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Sharemarket predications abound in December. Rather than be seduced by market noise, look for high-quality companies that are trading below their true value. Think like a company owner, not a sharemarket trader and focus on the trend.
I’m moderately bullish on equities next year. Improving global growth should support a better domestic economy. Higher non-mining investment, government infrastructure spending and resource exports will help offset weaker housing investment and consumption.
I’m not convinced the Reserve Bank will hike interest rates in the second half of 2018 given persistently low wages growth and inflation. Rates on hold next year, an Australian dollar closer to US70 cents and an economy grinding a little faster will please investors.
That should mean modestly higher earnings growth and a higher aggregate valuation (Price Earnings) multiple for the market. That combination will lift share prices, particularly if rates stay lower for longer than the market expects. Gains will be patchy, but a low double-digit return from equities (capital growth and dividends) is possible in the absence of a major external shock.
This brief analysis suggests a modest increase in portfolio allocations to Australian equities in 2018. Consider trimming exposure to US equities given the magnitude of this year’s gains and focusing a little more on our market, which has lagged offshore returns.
As I said earlier, the key is finding quality, undervalued companies. Wait to buy stocks on any significant market dips in response to offshore events.
Here are three stocks that fit my criteria for 2018. I’ve broadly broken them into a blue-chip, mid-cap and small-cap. I’ve also listed others considered for this list.
Readers hoping for an unknown stock gem that will soar in 2018 will be disappointed with Telstra’s selection. But the telco giant makes the grade on valuation grounds after slumping from $6.61 in early 2015 to $3.60, a near five-year low.
The market is concerned about Telstra’s ability to fill a $3 billion earnings hole caused by the National Broadband Network (once fully rolled out); regulatory risk; intensifying competition in the mobile-phone market (thanks to TPG Telecom’s entry); and its dividend cut.
Telstra’s ability to harness cost savings is the key to a share-price re-rating. The telco should be able to plug at least half of its NBN-related earnings hole through productivity gains as it streamlines operations, and is making a good fist of productivity enhancements.
For all the negativity, Telstra still has a leading market share in all key telco segments, a significant competitive advantage via its mobile and wireless networks, good management and a strong balance sheet. An expected dividend yield around 6% is another attraction.
But do not expect huge gains from Telstra in 2018. An average valuation of $3.83, based on the consensus of 15 broking firms, suggests the stock is mildly undervalued. I expect Telstra to do better than the market expects in 2018 and benefit from investor support as it maintains the dividend. It’s not glamorous, but the telco stacks up on a reward/risk equation.
Other blue-chips considered:
Auckland International Airport (AIA:ASX): New Zealand’s key airport is superbly placed to benefit from an inbound tourism boom from Asia. The share price is well off its high, partly because of market concerns about modest top-line sales growth. Watch for a re-rating as the market looks forward to the airport’s redevelopment and step change in retail floor space in the next few years.
Coca-Cola Amatil (CCL:ASX): The former market darling has been belted by concerns about declining demand for carbonated drinks, a move away from high-sugar products, pricing pressures and diminishing brand strength. But every stock has its price. At $8.12, the market is too bearish on Coca-Cola, which still has growth options as it introduces new products and different bottle sizes, and ramps up growth in emerging markets.
The plumbing-products manufacturer has been a favourite of this columnist since it listed in April 2016 through a $919-million float at $2.50 a share. The market took a while to twig on to Reliance, which reached a 52-week high of $4.22 and now trades at $3.87.
To recap, Reliance designs, makes and supplies water-flow and control products used in plumbing and is known for SharkBite push-to-connect (PTC) fittings, an innovation used in behind-the-wall plumbing systems that is faster and easier to install than copper joining.
SharkBite sales are rising in the US as Reliance expands its presence in Home Depot and accesses Lowes’ network. The Lowes rollout was completed ahead of schedule and is progressing well.
Stronger-than-expected growth in the US, new products and penetration into other countries should underpin a continued re-rating in Reliance in 2018. Gains might be slower from here, but there’s a lot to like about one of Australia’s most innovative, globally focused manufacturers.
Reliance Worldwide Corporation
Other mid-caps considered:
Aveo Group (AOG:ASX): The retirement-village operator was smashed this year after a damning Four Corners investigation into the company’s sales tactics and resident dissatisfaction. Aveo’s brand was tarnished, but the company has taken swift action through marketing campaigns and simplified contracts to reduce the fallout. Long-term tailwinds behind Aveo – an ageing population and shortage of retirement accommodation – will only strengthen in the next few years. The market has over-reacted at the current price.
Domain Australia Holdings (DHG:ASX): The inclusion of the online property-services group, recently demerged from Fairfax Media, might surprise. As I wrote for the Switzer Super Report in November, Domain shares were likely to fall upon listing and underperform the market – a familiar pattern with spin-offs. The shares have dropped from around $3.72 on listing to $3.40. The rationale for the spin-off made sense, Domain has a valuable position in a growth market, and options to expand its range of services through the property lifecycle. The best demergers often outperform their parent after an initial period of underperformance. That will be true of Domain later in 2018.
The engineering and services provider, identified in this report in April 2016 as a turnaround idea, rallied from a 52-week low of $2.58 to $4.47, before easing to $3.90.
I like RCR’s exposure to renewable-energy projects, a booming sector as more companies, State and Local governments install solar power. RCR has won several contracts for solar-farm installations and looks superbly placed to benefit from stronger demand for renewables.
RCR’s rail, tunnel and resource projects should also benefit from a boom in State Government transport projects.
RCR is better known for its work in resources, traditional energy and infrastructure. Infrastructure (which includes the renewable projects, in addition to rail transport) constitutes almost two thirds of its revenue. Renewable projects are the key to larger share-price re-rating.
The tailwinds driving RCR’s record order book and earnings are unlikely to ease in 2018. Macquarie’s 12-month price target of $4.64 looks on the money.
RCR Tomlinson (RCR)
Other small-caps considered:
Amaysim Australia (AYS:ASX): The emerging telco has been volatile since listing, in part because of a surprise guidance downgrade soon after its July 2015 float. The $1.80 issued shares initially soared, then slumped to $1.50 and now trade at $2. Amaysim’s online business model allows it to acquire telco customers cheaply and it has more than a million of them. That customer base has strategic appeal to a larger player, such as TPG Telecom, and Amaysim can grow earnings faster as economies of scale develop. The stock suits experienced investors comfortable with higher risk.
Apollo Tourism & Leisure (ATL:ASX): The manufacturer, seller and renter of recreational vehicles has rallied from a $1 issue price at its 2016 float to $1.52. The long-term thematic of an ageing population driving higher demand for Recreational Vehicles (RVs) is compelling, as is Apollo’s potential to disrupt the market by moving to a short-term rental model, via smartphone Apps. Even after recent share-price gains, the market is lagging Apollo’s potential to expand overseas and capitalise on the boom in international visitors who seek independent driving holidays (rather than tour groups).