When things are bad, even average appears good

CHALKIE

OPINION: The "new" normal for company results means earnings growth of 6 per cent is now considered pretty good.

Darn, that goody two-shoes continuous disclosure regime makes for a boring reporting season.

With few surprises, the profit reporting season is more about the "second derivative" - the likely change in the rate of growth being experienced by companies that investors are able to divine through clever interpretation of the company's outlook statement.

As the result season unfolds, analysts have to revisit their profit guesses for the following year in light of the sober numbers for 2010 and those all-important outlook statements put in front of them.

It is a time when the analysts have to get real with their forecasts. Previously conceptual numbers, for two years out, roll into being the predictions for next year upon which investors are intently focusing.

And the outlook statements in the latest batch of results are still generally austere, which is what you would expect given what companies and the economy have gone through.

Consumers and corporates are knuckling down to rebuild their balance sheets amidst the great global deleveraging.

Analysts, like the rest of us, are getting slowly used to what some US commentators have dubbed "the new normal" of static consumer and corporate demand, little revenue growth and the hard yakka of continuous cost-cutting to drive profitability.

Steak is off the menu, it's bread and sausages for a number of years in the Chalkie household and likewise corporate New Zealand.

A recent paper entitled Equity analysts: still too bullish, written by US consultancy firm McKinsey and Co, suggested that analysts "were typically over optimistic, slow to revise their forecasts to reflect new economic conditions and prone to making increasingly inaccurate forecasts when economic growth declined". "Moreover, analysts had been persistently overoptimistic for the past 25 years, with estimates ranging from 10 to 12 per cent a year, compared with actual earnings growth of 6 per cent." I guess they could argue they were half right.

The McKinsey study concluded that analysts need a strong economy for their forecasts to be met and that as the year progresses, there is normally a continual revising down of numbers.

These days 6 per cent growth in earnings is considered pretty good by most corporates. Analysts are gradually weaning themselves off the habit of adding 10-15 per cent to last year's numbers, although you do typically see growth rates of this magnitude for earnings two years hence when the economy is supposedly going to be "back to normal" (that would be the old normal as opposed to the new normal).

Hence, reporting season is like the first stage of the "profit forecast wind-back process".

Chalkie was reading a broker wrap sheet for last week which suggested that results were pretty much as expected and that positive surprises roughly matched the negative.

However, the brokerage said it had reduced 16 companies' earnings forecasts for 2011 and increased only six.

The exchange's largest company, Fletcher Building, made its forecast profit numbers, but the three broker write-ups Chalkie read had varying degrees (2 per cent-6 per cent) of earnings downgrades for next year.

Given the conservative commentary by the company, Chalkie reckons there will be more downgrades as the year progresses unless we all decide to build that dream home by Christmas.

It was hard to get a read on the economy from the profit season. Barometer company Freightways improved its operating profit (ebit) by 6 per cent in the second half after having experienced a decline of 15 per cent in the first half.

But SkyCity saw its second half operating profit drop 4 per cent compared with 10 per cent growth in the first half.

For those companies relying on Australian consumers, the last six months have been difficult as they cycled a period last year that included a government giveaway.

In New Zealand, retailing has been flat, although during August Hallenstein Glassons preannounced its result for the year ending in August and remarkably upgraded forecasts by about 10 per cent.

The Freightways second half number was rightly lauded as commendable which illustrates that "good growth" has been redefined unless a company has something special going on.

Within the dull reporting season, here are some of the bright lights:

Skellerup

Skellerup reported a profit of $14.5 million before one-off costs, 8 per cent above the top end of the management's guidance as the company came home with a wet sail in the last quarter. Operating profit measured $17.5m in the second half versus $6.6m in the previous corresponding period and $7.4m in the first half. Although the profit announcement talked about a recovery in inventory building, there is a perceivable growth ethic which has been introduced at this company. For some time there has been much talk in financial markets about the contribution of director David Mair to the turnaround story at Skellerup. He has been on the board since 2006 and became acting chief executive in July this year. He previously ran Interlock group which makes aluminium hardware for doors and windows.

Mr Mair is thought to have been promoting a growth culture within the company that is now bearing fruit. The industrial division has new "technical polymer" products designed for varied market niches.

So many New Zealand corporates are forced to accept a no or slow-growth outlook because of limitations of the markets in which they sell, and it is refreshing to see a company institute a successful growth strategy. The share price rallied 10 per cent on the result.

Nuplex

Operating profit was about 10 per cent more than the market was expecting, but the underlying numbers were even better. Sometimes, companies include as normal operating costs restructuring charges and this was the case with Nuplex. Chalkie didn't see explicit mention of this in the profit release, but the broker presentation material posted on the NZX and the detailed accounts suggest something of the order of $7 million of unusual costs were absorbed.

When you take the unusual costs into account, the company smashed forecasts by over 15 per cent, all through second-half performance.

Not all brokers revised up their profits on the release, but the confidence of previously "conceptual" 2011 forecast profit improvement being achieved would have risen substantially.

Delegat's

Sometimes the best performances by companies do not necessarily result in profit improvement.

Delegat's reported a 17 per cent decline in profit for the year, about in line with its guidance given at the half-year.

Chalkie reckons this was a miracle performance, given that the New Zealand wine industry is currently being hit by a confluence of negative factors - a global wine lake, the bulk export of sauvignon blanc and the growth of private labels by supermarkets, the dire weakness in Britain (and the pound) which is our major export market, and generally price consumers trading down a la Chalkie's kitchen.

To limit profit decline to less than 20 per cent when a large number of wine companies are in the hands of their banks speaks volumes of the quality of the Oyster Bay brand and management.

The company is forecasting a profit increase next year and who would bet against them despite the backdrop. The share price gained three cents on the announcement, but Chalkie reckons the market is mean-spirited.

Chalkie is an anonymous columnist. The name is derived from the people who used to "chalk" up the share prices on trading floors before the market went electronic.

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