Seven high conviction stocks in February

Andrew Tang

As we look ahead to reporting season, solid returns are still achievable in this market, but these returns should not come at the expense of investors taking on excessive levels of risk. We identify those stocks that we think offer the highest risk-adjusted return through 2018.

Three changes to our list this month

We add Corporate Travel Management (CTD) to our list in February. We expect CTD can continue to deliver strong double digit EPS growth over the coming years. Even against a strengthening AUD vs USD, we still expect a strong 1H18 result on the 21 February and believe CTD will resume making accretive acquisitions in 2018.

This month we remove Motorcycle Holdings (MTO) and Aventus (AVN) from our list.

Motorcycle Holdings is removed on the back of short-term risks, noting that industry road bike sales were down 15.9% for 2017. We expect MTO has continued to outperform vs competitors, but organic growth will still be negative. There is clearly a risk that MTO's underlying result underwhelms the market. We also note that MTO is cycling a very big 1H17 result, but a much weaker 2H result. We also doubt that industry sales will be down close to 20% for much longer, so the 2H should be a much better period and more acquisitions are on the agenda.

We remove Aventus given the near-term uncertainty around Steinhoff International's financial position and the implications for the local business (which is AVN's largest tenant and represents around 9% of income). Regardless, we do have confidence in the overall quality of AVN's portfolio and back AVN's management team to navigate.

Seven high conviction stocks in February

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 seven high conviction stock picks this month:

Oil Search (OSH)

Oil Search is a major oil and gas developer/producer. OSH's key asset is its 29% interest in the 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 toward 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. 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.

We retain our Add recommendation.

ResMed (RMD)

ResMed develops, manufactures and markets medical products for the treatment and management of respiratory disorders globally.

Key reasons to buy ResMed

  • Recent 2Q results were solid across the board, with patient volumes improving, strong device sales continuing and the mask annuity stream taking market share.
  • ResMed continues to cement its leadership position in healthcare informatics, with the high-margin Brightree SaaS model performing to expectations (low to mid teen growth), supporting device/masks growth and gross margin 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.

We retain our Add recommendation.

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.

We retain our Add recommendation.

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

  • 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.

We retain our Add recommendation.

Senex Energy (SXY)

Senex is an oil and gas company focused on operating and developing energy sources in Australia's Cooper, Eromanga and Surat Basins.

Key reasons to buy Senex

  • SXY is ideally positioned to make a material impact on the east coast gas market with two gas projects expected to transform earnings over the next few years.
  • SXY has advised it has finalised the design of sales gas processing facilities for WSGP and should have the plant online by late 2018. We expect sales revenue to start following the commissioning of this facility.
  • SXY is leveraged to rising oil prices through its existing oil production and longer term through its oil-linked WSGP gas sales agreement with GLNG.

We retain our Add recommendation.

Corporate Travel Management (CTD)

CTD is a provider of travel management solutions to the corporate market with a presence in Australia, New Zealand, the USA, Europe and Asia

Key reasons to buy Corporate Travel Management

  • We expect CTD can continue to deliver strong double digit Earnings Per Share growth over the coming years. Even against a strengthening AUD vs USD, we still expect a strong 1H18 result on the 21 February and believe CTD will resume making accretive acquisitions in 2018.
  • The highly fragmented nature of the global corporate travel market means there are significant market share opportunities for CTD to realise over time. The global corporate travel market is valued at US$1.4 trillion and is growing at US$40b per annum. In Europe and the US, CTD's market share is less than 1%, while in Asia it is over 1%, highlighting the substantial market share it could win over the coming years.
  • CTD also stands to benefit from lower tax rates in the UK (23% group FY19 EBITDA) and the US (33% of EBITDA) should they materialise.

We retain our Add recommendation.

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).

We retain our Add recommendation.

Contributed by Andrew Tang from the Morgans Blog: (VIEW LINK)


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