The December-half profit reporting season that ended yesterday has done what it was supposed to: confirm that Australian companies cleared the decks during the global financial crisis; they are much leaner than they were before the crisis hit; and they are ready to reap the rewards.
AMP Capital strategist Shane Oliver calculates that about 60 per cent of companies have posted profit gains in the six months to December compared with the same half in 2008, better than the 50 per cent ratio expected by analysts.
And close to half the earnings results were better than the analysts expected - pretty much on par with the historical average, but a big improvement on the December 2008 half, when only 27 per cent of the results surprised on the upside.
Cost cuts worked to keep profits growing in the December half even though sales growth was lacklustre, albeit improving: sales were down about 9 per cent overall in the December half compared with a year earlier, but up about 4 per cent compared with the June half, which was the bottom of the earnings cycle for Australian companies.
Net profits on the other hand were down, in line with the 9 per cent sales slide compared with the December 2008 half, but up about 12 per cent compared with the June half, outstripping the 4 per cent half-on-half sales rise. The December-half profit outperformance relative to sales is the dividend companies are taking from cost-cuts, and it is priming them for the second leg in their earnings recovery as their lower cost bases generate more profit per dollar of sales.
The expectation that growing demand will lead to growing revenue and not just a profit increase but an increase in core profitability underpins an improved outlook for the local sharemarket despite its recent gyrations.
Companies were not declaring that the boom times were back in their commentaries on the December-half results, and the chiefs of the banks and other financial institutions cautioned that the recovery was still fragile, and the markets still vulnerable to shocks.
But AMP's Oliver estimates that positive profit outlooks outweighed negative ones by six to one and, since the results season began, analysts have lifted their profit forecasts, by about 4 per cent for the current year to June. That pushes the forecast from a 2 per cent decline in earnings per share to a 2 per cent rise, and by about 2 percentage points for the year to June 2011, and pushes the earnings-per-share growth forecast for the year out from 22 per cent to 24 per cent.
Two things need to happen in coming months for these earnings forecasts to be vindicated: the economic recovery itself needs to continue; and companies need to demonstrate that the cost cuts they achieved during the crisis can be locked in to a significant degree.
The signs so far are that the economic recovery in Australia at least is on track. As Goldman Sachs JBWere equity strategist Chris Pidcock notes, recent domestic data on the economy has not raised any serious concerns. Interest rates have risen off their lows but are still low by historical standards, and the NAB quarterly survey in mid-February highlighted improving business confidence and conditions that suggest that business investment is poised to expand, replacing government spending as a more sustainable economic growth generator.
Pidcock says the markets will continue to react to news about the extent and speed of China's economic slowdown, the overall global economic outlook and the pace of interest rate increases in this market (After leaving its cash rate unchanged last month the Reserve Bank board meets again on Tuesday). But he says those external issues will also highlight the relative stability of Australia's outlook.
As for the cost cuts, not all of them will be retained. Employee numbers will rise again as the economy recovers, for example, and companies will take on new operating costs as they meet rising demand.
The expectation, however, is that a great proportion of the costs taken out by companies last year are gone for good; and Woolworths, which posted an 11.4 per cent higher $1.1 billion half-year profit yesterday is a template.
The retailer announced subdued sales growth of 4.2 per cent for the half on January 27 and in the following fortnight its shares fell by more than 14 per cent as investors braced for a weak earnings result. But yesterday's profit was strong, as usual, and Woolies' shares climbed by 6.5 per cent to $26.84, only 2 per cent under their level ahead of the January sales announcement.
The group's total cost of doing business edged up slightly, from 19.52 per cent of sales in the December 2008 half to 19.69 per cent, but that is still a world-class result. And chief executive Michael Luscombe said costs fell in the key supermarkets and liquor division, and at Big W.
Woolies was a big beneficiary of the Rudd government cash handouts that reached households towards the end of 2008. But even as that effect faded in the latest half, the supermarkets and liquor division lifted earnings before interest and tax (EBIT) by 11.4 per cent to $1.35 billion, and expanded its EBIT profit-to-sales margin from 6.04¢ in the dollar to 6.45¢.
The Big W discount chain squeezed a 6 per cent profit increase out of a 2.3 per cent sales rise, lifting its EBIT margin from 5.9¢ in the dollar to 6.1¢.
The only way Luscombe is likely to hand those gains back is in the form of lower prices, as he combats the rejuvenation of Coles under Wesfarmers' ownership.
mmaiden@theage.com.au
