Buy Hold Sell: 5 stocks in an upgrade cycle

Over the past 18 months, Australians have faced an onslaught of truly biblical proportions. One after the other, fires, floods and a literal plague have ravaged this place we call home. And yet, despite the seemingly endless lockdowns, our companies fought back, with earnings surprisingly upbeat at the beginning of this year. 

In the face of recent lockdowns, however, Macquarie found that only 20% of the ASX300 upgraded their earnings growth estimates for FY22. Meantime, around 48% of the market was flat, and 33% downgraded their earnings estimates for the year ahead. 

So in this episode of Buy Hold Sell, we've invited Investors Mutual's Simon Conn and Montgomery Investment Management's Roger Montgomery to share their thoughts on three companies that have plenty of earnings growth potential. These include Australian Clinical Labs, MNF Group, and Ingenia Communities.

Plus, they'll also name two stocks that could surprise the market with upgrades in the months to come. 

Note: This episode was filmed on Wednesday 13th October 2021. You can watch, listen or read an edited transcript below.

Edited Transcript

James Marlay: Hello and welcome to Livewire Markets' Buy Hold Sell. My name's James Marlay. I'm a co-founder of Livewire and today we are talking about the thing that investors love and that is stocks on a raging run and upgrading their earnings. Joining me today to talk about stocks with upgrades or upgrade potential, I've got Roger Montgomery from Montgomery Investment Management and Simon Conn from Investors Mutual. 

Now, Simon, we're going to start with you. A relatively new name on the market, Australian Clinical Labs. IPO earlier this year, but it just delivered a great profit of above prospectus and an upgrade of 30%. Is it a buy, hold or sell?

Australian Clinical Labs (ASX: ACL) 

Simon Conn (BUY): It's a buy for us, James. Australian Clinical Labs is the number three player in the pathology market in Australia. It's a very strong, defensive market, and this business generates good cash. Under private equity ownership, they have actually invested in technology. I think that's really come to the fore in the COVID period, where we've seen strong volumes, and this company's delivered really rapid turnaround times. It's also come through in the results. We've seen strong operating leverage where they've generated a huge amount of cash from the COVID underlying volumes.

But I think it's also a business that's well positioned to grow through M&A. So whilst COVID volumes will decline, the cash on the balance sheet will position them well for further bolt-on acquisitions, which I think they can really then leverage their technology platform. So well led by Melinda McGrath, good board, and really well positioned, I think, in a strong industry.

James Marlay: Roger, Australian Clinical Labs, a buy, hold or a sell for you?

Roger Montgomery (BUY): It's a buy for us as well. Some say it's another Sonic in the making. They've upgraded their first-half '22 guidance twice in September. That was mostly attributed obviously to the continued strong demand for COVID testing. But unlike Sonic, where underlying testing is flat, ACL have reported recovery in the underlying or base business. Obviously, the Victoria and New South Wales outbreaks have been a big kicker with revenue guides upgraded by 10%. I think NPAT was upgraded by over 30%.

EBITDA margins also look like they're ahead of prospectus, and management reckons margins are going to settle around 27%. Now what's interesting is that there will be, in the future, some sensitivity to PCR testing, which of course itself is tied to infection outbreaks, but we all know that efficacy drops after six months, enough to warrant booster shots, which I think a lot of people are going to forget or not get around to doing. That means we are going to be chasing our tails with respect to COVID for some time. So COVID testing is likely to settle at a higher than currently expected level. So overall testing is going to be higher in a post COVID world, and I think that's underestimated by the market. So that's why we've got it as a buy.

MNF Group (ASX: MNF)

James Marlay: Roger, staying with you, MNF Group, they had a bit of a patchy period, but the latest result came in really at the top end of expectations, and quite a bullish tone from management. Buy, hold or sell?

Roger Montgomery (BUY): That's a buy. Management have finally committed to their Asian rollout and that's because a couple of things. Number one, the megatrends in consumer technology that we've all experienced, they demand real-time telecommunication networks, and you've got to connect to that as part of the overall solution. So whether you're working from home or recording a call like this, or you're looking for an Uber, those tools need to find a phone number.

So in Australia, if you've done either of those two things, you've already used MyNetFone software. It's taken for granted. It isn't easy. And they do this in Australia, but they've re-engineered their software ready to be exported and deployed in new markets. And that's an opportunity that's 20 times bigger than their current market. So for us, it's a buy.

James Marlay: All right. Simon, MyNetFone, are you a buy, hold, or sell? Or do you need the phone a friend?

Simon Conn (BUY): It's a buy. It's a clear buy, James. It's a great business. I think they've really refocused the portfolio of businesses they've had. I mean, they've always had a very strong-growing wholesale business in there, which is really the B2B. It's not really understood by the consumer market, but they are one of Australia's leading telcos because they facilitate the transfer of voice over the internet. As the copper network's been de-registered or wound down, more and more voices are going through the internet.

Got a strong market position in Australia. Big service providers to people like Teams, Zoom. We're probably using the MNF software at the moment. We don't even realise it. As Roger's alluded to, the ability to take it to Asia, with Singapore being their first launchpad, and they're just about to launch, that really opens up the Southeast Asia market where there's no comparable service provider. That's a huge opportunity. They can bring those relationships that they have with companies like Twilio, Teams and Zoom, and provide those services across several Asian countries in time. So we think it's a big opportunity. Founder-led again by Rene Sugo. Good board. We think it's quite well-positioned for the future.

Ingenia Communities (ASX: INA)

James Marlay: Buy on MNF. Let's go from tech and fast growth to something which I had no idea was going to see the growth that it has. Retirement living and holiday parks, Ingenia. It seems every second park I drive past these days seems to be an Ingenia Lifestyles community. Simon, is at a buy, hold or a sell?

Simon Conn (SELL): Look, it's a sell for us, James, just on valuation. Simon Owen has built a really good business. He's done a great job, but like a lot of reopening trades, there's a lot priced in with this one. When 50% of your profits come from development, that's not a recurring business of our liking. It's a one-off profit generator. So on over 25 times, we think it's pretty full. Whilst it's obviously going to have a good summer with people holidaying domestically, you've got to look at their longer term earnings projection and the development profits that are already baked into that business.

James Marlay: Roger, the latest result from Ingenia was a 30% profit increase on the prior financial result. A buy, hold or a sell for you?

Roger Montgomery (HOLD): We own it. It's a hold for us rather than aggressive buy, for the reason that Simon mentioned, just on pricing. Manufactured home estates have been the single top performing property asset class overseas. In Australia, we've seen Stockland enter the market and Mirvac's going to follow suit.

The market's been underestimating how long the domestic holiday market's going to be strong for. We think there's a massive latent profit pool that sits inside those assets that are leveraged to that theme, which is also being underestimated. There are more caravans being sold in Australia than ever before. And nomads, not grey nomads, just nomads generally, have to take them somewhere to stay. Now our channel checks tell us that caravan parks and national park campgrounds are fully booked until the start of next year's school year. So you won't be able to get a space.

The other thing that's happening is a residential property boom means the grey nomads are cashed up. They've been selling at record prices and consequently, they've been paying record prices for manufactured housing estate homes. In Port Stephens, a manufactured housing estate home was sold for a million dollars. So it's a proper sea change event and it's already been driving 10% earnings growth. We think if you combine the fast growth with the high prices in Ingenia's development book, and the fact that they've grown their pipeline by 50% in the last couple of years, and they reckon they're going to grow another 50% over the next 12 months, we think the EPS growth could exceed 10% in the future. So it's a good hold for us at the moment.

Macquarie Telecom (ASX: MAQ)

James Marlay: Okay. Roger, I'm going to stay with you. We've asked each of you to nominate a company that you think is a strong candidate for an earnings upgrade. Roger, what have you got to pitch to us today?

Roger Montgomery: Macquarie Telecom. We think the market doesn't appreciate how they make their money from selling their volume. They often sell a large part of their available power, if you like, at a lower price. But they can make just as much money - they can actually double their revenue and their EBITDA - from selling the last 10% of the volume at 10 times what they sold the original 90% for. I don't think that's widely appreciated. So we've got valuation on the stock of over $100, and its recent weakness gives, I think, us and other people an opportunity to buy.

Orica (ASX: ORI)

James Marlay: Simon, same question for you. Have you got a stock that you think is a candidate for an earnings upgrade that you can tell our readers about today?

Simon Conn: I think Orica is one that has been underestimated by the market. You've got a new management team who are driving a harder focus on the business. They've put the Minova business up for sale. They are selling land, so paying down debt, and refocusing the portfolio on some of their high-quality mining technology.

So clearly mining prices have been good and we're seeing that now come through with mining volumes. But also the other benefit they're receiving is a low Aussie dollar and a high gas price is driving beneficial pricing opportunities for their ammonium nitrate. So obviously being the largest explosives operator in Australia, and in several countries overseas, puts them in a strong market position in those incumbent markets. So you've got a new management team, you've got a price that doesn't reflect the turnaround of the business. You've got volumes coming through, and a leader in the field in technology, which we think that the new management team will leverage, far better than they have in the past.

James Marlay: Well, ladies and gentlemen, they say the trend is your friend. These are five companies with great earnings momentum, and worth putting on a watch list for a deeper look. Thanks very much for tuning into that episode of Buy Hold Sell. I hope you enjoyed the show as much as I did, and remember to subscribe to our YouTube channel where we're uploading fresh content every week.

What stock do you think can surprise investors with an upgrade? 

Roger pointed to Macquarie Telecom and Simon chose Orica, but we would love to know what you think. Let us know what stock you think could surprise with earnings upgrades in the comments section below. 

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