TOL - 9th Jul, 2024
2 big buys (and the next steps for consumer stocks)
In this episode, two analysts share their outlook on consumer staples and discretionary stocks and outline their top picks in the sector.
Consumer stocks are split into two distinct categories - those that are sensitive to economic cycles (discretionaries) and those that aren't (staples). Both, however, have been on a tear over the past 12 months, despite a cost of living crisis that is continuing to take a bite out of Australians' wallets.
Take Lovisa, for instance, which has soared 59% over the past 12 months. Or Wesfarmers, up 35%. Or Nick Scali, up 44%. Meanwhile, consumer staples stocks, like Bega Cheese, Inghams, and Treasury Wine have risen 41%, 35% and 11% respectively.
All this is to say that the sector is looking pretty hot - other than the supermarkets, of course. However, with savings now starting to dry up, and the economy beginning to slow, how much longer can these stocks hold up?
To find out, Livewire's Ally Selby was joined by two consumer-focused analysts in Alphinity Investment Management's Jacob Barnes and Wilson Asset Management's Hailey Kim.
They share where they are seeing opportunities within the two sectors, some of the trends they believe investors should be aware of and outline which factors will be important to success over the coming 12 months.
Plus, they analyse three major players within the sectors and share their highest conviction buys right now.
Note: This episode was recorded on Wednesday 3 July 2024. You can watch the video, listen to the podcast or read an edited transcript below.
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Edited Transcript
Ally Selby: Hello and welcome to Livewire's Buy Hold Sell. I'm Ally Selby and today we're focusing in on consumer stocks. But with the economy slowing down and inflation starting to bite, can those companies still perform? To find out, we're joined by Jacob Barnes from Alphinity and Hailey Kim from Wilson Asset Management. Thank you so much for joining us today.
The consumer has held up far better than expected, but with savings almost blown and the real prospect of rates staying higher for longer, can the consumer hold up for much longer? Jacob, I'm going to start with you.
The outlook on consumer demand
Jacob Barnes: That's right, Ally. As you say, the consumer has held up stronger and for longer than many expected on the strength of those savings. Although, it's been clear for some time now that aggregate consumer demand per capita is quite soft. When you look at the trading updates released by retailers lately, the increased propensity for consumers to buy on promotion, and consumer confidence indexing below long-term averages, it's relatively clear that the consumer environment is still weak.
Ally Selby: Over to you, Hailey. Are you seeing similar signals in the market right now?
Hailey Kim: I agree with Jacob, but I am a little bit more glass half full. I don't think it's full doom and gloom for consumers in Australia because we've got a pretty strong labour market, wage growth is still quite strong, employment is relatively stable, and also participation is near record highs as well. And consumers are also getting the benefit from income tax cuts that came through from the 1st of July.
Ally Selby: What are you seeing in terms of trading down? And how is that impacting the stocks that you're actually finding attractive right now?
Consumers are increasingly "trading down" to save cash
Hailey Kim: We are seeing consumers becoming a bit more nimble and agile with their spending and they're definitely tightening up their spending, especially on the discretionary items including big-ticket items, and hence the reason why we are favouring staples over discretionary through stocks like Woolworths (ASX: WOW) and Coles (ASX: COL). As we saw from the retail spend data this morning that came out, consumers are really chasing those bargains and promotions that Jacob mentioned previously, and hence the reason why retailers are running those promotions and sale events a bit longer and more frequently. So we do expect those to bite on retailers' margins.
Ally Selby: Over to you Jacob, are you also a staples man right now?
Jacob Barnes: Yes, we are, but we're also seeing opportunities in discretionary. As Hailey said, down trading is a dynamic that's being increasingly called out by suppliers and retailers, and I think it's across the board, both within categories and across retailers. There are some important implications from this from a retailer perspective. As consumers look to purchase at lower price points, that weighs on absolute dollar spend. Retailers can look to try and support the absolute spend by offering better unit economics to consumers through larger pack sizes. But this typically comes at the expense of percentage margins. So it's an optimization problem for retailers I think at this point.
Ally Selby: Okay. Looking out over the next 12 months, what factors do you think will be important for investors when they are investing in this consumer area of the market?
The factors that will be key to investment success over the next 12 months
Jacob Barnes: Well, the Alphinity process is very earnings leadership-focused. And notwithstanding the fact that the consumer environment from a macro perspective is quite soft, we still see pockets of opportunity within specific consumer stocks to deliver earnings above expectations and we think that should be supportive of their relative returns. From a macro perspective, I'd say the path for inflation from here is critical, particularly from the consumer confidence perspective, but also in their ability to actually spend. It also has some important implications for retailers as they need to balance their volume and pricing decisions to try and mitigate any adverse operating leverage that will flow through from the inflation of their cost base.
Ally Selby: Over to you Hailey. What key factors do you think will be important for investors over the next 12 months, particularly when investing in these consumer stocks?
Hailey Kim: As the economic environment gets tighter, we think fundamentals will come back into the spotlight, not just for consumer stocks but for the broader equity market. So firstly, the ability to demonstrate earnings growth, as Jacob mentioned, is critical. There was a period of time when we saw retailers continue to get a valuation re-rating from better-than-expected earnings growth, despite the fact that year-on-year earnings growth was negative or flat at best. We think as the economy gets tougher, investors are unlikely to reward the lack of earnings growth momentum for these stocks. And secondly, valuations have to be reasonable. We are seeing a lot of companies with inflated valuations, largely driven by what's called momentum chasing by the market, and we think this is likely to unwind. We see a rotation into more quality stocks supported by valuation.
Endeavour Group (ASX: EDV)
Ally Selby: Let's get into some of those stocks now. First up today we have Endeavour Group, which owns Dan Murphy's and BWS. Hailey, I'm going to start with you today. Is it a buy, hold, or sell?
Hailey Kim (HOLD): Endeavour is a hold for us, we do like it long-term and its valuation is undemanding. But we are a little bit more cautious given the regulatory risk and also near-term risk around the liquor business. Longer term, they are investing in their hotels business, which has been quite starved of capital for a long time, so we do expect to see earnings uplift potential in the hotels business. And there's also a $1 billion opportunity to unlock value from their property portfolio. So it's a hold for now, but it can become a buy once those near-term overhangs lift.
Ally Selby: Its share price has fallen around 6% since the beginning of the year, but most brokers rate it as a buy. Over to you, Jacob, is it a buy, hold, or sell?
Jacob Barnes (HOLD): We agree with Hailey. It's a hold for us. Endeavour's been in an earnings downgrade cycle for some time now. And while the hotels business is likely to benefit from a robust environment in the slot machine category, we still see margin downside and earnings risk from the retail business. So, until we can get confidence that the earnings downgrade cycle has come to an end, notwithstanding the undemanding valuation, we're happy to stay on the sidelines.
Wesfarmers (ASX: WES)
Ally Selby: Next up today we have Wesfarmers, the parent company for everyone's favourite weekend sausage sanger craving, Bunnings. Jacob, over to you. Is it a buy, hold, or sell?
Jacob Barnes (SELL): Wesfarmers is a sell for us at current prices. Its earnings momentum has flat-lined recently after a pretty material upgrade that came from a robust margin result in the Kmart business in the last half. Supplier and industry feedback is pointing to some pockets of weakness in other parts of the business. It is notable that the softness in lithium prices recently will become increasingly consequential for their earnings as their Covalent Lithium business starts to ramp up production in FY '25 and '26. The stock's performed extremely well, and we think there's little valuation support at current prices, so we're a sell.
Ally Selby: As you mentioned there, the stock has performed exceptionally well, the share price is up 30% since the beginning of the year. Most brokers rate it as neutral, though. Hailey, over to you. Is it a buy, hold, or sell?
Hailey Kim (SELL): It's a sell for us as well. Love the management, but don't love the valuations. It's a fantastic conglomerate business and we love some of its businesses like Bunnings and Kmart. But like you said, it's run pretty hard this year and that's largely driven by valuation expansion and it's now trading on 26 times PE. We think that's a little bit overdone and especially with our cautionary view around discretionary spending, we see limited upside to the earnings and we see downside risks to the valuation.
CAR Group (ASX: CAR)
Ally Selby: Last up today we have CAR Group at share prices up around 10 per cent since the beginning of the year. Hailey, last one for you today. Is it a buy, hold, or sell
Hailey Kim (BUY): CAR is a buy. It's a quality business that's had a recent re-rating and it's got a bit of momentum behind it as well, supported by strong earnings growth, strong pricing power, and also it's got a very competitive positioning across all its four key markets, and very robust free cash flow as well. So it's a buy.
Ally Selby: Okay, over to you, Jacob. Most brokers rate the stock a buy. Do you agree? Is it a buy, hold, or sell?
Jacob Barnes (BUY): We do agree. We think CAR is a buy here, notwithstanding it has performed very well. As Hailey said, it's a very high-quality business. It's got demonstrable pricing power, and very robust competitive positioning in all its key markets. Pretty compelling growth opportunities from here domestically and internationally. And we like the management team, who to date, have proven themselves considered and thoughtful in the way they allocate shareholder capital. As I said, it has performed well, so the valuation upside isn't what it was, but we still see some upsides to earnings and valuations, so we think it's a good buy here.
Ally Selby: Okay, let's hopefully find some stocks with some upside now. We asked our guests to bring along their favourite stock within the consumer sector today. Jacob, I'm going to start with you. What's your top pick right now?
Aristocrat Leisure (ASX: ALL)
Jacob Barnes (HIGH CONVICTION BUY): I think our highest conviction stock in the consumer space is Aristocrat. The strong game performance that it continues to deliver means they're likely to continue to take share in outright sales and participation in North America, and there's a long runway to go there, which we think is underappreciated. The closure of the recent acquisition of Neo Games also means Aristocrat is now positioned as a vertically integrated supplier of technology and content to the rapidly growing iGaming market, both in North America and in Europe.
We also applaud management's recent decision to reassess their portfolio in the mobile gaming market. We expect the result of that will be their decision to reduce their exposure to elements of that portfolio where they don't have a competitive advantage. Couple this with a robust balance sheet and extremely strong free cash flow generation, and we see that Aristocrat is well positioned to fund buybacks for the foreseeable future, as well as invest for continued growth. We think Aristocrat, notwithstanding it is trading at almost all-time highs at the moment, still has valuation upside and earning surprise potential.
Ally Selby: Okay, over to you now, Hailey. What's your favourite stock within the consumer sector today, and why?
Treasury Wine Estates (ASX: TWE)
Hailey Kim (HIGH CONVICTION BUY): It's Treasury Wine Estates. It's a company that's really managed to reimagine its business model over the last three years with great management that can really execute its strategies. So, sitting here today, the Chinese market has reopened to Australian wine for the first time in three years, and we can really see the volume growth restarting in China, coupled with price rises as well. Treasury has also really expanded its global footprint, and they've made some great acquisitions like the DAOU Group and Frank Family Vineyards, and both have proven to be growth and margin accretive. So putting that together, we can see the company delivering double-digit earnings growth over the next three years. And yet, the company is still trading on 19 times PE, which we think is undervaluing the growth profile of the company, so we think it's a conviction buy.
Ally Selby: Well, thank you so much for your time today, both of you. It was awesome to feature you on the show. I hope you enjoyed that episode as much as I did. If you did, why not give it a like? Remember to subscribe to our YouTube channel. We're adding so much great content just like this every single week.
What's your highest conviction consumer stock right now?
Let us know in the comments section below.
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Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
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Livewire Markets
Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
Expertise
Livewire Markets
Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
Expertise
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