Equities

A rather unpleasant end to 2018 saw the S&P/ASX 200 index down 9% over the final quarter. Tactically it has been a blessing in disguise for investors at the start of the year. Valuations have de-rated sharply on the back of a multitude of macro-economic scares and have left the market trading in line with its historical average of 14.1x 12-month forward PE.

Elevated valuations proved a difficult hurdle over past reporting seasons with many high PE names falling under the weight of having to deliver to earnings forecasts. For the market to re-rate higher from here company outlook will be key and we look for signs of earnings stabilisation especially in cyclical sectors of the economy.

Some refinements to the high conviction process

We have updated our approach to the high conviction list, incorporating some additional qualitative and quantitative constraints to rank and measure stocks consistently across our coverage universe.

We take a scorecard approach which evaluates the stock candidate's earnings and dividend profile, industry structure and susceptibility to earnings risk, with a minimum score required to be considered for inclusion.

 

One addition to our list this month

This month we add Oil Search (OSH) into our High Conviction ASX100 picks after its share price fall on recent oil price weakness. Against this 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).

Six 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 six high conviction ASX100 stock picks this month:

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 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 of both the PNG expansion and Alaska projects.

We retain our Add recommendation. 

Cleanaway Waste Managment (CWY)

CWY is a provider of waste management services in Australia, with operations in both solid and liquid waste.

Key reasons to buy Cleanaway

  • New management has worked to improve the cost base, capital intensity, revenue generation and balance sheet over recent years.
  • Going forward we expect relatively defensive and solid earnings growth driven by organic sources, announced major contract wins and the acquisition of Toxfree (including cost-out synergies)
  • With the growing importance of sustainability in household, business and government decision-making, we expect waste management to become an increasingly valuable sector where CWY is the Australian leader.

We retain our Add recommendation.

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 recent price weakness has been driven by macro-economic uncertainties, which we think can pass in time.

We retain our Add recommendation. 

ResMed (RMD)

RMD is a global company involved in the development and manufacturing of medical products for the treatment and management of respiratory disorders, with a focus on sleep-disordered breathing.

Key reasons to buy ResMed

  • The company remains well positioned in our view, with continued growth across masks and devices, a solid pipeline of new products and an expanding digital platform helping to drive resupply, low setup costs and improve adherence rates.
  • Q2 was a little softer on the top-line but quarters tend to be quite volatile. We were impressed by the margins achieved – a sixth straight quarter of improving leverage and double-digit operating income growth. This continues to reflect the strength of the global business modal.
  • RMD targets a very large potential market opportunity. The National Heart Blood and Lung Institute estimates that 12 million Americans suffer from sleep apnoea. According to RMD, fewer than 4 million are diagnosed or treated each year.

We retain our Add recommendation. 

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 around 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.

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. 

Contributed by Andrew Tang from the Morgans blog



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Guowei Xu

On Oz Minerals, what recent price weakness are you alluding to?