Rudi’s View: Helia, Hub24, Judo, QBE, ResMed, Santos, Telstra & Xero

This story features AUDINATE GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: AD8

In this week's Weekly Insights:

-Healthy Health, Wealthy Wealth
-August Results: Early Observations
-Conviction Calls and Best Ideas
-FNArena Talks (2x)

By Rudi Filapek-Vandyck, Editor

Healthy Health, Wealthy Wealth

Higher bond yields and a tougher economic outlook have directed the market's attention to corporate vulnerabilities that previously were hardly ever mentioned.

Think balance sheet and debt; profitability and margins; and asset valuations.

This is why companies like Audinate Group ((AD8)), Megaport ((MP1)), SiteMinder ((SDR)), and Xero ((XRO)) are now being judged on their ability to achieve net positive cash flow, and accountancy profits.

This is also why most REITs listed on the ASX (and elsewhere) are trading at a notable discount to their intrinsic valuation; the market fears too much debt, as well as asset devaluations, and prefers to play it safe.

This also explains why share prices for companies like Amcor ((AMC)) and Ramsay Health Care ((RHC)) seem to be bereft of any sustainable positive momentum, despite the market overall putting in its best efforts this year. Both have paid past acquisitions with significant debt and the market simply likes to play it safe.

Incidentally, both Amcor and Ramsay Health Care also disappointed with their post-covid recovery, which doesn't help either.

In the share market, the most obvious, and most damaging expression of the toughening conditions for companies is through corporate failures. On Stock Doctor's number crunching, the ASX recorded 19 corporate failures throughout FY23; a big increase from the 8 failures in the financial year prior.

The list below is not confined to a particular industry. The common denominators are a small market capitalisation and a not so healthy business overall.

Viewed from a longer-term, broad perspective, the FY23 rate of failures doesn't seem that alarming, but these are slow-moving, elongated processes. Businesses don't die on a whim; inherent weaknesses can be masked and ignored for quite a while.

The below history of corporate failures in Australia goes back to 2000. One can clearly see how recessions and challenging economic times in 2000 and 2008 were followed up by higher rates of failures in the subsequent years.

Exceptional support from central banks and governments have kept the numbers well-below average post-2020, but conditions are now changing rapidly.

With the bulk of RBA rate hikes yet to hit the domestic economy, banks adopting a better-safe-than-sorry policy, and with bond yields likely to stay higher for longer, it seems but logical, and prudent, to expect history to repeat. This implies FY23's number of corporate failures will be broken to the upside in the years following.

For most investors this is one potential risk that doesn't genuinely feature. The list of 19 failures throughout the year past only contains a few companies that, on my observation, might have realistically appealed to a broad audience in recent years.

Wellness and beauty retailer BWX Ltd is the obvious one. Up until 2021 the company received plenty of media attention and many households might be regular buyers of Sukin or Andalou Naturals products. Others that might have proven a devastating value trap for the unsuspecting investor are Analytica, Hills Ltd, Openpay Group, and Red River Resources.

Don't think many among us would've even heard of the majority of those 19 failures. In this context: that's a good thing. As risk-aware guardians of our nest eggs and future retirement guarantee, we don't want any exposure to this high-risky end of the investment universe.

The prospect of further deteriorating financial health of corporate Australia is backed up by number-crunching and ongoing financial analysis by Stock Doctor on whose assessment nearly 78% of listed ASX-companies can be labeled as "financially unhealthy". This only leaves 22% as "financially strong" and "satisfactory".

The current percentage is some 5% above Stock Doctor's long term average assessment. It is likely today's percentage will continue to climb as companies are facing toughening conditions.

Stock Doctor's financial health analysis also reveals another reason why investors should pay attention: over time, shares backed by companies with "strong" health outperform those with weaker health. The table below shows the outperformance of the "strong" category since 1st January 2002 and up until October last year.

With a twenty-year average annual return of 11.6% companies of strong financial health significantly distance themselves from "satisfactory" and all other categories of weaker health.

A few examples: Amcor is currently seen as a marginally healthy company, while early warnings have been noted for Fletcher Building ((FBU)), with IPH Ltd ((IPH)) categorised as in distress. Examples of financially healthy companies include WiseTech Global ((WTC)) and Helia Group ((HLI)).

Stock Doctor's analysis covers circa 1800 ASX-listed companies with the remainder excluded due to not meeting the sufficient liquidity requirement. Its financial health assessment as per 1 July 2023 is shown below.

August Results: Early Observations

Overall, confession season in Australia has made a come-back, but it's been a rather mildly negative experience with a rare profit warning from quality large cap CSL ((CSL)) probably the stand-out. Earnings estimates have been sliding downwards generally, but mostly due to disappointments and deteriorating outlooks for mining companies.

Early indications are nevertheless that investors will have to be prepared for more negative consequences from higher interest rates and a more challenging operating environment.

Examples include credit provider Solvar ((SVR)) reporting an 81% increase in interest costs, engineering firm Downer EDI ((DOW)) announcing a -$550m impairment and CommBank ((CBA)) flagging a -$212m pre-tax provision in relationship to the BankWest transition.

Landlord BWP Trust ((BWP)) lost some -$131m through the devaluation of its properties, while credit collector Credit Corp ((CCP)) observed an increase in US payment plan delinquencies.

As to why exactly shares in ResMed ((RMD)) needed to be sold down in excess of -14% in the two days since releasing Q4 financials is not at all clear to me, for a quarterly outcome that merely missed by -5% on what might well turn out a temporary setback for the gross margin.

If I had to take a stab in the dark, I suspect quite a number of market participants had positioned themselves for a positive surprise, as overall optimism among analysts had only grown in the months past, but disappointment ensued and thus those trades have been quickly unwound, at a loss.

Similar to CSL previously, the FNArena/Vested Equities All-Weather Model Portfolio has grabbed the opportunity to purchase additional shares in ResMed.

For Australian banks in general no meaningful credit concerns are expected to show up in August, or later on in 2023.

In-house predictions made at Ord Minnett see 47% of company reports in August reflecting a positive outlook, with negative outlooks expected for 17% of companies and the remaining 36% on neutral.

All shall be revealed from this week onwards, but more realistically throughout the final two weeks of the month.

Starting tomorrow, the FNArena Corporate Results Monitor will be updated daily: https://www.fnarena.com/index.php/reporting_season/

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More on the upcoming August results season in Australia:

–https://www.fnarena.com/index.php/2023/08/02/rudis-view-awaiting-the-august-verdict/

–https://www.fnarena.com/index.php/2023/07/26/rudis-view-arb-corporate-travel-goodman-group-nextdc-orora-worley-xero/

–https://www.fnarena.com/index.php/2023/07/19/rudis-view-low-expectations-not-low-enough/

–https://www.fnarena.com/index.php/2023/07/12/rudis-view-fy23-returns-details-matter/

Conviction Calls and Best Ideas

Quant analysts at UBS have access to proprietary data on market positioning by hedge funds and institutional investors in Australia. This, so the narrative goes, allows them to assess when trades become overcrowded.

Applying their insights, and experience, with regards to the upcoming August results season, has delivered the following:

Most long crowded long side list:

-Helia Group
-McMillan Shakespeare ((MMS))
-APA Group ((APA))
-QBE Insurance ((QBE))
-CSR ((CSR))

Most short crowded short side stock list:

-Core Lithium ((CXO))
-ARB Corp ((ARB))
-Sayona Mining ((SYA))
-Wesfarmers ((WES))
-Ingenia Communities Group ((INA))

The general idea is that the first group might fail to perform positively, since those ideas might now be too overcrowded already, while the second group could see shorters scrambling to save their bacon, pushing the share price up significantly in the process.

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Morgan Stanley also has a quant team, and their special tool is called "composite earnings sentiment indicator", shortcut CeSI. Screening for positive and negative surprises ahead of results releases has generated a hit rate of no less than 87%, reports the team.

And thus…

Seemingly poised for positive surprise this month, and not rated badly by the fundamental analysts, are: Goodman Group ((GMG)), Iluka Resources ((ILU)), James Hardie ((JHX)), nib Holdings ((NHF)), Origin Energy ((ORG)), Sonic Healthcare ((SHL)), Santos ((STO)), Suncorp Group ((SUN)), and The Lottery Corp ((TLC)).

At danger for releasing the next disappointment are: Ansell ((ANN)), ASX ((ASX)), Bank of Queensland ((BOQ)), Cochlear ((COH)), Endeavour Group ((EDV)), Fortescue Metals ((FMG)), Harvey Norman ((HVN)), JB Hi-Fi ((JBH)), Mineral Resources ((MIN)), and Ramsay Health Care.

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Some portfolio management of the Focus Portfolio at Wilsons has seen exposures trimmed to Pinnacle Investment Management ((PNI)) and Cleanaway Waste Management ((CWY)) in order to purchase additional shares in ANZ Bank ((ANZ)) and Westpac ((WBC)).

The Portfolio remains Underweight the local banking sector as Wilsons continues to see margin pressures ahead. Pinnacle Investment Management has been removed from the Portfolio. A decent exposure to the China stimulus theme is kept through mining companies.

With an emphasis on earnings resilience and corporate quality, the Portfolio's holdings include APA Group, Aristocrat Leisure ((ALL)), CSL, Goodman Group, The Lottery Corp, Macquarie Group ((MQG)), Netwealth Group ((NWL)), NextDC ((NXT)), ResMed, Telstra ((TLS)), and Xero.

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Morgan Stanley's Australia Macro+ Focus List last experienced any changes to its composition in late January.

The ten stocks included are:

-Aristocrat Leisure
-CSL
-Goodman Group
-IDP Education ((IEL))
-Macquarie Group
-Northern Star Resources ((NST))
-Rio Tinto ((RIO))
-Suncorp Group
-Telstra
-Treasury Wine Estates ((TWE))

Noted: after Citi put the Australian share market in the Underweight basket recently, global asset allocators at Morgan Stanley have followed their example and downgraded Australia to Underweight last week.

As the analysts explain, Australia is now ranked 22nd of 27 global markets as earnings remain in a downgrade cycle and with valuations generally seen as "expensive".

A further deterrent is the prospect of downward pressure on bulk commodity prices as Morgan Stanley sees oversupply looming in the current half.

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Quants at Macquarie note a basket of stocks with high short interest can outperform during results season as stocks with the highest short interest usually prove a good contrarian indicator.

As such, the broker mentions Pilbara Minerals ((PLS)), Mineral Resources and Endeavour Group inside the ASX50, IDP Education, Harvey Norman and Domino's Pizza ((DMP)) inside the MidCap50, and Boral ((BLD)), Core Lithium ((CXO)) and Maas Group Holdings ((MGH)) among small caps.

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Analysts at Goldman Sachs have selected the following names for a potential positive surprise this season:

-Capitol Health ((CAJ))
-Data#3 ((DTL))
-Endeavour Group
-Judo Capital Holdings ((JDO))
-Megaport
-Qantas Airways ((QAN))
-QBE Insurance
-Santos
-Woolworths ((WOW))

Have been nominated for potential disappointment:

-Altium ((ALU))
-Challenger ((CGF))
-Maas Group
-Monadelphous ((MND))
-Nanosonics ((NAN))
-Pilbara Minerals
-Seek ((SEK))

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Specifically for Australian financials ex-banks, UBS' sector analysts are anticipating positive news from private health insurers, from insurance brokers, as well as from Computershare ((CPU)), Suncorp Group, Hub24 ((HUB)), GQG Partners ((GQG)) and Magellan Financial ((MFG)).

The analysts are bracing for potential disappointment from AMP ((AMP)), ASX, Insurance Australia Group ((IAG)), Challenger, Perpetual ((PPT)) and Platinum Asset Management ((PTM)).

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Fund manager DNR Capital has turned more positive on small cap opportunities now that earnings expectations are being wound back and many a share price is left looking attractive with a medium to longer term view.

Investors still need to remain selective and conscious of ongoing risks, according to DNR Capital with the fund manager recently adding Lovisa Holdings ((LOV)) and Breville Group ((BRG)) to its portfolio.

The fund is reducing exposure to the local mining sector.

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Morningstar's list of Best Ideas for ASX-listed companies has undergone three changes from last month, when the list was updated last. Out went WiseTech Global and AGL Energy ((AGL)) while the ASX has been added post a net negative share price performance year-to-date.

Morningstar's Best Ideas for Australia and New Zealand now comprise of 13 companies, with the following retaining their inclusion:

-A2 Milk Co ((A2M))
-Aurizon Holdings ((AZJ))
-Bapcor ((BAP))
-Fineos Corp ((FCL))
-Kogan.com ((KGN))
-Lendlease ((LLC))
-Newcrest Mining ((NCM))
-ResMed
-Santos
-TPG Telecom ((TPG))
-Ventia Services Group ((VNT))
-Westpac

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Technology analysts at Citi have nominated their three favourites for the sector locally: Carsales ((CAR)), NextDC and Xero.

FNArena Talks (2x)

1.) Your Editor participated in The Australian's James Kirby's podcast The Money Puzzle last week, discussing the local share market, healthcare stocks and ASX exposure to artificial intelligence (AI).

This podcast can be accessed through multiple channels. Here's one: https://bit.ly/3s230CP

2.) The tradition of a pre-results season interview by Livewire Markets remains in place. The interview went live today (Monday). FNArena will publish the interview in writing later this week.

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 7th August, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: contact us via the direct messaging system on the website).

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