Equity Strategy
7 February 2024
Reporting Season Preview: Great Expectations
Heightened Multiples Indicate Heightened Expectations

Stocks have broadly rallied over the past three months, with valuations expanding across most sectors. 

Healthcare, IT, Media, financials and retail have seen the most significant increases in their P/E ratios. 

This broad rerating suggests the market may be less forgiving of companies that miss earnings expectations in the upcoming reporting season. The market will be looking for upgrades over the next 12 months to match the valuation uplift.  

To navigate this potentially volatile environment, the Focus Portfolio has prioritised stocks with the following characteristics:

  • Resilience to a slowing economy: These companies offer products or services that remain in demand even as economic growth moderates. This should help them avoid earnings downgrades and associated price swings.
  • Upside potential after reporting season: As stocks that downgrade face pressure for missing estimates, stocks that avoid downgrades could see positive valuation adjustments as the market recognises their relative strength.
  • Sustainable earnings growth: In a period of tepid overall growth, companies that can demonstrate consistent and reliable earnings increases will be highly sought after. 

By focusing on these criteria, the Focus Portfolio aims to deliver superior returns through the next 12 months.

Figure 1: ASX 200 has broadly rerated across most sectors over the last 3 months; while there isn’t much expected index growth, there are still pockets of growth. The portfolio is positioned towards these pockets of growth
ASX 200 Sector PE (02/11/2023) PE (02/02/2024) PE Rerate 12 mth fwd EPS Revisions (3 month change %) EPS Growth (12 months forward)
IT 25.9 32.4 25% -0.9% 10.2%
Healthcare 24.1 29.8 24% 0.3% 18.3%
Energy 10.7 12.9 21% -17.5% -11.2%
Media 27.8 33.2 20% -0.7% 10.5%
Div Fins 14.5 17.3 19% -5.4% 4.2%
Banks 13.3 15.5 16% -1.3% -4.0%
Retail 19.2 22.0 15% -0.8% 3.1%
ASX 200 14.2 16.0 12% -0.5% 2.6%
Industrials 16.7 18.7 12% -1.6% 12.2%
Consumer Services 19.4 20.9 7% -0.1% 16.4%
Insurance 11.8 12.5 5% 0.2% 16.8%
Telcos 21.2 22.2 5% -1.0% 9.4%
Materials 11.4 11.8 3% 5.4% 2.4%
Consumer Staples 19.9 20.2 1% 0.8% 3.3%
Utlilities 14.9 13.6 -8% -3.0% 25.7%

Source: Refinitiv, Wilsons Advisory. 

Key Questions for Reporting Season

Time for defenses to shine?

Despite broad market valuation expansion, defensive equities multiples remain relatively subdued. Their inherent resilience and consistent performance history suggest lower downgrade risk amid economic uncertainty. This presents a potential catalyst for a rerating if they meet consensus earnings expectations in a backdrop of higher volatility and broader market downgrades.

This combination of relative safety and potential relative undervaluation could attract investors if reporting season gets volatile.

Can pricing power margins?

As costs have climbed steadily for the past two years, the 2024 reporting season could be the year where pricing power separates the winners from the losers. With supply chain bottlenecks easing and inflation potentially peaking, companies with the ability to raise prices without sacrificing demand are poised for margin expansion surprises. 

Companies like IAG, Amcor, and Telstra should showcase this dynamic. 

IAG, with its dominant insurance market position, can command price adjustments more readily. The insurers should see lower costs from perils and reinsurance relative to last year. 

Amcor (AMC), a global packaging leader, benefits from brand strength and restocking allowing for price hikes. Input costs for AMC have fallen over the last 6 months.

Telstra (TLS), holds a loyal customer base and after big missteps from competitors (Optus), TLS can  leverage network upgrades to justify price increases. 

Figure 2: We expect to see further margin expansion as TLS increases mobile plan prices
Figure 3: AMC margin recovery could be stronger than expected if costs fall quickly
Figure 4: IAG insurance margins are expected to improve as premiums increase and peril/reinsurance costs fall

Consumer peak or more resilience? 

Can retail stocks keep defying expectations with another strong reporting season? Super Retail gave us some clues about the state of the consumer in January. While the pre-released 1H24 result was above expectations, the trading update indicated volatility for 2H24 with trading deteriorating in key brands such as Rebel (like-for-like sales -7.7% yoy). 

This reporting season may be a similar story for many retailers. Strong performance in the last half as the consumer remains resilient vs soft trading updates for the first 5-6 weeks of trading in CY24.

The retailers have also rerated significantly over the last 3 months as rate cuts in this calendar year look more likely. Therefore, these stocks are more at risk of derating if earnings disappoint. 

The portfolio does not have any retail exposure at present. Opportunities to get a quality retailer at a discount may arise in this reporting season.

Figure 5: ASX 200 retailers have rerated very strongly, with the expectation of upgrades over the next 12 months
Company Name Ticker PE (31/10/2023) PE (05/02/2024) Rerate EPS Revisions (FY24) EPS Revisions (FY25)
Wesfarmers WES 22.0 24.8 13% -0.3% -1.6%
JB Hi-Fi JBH 13.0 16.2 25% 1.1% 2.7%
Harvey Norman HVN 12.9 14.7 14% -12.9% -0.1%
Premier Investments PMV 14.5 17.0 17% 1.5% 3.7%
Eagers Automotive APE 11.7 13.1 12% 3.2% 0.2%
Super Retail Group SUL 13.4 15.4 16% 2.6% 6.1%
Lovisa Holdings LOV 20.7 26.8 30% -2.5% -4.0%
Bapcor BAP 13.1 13.6 4% -9.1% -5.4%

Source: Refinitiv, Wilsons Advisory. 

Market view through this reporting season?

The market might choose to gloss over a disappointing reporting season if investors are convinced of a robust recovery by 2025. With FY24 partially played out, investors might already be shifting their attention to FY25 earnings forecasts. As these forecasts paint a rosier picture, it could dampen the impact of a lackluster 2024 reporting season.


Top Picks for Reporting Season

Focus back to earnings – Worley (WOR)

Worley (WOR) has de-rated to a 12-month forward PE of ~17x following news that it is unlikely to recover unpaid receivables from a state-owned enterprise in Ecuador, with the country alleging WOR has engaged in wrongdoing in the process (which has been firmly denied by WOR). The focus should shift back to earnings this reporting season, with an expected EBITDA of $438.5m (+20% YoY). WOR could provide upside surprise on margins (as WOR shifts to higher margin projects) and on the size of its backlog of work. WOR could rerate significantly following a good result. 


Negativity overdone – IDP Education (IEL)

While sentiment towards the company has been impacted by (likely temporary) changes to visa policies in Australia, Canada, and the UK, IEL’s focus on ‘high quality’ students attending leading educational institutions will lessen the impact of these changes. The pullback looks overdone and the company should address some of the market concerns in this update, providing colour on the quality of its students placement business. IEL trades on a 12-month forward PE of ~28x, which is attractive considering the high teens EPS CAGR the business is expected to deliver over the medium-term, the stock could rerate and see a short squeeze from a good update.


Key Things to Watch in the CBA Results (14th Feb)

  • Margin contraction: Did CBA adjust margins to retain market share in the face of competition and rate wars? Did higher rates attract new (cheap) retail deposits, or higher cost term deposits, or encourage customers to switch banks (with higher rates)? Consensus expects net interest margins to contract 5bps HoH.
  • Return on equity to continue to contract: ROE peaked in 1H23. Consensus is expecting ROE to fall by 0.3 percentage points over 1H24. This will be very contingent on margins. 
  • Costs flat: Consensus expects a cost-to-income ratio that is flat HoH. Can CBA contain costs? The other banks have not been successful in keeping costs down. 
  • Outlook for credit quality: What is CBA’s assessment of credit risk and potential future adjustments? Consensus expects a 1H24 bad debt expense of $499m vs 2H23 of $597m.
Figure 6: A key question is whether CBA sacrificed margins to get back to system growth in the last quarter

Valuation Concerns Keep us Cautious

While CBA is the highest quality bank in terms of return on equity and management team, it is by far the most expensive. CBA looks too expensive relative to its quality. 

High P/B Ratio raises stakes 

Its current P/B ratio is the highest among the Big Four, with the premium relative to peers the highest it has ever been (except March 2020). With its elevated valuation compared to peers, even minor missteps in the 14 February report could significantly impact the share price. 

Any indication that CBA faces similar cost pressures (like peers) or lower-than-expected NIMs could lead to a harsh market response.

Valuation preference

We prefer the other big 4 banks – NAB, Westpac (WBC), ANZ – on valuation grounds.

Figure 7: CBA trades on a significant premium to the other big banks
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Written by

Rob Crookston, Equity Strategist

Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.

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