Thursday, September 10th, 2015
Written by David Walker
Written & published by StocksInValue on 3 September 2015
The All Ordinaries Index has now fallen around 13% from its peak of 5,964 in late April. There are two points to understand about this.
The first is the correction swings the investing game further in favour of the self-directed investor who retained cash to invest, as we have recommended. Free of the pressure institutional investors face to deliver monthly and quarterly performance, retail investors can afford to buy undervalued quality companies and ride out the volatility until share prices recover.
Second, many quality companies have fallen into value. StocksInValue’s very popular “In Value Today” filter search today lists over 110 companies trading at a discount to our rigorous estimates of their intrinsic value, or true worth determined away from the sharemarket. We review just five of these below; there are many more to view in StocksInValue.
A beneficiary of the growth in inbound tourism to Australia: Crown Resorts (ASX:CWN)
This name is down some 40% from its peak over $18 in January 2014. We like the strong market position in Australia, with legislated casino monopolies in Perth and Melbourne leveraged to the surge in inbound tourism especially from China, with longer-term growth to come from the expanding middle class in Asia. Crown has about a $3 billion project pipeline with upgrades to its Melbourne and Perth properties underway and developments in Sydney and Las Vegas, which should strengthen its global brand and increase its leverage to growing numbers of affluent Asian travellers.
The Australian dollar’s depreciation increases the translation of foreign currency earnings into Australian dollars and attracts more foreign tourists.
Despite this attractive long term future the downturn in Macau VIP gaming volumes is affecting current earnings from high-roller gamblers via Crown’s 34% holding in Melco Crown, which owns casino properties in Macau. But Macau is transitioning from VUP to secular growth in mass-market gaming. We think CWN will be worth $14 less than a year from now. Including dividends the prospective one-year forward return is over 32%.
Downside risks more than priced in: Commonwealth Bank (ASX:CBA)
Investing success requires minimising losses and maximising profits. This means finding stocks where the downside is more than reflected in the share price, as the upside then eventually takes care of itself.
We think CBA is an example. We like the stock for its strong brand equity, leadership in technology, customer service focus and conservative management over many years but until recently it wasn’t cheap enough to buy. The current round of bank equity raisings and the general gloom on the market stemming from China and weak Australian economic data have now created an opportunity. Today the stock can be bought at a double-digit discount to our value next year of $83.50 and furthermore this is a conservative valuation because our profitability assumption is less than those of the ‘consensus’ of broking analysts who cover the stock. If a stock trades at a discount to a conservative valuation then it really is undervalued. Including the approximately 6% fully franked dividend yield the prospective one-year forward return at a $72 share price is 22%.
Currency volatility creates value: Computershare (ASX:CPU)
CPU is a leader in all major equity markets for equity investor record-keeping and employee share plan administration. A high proportion of revenue is recurring and underlying earnings are growing.
Using conservative assumptions we think CPU is worth $12.50, implying a one-year forward return at a $9.80 share price of 32% including dividends. This opportunity has arisen because management downgraded 2016 earnings guidance due to US dollar strength against other currencies in which CPU operates, and because low interest rates are reducing yields on client cash balances.
We think these problems are transitory and investors should focus on underlying value. CPU’s board agrees, judging by the current on-market buyback, which should help support the share price around current levels.
Illiquidity creating opportunity: Dick Smith Holdings (ASX:DSH)
Including dividends the prospective one-year forward return at a $1.38 share price is 99%. This extraordinary situation arises from the motivated selling of two institutional investors following a disappointing June quarter, when management slowed sales growth to avoid low-margin sales, plus inventory build (expected to unwind in 2016) and a small downgrade to 2016 earnings guidance. Our 2016 valuation on conservative assumptions is $2.60 – ~$1.20 above current prices.
DSH’s store rollout increases secular growth, which helps offset the currently soft economic conditions. Management is confident about profit growth in 2016 from the opening of 15-20 new stores, the introduction of small appliances in 100 Dick Smith stores and cost savings.
The retail format suits demographic change and is growing online sales to head off online competition. Margins declined slightly in 2015 but should improve over time from cost reductions, a higher-margin product mix and fixed cost leverage.
Investors should focus on this attractive growth story and look beyond the recent disappointments.
Market missing international growth story: Seek (ASX:SEK)
SEK is one of the world’s largest online employment classifieds businesses, and a provider of online education and training. The domestic business is very profitable due to the winner-takes-all nature of online classifieds and pricing power resulting from the network effect or virtuous circle, where more listings attract more page visits, which attract more listings. Over time these network effects are self-reinforcing and so are very difficult for competitors to replicate or disrupt.
SEEK International aims to replicate the domestic success in emerging markets with large populations and low internet penetration, where the migration of advertising from print to online should accelerate. SEK now operates in 14 countries with an addressable population of nearly 3 billion and internet penetration below 40%, around half the rate in Australia.
We think SEK is worth $13.50 next year. Including dividends this implies a 15% forward return at a $12 share price. The 2015 result was quite sound but management’s 2016 earnings forecast was subdued as SEK invests heavily in areas with longer-term payoffs. This short-term disappointment has created an opportunity in a successful growth company with management we admire.
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Figures correct at time of writing.
Disclosures: Clime Asset Management owns CWN, CBA, CPU, DSH and SEK on behalf of various mandates where it acts as an investment manager. Senior Analyst and author of report, David Walker owns shares in CBA, CPU, DSH and SEK.