Reporting season summary
Despite business surveys showing signs of improvement leading into August, meaningful cyclical tailwinds failed to materialise either through the results or outlook statements. Larger-than-usual volatility around reported results and the well-publicised large-cap misses Telstra, Suncorp, Ramsay Health Care and Woolworths) were the biggest surprises from reporting season.
Valuations remain elevated so we caution against expectations of above-average returns in this environment. Nonetheless, we continue to identify compelling opportunities in companies capable of thriving despite the low-growth backdrop.
Our high conviction stocks 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 typically our preferred sector exposures.
This month we add Aventus (AVN), NEXTDC (NXT) and PWR Holdings (PWH) to our high conviction list. Here are our six high conviction small to mid cap stock picks in September:
Aventus is a private investor and manager of large format retail centres in Australia with over 95,000sqm of retail showrooms in 14 large format retail centres across five states.
Key reasons to buy Aventus
- AVN offers an attractive 7% distribution yield and trades at a c4% premium to Net Tangible Assets.
- AVN offers exposure to large format retail assets which account for 22% of total retail spend in Australia. Income is underpinned by leases to a diverse range of tenants with structured rental growth (87% subject to annual fixed/CPI rent increases and no turnover leases).
- While headwinds are affecting the broader retail sector (online penetration increasing; Amazon), we believe AVN is well placed to navigate any challenges given low vacancy rates and incentives, the ability to re-mix tenants, low maintenance capex requirements, limited new supply and opportunities for consolidation in a fragmented market (AVN currently has 14% market share).
- AVN has an organic growth pipeline which can leverage off any future zoning and planning reforms.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for Aventus (AVN).
NEXTDC is a Data-Centre-as-a-Service (DCaaS) provider offering a range of services to corporate, government and IT services companies.
Key reasons to buy NEXTDC
- NXT's FY17 result was in-line with guidance and the outlook for FY18 is for 14-25% EBITDA growth, which is in-line with market expectations.
- In addition to rating NXT as a high quality investment, we see a number of potentially positive catalysts as likely to occur over the short term (i.e. likely resolution on the AJD REIT issue and the potential for large cornerstone customers in the new Generation 2.0 facilities (Brisbane 2 and Melbourne 2 are due to open within six months and Sydney 2 within 12 months).
- We expect there is a high likelihood of NXT securing meaningful cornerstone customers, especially in Sydney given the shortage of quality data centre offerings and increasing demand from offshore players.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for NEXTDC (NXT).
PWR Holdings (PWH)
PWR designs and produces cooling solutions for the high performance automobile industry and has an established track record in servicing elite motorsports, including Formula One, NASCAR and V8 Supercars.
Key reasons to buy PWR
- PWH is a world leading automotive cooling business that delivers technically advanced solutions to elite motorsports customers (eg. Formula 1, NASCAR).
- FY17 was a year of currency headwinds and higher investment costs. With that now largely out of the way, FY18-20 are set to be much stronger years.
- Key growth opportunities include capturing a greater share of customer spend on cooling solutions, partnering with OEMs on high performance/low production run vehicles, increased presence and entry into adjacent markets, increased penetration in the US automotive aftermarket segment and opportunities in emerging technologies such as Tesla and Google.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for PWR Holdings (PWH).
Australian Finance Group (AFG)
Since establishment in 1994, AFG has grown to become one Australia's largest mortgage broking groups.
Key reasons to buy Australian Finance Group
- An environment of increasing compliance and regulatory scrutiny for mortgage aggregators/brokers provides AFG with scope to attract more brokers to its network and expand market share. This is particularly the case given AFG is owned independently of any lender, has scale and a relatively good aggregator platform.
- We believe concerns regarding cuts to broker commissions stemming from the announcement of the major bank levy and concerns about the extent of softening in housing activity as a result of macroprudential rules are overblown. Such concerns have resulted in AFG offering good value at current prices and an attractive dividend yield.
- AFG had unrestricted cash of 40 cents per share on its balance sheet at 31 December 2016. We believe this cash could be used to uncover hidden value through EPS-accretive acquisitions of smaller aggregators or acquisitions in the fintech space.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for Australian Finance Group (AFG).
Bapcor supplies parts and consumables used in vehicle service and repair. BAP operates over 120 Auto Parts stores across Australia.
Key reasons to buy Bapcor
- Incorporation of the recently articulated Hellaby's synergies has lifted our forecasts and provided reassurance in BAP's ongoing growth via acquisition strategy.
- BAP's FY17 result was above our forecast at every line item with the group achieving slightly above the top-end of its guidance range. This growth business with defensive characteristics offers, in our view, an attractive investment opportunity.
- We see the articulation of potential future efficiencies from the warehouse optimisation process (which has been running quietly in the background) and the sale of non-core assets as upcoming catalysts.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for Bapcor (BAP).
Motorcycle Holdings (MTO)
MTO is Australia's largest motorcycle dealership operator, engaging in all aspects of the retail chain (new, used, parts, service, accessories, finance and insurance)
Key reasons to buy Motorcycle Holdings
- MTO is the first and only player looking to consolidate the highly fragmented motorcycle sales and support categories, driven by aligned management with more than 30 years experience.
- FY17 was a strong year for MTO with 12% revenue growth converting to 16% NPAT growth while further acquisitions should also drive material earnings growth into FY18.
- MTO looks to be trading on a fair multiple at 16 times FY18, but we think the market is always going to be chasing growth here as MTO executes a multi-year acquisition and consolidation strategy.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for Motorcycle Holdings (MTO).
Morgans clients can access the full list of high conviction stocks by viewing our latest High Conviction Stocks research report. If you would like more information, please contact your adviser or nearest Morgans office.
Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.