Stocks to consider for value: Transurban, Sydney Airports and the banks

Investment Committee, Switzer Dividend Growth Fund
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Despite the big sell off in the US on Friday, the month of May overall was not the major correction in equities that many headlines were looking for. Unlike recent years that were dominated with significant European macro shocks, this was more of a constructive rotation from some defensives that began in global markets in April, combined with some overall profit taking within equities following the strong performance year-to-date. There was also the rise in market volatility that challenged investor sentiment, following the Fed’s Ben Bernanke’s comments on the timing of when to begin tapering the QE (version 3.0). Profit taking from risk assets and a general flight to safety resulted.

The strategy

In general, a constructive overweight to equities, both domestic and international, are the tactical recommendations. The year-end target for domestic equities remains at 5,550. This implies single-digit earnings growth, with a marginal expansion of the multiple. Buying the dip is the theme. While equity valuations are more expensive versus year-ago levels, the investment backdrop was very much different. While multiples (one year forward or trailing) are just below long run averages, given the lower rate backdrop, I would anticipate additional multiple expansion before year end, driven by the non resource sector.

What sectors can deliver versus expectations?

The decreasing terms of trade underway looks set to continue, as the pulse of economic activity from the emerging economies, particularly China, softens versus expectations. They are simply growing very well, but at a decreasing rate. This implies a backdrop of a lower AUD (versus the past year average), lower rates for longer, due to a lower growth environment and a more subdued earnings environment across the resources sector. The challenge locally is how the other parts of the economy start to recover and ultimately contribute to more growth, therefore contributing more to earnings in the ASX200. The housing cycle, infrastructure and general CAPEX outside of resources and mining services are all currently constrained. These parts of the economy can improve from current low expectations and have the potential to grow earnings versus current expectations. This will be supportive for some sectors and stocks outside of mining.

What are some of the stocks across the sectors that look attractive?

Outside of the major resources, the opportunities will be in the following sectors and companies:

Banks: I am not a bank bear like many and a neutral bank sector weighting looks prudent, given the healthy dividend before the franking. They are just very well run, controlling costs and good capital management versus their peers globally. This implies a lower growth environment until other parts of the economy can recover.

Diversified financials: The opportunity for a recovery in the broader housing cycle, personal wealth and superannuation will be supportive for Macquarie Bank, AMP, Perpetual and the ASX to name a few. In the insurance sector IAG, Suncorp and QBE are the standard defaults.

Consumer staples and discretionary: A neutral to marginally underweight stance for staples, given their valuations, with a preference for Wesfarmers over Woolworths. In discretionary, the focus is on Myer and David Jones as an opportunity to accumulate towards the $2.25 levels. They have seen a fair bit of profit taking since mid April and will benefit with the slow improvement in wealth effects at the household level.

Transport and Infrastructure: Transurban, and a more cyclical infrastructure asset Sydney Airport, are both stocks to accumulate. Asciano is a transport company with diversified assets that is well placed to grow over an extended period.

Healthcare: With the adjustment in currency and the traditional defensive earnings profile of the sector, both ResMed and CSL have been the preferred exposure. Cochlear under $60 is a strong accumulation recommendation.

Summary

The prospect of more upside versus downside is my core view, therefore a more constructive increase in the risk position in June is recommended. There are headwinds, however the retracement in markets over the past six weeks is an opportunity to accumulate.

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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