Repricing finds value

I have been pretty bullish on the ASX over the past two weeks. The correction – and it was a correction – from the April high to the June low was certainly needed, as the ASX was clearly overvalued.

Source: Bloomberg

What was also interesting from the slide is that the ASX had already lost over 50% of the 10% correction before the China and Greece macro gyrations through June. During the volatile macro events in June, the ASX actually outperformed global peers and had started to recover.

To me, that has interesting connotations for the ASX:

  • Value was clearly overstretched and unsustainable at 6000 points at the beginning of the year. Companies are not static so one should always assume they are constantly growing. The question is whether earnings growth can sustain a price point in the major corporates that would push the ASX back to 6000? I am not sure of this yet but 5800 looks very probable.
  • The repricing has created value over the past three months and the market has responded well. The correction and even a bear market at one of the big four banks, plus the selloff in Telstra and Wesfarmers, meant deep value fishing could bear fruit. The pullback in the likes of Macquarie and the healthcare space had also increased the amount of fish in the value pool, showing there are still places to invest in the ASX.
  • However, ‘true value’ has been something of an enigma since the GFC, as stocks have been ‘cheap’ for a reason. The starkest examples of this are BHP and RIO. Both have been averaging around a 25% discount to net present value (NPV). Even with the asset write-downs over the past six to seven years, the market has almost immediately moved low to reflect this discount in the share prices.

Looking for the value

Value investing has (in Australia any way) been primarily about three things.

  • Consistently strong EPS growth (around 8% or more)
  • Low earnings risk (niche companies, duopolies, biggest names in a sector)
  • Low leverage (one of the biggest issues facing material and energy names in the current environment)

However, these thematics are ‘wish lists’ – finding stocks with these three themes trading at a discount to NPV is as rare as hen’s teeth. The perfect example of a ‘value’ stock in the ASX is CSL: it has all three of the value criteria above but the premium for these thematics is astronomical.

So quality value stocks are (almost) never cheap but the pullback has presented a cheaper entry point. Clearly the correction has given us that opportunity and it will again. I continue to see value in healthcare names like ANN, RMD and RHC. I also see ‘value’ for MQG, JHX and even NAB.

Earnings season starts tomorrow – earning estimates have been revised up slightly since they were overly pessimistic at the start of July. If you go on the assumption of ‘buy the rumour’ in July ‘sell the fact’ in August (as the short-term money moves out on inline numbers), there should be a value point coming in the future.

Ahead of the Australian open

The ASX looks like snapping out of its six-day winning streak this morning – we are calling the market down 36 points to 5670. The lead from the street is a negative one as IBM’s influence on the big board distorts the numbers.

It’s Apple, however, that will really see US futures under pressure. Afterhours trade has seen AAPL lose 8% and that will impact US futures and, by default, Asian markets. I would also suggest 5700 points looks like an interesting inflection point and may need a little more optimism to punch through here.

Australia CPI is due at 11.30am AEST. The trimmed-mean estimate (which is the RBA’s preferred measure) of 2.2% is well inside the ‘comfort band’ of 2 to 3%. With the Bank of Canada and RBNZ cutting rates over the past few months, some have suggested the RBA is next. The minutes were dovish yesterday, but if CPI holds, the conclusion would be there’ll be no more cuts in 2015.

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