Only one thing is harder than choosing great stocks to buy: knowing when to sell them. Even professional investors can struggle to sell exceptional companies that continue to perform strongly but have become overvalued after stellar share gains.
Every stock has its price. The discipline to take profits on overvalued stocks or exit them completely, separates great investors from the rest. They recycle profits into undervalued stocks, protect capital and rebalance their portfolio to maintain target allocations.
Inexperienced investors stick with their winners for too long, extrapolating past performance too far into the future and overlooking valuation. They end up with stocks with a share price chart that resembles a tombstone: they own it all the way up and all the way down.
A sudden fall from grace for infrastructure and utility stocks seems unlikely, given Australia’s record-low interest rates and expectations of further rate cuts in the next 12 months. The yield trade is alive and well as income investors seek stocks with reliable, higher dividends.
Economic uncertainty favours these defensive sectors. Stocks with strong “economic moats” or sustainable competitive advantages have greater capacity to maintain earnings and dividends growth. Think airports, toll roads, gas distributors and other monopoly assets.
However, it is time to take profits on star infrastructure stocks and utilities. That does not mean exiting these sectors completely, and this view is quarantined to portfolio investors seeking a mix of growth and income at an appropriate price.
I noted in May 2016 in a report on infrastructure Budget winners for the Switzer Super Report, that Sydney Airport and Transurban looked “fully valued”. Both have rallied further, reinforcing my view that it is time to take some profit.
A share market that has risen for seven weeks straight, and looks a bit stretched on aggregate valuations, adds to the case to trim exposures in what is traditionally a seasonally weak period for shares.
Still, share market traders and active investors will find little reason to sell Sydney Airport and Transurban, which have beautifully up trending share price charts.
Income-focused investors, who bought infrastructure stocks and utilities for their yield, also have reason to hold them. The sector’s yield still looks more reliable than other parts of the market, at least for the next few years.
But those looking to build portfolios through long-term capital growth should consider taking some profits on Sydney Airport, Transurban and Macquarie Atlas Roads Group, and using the proceeds to build up portfolio cash levels and pounce when the market is cheaper, perhaps even buying these stocks back at lower prices.
Those with significant capital losses might take profits before June 30 to absorb capital gains from these stocks. Discuss this end-of-financial-year strategy with your financial adviser first, because the big infrastructure stocks, if held for years, will have large capital gains.
The other reason for selling, of course, is to rebalance portfolios. Every investor is different, but those who hold winning stocks for too long, especially in the same industry, inevitably skew their portfolio’s sector exposures and reduce its diversification. Many retail investors have too much bank exposure, for example, because of strong gains in the Commonwealth Bank over the years.
I do not suggest taking profits on the big infrastructure stocks lightly. Also, I stress that this view is based only on valuations getting a little ahead of reality, not company performance. Sydney Airport, Transurban and Macquarie Atlas Roads are well run and their recent performance has exceeded market expectations. They have good prospects, but the share price has already factored them in and then some.
Sydney Airport
Sydney Airport has been a mainstay in my commentary since late 2008. It was an early inclusion in my Cash Club income portfolio for AFR Smart Investor magazine and has remained there since. I have written about Sydney Airport several times for the Switzer Super Report, most recently as “one of five stocks to buy in a market sell-off” in January 2016. Its one-year total shareholder return (including distributions) is 35%.
Over five years, Sydney Airport’s average annual total return is 27%. The price has increased fivefold since early 2009, despite some fund managers arguing it was overvalued, had too much debt and was too complex. Others said Sydney Airport has been bid higher because of its status as a “defensive yield” stock in an environment of low interest rates, rather than its fundamentals.
My interest was based on Sydney Airport’s exposure to inbound Asian tourism and the growing propensity of Australians to travel as discount airfares fell – a theme I outlined for the Switzer Super Report in my August 2015 analysis of the global tourism megatrend.
Sydney Airport’s April domestic and international traffic growth beat market expectations. Double-digit growth in international passengers in the year to April 2016 was exceptional and reminded the market just how leveraged Sydney Airport is to the coming Asian travel boom.
But Qantas Airways and Virgin Australia earlier this year complained of weaker domestic travel, and a patchy economy and a lower Australian dollar could discourage more people from travelling overseas (although that makes holidays here more competitive for international travellers). Qantas’ latest traffic statistics show an improving outlook.
The Australian Competition and Consumer Commission’s annual Airport Monitoring Report in 2014-15 said a lack of competitive pressures was aiding high airport profit margins. Sydney Airport earned 50.1 cents in each dollar of aeronautical revenue – the highest in Australia. This adds to rising regulatory risks for airports and is another headwind for airport price rises.
Sydney Airport’s valuation has factored in its surging traffic performance. On Macquarie Equities’ numbers, it trades on a CY16 EBITDA (earnings before interest, tax, depreciation and amortisation) multiple of 22 times.
Sydney Airport’s trailing price-earnings (PE) multiple is 57 times and the enterprise value/EBITDA multiple is 24 times, using consensus analyst estimates. This is the stuff of super-high growth stocks with exceptional assets.
The market might be extrapolating Sydney Airport’s outstanding performance too far into the future at the current price. Locking in profits, while maintaining some exposure to Sydney Airport, seems prudent, given the magnitude of its gains and rising valuation metrics.
Chart 1: Sydney Airport
Source: Yahoo
Transurban Group
Transurban has been one of my favoured stocks over the past few years. Its one-year total shareholder return (including dividends) is 24%. Transurban has soared from $7 at the start of 2014 to almost $12.
Like Sydney Airport, Transurban’s traffic performance continues to grow strongly. The toll road operator’s third-quarter traffic and revenue data beat market expectations after 13% revenue growth in its Sydney and Brisbane toll roads and 6.5% growth in Melbourne.
I viewed Transurban as a key beneficiary of rising population growth, urbanisation and congestion in the capital cities. The inability of state governments to agree on new road transport infrastructure, let alone fund it or give it the green light, also meant increasing usage of toll roads and potential for concession extensions as new investments were made.
I like Transurban’s ability to widen its toll roads, as in Melbourne, and support revenue growth through higher traffic volumes (albeit with short-term traffic disruption). An improving performance from its United States toll roads, a market concern, was another positive.
A consensus median price target of $11.68 from 11 broking firms suggests Transurban is a touch overvalued at the current price. Using Capital IQ data, Transurban has an enterprise value/EBITDA multiple of 26.5 times, more than Sydney Airport.
New projects should support continued strong earnings growth over the next few years, although lower inflation affects a big chunk of Transurban’s underlying earnings that are CPI-linked. The good news is falling inflation should reduce Transurban’s borrowing costs when debt is repriced in the next few years.
Nevertheless, it is worth locking in some profits given the strength of Transurban’s gains. Its expected 4% yield and low franking makes it less attractive for income investors.
Chart 2: Transurban Group
Source: Yahoo
Macquarie Atlas Roads Group
Like Transurban and Sydney Airport, Macquarie Atlas Roads Group has been a cracking performer: the one-year total shareholder return of 70% says it all. The three-year average annual return is 48%.
The global toll road operator had an excellent calendar-year result and its first-quarter 2016 traffic growth beat market expectations and continued a trend of strong underlying growth.
A median share price target of $5.08 suggests Macquarie Atlas Roads is slightly overvalued at the current $5.23. Price targets range from $4.30 to $5.70.
Of the three stocks, Macquarie Atlas has the strongest case for further short-term gains. A buoyant market for infrastructure assets gives it plenty of options to sell its interest in the Dulles Greenway toll road in the US, should it wish. The improving US economy is another benefit.
Still, the market is factoring in huge growth after a 70% return over 12 months. Locking in a few profits, in such an uncertain global economy, makes sense. As with Sydney Airport and Transurban Group and other stocks sensitive to interest rates, it is always better to take profits too early than too late.
Infrastructure stocks will underperform, if US interest rates rise faster than expected in the next few years, a risk that the market might be underestimating.
Chart 3: Macquarie Atlas Roads Group
Source: Yahoo
– Tony Featherstone is a former managing editor of BRW and Shares magazines. The column provides general media commentary only. It does not take into account individual reader needs and should not be used for formal stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis at 1 June, 2016.
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.
