Saturday, February 16 2013
Reporting season is under way and we thought we should send through some of our observations:
- Profits are finally starting to surprise on the upside. We are seeing a range of companies lift earnings including leaders such as the banks and Wesfarmers. This is providing a further kick along for these companies although in my mind it really just justifies the rally.
- The stocks performing best are those where Hedge Funds are short and the companies are showing signs that their earnings are bottoming out. This includes domestic cyclicals and some mining services. The trick for investors is to distinguish between those companies which have genuine operating upside as the cycle turns as opposed to a simple short covering rally. For example, we are reluctant to buy JB Hi Fi given they continue to face structural threats. Sales of CD’s, DVD’s and games are shrinking as consumers purchase on-line. The main categories which are growing (Ipads and other tablets) offer low margins.
- Resources leaders (BHP and RIO) are starting to run. Iron ore prices are trading at $155 a tonne which is well above consensus. With demand starting to return following Chinese New Year the market is beginning to have more confidence that higher prices can be maintained. Should the $155 be retained for the remainder of the year then RIO’s profits would be 39% higher than currently forecast (which is not meant to be a forecast but to highlight the leverage).
Some of those companies which have done well over the past six months are looking expensive (CBA, WES) but continue to have good support following strong results. We are more interested in those companies which can see improved earnings to drive stronger valuations. Stocklands is a good example. It is paying a 7% yield with leverage to improvement in the housing market which is showing some tentative signs of stabilising and improving (eg consumer sentiment is picking up, interest rates have improved affordability, rental income continues to increase and Conservative Governments in NSW and QLD in particular are more pro-development than previous regimes). Management provided some confidence that the dividend will be maintained so we are being paid to wait for a pick up in the cycle.
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