Stocks for your children's children

PORTFOLIO POINT: What stocks would you choose for later generations? Here are some ideas.

The month or so ahead are a wonderful time to do some strategic planning for your portfolio. It is also a great time to think about long-term planning for your children or grandchildren.

So in my final piece for Eureka Report in 2010 I want to tell you about the talented investment manager for a major financial institution who was looking to buy some shares for his young children that would yield long-term benefits.

It’s an interesting exercise, investing for the next generation. You need a much longer time horizon than when you invest for yourself and I found the stocks he chose fascinating.

He undertook the first part of exercise several years ago and at that made investments in two stocks for his first child. This year he has chosen another two stocks for his second child. We will look at the motivation of choosing the first two stocks before looking at his latest selections.

The first stock he chose two years ago was BHP Billiton (BHP). One doesn’t have to go into a lot of detail as to why because it is the cornerstone of most Australian portfolios and, along with Rio Tinto, provides a wonderful way to access the urbanisation of China through mineral exports.

But his second choice was one that very few would have chosen: AXA Asia Pacific (AXA). This particular investment manager understood that the mineral boom would ebb and flow but the rising standard of living in China, India and the rest of Asia would provide the greatest growth opportunity for savings products that the world has seen for generations.

For example, non-bank savings product demand in China and Indonesia are expected to grow by 14–15% annually for the next 10 years.

In Australia, AXA Asia Pacific is probably the best placed company in the world to participate in this and so two years ago he chose AXA as his second cornerstone stock to generate high long-term returns for his first child.

The great risk he faced was that the French would buy out the Australian shareholders before they had a chance to take advantage of the looming bonanza. And of course that is exactly what looks like happening and it is a tragedy for those who realised the fantastic long-term potential of AXA Asia Pacific.

Over the course of the year a number of bidders have emerged for AXA, including NAB and AMP. Importantly these bids were focused on the Australian assets, the Asian assets of the company would be snapped up by its French parent.

However, there is at least there is a chance that the government will block the French bid back on the ground of national interest. This, of course, would reduce the value of AXA stock in the short term but would be an opportunity for his children and all of us to participate in the bonanza ahead.

What he didn’t realise when he chose the stock was that AXA would gain “local” status in China via an amazing deal with the Industrial and Commercial Bank of China, the largest in the country. Being able to market to every person in China instead of just 5% of the market will not affect profits for the next two or three years but after that AXA Asia Pacific has the chance to achieve long-term growth higher than any other Australian financial services company could ever dream of.

And that’s why the French want to grab it before we wake up.

This year he had to pick two more stocks for his second child. In theory he could take BHP as his first pick but he is just a little nervous at the high prices being paid for commodities that we are now seeing and wonders whether they will be maintained for the rest of the decade.

But what will be maintained is the volume increases in Australian resources. One commodity in particular is coal.

China has built a great many coal-fired power stations and the demand for coal will continue for a long time. There are a number of ways to play the coal game but my friend’s suggestion was an unusual one: Asciano (AIO).

His selection was made on the basis that its ports handle large volumes of coal and it also has a substantial stake in Australian major container ports, which will grow steadily in the years ahead.

The company’s balance sheet is not as well structured as it should be (it carries far too much debt) but he believes that because of the strength of the assets it will be sorted out over time. It is a very good reminder to keep your eye on stocks that supply resource companies.

If they are managed properly they will do extremely well in the next two or three years. Remember the adage that it’s the businesses that sold the pick axes that do the best in a gold rush.

His second pick was Santos. He believes that gas is going to be a major source of lower-carbon energy and we haven’t yet recognised the strategic positions of Santos in the global market. In time that recognition will take place and the value of its links with Petronas will be better understood. By contrast, he felt that the potential of Woodside is well recognised and fairly reflected in the share price.

The manager will be very sad if AXA gets taken over, but as it is likely, he is thinking about selecting a replacement stock for his first child. No decision has been made but high on the list is Incitec Pivot, which again is a major supplier to the mining industry via explosives, and has a fertiliser business to take advantage of the huge growth everyone is anticipating in agriculture and soft commodities as global living standards rise.

Obviously not everyone will agree with his selections but they give you cause you to think. In particular, you will notice that he has not chosen a bank. He believes that the glory days of bank growth are over and the latest government rules will commoditise many consumer banking products (click here). Moreover the government will do whatever is required so that secondary banks get the funding they require.

Also missing from his list are retailers, which he sees as either fully priced and under attack from online retailers (for more on this, click here). He also sees their growth stunted by the two-speed economy, not to mention rising interest rates and higher utility charges, which are sapping the financial spending capacity of overleveraged Australian households.

But the good news about the total Australian situation is that a great many of our chief executives are starting to look at their long-term future and taking steps to maximise growth and/or adapt to any difficulties they may see in their own industry. Accordingly expect a lot of mergers or takeovers in the next year or two, which will help buoy the market.

Have a wonderful Christmas, New Year and we’ll see you in 2011.