Financials outside the Big Four – Magellan and FlexiGroup

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When last I conducted a review of the finance sector (excluding property trusts) on the 19th February 2013, only one of the big four, NAB, had an acceptable consensus rating by my definition for inclusion in a High Conviction portfolio. That is, they were in the top 100 and met my ‘2.5’ broker recommendation status (please see my paper on the Market Updates tab of our website www.woodhall.com.au) for details. Not meeting these criteria does not mean they would not have been good investments – particularly for a yield play – but for those wanting growth, the other three did not look like good investments.

From Table 1, all four big banks produced returns well in excess of the ASX 200 index (at +1.4%) and naturally gained around the same as the financials index (at 6.5%) being so large. But Challenger (+41.3%) and Henderson (+20.7%) in the top 100 and Magellan (+43.1%) in the next 100 kicked the lights out over the last six months.

Is it worth venturing outside the big four?

There are currently five financials stocks with a recommendation better than a ‘2’ in the top 200: Magellan Financial Group (1.50), Lend Lease Group (1.93), FlexiGroup (2.10), Suncorp (2.10) and ANZ (2.40). While I would not abandon my overall strategy of choosing larger companies with good ratings, I am not against substituting some of my exposure to big banks with smaller investments in smaller cap stocks.

Since Lend Lease (LLC) and Suncorp (SUN) are in the top 100, it is a no-brainer to at least consider them. ANZ is a genuine high conviction stock – but what about Magellan (MFG) and FlexiGroup (FXL)?

Magellan has had a spectacular run in the market and a massive run in funds-under management as a fund manager. I should declare a potential conflict of interest, in that I’m on an investment committee that has an MFG fund as one in which clients’ funds are invested. I’d have no problem in investing my own funds in that company if I felt the need to invest in a managed fund.

However, my concern is that, if by chance or management, their flagship fund has a bad quarter or two in terms of performance, could the gloss come off and the price run retrace a little? This is not a big chance in my opinion but that is why I would keep my Magellan exposure small, compared to that in the big banks.

FlexiGroup does retail point of sale finance for IT and electrical goods. I defer to brokers’ knowledge of the company and the improvement in the rating from 2.40 to 2.10 over six months, while the share price has only gone up by 3.8%. On this basis, if I were tired of just collecting dividend cheques from my preferred big banks, CBA and WBC, I could imagine reducing that banking exposure by say 10% to 20%, and replacing it with investments in Magellan and FlexiGroup – with a leaning towards FlexiGroup because of Magellan’s recent strong capital gains.

Sector outlook

From Table 2, it can be noted from my recent contributions to this column, our ASX 200 capital gains forecasts have slipped to as low as 10.4% for the next 12 months. When I take exuberance, or mispricing, into account (in the final column), the adjusted forecast for the market becomes 9.1%. The adjusted capital gains forecast for financials is only 2.1%, but the expected yield without franking is 5.6%. This seems like a reasonable motive to take a good look at Magellan and FlexiGroup.

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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