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 our sector exposures.
This month we add Link Administration (LNK) to our list. This month we also remove NextDC (NXT) from our High Conviction list. The stock has returned 14% since its inclusion at the end of reporting season and is now trading near our price target of $5.38. Potential catalysts on the horizon remain the resolution of the AJD bid and sign on of large cornerstone customers but we now view the stock as closer to fair value given its performance over the past few months. We retain a positive view on the outlook for the stock and keep it on the watchlist for future re-inclusion.
Spotting systemic risks in advance is difficult, but compared to 12 months ago we see fewer credible risks on the immediate horizon that might undercut the current economic expansion. Nonetheless, abnormally low volatility and high valuations make for a tricky investment environment.
We favour buying on pullbacks, particularly in the environment of improving corporate confidence and a global cyclical recovery. We prefer to pick stocks that can thrive irrespective of the macro-economic environment.
Here are our high conviction stock picks this month:
Link Administration (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 Administration
- 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.
Oil Search (OSH)
Oil Search is a major oil and gas developer/producer. OSH's key asset is its 29% interest in 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 towards 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.
- RMD continues to cement its leading position in healthcare informatics, with the high-margin Brightree SaaS model performing to expectations (low to mid teen growth), supporting device/masks uptake and GM 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
- 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.
Bapcor supplies replacement parts and consumables used in vehicle service and repair. BAP operates over 120 Auto Parts stores across Australia.
Key reasons to buy Bapcor
- Incorporation of the recently articulated Hellaby's synergies has lifted our forecasts and provided reassurance in BAP's ongoing growth via acquisition strategy.
- BAP's FY17 result was above our forecast at every line item with the group achieving slightly above the top-end of its guidance range.
- Upcoming catalysts include articulation of potential future efficiencies from the warehouse optimisation process which has been running quietly in the background and the sale of non-core assets.
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 centres 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).
You can access this report on the Morgans blog here: (VIEW LINK)
Andrew is a member of the Morgans Investment Committee, and is responsible for equity strategy bulletins, high conviction stocks, model portfolios and other products focusing on key areas such as reporting season, factor analysis and short interest.
Hi Andrew. I notice that three of the eight 'high conviction' stocks listed by Morgans relate to the automotive industry. I was wondering if there was a broader logic underlying Morgans recent focus on this sector?.