When markets get out of whack, long-term bargains can be found – so which stocks could be set for a quick turnaround if fortunes improve?
While few brokers are brave enough to predict a quick turnaround in anything, we found some that were willing to put their views on the table.
David Cassidy chief strategy with UBS Securities is one broker. He says that while some stocks have been justifiably sold-off due to excessive gearing or capital-raising fears there are good stocks out there that could be looking oversold.
So which stocks are on his watchlist?
Cassidy mentions industrial services firm Transfield Services (TSE), Perth-based conglomerate, Wesfarmers (WES), and Rio Tinto (RIO). He also suspects Worley Parsons (WOR) and Harvey Norman (HVN) could be early recipients of renewed optimism; according to Cassidy, Worley’s share price was unjustifiably linked to the fall in oil prices, while Harvey Norman may recover from the retail sectors better than expected Christmas sales figures.
Based on industry sector themes, he says both Telstra (TLS) and Tatts Group (TTS) could also surprise on the upside once recent regulatory reforms play out.
While Transfield was one of the worst performing stocks in the ASX200 index in 2008, UBS expects the balance of probabilities to be appreciably better for the stock in 2009. Following recent debt refinancing and equity raising, gearing is below 60 per cent. UBS analyst Owen Evans expects further improvements over the coming 12 months based on its demonstrable track record in generating cash, especially from its highly stable domestic business.
Transfield is currently priced as though it were highly exposed to capital spending in resources markets, placing stress on its earnings. Evans says that this isn’t the case at all; instead, the company is primarily exposed to maintenance of large manufacturing or energy producing assets – with major and second tier contracts generating between $150-200 million in annual revenue.
Now that its currency-driven debt blowout has been resolved (since its major equity raising), the group’s lingering problems appear to be non-operational. The most pressing being the appointment of a new Managing Director, changes to board composition, and more transparent presentation of results. “Presuming that the business continues to perform in a satisfactory manner, we would expect the present multiples to progressively move towards a market multiple,” says Evans. “This suggests to us that as a stock, Transfield has considerable upside, particularly in an environment in which domestic growth is slowing.”
While the market in the process of de-leveraging, Roger Leaning head of research at ABN Amro Morgans says significantly lower cash rates could see select infrastructure and utility stocks look more attractive.
With its gearing at more conservative levels (relative to counterparts), Leaning’s favoured potential turnaround stock is SP AusNet (SPN) – owner/operator of energy transmission and distribution assets in Victoria.
While SPN’s net-debt-to-assets, at 50 per cent, is higher than desirable, he says it’s more than offset by the quality of cash-flow and asset base (that’s effectively protected by regulation). And while 90 per cent of SPN’s total revenue is linked to CPI movements (and the transmission pricing decisions of the Australian Energy Regulator) – effectively imposing a ceiling on revenue growth, Leaning says it also limits the downside.
When fundamentals return to the market, he anticipates greater scrutiny on how stocks actually make money, including balance sheet strength and management capability. He says that it’s likely that stocks (like SPN) could be re-rated on the quality and sustainability of their underlying earnings. “The stability of SPN’s earnings provides a greater degree of certainty that this ‘yield-play’ will continue to maintain its distributions (yield at 10%),” says Leaning. “It also means profits and profitability are less likely to be impacted by movements in the macro economic cycle.”
Learning says that while there’s still a market overhang on capital-raising, there will be market volatility for several months to come. But sentiment is slowly returning.
Given these conditions, he says that locating fast turnaround stocks is tricky. But for anyone game to try their hand, Leaning recommends seeking out traditionally higher beta stories (leveraged to a particular theme or driver – like commodity prices or consumer confidence) where the current price justifies the associate risk.
Leaning also says that investors should keep a watchful eye on resource stocks like BHP, Rio Tinto, Oil Search and Origin (ORG) that could be early beneficiaries from a rally in commodity prices. “Origin’s vertically integrated business model and strong balance sheet (net cash position to end of 09) will help it to ride-out a lot of the sector’s current problems, notably reduced oil and gas prices,” says Leaning. “It’s under-geared balance sheet means it’s better positioned to reinvest as new opportunities arise.”
Like Cassidy, Leaning also expects large-caps (the Top 50) with clean balance sheets to be the first to bounce when sentiment returns to the market. “When it does, we’ll see a re-rating of sectors like banking (and retail) and our preferred stocks would be ANZ, Bank of Queensland, QBE, and Harvey Norman.”