4 stocks to watch for the new financial year

Looking forward to FY18, here are four growth companies that look attractive – despite industry situations that, for three of them, have generated plenty of negative headlines, about Amazon’s ability to lay waste to Australian retail, and the prospects for the iron ore price.

Mantra Group (MTR, $3.06)

• Market capitalisation: $910 million
• FY18 forecast price/earnings (P/E) ratio: 16.3 times
• FY18 forecast dividend yield: 4.1%, fully franked
• Analysts’ consensus target price: $3.64

Hotels and leisure company Mantra Group has a full suite of attractions: the company is benefiting from the international tourism boom, it is growing its earnings and fully franked dividends strongly; and there are constant rumours of big international hotel groups “running the ruler over” the company with a view to a takeover bid.

Mantra Group operates the Peppers, Mantra and Breakfree hotel brands, with more than 127 properties across Australia, New Zealand, Bali and Hawaii (where it owns the Ala Moana hotel), and more than 21,500 rooms.

Tourism is performing very strongly as a services export, driven by a growing flood of Chinese tourists, numbers of which grew by 22% in 2016. Until September 2015, the biggest source of tourists to Australia, but it’s now Greater China (China plus Hong Kong). In the year to April, 1,503,400 people from Greater China visited Australia, compared to 1,355,200 from New Zealand.

A record 1,245,500 tourists were from China, up 11.5% over the year. Tourist numbers from mainland China are expected to pass NZ numbers in their own right by the end of 2017. International visitors spent $39 billion in Australia in 2016, up 7%.

Mantra is right in the thick of catering to this increase: the company says the Chinese visitor market has fundamentally changed the performance of its resort destinations in particular, taking out the seasonality and turning them into year-round-destinations. (The company’s Melbourne and Sydney CBD hotels are also performing strongly, but the Perth, Darwin and Brisbane hotels are not going so well, because of the resources slowdown.) But Australians spend $61 billion a year on overnight accommodation; and as the largest accommodation provider on the Gold Coast, Mantra is expected to benefit from the April 2018 Commonwealth Games.

In the first half of FY17 financial year, Mantra lifted revenue by 16% to $356.2 million, and grew net profit by 26%, to $30.5 million. On Thomson Reuters’ collation, analysts expect Mantra to boost its earnings in FY17 by 5%, to 17.5 cents a share, and by 9% in FY18, to 19.1 cents. That prices it at 16 times FY18 earnings; with a 12.5-cent fully franked dividend forecast for FY18, the prospective yield becomes 4.1%, equating to a grossed-up yield of 5.8%. The analysts’ consensus target price for Mantra is $3.64, implying potential upside of 18.9%.

The added upside for Mantra is takeover potential. There has been a steady flow of reports in the business press that international hotel groups are looking closely at the company, with the low A$ adding to its attractiveness: names mentioned have been US hotel giant Marriott, the Hyatt and InterContinental Hotel groups, Thai hotel conglomerate Minor International, and Chinese-based hotel operators HNA and the Nanshan Group. Any corporate action would be a bonus.

Super Retail Group (SUL, $7.90)

• Market capitalisation: $1.56 billion
• FY18 forecast price/earnings (P/E) ratio: 10.6 times
• FY18 forecast dividend yield: 6.4%, fully franked
• Analysts’ consensus target price: $10.32

What? A retailer? Aren’t they all supposed to be quaking in their boots over the imminent arrival of Amazon Prime?

Not all.

Super Retail Group, the owner of the Rebel Sport, Super Amart, BCF, Ray’s Outdoors and Super Cheap Auto brands, seems relaxed about the online behemoth, saying that half of its top-selling automotive and leisure items are not available on Amazon, and nor are their equivalents. Super Retail’s share price has been cut by 24% this year, by a combination of market panic about Amazon and disappointing results in the sports category, particularly footwear: however, the company has stuck to its earnings guidance for FY17, which expects growth of 16%–18%.

The sports category, which generates about 44% of EBIT (earnings before interest and tax) will be vulnerable to Amazon, but the front-line of defence will be the auto and leisure categories, where Super Retail’s distribution relationships and knowledgeable customer service will come into play. The company says the auto and leisure categories are “high-involvement” categories, meaning that the shoppers are not just driven by product and price – they are highly engaged, and Super Retail believes its staff relate well to this.

Super Retail does not rule out trading on Amazon’s marketplace, but believes that it will be more competitive in these categories on its own. Super Retail has invested heavily in an “omnichannel” approach to retailing, integrating its online business with its stores.

The Amazon effect has pumped quite a bit of value into the Super Retail share price, with the stock trading on 10.6 times analysts’ consensus forecast for FY18 earnings, and a 6.4% fully franked dividend yield, which grosses-up to 9.1%. Analysts see very significant upside for SUL.

Greencross (GXL, $5.47)

• Market capitalisation: $645 million
• FY18 forecast price/earnings (P/E) ratio: 13.7 times
• FY18 forecast dividend yield: 3.8%, fully franked
• Analysts’ consensus target price: $6.97

Australia’s first listed veterinary group, Greencross listed in June 2007 with 32 veterinary practices. The company’s business proposition was to aggregate a strong position in a highly-fragmented industry: it has built its portfolio to 169 vet centres (139 GP clinics, 30 specialist and emergency centres) and more than 240 pet specialty retail stores and 75 grooming salons in Australia (Petbarn and City Farmers) and New Zealand (Animates). There are pet adoption centres in 100 of the stores. Greencross also has two pathology laboratories and two pet cremation sites. Australian retail generates 62% of revenue, Australian vet services contributes 26% and New Zealand generates 12%.

The pet care market in Australia and New Zealand is worth $9.5 billion, and grows at a steady 3% a year. It is still a highly-fragmented market: Greencross’ retail business is larger than its four largest specialty competitors combined, ad its veterinary business is larger than the three largest competitors combined. Greencross has plenty of room for growth.

Greencross is in a similar situation to Super Retail, with Amazon coming into its market: in the same way, it is banking on maximising customer engagement and cross-shop opportunities, through cross-referral, its group loyalty program, in-store service offering and integrated digital offering. The company says: “our expert knowledge and advice, focus on customer service and education and the breadth and convenience of our integrated product and service offering are key to differentiating us.” More than 85% of purchases in Greencross’ retail stores are made on its loyalty card.

The veterinary division represents almost 30% of the company, and is expected to generate more than $200 million of revenue and more than $25 million of EBITDA (earnings before interest, tax, depreciation and amortisation) in FY17. It employs over 500 vets and has more than 240,000 active vet clients. Yes, you can buy pet supplies cheaper on Amazon, but the latter doesn’t have that cross-referral ability. Nor does it have emergency centres and specialists: people are prepared to spend amazing amounts to treat sick pets; and the increasing take-up of pet insurance is expected to make these relatively high-cost services even more attractive to customers.

Greencross’ guidance for FY17 is for underlying EBITDA and net profit to grow at similar levels to FY16, which would imply growth of 12% and 10% respectively. On FN Arena’s collation, the analysts’ consensus expects earnings per share (EPS) to lift by 22.8% in FY17, followed by 7.2% growth in FY18: the fully franked dividend is expected to rise by 7% in FY17, to 19.8 cents, and by 6% in FY18, to 21 cents. Those numbers have GXL trading at 13.9 times expected FY18 earnings, and a fully franked yield of 3.8%, which grosses-up to 5.4%. And on analysts’ consensus price targets, there is plenty of value in Greencross.

Fortescue Metals Group (FMG, $4.66)

• Market capitalisation: $14.5 billion
• FY18 forecast price/earnings (P/E) ratio: 7.3 times*
• FY18 forecast dividend yield: 6.5%, fully franked*
• Analysts’ consensus target price: $5.83

Iron ore heavyweight Fortescue Metals has been hit on the share market recently by a fall in the iron ore price, from $US87.20 a tonne at the end of March to levels around $US56.75 a tonne. But that is a heck of a lot better than the US$20-a-tonne depths the iron ore price plumbed early last year, at a time when many analysts (and short-sellers) questioned whether Fortescue could stay in business with its huge debt load.

It’s history now that the iron ore price recovered on the back of Chinese demand, and Fortescue posted a standout December 2016 half-year profit of US$1.2 billion, up from US$319 million a year earlier.

Everyone knows that Chinese inventories are surging – iron ore stockpiles reached a record high of 139 million tonnes – and more low-cost supply is coming on to the market. But Fortescue’s lower-grade iron ore is actually being chased by the Chinese steel mills, to defend margins in the face of lower steel prices.

And what the company has achieved in terms of the things it can control is extraordinary. Over the last three years, Fortescue has cut its basic cash cost of production by almost two-thirds, from US$34.88 a tonne to US$12.54 a tonne. That has enabled cash flow to surge, to the point where Fortescue has slashed its debt from a peak of US$12.7 billion ($13.9 billion) in June 2013, to US$4.2 billion ($5.5 billion) at March 2017. Analysts have tipped the company could reach a net cash position – where it has more cash than borrowings – as early as FY18, which would be a remarkable achievement.

But what’s even more remarkable is that while eating into its debt pile at this rate, Fortescue has still been able to boost its fully franked dividend from 5 US cents in FY15 to 15 cents in FY16, and (on analysts’ consensus estimates) 32.2 US cents in FY17 – although analysts do see that declining to 22.8 US cents in FY18.

As well, Fortescue has flagged a US$1 billion–US$1.5 billion ($1.3 billion–$2 billion) spending program over 2018 and 2019, to replace its Firetail mine, is spending $US556 million ($731 million) on eight new ships and up to $US200 million ($263 million) on a tug haven at Port Hedland port. The company will also spend $US40 million ($52.6 million) this year on exploration in iron ore and as an early stage diversification effort in copper-gold in South Australia, NSW and Ecuador.

It’s been a brilliantly run turnaround at Fortescue, both in mining operations and in financial performance, and it puts the miner in a position where it has considerable room for growth, despite the fact of life, of the volatility of the iron ore price and the exchange rate. Analysts see plenty of upside for the stock.