There was a lot to like about the February reporting season. By our estimates, over 30% of large caps beat the market's expectations, while downgrades and significant misses among large caps were largely a non-event. However, the valuations investors are paying for earnings remain elevated by historical standards, and we caution investors who are expecting higher-than-average returns.
Current earnings growth sits well below the long-term average (approximately 9-10%), reflecting below-trend economic growth, while valuations (XJI on approximately 16x forward) appear to be pricing in earnings acceleration that is yet to be delivered. The market has been prone to overshoot the actual earnings trajectory in recent years and we think investors should stand ready to buy the dips when the inevitable bouts of market volatility hit, rather than chase expensive stocks higher.
Refer to our Reporting Season Review for more on our best stock ideas and key themes.
Two changes to our list this month
We add BHP Billiton (BHP) back to the list in March. Higher commodity prices, robust profitability, further valuation upside potential and rising shareholder returns all support our High Conviction call on BHP. The company also recently outlined that data rooms for all of its US onshore oil & gas assets would be open by the end of March, with the bids expected in the June quarter and assessed in the September quarter. We see this as the strongest positive catalyst for BHP in 2018. We also believe strong leverage to cyclical growth positions BHP well into a multi-year recovery for commodities.
This month we remove Corporate Travel Management (CTD) from our list. While we believe CTD can continue to deliver strong double digit EPS growth over coming years, the stock has put on 27% following its recent result, and has now exceeded our 12-month price target of $24.50. Beyond the strong result, share price catalysts include further accretive acquisitions with opportunities currently being evaluated in both North America and Europe.
Seven high conviction stocks in March
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.
Here are our seven high conviction stock picks this month:
Oil Search (OSH)
Oil Search is a major oil and gas developer/producer. OSH's key asset is its 29% interest in the world-class PNG LNG Project/Development, operated by ExxonMobil.
Key reasons to buy Oil Search
- OSH confirmed our long-term belief at the result that a 3-train expansion of its PNG LNG operations was now the new base case to which the respective joint ventures are working. This entails a 2-train operation supported by the Elk-Antelope reserve base, and a third new train supported by P'nyang (referred to formally as PNG LNG T3).
- We see a further upside scenario from Muruk potentially displacing P'nyang.
- We still hold the view that OSH is ideally placed to benefit from a global-scale organic growth profile, which could be further enhanced by additional exploration and appraisal.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for Oil Search (OSH).
ResMed develops, manufactures and markets medical products for the treatment and management of respiratory disorders globally.
Key reasons to buy ResMed
- Recent 2Q results were solid across the board, with patient volumes improving, strong device sales continuing and the mask annuity stream taking market share.
- ResMed continues to cement its leadership position in healthcare informatics, with the high-margin Brightree SaaS model performing to expectations (low to mid teen growth), supporting device/masks growth and gross margin gains.
- ResMed is a key beneficiary of a weaker AUD, with 95% of revenue derived from offshore and c80% of R&D expenses AUD dominated.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for ResMed (RMD).
Westpac Bank (WBC)
Westpac is Australia's oldest banking and financial services group, with operations throughout Australia and New Zealand.
Key reasons to buy Westpac
- WBC has a relatively low risk profile in terms of loan book positioning and low reliance on treasury and markets income.
- The bank stands to benefit most from re-pricing of investor home loans.
- We expect WBC to comfortably meet APRA's 'unquestionably strong' capital benchmark through undiscounted dividend reinvestment plans.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for Westpac Bank (WBC).
Link Administration (LNK)
Link is the largest provider of superannuation fund administration services to funds in the Australian super system and a leading provider of shareholder management and analytics and share registry services.
Key reasons to buy Link
- We are attracted to its significant levels of recurring revenue (>70%) backed by 3-5 year contracts in a relatively defensive industry (funds administration and registry services).
- We believe the market's view on LNK's core Fund Administration business being ex-growth is too bearish. We think it will at least grow at inflation levels from here. Moreover, the synergy target from the CAS acquisition of £25m would appear to be conservative.
- Trading on a 16x FY19F PE (first full year of CAS acquisition), we think LNK is inexpensive for a stock of its quality.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for Link Administration (LNK).
BHP Billiton (BHP)
BHP is the world's largest diversified resources company, with a large portfolio of diversified mining and energy interests.
Key reasons to buy BHP Billiton
- On recent selling pressure we step up our Add rating conviction, with the global diversified miner benefitting from a supportive commodity pricing environment.
- Stronger certainty of earnings and lower capital expenditure commitments have resulted in BHP stepping up shareholder returns in recent periods, a trend that is set to accelerate with BHP preparing to divest its US onshore oil & gas business.
- BHP asserts itself as an attractive sector exposure, with group EBITDA margin stable at an impressive 52%, balance sheet gearing down below 20%, and the prospect for excess cash flow being returned to shareholders.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for BHP Billiton (BHP).
Senex Energy (SXY)
Senex is an oil and gas company focused on operating and developing energy sources in Australia's Cooper, Eromanga and Surat Basins.
Key reasons to buy Senex
- SXY is ideally positioned to make a material impact on the east coast gas market with two gas projects expected to transform earnings over the next few years.
- SXY has advised it has finalised the design of sales gas processing facilities for WSGP and should have the plant online by late 2018. We expect sales revenue to start following the commissioning of this facility.
- SXY is leveraged to rising oil prices through its existing oil production and longer term through its oil-linked WSGP gas sales agreement with GLNG.
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for Senex Energy (SXY).
PWR Holdings (PWH)
PWR designs and produces cooling solutions for the high performance automotive industry and has an established track record in servicing motorsports, including Formula One, NASCAR and V8 Supercars.
Key reasons to buy PWR Holdings
- 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 and with that now largely out of the way, FY18-20 are set to be much stronger years.
- Key growth opportunities include: 1) capturing a greater share of customer spend on cooling solutions; 2) partnering with OEMs on high performance/low production run vehicles; 3) increased presence and entry into adjacent markets; 4) increased penetration in the US automotive aftermarket segment; and 5) opportunities in emerging technologies (Tesla, Google etc).
We retain our Add recommendation. Morgans clients can login to view our detailed research and share price target for PWR Holdings (PWH).
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.