Get back to the basics to find tomorrow's stars ::

Author: Helena Keers
Date: 17 March 2007
Publication: Australian Financial Review
Section: Smart Money

Companies that tap into rising concerns stand to be winners, writes Helena Keers.

Tomorrow's world, one that is likely to be governed by issues such as climate change, water shortages and an ageing population, will throw up opportunities for both new and traditional industries to make money. Which means stockmarket investors may well find an abundance of new companies vying for their cash. The first port of call for many investors thinking about futuristic developments are information technology, clean energy and biotechnology companies. They can be risky investments, but they also have the potential to deliver fat returns.

Less sexy sectors such as garbage, water and road management can be equally important. After all, with expansion in China and India, global growth will focus on basic industries such as infrastructure that will enable these economies to modernise.

According to the International Monetary Fund, emerging economies account for only one-quarter of the global economy at present market exchange rates. But this will increase.

"There will be continued strength in commodities, metals, banking, real estate and any companies related to these industries," says Conrad Burge, investment manager from Fiducian Portfolio Services, adding that companies providing services for the developing world, such as engineering company WorleyParsons, will also flourish.

Companies such as United Group, which has an emerging infrastructure and water business, benefit from future and current infrastructure projects, according to Credit Suisse equity strategist Adnan Kucukalic.

As populations expand in Australia and much of the developing world, global warming will increasingly become an issue. So alternative energy will become a necessity and water recycling and sanitation more important.

Platypus Asset Management chief investment officer Donald Williams thinks solar infrastructure will be a huge growth sector in the next 10 years, even though present investment opportunities are sparse. One company in this sector that recently hit the headlines is Dyesol, which sells dye solar cell technology.

Dyesol got a "speeding ticket" from the Australian Stock Exchange on February 2 after the company's share price moved from 59¢ to 76¢ in a day. The next day, the company declared a 282 per cent increase in first-half sales to $677,596. Although its net loss also increased 17 per cent to $1.4 million, the company has orders in hand of $2 million.

Apart from solar energy, other alternate sources of energy such as wind power are expected to burgeon if the price of oil goes up to $US150 a barrel, as some market experts predict.

Increasing costs and fears over global warming will also ensure water management, recycling and sanitation remain huge issues. For many investors, the drought in Australia has been a catalyst.

Clime Capital chairman Roger Montgomery says: "If the government does increase the cost of water after the next election, . . . it will become more economic to buy water tanks and drill bore holes, and industries in this area in Australia will flourish."

Another vital demographic development in Australia is the ageing population. Companies capable of meeting the demands of the ever-increasing body of retired Australians will be in a good position.

Financial services companies have been growing above the rate of gross domestic product growth in Australia for the past year, according to Platypus Asset Management's Williams and in the recent profit season, the strongest earnings growth came from diversified financials.

Fund manager Eley Griffiths portfolio manager Ben Griffiths says: "Financial services companies will obviously be an integral part of life for an ageing population and an important component of Australia's working population. It is hard to see [these] companies doing anything other than thriving."

His two top stocks in this sector are Challenger Financial Services Group and WHK Group.

As for the health-care sector, ABN Amro Asset Management portfolio manager Mark Nathan recommends three stocks: Resmed, a manufacturer of respiratory medical devices, ear implant company Cochlear and medical diagnostic company Sonic Healthcare.

Analysts pinpoint a clutch of biotech stocks that are due to report the results of late-stage drug trials over the next few months including Progen, Avexa and Chemgenex Pharmaceuticals. However, it is important to acknowledge the dangers of investing in more speculative companies and the recent failure of late-stage trials for an anti-obesity drug developed by Metabolic Pharmaceuticals illustrates this.

So while some experts, such as Credit Suisse's Kucukalic, think biotech stocks and anything to do with science will be sustainable investments, others disagree.

Smallco investment manager Rob Hopkins says: "We avoid biotechs because they are concept stocks that usually have no revenue for two years."

However, he does like other high-tech companies. His two top tips are Melbourne IT and Dark Blue Sea, which is being taken over by Photon.

Internet advertising in particular has been growing at 50 per cent a year for the past few years and now outpaces radio and outdoor advertising. Hopkins says: "We would expect this industry to grow strongly. It accounts for over 10 per cent of the overall advertising industry and so it continues to make big inroads into rival markets and we would expect this to flow through to the bottom line."

Griffiths says: "Any business planning on capitalising on an industry of the future needs to follow the time-honoured principles of sound management, good cash flow and realistic valuation benchmarks when growing via acquisition."

Clime Capital's Montgomery thinks uranium companies are shirking these principals. He asks whether it is rational for companies with "two or three pegs in the ground" to experience share price increases of 400 per cent on talk of uranium exploration.

"It's not enough to pick industries, you also need to pick sustainable companies," he says. "The phone, the train and the internet have changed the way we communicate and travel but billions of dollars were lost along the way through investing in the wrong companies."

Finally, Montgomery and Griffiths agree the Australian travel and tourism industry will flourish over time. Montgomery believes the rise in tourism will be driven by the Chinese, who, having seen parts of the West, will want to see more of it.

"We saw this happen in the 1980s with the travelling Japanese. As the Chinese become the dominant powerhouse, we will see the same thing with the Chinese travelling," Montgomery says.

Griffiths says growth in international tourism and discerning domestic holiday makers will lead to tourism and leisure-related stocks surging over the long term. He favours MFS for its tourism and leisure division, Macquarie Leisure and the Aspen Group. "Most industries of the future are with us now," he says, adding: "They may well evolve into different entities with different orientation over time but the rudiments of the business may well be as they appear today."

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