Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 298

Get me out of Australia?

Investors’ desire for growth outside of the suffering Australian economy was a major theme to emerge in the February 2019 Reporting Season, particularly in the small-to-mid-cap segment of the market.

Since around September 2018, economic data in Australia has weakened, largely due to the flow-on effect of falling house prices on consumers. Key data points such as retail sales, business confidence and consumer sentiment have all weakened as a result. The downward trend in business confidence has continued with the February 2019 NAB Business Survey confirming that business conditions decreased to the lowest levels since 2013. As shown below, Consensus Earnings per Share growth forecasts were cut after the Reporting Season results by more than anytime since the GFC.

Widespread impact of slowing

In addition to retail, the weakening economic data has impacted automotive, media and building materials contributing to the recent February reporting season being the weakest since the global financial crisis. According to Goldman Sachs' strategy team, housing-related cyclical companies have underperformed their industrial peers within the S&P/ASX200 by more than 80% over the last five years. Domestic cyclical companies such as Costa Group (ASX:CGC), Boral (ASX:BLD) and Bingo (ASX:BIN) disappointed expectations prior to the February reporting season, with these companies highlighting patchy demand over the December quarter.

With investors shying away from domestically-exposed cyclical companies, the divergence between value and growth companies has never been greater, with Goldman Sachs showing that the differential between value and growth is now at highs not seen since the ‘tech bubble’ in the early 2000s. According to Goldman Sachs, the bucket of ‘high price-to-earnings’ firms or growth companies are trading at a 70% premium to the market’s valuation which is 21% above the long-term average.

On our estimates, sectors exposed to the domestic economy represent approximately 31% of the S&P/ASX Small Industrials Index. Given the uncertainty associated with these sectors at present, investors have been looking for growth companies offering greater certainty to earnings, which has driven up valuations as a result.

With consensus now assuming that the RBA may cut the cash rate in the second half of the year, expectations are for the Australian dollar to continue to decline. This expectation has driven companies with strong offshore franchises, to outperform strongly.

Which companies are still doing well?

Companies such as IPH Limited (ASX:IPH), Breville (ASX:BRG), Lovisa (ASX:LOV), Appen (ASX:APX) and Altium (ASX:ALU) reported solid results and have seen their valuations increase to all-time highs. Following the lead of the FAANG (Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX), Google (NASDAQ:GOOGL)) stocks in the US, the Australian technology sector (what we call the WAAAX sector: Wisetech (ASX:WTC), Afterpay (ASX:APT), Altium (ASX:ALU), Appen (ASX:APX) and Xero (ASX:XRO)) has seen valuations increase to extraordinary levels with the average 12 months forward price to earnings multiple for these four companies a whopping 70x (excluding APT which is loss making) compared to the ASX Small Industrials Index which currently trades on 19x.

At Wilson Asset Management, we focus on undervalued growth companies in the market and like to invest in strong brands that have the potential to grow strongly in offshore markets. Two examples are Austal (ASX:ASB) and Infomedia (ASX:IFM).

ASB is a shipbuilding company with the vast majority of its earnings (92%) derived from its US business which has a contract to build Literal Combat Ships (LCS) for the US Navy until 2025. With the company currently outperforming its competitors, we see the opportunity for ASB to take market share and win large maintenance contracts on offer for the LCS fleet once it becomes operational over the next few years. The recent expansion of its low-cost Philippines shipyard has the ability to shift work away from Austal’s high-cost Australian operations. ASB is well placed to grow earnings above expectations, with its growing support business providing a scope for a rerating of Austal’s valuation.

IFM is a technology company which does not have a ‘sky high’ valuation such as its WAAAX peers. The company is a leader in parts and services software to the automotive industry and has a strong exposure to Europe and the United States, representing 75% of its revenue. The recent first-half result is a breakthrough result for the company, with the previous 12 months of investment paving the way for the business to achieve double digit growth over the medium-term. The recent acquisition of Nidasu and other bolt-on acquisitions will further boost Infomedia's product suite going forward. IFM is trading on a price to earnings multiple of 32x which is less than half the valuation of other technology companies mentioned previously and is well placed to beat earnings expectations going forward.

Despite a number of domestic cyclical companies currently offering investors value, we believe the attraction to offshore growth companies will continue. This reflects a highly uncertain domestic environment in Australia, fuelled by falling house prices and exacerbated by the upcoming NSW and Federal elections and the fallout from the Royal Commission into Misconduct in Banking, Superannuation and Financial Services Industry.

 

Oscar Oberg is a Lead Portfolio Manager with Wilson Asset Management. Listed investment companies managed by Wilson Asset Management were invested in ASB and IFM. This article is for general information purposes only and does not consider the circumstances of any investor.

 

RELATED ARTICLES

After 30 years of investing, I prefer to skip this party

Why it's a frothy market but not a bubble

FANMAG: Because FAANGs are so yesterday

banner

Most viewed in recent weeks

An important Foxtel announcement...

News Corp's plans to sell Foxtel are surprising in that streaming assets Kayo, Binge and Hubbl look likely to go with it. This and recent events in the US show the bind that legacy TV businesses find themselves in.

Warren Buffett changes his mind at age 93

This month, Buffett made waves by revealing he’d sold almost 50% of his shares in Apple in the second quarter. The sale not only shows that Buffett has changed his mind on the stock but remains at the peak of his powers.

Wealth transfer isn't just about 'saving it up and passing it on'

We’ve seen how the transfer of wealth can work well, with inherited wealth helping families grow and thrive for generations, as well as how things can go horribly wrong. Here are tips on how to get it right.

Welcome to Firstlinks Edition 575 with weekend update

A new study has found Australians far outlive people in other English-speaking countries. We live four years longer than the average American and two years more than the average Briton, and some of the reasons why may surprise you.

  • 29 August 2024

The challenges of building a portfolio from scratch

It surprises me how often individual investors and even seasoned financial professionals don’t know the basics of building an investment portfolio. Here is a guide to do just that, as well as the challenges involved.

Welcome to Firstlinks Edition 573 with weekend update

Steve Eisman, best known for his ‘Big Short’ bet against US subprime mortgages before the 2008 financial crisis, is now long and betting on what he thinks are the two biggest stories of our time: AI and infrastructure.

  • 15 August 2024

Latest Updates

Investing

Legendary investor: markets are less efficient and social media is the big culprit

Despite an explosion in data, investment titan, Cliff Asness, believes the market has become less efficient, not more, over his 34-year career. He explains why, and how you can take advantage of it.

Property

A housing market that I'd like to see

Our housing system isn't working, with prices and rents growing faster than wages, longer public housing waiting lists and more people are experiencing homelessness. Here are five ways to ease the crisis.

Retirement

It isn’t just the rich who will pay more for aged care

The Government has introduced the biggest changes to aged care in almost 30 years. While the message has been that “wealthy Australians will pay more for aged care”, it seems that most people will pay more, some a lot more.

SMSF strategies

Meg on SMSFs: At last, movement on legacy pensions

Draft regulations released this week finally provide the framework for unwinding legacy pensions cleanly and simply for members who choose to do so. There are some caveats though, including a time limit.

Investment strategies

A megatrend hiding in plain sight: defence

Global defence spending has inflected higher, bringing huge opportunity to a group of companies that have already outperformed broader market indices over the long-term.

Investment strategies

The butterfly effect, index funds, and the rise of mega caps

Index fund inflows to the US market are relatively tiny. Yet a new research paper suggests that they have distorted the size of the market's largest stocks to a surprising degree.

Investment strategies

Options for investors who don't want to sell overpriced banks

The run-up in Australian bank stocks has some investors confounded: do they continue to hold them in expectation of further gains - or sell and take profits now? There are alternative options to consider.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.