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12.10.2009Six Gorilla stocks to buy for the upturn

"Gorilla stocks" are back on radar as long-term, cornerstone holdings for savvy investors.


Due to their defensive profile, growth upside and history of rising profits and dividends, some global blue-chip companies, euphemistically dubbed ‘gorilla stocks’ are back on the radar as long-term, cornerstone holdings for savvy investors.

Known for their instantly recognisable brands and great distribution channels, the pricing power that comes from dominating markets displaying high barriers-to-entry, stable earnings and good yield - plus quality management and robust balance sheets, renowned global gorillas include: Wal-Mart, the world’s most valuable brand, Procter & Gamble, Intel, Google and IBM.

While they might not be in the same league as their US counterparts, Australia also has its own eclectic mix of large-caps equally worthy of gorilla status. But owing to investor fixation with cyclical stocks as markets continue recovering, Elio D’Amato CEO with Lincoln Indicators warns investors not to be deterred if Aussie gorillas displaying strong defensive and growth characteristics aren’t early beneficiaries of economic recovery.

Given that they’re not usually priced as ‘value-plays’, D’Amato says what investors pay for gorilla stocks is less relevant than the longer-term, three to five year upside. He also says that while retail investors might receive share price momentum from institutional buying of indexed stocks, the demise of Babcock and Brown and ABC Learning should remind them that not all large-caps stocks are worth holding.

With all the hallmarks that characterise their global counterparts, the six Aussie gorillas listed below share a return on equity (ROE) - earnings (revenue minus expenses, taxes and depreciation) divided by equity - of 25 percent or higher. Four of these stocks score favourably on a net-debt to equity ratio - a measure of borrowings calculated by dividing all financial debt by shareholder equity - of less than 80 percent.

Accordingly to D’Amato, the two that don’t - Telstra (TLS) and Coca Cola Amatil (CCL) still warrant inclusion due to the size of their market presence, underlying growth and sustainable cash flows.

Woolworths (WOW)

Having snared the accolade of Australia’s most valuable brand by the international valuation consultancy Brand Finance, Woolworths has earned its place as the most deserving Aussie gorilla. While the consumer staple has a net debt-to-equity higher than desirable – at around 58 percent – D’Amato says the company earns sufficient cash flow to cover it.

With an estimated 31 percent share of Australia’s grocery industry and 21 million customers a week, Woolworths has a higher ‘share-of-wallet’ - $1.25 for every $10 spent in Australian shops - than the world's premier store chain, Wal-Mart.

Despite experiencing its most challenging year ever, the retailer recently recorded a 12.8 percent annual profit rise, earnings per share (EPS) growth of 12.09 percent, 37.21 percent ROE, and a grossed-up dividend yield of 5.21 percent.

Size, scalability, and great management aside, D’Amato says the stock has done particularly well leveraging it’s with home-brands. He says the company’s excellent distribution model makes for a relatively cheap entrée into Australia’s home improvement market when it rolls-out 150 stores with JV partner, hardware giant Lowe's Companies over the next five years.

CSL Ltd (CSL)

Regarded by analysts as the best ‘defensive exposure’ in healthcare, CSL is a global, specialty biopharmaceutical company and the world’s second-biggest maker of treatments for blood disorders. Operating one of the world's largest plasma collection networks, underlying growth in the plasma market is coming from its HPV (human papilloma-virus) vaccine.

Boosted by the conversion of offshore funds into A$, the company recently announced a 63 percent increase in its 2008-09 profit to $1.15 billion, and EPS growth of 34 percent. By shifting its product mix to higher-margin therapies the company expects profit in the 12 months ending June 2010 to grow as much as 24 percent.

Despite potential currency headwinds, Roger Leaning head of research with ABN Amro Morgans still expects CSL to deliver EPS growth of 19.10 percent, and 20 percent for full year 2010 and 2011 respectively. The stock has an ROE of 33.81 percent, a low net-debt to equity ratio of 5.35 percent, and pays a grossed-up dividend yield of 3.06 percent.

Telstra Corp Ltd (TLS)

Despite recent government initiatives forcing Telstra to split its wholesale and retail businesses, many analysts have left their valuations unchanged, at least three still have a BUY on the stock, while UBS has maintained its 12 month target of $4.55.

Like many analysts, Tim Schroeders fund manager with Pengana Capital, suspects Telstra’s pending split may improve long-term shareholder value. “The split appears to be ‘net negative’ for Telstra, but could well be a precursor to unlocking the true value of the sum of its parts” says Schroeders.

And given that Telstra will use the pending split as a catalyst to accelerate some of its developments, he still believes Telstra is the best positioned it has been in a decade to make a tilt towards consistent growth. “The split raises the ‘tables-stakes’ of Telstra’s new board/management gaining a seat at the negotiating table on a national broadband business,” advises Schroeders.

With major acquisitions off-radar for now, Schroeders expects Telstra to focus on maintaining and growing earnings from its core domestic markets, notably mobile and broadband. Despite a 4.9 percent drop in fixed line PSTN revenue, Telstra managed to deliver 10.50 percent EPS growth following a net profit of $4.073 billion for the year to June 30 – with mobile services and retail broadband revenue up 10 percent and 15.9 percent respectively.

Meantime, while Citi has lowered its EBITDA by 4 percent to reflect lower margins, free cash flow at $6 billion, and yield at 8 percent are expected to remain intact post-split.

Leighton Holdings (LEI)

Australia’s largest mining and building contractor successfully squelched gloomy forecasts when it followed better-than-expected full-year profit of $440 million with predictions its order-book will exceed $40 billion next year. Despite its fully franked dividend being down 30c to 55c a share, the stock still delivered an attractive grossed-up yield of 4.69 percent.

Controlling an estimated 13 percent share of Australia’s overall engineering and construction market, Graeme Carson analyst with Patersons Securities says Leighton is well positioned to receive a good clip of large projects, especially infrastructure - with the bigger kickers coming from LNG and to a lesser extent coal.

As a potential Gorgon beneficiary, Citi expects Leighton to win another $1.3 billion of work on top of the $700 million already won, mostly in earthmoving/civil works in FY10-14, and has adjusted its target price from $27.00 to $32.00 accordingly.

Given that the stock looks over-priced with a P/E of 19X and EPS is expected to remain flat, Carson recommends buying Leighton on a three to five year outlook. However, he expects 9 percent EPS growth in 2011 to be followed by EPS growth of 10 percent in both 2012 and 2013 respectively.

Coca Cola-Amatil (CCL)

The country’s largest soft drink bottler benefits from having the world’s second most valuable brand within its stable. Despite tough trading conditions, it delivered a record first half net profit after tax of $189.8 million. While Coke trademark products comprise over 50 percent of Australia’s total non-alcoholic ready-to-drink beverage volume, it also controls a 30 percent share of both the functional water and energy drink sectors respectively.

Meantime, it’s Amatil’s food & services division, comprising cornerstone food business, SPC Ardmona delivered earnings before interest and tax (EBIT) of 20.6 percent - while its Pacific Beverages JV with SAB Miller delivered premium beer volume growth of over 50 percent. The company faces further hikes in sugar prices which account for 5 percent of cost of goods sold (COGs).

But given its ability to leverage its scale to support superior revenue management, Citi estimates sustainable top-line growth of 6-7 percent annually, net profit after tax (NPAT) of 10 percent for full years’ 2009 and 2010 respectively, a fully franked yield of 4.3 percent, and EPS growth and ROE of 9.8 percent and 30 percent respectively.

QBE Insurance (QBE)

One of the top 25 insurers and reinsurers worldwide with offices in 45 countries, in the first half of 2009 38 percent of QBE’s GWP (gross written premium) was derived from the Americas, 36 percent from Europe, 22 percent from Australia, and the remainder from Asia-Pacific. Following a 19 percent rise in half-year profits to a record $1.018 billion, the company recently claimed it has the capacity to acquire around $1 billion of GWP. Citi is forecasting 13 percent EPS growth over the next two years. And based on a forecasted improvement in margins, which rising interest rates – and some rise in premium rates - could nudge above 20 percent, Citi have lifted their target price from $20.00 to $22.00.

Citi expects the stock to deliver ROE of 18.3 percent, and a yield of 5.8 percent for full year 2009. The broker also expects ongoing acquisitions to boost growth over and above current estimates for full year 2010 and beyond.

Six Aussie gorillas – key performance ratios

Chart

 Source: Lincoln Indicators

 

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