Unveiling Top Picks for May 2023
This month, we sifted through all of these ideas to select three that we believe are particularly worth highlighting. They are the rail freight operator Aurizon, the biotechnology company CSL, and the data centre business NEXTDC. You can get a sense for the diversity of our analysts’ best ideas from these three alone!
NEXTDC
NEXTDC (NXT) is Australia’s largest independent data centre operator. They have invested billions of dollars and over a decade building 12 live data centre with more on the way. Their business model has, in our view, significant competitive advantage. Most people haven’t heard of NEXTDC but they are probably using its services indirectly. NEXTDC’s status an independent co-location provider means its crucial to Australia Digital economy.
Anyone using Microsoft, Amazon, Google and thousands of other clouds and applications is probably accessing them from a NEXTDC data centre. It’s the go-to place for digital connectivity and this is why thousands of partners and businesses (including Morgans) pay NEXTDC to help host their servers. Its high quality business and crucial infrastructure means NEXTDC is an attractive and relatively high growth digital infrastructure investment.
Growth of the digital economy will continue for decades and NXT is a beneficiary of this growth. The company recently signed their largest ever deal with one of the Global Cloud Service Providers. For confidentiality reasons NXT is not able to name some of its larger contract wins but based on publicly available facts with think it is probably Microsoft. The contract is likely to generate billions of dollars in revenue over its lifetime which could be more than 15 years.
Despite this being a record contract win, we expect there are still more to come over the next 6-12 months. NEXTDC have built significant inventory and management say they do not build inventory speculatively. Refer to our latest note for details but we think they could sign another 3 substantial customer contracts and if this happen the share price could appreciate materially. We have an Add rating on NEXTDC and it’s our preferred telecommunications investment.
Aurizon
Aurizon (AZJ) is Australia’s largest rail freight operator. It operates a regulated coal track infrastructure network in central Queensland, which makes up around half of its earnings. The rest of Aurizon’s earnings come from coal haulage contracts in Queensland and NSW and an expanding Bulk business that moves everything that isn’t coal and owns the Darwin-Adelaide railway. Aurizon bought One Rail last year and the costs of funding the acquisition, as well as the effects of wet weather on its rail operations, meant the first half result was weaker than the market had expected and the share price responded accordingly.
We think the extent of the share price decline was unjustified as the nature of Aurizon’s take-or-pay and regulatory protections means the underlying downgrade to this year’s EBITDA forecast was much less than the headline implied ($10-40m, rather than $50-80m).
So we think Aurizon’s share price fell further than it should have done after the interim results. Looking past this year, earnings look set to rise (unless there’s a repeat of this year’s unfavourable weather). We see a high likelihood of Aurizon receiving a regulated revenue uplift of around $125m in FY24 and most of this drops straight down to EBITDA. Even accounting for higher interest costs, the net positive impact will be material.
On top of this, we expect the revenue yield pressures that have affected the Coal haulage business to cease, with yield now closely linked to the contracted CPI escalation. As if this wasn’t enough, Aurizon will have ploughed about $1.85bn into its Bulk business and we’d expect to see a good return from this investment coming through by FY25.
Investors used to see Aurizon as a solid business with a good dividend and the opportunity for share buybacks. Of course some investors were disappointed when Aurizon reduced its dividend and stopped its buyback to fund its purchase of One Rail, but the likely earnings improvement over the next couple of years should justify your attention. We think the FY25 dividend might deliver a yield of about 7% (which grosses up to about 10%) at the current share price.
CSL Limited
While arguably a leading specialty pharmaceutical company and global vaccine manufacturer, CSL Limited (CSL) was not a ‘COVID beneficiary’, as its core plasma-based products (i.e. those derived and separated from the straw-coloured liquid portion of blood) were constrained on tight supply, a lengthy product cycle (9-12 months) and higher costs.
But as we transition out of the pandemic, the company is becoming a ‘COVID exit’ trade, standing at an inflection point where plasma collections have turned the corner, posting record 1HFY23 levels (+36% on pcp; 10% above pre-COVID) and are poised to propel plasma-based products and improve margins on growing fixed cost leverage and moderating cost inflation.
We view additional earnings contributions from recently acquired Swiss specialty pharmaceutical company Vifor, which is tracking to plan with integration going well, along with solid performance from Seqirus (seasonal influenza vaccine business), which has seen a significant pandemic impacted boost in demand, all reflected in a solid FY23 outlook (NPAT +13-18%).
Importantly, management is confident in a return to “sustainable growth”, pointing to internal efforts and a Vifor-expanded R&D pipeline in the “best shape it has ever been” (up c70% on pcp), with the majority late-stage programs (Phase 3 to registration/post-registration), well dispersed among core therapeutic areas, and fuelled by modest spend (10-11% of revenues).
Management estimate that at least 10 compounds (c20% of the total R&D pipeline) have the potential to be ‘standard of care’ for the targeted patient group. With c17% annual earnings growth estimated through FY25, undemanding valuation (30.9x vs 33.5x 10 year mean forward PE), this ‘COVID exit’ trade is a clear standout and represents a core portfolio holding.
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