Key Picks for 2020

The table below provides our key picks for 2020.

Source: Bloomberg, Banyantree

Declining interest rates means equity markets should benefit… In our view, over the course of 2020, the RBA will do as expected by consensus and lower the cash rate to 0.25% (presently 0.75%). It is important to note that, whilst declining interest rates occur, equity markets should benefit, ‘growth’ should prevail over ‘value’ stocks.  We remain focused on picking high quality companies, with solid balance sheets, solid free cash flow generation and earnings over a rolling 5 year timeframe. In this current environment, it is pertinent to deploy capital and lower cash weightings.

AMP Ltd (AMP)

Following the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, the disappointing underperformance in AMP’s share price makes the Company an interesting proposition. CEO Francesco De Ferrari, has announced a strategy to take the business in a new direction, beginning with the revised agreement for the AMP Life sale and the simplification of the business model with a focus on the Wealth Management, AMP Capital and Banking arms.

In our view, the determinative questions underpinning AMP’s future is how much of the issues (such as reputational damage) has been factored into the share price, which in our view is largely factored in and now investors look to execution and feasibility of AMP’s “three-year strategy”.

In our view, the quality of the assets on AMP’s books and their strong market position (even after recent tumultuous events) considerably brightens the outlook for the Company insofar as to lead us to reason that AMP will be able to focus on their core operations and achieve a turnaround by leveraging their strong financial planners network and infrastructure underpinning their operations; to capture market share in the Australian pension funds industry, which is the fourth largest in the world.

While we caution that investors take a conservative approach in the weighting of this stock in their portfolios (especially with the significant number of issues affecting future earnings, the Company is extremely difficult to accurately value), we believe that AMP’s share price should perform well in 2020.

Fortescue Metals Group (FMG)

As a reminder of its FY19 results, FMG posted a record underlying profit of US$3.19bn which came in ahead of consensus estimates of US$3.03bn on the back of a surge in iron ore prices after a mine disaster in Brazil created a global shortfall. The results helped the Company declare a bumper final dividend of A$0.24 per share taking full year dividend payment to A$1.14 per share (up +396% over pcp).

We like FMG in 2020 for:

1. FY20 guidance appears achievable
2. Their strong balance sheet with ample liquidity and reduced gearing (balance sheet is structured on low cost and investment grade terms with optimal gearing and liquidity levels to support ongoing operations, with the debt capital structure allowing optionality and flexibility for future growth);
3. Total dividend pay-out ratio of 50-80% of full year NPAT).

At the time of the FY19 results, management noted that it was still seeing solid demand growth despite trade tensions between China and the U.S (which we see abating in 2020) as China continues to raise stimulus measures to offset a slowdown in economic growth hampered by trade tariffs. We see some softness in iron ore pricing as Vale aims to bring some supply back online. FMG trades on a reasonable multiple of ~8x one-year forward price to earnings and attractive dividend yield.

Link Administration Holdings (LNK) 

As a reminder, LNK’s FY19 results announced back in September 2019, came in line with consensus estimates, with the Company also announcing an on-market share buyback of up to 10% issued capital.

For 2020, we see:

1. Management expects operating EBITDA from continuing operations to be stronger in the 2H20 versus 1H20, equating to a broadly flat year on year performance for FY20.
2. Management expects growth in other divisions to offset the lower expected contribution from Retirement & Super Solutions (RSS)
3. RSS is expected deliver revenue of $480-500m and operating EBITDA of $60-70m following the impact from PYS (Protecting Your Super) and previously announced client losses/client mergers.
4. Margins will be impacted again this year but are expected to improve over the medium term benefiting from the transition to global operating model.

Whilst the resolution of BREXIT should benefit LNK, and we expect FY20 to be difficult year (with earnings expected to be largely flat), with growth expected to resume post this trough year, given the current undemanding valuation over the medium term and earnings growth prospects, we see LNK as an opportunity in 2020 the market factoring in these highlights before 2020-end.

Orocobre Ltd (ORE)

Back in August 2019, the Company announced FY19 results which were disappointing due predominantly to lower lithium prices and the export duty cost of US$8.4m (introduced in September 2018).  Management is guiding towards +5% growth in production in FY20, which remains well below nameplate capacity. Lithium prices at the time were under pressure.

In FY20, we see:

1. FY20 production expected to be approximately +5% higher than FY19.
2. Olaroz Stage 2 Expansion finance is now complete.
3. 10,000 tpa Naraha Lithium Hydroxide Plant construction has commenced.
4. Lithium chemical prices are lower than previous periods, but long-term fundamentals remain intact.

Indeed, whilst the macro remains challenging in the near term, the Chinese’s government halt to reducing the subsidies offered for electric vehicles purchases should help ORE’s share price, and given the Company owns high-quality low-cost asset, it remains well positioned over the medium to long-term.

Newcrest Mining (NCM) 

Gold is a good hedge against wider macro risks. As a reminder, NCM shares were a little weaker after announcing their FY19 results in August 2019, which came in below market expectations. In the short term, the share price of NCM is predominantly being driven by macro drivers. NCM stands to benefit from its solid balance sheet, supportive gold price and best in class assets.

Woolworths Ltd (WOW)

In September 2019, WOW announced that the company delivered FY19 normalised EBIT of $2.72bn, up +5% over pcp and in line with consensus estimates of $2.7bn, driven by a solid performance in its core supermarkets business, which more than offset losses from Big W department store chain and weaker than expected contribution from it’s about to be spun off liquor division, Endeavour Drinks.

Management noted: “In FY20 the consumer environment remains uncertain with many customers experiencing cost of living pressures despite record low interest rates and recent tax stimulus, and input cost pressures remain for retailers and suppliers alike”.  However, in our view management looks well placed to respond to these challenges given the fact that WOW has made a robust start to FY20 with a +7.5% increase in same-store sales in the group’s core supermarket chain in the first eight weeks of the new year.

Furthermore, with the exit of Germany’s hypermarket chain, Kaufland from the Australian landscape, we see WOW most likely to benefit the most as a result. Further, whilst we expect the RBA’s decision to drive down the cash rate, to benefit growth stocks (and companies with flimsy business models), we also expect a large number of investors increasingly move to defensive stocks such as WOW which are more immune to an economic slowdown. As with the sale of Woolworths Petrol to EG Group in April 2019 whereby the Company returned proceeds of $1.7bn to shareholders through an off-market share buy-back, we similarly expect the sale of WOW’s Endeavour Drinks Group to provide the Company the opportunity to undertake capital management initiatives.