THE BIG PICTURE: Sales might be down, but companies are cashed up for expansion

At the time of writing the profit-reporting season was drawing to an end. So prepare to be inundated with post-mortems of the results by analysts, investor websites and the media over the coming week.

So how did it go? We have assessed the results for the 104 ASX 200 companies that have reported results for the year to June. In aggregate, profits lifted by almost 87% over the year to $40 billion. Clearly this result is significantly affected by bell-whether companies like BHP Billiton and News Corp. But stripping out those companies still reveals a 30% lift in aggregate earnings. And averaging the results reveals a similarly impressive 45% lift in earnings. (In the smaller sample of 34 ASX 200 companies reporting half-yearly results, earnings have lifted on average by 78% compared with a year ago.)

Interestingly, the lift in profitability wasn’t driven by consistent gains in sales (revenue). In fact average revenue growth was just under 5%. But neither were businesses slashing expenses to boost profitability. On average across the major companies, expenses fell by 5% over the year. But unlike last year write downs certainly weren’t an influence on profit results. A year ago companies (especially in finance and property sectors) were forced to downwardly mark to market the value of assets but over the past year asset values stabilised and there were rare upward revisions.

One other stand-out feature of the profit-reporting season has been the sharp lift in cash holdings. As at June 30, the 138 ASX 200 companies that have reported results had cash holdings of almost $100 billion, up 13% on a year ago. Not only are companies back in the black but they are cashed up for expansion. Retained earnings are even healthier at $136 billion, up 15% on a year ago.

Bloomberg has also compared the latest profit results with analyst expectations. Of the companies that reported full-year earnings, 45% were above consensus earnings per share estimates while 55% fell short of estimates. (Bloomberg assigns results to either positive or negative surprises and doesn’t have an “in line” category). Most positive surprises were in the basic materials sector (58%) while only 32% of results in the financial sector beat expectations.

While there was some disappointment on earnings from an analyst perspective, the lack of guidance from companies has also been a concern. Overall, analysts and investors alike should be happy with the health of company balance sheets, but as always it is the uncertain future that dominates. And that suggests that the sharemarket will continue to move sideways until better signs emerge on the US economy.

The week ahead

In the coming week not only does the calendar flip over from August to September but winter comes to an end. And as is usual with a change in seasons, there will be barrage of economic data to usher in the transition to spring. In fact there are no fewer than a dozen key indicators to be released over the week with GDP (economic growth) figures one of the stand-outs on Wednesday.

On Monday the Bureau of Statistics releases data on profits, sales and inventories. On Tuesday (“terrific Tuesday”) retail trade, building approvals, government finance, private sector credit and the current account are issued with a speech by Reserve Bank Assistant Governor Guy Debelle thrown in for good measure. The Performance of Manufacturing index is released on Wednesday alongside the GDP figures while international trade is issued on Thursday and the Performance of Services index and tourism data are slated for Friday.

At this early stage of data collection, we expect that the Australian economy grew by 1.1% with household spending and dwelling construction both higher and the trade sector likely to add a small 0.1 percentage point contribution to growth. Overall the result will signify that Australia is well on its way to notching up 20 consecutive years of economic growth, but it will mask the weakening in economic momentum over the past two months.

This loss of momentum has clearly shown up in consumer spending, up just 0.5% over the past five months. But the longer that the Reserve Bank stays on the interest rate sidelines, the better the outlook for retailers will be. We expect that retail trade lifted 0.4% in July after a 0.2% gain in June.

Dwelling approvals probably rose by 1.5% in July, for the simple fact that recent declines appear over-done. In fact approvals have fallen in five of the past six months and fell by 3.3% in June.

Of the other data, expect another solid trade surplus, flat readings for manufacturing and services activity and further weakness in tourism flows.

If the US is to avoid a ‘double-dip’ recession it all boils down to whether there is a pickup in job growth. If jobs aren’t created, consumers don’t spend and businesses don’t receive income, causing them to constrain investment and employment. Certainly businesses have been making money but they have been more focussed on cutting debt rather than growing.

Unfortunately economists don’t believe that the start of the jobs recovery began in August with predictions that only 44,000 private sector jobs were created in the month. And unemployment is tipped to have lifted modestly from 9.5% to 9.6 cent with no change in the average number of hours worked.

The other economic indicators are expected to provide mixed readings. Personal income and spending may have both lifted by 0.3% (Monday). And consumer confidence may have also edged higher in the latest month (Tuesday). But economists believe that the ISM manufacturing index eased from 55.5 to 53.3 in August (Wednesday) while the ISM services index may have also softened in the month (Friday).

Other indicators to watch over the week include house prices (Tuesday); construction spending, auto sales and the ADP employment index (Wednesday); and pending home sales (Thursday).

Sharemarket

If the conventional wisdom is to be believed, the Australian economy will continue to be protected from any gloom in the US and Europe by virtue of its strong links to Asia, especially China. But that rationale certainly hasn’t played out on the sharemarket – for this year at least. Two-thirds of the year is almost over and the Australian sharemarket has fallen by just over 10%. By contrast the US Dow Jones is holding up far better, even with an economy at risk of a double-dip recession. The Dow Jones has only fallen 3.5% over the year with the Nasdaq down 5.6%. Even in Europe the German Dax has only fallen 1% this year while the UK FTSE is down by 5.6%.

We haven’t changed our projection for the end of the year, but it is looking more challenging by the day. CommSec continues to tip the All Ordinaries/ASX 200 at 4,800 points by end year. While company balance sheets are healthy and the outlook for the Australian economy remains promising, our sharemarket continues to track offshore markets closely, especially the US Dow Jones.

Interest rates, currencies & commodities

The gap between fixed and variable mortgage rates has narrowed markedly in recent months and the process may have further to go. The Reserve Bank reports that 3-year fixed rates are around 7.50% currently, compared with 7.40% for the standard variable rate. Earlier this year, fixed rates were just over one percentage point higher than variable rates. In large part the gap has narrowed because variable rates have risen. But fixed rates have also eased 30 basis points between April and July. And with market rates down around 25 basis points over the past fortnight, fixed housing rates could fall even further, dropping below the variable rate. Just goes to show that you always need to keep your eye on the ball.

The Australian dollar is on track for a very average year. Over the past 25 years, the Aussie dollar has fluctuated on average by US13.5 cents a year. So far this year the Aussie dollar has moved US13.2 cents.

Craig James is chief economist at CommSec.