The ASX 200 Accumulation index returned a respectable 15.4% at the close of reporting season, and is poised to return a similar amount over the next 12 months if all goes to plan. Factset consensus forecasts anticipate another year of 7.2% earnings growth at a dividend yield of 4.6% which puts the ASX 200 on course for another year of double-digit returns.
We are cautious about the price investors are paying for stocks in some segments of the market (where price is diverging from fundamentals). We currently expect the S&P/ASX200 index to finish the year at 6,300 points, but the outlook is becoming more vulnerable given the prevailing global macro-economic risks.
Two changes to our list this month
We add Reliance Worldwide (RWC) to our list in October.
Recent share price weakness was on the back of softer than expected FY19 guidance. RWC gave EBITDA guidance of $280-$290m vs consensus of c$300m. This has reset market expectations and the stock now trades at 24x FY19 PE in line with broader Industrials (despite a solid c26% three-year EPS CAGR). We also think the recently updated synergy targets ($30m over three years) will prove to be conservative, which should provide further earnings upside.
We remove Atlas Arteria (ALX) this month following its recent share price strength which has the stock trading near our price target of $6.94. However, we remain optimistic on the outlook for the stock, particularly as new management initiatives may make the stock increasingly attractive as a takeover target.
Nine high conviction stocks in October
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 nine high conviction stock picks this month:
Reliance Worldwide (RWC)
RWC is the world's largest manufacturer of push to connect (PTC) plumbing fittings and specialist water control valves.
Key reasons to buy Reliance Worldwide
- RWC hold the #1 market position in a number of product categories and is the clear market leader in the US with 80% market share (on a volume basis) in the residential PTC fittings category.
- It has a stable earnings growth profile focused on the less cyclical residential R&R sector with operations in North America, Asia-Pacific and Europe.
- PTC fittings penetration in the US is >10%. Given its strong value proposition we believe there is still a lot of potential for further penetration of the category over the long term.
OZ Minerals (OZL)
OZ Minerals is a copper-focused international company based in South Australia.
Key reasons to buy OZ Minerals
- OZL enjoys robust cashflows from an established production base in copper, which has among the best outlooks in the commodities suite, driven by electrification of the developing world. OZL's balance sheet and cost structure provide good downside protection.
- We think OZL's counter-cyclical growth strategy will be rewarded as the Carrapateena development project is gradually de-risked in the coming 1-2 years, and can justify valuations closer to $12.50 per share upon successful commissioning.
- We think that recent share price weakness has been driven by macro-economic uncertainties, which we think can pass in time.
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.
Australian Finance Group (AFG)
Since establishment in 1994, AFG has grown to become one of Australia's largest mortgage broking groups.
Key reasons to buy Australian Finance Group
- We believe concerns about regulatory risk regarding broker remuneration models as well as consternation about the cooling housing market are overdone. Such concerns have resulted in this stock offering good value and an attractive dividend yield.
- We forecast 8% EPS CAGR over the next 3 years and strong cash flow generation. AFG presently has an restricted cash postion of approximately $60m.
- If surplus cash does not need to used for acquisitions then we expect more special dividends to be paid.
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.
Kina Securities (KSL)
KSL is a diversified financial service provider in PNG. The group has two operating divisions, Kina Bank and Kina Wealth Management.
Key reasons to buy Kina Securities
- We think the stock remains mispriced by the market. We expect KSL to produce a record profit in 2018, yet it still trades at a material discount to its IPO price. We forecast a dividend yield of 8.4% for 2018 and 10.8% for 2019.
- The recent ANZ PNG acquisition adds significant inherent value in our view. KSL paid only goodwill and yet the deal is 25-35% accretive post synergies.
- KSL's underlying business metrics continue to track solidly – delivering 20% loan growth, credit quality has been improving and backed by a strong capital position (approx. 17% pro-forma and well above the regulatory minimum of 12%).
Noni B (NBL)
NBL is a womenswear retailer which has recently completed a transformation of five underperforming brands from listed peer Specialty Fashion.
Key reasons to buy Noni B
- NBL now commands approx. A$1bn of sales and a material portion of the womenswear market. This should enable NBL to rationalise an industry which has been primarily focused on volumes and discounting, and in doing so increase profitability over time.
- The Specialty Assets cost-out targets should prove to be conservative. NBL has guided to an initial A$30m of cost out and an 'unqualified' amount of supply chain/gross profit benefit. We expect this initial phase of cost out will be largely complete by 1H19-end and see meaningful upside to management's cost-out targets over time.
- NBL trades on an undemanding valuation of 9.7x FY20F (a c25% discount to peer basket).
PWR Holdings (PWH)
PWR designs and produces cooling solutions for the high performance automotive industry and has an established track record in servicing elite 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)
- PWH typically invests ahead of the curve and we expect FY19 and FY20 to be strong growth years underpinned by further penetration in motorsports and an increasing contribution from OEM markets. For FY19, we forecast 18% underlying NPAT growth to A$14.3m.
- 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).
Volpara Health Technologies (VHT)
Volpara is a leading IT healthcare provider aiming to improve early detection of breast cancer.
Key reasons to buy Volpara
- Volpara's SaaS model is linked to a growing medical need, which has recently seen 36 US states mandate that women are told of breast density.
- Volpara's market share of breast screening in the US is currently 3.7% with a pathway to grow to 9% in FY19.
- A business model leveraged to growing and reoccuring revenue (FY19 guidance of NZ$9.0m) with the ability to pass on improved pricing over time (average US$3 per screen).
Contributed by Andrew Tang from the Morgans blog: (VIEW LINK)