Rudi’s View: Seeking Quality & Growth Offshore

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In todays Weekly Insights:

-Confession Season… It's Baaaaaack!
-Seeking Quality & Growth Offshore

By Rudi Filapek-Vandyck, Editor

Confession Season… It's Baaaaaack!

Once upon a time the two months preceding the end of financial year, and the subsequent weeks leading into reporting season in Australia, caused more than just a little bit of anxiety among investors as market updates might well translate into that universally dreaded Profit Warning that has the potential to inflict a lot of damage to a company's share price.

Recent years have not seen much in terms of profit warnings ahead of the official results season, but early signals are this year might be different. The past week alone has seen market updates by the likes of AdBri ((ABC)), Bubs Australia ((BUB)), Cluey ((CLU)), Mirvac Group ((MGR)), Synlait Milk ((SM1)) and Insignia Financial ((IFL)) force analysts to downgrade forecasts for the financial year running.

Troubled IOUpay ((IOU)) has effectively gone out of business. Most production updates by miners and energy companies proved disappointing too, marred by project delays, weather impact, lower prices and higher operational costs.

It's not all bad news though, as share prices of Bubs, Mirvac Group and Insignia Financial had already largely accounted for what was coming. Sometimes bad news can actually free-up the next move upwards on the reasonable prospect of less-bad conditions ahead, potentially.

Regardless, investors would be wise to not simply assume today's market laggards are by default a great bargain with Synlait Milk yet again proving there's no bottom when troubles keep accumulating.

Trading around $12 in 2018 and having started the running calendar year above $4, today's share price of less than $1.50 reminds me of the old share market joke:

What's a stock that's down by -90%?

That's a stock that first fell by -80%, and then halved yet again.

It's not all negative news though with corporate market updates to date, on balance, proving more positive than negative. Notable positive surprises have been delivered by Camplify Holdings ((CHL)), Helloworld ((HLO)), Megaport ((MP1)), Perpetual ((PPT)), Reliance Worldwide ((RWC)) and Stockland Group ((SGP)).

Such profit warnings (both negative and positive) are often quite random which makes it difficult for investors to prepare or anticipate. Yet one source of potential weakness is the so-called Second Half Club; companies that need a strong second half to meet guidance or market expectations.

The February results season saw this group of companies swell to nearly 50% of all companies, suggesting there is plenty of potential for a lot more negative surprises in the weeks and months ahead.

Local market strategists at Morgan Stanley offer another potential approach; adopting a theoretical framework developed by their colleagues in Europe to establish which companies have been over-earning due to covid previously, the local strategy team has identified four sectors in Australia in danger of an earnings reset, which in practice means: be careful, here's a higher chance for negative profit warnings.

The Morgan Stanley modeling has identified energy, discretionary retail, staples and real estate as sectors most at risk.

All shall be revealed in the weeks & months ahead.

Seeking Quality & Growth Offshore

The promotors of international markets have a way of making us all feel silly and ignorant: do you realise Australian equities represent no more than 2% of the global pie? If you stay local, you are missing out on 98% of what is out there!

It is difficult to argue with the numbers, but what should equally be front of mind is that Australia is inside the Global Top Three when it comes to long-term average investment returns. At the very least this provides local investors with plenty of reasons not to make any rash decisions.

Ultimately, investing is about sustainable return and there's little value in diluting one of the best performing markets with less-returning alternatives, just for the sake of it.

One such alternative are Emerging Markets; according to some a must-have exposure because of the much higher economic growth that is on offer, but if history shows one thing it is that higher economic growth does not by default translate into better performing equity markets.

Look no further than China where equities have pretty much endured a lost decade (and then some) post-GFC. Even today the prospects for Chinese equities in the years ahead remain one of the hottest debates around.

This is especially important as most exchange traded funds or ETFs that promise Australian investors easy access to above-average GDP growth in Emerging Markets tend to be overweighted towards China.

Take the iShares MSCI Emerging Markets ETF as an example. Its exposure (as per info on the Blackrock website) is 31%-plus China, 14.5% Taiwan, 13.5% India and nearly 12% South Korea.

Does this genuinely look like the right instrument for access to Brazil, Mexico or Indonesia?

Performances and momentum across various EMs can polarise significantly, and in most years that's exactly what happens. The added complication for Australian investors is that during times of local outperformance, the vulnerabilities elsewhere can be quite the painful experience.

Note also with China and Taiwan the two largest exposures, combined circa 45% of total assets for the ETF, geopolitical risk should be front of mind also.

Total return for the iShares ETF mentioned ended on minus -15.07% in 2022, having only returned 2.03% in 2021. US shares also underperformed Australia last year, but major indices are ahead thus far in 2023 mostly carried by a handful of Big Technology companies.

In Europe so far this year the German DAX30 index is close to mimicking the Nasdaq's return, while the gain for Japanese equities is equally above 10%. The Dow Jones Industrial Average, on the other hand, is only narrowly positive year-to-date.

In summary: adding international exposure to Australian equities is by no means an easy route towards better investment returns. It may, on the contrary, turn out a costly lesson during challenging times.

In recent years investors have witnessed an almost relentless outperformance by US markets (2022 not included), which no doubt has created the general impression that US markets simply perform better.

However, according to Credit Suisse's Global Investment Returns Yearbook the long term returns from investing in Australian and US equities are virtually equal, suggesting periods of outperformance by one are followed up by relative underperformance during other times.

Australia and the US are two of the Global Top Three performers since 1900, with South-Africa the only market with even better return, but also with much greater swings between large gains and outsized losses.

The Australian market has the added benefit of superior dividend yields, enlarged through the beneficial tax system of franking, plus it consists of companies that often literally operate in investors' backyard. The latter means much easier access to daily news flow, company officials and updated research.

It's much easier to stick with the Devil-you-know if that delivers some of the best returns available, over time, with the comfort of playing a home game. Life already has plenty of complications on its own.

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Having said all of the above, there is one strong argument as to why looking beyond Australia might not be a bad idea: the rest of the world offers more options.

At the end of the day, there's only one CSL ((CSL)) available on the local bourse, and the same applies to REA Group ((REA)), Carsales ((CAR)), Seek ((SEK)), ResMed ((RMD)) and Cochlear ((COH)).

And while Altium ((ALU)), WiseTech Global ((WTC)) and Pro Medicus ((PME)) are doing a commendable job in establishing themselves as a global leader in their respective markets, all still are relatively small-sized companies and, equally important, stand-out exeptions among lesser fortuned peers.

The ASX has a broader suite of offerings for investors wanting exposure to iron ore, gold and lithium, but even the local mining sector has some notable gaps including silver, diamonds, platinum, potash and palladium.

Looking beyond the limitations inside Australia's borders thus doesn't sound like too crazy an idea. The service FNArena provides, including ever more data, is specifically designed for investors investing in Australia, but we have equally access to research on foreign markets.

Some of recent reports are worth highlighting for those investors looking offshore.

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Recent research by UBS zoomed in on sustainable dividend growers, which seems like an obvious focus when the future looks uncertain (which is the general view at UBS).

History shows if/when economic recessions occur, dividend paying stocks outperform, with UBS research showing just that for the years 2001, 2008, and 2020. The best dividend exposures are through companies that combine dividend with rapid growth.

UBS's screening of US-listed companies highlighted the following with at least 10% dividend CAGR between 2022 and 2025 (ranked in line with predicted pace of growth, highest first):

-Fidelity National Information Services (FIS)
-Analog Devices (ADI)
-Houlihan Lokey (HLI)
-DuPont de Nemours (DD)
-American International Group (AIG)
-Intercontinental Exchange (ICE)
-FMC Corp (FMC)
-NextEra Energy (NEE)
-Darden Restaurants (DRI)
-Home Depot (HD)

The following are projected to grow at just below 10% dividend CAGR over the period:

-Bank of New York Mellon (BK)
-CVS Health Corp (CVS)
-Air Products and Chemicals (APD)

One thing Australian investors have to get used to is lower yields on offer relative to the 4%-5% and higher yields that are currently available on the ASX. The highest yield (forward-looking) in the lists above resides with Fidelity National Information Services at 4.5% with all others offering between 1.7% and 3.3%.

If one starts off from the highest yields and then adds the necessity for high growth, we end up with a different list. The stocks below offer between 6.2% at the top and 3.0%:

-Hannon Armstrong Sustainable Infra (HASI)
-Huntington Bancshares (HBAN)
-Fifth Third Bancorp (FITB)
-Fidelity National Information Services (FIS)
-American Electric Power (AEP)
-Public Service Enterprise Group (PEG)
-Exelon Corp (EXC)
-Bank of New York Mellon (BK)
-PPL Corp (PPL)
-Axis Capital Holdings (AXS)
-CVS Health Corp (CVS)
-Darden Restaurants (DRI)
-Cardinal Health (CAH)
-AES Corp (AES)
-American International Group (AIG)

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A recent strategy update by Wilsons highlighted the relative resilience of the Australian share market, which should this year find ongoing support from a domestic economy that is likely to avoid economic recession.

At the same time, Wilsons warns about complacent asset allocation which, in Australia, almost by definition implies portfolios have too much exposure to dividend-paying banks. Wilsons' model portfolio is underweight Australian banks.

It goes without saying if a recession in the US, and potentially in Europe and elsewhere, weighs on commodity prices this will most likely be reflected in lower share prices for the likes of BHP Group ((BHP)), Rio Tinto ((RIO)) et al.

Wilsons agrees with the philosophy of accessing more choice (through going international) and in particular highlights corporate profit growth ex-Australia has been far superior post-GFC in comparison with local EPS growth. The motivation is thus to look beyond the ASX to access more companies offering superior growth.

Wilsons is not a fan of seeking out any ETFs, instead pointing towards actively managed global equity funds that look best prepared to deliver strong, risk-adjusted returns over a full market cycle, in addition to an actively managed domestic equities allocation.

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Morgan Stanley is one of few that tries to identify the highest Quality companies that should prove their resilience both through challenging times, as well as over a longer-term timeframe, a la my personal research into All-Weather Performers in Australia.

A recent update is titled 30 for 2025, implying the following thirty High Quality North-American companies should be great to own, at least until 2025:

-Alphabet
-American Express
-Blackstone
-Cheniere Energy
-Costco Wholesale
-Eaton
-Eli Lilly
-Estee Lauder
-Exxon Mobil
-Hilton Worldwide
-Intuitive Surgical
-JPMorgan Chase
-Liberty Formula One
-Linde
-Lululemon Athletica
-MasterCard
-Microsoft
-Motorola Solutions
-MSCI Inc.
-NextEra Energy
-Nike
-Northrop Grumman
-Old Dominion Freight Line
-Prologis
-Raytheon Technologies
-Thermo Fisher Scientific
-T-Mobile US
-UnitedHealth Group
-Visa
-Yum! Brands

When the team in Europe sat down with the same task, they identified 35 Quality stocks for 2025:

-3i
-Air Liquide
-Ashtead Group PLC
-ASML Holding NV
-Biomerieux SA
-CaixaBank SA
-Cellnex Telecom SA
-Coloplast A/S
-Compass Group
-Dassault Systemes SA
-Deutsche Telekom
-Diageo PLC
-Edenred SA
-Endeavour Mining
-Experian PLC
-Intesa SanPaolo SpA
-London Stock Exchange
-Lonza Group AG
-L'Oreal SA

It goes without saying, nothing of the above is investment advice. Investors should always do their own research and consult with an advisor. The above can contain fresh ideas and function as a guide for additional research and further exploration.

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My personal research into All-Weather Performers is restricted to ASX-listed companies. My curated lists are 24/7 accessible to paying subscribers:

https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/

More reading:

–https://www.fnarena.com/index.php/2023/04/26/rudis-view-investing-in-megatrends-the-other-ones/

–https://www.fnarena.com/index.php/2023/03/22/rudis-view-all-weather-stocks-back-in-fashion/

Conviction Calls and Best Ideas:

-https://www.fnarena.com/index.php/2023/04/19/rudis-view-bond-market-says-regime-change-is-upon-us/

–https://www.fnarena.com/index.php/2023/04/12/rudis-view-wesfarmers-wisetech-worley/

–https://www.fnarena.com/index.php/2023/03/17/rudis-view-dominos-pizza-newcrest-qantas/

–https://www.fnarena.com/index.php/2023/02/10/rudis-view-aub-group-endeavour-lottery-corp-suncorp/

–https://www.fnarena.com/index.php/2023/02/03/rudis-view-csl-mineral-resources-ridley-readytech/

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A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 1st May, 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).

(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: contact us via the direct messaging system on the website).

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