Out in front and getting better

By ROB MERCER*

New Zealand equities have continued to outperform global equity markets, and the financial reporting results over the past six months have justified this outperformance.

Forsyth Barr Research believes the New Zealand equity market will continue to perform well over the next year.

For the six months to June 30, the NZSE-40 gross index increased by 3.5 per cent and has substantially outperformed all of the leading global equity markets.

So what has been driving this performance?



* Growth in earnings has been very strong.



* An appreciating currency has increased international confidence in the region.

* New Zealand has an excellent economic outlook. GDP is forecast to grow by around 3 per cent a year over the next two years and the inflation risk remains relatively low.

The problems with Enron, WorldCom and Xerox have highlighted the risks which continue to affect international equity markets.

Despite the expected economic global recovery, investor confidence is low and we do not see this changing soon.

While the New Zealand equity market will continue to be affected by any short-term negative sentiment from overseas markets, we believe it remains well placed to weather the short-term volatility. Key factors which remain positive for the New Zealand equity market are:

* Solid New Zealand economic outlook and low inflation.

* Strong profit outlook with earnings per share expected to increase 10 per cent a year over the next two years.

* High gross dividend yield of 5.7 per cent and 6.4 per cent forecast for this year and next respectively.

* A strong New Zealand dollar, which has improved international investor confidence in the region and should encourage investment in New Zealand.

* A stable political environment.

Over the first six months of this year, the equity market's performance was driven by a strong reporting season for company profits. In the first half, Forsyth Barr published reviews on 52 company results, a summary of the key attributes from the results were:

The median normalised earnings (reported earnings adjusted for abnormal items, tax and goodwill amortisation) increased by 16.8 per cent on the previous corresponding period.

Profit results were generally better than expected - 27 companies reported results better than Forsyth Barr's expectation and 17 companies reported results worse than expected.



Retailers and ports continue to perform better than expected, and this has contributed to their strong share price performance.

The key drivers behind the retail sector are the consistent high return on equity, buoyant trading conditions this year and the attractive growth opportunities being pursued by strong management teams.

Ports were driven by a very strong reporting season, which led to substantial earnings upgrades for all of the listed ports.

Of the 13 companies whose earnings shrank, eight were worse than expected, leading to earnings downgrades. The results confirmed the positive earnings momentum driving the New Zealand equity market.

We believe this will continue throughout the year and lead to a further positive re-rating in the share market. Forsyth Barr Research is forecasting the NZSE-40 gross index to increase by around 10 per cent over the next six months.



A stronger New Zealand currency also influenced returns over the period. Companies affected included agricultural stocks (Affco down 35 per cent, Sanford down 15 per cent, Pyne Gould Guinness down 12 per cent, Wrightson down 8 per cent) and NZ Refining, which was down 8 per cent.

The stronger dollar was one factor driving the 10 per cent increase in the Sky Network TV share price in the first half.



Several companies have enjoyed a share price recovery despite disappointing earnings. They include Air New Zealand (up 83 per cent), BIL International (up 113 per cent), Trans Tasman Properties (up 30 per cent) and Carter Holt Harvey (up 18 per cent).

Even though the earnings outlook for these companies has improved, we are not expecting their level of performance to continue.

Fisher & Paykel Healthcare and Baycorp Advantage, two of the darlings from last year, have performed very poorly this year.

We believe both have been substantially oversold and are excellent value at current prices.

Fisher & Paykel Healthcare ($8.25, down 50 per cent) had a disappointing December quarter result but earnings recovered in the March quarter. We believe its earnings outlook remains very exciting. Its growth is forecast to grow by more than 10 per cent a year over the next decade.

Baycorp Advantage ($4.20, down 45 per cent), formed through the merger of Baycorp and Data Advantage, has an exciting growth opportunity in Australasia and Asia and is poised for substantial earnings growth.

Although we remain with a positive outlook for the New Zealand equity market over the next 12 months, success in the market for investors is often stock specific rather than from a broad market focus.

Stocks that Forsyth Barr Research has a positive share price outlook for over the next year include Sky City, Waste Management, Baycorp Advantage, Auckland International Airport, F &P Appliances and F&P Healthcare.

* Rob Mercer is head of research at Forsyth Barr.