Three beaten up stocks set to bounce
Much has been made of the latest profiting-reporting season, which some commentators described as the “best in 20 years” due to a rebound in earnings and dividends.
I prefer focusing on companies left behind. My goal? To find stocks where the market over-reacted to weaker-than-expected earnings or overlooked good news.
Such companies were harder to find in the recently concluded December-half reporting season. About 56% of companies had higher profits, from 36% six months ago, on AMP numbers.
Remarkably, 47% of companies increased their dividend in the December half. That compares to 55% of companies cutting dividends six months ago when boards slashed or suspended the dividend at the peak of COVID-19 to preserve cash.
Better still, just over half of companies that reported beat market expectations. Only a fifth disappointed – the best result in years, as Australia’s economy roared back to life.
That’s the good news. The reality is the market priced a better reporting season into share prices at the start of 2021 when equities rallied. The market was down last week.
Rising bond yields sent a shiver through global share markets. A few months ago, inflation was an afterthought for many market participants. With so much spare capacity in a COVID-ravaged global economy, there seemed little chance of an inflation breakout.
They are now up 90 basis points in the US, and 130 basis points in Australia, on last year’s lows. These are big moves in bond yields.
Rising bond yields are bad for equity valuations. Witness the share-price falls in high-flying tech and cyclical stocks in the past few weeks. Higher bond yields are also bad for companies with lots of debt and for emerging markets, even though they signal improving economic growth.
In market terms, it’s a case of good economic news creating a bad share market result.
I don’t expect an inflation breakout this year, but wouldn’t be surprised if bond yields worldwide rose a little further (despite central bank rhetoric) as more selling routs the global bond market.
If this happens, the Australian share market could fall 5-10% in the next few months. Our market fell 1.8% last week (though it is up so far this week), so the correction could already be underway. After such strong gains to start 2021, a sell off in Australian shares is likely.
Expect any weakness to be short-lived. Any share market pullback is an opportunity to buy back in at lower prices. The S&P/ASX 200 index will comfortably finish 2021 above 7,000 points, underpinned by a fast-recovering Australian economy and record-low interest rates.
If I’m right, investors should take extra care with high-flying companies that were bid up before the profit season. They will fall hardest if bond yields keep rising. Instead, focus on higher-quality companies that were overlooked during the profit season, and offer value at the current price.
Here are three ASX 200 companies to consider:
1. Orica (ORI)
The mining explosives and chemicals company was smashed last week after foreshadowing lower earnings in its FY21 half-year announcement on May 21. Orica fell 18% on the news.
Orica said trade tensions between China and Australia were hurting demand for its services in thermal coal mining.
Also, COVID-19 remained a significant source of uncertainty for Orica, as was disrupting mining activity in emerging and some developed markets.
A rising Australian dollar has also worked against Orica and there were some unexpected arbitration and technology costs that will further weigh on half-year earnings.
To top it off, Orica announced a new CEO (Sanjeev Ghandi, an internal appointment).
The update was worse than the market expected. But Orica’s problems mostly look temporary. The global mining industry has excellent medium-term prospects as a potential “super-cycle” in commodity prices emerges, boosting exploration and production activity.
Yes, COVID-19 is a headwind for mining activity in pandemic-ravaged countries. But cases worldwide are falling and vaccines are being rolled out. There should be much pent-up demand for Orica’s services when mining activity returns to normal levels.
Furthermore, I can’t see the Australian dollar going too much higher from here (if it does, watch the Reserve Bank take action to drive it lower). The worst of the currency effects – and the one-offs with higher arbitration and technology costs – should be behind Orica.
It looks a good time to buy Orica. At $12.50, its shares are on a forecast FY22 Price Earnings (PE) multiple of about 16 times, which appeals for a company of its quality.
I’ve been wrong on Orica before, but continue to believe it offers long-term value.
Chart 1: Orica
2. Origin Energy (ORG)
As expected, the integrated energy company reported a weak result for first-half FY21. Its shares edged lower on the news, continuing a downtrend from $8.74 in early 2020 to $4.40.
Underlying profit fell 26% to $224 million for the half due to lower oil, gas and electricity prices, and faster depreciation of its retail technology systems that will soon be replaced.
In its interim result, Origin noted that COVID-19 significantly affected East Coast gas demand. Also, a milder summer (due to La Niña rainfall) subdued retail energy demand. In addition, growth in renewables put more downward pressure on electricity prices.
Origin should have a few tailwinds in 2021. Higher oil prices since November suggest the company’s Australian Pacific LNG joint venture (it owns 37.5%) will have a better second half. Stronger oil prices take a few months to flow through to contract LNG prices.
Morningstar predicts upside in Origin as its earnings recover and expects its dividend to almost double over five years. Morningstar’s fair value of $7 a share suggests Origin is materially undervalued.
Like Orica, several problems weighing on Origin are COVID-19-related and temporary rather than permanent. However, there are some longer-term challenges for Origin as lower wholesale electricity prices eventually flow into lower retail prices, as contracts are reset.
Origin’s earnings look like they have bottomed. A forecast dividend yield of about 7% in FY22 should placate investors if Origin’s earnings recovery takes longer than expected.
Origin’s exposure to volatile oil and gas prices means it has a higher risk profile. Conservative investors should stick to AGL, which also looks undervalued.
Chart 2: Origin Energy
3. Ampol (ALD)
Formerly known as Caltex Australia, the transport fuel wholesaler and convenience retailer has had a tough time on the market. Its shares are down from a 52-week high of $33.35 to $24.10.
In February, Ampol reported a 38% fall in group net after-tax profit to $212 million for full-year FY20. The full-year dividend fell 42% to 48 cents a share.
COVID-19 weighed heavily on the result. Ampol’s Australian fuel volumes fell on a year earlier, and jet fuel volumes tumbled. Convenience retail fuel volumes dropped over the year as government travel restrictions hurt fuel demand and petrol-station sales.
Still, Ampol reported a solid result in exceptionally challenging circumstances, not that one would know it by the market’s reaction.
For all the negativity, Ampol has an excellent position in wholesale and retail fuel supply in a highly competitive Australian market.
Ampol has much to gain when COVID-19 restrictions ease and life eventually returns to normal. Jet fuel demand will take a long time to recover, but Ampol should do a little better than the 13.5-14 billion litres of fuel supply it forecasts for 2021.
Moderating gains in our dollar will also help Ampol over the next 12 months. An Australian dollar that averages US79 cents in 2021 would wipe $40 million off Ampol’s earnings.
Like Origin Energy and Orica, Ampol is a quality company. It, too, has done a good job managing through COVID-19 and is well placed to recover when restrictions ease and travel resumes.
At $24.10, Ampol looks modestly undervalued. Much depends on COVID-19 containment and a recovery in travel and thus fuel demand. I’m optimistic on this front, so I like Ampol’s medium-term prospects and value offered at the current price.
Chart 3: Ampol