Eight high conviction stocks for August

Andrew Tang

Investors are waiting for a circuit-breaker. Stretched valuations limit upside potential for a further re-rating of the market multiple (15.8x 12month forward PE, Industrials ex-Financials at 21.8x) and without clear earnings momentum in either direction the market is likely to remain rangebound.

We prefer to err on the side of caution and take profits where prices have run ahead of fundamentals (CSL, DMP, BKL, BAL and CGC) and think rotation within the market rather than a clear breakout will define FY18 reporting season. We stick by our conviction calls and supplement them with higher-than-average cash levels. This will give investors capacity to deploy capital into the inevitable bouts of volatility.

Three additions to our list this month

We add OZ Minerals (OZL), Atlas Arteria (ALX) and Volpara Health Technologies (VHT) to our list in August.

OZ Minerals (OZL) enjoys robust cashflows from an established production base in copper, which has among the best outlooks in the commodities suite, driven by electrification of the developing world. OZL's counter-cyclical growth strategy will be rewarded as the Carrapateena development project is gradually de-risked in the coming 1-2 years, and could justify valuations closer to $12.50 per share upon successful commissioning.

Atlas Arteria (ALX) offers valuation support and strong potential distribution growth over coming years. French tollroad APRR is ALX's key asset. Cashflows are driven by growing toll revenues, cost containment, substantial decline in debt service and legislated corporate tax rate cuts.

Volpara Health Technologies (VHT) is a leading IT healthcare provider aiming to improve early detection of breast cancer. Volpara's SaaS model is linked to a growing medical need. Volpara's market share of breast screening in the US is currently 3.7% with a pathway to grow to 9% in FY19. VHT have a business model leveraged to growing and reoccurring revenue (FY19 guidance of NZ$9.0m) with the ability to pass on improved pricing over time.

Eight high conviction stocks in August

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:

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 expect WBC to comfortably meet APRA's 'unquestionably strong' capital benchmark through undiscounted dividend reinvestment plans.

We retain our Add recommendation.

Suncorp (SUN)

Suncorp is a financial services conglomerate offering banking, general insurance, life insurance, super and investment products.

Key reasons to buy Suncorp

  • We expect SUN to produce a solid 2H18 group result assisted by strong reinsurance protections. SUN remains at a substantial 4 PE point discount to IAG in FY19, and we expect this gap to close if management can deliver on stated FY19 management targets.
  • We think 1H18 was the low point for SUN's ITR (Group Insurance Margin) and we see a clear pathway for the ITR to rise above management's 12% target level.
  • The sale of SUN's life business is also a small catalyst in our view. A sale is largely earnings neutral, but will enable capacity for buybacks. It also improves SUN's ROE by 1% and SUN's RoNTA by 4%.

We retain our Add recommendation.

OZ Minerals (OZL)

OZ Minerals is a copper-focused international company based in South Australia.

Key reasons to buy OZ Minerals

  • OZL enjoys robust cashflows from an established production base in copper, which has among the best outlooks in the commodities suite, driven by electrification of the developing world. OZL's balance sheet and cost structure provide good downside protection.
  • We think OZL's counter-cyclical growth strategy will be rewarded as the Carrapateena development project is gradually de-risked in the coming 1-2 years, and can justify valuations closer to $12.50 per share upon successful commissioning.
  • We think that recent share price weakness has been driven by macro-economic uncertainties, which we think can pass in time.

We retain our Add recommendation.

Atlas Arteria (ALX)

Macquarie Atlas Roads, now Atlas Arteria, is one of the world's largest developers and operators of private toll roads.

Key reasons to buy Atlas Arteria

  • ALX offers valuation support and strong potential distribution growth over coming years.
  • French tollroad APRR is ALX's key asset. Cashflows are driven by growing toll revenues, cost containment, substantial decline in debt services, legislated corporate tax rate cuts, and (potentially) declining AUD/EUR.
  • Over the coming 12-24 months, restructuring initiatives related to both the APRR and Dulles Greenway may deliver further valuation accretion for shareholders.

We retain our Add recommendation.

Volpara Health Technologies (VHT)

Volpara is a leading IT healthcare provider aiming to improve early detection of breast cancer.

Key reasons to buy Volpara

  • Volpara's SaaS model is linked to a growing medical need, which has recently seen 36 US states mandate that women are told of breast density.
  • Volpara's market share of breast screening in the US is currently 3.7% with a pathway to grow to 9% in FY19.
  • A business model leveraged to growing and reoccuring revenue (FY19 guidance of NZ$9.0m) with the ability to pass on improved pricing over time (average US$3 per screen)..

We retain our Add recommendation.

Kina Securities (KSL)

KSL is a diversified financial service provider in PNG. The group has two operating divisions, Kina Bank and Kina Wealth Management.

Key reasons to buy Kina Securities

  • We think the stock remains mispriced by the market. We expect KSL to produce a record FY18 profit, yet it still trades at a material discount to its IPO price. We forecast a dividend yield of 10.2% for 2018 and 13.4% for 2019.
  • The recent ANZ PNG acquisition adds significant inherent value in our view. KSL paid only goodwill and yet the deal is 25-35% accretive post synergies.
  • KSL's underlying business metrics continue to track solidly – delivering 20% loan growth, credit quality has been improving and backed by a strong capital position (approx. 17% pro-forma and well above the regulatory minimum of 12%).

We retain our Add recommendation.

CML Group (CGR)

CGR provides small business financing solutions, primarily debtor finance (invoice factoring) and equipment finance to small-medium enterprises (SME) in Australia.

Key reasons to buy CML Group

  • CGR is the second largest non-bank provider of debtor finance in Australia.
  • The group is well capitalised to continue to deliver organic growth via its increased scale and improving market share.
  • In our view, CGR has the potential to outperform earnings expectations over the next two years, in part via executing on its recent acquisition (meaningful potential cost synergies). This is coupled with a relatively undemanding valuation of approximately 12x FY19 PE.

We retain our Add recommendation.

PWR Holdings (PWH)

PWR designs and produces cooling solutions for the high performance automotive industry and has an established track record in servicing elite 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).

We retain our Add recommendation.

Contributed by Andrew Tang from the Morgans blog: (VIEW LINK)


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