COMMENT:

The results season has been all about anticipation, but how have companies performed relative to investor expectations?

Share price performances on results days give conclusive answers to this question because announcements are usually released before the market opens.

Companies have clearly met investor expectations if share prices rise and they have disappointed if share prices fall.

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The most obvious extremes are Fletcher Building and a2 Milk, which have had totally different sharemarket performances on recent reporting days.

Fletcher Building has had four out of five down-profit reporting days and a median return of minus 5.7 per cent immediately following these announcements.

Meanwhile, a2 Milk has had four out of five up-profit reporting days and a median return of plus 6.1 per cent (see table).

Although Fletcher Building has clearly underperformed compared to a2 Milk in recent years, it is still worth exploring why this underperformance has been so extreme on their respective profit reporting days.

Fletcher Building's problems began on February 22, 2017 when it released its interim result for the six months to December 2016. The company had a sharemarket value of $7.1 billion just prior to this announcement.

The announcement was upbeat, with the company reporting operating earnings before significant items of $310 million, a 12 per cent increase over the six months to December 2015.

However, towards the end of the announcement there was a short comment that construction earnings were down because of "losses incurred on a major construction project".

These losses were incurred in the group's Building+Interiors (B+I) construction division.

Investors were concerned with this B+I development and the company's share price fell 5.2 per cent on heavy volume. Nevertheless, Chairman Sir Ralph Norris and CEO Mark Adamson remained remarkably optimistic and predicted operating earnings before significant items of $720m to $760m for the full 2016/2017 financial year.

This focus on earnings before significant items can be misleading because it allows companies to downplay major losses that can have a material impact on share prices.

On August 16, 2017, Fletcher Building announced operating earnings before significant items of only $525m for the 2016/17 year.

This didn't include significant item losses of $252m, mainly in relation to the writedown of Australian assets.

Adamson had left at this stage and interim CEO Francisco Irazusta wrote that he was confident the B+I business "will improve with new leadership and governance now embedded".

A week later, Norris sent an upbeat letter to shareholders which revealed that the company would be seeking "to strengthen the construction experience on the board".

Norris was also reasonably positive at the October 2017 annual meeting where he predicted an operating profit before significant items of $680m-$720m for the June 2018 year, excluding anticipated B+I losses of $160m.

The interim result for the six months to December 2017 was a shocker with the company reporting an operating loss of $322m, which included B+I losses of $631m.

This compared with forecast B+I losses of only $160m just four months earlier.

The company's share price plunged 6.9 per cent on the day of this release, after falling 9.3 per cent seven days earlier.

New CEO Ross Taylor was quoted as saying "operating earnings have decreased due to lower profits in the construction division, outside of B+I, as well as the building products division".

This revelation was made in the middle of a countrywide residential, commercial and infrastructure building boom.

Fletcher Building's result for the 12 months to June 2018 was followed by another terrible day on the market with the group's share price falling a further 5.7 per cent.

The company reported operating earnings before significant items of only $50m, including B+I losses of $660m.

There was an additional significant item loss of $168m due to restructuring.

At the October 2018 annual meeting the company's guidance was for operating earnings before significant items of $630m to $680m for the June 2019 year.

Fletcher Building's share price was hammered again last month, this time by 5.7 per cent on its profit announcement day.

The company announced operating earnings before significant items of $285m for the six-month period but raised its full-year guidance from the $630m-$680m to $650m-$700m range.

This implied second-half earnings between $345m and $395m compared with just $285m in the first six months.

After 30 months of unfulfilled guidance, investors have little confidence in Fletcher Building's forecasting ability, particularly as the latest $650m-$700m range contains a positive item that might normally be excluded from operating earnings before significant items if it was a negative number.

Why is Fletcher Building so hopeless at managing expectations? Why does it promise so much but fails to deliver on a consistent basis?

Fletcher Building has been described as a whack-a-mole company, a complex organisation where problems continually pop up at random.

These whack-a-mole entities require directors with industry knowledge who can anticipate upcoming problems.

Fletcher Building's board has limited industry experience and the group has a weak investor relations department.

The latter should play an important role in managing investor expectations.

These inadequacies are clearly demonstrated by the group's dreadful share price performance on its profit reporting days.

Shareholders will continue to be frustrated until the problem areas are sold or its board of directors comprises individuals who can anticipate and solve the group's problem areas.

By contrast, a2 Milk has been superb at managing investor expectations.

Thirty months ago, the infant formula company had a sharemarket value of only $1.9b, compared with Fletcher Building's $7.1b, but the former now has a market value of $10.6b compared with the latter's $4.1b.

A2's sharemarket success is partly due to its ability to communicate with investors in a realistic and understated manner.

On February 17, 2017, the milk-based group announced net earnings after tax of $39.4m for the six months to December 2016, a 290 per cent increase over the first half of the 2015/16 year.

CEO Geoff Babidge gave his usual downbeat guidance with no specific figures.

He made the following comments: "The company is anticipating lower infant formula sales in the second half, relative to the first half" and "investment in marketing will likely be higher during the second half by up to $15m".

Six months later, a2 Milk announced a net profit after tax for the full 2016/17 year of $90.6m — a 198 per cent increase over the previous corresponding 12-month period.

The November 2017 annual meeting was told that the company achieved net earnings after tax of $52.3m for the four months to October 31 but the outlook statement contained no specific figures.

The next three profit announcements were as follows:

• Net profit after tax for the six months to December 2017 was $98.5m, a 150 per cent increase on the previous corresponding period
• The company reported net earnings of $195.7m for the 2017/18 year, 116 per cent ahead of the previous year
• Last month the company announced net earnings after tax of $152.7m for the six months to December 2018, up 55.1 per cent year on year.

A2's profit announcements have several consistent characteristics — they contain no adjusted or significant item figures, they under-promise on future earnings and they highlight cost increases as well as revenue growth potential.

Fletcher Building has a lot to learn from a2 Milk, particularly in terms of realistic profit guidance announcements and the management of investor expectations.

- Brian Gaynor is a director of Milford Asset Management which holds shares in a2 Milk and Fletcher Building on behalf of clients.