Investment Watch is a quarterly publication produced by Morgans that delves into key insights for equity and economic strategy.

This latest publication covers

• Economics – A brighter outlook for Australian resources
• Fixed Interest Opportunities – 2024 Additions
• Asset Allocation – A decisive turn in the global rate cutting cycle
• Equity Strategy – Reweighting ASX 20 exposures
• Resources and Energy – China monetary stimulus impact
• Travel - Demand trends still solid
• Technology - Rate cuts lend support but fully valued overall
• Telco - Still seeing better value elsewhere
• Property - Nearing the peak

It has paid off to put cash to work this year with equity markets touching all-time highs and bonds benefitting from rate cut expectations. Looking ahead, the fundamentals remain supportive. The US economy is slowing but not stalling. Employment is also slowing but job losses are still minimal, while consumer spending is boosted by falling inflation. In our view, this is not the time to play defence and we continue to expect growth assets such as equities and real assets to do well. This quarter, we look at tactical opportunities on the back of a global push for policy stimulus which include: commodities, emerging market equities, and across the Australian equity market (resources, agriculture, travel and technology).

A brighter outlook for Australian resources

There has been much discussion about the slowdown in growth in China. Last year, Chinese GDP grew by 5.2%. We think growth will slow to 4.6% in 2024, just short of the official 5.0% target. However, it is still growing much faster than the United States, Japan or any major Western European economy. China has the largest steel industry in the world. This industry produces a little over half of all the steel in the world annually.  Chinese steel production indeed peaked in May 2021 at an all-time high of 99.5 million tonnes per month, and production has moved sideways since then. Yet, this still generates a very strong demand for Australian iron ore. Our model estimate for the equilibrium price of iron ore in August 2024 was $US106.42.

The standout economy is India. India will be the strongest and the most rapidly growing economy this year. In 2023, GDP grew by 7.8% and is expected to grow 6.8% this year. However, India is not the only economy producing this kind of growth and in fact this rate of growth has been produced by other countries in the Indo Pacific.  One historian has referred to these countries as the “Indosphere”.* This group of rapidly growing countries includes Vietnam, the Philippines and Indonesia. Vietnam is expected to grow by 6.0% this year and 6.4% next year. The Philippines is expected to grow by 5.7% this year and 5.9% next year. Indonesia is expected to grow by 5.7% this year and 5.1% next year.

Morgans clients receive exclusive insights such as access to our latest Investment Watch publication. Contact us today to begin your journey with Morgans.

Most results were thereabouts against expectations which saw the sector perform broadly in line with the index (All Ords flat since 1 August vs mining services -2%). Exploration activity remains soft despite positive macro-trends, though we expect market volatility to weigh on junior miner raisings in the near term. The development pipeline is experiencing wobbles given lithium project cancellations but still has breadth and depth in gold, iron ore, gas and wind. Production was varied with strength in bulks (though weakness in iron ore price presents a risk to high-cost projects) and continued softness in battery metals (lithium and nickel). Top picks are ALQ (multi-year margin recovery in Life Sciences will be supplemented by an eventual cyclical volume recovery in Commodities) and CVL (too cheap with strong cash generation and multi-faceted growth potential).

ALS Limited (ALQ)

ALQ looks poised to benefit from margin recovery in Life Sciences as well as a cyclical volume recovery in Commodities. Timing around the latter is less certain though our analysis indicates we may not be too far away (3- 12 months). In addition, commodity prices are supportive with both gold & copper around all-time highs at US$2650/oz & US$4.50/lb respectively.

Investment view:

ALQ is the dominant global leader in geochemistry testing (~50% market share), which is highly cash generative and is little chance of being competed away for a variety of reasons. The excess capital from Commodities is used to fund capital driven earnings growth in Life Sciences.

Civmec (CVL)

CVL reported a strong FY24 with EBITDA +11% YoY and NPAT +12% YoY. Although some large projects roll off in FY25, management sounded a confident tone that it could continue to deliver revenue and earnings growth, albeit at more modest rates. Margins in FY25 will serve to benefit YoY from the re-domicile costs ($1m) and additional overheads ($2-3m) which were carried in FY24, as well as potentially conservative margin recognition in 4Q24.  The valuation is compelling at 5x FY25 EBIT and 15% FCF yield, which undervalues a business of CVL’s quality.

Investment view:

CVL is a founder-led engineering & construction business with leading margins (EBIT ~10%), high ROE (~15%), best-in-class facilities, a robust balance sheet (net cash), a history of strong cash flows (conversion >100%) and multi-faceted growth potential.

The stock is trading on attractive valuation metrics at ~5x FY25 EBIT and 11-15% FCF yield in FY25-27. This undervalues a business of CVL’s quality, however, a discount exists due to liquidity constraints.

Morgans clients receive exclusive insights such as access to the latest stock and sector coverage featured in the Month Ahead. Contact us today to begin your journey with Morgans.

Oil demand is tracking modestly ahead of expectations, while robust supply is failing to keep pace. We expect the oil market to enter a deficit supply balance during 2H 2024. The oil market may be pricing in some demand destruction, but if that does not materialise, we expect Brent oil to recover to >$80/bbl in the next 1-3 months. Forced ranking of our oil-exposed coverage at current share prices: #1 WDS, #2 KAR, #3 BPT, and #4 STO.

Woodside Energy (WDS)

The tide is certainly out in terms of investor sentiment on WDS. Despite Brent oil trading in line with our long-term forecast, WDS’ share price implies a near cycle-low oil price level. We do not see this as capable of being explained by WDS’ growth profile (comfortably funded) or risks around non-core assets such as Browse. While the share price performance has been disappointing, supported by a strong balance sheet and high margins, we see WDS investors as capable of being patient.

Investment view:

We maintain an ADD recommendation believing WDS offers attractive long-term value.

Karoon Energy (KAR)

Supported by a strong balance sheet (amassing cash), and a modest capex profile, KAR remains ideally positioned to re-rate off a recovery in oil market expectations. The issue has been the steady string of disappointing operational performances and guidance downgrades. However, combined with a new 5% dividend yield and active on-market share buybacks, we have conviction that KAR will start to turn things around and are attracted to its discounted price which we believe has significant value buffer in it.

Investment view:

Trading at a large discount to our target price, we maintain an ADD recommendation.

Beach Energy (BPT)

New management has had three attempts in 2024 of ‘clearing the decks’ and resetting a baseline for market expectations. But the numerous downgrades, combined with consistent optimistic messaging, has gradually eroded investor confidence in BPT’s ability to execute on its plans and its valuation re-rate as a result. Similar to the market’s apparent concerns, we also hold some reservations over short-term execution risks but do view BPT as trading at deep value levels.

Investment view:

We maintain an ADD rating but continue to caution that patience may be required.

Santos (STO)

Selling pressure has pushed STO’s share price modestly below our A$7.50 valuation, but this still appears within a reasonably close range to our base STO and pricing assumptions. While pleasing for shareholders, it is at odds with the discount that has appeared in STO’s ASX-listed peers and leaves us viewing its investment profile as relatively less appealing as a result. This is also demonstrated by the smaller distance to its high case scenario valuation versus larger/safer peer WDS.

Investment view:

With its investment phase progressing successfully, we maintain a HOLD rating, but a deeper selloff could present interesting value.

Morgans clients receive exclusive insights such as access to the latest stock and sector coverage featured in the Month Ahead. Contact us today to begin your journey with Morgans.