Rudi’s View: M&A Targets – Who’s Next?

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In this week's Weekly Insights:

-M&A Targets – Who's Next?
-February: Brutal And Underwhelming, So Far
-Research To Download

By Rudi Filapek-Vandyck, Editor

M&A Targets – Who's Next?

One of the heaviest post-bubble punishments ever for small cap growth and technology stocks, rivalling the post-Nasdaq meltdown of 2000-2003, had already triggered takeover interest from mostly foreign suitors for ASX-listed companies including Elmo Software ((ELO)), Nearmap ((NEA)), Nitro Software ((NTO)), Proptech Group ((PTG)), Pushpay Holdings ((PPH)), ReadyTech Holdings ((RDY)) and Tyro Payments ((TYR)) – and that list is guaranteed to be incomplete.

Outside of technology, both energy retailers AGL Energy ((AGL)) and Origin Energy ((ORG)) have seen suitors emerging, but successfully completing deals has proven more problematic.

M&A potential didn't genuinely catch most investors' and institutional asset managers' attention until US-based gold producer Newmont announced it would like to re-join with its former Australian business unit, Newcrest Mining ((NCM)).

Not everybody is keen on dabbling into beaten-down, unprofitable, small-cap technology aspirants, but large cap resources, on the other hand…

With a market capitalisation of circa $21bn, Newcrest is the local heavyweight among ASX-listed gold miners with the likes of Northern Star ((NST)) on $13bn, Evolution Mining ((EVN)) on $5bn, and Perseus Mining ((PRU)) on $3bn far, far behind.

The revival in M&A appetite seems counterintuitive at face value, argue analysts at Morgan Stanley. The cost of debt is still rising, and likely to increase further, economic conditions look shaky at best (even if an economic recession can be avoided) and higher bond yields have de-rated market multiples for most sectors.

But this is the time when well-managed Quality companies can see opportunity, the analysts suggest, as those companies can exploit their relative valuation premium on top of conservatively managed balance sheet, supported by operational strength, a cost of funding advantage and easier access to capital.

In other words: it's on!

Looking at the market from a general top-down perspective, the spirit of the times is transitioning from capital preservation to capital allocation, explains Morgan Stanley. WiseTech Global's ((WTC)) acquisition of US-based Blume Global for US$414m, announced on Friday, would be yet more evidence backing up that statement.

Analysis by Morgan Stanley suggests investors trying to identify the next M&A targets listed on the ASX should be looking towards Lendlease ((LLC)), St Barbara ((SBM)), Westgold Resources ((WGX)), Appen ((APX)), Austal ((ASB)), Brainchip Holdings ((BRN)), Bravura Solutions ((BVS)), Charter Hall Group ((CHC)), Cromwell Property Group ((CMW)), Dexus ((DXS)), EML Payments ((EML)), GPT Group ((GPT)), Infomedia ((IFM)), Mirvac Group ((MGR)), Megaport ((MP1)), Mesoblast ((MSB)), Tyro Payments, Xero ((XRO)), and Nuix ((NXL)).

Apart from a number of technology companies, that list excels in REITs and property developers/managers, with the occasional gold miner as a bonus.

Morgan Stanley equally tried to identify which companies on the ASX could be looking to acquire and here the main candidates are: Altium ((ALU)), Fisher & Paykel Healthcare ((FPH)), TechnologyOne ((TNE)), WiseTech Global, CSR ((CSR)), Northern Star Resources, Rio Tinto ((RIO)), Regis Resources ((RRL)), South32 ((S32)), Sandfire Resources ((SFR)), Sims ((SGM)), Silver Lake Resources ((SLR)) and Syrah Resources ((SYR)).

Assuming Morgan Stanley's targets and candidate acquirers meet through real action in the months ahead, the local gold sector should indeed see a disproportional slice of the local M&A action.

Analysts at Wilsons have identified four themes that are likely to dominate M&A activity locally:

-Asset-backed steady earners
-De-rated opportunities
-Resources boom
-More FUM for asset managers

Among asset-backed steady earners, Wilsons puts forward Cleanaway Waste Management ((CWY)) and The Lottery Corp ((TLC)) as two prime candidates that look attractive and ripe for the picking. Others with similar characteristics include AGL Energy, Aurizon Holdings ((AZJ)), Ramsay Health Care ((RHC)), and APA Group ((APA)).

When rummaging through the post-bubble de-ratings, Wilsons sees potential take-over targets in Xero, Domain Holdings Australia ((DHG)), Pexa Group ((PXA)), Netwealth Group ((NWL)), Iress ((IRE)), Altium, and NextDC ((NXT)).

A number of fund managers are currently trading around 10x earnings, Wilsons observes, adding when an entire industry is relatively inexpensive compared to the rest of the market, it is likely to result in consolidation.

Perpetual ((PPT)) recently acquired Pendal Group ((PDL)) and Regal Partners ((RPL)) has acquired VGI Partners.

Magellan Financial ((MFG)) and/or HMC Capital ((HMC)) could be next, according to Wilsons.

Similar to Morgan Stanley's research, Wilsons also thinks 2023 will be a big year for resources, including a number of M&A deals.

Investors might keep in mind Deterra Royalties ((DRR)) is looking to diversify while the likes of Mineral Resources ((MIN)) are always on the lookout for a new deal.

February: Brutal And Underwhelming, So Far

It seems my pre-season prediction of an extra-brutal results season this February is being confirmed on a daily basis.

On Monday, as I write this week's Weekly Insights, shares in both BlueScope Steel ((BSL)) and nib Holdings ((NHF)) are down in double digit percentages following the release of financial results that will lead to analysts lowering their estimates.

It is easily forgotten by investors, but when companies release financial results the main action doesn't actually revolve around what those numbers look like. It's all about the impact on future projections. And on this account the season thus far has certainly underwhelmed.

As reported by Barrenjoey's data and quant analyst Jason Swinbourne, most financial results have led to negative changes to analysts' forecast numbers with profit forecasts upgraded in 14% of cases but downgraded in 25% of cases.

And while Australian boards in particular tend to opt for positive compensation through a higher dividend for shareholders, even on this account the numbers thus far do not look great: 15% upgrades versus 24% downgrades.

Inflation is having a positive impact on top line revenues with sales numbers triggering upgrades in 19% of releases against only 11% downgrades, but inflation is also present through higher costs, and clearly, margin pressure is omnipresent.

It is Monday, February 20th, but the FNArena Corporate Results Monitor has barely passed the 100 mark (out of an estimated 350 reports by month's end).

It begs the question whether one shouldn't hold back in drawing any conclusions just yet, but many an institutional investor looks at the market, and corporate trends, in terms of market capitalisation. Here the percentage has already risen above 60%. By Friday, it will be at 96%.

One difference to note is that reporting seasons in the past tended to start off on a positive note, but this hasn't been the case recently and it certainly has not been the case this month.

Witness, for example, how price targets after the first 107 reports have barely moved, in aggregate. Up until February last year, price targets used to rise following detailed market updates, sometimes up to 7% on average (!), but no more, it seems.

The numbers speak for themselves:

Movements in aggregate price targets:

-February 2022: -1.40%
-March-July 2022: -7.40%
-August 2022: -3.0%
-September-January: -2.50%

February, or so it appears, is not going to break that trend and catapult corporate Australia back to the positive days prior. On FNArena's assessment, 33 companies (30.8%) have disappointed, with 31 companies (29%) beating expectations and the remaining 43 (40%) performing in line.

Compared with historical data going back to August 2013, 'misses' are running above average and 'beats' below average. Not the kind of combination that leads a share market to a new all-time high.

Analysts at Macquarie summed it up as follows: "We still think it is hard to make a bull case for stocks when the Fed/RBA are likely to tighten further causing a rise in real yields that pressures already high PEs and we are in an EPS downgrade cycle".

Macquarie thinks net disappointments in dividends might indicate cautious boards preferring to hoard cash ahead of uncertain conditions.

In many cases, inventories are higher than forecast, which implies slowing underlying momentum but also highlights the risk to earnings for the rest of the year.

Reporting season analysts at UBS see plenty of signals of  "earnings exhaustion". It is clear, concludes UBS, the analyst community is seeing an economy past its peak. Earnings estimates are falling for FY23 and FY24.

In contrast, a number of CEOs remains unwilling to share the analysts' view, UBS observes. Some companies are missing forecasts for the first half but staunchly sticking with their prior guidance for the full financial year.

UBS thinks this is where the next set of corporate disappointments might come from. With the local economy already losing momentum, compensation through accelerated growth in the second half might prove a tad too ambitious for companies.

Companies that need a much better second half if they are to meet their own, unchanged guidance, include Origin Energy, AGL Energy, Corporate Travel Management ((CTD)), Domain Holdings, Fletcher Building ((FBU)), Magellan Financial, Lendlease, Pinnacle Investment ((PNI)), Suncorp Group ((SUN)), NRW Holdings ((NWH)), Southern Cross Media ((SXL)), Breville Group ((BRG)), Computershare ((CPU)), Super Retail ((SUL)), and Bapcor ((BAP)).

The one sector that has bucked the trend for negative earnings impact this month are the insurers with both Suncorp and QBE Insurance ((QBE)) receiving calls for ongoing re-rating post their financial updates.

Shareholders in Insurance Australia Group ((IAG)) will be hoping some of that positive sector sentiment might also drag the local industry laggard along.

On UBS's observation, positive momentum for insurers contrasts with the banks for which February has marked a shift in general market sentiment, with investors now focusing on bad debts and intensifying competition.

Hence why CommBank's ((CBA)) all-time record profit result triggered a sell-off for the broader sector that has turned the Australian market into an underperformer versus offshore peers in February.

The stand-out sector this month are domestic cyclicals, posting much better-than-feared operational performances as consumers have proven much more resilient with their spending, but Macquarie warns investors should not extrapolate because the impact from RBA rate hikes, the rising cost of essentials and falling house prices is yet to be felt.

Regardless, as things stand today, domestic cyclicals are enjoying net upgrades to forecasts, as financial results have mostly surprised ('beaten') and share prices have on average outperformed even when financials were a 'miss'. (Go figure!)

In terms of individual company reports, one of my personal observations is that many a market laggard is not rewarding shareholders' patience this month. Here investors might take note of Macquarie's observation that companies that delivered a 'beat' in either of the last two halves are more likely to post another 'beat' for the December half.

In similiar fashion, reports Macquarie, companies that missed in either of the past two halves, are prime candidates to miss again this month.

For evidence for Macquarie's thesis, see Orora ((ORA)), Audinate Group ((AD8)) and Sims ((SGM)) for positive 'beats' and Treasury Wine ((TWE)), Lendlease, Ansell ((ANN)), Southern Cross Media ((SXL)) and Corporate Travel Management for the follow-through disappointments.

I note all of AGL Energy, AMP ((AMP)), Aurizon Holdings ((AZJ)), Baby Bunting ((BBN)), Fletcher Building ((FBU)), Healius ((HLS)), Iress ((IRE)), Lendlease, Magellan Financial, Southern Cross Media and Temple & Webster ((TPW)) have simply added more punishment for long suffering shareholders this month.

Sometimes a cheap looking share price really is "cheap" for a very good reason.

On the other end of the ledger, one of the most remarkable phoenix-like resurrections has thus far come from autoparts manufacturer GUD Holdings ((GUD)) whose relatively unremarkable interim performance nevertheless triggered a 20%-plus rise in the share price, with analysts predicting there's more of the same ahead as long as there's no unexpected negative development.

As with almost every reporting season, the usual High Quality stalwarts keep on keeping on, releasing solid operational performances, not always necessarily rewarded with an uplift in share price.

In many cases, the only possible gripe investors can throw at these companies is a mumble about inflated valuations, which your typical value-investor almost every time does.

High Quality companies that yet again showed off their intrinsic resilience over the past twenty days include Amcor ((AMC)), Carsales ((CAR)), Cochlear ((COH)), CommBank, CSL ((CSL)), Goodman Group ((GMG)), JB Hi-Fi ((JBH)), Pro Medicus ((PME)), REA Group ((REA)), ResMed ((RMD)) and Wesfarmers ((WES)).

Another noteworthy good news story remains that of Telstra ((TLS)) whose share price bottomed at $2.65 in October 2020 ($4.21 today).

Since then, market dynamics have only improved and, judging from last week's release, the positive underlying trend continues. Note analysts are now projecting ongoing increases in Telstra's dividend payments.

Two years ago Telstra paid out 16c. That became 16.5c in FY22 and is now expected to lift again to 17c by August.

For next year, some analysts are prepared to pencil in 18c, potentially followed by 19c in FY25. UBS is prepared to put the forward trajectory in acceleration forecasting a dividend of 19c in FY24, rising to 22c in FY25, then 23c in FY26 and 26c in FY27.

Telstra shareholders looking forward to multiple years of higher dividends. That really is one change Australia hasn't witnessed in a long while.

Another BIG change is analysts now setting price targets as high as $18.70 for QBE Insurance shares; a level that hasn't been seen in more than a decade.

Corporate Results Monitor

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

(including calendar)

Research To Download

Research as a Service (RaaS) on Empire Energy Group ((EEG)):

https://www.fnarena.com/index.php/download-article/?n=4616E478-983E-9104-D890E589D211CCA5

Edison Research on Lepidico ((LPD)):

https://www.fnarena.com/index.php/download-article/?n=463EB69E-E28E-2ECE-7F1E60945D98C243

Edison Research on Lithium Power International ((LPI)):

https://www.fnarena.com/index.php/download-article/?n=4645F6F5-9544-991C-449AE6DE8A81637A

(This story was written on Monday, 20th February, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday 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: contact us via the direct messaging system on the website).

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