Brokers Update Stock Preferences

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By Greg Peel

Credit Suisse economists forecast global economic growth of 3.3% in 2014 assisted by generally accommodative monetary policy. The Bank of England is expected to be the first major central bank to raise its cash rate, in the March quarter 2015, while the US Federal Reserve will follow in the December quarter 2015, the broker assumes.

Credit Suisse’s global equity strategists remain bullish, seeing the US S&P 500 at 1960 by year-end and being most bullish on continental European markets. Asian markets should also see double-digit percentage gains from their low PE bases despite the headwind of slowing Chinese growth.

Despite macroeconomic (top-down) headwinds, the Australian market rallied in the March quarter. Credit Suisse identifies several microeconomic (bottom-up) factors which should drive local stock prices higher this year including rising cash flow, solid distribution growth and the world’s highest dividend yield. The ASX 200 is on track to meet the analysts’ end-2014 target of 5600 and 9% total shareholder return (price + dividends).

Credit Suisse has recently added Flight Centre ((FLT)) to its list of Long Ideas to replace a departing (presumably) David Jones ((DJS)). Already in the Long Ideas portfolio are Rio Tinto ((RIO)), National Bank ((NAB)), Telstra ((TLS)), Fortescue Metals ((FMG)), QBE Insurance ((QBE)), Sonic Healthcare ((SHL)), Mirvac ((MGR)), Caltex ((CTX)), Seek ((SEK)), Fairfax Media ((FXJ)) and CSR ((CSR)).

The broker has added Ramsay Healthcare ((RHC)) to its Short Ideas portfolio after a solid run up and removed Crown Resorts ((CWN)). Already in the Short Ideas portfolio are Santos ((STO)), Bank of Queensland ((BOQ)), ASX ((ASX)), Toll Holdings ((TOL)) and Metcash ((MTS)).

Morgans notes the ASX 200 was trading on a 15.2x PE multiple of FY15 consensus earnings last week which is about 10% above the ten-year average. But Morgans believes that multiple can regress to the average not because of a fall in price (P) but because of a rise in earnings (E). PEs typically run above trend on earnings expectation which then has to come to pass, and Morgans is forecasting that an earnings catch-up will affect a 9% rise in the ASX 200 to the end of 2014.

The spanner in the works may nevertheless be Wall Street. Economic fundamentals are highly supportive for equities in both the US and Australia but in light of the recent sell-off in overpriced US stocks (mostly in the Nasdaq), Morgans acknowledges the US markets look stretched and running on low momentum. Before a backdrop of Fed tapering/interest rate rise uncertainty, Morgans suggests a weak US GDP result for the March quarter, due later this month, could be the trigger for a 5-10% correction.

This would set Wall Street up perfectly for a typical “Sell in May”, but Morgans would see such a correction as a buying opportunity.

Morgans has rejigged its portfolio of High Conviction stocks. For the larger caps, this month sees the addition of Suncorp ((SUN)), Brambles ((BXB)), Stockland ((SGP)) and Oil Search ((OSH)) at the expense of Harvey Norman ((HVN)). Remaining in the portfolio are Crown Resorts, Flight Centre, Seek, Sydney Airport ((SYD)), and Transurban ((TCL)).

For smaller caps, this month sees the addition of Select Harvests ((SHV)) at the expense of GI Dynamics ((GID)). Remaining in the small cap portfolio are Domino’s Pizza ((DMP)), Pact Group ((PGH)) and Sundance Energy ((SEA)).

Morgans is not presently keen on gaming stocks Tabcorp ((TAH)) and Tatts ((TTS)), mining service stocks Leighton Holdings ((LEI)), Monadelphous ((MND)) and UGL ((UGL)), airlines Qantas ((QAN)) and Virgin ((VAH)), small online stocks Wotif ((WTF)) and Webjet ((WEB)), steel stocks Bluescope ((BSL)) and Arrium ((ARI)), food and beverage stocks Treasury Wine Estate ((TWE)) and Goodman Fielder ((GFF)) and gold stocks in general.

There are also higher quality names Morgans recommends skimming some profits off for redeployment elsewhere, including Amcor ((AMC)), DUET ((DUE)), TPG Telecom ((TPM)) and iiNet ((IIN)).

Morgan Stanley is also suggesting a rotation out of strong outperformers and into value names is prudent given the wide gap between expensive and cheap stocks. The broker has taken profits on Seek and eased weighting in Navitas ((NVT)), REA Group ((REA)) and Magellan Financial ((MFG)). Stockland ((SGP)) is removed from the model portfolio, as is Perpetual ((PPT)).

On the other side of the ledger, Morgan Stanley has added Automotive Holdings ((AHE)) and Bluescope Steel and increased weighting in Insurance Australia Group ((IAG)) and WorleyParsons ((WOR)).

BA-Merrill Lynch’s equity strategists have reallocated their model portfolio, noting a bottom-up improvement in return on invested capital and industry structure and a top-down preference for US over domestic earnings. The strategists do not see a compelling reason to be overweight resources and prefer reasonably priced growth to yield.

Merrills runs an extensive, market-wide model portfolio but recent changes include the addition of Bluescope Steel and Amcor to replace Aristocrat, which has run hard, and 21^st Century Fox ((FOX)), which is about to be delisted. In comes Sonic to replace the outperforming Ramsay and Transurban to replace a fully valued Wesfarmers ((WES)). BHP Billiton ((BHP)) and Iluka Resources ((ILU)) are preferred over Rio Tinto ((RIO)).

Merrills’ equity analysts also like BHP. Note that a broker’s equity strategists tend to take the top-down approach while analysts take a bottom-up approach and the two groups rarely socialise. Merrills’ analysts organise themselves between five “super sectors” of consumer, basic materials, interest rate sensitive, resources (including energy) and transport/utilities.

Aside from BHP, the analysts also like Brambles, Downer EDI ((DOW)), REA Group and Westfield Group ((WDC)).

Citi notes Australia’s more cyclical industrial stocks traded at a discount to defensive stocks for a couple of years but have rebounded over the past 18 months to leave some of the value once evident in these sectors now diminished. Lagging in the rebound have been mining, mining services and chemical sectors as well as small cap stocks in general.

Citi is not surprised by the small cap lag given lower interest rates have favoured Australian stocks with offshore earnings while smaller companies are more leveraged to the domestic economy. An improving Australian GDP over the next few years should thus offer scope for the Small Industrials to outperform.

Having identified those small caps trading at moderate, mid-cycle PEs and offering cyclical and/or turnaround stories, Citi prefers exposure to GWA Group ((GWA)), M2 Telecom ((MTU)), GUD Holdings ((GUD)) and McMillan Shakespeare ((MMS)) while seeing considerable challenges still ahead for Billabong ((BBG)), Ten Network ((TEN)) and Goodman Fielder.

Not only have Australian small caps underperformed, notes Goldman Sachs, Australia is the only market in the world without a small cap premium. Since 2004, small caps have outperformed large caps globally by an average of 60% while Australia's small caps have underperformed by 45%. Goldman believes the worst of the local small cap headwinds have now abated, given improving domestic demand and a weaker Aussie (the broker is forecasting US80c in 12 months).

Goldman’s picks of the small caps are Austbrokers ((AUB)), Blackmores ((BKL)), Cardno ((CDD)), Drillsearch Energy ((DLS)), Dick Smith Holdings ((DSH)), FlexiGroup ((FXL)), Kathmandu ((KMD)), SAI Global ((SAI)), SFG Australia ((SFW)), Skilled Group ((SKE)) and Super Retail ((SUL)).
 

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