As we look ahead to 2018, markets remain in a sweet spot with global growth becoming entrenched and inflation still conspicuously absent. Interest rates are expected to rise gradually leaving businesses with a decent backdrop to work with and healthy growth puts the world in a better position to deal with the next downturn. A key question for 2018 is whether investors continue to shrug off geopolitical risks including escalation of tensions in North Korea, increased trade protectionism and the future of the EU. Furthermore, higher interest rates usually signal a close to a bull market, so investors should be prepared for a return to more normal levels of market volatility.
Two changes to our list this month
This month we remove Bapcor (BAP) from out list, locking in a 12% total shareholder return in the last nine months. The recent trading update at the AGM was solid and we remain attracted to its defensive characteristics. We add Senex Energy (SXY) to our list in December. We think Senex is ideally positioned to make a material impact on the east coast gas market with two gas projects expected to transform earnings over the next few years. The company has positioned itself exceptionally well, particularly after picking up Project Atlas, which we see as having substantial value upside for the business. 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 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 the world-class PNG LNG Project/Development, operated by ExxonMobil.
Key reasons to buy Oil Search
- We maintain our high conviction call on OSH as we progress toward what we see as critical re-rating events for the stock.
- The PNG JVs are on track to deliver a formal co-operation agreement to the PNG government in Dec/Jan. Receiving that co-operation proposal, plus subsequent approval of the agreement by the PNG government would, in our view, materially remove justification for the discount that consensus is applying to the value of OSH's interest in PNG expansion.
- We still hold the view that OSH is ideally placed to benefit from a global-scale organic growth profile, which could be further enhanced by additional exploration and appraisal.
ResMed develops, manufactures and markets medical products for the treatment and management of respiratory disorders globally.
Key reasons to buy ResMed
- Mask capacity constraints seem to be a thing of the past, with strong 1Q growth (+14%, the highest in 4 years), positive patient/physician/provider feedback and being relatively early in the product life cycle.
- 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 (ASX: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 expect WBC to comfortably meet APRA's 'unquestionably strong' capital benchmark through undiscounted dividend reinvestment plans.
Link Administration (ASX:LNK)
Link is the largest provider of superannuation fund administration services to funds in the Australian super system and a leading provider of shareholder management and analytics and share registry services.
Key reasons to buy Link
- We are attracted to its significant levels of recurring revenue (>70%) backed by 3-5 year contracts in a relatively defensive industry (funds administration and registry services).
- We believe the market's view on LNK's core Fund Administration business being ex-growth is too bearish. We think it will at least grow at inflation levels from here. Moreover, the synergy target from the CAS acquisition of £25m would appear to be conservative.
- Trading on a 16x FY19F PE (first full year of CAS acquisition), we think LNK is inexpensive for a stock of its quality.
Senex Energy (ASX:SXY)
Senex is an oil and gas company focused on operating and developing energy sources in Australia's Cooper, Eromanga and Surat Basins.
Key reasons to buy Senex
- SXY is ideally positioned to make a material impact on the east coast gas market with two gas projects expected to transform earnings over the next few years.
- We expect initial operational results in January (December quarter result) from phase 2 drilling at SXY's West Surat gas project.
- SXY is leveraged to rising oil prices through its existing oil production and longer term through its oil-linked WSGP gas sales agreement with GLNG.
Motorcycle Holdings (ASX: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).
Key reasons to buy Motorcycle Holdings
- MTO is now trading on 13.3x FY19F PE (pre-amortisation) with strong growth on offer following the Cassons acquisition.
- We expect the group, with the assistance of the three acquisitions in late FY17, will be in a position to match 1H17 EBITDA (or slightly below) while the two month contribution from Cassons (pre costs) should see group EBITDA/NPATA/EPSA well up on the previous corresponding period.
- Acquisitions will continue to be a substantial part of MTO's growth strategy and is the key upside risk.
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).
Contributed by Andrew Tang from the Morgans Blog: (VIEW LINK)