[Editor’s note: Do not read the following commentary as stock recommendations. Do further research of your own or consult a licensed financial adviser before acting on themes in this article]

So far, the profit-reporting season has been reasonable, with retailers reporting that consumer spending is resilient, despite interest-rate hikes. Increased mortgage payments have yet to impact consumer demand but will catch up and likely alter spending patterns. 

Profit-margin pressure is building (due to rising costs) and will likely have greater impact in FY23 as consumer demand softens. 

Great expectations 

Morningstar’s Initial Market Reactions (IMR) of 100 ASX-listed companies across the major sectors tracks the share-price reaction to results in the 24 hours after the earnings announcement. This provides some insight on whether market expectations for a company’s earnings were met, exceeded or if they disappointed. 

In many cases, the market reaction has more to do with future earnings guidance than the reported results. We invest in the future, not the past. 

A positive IMR means a share-price increase between 3% and 5% after the result. A negative IMR means a price fall between 3% and 5%. At this stage of the reporting season, the IMR is pointing slightly towards a negative reading, according to Morningstar analysis.

The table below highlights companies with the largest positive or negative IMR after their result. [Editor’s note: this data is for the first half of the earnings season, to 19 August 2022].

Source: Morningstar; Data at 19 August 2022

Results from Australian Real Estate Investment Trusts (A-REITs) generally have been solid, in Morningstar’s view. 

So far, some miners and energy companies have reported record results. BHP’s (ASX: BHP) fiscal 2022 result of US$23.8 billion was underpinned in part by higher commodity prices. 

Australia’s second-largest oil and gas producer, Santos (ASX: STO), reported a 300% increase in underlying first-half net profit of US$1.27 billion - well above Morningstar’s forecast (US$836 million). 
 

Banks

In Morningstar’s view, banks reported reasonable results. However, their net interest margins remained under the spotlight and their earnings guidance was generally downbeat. [Net interest margin is the difference between interest paid and received].

Commonwealth Bank (ASX: CBA) delivered a larger cash profit than the market expected, up 11% to $9.6 billion, just shy of the bank’s record profit in 2017. 

Morningstar believes the trading results of National Australia Bank (ASX: NAB) and Westpac Banking Corporation (ASX: WBC) reflected sound credit quality, with the bulk of home borrowers ahead in their repayments. The Commonwealth Bank even reported a bad debt benefit (reversal of provisions) of $360 million in fiscal 2022.
 

Retailers

The surprise was consumer-facing stocks as consumers kept spending.  JB Hi-Fi’s (ASX: JBH) sales momentum supported its fiscal 2022 net profit of $545 million. 

Super Retail Group’s (ASX: SUL) net profit of $244 million beat Morningstar’s estimate by 19%. 
 

Challenging outlook 

However, these profit results are a bit like looking into the rear-view mirror. 

As this article highlighted earlier, interest rates are yet to impact consumer spending and filter through to mortgage repayments. 

The outlook remains cautious. With further interest rate hikes expected, borrowers will be increasingly stretched, and riskier loans will most likely start to tick upwards. 

Morningstar expects bank margins to eventually tighten as savers look for better deals. The big four banks have passed on the cumulative increase of rate hikes. To date, the Reserve Bank has hiked the cash rate by 1.75 percentage points to 1.85%. On the other side of the coin, saving rates are yet to be lifted as much. 

Dividends under pressure 

BHP’s result supported its 8% increase in fully franked dividends. But dividends in this reporting season were a bit less than Morningstar expected, reflecting the challenged outlook. 

Overall, the miners and energy companies, in particular coal and gas, will be constrained in borrowing for their capital expenditure, given that banks are restricting lending to them. Therefore, they will need to fund outlays from retained earnings, in Morningstar’s view.

CBA - the only one of the big four banks to post a full-year profit – reported a 10% lift in dividend from $3.50 to $3.85 per share. The dividend missed Morningstar’s expectations but the rate of growth in the dividend-per-share beat inflation. 

Cautious guidance

Going forward, Morningstar expects that companies will be mindful of the challenges ahead in 2023 and even in 2024. They will be cautious about dividend payouts. 

There may be some special dividends, but increases in ordinary dividends will be measured, with increasingly prudent management and boards keeping an eye on the challenged near-term economic environment, according to Morningstar analysis.

This earnings season was typified by company earnings guidance outlining the effect of inflation, supply chain issues and labour shortages. The impact of energy prices, whether they are going up or down, will have a pervasive impact, even seeping into food supply and prices. 

The Russia and Ukraine war will continue to impact the global economy. And while there was much talk of inflation peaking, increasing costs are still coming through, adding pressure to margins while rising interest rates dampen demand. Competition is likely to intensify to protect market shares. Thus, management guidance about their company’s outlook is going to be measured and cautious, in Morningstar’s view.

CBA CEO, Matt Comyn, was tempered in his view of the outlook. While acknowledging the challenging times, he said the bank remains “optimistic that a path can be found to navigate through these economic conditions”. JB Hi-Fi CEO Terry Smart noted the “increasingly uncertain retail environment and household budgets under pressure”. 

In Morningstar’s view, no CEO is going to be gung-ho about the outlook, particularly given the Reserve Bank’s current hawkish stance on rates (rates are expected to rise). 

Our corporate leaders are going to be cautious as central banks lift interest rates to a point where consumer demand comes back and inflation pressures ease. The central bank has still got a long way to go with raising interest rates, in Morningstar’s opinion.
 

What this could mean for FY23

Looking to fiscal 2023, Morningstar expects there will be more earnings downgrades and some upgrades once our analysts sift through the results.  

The top three economies in the world are struggling. The US economy has contracted in two consecutive quarters, albeit marginally. The eurozone is teetering on contraction and the Chinese economy is struggling. 

Australia will confront an environment of slowing global growth. It’s not clear whether we will see a technical recession, but it seems the market is not factoring this scenario in at the moment, according to Morningstar analysis.