Thursday, November 24th, 2016
Hello everyone, I’m David Walker from StocksInValue. It’s good to be back.
Recently you saw video presentations by Adrian and Stephen about our research agenda and approach in small-caps and mid-caps. Today I’d like to present on where we are going with large-caps, by which we mean the ASX 50, and what kinds of large companies you might see in the model portfolio in the future.
I’ll start by saying large-caps is a difficult space and we don’t see many new or emerging opportunities there. The stocks are deeply researched by many smart and dedicated analysts, so the share prices are mostly efficient, meaning they reflect fair value. Most of the stocks have macro themes and that’s volatile as you know with currencies, commodity prices, economic growth forecasts and bond yields all moving around daily, often substantially so.
It’s not really possible to find secular large-cap growth stories at bargain prices because if those stocks were cheap, someone else would have already discovered this and bid the stock up to value, as they are that well-researched. The best stories in large-caps are expensive and unfortunately that’s normal. This means the best time to buy quality large-caps, macro plays and secular growth stories alike, is in general panics. And you’ve seen us do that in the model portfolio.
The table on your screen now groups the ASX 50 into the categories we use when considering them: cyclicals, defensives, REITs and “problems”, or companies which are struggling to make an investment case but might be interesting if the management can restore growth, substantially improve profitability or reduce risk. Some stocks do have themes from other categories or unique themes, for example CSL differs from every other ASX 50 stock being a biotech play.
Woolworths and Wesfarmers are defensive in that grocery spending is relatively resilient to economic conditions and consumer confidence, but these stocks have problems of their own – especially their competitive intensity with each other and Aldi.
|Theme||ASX 50 stocks|
|Cyclical||ANZ, ASX, AZJ, BHP, CBA, CPU, CTX, IAG, IPL, JHX, LLC, MQG, NAB, NCM, ORG, ORI, OSH, QAN, QBE, RIO, S32, STO, SUN, TWE, WBC, WPL|
|Defensive||AMC, BXB, CSL, RHC, SHL, SYD, TCL, WES, WOW|
|REITs/Property||DXS, GMG, GPT, MGR, SCG, SGP, VCX, WFD|
|Problems||AMP, CCL, MPL, TLS|
Cyclicals are generally not suitable for long-term investing unless the cycle lasts particularly long. For example, the banks have benefited from 25 years of economic growth in Australia but this is unprecedented globally.
The insurance and resource cyclicals have been poor long-term investments but good trades if you bought them on the turn then sold them without thinking they were suitable for holding.
With eight or 16% of the country’s largest listed companies as property trusts or property managers, the ASX 50 is property-heavy. And the problem stocks have been serial disappointments or are likely to become so – though we follow even these in case they start to do better for investors.
The next slide presents the main themes driving the ASX 50 at this time.
In the model portfolio we’ve been on the right side of most of these themes. We’ve held banks through the rally of recent months and now they, Computershare and QBE are benefiting from the Trump reflationary trade. Banks didn’t like ultra-low interest rates because they compress net interest margins so the return to a positively-sloped yield curve, which means longer-term swap rates are higher than cash and deposit rates, helps them. Soon enough you could see earnings upgrades in the market for this reason. Meanwhile bad debts have stabilised while earnings growth before provisions for bad debts is 3-5%, so talk of banks being ex-growth could start to leave the market. We’ve included a separate slide on banks at the end of the transcript below this video.
So far we’ve avoided resources due to doubts about the longevity of this year’s commodity price rally and uncertainty about how soon the supply response will arrive.
We sold out of Transurban, our only bond proxy play, in early October at $10.94 and the stock’s now $9.95. We exited Telstra at $5.50 in August and that stock’s now below $5.
We also don’t have Wesfarmers and Woolworths. We like the Woolworths turnaround but even on optimistic forecasts we struggle to value the stock above $24, which is turning out to be a ceiling for the share price despite good news like the return to 0.7% same-store sales growth in the September quarter.
So to opportunities to make and save money. We intend to gradually diversify the model portfolio’s large-cap exposure away from banks. We’ve done well there in recent months and especially post-Trump but the stocks are volatile because they quickly adjust to changes in general investor sentiment caused by offshore macro shocks. They also depend heavily on growth in the Australian and New Zealand economies, consumer and business confidence, and the confidence to borrow to buy residential property with minimal bad debts here. Right now growth in Australia is patchy and below-par despite headline GDP at around 3%. Most people don’t benefit from commodity price rallies, are still concerned for their jobs and haven’t had much of a payrise if anything. Underemployment is a problem with the decline of full-time employment and there’s a chicken-and-egg problem with employers reluctant to put on more full-time staff until consumers spend more, and consumers reluctant to do that until they feel more secure in their jobs. Confidence will take a short-term knock from the US presidential election because Donald Trump is unpopular in Australia. So the rally in ASX banks towards and in some cases past our valuations will see us lighten here. The banks should be ok but they’re not as attractive as they were.
QBE and Computershare should start to see earnings upgrades in the market from, respectively, higher bond yields and cash rates. We’re reluctant to sell too soon here but will look to exit eventually because the businesses are not capable of steady secular growth. With QBE we’re evaluating whether to lighten between $11.10 and $11.40, respectively our 2016 and 2017 valuations, or whether that stock could rip to $14 in an overshoot.
The next slide shows the opportunities we’re considering as we seek to diversify away from banks.
Amcor and Brambles should do well in an improving US economy and both are quality companies we like. Both are also trading closer to our valuations than for quite some time, so these are at the top of our large-cap research agenda.
CSL and Ramsay Health Care we own. Both are Holds at current prices with CSL good buying in the mid-$90s and Ramsay possibly below $70 but we need to understand the outlook for the French private hospital business better.
ASX and Macquarie are our go-to stocks for betting against an equity bear market or correction so they are on the shortlist for when that happens.
In oil we expect an eventual deal to reduce supply growth but with the oil price in the mid-$40s there isn’t enough fear and pessimism in the market for us to take a position in Oil Search or Woodside just now. In iron ore and coal a lot of heat would have to come out of that market for us to be interested.
The eight property names and two bond proxy infrastructure plays, Transurban and Sydney Airport, account for a sizeable 20% of the ASX 50. All these stocks do best when interest rates fall, which is not the case now. Nevertheless they remain on the shortlist if bond yields get overextended. If bond yields were to go vertical we could switch from QBE and Computershare to some of these names.
Our large-cap research process uses company presentations and accounts, of course, and also benefits from sell-side research. We are active in meeting with the management of large companies at analyst result presentations and with investor relations throughout the year. I look forward to continuing to update you on our large-cap research through these videos and the model portfolio.
Tags: Amcor, ASX 50, ASX:AMC, ASX:BXB, ASX:CPU, ASX:QBE, ASX:RMC, ASX:TCL, ASX:TLS, ASX:WES, ASX:WOW, banks, Brambles, computershare, CSL, cyclicals, defensives, large-caps, qbe, ramsay health care, reits, telstra, themes, transurban, value investing, Wesfarmers, woolworths