Amid a pandemic ripping through equity markets, there are a set of stocks which quickly developed herd immunity and eliminated the virus from their growth trajectory to become the top-performing ASX 200 companies.
These five superstars, with an average market cap of $9 billion, emerged from March with a scorching vengeance to round-off financial year 2020 with a total return of 125% on an equally-weighted basis. Meanwhile, the S&P/ASX 200 lost 7.68% over that same period.
But has this WAAAX-filled, biotech-laden and gold-plated monster of a group gone too far, considering their PE ratios range from -454x to +72x this year’s earnings?
Notes:Watch, read or listen to the discussion below. This episode was filmed on 1 5 July 2020. Scroll down below for the performance table.
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James Marlay: Welcome to Buy, Hold, Sell, brought to you by Livewire Markets. My name’s James Marlay, and today we’re going to have a chat about the five best performing stocks from FY20. A couple of stats for you on these ones. Average market cap, $9 billion, 125% return in FY20 and a lazy P/E of -450 to +72, so a big range in what we’re looking at. Joining me to discuss these five top performers I’ve got Eleanor Swanson from Firetrail and Jun Bei Liu from Tribeca. Jun Bei, your first one, first cab off the rank, the hottest stock on the market at the moment, Afterpay defying gravity, buy, hold, or sell?
Jun Bei Liu (Hold): It’s a hold for me. Look, it was a buy, but certainly its share price has gone through the roof. We think the opportunity set is enormous for this company and they’re only just touching the surface of what they could achieve. 1% penetration in the U.S. and other markets. Now they’re moving into raise huge amounts of money and they got the war chest to go and go after those market share, so it is a hold for me.
James Marlay: Okay. Well, big market cap. They’ve executed flawlessly, huge capital raising, buy, hold, or sell?
Eleanor Swanson (Hold): It’s also a hold for me. Afterpay has absolutely dominated the retail market in Australia and it looks like they’re going to do the same thing in the U.S. However, we feel that’s largely priced into the current share price. To get upside from here, I need to see Afterpay starting to roll out into new markets. I tend to try and value it market by market, and each new market adds about $6 to the current share price. In addition, we think there’s an opportunity for Afterpay to really go after marketing for these retailers and build out a marketing platform. To put that opportunity into context, they generated 10 million leads for U.S. retailers in the month of April alone. They’re not monetising that at the moment and we think that’s a huge opportunity for the company. It’s a comfortable hold.
James Marlay: Okay. Mesoblast generated a lot of interest with some of its opportunities around COVID. Buy, hold, or sell?
Eleanor Swanson (Buy): Yeah, Mesoblast is a buy. The company is a global leader in developing stem-cell therapies. They’ve got multiple trials underway at present including one for chronic heart failure and another one for chronic lower back pain. Over the next six months it’s probably going to be some of the most exciting for the company just given they’ve got two phase three trial results coming out. If either of these prove to be successful we’re expecting a material rewriting in the share price because they are blockbuster drugs and it will just clarify the path to commercialisation for the drugs. Just given the upside potential we think Mesoblast should be in everyone’s portfolio, albeit a small position given that clinical trials are very binary in nature.
James Marlay: Okay. Can you get pumped up about Mesoblast? It should be in everyone’s portfolio. Jun Bei, is it in yours?
Jun Bei Liu (Sell): Okay, this seems like it’s a first for me. Look, no Mesoblast is a sell for me. When we talked to the rerate I felt it’s already been rerated, share price has gone up 70% since they took to the COVID-related trial that potentially could generate a lot of interest in the earnings. And to me, it’s already been priced in. And secondly, since the announcement, since the share price has gone up 70%, the standard care for COVID-related patients has already gone up significantly. Which means that it will be tougher for them to meet the end point, which means the chance of a failure is higher.
And secondly, they took to charging a huge premium should that trial be proven successful. To me that will be quite challenging just given we’ve seen some of the early indication, some of the steroids treatment out of the UK and the like are charging very low prices. There’s a lot of unknowns to do with why the share price rerate is 70%, and to me, firmly the risk is on the downside.
Fisher & Paykel Healthcare (ASX:FPH)
James Marlay: Fisher & Paykel Health. A manufacturer of a number of different products. One of them is ventilators, which has obviously put them in the spotlight. It’s had a cracking year. Buy, hold, or sell? Can it do it again?
Jun Bei Liu (Sell): Fisher & Paykel is a hold to sell. Look, I think it’s an incredible company, it’s probably a sell for me at this point. It’s an incredible company, done really, really well and delivered significant amount of earnings growth because of COVID-related products pull-through. And we think structurally will mean, and the hype for their product and the demand, will be significantly higher. However, the current lump earning is pull forwards of many years of growth in their future. And with the earnings of trading more than 50 times it certainly seems they’re bit too rich at this point. We prefer the cheaper alternative such as ResMed at this point.
James Marlay: Too rich for Jun Bei. Are you a buy, hold, or sell on Fisher & Paykel?
Eleanor Swanson (Sell): Yeah, we agree. Fisher & Paykel is a sell. As you’ve alluded to, two thirds of the business is focused on ventilators, selling them to hospitals. And just given COVID, Jun Bei has alluded to the pull forward of demand there. We do think some of that is sustainable, so they will retain some of the market share they’ve gained for this nasal high flow product. However, over 50 times earnings well and truly price priced in, and in addition a third of the business is focused on sleep apnea and they’re actually losing market share in this segment, so it’s a sell for us.
Perseus Mining Limited (ASX:PRU)
James Marlay: The complete other end of the spectrum in terms of drivers, but gold has been a big, bright spot on the market. Perseus Mining, mid-tier Australian miner. Buy, hold, or sell?
Eleanor Swanson (Hold): Perseus is a hold. Firetrail is overweight gold. We like gold because it’s a hedge against the extraordinary amounts of money being printed by central banks around the world. Perseus gold currently has two operating mines. One is in Ghana and the other is on the Ivory Coast. We think there’s better ways to play the gold thematic just given the higher risk of investing in miners in West Africa. Yeah, we like gold but it’s a hold for us.
James Marlay: Okay. Jun Bei, have you got a view on Perseus? Buy, hold, or sell?
Jun Bei Liu (Hold): I will probably move to more hold. Look, Perseus is a whole lot cheaper than the rest of the gold miners, simply because of where their mine is situated. You always need to be very mindful that for a company that is mining out of Africa, there’s a lot of risk that we can’t predict. And many years ago, Perseus had issues at its mines and share price has lost a significant amount of value. But since then they’ve done incredibly well, they’ve delivered to expectations. They’ve done a great job, but it just that risk premium, you need to take that into account. I would much rather play through the likes of Saracen, or Northern Star or even Macraes.
James Marlay: Okay, let’s round out our top five. Megaport, one of the new kids on the block in the Australian technology scene. Buy, hold, or sell?
Jun Bei Liu (Buy): It’s a buy. I like Megaport because Megaport is probably the only cloud infrastructure company that you can find in this market. Yes, there’s NEXTDC but NEXTDC is the future, essentially the future property trust. They build assets for companies to use and so that’s more cloud-related and demand for that type of product is going through the roof and COVID certainly has speeded up that kind of adoption. Now, Megaport is the future Telstra and it has innovated that space and it’s global. It’s the largest in its sector because it’s the innovator and it’s got enough runway for it to continue to expand global dominance. For me, it’s one of the rare exposure to that space in the Australian market.
James Marlay: Okay. Eleanor, moving to the cloud, it’s been one of the major trends in the structural shifts that we’ve seen accelerate through the past few months. Buy, hold, or sell on Megaport?
Eleanor Swanson (Buy): Jun Bei, I promise I’m not copying you but I’m a buyer on Megaport as well. What the company does is they facilitate the transfer of data by virtual cloud connections and they’ve got an amazing first mover advantage in building out their network footprint. The company has currently got 600 data centres, that is double their nearest competitor, and they’ve also managed to double the number of data centres installed on their network over the last 12 months. We expect the company to continue these phenomenal growth rates. And in addition they’ve got a new product pipeline which we expect to support valuation going forward, so it’s a buy.
James Marlay: Okay. Well, the five stocks had a cracking year in FY20 and I guess there will be more momentum left so don’t chuck them out just yet.
Throughout Buy Hold Sell, fundies have generally agreed that the best businesses to own in the current environment are those offering highly scalable technology solutions; essential healthcare products; defensive dividend yields and commodities.
In this episode we cover a delectable cross-section of these companies: two of which are Blake Henricks from Firetrail Investments‘ favourites: Newcrest Mining, the gold giant whose outlook is underappreciated; and Telstra, offering a 4.5% dividend yield that he says will increase. For Jun Bei Liu of Tribeca, the counter is Zip Co, which is giving Afterpay a red-hot run for its money, and Domain, a digital company springing into growth.
Despite bringing their favourites, Blake and Jun Bei don’t necessarily agree with each other’s choices. But they do settle on one thing: selling CSL, Livewire readers’ most-tipped big cap for 2020. Find out why below.
Notes:Watch, read or listen to the discussion below. This episode was filmed on 15 July 2020.
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James Marlay: Welcome to Buy Hotel brought to you by Livewire Markets. My name is James Marlay, and I’m joined by Jun Bei Liu from Tribeca and Blake Henricks from Firetrail. And we’re going to be talking about a few of their favourites and a couple of exclusions.
Newcrest Mining (ASX:NCM)
James Marlay: Blake, let’s start with you, Newcrest Mining, big, shiny, a little bit boring. Buy, hold, or sell?
Blake Henricks (Buy): It’s not boring, James. I take offence to that. It’s a buy. The reasons it’s a buy is current expectations are that production is going to decline over the next five years. The market is seeing it as a two-trick pony, which is Lahiri and Katiya. We actually think they’ve got three outstanding growth projects. Two of them are Brownfield in Canada and Australia, high free cash flow generation. One of the best miners globally. Newcrest is a buy.
James Marlay: Gold price is up 19% year-to-date. It’s been a great place to be. Buy, hold or sell on Newcrest?
Jun Bei Liu (Hold):: Newcrest is a hold for me. I agree with you on gold. We do prefer the others such as Saracen mainly for the consistency in terms of delivery. So they consistently delivered for seven years without disappointment. You pay a little bit more for the company like Saracen, but we do prefer that one instead. But I agree with Blake that Newcrest is underperformed at the peers. It’s pretty cheap relative to the others. And potentially there’s a bit of upside in terms of relative to expectations now heading into the reporting season.
James Marlay: Okay. Telstra? 4%+ dividend yield, been investing in 5G. Buy hold, or sell?
Jun Bei Liu (Hold): I’ll put on a hold. I agree. It’s dividend yield certainly is very defensive, especially in the face of banks and everyone else cutting dividends. But to me, it’s a company whose earnings is going backwards. I think for me to go out and buy in a bullish way would only happen when competition really stabilises. Now in early signs, Optus is not really going to compete aggressively and Telstra’s putting up their prices. But now the newly formed venture, Vodafone and TPG, even though they have a lot of debt, they might have to hold cash, but they just released a new plan that’s cheaper than everyone else. So there is competition there and it will take a while longer for me to feel comfortable with it.
James Marlay: Okay. Blake, Telstra. Buy, hold, or sell? It’s been around a while. We’ve all been on our phones using the data.
Blake Henricks (Buy): Telstra’s a buy. And the reason it’s a buy is 10 years ago, we were wondering how they were going to get rid of their declining fixed revenues. That’s actually happened now. The NBN bought their network; 80% of the valuation today is mobile in the infrastructure business. If you take the mobile business, there has been a massive price war. It’s been very, very damaging. In fact, we think Optus is close to breakeven once you strip out the NBN one-off receipts. So you’ve got a competitor on their knees. As JB said, prices are starting to lift. There’s a long way to go in the mobile repair on the earnings. The second thing is the infrastructure. They carved out the infrastructure business to show the quality of this business. There’s optionality around potential NBN privatisation. That 4.5% dividend yield is probably going to grow over the medium term. It’s solid. No one wants the banks. Telstra is a buy.
Zip Co (ASX:Z1P)
James Marlay: Okay. Blake, buy now, pay later has been all the rage. Zip. Buy, hold, or sell?
Blake Henricks (Sell): Zip’s a sell. When you think about these growing markets, it generally is winner takes all. Afterpay is probably going to be the one. And the other thing we’ve done is we actually took all the analyst expectations for all the buy now, pay laters and what the TAM (total addressable market) is, and I’ll tell you what, this is going to be a huge market if they’re all right. We don’t think they are. It’s a sell.
James Marlay: Jun Bei, Zip Co’s been the laggard in the buy now, pay later space. It’s only gone up 100% this year. Buy, hold, or sell?
Jun Bei Liu (Buy): It’s absolutely a buy for me. Well in many parts of the technology space, if the market is small enough, it’s winner that takes all, but this is an enormous market. In the U.S., a couple of BNPL players have now, with all that investment, only penetrated 1% of the U.S. Market; 8% in Australia versus 1% in the U.S. Now Zip Co just bought into that market. And now Zip has exposure to eight different markets. Now, there’s Canada, there’s U.K. There’s so many markets that could potentially be coming online. It’s enormous now. And this market is real because we’ve seen Silicon Valley investors putting money in Zip. We’ve seen Tencent putting money with Afterpay. And potentially there will be more further M&A and activity picking up because they are taking notice that this is a real market.
So today Afterpay said they now can be sold through Google Pay, Apple Pay, all of that. QuadPay, which has been acquired by Zip, is already on there. So, the market is enormous and they bought a great platform onto it. And in terms of market cap, Afterpay at $18 billion, Zip, $2.5 billion. And Afterpay has 10 million customers. Zip has now, including the acquisition, over three, close to four million customers. So Zip has a long runway to go. By then probably Afterpay will be in the top five Australian companies, but Zip certainly will catch up quite a lot on that basis.
Domain Group Holdings (ASX:DHG)
James Marlay: Well, the Australians love anything more than buy now, pay later, it’s property. Domain. Buy, hold or sell?
Jun Bei Liu (Buy): It’s a buy for me. Domain actually represents a very interesting opportunity. It’s highly leveraged to property listing numbers. Now property listing numbers, believe or not, actually has been negative for the last couple of years because properties just don’t list long enough. They just sell like that. And in January, we actually are finally seeing that listing numbers started picking up quite strongly. And just before the lockdown took place, of course, everything collapsed. But since then we have seen this huge pent up demand. And so in the latest numbers, we’re seeing the listing number now up 10%. Even in winter, people are selling their houses, even in winter, the minute a lockdown was lifted. Now investors have a unique opportunity at this point because the second lockdown in Victoria is seeing Domain’s share price come off a little bit, but it will get reopened. And now this is a seasonally low period. So when spring comes, the earnings growth is enormous. Growth is much faster than REA and only one-eighth of the market cap of REA. So that’s a good opportunity there.
James Marlay: Okay. Blake, Domain. Can you get us excited as June Bei?
Blake Henricks (Hold): I can’t get as excited as Jun Bei on any particular day, but not on this one, either. It’s a hold for me. Really solid business operating in a duopoly. This penetration we think is going to keep growing over time. But the listings are still the big question mark for us. Maybe if stamp duty goes, we might see a bit of a pickup in listings, less friction, but for now, it’s a hold for us.
James Marlay: Okay. We’ve got a couple of stocks that you both like. Can you tell me something you don’t like right now?
Blake Henricks (Sell): Well, I’d say we are funding some of these purchases through something like a CSL where great business, but there’s probably not the tailwinds that it’s had over the last few years in the next little while. So that’s a good funder for us.
CSL (ASX:CSL) & Fisher & Paykel (ASX:FPH)
James Marlay: Okay. Jun Bei, you got something that you are using to fund your Zip shares?
Jun Bei Liu (Sell): He took my stock! I was going to say CSL. We’re not going significantly underweight, but CSL, it’s done well and it’s pretty expensive and its earnings are going to be downgraded. So that’s a funder, but of course other things like Fisher and Paykel, we’ve done very well out of it. And we just feel earnings at over 50 times is a bit too expensive and we’re using that fund for other ideas. So that’s a sell.
James Marlay: Well, our two guests might not agree on the stocks they love, but they definitely see eye-to-eye on the one to sell.
With August results season around the corner, investors will finally get a clear picture of COVID-19’s impact on corporate Australia. We know it’s going to be bad, but how much is already in the price? When Jun Bei Liu of Tribeca Investment Partners considers that question, she’s upbeat about the month ahead.
“… it’s important to work out which analysts have been too conservative on what sectors and possibly, you have quite a lot of upside for those companies.”
For Blake Henricks from Firetrail Investments, the big things to watch are how companies protect balance sheets and whether the market buys management narratives around structural changes in response to the pandemic.
They expand on their views in this interview, answer whether they’re bullish or bearish on banks, resources, healthcare, technology and energy stocks, and call out where the re-rating opportunities are.
Notes:Watch, read or listen to the discussion below. This episode was filmed on 15 July 2020.
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James Marlay: Welcome to Buy Hold Sell, brought to you by Livewire Markets. My name’s James Marlay and I’m joined by Blake Henricks from Firetrail and Jun Bei Liu from Tribeca. We’re getting ready for reporting season and it’s going to be an odd one. It’s the first time a lot of companies are going to go in, not really knowing what their earnings are going to be, and so we’re going to chat with our guests, find out what they’re doing to prepare and what they think about some of the biggest sectors on the Australian market.
A reason to be upbeat
James Marlay: Jun Bei, I’ll start with you. First question, are you doing anything different for reporting season this year? How are you preparing for it?
Jun Bei Liu: Honestly, I think every reporting season, you’re meant to do the same thing, that you’re meant to understand the business and understand where earnings might come through and where the expectations are. Share price movements essentially are about surprises: surprise on the upside, the share price goes higher, and surprise on the downside, the share price goes lower. That’s something that you always have to do. Now, this reporting season will be very interesting because we are actually thinking that, heading into it, it’s looking actually reasonably positive.
This is the thing that we’re thinking because we have seen a significant amount of earnings downgrades in the last couple of months because we don’t know what the earnings will look like, so analysts have gotten very, very conservative. So, heading into reporting season, it’s actually important to work out which analysts have been too conservative on what sectors and possibly you have quite a lot of upside, for some of those companies.
Brace for dividends, cost-cutting strategies
James Marlay: Blake, whilst the earnings and the downgrades expectations have been perhaps a bit dour, the market’s been having a bit of a raging old party, are you in the same boat as Jun Bei? Have you been doing anything different going into earning season?
Blake Henricks: I think there are two things to think about this earning season. JB’s right on the EPS. Let’s talk about DPS for a second. Typically, the ASX 200 pays out about 70% of earnings as dividends, current expectations for about 60%. We actually think it’ll be lower than that because if you’re sitting on a board, you’re not going to pay out too much money. You’re going to protect that balance sheet. The second thing we’re going to see is a lot more on cost-cutting. We’ve seen many companies say this is an opportunity for a structural rethink; less office space, less people, and that’s one thing you can control if you’re a company, so lower dividends and more cost-out.
James Marlay: Are you expecting management teams to come to the table with more of a plan around what they are going to do, given we’ve been in this environment for three or four months? Have they had time to put together a more concrete plan?
Blake Henricks: I think what we’ll get out of it is, the companies who’ve held their guidance will probably, potentially give guidance again, but that’s only for the most defensive, because even some things that are typically defensive, toll roads, where you give DPS forecasts, you’re probably not going to give those. So I think, when you’re thinking about what management are going to do, they’re going to give six-week trading, say we’re ready for a range of scenarios, and the market will say, “Gee, I wanted to know more about what’s going to happen in the future.”
James Marlay: Right, so two things we got there. Jun Bei’s looking for those, where the earnings expectations might be a bit downbeat. Blake’s expecting dividends to get cut.
Banks: bullish or bearish?
James Marlay: Let’s get into a couple of sectors. Jun Bei, start with you. Bullish or bearish on banks?
Jun Bei Liu: Can I stay neutral?
James Marlay: I don’t see that in the run sheet. No fence-sitting!
Jun Bei Liu: Okay, no fence-sitting, then I’ll be just under the bullish tone because I think the outlook is not going to be great. The dividend will be cut by the banks and potentially be pushed out for another six months before we see any cashflow come through. And because they are such a bellwether of our economy and we’re in a recession, earnings are not going to look great, but because they’re on cheap valuations and because of all the stimulus that the government has pledged, it looks like it’s working quite well for some parts of the economy. We do think valuation is cheap enough. And when things resume to normal, we do think it looks reasonably decent. But, right now, it’s probably slightly above neutral for me.
James Marlay: Okay. Blake, banks, are you bullish, bearish, closer to the neutral?
Blake Henricks: I’ll give you bearish, James, bearish operating trends. There’s still competition, got to deal with the bad debts, but they are priced much better for the reality than they have been in the last four or five years. But I think the biggest question to ask is, everyone’s talking about bad debts, are Australians going to be renovating their homes at a rate of knots while defaulting on their mortgages? Because something’s got to give.
Commodities: bullish or bearish?
James Marlay: Well, one part of the market that’s actually been relatively immune to the goings-on of the coronavirus is the commodity sector, a big part of the Australian market. Iron ore miners have been raging on. Gold’s been a bright spot. Bullish or bearish on the outlook for the miners?
Blake Henricks: Bullish – very bullish on the miners. Yeah, you’ve got really super strong balance sheets. You’ve got supply, which is really being withdrawn, almost across the market. In Brazil, for iron ore, it’s down. If you look at copper, it’s down, because of COVID, and then in other sectors, the price is just too low, so supply is being taken out in areas, such as oil, they’re in a great, great position.
James Marlay: Blake’s bullish on the resource sector, who would have thought that the banks were cutting dividends and the miners are going to be boosting them? Are you bullish or bearish on the sector?
Jun Bei Liu: Certainly bullish into this reporting season. The dividend will look enormous, from especially some of the larger names. Cashflow looks fantastic and the dividend payout is fantastic, so I think that why we’re very bullish on that front. Now, there are a few things that when you ask most of the managers that you talk to, most of the people are probably bullish, so just to be a little bit mindful that we have with some of the tail risks now starting to tick up.
Things like trade conflict, the geopolitical uncertainty, and all of that now, will create some of the risk on the horizon for that resources space, because we need global growth to really tick up, and in that fragile juncture at this point, if you have started having trade tensions and geopolitical sensitivities, it will certainly weigh on the sector. So it’s just something to watch, but very bullish heading into the reporting season.
Healthcare: bullish or bearish?
James Marlay: The only thing that’s been more bullish than resources has been healthcare. It’s been a real sweet spot in the past little while. Has it got ahead of itself?
Jun Bei Liu: I think healthcare, there’s a reason it’s a bullish sector, because it has delivered that structural growth for many, many, many years, and that growth is underpinned, not by global growth. It’s actually underpinned by demand for the unique product. So, each company has a unique exposure to something special about them, customers coming to them buy those products and that’s the only place to get them.
However, I think the healthcare sector is at a very interesting crossroads. Some of them will do very well and others may lag behind a little. So the likes of CSL have delivered incredible growth over the years, but right now, because it has done well, in terms of its share price relative to others, it will be used as a funding source and its earnings might be facing a little bit of downgrade at this result.
But we’re bullish on the likes of ResMed or Ramsay Healthcare, for example. We think both of them would deliver good growth, and in the case of Ramsay, it’s going to benefit from the reopening thematic that is going to take place over the next six months, and the backlog for private hospitals is enormous. So overall in healthcare, you’ve got to be selective with what stock it is, and some of them you can do really well and these are V-shape recovery companies that you can see in this market.
James Marlay: Okay. Blake, have you go a V, a W or something else for the healthcare sector? Bullish or bearish?
Blake Henricks: Jun Bei’s got it covered. I’m bearish overall. You do have to be selective. There’s a couple of gems in there, but people have just crowded into it because of the defensiveness of the earnings and now there’s a lot in the price.
Technology: bullish or bearish?
James Marlay: Technology, another sector that’s been raging along. Bullish or bearish?
Blake Henricks: I’m bearish, technology. Still some gems in there, but I’d say, overall, with the types of discussions we’re seeing out there in the market, there’s just nothing factored in there for competition. There’s nothing in the price for regulation. There’s not much in there for the potential for higher rates or a stabilising economy. So, I think overall, I’m bearish versus current expectations.
James Marlay: Let’s finish with you on technology Jun Bei. Bullish or bearish?
Jun Bei Liu: How long do I get? I like technology as a sector, but again, it’s a stock by stock story. I really think the sector, the companies that are being impacted by COVID, and yet share prices are now probably at all-time highs. Some of those businesses will probably come under a bit of pressure at the reporting season, as people now start looking at the profit line and COVID has impacted some of those businesses, for example like Altium, WiseTech and the others.
But there is another part of the technology sector that is seen as the beneficiary of it, and they have actually gone from strength to strength, and I do think these other companies certainly will become some of the brighter lights over the next 12, 18 months, because these businesses have now this structural uplift, in terms of growth outlook, and their end market is, or target market is essentially enormous.
One of the things with the equity market we’re not very good at is estimating earnings for those companies, because, especially if you’re innovative, how do you know what the growth might look? Is it 200, 300%? And these other businesses, if you get your earnings right, get your outlooks right and market right, you can make an enormous amount of return. Of course, it will be volatile, but these are the names where you do need to do more work and the position in them.
Potholes to avoid
James Marlay: Okay, can you help people stay away from a few potholes? Is there a sector or a part of the market that you think is a candidate to disappoint?
Jun Bei Liu: I am continuing to avoid the travel sector. Look, this doesn’t include the airport. I like Sydney Airport, even though it is kind of travel, because Sydney Airport is a unique infrastructure asset. Its share price is not going to stay here for long, and at some point, it will be either bought out or a strategic buyer will come in, just because it’s a very, very unique asset.
But in terms of other travel-related sectors, it could be travel agents and others, I think these companies will go through prolonged pain. It will probably be a sort of prolonged U-shape or L-shaped type of recovery, and then their earnings structurally could potentially be much, much lower, over the long term, just because corporates work out you can save money and time by doing things over Zoom and the like, and we’re all set up now. We all went to JB Hi-Fi, bought all the computers, so we’re done.
James Marlay: It’s structurally challenged now.
Jun Bei Liu: That’s right. So I think there might be a bit of issue for all of those. There’s just too much uncertainty for that sector for me to be interested in it.
A re-rating opportunity
James Marlay: Okay, Jun Bei’s out of travel. Is there an area that you think looks vulnerable, Blake, something to stay away from?
Blake Henricks: I’ll give you one to have a look at, if that’s okay? I see a big rerating opportunity in oil. Everyone’s so focused on demand and demand was very, very tough, but we are seeing it come back slowly. We’re seeing a preference for driving, which is good for transport fuel demand, but I think when you look at what’s it in the equity prices now, people have taken out the growth projects, but the fundamental part about the oil market is that it’s a depleted industry and you need new projects to go forward. At $42 a barrel, there’s still a lot of pain out there.
So two things will happen. Once the market balances, the price will rise and the equity analysts in the market will start to re-price some of these growth projects again. So that’s one where it’s really on the nose, but at $42, it’s still not sustainable and we see an upside to some of the oil stocks.
James Marlay: Well, folks, it’s going to be an interesting reporting season. One thing you can be guaranteed is that it’s going to be at one end or the other. It seems like people have got an opinion, bullish or bearish, on just about every sector.
The short-term outlook for markets is uncertain. But looking beyond COVID-19 and the short-term uncertainty and volatility, there are some exceptional opportunities.
Join Blake Henricks, Firetrail’s Deputy Managing Director & Portfolio Manager, where he will discuss: • The once in a generation investment opportunities • The risks you need to consider in the current market environment • What we look for in capital raises to generate returns • How Firetrail is positioning portfolios • Why now is the time for active stock pickers
Buffett’s favourite metric is return on equity, or ROE, which gives investors a
measure of how well a company’s management team is using its equity to generate
CSL is a classic example of a company with a high ROE, and this has been instrumental to its long-term success. Using Bloomberg data, we screened the market to shortlist five midcap stocks that have had an ROE above 15% for each of the last three years.
In this episode of Buy Hold Sell, Jeremy Hook from TMS Capital runs these five names past Jelena Stevanovic from Platypus and James Miller from Firetrail Investments to see if this filter may have picked out the next crop of CSLs.
Jeremy Hook: Welcome to Buy Hold Sell. I’m Jeremy Hook from TMS Capital. With me today on the panel is Jelena Stevanovic from Platypus and James Miller from Firetrail. There are some terrific mid-cap companies in the Australian market, but ones we want to focus on today, for this session, is the ones that return a very good return on equity, something above 15%, three years in a row, in the last three years. And we thank Bloomberg data for that.
We’re going to look firstly at QANTAS. Jelena, what do you think? Buy, hold, sell?
Jelena Stevanovic: It’s a hold for me. Look, QANTAS is operating in a better environment than where it exited second half of last year in terms of fuel costs as well as its international portfolio, but it is trading at a two-times premium to its listed PE. So at this level it’s a hold.
Jeremy Hook: Okay, a hold for you Jelena. James, QANTAS, taking off, buy, hold, sell?
James Miller:QANTAS is a buy. There are two crown jewels in that business. It’s got a frequent flyer business, which is attached to 35% of all credit card transactions in Australia, that’s growing at double digits. And then you’ve got a domestic franchise, which has had five years of industry rationality, so QANTAS is undervalued.
Jeremy Hook: Okay, good one. Medibank Private, since it listed, it hasn’t received much of the rave reviews of a lot of stocks. It’s done pretty well. Buy, hold, sell?
James Miller: Hold on that one. It’s a great asset. It’s about 25% of health insurance members in Australia, and I think that will look attractive to an acquirer at some stage, but right now you’re paying about 21 times PE for not much earnings growth. It’s a hold.
Jeremy Hook: Yeah, they’re losing members and no real earnings growth at the moment, but a good basic business. Buy, hold, sell, Jelena?
Jelena Stevanovic: It’s a sell for me. It’s to your point, trading at a top end of its PE range and EPS growth profile is flat at best. Capping health insurance premium increases is still front of mind on political agenda. All that in mind, hard to see earnings growth.
Jeremy Hook: Okay. And Nick Scali has been a really good stock for a long time, but just last month, a profit warning. Buy, hold, sell?
Jelena Stevanovic: Look, sell for me, despite recent derating. The trading update provided by the company was significantly worse than a lot of its listed peers. It should benefit from improving domestic housing market. However, really, really downbeat trading update. Cannot not question company execution at this point.
Jeremy Hook: Interesting. James, it did bounce after being sold off pretty aggressively. Buy, hold, sell on Nick Scali?
James Miller: It’s a hold for us, and that’s really around timing. It is going to be a great beneficiary of this house price and house transaction lag, but that’s probably six months away.
Jeremy Hook: Yeah. Okay. Now, A2 Milk, since its result in August has gone sour. It’s gone down by $12 now. Is that a buy, hold, sell?
James Miller: It’s a great company and we’ve owned it in the past, but right now, it’s a sell. And the reason for that is that the China infant formula market has got competition heating up, and it has high costs as well in terms of serving the channels there too. So short-term earnings pressure, but medium term, it’s a good company.
Jeremy Hook: Okay. Jelena, A2 Milk, is that to your liking?
Jelena Stevanovic: Look, it’s the hold for me. There’s no doubt the low hanging fruit in the China infant formula market has been picked, and the company needs to invest in various marketing initiatives to grow further, but the US opportunities are immature, and it’s a huge potential. The company has a strong track record of executing. There’s no reason to believe they won’t be able to replicate success in the US market.
Jeremy Hook: Another one going very well in the US as Credit Corp. It’s almost doubled this year. Buy, hold, sell?
Jelena Stevanovic:Sell, purely on valuation. To your point, they have excellent track record of delivering earnings growth, have proven themselves to have good risk management and pricing strategy, but on a valuation, it’s a sell.
Jeremy Hook: Okay. James, do you agree? Is it too expensive? Buy, hold, sell?
James Miller: It’s a hold, and the main reason is valuation. It’s been growing at a great rate because it’s been buying these debt ledgers up to grow earnings, but when cash flow is severely lagged from where earnings are, we struggle with valuation.
Jeremy Hook: So we’ve given you five terrific stocks to look. But James and Jelena quite rightly don’t think all of them are buys at the moment.