Shane Oliver, Head of Investment Strategy & Chief Economist

The Australian share market and prots

EDITION 8 7 MARCH 2012

Olivers Insights
Key points
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This is the worst earnings results since February 2009, during the global nancial crisis (GFC). Reecting this, results were greeted cautiously with 52% of company share prices underperforming the market on the day results were released. While outlook statements have improved slightly from the last reporting season, the net balance of positive statements remains relatively low. Outlook statements have become slightly more favourable
80 60 40 20 0 -20 -40 -60 -80 Net balance of positive less negative outlook statements

The December half-year reporting season was lacklustre, with fairly at prots. Prot growth is likely to pick-up in the coming year but still lag consensus expectations for double digit growth. Australian shares are likely to rise over the year ahead as valuations are attractive and global shares are likely to rise, although we expect Australian shares to remain a relative underperformer for a while yet.

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(%)

Aug 08

Feb 09

Aug 09

Feb 10 Aug 10 Reporting season

Feb 11

Aug 11

Feb 12

Source: AMP Capital

Introduction
There were plenty of nerves around leading into February with announcements of December 2011 half-year reporting in Australia. Domestic demand has been weak, the strong Australian dollar (A$) is bearing down on trade-exposed sectors and resource sector prots were coming off a high base with commodity prices falling in the second half of 2011. The results were pretty much as expected, in a word: lacklustre.

Reporting season wrap up

In good news, most companies saw prot growth over the last year, with 68% of companies reporting a prot increase. Australian company prots relative to a year ago
100 90 80 70 60 50 40 30 20 10 0
Percentage of company profit results

Reecting the lacklustre reporting season, analyst revisions to earnings expectations have been generally negative. The next chart shows that the number of Australian companies seeing their earnings forecasts being revised down by analysts, has continued to outweigh the number of companies seeing upgrades. Additionally, the pace of downgrades has been far more intense than the last couple of years, which partly explains the relative underperformance of Australian shares. However, the good news is that the pace of downwards revisions is slowing, as is the case globally. In fact, based on weekly trends, we believe global earnings revisions are likely to turn into net upgrades soon. Downwards earnings revisions have been more intense in Australia, but have started to slow globally
80 60 40 20 0 -20 -40 -60 -80 Net, percentage consensus earnings revisions up versus down
Net positive revisions

World

(%)

(%)

79

89

67

73

50

42

59

70

67

67

68

up

Net negative revisions

Australia 02 03 04 05 06 07 08 09 10 11 12

21

11

33

27

50

58

41

30

33

33

32

down

00

01

Feb 07 Aug 07 Feb 08 Aug 08 Feb 09 Aug 09 Feb 10 Aug 10 Feb 11 Aug 11 Feb 12

Reporting season

Source: Thomson Financial, AMP Capital

Source: AMP Capital

Against this, only 31% of results announced beat expectations, down from the 37% of companies that beat expectations for the June 2011 half-year results and well below the norm of 45%. Australian prot results relative to market expectations
100 90 80 70 60 50 40 30 20 10 0
Percentage of results 64 58 49 49 47 44 38 27 27 44 49 38 37 37 31

The 2011/2012 nancial year consensus earnings expectations have been revised down to 3%, from 7% in late January 2012 and from 14% a year ago. The downgrades have been concentrated to resource, insurance, media and other nancials sectors.

Key themes
Above

(%)

11 25 Feb 05

18 24 Aug 05

27 24 Feb 06

39 12 Aug 06

36 17 Feb 07

39 17 Aug 07

29

43

37

38

29

39

31

36

46 In line

Several key themes have become apparent. Firstly, earnings growth was non-existent through 2011. Aggregate earnings have been effectively at or slightly lower compared to the December 2010 half-year results. Secondly, the weakness in earnings was broadly based across all major sectors with resource prots down slightly, non-bank industrials at and banks slightly up. A similar message is apparent from the Australian Bureau of Statistics with their measure of prots up just 2.7% compared to a year ago which were up 20%. Thirdly, the weakness in prots reects a combination of factors with the main ones being weak domestic demand, the strong A$ and commodity price softness during the second half of last year.

33 Feb 08

30 Aug 08

36 Feb 09

18 Aug 09

22 Feb 10

23 Aug 10

32 Feb 11

27 Aug 11

23 Below Feb 12

Reporting season

Source: AMP Capital

Non-bank industrials have been hit by a combination of weak domestic demand, sticky cost bases which partly reect the 2010 surge in workforces and the strong A$ bearing down on trade exposed sectors. Additionally, industrial sector prots have been doing it tough since before the GFC. Non-banks industrials earnings per share growth
30 25 20 15 10 5 0 -5 -10 -15 -20 -25 Financial years, percentage change
Consensus forecasts

domestic demand will remain constrained and the A$ will remain strong.

Where does this leave Australian shares?

A further downgrade in expected earnings growth is likely during the year ahead. The Australian share market is trading on a forward price to earnings (PE) ratio of 11.5 times. This is down substantially from 12.9 times a year ago. Even if the year ahead earnings expectations are downgraded by a further 5%, this would still leave room for circa 8% capital growth if the market were to rise to a forward PE ratio of 13 times. This level is below the markets 15 year average PE ratio of 14.5 times, but may be appropriate for the more volatile environment we are in. Another positive is that with corporate cash holdings at record levels and low gearing, there is plenty of scope for further increases in dividends, buybacks and other corporate activity going forward. Australian corporate sector gearing is benign and cash holdings are at record levels
180 140 (%) 100 60 20 88 Private non-financial corporate sector Debt relative to equity (LHS) Bank deposits relative to liabilities (RHS) 18 16 14 12 10 8 6 4 10

(%)

1988

1992

1996

2000

2004

2008

2012

Source: Deutsche Bank

Banks have seen prot growth slow to a crawl on the back of soft credit growth, pressure on bank margins from higher funding costs and disappointing trading income. Resources have seen prots stall, partly reecting the high base of 2010 but also a fall back in commodity prices during the second half of 2011 as well as increased costs associated with booming mining investments. Of course there have been some pockets of strength, such as within mining services companies, which have benetted from the surge in mining related investment as well as within health care stocks, among high quality franchises such as CSL, Cochlear and Resmed. The overall softness in prots is a conrmation of the broader weakness in much of the Australian economy.

90

92

94

96

98

00

02

04

06

08

Source: RBA, AMP Capital

Outlook
Consensus earnings expectations are for 12.6% earnings growth in 2012/2013 nancial year. Australian share market earnings per share growth
40 30 20 10 0 -10 -20 -30 Financial years, percentage change
Consensus forecasts

Notwithstanding the risk of a short-term correction, further gains in global shares on the back of attractive valuations, continuing global recovery, easy monetary conditions and decreasing risk of a European melt-down are likely to help pull up the local share market over the coming year. For the time being, the Australian share market is likely to remain a relative underperformer. Since late 2009, Australian shares have underperformed their global counterparts, thanks to a combination of tougher domestic monetary conditions which has constrained domestic demand and limited the ow of funds into shares. Additionally, the strong A$ and worries about a hard landing in China have adversely impacted markets. Fears of a Chinese hard landing are likely to recede further. However, there is unlikely to be much relief in terms of the strong A$ (barring another GFC-like event, which would obviously be bad news) and monetary conditions in Australia are unlikely to ease much, relative to the US and Europe. This suggests that Australian shares could rise further this year, but continue to lag global shares for a while yet. Dr Shane Oliver Head of Investment Strategy and Chief Economist AMP Capital Investors

(%)

1991

1995

1999

2003

2007

2011

Source: UBS

Prot growth is likely to pick up over the next nancial year. The resources sector, in particular, is likely to benet from an ongoing global recovery, modestly higher commodity prices and a rise in production. Industrials are likely to benet from corporate restructuring, further falls in interest rates and an eventual pickup in domestic demand, which should result in some margin expansion. Consensus expectations for margins are also more realistic than they were six to 12 months ago; however, prot growth is still unlikely to meet current consensus expectations for the 2012/2013 nancial year. We estimate an outcome of around 7% growth more likely, attributed to the likelihood that

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Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591) (AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investors objectives, nancial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investors objectives, nancial situation and needs. This document is solely for the use of the party to whom it is provided.

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