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Like many of you, I have been absolutely amazed by the strength of the US stock market. Day after day, a new record high. Who could possibly have imagined in mid-March when COVID-19 doom and despair was rampant that the markets would fully recover, trigger the fastest bull market in history, and within six months, set new record highs for the Dow Jones, S&P 500 and the NASDAQ 100?
That was the story until last Thursday in the US. A couple of days of nerves, almost like a “blow-off” top, has brought this to a halt.
I have been out of the Aussie share market for a few months now, feeling that the recovery was way overdone relative to the improvement in the economy, that the 6000 level (as it did on the way up originally) would prove to be a big hurdle, and that there would invariably be another dip down. While the Aussie market has been a laggard (buffeted in part by the stronger Aussie dollar), it has still remained pretty firm and has been nudging higher.
Now we may be seeing the start of a dip, as one thing’s for sure, we still take our lead from the US. This may be the opportunity. So it got me thinking – what are the stocks I really want to buy if we finally get a decent dip?
But before nominating the 5 stocks I want to buy, let me tell you about the stocks that I don’t want to buy.
Retail stocks, travel stocks and most IT stocks are off the agenda. The former, which include the likes of JB Hi-Fi, Harvey Norman, Nick Scali, Wesfarmers and even the supermarket giants Woolworths, Metcash and Coles, have done fabulously well because there has been so much money splashing around. At the end of September when Jobkeeper and Jobseeker start to wind down, super withdrawals dwindle away and social security recipients aren’t receiving “one-off” payments, it is going to be much tougher being a discretionary retailer. The supermarkets will also feel the pain.
On the travel side, so much of the “recovery” is already priced into these stocks that they are starting to look like “buy the rumour, sell the fact” candidates. A more bearish scenario is that the recovery and production of a vaccine takes longer.
With IT stocks, we will follow the lead from the USA. This applies to sector rotations, and because big cap IT has done so well in the USA (with good reason, because there has been a massive shift in consumer behaviour to online and cloud), the chances are increasing that a sector rotation out of IT is starting to happen. If that’s how it plays out, our IT stocks will also get hit.
So they’re the ones I won’t go near. Now here are the 5 stocks I will consider:
Analysts’ Consensus Target Price: $1.61
Last Price: $1.63
A week ago, it would have been unthinkable to include AMP in this list. But this has changed because of the decision by new AMP Chair Debra Hazelton to finally put AMP on the block and break it up. The sum of the pieces is worth more than the whole.
You can read more about my thoughts on AMP in my 'With AMP's break up inevitable, what's it worth? My ‘sum of the pieces’ valuation is as follows:
All up, a low case of $1.46 per share and a high case of $1.90 per share. And that’s not counting NZ Wealth Management or Australian Wealth Management, less of course some transaction costs.
A low risk buy.
Analysts’ Consensus Target Price: $18.15
Last Price: $16.70
I wrote about A2 Milk last October and again on 24 August, see Is A2 Milk still a buy? The market hasn’t agreed with me since my last tome and the stock has continued to drift lower. Insider selling, plus ongoing unease about the Australian/Chinese relationship, have acted as headwinds. On Friday, the stock closed at $16.70.
The chart below encapsulates why I like the company.
For FY21, the Company says: “it anticipates strong revenue growth supported by our continued investment in marketing and organisational capability”. It didn’t provide guidance but said that “it expects the EBITDA margin to be in the order of 30% to 31%” (FY20 was 31.7%).
For a company that has been growing at over 30% pa, a multiple of 29.5 forecast FY21 earnings (and 25.8 times forecast FY22 earnings) is not demanding. It has a strong balance sheet, and while there is “China” risk, it proudly says that it is a New Zealand company.
Further, its Chinese sales are increasingly being made in ‘mother and baby stores’ which has materially reduced the dependence on daigou (including international students and visitors) for sales. New market opportunities (the USA and South Korea) are potential upsides.
Analysts’ Consensus Target Price: $309.68
Last Price: $279.05
Another stock that I seem to be ‘out of sync’ with the market on is CSL. Despite reporting well, it is battling two headwinds – a stronger Aussie dollar and concerns that its collection of blood plasma may be disrupted.
I like CSL because:
Analysts’ Consensus Target Price: $13.96
Last Price: $12.21
I wrote about Lendlease in early July. I concluded (with the stock then trading at $12.70) that: “My sense is that there is ‘no hurry’ to buy Lendlease, as there is still considerable uncertainty as to the impacts of COVID-19. Also, I expect more of a market correction, so I am prepared to wait. Buy in the next market down-turn, this stock will be on my radar. Ord Minnett summarises it well with: “the potential rewards are high for those willing to go the distance”.
Lendlease describes its strategy as: “Employ our placemaking expertise and integrated business model in global gateway cities to deliver urbanisation projects and investments that generate social, environmental and economic value”. It operates through three segments – development, construction and investment. Its business model is to integrate these activities, such that more than one segment is engaged in a single project. It focuses on development of inner city mixed used developments, apartments and communities in gateway cities.
A key driver behind its strategy is urbanisation. There are other tailwinds as well – global infrastructure spending, an ageing population, and sustainability – but it is the urbanization theme and gateway cities that stands out.
It is targeting around 40% to 50% of EBITDA from the development, 10% to 20% from construction and 35% to 45% from the investment (funds management) segment.
According to FN Arena, the consensus target price is $13.96, about 14.3% higher than Friday’s closing price. There are 4 buy recommendations and 1 neutral recommendation.
Analysts’ Consensus Target Price: $77.25
Last Price: $94.78
A New Zealand company by origin, Xero is the leader in cloud accounting software in Australasia. Talk to any small business owner or their accountant, the chances are that they will sing the praises of Xero. It went to the cloud first and left established competitors, including MYOB and global player Intuit (QuickBooks), in its wake. With 914,000 subscribers in Australia (up 26% on the previous year), it is now the largest player.
It has also been expanding offshore, with 613,000 subscribers in the UK and 241,000 in North America. Overall, it grew subscribers in FY20 by 467,000 to 2.285m.
In the year to 31 March 2020, revenue grew by 30% (29% in constant currency) to NZ$718.2m, ARPU (average revenue per user per month) was up 2% to NZ$29.93 and EBITDA was NZ$64.6m higher at NZ$137.7m. Somewhat surprisingly for an IT “high flyer”, Xero actually made a profit, recording a maiden contribution NZ$4.8m.
The things I like about Xero are that its core product, accounting software, is incredibly sticky – typically accountants (and their clients) do not like change and churn is relatively low. It is cloud based which makes the business very scalable. You might be forgiven for thinking that this wouldn’t be much of a competitive advantage in 2020, yet remarkably, 80% of the accounting software in English speaking markets outside Australasia doesn’t sit in the cloud.
Finally, Xero has a great history of innovation and it is using this to drive its small business platform. This is the provision of services in addition to accounting such as bill paying, e-invoicing, access to capital, data leveraging applications etc. Ultimately, Xero is trying to build an eco-system around the accounting software that allows it to grow ARPU.
Xero’s challenge is to keep growing customers and revenue, and as it saturates the Australasian market, it has to head offshore. Because it is “priced for perfection”, expectations are high, so metrics such as LTV (lifetime customer value) and CAC (cost of acquisition), and the ratio LTV/CAC, become pretty critical (what is the value of a customer, and how much will it cost to acquire). Another key metric is the ARPU – and again, the trend is critical.
If you are a fast-growing company, you have to keep growing. The growth doesn’t have to be profitable in the short term but it does have to be profitable in the long term, so this is why it comes back to key metrics such as the LTV/CAC ratio. The net contribution or margin also needs to be heading in the right direction.
So far, Xero is ticking all the boxes on these fronts.
The question then for investors is “the price”, and on that front guidance from the broker analysts is important. Their consensus target price is $77.25, 18.5% lower than Friday’s close. Range is low of $58.50 from UBS to a high of $100 from Morgan Stanley.
I said at the outset that IT stocks were “off the agenda”, but I am going to make Xero the exception. The low to mid-eighties is where I am targeting.