Insights

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

• Asset allocation – Positioning for a cyclical slowdown/mild recession
• Economic strategy – US economic growth to slow
• Equity strategy – Moving from defensives
• Updated Morgans Best Ideas
• … and much more

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

Feature Article | 2024 Outlook

A rapidly evolving investment landscape and a year of likely political uncertainty make forecasting difficult in 2024. We outline three possible scenarios:

1. Economic soft landing involves a modest deceleration below trend in major economies, without significant shocks disrupting markets. The decision to maintain higher interest rates will bring inflation near central banks’ target range. This would enable a shift towards reducing interest rates, alleviating the strain on households and companies.
2. A cyclical slowdown/mild recession resilience driven by fiscally supported consumers and companies has been the biggest surprise of 2023, but barring something extraordinary, next year could see the global economy finally turn lower. Inflation would be sticky for a period before returning to target, with interest rates staying higher for longer periods, resulting in bouts of asset price volatility.
3. Economic hard landing/balance sheet recession will be defined by a sharp downturn in the global economy. A sharp acceleration in corporate defaults would significantly reduce corporate and consumer spending. Central banks would respond by cutting interest rates as growth and inflation fall away.

Equity strategy - Moving on from defensives

Our Asset Allocation update discusses three possible economic scenarios in 2024 and their investment implications in terms of portfolio asset allocation. Our base case scenario expects economic growth to contract in the first half of 2024 before returning to growth later in the year. Sticky inflation will keep interest rates higher for longer. Equities will likely remain range-bound until there is more certainty on the interest rate trajectory either peaking/falling.

Given Australia’s economic sensitivity to falling commodity prices, investors need to 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 toward what we believe are the best relative opportunities and the best risk/return profile e.g., small caps, quality cyclicals.

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Helloworld Travel Ltd (ASX:HLO) - Finally profitable

HLO's FY22 result beat expectations with the group returning to modest (EBITDA) profitability in the 4Q, despite the sale of the Corporate travel business. Cashflow and the balance sheet were also stronger than expected.

In a sign of confidence, HLO has rewarded shareholders with a 10cps final dividend. Add maintained.

Tyro Payments (ASX:TYR) - Pointing to a clear increase in operating leverage in FY23

TYR's FY22 Reported NPAT appeared below Bloomberg consensus (-A$29m versus -A$20m), but the result beat at EBITDA (A$10.5m versus A$8m consensus) while the mid-point of FY23 EBITDA guidance was ~+25% above consensus.

Add maintained. Our key result takeaway was the market had been waiting for TYR to give evidence of improving operating leverage, with FY23 EBITDA guidance of A$23m-29m (FY21 A$10.5m) particularly meeting that criteria.

Healius (ASX:HLS) - Pieces coming together- "a platform for growth"

FY22 underlying results were broadly in line with expectations, with double-digit revenue growth and ongoing cost outs driving leverage and robust cash flow. Not surprising, COVID testing underpinned the result, while Imaging and Day Hospitals went backwards on COVID-impacted elective surgery restrictions, lockdowns and increased costs.

We adjust our FY23-24 forecasts and roll forward valuation multiples. Add maintained.

Generation Dev Group (ASX:GDG) - A clean performance

In our view, this was a pretty clean result (without any obvious surprises), and it represented a relatively solid performance overall. Management also noted FY23 has seen a good start to the year for Investment Bond (IB) sales, albeit outlook commentary was pretty broad as per usual.

We continue to believe GDG is well positioned to execute a compound earnings growth story over time. Add maintained.

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Wesfarmers Limited (ASX:WES)

WES's FY22 result was comfortably above expectations.

Management said retail trading conditions have remained robust through the first seven weeks of FY23. FY23-25F group underlying EBIT changes by between -1% and +3%. We maintain our Add rating. We continue to view WES as a core portfolio holding for long-term investors.

Ramsay Health Care (ASX:RHC)

FY22 results continue to be materially impacted by COVID and higher costs, with margins contracting to multi-year lows and profit falling by double-digits.

Despite lingering volatility and FY24 a "normal" trading year, it takes a back seat to KKR's now revised offer, which we believe is likely to get up in some form. We have adjusted our FY23-24 earnings, rolled forward our valuation multiples, and maintained a takeout premium. Move to Add.

Universal Store (ASX:UNI)

We believe UNI will deliver double-digit growth in sales and earnings in FY23 as an expanded store network plays into the resilience of demand for fashion apparel from a young customer cohort experiencing high levels of employment, higher wages and more and more opportunities to go out and socialise.

FY22 earnings were slightly better than expectations. We have increased our EPS estimates by 5% in FY23 and by 1% in FY26.

Peter Warren (ASX:PWR)

PWR's FY22 underlying NPAT of A$61.7m was up 18% on the pcp, beating expectations.

We are conscious of the operating deleverage impact when GM 'normalises', however more constrained supply is likely to persist for some time.

Industry consolidation will continue - we expect PWR to be a participant (primary growth driver), or even a potential target in time.

Jumbo Interactive (ASX:JIN)

FY22 was a year of solid growth in revenue and earnings for JIN. The business continued to diversify its earnings base, with SaaS now making up nearly half of group EBITDA.

We reiterate our Add rating. We expect JIN to continue to achieve steady growth in the years ahead through a combination of organic contract wins, M&A and diversification.

Monash IVF Group Ltd (ASX:MVF)

MVF posted a solid FY22 result which was in line with expectations and sustained the high level of stimulated cycles on the bumper FY21 year. Strong industry fundamentals remain in play, and MVF continues to gain market share and attract new fertility specialists.

We maintain our Add recommendation.

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.

In the latest fiscal year, Wesfarmers Limited (ASX:WES) has impressively surpassed expectations, showcasing resilience amid challenging conditions.

FY22 Results Exceeding Expectations

Kmart Group, a standout performer, demonstrated a strong recovery in 2H22 following 1H22 lockdown impacts. Additionally, the FY22 Dividend Per Share (DPS) of 180cps exceeded forecasts and Bloomberg consensus. The Group's Return on Equity (ROE) surged by 330 basis points to an impressive 29.4%.

Challenges and Areas of Concern include a 120 basis points drop in the Group's EBIT margin to 9.3%. The Health division's EBIT, for the initial three months of ownership in FY22, reported at -$24 million. Furthermore, operating cash flow declined by 32% due to higher working capital, predominantly in inventory.

Retail trading conditions have remained robust, as assured by management through the first seven weeks of FY23. Projections for FY23-25F group underlying EBIT changes range between -1% and +3%.

Financial Performance

FY22 Result Overview: Underlying EBIT declined by 4% to $3,633 million, a 3% decrease in underlying NPAT to $2,352 million. Earnings in retail divisions were mixed, with Bunnings EBIT up slightly (+1%), while Kmart Group (-36%) and Officeworks (-14%) experienced weakness due to 1H22 lockdowns. The Industrials businesses had a good year, with WesCEF EBIT up 41% on the back of higher commodity prices, and Industrial & Safety EBIT rose 30%. EBIT for the newly created Health division (3 months) was -$24 million, including several one-off charges. Excluding these charges, Health EBIT was $12 million.

Bunnings and Kmart Performance

Bunnings Highlights

Bunnings FY22 EBIT rose by 1% on the back of 4.8% LFL sales growth. Although earnings were slightly below (-1%) forecasts, it was a commendable result given the strong growth over the past two years. EBIT margin fell 60 basis points to 13.1%, attributed to operational challenges related to COVID and ongoing supply chain disruptions. The change in mix from higher Trade activity also had a negative impact on margins. For FY23, Bunnings EBIT is forecasted to decrease by 3% to $2,248 million.

Kmart Group Resilience

Kmart Group FY22 EBIT decreased by 36% to $506 million, yet the result was 23% above forecasts. 2H22 performance (EBIT +12%) significantly improved from 1H22 performance (-58%), which was significantly affected by lockdowns. Trading conditions improved in 2H22 as restrictions eased. For FY23, Kmart Group EBIT is forecasted to jump by 67% to $843 million after cycling the lockdown impact in FY22.

Retail Conditions and Future Projections

Retail trading conditions have remained robust, particularly strong in Kmart Group, with sales significantly higher on both a one-year and two-year basis. Bunnings also continues to see positive sales growth on a one-year and two-year basis. Overall, the forecast for FY23 group underlying EBIT anticipates a 5% increase to $3,827 million.

Adjustments and Investment Outlook

Adjustments have been made to FY23F/24F/25F underlying EBIT by +3%/-1%/-1%. Underlying NPAT changes by -2%/-6%/-5%, reflecting a remodelling of net interest expense. The equally-blended (PE, SOTP, DCF) target price falls, maintaining the Add rating. Trading at 22.5x FY23F PE and a 3.8% yield, WES remains an attractive investment with a diversified group of retail and industrial brands, a solid balance sheet, and a strong leadership team poised to deliver long-term value for shareholders.

We preview the FY22 results of the five gaming stocks in our universe that report in August. We expect the best earnings growth from the two businesses primarily exposed to lotteries, Jumbo Interactive (JIN) and The Lottery Corporation (TLC).

Star Entertainment Group (SGR), Tabcorp (TAH) and BlueBet (BBT) are forecast to report a decline in EBITDA due mainly to the impact of COVID and increased operating expenditure. We have lowered EBITDA estimates in both FY22 and FY23 for all companies except JIN. We have downgraded SGR to HOLD.

The ratings for Aristocrat Leisure, BBT, JIN and TLC all remain ADD and TAH remains on a HOLD.

Watch

The Lottery Corporation (TLC) - ADD

TLC's FY22 result will be its first since the demerger with TAH. We expect a steady performance with EBITDA up 13% to $691m. The larger Lotteries division is forecast to deliver all of the growth in earnings (EBITDA up 18%), with Keno EBITDA down 15% after a strong FY21. We have updated the number of large jackpots in our model, which takes our FY22 EBITDA estimate down by 2%, 1% below consensus. We forecast 5% growth in EBITDA into FY23.

The Star Entertainment Group (SGR) - HOLD (previously ADD)

FY22 was a tough year for SGR. COVID restrictions enforced casino closures and operating restrictions. Regulatory investigations have been ongoing and could result in material penalties. We expect FY22 earnings to be down materially y/y. We have lowered our FY22 EBITDA forecast by 28% to $220m to take account of higher operating costs, bringing us in line with consensus.

Tabcorp (TAH) - HOLD

TAH held an investor day in June and we do not expect incremental new detail on the strategy to be released at the FY22 result. The focus is likely to be more on the costs and practicalities of the demerger, the impact of recent POCT changes and that of recent adverse weather. We have lowered our EBITDA estimate by 5% to $369m, 2% above consensus. We forecast 12% growth in EBITDA into FY23.

Jumbo Interactive (JIN) - ADD

We expect FY22 to have been another year of good growth for JIN. We have increased our EBITDA estimate by 3% to $55m, up 13% y/y with most of the growth driven by the rapidly expanding SaaS division. Higher assumed costs leave our EBITDA and EBIT estimates 3% below consensus. We forecast 24% growth in EBITDA into FY23.

BlueBet (BBT) - ADD

BBT's Australian business is forecast to achieve strong growth in turnover in FY22 (48%) as it increases marketing costs to drive customer acquisition. Those higher marketing costs are likely to reduce EBITDA in Australia to breakeven, with the investment in the US growth strategy pushing group EBITDA to a forecast loss of $1.2m. We have lowered our FY22 gross profit estimate by 4%. BBT has just signed an agreement for its fourth US state. The longer-term potential is significant.

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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.

We make two changes to the list this month, removing Hotel Property Investments (ASX:HPI) and MoneyMe (ASX:MME).

Large cap best ideas

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. While COVID-related staff shortages are 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 recent 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 a number of 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.

Santos (ASX:STO)

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.

Woodside (ASX:WPL)

We believe WPL has benefited from being in the right place, at the right time. With: 1) BHP/WPL having an existing relationship, 2) BHP eager to boost its ESG profile, and 3) WPL being a quality operator (safe hands which is important for BHP). From an economic standpoint we think WPL is getting the better of the deal, with synergies not baked into deal metrics and BHP willing to accept a discount. The deal is transformative, lifting WPL into being a top 10 global E&P with +2 billion barrels of 2P reserves, with EBITDA of US$4.7bn pa and growth options.

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 Australia 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.

Cochlear (ASX:COH)

Cochlear maintains a dominant position in the implantable hearing solutions segment. While we continue to believe a full recovery from Covid-based disruptions still has time to play out, improving demand and strong pipeline, coupled with management's increasing confidence, suggests an improving earnings profile.

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.

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 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.

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.

South32 (ASX:S32)

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.

Seek (SEK)

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.

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