Morgans' best ideas for September 2021 (and why we still favour cyclicals)

Post-results we see an opportunity to lighten exposure to names which have capitalised on recent trends CBA, COH, NAN, CAR, REA, BBN, REH, PME, ING.

So long as the vaccine rollout progresses according to plan, we believe the positive rotation towards coronavirus-vulnerable sectors will resume. Valuations remain attractive despite the strong run in some cyclicals (Retailers, Financials, Housing, Resources), we think there is scope for second phase COVID exit sectors Energy (STO, KAR), Gaming (ALL, TAH), Financials (MME, TYR), Travel (CTD, AQZ), and Chemicals (NUF, IPL) to benefit over the course of the year supported by strong household balance sheets, low-interest rates and improving consumer sentiment.

Cyclicals: Average PE Valuation

Source: Factset, Morgans. 

Earnings revisions and trends

Revisions to profit expectations heading into FY22 were benign despite strong results/dividends (positive), cautious outlook commentary (negative) and limited formal guidance (negative).

FY22 profit (EPS) expectations for ASX200 Industrials stocks which reported in August were trimmed by ~1.3%, with this cohort now expected to still grow EPS by a respectable ~9.7% in FY22.

FY22 profit (EPS) expectations for ASX200 Resources stocks which reported in August were trimmed by 5%, with the EPS of this cohort now expected to contract by 15% as a function of lower commodity prices.

Aggregate revision to FY22 EPS by sector, including largest stock contributions 

Source: Morgans

The easing in profit expectations did disagree with the 5% surge in ASX Industrials index through August, stretching the 12mf earnings multiple to 22.9x, its most exuberant level since February. We need to look to FY23 multiples to see better value in this segment, so it’s clear that investors continue to look through another “transitional year” for the economy and corporate earnings.

We believe investors are taking optimism from the growing social and political motivations globally to transition to an equilibrium of “living with COIVID”, and from successful vaccination and economic reopening models in the likes of the UK (68% vaccinated) and Israel (75%).

Stretched valuations do create an easy environment for corrections to occur, although we do think market earnings expectations remain conservative, offering some downside protection in terms of the “E” component of the market PE ratio. 

Price action has resulted in numerous recommendation changes across Morgans’ coverage universe. Former high conviction and best ideas names that were upgraded during reporting season include S32, BLX, HUB, OZL, and RBL. 

Morgans Best Ideas: September 2021

Our best ideas 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 our most preferred sector exposures.

New additions this month include this month include Transurban (ASX:TCL), Universal Store (ASX:UNI), Beacon Lighting (ASX:BLX), Hub24 (ASX:HUB), MoneyMe (ASX:MME), PTB Group (ASX:PTB) and Panoramic Resources (ASX:PAN).

New additions

TRANSURBAN (ASX:TCL) 

TCL owns a pure play portfolio of toll road concession assets located in Melbourne, Sydney, Brisbane, and North America. This provides exposure to regional population and employment growth and urbanisation. 

Given very high EBITDA margins, earnings are driven by traffic growth (with recovery from COVID) and toll escalation (roughly half at CPI and the remainder fixed c.4% pa). We think TCL will continue to be attractive to investors given its market cap weighting (important for passive index tracking flows), the high quality of its assets, management team, balance sheet, and growth prospects. 

Watch for rapid recovery in DPS alongside traffic recovery and WestConnex acquisition prospects. A negative overhang is the contaminated soil disposal issues related to its West Gate Tunnel Project.

Universal Store (ASX:UNI)

UNI is a ‘young’ business in terms of its store footprint. The opportunity to expand the network, combined with scale benefits and gross margin upside (private label/direct sourcing penetration), makes for a strong growth profile. 

UNI is also a compelling ‘exit play’. UNI has previously seen sales bounce back strongly following lockdowns as its core demographic seeks to make up for lost time. We expect a similar dynamic to play out as the current restrictions ease in NSW and Victoria. COVID also put the brakes on UNI’s store rollout plans for the best part of 18 months and we expect the rollout will pick up pace as Australian returns to normality. 

We see upside risk to UNI’s targeted +100 store target over time, from both regional locations and potential standalone private label concepts. UNI trades on an attractive valuation with a forward PE in the mid-teens.

Beacon Lighting (ASX:BLX)

We believe macro factors in Australia are likely to be supportive of customer demand for BLX’s products in the years to come. These factors include a buoyant housing market, supported by low interest rates, a busy construction industry, and a redirection of consumer spending from overseas travel into domestic expenditure. 

Affected by lockdowns and cycling double-digit comps, we expect LFL sales growth to be negative in the current year (FY22) but believe a rebound in trading to be very likely once restrictions ease. Underpinning this, BLX is building a Trade business that we believe has the potential to grow at a compound annual rate of nearly 30% over the next 3-5 years. 

Our scenario analysis suggests there could be around 20% upside to our base sales and earnings forecasts if BLX achieves its aspiration of growing Trade to 50% of group revenue over the next 5 years. BLX trades on an attractive 7x EBITDA multiple with consensus earnings that we see as highly conservative.

HUB24 (ASX:HUB)

HUB is a leading investment platform, administrating over A$44bn of funds (FUA) and utilised by over 3,000 financial advisers in Australia. HUB is benefitting from a structural shift of advisers to independent (or non-bank aligned) advice firms, that are looking to utilise leading and efficient investment administration technology (HUB and NWL are benchmarked as the leading providers). 

HUB has a target to grow FUA by a further 60% over the next two years and we expect the scale benefits to flow through to earnings post this. We see HUB as a long-term structural growth business. Short term valuation multiples are very high (which results in a more volatile stock), however think HUB should be considered as a long-term growth holding.

MoneyMe (ASX:MME)

MME is a consumer credit business that utilises its digital presence and technology platform to offer innovative loan products within Australia. It's cloud-based modular technology platform allows applications to be completed/processed within ~5mins. The platform uses AI and algorithms to provide risk-based pricing to balance the risk and return of the loan book. 

In our view, MME continues to deliver strong book growth and we believe its new innovative product suite, targeting niche under-serviced markets, has the potential to drive further top-line growth

PTB Group (ASX:PTB)

PTB’s US business performed strongly in the last half, growing 36% over 1H21 EBITDA. Customer demand coming from the Maldives looks to increase with the addition of 18 additional engines (approximately +8%) in the engine management program. 

We recently lifted our FY22 EBITDA forecast by 19% given our increased confidence in the outlook for the business. We think PTB’s strong cash flows will allow it to consider capital management or incremental value-accretive acquisitions. The company is due to provide FY22 earnings guidance at its AGM in late November which could confirm our views on PTB’s earnings growth.

Panoramic Resources (ASX:PAN)

PAN owns the Savannah Nickel Mine in the Kimberley region of WA. Mining activities have resumed, and processing is anticipated to restart in November with first nickel sales in December of this year. Once full production is reached (FY23), PAN is forecast to produce near 15,000t of nickel equivalent for 11 years (which includes copper and cobalt credits). 

PAN management have done a great job in the lead up to production and we understand everything is on track for first nickel this year. The nickel price can provide a boost to PAN’s forecasts from here, and we are beginning to see M&A activity return to the sector as well.

Removals this month include Inghams (ASX:ING)

Large caps

ANZ (ASX:ANZ)

We believe ANZ is the most compelling of the major banks on a valuation basis. We expect ANZ to continue to focus on absolute cost reduction over the medium term. ANZ has de-risked its loan book over recent years – particularly its institutional loan book – such that the quality of its loan book has improved. While ANZ’s Australian home loan book has been growing below system over recent months, we expect a disciplined margin performance from ANZ.

Treasury Wine Estates (ASX:TWE)

TWE has the China reallocation risk and it will take 2-3 years to recover these earnings in new markets. However, outside of China, its key markets, particularly the US, are recovering faster than expected from COVID. The new business units centred around the brands, are now fully in place and we are excited to see what they can earn with TWE effectively creating the benefits of a demerger without the extra costs. It also demonstrates that the SOTP is worth materially more than the whole. It shines a light on Penfolds and its best-in-class margins and may ultimately lead to corporate activity in some form in the future. We rate this management team highly.

Santos (ASX:STO)

We expect the resilience of STO's growth profile and diversified earnings base see it best placed to outperform against a backdrop of a continuing broader sector recovery. While pre-FEED, we see Dorado as likely to provide attractive growth for STO, while its recent acquisition increasing its stake in Darwin LNG has increased our confidence in Barossa's development. PNG growth meanwhile remains a riskier proposition, with the government adamant it will keep a larger share of economic rents while operator Exxon has significantly deferred growth plans across its global portfolio.

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