The ASX growth companies primed for a big year

First Sentier Investors’ David Wilson and Christian Guerra unpack why 2025 has opened to one of the most volatile reporting seasons in years. Discussing healthcare, financials, consumer and industrial names, they share their take on some surprising market disappointments – and the stocks they are excited about as growth investors. 

Transcript

Lauren Prendiville:

Welcome to the First Sentier Investors curious podcast. There has been a lot of commentary around the Australian economy struggling with growth and productivity, and the ASX certainly saw one of the most volatile reporting seasons in years as the market digested some interesting results. I'm Lauren Prendiville, and joining me once more today is David Wilson and Christian Guerra, who will talk us through the different experiences of Australia's listed companies throughout this reporting season.

As some of you may recall, David manages one of Australia's largest and longest running geared Australian share strategies. Christian is the head of research for the Australian Equities Growth team –one of Australia's largest investment teams. Welcome both to you, David and Christian.

Before we get started, just some very important reminders. This podcast is for general information only and is for an Australian audience only. It is not investment or financial advice and it does not account for specific investment objectives, the financial situation or needs of any particular person. Any stocks we talk about today are not a recommendation to buy or sell.

So, David and Christian, to kick off this conversation, my first question is how many reporting seasons have you covered together now as a team? And if you had to reflect back, how would you describe the reporting season in one word?

David Wilson:

Well, Lauren, I think we've covered about 20 reporting seasons together, although across our history in the markets, we've probably done well over a hundred at various times in previous roles. In terms of a word, that word would be ‘volatile’. One of the investment banks referenced the fact that over the last 10 years this was by far the most volatile reporting season.

Lauren Prendiville:

Thanks David. Well that's a clear shift from the markets report card given you felt ‘resilience’ captured the overall sentiment last time. Christian, I'd love to hear your one word and also could you please talk some more about what you saw happen across the broader market?

Christian Guerra:

Sure, Lauren. So the word that I'd probably use is ‘choppy’. I say that for three key reasons:

1. So firstly, overall earnings beat expectations. So, earnings beat by about two percentage points and that was really driven by better margins. Again, showing how corporate Australia when they need to can manage their costs. And we thought that was actually a pretty good outcome given there's obviously geopolitical tensions, consumer and business confidence is flattish. You've had rates, they're probably sort of higher for longer and you have had the cost-of-living pressures still buttressing households, so we thought that was a pretty good outcome.
2. Having said that, the market downgraded the forward outlook by about three to four percentage points and the market's now forecasting FY25 earnings to go backwards by about three to five percent. And if that does come to pass, that'll be the third consecutive year where we've had earnings go backwards for the ASX probably sort of reflecting I guess the choppy outlook and the choppy most recent history as well as obviously the rate dynamic.
3. The last thing I'd say in terms of that word ‘choppy’ is getting the earnings right actually didn't help you generate alpha in the reporting season. In fact, it was the stocks that missed – the stocks that missed expectations – that did the best in the month of February, which is quite a contrast of what we've seen in the past.

In terms of, I guess, where we saw the strength and when we saw the weakness, so, clearly the sort of big end of town, so the ASX 100 did really well compared to say the small industrials again, showing that again, those larger companies have, they've got pricing power, they've got the ability to manage their costs, they can flex their capital expenditure budget, so, we saw some strength there. 

We sort did see some weakness, as I said, in the smaller companies in particular the smaller resources which really struggle with cost pressures in their businesses. And then in terms of sectors in that top 100, in that sort of industrial space, insurance, we saw some really good results, so, the likes of Suncorp and QBE produced really, really good results. In media, the likes of REA Group produced a very, very strong result. And then lastly, in the sort of commercial services segment, we saw good results from both Computershare and ALS.

Lauren Prendiville:

David, just drilling a little bit more into that one word that you used and the ‘volatility’ perspective. Can you share from your perspective some insights as to what you think is driving these moves?

David Wilson:

I think there's a lack of liquidity at times in the market. You've also got a group of investors who are trading on a short-term basis and try and position themselves into particular results.

So, a lot of it is driven just by liquidity moves and market moves rather than fundamentals. And so sometimes it's hard to generalise, as Christian said, that often companies would surprise on the upside and yet the stock wouldn't perform that well and the other way around would happen as well. So, I think it's why you're getting these more trading moves in markets rather than fundamental moves.

But of course, that creates opportunities for people like ourselves.

Lauren Prendiville:

What themes can be constructed from the strong performance of some of the consumer stocks that you've seen in this season?

David Wilson:

I think Lauren, that even Christian touched on it just before, that you actually saw the larger companies, they're absolutely able to perform a little bit more strongly through reporting season.

So, you take the companies in the consumer sector, a company like Wesfarmers (ASX: WES) that owns Bunnings and Kmart, and Officeworks businesses, and JB Hi Fi (ASX: JBH) as well, and even Harvey Norman (ASX: HVN) as well. Those companies did very, very well in terms of just their ability to take market share and hold margin. Similarly, a company like Coles (ASX: COL), more of a consumer staple, but again, the company did very well, but it was able to achieve that through a very solid focus on costs. And I think Coles doing incredibly well in terms of managing their costs through what's been a relatively tough period.

Lauren Prendiville:

And as Christian framed in his first response, I thought it would be good for us to drill down into what we saw in industrials. How did domestic earners stack up against their internationally focused counterparts?

David Wilson:

Yeah, it's a really quite important question, Lauren. We saw actually quite a dichotomy between the industrial companies with international earnings versus those that are largely domestically based. So the expectation is for the industrials with offshore earnings that their EPS will grow of the order of 10% in FY25, where those that are rather more domestically exposed, their EPS is more likely to grow by about one percent, so there is quite a difference between the companies in that industrial space.

Lauren Prendiville:

Okay. Shifting sectors, I'm looking at some individual financial company results. Can we talk about the good and the bad?

David Wilson:

Lauren, we can start with the good and Christian's already referenced them.

Companies like the insurers, so QBE (ASX: QBE) and Suncorp (ASX: SUN) did incredibly well through reporting season. Both companies have been able to prune their operating portfolios over the last couple of years, and so being very much focused down on a core strength. Suncorp's basically offloaded their bank, their life insurance business, their businesses, some of their businesses in New Zealand as well, and so it's now distilled its business down to a core general insurer in Australia. And similarly QBE, which has historically struggled in North America, but done incredibly well in Europe and Australia has also been able to shrink the unprofitable parts of that North American business. And so both companies, their earnings and their returns actually improved appreciably through reporting season.

Lauren Prendiville:

And Christian, your perspectives on the banks?

Christian Guerra:

So Lauren, we saw one or two really solid results in the banking space and maybe some that were not so strong, and the place I'd probably start is the Commonwealth Bank (ASX: CBA). So CBA delivered a very, very, I thought, solid result.

• So their lending growth is really strong. So they're growing the balance sheet, they're growing both in housing and in small business.
• They managed their margins, which is a really good outcome.
• Asset quality is pretty benign, in fact it's probably improving.
• Provisioning is very, very strong, which I think is really important given that we are in a still uncertain type of environment in terms of the outlook.
• CBAs capital, which has been a hallmark of the bank for some time now continues to be very, very strong. So I thought the CBA delivered, I thought a very solid result.

In contrast, I thought maybe National Australia Bank (ASX: NAB) and Westpac (ASX: WBC) showed similar trends to be honest.

• So, margins were a bit weaker, so margins were lower than what the market expected. They probably fell a bit more than the market expected.
• And then in terms of capital levels, I mean they are fine. Both NAB and Westpac are well above regulatory minimums when it comes to capital, but it's more the fact that the excess capital hasn't really materialized, in fact, it's a bit less than what the market expected. And that has implications for future capital management like share buybacks for example.
• And then in the case of NAB, one of the features there was the fact that their asset quality is probably deteriorating a bit more than the other banks.
• Now it's nothing to be alarmed about. Their provisioning is very strong, particularly versus some of their peers in the banking sector, so that's an area of strength, but the asset quality in the portfolio is certainly deteriorating.

And then in the case of Bendigo Bank (ASX: BEN), that was different again.

• Their lending growth is incredibly strong, they're probably growing at one and a half to two times the overall system growth, so they're really growing strongly, particularly in housing.
• But they just got the margin management wrong, so their margins came under a lot of pressure in the December half and that combined with the fact that the costs were pretty elevated, so they're investing in some technology type infrastructure and the result of that sort of weaker revenue line plus costs being a lot higher meant that their pre-provision or their pre-cost of risk profit materially disappointed versus the market.

Lauren Prendiville:

Thanks, Christian. We saw the market go through a period of churn as referenced, David. So, given your preference for high quality growth stocks, what are the attributes that you are looking for?

David Wilson:

Yeah, Lauren, it's a really core part of our process. 

What we're looking for is companies, firstly that have got appropriate balance sheets for the businesses they're in, and then secondly, it's just their return on capital and also the trend in that return on capital. 

And that really helps us identify that companies can consistently reinvest in their business and drive profitable growth that's giving additional returns to shareholders.

Lauren Prendiville:

Thanks for that clarification, David. As I referenced in my opening introduction that there's been this huge amount of commentary about the lack of productivity within Australia and against the wider economy. How are you seeing this theme reflected in Australia's listed companies?

David Wilson:

It's a really interesting question at this point, Lauren. I think what we've seen over the last little while is just a malaise is probably too tough a word, but there's just been a sort of slowness in the Australian economy. But on the other side of it, we're actually not seeing that in the stock market where you've got companies like a Goodman Group (ASX: GMG) raising 4 billion to invest internationally. You've got, I mentioned the restructuring that QBE and Suncorp have undertaken, and you've also got a range of industrial companies that are actually the global leaders, in fact also our miners are also global leaders as well, but companies like the Brambles (ASX: BXB), the Aristocrats (ASX: ALL), the Cochlears (ASX: COH), the CSLs (ASX: CSL), the ResMeds (ASX: RMD), James Hardies (ASX: JHX), these companies are actually doing incredibly well in their international businesses, they're doing fine in Australia as well, but they're actually relatively small in the context of their total business. And so those businesses, despite the sort of malaise or just the lack of dynamism around Australian productivity, those companies are generating a lot of activity and a lot of growth and a lot of returns for our investors.

Lauren Prendiville:

Thanks, David. Let's also talk about the timeframe you prefer vs market when valuing companies. Pro Medicus (ASX: PME) rose nearly 160% over the last 12 months, but saw a modest slide during reporting season. Can you share your view on its valuation and claims that it's become too expensive?

David Wilson:

Yes, Lauren, I don't think when you're coming to valuation, can you be sort of too dogmatic. I mean, I'm quite a supporter of people using price earnings ratios. But when you come and look at something like a price earnings ratio for a stock Pro Medicus, it's actually not that helpful. The reason is because you need to look at Pro Medicus’ longer-term perspective with what the stock can do and how its earnings and sales and revenues can grow over a longer period of time.

And so, the stock is on around a PE of around 180x, but that's not particularly instructive because you need to look at, okay, where can this business get to, not just on a five-year basis, but on a 20-year basis, how much it can grow.

Recently, in this reporting season they’ve announced a new contract in Florida with quite a large group there. So, it's these opportunities that continue to accrue to Pro Medicus that support what looks like a prima facie high PE.

Lauren Prendiville:

And staying on healthcare, were there any results that disappointed the market?

David Wilson:

On the healthcare side of things, I think there was a little bit of disappointment around the ResMed (ASX: RMD) result.

ResMed made a comment about next quarter's earnings, and because of some of the short-term focus that sits in the market, the market reacted negatively, and so the ResMed share price fell five to eight percent.

We actually saw that as actually an opportunity because we think ResMed still very much has a longer-term double-digit earnings growth in place. You've got their devices in the US continue to grow a double digit and their masks business, in fact, all their products are growing at that sort of rate.

So, despite that sort of short-term commentary and hiccup in the ResMed share price and what looks as something of a short-term disappointment, we weren't concerned about that at all.

Lauren Prendiville:

Turning to you, Christian, the team looks for stocks that have the ability to compound earnings through the cycle. From your perspective, is there a company that you feel continues to surprise the market?

Christian Guerra:

So, for me, the name that probably comes to mind is Brambles.

Brambles (ASX: BXB) delivered, I thought, a pretty solid interim result. Sales are up sort of four or five percent, their profit was up about 10%. They have good growth in dividends.

And as David mentioned, one of the metrics that we look at in a lot of detail is return on capital and their return on capital improved by about one percentage point to 23%, which is clearly very healthy and clearly very strong.

Now, the thing for me on Brambles is it's now had consecutive financial years where the business has done quite strong earnings and profit growth.

So we're talking top line sales growing at, let's call it five to eight percent, mid-single digit profit, top line growth, but also they're growing profits at anywhere between 10, 15, 20% over several financial years.

Just as importantly for Brambles is the free cashflow story. So, in the past, the lack of cashflow has been one of the criticisms of this company, and that was, I think well founded. But the new management team has turned that around with better control over their asset pool, being the underlying pallets, and they've got a bit of pricing power now with their customers, given they're looking after their customers in probably a smarter way.

So they've had pretty good improvement in free cashflow over the last two financial years, but we think there's still a fair way to go yet in terms of cashflow improvement and we think that free cash flow story is actually enduring.

Lauren Prendiville:

Thanks, Christian. David, can we talk more about the history of Brambles and why it has become this global success story that Christian’s just talked about?

David Wilson:

I might sort of bore our listeners for a while, with the sort of long-term history of Brambles.

The company started back somewhere in the middle of the 19th century as a meat carrier in Newcastle, in regional New South Wales and evolved over time and stayed as pretty much as a transport company for the next of 50-100 years.

Then it was actually involved in a privatisation of pallets that were left behind by the American army after World War II. They bought these pallets in the 1950s, opportunistically, and grew the sort of pallet building business in Australia over the next 20 or 30 years. In time, they were able to take the business to Europe where they became the leader in the UK and then also a leader in continental Europe.

In the 90s it then expanded into North America at some risk because there was a lot of capital involved, but they were supported by the likes of Unilever and Proctor & Gamble when they went to the US.

So now you're in a situation where they're in Canada, they're in Latin America, they're through Eastern Europe as well, and it's now merged as a great Australian global success story.

It took a long time from those origins in the Hunter Valley in the 1860s, but here we are today where they are the global leader in pallet pooling where they're much larger than their number two competitors in both in Europe and in North America.

Lauren Prendiville:

Certainly not a boring response, David. I think it's always fascinating to have these corporate stories shared for our listeners, so thank you for that.

David Wilson:

I love talking about pallets. It's one of those great dinner party conversations.

Lauren Prendiville:

Thanks David. Drawing our conversation to a close I have one final question for each of you. David, you have a top 100 focus given your portfolio emphasis on quality companies. Are there any companies you consider global leaders to watch over for the next 12 months?

David Wilson:

I'm going to switch your question a little bit, Lauren, and sort of answer the question the way I would like to do it. And the reason is, I think actually what Australia has is actually, it's not one specific company, but many companies that are global leaders, and I talked about some of them before, and I think we will continue to surprise ourselves with the growth in companies.

The Australian companies for many years, people were sort of reticent to support them expanding internationally. But you look at those companies, you look at another company like an ALS or a Goodman Group, those companies continue to do incredibly well overseas. So, I think it's not so much a specific company, but the number of Australian companies that are able to succeed internationally.

Lauren Prendiville:

And turning to you, Christian, the team also manages an ex-20 portfolio, which focus on diversifying away from the resources and financial space. Where are you seeing opportunity across the broader share market over the next 12 months?

Christian Guerra:

Yes, thank you, Lauren. So, we love looking for opportunities outside of the big banks and the big miners, hence the focus of the ex-20 strategy. There are in our minds a number of opportunities.

So, David has already talked about some of the healthcare names, for example, Pro Medicus, and ResMed.

Technology continues to be a key focus of ours, and you've got some strong business models in that sector with very large addressable markets. Xero (ASX: XRO) and WiseTech (ASX: WTC) are the names that come to mind there.

In the online classified space, two companies there, so REA Group (ASX: REA) and Carsales (ASX: CAR) where you've got these rock-solid domestic businesses that have been success for over a number of years. But you've got these, again, growing and quite important international operations as well, where they're making in our view really strong earnings and good returns.

And then you think about the insurance brokers where you've got, again, quite defensive earnings, very good organic growth. They also have M&A opportunities there to grow their share of the pie.

And then lastly, again, and David mentioned this, but in the consumer space, again, rock-solid business models like JB HiFi (ASX: JBH) and like ARB Group (ASX: ARB).

Lauren Prendiville:

Thank you so much David and Christian. We are so fortunate to have your experienced and seasoned perspectives. Thank you too to our listeners for tuning in. David and Christian will be back with future reporting season updates, so please don't forget to follow the curious podcast and that way you'll receive notifications about podcast episodes from our group of investment managers. Thank you very much.

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