A mixed Q2 and Half Yearly earnings season but financial stresses lower than expected
With the earnings season largely behind us, macro factors and company execution against guidance has been at the forefront for investors. The lag effects of monetary tightening is still playing out while overall sentiment has improved since the 1H of the calendar year.
In the US, 79% of S&P 500 companies reported a positive EPS surprise and 64% of S&P 500 companies reported a positive revenue surprise according to Factset as of 1 September 2023. However, negative earnings guidance for the next quarter is above the 5-year average of 59% but below the 10- year average.
In Australia, we saw an overall mixed reporting season with balanced positive and negative surprises and companies managing with higher cost bases and positioning to a ‘higher for longer rate’ environment. The RBA meeting on September 5, which was Phillip Lowe’s last as governor, also saw rates remain unchanged at 4.1%. Rates are expected to hold steady for the rest of the year, providing breathing room for consumers and corporates. According to Stephen Bruce, Lead Portfolio Manager at Perennial Value,
“The Commonwealth Bank result showed that credit quality remained very good with negligible evidence of financial stress so far, despite the sharp increases in interest rates. House prices are rising again supporting the mortgage books and, should there be a downturn, business credit losses are more likely to end up in private credit funds (which write the loans banks don’t want to). Further, the banks are rock solid, with very strong levels of capital and liquidity and high levels of provisioning.”
IPOs are showing signs of life
The IPO market is showing signs of life with economic and geopolitical stability being important for the window to remain open. The new class of IPOs will need to be priced appropriately to see aftermarket support, particularly in the face of a macro environment where inflation, while trending in the right direction, has not been tamed and remains well above the long-term levels aspired to by the central banks. With no major shocks coming out of earnings season and lower market volatility, we can expect an uptick in IPO activity for the remainder of the year.
In the US, the upcoming IPOs of Arm (chip designer), Klaviyo (marketing automation) and Instacart (grocery delivery) will finally see venture backed companies return to the market. Notably, the latter two IPOs demonstrate solid topline growth coupled with profitability. Arm’s IPO which is expected to price on 13 September 2023 would be valued at US$55bn at the top end of the targeted range and is seeking to raise US$4.87bn. While this is expected to be lower than the expected US$60bn-US$80bn valuation target and $8bn-US$10bn raised, Arm will be one of the world’s largest IPOs and the largest since Rivian’s US$13.7bn IPO in October 2021. Arm has a flat revenue growth profile but highly cash generative and its technology is ubiquitous in smartphones. The business is looking to expand into advanced computing for data centres and AI applications.
In Australia, the more recent non-resources IPOs have fared comparatively well relative to the (scant) classes of 2021 and 2022 IPOs. Of note are: Redox (chemicals and ingredients distributor) which is trading just above IPO price, Abacas Storage King’s (self storage) demerger which is down c.10% and CurveBeam AI (orthopaedic imaging and AI software) while being unprofitable has found support and trades just a tad below IPO price at the time of writing.
Private markets recent trends
Funding is still tight with investors being more discerning
Investors are taking time to complete due diligence and we have also seen a few startups meet their demise. More startup deaths may still be on the cards where companies cannot find the path to profitability or have unit economics which do not stack up resulting in the lack of internal or external investor support. Cash management still remains key such that private companies cannot leave a funding round too late or seek debt funding with a weak balance sheet. The market has become bifurcated with some companies able to continue to raise at up rounds while some companies struggling to raise with long capital raise processes.
Activity in August has picked up
We are now seeing a healthy uptick of activity through August with companies seeking to raise capital and more investors getting to know companies well ahead of a capital raise. There was a lull in July owing to the holiday period and a reticence of companies looking to test the market knowing investors’ attention lied elsewhere.
Australian unicorns see support for flat to higher valuations
Recent notable raises include: Canva which completed a secondary at a flat round to the current valuations held by Australia’s major venture funds and both SafetyCulture and Pet Circle completed an up rounds. In addition, Go1 completed an up round alongside an acquisition. Globally, there are >1,200 unicorns as of July 2023 according to CB Insights and many are looking at the IPO markets with interest. M&A has not been a good route for these larger companies as according to Pitchbook, there were only five acquisitions of unicorns in 2022, compared with 24 in 2021 and 17 in 2020. Should the IPO window open more comprehensively, this should help to unblock later stage funding and more unicorns and non-unicorns could come to the listed market.
Liquidity is becoming king
Australian ventures funds are publicly speaking to DVPI (distributed value to paid in capital) which is demonstrative of a higher focus on returning capital to investors versus showing paper gains. Accordingly, we would expect to see more secondary activity as private funds look at creative ways to return capital to investors/LPs outside of traditional IPO and M&A exits.
(Cautious) optimism returning
Investor sentiment has picked up with more groups actively looking at deals and generally a more glass ‘half full’ view of the world. This sentiment is also shared by founders, especially with the decline in broader volatility in the public markets.
Outlook buoyed by more positive sentiment
Managing investor expectations remains vital for both public and private markets. We have seen this in the earnings season with listed prices adjusting to how companies have reported relative to expectations. The same can be said for private companies in that companies which continue to demonstrate robust growth, pathways to profitability are still viewed attractively by investors. Companies that remain in burn mode either need to ensure they have a long runway to execute on growth or profitability plans or demonstrate the burn is there to fuel the growth engine. Absent macro shocks, a less volatile environment has seen more positive sentiment return which is positive for companies raising capital and potentially with more companies testing the IPO markets expected through 2024.
Disclaimer: Please note that these are the views of the writer and not necessarily the views of Perennial. This article does not take into account your investment objectives, particular needs or financial situation. Some small changes were made to this article, based on updated information.