Rudi’s View: August 2020 Lifts Price Targets

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Dear time-conscious investor: Conviction Calls, stock ideas and investment themes post-August

In this week’s Weekly Insights:

-August 2020 Lifts Price Targets
-Stock Ideas & Conviction Calls
-Extras & Bonuses

August 2020 Lifts Price Targets

By Rudi Filapek-Vandyck, Editor FNArena

For securities analysts, each reporting season offers a welcome update on how companies are faring operationally, and this includes contracts, investments and sales, as well as margins, inventories and cash flows.

Within this framework, market forecasts had never looked as wide and as diverse as post-February, so the August reporting season has been more than just welcome, with widely diverging forecasts in many cases rejoining around a much more feasible middle ground.

For many an investor/shareholder, this background re-adjusting of modeling and forecasts is often largely ignored, even though paying attention can provide clues about future sentiment towards and the direction of a share price.

Not every investor is convinced these analysts are worth every cent they are being paid, but fact remains: upward and downward adjustments to forecasts act like a magnet on share prices, sometimes even on what looks like rather small changes.

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One of the easiest accessible indicators for what is happening behind the scenes of daily volatile market moves are consensus price targets for individual stocks.

In essence, these targets symbolise the general idea of where analysts think the share price should be, roughly, incorporating current information and with all else remaining equal.

As I have pointed out numerous times over the years, share prices often tend to converge with these targets, unless there are other factors in play that weigh on investors’ sentiment.

[Special Note: the FNArena service includes The Icarus Signal, which signals when share prices are above or very close to consensus targets, though investors should always include context and their own insights and observations when taking guidance from such a broad-based, generalising, automated tool.]

Hence, every reporting season one of the key indicators I look at is what happens to price targets once companies have publicly disseminated and discussed their financial performance, and analysts have digested the numbers, and put fresh insights through their now updated modeling.

In simple terms: when targets move higher, it’s probably because forecasts have gone up, and this usually means the share price will rise.

If the above coincides with a positive “surprise” (otherwise known as an earnings beat) and the share price is nowhere near the new targets, then you can almost be assured the share price is now being carried further by ongoing positive momentum.

Such momentum carries into general sentiment, and before you know it, we’re talking multiple weeks, if not months of additional gains.

The opposite holds true as well. Irrespective of whether a financial result met forecasts or not, if the outcome post-release is falling expectations and a reduction in valuations and targets, chances are very much in favour of persisting downward pressure on the share price.

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As happens in every reporting season, August offered plenty of examples for each of these scenarios.

AGL Energy ((AGL)) surprised most with a downbeat guidance and the consensus target for the stock tumbled to $14.84 from $16.45 prior to the FY20 release.

In response, the AGL share price quickly reset around $15 from $17-$18 before the market update.

The AGL board promised to pay out 100% of cash earnings to shareholders in the next two years, but this hasn’t prevented analysts from putting the knife in their forecasts, assuming near 100% payouts in FY21 and FY22, but ultimately forecasting a lower dividend in two years’ time.

The reset in profit forecasts is clearly visible on the bottom part of the share price graph that can be found via Stock Analysis on the website, idem for the reduction in consensus target.

The same basic principle applies to similarly underwhelming market updates released by companies such as Bendigo and Adelaide Bank ((BEN)), Blackmores ((BKL)), Challenger ((CGF)), Cimic Group ((CIM)), GWA Group ((GWA)), InvoCare ((IVC)), Japara Healthcare ((JHC)), Mayne Pharma ((MYX)), Origin Energy ((ORG)), Seek ((SEK)), Telstra ((TLS)), and Seven West Media ((SWM)).

In all of these examples, price targets have fallen post the release of financials, and in all cases the share price has not even made a half-hearted attempt since to close that glaring gap between share price and target.

Data-analysis from past reporting seasons in Australia has shown share prices post earnings disappointment are poised for persistent underperformance that can last three months, at times even longer.

I haven’t done any broad analysis regarding falling forecasts and price targets and their effect on share prices, but anecdotal observations suggest these are the kind of stocks that are, for the time being, likely to remain deprived from any sustainable upward momentum.

Until things turn around, which can take a while.

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It goes without saying, each reporting season has plenty of examples of companies outperforming expectations, forcing analysts to lift forecasts, which usually pushes up price targets, providing ongoing momentum to already rising share prices.

August saw plenty of such events with, on FNArena’s calculations, the average gain for price targets during the month climbing to 6.49%. All price targets in aggregate rose by 5% (net) over the month.

Considering that profit forecasts went down to -20% for FY20, and they fell a little further (net) throughout the season, those target data easily explain as to why August 2020 turned into a positive experience for Australian investors.

The key insight, however, is that these numbers are predominantly generated outside of the ASX50. Consider the following:

–For the ASX50 (44 companies)

-Total Beats: 11 (25%)
-Total Misses 12 (27.3%)
-Average increase in individual price target: 1.67%
-Total increase in aggregate price targets: 3.14%

Now consider the total stats for 318 companies recorded for the season (which also includes the ASX50):

-Total Beats: 114 (35.8%)
-Total Misses 61 (19.2%)
-Average increase in individual price target: 6.49%
-Total increase in aggregate price targets: 5%

If there is still anyone out there who questions as to why there is such a wide gap between winners and losers in the share market, and why the Australian share market finds it nigh impossible to keep up with the US in this bull market, or why so many investors instinctively are drawn to smaller cap  companies when looking for the next opportunity, I think the above numbers tell all.

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Some of the eye-catching, stand-out performances last month, with price targets literally jumping into a higher dimension, came from Adairs ((ADH)), Afterpay ((APT)), Ansell ((ANN)), ARB Corp ((ARB)), AUB Group ((AUB)), Australian Vintage ((AVG)), Austal ((ASB)), Autosports Group ((ASG)), Aventus Group ((AVN)),.. I am still only at the first letter of the alphabet while going through the final conclusions of the FNArena Results Monitor for August…

If you are an FNArena subscriber, my message to you is: we built this easily accessible tool. It’s available 24/7 on the website. Use it. (There is an archive too going back to August 2013).

The more intriguing cases are those where forecasts & targets and the share price have moved in opposite directions. Similar to the examples mentioned above: it all comes down to specific strategies and horizons, and to personal knowledge and convictions.

Appen’s ((APX)) FY20 result was not well-received and it certainly did not help that the release was preceded by a rally in the share price to $44 from $36 (so much for the market knows best, n’est-ce pas?)

Fact remains, while the share price got clobbered post event, the average target actually went up; to $37.75 from $34.58.

Admittedly, opinions among analysts covering the company have become more polarised and nothing is ever without risk, but I am siding with the optimists: there still is so much growth ahead of this company, and that is what will ultimately drive the share price.

Appen remains part of the FNArena-Vested Equities All-Weather Model Portfolio and we have used this weakness to buy additional shares, as we did with ResMed ((RMD)).

In similar vein, Nanosonics ((NAN)), MNF Group ((MNF)) and APA Group ((APA)) all sold off post results release – see last week’s Weekly Insights.

Not every share price that falls represents an equally attractive investment opportunity, but when analysts are adding to their valuation it’s good to remember that if these valuations stand their ground, the share price will follow, eventually.

Stock Ideas & Conviction Calls

Some statistics from the research department at Macquarie:

-Earnings per share (EPS) fell by -20%, an outcome on par with the GFC, says the broker (Others have estimates falling by between -17.5%-22%)

-Earnings beats were primarily driven by small caps and new economy companies

-Macquarie’s buy ideas from the August season, included in the strategy portfolio, are Charter Hall ((CHC)), Amcor ((AMC)), Worley ((WOR)), Fortescue Metals ((FMG)), BHP Group ((BHP)), Crown Resorts ((CWN)), Sydney Airport ((SYD)), Ramsay Health Care ((RHC)), Telstra, and Oil Search ((OSH))

-Maquarie’s EPS growth forecasts are for 4.8% in FY21 -driven by iron ore- and 11% in FY22

-Macquarie has singled out two covid-19 beneficiaries that seem destined for underperformance: ResMed and Ansell

-Investors looking to rotate into covid-19 losers should consider Crown Resorts, Star Entertainment ((SGR)), Sydney Airport, Qantas ((QAN)), Cochlear ((COH)), and IDP Education ((IEL))

-Value opportunities to consider include Qantas, BlueScope Steel ((BSL)), Challenger, Telstra, Oil Search, Stockland ((SGP)), Link Administration ((LNK)), nib Holdings ((NHF)), Transurban ((TCL)), BHP Group, Lendlease ((LLC)), Ramsay Health Care

-Stocks to avoid, Macquarie suggests, include Hub24 ((HUB)), Netwealth Group ((NWL)), Ansell, and Newcrest Mining ((NCM))

-Potential value traps, according to Macquarie: Bendigo and Adelaide Bank, Alumina Ltd ((AWC)), InvoCare, Whitehaven Coal ((WHC)), and CommBank ((CBA)) – I bet you haven’t seen the latter being called a value trap, possibly ever!

Some additions from stockbroker Morgans:

-50% of companies that reported FY20 earnings are forecast to return to FY19 numbers in FY21 (pretty good, considering)

-In general terms, market earnings in Australia are forecast to recover to FY19 levels by 2022

-In this context Morgans finds the local market’s 17x FY22 profit forecast “passable” on the proviso investors remain happy to look through the two years' earnings dip and wear associated risks to the economic recovery

-Dividend payers considered well-placed to weather the risks, include Aurizon Holdings ((AZJ)), APA Group, Centuria Industrial REIT ((CIP)), Iress ((IRE)), IPH Ltd ((IPH)), and Waypoint REIT

UBS made the point that heavily shorted stocks were among major market outperformers in August.

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Sze Chuah, senior investment strategist at Ord Minnett, has equally made a number of changes post reporting season.

Ord Minnett has identified five themes for investors to incorporate in their strategies and portfolios; four positive and one negative.

Theme 1: Reopening and recovery

Preferred exposures include National Australia Bank ((NAB)), Origin Energy, Star Entertainment, and Sealink Travel Group ((SLK))

Theme 2: Flight to quality

Here Ord Minnett’s assessment of “quality” is clearly different from mine (in some cases). Preferred exposures are Amcor, APA Group, Coca-Cola Amatil ((CCL)), Coles ((COL)), GPT Group ((GPT)), Rio Tinto ((RIO)), and Sonic Healthcare ((SHL))

Theme 3: Dividend defenders (low chance of having to cut)

Preferred exposures: AusNet Services ((AST)), Charter Hal Long WALE REIT ((CLW)), Perpetual ((PPT)), Service Stream ((SSM)), and Waypoint REIT ((WPR))

Theme 4: Policy tailwinds (companies that rely less on economic conditions)

Suggested exposures: Clover Corp ((CLV)), Cleanaway Waste Management ((CLW)), Hub24, and Lynas Corp ((LYC))

Theme 5: Risky Business (best to avoid)

Here Sze has removed Flight Centre ((FLT)) and TechnologyOne ((TNE)), both following share price weakness.

Remain on the avoid list: Computershare ((CPU)), Northern Star ((NST)), Goodman Group ((GMG)), Tabcorp Holdings ((TAH)), and Treasury Wine Estates ((TWE)).

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Small Cap specialists at UBS have updated their list of most preferred stocks, now including Eagers Automotive ((APE)), Appen, Bapcor ((BAP)), Breville Group ((BRG)), Collins Foods ((CKF)), EclipX Group ((ECX)), Graincorp ((GNC)), Harvey Norman ((HVN)), IDP Education, NRW Holdings ((NWH)), NextDC ((NXT)), and United Malt Group ((UMG)).

UBS’s key sell recommendation remains TechnologyOne, with the analysts suggesting while this remains a high quality business, risks are building short term from covid-19 interruptions and a potentially slower migration to SaaS by clients.

The team has also lined up a list of “laggards” that could well turn into winners over the next six months: Webjet ((WEB)), G8 Education ((GEM)), Servcorp ((SRV)), Flexigroup ((FXL)), Audinate Group ((AD8)), Corporate Travel Management ((CTD)), Bingo Industries ((BIN)), and AMA Group ((AMA)).

Their peers at JP Morgan have elevated Superloop ((SLC)) to be their Top Pick, while Flight Centre is Bottom Pick.

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Strategists at Morgans see the biggest potential for upside surprise from here onwards with companies higher leveraged to economic activity and currently held back by low expectations. Think sectors like Travel, Gaming, Energy, and Commercial Services.

Key stock ideas post August are divided over four baskets:

-Blue Chips:

Westpac ((WBC)), BHP Group, Rio Tinto, Macquarie Group ((MQG)), Amcor, Aurizon Holdings, Coles

-Quality Growth:

-ResMed, Aristocrat Leisure ((ALL)), NextDC, Breville Group, Hub24

-Recovery plays:

-Sydney Airport, Corporate Travel Management, ALS Ltd ((ALQ)), Aventus Group ((AVN)), Santos ((STO)), Beach Energy ((BPT)), Eagers Automotive, Incitec Pivot ((IPL))

-Defensive yield:

-APA Group, APN Convenience Retail REIT ((AQR)), and Waypoint REIT

Morgans also retains a positive view towards retailers, with the strong sales momentum experienced by many leading into August expected to remain firm at least until the start of 2021.

Morgans argues retailers face two large risks: societies opening up quicker, or government support being withdrawn.

Preferential ideas leading into AGM season include Adairs, Accent Group ((AX1)), Baby Bunting ((BBN)), Domino’s Pizza ((DMP)), and Super Retail ((SUL)).

Following August, and a strong rally for many retailers, Morgans’ sector preference lays with Adairs, Eagers Automotive, Breville Group and Super Retail.

The broker prefers a cheaper entry point for Baby Bunting, and is willing to be patient with Lovisa Holdings ((LOV)).

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Market strategists at Wilsons stick with their Quality and Growth bias, but have nevertheless decided it’s best to add more cyclicality to their Australian Focus List portfolio, as positive vaccine news can potentially change market dynamics instantly and dramatically.

Wilsons added Reliance Worldwide ((RWC)), while also adding to exposure to BHP Group, Seven Group Holdings, Santos, and News Corp ((NWS)).

Equally remarkable, Wilsons has decided to remain Overweight the local healthcare sector and has reduced the weighting of CSL ((CSL)) but increased exposure to ResMed.

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Strategists at Citi highlight the point the division between higher valued and lower valued stocks is, essentially, a division between those who have growth, and are expected to continue to grow, and those who don’t have it.

Sectors expected to continue growing earnings over FY19-FY22 are healthcare, food & beverages, retailing and technology.

With exception of food & beverages, these are the sectors that outperformed throughout August, further underpinning Citi’s analysis.

Value investors should be aware that if current market expectations continue to be met, the same growth companies should continue to outperform the market laggards, where growth remains absent, suggests Citi.

As such, the analysts observe sectors that offer growth outperform, irrespective of downgrades to forecasts.

Which then leads to the following statement: “Until COVID-19 distortions to economies begin to fade, companies with earnings growth should continue to outperform and widen the valuation divide.”

Citi’s forecasts are more subdued for FY21, with a much bigger growth recovery projected for FY22 (16.9%). The difference for FY21 seems to be in Resources, which suggests a different view on iron ore, or simply one catch-up short that still needs to happen.

This doesn’t negate the fact that, as forecasts stand post August, the big focal point for today’s value & laggard stocks, and the Australian share market in general, is FY22, not the year ahead.

Citi strategists in the US also believe today’s elevated valuations for the top leaders on the US stock market are similar to the bubble-alike valuations back in 2000, when measured by backward looking data and corrected for the much lower taxes being paid today.

While fully well realising how contentious this type of analysis/conclusions are, the strategists do acknowledge the fact such valuations were more broad-based back then.

Peter Warnes, head of equities research at Morningstar, believes Trump will win the November 3 election in the US.

Extras & Bonuses

Pitt Street Research is offering a special discount of $100 (33%) for FNArena subscribers who’d like to purchase their 50-page research report into the Buy Now, Pay Later sector.

Use the following link: https://stocksdownunder.com/buy-now-pay-later-report-fnarena

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Independent Investment Research (IIR) is offering to share a few publications:

-August pharma & biotech newsletter:

https://www.fnarena.com/downloadfile.php?p=w&n=0D80CCAB-EB90-180A-19B2090C07DAE822

-initiation of coverage on BNK Banking Corp ((BBC))

https://www.fnarena.com/downloadfile.php?p=w&n=0DA28E79-D35D-2A94-D9AAF12D4E49D1C2

-Listed Managed Investment Indicative NTA Report

https://www.fnarena.com/downloadfile.php?p=w&n=0DAED2AE-0AC1-86CC-A4EE44C40BAFDA41

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Research as a Service (RaaS) is offering two recent updates:

-Total Brain ((TTB))

https://www.fnarena.com/downloadfile.php?p=w&n=0DC30F8A-0CD8-4C34-46E171107B05CDE5

-Shekel Brainweigh ((SBW))

https://www.fnarena.com/downloadfile.php?p=w&n=0DD9F17E-A6C1-C43E-02A1E44BE700FBF1

(This story was written on Monday 7th September, 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website).

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via the direct messaging system on the website).

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– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
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