Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 259

Profit downgrade? Blame it on the rain

During the late 1980’s, a German pop band named Milli Vanilli became an overnight sensation. Their success was driven by the release of the album Girl You Know It’s True, which included several top-five hits and resulted in them winning the 1990 Grammy Award for Best New Artist. One of the top songs was called Blame It On The Rain. The lyrics for the chorus are:

“Blame it on the rain that was falling, falling
Blame it on the stars that shine at night
Whatever you do
Don't put the blame on you
Blame it on the rain, yeah-yeah
You can blame it on the rain.”
Source: https://genius.com/Milli-vanilli-blame-it-on-the-rain-lyrics

Around the time they received the Grammy, a scandal broke out that Milli Vanilli had been lip-syncing in their performances and it was not their voices on the recorded album. They ended up having to hand back the Grammy award. The band lost all credibility and thereafter, we have found it hard to believe people who blame things on the weather.

Never thank the weather gods

Each year during April, several companies provide quarterly trading updates to the market. They are often provided in conjunction with the annual Macquarie Conference which occurs in late April/early May and provides an opportunity for investors to meet with management teams. One trend we noticed this year was the number of companies which downgraded their earnings due to the impacts of weather.

We understand that significant weather events can have an impact on the operations of a business, however, we are sceptical when management call out the weather as a core driver for operational underperformance.

Some companies which have downgraded due to unfavourable weather include Boral (ASX:BLD), JB Hi-Fi (ASX:JBH), Village Roadshow Limited (ASX:VRL), Experience Co Ltd (ASX:EXP), and Myer (ASX:MYR). Exogenous, uncontrollable shocks can directly affect the short-term earnings of some companies and hence there is a justification for this highlighting. However, we believe there is an asymmetry whereby companies will always call out uncontrollable headwinds but almost never call out when there are tailwinds to earnings outside of their control.

One such example was JB Hi-Fi. In a presentation to the Macquarie Conference, JB Hi-Fi downgraded its full year Group Net Profit After Tax (NPAT) guidance from $235-240 million to circa $230 million. The company commented that:

The Good Guys performance has been impacted by challenging conditions in the Home Appliance market, due to unfavourable weather conditions …

Put simply, the company sold less air conditioners than it had budgeted in the 2018 summer because it was not as hot as the 2017 summer.

So was 2018 too cool or 2017 too hot?

So, was it actually hotter in the 2017 summer? We looked at the average temperatures in January 2017 and January 2018. The only city where there was a material change in temperature was Sydney. In January 2018, the average daily maximum temperature fell from 29.9 to 28.5 degrees Celsius. That may not seem like much but it is enough to make a meteorologist blush.

January Average Temperatures for Sydney

Source: Bureau of Meteorology

Therefore, if The Good Guys is represented in New South Wales (which it is), there is some justification that a material part of its downgrade was due to the cooler weather in 2018 relative to 2017. However, what we find interesting about the above chart is that 2018 was just a regression to the average temperature. It seems that rather than 2018 being colder than average, 2017 was materially hotter than average.

So, did JB Hi-Fi highlight that 2017 profit benefitted from unusually hot weather in 2017? Alas, No. In fact, when asked on a conference call, the company played down the positive impact the weather had on their sales due to the fact that they are underrepresented in NSW:

“…the only note of caution in a sense of attributing too much to seasonal is we are underrepresented as the proportion of our portfolio in New South Wales … so we haven’t seen quite the same uplift that maybe Harvey’s had.”

So, on the one hand the company called out the cooler weather in 2018 as to the reason for the downgrade when it was actually a normal summer, but on the other hand played down the positive impact of what was an abnormally hot 2017 summer. They can’t have it both ways.

Companies and fund managers both do it

We don’t mean to pick on JB Hi-Fi. The downgrade was not even that big. It is just an example of something we are seeing more in company announcements. Companies are quick to blame uncontrollable headwinds for poor short-term earnings and play down uncontrollable tail winds which help performance. It could be weather, FX movement, irrational competition, or market dislocations.

Fund managers are no different. When our style is out of favour, we blame the market conditions, but when our style is in favour, we attribute all the alpha generation to our superior skills. What we are pointing out is just human nature, however it is an asymmetry across most companies we analyse in Australia.

The point of this is not to focus too much on whether or not a company makes its short-term earnings forecast. We believe that the market puts too much emphasis on next year’s earnings and not enough time on understanding longer-term value drivers of a business. More important to us is the implication this sort of behaviour may have on the internal culture of a company. Just like in funds management, we believe intellectual honesty is important.

It is hard as an outsider looking in to get a good feel for the culture of a company. We need to rely on signals. We like a culture where mistakes are owned by management and excuses are not made for poor performance. In that sort of culture, people don’t make the same mistake twice and problems are fixed. Companies and employees which make excuses for not meeting goals tend not to result in great cultures.

“Whatever you do, don’t put the blame on you.”

 

Anthony Aboud is Portfolio Manager at Perpetual Investments. This article was written for educational purposes and is not meant as a substitute for tailored financial advice.

Perpetual is a sponsor of Cuffelinks. For more articles and papers from Perpetual, please click here.

 

RELATED ARTICLES

Why August company reporting season was poor

banner

Most viewed in recent weeks

Unexpected results in our retirement income survey

Who knew? With some surprise results, the Government is on unexpected firm ground in asking people to draw on all their assets in retirement, although the comments show what feisty and informed readers we have.

Three all-time best tables for every adviser and investor

It's a remarkable statistic. In any year since 1875, if you had invested in the Australian stock index, turned away and come back eight years later, your average return would be 120% with no negative periods.

The looming excess of housing and why prices will fall

Never stand between Australian households and an uncapped government programme with $3 billion in ‘free money’ to build or renovate their homes. But excess supply is coming with an absence of net migration.

Five stocks that have worked well in our portfolios

Picking macro trends is difficult. What may seem logical and compelling one minute may completely change a few months later. There are better rewards from focussing on identifying the best companies at good prices.

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Six COVID opportunist stocks prospering in adversity

Some high-quality companies have emerged even stronger since the onset of COVID and are well placed for outperformance. We call these the ‘COVID Opportunists’ as they are now dominating their specific sectors.

Latest Updates

Retirement

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Interviews

Sean Fenton on marching to your own investment tune

Is it more difficult to find stocks to short in a rising market? What impact has central bank dominance had over stock selection? How do you combine income and growth in a portfolio? Where are the opportunities?

Compliance

D’oh! DDO rules turn some funds into a punching bag

The Design and Distribution Obligations (DDO) come into effect in two weeks. They will change the way banks promote products, force some small funds to close to new members and push issues into the listed space.

Shares

Dividends, disruption and star performers in FY21 wrap

Company results in FY21 were generally good with some standout results from those thriving in tough conditions. We highlight the companies that delivered some of the best results and our future  expectations.

Fixed interest

Coles no longer happy with the status quo

It used to be Down, Down for prices but the new status quo is Down Down for emissions. Until now, the realm of ESG has been mainly fund managers as 'responsible investors', but companies are now pushing credentials.

Investment strategies

Seven factors driving growth in Managed Accounts

As Managed Accounts surge through $100 billion for the first time, the line between retail, wholesale and institutional capabilities and portfolios continues to blur. Lower costs help with best interest duties.

Retirement

Reader Survey: home values in age pension asset test

Read our article on the family home in the age pension test, with the RBA Governor putting the onus on social security to address house prices and the OECD calling out wealthy pensioners. What is your view?

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.