In a challenging environment with cost pressures and anemic volumes, high-quality companies are defying expectations by maintaining or even boosting their margins.
This impressive feat, achieved through a mix of strategic price adjustments, cost reductions, and efficiency improvements, has led to earnings upgrades and painted a surprisingly rosy picture for reporting season so far.
Despite recent earnings challenges, Focus Portfolio holdings ResMed (RMD) and Amcor’s (AMC) demonstrated evidence of earnings turnarounds this reporting season.
ResMed (RMD) - Improving Gross Margins
ResMed reported better-than-expected margins, exceeding analyst expectations. The company reported that lower freight costs, price increases, and favorable foreign exchange rates provided a benefit to earnings.
Our investment thesis remains unchanged, with growing evidence suggesting GLP-1 drugs and CPAP machines complement each other in the medium term, discrediting the view that weight loss drugs will eliminate the need for CPAP. Philips' delayed US market re-entry due to recalls further strengthens RMD's position, supporting earnings growth.
RMD is still attractive on a 12-month fwd P/E of 22x with double-digit earnings growth expected over the medium term.
GLP-1s and CPAP – Breathing Easier
New data presented by RMD provides evidence that GLP-1 weight loss drugs are unlikely to erode demand for RMD's CPAP products - as some in the market have argued.
Key findings:
- Study of 529,000 patients shows CPAP usage remains strong even with GLP-1 use.
- Real-world data analysis in the sleep apnea (OSA) population shows a significant positive correlation between GLP-1s and CPAP therapy.
- Patients with an OSA diagnosis and prescribed a GLP-1 drug are 10% more likely to initiate CPAP therapy.
- Incomplete effectiveness of GLP-1 drugs for OSA supports the need for combined therapy with CPAP.
Implications for RMD:
- Reduced threat from GLP-1 competition, supporting future CPAP demand.
- Potential for collaboration with GLP-1 manufacturers to offer combined treatment solutions.
- Overall, this update provides positive news for RMD by indicating that GLP-1's drugs pose less of a threat to the company's core business and may even present new opportunities for collaboration and market expansion.
Amcor (AMC) – Packaged Up for 2H24
Amcor, despite experiencing weaker-than-anticipated volumes, managed to shore up its results through cost reductions, utilising effective internal efforts to optimise expenses. AMC achieved more than $200 million in cost savings in the first half, with a focus on productivity gains, discretionary spend reduction, and labour reductions. This maintained EBIT margins at a group level.
While the recovery in consumer volumes has been delayed, customer destocking is slowing and management guided to improvements in Q4
- AMC reaffirmed its full-year guidance of adjusted EPS of $0.67 to $0.71 per share. This guidance assumes mid-single-digit volume declines in Q3 and low-single-digit declines in Q4.
- January volumes showed improvements, suggesting Q2 was the low point for volume declines (although we are wary to extrapolate January for the next 5 months).
- The company is not assuming an improvement in consumer demand and will continue to take proactive actions to manage its cost base and pricing strategies. Earnings growth is expected to return in Q4, driven by cost savings, reduced headwinds from higher interest costs, and improved earnings leverage.
Margin Winners
REA Group (REA) – high teen revenue growth amidst benign listings driven by price/mix
REA Group, the dominant online real estate classifieds player, is the quintessential example of pricing power on the ASX. The company’s ability to use the pricing lever was on full display in its 1H24 result, which saw the business report +19% growth in residential buy revenues, despite only modest listings volumes growth of +4%. The balance of REA’s top line growth was driven by price increases (+13%), depth penetration (i.e. growth in higher priced premium products) (+2%), and geographical mix (+3%). Overall, strong pricing action saw the group report revenue growth of +18%, exceeding cost growth of +11%, driving positive operating jaws for the group and higher margins.
ISG View - REA too expensive
REA’s quality is undeniable, evidenced by recent price increases. However, its current valuation of 46x P/E with 13% projected earnings growth is not attractive compared to other high-quality businesses offering stronger growth potential.
JB Hi-Fi (JBH) - Managing the cost of doing business (CODB)
JBH Hi-Fi (JBH) is weathering the consumer storm with impressive cost control. Pressures on the cost front include rising wages and inflation-linked rent, but JBH's lean operations and strategic moves are optimising margins.
The key lies in JBH’s two-pronged approach: tightening belts internally and harnessing the efficiency of online sales.
JBH has instilled a "do more with less" mentality, maximizing productivity. Additionally, the power of an omnichannel model is evident. Consumers are increasingly researching online before visiting stores and shifting purchases online, as evidenced by the significant growth in online sales for JB Hi-Fi Australia (15.0% vs. 6.3% in 1H20) and The Good Guys (13.9% vs. 6.9% in 1H20), increasing sales efficiency vs traditional in-store sales.
These measures have paid off. While cost pressures are prevalent, JBH's cost of doing business (CODB) growth was below market expectations as a result.
However, challenges remain. The consumer is getting weaker, sales fell 2% pcp for the group, and discounting is rising. The trading update for January indicated a resilient JB Hi-FI customer in Australia, although NZ and The Good Guys looked soft.
Taking a step back, it is worth noting that NPAT fell 20% pcp, and the market reaction was due to a better than expected fall rather than strong profit growth.
ISG View - Quality but without the growth
JBH has shown it's quality in this result. Managing costs is a key factor of a successful retailer. While JBH is a quality retailer, we do not hold the stock due to the lack of growth over the next few years, and now elevated multiple.
Written by
Rob Crookston, Equity Strategist
Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.
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