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Hyperion

Reporting Season Insight: Focus remains on sustainable long-term earnings growth

24-Mar-2017

At Hyperion, our investment process centres on investing in companies that can generate sustainable earnings growth over the long-term. Reporting season not only provides an earnings data point that helps form part of a company’s long-term earnings journey, but also refocuses the market on the fundamental earnings power of listed businesses. Our focus on predictability of earnings growth typically results in us avoiding businesses that operate in cyclical industries. The reporting season in February provided a good reminder to investors that companies operating in cyclical industries will from time to time produce impressive results when prevailing market conditions, which they often have little control over, are supportive. However investors should be wary of extrapolating these conditions too far into the future and assuming these supportive conditions will persist. 
Calendar year 2016 saw a strong recovery in commodity prices, which has continued through the beginning of 2017.  This proved to be a boon for resources companies with many reporting strong revenue and earnings growth as commodity prices advanced. The ASX 300 Resources sector generated average sales growth of 8.8%, earning per-share (EPS) growth of a whopping 241% and dividend per-share (DPS) growth of 127% in HY17.  This compares to the ASX 300 Index, excluding the Resources component, that returned sales growth of -4.1%, EPS growth of 4.0% and DPS growth of 2.8%.  
There are several high quality resources companies listed on the ASX, that enjoy competitive advantages from economies of scale and high barriers to entry. One disadvantage that characterises resources companies however is that they typically lack pricing power. This means that the company usually does not have the ability to unilaterally raise the price of the commodity it sells – it must sell at the prevailing market price.
Accurately predicting the movement of commodity prices is difficult to do, and very difficult to do consistently, in our view. The task requires a balance of an almost infinite list of factors that influence supply and demand as well as general macroeconomic conditions that largely drive commodity prices. Over time, commodity prices will fluctuate, which results in volatile results for resources companies that are inherently difficult to predict over the long-term.  A look at the first-half results over recent times in the table below shows how volatile the results have been, compared to the overall market and the Hyperion Australian Growth Companies Fund.

Sales growth, EPS growth and DPS growth rates
HY13
HY14
HY15
HY16
HY17
Resources sector*
Sales growth
-6%
+14%
-10%
-15%
+9%
EPS growth
-33%
+41%
-30%
-70%
+241%
DPS growth
+1%
+25%
+2%
-59%
+127%
ASX300 ex Resources*
Sales growth
+0%
+4%
+4
-3%
-4%
EPS growth
+5%
+5%
+7%
-5%
+4%
DPS growth
+6%
+8%
+6%
+3%
+3%
Hyperion Portfolio
Sales growth
+9%
+16%
+19%
+15%
+7%
EPS growth
+4%
+12%
+17%
+18%
+9%
DPS growth
+9%
+15%
+15%
+16%
+14%
*Based on Macquarie data
Over the long-term, we believe that share prices will follow the earnings growth of the underlying business.  Although every enterprise is affected by prevailing economic conditions and sentiment to some extent, we prefer to focus our research on companies that generate earnings that we believe are more predictable over the long-term. This is often due to the business providing an attractive value proposition to its customers, and this value proposition is unique to the business because of some competitive advantage it enjoys. We also attempt to identify companies that have strong organic growth options who can grow irrespective of the state of the economy or commodity prices.
Overall, businesses that operate in cyclical industries will produce great results from time to time, and it is easy for investors to be attracted to such companies during these periods, especially when market pundits are predicting stronger commodity prices will persist. However at such times we believe it is important to focus on the long-term outlook for the earnings power of these businesses, and ask how predictable the earnings streams are likely to be. This investigation typically results in us dismissing a large proportion of the listed universe of businesses, including those in cyclical industries. This leaves us with a list of companies that are typically benefiting from structural growth and possess a sustainable competitive advantage. It is our view that this approach to investing is a more prudent way to preserve and grow investor capital over the long-term. 

The information in this document was prepared by Hyperion Asset Management Limited (‘Hyperion’), ABN 80 080 135 897 AFSL 238 380, for wholesale investors. The information is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. This document does not take account of any person’s objectives, financial situation or needs and before acting, an investor should consider the appropriateness of the investment having regard to their objectives, financial situation and needs. Any opinions or forecasts reflect the judgment and assumptions of Hyperion and its representatives on the basis of information at the date of publication and may later change without notice. This document is provided to the recipient only and must not be copied or passed on to any other person without the consent of Hyperion Asset Management Limited. Past performance is not an indicator or guarantee of future performance. Investment performance is presented gross of investment management fees and other expenses, including custody. Hyperion Asset Management Limited believes the information contained in this communication is reliable, however, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. To the extent permitted by law, Hyperion disclaims all liability to any person relying on the information in respect of any loss or damage (including consequential loss or damage) however caused, which may be suffered or arise directly or indirectly in respect of such information contained in this communication. Figures provided as at 31st May 2017. Morningstar Awards 2016 (c). Morningstar, Inc. All Rights Reserved. Awarded to Hyperion Asset Management for Fund Manager of the Year, Domestic Equities – Large Caps Category Winner and Domestic Equities – Small Caps Category Winner, Australia. 




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