There is a very plausible scenario that we are approaching the peak of the global inflation cycle.
Central banks will start to turn progressively less hawkish and bond yields will continue to compress further. As we enter 2023, this should be a key consideration in Australian equity strategy.
A definitive peak in the inflation cycle would likely prompt central banks (namely the US Fed) to slow down their aggressive tightening cycle.
A genuine Fed pivot (an easing in monetary policy) may not occur until mid-CY2023, or indeed late-CY2023. However, as always, the market has the capacity to be forward-looking if some encouraging inflation trends emerge.
Growth stocks tend to be the most sensitive to bond yields. These stocks have underperformed during periods of rising bond yields and outperformed when bond yields fall. This past year has been no different. The quick-fire rise in bond yields has been a significant headwind for growth stocks YTD.
Therefore, a dovish shift in the Fed’s narrative should be a tailwind for growth stocks as bond yields fall further. We believe this macro environment would also benefit REITs, gold miners and also select small caps.
Rerate Screen
We have screened the ASX 100 for stocks we believe can outperform in the face of lower inflation and lower bond yields.
These include online classified stocks such as REA Group (REA), Seek (SEK), Carsales (CAR); Real Estate such as Goodman Group (GMG) and Lendlease (LLC); Industrials such as Qube Holdings (QUB) and ALS (ALS); Consumer Discretionary such as Domino's (DMP), Aristocrat Leisure (ALL) and Wesfarmers (WES); and Tech such as Xero (XRO), NextDC (NXT), Altium (ALU) and Wisetech (WTC).
We have screened these stocks by:
- Forward PE multiple compression of >20% this YTD.
- 3-year consensus EPS CAGR above market (5%).
- ISG qualitative overlay – no thesis break, quality company, strong balance sheet.
| Company Name | Ticker | 12mth fwd PE (as at 31/12/21) |
12mth fwd PE (as at 29/11/22) |
Change in PE from beginning of the year | YTD Price Change | EPS FY0 | EPS FY3 | EPS CAGR % (FY0-FY3) | Dividend Yield % (12mth fwd) | ROE FY1 | Net Debt/EBITDA (FY1) | 90 day EPS revision (FY23 EPS) |
| Communication Services | ||||||||||||
| Carsales.Com | CAR | 34.6 | 27.2 | -21% | -9% | 0.7 | 1.0 | 11% | 2.8% | 15% | 2.3 | 0% |
| REA Group | REA | 50.3 | 35.9 | -29% | -26% | 3.1 | 4.3 | 12% | 1.5% | 29% | 0.1 | -5% |
| SEEK | SEK | 50.1 | 28.4 | -43% | -33% | 0.7 | 0.9 | 8% | 2.2% | 14% | 1.8 | 1% |
| Consumer Discretionary | ||||||||||||
| Aristocrat Leisure | ALL | 26.3 | 19.0 | -28% | -18% | 1.7 | 2.2 | 9% | 1.8% | 20% | -0.5 | 0% |
| Domino's Pizza Enterprises | DMP | 45.2 | 31.8 | -30% | -44% | 1.9 | 2.8 | 14% | 2.5% | 36% | 3.6 | -11% |
| IDP Education | IEL | 70.6 | 45.2 | -36% | -15% | 0.4 | 1.0 | 36% | 1.6% | 34% | -0.3 | -1% |
| Wesfarmers | WES | 28.6 | 22.5 | -21% | -18% | 2.1 | 2.5 | 7% | 3.9% | 29% | 1.7 | 0% |
| Industrials | ||||||||||||
| ALS | ALQ | 23.5 | 18.2 | -23% | -6% | 0.5 | 0.7 | 10% | 3.2% | 27% | 1.7 | 4% |
| Qube Holdings | QUB | 31.9 | 22.9 | -28% | -12% | 0.1 | 0.1 | 12% | 2.8% | 7% | 2.5 | 0% |
| Information Technology | ||||||||||||
| Altium | ALU | 81.4 | 45.9 | -44% | -17% | 0.4 | 0.8 | 23% | 2.0% | 23% | -2.3 | 1% |
| Nextdc | NXT | 480.6 | 376.9 | -22% | -23% | 0.0 | 0.1 | 63% | 0.0% | 0.3% | 4.7 | -1% |
| Wisetech Global | WTC | 105.3 | 65.6 | -38% | -5% | 0.6 | 1.3 | 31% | 0.3% | 20% | -1.4 | 1% |
| Xero | XRO | 412.2 | 155.0 | -62% | -51% | 0.1 | 1.1 | 117% | 0.0% | 4% | 0.1 | -31% |
| Real Estate | ||||||||||||
| Goodman Group | GMG | 32.3 | 19.6 | -39% | -29% | 0.8 | 1.1 | 10% | 1.6% | 11% | 0.9 | 0% |
| Lendlease Group | LLC | 18.0 | 12.6 | -30% | -28% | 0.4 | 0.9 | 33% | 2.9% | 5% | 3.5 | -16% |
Source: Refinitiv, Wilsons.
Our Pick From the Screen
NextDC (NXT) - Focus Portfolio 3%
NXT is a leading data centre operator with a network of 9 facilities spread across NSW, Victoria, Queensland, ACT, and Western Australia.
We are attracted to NXT given:
- The long runway for further structural growth in cloud computing. In our view, this is one of the leading thematics of the next decade.
- Its high degree of earnings predictability, which is supported by recurring earnings based on long-term contracts with embedded cost pass throughs.
- Attractive margins (~80% EBITDA margin) at scale.
NXT has already started to rerate on a positive update at the AGM where the business reaffirmed its FY23 guidance. The stock is up 19% MTD, driven by a rerating. We think the stock can continue to rerate if we get more positive news on inflation over the next few months.
Our Research team remains positive on the stock.
Read latest update NEXTDC (NXT) | FY22 AGM Update: FY23e Guidance Reiterated, “Strong Start to FY23e”
Select Smalls
Valuation compression has led to a tough period for some small caps. We believe increasing portfolio weights to smalls could be an effective strategy.
We screened the small and mid-caps universe for high quality companies with strong earnings growth outlooks that may have been oversold by the market, we have applied the following criteria:
- Wilsons O/W rated companies only.
- Forward PE multiple compression of >15% this YTD.
- FY23 consensus EPS growth broadly flat at least (>-3%).
- 3-year consensus EPS CAGR >10%.
- ISG qualitative overlay.
| Company Name | Ticker | Wilsons Rating | PE (start of year) | PE (latest) | PE derate | YTD Price Change | 3 yr EPS CAGR | Dividend Yield % (12mth fwd) | ROE FY1 | Net Debt/EBITDA (FY1) | 90 day EPS revision (FY23 EPS) |
| Communication Services | |||||||||||
| HT&E Ltd | HT1 | OW | 15.71 | 8.06 | -49% | -48% | 14% | 9% | 8% | 0.5 | -4.8% |
| Consumer Discretionary | |||||||||||
| Accent Group Ltd | AX1 | OW | 17.40 | 12.67 | -27% | -31% | 40% | 6% | 15% | 1.4 | 4.7% |
| GUD Holdings Ltd | GUD | OW | 13.13 | 9.48 | -28% | -28% | 10% | 6% | 13% | 2.0 | -0.6% |
| Universal Store Holdings Ltd | UNI | OW | 18.09 | 12.40 | -31% | -27% | 20% | 6% | 26% | 0.9 | 10.2% |
| Financials | |||||||||||
| Pinnacle Investment Management Group Ltd | PNI | OW | 32.98 | 21.65 | -34% | -43% | 11% | 4% | 19% | 0.9 | -4.7% |
| Healthcare | |||||||||||
| Clinuvel Pharmaceuticals Ltd | CUV | OW | 37.57 | 26.87 | -28% | -31% | 22% | 0% | 23% | -2.9 | 10.0% |
| Pro Medicus Ltd | PME | OW | 128.93 | 96.08 | -25% | -4% | 26% | 1% | 47% | -1.0 | 1.0% |
| Information Technology | |||||||||||
| TechnologyOne Ltd | TNE | OW | 48.53 | 41.17 | -15% | 6% | 14% | 1% | 37% | -1.1 | 3.1% |
Source: Refinitiv, Wilsons.
Our Picks From the Screen
Universal Store (UNI)
UNI is a specialty retailer of casual and youth apparel with a diversified brand portfolio (Universal Store, Perfect Stranger, Thrills) and a fast-growing online platform. The business has an attractive product offering, an experienced executive team and attractive runways for growth online.
We like the stock as:
- Strong earnings growth expected due to private label expansion (higher margins) and physical store rollouts.
- Despite potential near-term cyclical headwinds, after de-rating to a forward PE multiple of ~12.4x, UNI’s valuation looks relatively attractive considering its consensus 3-year EPS CAGR of ~20%. This is a PEG of 0.6x.
- The company is capital light and generates a return on capital invested (ROIC) of ~50%.
- We think the business will be more defensive than the market is expecting, with UNI’s average customer-base (under 30s) being more resilient to a slowdown.
Read the latest research report: Universal Store (UNI) | O/W: THRILLED
Pinnacle Investment Management (PNI) (Focus Portfolio 1%)
PNI is a multi-affiliate investment management firm that provides distribution, fund infrastructure and support services to affiliate investment managers while typically taking equity stakes of between 20-50% in its affiliates.
The business has de-rated considerably due to the negative FUM and fee impacts associated with equity market weakness and fund underperformance, particularly amongst its growth-focussed affiliates such as Hyperion.
While PNI’s leverage to capital markets has been a material headwind in FY22, we believe the company’s affiliates are exposed to significant long-term growth opportunities once markets recover.
Read the latest research report: Pinnacle Investment (PNI) | O/W: Retail resilience
Constructive on REITs
The REITs sector has underperformed the broader market YTD. Valuations have been under pressure as higher bond yields have put pressure on cap rates and therefore asset valuations. This follows a decade of cap rate compression across global real estate markets, driven by the low rate environment. As bond yields fall, this would likely be a tailwind for REIT valuations.
We remain neutral in the REITs sector. While underperformance due to bond yields may be over, structural issues within some sectors, such as office and retail REITs, may be further exacerbated by an economic slowdown. Our preference is to invest in sectors with structural tailwinds and defensive earnings, such as logistics such as Goodman Group (GMG) and healthcare REITs such as Healthco Healthcare and Wellness Reit (HCW). See our July report below on our preference to GMG and HCW.
Golden Opportunity For Precious Metals?
The Focus Portfolio is broadly neutral to the gold miners with a 2.5% position in Northern Star Resources (NST), which compares to the sector’s ~2.3% ASX 200 weighting.
We think the outlook for gold has improved as real yields are likely to peak and normalise over the medium-term.
This view is consistent with our expectations that inflation will unwind over the next year and nominal bond yields should stabilise. This scenario would likely be supportive of the gold miners, given gold prices typically have a strong inverse relationship to real yields.
This is because the opportunity cost of owning non-productive assets like gold, which doesn’t pay coupons or dividends like bonds or shares, is lower in a low real yield world, meaning the price should be higher.
As a safe haven asset, gold can also provide a portfolio hedge against tail risks like wars or financial crises.
Our gold pick - Northern Star Resources (NST) (Focus Portfolio 2.5%)
High quality gold portfolio with strong production growth
The company offers pureplay exposure to gold through its ownership of 3 world-class gold mines located in the low sovereign risk jurisdictions of Australia (Kalgoorlie, Yandal) and North America (Pogo).
NST is poised to deliver production growth of ~8% p.a. to FY25 as it delivers on its 5-year profitable growth plan which targets 1.8-2.2Moz of gold sold (vs 1.6Moz in FY22), a 20+ year mine life, and positioning on the first half of the global cost curve.
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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