ASX earnings season: Opportunities to be found in industrials

Despite some negative surprises among ASX industrials this earnings season, there are still opportunities for stock pickers. Pendal analyst ANTHONY MORAN explains his approach

• Industrials hit by changes in customer behaviour.
• Opportunities in sold off stocks, but watch margin pressures
• Find out about Pendal Focus Australian Share fund

THERE have been plenty of negative surprises among industrial stocks this ASX earnings season, showing how companies across the economy are changing their behaviour, says Pendal equities analyst Anthony Moran.

It’s an environment that provides opportunity for stock pickers – if you know what to look for.

“Several industrials companies have demonstrated weakness for the December six months and it’s been a surprise,” Moran says.

“There is more weakness than expected and that’s manifesting in corporate results.”

Moran nominates packaging group Amcor where volumes were down 10 per cent for the December quarter, year-on-year.

“That’s quite astounding for a company that sells packaging for centre-of-the-aisle groceries.

“It highlights that there is weak demand in certain sectors, and the de-stocking impact has exceeded expectations,” Anthony says. Pendal holds Amcor.

More broadly, it shows that companies across the economy are trying to manage higher interest costs by reducing working capital and maximising their cash balances, he says.

“Amcor saw it. Fletcher Building experienced it through the New Zealand construction cycle.

“Treasury Wine Estates saw it in their US wine business and in their Asian premium business. At Treasury there is more destocking then expected along with a weaker consumer.” Pendal holds Treasury Wines.

Where to look for opportunities

The macro shifts hitting individual companies throw up opportunities for investors, Moran argues.

“There are companies that have cyclical weakness, and their valuations can be attractive.

“You want to look for a company that has the ability to grow above its end market and has the potential to accelerate its share, even in a declining market.

James Hardie (held by Pendal) is an example, he says.

“It’s shown strong growth in the last 12 months even as the repair-and-remodel cycle has been down double digits in the US.

“You want companies that are able to do that,” he says.

Another example is Orora (also held by Pendal) which is a major packaging distributor which has spent time implementing a new operating model, that is now showing sustained market gains, Anthony says.

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Delivering good performance from a core business, even if the market is not growing, is attractive to investors, Anthony says.

“Aristocrat Leisure is doing that at the moment. The US casino market is stable, but Aristocrat is delivering good performance.” Pendal holds Aristocrat.

Look for companies emerging from down cycles

He says investors should consider looking for industries that are emerging from down cycles, particularly if they are worried about the economic outlook.

Another theme coming through earnings season, particularly across industrials, is margin disappointment, Anthony says.

“In Fletcher Building’s case, the sensitivity of the margins surprised but that’s what you get in big volume downturns.

“But for someone like Hardie, it did disappoint on its margin outlook, and that’s because some of the cost relief they got during Covid is starting to normalise up.

Transurban is another example where they recorded another year of cost growth above inflation and that’s crimping their margins.

“The headline is that costs are still an issue for a number of companies and for most industries pricing power is coming off. It means investors need to watch margins,” Anthony says.

“The next 12 to 24 months is going to be the great normalisation of the post-Covid super-cycle in margins, at least for the industrials sector.”

About Anthony Moran

Anthony Moran is an analyst with more than 15 years of experience covering a range of Australian and international sectors. His sector coverage has included Australian Industrials and Energy, Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure.

He has previously worked as an equity analyst for AllianceBernstein and Macquarie Group, spending a further two years as a management consultant at Port Jackson Partners and two years as an institutional research sales executive with Deutsche Bank.

Anthony is a CFA Charterholder and holds bachelor’s degrees in Commerce and Law from the University of Sydney.

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