Further downgrades on earnings expectations are likely over the next year, Maple-Brown Abbott has warned, as the full impact of higher rates and the rising costs of living takes effect.
According to the firm, Australia appears to be lagging the rest of the world by six to 12 months, with certain segments of the market still in the early stages of the downgrade cycle.
“The Australian market is at an interesting juncture, with the shift to the new ‘post-pandemic’ normal well underway; however, the end point is still uncertain,” said Phillip Hudak, co-portfolio manager for Australian small companies at Maple-Brown Abbott.
“The opportunity for investors is to find those companies with structural growth stories and industry tailwinds that are well placed to withstand any future downturn, and we believe that active management will be key to this.”
Among the characteristics that Mr Hudak and fellow co-portfolio manager, Matt Griffin identified, is pricing power to offset cost inflation as the key for investing in the current environment.
“Companies that can maintain margins and profitably should continue to perform well for investors,” Mr Griffin predicted.
Maple-Brown Abbott highlighted the retail sector as a segment of the market that has held up well so far but where the effects of the higher cost of living have yet to flow through.
“The lead up to the Christmas shopping period will therefore be crucial for the retail sector. Inventory levels look elevated and continue to rise, as a result of concerns about supply chain risk, which has led a number of retailers to order well in advance to have stock on hand,” said Mr Griffin.
“However, purchasing decisions and forecasts may be based on last year’s Christmas sales which were very elevated. This means there is a big risk if demand slows, as those retailers with a high inventory level will need to discount heavily which will hit margins and profitability. We’re starting to see this in global markets already.”
In the retail sector, Maple-Brown Abbott stated that its attention will be on companies with good cash flow models, very light inventory models, and scalability.
Meanwhile, travel was highlighted by the firm as having significant tailwinds, with some companies emerging stronger than before the pandemic, and recovering at a faster rate than the broader sector.
“Overall, we see upside potential for those companies that have sustainable business models and strong medium-term earnings trajectories. This is particularly crucial in the small-cap end of the market, which has experienced a significant multiple de-rating so far this calendar year,” Mr Hudak suggested.
“The pullback — triggered by tightening financial conditions, elevated inflation and higher living costs — has been indiscriminate across many stocks which brings stock-picking to the fore.”
