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Rudi’s View: MNF, REA Group & Afterpay Touch

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Sep 27 2019

In this week's Weekly Insights (this is Part Two):

-Market Rotations Are Not The Key Message
-No Weekly Insights For Next Two Weeks
-Conviction Calls
-Is Everybody Into iSignthis?
-Rudi On Tour

[non-highlighted items are in Part One, published on the website on Thursday]

Conviction Calls

By Rudi Filapek-Vandyck, Editor

Morningstar has lined up the biggest casualties from the August reporting season in Australia. The underlying attempt is to identify which stocks have undershot too far to the downside, and thus represent excellent value for investors prepared to sit out the remainder of the bad news cycle, as well as those stocks that have overshot to the upside, and look poised for a serious correction to the downside.

On Morningstar's assessment, the ten stocks that look too cheaply priced post reporting season are CYBG ((CYB)), Iluka Resources ((ILU)), Adelaide Brighton ((ABC)), oOh!media ((OML)), Pact Group ((PGH)), Cimic Group (CIM)), Boral ((BLD)), InvoCare ((IVC)) and Viva Energy Group ((VEA)).

Those outperformers that might be poised to turn into post-season casualties are Afterpay Touch ((APT)), Independence Group ((IGO)), Vocus Group ((VOC)), JB Hi-Fi ((JBH)), WiseTech Global ((WTC)), Downer EDI ((DOW)), Qantas Airways ((QAN)), ALS ltd* ((ALQ)), Credit Corp Group ((CCP)), Orica ((ORI)), Treasury Wine Estates ((TWE)), Spark New Zealand ((SPK)) and Flight Centre ((FLT)).

*[ALS ltd releases its official earnings report on Monday.]

Investors should note Morningstar has a stringent valuation-oriented system for ranking stocks which is solely based on what valuation the in-house analyst calculates for a given stock. This calculation can diverge significantly from modeling done elsewhere.

For example, Morningstar recently initiated coverage on Afterpay Touch with a fair value calculation of $22.


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In similar fashion, and following on from its update on the list of Conviction Buys, stockbroker Morgans has put together three selections of stocks that come with a clear negative assessment. Morgans has been one of the local experts who has been warning about bloated valuations for a while now, and that theme continues to dominate the stockbroker's preferences post August.

Stock that should be sold, according to Morgans, include Costa Group ((CGC)), Flight Centre, Orica, Magellan Financial ((MFG)), Insurance Australia Group ((IAG)) and Paradigm Biopharma ((PAR)).

Stocks that are best avoided ("no need to be there") include Coles ((COL)), Newcrest Mining ((NCM)), Nufarm ((NUF)), Graincorp ((GNC)), Blackmores ((BKL)) and Bega Cheese ((BGA)).

Stocks that look too expensive, with the recommendation that investors should trim their holding, include Spark Infrastructure ((SKI)), AGL Energy ((AGL)), ASX ((ASX)), REA Group ((REA)), Carsales ((CAR)), Domain Group ((DHG)), Fortescue Metals ((FMG)), Coca-Cola Amatil ((CCA)) and Freedom Foods ((FNP)).

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Equity market strategists at Macquarie report they maintain a defensive bias in their Model Porfolio given the combination of high valuations and downside risks. Macquarie suggests even if we were to witness a sustainable resolution to the US-China trade war, equity valuations have little room to rise further while bond yields could rise materially.

The latter would likely trigger a correction in high PE multiples, even with growth prospects improving.

As a comparison, Macquarie's Model Portfolio has a 39% weight towards Defensives while the market is probably about 30% Defensive, on the strategists' calculations. Without a broad cyclical recovery, suggests Macquarie, a sustainable recovery in bond yields (bonds selling off which pushes up yields) does not look on the cards.

As the local trend in earnings growth and estimates continues to deteriorate, Macquarie does not find the Australian share market attractive.

In simple sector terms, Macquarie's Model Portfolio is Overweight materials (James Hardie ((JHX)), Amcor ((AMC)), Orora ((ORA)), communications (telcos and media) and real estate, and Underweight financials, resources, and technology.

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Stockbroker EL&C Baillieu equally lined up its Top Stock Picks post underwhelming August reporting season among ASX-listed mid and small caps: Adairs ((ADH)), Ardent Leisure Group ((ALG)), Bapcor ((BAP)), EQT Holdings ((EQT)), Hansen Technologies ((HSN)), Monadelphous Group ((MND)), MNF Group ((MNF)), Steadfast Group ((SDF)) and Village Roadshow ((VRL)).

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Patersons Securities also showcases its stockpicking capabilities through a selection of Best Investment Ideas, but instead of publishing a select list of a handful, or maybe a dozen, Conviction Calls the WA stockbroker lines up its best ideas across the main sectors and categories that make up the Australian share market.

Hence why the Patersons' list of Best Investment Ideas takes up a bit more space:

First up Cyclicals

Best Ideas among Resources: BHP Group ((BHP)), Alumina ltd, OZ Minerals ((OZL)), Iluka Resources, Regis Resources ((RRL))

In Oil & Gas: Woodside Petroleum ((WPL)), Origin Energy ((ORG))

Banks: National Australia Bank ((NAB))

Financials: Macquarie Group ((MQG))

Building Materials: Boral, Reliance Worldwide ((RWC))

Next come the Sensitives

Industrials: Brambles ((BXB)), Cleanaway Waste Management ((CWY))

Infrastructure: Transurban ((TCL)), Atlas Arteria ((ALX))

Info Tech: REA Group, NextDC ((NXT))

Utilities: AGL Energy ((AGL))

Communication Services: Nine Entertainment ((NEC)), Over the Wire Holdings ((OTW)), MNF Group

Third come the Defensives

Healthcare: CSL ((CSL)), Sonic Healthcare ((SHL)), Ansell ((ANN))

Wagering & Gaming: Aristocrat Leisure ((ALL)), Tabcorp Holdings ((TAH))

Consumer Staples: Treasury Wine Estates

And finally Listed Property

AREITs: Stockland ((SGP)), Abacus Property Group ((ABP))

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Goldman Sachs has decided to throw overboard the limitations of sticking with Price-Earnings (PE) ratios for accurately valuing Afterpay Touch, this week upgrading the stock to Buy, while at the same time adding the stock to its Conviction Buy list.

What might be in particular eye-catching is the fact analysts Ashwini Chandra and Grace Fulton raised their price target to $42.90, well above FNArena's consensus target of $33.51 derived from Citi, Ord Minnett and Morgans.

Goldman Sachs is essentially arguing investors should focus on the value creation that comes from improving quality as the network effect and entrance into new geographical markets accelerates in the years ahead. While the company needs to ramp up spending (both opex and capex), the analysts believe an "increase of use" of the Afterpay Touch service will ignite strong operating leverage, which should drive the bottom line, and the share price, substantially higher.

The broker's so-called upside case scenario delivers a valuation of $38.65 for the shares ($30.05 for the base case) but the analysts also add an M&A premium to push it to $42.90.

On Thursday, the day after the AUSTRAC related update, Bell Potter followed up with a price target increase to $41.61 from $38.41.

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)  

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ABC ABP ADH AGL ALG ALL ALQ ALX AMC ANN APT ASX BAP BGA BHP BKL BLD BXB CAR CCA CCP CGC COL CSL CWY DHG DOW EQT FLT FMG FNP GNC HSN IAG IGO ILU IVC JBH JHX MFG MND MNF MQG NAB NCM NEC NUF NXT OML ORA ORG ORI OTW OZL PAR PGH QAN REA RRL RWC SDF SGP SHL SKI SPK TAH TCL TWE VEA VOC VRL WPL WTC