Rio leads way in dampening expectations

When Rio Tinto foreshadowed more cost-cutting this year it set the tempo for profit season as companies try to meet market expectations after a series of profit downgrades and poor return on invested capital in the past few profit seasons.

Cost-cutting and more conservative capital management bode well for a continuation of the sharemarket rally, which hit a 21-month high in midday trade.

The rally this morning was spurred by NAB’s latest business survey, which showed business confidence rose in December, and some panic buying of stocks head of the reporting season.

According to some pre-profit season reports released this morning, this season is important “in providing a reality check as to whether recent market optimism is suitably placed” and extent to which prices have run ahead of fundamentals.

It also appears that expectations are more realistic after a number of analysts – and companies – got egg on their faces last year for being too bullish about earnings forecasts. The upshot is that savage downgrades to earnings during the last reporting season resulted in a rush to take the knife to 2013 forecasts, with an expectation of flat earnings for the year.

Goldman Sachs’s latest report forecasts little positive earnings surprise through reporting season, with domestic economic momentum remaining poor. “If anything, we expect modest downside risk to earnings forecasts consistent with the trends seen through the October-November AGM season.”

Over the past year, Goldman Sachs has halved its earnings estimates for the ASX300 for 2013. But it sees earnings surprise versus consensus earnings from stocks including IAG, Suncorp, Transfield and Boart Longyear.

On the downside, it fingers Cochlear, Transpacific, Downer EDI, Sedgmen, UGL and FKP property group as the most likely to disappoint against consensus.

Since July 1, 2012, most have only upgraded earnings across four sectors diversified financials, telecommunications, general insurance and healthcare. The mining sector has suffered the biggest downgrades as commodity prices fell and costs exploded.

As miners started to mothball projects and take a hard line on costs, engineers, contractors and developers took a hit. Goldman Sachs estimates that the largest earnings per share downgrades across the industrials sector came from steel, transport, agriculture and chemicals and building materials.

In its report, Citi says: “If we’re right and the reporting season is reasonable, it should give further impetus to the market, though it has run hard lately, and partly on some encouraging signs about the results.

But we still expect the market to go higher through the year, with our ASX200 target of 5200 for end 2013, as moderate earnings growth returns in FY14.”

Citi identifies 10 stocks that it believes will surprise this reporting season. On the upside, they believe IAG, Myer, Santos and McMillan Shakespeare will do better than consensus. Those that face downside risk including Leighton Holdings, Cochlear, as it faces the roll-off of foreign exchange hedge gains, David Jones, Woodside Petroleum and Origin Energy.

The original release of this article first appeared on the website of Hangzhou Night Net.

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