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One of the worst words you can use in investment circles is the ‘r’word – recession. And with recession rearing its ugly head, investors are starting at least to assess their portfolios to try to see how exposed they may be to an economic downturn.
Globally, what concerns investors is that many of the dire macro-economic issues that have been swirling for several years may be worsening, such as a Chinese slowdown, US-China trade conflict, weak European growth and the mountain of global debt. The inversion of the US yield curve last month – when short-term bond interest rates moved higher than long-term rates – which historically has tended to precede a recession, is one sign; as is the rising proportion of bonds that are being issued as negative-yield – that is, where investors are prepared to pay the issuer to look after their money, rather than expect a return. Investors appear to be, if not actively preparing for recession, certainly thinking very deeply about its likelihood.
In Australia, the latest data confirms that the nation’s economy has slowed notably, with annual gross domestic product (GDP) growth falling in the December 2018 quarter to just 2.3% — well below the Reserve Bank’s 2019 forecast of 3%.
The December quarter was the second consecutive quarter in which the economy shrank on a per-capita basis, leading to headlines that Australia had entered a “per-capita” recession for the first time in 13 years. On the more accepted definition of recession – two consecutive quarters in which GDP shrinks – Australia has not experienced recession since 1991.
Out in company-land, that is almost a semantic debate, as businesses deal with an economy that is struggling, and in which it is getting harder and harder for companies to generate growth – domestically or internationally.
The times certainly warrant a close look at an investment portfolio to assess how exposed it is to slowdown, if not actual recession.
Investors should be wary about the proportion of their exposure to cyclical stocks, those whose revenue, earnings, profit and share prices tend to be more aligned to the fortunes of the broader economy. In this category, prime examples are the resources companies, whose profits come from global industrial activity; and “consumer discretionary” stocks, which rely on consumers’ desire to spend on items they want more than they need.
Conversely, these are the kind of times that justify a larger weighting to the economy’s “defensive” stocks, which supposedly hold up better in times of economic weakness when consumers are tightening their belts. For example, healthcare, utilities and “consumer staples” – the boring stuff that people buy week-in, week-out – are usually thought of as the defensive sectors, as are banks and real estate investment trusts (REITs).
Examples of stocks usually considered defensive are Sydney Airport, Transurban, Telstra, Cochlear, Amcor, CSL, Wesfarmers and ASX Limited. However, defensive performance is not always guaranteed, because stocks can always be affected by company-specific factors.
An even-better proposition is a “recession-proof” stock. But is this a mythical status? Let’s take a look at some candidates, led by funeral providers InvoCare and Propel Funeral Partners. This pair ought to qualify as recession-proof stocks in that their business depends on the most guaranteed thing in the world – people dying. That is a business driver that does not depend on the economy.
But even death can fluctuate.
Mild Australian winters, and in particular, lower numbers of people contracting bad cases of influenza, actually saw the nation’s death rate fall in both 2017 and 2018: the number of deaths fell by 3.1% in 2018. As InvoCare pointed out in February, in its full-year 2018 result, two consecutive years of reduced deaths is rare – it last occurred in 1990/1991. However, InvoCare expects this rate to return to “positive longer-term trends” in 2019. It says the long-term fundamentals for the funeral industry are strong, driven by Australia’s ageing population: from about 160,000 deaths in 2018, InvoCare expects about 240,000 deaths a year by 2034.
Market capitalisation: $1.6 billion
FY19 (calendar-year) estimated yield: 3%, fully franked
Three-year total return: 8.3% a year
Analysts’ consensus target price: $13.38 (Thomson Reuters), $13.22 (FN Arena)
InvoCare is the largest operator of private cemeteries and crematoriums in Australia, with a market share in Australia of about one-third: operates under several brands – including White Lady Funerals – in Australia and New Zealand, and has also expanded into Singapore. That’s the good news. But even with a guaranteed supply of the need for your product or service, there is still the fact that running a business can be tricky.
InvoCare has been highly acquisitive in recent years, and is also investing heavily in upgrading and refurbishing its locations, under its four-year ‘Protect & Grow 2020’ program, which it estimates will cost a total of $200 million – this is placing strain on the business. Despite revenue growth of 1.4% in 2018, expenses growth outpaced this, up 3.3% to $361.2 3.3% million; the upshot was after-tax operating earnings sliding by 22.1%, to $49.5 million, and reported net profit slumping by 57.7%, to $41.2 million.
This was, however, better than expected, and in fact brought about a share price surge, given that InvoCare had been heavily short-sold. The company has taken advantage of the surge from levels around $10.60 to about $14.70, and has announced a $65 million capital raising to strengthen its balance sheet.
Market capitalisation: $293 million
FY19 estimated yield: 3.8%, fully franked
Three-year total return: N/A
Analysts’ consensus target price: $3.54 (Thomson Reuters)
The smaller Propel Funeral Partners has become the second largest participant in the Australian and New Zealand funerals market behind InvoCare, having expanded significantly since listing on the ASX in November 2017.
In the 12 months to 30 June 2018, Propel reported better-than expected results, with revenue rising by 76%, to $80.9 million, and pro forma net profit up 128% to $12.5 million. The company’s funeral volumes rose by 67% to 10,111, with average revenue per funeral increasing by 5.5% to $5,508.
Propel followed that with a December 2018 half-year revenue lift of 20.9%, to $47.1 million, with net profit up 1.3%, to $6.4 million. Average revenue per funeral increased 2.2%, to $5,549. From 80 locations in December 2017, the footprint increased to 109 locations. The maiden interim dividend was 5.7 cents a share, fully franked.
The same caveats apply as to InvoCare: management must be disciplined with what it pays for acquisitions, and in maintaining a healthy and flexible balance sheet. As Propel also waits for “death volume growth to accelerate,” it could be seen as a much better-value death prospect than InvoCare.
Then there are the companies that are not so much resistant to recession – they arguably thrive in them.
Market capitalisation: $1.1 billion
FY19 estimated yield: 3.3%, fully franked
Three-year total return: 34.1% a year
Analysts’ consensus target price: $23.47 (Thomson Reuters), $23.55 (FN Arena)
Australia’s largest listed debt buyer, Credit Corp’s business is to buy banks' bad loans, and proceed to collect them. It does this in Australia and more recently, the US, and also offers loans. After it buys debt ledgers, it arranges repayment plans to recover these, working more closely with the customers than the banks could. The company has developed extensive database and analytic capabilities to do this sensitively.
Tough economic times, and the banks’ increased willingness to sell debt books to someone more specialised and with greater time and incentive to recover them, are the main business drivers for Credit Corp. Analysts believe its US expansion has a lot of potential: just this morning, Credit Corp launched a $100 million institutional equity placement, to accelerate expansion plans into North America.
CCP has been an excellent performer on the stock exchange for a long time, and seems capable of double-digit earnings growth again this year – with a worsening economic situation a potential boost.
Market capitalisation: $178 million
FY19 estimated yield: 6.6%, fully franked
Three-year total return: 16.4% a year
Analysts’ consensus target price: $1.60 (Thomson Reuters), $1.34 (FN Arena)
Debt collector Collection House has bought three new debt portfolios in the last six months, including telco receivables management firm ACM: CCH bought ACM’s entire purchased debt book, with a face value of more than $400 million, for just $40.3 million. ACM was found by the Federal Court of Australia in 2018 to have engaged in misleading or deceptive conduct, harassment and coercion, and unconscionable conduct towards vulnerable consumers. It’s an interesting expansion for CCH, which says it will be able to use its edge – technology and more sensitive communications to consumers – to manage these receivables better.
Business is not exactly bounding ahead for CCH, which brought out quite flat results for the half-year ending December 2018: revenue was up 4%, to $66 million, and net profit rose 3%, to $8.5 million. The company’s FY19 EPS guidance of 19.2 cents–19.5 cents a share is not much higher than FY18’s 19.2 cents: analysts are banking on the company bettering that. In the meantime, CLH offers, on estimated dividends, a highly attractive yield.
Market capitalisation: $138 million
FY19 estimated yield: 6.5%, fully franked
Three-year total return: 13.8% a year
Analysts’ consensus target price: $2.56 (Thomson Reuters)
Pioneer Credit specialises in buying retail debt portfolios, which are generally more than 180 days overdue, and working with the indebted customers to bring their payments under control. It also offers personal loans. As debts can be expected to mount in a recession, its bespoke approach to “servicing” (that is, collecting) debts that have been put in the too-hard basket by the companies that hold them can also be expected to be more in demand.
Pioneer has been a market darling over the past three years, but that status has been heavily threatened in the last six months by a qualified audit review, an unexpected profit fall and a battle with the corporate regulator ASIC, its auditor (PwC) and the Australian Securities Exchange over its methodology of applying “fair value” to its debt portfolio assets instead of amortised cost, which is used by comparable companies around the world.
Analysts see the share price recovering, and Pioneer is an attractive yield play on forecast dividends, but PNC is yet another example of a company having a business model that should thrive in worsening economic times, but this general proposition being hostage to company-specific factors.
Market capitalisation: $129 million
FY18 historical yield (no estimates available): 6.8%, fully franked
Three-year total return: 5.5% a year
Analysts’ consensus target price: N/A
FSA Group – which operates under the Fox Symes brand – has a market niche that should definitely bring it to investor attention if Australia enters a recession. FSA’s core business is arranging Part IX Debt Agreements between clients and lenders to settle debts or to freeze repayments until they recover financially secure. It is a process very similar to insolvency, for low-income earners.
Debt agreements are binding contracts to repay an agreed amount to creditors over a certain period, while debt consolidation merges multiple debts into one facility. With consumer debt levels at a record high, FSA should be able to expect increased demand – especially if interest rates rise.
FSA also has a lending division specialising in sub-prime home loans and personal loans, usually for the purposes of debt consolidation. Its loan book is backed by Westpac.
As an alternative to bankruptcy, debt agreements have surged in popularity over the last decade, growing at a compound annual growth rate of 7.5% since 2004 (14,000 agreements were signed last year). Some investors may see FSA as having regulatory risk, given that the government has recently changed bankruptcy laws, to clamp down on what it describes as “unscrupulous practices by a small minority of debt agreement administrators” – and a change of government may see this clampdown harden – but the company is a strong advocate for its range of services, which it can argue allow people with genuine financial difficulties a better way forward than the alternative.