the current fiscal year [2017-18] is expected to be far more subdued overall at around 4 per cent as resource profits fall back a notch after a huge surge and non-resources profits remain relatively subdued at around 5 per cent on the back of subdued nominal growth in the economy, including from wages."

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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

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