Australia's Report Card

The recently completed reporting season has been one of extremes with many peaks and troughs, similar to that of the sharemarket turbulence we have been experiencing.

Across the more than 200 companies Macquarie's analysts cover, approximately 58 per cent showed a negative price movement during the two weeks leading up to their result and, for 54 per cent, their share price fell in the week following their results announcement.

However, on the flip side, 52 per cent of the stocks analysed that rallied during the lead up to their result showed an increase in their share price in the week following their announcement.

Strong results were delivered by CSL, Coca Cola, Computershare, Origin Energy, Wesfarmers and Woolworths. For Wesfarmers, for example, the Coles Group delivered higher than expected results, with its industrial businesses and Bunnings also showing good growth. Woolworths' positive performance was driven organically, resulting from both market segment growth and market share growth, especially in Australian food and liquor. These two companies will have benefited from the high consumer spending levels seen during 2007, although the latest reports do suggest that consumer sentiment is beginning to decline following the interest rate hikes.

Weaker results of the season were seen from companies including IAG, Suncorp and ABC Learning Centres, driven largely by credit issues. Within the current conditions, all but the most 'cash rich' companies will need to access credit. The impact of this is being seen most heavily in the financials sector, where the velocity of money is quickly slowing, but it is likely to have some flow on effects to other sectors as we move through 2008.

The reporting season also revealed some long-term solid performers who surprised the market negatively, with QBE being a good example, which disappointed despite high expectations for its result. In this instance however, a less than expected result does not mean a bad report card.

The main drivers of QBE's earnings downgrades was its premium income, which did not deliver as strongly as expected, driven by the impact of the stronger Australian dollar and a combination of increased competition and portfolio culling. That said however, the 2008 premium guidance for QBE is already largely in the bag, reflecting the full year impact of some past acquisitions. If QBE makes any further acquisitions during the remainder of the year, this should only lead to further upgrades.

Global liquidity issues that began back in August 2007 have had a mixed impact on many sectors within the market, especially Australian banks. For the banks, while margins caused pressure, they benefited from strong asset growth driven by the combined effect of customers moving to quality and the reintermediation of business credit.

This represents a true shift in way of thinking for our local banks. For more than a decade household credit growth has outstripped growth in the more capital intensive business segment. Today however it is a different story, with business credit growth at 26 per cent while mortgage growth has decreased to 12 per cent. The amount of capital needed to secure a business loan is at least double the amount needed for a mortgage.

The companies that delivered weaker results in the recently completed reporting season are feeling the impact of both the global credit market issues and an increase in costs. Cost increases were a major feature of the reporting season, coming up in results again and again, with many companies finding it hard to pass on these additional charges quickly enough to maintain the margins they had built in their operating costs.

With the potential for the cost of debt to continue increasing, 'cash' profit performance will be critical for companies during the next six to 12 months. Those companies that are able to generate strong operating cashflow growth, combined with only a modest level of gearing, have a lower risk of causing disappointment with their earnings during the next few months.

So, some key focuses in the near future are costs and, of course, debt.

It is clear to see that the current market environment presents several challenges for even the most confident and experienced investor. The market is still facing a series of economic risks, including uncertainly around economic growth, potentially overstated company valuations, further inflationary risks and the risk of current credit conditions.

So while the reporting season has provided a clearer picture to the market and its investors about the underlying value of the companies we invest in, the question really remains - how can you navigate these risks?

The important factor is to avoid automatically assuming that your strategy is no longer appropriate, because of the market conditions we are seeing. When looking at the asset allocation within your portfolio, most long term investors should keep the same level of both international and domestic equities as agreed with your financial adviser and that fits within your risk profile.

The reason for this is that the likelihood of these bear markets persisting for a very long period of time is relatively low. Although your returns might not be as high as you would currently like, forecasts for long term returns are more positive.

When investing with a short term outlook however, perhaps during the next six months, asset allocation decisions become more of a challenge. While the share market provides good upside, risks do exist and predicting the timing of a turnaround is extremely difficult. Taking this into consideration, being slightly underweight in international and domestic equities, and selecting the stocks carefully with your adviser, might be more appropriate from a risk perspective, until the skies brighten again.

To find out more contact us.

Published on April 4-th, 2008 in Financial Planning
Damon Rasheed is the CEO of Rate Detective, an Australian financial service comparison sites specialising in Life Insurance, Income Protection Insurance and home loans. Damon holds a Master's Degree in Economics from the University of Melbourne and has been involved in many start-up internet businesses.

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