All-weather stocks – Back in fashion

This year's deterioration in economic prospects, now complemented with a banking crisis in the US and the inevitable demise of Credit Suisse, has strengthened expert calls for robust, defensive, reliable, High-Quality equity exposures.

Many of the calls made include a large overlap with my personal research into All-Weather Performers listed on the ASX.

Outside of my personal selections, references often include Cleanaway Waste Management (CWY), Ramsay Health Care (RHC), Sonic Healthcare (SHL), and Washington H Soul Pattinson (SOL).

The general idea is that indiscriminate selling will at some point recognise not all companies are of similar core characteristics and those with more robust and dependable earnings will ultimately outperform.

Traditional labelling by the investment community refers to defensives versus growth companies, and many of the High-Quality companies listed on the ASX are usually included when the market focus shifts to defensives, but differences still matter.

A recent research paper released by Wilsons suggests investors have a choice between 'defensive' and 'defensive growth' - the difference in return between these two categories can be significant over time.

To illustrate their thesis, analysts at Wilsons compared the performance of CSL (CSL) and Woolworths (WOW) shares over the past ten years. Woolworths functions as your typical defensive exposure, while CSL is the counter-example of a defensive growth company.

Back in early 2013, CSL shares were trading on a PE multiple of circa 21x and a forward-looking implied dividend yield of 1.9% only. Woolworths looked a lot more attractive, trading on a PE of 13.3x and offering a yield of 5.3%.

Fast forward to 14 March 2023 and $100,000 invested in CSL shares back then would have generated $525,473 while total return from Woolworths only reaches to $142,078.

The first calculation amounts to an annual capital return of 18% over the decade while investors in Woolworths had to satisfy themselves with an annual return of 3.6%, 5.4% in total if we include dividends.

Wilsons still thinks CSL shares are more attractive than Woolworths today. Its projections for CSL are for EPS CAGR of 24% between FY23-FY25. For Woolworths the comparative pace of forecast growth is 7%.

The underlying message from this research is that growth matters, growth ultimately creates the difference in return between shares. The lowest valuation is not by definition the better choice (even though this may not be apparent in the short term).

The same principle applies to the highest dividend yield. My namesake at First Sentier Investors, head of equity income, Rudi Minbatiwala explained recently how investors looking for income in early 2013 had better ignored the high yield on offer from Telstra (TLS) and instead should have opted for what appeared a pitiful yield at the time from shares in REA Group (REA).

When making up the final balance after ten years of owning either Telstra, an oft-cited income stock, or a fast-growing REA Group, investors might be surprised total income received from REA exceeds total dividends paid out by Telstra. And that's without the obvious difference in capital appreciation (Telstra shares went backwards over the past decade).

On Wilsons' labeling, circa 25% of the ASX300 can be categorised as 'defensive' - not everybody is on board with traditional labeling, but selections usually include Amcor ((AMC)), APA Group ((APA)), Brambles ((BXB)), Coles Group ((COL)), Endeavour Group ((EDV)), Medibank Private ((MPL)), The Lottery Corp ((TLC)), and Transurban ((TCL)), among others.

It's probably worth highlighting smaller cap companies can also be labelled 'defensive', but a smaller size and less diversified shareholder register tends to go hand in hand with greater volatility when things get truly hairy in markets. A smaller-sized business tends to be more vulnerable to negative developments which also reduces the solidity of earnings.

When choosing which defensives should be included in the portfolio, Wilsons' preference is for defensive growth. Its portfolio currently includes CSL, ResMed (RMD), Insurance Australia Group (IAG) and Cleanaway Waste Management as your typical 'growth defensives' while its top defensive choice is The Lottery Corp, with Telstra also included.

Two other opportunities highlighted are Ramsay Health Care and Treasury Wine Estates (TWE).

One potential deterrent for investors to consider investing in the companies mentioned is that Quality and Defensives, in particular during uncertain times, are seldom trading on truly attractive-looking, low PE multiples. But, as explained by James Abela, portfolio manager for the Fidelity Future Leaders Strategies, the 'trick', so to speak, is for investors to distinguish between Quality and Momentum stocks.

Both enjoy above-average valuations, but not for the same reasons. Momentum stocks are companies that temporarily enjoy the triple peak in earnings, valuation multiples and market sentiment. The latter usually involves large participation from the so-called 'hot' money crowd. They'll leave instantly when momentum wanes.

Recent examples would include the BNPL sector and technology stocks such as Appen (APX), as well as online retailers; think Redbubble (RBL) and Kogan (KGN), for example.

This is not to say Quality stalwarts cannot get into trouble, or lose their way.

Woolworths once lost its way when hubris gripped top management and the board (2014-16) and Brambles is only now seemingly ready to awaken from its slumber that has lasted half a decade-plus. Contrary to opinions voiced elsewhere, I also believe the longer-term outlook for Ramsay Health Care is a lot more clouded, which raises serious question marks about this company's inclusion in the local Quality basket.

Regardless, the value of owning Quality companies over long periods of time has over the decade past increasingly been acknowledged by investment experts, including many of your typical 'value' investors who traditionally would shun these stocks as they were 'too expensive' or at least 'not cheap enough' by default.

The obvious statement to add here is that a cheaper share price should only add to the attraction, and to prospective longer-term returns, from owning Quality companies.

All-Weathers: Post-February

The first observation to make is that Australia's Quality companies usually perform well during results seasons. 

This doesn't mean they cannot miss forecasts or suffer from share price weakness, as macro and general sentiment play a role as well, but overall, your typical Quality company is a great place to be when reported financials are measured against medium- to longer-term expectations.

The first company to highlight post-February financials is CSL with the interim report indicating the negative impact from covid and lockdowns on plasma collection is now truly in the past. Underlying, this company is yet again ready for solid, double-digit percentage growth in EPS, which is also reflected in today's consensus forecasts.

To some, the primary observation is that CSL shares have effectively trended sideways since 2020, but if I picture a conversation between Mr Market and CSL, it revolves around that old cliche: "it's not you, it's me". 

Investor focus in Australia has been all about COVID beneficiaries, bond yield victims, inflation protection and China leverage. None of these themes du jour include the largest healthcare company on the ASX.

This too shall pass, eventually. It might still take a while before enough investors feel confident about the acquisition of Vifor, but I still remember the scepsis surrounding the purchase of Novartis' global influenza vaccine business in 2014. 

It proved overly conservative and unnecessary. CSL has had Vifor on its wishlist for more than a decade. Already, analysts have been positively surprised, and excited, about the add-ons Vifor brings to the CSL future product pipeline.

This is not to say there are no risks. There's a small Dutch-based company, Argenx, that is on everyone's radar. And CSL management itself is not super-confident where exactly profit margins will be in 18 months' time, as higher operational costs might stick around for longer.

But if history is any guide, sceptics will again be left barking in the wind, while shareholders enjoy the rewards from their loyalty. As Warren Buffett tends to say: invest in companies, not in the share price. Longer term, share prices do follow underlying fundamentals.

We might as well stay with the Wilsons comparison... Indeed, Woolworths is more 'defensive' than 'growth', and its typically elevated valuation multiple became a big burden to bear last year. 

But make no mistake: Woolworths is the superior operator in its sector, similar to CommBank ((CBA)) among local banks, and this superiority will prove its value, one way or another, throughout the ups and downs ahead.

I have become a big fan of picking market leaders in sectors as I have come to appreciate their sustainable, long-duration competitive advantages vis-a-vis smaller competitors. 

Other obvious examples are REA Group versus Domain Holdings Australia ((DHG)), Sonic Healthcare versus Healius ((HLS)), and Aristocrat Leisure ((ALL)) versus Ainsworth Game Technology ((AGI)).

Woolworths runs the superior franchise in Australia and as a typically defensive, its valuation is probably high because of the multiple uncertainties out there. Then again, current consensus forecasts confirm the market leader's superiority versus Coles and Metcash ((MTS)).

Supermarkets and big box department stores have their challenges ahead, including pressure on household budgets and rising costs, but Australia is still an island and many of the products are non-discretionary. The possibility of a weaker share price later in the year will be very much dependent on what is going on elsewhere, including for the Australian economy generally.

One Quality market leader that is using post-covid uncertainties to strengthen its future growth platform is Carsales ((CAR)). 

Usually, most attention goes towards REA Group, also because real estate remains a long-term no-brainer in Australia, and Seek ((SEK)), with the latter a prime example of the long-term value of making strategic investments, but this time Carsales' strategy of buying out its partners in offshore portals are catching investors' attention.

First the US, then Brazil. Carsales is effectively broadening its growth and appeal beyond the Australian market in which it remains the undisputed number one. 

Expanding offshore is not a guarantee of success, even REA Group can attest to that statement, but Carsales knows the businesses it is buying. And locally it has discovered the advantages of exerting pricing power, as well as strengthening relationships when covid hit dealerships hard.

If there's one Quality, sustainably growing market leader that has seen value investors appearing on its register in recent years, it has been Carsales. Maybe this is because, on a simple comparison with REA Group and Seek, PE ratios of 28x and 25x don't look too bad for a platform operator that promises 10%-plus growth (pretty much) annually with a dividend yield of circa 3%?

One company that 100% doesn't receive enough attention in Australia is Ebos Group (EBO). This NZ-listed company joined the ASX in late 2013 and has proven a consistent and reliable performer since, which is also reflected in its share price over the period. 

Ebos Group might be the one ASX name whose shares are trading at an all-time high while most investors locally might still respond with: huh, who?

Some might be familiar with chemist brands including Terry White Chemmart, Symbion and Pharmacy Choice+, but Ebos does a lot more, calling itself the largest and most diversified Australian marketer, wholesaler and distributor of healthcare, medical and pharmaceutical products. It shares with Woolworths the recognition of the potential of moving into animal care products.

Ebos wasn't always included in my selections, but it had been on my radar for multiple years, until I decided to add it as a Potential All-Weather Performer.

The February results season offered plenty of misses and disappointments, but from the perspective of All-Weathers, the biggest disappointment was delivered by Domino's Pizza (DMP). 

I could read between the lines of multiple research reports post the interim result that analysts had been quite shocked by how dreadful things had become operationally in such a short time.

Will this be the (negative) turning point in what has been an extremely volatile, but also exceptionally successful international trajectory for this company over the past decade?

I dare not to make any firm statement at this point, other than that history has taught me it's usually best to remain prudent, and not on the register, of companies whose fortunes turn in such a quick and decisive manner. 

Others that have preceded Domino's in past seasons, think a2 Milk (A2M), Appen (APX) and Blackmores (BKL), are hardly encouraging examples to look back upon.

Other companies on my curated selections that caught my attention in February include Audinate Group (AD8), Endeavour Group, Goodman Group (GMG), NextDC (NXT), ResMed, Seek, Steadfast Group (SDF), Wesfarmers (WES), and WiseTech Global (WTC).

With exception of NextDC, all those companies have been registered in FNArena's Monitor as a 'beat'.

I remain confident Pro Medicus (PME) is one of the highest Quality growth companies on the ASX. 

Getting on board is simply a case of picking one's entry-level, while ignoring the multiples and the dogs on the sideline barking in the wind.

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