The Half Year reporting period for Australia’s listed companies was eagerly anticipated, following what was largely a highly unpredictable six-month period. The results broadly exceeded the expectations of investors, with many major companies effectively reducing their operating costs significantly throughout the pandemic and achieving better than expected revenue growth as Government stimulus provided some cushion for the economy.
This resulted in strong margin performance across many companies, with strong cash flow and company balance sheets in a better place than what the market would have expected coming into the reporting period. However, the next phase for economic recovery will require businesses to move beyond just managing costs to investing for long-term growth.
Banks and resources attract income hungry market
The major banks appear to be better placed at this point of time, reinforced by the recent CBA result, as the level of provisions for bad and doubtful debts appear to be conservative with their balance sheets in a generally strong position. As a result, banks could be in a better position to increase their dividends from COVID lows, although they will still need to keep an eye on underlying economic conditions and level of competition which still has the most influence on their capacity to grow profits. The improved outlook for banks has been reflected in recent strong share price performance.
Strength in the iron ore price has seen the resources sector, particularly companies like BHP and Rio Tinto, emerge in a robust position and confident to pay better than expected dividends.
The response from the market across these sectors shows investors are clearly looking for yield, which is a reflection of the current interest rate environment.
Performance solid, but companies must now invest for growth
As government fiscal support is gradually withdrawn, many companies will continue to reduce costs, improve their balance sheets and margins as they search for opportunities to invest to generate revenue. Those that succeed will be in a better position to grow dividends over time. Typically, these are the better-quality companies in the market and the ones that AFIC looks to invest in.
In the long term, growth for companies won’t come from macro-economic drivers and managing costs will not sustain the uplift in performance we’ve seen in many of Australia’s large companies. Businesses will now need to focus on investing for growth. The earnings profile of a business will be key for us going forward.
Long-term growth over cyclical trends
The impact of COVID-19 has been different for various industries and businesses within those industries. For some industries, such as e-commerce, it had a positive impact as the trend towards online shopping accelerated with lockdowns around the world restricting consumer movement. For others, such as the travel industry, the impact has been devastating in the short-term.
At AFIC, we invest in businesses that have the structural drivers, such as the ability to invest back into the business, for continued growth over five to ten years, opposed to looking at cyclical winners and losers.
We do not expect a sustained pick-up in the aggregate demand in the economy, meaning that the overall economic recovery will continue to vary slightly across industries and markets. The next phase of recovery for businesses will also be influenced, to some degree, by how consumers and investors reallocate the money many have saved over the last six to twelve months due to limitations on how they could spend it.
AFIC continues to focus on quality businesses that have opportunities to invest for growth in this current climate. Many companies that we hold have the potential to return to a dividend profile that is attractive to AFIC, and as a long-term investor, we believe the portfolio remains well positioned but is being adjusted as opportunities arise.