The bargain hunters guide to undervalued stocks for the end of 2023

In a world where cost of living pressures remain high and we’re staring down the barrel of at least one more rate rise, who doesn’t love a bargain? And what better bargain, than a high-quality stock, that can form a valuable part of your long-term portfolio, at the right price?

Morningstar have released their Australia Equity Market Outlook Q4 2023 and there’s at least one addition to the list which other fund managers have also taken a closer look at. It’s also a slightly different sector story to the last quarter where the research house saw the best opportunities in the consumer discretionary sector. This time round, it’s real estate that has devalued significantly, though healthcare, technology, energy and communications are still viewed positively by Morningstar.

In this wire, I’ll look at their picks for value and take a closer look at their favoured sectors.

The state of the nation

Peter Warnes, Head of Equities Research ANZ for Morningstar, tips a muted outlook for Australia. It’s hardly a surprising take given forecasts provided in August reporting and ongoing pressures from inflation.

“Household consumption, the main driver of economic growth, is being affected by an unpleasant mix of high mortgage rates, elevated cost-of-living expenses, and sticky core inflation, which are collectively driving a contraction in real disposable income,” Warne says.

He expects this pressure to continue through to the June quarter of 2024, meaning weak household consumption. It hardly spells good news for retailers, particularly as we head into the festive season.

He also points to the more than 25% surge in global oil prices since June 30 as an added pressure on household spending and inflation. It’s certainly something that the RBA will be watching, particularly in the upcoming November meeting.

Where the value lies

While this may all be concerning, the dampening of the stock market is not necessarily a bad thing for bargain hunters.

“Stock markets trended lower through the September quarter. As of Sept 22 2023, our Australia and New Zealand coverage trades at a 9% discount to fair value on average, compared with a 15% discount at the September 2020 low and an average 5% premium over the past 10 years,” says Adrian Atkins, Senior Equities Analyst, Utilities.

He notes that high-quality stocks are in high demand as investors seek to manage uncertainty, but he still sees plenty of opportunities, particularly in real estate, technology, healthcare, energy, and communications.

“The real estate sector is significantly undervalued after a selloff in September triggered by fears of higher bond yields depressing distribution potential and hurting credit metrics. 

Further downside is possible, particularly for highly geared REITs, but we see plenty of opportunities for investment in high-quality names with more favourable outlooks,” Atkins says.

Top-rated picks per sector

We’ve narrowed down the picks from Morningstar to the top star ratings in each sector, then by the lowest price to fair value rating. Morningstar’s rankings are based on data as at 22 September 2023. Prices and broker consensus ratings are sourced from Market Index as at 24 October 2023. (Scroll right for full data)

A closer look at the most undervalued sector – real estate

Lendlease (ASX: LLC)

The international property and infrastructure group has had an interesting year. Back in July, it cut 10% of its workforce and has found challenges in sustaining growth. Lendlease featured as Morningstar’s most undervalued pick in the third quarter too. That said, it continues to work on new projects, with a new joint venture in Sydney’s west with Phoenix Property Investors, a partnership with City of Melbourne to revitalise the Queen Victoria Market, a technology partnership with Optus, and plans to generate most of its earnings from funds under management and investment operations in the future.

Equity analyst Alex Prineas believes that downside risks are already priced in.
“We expect further substantial uplift in development earnings in 2024, and management earnings longer term,” he said.

Market Index’s Broker consensus tool views Lendlease as a Hold.

Morningstar also tips Dexus (ASX: DXS) and Charter Hall Group (ASX: CHC) as picks, noting that Dexus’ office portfolio is stabilising, while Charter Hall should benefit from a trend towards institutions investing in property via specialised managers.

A high-quality healthcare stock joins the undervalued mix

ResMed (ASX: RMD)

The medical equipment company has been hard hit recently, and Morningstar is not the only firm seeing the potential.

Several fund managers have recently pitched the value in ResMed on Livewire’s platform, including Forager’s Alex Shevelev who argued that there was capacity for margins to improve, particularly given ResMed’s sleep apnoea machine is one of the best options on the market and has a dominant market share. Similarly, Vinay Ranjan from Airlie Funds Management titled the current valuation as a rare investment opportunity and added ResMed to the top ten holdings in Airlie’s portfolio.

“ResMed’s selling, general and administrative expenses have ticked up recently as a proportion of sales, but we expect those costs to stabilise lower due to operating leverage,” said equity analyst Shane Ponraj, CFA.

Market Index’s Broker consensus tool views ResMed as a Buy.

A look at technology, energy and communications

Technology

Technology has been a big winner of the year, particularly those stocks fuelled by the trend to AI. But it’s an area that Morningstar sees continued opportunity for value.

“As the tide of free money has been going out, investors are starting to see which technology companies have been swimming naked,” equity analysts Dr Roy van Keulen and Shaun Ler said.

That is, it’s becoming easier to see which companies have strong value propositions, competitive advantages and balance sheets.

“Businesses with stronger customer propositions, such as Tyro and Fineos, continue to attract new clients and/or are improving margins,” they said.

Fineos (ASX: FCL) is not yet profitable but Morningstar believes it is well-placed to win new business and has a sticky existing customer base. It also sees the potential for cost efficiencies from client transitions to cloud, automation and expansion to emerging economies.

Those who prefer a look at more profitable opportunities might be more interested in Morningstar’s nominations of WiseTech Global (ASX: WTC) and Megaport (ASX: MP1), the latter of which is close to breakeven and also showing value in the current market.

Energy

Given the strengthening oil prices in the past few months, the idea of value opportunities in energy markets may come as a surprise. Senior equities analyst Mark Taylor believes near-term energy prices are well supported and lists Santos (ASX: STO), Beach Energy (ASX: BPT) and Whitehaven Coal (ASX: WHC) as undervalued picks.

“We don’t think Santos is being sufficiently credited for new oil and gas developments underway. A solid balance sheet and low costs, including a freight advantage to Asia, mean the company is well placed to weather any cyclically low prices,” said Taylor.

He noted that prices are strong at present, and expects this to positively benefit four-year earnings for Santos.

Communications

Director of equity research,  Brian Han, CFA, believes this sector is benefiting from the decline of legacy high-maintenance voice and copper-related operations and low-margin consumer broadband on the telecommunications side. From the perspective of media companies, he notes such businesses have stronger balance sheets than the 2020 downturn.

“Cash flows are positive across the board and every group under our coverage is either buying back shares or recently finished doing so,” he said.

Southern Cross Media Group (ASX: SXL) featured last quarter in Morningstar’s communications picks. While the media group is hampered by a weak advertising market, Han believes it will be supported by normalisation in radio advertising and it also has solid fundamentals.

“The balance sheet is solid, the company is free cash-generative, trading multiples are depressed and the yield is attractive,” Han said.

Over to you

What are your undervalued picks this quarter? 

Let us know in the comments below.