The re-rating of Australia’s most expensive stocks is typical of a late phase bull market. Strong momentum of fund flow has driven a sharp re-rating of high price earnings ratio (PER) stocks. The top quintile for the ASX 200 is now trading at 50% premium to the median stock on the ASX 200, this is the highest premium in almost 20 years. This is representative of valuations for CSL, COH and RMD in the healthcare sector and Cleanaway Waste Management in the industrial sector.
-> High PER vulnerability when earnings growth begins to slow. This is typified by the retracement in the share price of Ramsay Healthcare whereby earnings per share growth has slowed from 12%-14% in FY16 to the company forecasting c.2% in FY19.
-> The chilling effects of regulatory intervention across a growing list of industries including: aged care, banking/financial services, retail energy markets, private health insurance.
-> The banking sector is facing mounting headwinds of higher compliance costs, credit contraction and higher wholesale funding costs. Earnings quality is at risk as property prices decline and borrowers move from “interest only” loans to “principle and interest” repayments.
-> The impact of reduced credit availability is impacting the property development sector. Specifically, Brickworks cited a slowing of property development pipeline due to lack of bank finance.
-> Technology disruption in the banking sector. We spoke with a major retailer who is replacing its point of sale (both online & offline) with a global payments system that avoids bank merchant fees, historically a rich source of revenue for the banking sector.
-> A greater focus by large companies incorporating technology to better understand its customer base and improve competitiveness using data analytics, digitalisation & automation.
-> Industrial companies citing the significant impact of cost inflation of rising energy prices, labour scarcity and higher transport costs. Most notable with Australian companies operating in the US where the strongest economy in 30 years is placing unprecedented cost pressures on supply chains.
-> Companies increasing pay-out ratios via special dividends, e.g.: special dividends from Adelaide Brighton, IAG, QUB and Woolworths.
-> Early signs of an uplift in capital expenditure by the major resource companies.
How to approach this market
As the Australian equity market is close to decade-highs, finding value in an absolute sense is proving to be challenging.
Hence, at this point in the equity market cycle, it is increasingly important to seek stock ideas with a value bias, for example by weighting toward companies that provide a “margin of safety”. This can be done either through holding companies that have already rebased their returns to more sustainable levels (Brambles, Coca-Cola Amatil, QBE & Woolworths) and/or companies focused on capital discipline and healthy balance sheets (ASX, BHP, & Wesfarmers).
Our investment process of an active company and industry visitation program continues to underscore the value of identifying catalysts and inchoate themes in the Australian share market.
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