It could even be argued that the dividend tsunami we saw speaks more to companies shrinking than become sustainably stronger.
Special dividends and buybacks from Rio Tinto, Brambles and Wesfarmers flowed from asset sales, which of course cannot be repeated and will reduce income in the future.
Outside of the “less-worse” theme, investors should focus on three C-bombs as they reassess after reporting season.
C-bomb 1
The first is costs and, specifically, what is happening to margins.
Companies right across the economy are battling with rising raw material costs, rising energy costs, rising supply-chain costs and rising labour costs.
Coles and Woolworths led a string of retailers reporting higher costs across all these areas. Chicken giant Inghams contended with rising feed costs because of the drought. For Reliance Worldwide, it was higher copper costs, which fortunately are coming down.
It’s hard to see much relief on most of these costs, particularly labour, given a Labor government is likely to look to industrial relations changes that will empower workers.
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C-bomb 2
The other C crimping margins is competition, which appears to be rising across many sectors for a range of reasons.
Retail is belted by both online competition and, in the case of some sectors (such as supermarkets), new entrants.
This is being passed down the line – take the example of consumer products business Pental, which makes soap and distributes other products, and reported spending on price cuts and rebates to retailers soared 64 per cent during the period.
Companies in the construction and infrastructure sectors are suffering similarly.
Engineering appears so competitive right now that Lendlease wants out, and RCR Tomlinson has already exited the backdoor.
Waste management firm Bingo and Seven Group Holdings subsidiary Coates Hire both reported a sharp increase in competition. IOOF and other wealth providers suffered shrinking margins as they reacted to competitors that had dropped their prices.
The flip side to both these competition and costs is that companies that have pricing power and can maintain and increase their margins should be prized.
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CSL, Treasury Wine Estates, outdoor advertising group QMS and online classifieds firms Seek, Domain, REA Group and Carsales were all examples of businesses that pulled this up.
C-bomb 3
The final “C” to watch is capital expenditure, which was another feature of the reporting season. Here there seems to be two distinct groups.
The first is those companies investing to catch up.
Retailers such as Woolworths, Coles and even JB Hi-Fi are investing varying amounts as they work to keep pace with changing consumer trends – putting capital into technology, in supply chain, in service options and store refurbishments.
Banks and financial services companies who are pumping money into improved compliance systems are in catch-up mode too. This is money that should have been spent over the past decade – the fact it wasn’t is what partly led to the royal commission.
Then there are those businesses who are investing to make their businesses better over the long term.
BHP and Rio are spending about $US8 billion ($11.2 billion) a year each in growth. In fact, investors should probably be asking if this is enough.
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Afterpay is investing in its overseas ventures, as is A2 Milk. Both are looking to growing quickly, but are correctly sacrificing short-term profits for long-term sustainability.
BlueScope Steel is looking at a $1 billion upgrade to its North American steel plant. Giants such as CSL and Cochlear are pumping cash into research and development.
In all of these cases, it appears investors trust the companies to balance the short term with the long term. The competitive advantages they have built look especially attractive in an environment where margins are under so much pressure.
James Thomson
j.thomson@afr.com