Jun Bei Liu shares key learnings from reporting season

 

Woolies, Wesfarmers are expensive profit season winners

The latest reporting season has been fun to observe and a thrill to live through while working from home and homeschooling two young children.

In general, it was positive. More companies met expectations than those that missed, and most management were more optimistic than they were this time last year.

Despite the latest lockdown across many parts of Australia, corporate Australia seems in good shape, with a stronger than expected rebound from consumer spending and housing activities supported by the government stimulus and lower interest rates. In fact, many companies are on the verge of achieving a debt free balance sheet.

This reporting season we have had special dividend and buy backs not only from the big miners and banks, but even retailers, property trusts and industrial companies are buying back their shares and paying out big dividends.

This is a sure sign of “things are good”. But what are we actually paying for those blue chip COVID-19 winners?

Take Woolworths for example. It is no doubt the best performing supermarket business in Australia and has traded strongly throughout the pandemic and gained market share against competitors at the same time.

Despite adding costs into the business with the various COVID-19 restriction requirements, its earnings grew 23 per cent in FY21 capitalising on increased consumer spending on food during lockdowns.

Aside from a strong result, investors are also anticipating a $2 billion buy back post separation of Endeavour (its liquor business). That is a whopping 4.5 per cent of the share base. This is all great news for a quality mature business, but at what valuation?

 

An eye watering figure

Woolworths is now trading on an earnings multiple of 30x FY22. An earnings multiple that used to be subscribed to by high-growth businesses with global footprints such as Dominos.

It also seems an eye watering figure when compared to its closest peers such as Coles and Metcash which trade on 23x and 16x respectively.

Let’s also not forget what’s going to happen to its earnings when we do eventually come out of current lockdown. For the next two years, Woolworths is expected to have revenue declines.

Wesfarmers is another name that has been a big beneficiary of the government stimulus in the past 12 months. Cash handouts and builders’ incentives have driven a strong housing market and renovation boom.

Bunnings – with its stores remaining open throughout lockdowns, before recently changing to click and collect – has captured an enormous uplift in earnings, which are expected to grow 15 per cent for FY21.

While we rank Bunnings probably as one of the highest quality retailers around the world, it is maturing.

Before COVID-19, its same store growth rate had fallen from the high single digits achieved in the past decade down to 4 per cent just before COVID-19 hit. It is currently doing 25 per cent same store growth purely due to the construction boom and the COVID-19 disruption.

 

This is lazy investing

Wesfarmers earnings are expected normalise over the next two years, and at the current price investors are paying 32 times FY22 earnings compared to the 20 times that it traditionally trades on.

Some may argue times have changed, that lower interest rates and abundance of cheap money are pushing up asset prices, and we will have to learn to live with inflated multiples for high-quality companies. But at what price?

In our view, this is lazy investing. Investing involves finding the quality company and paying the right price, not one without the other. The incredible thing about the share market is that most investors have tunnel vision, and can only define stocks in two groups: “hot stocks” or “not so hot stocks”.

Valuation for those hot stocks is often irrelevant until earnings begin to turn. And not many people want to know about the “not so hot stocks” that lack a catalyst.

As a seasoned active investor that has been investing in the Australian market for many years, we believe the current market is ripe with those silly price inefficiencies which we regularly take advantage and profit from.

Wesfarmers and Woolworths are both examples of crowded trades where valuation seems to have slipped off the investor’s chart book.

 

Ramsay as an incredible value opportunity

In contrast, Ramsay belongs to the group of stocks that lack so called catalysts. It is the largest private hospital operator in Australia and a leading provider in France, the UK and a number of Nordic countries. Ramsay has a long history of delivering steady growth supported by the ageing demographic.

The COVID-19 induced lockdown has meaningfully affected its previous 18 months earnings as governments restrict access to elective surgeries to keep hospital beds available for pandemic patients.

As recovery rolls on, there is increasing evidence of long waiting lists building for private hospital services before the latest lockdown.

We view Ramsay as an incredible value opportunity, trading on 24 times current COVID-19 affected earnings compared to its peer healthcare group of over 40 times, with low double-digit defensive growth expected over the next few years underpinned by the recovery of private hospital services.

Bears have talked about the exuberance in the current share market and predicted its imminent bust. But we believe exuberance lies with crowded trades and plenty of great value quality businesses which, in 12 months, may well become “hot” again. Sometimes investors just need to open those blinkers a little.

 

 

This article was originally posted on The Australian Financial Review here.

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