3 quality ASX stocks for an uncertain 2024

Rolling into 2024, investors face a continuing uncertain outlook for global economies. Market forecasters have wide-ranging views from continued disinflation and rate cuts to rebounding inflation and higher for longer bond yields. Will the US and global economy head into a hard landing in 2024, or will the cycle persist and not experience any landing at all?

In the face of this uncertainty, quality investing offers a robust framework for navigating the uncertainties and capturing sustainable returns. High-quality companies tend to outperform markets over the long term, with their quality attributes of durable competitive advantages, supportive industry structures and aligned management teams, allowing the companies to thrive regardless of the economic cycle.

At Blackwattle Mid Cap Quality, we try not to over-focus on looking into a crystal ball to an unknown future and instead focus on investing in high-quality businesses over the longer term. As we position the portfolio for an uncertain 2024, we are specifically looking for high-quality businesses diversified across industries that have internal improvement opportunities, which we believe can help navigate whatever challenges 2024 brings up.

We discuss three high-quality stocks with significant internal improvement as part of our thesis:

Xero (ASX: XRO)

XRO is a high-quality, accounting SaaS platform with a long (global) growth pathway. XRO brought in a new CEO, Sukhinder Singh Cassidy, in early 2023 to deliver cultural change. This change would transform the business from a focus on unprofitable sales growth to a balance of growth and profitability. To transition XRO from sales growth to earnings growth, XRO’s CEO has pivoted to improved cost productivity and price rises. We expect the full benefits of this transition to be realised in 2024.

"The significant improvement in XRO’s profitability alongside its high-quality attributes (market leading products, rational industry structure and strong cash generating business model) should see 2024 being a pivotal year for XRO, even allowing for prevailing economic uncertainty." 

We believe XRO’s 2H24 financial results in May should deliver validation of this new strategy. We expect XRO to generate a record operating margin of close to 20% in 2H24 and this earnings momentum should flow into FY25.

Beach Energy (ASX: BPT)

BPT is a low-cost domestic oil and gas producer with 5 key assets in Australia and New Zealand, providing asset diversification in low-risk jurisdictions. BPT is close to the end of a 5-year journey to increase production by ~30%, having spent almost A$3 billion in growth capex over 5 years. The final growth project to be delivered is the Waitsia Gas Project in the Perth basin, we expect the commissioning and ramp-up of production of this project in the first half of 2024.

"This period of investment provides an excellent setup for BPT in 2024, as growth capex reduces significantly, while production grows, generating significant free cash flow (FCF)."

BPT’s board and ownership structure is an attractive feature with Seven Group (ASX: SVW) dominating the register. The SVW track record of strong capital allocation provides another layer of protection that BPT shareholders will be rewarded for their patience over the past 5-year heavy investment period. We expect in FY25 that BPT’s FCF will rebound to ~$700m from -$150m in FY24. With BPT’s new capital management framework, we forecast BPT to be currently trading on a sustainable ~9% fully franked dividend yield (using spot commodity prices). While BPT is exposed to volatile commodity prices, the materiality of the outlook for FCF generation provides a large buffer against prevailing economic conditions in 2024.

Light & Wonder (ASX: LNW)

Light & Wonder is a global, cross-platform gaming company and has been quite the revelation since it was listed on the ASX in May 2023. Investors began to recognise the Aristocrat-like (ASX: ALL) turnaround story as LNW’s ex-ALL-dominated management transitioned LNW from a market share donor to a competitive threat. We expect 2024 to be a significant year for LNW as the turnaround momentum accelerates and LNW benefits from the significant reinvestment into content generation.

"The 2024 story is all about successful internal execution and market share gains, and should see LNW thrive despite uncertain economic conditions and take another step towards their long-term target of US$1.4 billion EBITDA in FY25."

LNW’s management team utilised the same playbook from ALL a decade ago to improve the R&D flywheel. LNW has significantly increased investment into content, which generates improving sales and then allows for further content reinvestment the next year. 2024 appears to be a pivotal year for LNW, as the past three years of content reinvestment have culminated in exciting new games such as Dragon Train and the Universal Monsters franchise, which are set to realise monetisation through 2024. With the acquisition of the remaining 17% of Sciplay (mobile social games) in late 2023, 2024 should also see further benefits to LNW from their cross-platform monetisation strategy. 

Quality Investing

At Blackwattle we are constantly on the lookout for these mispriced, high-quality businesses with internal levers. We understand the exceptionalism of these businesses in generating significant shareholder returns, so when we do discover one, we look to become long-term shareholders and capital partners, enabling our portfolios to capture the long-term compounding of outperformance through market cycles.