Rudi’s View: Shaky Sentiment Ahead Of Corporate Updates

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In this week's Weekly Insights:

-Shaky Sentiment Ahead Of Corporate Updates
-Everybody's A Gold Bull
-Best Buys & Conviction Calls

By Rudi Filapek-Vandyck, Editor

Shaky Sentiment Ahead Of Corporate Updates

Analysts at Morgan Stanley made a big hullabaloo about it, as would I if ever I came to walk in their shoes, with early market leadership in Generative AI now projected to result in Microsoft doubling its earnings per share by FY29.

Let's pause for a few seconds and think about this a little longer. Microsoft, one of the largest companies of our time, generating some US$244bn in annual revenues, of which US$107bn ends up as operating income, with free cash flow estimated in excess of US$63bn, is set to double its profits for shareholders over the next five years.

For the mathematically gifted among us, doubling profits in five years requires a cumulative annual growth rate (CAGR) of circa 14.87% per year. Morgan Stanley's recently updated projections are actually above that with revenues expected to grow at a CAGR of 14% and EPS at 16% per annum.

Hence, to be precise about this: Microsoft is projected to MORE than double its EPS in the next five years.

There are multiple reasons why I bring this up.

With bond yields rethinking the pace and starting date for Fed rate cuts, and geopolitical tensions lifting, the natural response from most investors is to sell exposure to equity markets that are being perceived as too 'expensive'.

It's good to be reminded that if the above projections prove accurate in the years ahead, Microsoft shares will be trending a whole lot higher than where they are today.

No doubt, were Risk-Off sentiment to dominate in the days or even weeks ahead, Microsoft shares will likely weaken, maybe even weaken a lot, but should this be our only and key focus? The world will be a very dark place for this company to not grow at all from here onward.

In Australia, analysts at Macquarie recently published similar forecasts for leading biotech CSL ((CSL)) with a five-year EPS CAGR projection of 15% per annum which, you guessed it already, implies that company's EPS should more than double by FY29. Little surprise thus, Macquarie thinks CSL's share price could well reach $500 in three years' time from around $280 now.

To the sceptics out there, would it really be such a great disaster if these companies only grew by, say, 12% per annum? Or if those anticipated rate cuts come in fewer doses and later than expected? When a fresh growth driver announces itself, investors tend to significantly underestimate the impact on well-positioned beneficiaries.

We all get drawn in by risks and developments in the here and now, but keeping a broad perspective is imperative if our aim is to be a successful investor long term.

These projections equally shine a light on the ongoing opportunities that remain with large cap companies, both in the US as on the ASX. This equally serves as a timely reminder when all and sundry are looking for the next ten-bagger in the small cap space.

It is also one key reason as to why I am not joining the chorus of nervous nellies on the sidelines who keep using terms such as 'bubble' and 'excessively priced equities'. Putting a valuation on listed companies goes well beyond referencing a generic PE ratio.

In Australia, mid-cap IT services provider TechnologyOne ((TNE)) has managed to double in size every five years for circa two decades now. I remember back in 2022, one fund manager published an extensive expose as to why, at $10, there was no chance in hell investors would see a profitable return from their shares.

The arguments put forward read very convincingly.

That share price surpassed the $17 mark last month; 70% above where any further upside was considered negligible. Management at TechOne continues to express confidence the business will yet again double over five years.

Has there been volatility in the share price in between? You bet! But volatility, no matter how scary in the short term, is beyond anyone's control and ultimately it is just that. It is also what provides the better entry points for those investors not yet on board or that like to top up their exposure.

Aussie Banks – The Debate Is Raging

Having said all of the above, investors should never be afraid to question the appropriateness of share prices and asset valuations. Plenty of examples around of share prices that once were trading on much higher levels, never to be seen again.

The key debate in Australia is once again surrounding the local banks. With share prices rallying by double digit percentages, and CommBank ((CBA)) shares posting an all-time record high above $120, the public debate is yet again zooming in on bank share prices and whether the sector's de-coupling from wobbly-looking fundamentals is a bridge too far, or doesn't have to be.

On current forecasts set by most analysts covering the sector, margins will likely remain under pressure for longer and loyal shareholders should not expect anything spectacular in terms of further increases to dividends. Some analysts, it has to be said, are toying with the idea that dividends won't increase at all, possibly for two years in a row, with risk of small decreases.

The reason as to why share prices have rallied hard is usually framed through index-buying (ETFs and the like) while safe-haven seekers in Asia, China in particular, might have contributed as well. The prospect of RBA rate cuts and ongoing buoyancy in the local property market are oft cited as supportive factors as well.

Traditionally, I regard Aussie banks, the Four Majors in particular, as an obvious barometer for investor sentiment and the recent months have again played to that script.

Whatever the reasons, most strategists at the brokerages that dominate investor fund flows for the local share market are negatively disposed towards the sector. If it's not because valuations are seen as 'bloated', and undeservedly so, the reason cited are questionable fundamentals, if not a soggy outlook with only a tepid recovery expected for next year.

One notable exception are analysts at Morningstar who seem to have adopted the view that, by the time the dust has settled regarding household budgets stress, cost inflation, and RBA rate cuts, Australian banks will likely prove relatively resilient, and thus reasonably okay.

No doom scenarios from mortgage arrears or bad debts should be expected, and with the demand for credit continuing to grow, and competition to lessen, net interest margins should bottom soon and start trending upwards again, predicts Morningstar.

The other side of the argument this time around is put forward by veteran Jonathan Mott, once revered at UBS and nowadays continuing sector analysis at Barrenjoey, and his team.

Mott's analysis should be compulsory reading for every investor whose portfolio has a large exposure to the local banks. If Mott's analysis proves correct, bank share prices will, longer term, trend in the opposite direction of the Microsofts in this world, as they (ex-CBA) have done post GFC.

The key thesis put forward is banks have increasingly scaled back risk-taking and this is reflected throughout their operations. Mortgages are heavily skewed towards wealthier households, small businesses without property ownership (collateral) are largely ignored, mortgages are predominantly sold through external broker networks.

The result is banks in Australia are increasingly looking like each other's copy-cats, with competition for growth and market share essentially coming down to 'price' in a commoditised market for lower-risk loans. This is, essentially, the road to nowhere for the sector, and if things don't change in the foreseeable future, the research states bank dividends are at risk of becoming unsustainable.

Bank of Queensland ((BOQ)) will open the results season for the local sector on Wednesday this week, with three of the Majors — ANZ Bank ((ANZ)), National Australia Bank ((NAB)), and Westpac ((WBC)) — to follow suit in the following weeks.

I doubt whether the debate will swing decisively either way with these upcoming financial updates, but each release has the potential to become a catalyst either way, both for the sector as for the local share market generally.

Local Quarterlies

Outside of the local banks, the weeks ahead will offer investors plenty of fresh market updates to digest. Not only are commodity producers lining up to reveal quarterly production achievements, companies including Hub24 ((HUB)), Block ((SQ2)), Amcor ((AMC)), Brambles ((BXB)), Goodman Group ((GMG)), Macquarie Group ((MQG)), Newmont Corp ((NEM)), and ResMed ((RMD)) will be releasing quarterly updates.

As shown by Netwealth Group ((NWL)) last week, simply releasing a strong set of financial data might not suffice in the current nervous environment. At least not for the short term. Netwealth shares have remained under pressure even though most analysts believe the quarterly update yet again marked another "strong" performance.

At least half of all analysts covering the company believe the share price looks too highly priced, which might well be the reason why. In sympathy with Netwealth, Hub24 shares are now under pressure too.

Both financial platform operators have grown strongly throughout the decade past, and they are still expected to continue to expand their market share and grow strongly in the years ahead.

Goodman Group's next market update is scheduled for May 8. Analysts at Citi, who've become very supportive, are anticipating more robust data, potentially with an earnings guidance upgrade for FY24.

As far as those commodity production updates are concerned, the coming weeks are likely to see weather impacts, capex updates, including cost overruns and delayed time-schedules, and possibly more news on asset sales and M&A activity too.

In many cases, including for Rio Tinto ((RIO)), Santos ((STO)) and Woodside Energy ((WDS)), production volumes are expected to have shrunk during the March quarter, which leaves realised prices and cost management as the obvious catalysts in the short term, as well as guidance for the months ahead.

The most important market updates might well occur in the US where the March quarterly reporting season is now underway. This week sees 41 companies, representing 8.5% of the S&P500 market capitalisation releasing financial updates, including the likes of Johnson & Johnson, United Airlines, Travelers, D.R. Hortons, and Procter & Gamble.

As much as we like the local share market to take guidance from local updates, the outcomes and signals from those releases might prove all-important, against a background of shaky Fed policy expectations and ongoing risk for an all-out war in the Middle East.

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More reading:

–https://fnarena.com/index.php/2024/04/10/rudis-view-lessons-observations-from-asx-all-weathers/

–https://fnarena.com/index.php/2024/04/04/rudis-view-in-search-of-the-holy-grail/

Everybody's A Gold Bull

With geopolitical tensions rising markedly, it appears every financial markets commentator has turned into a gold bull in April.

The continued promise of central bankers delivering rate cuts, the strong buying activity from central banks, and the absence thus far from financial institutions and speculators is keeping optimism alive for gold to visit higher price levels throughout the months ahead.

There's the added observation most share prices of gold producers the world around are still lagging bullion's performance to date. There's also the realisation gold's move might have been too rapid in the short term, risking a short-term retreat on technically overbought readings.

One additional reason as to why investors might be enticed to own exposure to gold was provided recently by Charles Gave of research house GaveKal.

Comparing the price of gold bullion with US equities (and corporate earnings and dividends) through the S&P500 index, Gave concludes the index is currently some 33% above its long-term trend, leaving gold extremely undervalued. On Gave's estimations, gold could well be undervalued by -52% against the index and by -13% against its own long-term trend level.

Also throwing energy in the mix, Gave recalls the three assets tend to converge over time and the last time this occurred was in 2015. Since then, the three have diverged noticeably. Gave's argument is: convergence shall happen yet again. The only question is: when exactly?

Oil, like gold, is seen as cheaply priced. US equities are on the opposite side of the spectrum. Gave suspects convergence will occur through oil prices rising (and US equities falling in response).

Investors who genuinely are of the intent to benefit from the upcoming convergence are advised to allocate at least 20% of their portfolio to gold.

Best Buys & Conviction Calls

It's not necessarily what analysts and market strategists had in mind last month and earlier in April, but share prices generally have come under pressure following a solid three months opening of calendar 2024, and commodities and related share prices are functioning as 'defensives'.

A number of research houses had been publishing their sector favourites and conviction calls. Below is a brief overview.

The Global Mining Best Ideas as compiled by sector analysts at RBC Capital has seen the withdrawal of gold miner Northern Star ((NST)).

RBC analysts remain positive on base metals, energy, precious metals, and uranium.

Looking specifically for ASX-listed exposures, we spotted the continued inclusion of Champion Iron ((CIA)), De Grey Mining ((DEG)), Sandfire Resources ((SFR)), and Pilbara Minerals ((PLS)).

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Mining sector analysts at Morgan Stanley have equally rolled out their most preferred exposures across the globe.

Specifically zooming in on ASX-listed companies, their selection includes Rio Tinto ((RIO)) and South32 ((S32)).

Morgan Stanley has also released a list of Least Preferred exposures, which contains no ASX-listed inclusions.

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In back-up of a positive view on the outlook for copper prices, analysts at Citi explained diversified conglomerate BHP Group ((BHP)) is blessed with the largest leverage to copper in FY24, while offshoot South32 has the largest leverage to base metals generally by FY28.

Rio Tinto's base metals exposure through copper and aluminium is projected to handsomely beat BHP's exposure through copper and nickel by FY28.

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Evans and Partners has kept Beach Energy ((BPT)) as its Number One pick among local energy companies.

The sector generally is seen to be undervalued and underappreciated and thus shares in Santos and Woodside Energy are considered poised for a catch-up.

Wilsons is equally positive about the ASX-listed energy sector, with a preference for Woodside shares.

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Market strategists at Wilsons have been trimming portfolio exposures to global larger cap growth stocks.

Locally they've added Breville Group ((BRG)) and Webjet ((WEB)) to a tiny selection of Most Preferred Direct Equities. Both additions have been labelled "quality cyclicals" carried by Wilsons' belief the local earnings cycle is set to improve from FY25 onwards.

The list only contains three other inclusions: Aristocrat Leisure ((ALL)), Collins Foods ((CKF)), and IDP Education ((IEL)).

Wilsons analysts do offer a number of other ideas, with Beach Energy and Liontown Resources ((LTR)) put forward in the local Resources space, and with biotechs Immutep ((IMM)) and Clarity Pharmaceuticals ((CU6)) as 'speculative ideas'.

Wilsons has identified six quality growth companies that are still worth considering adding to the portfolio:

-Ridley Corp ((RIC))
-TechnologyOne
-Universal Stores ((UNI))
-ARB Corp ((ARB))
-Neuren Pharmaceuticals ((NEU))
-Pinnacle Investment Management ((PNI))

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Retail sector analysts at Jarden believe the market is underestimating the likely pace of consumer spending in FY25, following tax cuts and RBA loosening.

But there's more to take into account for investors, as competition in certain categories is heating up, and operational costs remain high, while some retailers will be forced to step up investment in customer loyalty, data, and supply chains.

Investors are advised to seek out those retailers that have (international) expansion plans, have the luxury of a long runway of growth ahead of them, and maybe even with the prospect of ROIC (return on invested capital) improving.

Jarden favours Flight Centre ((FLT)), Helloworld ((HLO)), Webjet, Temple & Webster ((TPW)), Lovisa Holdings ((LOV)), The Reject Shop ((TRS)), and Domino's Pizza ((DMP)).

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(This story was written on Monday, 15th April, 2024. 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.

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