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Background
ASX profit reporting season finishes – ABS National Accounts released
The end of August marked the end of the profit reporting season for the majority of listed Australian companies.
In this week’s Investment Matters, we will briefly discuss interesting trends from the reporting season and continue to cover company results that we did not expressly document throughout August. This edition discusses the results for Steadfast Group (SDF), Bapcor Group (BAP), and the new portfolio positions in Healius (HLS) and Australian Clinical Labs (ACL).
The Market
Australian National Accounts
On Wednesday, the Q2 ABS National Accounts data were released. Although a little backward-looking, the National Accounts can provide corroborative evidence of the trends we see from the company reporting season. The National Accounts also provides a clearer picture of which sectors of the economy (business, households, or government) are driving growth or its absence.
Movements in savings rates, measuring household and corporate exposure to interest rates, and measures of productivity also provide investors with a basis for considering future movements in aggregate demand.
The National Accounts also provided a critical backdrop to an emerging political debate between the RBA and Federal Treasurer Jim Chalmers.
Some simple dot points:
- Australia’s growth figures are globally weak. This is, of course, by design; interest rates, while lower than in many other countries, now have traction and are acting as a major constraint on private sector growth. (Barrenjoey)
- The worst productivity declines are behind us; hours worked are falling, leading to weaker household income. Productivity growth through less employment is the least preferred version; we would prefer improvements through innovation and micro-economic reform.
- Government spending is the only support for growth.
- The economic slowdown is broadening beyond the household sector and into private investment.
The figure below shows that GDP growth, excluding the public sector, was 0 percent YoY to Q2. This means the public sector is smoothing out the economic cycle, with the private sector proving more responsive to higher interest rates.
GDP growth, including and excluding Public Sector
Source: ABS
However, the RBA believes that there is still excess demand in the economy, and this is stoking future inflation. In this scenario, public demand is prolonging inflation and, hence, requiring higher levels of rates.
Our concern, shared by others in the market, is that the RBA could be wrong about very technical aspects of economic data that match the interplay between capacity and pace the economy is slowing. But real-life per-capita economic outcomes are historically weak; this part is clear, as is the role of government spending.
Treasurer Chalmers’ statements blaming successive interest rate rises for “smashing the economy” and noting the importance of Government spending are simply saying that without this spending Australia would likely be in a material recession – lower inflation at the cost of a hard landing.
The “smashing the economy” comments, obviously rhetorical, do at least shadow the data on household consumption, which fell in Q2. Considering that population growth is at least 2.5%, Australia experienced an extraordinary consumption retracement at the household level.
The price the economy should pay to reduce inflation to a certain level is worthy of debate.
Q2 consumption falls are rare in Australian history
Source: ABS, Barrenjoey
The drawdown in consumption volumes was, of course, due to the higher costs of living and higher interest rates. Households tried to mitigate the pressure by reducing their savings. The following chart shows the fall in the household savings rate.
Interestingly, the ABS only recently revised past estimates of savings (shown in Q1-24 vintage and Q4-23 vintage). That is, households have been doing it tougher for longer than they realised. With average households saving around 1% and many wealthier households saving enormous amounts, it is clear that broad-based consumption growth will be difficult to support without radical changes in economic policy or interest rates.
Q2 National Accounts: Household Saving ratio
Source: ABS, Barrenjoey
When combined with the profit reporting season trends discussed below, the National Accounts figures supported our reticence to invest in sectors exposed to consumer and household revenue growth.
We continue to look for businesses that benefit from government spending, volume growth in mining, growth related to overseas operations or the limited number of companies with pricing power.
Profit Reporting Trends
It can be superfluous to infer trends across hundreds of companies when so much information is available concerning the companies themselves. However, when market-wide solid trends emerge, they are worth consideration.
Two trends observed in August were (a) volatility in share price responses and (b) declines in future expectations reflected by downgrades to FY25 earnings estimates.
The figure below shows the wide breadth of share price responses now endemic to the ASX. These moves are consistent with the reactions we have seen in overseas markets for several years.
For clients, we believe that it is important to understand that higher share price volatility is not the same thing as larger movements in the fundamental value of the companies that are listed on the market. Such movements are rarely so large. Instead of creating concern for clients, we argue excess volatility in share prices creates better opportunities to find value.
Share price movements post profit report across more than 230 companies in August – Share of companies by price movement
Source: UBS, First Samuel
The chart above shows that 12% of companies saw a share price reaction since their results to the end of August of more than negative 10%; and 17 per cent saw a response of more than positive 10%.
Movements of plus or minus 20% are no longer rare, and the number of companies with a reaction of less than 5% either way was less than 50%. Despite the magnitude of the individual changes, the overall market was relatively flat.
So, what drove the changes, and what did the commentary say about the future?
The most significant share price reactions were associated with disappointing dividends (negative impact) and positive earnings (positive impact).
Overall ASX200 earnings estimates were downgraded by 2.3% during the period. The August 2024 reporting period ranks as the 7th worst out of the 48 past reporting periods stretching back to 2001. The chart below shows the change in August 24 compared to changes since 2014.
Comparing reporting seasons – change to forecast growth in earnings per share (EPS) for the ASX200
Source: MST Marquee
Reductions in expected profit margin estimates by 0.8% in August have driven the earnings downgrades in industrials in particular.
The National Accounts corroborated this margin downgrade and provided us with more evidence of further compression to come. The private non-financial corporate profit share of gross domestic product (GDP) is still hovering at 0.7-0.8%, slightly above what would be expected from an economy running at the current pace.
With a weak credit impulse (from higher rates), slower growth will still need to filter through many companies’ results, especially with a soft underbelly for consumers weighing on pricing power. We continue to look for deep value in company assets or companies that can drive growth from other sources.
Steadfast (SDF)
First Samuel View: Positive
Market reaction to the end of reporting season: +2.7%
Steadfast is a consistent earnings performer that gets rightly rewarded by the share market. FY24 represented another year of good execution and continued growth in industry Gross Written Premiums (GWP), further shift towards broker utilisation and progressive expansion of market share via continued acquisition of businesses.
Enviable track record of EPS and DPS growth in the past decade
Source: Company reports
FY24 was another year of outstanding growth in earnings and dividends at the run of an excellent decade since IPO.
Organic growth
The vast majority of Gross Written Premium growth (>80%) was attributed to organic growth, with price increases by insurers across all non-statutory lines and volume increase of 3%. This still remains a favourable top-line operating environment for both insurers and the insurance brokers who distribute their product for commission.
Supplemented by acquisition
Steadfast also continues to benefit from a consistent strategy of acquiring insurance brokerage businesses. This may include the outright purchase of the entire entity or a progressive ‘unlocking of ‘trapped capital’ being additional equity in the franchises which it already has a partial interest, as principals look to release capital and progressively relinquish control.
Source: Company reports
Steadfast’s investment in technology is further embedding its network of brokers. The Client Trading Platform assists brokers in improving turnaround times to customers, providing fixed commissions to brokers to ensure impartiality and delivering for Steadfast both its revenue take and the stickiness of its franchise brokers. This helps drive a higher valuation multiple for the stock.
Steadfast Client Trading Platform – further embeds the upside
Source : Company reports
In addition, there remains vast prospects for further expansion both domestically and offshore which should continue to enhance top-line growth.
The company made its first significant foray into the US market with its acquisition of ISU in September last year (market size is estimated to by 9x that of Australia) and in the short term has identified $300m of domestic acquisitions for FY25.
First Samuel take
While often we find value in companies and assets which have been ‘neglected’ and overlooked by the market (often due to poor management), we think that it is important to also have a mix of high quality companies which are well managed and can be expected to find growth and superior returns due to their strong market position and great execution. Names like Seven Group Holdings, Macquarie Group, Reliance Worldwide and Steadfast represent examples of this within your portfolios.
“Insurance brokers have typically seen far less volatility than insurers, to both revenue and margin, during periods of premium rate variability. Despite this, SDF is caught in the investor debate around peak-cycle premium rates, even a few hours after guiding to 12-16% EPS growth for the next 12 months. Trading back at historical low PERs, we continue to see value and maintain our Overweight rating.” Barrenjoey
Pathology – Healius/ACL
First Samuel View: Positive
Market reaction to the end of reporting season: ACL +12.7%, Healius +13.6%
After substantial due diligence, we recently added these names to client portfolios, including several conversations with industry participants. We’ve been delighted and a little surprised by the performance of both stocks in the short time that we’ve owned them.
ACL is 29% higher than at 30 June and Healius 13%.
Both companies reported in August, providing the market with more comfort regarding current operating conditions. Both offered clear evidence of strategies that can address the margin decline witnessed since COVID.
Our view of the assets’ long-term value will take longer to prove, but better operating conditions will only assist with the likely medium-term transformation we envisage.
In previous Investment Matters, we outlined how rising costs, especially rents, the impact of one-off benefits from COVID, and slower volume growth had dramatically changed the fortunes of the businesses.
The return of pathology “episode” growth in FY24 will buffer some of the pressure. With growth in pathology running ahead of growth in the very depressed overall doctor visit numbers, any improvement in doctor supply or bulk-billing could accelerate pathology demand.
Source: HLS company reports
However, the pathology industry still needs to improve. It could convince the Government to introduce indexation in the pricing of more pathology testing and find more cost-efficient ways to deliver its services.
In the medium term, we see an opportunity to radically change the relationship between pathology providers and the landlords they currently use. A substantially reconfigured solution could generate significant value. A buyer of adjacent health products and services may initiate this value creation.
At the individual company level, we see positive progress at Healius regarding its Lumus Imaging sale, which will substantially repair its balance sheet. Its smaller but faster-growing business, Agilex Biolabs, also represents an exciting niche opportunity.
Australian Clinical Labs remains committed to its operating model and an emphasis on efficient execution. The combination of both holdings in client portfolios should allow us to profit from each of the following factors without excessive single-company risk.
- Rebound in operating conditions
- Radical change in the sector’s operating costs
- Government funding changes
- Possible corporate activity
What they said – “Back in the game”
“ACL expects an ongoing market recovery, with increased operational efficiencies partly offsetting inflationary pressure on the cost base. EBIT guidance is predicated on revenue growth of 4-8% YoY, with revenue guidance of $725-757m (vs MQe ~$714m).” Macquarie
Bapcor (BAP)
First Samuel View: Neutral
Market reaction to the end of reporting season: -1.1%
Clients will recall that we have built a small position in Bapcor in response to the range of management and board concerns of recent years. The underlying assets are great, but we felt they could be better served by new management or a takeover.
Both have occurred, and the profit results showed some stabilisation in operating performance. Bapcor delivered an underlying result that was in line with recent company guidance, and early trading in FY25 was more encouraging than recent updates.
After years of tumult, new leadership is now installed. Our due diligence on the incoming CEO has been positive. As the Executive Chair, an unusual role in a listed company in Australia, Angus McKay has a real mandate, and financial incentives, to improve and ultimately to find an acquirer for the business.
On the takeover front, the automotive parts group behind the Autobarn and Burson chain, has rejected an all-cash $1.83 billion buyout offer from Bain Capital, around $5.40 per share. Although the offer was rejected future interest remains likely in our view.
In the coming twelve months, patience will be required. Uncertainty about the incoming CEO and any possible changes to company strategy that may result are weighing on the fundamental valuation multiple. The disclosed approach by private equity places a level of support on the Bapcor share price.
Some of the more problematic strategy mistakes made by the former team has been discarded including the McKinsey inspired “Better Than Before”.
at we’ve seen a bottom in earnings and the share price.
What they said – “Cost out to the rescue”
“Bapcor delivered an underlying result in line with recent company guidance. However, recent trading is a bright spot indicating that the low point in sales has been reached. (MST Marquee)
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.