Morningstar's top undervalued Australian stocks by sector

The cycle has changed. Value is in. Growth is out. If this sounds like old news, it’s because most commentators have been preaching this for the past year. But finding value is not always easy. When Livewire spoke to a range of fund managers in August and October for Australian and US reporting seasons, the general consensus was that the market was fairly valued. If that’s the case, how can we find those golden value opportunities that should exist right now?

Value has always been a research-intensive effort for investors. Does the market price match the fundamentals and long term prospects of a company? Are you hoping to make a gain from a company being undervalued? Are you comfortable with the price if you are planning to hold for the long term?

Whichever you choose, Morningstar has released the top undervalued stocks for the fourth quarter of 2022 and it might just be a good starting point for your research. Brian Han, Senior Equity Analyst for Morningstar also shed some light on the best and worst performing sectors. 

Which were the best and worst-performing sectors?

It should come as no surprise that energy, utilities and financials have been the top performers of the year so far, according to Han.

Energy prices and associated commodities have spiked across the year. Oil and gas prices in particular have seen large gains as a result of a lack of supply (from decades of underinvestment) combined with the added pressures from the Russian invasion of Ukraine. While efforts have been made to free up supply, Europe is heading into a challenging winter.

By contrast, information technology, real estate and consumer discretionary sectors have been the worst performers of the year so far.

Growth stocks have been on the nose this year so falls in tech shouldn’t come as a surprise. Real estate has had the double whammy of interest rate rises making buyers nervy, along with a jump in the costs to build and develop courtesy of supply chain challenges. In a year where the cost of living and rate rises have been large talking points, unsurprisingly there’s been less consumer money directed the way of consumer discretionary stocks.

In light of this, you might assume Morningstar’s value picks are to be mainly found in poor performers. Not the case – the research house has identified opportunities on both sides of the scale, and for every sector.

The top undervalued stocks by discount to fair value

Note: These are based on prices at the close of business on 25th October 2022.

Basic materials – Newcrest Mining (ASX: NCM)

Newcrest is the largest Australian listed gold producer and one of the world’s largest gold mining companies. Arguably a good thing to be given gold has traditionally been viewed as an inflationary hedge and defensive play in volatile times.

“No-moat Newcrest Mining remains the better-value pick among the Australian listed miners.” Australia and New Zealand Equity Market Outlook, Fourth Quarter 2022

Communications – Southern Cross Media Group (ASX: SXL)

Southern Cross Media is a TV and radio broadcaster in Australia with revenue largely generated from advertising.

Morningstar notes that the group is seeing a recovery in advertising for radio and regional TV and has restructured its cost base.

Consumer discretionary – GUD Holdings (ASX: GUD)

GUD owns a portfolio of companies in the automotive aftermarket and water products sectors in Australia and New Zealand such as Ryco Filters, Injectronics and Davey brand.

While GUD rates as one of the larger discounts, Morningstar also believe InvoCare (ASX: IVC) is trading at good value and will continue to dominate Australian deathcare.

Consumer staples – Costa Group (ASX: CGC)

Costa Group is a leading grower, packer and marketer of fruit and vegetables in Australia.

“Costa's share price presents a buying opportunity for patient investors, but there are some headwinds: citrus quality was hit by wet weather conditions; subdued avocado pricing remains a headwind due to excess supply; and the resignation of the CEO has sown further pessimism." Australia and New Zealand Equity Market Outlook, Fourth Quarter 2022

Energy – Beach Energy (ASX: BPT)

BPT is an oil and gas exploration and production company based in Adelaide. It has production in five basins across Australia and New Zealand.

This is one of Morningstar’s five-star rated companies, a top rating. At the time of analysis, they estimated the stock was trading at a significant discount to fair value. If oil and gas prices stay elevated, Morningstar estimates the upside could continue.

Financials – AUB Group (ASX: AUB)

AUB comprises insurance brokers and underwriting agencies across Australia and New Zealand. It also owns equity stakes in partner businesses.

Morningstar anticipates that AUB can benefit from rising premiums along with ownership interests in brokers. It also remains positive on the value of the big 4 Australian banks, pointing to Westpac as the cheapest of the majors.

Healthcare – Ansell (ASX: ANN)

Ansell manufactures protective PPE and safety solutions such as industrial and medical gloves and body protection.

“We see limited competitive pressure on Ansell’s differentiated products and reiterate its narrow-moat rating based on intangible assets." Australia and New Zealand Equity Market Outlook, Fourth Quarter 2022

Industrials – Seven Group Holdings (ASX: SVW)

Seven Group is a diversified operating and investment group across industrial services, oil, gas and media. Some examples of businesses it owns and operates include Coates Hire, and Allight and Sykes.

Morningstar believes Seven Group’s exposure to government spending plans should be protected from rising interest rates.

Real estate – Lendlease (ASX: LLC)

Lendlease is a globally integrated real estate company that operates in investment management, construction, urban redevelopment, communities, retirement living, health science, data centre and digital scopes across Australia, Asia, America and Europe.

Lendlease is highly rated by Morningstar and was trading at one of the largest discounts to fair value. Morningstar also sees opportunities in Dexus Group (ASX: DXS) which holds a narrow moat (slight competitive advantage).

Technology – Megaport (ASX: MP1)

Megaport is a ‘network as a service’ provider offering connectivity, scalable bandwidth, cloud strategies, connection to software providers and data centre management to companies.

Megaport is highly rated by Morningstar but doesn’t have a moat (competitive advantage). While it is undervalued, Morningstar suggests the biggest opportunity in the tech sector is actually WiseTech (ASX: WTC).

“Logistics software solutions provider WiseTech stands out in the beaten-down information technology sector, given its narrow moat rating and strong long-term earnings growth outlook,” says Brian Han, Senior Equity Analyst for Morningstar.

Utilities – AGL Energy (ASX: AGL)

AGL is an essential services provider of energy and telecommunications services. It has the largest electricity generation portfolio in Australia, accounting for 20% of the total electricity generation capacity in Australia’s National Electricity Market.

Also a highly rated stock, AGL has a narrow Moat (slight competitive advantage) and Morningstar believes that operating conditions are improving for the business.

Investing in value opportunities

While Morningstar identified these stocks as undervalued in late October, it’s worth remembering that markets can move a lot in a day let alone a month. However, each stock ranked strongly on Morningstar’s star rating process which is a good measure of the qualities of these businesses, ignoring daily prices. Value investing is typically more about the long term dynamics of a company rather than the opportunity to make money out of short-term trades.

“Instead of following the “don’t just sit there, do something” playbook urged by the daily news and social media posts, it is often better to subscribe to the adage “don’t just do something, sit there.” After all, take the “long term” out of “long term investing”, what is left is nothing but punting,” says Han.

It’s a worthwhile reminder in volatile markets.

Where are you finding value opportunities? Let us know in the comments.

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