insto - Australian financial markets

The debate on accounting treatment of financial instruments is still far from resolved, with international standard setters working furiously to develop a raft of new rules, writes Bernard Kellerman.

While Australian 2008-09 profits are down around 18 per cent, making it the biggest slump since 1990-91, it has not been the disaster that had been feared. In fact, the profit reporting season overall has been pretty positive. This is the view of Shane Oliver, Shane Oliver, head of investment strategy and chief economist AMP Capital Investors. The following notes are his observations.

Firstly, positive surprises have dominated making it the best season for results relative to expectations in two years. 44 per cent of results have come in better than expected compared to only 18 per cent below. This is a big improvement on the last two reporting seasons when there were more companies surprising on the downside than the upside. In fact, the net balance of positive less negative surprises of +26 per cent is the best it has been since the August reporting season two years ago, as the chart below shows:

Fig 1: Profit results relative to market expectations

Source: AMP Capital Investors

Secondly, company outlook statements have been far more positive than was the case in the last two reporting seasons. While companies remain somewhat cautious, positive outlook comments have dominated negative comments by a ratio of nearly four to one, whereas in the last two reporting seasons negative comments dominated.
Other key themes have been strong margins thanks to cost control and the economy holding up better than feared six months ago, dividends being cut but not by as much as expected and continued capital raisings in order to reduce gearing and (possibly) fund takeovers. By sector, the key areas of upside surprise were in energy, retailing and capital goods and the key areas of downside surprise were in real estate, transportation and telcos.

As a result of better than expected results and more favourable outlook statements, equity analysts’ earnings expectations for the 2009-10 financial year have been upgraded by around 3 per cent, signalling the likely start of an earnings upgrade cycle after two years of downgrades. The next chart shows that the number of companies seeing their earnings being revised up by analysts for the year ahead now outweighs the number of companies seeing downgrades. This follows two years of net downwards revisions. It’s the same picture globally after better than expected earnings reporting seasons in most countries.

Fig 2: Share analysts' revisions to earnings forecasts are now turning positive

Source: Thomson Financial, AMP Capital Investors

With companies having reduced costs and economic recovery pointing to stronger revenues going forward it’s likely that further upwards revisions to earnings expectations lie ahead. This is favourable for shares.

Are shares now expensive?
There are numerous ways to measure share market valuations. The simplest way to is to compare the level of share prices to earnings and a common approach along these lines is to use the consensus of equity analysts’ earnings expectations for the year ahead. This is usually called the forward price to earnings ratio as earnings are for one year forward. On this basis, global and Australian shares have risen from forward PEs of 8 or 9 times, which was historically low, to now around 15 times which is in line with long term averages.

Even after the rebound in the share market since March, profits would need to fall another 30 per cent to justify shares at current levels. With signs the economy is stabilising and the outlook for profits is improving this seems unlikely.

Finally, it should be noted that our analysis has made no allowance for the fact the earnings yield and dividend yield on shares is now running well above the yields available on cash and bonds, providing another indication that shares are not expensive.

The bottom line is that while the rally in shares means shares are no longer dirt cheap, they are not expensive either and most valuation measures suggest there is still more upside left.
 

Another round of potentially costly compliance regulations are being considered by accounting standards setters. Australian companies are at risk from a dramatic increase in costs and resources imposts under a proposed International Accounting Standards Board (IASB) standard that calls for companies to quantify and disclose their “aggressive tax positions”.

The truth-telling season is upon us, and companies that were getting in early with revised guidance announcements during the first full week of the new financial year include:

• Centrebet International said its full year result will be at the upper end of guidance given in April of $10 million to $11 million NPAT “on an adjusted basis” and between $7.5m and $8.5m on an actual basis (these terms were not defined in its ASX announcement).
• ABB Grain expects a slowdown in demand from Asian customers, and has lowered its full year NPAT guidance from a range of $53m to $63m down to $43m to $53m.
• Transpacific Industries Group, in the process of attracting a private equity fund as a cornerstone investor in a new capital raising, now expects its full year EBITDA to be 9 per cent less than last year, among a number of other adjustments (this is a result of imposed transparency following due diligence by the prospective major investor).

Fitch Ratings said that the Australian Energy Regulator's final price determination for the four New South Wales electricity distribution and transmission companies highlights the need for significant additional investment in the sector. In addition, the agency notes that the reduction in the allowed return (the weighted average cost of capital or WACC) of almost 1 percentage point from the draft determination may come as a shock to the companies. Independently, the AER's proposals for WACC parameters for the next electricity network reviews are due to be released on 1 May 2009.

Will fiddling with the US accounting standards actually make Wall Street's near-bankrupt banks get better overnight? Non-accountants seem to believe it, writes Bernard Kellerman.