Following on from last week’s article on the FY23 reporting season and the outlook for Australian REITs (which can be read here), in this Part 2 of the series we provide a brief overview of the different sectors FIIG’s Research team covered during FY23.
Background
As part of the FY23 reporting season, the FIIG Research team covered over 30 different credits and produced over 20 reports for clients, providing insight into the performance and outlook for each company.
Across this, we provide a brief overview of the Insurance, Airline, and Real Estate sectors, which is useful when considering portfolio allocations and performance going forward.
As a broader comment, while Australian companies had a strong 1H23, it’s a trend that doesn’t look to be sustainable with the second half 23 clearly a lot weaker. Figure 1 compares 1H23 NPAT against 2H22 NPAT, and 2H23 NPAT against 1H23, with a downward shift in profitability that is likely to continue into FY24.
Figure 1: A story of two halves – decline in NPAT in 2H23 vs. 1H23
While this typically doesn’t bode well for equity holders, it can be a different story for those with a bond portfolio, which generally sees less price volatility and coupons are unaffected, unlike dividend payments which can be at the mercy of being cut.
Insurance Sector
In all cases, the Insurance sector is showing fairly solid performance, mainly the result of cyclical (e.g. inflation) and somewhat structural elements (e.g. catastrophe events becoming more frequent) which has led to pass-throughs of costs to consumers. All of the insurers we cover (IAG, QBE, Suncorp) experienced very strong rebounds in profit and cash earnings in the recent reporting season. The below table in Figure 2 highlights these movements on a full-year basis.
Figure 2: Cash earnings and net profit after tax (AUDm) as of 30 June 2023
The cost of reinsurance programs has increased following a broader reassessment of risk throughout the industry. It is a similar thematic to the one described for hazard costs (regular disasters -> reinsurers face more claims -> more losses). Historically, reinsurers would underwrite the vast majority of business brought to them because the occurrence of large events was irregular, but today, are more conservative about the level of cover they provide. In some cases, they are now offering less coverage for events.
While some degree of mark-to-market losses continued in the period, it is important to remember that insurance groups continually make changes to their portfolios to suit the then-current economic cycle. Put simply, as new assets were added to investment portfolios, they earned higher incomes, which in total were greater than the losses experienced from existing asset price declines. A quick analysis of the asset allocation in each insurer’s investment portfolio shows that there appeared to be a concerted effort to lift the proportion of fixed income securities in the period to 31 December 2022, to take advantage of better spreads on offer.
Airline Sector
Airlines benefitted from the post-COVID-19 ‘revenge spending’ spree, (with Qantas Airways Group posting its strongest earnings on record at around AUD900m), although in this context the outlook for FY24 appears somewhat mixed with some evidence of the rebound in travel seen post-COVID-19 is running out of steam (and arguably has).
The sector has seen improvement in terms of capacity which no doubt played a role in the increase of passengers carried in FY23 (see Figure 1 for Jetstar and Qantas). Domestic has mostly recovered to pre-pandemic levels, while International is still catching up. However, supply is still heavily outweighed by demand, with reports the consumer intent to travel remains high.
Figure 3: Passengers carried per operating segment
Real Estate Sector
Given what has been taking place with global interest rates and building costs, it’s no surprise that the sector faced challenges across FY23. This resulted in some companies reporting non-cash revaluations taken across investment properties, equity-accounted investments, and financial assets.
The sector did benefit in terms of Development, with a pick-up in global commencements and completions as COVID-19 delays were unwound. The Construction segment has come through a difficult period with higher costs denting EBITDA margins.
In terms of Funds Under Management (FUM), the sector exposure is still dominated by ‘Workplace’- management's new euphemism for ‘Office’, given structural changes in the sector.
Conclusion
FIIG’s Research coverage of each reporting season provides an opportunity to review positions and ensure a portfolio has a healthy mix of sectors to better diversify and improve returns. Here we provided a brief overview of the Insurance, Airline, and Real Estate sectors.