Hasan Tevfik: revenue delight eroded as costs bite in profit season

Australian companies have managed to grow their top lines in 2017-18, but the benefit of higher revenue growth is being eroded by costs, which are rising even faster, as a consequence of more expensive labour, raw materials and energy prices.

Hasan Tevfik, senior analyst at independent securities research house MST Marquee, finds that cost growth is one of the biggest sources of revisions to 2018-19 estimates for the bulk of S&P/ASX 200 companies.

And while it has been a good earnings season in that forecast earnings-per-share downgrades were just 0.5 per cent versus the long-term average of 0.8 per cent, it was even better for dividends, which are on track to hit $78.2 billion by June 2019, from $75.5 billion, excluding the benefit of new buybacks that could be in the region of $1 billion.

Capex is also higher, reflecting a degree of corporate confidence that is at odds with the dominant view that business investment will be sapped by the change of leadership within the Liberals and likely change of government at the next election.

“There’s a bit of corporate confidence in the earnings season,” Mr Tevfik said on Monday. “On costs, there is some sign that costs have been hard to contain. These are becoming bigger issues, they were already negative issues and it looks like they’re impinging on profits more this reporting period than last.”

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Australia Inc “could be squandering a buoyant revenue environment by not containing costs”, he warned.

Mr Tevfik joined MST from Credit Suisse, where he was the Australian equity strategist. Previously, he authored original research on the true picture of foreign interest in Australian residential property and foreshadowed how self-managed super fund activity in the equity market would unleash a dividend boom at the expense of capital investment. Since the dividend cuts of 2016, a better balance has been found.

Cost pressure

One of the strongest themes to emerge from the reporting season finishing this week is cost inflation.

Non-financial company profits were revised down by 40 basis points, at the same as revenue forecasts were revised up by 70 basis points. “Quite simply, costs were revised up by 110 basis points,” Mr Tevfik said.

From CSL to Whitehaven Coal, cost control has been a recurring challenge. CSL forecast a “modest” increase in plasma cost, referring in its presentation materials to US labour cost growth. It still delivered a better-than-expected result to justify its valuation.

Whitehaven experienced cost pressure from “fuel and inflation”, specifying the temporary impact of longer hauls and increased elevation at its Maules Creek mine, contractor costs, and higher diesel prices.

Although labour was a recurring factor, some stocks in the same sector reported different outcomes. JB Hi-Fi reduced its cost of doing business in JB Hi-Fi Australia by 14 basis points. Woolworths, which experienced a 41-basis point cost-of-doing-business increase as a result of investment and customer-driven transformation, also blamed structural inflation.

Woolworths attributed about $30 million to increases in underlying electricity costs and transaction costs as customers shifted from cash to more-expensive contactless payment technology.

The drought has played a role, with companies such as Ingham’s cautioning that higher grain prices would lead to more-expensive meals for consumers.

“Feed prices have continued moving higher driven by dry conditions in Australia,” Ingham’s said. To address energy costs, the company signed a three-year gas contract “to provide cost certainty” through to 2020-21, and 100 per cent of its electricity supply for 2018-19 and 20 per cent of the first half of 2019-20 were secured.

“Compared to last reporting season, weather was a bigger issue,” Mr Tevfik said, based on his data and analysis of company transcripts.

Pact Group, the packaging company, disclosed lower rigid packaging volumes because of a major dairy customer plant closure and drought conditions in the agricultural sector. Pact also reported a delay in recovering “significantly higher” raw material input costs as well as withstanding higher energy bills.

An arguably counter-consensus result is that interest expenses are trending more positive than negative, despite higher bond yields. This is because companies are enjoying improved credit ratings, tapping new debt markets, and more-expensive debt issued five to six years ago is rolling off.

Rising long-term yields have affected valuations of interest-rate-sensitive stocks.

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