Undervalued ASX stocks from the recent market dislocation

"Typically, the Ex-20 part of the market trades at a premium P/E to the ASX 20, and that's because it's typically delivered the best earnings growth," says Mumford. 

"That really hasn't changed over time and it's still the case today. And the only real exceptions to the Ex-20 part of the market trading at a P/E premium are periods of market panic like COVID, and that tends to be pretty brief."

But what has happened over the last 2 months, says Mumford, is a huge derate in the Ex-20 while the ASX 20 has performed well, creating huge market dislocation.

"The PE multiple gap between the ASX 20 and the rest of the ASX right now is at the widest it's ever been," he says.

Mumford lays out two major sectors that have been hit in recent months: consumer discretionary and tech. 

As macro fears like rate hikes and oil prices crystallise, ASX retailers have been broadly sold off, despite fundamentals holding up well on certain stocks. 

He picks out Nick Scali (ASX: NCK) and Lovisa (ASX: LOV) as two that have dropped 40-50%, despite having some of the best return on equity metrics on the ASX.

"There's been huge moves in some of the best retailers on the ASX."

A broadly positive February result and a successful expansion to the UK should have been catalysts for Nick Scali, says Mumford, but instead it finds itself trading at lower multiples, around where it was before the global rollout.

"You've got one of the highest-quality ASX businesses and it's trading on 15 times PE, which is a discount to the broader market."

"Over the sales period of November to January, which is the key period for the company, their like-for-like sales were growing at 9%, and they continue to roll out stores in Australia."

"And importantly, the UK rollout is going really well. Management continued to gain conviction in that story, and they're talking about opportunities to grow their UK store network by about 25% in the near term, which we think is just the start."

It's a similar story for Lovisa, which boasts high margins (~80%) and is one of the few ASX stocks with a higher return-on-equity than Nick Scali. 

A disappointing result in February and losses across its upmarket sister brand, Jewells, have scared off investors, but Mumford believes it is well-placed to capitalise on the collapse of its key global rival, Claire's, and its own global growth. 

"Management is saying that the rollout story for Lavisa across the world is as strong as it's ever been and that's really what drives the economics of the business."

Where AI is creating value plays

One of the key contributors to the market dislocation on the ASX has been the disruptive influence of AI. According to Mumford, there are three key questions it raises for companies across the economy. 

"The first risk is that AI will now enable software developers to replicate existing software products at low cost, and that's going to impact the economics of the incumbent software products over time," he says. 

"The second risk is that consumers will perhaps now start their research and consumption journey in AI applications like ChatGPT, and that could flow through to the rest of the consumption funnel and impact the economics of businesses along the way."

"And the third risk is really what's going to happen to white collar employment if some of these AI forecasts play out."

He details three core defences companies have against AI disruption: valuable proprietary data, network effects and being part of an industry with high-stakes outcomes.

One sector he thinks offers all three defences but has still been hit hard by AI is the insurance industry.

Steadfast (ASX: SDF) and AUB Group (ASX: AUB) are two stocks Mumford believes are presenting an opportunity right now. They're trading at low double-digit P/Es, below where they were at the depths of Covid.

Mumford says there are two reasons for this underperformance - AI and slowing growth in the sector. The latter is a legitimate risk, even if the growth outlook still looks positive.

"At the peak, Steadfast's premiums were growing at about 9%, and today that's closer to 2.7%, but we're still talking growth across the sector. Steadfast expects its earnings to grow at 6% minimum this year, and Austbrokers [AUB] is forecasting growth ahead of that."

On the AI front, an AI insurance tool released by OpenAI rattled the sector. "That's really scared the market that insurance brokers, which insurers have long disliked, are at risk of disruption," says Mumford.

But insurance remains a highly complex, nuanced industry that Mumford believes is unlikely to be replaced by AI anytime soon.

"It's quite a complex value chain," he says. "These are high stakes areas with complex regulation and where relationships matter. If anything goes wrong with your insurance policy, you want someone to talk to and to blame."

He also points to Morgan Stanley data that shows insurance brokers have gained 10% market share over the last decade, but are still trading at discounted P/Es. 

Outside of insurance, REA Group (ASX: REA) is another stock Mumford believes has been disproportionately affected by AI disruption concerns. 

Like many online classified companies, its web traffic-based business model is perceived to be at risk from AI chatbots. But the data so far doesn't bear that out, according to Auscap's research, which shows traffic to Realestate.com.au from ChatGPT has remained below 0.1% over the last 12 months. 

REA also generates around 10 times more profit and has 5 million more users than its nearest competitor, Domain.

"Right now, Realestate.com.au is trading on a P/E multiple of about 28 times. It's growing earnings at about 15% per annum at a return on equity of about 30%. It's got really strong financials and its P/E multiple is, again, lower than where it was in March 2020."

"If you're passively invested in the ASX right now, over 25% of your money is going into four companies: CBA, ANZ, Westpac, and NAB," says Mumford. "If you were to put these companies together and turn it into one super company, that company would be growing its earnings over the last decade at about 1% per annum."

Now there is finally a legitimate competitor to the Big Four hegemony in the form of Macquarie (ASX: MQG), offering impressive growth and an attractive valuation. 

"In the mortgage market over the last 12 months, the dollar growth in Macquarie's mortgages was bigger than the dollar growth in mortgages at ANZ and NAB combined," said Mumford. "Macquarie is the dominant mortgage lender across the mortgage broker channel, and that channel is fast becoming 80% of total new mortgages written in Australia."