Macro and Australian equity strategist, Macro Strategy Advisors

Shane Lee

Macro and Australian equity strategist

Macro Strategy Advisors

Thematic (Sector/Industry)

Australia Industrials / Thematic (Sector/Industry)

<ul><li>Pushing up the payout ratio in a falling interest rate environment has been rewarding in the past 6 years. However, this reporting season revealed a list of stocks that couldn’t squeeze more juice out of the lemon.  VOC, CWN, ORG, TLS, TRS, SGR, BBN, and HVN all succumbed to the pressure of raising payout ratios and disappointed dropping dividends.  However, the most alarming concern was that after resetting payout ratios lower in FY17 many of these same stocks guided to a rebound in FY18.  We are not convinced.</li><li> The outlook for Capex has improved, but at this stage, it is narrowly based and confined mainly to the Resources, Utilities and Infrastructure sectors. The contractors (CIM, DOW, MND and WOR) guided to an improving outlook.  It wasn’t then surprising that the materials stocks (BLD, CSR) also guided to a solid outlook suggesting housing activity will remain elevated for some time yet.  We agree with this assessment.</li></ul><ul><li>Operating cash flows have deteriorated, with the cash conversion ratio of the market excluding banks, resources, and property falling below 100%. Cash flows are under pressure and this was evident across a multitude of stocks (CWN, LLC, ORI, IPL).  However, analysts expect this was a one-off and expect cash conversion ratio to bounce back in FY18 for every ASX100 (ex-resources and Property) stock that suffered a decline in FY17 with the exception of TWE, ALL, ORA, and ABC. This seems optimistic.</li></ul><ul><li>Resource upgrade cycle continues on the back of a combination of improving operating efficiencies and higher commodity prices. Cash is 10% of resource sector assets vs 5% for Industrials and Net Debt: Equity has fallen to 27% vs 48% for Industrials.  Energy stocks are beginning to deliver on efficiencies.  They are also repaying debt and getting positive operating leverage.  Stocks that were upgraded in the sector include STO, OSH, ORG, WPL, BPT.</li></ul><ul><li>The patchy consumer continues to trade down. LOV and SUL outperformed both bricks and mortar stocks (JBH, HVN, MYR) and specialty retailers such as GXL, BBN, and NCK. </li></ul><ul><li>Rising energy costs are cutting into manufacturers margins driving as a raft of downgrades (led by BSL). The developers remain optimistic, with SGP, MGR, LLC all guiding for a strong outlook.  We expect housing activity to remain solid until the RBA begins to nudge rates higher, possibly around the middle of next year. </li></ul>

Pushing up the payout ratio in a falling interest rate environment has been rewarding in the past 6 years. However, this reporting season revealed a list of stocks that couldn’t squeeze more juice out of the lemon.  VOC, CWN, ORG, TLS, TRS, SGR, BBN, and HVN all succumbed to the pressure of raising payout ratios and disappointed dropping dividends.  However, the most alarming concern was that after resetting payout ratios lower in FY17 many of these same stocks guided to a rebound in FY18.  We are not convinced. The outlook for Capex has improved, but at this stage, it is narrowly based and confined mainly to the Resources, Utilities and Infrastructure sectors. The contractors (CIM, DOW, MND and WOR) guided to an improving outlook.  It wasn’t then surprising that the materials stocks (BLD, CSR) also guided to a solid outlook suggesting housing activity will remain elevated for some time yet.  We agree with this assessment.Operating cash flows have deteriorated, with the cash conversion ratio of the market excluding banks, resources, and property falling below 100%. Cash flows are under pressure and this was evident across a multitude of stocks (CWN, LLC, ORI, IPL).  However, analysts expect this was a one-off and expect cash conversion ratio to bounce back in FY18 for every ASX100 (ex-resources and Property) stock that suffered a decline in FY17 with the exception of TWE, ALL, ORA, and ABC. This seems optimistic.Resource upgrade cycle continues on the back of a combination of improving operating efficiencies and higher commodity prices. Cash is 10% of resource sector assets vs 5% for Industrials and Net Debt: Equity has fallen to 27% vs 48% for Industrials.  Energy stocks are beginning to deliver on efficiencies.  They are also repaying debt and getting positive operating leverage.  Stocks that were upgraded in the sector include STO, OSH, ORG, WPL, BPT.The patchy consumer continues to trade down. LOV and SUL outperformed both bricks and mortar stocks (JBH, HVN, MYR) and specialty retailers such as GXL, BBN, and NCK. Rising energy costs are cutting into manufacturers margins driving as a raft of downgrades (led by BSL). The developers remain optimistic, with SGP, MGR, LLC all guiding for a strong outlook.  We expect housing activity to remain solid until the RBA begins to nudge rates higher, possibly around the middle of next year. 

Australian FY17 Reporting Season: When Reality Bites