Morningstar’s top undervalued Australian stocks for the start of 2023

It’s no secret that conditions are now prime for value investments. We’ve had a rough start to 2023, and the expectations are for more pain to come in terms of inflation and interest rates. But by many accounts, however, markets have already priced this in. And in some cases, it is argued, this pricing may have gone too far. What this all amounts to is the chance to hunt down some serious value opportunities and position your portfolio for a future bull market.

Morningstar released its Market Outlook for the first quarter, covering the equities research team’s market expectations and stock valuations.

Peter Warnes, Head of Equity Research ANZ at Morningstar, is unsurprisingly tipping inflation, rising interest rates, and geopolitical activity to remain dominant themes this year. Warnes notes that Australia is better positioned than many, and the resources sector should benefit from China’s efforts to stimulate its real estate sector. He also predicts that the RBA is likely to hold rates after March, with the earliest chance for cuts in 2024.

So, where does this leave us in terms of investment opportunities?

“Currently, we see the best value in energy, real estate, financial services, and telecommunications sector. Our usual preference for sector diversity and bias towards lower-risk and meatier stocks applies, particularly now,” Warne says.

Even better, Adrian Atkins, Senior Equities Analyst at Morningstar, says that a historically high percentage of stocks that Morningstar covers are ranked as undervalued. That leaves plenty of ground to cover for investors on the hunt. But should you need a starting point, here are some of the top opportunities Morningstar has identified by sector with a five-star rating. If no five-star stocks are referenced, then I’ve identified the highest four-star stock based on price-to-fair-value. Valuations are based on Morningstar data as of 12 December 2022 – so keep in mind, the market has moved since then, and you should do your own research before deciding whether or not to invest.

The top undervalued stocks by discount to fair value

Note: These are based on prices at the close of business on 12 December 2022.

Basic materials – Newcrest Mining (ASX: NCM)
Morningstar calculation of Price/Fair Value – 0.69

Newcrest Mining remains a top pick and was actually identified back in Morningstar’s Q4 2022 picks.

Newcrest Mining is Australia’s largest Australian-listed gold producer and one of the world’s largest gold mining companies. It will likely benefit from a recovery in the gold bear market, along with gold’s traditional position as an inflation hedge and defensive play.

Greg Canavan, editorial director at Fat Tail Investment Research, told Livewire’s Hans Lee that there was opportunity in large-cap stocks like Newcrest Mining late last year.

“ASX gold stocks will have a big first half, possibly even outperforming the ASX200 as a whole,” Canavan said.

Jon Mills CFA, Equity Analyst at Morningstar says, “We think Newcrest is likely to overcome recent production challenges at Lihir, and both Lihir and Cadia remain better-than-average gold mines, helping Newcrest remain in the bottom decile of the gold industry cost curve.”

Southern Cross Media is a TV and radio broadcaster in Australia with revenue largely generated from advertising.

“As the clear market leader in the key radio segment (over 80% of group earnings), we expect no-moat Southern Cross to continue to enjoy profit growth as revenue recovers, on a cost base that has been restructured,” says Brian Han, Senior Equity Analyst for Morningstar.

The online retailer offers a range of products and services across household goods and furniture, insurance, and even mobile and internet. In the last few weeks, it has added again to its lineup by purchasing luxury furniture retailer Brosca and partnered with Luxury Escapes in a relaunch of its Kogan Travel brand.

Morningstar is optimistic about Kogan's prospects based on e-commerce trends.

Consumer defensive – Bega Cheese Ltd (ASX: BGA)
Morningstar calculation of Price/Fair Value – 0.7

Bega may be best known as a cheese producer and the owner of Vegemite, but there’s more than meets the eye. The food manufacturer has an extensive portfolio across dairy, fruit juices and spreads, such as Vegemite, honey and peanut butter.

Mathan Somasundaram from Deep Data Analytics lists Bega as one of the top 10 ideas to come from the Deep Data Analytics’ Growth-at-a-reasonable-yield model. See more below:

Investment Theme

GARY Top 10: Delivering positive returns in a bear market with yield investing

View

By contrast, MarketIndex recently identified Bega as seeing a big jump in short interest, highlighting that many are betting against the company's fortunes - something to keep in mind while doing your research.

Energy – Santos (ASX: STO)
Morningstar calculation of Price/Fair Value - 0.59

The energy category is one of Morningstar’s best-valued sectors for the first quarter and it was a close call for top place with Beach Energy (ASX: BPT). Morningstar argues that it is not being sufficiently credited for the new oil and gas developments underway.

The oil and gas company is the biggest supplier of natural gas in Australia. It is currently facing some concerns due to the Australian Federal Government’s proposal for price capping on gas prices but is likely to otherwise benefit from the continued high prices in gas and oil markets.

Other brokers have similarly listed Santos as a buy or an outperform, which you can read more about here.

Stefan Hansen from Tyndall Asset Management expects gas markets to see pressure in the coming year due to the ongoing war in Ukraine creating continued demand.

“This should create sustained pressure on global gas markets to the benefit of incumbents, with spot market capacity (e.eg Woodside Energy Group (ASX: WDS) and those with contracts up for renewable and new projects requiring offtake partners (e.g. Santos)),” said Hansen.

Investment Theme

Why Tyndall is buying up these energy stocks

View

AUB comprises insurance brokers and underwriting agencies across Australia and New Zealand. It also owns equity stakes in partner businesses. Morningstar notes that its acquisition of UK lender Tysers will be a long-term positive due to synergies with the broader business.

AUB was also recently rated in MarketMeter’s data on top companies ranked by CEO effectiveness.

Seven Group is a diversified operating and investment group across industrial services, oil, gas and media. Some examples of businesses it owns and operates include Coates Hire, and Allight and Sykes.

Morningstar believes Seven Group’s exposure to government spending plans should be protected from rising interest rates.

Similarly, Seven Group ranked in Deep Data Analytics' top 10 based on a reasonable price for yield model, along with ranking in MarketMeter’s top companies based on sustainability reporting and CEO effectiveness.

The Charter Hall holds a variety of portfolios, such as its REIT portfolio of convenience retail shopping centres and other convenience assets with a long weighted average lease expiry (WALE) across Australia and NZ.

Morningstar views the fundamentals for Charter Hall as being strong for challenging times.

“Charter Hall has no debt on its balance sheet, and look-though gearing (including debt in its funds) is a modest 25%, so we think Charter Hall is well-prepared for tougher conditions. We think the security price more than discounts expected weaker operating conditions, and its development pipeline is likely to continue to add to funds under management," says Alex Prineas, Equity Analyst for Morningstar.

*Please note an earlier version of this article incorrectly referenced the Charter Hall REIT rather than Charter Hall Group as Morningstar's undervalued pick.*

Megaport is a ‘network as a service’ provider offering connectivity, scalable bandwidth, cloud strategies, connection to software providers and data centre management to companies.

Equities

Ouch! 9 painful calls from 2022

View

That said, it’s not a sell for Jun Bei Liu.

“It's a small position for us, but we always believe you need to future-proof your portfolio and a little company like that, with such fast growth and adoption across the cloud, is well leveraged to the growing demand for the cloud and data,” she says.

Morningstar argues the stock is on the cusp of generating cash and has been overly punished for its status as a high growth, not yet unprofitable business.

AGL is an essential services provider of energy and telecommunications services. It has the largest electricity generation portfolio in Australia, accounting for 20% of the total electricity generation capacity in Australia’s National Electricity Market.

Investing in value opportunities

Some of these stocks may continue to have challenges across 2023. Value investing is about the long-term prospects for a company and an assessment of the strength of the underlying fundamentals. That can all change, so careful research is a value investor’s friend.

Where are you finding value opportunities at the moment?

Never miss an insight

If you're not an existing Livewire subscriber, you can sign up to get free access to investment ideas and strategies from Australia's leading investors.

And you can follow my profile to stay up to date with other wires as they're published – don't forget to give them a “like”.