It’s all about the cyclicals – JBH, WOW and a Dick Smith float

Chief Investment Officer and founder of Aitken Investment Management
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Late last week and earlier this week, over three days, I met with Asian long only, hedge fund and family office investors, who control over a trillion dollars in assets.

When you embark on these investor road shows to talk about Australian specific investments, you can never be quite sure what reception you will get. However, I must say, on this round, I was very pleasantly surprised by the constructive attitude towards Australia and the way the Asian investment community approaches generating alpha from Australian equities.

What really impressed me and got me heavily engaged is everyone wanted to talk domestic macro themes and individual stock selection. The focus was very, very domestic and on how to capture maximum alpha in Australia. Any Australian idea had to offer growth/value similar or better than what was on offer in greater Asia.

How to invest in Australia

My answer to how to approach Australia, if I was sitting in Asia, was relatively simple. It didn’t get too much disagreement.

I said I would be short AUD/USD as the overlay trade with an 80 US cents target, then be high conviction long specific domestic structural and cyclical growth themes that are supported by monetary policy, fiscal policy or legislation. The biggest ideas are supported by all three.

When I was speaking to Asian investors, I strongly encouraged them to think about a more normalised Australian economy, with conservative political leadership and a more balanced GDP contribution from traditional Australian sectors. They really need to dust off the playbook from the early to mid-00’s in Australia and that period saw very strong outperformance from East Coast cyclicals.

Let’s go shopping!

Where there was the greatest debate was on Australian consumer discretionary stocks. Nobody really disagreed that rising median property prices, rising consumer confidence, rising superannuation balances, rising equity prices (particularly those owned by mums and dads) and full employment should lead to Australian households loosening their purse strings to a degree. The much larger debate was about discretionary retail stock selection in Australia.

The generally feeling is the good retailers in Australia with a structural advantage of some nature are very well priced, while those who are facing structural challenges are cheap for valid reasons. Many Asian investors had genuine concerns about the long-term ramifications of global brands, such as Zara, H&M and Top Shop arriving in Australia. They see these companies as “fast moving fashion goods” (FMFG) and likely to make traditional Australian department store offerings look poor value and slow in terms of seasonal fashion.

I think that FMFG concern is a genuine structural change in Australian retailing and I suspect for people like Premier Investments (PMV), Myer (MYR) and David Jones (DJS), it restricts Asian investor interest. However, I did get an audience to come around to JB Hi-Fi (JBH) in terms of consumer electronics and I also suspect the Dick Smith float will get Asian investor interest on the same basis.

Interestingly though, Woolworths (WOW) came up a lot as a relative value way of playing consumer spending rising in Australia, with Asian investors far more tolerant of short-term start-up losses in the Masters strategy than many domestic investors. I suspect WOW could get Asian default money, if we see further data evidence of a rise in domestic consumer spending.

Confirmation bias

The final point I left Asian investors to consider on this East Coast recovery theme is the fact I think analysts and the market in Australia are very slow in cyclicals.

There appears to be about a six-month delay between real time evidence of activity increasing in Australian cyclical industries and consensus analyst numbers being upgraded. I stressed to Asian investors that the majority of Australian industrial cyclical analysts wait for confirmation from the companies of better profitability, which leads to a clear time arbitrage opportunity in Australian cyclicals, once the upgrade arrives.

Right here, right now, the consensus view from strategists and cyclical analysts is that Australian East Coast cyclicals have run ahead of fundamentals. There are sell/neutral recommendations everywhere.

I can’t stress enough how much I disagree with that view. I strongly believe that current-year and particularly forward-year consensus estimates in Australian cyclicals are underestimated. I believe we are at the infancy of a multi-year earnings upgrade cycle, where P/E will be added concurrently with EPS/DPS upgrades.

I simply believe analysts are underestimating both the top down and bottom up drivers of East Coast cyclical earnings. That was the no.1 message I left with Asian investors and I think they are dusting off the research files on these deeply cyclical East Coast Australian names that they haven’t looked at for many, many years.

It’s all about stock picking now.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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