Two Aussie stocks with diversification potential

Gaston Amoros and I have previously discussed several higher-growth or idiosyncratic opportunities within the Forager Australian Shares Fund. In this video, we take a quick look at two larger, lower-risk lower-reward businesses that help balance out the portfolio with liquidity and diversification.

The first is Downer (ASX: DOW), which is currently trading just below the five-year average. We explore how Downer has been punished for sins of the past, but that its continued solid performance could soon change the perception of this business – making its true multiple (and potential) much greater.

The second is Integral Diagnostics (ASX: IDX), which is Australia’s largest operator of imaging centres. Although this business has suffered from the many flow-on effects of COVID lockdowns, we reveal why they consider this a strategic asset with the potential to pay multitudes in future.

Transcript

Alex Shevelev:

Hello everybody. My name is Alex Shevelev, Senior Analyst on the Australian Shares Fund here at Forager. And today joining me for this week’s video is Gaston Amoros, also Senior Analyst on the Australian Shares Fund. Hi, Gaston.

Gaston Amoros:

Hi, Alex.

Alex:

So today we’re going to be talking about businesses in the lower-risk, lower-reward bucket of the portfolio. Now over the last couple of weeks, we’ve touched on a couple of stocks that are in the higher-growth basket. We’ve touched on a couple of interesting idiosyncratic opportunities out of reporting season. And here we’ve got another part of the portfolio in this Australian Shares Fund that gives us a little bit more liquidity. It gives us a little bit more diversity and a little bit more of a steady, dependable business. So on that note, Gaston, let’s kick off with the first one.

Gaston:

Thank you, Alex. So the first one would be Downer. It’s urban services or road maintenance, telecom, utility network maintenance type of business. It’s a large company, we’re talking around the $4 billion market cap at the moment. And it’s, as you said, a very steady business or should be a very steady business. Management has done in the last few years a great job of cleaning up the business. It’s posting at the more volatile and capital-intensive segments like mining, laundries and shrinking the engineer and construction book. And it has focused the remaining company around three core service areas: roles, utilities, and facility maintenance. They are mostly billed to the government in Australia and in New Zealand. So there’s very little or no effects risk or geopolitical risk.

I think it’s interesting because the market continues to punish the Downer stock for the sins of the past, even though, as we said, it has been cleaned up already. And we have seen a few halves already of steady execution and good delivery on numbers. So to give you a sense, Downer is now trading at around 12 times P/E, which is slightly below than the average of the last five years. And there compares with favourably to the ASX industrials these days. And that includes a dividend yield of 5%, 6%. So we think that as the management really delivers a steady execution on their roadmap, there’s no reason why the stocks shouldn’t raise from the 12 times P/E to something higher, more commiserate with the lower volatility of earnings.

Alex:

Okay. So that’s Downer for us, the first one of these stocks. Now the second one is Integral Diagnostics. We actually participated in the capital-raising for this business, both on the institutional and underwriting some of the retail rights here as well. Maybe just take us through that business and why it’s also in this lower-risk, lower-reward camp.

Gaston:

Yeah, sure. So Integral Diagnostics is the largest public-listed operator of imaging centres in Australia with 80 clinics and around 180 or so radiologists. So this is where you go to get an MRI or a CT scan done. And Integral is interesting because they tend to over-index, to hire complexity modalities like MRIs and CT scans, which are typically more expensive and more complex. It’s not like a very simple x-ray at the lower price point that you can do them down the corner. And because of that, we think it’s a much more – a very defensive business. So whether you need to have an MRI for your knee or your brain sooner or later, you need to have it – it doesn’t matter whether we are on lockdown or elective surgeries that have been postponed. At some point surgeries resume and people need to get all their imaging done.

So if you look at the share price, it’s currently suffering from, in our opinion, excessive short-term focus of the market on Omicron and mobility issues in Australia. But more importantly, they have 15% of the business in New Zealand. And that’s been severely affected in the half that we just saw. But as we know from past experience, the recovery post-lockdown tends to be quite sharp and the business is very well capitalized and very well run. So on top of that, we think it’s a strategic asset that could find itself a subject to take-over approach at some point. And again, it’s a very sensible valuation for high teens, for low double-digit earnings growth and a dividend yield of three or three and a half percent at these levels. So quite appealing.

Alex:

There you have it. Two businesses that fall very neatly in the lower-risk, lower-reward part of the portfolio. We complement, of course, this part of the portfolio with some of the higher-growth businesses that we talked to in prior videos, as well as a whole host of other interesting idiosyncratic opportunities. But this part of a portfolio is really interesting as it offers that diversity. It offers a little bit more liquidity, and it really helps position the portfolio in a good risk-reward framework into the future. So thank you for listening today and we’ll see you next time.