Insights

Commonwealth Bank (ASX:CBA) recently unveiled its 1Q24 trading update, revealing a stable performance with revenue, pre-provision operating profit, and cash NPAT aligning with the 2H23 quarterly average.

Fiscal Projections and Downgrades for FY25-26F

Explore the financial landscape as 3-4% cash EPS downgrades for FY25-26F emerge, driven by a combination of mild earnings adjustments and smaller future buyback assumptions.

Target Price Adjustments and Holding Strategy

Delve into the details of the revised target price, as Commonwealth Bank retains a HOLD rating. Uncover the reasoning behind the decision, with a potential -5% Total Shareholder Return (TSR), including a 4.4% cash yield.

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: There are no new additions this month.

Removals: This month we remove Pilbara Minerals (ASX:PLS).

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.

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.

Insights from Morgans Institutional Conference in Noosa, Queensland

In mid-October, Morgans had the privilege of hosting its annual Institutional Conference in the serene backdrop of Noosa, Queensland. This year marked the 33rd edition of our Queensland Conference, bringing together 42 prominent companies representing diverse sectors of the Australian economy.

Featured Companies

We spotlight three noteworthy companies that left an indelible mark on our Conference: Corporate Travel Management (CTD), Eagers Automotive (APE), and Monash IVF Group (MVF).

Corporate Travel Management (CTD)

CTD is benefitting from new client wins transacting. Importantly its larger clients are gradually travelling more. With airfares coming down, corporate travel is becoming more affordable, so budgets aren’t used up earlier. Airline and airport reliability continues to improve, helping corporate travel recover, with day trips slowly returning.

Eagers Automotive (APE)

Demand in the underlying business remains solid. Recovering supply is indicating a record year of deliveries in Australia, with APE expecting a stronger margin outcome (LFL basis) for FY23 compared to FY22. The recent acquisition has provided an opportunity to improve margins and will add significant turnover from 2024. APE is bolstered by the opportunities of ongoing consolidation and original equipment manufacturers pointing to fewer dealers.

Monash IVF Group (MVF)

The post-COVID boom in IVF industry cycle volumes has been sustained. It should continue to grow from here, driven by tailwinds in the underlying growth drivers – increased maternal age, egg freezing, increase in LGBTIQ+ couples, and increased government support for genetic testing. There has been some movement in fertility specialists due to a change in ownership amongst peers, Monash has been a beneficiary and expects there to be some movement still.

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.

Inghams (ASX:ING) recently shared their 1H24 guidance, surpassing expectations significantly. The positive trajectory, initiated by a robust 2H23 recovery, continues to drive operational performance in the first half of FY24.

Continuous Momentum from 2H23 Recovery

Inghams' strong recovery in the latter half of 2023 has seamlessly transitioned into a positive start for FY24, forming the basis for their impressive 1H24 guidance. We have made substantial upgrades made to our forecasts in response to Inghams' remarkable performance, reflecting the company's resilience and growth potential.

Undemanding Valuation and Investment Outlook

Evaluate Inghams' undemanding valuation, trading at an FY24F PE of 10.8x, coupled with an enticing fully franked dividend yield of 5.6%. With this, we maintain an Add rating, shedding light on the investment outlook for prospective stakeholders.

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.