4 key recovery themes to act on now

#1 The retail recovery 

On the back of 10-year highs in consumer and business confidence, retail is primed to fire. With fiscal stimulus set to continue, strong management and the leveraging of e-commerce can fuel success in the retail sector.

"Better management in the consumer sector have seen hitherto unimaginable increases in profitability through the past twelve months...rocket fuelled by fiscal policy, monetary policy, rental and wage holidays and strong consumer confidence, more than offsetting lockdowns and viral concerns."

In order to capture this wave, Schroder's have highlighted the impressive performance of Premier Investments (ASX: PMV) operators of specialty retail fashion chains accross ANZ, Asia and Europe. Major brands include retail conglomerate Just Group and a 28.06% stake in electrical consumer products manufacturer Breville Group. 

Led by impressive management, they had more than doubled profitability over the past decade. Then covid hit, and their profits skyrocketed from 120m to 220m: "More than a decade of hard-won growth in a year."

The major caveat to this is the backdrop of exceptional circumstances: considering the long term narrative in the retail sector as a result of the influence of e-commerce and the prospect of an eventual reversion to the mean should be at the core of considerations. 

# 2 The incessant rise of IT

As mentioned in this previous sector-by-sector performance breakdown, there is no doubt that innovative tech has been a major success story in Australia. With eye-watering valuations continuing to drive market multiples higher, the degree of profitability does not seem to be of concern to investors. 

No profitability at all doesn't bother them either, with Edward Rosenfeld from Lazard Asset Management finding that unprofitable information technology companies outperformed by 40% through 2020. 

Fleming remarks that reliable performers such as Computershare and Link may not have the pizzaz of Afterpay and co. when it comes to explosive revenue growth, yet their proven cash flows that can deliver long term certainty. 

"The sector has two stocks which make strong cashflows but have low revenue growth – Computershare and Link... It’s all about the g – growth is the word, and revenue growth especially is the magnetic force for market attraction. In a low growth world, that’s understandable, but the risk attached to the presumption that early stage revenue growth will translate to longer term free cashflow, let alone cashflow growth, is not to be underestimated."

#3 To build or not to build

Building materials companies have experienced a massive resurgence as activity levels in Australia rose to record highs. Oxford Economics estimates that despite a 10.4% contraction in the Australian construction sector in 2020, it is set to grow by 7.1% in 2021, driven by population growth and a quarry of infrastructure projects. Whilst the USA is not tipped to recover to previous levels until 2022, James Hardie Industries (ASX: JHX), has managed to flourish in both markets:

"Against the odds, Hardies hasn’t just held high performance levels in the US during the past two years, they have lifted the bar materially. Profitability and returns are at all-time highs with housing starts still 39% below the all-time high levels of a decade ago."

Other construction names benefitting from Australia's uptick are Fletcher Building (ASX: FBU) and Boral (ASX: BKD), although they remain exposed to economic cycles given respective low secular revenue growth. 

# 4 Doing the dirty work

The waste industry can be split into solid waste, industrial waste and liquid waste & health. In a climate where business operations reached a standstill, we saw waste from commercial operations (industrial waste) sliding 15-20%. However, interestingly, this was generally offset by household waste (UberEats, anyone?). Recent industry disruption among incumbent players Suez and Veolia has opened up opportunities for Cleanaway (ASX: CWY) 

Cleanaway had seen billions of value destroyed in poor M&A activity and operational sloppiness in the decade prior to 2015....however success of the business through the past several years has seen the workforce increase by 50% to 6,000 people and workplace injuries have declined at 15% CAGR ... Margins have also increased towards the levels of the best global operators through the past several years.

Finally, an initial bid for Bingo Industries drove further interest across the sector. Whilst conflicts with contracts, intolerance of diversity and unsustainable margins were all highlighted in a recent short report, a commitment to innovation holds them in good stead:

We remain unabashed admirers of the group’s ability to grow revenues and gain share whilst having a focus on using technology and innovation to be the lowest cost producer in the market... given the increasing environmental focus upon recycling rates and waste to energy opportunities in the market, it is hard to believe that the best is not yet to come for Bingo and its shareholders

Conclusion 

A rapid ascent in market prices has led to much noise in equity markets. Conflicting signals continue to run rampant and hence being diligent with portfolio holdings and asset allocation is imperative. Fleming concludes on this note: 

"The bifurcation between the winners and losers within the market remains as large as ever; growth stocks have never been more highly prized, nor value stocks more despised. Management decisions in capital allocation, pricing and productivity will continue to have just as much influence in determining returns as those transient macro conditions, and that in turn is driving our portfolio positions and changes wherever possible."

Read the entire commentary here.