Earnings outlook: A growing economy drives multi-year earnings rerates

Massive stimulus and monetary support since the pandemic has seen the Australian economy rebound from the two-quarter technical recession (with pandemic growth of -2.4% in 2020) towards a consensus growth outlook for 2021 of 4.5%, and an Ausbil forecast of 4.9%.
Company reporting in February 2021 confirmed the house view that earnings would rebound on the back of the extensive stimulus put in place in 2020, as illustrated in Chart 1.

Chart 1: The 2021 earnings outlook reversal

Source: Ausbil, FactSet

With vaccines and the easing of lockdowns, the path for a return to more normalised earnings was apparent, though at that time Ausbil was well ahead of consensus on FY21 earnings growth by some 5+%, a significant amount.

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We still think that the market is under-estimating the rebound in earnings that will occur in the prevailing economic conditions, with low rates, and world economic growth a strong tailwind. Key sectors where we see earnings surprise are banks and resources.

Banks, which offer exposure to a recovering economy, already battered by Hayne, were sold down on fears that the COVID recession would impact their lending books. Banks provisioned majorly for the potential for credit loss, and APRA curtailed their dividends.

It is now evident that the bad and doubtful debt experience was nowhere near predictions, and that the banks had over-provisioned for losses. With the resurging economy, an unwind of this over-provisioning is expected to drive a rerating of bank earnings.

Two fundamental themes in global resources investing are driving metals and mining. The first is the super-cycle demand for Australia’s bulk commodities including iron ore, from China, and a growing world economy, which is expected to drive earnings in companies like BHP, Rio Tinto and Fortescue Metals.

The second is the ‘boom’ in renewable energy and electric vehicles, driving secular demand for bulk, base and battery materials (copper, lithium, cobalt, zinc, manganese and rare earths). ‘Electrification’ is forecast to drive earnings for decades, benefitting companies like Galaxy, Orocobre and IGO (in lithium), OZ Minerals (in copper) and Lynas Rare Earths.

In the expansion phase of 2004-2007, consensus significantly and consistently undershot actual EPS growth. We are at the start of a similar expansion today. Since the GFC, aggregate earnings have moved sideways, driven by P/E expansion rather than earnings expansion. Ausbil’s outlook is for the return of strong multi-year earnings growth over the next 2-3 years.

History shows that while markets are volatile, comparing market and EPS levels over time shows that the market tends to rise when earnings are in a rising pattern, or conversely, the market is unlikely to fall significantly when it is in an earnings upgrade cycle.

Rather than worry about inflation, which we do not see as a sustained threat for some years, investors should instead be looking to capture this multi-year earnings growth while it is on offer, preferably in the best quality companies they can find.

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