InvestSense Update- What we are working on this week

Jonathan Ramsay- Director- InvestSense Pty Ltd

 

The team has now had a few weeks to digest the latest Australian reporting season and discuss with local fund managers. The key takeaway was that demand, and hence revenue growth, has been holding up reasonably well. However, earnings have been less resilient, especially in real, inflation-adjusted, terms.

 

Australian Reporting Season

The team has now had a few weeks to digest the latest Australian reporting season and discuss with local fund managers. The key takeaway was that demand, and hence revenue growth, has been holding up reasonably well. However, earnings have been less resilient, especially in real, inflation-adjusted, terms. Many companies cited increasing costs (particularly in wages) as a significant factor behind margin compression and reduced earnings.

In contrast, US companies reported slightly higher sales, with earnings exceeding expectations. The difference in performance can be attributed to the US companies’ proactive approach to reducing costs, particularly in wages. This cost-cutting strategy has allowed them to achieve positive earnings growth despite flat sales.

 

Sector Performance

The consumer discretionary sector experienced unexpected growth, suggesting that consumer spending may not be as severely impacted by economic downturns as previously thought. This unexpected growth can be attributed to companies within the sector showing signs of bottoming out after a prolonged period of weaker results.

In contrast, sectors such as healthcare and materials, which had previously held up well, experienced cost increases within their structures, impacting their overall performance.

 

Impact on Share Prices

Companies that had previously signalled cost increases to the market experienced a more favourable response when reporting weaker results. This signalling allowed investors to adjust their expectations accordingly, resulting in share price rallies for these companies. For instance, Wesfarmers revenue was up 20% (for reasons that are not expected to persist) and earnings were up by 5% (arguably negative in real terms). This result was in line with forecasts and “better than feared” and the stock jumped by 20% on the day.

Conversely, companies that did not communicate cost increases faced negative reactions from the market, leading to quite dramatic declines in share prices in some cases. Prominent examples included Ramsay and ResMed. The latter is now down almost 50% since reporting despite reporting 20% growth in earnings and guiding higher but also highlighting some cost pressures in the supply chain. Very negative sentiment is also related to the apparent threat of anti-obesity drugs but the timing of such precipitous falls around the earnings announcement is very interesting and is something we will be discussing further with a few fund managers.

Overall, there were many interesting insights about the evolving cost structure of the local and global economy. The former will give us something to chew on as we update the asset class Dashboard assumptions in a few weeks, while the latter may be providing an opportunity for level-headed fund managers in a skittish environment.

 

The AI Revolution: More Than Just A Tech Story

In a similar manner, we have attempted to quiz managers on where they might be seeing productivity gains seep into the real economy. We have a thesis that the stock market gains have been overly concentrated in a handful of obvious beneficiaries and in fact, intense competition in AI-related goods and services could result in the industry ‘eating itself,’ to some extent. Certainly, we feel that we are the beneficiary of that as increasingly powerful, yet scalable and inexpensive, services come online.

If our thesis proves correct, we suspect that a lot more must be happening below the surface within some industries and companies, but the nature of the ‘corporate veil’ and modern disclosure requirements means that fundies may not be the best source of information. We came across what we thought was a very good presentation on the subject last week from an independent research firm. We are going to reach out and see if we can share some recordings from the evening, but in the meantime, here is a summary (AI generated of course):

  • Significant productivity gains from applying AI and generative models across sectors like energy, manufacturing, pharmaceuticals, etc. Automation of repetitive tasks and optimization of processes expected.
  • Cost reduction from automating white-collar office work. Back-office functions in areas like accounting, HR, and legal expected to see headcount cuts of 10-30% over the next 3-5 years.
  • Boost margins with early adopters gaining windfall from AI productivity gains. Laggards will feel cost pressures.
  • Acceleration in software innovation as AI generates domain-specific bespoke solutions, ending the shortage of software engineers, and launching new software supply.
  • Job losses among lower and middle-skill workers as repetitive tasks are automated. Only creative elite workers are likely to be augmented and made more productive.
  • Quick adoption across legacy sectors like oil and gas, industrial manufacturing, and pharma. AI embedded in operational processes.
  • Surge in demand for robotics, particularly with easier programming and training of devices. Service sector automation of restaurants, healthcare, logistics, etc.
  • A significant boost to R&D productivity from AI assistance in fields like drug discovery, materials science, etc.

In summary, AI is expected to drive an acceleration in productivity, innovation, and margins but also disruption of labor markets over the next 5-10 years with widespread adoption beyond the tech sector coming soon.

 

 

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