We thought it was prudent to remind investors about the unique conditions that are suppressing market volatility at abnormally low levels. This is a tricky market to interpret. Equity valuations are elevated, the economic environment is difficult to forecast (ultra-liquidity from central banks is ending), and to say geopolitical risks are high is an understatement. Despite this, US markets are hitting record highs and US equity volatility is close to a 24-year low. We don't pretend to be able to call the macro with precision, and prefer to pick stocks that can thrive irrespective of the macro-economic environment.
This month we remove Australian Finance Group (AFG) from our list. AFG was added to our high conviction picks in July and has provided a total shareholder return of approximately 38% since inclusion. The growth outlook for AFG remains solid and is backed by an attractive dividend yield but the stock now trades around our share price target which we see as fair value.
Our high conviction stocks are those that we think offer the highest risk-adjusted returns over a 12-month timeframe, supported by a higher-than-average level of confidence. They are typically our preferred our sector exposures.
Here are our eight high conviction stock picks this month:
Oil Search (OSH)
Oil Search is a major oil and gas developer/producer. OSH's key asset is its 29% interest in world-class PNG LNG Project/Development, operated by ExxonMobil.
Key reasons to buy Oil Search
- The recent Muruk discovery could be a game changer, and could even overtake as preferred development option for train 3 at PNG LNG. Drill testing its extent continues.
- Recent growth in 1P reserves underpins PNG LNG's ability to sustain production above nameplate over the long term, while also helping to underpin the next leg of growth.
- OSH looks ideally positioned for near-term upside as it progressively de-risks its growth profile and expands its upside case through appraisal and exploration.
ResMed develops, manufactures and markets medical products for the treatment and management of respiratory disorders globally.
Key reasons to buy ResMed
- A new mask product cycle is underway with positive patient/physician/provider feedback and management are confident category growth will accelerate.
- ResMed continues to cement its leadership position in healthcare informatics, with the high-margin Brightree SaaS model performing to expectations, supporting device/masks growth and gross margin gains.
- ResMed is a key beneficiary of a weaker AUD, with 95% of revenue derived from offshore and c80% of R&D expenses AUD dominated.
Westpac Bank (WBC)
Westpac is Australia's oldest banking and financial services group, with operations throughout Australia and New Zealand.
Key reasons to buy Westpac
- WBC has a relatively low risk profile in terms of loan book positioning and low reliance on treasury and markets income.
- The bank stands to benefit most from re-pricing of investor home loans.
- We see a relatively low risk of dividend cut as a result of its strong regulatory capital position and good organic capital generation capacity
Bapcor supplies replacement parts and consumables used in vehicle service and repair. BAP operates over 120 Auto Parts stores across Australia.
Key reasons to buy Bapcor
- Incorporation of the recently articulated Hellaby's synergies has lifted our forecasts and provided reassurance in BAP's ongoing growth via acquisition strategy.
- BAP's FY17 result was above our forecast at every line item with the group achieving slightly above the top-end of its guidance range.
- Upcoming catalysts include articulation of potential future efficiencies from the warehouse optimisation process which has been running quietly in the background and the sale of non-core assets.
NXT is a Data-Centre-as-a-Service (DCaaS) provider offering a range of services to corporate, government and IT services companies.
Key reasons to buy NEXTDC
- NXT's FY17 result was in-line with guidance and the outlook for FY18 is for 14-25% EBITDA growth, which is in-line with market expectations.
- Potentially positive catalysts include likely resolution of the AJD REIT issue and the potential for large cornerstone customers in the new Generation 2.0 facilities (Brisbane 2 and Melbourne 2 are due to open with six months and Sydney 2 within 12 months).
- We expect there is a high likelihood of NXT securing meaningful cornerstone customers especially in Sydney given the shortage of quality data centre offerings and increasing demand from offshore players and believe this could be well received by the market.
Motorcycle Holdings (MTO)
MTO is Australia's largest motorcycle dealership operator, engaging in all aspects of the retail chain (new, used, parts, service, accessories, finance and insurance)
Note: Morgans is the Lead Manager and Underwriter to MTO's capital raising and is therefore in research blackout.
AVN is a private investor and manager of large format retail centres in Australia with over 95,000 sqm of retail showrooms in 14 large format retail centre across five states and valued at approximately A$1bn.
Key reasons to buy Aventus
- AVN offers an attractive 7% distribution yield and trades at a c4% premium to NTA.
- AVN offers exposure to large format retail assets which account for 22% of total retail spend in Australia. Income is underpinned by leases to a diverse range of tenants with structured rental growth (87% subject to annual fixed/CPI rent increases and no turnover leases).
- While headwinds are affecting the broader retail sector (online penetration increasing; Amazon), we believe AVN is well placed to navigate any challenges. AVN also has an organic growth pipeline that can leverage off any future zoning and planning reforms.
PWR Holdings (PWH)
PWR designs and produces cooling solutions for the high performance automotive industry and has an established track record in servicing motorsports, including Formula One, NASCAR and V8 Supercars.
Key reasons to buy PWR Holdings
- PWH is a world leading automotive cooling business that delivers technically advanced solutions to elite motorsports customers (eg. Formula 1, NASCAR)
- FY17 was a year of currency headwinds and higher investment costs and with that now largely out of the way, FY18-20 are set to be much stronger years.
- Key growth opportunities include: 1) capturing a greater share of customer spend on cooling solutions; 2) partnering with OEMs on high performance/low production run vehicles; 3) increased presence and entry into adjacent markets; 4) increased penetration in the US automotive aftermarket segment; and 5) opportunities in emerging technologies (Tesla, Google etc).
Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.
Andrew is a member of the Morgans Investment Committee, and is responsible for equity strategy bulletins, high conviction stocks, model portfolios and other products focusing on key areas such as reporting season, factor analysis and short interest.