Perceived structural changes present buying opportunity

Vince Pezzullo

Perpetual Asset Management (Australia)

In this wire, I explore the numerous opportunities we continue to see in the Australian and global market to generate income and capital growth, identify three stocks best performers,  and provide a special focus on one specific oversold stock.

Let's go back a month or so. 

Over April, the Australian benchmark surged over the psychologically important 7,000 point hurdle. This “reopening momentum” led the market to advance after trading in a narrow band since the start of the year. 

Then, talk of a large infrastructure stimulus in the US permeated through global markets and the International Monetary Fund (IMF) upgraded the forecast for Australian economic growth in 2021 from 3.5% to 4.5%. Indeed, Australian business conditions (trading, profitability and employment) rose to the highest levels ever recorded since the National Australia Bank (NAB) survey began in 1997. 

A number of growth stocks extended their weakness from earlier in the year as concerns around valuations and rising inflation fears lingered in the background. Commodity prices continued their upward march with iron ore prices moving from $165 to $185 a tonne.

An oversold Dexus presents a perfect opportunity

Dexus (ASX: DXS) is an Australian Real Estate Investment Trust (A-REIT) that derives the majority of its earnings from rental income received from directly owning Australian property. DXS also has an unlisted funds management business where they receive management fees based on the assets under management on behalf of third party capital partners. 

2020 was a tough year for A-REITs generally, but particularly those with material exposure to the Office sector. With around 75% of its income from Office Investment Properties, DXS was severely impacted and its share price fell from $13.42 in February 2020 to a low of $8.03 only a month later. This was driven by analyst and investor concerns about the impact of the COVID-19 pandemic on office occupancy, rent, incentives, income, and ultimately asset valuations. 

The consensus view was that COVID-19 would lead to a significant structural decline in the demand for office space. However, we took a different view.

In our view, offices will continue to play a critical role in most people’s working lives. It is a place for collaboration, innovation, culture building, up-skilling, career progression and social interaction. We would argue that most of these things are difficult to achieve through a virtual network. And it would appear that others agree – with the physical occupancy of our CBDs continuing to grow as COVID-19 restrictions are removed. For example, the Property Council of Australia estimates that offices in the Sydney CBD had an occupancy rate of 59% in April 2021, up from a low of 35% in September 2020. More importantly, a number of direct property investors appear to agree with us. Since early last year, there have a number of direct market transactions either at or above the building’s net tangible asset value. For example, 452 Flinders St, Melbourne, 60 Miller St, North Sydney and 10 Eagle St, Brisbane. 

At its March 2020 low, DXS was trading at close to a 30% discount to its net tangible asset backing. As at April 2021, DXS is trading at less than a 10% discount as analysts and investors concerns have faded. We continue to see significant value in this stock.

Best performers 

La Francaise Des Jeux (PAR: FDJ): FDJ returned 11.0% in April and is a prime example of a company we believe is experiencing long-term structural growth. This is predominantly through their ongoing margin expansion with the shift from retail sales to online sales.

BlueScope SteelLimited (ASX: BSL): During the month, BSL increased its earnings guidance for 2H FY2021to be in the range of $1.0 billion to $1.08 billion subject to spread, foreign exchange and market conditions. This is up from its prior guidance of $750 million to $830 million.

Boral Limited (ASX: BLD): BLD performed well after finalising the US$1.02 billion sale of its 50% stake in its USG Boral joint venture to Germany's Gebr Knauf KG. Management reported that it expects to generate a post-tax profit of A$450 million (US$341.9 million) on the divestment and intend on using the proceeds to reduce its net debt position from ~$1.9 billion to its target of $1.5billion and to distribute surplus capital via an on-market buyback of up to 10% of its shares on issue over the next 12 months.

In addition to BSL and BLD, the strong performances of materials and mining companies have cemented our views that they are likely to be key beneficiaries of economic recovery. 

Largest detractors 

Flutter Entertainment Plc (LON: FLTR): After a strong run-up over the last year, FLTR’s share price consolidated in April despite releasing a strong first quarter update in late April. We remain optimistic around the long-term opportunity for the business and believe FLTR is undervalued at current levels. 

Oil Search Limited (ASX: OSH): OSH’s share price was impacted as oil prices fell in April. This came as fears mounted that global outbreaks of COVID-19 might suppress oil demand.

Qantas Airways Limited (ASX: QAN): QAN’s share price was also impacted by the concerns lingering about new strains of COVID-19 which have disrupted a return to more normalised travel arrangements. We are of the view that QAN have successfully reset their cost base through their recent restructuring. 

Interested in income and capital growth?

Our strategy is to create a concentrated and actively managed portfolio of Australian securities with typically a mid-cap focus and global listed securities. Find out more by clicking 'contact' below, or hit 'follow' to be the first to receive our latest Livewire insights.

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Vince Pezzullo
Deputy Head of Equities
Perpetual Asset Management (Australia)

Vince is the Deputy Head of Equities at Perpetual Asset Management Australia and is the Portfolio Manager for Australian Share, Geared Australian Share and the Perpetual Equity Investment Company Limited (ASX:PIC).

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