As the 2015 financial year draws to a close, most businesses now have an accurate estimate of their operating results for FY15. In keeping with the ASX continuous disclosure rules, many companies will release market updates relating to any expected changes in trading conditions. During the past week several ASX200 businesses operating in various industries have issued profit downgrades in what could be a sign of things to come this reporting season.
17 June – Woolworths Limited (ASX: WOW) released a grim market update downgrading its full-year net profit after tax (NPAT) guidance and announcing the unexpected resignation of its Chief Executive Officer, Grant O'Brien. It was only late February 2015 when Woolworths said it expected to achieve NPAT growth at the lower end of analyst estimates, between 1.8% and 6.6%. Woolworths shares have fallen over 20% after delivering the lower-than-expected guidance in February.
22 June – SEEK Limited (ASX: SEK) shocked the market yesterday announcing that NPAT in H2 FY15 would be largely in line with H1 FY15. Like Woolworths, in February this year the Seek management team told investors to "expect underlying NPAT in H2 FY15 to be moderately greater than H1 FY15." The stock price plunged nearly 14% following the announcement.
23 June – Flight Centre Travel Group Ltd (ASX: FLT) shares nosedived 13% yesterday after warning that its underlying profit before tax (PBT) for FY15 would be between $355m and $365m. In December 2014 management released its first profit downgrade stating PBT for FY15 would be between $360m and $390m, opposed to initial guidance of $395m and $405m.
Profit downgrades are often accompanied with a sharp drop in the share price, as highlighted above. Smart investors can use these events to purchase shares at discount prices, however, further analysis of the business and industry must be completed before a purchase is made.
Are the issues temporary or structural?
Investors must determine what caused the poor business performance. Is the issue temporary and likely to reverse in the near future or is it a structural change that will permanently affect the business?
The answer will help you decide whether the reduced share price is truly a bargain or whether it reflects a business undergoing structural changes, where one period of poor performance can lead to many more in the future.
For example, Woolworths has suffered from a complacent management team that did not adequately respond to the competitive threat of rivals Coles, Aldi and Costco. Its sector-leading margins will be squeezed as the business significantly increases capital expenditure in an attempt to regain market share. This will likely reduce profits for years to come and is not a temporary issue.
The full extent of this change and its impact on the business is hard to predict and, whilst I wouldn't consider the Woolworths business to be in structural decline, investors should keep this in mind when analysing its future prospects.
In comparison Flight Centre has been affected by weaker than usual Australian trading conditions and is likely to be subject to a temporary reduction in profit. Any upturn in the Australian market will significantly improve the domestic business results. In the meantime its international operations are expanding which should act as a hedge against the current lull in the domestic market. I consider this a bargain investment following the share price drop.
The Australian economy has suffered some headwinds during the past year and as a result investors should expect more profit downgrades in the coming weeks. Whilst this may create some excellent opportunities investors must understand the cause of the poor performance and ensure they are still confident in the future prospects of the business.
Buying at opportune times such as these can greatly improve your long-term investment returns. Another opportune time to buy is during market a market crash:
The ASX's recent fall from nearly 6,000 has some experts predicting a market crash…
