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Three ASX stocks to buy for the long term

Shani Jayamanne makes the case for three potential homegrown winners.

If we look over to the US, growth stocks had the upper hand in 2023: The Morningstar US Growth Index outperformed the Morningstar US Value Index by more than 26 full percentage points for the year. And that outperformance has continued so far in 2024 as growth is up around 4 percentage points over value for the year to date.

Back in Australia, the story looks much the same. There are no 5 star stocks under our coverage. 17% sit in 4 star territory, but the majority sit at fairly valued or overvalued.

 

Can the growth stock rally last?

“Growth stocks as a category are now overvalued, and it has become increasingly difficult to find many undervalued opportunities left for investors,” observes Morningstar’s senior U.S. market strategist Dave Sekera. “However, there are still several stocks that continue to trade at a discount to our intrinsic valuations. As we forecast the rate of economic growth is poised to slow over the next few quarters, we prefer investing in higher-quality companies with wide economic moats.”

Our best growth stocks to buy for the long term share a few qualities:

  • They land in the growth portion of the Morningstar Style Box.
  • Companies on this list have wide Morningstar Economic Moat Ratings. This means that our analysts believe that the company can sustain their competitive advantage for at least 20 years. This is particularly important for this list, when looking for stocks to buy for the long-term.
  • They are run by management teams that make smart capital-allocation decisions, with either an exemplary or standard capital allocation rating. 
  • Many growth stocks are sitting in overvalued territory. Although not undervalued, the stocks selected are trading near Morningstar’s fair value estimates (at 20 February 2024).

 

3 Best Growth Stocks to Buy for the Long Term

The 3 most reasonably priced growth stocks with the above criteria are:

  1. Auckland International Airport AIA
  2. The Lottery Corp Ltd TLC
  3. Transurban Group TCL

 

Auckland International Airport AIA

Price/Fair Value: 0.97

Morningstar Uncertainty Rating: Medium

Morningstar Style Box: Large Growth

Morningstar Capital Allocation Rating: Exemplary

Industry: Airport & Air Services

 

Auckland Airport is the largest airport in New Zealand. We expect air travel in New Zealand to rise more than 50% over the next decade, and no other airport in the country is likely to outdo Auckland as an international hub. That combined with a favorable regulatory environment justifies a wide economic moat. Aeronautical and nonaeronautical operations each contribute about half of revenue. Retail is the biggest part of the nonaeronautical business, and relies on international passenger traffic. The property business is about half the size of retail, but has grown faster, driven by new and rent reviews. On the aeronautical side of the business, landing fees and per-passenger charges are reviewed every five years in consultation with the airlines, and have historically increased at or above inflation. After a downward reset in fiscal 2020 due to COVID-19, we expect this upward trend to resume over the long term.

Auckland enjoys high earnings margins versus other global airports, reflecting a light regulatory environment and a larger proportion of international passengers. Airlines must pay a significantly higher per-passenger fee for international travellers, and retail spending by these flyers far exceeds domestic passengers.

Auckland Airport can expand its commercial property portfolio on its enormous land bank, and retail earnings should grow as the airport expands and passenger numbers increase.

We view Auckland Airport’s Capital Allocation as Exemplary. Its weak point is high gearing, which forced it to raise equity in 2020 at dilutive prices to ensure liquidity. Lofty profit margins disappeared in the virus crisis and the large portion of revenue that is partly regulated to ensure returns match the cost of capital, didn’t prevent earnings from plummeting. We do acknowledge that COVID-19 particularly impacted the international air travel industry and few predicted its consequences back in 2019.

In contrast to its weak balance sheet, we view Auckland Airport’s investment quality as exceptional. Most of the company’s investments are completed under a regulated scheme, in which returns are set at roughly the cost of capital. But the firm’s other, nonregulated investments have added value, including commercial and industrial development in the surrounding airport precinct and minority stakes in smaller airports, such as Queenstown, New Zealand. We expect these investments to support future solid return on invested capital and the airport’s wide economic moat.

Auckland Airport’s shareholder distributions are appropriate. The company set its dividend policy so that payouts are covered by free cash flow--that is, after considering capital spending needs. Slashing distributions to zero in 2020 when earnings were curtailed was an appropriate response in our view. Distributions were reinstated in the second half of 2023, in line with the recovery in international travel, which we also think is reasonable.

 

The Lottery Corp Ltd TLC

Price/Fair Value: 1.01

Morningstar Uncertainty Rating: Low

Morningstar Style Box: Large Growth

Morningstar Capital Allocation Rating: Standard

Industry: Gambling

 

Regulation limits competition via compulsory licensing, bestowing The Lottery Corp with a near-monopoly on long-dated licences in all Australian states and territories except Western Australia. We do not expect any significant changes in regulation due to the government and community's dependence on The Lottery Corp revenue.

The Lottery Corp has just three digital-only competitors with an estimated combined market share of around 5%. None of the digital competitors have the same brand strength, with the 50-year history of The Lottery Corp's brands, physical retailers, range of games, and televised lottery draws all aiding its brand equity. We think a lack of brand recognition will prevent digital competitors from gaining sufficient market share due to their relative obscurity. The Lottery Corp enjoys a wide economic moat by virtue of its intangible assets, including this brand equity as well as regulation which limits competition via compulsory licensing. We forecast return on invested capital to remain above 30% over the next decade—comfortably exceeding the firm's 7% weighted average cost of capital.

We view digitisation of lottery products as an opportunity for The Lottery Corp, which already conducts around 38% of lottery and 14% of Keno sales online. We think the lower commission margin paid on online sales more than offsets the impact from closure of retail outlets such as newsagents. The Lottery Corp pays sales commissions to digital retailer, Jumbo Interactive and Jumbo pays an upfront licence fee and a percentage of sales in service fees. We think The Lottery Corp has the power in this relationship to renegotiate commissions lower as the dollar amount grows. The retail franchises operate under a similar agreement but command a higher margin.

 

Transurban Group TCL

Price/Fair Value: 1.05

Morningstar Uncertainty Rating: Medium

Morningstar Style Box: Large Growth

Morningstar Capital Allocation Rating: Standard

Industry: Infrastructure Operations

 

Transurban is a major toll road investor with concessions to operate 14 Australian and three North American motorways. Concessions grant the right to operate the roads and collect tolls for predetermined amounts of time. The core Australian roads are integral parts of the motorway networks in Australia's three largest cities: Melbourne, Sydney, and Brisbane. The roads benefit from strong competitive advantages, and the assets generate attractive returns on initial investment, warranting a wide economic moat rating.

This wide economic moat rating is underpinned by efficient scale and other competitive advantages in existing markets. While the firm may invest in new markets where competitive advantages are unlikely, we are comfortable with the view it will continue to make excess, albeit lower, returns in 20 years. This view is reinforced by the firm's long-weighted average concession life of around 28 years and large pipeline of attractive development opportunities in existing markets.

While Transurban's assets have strong and enduring competitive advantages, the firm only operates them under lease for a predetermined period. As such, it must continually invest in new assets to extend its existence. Processes to buy existing roads or bid on developing a new road are generally open to competition, suggesting excess returns are unlikely without a cost advantage. While returns could be strong for greenfield developments, forecasting risk is high.

In existing markets, we believe Transurban's ability to leverage existing operations give it the edge on new entrants in terms of operating costs. Additionally, it can reduce risk, and thus costs of capital, through novel funding arrangements such as subsidising new projects with increased tolls and concession extensions on existing roads, if the government agrees.

Shani Jayamanne is an investment specialist, Individual Investor, Morningstar Australia.

 

First published on the Firstlinks Newsletter. A free subscription for nabtrade clients is available here.

 

All prices and analysis at 21 February 2024.  This information has been prepared by Morningstar Australasia Pty Limited (“Morningstar”) ABN: 95 090 665 544 AFSL: 240 892. 

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About the Author
Firstlinks

Firstlinks is an investments newsletter providing content written by financial market professionals with experience in wealth management, superannuation, banking, academia and financial advice. Authors are investors and market practitioners with long careers in senior management positions. Firstlinks shares both their knowledge and their battle scars. Our community of 80,000 users discusses ideas from an informed and impartial point of view. Firstlinks was acquired by Morningstar Australasia in October 2019 to enable an expansion of its services and audience.