From Goldman:
Entering the peak month for profit warnings; Outside the reporting periods (Feb & Aug), May has typically represented the peak month of company earnings updates given firms have greater clarity around trading conditions into their year-end. Over the past decade, 12% of industrial firms have seen a >5% consensus EPS downgrade during May. Against this backdrop we screen for earnings risk candidates and highlight those areas of the market where we think risks are most elevated.
The most likely sources of consensus earnings downgrades:
1) FX is now a headwind: After 3-years of a falling A$ having been a tailwind to earnings growth, it has rallied against most major cross rates this half (with the exception of JPY -6%). 30% of industrial revenues are derived in foreign currencies, and given the geographic mix, we expect spot FX will be about a 1% headwind to ASX 200 Industrial revenues. Most impacted will be firms with UK exposures given the 9% rally in the AUD/GBP. Firms with >10% of revenue from UK: HGG 70%, BTT 70%, IRE 22%, LLC 19%, CPU 16%, CAB 10%, QBE 10% & RHC 10%.
2) Softer selling prices: Q1 headline inflation printed at -0.2%, the weakest level since the GFC. Of the components most relevant to equity investors, fuel prices (-10% qoq), clothing/footwear (-2.6%), telecommunications (-1.5%), recreation/tourism (-1%) and furniture (-1.2%) were the areas that delivered the most downside surprise. Given a downside inflation surprise of this magnitude, we would expect to see softer selling volumes across consumer-related sectors on top of weaker prices.
3) Impact of a slow-down in housing activity: Recent data on housing activity continues to suggest that the housing cycle is starting to fade, with building approvals printing the largest annual decline since July 2012 and housing credit growth also moderating. As macroprudential policies continue to take effect and the prospect of further mortgage rate hikes remains, we expect to see some further softening in sentiment in the sector. Recent data on house prices and auction clearance also point to a stabilization, especially in Sydney, where we remain wary of the effect of slowing foreign capital inflows. Stocks exposed to turnover of the housing stock should see more significant headwinds.
4) Slowing tourism: CY15 saw a 22% increase in the number of Chinese tourist arrivals to Australia (to just over 1Mn arrivals for the year, up 50% since 2011). With the Chinese economy seemingly finding a bottom, concerns over a depreciation of their currency fading, house prices rising and the impact of anti-corruption measures starting to fade, we believe there is increased risk that Chinese tourist numbers will start to slow. Given Chinese tourists spend 5x more on gambling per visit than the average tourist, we feel this impact would be most heavily felt across the domestic casinos. Qantas’s recent comments suggested demand for domestic flights had softened considerably in recent months, and we expect this will likely have flowed through to weaker activity across a number of tourism-related firms that are now cycling higher comps.
5) Where FY17 estimates imply too large a recovery: In aggregate, consensus expects just 0.3% EPS growth for the ASX Industrials (ex-financials) in FY16. With every sector of the market already expected to deliver a lower rate of growth in FY16 than it achieved in FY15, the magnitude of earnings downgrades to FY16 may be smaller than in previous years. That said, consensus expects EPS growth to accelerate to 8.5% in FY17, with 7 out of 10 sectors expected to show a very significant improvement in growth (Staples, Services, Media & Materials are all expected to see EPS growth rates sequentially improve by >5% from FY16 to FY17). While many sell-side analysts may wait until full year results to start to trim FY17 estimates, we expect any cautious outlook commentary from 3Q trading updates will get that process started.
Pretty much everything except resources!
