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Australian equity strategy: The 4 key questions for the August-23 reporting season

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2023-07-17

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Investors in the Australian equity market are gearing up for the upcoming August-23 reporting season, focusing on four key questions that will shape their investment decisions. Amid concerns about a decelerating economy, a strained consumer, and the lagged effects of the Reserve Bank's hiking cycle, market attention will primarily revolve around gauging the extent of the challenges faced by companies. While the ASX offers promising opportunities, any optimistic stories are likely to be overshadowed in the coming month.

Is the consumer crunch now happening?
Recent surveys by UBS Evidence Lab indicate a significant shift in Australian households' intentions regarding discretionary spending. Over the past quarter, intentions have flipped from positive to negative, suggesting a slowdown in consumer spending. As a result, earnings results are expected to reflect this decline, with trading updates for the opening weeks of FY24 likely to appear bleak.

Are labour costs beginning to break out?
Data points indicate that wage restraint in Australia may be starting to weaken. Several labour cost surveys have shown a surge since the minimum wage decision in June, implying an annualised wage bill growth of around 10%. While the return of migration has provided some relief to companies facing labour shortages, the unemployment rate remains historically low. Consequently, corporate wage cost pressures are expected to continue.

Can profit margins be maintained?
An analysis of the relationship between output and input prices suggests that Australian companies have demonstrated the ability to maintain profit margins despite higher input costs. However, this resilience may not be sufficient to prevent further earnings downgrades. The anticipated decline in earnings is likely to be driven more by a slowdown in sales than a squeeze on profit margins.

Are interest expenses manageable?
While long-term bonds have remained relatively stable over the past year, short-term interest rates have risen noticeably. As a result, companies are expected to report higher interest expenses than anticipated. In an environment where revenue and margins are under pressure, the impact of these increased expenses on bottom-line earnings becomes more challenging to mitigate.

Recommendations: Owning sectors detached from recession risks
In light of the prevailing economic challenges, UBS recommends a less cyclical approach to equity investments. Their sector allocations focus on two key themes: exposure to non-cyclical growth channels unaffected by the consumer slowdown (overweight on Technology, Insurance & Healthcare) and exposure to income equities that offer high and stable dividends (overweight on Infrastructure, Utilities & Insurance).

As the August-23 reporting season approaches, investors will closely scrutinise the performance of Australian companies and assess their future prospects. With concerns about the consumer crunch, rising labour costs, maintaining profit margins, and managing interest expenses, investors will be keen to gauge the extent of these challenges and make informed investment decisions based on the outcomes of the reporting season.

Disclaimer: This report was prepared by UBS Securities Australia Ltd. Investors should consider this report as only one factor in making their investment decisions. UBS does business with companies covered in its research reports, which may present a conflict of interest affecting the objectivity of this report.

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