Money
Issue No. 30 - August/September 2006
SA Stocks in review
by Mr Marcus Campbell
With companies reporting their full year results, it's a critical time. A stock’s valuation is based on a set of expectations and the profit reporting season gives investors the means to assess whether these expectations are realistic.
Costs have been increasing on a number of fronts: energy, commodities, compliance, interest, and imported goods, care of a weaker A$ and potential price increases from Chinese suppliers. It is clear that cost pressures will continue to evolve and flow through into 2006/07.
In addition, labour market conditions are tightening. The unemployment rate is at an all-time low (4.9%).
The big question the reporting season needs to answer is whether the ASX200 companies can still deliver profit margin expansion in a macro environment that suggests it should be difficult.
The consensus view appears to be that they will, not only in 2006/07, but also in 07/08 and 08/09. The charts below show our estimates for net profit margins and return on equity (ROE) for the Industrials and Industrials (ex-financials, Telstra and News Corporation, Inc).
While the P/E multiple for the market may not look all that demanding (the ASX200 Industrials is trading on a FY07 multiple of 15.0x), the corporate performance underpinning the ‘E’ (as reflected by margins and ROE) is already at all-time highs.
So the industrial market is only ‘cheap’ if you believe margins and returns will continue to improve in the medium term. If margins/returns revert to mean, it would imply significant downside risk for ‘E’.
Certainly, we acknowledge that margins are benefiting from the structural evolution of the ASX200 and the steady disappearance of capital intensive/low return/volatile industries. But this transition is now well-advanced and we feel it will be a big ask for the industrial market as a whole to deliver a decade of improving returns against a cyclical outlook of rising costs and i...
