Insights

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: This month we add Woodside Energy Group (WDS) and Camplify Holdings (CHL).

Removals: This month we remove Westpac Banking Corp (ASX:WBC), Wesfarmers Ltd (ASX:WES), Goodman group (ASX:GMG), Santos Ltd (ASX:STO) and Super Retail Group Ltd (ASX:SUL).

Large cap best ideas

Treasury Wine Estates (ASX:TWE)

It may take some time for the market to digest TWE’s acquisition of Paso Robles luxury wine business, DAOU Vineyards (DAOU) for US$900m (A$1.4bn) given it required a large capital raising. The acquisition is in line with TWE’s premiumisation and growth strategy and will strengthen a key gap in Treasury Americas (TA) portfolio. Importantly, DAOU has generated solid earnings growth and is a high margin business. It consequently allowed TWE to upgrade its margins targets. While not without risk given the size of this transaction, if TWE delivers on its investment case, there is material upside to our valuation. The key near term share price catalyst is if China removes the tariffs on Australian wine imports.

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)

They are: (1) Long-term organic growth potential in the US. 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. (3) Strong platform for continued investment following its acquisition of NeoGames.

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 gradual recover. 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.

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.

Woodside Energy (WDS) - New addition

A tier 1 upstream oil and gas operator with high-quality earnings that we see as likely to continue pursuing an opportunistic acquisition strategy. WDS’s share price has been under pressure in recent months from a combination of oil price volatility and approval issues at Scarborough, its key offshore growth project. With both of those factors now having moderated, with the pullback in oil prices moderating and work at Scarborough back underway, we see now as a good time to add to positions. Increasing our conviction in our call is the progress WDS is making through the current capex phase, while maintaining a healthy balance sheet and healthy dividend profile. WDS still has to address long-term issues in its fundamentals (such as declining production from key projects NWS/Pluto), but will still generate substantial high-quality earnings for years to come.

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.

February marks a pivotal time for investors as ASX-listed companies unveil their half-yearly results. At Morgans, we're thrilled to present our comprehensive Reporting Season Playbook in this edition of The Month Ahead. Bursting with forecasts, company previews, and expert investment insights, our playbook equips you with the tools needed to navigate the upcoming weeks with confidence. Delve into our series of insightful videos where our analysts uncover the stocks poised to surprise investors, both positively and negatively, along with the key emerging themes shaping the market landscape. Stay informed as the results unfold and make informed investment decisions with Morgans by your side.

Technology, Media and Telecommunications Preview

With Nick Harris, Steven Sassine, James Filius and Leo Partridge.

Financials Preview

With Nathan Lead, Richard Coles and Scott Murdoch.

Healthcare Preview

With Scott Power, Iain Wilkie and Emily Porter.

Resources Preview

With Adrian Prendergast, Tom Sartor and Chris Brown.

Consumer Discretionary Preview

With Alexander Mees, Head of Research.

Travel & Tourism Preview

With Belinda Moore and Billy Boulton.

Consumer Staples Preview

With Alex Lu and Belinda Moore.

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.

Morgans Chief Economist Michael Knox says that Federal Reserve rate cuts later this year will be shaded by a major program of quantitative tightening.

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Morgans Chief Economist Michael Knox walks us through his model for the US Economy using the Chicago National Activity Indicator, which explains 78% of YoY growth in US GDP.

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• Earnings trends remain remarkably stable despite widespread expectations of an impending earnings slowdown. While the 9% rally in the ASX200 and subdued outlook statements might temper some good results, we still see potential upside surprises in February.
• Quantity and quality of earnings will come into focus as the macro takes a back seat to company fundamentals. Key themes to watch include: the risk of hiding in defensives, small-cap/cyclical rotation, focus on cashflow and operating leverage, short selling signals and revisiting REITs.
• Morgans analysts preview the results for 150 stocks under coverage that report in February and call out likely surprise and disappoint candidates from page 10.
• Key tactical trades (page 3) include CSL, ResMed, A2 Milk, Domino’s Pizza, Tyro and Megaport, among many others.

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We reset our strategy following the 9% run since November

We update our strategy heading into February. First on the back of the late surge in 2023, we advocate being opportunistic on pullbacks.

Second, given the ongoing macro concern, we do not think the “focus on fundamental” regime is over - anything other than a path back to historically low rates and plentiful liquidity is likely to keep investors on the hunt for near-term cash and earnings generation. And last, cyclicals typically find valuation support as interest rates come down, providing an attractive alternative to growth and defensives.

Rising rates, recessionary fears and weak investor sentiment provided plenty of reasons for investors to hide in defensives in 2023. However, as conviction around a cyclical peak in interest rates firmed, a rotation to growth and cyclicals ensued late in the year with defensives all underperforming the ASX200.

We continue to favour a rotation away from defensives (telco, staples) as earnings growth broadens across the market.

Look below the surface – solid earnings growth on offer

We see the S&P/ASX 200 index rangebound in 2024. FY24 EPS is forecast to decline 5% before rebounding 5% in FY25, leaving the heavy lifting down to P/E multiple expansion, but at 16x vs the 14.5x 20-year historical average, there is limited scope for further expansion barring a sharp retreat in interest rates.

While we do not expect the index to do much at the headline level, high-level numbers conceal significant variation across sectors. Cyclicals including consumer and commercial services, media, retail and capital goods offer mid-to-high EPS growth into FY24 at lower relative valuations.

Cyclical stocks that look interesting include Acrow, GQG Partners, Alliance Aviation, Baby Bunting and Santos.

Small-caps continue to look constructive

Small-caps have historically bounced hardest upon confirmation of a flattening-out in the rates cycle. Several ingredients remain in place supporting a rebound in this space (rates, trading/fundamentals, sentiment/positioning).

We think the tide is turning for small-caps, and now is an opportune time to build exposure to forgotten small-caps including Helloworld, Credit Corp, IPH Limited, Clinuvel, Veem, Vulcan Steel and DGL Group.

Time to rethink REITs

REITs was the best performing sub-sector of the ASX200 in late 2023 on broadening views that the rates cycle in major economies has likely peaked and that material rate cuts are possible in 2024.

While we still see some earnings risk in Retail and Office that could weigh on the sector and valuations on the balance sheets that could fall in 2024, the downside looks more than priced in when we look at discounts to NTA of 20-40%.

We also expect strong balance sheets to help buffer any falls in book values. Our preferred A-REITs are Goodman Group, Qualitas, HomeCo Daily Needs REIT and Dexus Industria REIT.

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.

Fixed interest securities offer investors investment income and portfolio diversification and come in many forms.

ASX-listed Corporate and Bank issued securities offer investors the benefit of higher returns than investments such as Government bonds or bank deposits while providing liquidity liquidity via the ASX platform, however they also carry a higher level of risk.

The income paid will be based on either a fixed or floating rate. Investors should understand the three primary sources of risk which are the credit quality of the issuer, interest rate exposure and the specific structural features of a security.

Main characteristics

• face value – is the price at which the security is issued and the amount payable to the investor at maturity/redemption by the issuer
• distribution/dividend/coupon – the income stream payable to investors either quarterly or semi-annually
• maturity/redemption – the date at which holders will be repaid the face value of the security in cash
• conversion – the date when a preference share or other convertible security will convert into ordinary shares in the issuer (assuming the required conversion conditions are met)

Why invest in fixed interest securities?

Fixed interest securities are generally suited to investors seeking income; however where a security trades at a discount to face value, some capital growth over time can also be expected as the security moves back to its face value at maturity. Conversely, where a security is purchased at price above its face value, only the face value will be repaid at redemption.

Investors seeking portfolio diversification should also consider ASX listed Exchange-traded Government Bonds which, while generally paying lower levels of income than bank and corporate securities, carry a lower level of credit risk. This is because all interest payments and the repayment of the bond's face value are guaranteed by the Government. Government bonds also provide significant portfolio diversification benefits. This is because in times of economic stress where shares and other higher risk asset classes might be expected to fall in price, Government bond prices generally rise.

It is very important to read and clearly understand the security issue terms as the securities in this sector vary greatly. Some general advantages and risks associated with investing in fixed interest securities are outlined below:

General features

• known return profile with distributions / dividends / coupons being either fixed or floating in nature
• yields are higher than government bonds and bank deposits
• returns are more predictable than ordinary share dividends, and in the event that they are not paid on these instruments, companies are generally unable to make payments to ordinary shareholders
• franking is often a component of investor returns for preference shares
• issuers are generally known and trusted names
• ASX listing provides liquidity
• price volatility is generally lower than the underlying ordinary share of the issuer

General risks

• preference share / capital note distributions are are subject to the issuer having sufficient distributable profits to make the payment and in many cases are discretionary
• subordinated note coupon payments may be deferred in certain circumstances
• investors are exposed to interest rate risk and market price risk
• returns to the investor upon conversion or preceding conversion may be affected by movements in the underlying ordinary share price
• in the event that the issuer is wound up, investors may receive less than the security's face value if there are insufficient funds following the repayment of higher ranking creditors
• securities issued by the APRA regulated entities i.e. banks & insurers, may in certain extreme circumstances be converted to equity or written-off resulting in financial loss.

Capital Structure

The size and depth of the listed security market has grown over the past few years, from one which consisted largely of hybrid securities to one which now provides investors with access to a range of instruments across the capital structure (with the exception of covered bonds issued by financial institutions).

Senior Secured Debt

If a company is declared bankrupt or enters liquidation, senior secured debt holders are the first to get their money back and most likely 100% of the principal invested. This is because this class of investor or lender has direct and definable security or legal charge over specific assets of the company e.g. mortgage/lien over real property or other assets.

Senior Unsecured Debt

As we move down the capital structure the probability of receiving all of the money invested decreases in the event of a company's failure. The expected level of recovery will vary depending on the initial financial strength of the company but senior unsecured creditors have the first access to the proceeds in the event of liquidation (behind any secured lenders). Most corporate debt is issued on an unsecured basis.

Subordinated Debt

This is another notch down in the capital structure and while still debt with a defined maturity date and interest payment obligations, in the event of wind up, the interests of the subordinated-debt holders will rank behind the senior debt holders (both secured and unsecured). Companies also issue subordinated debt as in many instances rating agencies look favourably on these instruments and provide them with "equity credit".

Capital Notes / Preference Shares

Capital Notes and Preference Shares, often referred to as Hybrids, pay dividends which rank ahead of the payment to ordinary shareholders. These securities follow the sequential nature of risk, just as subordinated debt is subordinate to other forms of debt; hybrids are subordinate to all forms of debt, but generally rank ahead of ordinary equity in the event of a wind-up.

Ordinary Equity

Finally, ordinary equity sits at the bottom of the capital structure. If things turn sour, this is the first call on capital or funding to wear the pain. This arises from the fact that there is no obligation to repay equity or provide any income stream, so companies are breaking no agreements or laws by losing shareholder value or not paying dividends. There are risks associated with moving down the capital structure from senior secured debt to ordinary equity which include:

• a reduction in the security of cashflows
• no recourse against an issuer should payments not be made or capital is put at risk;
• liquidity in the instrument may decrease particularly in times of financial stress
• ranking or priority of claim in the event of the issuer being wound up

Types of listed fixed interest securities

While the major details of fixed interest securities have been outlined above including, the features and risks of investing in this asset class, it is important to understand the differences between the various types of securities on issue.

Download the PDF to learn about the types of securities available, including:

• debt securities
• convertible preference shares
• convertible notes
• reset preference shares
• income securities
• step-up preference shares

This document also has more information on the risks and factors impacting fixed interest securities.

Key terms and their meanings

There are a number of terms used in the fixed interest market which may be unfamiliar to many investors. These are explained below:

• Current price – most recent security price as at the date of publication
• Price target – may be set at a discount or premium to the Morgans assessed fair value depending on a variety of factors
• Cash running yield – is calculated as the cash distribution payable to holders (based on the security’s issue margin plus the one year swap rate) divided by the last traded price of the security
• Gross running yield – is calculated as the cash distribution payable to holders (based on the security’s issue margin plus the one year swap rate) plus franking credits (if applicable) divided by the last traded price of the security
• Yield to maturity/call (YTM/YTC) – investor's expected return having paid the published current price and assuming all distribution payments are made through to conversion. In addition, the calculation assumes investors realise the face value of the security and fully utilise any franking benefits. Income forecast for the calculation of the YTM/YTC is calculated using the interest rate swap curve
• Trading margin – the YTM/YTC minus the relevant swap rate and shows the return premium required by investors to purchase the security rather than investing in bank bills. The relevant swap rate is determined by looking at the maturity/conversion date of the security and matching that to a comparable level along the interest rate swap curve. i.e. if a security has a YTM/YTC of 7.00% and four years to maturity, this would be benchmarked to the four year swap rate (e.g. 4.00%); subtracting this from the YTM/YTC gives a trading margin of 3.00%.
• Accrued distribution – the income accrued to date in the current dividend or distribution period
• Swap rate – this is a benchmark yield that is determined on a daily basis by a panel of banks across a range of terms and provides a benchmark from which a range of financial instruments and transactions are priced