- Australian corporates again shrugged another reporting test, navigating slowing demand and higher interest rates to post respectable half-year results in February.
- The market’s surge since late 2023, pushing prices to narrow discounts, appears a bigger hurdle to 2024 upside for the ASX20 leaders than earnings or economic fundamentals.
- We explore key themes including: 1) resurgent activity in mid/small caps including M&A; 2) politicisation of supermarket profits; 3) a resilient high-end consumer; and 4) better-than-feared A-REIT results.
- Our best ideas from reporting season include: RMD, NXT, TWE and QBE. Tactical small cap opportunities include: UNI, HLO, AVH, AHL, HCW and AIM.
Watch
February results snapshot and 2024 outlook
Overall, February results provided another important signpost that the health of Australian listed companies remains in good shape. Large-cap stocks missing expectations did remain slightly elevated, reflecting a softer economy. However, this trend, along with a pickup in dividend payout ratios, did improve on August lows, offering comfort that Australian corporates are in robust shape.
Earnings expectations for FY24 actually ratcheted 0.5% higher led by the Banks, Healthcare and Retail. This suggests ongoing conservatism in market forecasts, offering some margin of safety against surging valuations. While plenty of companies did miss expectations, price reactions across the market were positively skewed reflecting a sense that results were largely better-than-feared.
We’re not calling the start of another bull market but do see plenty of reasons to be optimistic in 2024. A likely reduction in interest rates, cooling inflation and plenty of dry powder should be broadly supportive for equities. While there will be some bumps along the way, barring an economic collapse, we think the next 12 months will be kind to investors.
However, discounts to consensus price targets among the market leaders have narrowed significantly. In fact Morgans analysts retain an Add on only four out of the ASX20 large-caps we cover (COL, CSL, S32, WDS). This narrows the path for returns in 2024. We think the best opportunities lie among smaller caps and those positively leveraged to declining interest rates and stickier inflation (A-REITs, small growth and cyclicals).
Solid earnings not enough to sustain large cap valuations
The market’s 12% rally from November to January provided resistance against rewarding larger companies at February results. The ASX 20 large-caps had a sluggish February, easing 0.4%, as heavyweights BHP, WDS, CSL, TLS and WOW fell between 5-9%.
Results were mostly inline but we think a tepid growth outlook (Banks), political risk (Supermarkets) and above-average valuations (ex-Resources) contributed to these stocks’ inability to find another gear
Small-cap resurgence takes shape
Small/mid-cap growth and cyclicals were the bigger story in February, providing a higher proportion of results beating expectations, with a higher-than-average number positively surprising on margins and revenue. Earnings forecasts also held up well in key cyclical segments.
Notably, cyclicals (Retailers, Industrials) represent a larger proportion of the small cap index than for large-caps. So, if the slowdown proves to be milder than anticipated and earnings hold, valuations provide plenty of support here.
We expect plenty of ongoing opportunities in small-caps as the segment continues to re-base. Fresh small-cap opportunities being called out by Morgans analysts include Helloworld, NextDC and Universal Stores.
M&A tailwinds in place
M&A activity has returned with some vigour with ABC, BLD, CSR, APM, AWC, AND, SLC, and AVG having received recent interest.
Activity looks set to accelerate on belief in a turn in the interest rate cycle combined with plentiful cashed-up buyers (particularly private equity and super funds) seeking acquisitive growth as an alternative to sluggish organic growth.
Morgans analysts nominate 24 companies with takeover appeal including Judo Bank, Dalrymple Bay Infrastructure, Tyro Payments, Pilbara Minerals and AI Media.
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