Five high conviction stocks in June

Andrew Tang

Economic growth overall is still supportive for equities, and we currently expect the ASX200 to edge higher to 6200 by year-end. The outlook however, particularly this late in a sustained global business cycle, is becoming more vulnerable to various risks, notably higher bond yields and geopolitical issues.

After the calm and rewarding 'goldilocks' period of last year, 2018 is not a year for complacent investing. While we don't subscribe to the view that we are heading into a deep bear market, there are forces at play that will unshackle the dormant volatility in coming months. We think investors should stand ready to buy the dips when the inevitable bouts of market volatility hit.

It is true that the environment going forward will not be as favourable for pure Growth Strategies, particularly in the context of rising interest rates. However, most of the outperformance and higher valuations of Growth vs Value can be explained by higher margins, earnings and ROE. This suggests that backing genuine Growth companies still makes sense, but it is time to be more selective now.

Two changes to our list this month

We remove BHP Billiton (BHP) and Link Administration (LNK) from our list in June. BHP remains in good shape, with the continuing recovery cycle for metal prices supplying a powerful tailwind for earnings. However, as the recovery cycle has gained pace, so has market expectations, with much of this upside now priced in. The strength of BHP's fundamentals still presents it as a solid core stock to hold in our Model Portfolio.

We remove LNK this month as regulatory risks on the financial sector continue to escalate on LNK's Fund Administration business. We continue to like the longer-term story but negative sentiment and regulatory risks will weigh on the stock over the short term.

Five high conviction stocks in June

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 five high conviction stock picks this month:

Cleanaway Waste Management (CWY)

Cleanaway is a provider of waste management services in Australia, with operations in both solid and liquid waste.

Key reasons to buy Cleanaway

  • New management has worked to improve the cost base, capital intensity, revenue generation and the balance sheet over recent years.
  • Going forward, we expect relatively defensive and solid earnings growth driven by organic sources, announced contract wins and the acquisition of Toxfree (including cost-out synergies).
  • With the growing importance of sustainability in household, business and government decision-making, we expect waste management to become an increasingly valuable sector with CWY the Australian leader.

We retain our Add recommendation.

Suncorp Group (SUN)

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

Key reasons to buy Suncorp Group

  • 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 SUN's 12% target level.
  • We also 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.
  • 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.

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.

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 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, which you can access here.


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