Credit Suisse Asia Equity Focus Australian EPS momentum slows but valuation remains attractive

Australian reporting season is in line with expectations but outlook statements are cautious
The recently completed FY 2010 (ended June 2010) earnings season in Australia
has come in largely in line with expectations. Although there were some early
disappointments, the number of positive and negative surprises seems to be largely
balanced at the end of August. The outlook statements of companies are an area of
disappointment, however. These were either not forthcoming or often weaker than
expected. The notable exception is the resources sector, where both the actual
results and the outlook comments were positive across the sector. We believe that
roughly half of companies reporting met expectations. On balance, there appears to
be a fairly even spread between positive and negative surprises. IBES consensus
data suggest that growth for the 2010 year is close to the 10% estimated prior to
the reporting season. The weaker outlook statements have resulted in modest
downgrades to the 2011 EPS growth outlook – but not the savage downgrades that
some pessimists were predicting. Companies reporting weaker-than-expected
outlooks were located in diverse sectors, including areas such as healthcare, general
insurance, consumer and, to a lesser extent, banks (with the notable exception of ANZ, which outperformed its peers).

Offsetting the weaker outlook statements were many positive surprises in the area of
dividends. Market data suggests that positive dividend surprises outweighed the negatives by 2 to 1. We believe this reflects the solid balance sheets and strong
cash flows reported by most companies. While giving cautious outlooks or sometimes unable to give any guidance at all for the coming year due to the uncertainty, companies find themselves in a comfortable financial position at present.

Although the outlook for EPS growth for FY 2011 (ending June 2011) has been lowered following the reporting season, the consensus is still expecting strong growth. The market growth estimate prior to the reporting season was around 25%, according to IBES. This has now been lowered to around 20%, but it still represents strong growth. The key driver of the big growth estimate is the resources sector. Higher commodity price estimates and currently very high prices for iron ore and coal result in an estimated growth rate for this sector of 46%. The expectation for the industrials sector is for growth of around 8%, similar to 2010. Updates from banks suggest revenue growth is subdued and interest margins remain under pressure. Offsetting this is the continued drop in bad debt charges as the domestic economy continues its solid performance. EPS growth estimates for the banks in 2011 are for +13%, following +1% in 2010. This is one sector we believe could face further negative revisions. The ASX 200 has fallen by 9% YTD as investors have become nervous about a double-dip recession in the USA and slower growth in China. An increase in risk aversion has impacted the Australian index, as it is seen as a play on world growth and on China, in particular. This is despite the fact that the domestic economy has continued to perform well and that EPS growth has largely met expectations.

Despite the still uncertain outcome of the federal election, we believe the fundamentals for the Australian equity market remain positive. The Australian economy has continued its solid performance. We do not see a significant impact of the election outcome on the macro economic variables. We expect the Reserve Bank of Australia to remain on hold in the short term, but forecast a further 75 bp of rate increases on a one year view. We do no not expect a "double dip" and continue to believe the major economies are heading for a period of more moderate but still positive growth. We expect the strong Chinese growth to continue, which is also an important driver of the Australian economy and of commodity prices and the mining sector, in particular. The ASX 200 is trading below its longer-term average P/E and the outlook for EPS growth in FY 2011 (ending June 2011) remains positive.

In the short term the market is likely to remain volatile as investors focus on major global economic releases. The domestic political uncertainty could also overhang the market in the very short term. The risks of a downside surprise on the global economic front have certainly increased, but our central case remains that a "double-dip" recession is unlikely. On a 12 month view, we believe that growth momentum will continue, even if it is at a more modest rate. We see a positive medium-term outlook for commodities and are overweight mining and related cyclical stocks. The positive results announced by companies in the resources sector have added to our confidence regarding this call. Our TOP PICKS in the sector include Rio Tinto (RIO AU, BUY), Fortescue Metals (FMG AU, BUY) and Orica (ORI AU, BUY).