Alex David Walker

Written by David Walker
Senior Analyst, StocksInValue

Original article published by StocksInValue on 21 August 2015

As we edge towards the close of reporting season, some of the more interesting results can be grouped into four categories: larger stocks with slowing growth, smaller companies returning to favour or being turned around, way-overvalued stocks which shouldn’t keep rallying but do, and stocks the market seems not to understand. Some examples:
Larger stocks with slowing growth
Although Telstra’s 2015 numbers were all in line with or marginally better than market expectations, the shares sold off post-result because the outlook underwhelmed the market. Management forecast low single-digit earnings growth in 2016, which fell short of market expectations for mid-single digit growth. Telstra faces a degree of margin compression as the profitable, legacy fixed line business gradually declines with customers’ switch to mobile.
Also, competitors in mobile are getting their act together after leaving the best of the growth to Telstra for several years. Customer memories of the ‘Vodafail’ network problems of 2010 are fading and Optus has increased investment in its mobile network.
In most of Commonwealth Bank’s divisions there was a marked slowdown in the second half. The result was also of questionable quality and the $5 billion equity raising dilutes return on equity. Banks face a constrained earnings outlook in Australia’s slow-growth economy where the earnings tailwind from falling loan impairment expense is now over.
Arguably this is more than factored into the share price with the stock down ~25 per cent from its peak. In our model portfolio we have increased our CBA position.
Smaller companies returning to favour or being turned around
Our model portfolio made sizeable gains in SMS Management & Technology and Reject Shop after both 2015 results and management guidance statements exceeded market expectations. SMS’s result was a solid recovery from the earnings nadir of 2014. Recent acquisitions have exceeded expectations. SMS reported market share gains with a solid pipeline of tenders to come.
This strong performance reflects growth across the financial services, government, telco, media and technology sectors. More confidence in the market for recruitment and contracting is an underlying driver. Management initiatives on costs, project margins, managed services capability and billable utilisation have delivered.
Similarly, Reject Shop delivered 2015 sales, earnings and dividends above market expectations. Financial performance and management commentary was upbeat, with promising growth in same-store sales in the second half, fourth quarter and into July, solid operating cashflows, rationalisation of unprofitable stores and net cash on the balance sheet.
After a very long journey of underperformance from TRS it is rewarding to see hard evidence of the turnaround underway.
Way-overvalued stocks which shouldn’t keep rallying but do
The ongoing rally in Domino’s Pizza defies investment logic. Here we have a company which earned $64 million in 2015 with an equity market capitalisation of $3,474 million for a trailing price-earnings ratio of an amazing 54 times. This is reminiscent of US technology stock multiples in the tech mania of the early 2000s.
This reporting season has been a disappointing experience for shareholders of many companies which merely met market expectations, and a bitter one for owners of companies which disappointed. Watch out DMP shareholders if the company ever disappoints.
Stocks the market doesn’t seem to understand
Last week we increased our model portfolio’s weighting in SEEK. We are prepared to be patient and could have to be given recent earnings disappointments and downgraded guidance for 2016, but the market seems overly focused on these current disappointments and is missing the company’s likely growth in coming years.
SEEK International aims to replicate its domestic success in emerging markets with large populations and low internet penetration. As internet penetration increases, the migration of advertising from print to online should accelerate. Major acquisitions include country-leading online employment classifieds businesses Zhaopin (China), JobsDB and JobStreet (South East Asia), Catho and Manager Online (Brazil) and OCC Mexico. Seek now operates in 14 countries with an addressable population of nearly 3 billion and internet penetration below 40 per cent, around half the rate in Australia.
The early signs are positive. Seek’s international portals currently lead competitors on key online usage metrics and segment revenues and operating earnings have grown strongly. If Seek can establish network effects in these markets it could achieve its objective to become the global leader in online employment, and could become a much larger business. We think this will happen. Zhaopin has already achieved leadership across Chinese job seekers and hirers in FY15 but has penetrated only 17 per cent of the potential market.
We agree with founder and CEO Andrew Bassat’s public criticisms of the short-termism in the Australian equity market, which reflects the gloom and fear associated with the current market correction, the growing power of short-sellers and the lack of growth in the economy. The market is extrapolating current disappointments well into the future. We agree with Seek’s strategy to invest to build revenue streams on a five-year view. It would be disrupted and impaired if it didn’t, and would miss growth opportunities.
Disclosure: Clime Asset Management owns shares in TLS, CBA, CPU, SEK, SMX and TRS on behalf of various mandates where it acts as an investment manager.