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Strong earnings are coming but don’t expect a repeat

Lewis Jackson  |  30 Jul 2021Text size  Decrease  Increase  |  
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Corporate earnings are likely to impress when they start next week, but investors shouldn’t jump into the market expecting a repeat performance, says Morningstar head of equity research Peter Warnes.

Australian corporations have been helped by more than $290 billion in government stimulus, an economic rebound in China and the willingness of people to keep spending through the pandemic.

But don’t expect a second act, says Warnes. The “tide is going out” on government support and spending patterns are eventually going to return to normal.

“The economy has done very well because of the stimulus that’s been thrown it. Conditions haven’t been too bad, and consumers have been spending, but that support is starting to withdraw—albeit not in NSW,” he says.

“Every house has new carpets, new blinds and the best entertainment system they can afford. But that spending has been pulled forward and can’t be sustained at those levels, and it wont be.

“That’s why you need to be a bit cautious about what’s going to happen in financial year 2022 and 2023.”

Share markets have shown little sign of caution yet. The S&P/ASX 200 returned 24 per cent for the last financial year. The once-struggling financials sector returned 35.6 per cent, fifteen times its 5-year average.

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Investors should treat any comparisons to 2020 with care, says director of equity research Brian Han. Earnings growth will look especially flattering in light of how bad the June half of 2020 was.

"Don’t extrapolate the strong June half into the future, especially now the country is back in lockdown,” he says.

Investors got a preview of the earnings season to come when Rio Tinto (ASX: RIO) reported on Wednesday.

The miner raked in half-year profits greater than its 2020 total and announced a record half-year dividend of $US5.61 a share, more than double the previous record of $US2.12.

The profits are thanks to record iron ore prices, which have hovered above $US200 for much of the year thanks to Chinese demand and supply shortages in Brazil.

But iron ore prices are elevated and no one expects them to stay where they are, says equity strategist Gareth James.

The government’s budget forecasts are based on a long-term iron ore price of US$55, while Morningstar’s director of equity research Matthew Hodge expects it to normalise around $US43 from 2025.

Companies are reporting on the six months already gone and investors should remember that investing is ultimately about the future says Mark LaMonica, co-host of Morningstar’s Investing Compass podcast.

“The best investors use the past to get hints about the future. They look at results in the context of the broader environment to understand why they occurred,” he says.

“Unsuccessful investors succumb to recency bias and extrapolate the near-term past into the future."

What to look for in retail, energy and leisure

Retailers enjoyed a boom last year as lockdowns and government stimulus combined to send millions online to shop. Retailers JB Hi-Fi (ASX: JBH) and Harvey Norman (ASX: HVN) are up 5.9 and 58 per cent in the last year, respectively.

Warnes doesn’t expect it to last.

“As the borders open and vaccinations increase, the money that has gone into retail will flow into hospitality and leisure.

“You won’t see the Harvey Normans and the JP HiFi of the world doing what they did or the last year in my view.”

A recovery in the price of oil and natural gas is good news for the energy sector although it may take a quarter or two for higher prices to filter through to corporate earnings, says Warnes. Expect those stocks to do very well in September and December.

The spot price for Henry Hub natural gas is up 24 per cent since April. Brent crude oil is up 48 per cent this year.

A new wave of lockdowns have put the spotlight back on leisure and travel and Han is keeping a close eye on their levels of debt and cash.

“Do these leisure companies have the balance sheet to ride through this? Its all well and good to say we’ll be back to normal in two or three years but if you run out of money before then its cold comfort.”

Earnings will kick off next week with Centuria Office REIT (ASX: COF) on Tuesday. Media-giant News Corporation (ASX: NWS) will report on Friday. Big names such as Commonwealth Bank (ASX: CBA) and Transurban (ASX: TCL) will follow the week after.

To find out when your stocks are reporting, Morningstar has compiled a list of more than 150 companies under coverage that will release earnings results during the August 2021 reporting season.

Bookmark this page. We'll update the list daily with access to research notes from our Morningstar equity analyst team.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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