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After being a lonely contrarian bull on the Australian Dollar for the last 12 months, I have now changed my view to bearish at 80 US cents. The +10% rally in the Australian Dollar has not been driven by improving Australian economic growth fundamentals, it has been driven by a weak six months for the US Dollar (-9%). I believe this US Dollar weakness is transitory and the AUD will track back to 75 US cents in the months ahead as the Fed ploughs ahead with interest rate rises and balance sheet reductions. On the other side of the equation, the RBA will stand pat.
On that basis I think Australian-based investors should be increasing US Dollar exposure in terms of direct currency allocation and US Dollar equity earnings streams. I also think Australians should be increasing British Pound exposure at the expense of Australian Dollars. Basically, I think Australians should be using this unsustainable bounce in the AUD to asset allocate to more international exposure.
However, at Aitken Investment Management we don’t just hold international stocks for US and UK exposure, we also hold ASX listed foreign earners. In late July, we had been adding to our ASX listed foreign earner exposure in stocks like Aristocrat Leisure (ALL), Treasury Wine Estates (TWE), CYBG PLC (CYB), EML Payments (EML) and Link Group (LNK).
We strongly feel these stocks had underperformed in July solely because of AUD strength and that it had nothing to do with the underlying fundamentals of the companies. This week alone, we have been vindicated in that view in both Treasury Wine Estates (TWE) and CYBG PLC (CYB). TWE reiterated their profit guidance after the stock fell -4% on the back of some classic analyst “scarebroking”. TWE believed the analyst report could lead to confusion, so quite rightly they responded with confirming their earnings guidance. CYB issued a trading update that was much better than analyst expectations and led to consensus upgrades of +8% in FY17. The stock rallied +8% from its lows and remains a very cheap stock with solid upside potential over the next few years.
The earnings and valuation table below shows you are buying CYB at .7x book value, yet we have three years of double-digit EPS growth ahead and a rising ROE. The company will also revert to paying dividends next year. On a PEG ratio less than 1x and a significant discount to book value, we see at least another +30% upside in CYB in the years ahead.
In fact, as CYB gets you GBP exposure versus the AUD, it had an added attraction to us. Not only is this a classic “self-help” turnaround story, with extremely cheap investment arithmetic, but we get to buy GBP earnings at the low of the GBP versus AUD.
Aristocrat (ALL) shares also bottomed and started to recover as US peers reported strong numbers. ALL is now the cheapest ASX listed USD earning structural growth stock we can find on price-to-growth metrics and we think it is cum further earnings upgrades. We have used this pullback in ALL to have a real crack, with the stock now right at the top of our portfolio in terms of holdings. If we are right and ALL continues to upgrade earnings and the AUD pulls back to 75 US cents, then I think ALL has 50% upside from here over the next two years. I think it is excellent risk/reward buying anywhere around $21.00.
The chart below confirms no change to FY17 EPS forecasts for ALL but a significant share price pullback. We see that as simply allowing you to buy ALL at a cheaper PE than a few weeks ago and we have taken advantage of that development.
We have also added to Link Group (LNK) into weakness, feeling the growth ahead from their recent large UK acquisition is cheap in the current share price. LNK shares are working through the natural indigestion from a large rights issue but that will be over shortly and I think there’s 20% upside in LNK over the next 12 months.
Below is LNK’s share price vs consensus FY17 EPS.
Bell Potter’s analyst wrote a good summary on the investment case for LNK this week and I thought I’d share it with you as I agree with it.
Link Administration Holdings Limited (ASX Code: LNK) is the largest outsourced fund administration service provider for super funds in Australia and is split into three divisions: 1) Fund Admin (75% of Group); 2) Corporate Markets (23%) provides services such as: share registry and share plans, and; 3) IDDS (26%) provides the technology that support Link’s operations.
As the superannuation rules are extremely complex and the government has mandated that nearly every employee in the country has to set aside a small part of their pay packet to saving for their retirement, there are millions upon millions of transactions that must be recorded, monitored and reported upon to the millions of members in the superannuation system. It was a big surprise to me that most of the big Australian super funds still administer their funds in-house, and so this process is replicated over and over by each of the respective funds.
The Fund Admin business accounts for more than 75% of LNK’s total business and relies largely upon the super funds recognising that their primary function is to invest superannuation money on behalf of their members and that they would be better off out-sourcing the largely ubiquitous administrative functions to someone that specialises in this service. To that end, Link believe that they can provide their clients with a more efficient service at a lower cost. Lowing costs also goes some way to increasing member returns – which is hugely important given members of industry super funds can now move freely from one fund to another with relative ease.
LNK are already the largest fund administrators in Australia, and presently administer more than 10 million superannuation account holders and processing more than 6 million separate employer contributions every year. There are more than 30 million superannuation accounts in Australia and most of these are still being administered by the same organisations that are responsible for investing the money. There is still massive scope for LNK to win new business in this area once the managers realise the cost benefits from outsourcing this function that then ultimately accrues as better returns to their members. Whilst LNK will never have 100% of the Australian market, they are confident that their systems are scalable to the extent that they could presently handle every superannuation fund in the country with only a small incremental investment.
Growth beyond the Australian market has always been a well-articulated aspiration for management and in late June 2017 they announced that they had acquired 100% of UK-based Capita Asset Services for A$1,493m. This business is involved with the administration of UK based investment funds, is a top 3 registrar to listed companies in the UK, services debt assets and provides corporate and private client solutions. In short, this business is an extremely strong strategic fit with LNK’s Australian business and will provide a pathway for LNK to leverage their existing technological capabilities across new markets and new products in new geographies. This acquisition was partially through a well-received A$883m rights issue and existing debt facilities. This transaction is expected to be extremely earnings accretive with Earning Per Share (EPS) expected to improve an already impressive growth profile by more than 20% once the transaction is completed and all benefits realised. Following this transaction, we now expect LNK to grow its earnings by 14.7% over the current FY2018 and then a massive 34% in FY 2019. Whilst the Price Earnings Ratio (PER) of 20x current year earnings looks a little rich, this drops substantially to 15x next year’s earnings.
In my view, LNK still has many more growth opportunities over and above the ones that are factored into our numbers. With the super rules growing in complexity and a low return environment and the increasing member choice options keeping pressure on managers to keep fees low, it is highly likely that more and more managers will contemplate outsourcing the administration function. LNK’s forecast growth of 24% pa for the next two years is well ahead of the market average and it would be my expectation that the medium term share price appreciation will compensate you generously whilst the dividend yield remains relatively low.
So there are some ASX listed stocks to add to if you agree with my view that the AUD’s stay at 80 US cents will be limited. We have added to our exposures in USD and GBP earning companies and feel that is now where the value is in Australian equities. The AIM Global High Conviction Fund owns ALL, TWE, CYB, EML and LNK.