Sweet Spot Stocks: Telecoms Prove Their Mettle

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By Rudi Filapek-Vandyck, Editor FNArena

Three types of Australian listed stocks have proved an absolute boon for loyal shareholders and investors in the post-2008 era: reliable dividend payers such as Telstra ((TLS)) and the Big Four Banks, All-Weather Performers such as Woolworths ((WOW)), Amcor ((AMC)) and CSL ((CSL)) and stocks experiencing an operational sweet spot, generating strong profits and shareholder returns along the way.

All three categories have one key characteristic in common: they are able to generate satisfactory returns even when risk appetite retreats or economic momentum wanes. Last week, we opened this new series with an inaugural update on All-Weather Performers, see story "All-Weather Stocks: MND And BKL In The Red". This week we take a look into stocks we think are experiencing an operational sweet spot. Note that we intend to make this an interactive exercise: readers are encouraged to nominate stocks they believe should be added to our updates. Send your nominations to info@fnarena.com and we will follow up and consider.

At the basis of all this lays my research since late 2007 which earlier this year led to the publication of "Make Risk Your Friend. Finding All-Weather Performers", an eBooklet which to date is exclusively available to paying FNArena subscribers (if you haven't received your copy as yet, send an email to info@fnarena.com).

The eBooklet argues that successful investing is closely correlated to minimising and managing risk. Hopefully the framework we are creating with these regular updates will assist subscribers in executing successful, long term investment strategies.

Next week we will zoom in on sustainable dividend payers.

It has to be pointed out that no company, regardless of its quality or credentials, can ever claim 100% immunity from hardship or headwinds. But some companies can take an unexpected kick against their shins much better than others. Probably the best example was this week provided by Breville Group ((BGR)), which had been explicitly named as a Sweet Spot Stock in the eBooklet.

Breville Group shares put in an ab-so-lu-te cracker of a performance throughout calendar 2012, but this year the going has proved a little tougher because of the pending loss of a distribution agreement with Keurig in the Canadian market. Investors don't like negative surprises, even when it's not management's fault, and the share price has been re-set at a lower trading range than where the shares started at the beginning of the year.

However, ask most brokers that cover the stock and none of them sees more than a temporary setback for what remains one of the stronger growth stories in the Australian manufacturing space. Because of the share price re-set, the dividend yield has jumped to 4.9%. Alas, because of the loss of the Canadian sales next year, reported group profits are expected to suffer, that year, and thus it is more likely than not there won't be an increase in dividends next year. Underlying sentiment is expected to remain supportive though as most analysts (if not all of them) remain of the view that this company still has plenty more years of strong growth ahead.

Breville Group is missing from today's list of selected Sweet Spot Stocks (maybe we should create a bench stocks can "come off" or be "sent to" – something to consider before the next update) but on the list are telecommunication companies Amcom Telecom ((AMM)) and iiNet ((IIN)) and it is only because of our own oversight that the list does not also include TPG Telecom ((TPM)) and M2 Telecommunications ((MTU)). Clearly, the telecom sector is experiencing a purple patch ahead of the federal government sanctioned National Broadband Network (NBN) roll-out in Australia and this week's reported results and announced acquisitions in the sector once again proved just that.

Here's an easy to make observation: companies that are enjoying the wind in the sales find it much easier to report positive surprises, all else being equal. Otherwise, it's not a genuine failure when expectations are very high and the result misses by an inch; the market won't ignore the fact that the result was still solid and strong. The same conclusions applied this week as did during the February reporting season. We will make a mental note to also add TPG Telecom and M2 Telecom to our list by the next update.
 

We published two stories on the sector this week that may be of particular interest:

– TPG Rings Up Strong Subscriber Growth

– M2 Telecom Acquires Businesses And Risk

Meanwhile, take a look at what has been happening to the share price of Ainsworth Gaming ((AGI)); the company is staring at a breather this year with profit growth anticipated to turn negative, but investors have so far put a firm bid under the share price. Market logic? Maybe confidence in FY14's resumption of growth is too high to allow the share price to become genuinely cheap at this stage?

Another high-flyer so far this year is Collection House ((CLH)) but then double-digit profit increases are anticipated to remain on the menu. Most performances for the stocks on the list look pretty impressive. ResMed ((RMD)) shares have been rejected at the $4.60 price level. There's some chatter in certain corners that margins might come under pressure because of changing market dynamics in the US. Certainly something to keep an eye on.

Otherwise, spare a few moments to admire the performance of Technology One ((TNE)) shares post 2008. Readers, this is an IT stock! While nobody was paying attention, Technology One has become the benchmark for consistent performance in the Australian IT sector. A Price-Earnings ratio of 20 suggests investors are looking over their shoulders when making investment decisions this year. Share price performance thus far beats the index in 2013 but profit growth is expected to remain at low double-digits in the years ahead.

Maybe what Technology One shares are suggesting is that the main danger for known and proven performers in the Australian share market is the fact that valuations can run up too far? Wesfarmers ((WES)) is probably another example of this (equally on a PE of 20 but with a slower growth profile).

Attached is a file (see top of this story) with share price performances for 13 stocks which we believe deserve to carry the label "In The Sweet Spot". The list will be a little longer by the time we publish the next update. You can nominate your own candidates via info@fnarena.com

If you do download the file: the first row of data for each company is the share price at the start of each calendar year, the second row is the difference with the previous year's share price in percentage terms. So no dividends are included and each percentage thus refers to the share price performance in the previous year. All this remains very much work in progress and we intend to add, amend, expand and refine in future updates.

All feedback welcome at info@fnarena.com or via Editor Direct on the website.

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