Insights

At her first Board meeting, Michele Bullock stuck to the script. Against the backdrop of a weak AUD and upward pressure on benchmark bond yields - making the battle against inflation more challenging, Governor Bullock decided to leave the cash rate steady at 4.10%, preferring to let the 4 percentage points of rate increases since May 2022 play its role in dampening inflation.

Last month’s CPI report (5.2%) was broadly in line with consensus, with a further easing in annual core inflation (5.6%), which would have comforted the board.

Meanwhile the Australian consumer appears to have run out of steam, Retail sales for August were up just 0.2% month-on-month (m/m) which was slightly below consensus expectations of +0.3%. Compared with August 2022, retail sales were up 1.5% year-on-year, which was below the rate of inflation (5.2%), meaning retail turnover was down in real terms.

So where to from here? Ahead of the announcement, the swap market had predicted one further 25bps rate rise by February 2024 and moving to rate cuts in 2H 2024. With core inflation (5.6%) still well ahead of Bank’s forecast of 4% by year-end, we do not expect today's decision to alter this outlook.

Our economist, Michael Knox, maintains the view that the RBA will need to track the US Federal Reserve given persistent underlying services inflation and the Australian inflation rate remains stubbornly higher than the US.

He expects the RBA to lift the cash rate three more times to 4.85% and remain at this level for much longer than the market expects - he anticipates the first rate cut in late 2024.

“We believe that the RBA will encounter the same problem in the Australian economy that the Fed is encountering in the US economy. Even though goods inflation is falling, wage inflation is beginning and will continue to rise. This means that falling inflation in goods will collide on the way down with services inflation coming up. The result in the US economy seems to be that core inflation first declines and then gets stuck at around 5%. We think it’s likely that Australia is going to encounter the same problem after a short lag to the US. Hence, we believe that further increases in the Australian cash rate will be necessary. We hold to our target that the Australian cash rate will continue to rise to a final level of 4.85%.” Economic Strategy: Rates to 4.85%, July 2023.

What does this mean for the Australian economy and markets?

Lags in the transmission of monetary policy through the economy mean that the full effects of the policy tightening over the preceding year are only now starting to show.

There remains considerable uncertainty about the resilience of household consumption and that the squeeze on many households’ finances could result in consumption slowing more sharply than implied by current forecasts. Higher interest rates could also be expected to encourage households to save more, which would affect consumption.

In our Q4 Asset Allocation update (Morgans Clients Only), we moved to underweight on Australian equities as we see ongoing volatility from high interest rates and a moderating pace of economic growth challenge returns in the short term. US fiscal policy is contracting, hitting commodities prices and curbing economic growth, further prolonged weakness in the AUD will continue to drive up cost pressure.

Given Australia’s economic sensitivity to falling commodity prices, investors must tread carefully over the next 3-6 months. As tailwinds from commodity prices fade, we think above-average earnings growth for the market will be harder to come by. Accordingly, we prefer a targeted portfolio approach, tilting what we believe are the best relative opportunities and the best risk/return profile e.g., small caps, quality cyclicals.

Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.

• The US economy has remained resilient supported by robust job gains and consumer spending. The Fed’s aggressive rate hikes will slow the economy and lead to a slowdown into year-end. US consumer spending will likely fade now that excess savings are depleted and job growth moderates. We think investors will do well playing defense to close out 2023.
• This quarter, we increase our cautious tilt: overweight cash, and underweight risky assets including Global and Australian equities, and real assets. We remain balanced on fixed interest.

Treading carefully over the next 3-6 months

The surprising resilience of economic activity in the first half of 2023 is unlikely to last: we forecast a slowdown in the major advanced economies as the effects of tighter monetary policy feed through and China’s recovery falters. Expansionary US fiscal policy which has fueled risk assets over the past few years is contracting, hitting commodities prices and curbing economic growth.

We fear the next leg down will be corporate profits. Given Australia’s economic sensitivity to falling commodity prices, investors need to tread carefully over the next 3-6 months. As inflation pressures start to fade and growth slows, attention will increasingly shift towards policy easing.

Policy rate cuts are unlikely until some way into 2024, but once they start, they will be more rapid than what is currently priced in. Overall, our more cautious view on growth does not appear to be discounted in financial markets.

This suggests that the outlook for risky assets is poor in the near term as risk premia, which now appears relatively low, is likely to widen again and earnings expectations are disappointed.

However, poor investor sentiment and elevated cash levels will ensure a relatively short-lived pullback in asset prices, so it’s important to remain nimble. Our tactical position retains higher cash but remains invested given our view that inflection points for risk assets will be difficult to time.

Looking further ahead: AI – what’s all the fuss about?

Given its wide range of potential applications, the new breed of AI tools would appear to have all the characteristics to become a standalone general-purpose technology (GPT). In the next phase of AI innovation, we expect smaller firms to lead the way in developing tools that integrate the new technology into workflows and add-ons to existing software.

Generative AI in particular, have the potential to revolutionise how cognitive tasks are performed by knowledge workers mostly, but not exclusively, in the services sectors.

This revolution is already well underway in the software industry and, within the next few years, will spread quickly in other areas such as education, translation services and medical diagnostics.

The process will create winners and losers across sectors, with the impact determined by the speed and extent of adoption. We believe that the revolution in AI is likely to be a positive for stock markets, especially for sectors and countries that are key providers – notably US AI application developers and advanced semiconductor manufacturers.

One reason is that we expect the revolution to result in even faster growth in earnings than in output. Another is that we think rising stock valuations will accompany it.

Key changes to our asset allocation settings

This quarter, we increase our cautious tilt by adding to cash (+6%) and reducing exposure to risk assets (Australian Equities -3% and Real Assets -3%).

Figure 1: Morgans recommended asset allocation settings

Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.

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.

Additions: WH Soul Pattinson & Co (ASX:SOL).

Removals: There are no removals this month.

Large cap best ideas

Commonwealth Bank (ASX:CBA)

We rate CBA a HOLD at current prices. As well as being Australia’s largest bank, compared to its peers CBA has the highest ROE, lowest cost of capital, leading technology, largest position in the low risk residential mortgage market and largest low cost deposit base, and a loyal retail investor and customer base. However, investors pay for this quality via the highest earnings and asset-based multiples and lowest dividend yield amongst its peer group.

Westpac Banking Corp (ASX:WBC)

We endorse an ADD rating for WBC. WBC has a similar asset base, funding mix and domestic retail concentration as the premium priced CBA. However, its growth, profitability and ROE have been significantly weaker than this larger competitor, which is ultimately reflected in WBC’s lower earnings and asset-based trading multiples and higher cash yield. If WBC can materially improve its business performance (this is not without significant risk of disappointment) then an investment in its stock could deliver attractive returns as the share price rerates upwards and cash returns to investors lift.

Wesfarmers (ASX:WES)

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. We believe WES’s businesses, which have a strong focus on value, remain well-placed for growth and market share gains in a softening macroeconomic environment.

Treasury Wine Estates (ASX:TWE)

Given TWE's undemanding valuation compared to other luxury brand owners, we see value in TWE. With Penfolds outperforming expectations (makes up ~72% of our valuation) and a clear strategy to improve performance at Treasury America and Treasury Premium Brands, we expect earnings to accelerate from the 2H24 onwards. While risks remain, we back this management team to deliver. The key near term share price catalyst is if China removes the tariffs.

Santos (ASX:STO)

The resilience of STO's growth profile and diversified earnings base see it well placed to outperform against the 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 it continues to gain market share in Australian mortgages.

CSL Limited (ASX:CSL)

While shares have struggled of late, we continue to view CSL as a key portfolio holding and sector pick, offering double-digit recovery in earnings growth as plasma collections increase, new products get approved and influenza vaccine uptake increases around ongoing concerns about respiratory viruses, with shares trading at 25x, a substantial discount (20%) to its long-term average.

ResMed Inc (ASX:RMD)

While weight loss drugs have grabbed headlines and investor attention, we see these products having little impact on the large, underserved sleep disorder breathing market, and do not view them as category killers. Although quarters are likely to remain volatile, nothing changes our view that the company remains well placed and uniquely positioned as it builds a patient-centric, connected-care digital platform that addresses the main pinch points across the healthcare value chain.

Transurban (ASX:TCL)

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 70% by at least CPI and approximately one-quarter at a fixed c.4.25% 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.

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 8x FY24F PE.

Aristocrat Leisure (ASX:ALL)

We have three key reasons for being positive on ALL. They are: (1) long-term organic growth potential. ALL is better capitalised than many of its competitors and has what we regard as a strong platform to continue investment in design and development in both its land-based gaming and digital businesses; (2) strong cash conversion and ROCE. ALL is a capital-light business despite its ongoing investment in Gaming Operations capex and working capital. It has a high level of cash conversion and ROCE; and (3) strong platform for investment. ALL has funding capacity for organic and inorganic investment in online RMG, even after the recent buyback. Its current available liquidity is $3.8bn.

Mineral Resources (ASX:MIN)

MIN is a founder-led business and top tier miner and crusher that has grown consistently despite barely issuing a share over the last decade. Also helping our investment view is that MIN’s diversification leaves it far more capable of tolerating volatility in lithium markets than its peers in the sector. We see MIN’s lithium / iron ore market exposures as an ideal combination to benefit from the China re-opening increase in demand during 1H’CY23. We also see MIN as well placed to grow into its valuation, even if we see unexpected metal price volatility, given the magnitude of organic growth in the pipeline.

Pilbara Minerals (ASX:PLS)

We rate PLS as our best pick of the pure-play lithium stocks. It is well funded, has a long resource life and is an established Australian operator with multiple growth options ahead of it. We think FY24’s starting cash balance of over $3.3bn combined with strong operating cashflow will allow the company to pursue a meaningful capital management program while simultaneously funding growth. Updates on the company’s downstream growth strategy are expected later this half which will guide towards the potential scope of special dividends and / or buy backs.

South32 (ASX:S32)

S32 has transformed its portfolio by 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.

Goodman Group (ASX:GMG)

GMG represents c.27% of the ASX A-REIT index and is one of the few offshore earners in the A-REIT space. GMG rarely screens cheap against domestic peers, but within the context of its offshore peers, it consistently delivers higher returns at lower levels of leverage and at a comparable price to book ratio. Growth in Assets Under Management and development completions are a key determinant of value and an AUM of A$80bn (US$50m) is comparatively modest in a global context, whilst A$7bn (US$5.5n) of completions pa we see as likely sustainable. With continued increases in interest rates and persistent inflation (most notably construction costs), risks abound the REIT sector. This drives our preference for beds and sheds, reflecting the strength of those underlying operating markets. Given the duration risk from higher rates, we prefer more active managers who can grow AUM and add value from an active buy, build, manage strategy. To this end, strong balance sheets are also key to navigate any deterioration in book values.

Qantas Airways (ASX:QAN)

QAN is trading at a material discount compared to pre-COVID multiples, despite having structurally higher earnings, a much stronger balance sheet, a better domestic market position, a higher returning International business and more diversification (stronger Loyalty/Freight earnings). The strong pent-up demand to travel post-COVID should result in a healthy demand environment for some time, underpinning further earnings growth over FY24/25. QAN’s balance sheet strength positions it extremely well for its upcoming EBIT-accretive fleet reinvestment and further capital management initiatives (recently announced another A$500m on-market share buyback at its FY23 result).

Morgans clients can download our full list of Best Ideas, including our mid-cap and small-cap key stock picks.

Expanding Our Coverage Universe

Explore these new additions to our coverage and stay ahead of the curve in the ever-evolving investment landscape. Whether you're seeking stable blue-chip options or higher-risk opportunities, Morgans has you covered.

PolyNovo (PNV)

PolyNovo is a medical device company that specialises in the development and commercialisation of dermal regenerative solutions. The approved devices, NovoSorb® BTM and NovoSorb® MTX, are synthetic polymer-based scaffolds designed to be used in the treatment of burns and surgical wounds.

PolyNovo’s NovoSorb® technology has gained rapid market traction, initially in burns and extending into trauma. We talked to some surgeons about it and their conversations gave us confidence in the effectiveness of the product.

We believe PolyNovo’s growth trajectory will see revenue tip over $A100m within just two years. PolyNovo itself thinks the overall market potential of its current devices is US$1.7bn, of which it has less than 4% share. Clinical trials could support expanded indications.

PolyNovo may also enter into new geographies. We estimate these factors will drive revenue growth by ~30% pa over the next three years. On 5 September, we initiated coverage with a target price of A$1.88 and an Add recommendation.

CSR Limited (CSR)

CSR manufactures and distributes building products to its 18,000+ customers across Australia and New Zealand, as well as maintaining a portfolio of surplus land and 25% interest in the Tomago aluminium smelter. We think CSR is well positioned for long-term growth, having cemented its position as a leading manufacturer and supplier of building materials.

We believe it is more than capable of innovating to capture further market share. In our opinion, investment in CSR’s sustainable building material, Hebel, and property earnings upside through FY25-30 will underpin sustainable earnings growth.

CSR’s property division holds a suite of projects capable of delivering material earnings over the next 5-10 years. Short-term macroeconomic factors mean that CSR’s FY24 result will likely disappoint the market (it has a March year-end), with earnings expected to decline on the prior year.

Over the medium-term, however, we do anticipate earnings to be resilient, with CSR to benefit from the residential construction backlog, along with the latent demand for additional affordable housing. At the time of our report on 11 September, we saw all this as largely reflected in the share price, which was up 30% for the year at that point (it has since fallen back a bit).

We initiated coverage with a Hold recommendation and a 12-month target price of A$6.30/share.

True North Copper (TNC)

True North Copper is an emerging copper producer in the Mount Isa district, of north-west Queensland. Immediate production from its Cloncurry Project offers True North the potential to self-fund exploration across an extensive portfolio of known copper deposits.

The company holds a highly strategic and complementary portfolio of copper assets in a well serviced copper region, where we think the value of in-situ copper will only continue to appreciate in line with the market.

The stock looks far too cheap to us against comparable peers given our expectation of a significant uplift in cash flows. Back on 5 September, we initiated coverage with a Speculative Buy rating and 45cps target.

We like True North’s multi-year production cashflow opportunity, especially given possible upside to the mine life. Furthermore there is an exciting, higher grade development prospect at Mt Oxide, which could deliver further 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.

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.

Additions: Treasury Wine Estates (ASX:TWE), A2 Milk (ASX:A2M), Pilbara Minerals (ASX:PLS), Tyro Payments (ASX:TYR) and Accent Group (ASX:AX1).

Removals: Telstra (ASX:TLS), Super Retail Group (ASX:SUL), Seek (ASX:SEK) and Orora (ASX:ORA).

Large cap best ideas

Commonwealth Bank (ASX:CBA)

We rate CBA a HOLD at current prices. As well as being Australia’s largest bank, compared to its peers CBA has the highest ROE, lowest cost of capital, leading technology, largest position in the low risk residential mortgage market and largest low cost deposit base, and a loyal retail investor and customer base. However, investors pay for this quality via the highest earnings and asset-based multiples and lowest dividend yield amongst its peer group.

Westpac Banking Corp (ASX:WBC)

We endorse an ADD rating for WBC. WBC has a similar asset base, funding mix and domestic retail concentration as the premium priced CBA. However, its growth, profitability and ROE have been significantly weaker than this larger competitor, which is ultimately reflected in WBC’s lower earnings and asset-based trading multiples and higher cash yield. If WBC can materially improve its business performance (this is not without significant risk of disappointment) then an investment in its stock could deliver attractive returns as the share price rerates upwards and cash returns to investors lift.

Wesfarmers (ASX:WES)

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. We believe WES’s businesses, which have a strong focus on value, remain well-placed for growth and market share gains in a softening macroeconomic environment.

Treasury Wine Estates (ASX:TWE) - New addition

Given TWE's undemanding valuation compared to other luxury brand owners, we see value in TWE. With Penfolds outperforming expectations (makes up ~72% of our valuation) and a clear strategy to improve performance at Treasury America and Treasury Premium Brands, we expect earnings to accelerate from the 2H24 onwards. While risks remain, we back this management team to deliver. The key near term share price catalyst is if China removes the tariffs.

Santos (ASX:STO)

The resilience of STO's growth profile and diversified earnings base see it well placed to outperform against the 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 it continues to gain market share in Australian mortgages.

CSL Limited (ASX:CSL)

While shares have struggled of late, we continue to view CSL as a key portfolio holding and sector pick, offering double-digit recovery in earnings growth as plasma collections increase, new products get approved and influenza vaccine uptake increases around ongoing concerns about respiratory viruses, with shares trading at 25x, a substantial discount (20%) to its long-term average.

ResMed Inc (ASX:RMD)

While weight loss drugs have grabbed headlines and investor attention, we see these products having little impact on the large, underserved sleep disorder breathing market, and do not view them as category killers. Although quarters are likely to remain volatile, nothing changes our view that the company remains well placed and uniquely positioned as it builds a patient-centric, connected-care digital platform that addresses the main pinch points across the healthcare value chain.

Transurban (ASX:TCL)

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 70% by at least CPI and approximately one-quarter at a fixed c.4.25% 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.

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 8x FY24F PE.

Aristocrat Leisure (ASX:ALL)

We have three key reasons for being positive on ALL. They are: (1) long-term organic growth potential. ALL is better capitalised than many of its competitors and has what we regard as a strong platform to continue investment in design and development in both its land-based gaming and digital businesses; (2) strong cash conversion and ROCE. ALL is a capital-light business despite its ongoing investment in Gaming Operations capex and working capital. It has a high level of cash conversion and ROCE; and (3) strong platform for investment. ALL has funding capacity for organic and inorganic investment in online RMG, even after the recent buyback. Its current available liquidity is $3.8bn.

Mineral Resources (ASX:MIN)

MIN is a founder-led business and top tier miner and crusher that has grown consistently despite barely issuing a share over the last decade. Also helping our investment view is that MIN’s diversification leaves it far more capable of tolerating volatility in lithium markets than its peers in the sector. We see MIN’s lithium / iron ore market exposures as an ideal combination to benefit from the China re-opening increase in demand during 1H’CY23. We also see MIN as well placed to grow into its valuation, even if we see unexpected metal price volatility, given the magnitude of organic growth in the pipeline.

Pilbara Minerals (ASX:PLS)

We rate PLS as our best pick of the pure-play lithium stocks. It is well funded, has a long resource life and is an established Australian operator with multiple growth options ahead of it. We think FY24’s starting cash balance of over $3.3bn combined with strong operating cashflow will allow the company to pursue a meaningful capital management program while simultaneously funding growth. Updates on the company’s downstream growth strategy are expected later this half which will guide towards the potential scope of special dividends and / or buy backs. We have an ADD rating on PLS based on rounding our DCF valuation to the nearest 10cps.

South32 (ASX:S32)

S32 has transformed its portfolio by 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.

Goodman Group (ASX:GMG)

GMG represents c.27% of the ASX A-REIT index and is one of the few offshore earners in the A-REIT space. GMG rarely screens cheap against domestic peers, but within the context of its offshore peers, it consistently delivers higher returns at lower levels of leverage and at a comparable price to book ratio. Growth in Assets Under Management and development completions are a key determinant of value and an AUM of A$80bn (US$50m) is comparatively modest in a global context, whilst A$7bn (US$5.5n) of completions pa we see as likely sustainable. With continued increases in interest rates and persistent inflation (most notably construction costs), risks abound the REIT sector. This drives our preference for beds and sheds, reflecting the strength of those underlying operating markets. Given the duration risk from higher rates, we prefer more active managers who can grow AUM and add value from an active buy, build, manage strategy. To this end, strong balance sheets are also key to navigate any deterioration in book values.

Qantas Airways (ASX:QAN)

QAN is trading at a material discount compared to pre-COVID multiples, despite having structurally higher earnings, a much stronger balance sheet, a better domestic market position, a higher returning International business and more diversification (stronger Loyalty/Freight earnings). The strong pent-up demand to travel post-COVID should result in a healthy demand environment for some time, underpinning further earnings growth over FY24/25. QAN’s balance sheet strength positions it extremely well for its upcoming EBIT-accretive fleet reinvestment and further capital management initiatives (recently announced another A$500m on-market share buyback at its FY23 result).

Morgans clients can download our full list of Best Ideas, including our mid-cap and small-cap key stock picks.

Unveiling September's Investment Prospects

Insights from the August Reporting Season

We unlock the insights from the August reporting season and dive into the potential opportunities shaping the Month Ahead for September. As we analyse the outcomes and implications of the reporting season, we spotlight three key sectors deserving of your attention. From retail to travel and industrials, discover the trends and top picks influencing the investment landscape.

Reporting Season Wrap

Delve into our review of the August 23 reporting season and gain valuable insights into the resilient earnings outlook and market expectations post-pandemic.

Retail Sector Wrap

We were positively surprised by the resilience of the earnings of discretionary retailers in FY23. On average, the companies we follow grew sales by 9%, outstripping the rate of inflation, with pre-tax earnings growing by an average of 19%. The fastest growth was reported by Lovisa, Accent and Universal Store, while Baby Bunting and Domino’s Pizza Enterprises reported operating earnings more than 20% below the prior year.  

Consumer demand has clearly softened, but the decline has not been precipitous and there are reasons to expect growth to resume in the months ahead. Gross margins look likely to be stable in FY24, supported by lower freight and supplier costs, although operating profit margins will likely moderate as retailers absorb significant wage inflation.

Our key picks coming into FY24 are Lovisa, Accent and Beacon Lighting. These are businesses with strong brand equity and the ability to grow sales in a subdued consumer environment and to find cost efficiencies.

Travel Sector Wrap

Reporting season held few surprises given all the travel stocks either upgraded or provided trading updates in the weeks leading up to this event. For us, Helloworld Travel (HLO) had the strongest year. After three profit upgrades, HLO’s FY23 result came in at the top end of guidance. All companies continued to recover strongly from COVID. It was evident that the companies didn’t waste the COVID induced travel downturn and are coming out of it with structurally higher margins. Many have also made highly accretive acquisitions.

The Leisure travel recovery continued to lead Corporate travel. Following three years of travelling at home, the demand for international travel is very strong, despite the high airfares. HLO said there has never been a better time to be a travel agent. Given all the companies are generating strong cashflow, pleasingly, they have all returned to rewarding shareholders with a final dividend.

Outlook commentary was upbeat with consumer’s prioritising travel over other discretionary categories. It was noted that leisure travel has emerged as a non-discretionary item in the household budget. We believe that the AGM season over October/November will be the next catalyst for the sector given the companies will all provide trading updates and reiterate or issue FY24 earnings guidance. While we have all stocks on a BUY recommendation given positive industry fundamentals and their attractive valuations, our key pick of the sector is HLO.

Industrials Sector Wrap

On net, the FY23 results season was positively received by investors, with many stocks bouncing off the share price lows which followed the guidance downgrades of May/Jun-23. The highlight was GMG (BUY), with the share price up 13% (week post result), as the company beat FY23 guidance (EPS growth of +16% vs +15% guidance), issuing FY23 guidance (EPS growth of +9%), along with management’s discussion of the potential for their data centre business – which now comprises 1/3 of their $13Bn of work in progress.

In light of the recent shift in interest rates, investors were rightly focused on balance sheet health – MGH being a great example, where the stock responded positively as gearing came in below expectations and management outlined a plan for further capital recycling. Housing markets, and in turn the building material companies, remain circumspect about a quick turnaround in demand, albeit management across the board see the medium term opportunity from latent demand driven by underbuilding during Covid, increased immigration and record low rental vacancies.

Top picks from this diverse group of industrial companies which spans building materials, real estate, maintenance services and labour hire are Ventia (VNT), Qualitas (QAL) and MAAS Group (MGH).

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.