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04.06.2010Defensive stocks to withstand market volatility

This share portfolio aims to withstand sharemarket volatility while delivering solid capital growth and income.


The flight to safety is an appropriate investment strategy amid uncertainty fuelling volatility in global equity markets. Jittery investors are wasting no time in selling and buying stocks on a sniff of bad or equally good news. The Greek debt crisis, a trillion dollar rescue package, a weaker Euro, China's unsustainable economic growth, Australia's 40 per cent resource super profits tax and rising interest rates continue to test the nerves of investors.

So, in response, analyst Andrew Doherty, of Morningstar, has established a share portfolio he believes will withstand acute sharemarket volatility and deliver investors sustainable capital growth and income returns during the next few years.

Doherty says sharemarket volatility presents a good opportunity to buy quality stocks at a discount price. His portfolio isn't a recommendation to buy, but Doherty offers his views as to why investors should have Cochlear, CSL, Foster’s Group, David Jones, Wesfarmers and Woolworths in their portfolios.

Doherty says Cochlear, a hearing implants manufacturer, is a notable blue chip company, offering an enviable track record and is a stock for all seasons. It benefits from a first mover advantage and is rewarded for focusing on innovation. “Between 15 and 20 per cent of revenue is ploughed back into research and development each year,” Doherty says. “The company’s products enjoy a reputation for quality, which is crucial when surgeons choose products to use in their operations.” Doherty says the company reported revenue of $712 million in full-year 2009 and posted a net profit after tax (NPAT) of $131 million, up 14 per cent on the previous year. “The company offers robust growth opportunities in the US, Europe and Asia,” Doherty says. “It generates healthy margins and cash flows.”

CSL’s share price has been under pressure over suspicions this season’s influenza vaccine may have caused adverse effects in children. CSL is one of several suppliers of flu vaccine in Australia. Also, CSL is vigourously defending a multi-million dollar civil class action in the US, alleging price fixing of plasma.  On the positive side, Doherty says CSL is a leading player in the blood plasma industry, which has consolidated into a few fully integrated global suppliers. “Industry consolidation has led to favourable pricing and lifted returns,” Doherty says. He says CSL generated revenue of $4.8 billion in full-year 2009 for a NPAT of $1.02 billion, up 45 per cent on the previous year. Competitive advantages stem from economies of scale and integrating services from blood collection to product manufacture. CSL´s Human Papillomavirus (HPV) vaccine offers a new earnings stream. “This company has healthy margins and cash flows and the impact of economic cycles is limited,” he says.

Foster’s Group has been out of favour with several analysts for failing to meet their expectations in the face of a wine glut. For Doherty, the Foster’s share price is providing investors an opportunity to gain ground floor entry amid a brighter medium term outlook and constant speculation about asset sales and corporate activity. “What appeals about Foster’s is its solid and reliable cash flow from beer and the turnaround benefits from its wine restructure,” Doherty says. He believes the bad news is mostly behind Foster’s, but during the restructure, the stock is offering an attractive-fully franked dividend yield above 5 per cent.

Doherty suggests long-term investors focus on companies able to generate reliable earnings growth. “More than reasonable returns can be generated this way without the need to stress about daily fluctuations in the sharemarket,” he says. Doherty says each of his stock suggestions has performed relatively well during the recent downturn and they offer considerable upside in an improving global economy. He says his stocks may not be the most exciting performers, but they have solid businesses behind them and are poised to make money in challenging times.  

Doherty says it may surprise some to include David Jones in a defensive portfolio as discretionary retailers generally do it tough in a rising interest rate environment. But, he says, David Jones is a well managed company that mostly appeals to high income earners able to withstand higher interest rates. “It operates a chain of 38 retail stores selling exclusive brands within a proven business model,” he says. “Smart cost cutting has supported earnings growth during the difficult recent past despite flat revenue. And the full franked dividend yield around 7 per can’t be overlooked.”

Industrial conglomerate Wesfarmers is one of the major corporate success stories, according to Doherty. He says Wesfarmers has created an efficient cash-generating machine, and the acquisition of Coles Group has the potential to underwrite solid earnings growth during the next decade. He says Wesfarmers is forecasting a full-year NPAT of $1.8 billion for 2010. The Bunnings hardware chain continues to contribute strong operating cash flows. “The fully franked dividend yield around 4 per cent is decent,” he says.

Wesfarmers competitor Woolworths should be part of any balanced share portfolio, with Doherty describing Woolworths as “one of the strongest businesses in Australia”. “Reliable revenue growth stems from store roll-outs, refurbishment of existing stores to improve its sales per square metre ratio and extending into related retail formats, such as petrol and liquor,” he says. Doherty says Woolworths has a strong profit record, and delivered a NPAT of $1.8 billion for 2009, up 13 per cent on the previous year.  “Margins and cash flows are boosted by the company investing in efficiencies and using scale to squeeze supplier margins,” Doherty says.           

Company ASX Code
 Share Price Close May 28, 2010
Cochlear
 COH $73.19
CSL
 CSL$31.40
Foster's Group
 FGL $5.50
David Jones
 DJS$4.40
Wesfarmers
 WES $28.90
Woolworths
 WOW$26.41

 

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.


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