Andrew McKie from our strategic partner, Elston Asset Management, talks about six companies across multiple sectors that meet their investment criteria.
As style-neutral managers, we constantly seek relative value, assessing the multiples we pay against earnings growth rates. We aim to avoid value traps – seemingly cheap stocks with no growth potential – and growth traps, where high multiples are delivered for overly ambitious growth prospects.
Healthcare sector: A prescription for success
Currently, we see significant prospects in the healthcare sector. Our analysis compares sectors' relative value to their potential growth, market averages, and historical multiples. We've recently shifted from a 13% underweight in 2018 to a 6% overweight. It's like finding a hidden gem in a treasure hunt—healthcare's forward P/E ratio has dropped from a hefty 38 times to a more reasonable 27 times.¹
Our change of weighting over this time demonstrates our investment process tends to unearth relative value opportunities, and we capitalise on them when it does. Two factors have influenced healthcare's recent de-rating: increased long-term bond yields, pressuring high multiples, and concerns about demand impacts from GLP-1 diabetes drugs.² However, considering the unique impacts on our specific healthcare company exposures, we believe the latter is overstated.
Diagnosing the following big winners
Our recent investment in Sonic Healthcare (ASX: SHL) is driven by its impressive digital infrastructure, AI technology, and robust leadership. With a focus on specialist and hospital markets in pathology, coupled with a strong balance sheet fortified by COVID-19 testing profits, SHL is well-positioned for future acquisitions and enhancing shareholder returns. At present valuation, the market is underappreciating these factors.
ResMed’s (ASX: RMD) valuation has notably halved from its peak in 2021 of 36 times to 18 times forward EV/EBIT.³ While GLP-1 drugs have divided market participants the most with this company, anticipating what future clinical trials will reveal, we believe today’s price is also not factoring in RMD’s market-leading offering, structural growth tailwinds and strong free cash flow generation. Over a longer time horizon, we see further opportunities for value creation from capturing their growing addressable market, extending industry market share against competitor Philips, and expanding margins as high-cost legacy supply contracts are struck during the COVID-19 rolloff.
Cochlear: Tuning into future growth
Similarly, we believe Cochlear’s (ASX: COH) value, while optically high by market participant standards, underappreciates its long runway for growth. It is estimated that of the 460 million people with a hearing disability, there are 15 million people with severe to profound hearing loss.⁴ Regarding market penetration, less than 5% of that 15 million have received treatment. This means COH has the potential for solid growth for many years, provided it can maintain its market-leading position. This is coupled with a revenue profile not tied to general macroeconomic conditions and the desire to reinvest up to 13% of sales into the business to maintain and extend its competitive advantage.
Consumer Staples: The comfort food of investments
Another sector of interest is Consumer Staples, which is appealing for two reasons. Firstly, tighter credit conditions, rising interest rates, and growing unemployment in 2024 will likely bolster the sector's defensive earnings. Secondly, it trades at a historical discount to the market, with above-average dividend yields. Even with a possible monetary easing in 2024, the delayed effects of 2023's monetary tightening make this sector a focus for the following year.
Treasury Wine Estates: From tariffs to triumph
We highlight Treasury Wine Estates (ASX: TWE) within consumer staples. Its strategic shift from China post-tariff implementation to geographical diversification has strengthened its premium wine business. The possibility of tariff removal on Australian wines in China, coupled with its recent U.S. acquisition, presents long-term investors with a short-term opportunity to acquire this high-quality franchise.
Another name is Endeavour Group (ASX: EDV). Following increased gaming regulations and lower sales, EDV's valuation has declined from 20x to 14x forward EV/EBIT.⁴
With plans to increase EBIT by $150m+ in the Hotels division and a diversification strategy, we anticipate positive market reactions to EDV's evolving business model.⁶ This is further supported by their share of gaming being a smaller % of hotel revenue moving forward as Food & Beverage is expected to outperform over the next five years.⁷
The Lottery Corporation (ASX: TLC): The safe bet for turbulent times
We are positive about the long-term outlook for TLC. While S & P defines TLC as a consumer discretionary company, gaming spending is quite defensive and more akin to a consumer staple definition. This, combined with TLC’s loyal customer base and a firm brand name, we expect the company to generate a resilient revenue profile throughout the economic cycle, with further growth driven by product innovation, game changes and omnichannel delivery. Over a longer investment horizon, we see TLC capable of improving margins through its continued investment in digital and online markets.
In the investment race of 2024, we're putting our money on healthcare and consumer staples. It's not just about following trends; it's about finding sectors as dependable as a trusty old friend yet as exciting as a new adventure.
References
¹ & ³ & ⁵ Source: FactSet.
² GLP-1 (glucagon-like peptide 1) diabetes drugs are well-known in the current Healthcare Sector.
⁴ Source: World Health Organisation (WHO). (VIEW LINK)
⁶ & ⁷ Source: EDV December 2023 Investor Day Presentation. (VIEW LINK)
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