February’s reporting season was one of those rare situations where we were better off than when we started. The changes to EPS growth expectations for FY21 have increased six percentage points to 16.8% and all forecast years appear to have risen. Dividends were the highlight, having grown more than earnings. The understandable lack of guidance from many companies during 2020 had arguably led market earnings forecasts to be cautious going into reporting season which contributed to the record high in “beats”. However, there is no doubt that a strong recovery is taking hold.
Resources and banks were the standout during the month. Banks reported significant beats driven primarily by much lower impairments, often helped by write backs. However, the underlying results were also better, with margins surprising to the upside as competition in deposit pricing has reduced. Incredibly, there were a number of stocks that beat on EPS, DPS and sales relative to pre-pandemic forecasts. These included the largely immune iron ore related companies such as BHP, Rio Tinto, Fortescue Metals, BlueScope Steel and Mineral Resources together with the COVID-19 winners such as JB Hi-Fi, Nick Scali, Super Retail, Dominos and Ansell.
Overall, earnings are still down relative to pre-pandemic levels, but the market is now expecting to recover to FY19 levels by FY21. This is an extremely fast and rare rebound of earnings out of a recession.
The ongoing global COVID-19 situation remains fluid. Vaccinations continue to be rolled out across Australia and the rest of the world. However, the sheer scale of the task at hand means that the pathway back to normality will be long and bumpy.
The global business cycle remains strong with strong Purchasing Manager’s Index (PMI) and Institute of Supply Management (ISM) data helped by the unprecedented and rapid government interventions. The latest data shows Australian GDP growth remaining strong with Q4 expanding 3.1% over the quarter which was much better than consensus. Incredibly, Australia’s GDP is only 1.1% below the level in Q4 2019, compared to the global median decline of 3%.
Interest rates have essentially been anchored by central bank intervention globally while inflation expectations are showing strong signs of recovery from low levels. Yield curves have steepened substantially globally which has been historically positive for value, as the under-priced and economically sensitive cyclical and financial stocks do well.
Despite the rotation and sharp rally in value that began in late 2020, it has still materially underperformed growth over the past 12 months and has a long way to reverse this underperformance, let alone the underperformance of the last few years. Value typically outperforms for at least 12 months after a major trough in earnings and we see little reason for this outcome to not be repeated.
The tough decade for value investors has created attractive investment opportunities that a well-disciplined value investor can harness. Our process is well positioned to take advantage of the opportunity set that requires a long-term investment horizon that looks through the current uncertainty, and a detailed bottom-up focus that identifies attractively priced companies that we believe are positioned to be rewarded in the economic recovery.