4 beaten down sectors (and if now's the time to buy)

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Livewire Markets

The ramifications of Covid-19 have been felt across economies around the globe, however, it has become evident that not all sectors have been treated equally. With extended lockdown and border closures looking set to continue, is there any hope for the most vulnerable industries?

Tourism, REITs, banks and energy have all fallen victim to the shocks in consumer spending, government policy and travel restrictions brought about by the pandemic. Despite these short-term hardships however, there’s an abundance of value and opportunity for the patient investor willing to dig into some of these distressed pockets of the market, explain Matt Williams from Airlie Funds Management and Sean Fenton from Sage Capital.

In this thematic, Matt and Sean discuss whether they are bullish or bearish across the four worst affected sectors, as well as the stocks that are set to benefit from a return to relative normality.

Notes: Watch, read or listen to the discussion below. This episode was filmed on 7 October 2020

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Edited transcript

Vishal: Welcome to Buy, Hold, Sell, brought to you by Livewire Markets. My name is Vishal Teckchandani, and today we're going to talk about four beaten down sectors. These are parts of the market which are down, they're out. But can they survive and thrive like Chuck Norris.

Joining me to discuss this thematic is Matt Williams from Airlie Funds Management and Sean Fenton from Sage Capital. Welcome to the show gents.

Is it time to tour travel stocks?

Sean, let's start off with the travel industry. We've got bubble talk everywhere. New South Wales, South Australia, New South Wales, Queensland hopefully. We're even letting the poor Kiwis into the Northern Territory. I don't know what they're going to do there, but is this the signal? Do you want to now be bullish on the travel sector?

Sean: In the medium term, you've got to be bullish. COVID's not going to last forever, so it will open back up. I must say I was more bullish yesterday, when we had no cases in New South Wales for about 11 days. Three today, just puts that back a little bit.

Ultimately, we're actually bullish on a vaccine being developed some time next year. There's a huge amount of money being thrown at that. There's already nine candidates in late stage trials. We could have some positive news on that by the end of the year.

But even without that, we are doing a great job in Australia, in terms of managing the virus, getting it under control. Once you get some state elections out of the way in Queensland, and the like, we'll start to see borders reopen. And there's some great leverage to travel companies actually coming back and benefiting from that.

Vishal: You sound bullish. What's your preferred way to play travel?

Sean: Qantas is probably the best way to play it, which is probably a little bit consensus. But Qantas has done a great job in recent years, under a lot of pressure, in stripping costs out, and this is an opportunity to do more of that. It's going to be leaner and meaner.

The industry's pretty consolidated. Virgin basically went broke in the first week of COVID, so Bain's in there now. They're going to want to get a return on their investment, so we see a pretty rational domestic duopoly being maintained, and that profit pool coming back.

Qantas's exposure international is less than it used to be, meaning they've actually outsourced a lot of the capital. They've joint service agreements within international airlines. Their capital's actually invested in the planes. It's a capital-light model. It can take a little bit longer to come back. But between domestic travel and a loyalty programme that's world-class, continues to grow, that's a business we like. As long as they get through this, preserving cash, then there's a quick rebound down the track for them.

Vishal: Matt, same question to you, but I'm going to frame it in a different way. We've seen this travel bubble stuff happen in Europe after they got their first wave under control. Second wave is well and truly alive, and these countries have started to actually tighten some of their travel restrictions. Is that the risk if you buy into the travel sector now? That, potentially, you could see borders go back up. Are you bullish or bearish on travel?

Matt: I'm bullish on domestic travel. I think for the reasons you're talking about, international travel is a much different proposition. Yes, it's going to be bumpy (pardon the pun). There's going to be spikes in the cases, but before we get the vaccine, as Sean has pointed out. There'll be some nervousness and some... It'll be a difficult navigation period.

But I'm bullish on domestic travel. I think it's going to explode, and that people have got money to spend, they have saved money, there's a lot of stimulus still out there, the budget's helping with the tax cuts. I believe that domestic travel's just going to go gangbusters.

Vishal: It's going to go bonkers, what stock are you investing in to play this sector?

Matt: Like Sean, Qantas is the best way to play that domestic travel. Flight Centre and Webjet are much more exposed to international travel, and as I said, that's going to be much more difficult, and much a long road before they get back to any kind of normality, in terms of the earnings that they used to have.

Opportunities emerging in REITs

Vishal: Staying with you Matt, next sector, the REIT market. These companies used to deliver rivers of gold, of stable income, but then work from home happened, e-commerce happened. Do you want to now get out of REITs? Are you bullish or bearish on REITs?

Matt: I'm bullish on some REITs. We like Waypoint REIT, which is the old Viva Energy REIT, that owns petrol stations. We think that's a very solid business, and that's going to continue. And that is really the old style REIT as you know. It just collects the rent, and passes it through.

And we like the regional shopping centre REIT, SCA. It just owns neighbourhood supermarkets and services around that. Very low exposure to apparel - we like that.

I think the problems in the office and the retail REITs are really well known, and well discussed, in the price potentially. The situation is interesting because at the moment you get the sense that the market, and investors, have taken the worst-case view of how we go back to work and office and retail. Accordingly, we're having a look at some of those now for value, if there's any.

Vicinity is quite interesting. It's yielding prima facie, quite a high yield. It's raised money, it's raised equity. Naturally, that's probably the one we look at first.

Vishal: Matt's got plenty of REITs on his shopping list Sean, what about you, bullish or bearish on REITs?

Sean: I'm probably neutral on REITs really, but it is one of the most fascinating areas to come out of this whole COVID crisis. As we just discussed, travel's likely to bounce back, spending's going to shift from people locked up at home and spending at home, back to going out and traveling. But we just don't know what's going to happen with working from home, and how permanent that's going to be.

Everyone I've spoken to, including myself and my team, are very keen to work from home at least a few days a week. And you add that up across the market, across big law, accounting firms, a lot of professional services, that flexible working arrangement could really rip a lot of foot traffic, on a day to day basis, out of the CBDs.

The implications for office, and all the services around there, are pretty material, so we're pretty cautious still on that space, but we do see value in some of the REITs. Vicinity, I don't disagree with. Scentre Group, we don't mind as well as high-quality REITs.

Shopping centres are a bit under pressure from online trading from before COVID anyway, and were discounted to a degree. People will go back to malls and shopping again once social distancing's ended, so high-quality REITs, and potentially that shift in spending out to more urban areas as well could be of benefit. We don't mind that.

Probably our preferred exposure is Charter Hall, which really runs a fund's management model. They really have a lot of vehicles under them, and continue to raise money and charge management fees.

Catalysts for a rebound in the financial sector

Vishal: No conversation about beaten down, smashed sectors is complete without talking about the banks. Lots of headwinds in the banks. Low interest rates, high consumer debt, weak economy. Sean, bullish or bearish on the financials?

Sean: I think financials, banks in particular, are really just a funding source for other opportunities in the market. The banks are not going to go broke because there's so much government support out there; forbearance, even APRA has come to the party, in terms of shifting a lot of the accounting rules in terms of what's a bad debt, and what's being deferred.

But underlying that, we've got zero cash rate, a flat yield curve. The RBA's there controlling it. It's not going to change for a while meaning that the bank's premise of borrow short, lend long, trade-off that yield curve, just doesn't exist.

There's competition coming in. High return on capital in mortgages has gone so there's just ongoing pressure in the banking sector. Capital intensity's gone up. Costs continue to go up, compliance costs. And there's the big unknown of a huge amount of loans and forbearance. What's really going to happen with that? We don't know.

Banks are a good funding source. We prefer things in the financial space. Something like a Credit Corp that could benefit from bad debts, buy some cheap debt ledgers, and collect on them down the track.

Vishal: Matt, can you count on a rebound in the banking sector? Are you bullish or bearish?

Matt: I think you can count on a rebound in the short term. The pessimistic scenario that we were looking at back in March, April, it certainly hasn't turned out that way. In fact, it's turning a lot better. If we didn't have the Victorian stage two lockdown, we'd be really looking good.

I can see a point where the bad debt cycle that Sean mentioned, is not as bad as what the market has factored in, analysts have factored in. I can see a short term rally. I can see an easy 10% in the banks between now and Christmas, for the short term traders who are watching the show, but I'm sure there are no short term traders watch this.

I think we could have that short term rally. But the medium term, it is tough. Those big factors that you mentioned are out there, and are not going away. And so the profitability of the banks to grow is going to be a struggle.

Vishal: Your preferred pick in the sector?

Matt:  I like Commonwealth Bank. It's that retail bank. If you could only own one or two businesses in Australia, and you had that choice, I'd choose that retail bank. It's got such a great franchise, such a big market share, great deposit base. It's well placed, the CommBank.

What does the future hold for the energy sector?

Vishal: Saving the worst for last, is the energy sector. Now if the banks have headwinds, boy, does the energy market really have headwinds. You've got a supply shock. Who knows what can happen with demand. Who knows what OPEC can do at any time. A lot of these producers are really struggling, but is it all in the price? Bullish or bearish on energy?

Matt: I don't know whether I'm bullish or bearish on energy. It depends on the oil price, and I've never met anyone who can pick that with any certainty regularly. It's just so hard.

It's very tough. But the fact is, that if we do get a vaccine in the middle of the year, global growth picks up a bit, things do improve, then you can make a case that the oil price will be higher this time next year than it is now. I think that's a fair assumption to make - you'd want to have some exposure to that.

The best places for us, we like Origin and to a lesser extent, Beach. And these are not the real leverage players in the market. You can get bigger leverage in something like an Oil Search, if the oil price goes up. But we like Origin and Beach, in the sense that if the oil price falls back again, you're going to get less hurt. There's factors around their businesses that support, where they're not as leveraged to that oil price.

Vishal: Matt's sticking with some relatively defensive plays in a very cyclical market. Sean, what about you, bullish or bearish on energy?

Sean: I'm inclined to agree. It's a bit of a choose your own adventure with energy. You can come up with any scenario you like. Supply-side is such a big factor in energy, and particularly OPEC versus non-OPEC. You can make a fair case that the weak oil prices now are killing investment, particularly US shale which has really flooded the market and suppressed prices in recent years. That's pulling back. And the under-investment now can see high prices down the track as we recover. Or you could argue that OPEC's just got oodles of spare capacity, and they keep a lid on prices.

We're probably a bit cautious on energy. I think it's too early to get too bullish there. And I agree, the best way to play it is really through stocks that don't have too much oil price leverage, but a good production upside.

Our favourite is actually Senex Energy, which has delivered consistent production reserve upgrades, and is pretty attractively valued. Domestic gas contracts, not a lot of oil price volatility.

Vishal: Well, if you're going to play some of these rebound stocks, Matt Williams reckons the Airlie bird gets the worm. Sean Fenton would agree that that's Sage advice.

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