A new financial year presents an opportunity for investors to take a fresh look at portfolios. Ahead of the August reporting season, stocks that have had a difficult FY17 have an opportunity to make a fresh start, particularly if operating conditions improve over the course of the year as we expect.
The outlook for growth remains patchy, with export oriented sectors such as agriculture and healthcare continuing to shine while those exposed to the weaker consumer environment – retail and telco – remain under pressure. In this environment investors need to be cognisant of the underlying structural trends.
Ahead of the August results we remove Orora (ORA) and Speedcast (SDA). Our overall favourable view on both stocks remains undiminished, but some near-term headwinds present an opportunity to lock in profits (ORA has returned 26% and SDA has returned 23% since inclusion in our high conviction list). In an expensive market, investors have been unforgiving when it comes to unexpected earnings surprises.
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. This month we add Australian Finance Group (AFG) to our high conviction list.
Here are our five high conviction stock picks this month:
Oil Search (OSH)
Oil Search engages in the business of oil and gas exploration. OSH's main asset is its 29% interest in the 6.9MTPA PNG LNG project, a world-scale liquefied natural gas (LNG) 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 50% 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.
- We see OSH as ideally positioned for near-term upside as it progressively de-risks its growth profile and expands its upside case through appraisal and exploration.
ResMed is a global company involved in the development, manufacturing and marketing of medical products for the treatment and management of respiratory disorders.
Key reasons to buy ResMed
- We estimate a solid 10.9% earnings CAGR through FY19, with valuation undemanding (21x forward; in line with long-term average).
- 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
- Relatively low risk profile in terms of loan book positioning and low reliance on treasury and markets income.
- Westpac stands to benefit most from re-pricing of investor home loans.
- Relatively low risk of dividend cut as a result of strong regulatory capital position and good organic capital generation capacity
Bapcor supplies replacement parts and consumables used in the service and repair of vehicles. BAP operates over 120 Auto Parts stores across Australia.
Key reasons to buy Bapcor
- BAP's 1H17 result and upgraded guidance to the base business provided us with even more confidence in BAP's growth profile, management execution and its consistent ability to outperform targets.
- We were reassured by the flow-through of material synergies from the ANA acquisition and the strong performance of recent acquisitions. Importantly, we believe that further synergies will materialise from the Hellaby's acquisition in FY18/19.
- We see two clear upcoming catalysts for the stock: 1) divestment of the non-core Hellaby's businesses (+cA$100m to be released); and 2) articulation of potential synergies from the Hellaby's acquisition (which we expect could be meaningful).
- We forecast 37% EPS growth in FY17, followed by a further 20% in FY18. We believe this growth business with defensive characteristics offers an attractive investment opportunity.
Australian Finance Group (AFG)
AFG has been around since 1998 and has grown to become one of Australia's largest mortgage broking groups and one of the country's leaders in financial solutions.
Key reasons to buy Australian Finance Group
- An environment of increasing compliance and regulatory scrutiny for mortgage aggregators/brokers provides AFG with scope to attract more brokers to its network and expand market share. This is particularly the case given AFG is owned independently of any lender, has scale and a relatively good aggregator platform.
- We believe concerns regarding cuts to broker commissions stemming from the announcement of the major bank levy and concerns about the extent of softening in housing activity as a result of macroprudential rules are overblown. Such concerns have resulted in AFG offering good value at current prices and an attractive dividend yield.
- AFG had unrestricted cash of 40 cents per share on its balance sheet at 31 December 2016. We believe this cash could be used to uncover hidden value through EPS-accretive acquisitions of smaller aggregators or acquisitions in the fintech space.
Morgans clients can access the full list of high conviction stocks by viewing our latest High Conviction Stocks research report.
If you would like more information, please contact your adviser or nearest Morgans office.
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.
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