3 quality ASX stocks trading below value

High-quality companies tend to outperform markets over the long term, due to their quality attributes: durable competitive advantages, supportive industry structure and aligned management teams. This leads these high-quality companies to often trade expensively, as investors crowd into these names.

Investors often find it difficult to build new positions in these stocks, as high multiples and outperforming share prices can make us feel like we’ve missed the boat. However, the long-term outperformance of these high-quality companies isn’t linear, and these companies face short term bumps just like any other, providing opportunities for new investors.

August was a volatile reporting season which saw plenty of big moves skewed to the downside as the market remains cautious on an uncertain macro-outlook. At Blackwattle, we are focused on high-quality companies and short-term share price setbacks are a significant alpha opportunity for us as longer-term investors.

We discuss three high-quality stocks trading below value due to short term issues:

Reliance Worldwide (ASX: RWC)

Reliance is a high quality, cyclical industrial business that has done well from strong housing construction, renovation & repair in the US, UK/EU, and Australia, cementing its place as the dominant plumbing supplier in all markets and the go-to-brand for plumbers. Given the uncertain macro-outlook, Reliance management have conservatively guided to the market for their operations to reduce manufacturing and inventory (improving cashflow) and move more manufacturing to their cheaper US manufacturing sites. This has caused short term earnings weakness for 1H24, but an improving 2H24 as manufacturing production rebounds.

"We continue to back Reliance’s long standing, highly aligned and founder-like management team to grow shareholder returns through strong FCF generation and capital discipline."

The market is rightly cautious on an uncertain macro-outlook, and with weaker short-term earnings has sold off Reliance. However, we think Reliance’s low FY24 PE multiple of 13x (Source: Refinitiv) already prices in the cyclical macro risk and we are willing to look through a modest FY24 into FY25 and beyond. We believe Reliance’s dominant position and new SharkBite Max product will allow for further market share gains through the macro cycle, bolstered by their improved cost base. 

WiseTech (ASX: WTC)

WiseTech has been an ASX darling for years, defying naysayers as it has delivered incredible sales growth, expanding margins and strong FCF generation. Harry Hindsight would say that the stock got ahead of its skis coming into August reporting season, rallying 50%+ in 2023, hitting an all-time high and trading on a ritzy ~90x PE. Whilst the company reported a strong FY23 result, lower margin guidance for FY24 wasn’t what investors were looking for, and the stock fell 20% on its result day. A look into WTCs past record should give investors the confidence that management have gone through this before and come out the other side stronger. The business has a history of acquiring earlier stage businesses with lower profitability, diluting overall margins, then being able to implement cost productivity and continued revenue growth to improve group margins.

"We forecast WiseTech margins growing back to and ultimately above FY23 50% EBITDA levels with the CargoWise product continuing to grow strongly as the recent acquisitions open a broader market opportunity."

Recent major client wins give the product the tick of approval and lack of competitors provide strong pricing power. As quality focused, longer-term investors, we are happy to look through a ~12-month period of 45% margins (!) for a recovery beyond, where we see WTC trading on ~30x EV/EBITDA for FY25, well below its historical average of almost 50x (Source: Refinitiv), for one of the highest quality companies on the ASX.

Orora (ASX: ORA)

Trading at ~$3.50ps going into August reporting season, we viewed Orora as trading around fair value for a quality, defensive industrial business. Post reporting season, they acquired Saverglass for an enterprise value of ~$2.2b, a significant bite for a company with a market cap of only ~$3b. To fund the deal ORA needed to raise almost 60% new shares, leading to a highly discounted (23% to last) equity raise. Given the quantum of new shares to be digested, the stock hasn’t since traded much above the raise price of $2.70ps, putting the stock on only ~11x FY25 PE compared to a historical average of ~16x PE (Source: Refinitiv).

"The acquired Saverglass business compliments Orora’s glass packaging business, allowing the company to move into higher margin, premium glass bottle manufacturing, improving the quality attributes of the group."

Again, as quality focused, longer-term investors, we view this is a great opportunity to look through the short-term deal dynamics to own a quality, defensive industrial business.

Quality Investing

At Blackwattle we are constantly on the lookout for these mis-priced, high-quality businesses. We understand the exceptionalism of these businesses in generating significant shareholder returns, so when we do discover one, we look to become long-term shareholders and capital partners, enabling our portfolios to capture the long-term compounding of outperformance through market cycles.

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Tim Riordan & Michael Teran