12 stocks and 6 ETFs for the next part of this cycle

Nathan Lim

Morgan Stanley Wealth Management

We are now in the mid-cycle. Morgan Stanley believes investors should be rotating within their equity allocation to be more aligned to the cyclicality of the current economic backdrop. Investors should focus on the Value and Quality factors, favouring the energy, material, and financial sectors as these sectors typically do well during the middle of the economic cycle. In addition, positive fundamentals support these sectors.

Volatility remains ever-present and will likely remain elevated as the mid-cycle generally brings rotation in equity leadership. We suggest also adding some defensive equity exposure to help smooth out this volatility.

We have outlined our key sector views below and suggest various ways to gain appropriate equity exposure.


Morgan Stanley believes the global oil supply will likely peak earlier than demand, and this imbalance will lead to higher oil prices. Global restrictions on carbon emissions continue to grow; therefore, oil consumption needs to peak. Accordingly, companies have already begun to respond by cutting investment into new capacity.

We see oil demand only peaking towards 2030, driven primarily by population growth. The International Energy Agency's "Net Zero" scenario sees demand falling much sooner but still requiring the oil industry to invest about US$365 billion per year to 2030. 

In 2020, the global oil industry only invested about US$350 billion in new production. Spending has not rebounded in 2021 and is unlikely to happen in 2022. If capital expenditure stays stable at current levels, the global oil supply will likely roll over around 2024 and decline sharply after that. Unless more investment is forthcoming or major demand break-throughs are made, oil prices will probably search for levels where some demand erosion eventuates. 

Morgan Stanley has raised its first-quarter 2022 Brent oil forecast to US$95 per barrel and our long-term forecast from US$60 to US$70 per barrel (see The Oil Manual: Which Will Peak Earlier? Supply? Or Demand? 19 Oct 2021).

A similar dynamic is also playing out in the global LNG market. Reduced appetite for capital intensive, long-cycle oil and gas projects has reduced the number of companies actively advancing new LNG facilities. However, at the same time, there is good policy support for natural gas as a transition fuel given the view it is a reliable and scalable lower-carbon energy source across critical markets, including China. Morgan Stanley anticipates an average annual supply deficit of 11 million tonnes per annum (mtpa) from 2022 to 2025, rising to 73 mtpa by 2030. This represents an investment shortfall of around US$65 billion. Morgan Stanley has raised its long-term LNG price forecast to US$10 per Metric Million British Thermal Unit (mmbtu) (see Global Gas & LNG: Assessing the ‘New Normal’ – Stronger for Longer? 24 Oct 2021).

Karoon Energy Ltd (ASX: KAR)

Stock rating: Overweight

Price target: A$2.10

KAR is an Australia-based oil and gas exploration and production company with a producing asset in Brazil. KAR is a pure oil producer and its medium-term business plan is to double production at its Bauna asset based on a number of well-work overs and a successful Patola drilling and tie-in. EV/EBITDA multiples illustrate the result of successful execution, which compress from around 3.8 times in FY22 to ~0.8x in FY24. Free cash flow yields also exceed 30% at US$70 per barrel in FY24. Catalysts from here include progress on KAR’s current Bauna work-over program and the 28th October Strategy Day where a decision will be made on the development of KAR’s discoveries - Neon and Goia. For longer-term investors, KAR offers the potential for further acquisitions in Brazil, albeit we think execution on its existing work program should be the priority (see Karoon Energy Ltd: Transformation value still to come, 20 Sept 2021).

Cheniere Energy Inc. (US: LNG)

Stock rating: Overweight

Price target: US$132.00

Cheniere Energy Inc. provides a pure-play exposure to liquefied natural gas infrastructure with a first-mover advantage in exporting LNG out of North America with the construction of nine liquefaction trains including an estimated nameplate capacity of about 40 million tonnes per annum (MTPA). Morgan Stanley notes a stable stream of cash flows from firm, fixed fee, 20-year take-or-pay contracts that generate substantial free cash flow in 2023 and beyond. Cheniere Marketing (CMI) maintains upside to increases in global LNG prices as the natural gas market recovers. CMI can market approximately 4.5 MTPA in the spot market, ~10% of annual sales. At this level of spot exposure, each US$1/mmbtu move higher in LNG sales margins drives a ~US$200 million increase in EBITDA. Morgan Stanley recently increased our 2022-23 EBITDA by 25%, adding Corpus Christi Stage 3 to our base case, and boosted our long-run marketing margins from US$2.50 to US$3.75 (see Cheniere Energy Inc. Stronger for Longer – Raising PT to $132, 24 Oct 2021).

BetaShares Global Energy Companies – Currency Hedged ETF (ASX: FUEL)

PIC Status: Approved – Focus List

Our preferred energy sector ETF is FUEL, which tracks the Nasdaq Global ex-Australia Energy Hedged Index. This offers a diversified exposure to global energy companies as it invests in all levels of the energy supply chain (e.g. production, transportation, storage and refining). And because this ETF is ex-Australia, it is diversified across more than 10 countries (see Focus List: BetaShare Global Energy Companies Currency Hedged ETF Factsheet, 30 Sept 2021).

BetaShares Global Energy Companies ETF - Currency Hedged
Global Shares


Within the materials sector, Morgan Stanley currently views aluminium and copper as attractive. Domestic production constraints in China are colliding with robust global demand growth for aluminium, which has driven a visible decline in global inventory levels. Combined with industry-wide cost pressures, we see strong support for aluminium prices. China has set energy consumption targets for 2021, which limits aluminium smelter production. The latest cuts in critical aluminium producing provinces should result in a growing deficit in China, leading to continued elevated primary metal imports. Also, rising natural gas prices put upward pressure on grid gas-based smelters, which pushes up the industry cost curve. While Chinese production constraints should ease in 2022, we acknowledge upside risk should China's power availability remain constrained. Morgan Stanley has raised the fourth-quarter 2021 aluminium forecast 28% to US$2,998 per tonne. The 2022 forecast has been raised 23% to US$2,695 per tonne (see metal&ROCK: The Price Deck – 4Q2021, 28 Sept 2021).

From a secular perspective, copper is key to the green revolution. As falling costs and ambitious decarbonisation targets accelerate investment in renewable energy, there is a pivot towards even more copper-intensive forms of renewable generation: enormous offshore wind projects and utility-scale solar. In addition, Morgan Stanley forecasts 131 million battery electric vehicle sales from 2021-30, which brings a significant uplift in copper's intensity usage across both sectors. 

We predict that these two sectors will consume on average twice as much copper per year from 2021 to 2030 versus the previous ten years (255,000 tonnes per annum versus 99,000 tonnes per annum). Near term, we have previously highlighted that China is unlikely to restock on copper before the end of 2021 as they built up a substantial inventory of about 1.3 million tonnes in 2020. Accordingly, Chinese demand has been met this year with existing stocks, while semiconductor shortages hampered the production of automobiles and electronics and limited ex-China demand. As such, copper has been rangebound for much of 2021. Nevertheless, we remain constructive for its longer-term outlook (see metal&ROCK: Copper cools, 5 July 2021 and Global Commodities, Copper and Renewable, 23 Mar 2021).

South32 Ltd (ASX: S32)

Stock rating: Overweight
Price target: A$4.20

In FY21, S32's profit contribution from its mix of commodities was approximately: 

  • aluminium (23%), 
  • manganese (23%), 
  • alumina (21%), 
  • silver, lead and zinc (20%), 
  • nickel (9%), and 
  • metallurgical coal (4%). 

S32 has a strong balance sheet with a net cash position, and its operating assets are amongst the lowest-cost producers in the world, meaning cash flow generation is strong through the cycle. This allows the company to reward shareholders with buy-backs and special dividends regularly. The company’s recent deals to increase its stake in Mozal and buy a 45% stake in Sierra Gorda have been materially accretive to shareholders. S32 trades on an FY22 EV/EBITDA of only ~3x based on Morgan Stanley's forward price expectations which are generally below spot prices. Morgan Stanley also forecasts an FY22 dividend yield of ~6.4% (see South32 Ltd: Sierra Gorda – Another value-accretive deal after Mozal, 14 Oct 2021).

29 Metals Ltd (ASX: 29M)

Stock rating: Overweight
Price target: A$3.10

29M comprises two producing assets – Capricorn Copper and Golden Grove – both situated in the tier 1 jurisdiction of Australia. The company’s 2022 revenue is expected to be derived 58% from copper, 24% from zinc, 27% from lead and precious metals (9% gold, 7% silver), providing significant diversification. We acknowledge that 29M’s assets are old (Golden Grove first produced in 1990 and Capricorn large scale in 1969) and higher on the cost curve. However, we see there is still a significant margin to the current copper price (~US$4.53/lb). Furthermore, management plans for brownfield production growth is compelling. Budgeted at around A$316 million, production can potentially be lifted by around 50% from 2021 to 2025 which could also potentially reduce C1 costs from US$1.66/lb in 2021 to US$0.87/lb in 2025 (see 29Metals: Attainable copper growth, Initiate at OW, 1 Aug 2021).


Financials is a highly cyclical sector that tends to benefit from improving macro conditions. At this point in the cycle, we anticipate good loan growth, low default rates and the potential for higher nominal interest rates. Banks are key beneficiaries of rising interest rates as they can generally reprice their loan book faster than their liabilities. Said another way, they can lift mortgage rates more quickly than they have to raise term deposit rates, enjoying a profit margin tailwind as the cycle advances.

Westpac Banking (ASX: WBC)

Stock rating: Overweight
Price target: A$28.90

Morgan Stanley sees improving franchise performance, including stronger housing loan growth and margin management. WBC’s credible new cost strategy and targets should support earnings and a recovery in return on equity. The potential for further divestments on top of already announced asset sales will help to boost capital and simplify the business. The bank has taken sound provisioning measures and we observe falling loan losses. We anticipate building excess capital, with shareholder-friendly buybacks a likely consequence. The payout ratio is sustainable and we forecast a strong, multi-year dividend rebound. We also observe WBC’s discount to peers as too wide. 

WBC will report financial results next week and second-half 2021 cash profit is expected to include around $1.3 billion of notable items. Morgan Stanley believes the key areas of focus regarding the result will be: 

(i) Australian loan growth trends, 

(ii) the 2H21 margin decline and outlook commentary, 

(iii) an update on the Cost Re-set plan and any FY22 expense guidance, and 

(iv) a potential off-market buyback (see Westpac Banking: Areas of Focus, 12 Oct 2021).

Macquarie Group Ltd (ASX: MQG)

Stock rating: Overweight
Price target: A$240.00

MQG has potentially the world's best green capabilities among financial stocks, with Macquarie Capital/GIG as a renewable developer, MIRA as an infrastructure operator and CGM as an energy trader. MQG's combination of these capabilities is unique, which means that they can offer turnkey renewables solutions backed by almost 20 years of experience. MQG's scale and deep expertise in renewables, especially in the US and Europe, means the stock should command a green premium. Morgan Stanley’s price target of A$240 implies an FY23 PE of ~23.5 times, which is attractive compared to global alternative asset managers in light of the stock’s green growth options (see Macquarie Group Ltd: Powered by Green Energy, 14 Oct 2021).

BetaShares Global Banks – Currency Hedged ETF (ASX: BNKS)

PIC Status: Approved – Focus List

Our preferred financials sector ETF is BNKS.AX. BNKS.AX invests in a portfolio of the world’s largest banks outside of Australia, tracking the Nasdaq Global ex-Australia Banks Hedged Index. Being ex-Australia, BNKS.AX enables investors to spread their financial risk beyond the Australian banking sector with around ~41% of the portfolio in the US (see Focus List: BetaShare Global Banks Currency Hedged ETF Factsheet, 30 Sept 2021).


Vanguard Global Value Equity Active ETF (ASX: VVLU)
PIC Status: Approved - Focus List
To gain exposure to the Value factor – our preferred ETF is VVLU.AX. VVLU.AX is one of the purest exposures to the value factor on the ASX and has a mild cyclical bias. The ETF’s performance has been strong, up ~55% for the year, while also having the lowest fees and largest funds under management compared with peers (see Focus List: Vanguard Global Value Equity Active ETF Factsheet, 30 Sept 2021).

VanEck MSCI World International Quality ETF (ASX: QUAL.AX, Hedged ASX: QHAL.AX)
PIC Status: Approved – Focus List
To gain exposure to the Quality factor, our preferred ASX-listed ETF is QUAL.AX as it has the lowest total cost of ownership, largest funds under management and solid long-term performance. QHAL.AX is our preferred hedged quality ETF on the ASX. QUAL.AX and QHAL.AX are designed to track the performance of the MSCI World ex Australia Quality Index. The ETF’s both hold a portfolio of ~300 international equities displaying three quality fundamentals: 1) high return on equity; 2) stable year-on-year earnings growth; and 3) low financial leverage. Equity exposure is focused in the United States (see ETF Research Report: International Quality ETF Review, 26 Oct 2021).

iShares Edge MSCI World Quality Factor UCITS ETF US$ Acc (LSE: IWQU.L)
PIC Status: Approved – Focus List
To gain exposure to the Quality factor, our preferred UCITS ETF is IWQU.L as it has the largest funds under management, lowest total cost of ownership at 0.43% and lowest tracking error. IWQU.L tracks the performance of the MSCI World Sector Neutral Quality index. The ETF holds a portfolio of ~300 international equities displaying three quality fundamentals: 1) high return on equity; 2) stable year-on-year earnings growth; and 3) low financial leverage. Equity exposure is focused in the United States. Unlike QUAL.AX, the index also takes a “sector neutral” approach to portfolio construction, maintaining the sector weights of the parent index (MSCI World Index), and overweighting the highest quality stocks within each sector (see ETF Research Report: International Quality ETF Review, 26 Oct 2021).


Qantas Airways Ltd (ASX: QAN)
Stock rating: Overweight
Price target: A$7.00
Morgan Stanley sees upside in QAN's share price as we look forward to its "recovered" earnings capacity, which is anticipated in 2024 when passenger traffic fully recovers to pre-Covid levels. In FY24, Morgan Stanley forecasts recovered EPS about 50% above pre-Covid levels - driven by significant structure cost-out and a modest increase in unit revenues, supported by domestic market discipline. Despite significant leverage to reopening, QAN is trading in line with the stock’s pre-Covid market capitalisation. We believe the current share price is capitalising activity levels still about 20% below normal and assumes the minimal realisation of permanent cost cuts taken by management despite their strong track record executing in this area (see Qantas Airways Ltd: Just a little bit longer, 26 Aug 2021).

Corporate Travel Management Ltd (ASX: CTD)
Stock rating: Overweight
Price target: A$23.50
When Covid-19 impacted CTD, the company had net cash on its balance sheet. CTD managed to reduce cash burn to very modest levels in stark contrast to listed peers Webjet, Flight Centre, and Helloworld Travel which undertook (in some cases several) capital raisings to remain solvent. CTD also raised capital during the crisis but opportunistically acquired a large US travel management company at a steep discount. CTD remained resilient during the crisis and outperformed all peers, despite being heavily sold on cashflow concerns.

Investors now debate whether CTD will continue to thrive in a post-Covid world that faces structurally less travel. Morgan Stanley expects the significant cost-cutting during Covid should lead to improved profitability, and even on a much lower revenue base. We feel the market share growth CTD experienced pre-Covid will continue post-Covid, supporting continued double-digit revenue growth as the market remains highly fragmented. We acknowledge travel patterns will change, but revenue-generating travel and connecting remote working teams (a much larger market) are likely to stay strong (see Corporate Travel Management Ltd: When, not if, 18 Aug 2021).

Tyro Payments Ltd (TYR)
Stock rating: Overweight
Price target: A$4.70
Morgan Stanley sees continuing structural growth in consumer payments switching to digital (i.e. replacing the use of cash). We forecast TYR to continue to make further market share gains (currently only ~5% share), predominantly taking Small Medium Enterprise (SME) customers from the major banks, underpinned by TYR’s faster, more efficient, and more flexible payments platform. In addition, we believe the market is under-estimating the upside from TYR’s acquisition of Bendigo Bank’s SME payments customers in June 2021. We also see upcoming new hardware launches (new dongle and mPOS) as drivers of TYR share gains. 

Morgan Stanley’s bull case scenario will come into play if TYR is able to secure another outsourcing deal with another Australian regional bank or large bank, along the lines of the Bendigo Bank deal. We expect this would be highly value-enhancing as it would add TTV volume to the platform and likely be meaningfully additive to TYR’s margins and returns. Currently, TYR is trading on an ~11x FY21 EV/Sales, which is below its historic average of 13x and below Australian software peers of 10x-25x. This valuation is particularly attractive given we expect an acceleration in revenue growth as NSW and VIC emerge from lockdowns and consumers return to previous spending patterns in hospitality and retail. The next catalyst is likely TYR’s 2021 AGM scheduled on 3 November 2021 (see Tyro Payments Ltd, TYR FY21 results in-line…positive news on lower churn + rising new applications + good start to BEN JV + new hardware coming. Keep OW, 26 Aug 2021).


Telstra Corporation (ASX: TLS)

Stock rating: Overweight
Price target: A$4.50

Morgan Stanley upgraded its rating to Overweight (from Underweight) earlier this year based on three critical factors:

1) Improved mobile industry outlook for Average Revenue Per User (ARPU) increases and higher returns.

After several years of intense competition and consecutive falls in mobile ARPU, Morgan Stanley believes the industry is now moving into a phase of ARPU repair, with each of the 3 Mobile Network Operators – Telstra, Optus and Vodafone – focused on mobile yields and striving for higher returns on their investment in 5G spectrum and equipment.

2) Sale of Mobile Towers business and exploration of additional monetisation opportunities for TLS infrastructure assets.

TLS achieved a superior outcome on the sale of its Mobile Towers business – a higher multiple, more advantageous JV structure and earlier than expected – and has applied the proceeds to a current on-market share buyback. Furthermore the company states it continues to explore opportunities for the rest of its telecommunication infrastructure assets, including a potential deal with the NBN, which we feel could be value-enhancing for TLS shareholders.

3) The NBN pain nearing an end.

An improved outlook for fixed-line/broadband earnings is expected given the dilutive NBN roll-out is drawing to an end. Furthermore, TLS is supplementing the company’s returns with Fixed Wireless.

Morgan Stanley’s conviction in these three key drivers of positive returns remains high. Notwithstanding the company’s outperformance year to date, we continue to see TLS’s valuation as attractive, trading on ~8x FY22 EV/EBITDA multiple. The dividend yield of ~4% is fully franked and sustainable, with some scope for growth over time. With TLS’s annual investor day and AGM now past, the next likely catalyst for the shares will be the commencement of the announced A$1.35 billion on-market share buyback (~3% of shares on issue) which we expect to occur over October and November 2021. For further details see Telstra Corporation: FY21 results supportive of our positive thesis…Mobile growth resumes + Organic earnings growth to fund dividends + Share buyback, 12 Aug 2021 and Telstra Corporation, Upgrade to OW (from UW) … Mobile Towers spin-out + improving industry + options to create value, 29 Mar 2021).

Sonic Healthcare Ltd (ASX: SHL)

Stock rating: Overweight
Price target: A$45.50

SHL’s FY22 earnings should benefit from ongoing Covid testing and an anticipated recovery in base business volumes. For now, Morgan Stanley assumes Covid testing continues at around 8% of the peak value observed in FY21 into perpetuity. Covid testing has driven SHL's gearing to record lows (0.4x Net Debt/EBITDA as of June 2021) and well below the 3.5x debt covenant limit. SHL's strategy to grow via acquisitions is unchanged, and the company’s unburdened balance sheet allows SHL to be opportunistic (see Australia Healthcare: FY22 outlook more positive, 5 Sept 2021).

APA Group (ASX: APA)

Stock rating: Equal-weight
Price target: A$10.11

APA is a high-quality exposure to growth in energy infrastructure. Energy infrastructure is in a structural growth phase driven by global efforts to reduce the carbon intensity of our power systems (energy transformation). The company's near-term catalyst is most likely developments with the AusNet Services (ASX: AST) transaction, which currently has AST and APA engaging on terms for due diligence. Morgan Stanley's proforma analysis of the combination suggests that the merger could be accretive to APA’s cash flow and distributions in the first full year (presumably FY23) with only modest synergies required. APA's recent derating provides an attractive entry point given its FY22e dividend yield of ~6% (see Australia Energy Infrastructure, Pro Forma Analysis, 27 Sept 2021).

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Nathan Lim
Head of Wealth Management Research
Morgan Stanley Wealth Management

Nathan is the Head of Wealth Management Research for Morgan Stanley Australia. Joining in 2016, he reshaped the team’s coverage to support the firm’s holistic advice business. Previously, Nathan worked for Australian Ethical Investment where he...

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