Rudi’s View: ARB, Corporate Travel, Goodman Group, NextDC, Orora, Worley & Xero

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

In this week's Weekly Insights:

-Opportunities With A Five Year Horizon
-Company Reports: Early Trends
-Company Reports: Inflation
-Company Reports: Conviction
-Company Reports: Technology Sector
-REITs In Focus

By Rudi Filapek-Vandyck, Editor FNArena

Opportunities With A Five Year Horizon

Most investors like to profess they are in it for the long term, but let's be brutally honest: we are all influenced by what happens in the here and now, irrespective of what the consequences might be in the long run.

Which is also why my own investor heart tends to skip a beat whenever an experienced market researcher makes the effort to identify great opportunities with a longer term focus.

At the very least, in my humble opinion, such research offers the rest of us mere mortals with valuable input to think about, detached from the immediate and daily share price movements.

One extra observation to throw in the mix: whenever analysts try to identify great longer-term investments, they mostly end up overlapping each other's selections, with personal preferences often creating the minor differences.

Wilsons' latest effort fits in almost perfectly with my own research into All-Weather Performers on the ASX.

Last week Wilsons published a list of five stocks for the next five years; a small selection of genuine bottom-drawer stocks, that can be owned and trusted to reward shareholders over the next five years, at least. The selection is supported by attractive structural trends such as healthcare innovation, energy transition, cloud computing, and financial industry disruption.

The five companies selected because, in the words of Wilsons, they deserve a place in every investor's portfolio, are CSL ((CSL)), Macquarie Group ((MQG)), Netwealth Group ((NWL)), NextDC ((NXT)), and Worley ((WOR)). Three of those are currently held in the FNArena/Vested Equities All-Weather Model Portfolio.

Other attractive long-term buys, according to the same analysts, include APA Group ((APA)), Aristocrat Leisure ((ALL)), Goodman Group ((GMG)), James Hardie ((JHX)), IDP Education ((IEL)), The Lottery Corp ((TLC)), ResMed ((RMD)), Telix Pharmaceuticals ((TLX)), and Xero ((XRO)).

More overlap.

Paying subscribers have 24/7 access to a dedicated section on the website on my research into All-Weather Stocks:

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

Company Reports: Early Trends

The focus of investors will increasingly shift towards corporate earnings and their likely outlook, both in Australia and overseas, though the macro picture consisting of central bank actions, China stimulus, bond yields and economic indicators will still be ever-present.

Thus far in 2023, equity indices like to rally on macro-influences, while corporate earnings have not genuinely followed suit, even though there has been no fall-of-the-cliff experience either.

The Australian share market has seen the return of Confession Season, when companies confess they won't make the target for the financial period, but it hasn't been an all-out tsunami of negative announcements.

Companies that came clean over the weeks past have seen their share price fall in response, at times by -10% or more, including the likes of Ansell ((ANN)), Aurizon Holdings ((AZJ)), ASX ((ASX)), Boral ((BLD)), Cleanaway Waste Management ((CWY)), CSL, Johns Lyng Group ((JLG)), Link Administration ((LNK)), Northern Star Resources ((NST)), and Domino's Pizza ((DMP)).

There have been the occasional good news surprises, including from AGL Energy ((AGL)), Ampol ((ALD)), Fletcher Building ((FBU)), and Megaport ((MP1)).

The two lists might not be complete, but I think it's fair to say the bias is leaning towards the negative.

The mining sector certainly is generating its own negative contributions as also witnessed on Monday with South32 ((S32)) flagging a record -US$1.3bn asset write-down, hot on the heels of IGO Ltd's ((IGO)) substantial write-down in the week prior, and Core Lithium ((CXO)) downgrading production guidance.

Ship builder Austal ((ASB)) has requested a trading halt, potentially to downgrade market expectations.

Most strategists in Australia seem to be cautious at best. See also last week's edition: https://www.fnarena.com/index.php/2023/07/19/rudis-view-low-expectations-not-low-enough/

Over in the USA, EPS forecasts are dropping quite rapidly as early Q2 financial reports are being released. It wasn't that long ago the average EPS forecast for the quarter for the S&P500 was sitting at a negative -7% year-on-year. That percentage has over the past two weeks or so quickly dropped to -9%.

It's still early in the season, of course, but positive surprises thus far amount to 75% of reports versus a five-year average of 77%.

What should genuinely worry investors in Australia is how earnings releases in general are being received on Wall Street and in Europe. Market watchers have been observing the trend tends to favour share prices to underperform when companies miss the mark while companies that beat expectations are not necessarily receiving a reward for it.

It also seems the bias has shifted towards more 'misses' and fewer 'beats'. The punishment for a 'miss' tends to be noticeably larger than the reward for a 'beat'.

If Europe is leading Australia, the following trends should be expected to show up locally:

-Momentum is slowing, feeding into more cautious guidances and ongoing downgrades in earnings forecasts
-Less companies are able to beat market forecasts
-Large cap companies are faring noticeably better than smaller cap peers
-Cyclical sectors Energy and Materials are among segments with the weakest earnings trends, but so are Growth companies

The Q2 season in the US has only just begun, but similar observations have been made.

Reporting season in Australia starts unofficially on Wednesday, when Rio Tinto ((RIO)) sets the early tone, followed the next day by Champion Iron ((CIA)), Garda Property Group ((GDF)) and Sandfire Resources ((SFR)).

The following week sees financial updates released by Credit Corp ((CCP)), Janus Henderson ((JHG)), Block ((SQ2)) and ResMed ((RMD)) but, realistically, the August reporting season only starts ramping up the week after next week.

Even then, as has become the local tradition, Australian companies wait until the middle of the month has passed, and only then a true tsunami of corporate updates will be unleashed upon investors and analysts. Many of the small cap companies, those with not great results in particular, wait until the final days of the season.

FNArena will be keeping a close eye, as has become our own self-made tradition since mid-2013. Our dedicated Corporate Results Monitor will be brought to live by the end of this week:

https://www.fnarena.com/index.php/reporting_season/

(The Corporate Results Monitor also includes a calendar for the season).

Company Reports: Inflation

Blame it on excess government support, a resilient consumer, or a this-time-is-different cycle, but resurgent inflation has equally been a supporting factor for corporate results over the year past.

When inflation runs high, many a company finds it much easier to justify a price increase to its customers, even if the latter feels the pain. And as we all live in a nominal world, high inflation also acts as an artificial growth engine; even when customers are ordering less, the increase in prices tends to still lift overall sales and revenues at the top line.

With inflation deflating, as is undoubtedly happening at the moment, achieving growth becomes more difficult for companies. Many will be facing price decreases instead, and with economic momentum slowing, there no longer is an automatic rise in nominal sales and revenues.

Some industries will be faced with too-high inventories and an urgency to ship out products and services through discounted prices.

At the macro-level, falling inflation should see central bankers relax and pause, and bond yields trend lower, which supports higher valuations for listed assets.

Exactly how this combination of negatives and positives from receding inflation will play out is anyone's forecast, but a worst case scenario would imply that higher valuations are already in place, while slower growth still needs to be accounted for.

The Australian share market is currently trading near or above its long term average PE ratio, depending on whose number crunching we rely on. But strip out banks and resources and Shaw and Partners' CIO Martin Crabb believes the average PE ratio is around 20x next year's forecast EPS – not cheap by anyone's account.

All else being equal, companies might have to convince the market they are truly worth the multiple they are trading on, even with lower bond yields potentially providing valuation support (in a general sense).

Company Reports: Conviction

It's never easy or straightforward to know in advance which companies won't disappoint in August, but Morgan Stanley analysts have identified ten ASX-listed companies that come with High Conviction attached:

-Atlas Arteria ((ALX))
-Cleanaway Waste Management
-Corporate Travel Management ((CTD))
-CSL
-Goodman Group
-McMillan Shakespeare ((MMS))
-Medibank Private ((MPL))
-Orora ((ORA))
-Telstra ((TLS))
-NextDC

****

Strategists at Morgans suggest corporate earnings look vulnerable ahead of August, with investors' attention not simply focused on FY23 results, but probably more so on the outlook for FY24.

Key themes to watch, according to Morgans, are the underlying trend for earnings, higher interest costs, cyclical signposts (consumer demand, industrial margins), small cap performance, short selling and investor positioning in resources.

Morgans has lined up a number of key tactical trades for the season at hand (positive outcomes expected):

-Flight Centre ((FLT))
-Lovisa Holdings ((LOV))
-Medibank Private
-Orora
-QBE Insurance ((QBE))
-ResMed

As debt financing costs will come under scrutiny, Morgans sees risk rising for:

-Amcor ((AMC))
-Aurizon Holdings
-Costa Group ((CGC))
-Cleanaway Waste Management
-Cromwell Property Group ((CMW))
-Domino's Pizza
-Star Entertainment Group ((SGR))
-Wagners Holding Co ((WGN))

Also at risk for delivering disappointment:

-APA Group
-ARB Corp ((ARB))
-Treasury Wine Estates ((TWE))
-Transurban ((TCL))

Have been identified for potential upside from capital management:

-Computershare ((CPU))
-Suncorp Group ((SUN))
-Super Retail Group ((SUL))

Costa Group and Iress ((IRE)) have been singled out for potential balance sheet risk.

Company Reports: Technology Sector

One sector that might have to justify this year's share price performances more than others is the local technology sector.

One exception, possibly, suggest analysts at Jarden, are the payment processors with share prices for the likes of Zip Co ((ZIP)) and Tyro Payments ((TYR)) still suffering from prior Afterpay-led exuberance.

Jarden believes investor focus will be on delivery of cash flows and specific outlook commentary, including cost containment and the way to reaching break-even.

As things stand towards the end of July, Jarden only has one Buy rating left for the sector in Australia, for SiteMinder ((SDR)). Four other stocks are rated Overweight (one step below Buy): WiseTech Global ((WTC)), Xero, REA Group ((REA)) and Seek ((SEK)).

Sector analysts at Goldman Sachs recently used an update specific to IT services to reiterate their preferences for Macquarie Technology ((MAQ)) and Data#3 Ltd ((DTL)).

REITs In Focus

One market segment that has experienced a tough time during covid and lockdowns, and then on higher bond yields, under-utilised offices and a slowing in consumer spending are real estate investment trusts.

AREITs are not immune to rising costs, including for servicing debt, and many might find themselves without much organic growth for the year(s) ahead. One can see the general theme already: stockpicking is critical!

Sector analysts at Jarden's preference lays with those who appear to have the strongest growth prospects; Goodman Group, Scentre Group ((SCG)), National Storage ((NSR)), Arena REIT ((ARF)), Vicinity Centres ((VCX)) and Lifestyle Communities ((LIC)).

General apprehension towards the sector has made a few looking very cheap, which is equally attracting Jarden's attention: Region Group ((RGN)), Charter Hall Retail REIT ((CQR)) and HomeCo Daily Needs REIT ((HDN)).

****

Analysts at Macquarie, where the in-house view remains that Australia is facing economic recession, remind investors REITs typically underperform in the early contraction stage of the market cycle. Hence Macquarie's preference for the more defensive exposures in the local sector.

Macquarie's preference lays with Goodman Group, GPT Group ((GPT)), Dexus ((DXS)) among large caps, and Centuria Industrial REIT ((CIP)), Arena REIT and Qualitas ((QAL)) for smaller cap exposures.

For investors worried about potential balance sheet risks, Macquarie is most cautious on Charter Hall Long WALE REIT ((CLW)), Scentre Group, and Lendlease.

****

Ord Minnett remains cautious on office assets, with property valuations in general (read: devaluations) potentially a key factor in August, together with debt profiles and tenant demand in the wake of higher costs. AREITs will need to show fresh initiatives to convince investors they are not ex-growth, suggest the analysts.

Ord Minnett is supportive of landlords of convenience shopping assets, expecting Charter Hall Retail REIT, HomeCo Daily Needs REIT and RAM Essential Services Property Fund ((REP)) to report solid operating results.

The broker's Top Picks are Waypoint REIT ((WPR)), Dexus Convenience Retail REIT ((DXC)), and RAM Essential Services Property Fund.

****

Morgan Stanley states AREITs were traditionally seen as providing relatively steady outlooks for investors, but this has changed in recent times. Hence, those who still can provide stable outlooks are likely rewarded with a valuation premium, the broker suggests.

AREITs best placed to present investors with a stable performance plus outlook in August, according to Morgan Stanley, include Goodman Group, Scentre Group, and Vicinity Centres.

Risk to specific guidances are considered for Mirvac Group ((MGR)), Stockland ((SGP)), Charter Hall ((CHC)), Dexus, and Centuria Office REIT ((COF)).

****

UBS's sector preferences reside with "REITs with business models suitable for either a 'higher for longer' rate environment or with robust cash flow growth in a period of economic weakness."

UBS's most preferred exposures are Goodman Group, Mirvac Group, GPT Group, Lendlease, HomeCo Daily Needs REIT, Centuria Industrial REIT, and Lifestyle Communities.

The broker's list of least preferred REITs include Scentre Group, Vicinity Centres, Dexus, Charter Hall, Region Group, BWP Trust ((BWP)), and Ingenia Communities Group ((INA)).

FNArena Subscription

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, 24 July, 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).

Click to view our Glossary of Financial Terms