Buy Hold Sell: 5 resilient cash cows

Here at Livewire, we are fortunate enough to speak with the country's top investors every day. And if there is one recommendation these pros have consistently repeated in what has become a tumultuous year of rising interest rates, it's the importance of investing in stocks with tangible and growing profits. 

Unlike their long-duration counterparts, stocks earning a nice clip in the here and now have managed to be quite resilient in an otherwise volatile year. 

So in this episode, Livewire's Ally Selby was joined by Medallion Financial's Michael Wayne and Hayborough Investment Partners' Ben Rundle for their analysis of three profitable ASX darlings.

Plus, they also bring along one small cap that they believe will continue to spew out cash (and remain resilient) over the year ahead.   

Note: This episode was filmed on Wednesday 12th October 2022. You can watch the video, listen to the podcast, or read an edited transcript below.

Edited Transcript 

Ally Selby: Hey, how are you doing? And welcome to Livewire's Buy Hold Sell. I'm Ally Selby, and today we're talking all things cash. With interest rates on the rise, stocks with actual earnings and actual profits have really been favoured over those without them. Today, we're going to be taking a look at five of those within the small-cap arena. We're joined by Ben Rundle from Hayborough Investment Partners and Michael Wayne from Medallion Financial. 

First up today, we have Pro Medicus. It reported profits of $44.4 million for FY22, up more than 44% from the previous year. Ben, starting with you, is it a buy, hold or sell?

Pro Medicus (ASX: PME)

Ben Rundle (BUY): I think it's a buy. Look, I recognise that it's on an eye-watering valuation, but it's just such a high-quality business. The quality of its earnings is fantastic, it has a fantastic management team, and a great product. It's really hard to bet against this company. It has all the qualities of a compounder, and therefore I think it keeps compounding.

Ally Selby: It's been relatively defensive over the past year. It's down just over 2%. Michael, over to you. Is it a buy, hold or sell?

Michael Wayne (BUY): I'm going to go buy as well on this. It's one that we've held for some time and continue to like it. You look at the balance sheet, all those key metrics are trending in the right direction - revenue, earnings, margins, and return on equity. They developed a very good product, and have been able to go out and market it very well and win very high-quality contracts. A lot of their contracts are six to eight years. A lot of those have been renewed and rolled over. They've also got a good backlog of inquiries for different tenders.

One concern that we might have just to be careful of long term is they've targeted the academic hospitals in the US (private academic hospitals). They've been very successful there. A lot of those hospitals aren't as cost-conscious as some of the others, so they might struggle to have as much of an impact on the broader hospital network in the US. However, it's a proven product. It's very, very technologically advanced and can save a lot of time within those hospital operations. So I'll go with a buy. The momentum's strong.

OFX Group (ASX: OFX)

Ally Selby: Okay. Next up, we have OFX Group. Its profits were $24.5 million, up 102% from the previous year. Michael, is it a buy, hold or sell?

Michael Wayne (HOLD): I'm going to go a hold on OFX. Basically, their balance sheet's not too bad. Revenue growth's been pretty consistent over the years. Looking at earnings and margins, it's a bit volatile. And return on equity's been in decline.

But look, there are definitely aspects of the business that have been doing well. Their average transactional volumes are up. Their bad debts are down significantly, but it's a pretty good environment, you would have to think, for a lot of these currency-type businesses. The big four banks are still the incumbents and do dominate the space, but there are a lot of competitors. I just struggle to see long-term how OFX maintains any sustainable competitive advantage. So for that reason, I'm reluctant to give it a buy, but I'm happy to hold because I do think the current conditions for a business like this are favourable.

Ally Selby: Its share price has done pretty well over the past year. It's up 55%. Ben, over to you. Is it a buy, hold or sell?

Ben Rundle (BUY): I think it's a buy. I think Michael made some great points. I think this management team's done a fantastic job - and I've been following it for a long time. They're a low-cost operator in a really big market. They've only got a very small market share, so there's plenty of room for them to grow. They do have a lot of earnings momentum in the business at the moment, which we've obviously seen through the last few quarters. I don't think you're overpaying for it at this price, so I'm happy to still buy OFX here.

Lovisa Holdings (ASX: LOV)

Ally Selby: Okay, next up we have Lovisa. It reported profits of $59.9 million, up 116% from the prior year. Ben, staying with you, is it a buy, hold or sell?

Ben Rundle (HOLD): I think it's a hold. I really, really like this company, but I think you get your opportunities in it being a discretionary retailer. Brett Blundy's just a first-class retailer. He has his man, Victor Herrero, running the business now. Victor is ex-Zara. He has a lot of experience with a high-turnover retail environment with a fast rollout associated with it as well. So I think he's the right man for the job. But given the run it's had and the opportunities you do get in this company, I don't think those opportunities come about after it's doubled in quick succession. So just hold for now.

Ally Selby: The rest of the sector has been hit super hard, but this stock has lifted 19% over the past year. Michael, over to you. Is it a buy, hold or sell?

Michael Wayne (HOLD): I'm going to go a hold. It was probably the report of the August reporting season. They continue to roll out a significant number of stores. I think that was 85 stores last year. They're looking to do that again, at least, if not up to 130-odd stores. And you would have to think that their customer base, being a younger generation, is less impacted by the monetary policy rate rises that we're seeing as well. Look, it's definitely a stock that is going through a growth phase at the moment, but I'm always conscious of fast fashion. I do think that taste and fashions do change over time, so I am a bit cautious about that. But it is hard to bet against the momentum in this business at the moment. I'm going to stick with a hold for now because of that rollout momentum that they've got.

IDP Education (ASX: IEL)

Ally Selby: Okay, we asked our fundies to bring along one resilient small cap for the year ahead. Michael, what have you brought for us today?

Michael Wayne (BUY): So IDP Education has been flat basically over six months, which in this environment's not too bad at all. Basically, they've got two parts to their business. They've got the student placements aspect to their business and also the English language testing systems. They had a little bit of a setback during COVID-19, where revenues and earnings pulled back, but we've seen that recover. So this was another very good result from earnings season. They've now reached record revenue growth, and that's despite the Australian component of the business actually struggling a lot.

The business was owned 50% by a series of universities. That's now been reduced to 25%. So there has been a bit of an overhang as these universities have looked to exit the stock. It's been a hugely profitable adventure for these companies. They used that cash flow to help them through the COVID-19 period. However, we're now coming out of that. I think that overhang of stock has disappeared, and the company's growth trajectory looks very, very good as universities globally open again and students from places like India in particular continue to come to western universities. So I'm going to go buy on IDP Education.

Netwealth Group (ASX: NWL)

Ally Selby: Okay, Ben, your time in the hot seat. Can you beat IDP? What's your resilient small cap for the year ahead?

Ben Rundle (BUY): I think Netwealth. The price has been sort of resilient. I think the earnings are probably more resilient than people think. So the way these platforms make money, is they obviously get a fee on their funds under management, but they also charge a margin on the cash balances that they have holding on behalf of clients. As you see interest rates rise, their cash margin rises too, and that drops straight to the bottom line. So I think that will show a lot of resiliency to their earnings.

If we get a situation where rates stop rising for the time being, then equities will rally and that'll help their FUM as well. So I think there are two sides to the business that buffer it pretty well. I appreciate that HUB24 (ASX: HUB) is cheaper and has a better growth profile from here, but I'm happy to back the founder-led team with Netwealth.

Ally Selby: Okay, well that's all we have time for today. I hope you enjoyed that episode of Buy Hold Sell 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 every week.

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