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With reporting season over, what next?
The February earnings season produced some of the best results in nearly a decade. The tough operating environment brought on by the pandemic is largely over and we are now at the beginning of an earnings recovery. The number of coronavirus cases reported from US nursing homes has fallen by more than 80%.
The turnaround is an encouraging sign that the vaccines are working and a return to normality is in sight. The good news triggered investors, who originally helped push COVID “winners” such as tech stocks to record highs, to take aim at COVID “losers.” Investors rotated from growth to value shares after Pfizer said its COVID-19 vaccine was more than 90% effective.
COVID Losers become winners, rotation from growth to value & cyclical
A theme that started towards the end of reporting season, was the sale of COVID-19 winners, despite producing reasonable results, and the popularity of COVID-19 losers. To highlight the rotation, technology stocks such as Afterpay (ASX:APT) and Zip Co (ASX:Z1P) were sold-off in favour of travel and leisure stocks such as Flight Centre (ASX:FLT) and Webjet (ASX:WEB).
This thematic looks set to continue throughout the second half (to June), according to many analysts and market experts. The biggest earning upgrades in the half-year results came from media companies, banks and retailers, with airlines and airports enduring a painful year with shares trading at historic lows. Many are trading at big discounts to growth stocks.
According to a report released from Citi, US “growth” stocks now trade at an average price-to-earnings ratio of 38 times – compared with the 47 times peak at the height of the dotcom bubble in 2000 – while value stocks trade a PE ratio of 17 times.” With last week dubbed the turning point, it makes sense that the growth to value-and-cyclicals rotation trade will gather steam backed by a bumper earnings season, rising bond yields, and the likelihood that the pandemic will soon hopefully be a thing of the past. We think this thematic provides investors with the greatest opportunity.
Analysts have highlighted two sectors where investors may be able to gain the greatest recovery opportunities from current levels:
Banks are trading below pre-COVID levels with the S&P/ASX 200 Financials index (ASX: XFJ) trading at 6056 points versus its pre-COVID high of 6494 points on 23 March 2020. That’s roughly a 7% difference. The banks as a sector did remarkably well last month, producing solid rises in earnings and dividends. According to Morgans analysts, lower credit impairment charges for the major banks together with a rise in house prices and JobKeeper coming to an end on 28 March creates upside opportunity to dividends at the full-year results next quarter. Westpac (PE 13.94x, yield 5.1%), ANZ (PE 13.25x, yield 4.9%) and NAB (PE 14.88x, yield 4.6%) post accounts and declare dividends on March 31, CBA (PE 18.81x, Yield 3.9%) after June 30.
Travel – Sector gains in February confirm the rotation trade with Banks (5.6%), Diversified Financials (3.9%), Travel (13.7%), Consumer Services and Gaming (4.3%), Materials (7.3%) and Energy (2.4%). The second sector that is exposed to the rotation trade is travel. During the pandemic, travel companies shut up shop, unable to function without foot traffic. During this time, the proactive ones took the downturn as an opportunity to cut costs and streamline operations, for which, read “redundancies and mass staff stand-downs.” Extraordinary fiscal stimulus has created significant household income growth leaving plenty of dry powder as the economy switches back on. As conditions improve and restrictions ease, these companies could see a significant increase in earnings, according to researchers. Surprises here will be concentrated in stocks leveraged to the economic recovery. Morgans has listed the following stocks with significant leverage to a cyclical recovery: Webjet (ASX:WEB), Flight Centre (ASX:FLT), Boral (ASX:BLD), AP Eagers (ASX:APE), Corporate Travel (ASX:CTD), Southern Cross Media (ASX:SXL), Nine Entertainment Co (ASX:NEC), and Nanosonics (ASX:NAN).
A summary of the key ideas and values is as follows:
Growth (High PE) stocks at risk of sell-off during the rotation
Value (Low PE) cyclical stocks likely to be in favour during the rotation
Loss-making companies likely to be in earnings recovery this year
