Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 303

Two value opportunities in domestic cyclicals

It looks clear that 2019 will be a challenging year for the consumer. The daily headlines on falling house prices, declining car sales, tightening credit, election uncertainty and regulatory changes are having a reinforcing loop. As always, but particularly in such an environment, we’ve looked to tilt the portfolio away from poorly-positioned consumer-exposed stocks. What does poorly positioned mean? Companies that sell goods and services that are easily interchangeable or are in a highly competitive industry.

An example of a company that is not poorly positioned is Bunnings (owned by Wesfarmers) – sure, sales growth is slowing but it dominates the hardware segment in Australia and will be untouched by disruption, either technological or regulatory.

The balance to this view, though, is that a lot of consumer-facing stocks are looking attractively priced – sometimes up to a 50% valuation discount to the broader market averages. So there are opportunities. Analysing industry structure is how we identify those businesses that should be more resilient in a weaker domestic economy.

oOh!Media

One such opportunity is oOh!Media, an outdoor advertising company. The stock has sold off on concerns around advertising spending, which are cyclical and consumer-sentiment driven. However, the outdoor media industry is taking a larger share of the broader advertising market, averaging 9% growth p.a. for the 10 years to June 2018. Outdoor is boosting its reach thanks to digital billboards and because it is an advertising medium that is retaining its audience, allowing it to offer attractive “reach” to advertisers, particularly against free-to-air TV and print that are experiencing audience fragmentation or decline. Generating 47% of outdoor industry revenues, oOh!Media is the market leader and is well placed to capitalise on gains in market share.

Further, we like the market structure, with the market recently consolidating from four main players to two, after oOh!Media acquired Adshel and competitor JC Decaux bought APN Outdoor. As a result, we think the industry is set to become more rational. We’ve yet to see an industry go from four players to two and see pricing get worse. Trading on eight times enterprise value over earnings before interest, taxes, depreciation and amortisation versus transaction comps and international peers on 10 times, the valuation in our view is yet to reflect an improving industry structure and long-term structural tailwinds for outdoor.

Qantas Airways

Another stock that we expect to perform well in a softer environment is Qantas Airways. The Qantas first half result for fiscal 2018, while at first glance looked ho-hum as profit was down, showed the incredible strength of its franchise. Battling a fuel cost increase that on its own would have led to a halving of profit (see chart below), the company was able to pass all the fuel cost increase through to customers.

Click to enlarge. Source: Qantas presentation, 2019.

Since the end of the capacity war with competitor Virgin five years ago, Qantas has experienced a golden run. The shares are up from $1 to $5.60; the balance sheet is strong; dividends have been re-instated; and more than 25% of the shares on issue have been bought back – a remarkable turnaround. Can it continue? We think it can (subject to the usual caveats re consumer demand, oil prices and competitor behaviour) for the following reasons:

  • The pincer movement Qantas has put on Virgin with Qantas mainline and Jetstar encircling the premium and budget market thus allowing Qantas to achieve more than 60% market share but more than 90% profit share.
  • The remaking of international routes and alliances, which should make blowout losses a thing of the past.
  • The strength of the loyalty program (more than 10 million members) resulting in consistent delivery of about 25% of Qantas’s total profit.

Much can go wrong in an airline business but as we study the industry globally we are hard-pressed to find a company that has the unique advantages possessed by Qantas. The share price values Qantas as if it were no better than most global comparables with a price-earnings ratio (PE) of 9 times. If returns can be maintained, we believe Qantas could justify a PE ratio of 12 times, putting it on a similar valuation to premium-rated airlines such as Southwest Airlines (US) and Ryanair (Europe).

While Qantas and oOh!Media have sold off to low PE multiples of 9 times and 13 times respectively versus the broader market average PE of 17 times, we believe their improving industry structures should drive resilient profitability in the face of a weaker domestic consumer.

 

Emma Goodsell is Deputy Portfolio manager at Airlie Funds Management. Magellan Asset Management, a sponsor of Cuffelinks, bought Airlie in early 2018. This article is general information and does not consider the circumstances of any investor.  

For more articles and papers from Magellan, please click here.

 


 

Leave a Comment:

     

RELATED ARTICLES

Why August company reporting season was poor

Let's focus on modern slavery in Australia

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Strategy

$1 billion and counting: how consultants maximise fees

Despite cutbacks in public service staff, we are spending over a billion dollars a year with five consulting firms. There is little public scrutiny on the value for money. How do consultants decide what to charge?

Investment strategies

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Financial planning

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.

Strategy

Many people misunderstand what life expectancy means

Life expectancy numbers are often interpreted as the likely maximum age of a person but that is incorrect. Here are three reasons why the odds are in favor of people outliving life expectancy estimates.

Investment strategies

Slowing global trade not the threat investors fear

Investors ask whether global supply chains were stretched too far and too complex, and following COVID, is globalisation dead? New research suggests the impact on investment returns will not be as great as feared.

Investment strategies

Wealth doesn’t equal wisdom for 'sophisticated' investors

'Sophisticated' investors can be offered securities without the usual disclosure requirements given to everyday investors, but far more people now qualify than was ever intended. Many are far from sophisticated.

Investment strategies

Is the golden era for active fund managers ending?

Most active fund managers are the beneficiaries of a confluence of favourable events. As future strong returns look challenging, passive is rising and new investors do their own thing, a golden age may be closing.

Sponsors

Alliances

© 2021 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. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). 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.

Website Development by Master Publisher.