Companies struggle with profit downturn

With expected forward earnings for the market currently sitting below their post-Covid reopening peak, many companies will continue to struggle how to survive the profit downturn, according to the analysis from Martin Currie.

The most recent reporting season in Australia has revealed the critical signals and fundamental information with regards to how investors should reposition their portfolios and prepare themselves for the contractionary economic environment.

According to Reece Birtles, Martin Currie’s chief investment officer, the guidance for expected growth was now “more likely to be zero or negative”.

“Our analysis and one-on-one meetings with company management over August has highlighted the difficult situation for companies in surviving the profit downturn when more interest rate rises to curb inflation are factored in,” he said.

He added that the boom period for gross profit margins for companies, especially those consumer facing, was now over, with selling prices no longer offsetting falling volumes.

Also, many companies were starting to feel the pain of growing wages, accelerating rent rises as well as higher insurance, electricity costs or tech spend.

On top of that, weak China steel demand remained a growing concern.

“We have built a demand model for China steel based on real world monthly inputs, which has highlighted that China’s growth dominoes are collapsing,” Britle said.

“We are now seeing the key drivers of steel demand falling significantly since April due to ongoing weakness in property, infrastructure growth rolled over from April, machinery demand turned negative in July, autos slowing in July but consumer goods holding out.

“The message to us from this data is that current steel production looks too high and needs to fall ~10% to match demand. This of course has negative implications for Australian iron ore prices, which appear to be holding up on the hope of stimulus,” he noted.

Birtles said that overall the rising demand and share prices for growth stocks resulted in the recent poorer performance for traditional value-style stocks and indices since December 2022.

“With Growth stocks (led by tech) currently trading at extreme valuations, we believe that there is an advantage for Value-style stocks within this pricing disparity.

“For our portfolios, we have found real alternatives that offer superior valuation upside potential, more defensive revenues and cost inflation-protected characteristics.

“We are focussing on companies that can continue to raise prices ahead of inflation and control costs in this environment and not be exposed to valuation risk.”