Recent data suggest that the global economy is strengthening. This should provide support for growth assets, although on current elevated valuations there is little room for earnings disappointment. In the middle of what is a traditionally weaker period for markets (May-June), we make two changes this month, removing Macquarie Atlas Roads (MQA) and Beacon Lighting (BLX).
Following a 21% total return since Macquarie Atlas Roads was included in our stock picks in March, we have chosen to remove for two reasons. Firstly, Strong share price growth significantly compressing future potential returns, and secondly uncertainty arising from the sell-down by one of MQA's co-investors in the APRR toll road in France (expected in 2H17).
We remove Beacon Lighting due to the recent stark reduction in consumer spending and sentiment in the Retail sector in the short term. We do however, retain our Add recommendation for BLX due to its strong competitive advantage, growth prospects and management team.
We continue to look for opportunities to add to our list on a pullback as highlighted in our Tactics around seasonal opportunity – best buy ideas research note here.
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 four ASX100 and two ex-ASX100 high conviction stock picks this month:
Oil Search (OSH)
Oil Search engages in the business of oil and gas exploration. OSH's main asset is its 29% interest in the 6.9MTPA PNG LNG project, a world-scale liquefied natural gas (LNG) development operated by ExxonMobil.
Key reasons to buy Oil Search
- The recent Muruk discovery could be a game changer, and could even overtake as preferred development option for train 3 at PNG LNG. Drill testing its extent continues.
- Recent 50% growth in 1P reserves underpins PNG LNG's ability to sustain production above nameplate over the long term, while also helping to underpin the next leg of growth.
- We see OSH as ideally positioned for near-term upside as it progressively de-risks its growth profile and expands its upside case through appraisal and exploration.
Orora manufactures and distributes fibre and beverage packaging primarily in Australia and North America.
Key reasons to buy Orora
- We are attracted to ORA's defensive characteristics, strong balance sheet and exposure to an improving US economy. We estimate ORA derives around 60% of revenue from highly defensive sectors such as food and beverage. Given market appetite for earnings certainty, we think the stock should receive good support.
- A falling AUD/USD provides a tailwind to earnings given around 35% of earnings are generated in North America.
- ORA has made a number of growth investments over the last two years that should set the business up for solid earnings growth over the medium term with potential upside from acquisitions.
ResMed is a global company involved in the development, manufacturing and marketing of medical products for the treatment and management of respiratory disorders.
Key reasons to buy ResMed
- We estimate a solid 10.9% earnings CAGR through FY19, with valuation undemanding (21x forward; in line with long-term average).
- A new mask product cycle is underway with positive patient/physician/provider feedback and management are confident category growth will accelerate.
- ResMed continues to cement its leadership position in healthcare informatics, with the high-margin Brightree SaaS model performing to expectations, 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.
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
- Relatively low risk profile in terms of loan book positioning and low reliance on treasury and markets income.
- Westpac stands to benefit most from re-pricing of investor home loans.
- Relatively low risk of dividend cut as a result of strong regulatory capital position and good organic capital generation capacity
Bapcor supplies replacement parts and consumables used in the service and repair of vehicles. BAP operates over 120 Auto Parts stores across Australia.
Key reasons to buy Bapcor
- BAP's 1H17 result and upgraded guidance to the base business provided us with even more confidence in BAP's growth profile, management execution and its consistent ability to outperform targets.
- We were reassured by the flow-through of material synergies from the ANA acquisition and the strong performance of recent acquisitions. Importantly, we believe that further synergies will materialise from the Hellaby's acquisition in FY18/19.
- We see two clear upcoming catalysts for the stock: 1) divestment of the non-core Hellaby's businesses (+cA$100m to be released); and 2) articulation of potential synergies from the Hellaby's acquisition (which we expect could be meaningful).
- We forecast 37% EPS growth in FY17, followed by a further 20% in FY18. We believe this growth business with defensive characteristics offers an attractive investment opportunity.
SpeedCast is a global network and satellite communications service provider offering managed networks services in over 90 countries.
Key reasons to buy Speedcast
- Post the recent Harris Caprock acquisition, SDA looks attractively priced with solid double-digit earnings growth prospects.
- SDA reports in USD which translates to a higher valuation as the USD strengthens in response to a re-inflationary environment.
- With ~45% revenue now exposed to the energy sector, we see significant upside if energy prices trend higher from current levels.