Treasure Chest: Brokers Update Conviction Calls

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By Greg Peel

In a general sense, a broker’s “conviction list” represents a selection of stocks for which analysts have a greater conviction in their recommendation beyond simply a Buy or Sell rating. Individually, brokers approach their conviction list allocations using different parameters.

BA-Merrill Lynch has now taken up the conviction list theme by introducing a quarterly “favourite ideas” selection.

Merrills’ Australian retail team is structured around five “super sectors” within the market, which combine the more numerous general sectors. The super sectors are consumer, basic materials, interest rate sensitive, resources/energy, and transport/utilities, representing a pool of 188 stocks. The team looks at the stocks within these sectors from both the equity strategy (top-down, macro) perspective and the stock analysis (bottom-up, micro) perspective and determines where those two approaches align to provide a more emphatic recommendation. Top-down and bottom-up analysis does not always concur. Using this approach, Merrills has come up with five stocks which are branded “favourite ideas”, explained as follows:

Investors are demanding high yield property exposure, and that puts Lend Lease ((LLC)) in the frame. As Qantas ((QAN)) undergoes a structural change, a return to break-even for International and an easing of the Domestic war should make the airline’s 30% discount to Asian peers look overdone. Rio Tinto ((RIO)) is the best value proposition of the big cap miners. Treasury Wine Estate ((TWE)) is in “excellent shape” since its divorce from Foster’s beer and well placed for a long cycle back up in wine. WorleyParsons ((WOR)) is in a strong position to benefit from further oil & gas capex as economic conditions improve and new energy sources are monetised.

Merrills’ total shareholder return forecasts (12 months) for each of these stocks are LLC 9%, QAN 25%, RIO 48%, TWE 75% and WOR 25%.

Goldman Sachs has maintained a long-running conviction list, which the broker calls its Conviction List (A&NZ). The analysts have now added National Bank ((NAB)) to the list given an above-peer growth profile and ResMed ((RMD)) due to volume and margin growth and capital management.

Those stocks join Asciano ((AIO)), Air New Zealand ((AIZ)), Ausbroker Holdings ((AUB)), Fonterra Shareholders Fund ((FSF)), Guinness Peat ((GPG)), Infratil ((IFZ)), Mirvac ((MGR)), OceanaGold ((OGC)), Orica ((ORI)), Oil Search ((OSH)), Santos ((STO)), Wesfarmers ((WES)) and Westfield Retail Trust ((WRT)) as Buy convictions and Western Areas ((WSA)) as a Sell conviction.

Credit Suisse’s quant boffins have been locked in the basement, closely examining Australia’s (and the world’s) current obsession with yield. Defensive stocks, banks and REITs are all being bid up on their superior yields but the quant team warns it’s not a good idea to confuse yield for yield sake with quality.

Quality factors come to the fore from a contrarian stand point when global growth is looking wobbly, Credit Suisse notes, and that’s where we are now. Value becomes a theme when prices have been knocked down but is not worth pursuing when companies are deleveraging. The recent inversion in the Australian yield curve suggests, says CS, that the RBA has fallen behind the curve again and thus there is more corporate deleveraging to come. The value factor is thus now dependent on RBA policy.

The quant team believes defensives are still the right horses to back and not so resources, but with quality in mind rather than recent momentum. They thus like Telstra ((TLS)), Woolworths ((WOW)), Coca-Cola Amatil ((CCL)) and Aristocrat ((ALL)) as defensives and like the US dollar exposure of CSL ((CSL)), Cochlear ((COH)), James Hardie ((JHX)), Amcor ((AMC)), Brambles ((BXB)) and News Corp ((NWS)).

The quants do not like Whitehaven Coal ((WHC)), OZ Minerals ((OZL)), Atlas Iron ((AGO)), Lynas ((LYC)), Iluka Resources ((ILU)), Newcrest Mining ((NCM)), Alumina ((AWC)), Perseus Mining ((PRU)), Sims Metal Management ((SGM)), PanAust ((PNA)), Beach Energy ((BPT)), Oil Search, Arrium ((ARI)), Santos and BHP Billiton ((BHP)).

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