Is It Time To Switch Back to Defensives?

Array
(
    [0] => Array
        (
            [0] => ((WOW))
            [1] => ((CSL))
            [2] => ((SHL))
            [3] => ((RMD))
            [4] => ((TLS))
            [5] => ((FGL))
            [6] => ((AGK))
        )

    [1] => Array
        (
            [0] => WOW
            [1] => CSL
            [2] => SHL
            [3] => RMD
            [4] => TLS
            [5] => FGL
            [6] => AGK
        )

)

This story features WOOLWORTHS GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: WOW
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Andrew Nelson

Since the market recovery started back in March, Australian bank shares have been among the front runners as they first strove to claw back their early GFC losses and then moved higher as investors cottoned on to the returning stability of the sector. A few months into the recovery and commodity stocks also started to outpace the broader market as underlying commodity prices started to bounce back.

The trouble that started a year and a half ago meant the best place to be for a long time was defensive stocks. However, as the recovery progressed, so too did cyclical stocks recover. Yet while the cyclicals were enjoying their day in the sun, defensive stocks continued to lag the market and an increasing value gap started to open up. That brings us to where we are today.

Analysts from Deutsche Bank are now eyeing that value gap, while at the same time noting there is a growing sense among many in the market that the best value on offer in the Australian share market is once again among the” loosely-termed” industrial stocks.

The broker believes this is more than understandable given investors are now looking at stocks like Woolworths ((WOW)), CSL ((CSL)), Sonic ((SHL)) and Resmed ((RMD)), which were some of the impressive growth stocks of the decade, but are now trading closer to market multiples. Meanwhile, other big label stocks like Telstra ((TLS)), Fosters ((FGL)) and AGL ((AGK)) are trading on some very modest PEs, the broker points out.

The defensives have begun to outperform at least a little in the past month or so, and can be considered something of a contrarian strategy. Deutsche explains that the economic recovery that seems to be building up stream will be an inarguable boon to defensives, while the recovery is seen by many as being already largely priced into cyclical stocks.

Defensive stocks are generally trading on considerably lower multiples than what has been “normal” in the past. However, while the decline in multiples for the defensive stocks has been laid at the feet of the financial crisis, the broker feels that other factors have also weighed, and thus combined, these issues have equally contributed to the general decline in growth prospects for the defensives. While the broker admits that it is somewhat coincidental that this has happened across different stocks at more or less the same time, it still believes that it was more than just the GFC that caused the lower earnings growth forecasts over the medium term.

For some of the healthcare stocks, growth prospects have slowed because of a general maturing of  markets. Woolworths is struggling with the perception of increased competition in food retailing. Telstra, Tabcorp and Tatts are struggling with regulatory changes and the potentially scary impact this could have on future earnings.

So is it time to switch? Deutsche Bank thinks: Not yet.

While noting the points above, the broker believes that a good part of the de-rating of many of the defensive stocks has at least something to do with structural issues. Thus, when the broker compares the multiples with the lower growth forecasts that are on the cards, it just doesn’t find as much value in defensive stocks yet.

Deutsche admits that prospects will evolve and growth could be upgraded again, but in the near-term, it still sees cyclical stocks as offering better value. The broker especially likes sectors such as transport, general retailing, media and construction, where forecast earnings growth is generally higher than it was in the earlier part of this decade.

This may be partly due to the current economic recovery, but the broker also notes that right now, these sectors are simply carrying far fewer structural issues.

Click to view our Glossary of Financial Terms