Treasure Chest: Stock And Sector Themes For 2014

This story features NINE ENTERTAINMENT CO. HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: NEC

By Greg Peel

2013 was the year of PE expansion. While the stock market has ostensibly rallied since 2009, the initial phase was to recover from low PEs in the oversold post-GFC panic and the next to regain average PE levels based on earnings recovery. Thereafter PE expansion has been based on the expectation of earnings growth ahead as the GFC spectre fades. The challenge is for earnings to indeed grow to justify prices now ascribed.

The bottom line is that stock analysts and equity strategists expect 2014 to be a year of earnings growth but not of further PE growth, at least not of a similar magnitude. This does not mean stock prices cannot rise further, it just means that upside is more limited while earnings growth is gradually confirmed. Or not.

The UBS strategists see the “most plausible” central case for 2014 is one of the market PE ratio tracking sideways over the year or maybe a touch higher. Capital gains are more likely to be aligned with earnings growth, meaning more moderate than in 2013. The theme of a depreciating Aussie dollar will provide for earnings growth in general but the going will remain tough for many companies, says UBS.

UBS’ key sector themes for 2014 are overweight mining and energy, overweight beneficiaries of a lower AUD in general, overweight selected domestic cyclicals, underweight banks and underweight mining services.

The strategists have added Nine Entertainment ((NEC)), Transurban ((TCL)), Sonic Healthcare ((SHL)) and Aristocrat Leisure ((ALL)) to their model portfolio at the expense of Goodman Group ((GMG)), Primary Health Care ((PRY)) and ASX ((ASX)).

Extending the stock picking further to emerging companies, UBS likes stocks exhibiting above average growth rates or cheap valuation. The emerging industrials sector is trading at an average 17.7x FY14 earnings so is not cheap, the broker notes, and indeed trading in line with the ASX 100 large caps.

That said, UBS likes Flexigroup ((FXL)), Premier Investments ((PMV)), Technology One ((TNE)) and Vocation ((VET)) for their growth profiles, Mermaid Marine ((MRM)) on a relative valuation basis and both Macquarie Atlas Roads ((MQA)) and Transpacific Industries ((TPI)) for balance sheet restructure upside.

BA-Merrill Lynch Asia Pacific promotes an “Asia Pacific Focus 1 List” of preferred stocks in the region. Of the twenty stocks included, the Australian representatives are currently Treasury Wine Estate ((TWE)), Lend Lease ((LLC)), National Bank ((NAB)), Rio Tinto ((RIO)) and Fortescue Metals ((FMG)). Note that Merrills has a market stand-out target price on TWE based on the value of the Penfolds brand, if unlocked.

Locally, Merrills has structured its 2014 ideas around five “super sectors”, being consumer, basic materials, interest rate sensitive, resources/energy and transport/utilities. A mere 183 stocks fall into this grouping, but the analysts then overlay their macro outlook to arrive at preferred selections. Basically it’s where bottom-up valuation intersects with top-down valuation. This leaves us with five stock picks.

Merrills likes Crown ((CWN)) for Macau upside, Incitec Pivot ((IPL)) on a long awaited improvement in fertiliser prices, the ramp-up of Moranbah and a weaker Aussie, Origin Energy ((ORG)) on lower gas discounting and churn downstream, and APLNG upstream, Oil Search ((OSH)) for the PNG LNG start-up, and QBE Insurance ((QBE)) on rising rates, a falling Aussie and return to balance sheet strength.

Merrills has also looked at one of the stars of 2013 – the online media sector. Aforementioned PE expansion drove a 61% average re-rating of the sector in 2013, underpinned by expectations of strong earnings growth ahead. In short, the broker does not expect a repeat performance. Indeed, the broker expects returns to be “vastly different” across the sector itself.

Despite a re-rating for REA Group ((REA)), the broker feels the market is still underestimating the long term revenue growth upside of a fee-per-listing model, enhanced by a tailwind of improving Australian real estate. REA’s 30% premium to peers is more than justified, Merrills believes.

The opposite is true for Seek ((SEK)), for which the broker sees a re-rating based on expectations of a domestic recovery in 2014 as misguided. Indications are for declining job ads and increasing unemployment, and leakage to social media and outsourcing platforms is evident. Growing competition in China is also set to undermine Zhaopin, Merrills suggests.

Carsales.com ((CRZ)) is the least cyclical of the online media stocks, and the broker expects another year of solid earnings growth for auto as well as non-auto classifieds and data services, with margin improvement the driving force.

Trade Me ((TME)) is Australian-listed but New Zealand-centric, and the broker sees a year of earnings consolidation as TME expands its cost base to support future growth. The stock trades at a 25% discount to peers and the broker expects this gap to close from FY15 as classifieds, particularly real estate, become the prime earnings driver.

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