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Rudi’s View: Woodside, REA, QBE, Appen & Megaport

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Sep 08 2022

This story features PPK GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: PPK

In this week's Weekly Insights:

-August Reports: Closing Remarks
-Conviction Calls
-Research To Download

By Rudi Filapek-Vandyck, Editor

August Reports: Closing Remarks

The key attraction for investing in small and micro cap companies is the ability to generate oversized gains when things fall into place at the right time.

But just about every reporting season shows the opposite holds equally true and this time around the true stinkers from the August reporting season are called PPK Group ((PPK)), Redbubble ((RBL)) and Appen ((APX)).

In particular the erosion in the share price of "innovative technology investor" PPK Group looks genuinely gut-wrenching since the share price peaked above $21 in July last year. In August, the stock lost an additional -40%, pulling it closer to $1.52.

The thesis that when market dynamics toughen up, smaller cap stocks become relatively more vulnerable doesn't need such extreme examples to prove its validity. One look into the finer details of the FNArena Corporate Results Monitor can be just as revealing, and affirmative.

At face value, the inclusion of 344 corporate results released in August has generated 30.8% better-than-forecast results while 26.7% disappointed and 42.4% simply fell in line with guidance and/or expectations. The numbers look decisively better when we zoom in on respectively the ASX50 and ASX200.

Of the 44 companies of the ASX50 that reported in August only 20% (9 companies) were marked down as a "miss" with 29.5% (13 companies) surprising to the upside. For the 161 companies of the ASX200 the numbers don't look fundamentally different: 23.6% disappointed (38 companies) against 32.5% (52 companies) that delivered a better-than-expected performance without also issuing negative guidance for the year ahead.

These statistics reveal that when it comes to "disappointments", the percentage of negative market updates is noticeably higher for small cap companies that are outside of the ASX200. Apart from PPK Group, the list of small caps delivering big disappointments in August includes the likes of Kina Securities ((KSL)), Polynovo ((PNV)), Service Stream ((SSM)), SiteMinder ((SDR)), Southern Cross Media ((SXL)), and Veem ((VEE)).

Admittedly, the outsized punishments have been matched by significant gains for the likes of Nearmap ((NEA)), Tyro Payments ((TYR)) and Lovisa Holdings ((LOV)).

One of the key reasons as to why smaller companies are more vulnerable is the lack of a genuine moat or pricing power, while a relatively minor headwind can cause major problems when the company is only small-sized.

But one of the key observations from the August results is equally deserving to be highlighted: as a population, we had been all too eager to return back to old habits from the moment covid-restrictions and lockdowns became a thing of the past.

The demise in 2022 of former high flyers such as Booktopia Group ((BKG)) and Redbubble is equally evidence that, as a community of analysts, investors and speculators, we had been too eager to accept that covid had pulled some of the megatrends into irreversible acceleration.

As it turned out, those megatrends including working from home and spending online simply went through an artificial growth-spurt; one that was quick to deflate from the moment the valve was released.

There is no stopping these trends, of course, and they will most likely continue for many years yet to come. But many of the companies that were previously riding on the coat tails of megatrend market enthusiasm might now be facing a tough twelve months ahead.

And that's on top of this year's new market-led requirement that companies not profitable or cash flow positive establish and communicate a plausible pathway to break-even.

Given the many question marks and uncertainties ahead, it should be no surprise investors are, on average, not in a mindset of giving such small cap companies the benefit of the doubt before anything concrete shows up in financial numbers.

While cheap-looking share prices can always attract the interest from a corporate suitor, as has happened for Nearmap, Nitro Software and Link Administration ((LNK)), in the absence of a take-over, investors might have to be patient for longer before share prices in companies such as Aussie Broadband ((ABB)), Fineos Corp ((FCL)), Life360 ((360)) and Megaport will see sustainable momentum return.

And given so many worries about how ongoing tightening by the US Federal Reserve, and the RBA here in Australia, will deflate the housing market, and how that will impact on household spending, and exactly when, it seems very likely the same patience might have to be tapped into for ASX-listed consumer and housing-related companies.

Comparing the August stats with prior years, the final balance is far from fantastic, in particular the relatively high percentage of "misses", but also the -2.95% adjustment in average individual target price.

With two-thirds of companies seeing forecasts reduced post results release, one of the key questions for the six months ahead remains whether those reductions are now appropriate, or still too high.

I don't like to see the world through the prism of bears versus bulls, but in trying to ascertain the most plausible answer to that question, it quickly becomes apparent there's a big divide between the optimists and everybody else.

For Macquarie, where preparations are being made for a global recession in 2023, the August season looked pretty disappointing with the broker's aggregate EPS forecast literally melting away throughout the month, starting from a positive 15% in growth to ultimately end up with a negative -0.4% forecast.

As the analysts highlight, many of such downgrades to growth forecasts have been driven by company guidance of which about 50% came out below consensus. In line with my earlier observations, the rate of downgrades was higher for smaller cap companies. Macquarie equally adopted a more cautious view towards commodities, including iron ore and copper.

Macquarie is understandably rather cautious about the near-term trajectory for equities, now also explicitly referencing the step up in quantitative tightening by the Federal Reserve, starting this month (September).

But then one reads JP Morgan and it's almost as if we need to check the date on the report. Is this really about the same Australian companies in the same month of August this year?

Consider that, contrary to general practice elsewhere, JP Morgan analysts ended up with higher EPS forecasts following the onslaught of August corporate results. Pre-season the forecast was for 4.2% EPS growth in FY23. That number has now grown to 4.6%.

Six sectors are responsible for the increase: Communication Services, Energy, REITs, Industrials, Materials and Discretionary retailers with truly stand-out positive surprises delivered by companies in Technology, Communication Services and Industrials.

The biggest disappointments, as far as JP Morgan's forecast adjustments are concerned, came from utilities, consumer staples and healthcare companies.

The obvious observation to make is the sharply different starting point for both teams of analysts, but this still leaves the question open: is the -0.4% forecast from Macquarie now too low or is the 4.6% from JP Morgan too high?

The answer for individual investment portfolios will be found in specific individual companies. Whenever someone predicts it's becoming a stock pickers' market now, I tend to agree. Wide divergences are likely to characterise share markets and sectors internally.

On JP Morgan's assessment, the difference between its own projections and those of other forecasters can be explained through the Energy sector. JP Morgan has higher forecasts for Woodside Energy ((WDS)), Santos ((STO)) & Co, which also implies its forward projections are not that different from Macquarie for other sectors, such as the miners.

Conclusion: the outlook is for subdued growth ahead. With the local share market trading in line with its long-term PE average of circa 14.5x, does this then seem appropriate?

I have real doubt. Also because it seems but a valid thesis that the full impact from central bank tightening has yet to be felt across economies. I think it's best to adopt a more cautious stance, not in the least because mid-September/mid-October traditionally can be a very tricky period.

With Jay Powell's Jackson Hole speech continuing to reverberate, and quantitative tightening drawing more liquidity out of markets this month, I think the weeks ahead can become very tricky to navigate indeed.

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FNArena's Corporate Results Monitor: https://www.fnarena.com/index.php/reporting_season/

Conviction Calls

Technology sector analysts at Goldman Sachs have been, overall, pleased with corporate results released in August.

Among the positives cited is the fact most non-profitable businesses have changed strategy towards an accelerated pathway to becoming break-even.

The team at Goldman Sachs has grabbed the opportunity to reiterate their Buy calls for REA Group ((REA)), Xero ((XRO)), Domain Holdings Australia ((DHG)), Megaport ((MP1)), Nitro Software ((NTO)), ReadyTech Holdings ((RDY)), and Objective Corp ((OCL)).

REA Group is on the broker's Conviction List.

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Three to four years of limited growth. Such is the prediction of REIT-sector analysts at Jarden regarding the impact from higher bond yields and interest rates.

The underlying suggestion: time to be more selective!

Jarden: "Our analysis shows that the rising cost of debt will hold back earnings growth for at least 3-4 years, as cheap hedges roll off. This is particularly evident in passive and externally managed REITs. We prefer REITs that have been able to reset interest expense early and those with stronger top-line momentum."

The broker has seven REITs on a Buy rating: Scentre Group ((SCG)), Charter Hall ((CHC)), Lifestyle Communities ((LIC)), Centuria Capital Group ((CNI)), Ingenia Communities Group ((INA)), Shopping Centes Australasia Property Group ((SCP)), and Abacus Property Group ((ABP)).

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Healthcare analysts at Macquarie have nominated CSL ((CSL)) and Healius ((HLS)) as their two top picks, with both ResMed ((RMD)) and Ansell ((ANN)) equally carrying the broker's Outperform rating.

Two companies are currently Sell-rated: Cochlear ((COH)) -downgraded in August- and Sonic Healthcare ((SHL)).

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Macquarie has also communicated its preferences among A-REITs, with the broker still not keen on office, discretionary malls or residential properties.

The greater defensive qualities are to be found in the small to mid-cap space, argues the broker, where exposure to convenience retail through HomeCo Daily Needs REIT ((HDN)) or Charter Hall Retail REIT ((CQR)) has its preference, as does HealthCo Healthcare & Wellness REIT ((HCW)).

Active fund managers remain on the broker's wishlist though Outperform-rated Goodman Group ((GMG)), Charter Hall and Qualitas ((QAL)), supplemented for this time with Lendlease ((LLC)); the latter on confidence in a FY24-recovery.

The greatest level of caution is reserved for Stockland ((SGP)), Scentre Group, Vicinity Centres ((VCX)) and National Storage ((NSR)).

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Goldman Sachs' advice for investors looking to increase exposure to A-REITs is to focus on cash flow and dividend sustainability, with REITs that have a lower payout currently considered best-placed to increase dividends in the years ahead.

Goldman Sachs likes the fund managers Goodman Group and Home Consortium ((HMC)), as well as Stockland for residential exposure, and GPT ((GPT)) as a 'value' play.

For retail exposure, Goldman Sachs points at Scentre Group and HomeCo Daily Needs REIT, while this broker also likes HealthCo Healthcare & Wellness REIT, Charter Hall Social Infrastructure REIT ((CQE)), as well as Waypoint REIT ((WPR)).

Charter Hall Social Infrastructure REIT is included in the broker's Conviction List.

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Morgan Stanley's Australia Macro+ Focus List contains the following ten stocks:

Amcor ((AMC)), Computershare ((CPU)), CSL, Goodman Group, Macquarie Group ((MQG)), Orica ((ORI)), Qantas Airways ((QAN)), QBE Insurance ((QBE)), Woodside Energy ((WDS)), and Telstra ((TLS)).

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Insurance sector analysts at Credit Suisse have nominated QBE Insurance as their top pick, followed by (in order of preference) Suncorp Group ((SUN)), Insurance Australia Group ((IAG)), AUB Group ((AUB)), Steadfast Group ((SDF)), Medibank Private ((MPL)) and nib Holdings ((NHF)).

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Small cap specialists at JP Morgan have GUD Holdings ((GUD)) as their Top Pick and Appen ((APX)) as their Bottom Pick (least preferred).

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Macquarie's team of technology analysts has nominated Megaport as the sector's Top Pick while Appen is least-preferred.

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Stockbroker Morgans believes health insurers Medibank Private and nib Holdings delivered some of the strongest performances among insurance and diversified financials companies, alongside equally strong performers QBE Insurance, Tyro Payments ((TYR)) and Generation Development Group ((GDG)).

Two of the weakest performances, in the broker's view, were delivered by Suncorp Group ((SUN)) and Challenger ((CGF)).

Morgans' order of preference is currently QBE Insurance on top, followed by Computershare, Suncorp, Generation Development Group, Tyro Payments, Challenger, with Kina Securities ((KSL)) last in line.

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A cautious Macquarie, still focused on the global recession that is anticipated for 2023, keeps singing the praise of defensive sectors such as paper & packaging.

In Australia, the broker's sector favourite is Orora ((ORA)) with Pact Group ((PGL)) least preferred and Amcor in the middle.

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Dave Rosenberg: "It is suggested investors brace themselves — book profits, reduce worrisome positions, tighten stops, and/or apply option strategies — the next few weeks could prove treacherous."

Research To Download

Edison Research has updated on:

-AFT Pharmaceuticals ((AFT)): https://www.fnarena.com/downloadfile.php?p=w&n=71647B8A-CA2D-262A-ACA71307569EEDFA

-EML Payments ((EML)): https://www.fnarena.com/downloadfile.php?p=w&n=71680F51-ACB1-DA73-80A5576E719D4A33

-Medlab Clinical ((MDC)): https://www.fnarena.com/downloadfile.php?p=w&n=716EC7FD-D0CA-D90B-0E1ABD82E1A63541

(This story was written on Monday, 5 September, 2022. 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).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer 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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– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
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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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CHARTS

360 ABB ABP AMC ANN APX AUB BKG CGF CHC CNI COH CPU CQE CQR CSL DHG EML FCL GDG GMG GPT HCW HDN HLS HMC IAG INA KSL LIC LLC LNK LOV MDC MP1 MPL MQG NHF NSR NTO OCL ORA ORI PGL PNV PPK QAL QAN QBE RDY REA RMD SCG SDF SDR SGP SHL SSM STO SUN SXL TLS TYR VCX VEE WDS WPR XRO

For more info SHARE ANALYSIS: 360 - LIFE360 INC

For more info SHARE ANALYSIS: ABB - AUSSIE BROADBAND LIMITED

For more info SHARE ANALYSIS: ABP - ABACUS PROPERTY GROUP

For more info SHARE ANALYSIS: AMC - AMCOR PLC

For more info SHARE ANALYSIS: ANN - ANSELL LIMITED

For more info SHARE ANALYSIS: APX - APPEN LIMITED

For more info SHARE ANALYSIS: AUB - AUB GROUP LIMITED

For more info SHARE ANALYSIS: BKG - BOOKTOPIA GROUP LIMITED

For more info SHARE ANALYSIS: CGF - CHALLENGER LIMITED

For more info SHARE ANALYSIS: CHC - CHARTER HALL GROUP

For more info SHARE ANALYSIS: CNI - CENTURIA CAPITAL GROUP

For more info SHARE ANALYSIS: COH - COCHLEAR LIMITED

For more info SHARE ANALYSIS: CPU - COMPUTERSHARE LIMITED

For more info SHARE ANALYSIS: CQE - CHARTER HALL SOCIAL INFRASTRUCTURE REIT

For more info SHARE ANALYSIS: CQR - CHARTER HALL RETAIL REIT

For more info SHARE ANALYSIS: CSL - CSL LIMITED

For more info SHARE ANALYSIS: DHG - DOMAIN HOLDINGS AUSTRALIA LIMITED

For more info SHARE ANALYSIS: EML - EML PAYMENTS LIMITED

For more info SHARE ANALYSIS: FCL - FINEOS CORPORATION HOLDINGS PLC

For more info SHARE ANALYSIS: GDG - GENERATION DEVELOPMENT GROUP LIMITED

For more info SHARE ANALYSIS: GMG - GOODMAN GROUP

For more info SHARE ANALYSIS: GPT - GPT GROUP

For more info SHARE ANALYSIS: HCW - HEALTHCO HEALTHCARE & WELLNESS REIT

For more info SHARE ANALYSIS: HDN - HOMECO DAILY NEEDS REIT

For more info SHARE ANALYSIS: HLS - HEALIUS LIMITED

For more info SHARE ANALYSIS: HMC - HMC CAPITAL LIMITED

For more info SHARE ANALYSIS: IAG - INSURANCE AUSTRALIA GROUP LIMITED

For more info SHARE ANALYSIS: INA - INGENIA COMMUNITIES GROUP

For more info SHARE ANALYSIS: KSL - KINA SECURITIES LIMITED

For more info SHARE ANALYSIS: LIC - LIFESTYLE COMMUNITIES LIMITED

For more info SHARE ANALYSIS: LLC - LENDLEASE GROUP

For more info SHARE ANALYSIS: LNK - LINK ADMINISTRATION HOLDINGS LIMITED

For more info SHARE ANALYSIS: LOV - LOVISA HOLDINGS LIMITED

For more info SHARE ANALYSIS: MDC - MEDLAB CLINICAL LIMITED

For more info SHARE ANALYSIS: MP1 - MEGAPORT LIMITED

For more info SHARE ANALYSIS: MPL - MEDIBANK PRIVATE LIMITED

For more info SHARE ANALYSIS: MQG - MACQUARIE GROUP LIMITED

For more info SHARE ANALYSIS: NHF - NIB HOLDINGS LIMITED

For more info SHARE ANALYSIS: NSR - NATIONAL STORAGE REIT

For more info SHARE ANALYSIS: NTO - NITRO SOFTWARE LIMITED

For more info SHARE ANALYSIS: OCL - OBJECTIVE CORPORATION LIMITED

For more info SHARE ANALYSIS: ORA - ORORA LIMITED

For more info SHARE ANALYSIS: ORI - ORICA LIMITED

For more info SHARE ANALYSIS: PGL - PROSPA GROUP LIMITED

For more info SHARE ANALYSIS: PNV - POLYNOVO LIMITED

For more info SHARE ANALYSIS: PPK - PPK GROUP LIMITED

For more info SHARE ANALYSIS: QAL - QUALITAS LIMITED

For more info SHARE ANALYSIS: QAN - QANTAS AIRWAYS LIMITED

For more info SHARE ANALYSIS: QBE - QBE INSURANCE GROUP LIMITED

For more info SHARE ANALYSIS: RDY - READYTECH HOLDINGS LIMITED

For more info SHARE ANALYSIS: REA - REA GROUP LIMITED

For more info SHARE ANALYSIS: RMD - RESMED INC

For more info SHARE ANALYSIS: SCG - SCENTRE GROUP

For more info SHARE ANALYSIS: SDF - STEADFAST GROUP LIMITED

For more info SHARE ANALYSIS: SDR - SITEMINDER LIMITED

For more info SHARE ANALYSIS: SGP - STOCKLAND

For more info SHARE ANALYSIS: SHL - SONIC HEALTHCARE LIMITED

For more info SHARE ANALYSIS: SSM - SERVICE STREAM LIMITED

For more info SHARE ANALYSIS: STO - SANTOS LIMITED

For more info SHARE ANALYSIS: SUN - SUNCORP GROUP LIMITED

For more info SHARE ANALYSIS: SXL - SOUTHERN CROSS MEDIA GROUP LIMITED

For more info SHARE ANALYSIS: TLS - TELSTRA GROUP LIMITED

For more info SHARE ANALYSIS: TYR - TYRO PAYMENTS LIMITED

For more info SHARE ANALYSIS: VCX - VICINITY CENTRES

For more info SHARE ANALYSIS: VEE - VEEM LIMITED

For more info SHARE ANALYSIS: WDS - WOODSIDE ENERGY GROUP LIMITED

For more info SHARE ANALYSIS: WPR - WAYPOINT REIT LIMITED

For more info SHARE ANALYSIS: XRO - XERO LIMITED