The companies the Easter Bunny should deliver to your portfolio (and which to avoid)

Just in case the rows upon rows of foil-covered chocolate rabbits and eggs in the supermarkets haven’t reminded you, Easter is coming.

Perhaps you have already purchased some of the more the 450 million chocolate eggs and 15 million chocolate bunnies that Cadbury expects to have sold to Australians and New Zealanders this Easter. Or perhaps, you’ve taken a healthier approach and purchased carob versions. (To be clear, about as healthy as my selection gets is my love of dark chocolate so no judgement here).

But spare a thought for your portfolio. Don’t your hardworking investments deserve a little visit from the Easter bunny, too?

What companies might be the chocolate eggs – that is, popular but not necessarily great for your bottom line – compared to the carob – aka less exciting but offering a solid long-term player in your portfolio… the healthy choice?

I pulled together the Aussie Equities Easter Bunny Advisory Committee (AEEBAC - it's a real thing), with the following good sports agreeing to help me out:

• Tim Carleton, Chief Investment Officer for Auscap 
• Emanuel Datt, Principal for Datt Capital 
• Justin Woerner, Portfolio Manager for Elston Asset Management
• Steve Johnson, Chief Investment Officer for Forager

You might be surprised by their answers. Perhaps it will even tempt you to switch to carob for your eating as well… (OK, just your portfolio, we wouldn’t want to be so hasty as to write off chocolate).

The chocolate eggs – short-term satisfaction but watch out for the future

The list of chocolate eggs includes some miners, a tech company and an embattled retail pick, with two ASX-darlings in the firing line. All bar one is a large-cap.

1. BHP (ASX: BHP) - Tim Carleton

The Big Australian has been a blue-chip for so long that I’m sure its nomination is one of the biggest surprises of this wire. Carleton notes it has very strong cashflows and an attractive dividend yield, but its outlook places it in the chocolate category.

“As we look forward, we think the supply and demand outlook for iron ore warrants caution. A significantly lower iron ore price would have a meaningful impact on BHP’s earnings and cash generation. If the iron ore price is a lot lower than where it is today, we would expect the stock to reflect this,” says Carleton.

He cautions that the steel story has been dominated by China, which has consumed more than 50% of the world’s produced steel annually but is now in significant decline. In addition, there is likely to be increased supply from ramped up production from Mineral Resources and the two Simandou projects, meaning Carleton is wary of the iron ore pricing outlook.

2. Evolution Mining (ASX: EVN) - Emanuel Datt

Gold has benefited from a flight to safety in the past year, as investors sought to hedge against inflation. Unsurprisingly, gold producers were a happy beneficiary of this, but Datt reminds investors of the old phrase “all that glitters…”

“A number of challenges are being fought by all producers in the sector. Costs have risen considerably for all players over the past four years, above the rate of inflation.

The primary cost inputs of labour, energy and equipment have contributed as well as the usual mining challenge of wrestling with declining geology over time,” Datt says.

He views Evolution Mining as a key example of this. The gold producer recently acquired Northparkes Mine, which had an existing third-party economic interest and will need to carefully manage costs.

“The company appears overleveraged, and we are cautious about exposure to this stock,” he says.

“Most large-cap gold producers are richly valued relative to their underlying, all-in economics, so we suggest exercising caution when considering an investment in this sector.”

3. Lovisa (ASX: LOV) - Justin Woerner

As Woerner puts it, Lovisa is riding a wave of positive sentiment, offering more than enough for a short-term sugar hit. After all, it has generated strong revenue growth, and the company-owned store network has increased by 40%, expanding into 12 new countries. 

“Investors seem to be celebrating the fast pace of expansion and the understanding that it’s not over, with management intent on continuing to add new territories and expand store numbers,” Woerner says.

It all sounds promising, but Woerner points to the sustainability of the expansion program as a major concern for a business “priced for perfection”.

“To deliver an adequate five-year return requires perfect execution, meaningful success within China and no deterioration in store economics,” he says.

He cautions investors to monitor the progress of the store rollout and the underlying store economics, while pointing to the fact management has lifted its use of debt.

“An increase in the number of store closures could be an indication of lower quality locations. Furthermore, a deterioration in same store sales growth could be another signal the accelerated rollout is harmful to longer term value,” Woerner says.

4. NextDC (ASX: NXT) - Steve Johnson

“NextDC is a popular stock that delivers plenty of AI sugar rush,” says Johnson.

On one hand, you might see this as a stock with plenty of ongoing potential, given the need for more processing power to support the nascent AI technology, but Johnson says the valuations aren’t justified.

“This is a capital-intensive business selling a commodity offering. Most of the current capacity is already contracted at set rates, and won’t benefit from surging demand. Industry supply will eventually catch up,” he says.

He suggests prospective investors keep an eye on the cash flow state – particularly capital expenditure costs, along with data centre capacity and how quickly it responds to surging demand.

The carob eggs – long-term solid players for your portfolio

These names might not sound as exciting, but investing in them could be a great long-term boost to your portfolio. In a twist, they all come from the small-caps end of the market – who would have thought the side of the market oft-maligned as riskier could turn out some solid players? (Actually, every small-caps manager I’ve ever spoken to… it pays to be selective and look at fundamentals)

1. HomeCo Daily Needs REIT (ASX: HDN) - Tim Carleton

“For a business offering lower than market risk, we think the total return is quite compelling,” says Carleton.

The only listed trust on the carob list, HomeCo Daily Needs REIT invests in retail, health and services assets – think renting to consumer staples businesses like Woolworths rather than to discretionary retail businesses.

“HDN is a geographically diversified retail landlord, with predominantly large multinational and publicly listed retailers as tenants, offering investors a dividend yield of over 6% that we expect will growth at 3-4% through the cycle,” Carleton says.

He notes that this growth is supported by contracted rental increases over time and strong portfolio occupancy of 99%.

2. WA1 Resources (ASX: WA1) - Emanuel Datt

Datt focuses on companies with scarce, strategically important assets and has a solid growth path ahead. One that fits the bill is WA1 Resources “which has discovered an enormous niobium deposit in Western Australia.”

Why get excited about niobium?

“Niobium is a rare critical mineral produced from only three mines globally, however, is essential for the continuing global energy transition. The primary use of niobium is in the steel industry where 300grams of niobium alloyed into a tonne of steel results in a 25% reduction of steel required in most applications,” says Datt.

It makes lighter and stronger steel. In addition, there’s emerging use in battery technology, “where niobium-based technology is demonstrating charge times of 5 minutes relative to the present 90 minutes with existing technology.”

Currently, the Araxa Mine, owned by Companhia Brasileira de Metalurgia e Mineracao, produces 85% of global production, but Datt says the WA1 Resources deposit holds promise as the “second-best commercialisable niobium deposit on earth”.

“We believe the stock’s valuation looks modest at circa $730 million relative to past transaction values for minority interests in the Araxa mine, and believe their value differential will close as the project is further derisked over time,” Datt says.

3. Baby Bunting (ASX: BBN) - Justin Woerner

“We wouldn’t want to force anyone to endure carob, however, if you are looking to avoid the sugar high, we believe Baby Bunting is a business with longer-term potential,” say Woerner.

The baby retailer has faced several challenges over the year, such as supply chain issues, pressure from inflation and costs from expansion into New Zealand. Woerner thinks the new CEO and an achievable set of strategic priorities for the business could be the ticket to success.

“The next 12 months are likely to be a period of testing and refining before we start to see the initial benefits. If successful, a reinvigorated Baby Bunting should deliver robust earnings growth as management drive sales growth and improve profit margins,” he says.

Woerner also notes the strong brand recognition Baby Bunting holds as the only national baby goods retailer.

4. Dalrymple Bay Infrastructure (ASX: DBI) - Steve Johnson

“It’s about as boring as they come, but some like their eggs that way,” says Johnson (with no offense meant to carob-lovers).

Johnson doesn’t hold this stock because he focuses on long-term capital gains, but he argues that this option is “about as safe as they come” and offers reliable income.

“This heavily regulated Queensland coal terminal yields about 8%. The regulatory regime means that yield should rise in line with inflation and the long-term nature of the agreements means there is no commodity price risk,” Johnson says.

Chocolate vs. carob?

I don’t know about you, but the carob is starting to sound, dare I say it, tasty. Those on the hunt could do worse than make “healthy” choices for their portfolio, and these companies could be a good option for starting your research.

Are you hunting for chocolate or carob in your portfolio this Easter? Join the Aussie Equities Easter Bunny Advisory Committee and share your picks in the comments.