Morgan Stanley’s top 6 ASX small and mid-cap ideas for August reporting season

Reporting season kicks off today (with Rio Tinto after the bell) and it is shaping as one of the most important seasons for some time.

Inflation has soared in the past 12 months, interest rates have surged, and economic conditions have become increasingly unstable.

What will it mean for company bottom lines?

That remains to be seen but it hasn’t stopped the team over at Morgan Stanley from coming up with six ideas “where we have conviction into earnings and on out/underperformance into FY24.

Idea #1 Corporate Travel (ASX: CTD)

Morgan Stanley says “while travel peers were undertaking emergency capital raisings to survive [during Covid], Corporate Travel was widening its scale advantage at depressed multiples.”

“Corporate Travel’s relative resilience vs. travel peers came following a period of unfound bearish sentiment around the quality of cash generation. Yet leisure names have rallied harder on faster normalisation. We see CTD’s tailwinds as more durable.”

Peers like Flight Centre (ASX: FLT) and Webjet (ASX: WEB) are up a respective 36.7% and 52.7% in the last twelve months versus Corporate Travel’s 13.3% gain.

One of the more profound tailwinds for Corporate Travel is its implied FY24 price-to-earnings of 16.5, which represents a 40% discount to the stock’s long term average. The analysts believe the market has not priced in the company’s ability to meet its FY24 guidance.

An OVERWEIGHT rating was maintained with a $28.60 target price.

Idea #2 Audinate (ASX: AD8)

Audinate is a leading provider of Audio Visual (AV) networking technology or in simple terms – the transmission of digital audio and video over standard ethernet networks. This enables AV professionals to create complex, networked systems without the need for expensive and complex proprietary networking solutions.

“Audinite’s leadership position is strengthening, and we view its competitive position and rebound potential as underappreciated,” the analysts said, adding that “networked AV shift seems inevitable – and Covid-19 has accentuated its superiority.”

Morgan Stanley expects the company to deliver a revenue compound average growth rate of 27% between FY22-25 whilst reaching cash flow breakeven in the second half of 2023.

The stock has an OVERWEIGHT rating with an $11.00 target price.

Idea #3 Life360 (ASX: 360)

“We see few ASX listed mid-caps with 50 million monthly active users, growing sales +30% with the ability to shift rapidly to profitability,” says Morgan Stanley.

While the stock has experienced a material re-rate (up 60% year-to-date), the analysts see further scope to grow monthly active users as well as repricing and product premiumisation tailwinds.

Life360 has guided to US$300-310 million revenue for FY23, which is expected to translate to $1.6 million in normalised profits (up from a $37.9 million loss a year ago).

“We see an accelerated path to turning free cash flow positive – With guidance of ongoing profitability pulled forward to the second quarter of 2023,” the analysts said.

“Given the re-rate in Xero, Megaport and other software names on margin expansion, we see upside skew to risk-reward.”

An OVERWEIGHT rating was maintained with a $9.50 target price.

Idea #4 – McMillan Shakespeare (ASX: MMS)

In terms of why MMS made the list, Morgan Stanley highlights relative earnings visibility as the key reason, saying “public novated volumes are generally more stable vs broader new vehicle sales, large order backlog, and EV tailwinds on earnings. We think this provides near term visibility into FY23e and also out into FY24e”.

MS adds that the base case multiple will likely hold “given the EV tailwinds in particular. “We feel MMS can at least hold its current multiple towards the top end”.

In terms of what is not in the price, MS adds that it is the extent of EV tailwinds. “To be clear, we do think the MMS stock price YTD reflects some optimism, but this is yet to be fully factored into forecasts”.

Morgan Stanley is OVERWEIGHT with a $20.60 target price.

Idea #5 – Breville Group (ASX: BRG)

Morgan Stanley rates BRG as OVERWEIGHT with a $25 target price, saying it sees limited risk to FY23 earnings “given the midpoint of its EBIT guidance implies a 1H/2H split of 72%/28% (vs. the five-year average of 68%/32%)”

Over the longer-term, MS believes BRG has a “long runway for growth as it expands into a $10bn global revenue opportunity, supported by strong brand equity and product innovation leadership”

The team adds that the risk-reward looks attractive at 26x FY24E P/E (in line with the 10-year average) for a +10% EPS CAGR (FY22-25E)

In terms of catalysts that MS believe could drive the share price, they cite the following:

1. Resilient demand – MS note that “consensus FY24E sales growth of +8% is highly achievable” given that Breville products are often purchased by higher income consumers that should be more resilient
2. Peak inventory – MS expects inventory levels to decline, by as much as $65m (from $465m to $400m) by the end of FY23.
3. Margin upside – “Consensus FY24E EBIT margin of 11.6% is below the FY19A level of 12.8% because BRG has reinvested aggressively in R&D and marketing”, says Morgan Stanley.

In terms of risks, BRG highlights slowing demand from softer consumers, spending shifts/share losses, margin headwinds, and margin pressure from higher reinvestment.

Idea #6 – IPH (ASX: IPH)

According to Morgan Stanley, IPH made the list primarily due to its defensive and predictable earnings, noting that “Patent filings tend to be resilient through economic cycles and each filing starts a 3- to 5-year rev stream”.

MS also believes that IPH has a competitive advantage which is supported by scale, highlighting that they are dominant in key markets. Low customer churn and strong brands are also positives.

The valuation: The MS team highlights an attractive risk/reward with the stock trading on 17x FY24 P/E, which is approximately a 15% discount to the 8-year average (20x). Throw into the mix a 4.3% dividend yield and an estimated +9% EPS CAGR out to 2025 for good measure

Finally, MS cites 2 factors which could provide boosts for the business – M&A optionality and new country launches.

On the former, MS says “IPH has access to capital, a solid track record on M&A and a scalable business model, which could support further potential M&A”. On the latter, MS says “IPH operates in nine countries across Asia Pacific and Canada. The company has ambitions to become the leader for patent filings in secondary markets (i.e. outside of the US, EU, Japan and S. Korea). Therefore, we expect further regional expansion over the medium term”.

Whilst Morgan Stanley has an OVERWEIGHT rating and a $10.50 target price for IPH, they note the key risks as higher competition driving share losses, acquisition integration issues, and further cyber breaches.