Two standout stocks and why the ASX will push higher

Matthew Kidman: Hello, and welcome to the thematic discussion on Buy, Hold, Sell. My name is Matthew Kidman and yes, reporting season, at last, it's over. You can hear the sigh of relief going around the city, or in our own homes these days, being locked down. There was some good, there was some bad, and some ugly. There were some absolute rippers and some absolute dogs. And here to discuss it are two of the best in the business; really looking forward to this, Chris Stott from 1851 Capital, and James Gerrish from Market Matters. Welcome, gentlemen. Chris, let's start with you, one word to sum up reporting season.

Chris Stott: Matthew, I've got two words to summarise; cautious optimism. I think reporting season was set up to be one of the best we've seen for over 10 years. I think that was tempered clearly with the recent east coast lockdowns and the cautiousness we saw amongst various companies on the outlook statements was really the key feature around that. But I think certainly a lot of companies also did call out that they do expect that once the lockdowns do end later on this year, that the economy will continue on its very positive trajectory.

Matthew Kidman: James, can you do it in one word? Chris needed two.

James Gerrish: I can, I'll stick to the script Matthew. My one word is payouts. I think it's been a reporting season that's had a huge payout from the large-cap sectors. So a huge amount of money is going back into investor pockets over the next couple of weeks. That should ultimately find its way back into the market.

Matthew Kidman: James, I'll stick with you. Chris actually brought it up. Everyone thinks that after these lockdowns, because the lockdowns have come in pretty well post June 30, post these numbers that have been reported, that there's an element of complacency that everyone thinks; well, they've seen the playbook before we know how to read it. Everything will bounce back. Do you get that feeling and is that right?

James Gerrish: I actually don't think there's a huge level of complacency in the market. I think one of the themes that became obvious as reporting season went on is analyst reluctance to upgrade earnings going out in the next 12 months. So normally, and this is not just an Australian phenomenon, it's globally as well. So normally you see analysts getting reasonably optimistic. They are an optimistic bunch. We often see upgrades going out into the outer years. I think there's a real reluctance and almost a caution in terms of the analyst community around that. So, I don't think the market is overly bullish at this point in time, even though we're trading up around all-time highs.

Matthew Kidman: Chris, have you got a view on that because no one really suspected going back a few months that Sydney, Melbourne and other parts of Australia would be in hard lockdown again. Do you think there is an element of complacency among companies and investors?

Chris Stott: Perhaps a little bit Matthew. It depends on the sector you're looking at. Everybody's excited about the travel sector as a reopening trade over the next one, two, even three years. And we just know that it's going to be a bit of a longer process in that regard around the restrictions that are in place for quite a long time, to be frank. In discussions with companies, the difference this year is that we don't have the stimulus packages that we did last year. That really carried our economy through that recession we had last year. And let's hope we double dip this time around, I don't think we will. What we do know is that on the consumer discretionary side of things that last year consumers saved an awful amount of money while they were staying locked down at home. We think that's occurring this time around again. So certainly, consumers’ wallets are primed for a big Christmas period for the retail sector, we think.

Matthew Kidman: One of the themes that when we went into reporting season, was the emergence of inflation and especially so in Australia with people not being able to move around. Wages on the rise, commodity prices on the rise. Did you see that come through in any of the results and how do you feel about it?

Chris Stott: It was one of the key features. In fact, it was probably a bit worse than we thought in terms of cost pressures being highlighted by companies. In particular shipping costs were anywhere from 5 to 10 times, their normal rates. So it's critical at this point in time, the company's ability to pass on that extra cost to recoup that to preserve margins. Companies were on the front foot in terms of highlighting that risk going into the new financial year. And it certainly doesn't look like it's going to abate any time soon.

Matthew Kidman: James, are you worried about inflation? We all saw it. All the companies were talking about it, but no one seems to be too worried about margins.

James Gerrish: I guess again it depends in what areas and which companies have been able to manage it better than others. We saw margin pressure across the board, coming out of some companies but not others. The inflationary pressures were really pronounced in US earnings season that has just been. I looked at a lot over there as well. You've seen lumber prices up 2 to 3 times, steel prices up an equivalent amount. So the pressures are there. In some sectors in Australia, wage pressures were really the focus. So particularly in areas that are relying on workers going to WA; mining services spring to mind there. So in some parts, yes, I think inflation is there. I think wage pressure is starting to bubble away and obviously, that's going to feed into higher prices over time.

Matthew Kidman: That's the backdrop let’ get into the guts of it. Give us a stock that really performed well, that you thought shot the lights out.

James Gerrish: I thought Aussie Broadband (ASX:ABB) was a really strong result. So obviously the stock has run pretty hard, but they're growing customers at a really strong clip. If we look further out over the next 12 months, they've got a really interesting pipeline of potential acquisitions and growth is going to tick higher. So not only has it had a good run but it's got some catalyst over the next 12 months to drive it higher. So Aussie Broadband was one that I like the look of.

Matthew Kidman: Chris, have you got anything that can match that power hose that's Aussie Broadband?

Chris Stott: Tough one to match, certainly. I agree with James, Aussie Broadband is certainly one of the standout results of the season, the share price certainly reacted accordingly. But one that didn't see significant share price appreciation on the back of a record result was AP Eagers (ASX:APE); the largest owner of car dealerships in the country. To James' point; people don't believe that that can maintain these current elevated margins going into the next one or two years. The company made a really good point of saying to the market that they think those margins are sustainable over the medium to longer term. So, we think that that's one that certainly was underappreciated by the market, but delivered an outstanding record result.

Matthew Kidman: Chris, stay in your car and drive us around the portfolio. Any major changes in what you're doing with your portfolio, post looking at all the companies over the last month or so?

Chris Stott: We’re still working through those Matthew, but in summary, we're looking to more of the re-opening trades at the moment. We talked about travel being a place to be over the next few years. It will perhaps be a little bit slower than some are expecting with the various restrictions that will be in place. Companies like oOH!Media (ASX:OML) we think are well-positioned from a re-opening perspective. We still believe that the economy will continue on its really strong trajectory moving into 2022, perhaps forcing the RBA to push rates up in '23, but in the meantime, we've got a good 12 to 18 months of good runway ahead for the equity market.

Matthew Kidman: Keep hold of that steering wheel and tell us what you're might be moving out of, or avoiding, or steering clear off.

Chris Stott: It's companies in our particular portfolio with low liquidity. Some of these micro caps have had extraordinary runs over the last 12 to 18 months off the March lows that we saw last year. So it's the companies that are exposed a little bit more to the housing market. We think in some cases that they've run a little bit too hard, particularly the market might be missing some of the elevated cost pressures that we talked about a little bit earlier on. They're not factoring those into their forecast. So that just gives you a bit of a sample of some of the companies that have been looking to recycle capital.

Matthew Kidman: James, take us for a drive through your portfolio. What's changed from before and after reporting season, where you're moving into?

James Gerrish: There hasn't been a huge dramatic change going out of reporting season, Matthew. I think one obvious thing and it comes to Chris's point, although I'll disagree slightly in terms of the retailers, is I think we've reduced retailers coming out of the reporting season and we've used those funds to increase our exposure into travel in the re-opening trade, similar to what Chris has suggested.

The reasoning there is obviously retailers have come off a really strong FY21, so their FY22 is going to be comping really strong numbers. They've got to deal with a lockdown in the first couple of months of the year and then also the roadmap out of this is all around vaccination. So we're all going to go out there and get the jab. When we all get the jab, we're all going to open up and we're going to stop buying stuff and start saving for travel. So that's how we see things going out in the next 12 months, which is going to be different from the last and that's how we are positioned accordingly.

Matthew Kidman: With that backdrop, James, does the reporting season, what you saw and that outlook around the virus and vaccinations, does it take the market higher over the next six months until we get the next lot of reports?

James Gerrish: I think it does, but I think obviously the backdrop for earnings is good, but we've got low rates. We've got heaps of stimulus, we've got accommodative central banks, et cetera. So all of those things factor into the market that I think it pushes higher. I haven't seen anything in this reporting season that would get me overly cautious. That's probably a scary thing to say at this point in time and it scares me a little bit, but from what I've seen, I think we should maintain a bullish stance.

Matthew Kidman: Chris, put some numbers around what cautious optimism means. Next 6 months of the market, can it propel higher? It's had a terrific run.

Chris Stott: It certainly can, we think, and it has had a good run. But in terms of what are the risks to the outlook? I think certainly that people are expecting that the economy will fully reopen in October or November. We just don't think that will be the case with hospital ICU capacity being stretched. So life will not be back to normal by Christmas, but certainly, hopefully, we are able to travel interstate. That depends on the states in that regard. So it will be perhaps a bit of a slower, more of a grind out of these lockdowns, particularly for Sydney and for Melbourne. But that's in addition to what James said, interest rates aren't going anywhere anytime soon. Accommodative conditions remain from a monetary policy standpoint. And even from a fiscal standpoint as well, the government keep throwing money at this. And certainly, it would be a terrible look for them to go in with a double-dip recession going into an election in May next year. So, yeah, I think that the support is there for the equity market to continue to move higher.

Matthew Kidman: The market might want to be locked down forever. Given the performance. It feels great to be optimistic, even with a little caution, look forward to the next six months. 

Give this wire a like if you've enjoyed the discussion and hit follow to be notified when new episodes are released.

If you're not an existing Livewire subscriber you can sign up to get free access to investment ideas and strategies from Australia's leading investors.