March has been a volatile period for financial markets. The “higher-for-longer” interest rate scenario has dramatically reversed over the past few weeks, with “surprising” signs of stress in the US/global banking system.
Global bond yields have bounced around, while the domestic share market has fallen close to its January lows.
While it is too early to say this period of volatility is over, this pullback presents an opportunity for investors to buy quality stocks that look to be oversold.
Quality cyclicals
Quality cyclicals usually have a structural growth story embedded within the company that should drive superior earnings growth over the medium term. Economic downturns may impede growth, since these stocks are more exposed to economic conditions. Nevertheless, the growth drivers should typically outweigh the cyclicality over the medium to long term.
In general, these companies are astute managers of capital deployment and cover their costs of capital at the bottom of the economic cycle – a characteristic we like when holding these stocks throughout the cycle.
The current market turbulence may represent a good opportunity to buy quality cyclicals at a reasonable price after they have experienced a challenging period in the broader sell-off.
Macquarie (MQG): Quality Cyclical at a Value Price
MQG thrives in volatility
MQG takes advantage of challenging market conditions by making accretive acquisitions at attractive valuations. Surplus capital (~$12.5bn at December 22) provides an opportunity for MQG to pull the trigger on potential targets.
Quality at value prices
MQG’s current 12-month forward PE looks relatively cheap compared to its historical average.
MQG as a business has also changed significantly since the GFC. We think the market underestimates the higher quality, higher multiple parts of the business, such as asset management, which have grown after making acquisitions in the space, notably Waddell & Reed and AMP’s global equities and fixed income units over the last few years. On a PE multiple of 14x, the business looks oversold on the current macro uncertainty when you consider the high proportion of annuity style income that MQG generates (~55% on average over the last 5 years).
Energy: Growth Fears Outweighing Fundamentals
Oil prices have come under pressure from the current crisis in the US/European banking sector. Fears of a global downturn have led to a weak period for oil prices, dropping to ~US$72/bbl on Monday.
The fall is likely temporary and not underpinned by supply-demand fundamentals surrounding the physical commodity. Investors tend to move away from risky assets like oil during times of market volatility.
We remain positive on the sector. China's reopening should boost oil demand, even with the global economy slowing. Global oil demand is expected to exceed a record 102 million barrels per day by the end of 2023, according to the International Energy Agency (IEA). The IEA cites rebounding air traffic and the release of pent-up Chinese demand to dominate the recovery.
While a global downturn would be negative for oil and gas, this is not our base case, and therefore believe the current oil price turmoil is overdone.
ISG opportunities: Woodside (WDS) and Worley (WOR) look like good buying opportunities after a derate in these stocks.
Lithium Miners: Recharging After a Strong 2022
Lithium stocks have fallen over the last the lithium carbonate price has fallen ~30% since its peak in November.
We think this has been driven by:
- The end of subsidies used to stimulate EV sales in China has impacted Chinese EV sales and sentiment. However, there is a seasonal element to China’s EV sales (Lunar New Year), and expect the reopening over the next few months to spur Chinese EV demand.
- Concerns about a supply surplus in 2023, with fresh speculation on higher supply incentivized by higher prices.
- Over the last month, investors have pulled away from riskier assets such as lithium.
However, we are still positive the sector. While demand may be more volatile in the short term, we still expect a considerable shift to EVs over the next decade, supporting battery and lithium demand.
Periods of short-term weakness may occur, but we believe the uptake in EVs will be faster than expected over the medium term.
Additionally, bringing supply online is proving more challenging than expected. Construction delays are common for lithium mines, which can take 4-7 years to come online. We believe this supply challenge is underestimated by the market. This will likely keep supply trailing demand and keep prices higher for longer.
ISG opportunity: We think there is a great opportunity to buy Allkem (AKE) at these prices.
Banks: A High Quality Banking Sector
The ‘Big 4’ Australian Banks are among the highest quality, and ‘safest’ in the world when it comes to the strength of their balance sheets.
All of the Big 4 are AA- rated, and every one of their risk-weighted capital ratios (CET1) eclipse the closest peer globally thanks to strict regulation from APRA when it comes to bank liquidity requirements.
We believe the string of offshore bank failures – most notably Silicon Valley Bank and Credit Suisse – are more isolated than systemic (in contrast to the GFC) and are largely a reflection of poor financial management.
Therefore, given the strong financial position of the Big 4, we think this recent pullback presents a reasonable buying opportunity – particularly for investors with sizable underweights to the benchmark.
The Focus Portfolio has 16.5% exposure to the Big 4 Banks, compared to the ASX 300 at 18.5%.
Our modest underweight to the sector reflects our base case view that net interest margins (NIMs) are likely near their cyclical peak as the RBA approaches the end of its hiking cycle, while credit growth is likely to slow with the economy over the medium-term, though we do not anticipate any significant issues with bad debts. Credit quality is likely to be as good as it gets.
ISG opportunity: NAB is our top pick (Focus Portfolio 7.5%), which we believe is a top-tier quality bank that can be purchased at a substantial discount to peer CBA.
Derated Opportunities Screen
We have taken a screen of the ASX 200 and looked for stocks which we believe have been oversold in the market turbulence.
The screen filters by stocks that have de-rated heavily since the market peak in February and after the news of SVB in early March (using the change in the 12-month fwd PE).
We then provide our own ISG qualitative overlay to determine whether these stocks have been oversold.
| Company Name | Ticker | 12 month forward PE | Share Price Change (from Market Peak) | Share Price Change (Post Banking Crisis) | ISG Comment | ||||
| Feb Peak 03/02/2023 | March (Pre Banking Crisis) 07/03/2023 | Current 21/03/2023 |
PE derate (from Market Peak) | PE derate (Post Banking Crisis) | |||||
| Banks | |||||||||
| ANZ | ANZ | 10.8 | 10.2 | 9.3 | -14% | -8% | -13% | -8% | After derating ~10%, we think the 'big 4' banks offer reasonable value considering their 'fortress balance sheets', which have some of the highest risk-weighted capital ratios globally, and given our view that the recent string of offshore bank failures seem more isolated than systemic, with poorly managed banks being exposed the most. While we are underweight the banks (16.5% vs the ASX 200 at 19.0%) on the view that NIMs are near their cyclical peak and credit growth will likely slow from here, we see this as a decent buying opportunity (particularly for investors with sizeable underweights vs the benchmark). NAB is our top pick of the big 4. |
| NAB | NAB | 12.8 | 11.9 | 11.2 | -12% | -6% | -13% | -6% | |
| Westpac | WBC | 11.1 | 10.5 | 9.9 | -11% | -5% | -12% | -6% | |
| Consumer Services | |||||||||
| Aristocrat Leisure | ALL | 18.9 | 19.2 | 17.8 | -6% | -8% | -5% | -8% | We think ALL is attractive buying at these levels. The company has both 'quality cyclical' and 'structural growth' characteristics with a strong track record of growing above its cost of capital through the cycle. While its core electronic gaming machine (EGM) business benefits from customer expenditures that are non-discretionary in nature, historically EGM revenues have been relatively stable amidst even recessions. Moreover, ALL is increasingly diversified with growing exposure to recurring revenues and non-wagering based, free-to-play mobile games via its Pixed United business. In the near-term, ALL is a 're-opening winner' while the long-term runway for growth in its digital segments remains significant. |
| Diversified Financials | |||||||||
| Pinnacle Investment Management Group | PNI | 25.2 | 21.9 | 18.2 | -28% | -17% | -27% | -17% | The recent de-rate of MQG and PNI presents an attractive buying opportunity in our view. While both businesses have an element of cyclicality given their leverage to capital markets, they both have attractive long-term earnings growth outlooks; with MQG being a beneificary of the decarbonisation thematic, while PNI is poised to benefit from FUM growth and the associated operational leverage across its affiliates. |
| Macquarie Group | MQG | 16.8 | 16.6 | 14.3 | -15% | -14% | -12% | -13% | |
| Energy | |||||||||
| Woodside Energy Group | WDS | 9 | 10.7 | 9.1 | 1% | -15% | -13% | -18% | In our view, the energy sector has been oversold on fears surrounding the near-term economic backdrop. The global economy remains in decent shape overall and we see near-term upside to energy demand from China's re-opening. Over the longer term, the structural story remains intact (underinvestment into key transition energy sources like oil and gas over the past decade while demand should hold up for some time). WOR specifically has a sizeable backlog of project work including a growing pipeline in the renewables sector where there are long-term structural tailwinds. |
| Worley | WOR | 20 | 22 | 19.1 | -4% | -13% | -11% | -15% | |
| EV Minerals | |||||||||
| IGO | IGO | 8.2 | 7.5 | 6.4 | -22% | -14% | -20% | -14% | We think a number of the 'green minerals' (e.g. lithium, rare earths) have been oversold in recent volatility. Rare earths in particular have been impacted by negative sentiment following Tesla's investor day (when the EV maker announced some of its future models will be 'rare earth free') . We note rare earths remain the stand-out choice for EV drive-trains when it comes to the cost/performance trade-off and growth in rare earths demand will also be driven by other uses including wind turbines. We still believe the structural outlook for both lithium and rare earths remains strong with significant growth in demand likely to outpace future supply over the medium to longer-term. Therefore, we see the recent de-rate as a compelling buying opportunity. |
| Pilbara Minerals | PLS | 6.8 | 5.8 | 4.9 | -28% | -15% | -29% | -16% | |
| Allkem | AKE | 8.3 | 7.6 | 6.5 | -21% | -14% | -23% | -16% | |
| Mineral Resources | MIN | 7.1 | 7 | 6.1 | -14% | -13% | -13% | -13% | |
| Lynas Rare Earths | LYC | 15.4 | 15.9 | 14 | -9% | -12% | -34% | -16% | |
| Iron Ore | |||||||||
| BHP Group | BHP | 11.1 | 10.9 | 9.9 | -11% | -9% | -10% | -10% | We see the recent pullback in the iron ore miners as a decent opportunity to add exposure (particularly for investors with sizeable underweights vs the benchmark) with the near-term tailwind of China's re-opening continue to play out, benefitting iron ore demand. We remain underweight (10% vs the ASX 200 at 14.4%) with BHP being our preference considering its more diversified commodity base (with a growing green minerals exposure ) and its stronger managment team. |
| Rio Tinto | RIO | 11.1 | 10.8 | 10 | -10% | -7% | -7% | -9% | |
| Retailing, Consumer Durables and Automotive | |||||||||
| Breville Group | BRG | 26.1 | 24.5 | 22.2 | -15% | -9% | -18% | -9% | BRG's de-rate presents a compelling buying opportunity with medium-term earnings growth expected to be driven by new product launches and its international expansion. Despite the immediate economic headwinds, gross margins are expected to hold up well with no discounting expected considering its ability to hold inventory at low/neglible costs. BRG has a track record of generating double digit constant current sales growth through the cycle and has an experienced and well-regarded management team. |
| Lovisa Holdings | LOV | 31.3 | 28.8 | 25.9 | -17% | -10% | -14% | -10% | LOV is attractively priced relative to its strong earnings outlook driven in the near-term by the ongoing 're-opening' post-pandemic and subsequent operational leverage, while longer-term earnings growth will be supported by its global store roll out strategy. |
Source: Refinitiv, Wilsons.
Written by
Rob Crookston, Equity Strategist
Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.
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