With the growth stocks’ momentum coming off the boil in the wake of FY19 results – given that investors are being asked to keep paying eye-watering earnings multiples for growth heavyweights, such as Afterpay Touch (122 times expected FY21 earnings) and WiseTech (92 times expected FY21 earnings) – the search is on for “value” stocks.
While this is fraught with danger in times of low economic growth, and particularly when earnings downgrades are common, investors are sifting the market for value. The problem, always, with trying to find out-of-favour “value” stocks is that they are trading on apparently alluring valuations for very good reasons – in other words, they are “value traps,” on either price/earnings (P/E) multiple or dividend-yield grounds.
Still, brokers report an increased willingness to pull money out of the momentum stocks — those that have had the best returns over the past year — and into stocks seen as exhibiting value. This is a stock-by-stock approach, that is being conducted in an environment where overall share market return expectations are turning negative.
According to Thomson Reuters, the market’s average P/E ratio for June 2019 earnings is 18.1 times, while the average forward P/E for FY20 earnings is 16.2 times. Investors are scouring the lists for stocks trading at a discount to these multiples, with the value-trap caveat always at the back of their minds. Always, there has to a be a credible growth “story,” too, to back-up the perceived value.
Here are 5 value candidates.
1. Whitehaven Coal (WHC, $3.33)
Market capitalisation: $3.4 billion
12-month total return: –24.9%
FY20 forward P/E: 11.9 times (Thomson Reuters), 12 times (FN Arena)
FY20 estimated dividend yield: 4.8%, 50% franked
Analysts’ consensus target price: $4.30 (Thomson Reuters), $4.12 (FN Arena)
While there may be investors who do not wish to invest in coal, the Asian market requires high-quality coal – both thermal (energy) and metallurgical (steel-making) coal – and Whitehaven’s portfolio of mines gives it exactly the product suite to tap into those opportunities: 81% of Whitehaven’s sales is thermal coal, with the remainder metallurgical. Increasing per capita electricity consumption is the main driver of higher demand, in particular the growing adoption of super-critical (SC) and ultra-supercritical (USC) coal-fired power plants, which generate electricity with less emissions.
Japan is Whitehaven’s largest customer, followed by Korea and Taiwan. India is a growing market for steelmaking coal, and while Whitehaven does supply to China, its demand growth is much more leveraged to the South-East Asian economies – the company says its “markets to watch” are Malaysia, Vietnam, the Philippines, New Caledonia (the nickel industry) and Bangladesh. Whitehaven sees its coal production growing from about 23 million tonnes in FY19 to about 50 million tonnes when “fully ramped up” by 2030. Coal prices are the main headwind in the medium term, but the stock’s weakness over the last 12 months puts it firmly into value territory.
2. Qantas (QAN, $6.40)
Market capitalisation: $9.9 billion
12-month total return: 6.2%
FY20 forward P/E: 9.8 times (Thomson Reuters), 9.8 times (FN Arena)
FY20 estimated dividend yield: 4.1% fully franked
Analysts’ consensus target price: $6.47 (Thomson Reuters), $6.35 (FN Arena)
Higher fuel costs and patchy demand hurt Qantas Airways in FY19, leading to a 17% fall in underlying profit before tax to $1.3 billion, hurt by a $614 million increase in fuel costs and $154 million hit from foreign exchange. The international division delivered underlying earnings of $285 million, down 28%, while the domestic division saw a 4% fall in underlying earnings to $1.03 billion, despite revenue from Qantas and Jetstar’s domestic operations growing by 4%. CEO Alan Joyce spoke of confidence in the outlook, based on hedging the group’s fuel supply, a focus on costs, a strong financial position and Qantas’ ability to manage its capacity. Qantas’ earnings momentum may already have turned – in which case the stock would offer good value – but not all analysts are yet convinced: the bullish case is led by Citi, which posts $6.90 as its price target.
3. Adairs (ADH, $1.74)
Market capitalisation: $289 million
12-month total return: –18.4%
FY20 forward P/E: 9.5 times (Thomson Reuters), 9.6 times (FN Arena)
FY20 estimated dividend yield: 8.6%, fully franked
Analysts’ consensus target price: $2.03 (Thomson Reuters), $2.10 (FN Arena)
Furniture and homewares retailer Adairs was hurt by a weak Australian dollar and a flat trading environment in FY19 posting a 1.3% decline in net profit to $29.6 million, despite an excellent performance from online sales, which grew by 42% per cent. The stock had a tough year, with the company cutting profit guidance twice in 2019 – in February and again in June – and reporting a deteriorating outlook for same-store sales growth at the end of May. For the year, like-for-like sales rose 7.2% – half the growth rate of 2018 – and overall revenue increased 9.7%, to $344.4 million.
ADH expects sales to rise to between $360 million–$375 million in the current year, underpinned by four to six new stores and strong online growth, while operating earnings are forecast to fall by as much as 0.9%, or in the company’s best-case scenario, rise by 6% to between $43 million–$46 million. The market likes the fact that Adairs is growing sales faster than the broader market and taking market share from both Myer and David Jones, but margins have been undermined by the weaker Australian dollar. However, the FY19 result spoke of sales growth being visible in the early part of the current financial year. That optimism has analysts prepared to bet on a small return to earnings growth in FY20, with momentum improving into FY21 – and on that basis, quite a bit of value in the stock.
4. Maca (MLD, 95.5 cents)
Market capitalisation: $256 million
12-month total return: –17.8%
FY20 forward P/E: 8.8 times (Thomson Reuters)
FY20 estimated dividend yield: 4.1% fully franked
Analysts’ consensus target price: $1.20 (Thomson Reuters)
Mining support services, construction and infrastructure contractor MACA has done a good job in recent years in diversifying itself by industry, commodity and geographically. Currently it operates in Australia (mainly Western Australia and Queensland) as well as Brazil and Cambodia. Australian mining work generates the bulk (62%) of revenue, but civil construction is increasingly important, at 21%. By commodity, gold generates most revenue, at 62%. The stock has spent quite a bit of time in purgatory, particularly on the back of MACA’s troubled open-pit gold mining contract with Australian company Beadell Resources at Tucano in Brazil, where MACA pulled out of the five-year partnership 18 months early.
Poor results in FY18 (earnings down 26%) and the December half of FY19 (down 34%) did not help, and while the reported net profit for the full-year FY19 also fell 13%, to $20.6 million, MACA’s work in hand surged by 65%, to $2.1 billion. Mining work accounts for 88% of that, with 59% in gold and 34% in coal. MACA expects FY20 revenue to rise by about 8.2%, to $720 million – from that, on Thomson Reuters’ collation, analysts expect earnings per share (EPS) to grow by 42%, from 7.6 cents a share to 10.8 cents. That prices the stock at just 8.8 times expected FY20 earnings; forecast further EPS improvement to 13 cents in FY21 gives an estimated forward P/E of 7.3 times earnings.
5. Link Administration Holdings (LNK, $5.63)
Market capitalisation: $3 billion
12-month total return: –22.8%
FY20 forward P/E: 18.2 times (Thomson Reuters), 17.9 times (FN Arena)
FY20 estimated dividend yield: 3.2% fully franked
Analysts’ consensus target price: $6.47 (Thomson Reuters), $6.71 (FN Arena)
Outsourced financial administration services group Link Administration is one of the largest providers of services to Australia’s superannuation fund administration industry, performing the essential services of fund administration, share registry and company secretarial services, as well IT services and data analytics. Link downgraded its profit guidance in May, which stripped 30% from the share price. The company was also hampered by an investigation in the United Kingdom over alleged misconduct by a client in relation to the running of a managed fund, but the resultant weakness in the price appears to have opened up good value for a business that has 80% of its revenue recurring, and which benefits from long-term growth in the super sector. Underlying earnings were actually 3% lower in FY19, but revenue growth was good, at 17%, and the company’s outlook was optimistic in terms of cash flow growth and cost reductions; a share buy-back also impressed the market. Looking out to FY21 results, the market sees LNK trading at 14 times–15 times earnings, a view that implies a cheap entry point at the current price.
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