Coca-Cola is offsetting low growth from traditional economies with profits in new markets. Photo / Supplied
Reporting season is the time of year when companies announce their profits, talk to analysts and give some comments on their own prospects as well as those of the broader economy.
It is always an interesting time in financial markets because, for all of the speculation that goes on, the reporting season gives some insights into how things really are at the coal-face and if the hard evidence matches our guesswork.
In New Zealand and Australia, most companies report their results every six months. Most of those announcements occur in February and again in August. In the United States, companies have to report every quarter, so it feels like the next reporting season starts almost as soon as the previous one has ended.
Reporting season in the US is just winding up as ours begins. Over the next few weeks, a raft of companies will provide updates on their operations, which will give insight into the strength of the economy, the risks and the mood of company management.
If there is any good news out there at the moment, it is that the corporate sector is still in excellent financial shape. Despite all the market turmoil we have seen originate in America, the US reporting season has been very solid.
Of the 500 companies in the S&P500, the broadest US market index, 425 have reported quarterly results during the past few weeks. Of those, 75 per cent have reported an increase in profits averaging 18 per cent. In addition, 76 per cent of companies have reported results above market expectations by an average of 5 per cent.
A string of strong results like this contradicts what we are reading in the news, with most discussion focusing on highly indebted governments and troubled economies. There are a few key reasons for the dichotomy between the real world (where companies continue to build things, sell services, employ staff, generate profits and pay dividends) and the financial world (where share prices, currencies and interest rates fluctuate wildly on a daily basis amid headlines about market turmoil).
The main reason is that about half of US company sales come from international operations. Companies have been focusing more in recent years on high-growth areas such as Asia, Latin America and other emerging markets. Traditional markets like the US, Europe and the UK (where all of the problems seem to be) are still important, but nowhere near as much as before.
Household names like Apple and Coca-Cola are offsetting low growth from these traditional economies with strong profits in new markets. Apple's international sales now account for 62 per cent of revenue. Coca-Cola's latest result shows worldwide volume growth of 6 per cent, with growth strongest in China (up 24 per cent) and Russia (up 17 per cent). The trend follows across the whole market. The weakening US dollar has further boosted the benefits from such a global spread.
Secondly, companies are extremely lean compared to a few years ago. After the financial crisis, costs were reduced, projects delayed and capital expenditure levels carefully looked at. Companies were forced to do more with less and have emerged much more efficient. The effect of cost-cutting has been very noticeable in bottom-line performance and, although this cannot go on forever, it does mean companies are better positioned.
The corporate world is in a much stronger financial position than it was going into the financial crisis in 2007. A balance sheet with a lot of debt quickly became a threat to survival and many companies raised new equity from shareholders to reduce their reliance on debt. A huge amount of new capital was raised over the period and many companies went from having high levels of borrowing to having very little debt. Many companies even have excess cash on their balance sheet.
Average debt levels for companies in the US are less than half what they were three years ago, with the ratio of net debt to earnings at only 2.6, compared with 5.1 in 2008. In Australia and New Zealand, a similar trend can be seen, with debt levels about half those seen a few years ago.
With a greater diversification of earnings across the world, more efficient cost structures and lower levels of borrowing, the corporate world (in contrast with some governments) is much more conservatively positioned than three years ago. Although this doesn't mean it is immune from the effects of an economic slowdown, it is on a much stronger footing than before.
In Australasia, the focus of the reporting season will be on the outlook commentary about the coming year. We expect a relatively solid set of results from our major companies but, given recent events, it will probably come with a cautious tone.
This part of the world is clearly a safer place to be economically than Spain or California, where unemployment is 21.3 per cent and 11.8 per cent respectively. We have a stable banking system, our key exports are in strong demand, we are close to the growth engines of the world in Asia and we have sensible political leadership.
In New Zealand, the economic momentum has been stronger than that of our neighbour and largest export market. Economic growth and inflation recently came in above expectations, enough for the Reserve Bank to signal a clear intention to increase the official cash rate by 0.5 per cent to 3 per cent at its next meeting. Australia was also expected to raise its benchmark interest rate from its current 4.75 per cent level.
Recent global events have completely turned around these expectations. The Reserve Bank will probably leave interest rates alone for now and our Australian counterparts may even go a step further and reduce theirs. At least they have that luxury, because the US central bank has run out of bullets with an interest rate that's been at zero since 2008.
However, high currencies remain problematic for both countries, despite some weakness over this past week, and I expect this will be reflected in some difficult commentaries from exporters. The Australian mining companies are large exporters and they will release strong results, because commodity prices have been high, but manufacturers will be suffering.
Another sector where negative sentiment is likely to prevail will be the retailers. Australian consumer confidence has been very weak and many local retailers have transtasman operations that will be affected.
While the local economy is holding up better, I expect that high levels of discounting, low consumer spending and a currency-driven shift towards online shopping have kept profit growth subdued.
While there will be a few surprises, good and bad, I expect some of the best performing companies are likely to be those with a high degree of earnings certainty. These include solid defensive companies such as Port of Tauranga, Sky TV and Auckland Airport. In Australia, the resources companies and the banks look well positioned, as do those with strong market positions and pricing power, such as food retailer Woolworths. Infrastructure and utilities companies such as MAP Airports, AGL Energy and APA Group are also likely to prove resilient.
Whatever the outcome, a series of company results and discussions with local management will provide an opportune reason to turn away from overseas political dysfunction and refocus on some feedback from the real economy.
* Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as personalised investment advice.
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