Morgans Best Ideas: June 2022
About the author:
- Author name:
- By Andrew Tang
- Job title:
- Analyst - Equity Strategy
- Date posted:
- 02 June 2022, 9:30 AM
- Sectors Covered:
- Equity Strategy and Quant
Our best ideas are those that we think offer the highest risk-adjusted returns over a 12-month timeframe supported by a higher-than-average level of confidence. They are our most preferred sector exposures.
New additions this month: Aristocrat Leisure (ASX:ALL) and Domino’s Pizza (ASX:DMP).
Some housekeeping: We narrow down our list this month given the near-term volatility and market risk-off sentiment. Key large-cap removals include WDS and COH. While we still rate these companies highly and retain an ADD on both names, we have a slight preference for others in the sector. Rising interest rates and poor investor sentiment will continue to weigh on high PE long duration names and, as such, we remove ALX, HUB, VHT, AMS and UNI. We will look for opportunities to revisit these exposures over the next few months as sentiment returns. We also narrow our focus in agriculture and REITs removing NAM (strong performance), HCW and WPR (preference for DXS and HDN).
Change of coverage: Change of analyst coverage sees BOQ, PAN, RMS, and RED drop off the list this month.
Due to changes in analyst coverage and near-term market volatility, we narrow our best ideas list this month.
Large cap best ideas
WES possesses one of the highest quality retail portfolios in Australia with strong brands including Bunnings, Kmart and Officeworks. The company is run by a highly regarded management team and the balance sheet is healthy. While COVID-related staff shortages are proving to be a challenge, the core Bunnings division (>60% of group EBIT) remains a solid performer as consumers continue to invest in their homes. We see the pullback in the share price as a good entry point for longer term investors.
Endeavour Group (ASX:EDV)
While EDV’s Retail division has significantly benefited from lockdowns and higher at-home consumption over the past two years, its higher margin Hotels business has been negatively impacted by lockdowns and restrictions. With the Australian economy now largely reopened and we move into a ‘living with COVID’ environment, this should be positive for the Hotels outlook.
Treasury Wine Estates (ASX:TWE)
TWE owns much loved iconic wine brands, the jewel in the crown being Penfolds. We rate its management team highly. The company recently reported an impressive 1H22 result despite facing several material headwinds. The foundations are now in place for TWE to deliver strong double-digit growth from 2H22 over the next few years. Trading at a material discount to our valuation and other luxury brand owners, TWE is a key pick for us.
We expect the resilience of STO's growth profile and diversified earnings base see it best placed to outperform against a backdrop of a broader sector recovery. While pre-FEED, we see Dorado as likely to provide attractive growth for STO, while its recent acquisition increasing its stake in Darwin LNG has increased our confidence in Barossa's development. PNG growth meanwhile remains a riskier proposition, with the government adamant it will keep a larger share of economic rents while operator Exxon has significantly deferred growth plans across its global portfolio.
Macquarie Group (ASX:MQG)
We continue to like MQG’s exposure to long-term structural growth areas such as infrastructure and renewables. The company also stands to benefit from recent market volatility through its trading businesses, while the company continues to gain market share in Australian mortgages.
QBE Insurance Group (ASX:QBE)
With strong rate increases still flowing through QBE's insurance book, and further cost-out benefits to come, we expect QBE's earnings profile to improve strongly over the next few years. The stock also has a robust balance sheet and remains relatively inexpensive overall trading on ~14x FY22F PE.
ResMed Inc (ASX:RMD)
While we believe the next few quarters will likely be volatile, as Covid-related demand for ventilators continues to slow and core sleep apnoea volumes gradually lift, nothing changes our medium/longer term view that the company remains well-placed as it builds a unique, patient-centric, connected-care digital platform that addresses the main pinch points across the healthcare value chain.
TCL owns a pure play portfolio of toll road concession assets located in Melbourne, Sydney, Brisbane, and North America. This provides exposure to regional population and employment growth and urbanisation. Given very high EBITDA margins, earnings are driven by traffic growth (with recovery from Covid) and toll escalation (roughly half at CPI and the remainder fixed c.4% pa). We think TCL will continue to be attractive to investors given its market cap weighting (important for passive index tracking flows), the high quality of its assets, management team, balance sheet, and growth prospects. Watch for rapid recovery in DPS alongside traffic recovery and WestConnex acquisition prospects. A negative overhang is the contaminated soil disposal issues related to its West Gate Tunnel Project.
Aristocrat Leisure (ALL) - New Addition
ALL is a global market leader in the rapidly growing land-based gaming and mobile gaming industries. It has delivered revenue growth of 17% pa over the past five years and 80% of revenue in FY21 was recurring. We expect ALL to continue to take market share in all its product segments. Demand for its gaming machines and digital games is resilient to economic cycles. The recent underperformance of the shares may have been a function of concern about ALL’s exposure to Ukraine, although it has recently stated that 75% of its staff there have relocated to safer locations and there is no material impact on earnings. The underperformance means, however, that ALL’s 1-year forward P/E has derated to less than 20x from a high of 30x last September. With $3.3bn of currently available liquidity, ALL has significant funding capacity for growth, even after the buyback. It has a stated ambition to build a meaningful presence in the rapidly growing online real money gaming segment, which we believe may be achieved both through organic investment and inorganic acquisitions.
BHP Group (ASX:BHP)
We view BHP as relatively low risk given its superior diversification relative to its major global mining peers. The spread of BHP’s operations also supplies some defence against direct Covid-19 impact on earnings contributors. While there are more leveraged plays sensitive to a global recovery scenario, we see BHP as holding an attractive combination of upside sensitivity, balance sheet strength and resilient dividend profile.
S32 has transformed its portfolio divesting South African thermal coal and acquiring an interest in Chile copper, substantially boosting group earnings quality, as well as S32's risk and ESG profile. Unlike its peers amongst ASX-listed large-cap miners, S32 is not exposed to iron ore. Instead offering a highly diversified portfolio of base metals and metallurgical coal (with most of these metals enjoying solid price strength). We see attractive long-term value potential in S32 from de-risking of its growth portfolio, the potential for further portfolio changes, and an earnings-linked dividend policy
Of the classifieds players, we continue to see SEK as the one with the most relative upside, a view that’s based on the sustained listings growth we’ve seen over the period. The tailwinds that have driven elevated job ads (~250k currently, +35% on pcp) and updated guidance (FY22 EBITDA updated ~16% at the midpoint to A$490m-A$515m) appear to still remain in place, i.e. subdued migration, candidate scarcity and the drive for greater employee flexibility. With businesses looking to grow headcount in the coming months and job mobility at historically high levels according to the RBA, we see these favourable operating conditions driving increased reliance on SEK’s products.
For our full list of Best Ideas, including our mid-cap and small-cap key stock picks, download our full research note (Morgans clients only):
Best Ideas June 2022
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