INSIGHTS

Reporting Season Wrap Up – August 2023

Overview


The ASX’s reporting season is held twice a year in February and August. Over the course of a few weeks during reporting season, listed companies report their periodic financial results to the market and have the opportunity to update their outlook for the year ahead.

For investors, reporting season provides a valuable insight into the financial health of the companies they are invested in and allows them to understand the future direction of those companies, as well as potentially identify new investment opportunities.

As the August 2023 edition comes to a close, we thought it would be interesting to hand pick five notable results and dig into what they can tell us about the current state of the economy both in Australia and abroad.

Commonwealth Bank (CBA)


Commonwealth Bank reported a record $10.2 billion net profit after tax for the 12 months ended 30 June 2023. Some have questioned the morality around banks recording record profits at a time when the economic environment is getting tougher for consumers, but the fact of the matter is that banks have historically proven to perform well when interest rates are higher.

There has been a lot of hype around the so-called “fixed mortgage cliff”. This is the wave of homeowners that took out fixed mortgages at ultra-low rates during Covid, which are now rolling off onto much higher variable rates. The fixed mortgage cliff hit its peak in the last couple of months.

It is anticipated that the fixed mortgage cliff will cause arrears to increase, which could force the banks to provision for losses which would negatively impact their profitability. While some riskier non-bank lenders are experiencing a moderate uptick in arrears, Commonwealth Bank’s arrears remain very low compared to historical levels, supported by low unemployment in the economy. The level of arrears is something we will be watching closely over coming months for Commonwealth Bank and the other financial institutions.

James Hardie (JHX)


James Hardie is a world-leading manufacturer of premium wall and floor building products. Their products are used across a number of markets globally, including new residential construction, manufactured housing, repair and remodelling, and a variety of other commercial and industrial applications.

James Hardie’s share price has been on a wild ride over the last couple of years. From a low of around $17 during the Covid sell-off in March 2020 to a high of around $56 in late 2021, the stock more than tripled as interest rates plummeted which encouraged housing construction activity to pick up – a positive for James Hardie. Then as the realisation set in that inflation was more of a problem than previously feared and interest rates were set to rise which would result in a dampening effect on housing activity, the share price halved over the next 12 months, back to around $26 at December 2022. From there it has been smooth sailing once again, as James Hardie has weathered the storm well and demand has held up better than expected, resulting in another ~80% increase in the share price to $47 at the time of writing.

One of the main features of James Hardie’s ability to weather the storm this year is what’s happening in US housing, which is a key market for them. The US mortgage market is predominantly comprised of 30-year fixed rates, a stark contrast to here in Australia where the majority of mortgage holders are on variable rates.

From a low of 2.65% in January 2021, the average 30-year fixed mortgage rate in the US has risen to a 20-year high of 7.2%. What this essentially means is that anyone who has taken out a mortgage in the last 20 years would today face a higher interest rate if they were to sell their house and purchase a new house. As a result of this dynamic, many homeowners are essentially “trapped” in their current residence, unwilling to sell with supply of existing housing having fallen. More people are now building in new developments due to the constrained housing supply, which equates to strong demand for James Hardie’s products.

Qantas (QAN)


After a difficult 3 years of Covid-related disruptions, Qantas came back with a bang in the 2023 financial year. Amid a sea of built-up demand for domestic and international travel being realised, the company reported $19.8 billion in revenue, more than double the previous year, and a record $2.7 billion earnings before interest & taxes (EBIT). Strong demand allowed Qantas to charge higher prices for flights, while the company now have a much leaner cost base following a significant restructure of the business during Covid.

Qantas has been hot in the press over the last few weeks due to a number of issues, including their handling of travel credits for Covid-related flight cancellations. Qantas indicated that all outstanding credits at the end of 2023 would be written off because customers had now been given adequate time to use their credits. However, Qantas have been under fire because a) they have made it incredibly difficult to actually cash in the credits, and b) in some cases the flights are up to 70% more expensive than they were pre-Covid resulting in customers being left out of pocket for the same service they had previously paid for. Qantas have since backflipped on that decision and said the Covid travel credits would not expire.

Another issue impacting Qantas is their ageing aircraft fleet. It is well documented that Qantas have historically underinvested in their fleet which could artificially inflate profit over the short-term. Coinciding with their August result, Qantas also announced they had ordered 12 Airbus A350’s and 12 Boeing 787’s for their international fleet. The new aircraft are expected to start arriving in the 2027 financial year. We expect that increased spend on fleet upgrades will be a slow burn for Qantas going forward following years of underinvestment.

ResMed (RMD)


ResMed designs, manufactures, markets Continuous Positive Airway Pressure (CPAP) machines and consumables (masks) that go with the machines. These machines help diagnose, treat and manage a range of respiratory diseases but primarily sleep apnoea. ResMed also offers a cloud-based software application which is packed with data and helps doctors optimise treatment for their patients.

ResMed reported net income of US$897 million, a 15% increase on the year prior. However, the share price has subsequently fallen by ~25%. The primary issue in the result was ResMed’s gross profit margin which came in below expectations, falling from 57.8% in the previous period to 55.8%. This may seem minor but a small miss can result in a big reaction to the share price, as we have seen following the result.

The other issue impacting ResMed is the rapid growth of a new breed of injectable diabetes drugs used for weight loss, including the Ozempic drug from Novo Nordisk. While Ozempic is not a direct competitor to ResMed, there is a high correlation between obesity and sleep apnoea. The market is extrapolating the idea that Ozempic will continue to grow and shrink the size of ResMed’s potential customer base. While we are aware of the risk that Ozempic poses to ResMed, there is no hard evidence to suggest that the two are mutually exclusive, and we believe that sleep apnoea remains a huge market which is underpenetrated and has numerous growth drivers over the long-term.

ResMed has been in a supportive environment over the last couple of years as their main competitor Philips had a product recall. 100% of Phillips production capacity was shifted to replacing the faulty machines and ResMed has taken over a good amount of market share. Our read on the ResMed result is that Philips is preparing to re-enter the market and ResMed is making one last push to gain market share at the expense of their profit margin in the short term. Market share should be sticky, and if margins recover to their prior levels then ResMed will be incredibly well positioned.

We acknowledge that it was a disappointing result for ResMed and a hit to management’s credibility, given that they had guided the market to higher margins for this result. However, on a price-to-earnings (P/E) basis, ResMed is now trading at a multi-year valuation low, and more cheaply than some companies which are in a much more saturated market and growing slower than ResMed is.

Telstra (TLS)


Telstra’s result was largely in line with the market’s expectations, as it delivered $21.2 billion in revenue and $7.2 billion in earnings before interest, taxes, depreciation and amortization (EBITDA). Telstra’s revenue and earnings are relatively defensive in nature. No matter how bad the economy gets, mobile phone and internet services are generally treated as an essential expense, so it’s less likely that we’ll get a big surprise one way or the other with Telstra’s results.

Despite the result being broadly in line with expectations, Telstra’s share price subsequently dropped ~5% due to some unexpected commentary around the potential separation of their infrastructure assets (entity called InfraCo). Effective from 1 January 2023, Telstra enacted a corporate restructure from Telstra Corporation Limited to Telstra Group Limited. This change means that the various underlying businesses under the Telstra umbrella are now reported on separately – allowing for a cleaner split if they were to offload any of the underlying businesses.

Telstra’s infrastructure assets (mobile towers) would be an attractive asset for large pension funds and private investors who may value the revenue stream more highly than Telstra shareholders. For Telstra, a potential sale of InfraCo would bring a significant amount of cash into the business (estimated around $15 billion) which could be returned to shareholders via increased dividends and/or share buybacks.

Telstra’s management have previously hinted at a potential InfraCo spin-off. However, at this result CEO Vicky Brady indicated that Telstra will be hanging on to InfraCo for now given the opportunity set around artificial intelligence and cloud storage demand. While not ruling out the demerger altogether, our take on the situation is that some large institutional investors have essentially moved on to different opportunities with more near-term catalysts, which has led to a slight de-rating in Telstra’s share price.

Summary


The August 2023 reporting season will go down as one of the more polarising in recent memory. Expectations going in were highly uncertain and many share prices rose or fell by 10% or more on the day of their report. An interesting anecdote more broadly was that interest costs are climbing for companies that are highly indebted. This is something we will be closely watching over the coming months, a period which will be crucial to determine if central banks are able to pull off the soft landing of returning inflation to target without causing a deep recession. At this point in the cycle, we have a preference for high quality businesses with little or no debt, which should continue to deliver solid results through a range of potential economic outcomes.

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