10 stocks to buy - Switzer Report · earnings and dividend growth might appear tepid. But the...

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10 stocks to buyin 2017

By James Dunn

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CONTENTS

Important information: 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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Commonwealth Bank of Australia............................................

National Australia Bank...........................................................

Transurban.............................................................................

CSL........................................................................................

Ramsay Health Care...............................................................

SEEK......................................................................................

Aristrocrat Leisure...................................................................

Market Capitalisation...............................................................

oOh!media..............................................................................

FlexiGroup..............................................................................

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03

COMMONWEALTH BANK OF AUSTRALIA (CBA, $80.38)

Market capitalisation: $138.3 billion1-year total return: 7.7%3-year total return: 8.8% a year5-year total return: 16.3% a yearAnalysts’ consensus forecast yield FY17: 5.2% fully frankedAnalysts’ consensus price target: $76.38

The Australian stock market’s largest company by market value is not expected to set the world on fire in terms of earnings and dividend growth over FY17 and FY18. Analysts’ consensus expects earnings per share (EPS) to decline by 0.4% and 1.1% respectively, leading to a 1% dividend cut in FY18. There’s no pressure to speak of in bad and doubtful debts, and the capital position is stronger (at the first quarter) than analysts expect, but the net interest margin and total revenue appear to be under slight pressure.

With house price growth expected to slow, the economy showing middling growth (by Australian standards) and banking competition intensifying, CBA’s expected earnings and dividend growth might appear tepid. But the quality of the bank’s franchise – despite two high-profile scandals that tarnished the brand’s customer service gloss – is first-class. CBA is the lowest-yielding of the big four banks, but arguably the strength of the franchise justifies that premium. On consensus, analysts see CBA as over-valued, but the banking sector should have a strong 2017, making a price of at least $85 achievable. On price/earnings (P/E) ratio grounds, CBA usually trades at a premium of about 14% to its Big Four peers, but that premium has been almost halved. While the stock has a ‘big-ticket’ price, look for CBA to work to push that premium back out.

10 stocks to buy in 2017

Source: Yahoo!7 Finance

Commonwealth Bank of Australia (CBA)

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04

NATIONAL AUSTRALIA BANK (NAB, $29.61)

Market capitalisation: $78.4 billion1-year total return: 11.2%3-year total return: 3.3% a year5-year total return: 11.3% a yearAnalysts’ consensus forecast yield FY17: 6.3%Analysts’ consensus price target: $28.79

The smallest of the big four by market value, National Australia Bank (NAB), still clocks in as the nation’s fifth-largest company. NAB trades at a discount to the other three, at 12.5 times expected FY17 earnings versus a range of 13.0 times–21 times, but that also gives it the highest yield, even with forecast small cuts to dividends. With franking, NAB’s yield for FY17 and FY18 equates to 9% plus – meaning that

for Australia’s army of self-managed super funds (SMSFs), it’s a core holding, and likely to stay that way.Although priced at a discount, NAB is performing strongly, with cash earnings of $6.48 billion in FY16, up 4.2%. While the second half of FY16 was challenging for all the major banks, Deutsche Bank says NAB’s cash and underlying earnings growth was the strongest, supported by a 2% reduction in costs. With the last of its troublesome UK exposures now gone, NAB is a pure Australasian operation for the first time in almost 30 years. NAB has a heavy business banking focus: this represents about 45% of its revenue base, although the division struggled in the early part of the decade. NAB is poised to benefit from strong support flowing into Australian bank stocks.



National Australia Bank (NAB)

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04

TRANSURBAN (TCL, $10.23)

Market capitalisation: $20.9 billion1-year total return: 6.0%3-year total return: 20.6% a year5-year total return: 18.5% a yearAnalysts’ consensus forecast yield FY17: 5%, 16% frankedAnalysts’ consensus price target: $11.69

Transurban’s (TCL) portfolio of 15 toll roads – 13 in Australia, two in the US, and six of them wholly owned – is an income investor’s dream. It generates growing inflation-linked dividends from stable, long life, defensive assets that have high barriers against competitors and low operating expenses, meaning high margins. Rising traffic volumes are virtually assured: its toll roads, located in Melbourne, Sydney, Brisbane and Virginia,

are major traffic arteries in their respective locations. Dividends have grown at a compound rate of more than 10% a year since 2009.As a yield stock, TCL comes under pressure in a rising bond yield environment. Indeed, broker UBS says TCL has been caught up in the yield sell-off, with its shares underperforming by 20% since July – arguably an overblown adjustment.

But despite interest rates going up, TCL can argue that because of the schedule of projects that it has coming onstream, earnings can grow by 7–8% a year over the next three to five years. In August, Transurban forecast double-digit growth in dividends for 2017 after it reported a statutory net profit of $22 million, compared with a loss of $373 million a year earlier.



Transurban (TCL)

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04

CSL (CSL, $95.03)

Market capitalisation: $43.3 billion1-year total return: –3.1%3-year total return: 15% a year5-year total return: 26.3% a yearAnalysts’ consensus forecast yield FY17: 1.8%, unfranked (CSL reports in US$)Analysts’ consensus price target: $108.99

Australia’s biotech heavyweight CSL is one of three major players in the global blood plasma-derived biotherapies field. The company is a strong performer, consistently generating returns on invested capital (ROIC) above 20%. However, FY16 saw worsening losses at its Novartis influenza business, higher overall operating costs and an appreciating Australian dollar in the second half, which combined to cause a 12% fall in earnings per share (EPS), although the dividend increased.The company appears also to have been caught up in uncertainty in the biotech world regarding US President-elect Donald Trump’s

mooted plan to control drug pricing, with an 8.5% fall since the election. However, CSL is making excellent progress on innovation, and new product launches will add to its near-term growth prospects. UBS says several developments are ahead of schedule and the company is already setting sales targets.

The standout is CSL112, CSL’s potential blockbuster treatment for reducing major adverse cardiac events after a heart attack. Broker Citi believes this could be “transformative” medicine for the company, generating an estimated $1 billion in sales in the first five years after a successful launch. CSL is a true Australian global leader, but with the risks of the biotech industry.Analysts like its near-term price prospects, but it needs to solve the problems at its flu subsidiary – there’s not much point being the second largest influenza vaccine manufacturer in the world if it loses you money.



CSL

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04

RAMSAY HEALTH CARE (RHC, $66.51)

Market capitalisation: $13.4 billion1-year total return: 5.1%3-year total return: 19.7% a year5-year total return: 30.8% a yearAnalysts’ consensus forecast yield FY17: 2%, fully frankedAnalysts’ consensus price target: $79.17

Ramsay (RHC) is another Australian global healthcare player: it is one of the top five private hospital operators in the world, operating more than 220 hospitals and day surgery facilities across Australia, France, the United Kingdom, Indonesia and Malaysia. With about 25,000 beds, RHC employs more than 60,000 staff across five countries and treats almost three million patients a year. The company recently announced its entry into pharmacy, with around 19 community pharmacies.

Ramsay has racked up impressive returns over the last decade, and looks set to

continue, with analysts forecasting 19% and 12% growth in earnings per share in FY17 and FY18 respectively, allowing dividend increases of 14% and 13% respectively – albeit not to any great shakes in the yield department. The company has given guidance for FY17 profit growth of 10%–12%. Given rival Healthscope’s (HSO) recent profit downgrade, Ramsay’s confidence is impressive in the light of a difficult market.

On consensus price target, the analysts that follow the company see it priced 19% higher than the current price. While such appreciation would be welcome, it would still see RHC trading at less than its September 2016 peak of $83.66. But the demographic tailwinds behind Ramsay, of ageing populations and increasing health spending, aren’t going away. “Ramsay is one of my two favourite health stocks – CSL is the other,” says Paul Rickard, co-founder of Switzer Super Report. “It’s been out of favour for a few months, but it has delivered year after year,



Ramsay Health Care (RHC)

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04

SEEK (SEK, $14.40)

Market capitalisation: $5.1 billion1-year total return: 7.6%3-year total return: 8.2% a year5-year total return: 21.6% a yearAnalysts’ consensus forecast yield FY17: 2.7%, fully frankedAnalysts’ consensus price target: $15.88

Seek (SEK) is the company behind Seek.com.au, the dominant website for job advertisements in Australia. It also operates Seek domains in New Zealand and the United Kingdom. The company’s international division invests in online employment websites JobsDB (operating in six countries across South East Asia), Zhaopin (China), Brazil Online (Brazil) and OCC (Mexico).

SEK also has interests in international associates JobStreet (based in Malaysia), One Africa Media (based in seven countries across Africa) and Bdjobs (based in Bangladesh). Seek also owns Seek Asia, which operates in several South-east Asian countries.

SEK has expanded offshore by buying minority stakes in dominant online sites within large, populated and developing markets with low internet penetration, giving it excellent long-term prospects. The largest part of its international business is the Chinese site Zhaopin, of which Seek owns 61.5%. Its earnings from Zhaopin could, in time, exceed its earnings from the Australian market.The Asian growth opportunity is outstanding, but there have been problems at home.



SEEK (SEK)

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04

ARISTOCRAT LEISURE (ALL, $14.89)

Market capitalisation: $9.5 billion1-year total return: 57.2%3-year total return: 53.8% a year5-year total return: 47.7% a yearAnalysts’ consensus forecast yield FY17: 2.5%, unfrankedAnalysts’ consensus price target: $18.40

Gaming machine supplier Aristocrat Leisure (ALL) reported a cracking result in November. Revenue rose 34% to $2.13 billion and net profit surged more than 67% to $398 million, well ahead of market consensus of $383 million. The stellar result was driven by a booming business in the US, as its casino machines and digital gambling products win over more customers and higher industry market share.North American earnings before interest, tax, depreciation, and amortisation (EBITDA) grew 28.3% to US$434 million on the back

of significant market share growth from its US premium gaming operations segment. The digital operations contributed a 127.1% increase in EBITDA to $114 million, driven mainly by the success of Aristocrat’s Heart of Vegas game following its Android launch.

The company saw profit margins growing across both its Australian and international operations, in addition to an 8.4% margin gain for its digital division. The 2015 deal to buy US group Video Gaming Technologies (VGT) for $US1.3 billion has transformed ALL, lifting the percentage of its earnings defined as “recurring” from 15% to 50%, giving it predictability and stability it has never had before. As chief executive Jamie Odell hands over to successor Trevor Croker, he can reflect on the fact that he has helped to build another Australian international success story. And the best thing is that there’s 24% upside in the stock price, according to analysts.



Aristocrat Leisure (ALL)

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04

APN OUTDOOR GROUP (APO, $5.40)**

Market capitalisation: $893 million1-year total return: –4.9%3-year total return: N/A5-year total return: N/AAnalysts’ consensus forecast yield FY17: 38%, fully frankedAnalysts’ consensus price target: $6.30

Outdoor advertising group APN Outdoor (APO) is one of the many industrial companies on the stock exchange to have been savaged for a mis-step in 2016. In its case, a surprise profit downgrade in August stripped 33% from its market valuation. The downgrade came with the half-year result, which saw revenue and net profit rise by 10% and 49% respectively, but APN

Outdoor lowered its full-year profit guidance by 5%, and was hammered. That’s a situation Charlie Aitken, chief investment officer and founder of Aitken Investment Management, likes, when he sees that a good structural growth situation has suddenly become cheaper.

APN Outdoor had more than doubled in price in the previous year, and at a hint of trouble – the company said the extended federal election period had softened the billboard market – it was slashed in price. But Aitken knew that APN Outdoor and its main rival oOh! Media (OML) were leading the move to upgrade billboards from static to digital, giving them an opportunity to generate strong shareholder returns.**Now, the outdoor advertising sector is growing at a double-digit rate, coming into



APN Outdoor Group (APO)

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04

OOH!MEDIA (OML, $4.35)**

Market capitalisation: $653 million1-year total return: –2%3-year total return: N/A5-year total return: N/AAnalysts’ consensus forecast yield FY17: 3.6%, fully frankedAnalysts’ consensus price target: $5.62

It’s the same story at OML, which has been cut back 22% by the market from its 2016 peak, to be trading at 14.5 times analysts’ consensus expected FY17 earnings. OML fell 16% in sympathy with APO in August on the latter’s profit downgrade, but rebounded strongly when the company’s own half-year result came out, showing an 18.2% jump in revenue and net profit up 35%. OML said digital revenue represented 44.5% of total

revenue, well ahead of its target to have digital revenue of up to half of total revenue by the end of 2018.

Analysts expect OML’s 2016 (calendar year) earnings to come off by 30%, but resume strong growth in 2017. They also expect growing dividends, with 11.6 cents forecast this year and 15.7 cents expected in 2017, up from 9.5 cents in 2015. OML has a greater national reach than APO, through its strong regional presence. It has invested heavily in both online and offline advertising delivery and acquired online content and publishing company Junkee Media in June to drive this part of its business. Aitken says OML and APO make a “wonderful duopoly”, exposed to strong structural growth, and he says investors should own both.



oOh!media (OML)

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04

FLEXIGROUP (FXL, $2.45)

Market capitalisation: $1 billion1-year total return: –5.9%3-year total return: –11.3% a year5-year total return: 8.5% a yearAnalysts’ consensus forecast yield FY17: 6%, fully frankedAnalysts’ consensus price target: $2.55

Finance and leasing company FlexiGroup (FXL) has gone through a transition in which it has got rid of non-core businesses to focus on its core consumer cards and consumer lending segments. The company is concentrating on providing finance solutions to the consumer and small to mid-sized enterprise (SME) sectors. Finance solutions include no interest ever (Certegy), interest-free credit cards (Lombard, Once, Q Card, and Farmers Finance), and leasing to consumer and SME (FlexiRent, FlexiCommercial, FlexiWay, Equico, TRL Leasing, and EFL). Peter Switzer, economist and co-founder

of Switzer Super Report, says FlexiGroup CEO Symon Brewis-Weston – appointed a year ago – inherited a company with a number of problems, but has cut off a lot of the dead wood and has innovative plans for the company, based on better use of the company’s data in its credit pricing processes and digital origination capabilities, and to leverage its funding capacity and client relationships to give it advantages over smaller competitors. FlexiGroup wants to be the leading non-bank, trans-Tasman provider of diversified financial services, and Switzer says Brewis-Weston, who came out of CBA, has a strategy to achieve that.

FXL is an unloved company in an unloved sector. And, reflecting this status, it trades on 9.7 times earnings for FY17 and 8.8 times earnings for FY18, on analysts’ consensus expectations, and fully-franked yields of 6% for FY17 and 6.4% for FY18. Switzer says he “wouldn’t be afraid to buy FXL, and says it is a speculative play that could surprise in 2017.



FlexiGroup (FXL)

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