Overall economic growth and lower interest rates remain supportive for equities but the outlook, particularly this late in the business cycle, is becoming more vulnerable to various risks (trade concerns, elevated valuations, political uncertainty).
Despite some 'green shoots' in the domestic economy, earnings momentum generally slowed in reporting season. Cautious trading and elevated valuations will test investors' tolerance for bad news in the months ahead.
Segments of the market have been prone to over-shooting fundamentals in recent years and we think investors should stand ready to trim crowded high PE trades, particularly as attention turns from fundamentals back to the broader macro.
Three changes to our High Conviction picks this month
We add Woodside Petroleum (WPL) into our High Conviction list. We're happy to buy this established energy franchise given its high quality of earnings, with an EBITDA margin >70% and stretch goal to maintain a dividend payout ratio of 80% of earnings (despite investment in growth).
Our growing conviction is that WPL will be capable of finalising the JV agreement to tie in its Browse field to the NWS and Scarborough field to Pluto LNG, de-risking growth assumptions around WPL.
We also add Cleanaway Waste Management (CWY) this month.
With the growing importance of sustainability in household, business and government decision-making, waste management is becoming an increasingly valuable sector with CWY the Australian leader.
CWY continues to invest in its network of strategically important post-collection assets, including recycling facilities.
Removing Australian Finance Group
We remove Australian Finance Group (AFG) this month given recent share price strength. We believe the stock is now close to fair value.
We are closely monitoring emerging signs of a recovery in home lending; if the rebound in residential lodgements seen in the month of July 2019 is sustained then we see upside risk to our earnings forecasts and target price.
Seven high conviction ASX100 stocks in September
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 ASX100 stock picks this month:
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 regarding loan book positioning and low reliance on treasury and markets income.
- Concerns about the asset quality and margin ramifications of WBC’s relatively high interest-only home loan exposure continue to weigh on its share price in our view. However, we continue to believe these concerns are overblown. WBC has reduced its interest only exposure from 50% of its Australian home loan book at Mar-2017 to 32% at Dec-2018 without its asset quality underperforming peers in any material way and its group NIM has been broadly flat over this period.
- Strong capital position and sound asset quality support dividend. WBC reported a CET1 capital ratio of 10.6%, above APRA's 'unquestionably strong' benchmark.
Oil Search (OSH)
Oil Search is a major oil and gas developer/ producer. Its key asset is a 29% interest in the world-class PNG LNG Project/ Development, operated by ExxonMobil.
Key reasons to buy Oil Search
- We continue to rate OSH as a top large cap pick in oil and gas based on the strength of its earnings and quality of its growth profile.
- Despite a challenging political backdrop, OSH and its partners have continued to make progress on its global-scale organic growth profile, with high margin/value growth from expansion of its PNG-based LNG operations and the upsizing and development of its large greenfield oil project in Alaska (also high margin).
- We view OSH's current share price as adequately reflecting the value of existing production from PNG LNG T1 & T2 operations, while we believe the market remains too conservative on the upside potential for the PNG expansion and Alaska projects
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 $13.00ps upon successful commissioning.
- We think that recent price weakness has been driven by macro-economic uncertainties, which we think can pass in time.
RMD is a global company involved in the development and manufacturing of medical products for the treatment of respiratory disorders, with a focus on sleep disordered breathing.
Key reasons to buy ResMed (RMD)
- We continue to view the company as well positioned, with solid growth expected across the core business, an "exciting" pipeline of new products and a growing digital platform via new module launches, new customer adds and price increases.
- 4Q results beat across top and bottom lines, underpinned by continued double-digit sales growth and adjusted op income on new products and strength in the company's leading connected-care offering.
- RMD targets a very large potential market opportunity. The National Heart Blood and Lung Institute estimates that 12m Americans suffer from sleep apnoea; according to RMD, fewer than 4m are diagnosed or treated each year.
Sonic Healthcare (SHL)
SHL is an international medical diagnostics company, offering laboratory medicine/pathology and radiology services to the medical community.
Key reasons to buy Sonic Healthcare
- We see Sonic as being ideally positioned as a global diagnostic and pathology provider, backed by defensive earnings, growing scale and a strong balance sheet. We forecast high single digit earnings growth through 2021.
- SHL’s valuation is currently in line with its historical average 12-month forward PE multiple of 20.8x and offers a 3.5% partially franked dividend yield.
- The strategic Aurora Diagnostics acquisition not only increases scale in anatomical pathology, but also offers cross-selling opportunities in clinical pathology, supporting margin uplift and profit growth.
WPL is an Australian oil and gas company. WPL has a portfolio of offshore platforms, oil floating production storage and off-loading vessels. WPL also holds operating assets both in Australia and internationally.
Key reasons to buy Woodside
- Strong established energy franchise with high quality of earnings, with an EBITDA margin >70% and stretch goal to maintain a dividend payout ratio of 80% of earnings (despite investment in growth).
- We think WPL will be capable of finalising the JV agreement to tie in its Browse field to the NWS and Scarborough field to Pluto LNG, de-risking growth assumptions around WPL.
- While we find fears around longer term LNG supply risks justified, we also see upside potential for global LNG demand scenarios that could help to offset. In the meantime, WPL looks attractive compared to our target price of A$34.97 and expectation of an oil market recovery.
CWY is a provider of waste management services in Australia, with operations in both solid and liquid waste.
Key reasons to buy Cleanaway
- With the growing importance of sustainability in household, business and government decision-making, waste management is becoming an increasingly valuable sector with CWY the Australian leader.
- CWY continues to invest in its network of strategically important post-collection assets, including recycling facilities
- We expect CWY to be able to deliver mid-single digit compound EBITDA growth leveraging into high single digit/lower double digit growth in EPS. Organic growth and achievement of TOX-related synergies will drive growth in the short term, albeit the business is partly exposed to a slowing domestic economy. The growth outlook could be enhanced by CWY using capacity in its balance sheet to undertake growth investments (it is under-geared vs large scale North American peers).
This report was contributed to Livewire from the Morgans Blog.