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Positive signs for the market following FY23 reporting season
Positive signs for the market following FY23 reporting season

Positive signs for the market following FY23 reporting season

The company reporting season for 2022-23 generally produced better-than-expected results, however the outlook for 2023-24 remains cautious. AFIC portfolio manager David Grace shares his takeaways from reporting season and considers what may lie ahead.

Heading into the FY23 reporting period, expectations were company results would be subdued as the impact of the current economic environment was predicted to weigh on performance.

Across the AFIC portfolio of companies however, results generally exceeded expectations and, while earnings growth for many companies appears set to slow in the year ahead, the outlook is more positive than initially predicted.

It wasn’t all positive news; there were mixed results for companies and the increase in wage costs and elevated interest rates are exerting pressure on some companies more than others.

Quality matters as earnings growth set to ease

Following relatively strong earnings growth for companies generally over the past two years, we expect that earnings growth will likely stabilise over the short term. Some companies’ recent strong earnings growth was generated from their ability to pass on higher costs through increased prices but lifting prices into the future may prove more challenging.

Although inflation trends are stabilising, companies are still facing elevated costs, particularly in relation to wages, while higher interest costs are also starting to have an effect. So, while inflation has potentially peaked, companies are still left with a higher cost base compared to the previous two years at a time when the ability to keep pulling the price lever is becoming harder. Consequently, we expect companies will still generate earnings growth but at a slower rate than over the last two years.

Higher interest costs will be a particular focus for companies that have a high level of gearing. For AFIC’s portfolio however, this is not of such concern. Our investment philosophy focuses on quality companies that have strong balance sheets and which can deliver attractive returns to shareholders over the long term despite shorter term economic challenges. Our portfolio contains companies that have higher operating margins, providing them with greater ability to withstand pressures on earnings - whether it be from wages inflation or higher interest costs.

Dividends and valuations

Generally, dividends were reduced compared to last year. The main downward pull on dividends was from the resources sector, largely reflecting lower commodity prices.

Inflation also impacted the level of dividends. Capital expenditure now costs more and companies have less cash available to pay in dividends to shareholders.

As for valuations, the market based on the ASX200 Index is in line or slightly above its long-term average, Many companies look fully valued or near to being fully valued and, in an environment of potentially slowing earnings growth, the multiples at which some companies are currently valued may prove to be unjustified.

Highlights from our quality portfolio

Three companies in our portfolio stood out during reporting season, and we either added to our existing holdings of these companies just prior to or after the results period. These companies really exemplify the characteristics that we look for in our investments, including good management, a strong balance sheet, high-quality assets, and the ability to deliver sustainable, attractive returns over the long term.

The first one is blood products and vaccines supplier CSL. Market demand for CSL’s products remains strong, and we believe the company is set for strong earnings growth over the next three to five years. CSL is reinvesting cash flows back into its R&D pipeline, developing new drug therapies that should generate good earnings growth. CSL has also invested in capital expenditure over the last 20 years and is now really reaping the benefits. The company is operating more efficiently and has better positioned its manufacturing supply chain.

The second company that impressed was We’ve owned shares in Carsales for a while, but we’ve grown even more confident in the longer-term earnings outlook for the company. Carsales acquired a business called Trader Interactive in the US a couple of years ago and it is now well integrated into the group. Carsales has taken some of the product initiatives from the Australian market and rolled them out successfully in the US.. The company’s acquisition of Web Motors in Brazil is also performing well and reinforces the fantastic long-term opportunity for Carsales in these international markets.

A third company that we really liked was Goodman Group, which is a developer of distribution centres and industrial warehouses. Around five years ago, Goodman repositioned its property portfolio away from secondary locations to prime locations around the world for logistics infrastructure. Since then, the company has built up a land bank and various end-users, including data centres, want access to that land. As a property developer, Goodman can facilitate the needs of those end-users. It also has the advantage of strong development margins and balance sheet.

We remain vigilant for opportunities

Economic growth has proven to be resilient, inflation trends are improving, and there are no signs that we’re heading for a recession in the near-term. On the other hand, inflation appears to be stubborn, and there is still a possibility that reserve banks may have to lift interest rates again to curb it.

Nonetheless, as far as the AFIC portfolio is concerned, we remain positive.

The current economic environment has many moving parts and highlights the value of our approach of maintaining a diversified portfolio of high-quality companies.

In this environment, we remain alert to capturing opportunities when they arise from any short term movements.

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