So here we go, the world is worried about Donald Trump being President of the United States of America. Fair enough, it’s a genuine concern but this election is a genuine coin toss and the outcomes for markets are binary. Either way I encourage you to be a little brave and consider a trifecta of beaten up Australian growth stocks that have already suffered deep and, in our view, over-done corrections.
There are three stocks I am “thumping the table” on: Star Group (SGR), Link (LNK) and APN Outdoor (APO) after heavy corrections. Remember the idea is to buy low.
At the macro level, we continue to believe interest rates globally and locally have bottomed for the cycle. Similarly, we believe bond yields have bottomed for the cycle and bond investors face the potential for genuine and permanent capital losses. Bonds remain real return free capital risk in our opinion.
Our conviction on shorting long bonds was increased in October as global inflation readings surprised on the upside and commodity prices continued to advance. Chinese PMI was positive and US GDP growth accelerated in Q3. We think long bond yields now face the triple threat of central bank tapering, fiscal spending increasing and inflation rising from a low base.
Our biggest short is in US 30 year Treasuries where we believe the best potential short “pay off” lies over the months and years ahead. We are shorting the longest duration we can, as we feel that is where the greatest bond mispricing lies. We are also considering broadening the short to High Yield (Junk Bonds) and Corporate Credit where we feel risks are also rising.
Back to Australia and we want to be clear that we believe that our key holdings were unfairly punished in October and offer genuinely compelling risk/return characteristics at current low prices. This is why we increased our exposures to our key holdings and crystallised some gains on successful shorts.
The ASX has seen more index and stock specific volatility this month than any other developed equity market we invest in. While the benchmark ASX200 is down -2.2%, this somewhat masks the fact that 1:5 ASX 200 companies are down more than -10%. Yes, 43 of the ASX200 are down -10% or greater this October.
As well as that, over 100 of the ASX200 are down more than -5% last month. An equal weighted index of the ASX200 members is down -4.2% for the month.
This is a very Australian specific event and the AIM Global High Conviction Fund has taken advantage of what we feel are unjustified pullbacks in what we consider Australian structural growth stocks.
There has been some genuine “baby out with the bathwater” style behaviour Australian equities, which we haven’t been immune to in terms of a couple of stocks dragging on our short-term fund performance (despite our shorts in yield names, healthcare and long bonds working well), but it has given us the opportunity to top our holdings at prices we think are oversold in specific Australian stocks and we remain high conviction on their medium-term investment case.
Star Group (SGR) has quite simply been punished for a “crime” it didn’t commit. In the remarkable way short-sighted equity markets work, SGR actually fell MORE than Crown Resorts (CWN) this month, despite having no direct problems in China.
Analysts have downgraded FY17 SGR earnings forecasts but the share price fall is much larger than the consensus earnings downgrades. We tend to think the earnings downgrades chased the share price down as analysts erred on the side of caution. SGR consensus FY17 EPS forecasts have dropped from 31.8c to 29.2c (-8.1%). We think they will prove too conservative and the 2H of FY17 for SGR will prove better than expected as we get more certainty about Chinese VIP numbers (12% of SGR revenue) and the end of refurbishment interruption at Star Sydney and the Gold Coast.
At $5.00 we believe SGR is outright cheap. Negative SENTIMENT has gone too far. On a P/E of 17.1x now conservative FY17 earnings forecasts and offering a dividend yield of 3%, we believe the total returns from SGR from $5.00 will be compelling. We remain strong believers in the growth in Chinese international tourism and feel SGR is very well positioned to capture a disproportionate share of that inbound tourism growth into Australia over the years ahead.
Another stock to have been sold off aggressively recently is Link Group (LNK), which has fallen from an all-time high of $9.00 to a recent price of around $7.25. Link produced solid results in August that saw slight upgrades to consensus numbers in FY17 and FY18. We believe the reason for the de-rate is twofold: Firstly, in mid-September the private equity groups who floated the business sold out of their remaining stakes (105m shares or ~30% of the company) in a well-flagged sell-down at $8.38. This sell-down had long been expected and occurred in-line with expectations at the time of the IPO in October last year.
However an ~$850m block is always going to cause some indigestion in the secondary market. Secondly, the ACCC pre-emptively issued a Statement of Issues regarding a potential bid by Link for a small government owned competitor (Pillar Administration) stating that it sees potential competition issues for a tie-up between the two companies. Whilst Link had flagged interest in submitting a bid for Pillar in the government sell-down process, a positive outcome for Link was far from certain. An acquisition of Pillar was not in our numbers and not in any sell-side analysts forecast numbers either. However, according the AFR, Link is in the last two bidding for the asset. A positive surprise could be coming here.
The chart below highlights the de-rate that has occurred in the stock, it shows the share price (in white) overlayed against the consensus earnings for next year (in red). The stock is back at levels not seen since shortly after its IPO, whilst earnings estimates have tracked up by around +8-10%. This equates to a PE de-rate of over 25% from the highs of the stock prior to the recent sell-down.
LNK remains our no.1 exposure to the structural growth of Australian compulsory superannuation services.
APN Outdoor (APO) is the final Australian stock we have built a position into a major de-rating. APO is a play on the “digital economy” via switching its billboards from static to digital screens therefore enhancing their revenue yield. APO is a classic example of an investment idea you can see with your own eyes in everyday life. APO signs dominate every major motorway and airport we travel through and the digital screens clearly attract your attention more than a static billboard. You can see how dominant their billboard positioning is and how much more effective the digital screens are as they flick between advertisements.
We believe outdoor advertising will continue to take share from other traditional media platforms. The outdoor segment has growth +16% in the first nine months of 2016. The table below from Morgan Stanley confirms the revenue share gains that outdoor is taking.
Advertisers want more digital boards because of the speed to market, added functionality and effectiveness.
APO’s great advantage is it currently has around 600 traditional (static) billboards that are ripe for conversion to digital screens over the years ahead. Note well that new approvals of billboards are proving harder for the entire industry, so existing inventory is increasingly valuable. The equity market appears to not really value these 600 “old” boards at anything, but they are the key attraction of APO and will be how the company delivers double digit compound EPS growth over the years ahead as they are converted to digital.
APO’s current guidance is to convert 15-20 billboards to digital per annum. But there’s no reason why this debt free company shouldn’t accelerate that rate. Digital billboards have an ROIC of greater than 50% and a 2-3 year pay back. On that maths, accelerating the conversion rollout is a no-brainer. This is particularly so when you look at the table below from Morgan Stanley and see digital conversion is they key driver of APO’s profit growth.
AIM did not own APO before its spectacular de-rating, post its last result, but we think the stock is now compelling value and will revert, through time, back to a growth multiple from its current value multiple. We feel the profit warning will prove “one off” due to the Federal Election and Olympics and that APO will resume growth.
APO is a classic example of a mid-cap stock that got over-owned and over-priced, yet we feel the register wash-out has now occurred and the road to recovery will be with less expectation. We now believe APO is structural growth at a cheap price.
The chart below shows that CY17 EPS forecasts have fallen but the APO share price has fallen significantly further.
At $4.75, APO is trading on a forward CY17 P/E of 13.9x and offers EPS growth of +15% and a dividend yield 4.10%. EV/EBITDA is just 8.76x CY17 estimates. That is a -20% valuation discount to the ASX200.
In volatility there is opportunity and AIM has taken advantage of what we think will prove three oversold/undervalued structural growth situations in Australia: SGR, LNK and APO.
We remain very focused on positioning the portfolio for the next six, 12 and 24 months, both in structural long and short positions globally and locally.
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.
