Buy Hold Sell: 6 ASX stocks built to handle tough conditions

Even when households tighten their belts, the groceries still need buying, the phone bill needs paying and hospitals need to keep running. It’s easy to see why investors turn to essential goods and services when the outlook gets tougher.

But how much protection does reliable demand actually offer shareholders? And can the price you pay undermine the defensive qualities you’re buying?

With the Spring Racing Carnival upon us, this episode of Buy Hold Sell looks at businesses that might be suited to tougher conditions. We’re considering what happens when spending slows, confidence weakens and investors become less forgiving.

Joining me are Nick Pashias from Antares and Luke Laretive from Seneca who explain what they look for in a resilient investment and the warning signs that a supposedly defensive business might disappoint.

We put Coles (ASX: COL), Telstra (ASX: TLS), HMC Capital (ASX: HMC) and Pro Medicus (ASX: PME) to the buy, hold or sell test, before each guest shares another stock they’re backing.

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Edited transcript

Patrick Poke: Hello and welcome to Livewire’s Buy Hold Sell. I’m Patrick Poke, managing editor at Livewire Markets.

A change in conditions can quickly change the prospects of a race and an investment. Today we’re looking at businesses that might hold their ground when the economy weakens or markets get more difficult. Joining me are Nick Pashias from Antares and Luke Laretive from Seneca.

What makes a resilient investment?

Patrick Poke: Luke, what do you look for when you’re looking for a resilient business?

Luke Laretive: For starters, price. If you can buy almost any business at a cheap enough price, from an investment perspective you’re going to get resilience. You’re buying it with a margin of safety.

It’s really hard to forecast earnings. It’s really hard to forecast sales. It’s really hard to forecast unforeseeable or unlikely events that may impact any business operating in the economy.

Regardless of how bulletproof you think something is, things often do go wrong. From our perspective, it’s valuation discipline that allows you to maybe not lose as much money as you otherwise would. It certainly gives you the opportunity to sometimes sell stocks for reasonable prices, even when they’re going well, and maybe avoid that eventual earnings downgrade.

Patrick Poke: Nick, what’s a warning sign for you that a business that’s supposedly defensive might not be quite as defensive as it looks?

Nick Pashias: I’d say inaction from management. Sometimes things happen, things change, and management are wedded to their previous view and don’t take into consideration the changing landscape.

Markets and the global economy are always changing, so I think you have to be a participant in that. You have to act accordingly when things change.

Coles (ASX: COL)

Patrick Poke: Luke, to you first. Coles: obviously essential services. People are reining in their spending, but you can’t really rein in your spending on the grocery budget. What do you think in this market? Is it a buy, hold or sell?

Luke Laretive: (SELL) The great oligopoly of supermarkets. You don’t own it for the 3.62% dividend yield – the risk-free rate is higher than that. You don’t own it for the 2% profit growth.

It’s not exactly a value trade. The stock’s on 24 times earnings, a 37% premium to the rest of the market.

Unless you’re a market-neutral pairs trader and you’re going to take a particular view on groceries – buy Coles and sell Woolies – I don’t really see the point in owning this stock at all.

So it’s a sell from me. Plenty of other good things you can buy that actually go up when the market goes up.

Patrick Poke: Nick, Coles: how much protection does essential spending actually give to shareholders? Buy, hold or sell?

Nick Pashias: (BUY) For us, it’s actually a buy because we think it is very defensive. We’re all eating at home more. There’s no doubt the cost of living has got those pressures.

Coles is in a unique position where they’ve spent billions of dollars, and I think five years, building their supply chain to the point where it’s now starting to deliver that fixed-cost leverage.

Even today, Woolworths put out their sales numbers – six-odd per cent. We still think sales growth for the pair of them will be quite strong, and Coles should now enjoy that on a relatively fixed cost base.

They’ve spent billions of dollars, as I said. I don’t know if you’ve been down to the Ocado fulfilment centre, but it’s an amazing complex. You have these big trucks bringing in bulky goods, and out the other end you’ve got the smaller trucks delivering to our homes.

In the middle is this huge factory with very, very few people in it. It’s quite amazing what they’ve been able to do. We think that will drive profit growth, and we think it’s defensive.

Telstra (ASX: TLS)

Patrick Poke: From one defensive stock to another: Telstra. Would you put that on a buy, hold or sell?

Nick Pashias: (HOLD) Sorry to sit in the middle, but this one’s a hold for us. We think it’s the ultimate defensive in terms of how we consume telecommunications. I think people will spend on that before they cut it to spend elsewhere.

The risk is what’s happening with SpaceX at the moment in the US. SpaceX is using its satellite network to deploy telecommunications to the US consumer. That’s their plan over the medium to long term, and we’re worried that might have implications down here.

We’ve done some early work around it, and we don’t think the Australian marketplace is susceptible to that extent. We think Telstra should be okay, but we’re doing more work to convince ourselves that’s the case.

It’s not super cheap. The dividend yield is still pretty good – I think about 4.5%, fully franked – but right now there are still a few risks we need to get our heads around.

Patrick Poke: So it’s not just the customers who are on hold for that one.

Nick Pashias: That’s a very good one.

Patrick Poke: Some of the fund managers are as well.

Luke, do you think the business can produce enough growth despite its maturity? Is it a buy, hold or sell for you?

Luke Laretive: (SELL) I’ve hung up on the call centre from Telstra. It’s a sell for me.

Telstra’s earnings per share are up about 12% over the last two years. The two competitor brands, Superloop and Aussie Broadband, are up about 80% in the same period.

Our view is Telstra’s continuing to be challenged in the mobile market and continuing to be challenged in the broadband market. Despite that, it still trades on 22 times earnings. You can go out and buy Aussie Broadband on 13 times earnings.

From our perspective, no need to get too cute here. You’ve got a business that’s just reaffirmed guidance, that’s growing faster, that’s got clear rerating potential from a valuation perspective, and it’s on an earnings growth trajectory much faster than Telstra will ever be able to do.

I would much rather have a business like that in my portfolio, which I think can outperform, than something that’s maybe just going to give me low beta for the days when the market’s down.

HMC Capital (ASX: HMC)

Patrick Poke: HMC Capital is an alternative asset manager that offers exposure to infrastructure, credit and other areas of the market. Would you put that one on a buy, hold or sell, Luke?

Luke Laretive: (BUY) It’s a buy from us, Patrick. It’s the biggest holding in both of our funds at the moment.

Rewind two years ago: it was a stock on 30 times earnings. We didn’t own it back then. Back then, it did 45 cents of earnings per share. It’s now on eight times consensus earnings of roughly 35 cents a share, and I think that’s the problem.

I think the analysts are asleep at the wheel here. This company had three issues that caused that decline in earnings per share and that significant derating.

It had a tenant in its hospital REIT that went into administration, Healthscope. That’s been re-tenanted now.

It had a DigiCo IPO that was too liked by retail, too well sold to them, and was probably deploying capital in an inefficient way. That’s also fixed now. They’ve sold the US for above book value and reinvested that money in SYD1, which is, by all measures, an amazing asset. They’ve just had Anthropic come in and take a big chunk of that capacity.

They’ve got this renewables business, which is a little misunderstood because it’s like a private investment vehicle. You go out to the Victorian Big Battery: they’re doubling the capacity out there and expanding that even more. From the latest guidance, that’s on track to meet its 20%-plus IRR targets for its investors.

We expect HMC to get back to peak earnings over the next couple of years. At that point, it’ll either be trading on a 10% dividend yield and a PE of four, or it’ll be six bucks a share.

Our view is that all asset managers and fund managers, as we covered in the previous episode, are under a bit of pressure at the moment. But we think this might be the one that bounces back the hardest.

Patrick Poke: A lot of value out there in the funds management space at the moment, but how much protection does the defensive nature of the underlying assets actually offer when you’re buying the manager? Buy, hold or sell?

Nick Pashias: (HOLD) It’s an interesting one. I agree with a lot of what Luke said, and it’s clear how you can paint a very positive picture for this company because it’s trading on a very low multiple. It does have assets.

But those assets, we feel, require a buoyant market in order to transact, to recycle and to get those fees. That’s the downside.

We think there’s a wide range of outcomes, and we’re not convinced the probabilities are skewed to the positive in this case. That’s the risk with this one.

We can see the appeal, but we need to convince ourselves that the probabilities are skewed to the outlook Luke articulated. So for us, it’s a hold.

Patrick Poke: A hold? I thought you were going to go with a sell.

Nick Pashias: I can see both sides of it. That’s the dilemma with this one.

Pro Medicus (ASX: PME)

Patrick Poke: To Pro Medicus: medical imaging software. Obviously hospitals still need to process scans even when the economy isn’t doing so well. Nick, would you put that as a buy, hold or sell?

Nick Pashias: (BUY) We’ve actually got it as a buy because of exactly what you said. Hospitals still need to scan.

Pro Medicus has about $1.3 billion of contracted revenue. Their retention rate is 100%. Their incremental margin is very, very high.

These are businesses that have a big moat around them. They have FDA approval; they sit inside hospitals. It’s not easy to disrupt this type of business.

No doubt it’s trading on a very, very high multiple, but they’re still at the early stages of their penetration, particularly in the US – about 11%. There are other scans coming behind it as well, so there are other markets that will open up. For us, it’s a buy.

Patrick Poke: Luke, we’ve looked at the scans. Now how about the bill? Would you put Pro Medicus on a buy, hold or sell?

Luke Laretive: (HOLD) Patrick, I feel like this is the saga of Luke and Patrick. Every time I see you, we talk about Pro Medicus.

You would have been proud of me. We bought the stock earlier this year at about 120 bucks and flipped it out for 180. We were pretty happy with ourselves.

But it’s still not that cheap on 70 times EBITDA at the moment. It does have some leverage to a cyclical recovery in markets. It’s the kind of high-quality growth stock everybody wants to own when they get an inflow, but they’re not getting any inflows at the moment.

It’s continuing to win contracts. They’re small contracts in the context of the market cap these days. Back in the old Pro Medicus days, it used to win a contract and it was a huge deal, and the stock would go up 40%.

It’s a big business now, a bit harder to move the dial, but definitely still moving in the right direction from an operational momentum perspective.

It’s a hold from us. You could do a lot worse on the ASX at the moment, for all the reasons Nick very astutely outlined. But I do think if you’re going to buy software for a recovery in markets, this isn’t going to be the best-performing one of those stocks.

Luke’s pick: NEXTDC (ASX: NXT)

Patrick Poke: I’ve asked you each to bring along a defensive stock you like. I’ll start with you, Luke. Could you tell us about the stock you’ve brought for us today?

Luke Laretive: I’ve paid no attention to the brief, as per usual, Patrick, so you’ll be happy with that. I’ve brought along NEXTDC. I don’t know about defensive, but it’s a stock.

We’ve never owned this thing before. We always thought 30–40 times EV/EBITDA was unjustified, both in absolute terms and relative to peers around the world and the multiples these businesses are going to trade on.

It is a recent addition to the portfolio, and our thesis is quite simple. This M3 power infrastructure delay is only pushing the project back three months. The three months isn’t for anything technical; it’s just for community consultation.

That doesn’t warrant a $4 billion or $5 billion decline in market capitalisation, in our view. Even if we say we don’t think it’s worth what it was trading on before, there’s still some pretty good upside here. M3 was only forecast to make $140 million of EBITDA for NEXTDC.

The primary objection from the community hasn’t actually got much to do with the data centre. It’s to do with the power poles out the front of their houses. The data centre is a secondary issue they’re leveraging off as a community, but it’s more to do with the power poles going in.

Unfortunately, these poles need to be a certain height to make sure the high-voltage power isn’t close to humans. It is what it is.

I think there are worries in the market around contagion: that NEXTDC’s lost its social licence to operate and it’s not going to be able to build a data centre anywhere else in Australia ever again. We think that’s a little overdone.

Most data centres they’re building are in industrial or commercial areas. They’re not as close to residents as this particular data centre is.

We think NEXTDC needs to take a leaf out of the BHPs and Rios. These guys are gurus at community consultation and engaging with the community: sponsoring sports teams, building childcare centres, doing the stuff that allows you to operate in the community.

Then you won’t have as many people whingeing about power poles because they’ll be happy their sports club’s got new changerooms and the childcare centre’s got some more stuff.

Patrick Poke: Read any mining company presentation and they definitely seem to be very interested in engaging with the community.

Luke Laretive: NEXTDC haven’t done any of that, so there is a management issue here as well.

From my perspective, you’re buying a stock at a 30% – or maybe 20% after today’s little rally – discount to NTA. You’ve got a business that’s been trading on three times NTA, essentially, since it’s been listed.

There’s a lot of value here. I don’t know how high this thing goes, but from $5.50, or whatever we paid for it recently, I think it’s going to be a good trade for us.

Nick’s pick: Ramelius Resources (ASX: RMS)

Patrick Poke: Nick, hopefully you’ve got a defensive stock for us. Could you tell us what you’d like to share with us today?

Nick Pashias: It’s the same as last year, and it’s kind of defensive. It’s a gold producer, so geopolitical risk and all that sort of stuff is hopefully taken care of. It’s Ramelius.

Over the last 12 months, it’s gone from promise to proof. This time last year, they’d just taken control of Spartan Resources, which had the Dalgaranga deposit. Now they’re starting to mine that deposit, and it’s producing ounces. The last couple of quarters, they’ve been doing that.

They’re on the path from about 200,000 ounces of gold production to 600,000 ounces by the end of the decade. A threefold increase over that time.

They’ve got the balance sheet. They’ve got the resources in the ground. It’s just a matter of execution, and they’re starting to tick the boxes.

They’ve got their environmental approval locked in for Rebecca and Roe, which is one of the other growth projects. I can see all the boxes starting to be ticked.

At the end of that time, you’ll have a 600,000-ounce producer generating over a billion dollars of free cash flow at current prices. I think it’s a standout, to be honest.

Luke Laretive: Couldn’t agree more. I think Dalgaranga ore is completely underappreciated by the market. It’s a significant step up in grade and recovery, so that’s going to make a lot of money for investors over the next little while.

Patrick Poke: We’ve got some agreement here in the end.