In the stock market slump of 2007-2008, don’t bother looking for the defensive sectors of the market to hide – there aren’t any.
All of the Australian Securities Exchange’s GICS sectors are down for the year to date. With the market down 20 per cent, the best you could have done was to be down 6 per cent, in healthcare.
Traditionally the defensive sectors have been considered banks, high-yielding property trusts and infrastructure assets, because interest and rental income are fairly constant. That theory has been blown out the window this summer: when the market focuses on debt, stocks from these sectors have been shown to be some of the riskiest.
Consumer staples stocks – for example, Woolworths – are also considered defensive, because people have to eat. The brewing and wine stocks are regarded as almost recession-proof; as are gaming stocks like Tabcorp and Tattersall’s, because Australians have demonstrated that they don’t let an irrelevance such as the economic environment curtail their love of the punt. Healthcare, too, is considered defensive, because people get sick regardless of economic or stockmarket conditions.
But the problem with finding defensive stocks at the moment is that “the market is not trading on fundamentals”, says Allan Furlong, manager of private client services at broking firm Joseph Palmer & Sons. “Stocks that brokers traditionally see as defensive are being hit just as badly as anything else, which is a sign of the absolute fear that’s out there.
Furlong says the banks have traditionally been looked upon as stalwarts, but there is “absolute fear” around that sector. “Foster’s is perceived to be a defensive stock because it’s diversified beverages, but it didn’t perform in the bear market in 2002 and it hasn’t performed in the bull market since then. Coca-Cola Amatil is another one, but the market is pretty bearish on all of them.
“Healthcare stocks are generally defensive stocks, but that’s not helping API (Australian Pharmaceutical Industries) or Sigma (Pharmaceutical) at the moment. We’re not seeing any strength in those stocks because everyone’s confidence has been shaken so badly.
“Woolworths would be the sort of stock that you would hope would hold its ground, because it’s been trading at an extraordinary premium over the last few years, because it’s been putting the runs on the board. But it doesn’t look fundamentally cheap – you’d have to pay that premium if you wanted the fundamental exposure,” says Furlong.
Brent Mitchell, head of research at Shaw Stockbroking, says CSL is “probably the best of the defensive exposures” in healthcare. “To a certain extent it relies on a commodity price (intravenous immuno-globulin, or IVIG) but the main thing that has been driving CSL has strong underlying growth in the plasma market, and a big positive in terms of its HPV (human papillomavirus) vaccine.
“Sonic Healthcare is another: it’s more of a healthcare services business in pathology. People continue to get sick and continue to need to be tested for various things. So Sonic hasn’t been affected to the same extent as the general market,” says Mitchell.
According to Macquarie Research Equities, the Healthcare sector is “typically defensive in terms of debt exposure and low cycles of revenue and costs”. In this market, Macquarie prefers ResMed, which makes sleep-disordered breathing (SDB) apparatus. ResMed’s biggest market is the treatment of obstructive sleep apnoea (OSA) in the US. ResMed trades at $4.54, but Macquarie has a 12-month price target on the stock of $5.00.
Food and beverage group Coca-Cola Amatil has benefited in relative terms from its perceived defensiveness, but the research team at JP Morgan says this is “more than reflected” in the stock’s 19 per cent out-performance in the year to date. With rising aluminum and sugar costs in FY09, slowing economic growth in Indonesia (where it is the main Coca-Cola licensee) and the impact of rising fuel prices in Australia, JP Morgan says the earnings risks are mounting, and the stock’s defensive premium “is likely to be questioned over the next six to 12 months.”
Broker Citi says Metcash (which operates IGA Distribution, Campbells Cash & Carry and Australian Liquor Marketers) is “best-positioned to benefit from an expected spike in food inflation over the next six months”. With higher inflation set to boost the grocery companies’ earnings in the short-term, Citi estimates that Metcash generates 93 per cent of its EBIT (earnings before interest and tax) from Australian grocery sales, compared with 65 per cent for Woolworths and 26 per cent for Wesfarmers (which owns Coles Group). Citi says Metcash’s business model “provides a direct link to food inflation” because its service fee is based on nominal prices.
Instead of looking at the sectors usually thought to be defensive, Mitchell says investors have to “scour the market” for individual stocks that have characteristics that should enable them to hang tough in the downturn. “We’ve been looking at a stock called Redflex Holdings (RDF), which supplies traffic cameras, mainly in the USA. That’s hardly fallen at all.”
He says Redflex has a strong pipeline of installations and its revenue keeps rising as the cameras go in place. “We think that’s a very secure revenue flow coming through. Economic conditions don’t determine whether drivers speed or not. Redflex is a classic economically non-sensitive stock. Gearing is under control as well, at about 38 per cent debt-to-equity. You could argue that Redflex is a defensive stock because its characteristics aren’t affected by factors like the sub-prime crisis or economic fluctuations in general.”
In the same vein, Martin Pretty, head of research at Bell Potter, likes educational company Navitas (NVT), which offers English-language high school, university preparation and university degree programs. “Navitas is not greatly liquid, and it’s not well known, but it’s growing very rapidly, because it’s exposed to Chinese middle-class demand for English-language education.
“I think you can make the case that Navitas is defensive – certainly, its share price has held up very well – or it might be more correct to say that it has good things going for it at a time when stocks in general aren’t going very well. But if you look at its share price, it has gone from $2 to $1.88 over this time of turmoil, so you could say that’s showing defensive characteristics at the moment,” says Pretty.