Having watched the Australian share market for a long time, I have developed some favourite stocks – companies whose track record of business growth, and the way they’re managed, I’ve come to admire greatly. This doesn’t necessarily mean that they’re screaming buys right now: but they’re companies that have demonstrated an ability to grow their businesses, and in some cases, adapt their businesses to respond to what the market was telling them.
Here are four of my personal favourite stocks, both in terms of what they’ve done in the past, and what I believe to be a rosy future.
CSL (CSL, $128.42)
Market capitalisation: $8.3 billion
5-year total return: 30% a year
FY17 estimated yield: 1.41%
Analysts’ consensus target price: $130.67
Clearly, the Australian government had no idea what it owned when it sold the former Commonwealth Serum Laboratories (CSL) on the stock market in June 1994. CSL was floated at $2.30 a share: a three-for-one share split in 2007 means that was effectively 77 cents. CSL now trades at $128.42 – meaning original shareholders have made 167 times their money, just on the share price. But original CSL shareholders have also received $13.565 in dividends, which swells their total return to 184 times their investment.
From a government-owned vaccine maker, CSL has become a global biotech leader, the world’s largest maker of plasma-based therapies. That is its main business: CSL collects blood, either from voluntary donors in countries like Australia or paid donors through a network of collection centres in the United States, and separates it into its constituent parts through a process called fractionation, at its plants in Australia and Switzerland.
These individual blood components have a very wide range of therapeutic applications: for example, immunoglobulins can help sufferers of immune diseases; clotting factors can be used to treat sufferers of haemophilia; and the protein albumin is used to treat shock, burns, to assist organ transplantation, as a surgical aid, and in fluid replacement therapy.
CSL has made some crucial acquisitions. In 2004, it bought global plasma therapeutics business Aventis Behring, which made it a truly global business, with R&D and manufacturing operations in Switzerland, Germany and the USA. In 2015, CSL bought the influenza business of Novartis, merging it with its own vaccine subsidiary, bioCSL, to become the second-largest player in the $US4 billion flu vaccine market, after Sanofi.
Now named Seqirus, the business manufactures influenza vaccines at state-of-the-art production facilities in the US, the UK and Australia. The business was a loss-maker under Novartis, but CSL says it is on track to break even in FY18 – meaning that it should become a new source of upside for the company.
CSL has been responsible for a string of major therapeutic products, such as Gardasil, the human papillomavirus (HPV) sold by Merck and Co., which protects against cervical cancer, and the immune treatments Privigen and Hizentra. It has a strong range of new potential winners, such as haemophilia therapies Idelvion and Afstyla, its Berinert and Haegarda treatments for hereditary angioedema, and Kcentra, a treatment for perioperative bleeding.
Longer-term, CSL is also a potential China play, as the increasingly affluent Chinese market looks for Western therapies. At the moment, CSL sells albumin in China – its sales there surged 35% last year – but is restricted from selling most of its other plasma-related products in China. This could well change over the longer term – but CSL sees China as a growth market that will take 10 years or more to open fully to it.
About 90% of CSL’s revenue comes from overseas, with about 38% of that from North America: that makes CSL a particularly great stock for periods when the A$ is weaker, but under former CEO Brian McNamee and his successor Paul Perreault, CSL is simply a very well-run company that has been an outstanding stock exchange performer, and still offers a very attractive growth outlook. The only quibble is that CSL is not a great dividend yield story – investors are mostly banking on the continuing growth story.
Macquarie Group Limited (MQG, $87.73)
Market capitalisation: $29.8 billion
5-year total return: 31.6% a year
Analysts’ consensus target price: $89.56 (Thomson Reuters)
FY17 forecast yield: 4.9%, 42.2 franked (Thomson Reuters)
Australia’s homegrown investment bank has mostly been a great success on the stock market since it listed at $6.50 a share in 1996 – if you overlook the drubbing it took in the GFC. Macquarie moved smoothly to $90 in its first 11 years on the stock market, with its model of satellite financial and investment vehicles directing a $700 million-a-year river of fee income back to the mother ship perfectly suited to the times. But the GFC stripped Macquarie quickly back below $20 a share, as its reliance on volatile trading and capital markets income was shown to be unsustainable.
However, the management team under Nicholas Moore has done a great job since then of transforming the business to a much more sustainable and robust footing based on recurring ‘annuity-style’ income. The company now shows a clean split between its annuity-style businesses, which are Macquarie Asset Management, Corporate Asset Finance and Banking and Financial Services, and its more volatile ‘markets facing’ businesses, which are Commodities and Financial Markets, Macquarie Capital and Macquarie Securities.
With each year, Macquarie becomes less reliant on the markets-facing businesses: the share of operating income from ‘annuity-style’ sources has risen from 23% in 2007 to more than 70% at the latest result. It’s been a remarkable transformation and one that suits investors down to the ground. Macquarie is also a big overseas earner: just under 70% of revenue now comes from outside Australia.
The group has a very strong balance sheet, and has very effectively repositioned itself as a low-risk, stable financial institution with predictable earnings. Earnings per share (EPS) is expected to slip in the soon-to-be-released FY17 result, but resume rising in FY18. Macquarie is also a high-yielding stock, offering 4.9%–5% on consensus estimates in FY17 and FY18, but that is tempered somewhat by relatively low franking.
Analysts see Macquarie as fairly fully valued for now, and it is a stock that benefits from a weaker Australian dollar and positive share markets – but it is an extremely smart and well-positioned Australian business that is a reliable financial earnings machine.
Aristocrat Leisure (ALL, $19.28)
Market capitalisation: $12.3 billion
Five-year total return: 47.4% a year
Expected FY17 dividend yield: 1.7%, unfranked
Analysts’ consensus target price: $19.70
I don’t play poker machines: I’ve never understood the attraction. But seeing that millions of people don’t share my view, I’m happy to benefit from their willingness – and I also like Australian companies that are global leaders. Which makes Aristocrat Leisure (ALL) one of my favourite stocks.
Quite simply, Aristocrat dominates its field like few other Australian companies, with some of the best products and services in the global poker machine business. It is investing heavily in R&D – actually at a record high – at a time when many of its competitors are over-geared and having to manage balance sheet issues: this means it should be able to boost its market share even further. This is particularly the case in the video slot machine market, where Aristocrat’s superior product design gives it a competitive advantage: this market is growing much more than the traditional ‘one-armed bandit’ style of machine.
Aristocrat recently reaffirmed its profit guidance, for 20%–30% in FY17 in its preferred measure, which is normalised net profit after tax and before amortisation of acquired intangibles (NPATA).
This comes after NPATA grew by 69% last year, in Aristocrat’s 11th consecutive year of profit growth, well and truly beating market expectations. Revenue grew more than 34% to a record figure of just over $2 billion. The company’s profit margin in Australia and New Zealand increased by 4.8 percentage points, to 41%, while the margin in its North and Latin Americas division rose 1.6 percentage points to 47.8%. The digital division’s margin jumped by 8.4 percentage points, to 42.4%.
Like Macquarie, Aristocrat has made important strides in lifting its proportion of recurring revenue. By 30 September 2016, the proportion of revenue derived from recurring sources had doubled in two years, from 24% to 50%. And the rapidly growing digital business more than doubled its profit contribution, from 6% just two years ago to 13%.
Aristocrat has a new CEO this year, as Trevor Coker replaces Jamie Odell: Croker has been with the company since 2009. He is based in North America, reflecting the scope of Aristocrat’s business.
Don’t be surprised if further profit upgrades emanate from Aristocrat this year: the momentum in its business appears very healthy. This stock can certainly demonstrate an ongoing, justifiable structural global growth story. The caveat is that investors have to rely much more on capital growth than dividends.
Nick Scali (NCK, $7.41)
Market capitalisation: $600 million
Five-year total return: 46% a year
Expected FY17 dividend yield: 4%, fully franked
Analysts’ consensus target price: $7.90 (FN Arena), $7.93 (Thomson Reuters)
I wrote about up-market furniture specialist retailer Nick Scali in this newsletter in January as one of the best-managed Australian companies, that was a stock to watch in 2017. NCK has surged by 20% since then, after unveiling a better than expected 45% increase in interim net profit, to a record $20.4 million. The result was even better than the company’s upbeat guidance, which foreshadowed a 30%–35% profit rise.
Gross margins rose to a five-year high of 62%, up from 60.6%, while the cost of doing business fell to 36.4% from 39.5%. The result made light of what is supposed to be a fragile retail environment, and showed that the business, led by CEO Anthony Scali, is one of the stock exchange’s best-managed companies, getting its product buying consistently right.
Analysts see strong profit growth in FY17 and FY18 flowing through to commensurate dividend growth, putting NCK on track to yield 4.4%, fully franked, in FY18, with potentially double-digit total return coming from the share price, as the company expands into New Zealand in 2018, grows its budget sofa brand Sofas2Go, and continues to ride the wealth effect from rising house prices, which sees homeowners upgrading their furniture. NCK cost 50 cents back in 2008: it has been a great performer.
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