Six value stocks with impressive potential

Unless you’ve been living under a rock, you’re probably aware the performance of value stocks outstripped growth at the end of last year, for the first time since before the GFC.

Value stocks have beaten growth by about 12% since last November, after lagging for around 14 years. Big share price gains in mining and resources stocks were a prominent feature of this so-called “rotation” here in Australia during the final quarter of 2020. Stock prices for the likes of BHP, Rio Tinto and Woodside Petroleum gained around 30% during the period.

Given the extensive coverage of this rotation within the financial press, you could be forgiven for thinking the value universe is now largely “fished out” of any further opportunities. But as the below chart shows, this period of outperformance is little more than a blip in the recovery of value stocks.

With plenty more potential for further gains, in the following wire, four portfolio managers reveal a value stock they expect to outperform over the next 12 months or more.

Source: Maple-Brown Abbott, Bloomberg data to December 2020

The time to fly will come again

Robert Miller, portfolio manager, NAOS Asset Management 

Our core focus is industrial-type businesses outside the ASX 50. To us, the tourism sector has suffered perhaps more than any other sector during the pandemic. It has had some initial recovery priced in, but could have a long way to go.

We are big believers in the domestic tourism recovery, higher levels of consumer savings and baby boomers in retirement age looking to travel. And when international borders do eventually open, Australia will be even more of an attractive destination for overseas visitors for a multitude of reasons – which is an additional longer-term driver for us.

A company we believe could benefit from these tailwinds over time is Experience Co Limited (ASX: EXP), an adventure tourism company founded in 1999. The company offers adventure experiences such as tandem skydiving and tours to the Great Barrier Reef. Recently, management announced the creation of a third “premium adventure” pillar of operations. Seeded with the acquisitions of two walking businesses, we believe this is a prudent approach to growth, as EXP further diversifies its revenue and customer base.

Under a very capable board and management team, EXP is one of very few tourism and travel companies that didn’t need to raise capital since COVID-19 struck. Further to that, the strong cash generative nature of the business has seen the company actually improve its balance sheet by reducing debt during this period.

Will EXP outperform over 12 months? We don’t know. But we believe EXP has short, medium and long-term tailwinds around travel and the desire for travellers to have ‘experienced based’ travel.

Food, glorious food

Michael Goldberg, executive director and portfolio manager, Collins St Asset Management

Without a doubt, Retail Food Group (ASX: RFG). This is a company that has been drastically oversold off the back of regulatory action and which, under the new management team, are taking a very collaborative and welcome approach to franchisee relations.

We believe that on the regulatory action front, any news will in fact be good news for RFG as it will put all of the historical overhangs on the stock away for good and allow for a refreshed management team to capitalise upon the opportunities in front of them.

Improved franchisee relationships which focus on genuine collaboration and franchisee success measures will support revenue growth. This has been lacking for quite some time and, granted, it may take time for the market to believe in the story, but we are very confident in management’s ability to execute on this front.

Moreover, with shopping centres starting to open back up, more foot traffic flowing through local and suburban malls all around the country, the outlook for their core pizza, doughnut and bakery businesses should see the share price go from strength to strength.

Mining exposure, explosive potential

Daniel Moore, co-portfolio manager, Investors Mutual 

Orica (ASX: ORI) is my pick – the largest explosives company in the world. Demand for its product is driven by mining volumes, so it has a good recurring nature to its earnings.

Like many cyclical stocks, it was hit by COVID-19, which saw several of its mines shut down. Its share price dropped materially, unlike other cyclicals that have bounced quite heavily and are pricing in very favourable outcomes.

We talk about it often: a lot of cyclicals are quite a high risk, but are priced by the market as low risk. In the case of Orica, its share price is still highly depressed – it hasn’t had that recovery bounce yet.

We think there are very good reasons to expect in a post-COVID-19 world that mining volumes will recover. The major reason for that is that commodity prices across the board are very strong. If miners could, they’d be mining as much volume as possible. So, once the restrictions ease, and they are slowly easing, mining volumes will come back and we expect to see a resultant recovery in the price of explosives.

Another thing we like about the company Is that it has been investing heavily in R&D for several years, and has some exciting new products, particularly around wireless blasting. We think these have significant long-term implications and should revolutionise mining in the future. We think the long-term future for the company is bright.

Businesses interrupted, not insurer’s long-term profits

Stephen Bruce, director of portfolio management, Perennial Value Management

In financials, I’ve called out the insurance segment, where the premium rates remain strong. And as we go through the period of concern around business interruption insurance claims, you can see insurers starting to perform well because they’ve been sold off very significantly. For example, IAG has raised a very large amount of money to pay for potential claims, so it’s priced in to the stock to a large extent. I think there’s a potential cyclical recovery there.

In retail, I’ve mentioned stocks like JB HiFi (ASX: JBH) which has done incredibly well while others have lagged, and another is Kathmandu (ASX: KMD), which also owns the Rip Curl surfwear brand. With more activity, that will also start to pick up. And in the cyclical sector of agriculture, Nufarm (ASX: NUF) is a stock in this cycle. At the moment, farming conditions are good everywhere, it’s not just an Australian phenomenon. And soft commodity prices are also very high, so we think that’s one that can go well over the next 12 months.

In conclusion

In the first two instalments of this series, our four contributing fundies answered the “how” and “where” questions about their equity portfolios. They detailed how they find cheap stocks, and which parts of the four key cyclical categories – materials, consumer, financials, real estate – they regard as safest over the next couple of years.

Many of the same fundamentals featured in the selection processes of the other fund managers Investors Mutual, Collins St Asset Management and Perennial Value Management. But Perennial’s inclusion of dividends and franking credits also stood out.

And there were also a few surprises in some of the stocks mentioned above, highlighting once again the value an active manager brings in unlocking opportunities amateur investors would often overlook.

Disclaimer: This article is for informational and educational purposes only, it is not a recommendation to buy or sell any of the securities mentioned. Contributors to this article may have investments in the securities mentioned.

Stay up to date with this series

Make sure you "FOLLOW" my profile to be notified of the upcoming entries in this series. In part one, our four fundies discussed how they parse the equity universe for stocks that are both cheap and good. And in part two, they explained which cyclical areas - materials, consumer, financials or real estate - hold the most appeal over the next couple of years.