Consumer stocks are approaching an inflection point. They have been among the best performers this year, but large cracks in market confidence are starting to appear.
Worryingly, some experts are now sounding the alarm that the sector has run too far ahead of fundamentals as we close in on the critical Christmas trading season.
This is the time of the year when most retailers make the bulk of their annual profits, and many investors have been piling into the sector in anticipation that a rebound in sentiment following the federal election will entice consumers to spend big during the festive period.
That is the line Treasurer Joe Hockey is pushing, and the logic does make sense. Consumer confidence has rebounded strongly since the September 7 election and house prices have risen materially in key cities.
This should put retailers in a sweet spot ahead of Christmas, if not for the fact that there is next to no evidence that improved sentiment is translating to an increase in consumer spending.
According to official statistics households are saving a little over 10% of their disposable income, which is close to a three-decade high. Yet, trend growth in retail sales in August was flat.
If a notable pick-up in consumer activity doesn’t happen soon, it could trigger a de-rating in consumer discretionary stocks; and there’s plenty of room for them to fall given how far they have climbed.
Credit Suisse strategist, Damien Boey, tells Eureka Report that if consumers are more willing to spend, they would be already.
“Most people would expect [that] with house prices up, employment still ticking over and wage growth still positive that retails sales would be accelerating,” says Boey.
“But anecdotal evidence says ‘no’ and I believe, in part, that is because the decoupling between activity and sentiment is a global theme at the moment.”
He points out that a similar story is playing out in the rest of the world, where consumers are slow to spend despite growing confidence in the economic outlook.
Further, he adds that Australian households are using cash to pay down debt, and demand for home equity withdrawals is low. This means rising home prices are not likely to fuel consumer spending like they have in previous cycles, and that is why Boey is recommending investors go underweight on the sector.
But you won’t find consensus on this topic. John Hughes from Thorn Group (TGA), the operator of the Radio Rental chain, thinks consumers are poised to change their conservative habits in a big way.
“We have seen no immediate change [since the election] and I don’t expect there to be any,” says Hughes.
“In my 40-plus years in retail, when I see environments like this, things just don’t happen [overnight]. Things change gradually and momentum builds.”
There is little doubt in his mind that consumers will be back in force, but we may not see the full impact of this until March next year.
The chief executive of advertising group Ogilvy Australia, Andrew Baxter, has also noticed a change in the air and he is expecting discretionary spending to be buoyant during the Christmas shopping season.
“It’s only been seven weeks, but the trend we are seeing across a range of retail categories is that consumer confidence is more positive than it was pre-election,” he says. “There is a slight lag in business confidence, particularly in the small business sector, but we expect this to rectify itself soon.”
Ogilvy Australia is owned by STW Communications (SGN), which is part of the Uncapped 100.
I tend to agree with Hughes and Baxter because there is a lag effect when it comes to consumers feeling better about their future and opening their wallets. In fact, we should be worried if we saw a sharp rebound in spending immediately after the election as it would raise questions about the sustainability of the change in behaviour.
It will also be a bearish sign for the market on the whole if consumers do not come back in any meaningful way, as that will have pretty big knock-on effects on business confidence. If you are bullish on equities, like I am, by default you have to have faith in consumers and JB Hi-Fi’s pleasing sales update at its annual general meeting today is reassuring.
The electronics and music retailer reported an 8.1% increase in sales in the September quarter and reaffirmed its revenue growth target of 6% to 8% for the current financial year.
By extension, this Christmas should be markedly better than the last few unless something comes out of left field. Don’t get me wrong, it won’t be sunshine and lollipops for the sector and the internet threat is still a big challenge for many consumer discretionary companies.
However, a number of Uncapped 100 stocks are well placed to see earnings upgrades should consumer spending momentum start to build. I’ve highlighted Specialty Fashion Holdings (SFH) as a buying opportunity in August, but there are another two worth looking at.
Uncapped 100 with "outperform" recommendations
|Company||Code||Article date||Price* ($)||Article title||Total rtn* (%)|
|eBet||EBT||26-Jun-13||$1.13||Small cap with biggest earnings upgrade||197.8|
|Tiger Resources||TGS||3-Jul-13||$0.19||Why a dog can be an investor's best friend||107.9|
|Mint Wireless||MNW||2-Oct-13||$0.18||Four new stocks for Uncapped||80.6|
|WDS||WDS||14-Aug-13||$0.59||A mining services revival?||66.2|
|GI Dynamics||GID||17-Jul-13||$0.60||Five bargains for under a buck||37.9|
|LogiCamms||LCM||7-Aug-13||$1.47||The next dividend dazzelers||35.2|
|NRW Holdings||NWH||14-Aug-13||$1.14||A mining services revival?||30.7|
|Newsat||NWT||3-Jul-13||$0.40||Why a dog can be an investor's best friend||26.6|
|Colorpak||CKL||17-Jul-13||$0.73||Five bargains for under a buck||21.2|
|Thinksmart||TSM||21-Aug-13||$0.36||Biggest smalls earnings surprises||9.9|
|M2 Telecommunications Group||MTU||10-Jul-13||$6.02||Big expectations for small caps||7.9|
|Beadell Resources||BDR||28-Aug-13||$0.87||Short-selling gold signals||7.8|
|Wide Bay Australia||WBB||16-Oct-13||$5.60||Appetisers from the agri stocks field||5.5|
|Silex Systems||SLX||3-Jul-13||$2.32||Why a dog can be an investor's best friend||3.5|
|Ridley Corporation||RIC||16-Oct-13||$0.85||Appetisers from the agri stocks field||0.6|
|YTC Resources||YTC||9-Oct-13||$0.26||Xmas sale starts early for small caps||0.0|
|Specialty Fashion Group||SFH||18-Sep-13||$0.93||Small cap surprises for 2014||-3.2|
|Collins Foods||CKF||7-Aug-13||$1.76||The next dividend dazzelers||-4.3|
|Starpharma Holdings||SPL||17-Jul-13||$0.94||Five bargains for under a buck||-4.8|
|Horizon Oil||HZN||17-Jul-13||$0.36||Five bargains for under a buck||-5.1|
|Universal Biosensors||UBI||4-Sep-13||$0.68||Smalls in sweet spot||-8.1|
|Forge Group||FGE||18-Sep-13||$5.23||Small cap surprises for 2014||-14.0|
|STW Communications||SGN||30-Oct-13||New||Small consumer stocks at Christmas crossroads||New|
|*As of publishing date|
|Source: Eureka Report, Bloomberg|
STW Communications (SGN)
Any upswing in discretionary spending should breathe some life back into the anaemic advertising market, and that will only play into the hands of the advertising group.
But there are other reasons why I like STW. First, expectations are relatively low as the market is only ascribing inflation-plus like growth for the group in 2014 and 2015 (its financial year is the same as the calendar year).
What’s more, analysts polled on Bloomberg are playing it safe and are expecting 2013 earnings per share (EPS) to fall 16% to 12.6 cents when management said at its half-year result in August that “mid-single digit EPS growth remains achievable”.
Second, STW is trading on reasonable valuations, even though it has jumped 40.5% over the past year. Based on the downbeat consensus expectations, the stock is on a 2014 estimate price-earnings multiple of under 12 times, or around a 40% discount to its global peers, and has a yield of about 8% once franking credits are applied.
More importantly, the group is well run and has a pretty good track record in generating earnings and sales growth over the past few years in what can only be described as a challenging environment.
I have a new “outperform” recommendation on the stock.
Retail Food Group (RFG)
The franchise food brand owner announced a capital raising on Tuesday and reaffirmed its 2013-14 net profit growth of around 15%.
While that is a little behind consensus estimates of 17.5% net profit growth to $37.6 million, I won’t be surprised if management upgrades its full-year guidance at its half-year result.
Reading between the lines, its chief executive Tony Alford was tempted to, but decided to err on the side of caution, when he said it was “premature” to revise its current year guidance.
Details on the capital raising will only be released on Thursday but the proceeds are likely to be used to advance the expansion of its new pizza outlets and acquisitions as the current environment has created some attractive earnings accretive opportunities.
What I also suspect is that Retail Food Group will beat consensus net profit expectations for 2014-15 and 2015-16 as the roll-out of new Pizza Capers and Crust Gourmet Pizza outlets is going better than envisaged.
Management initially planned to open 70 outlets in 2013-14 and 60 outlets the following year, but will now open around 85 outlets before June 30 next year.
The opening of new stores for a retail establishment is significant for earnings as each new outlet tends to give the group added operating leverage. This means net profit is likely to grow in excess of sales.
Retail Food Group also owns franchise brands Donut King, bb’s cafe, Brumby’s Bakeries, Michel’s Patisserie and Esquires Coffee Houses.
I am upbeat on the news, but I will start my recommendation on the stock with a “neutral” until I see the details of the capital raising. Stay tuned as I will give an update on Live Markets on the Eureka Report site.
(UPDATE: Retail Food Group said on Thursday morning (October 31, 2013) that it has completed a $53 million placement to professional investors and is looking to raise another $7 million from existing shareholders via a shareholder purchase plan (SPP). I believe the SPP will be very well supported and urge shareholders to participate in the raising. Further, I am upgrading the stock to “outperform” as the growth in earnings from its aggressive store rollout and acquisitions will more than offset the dilution from the raising.)
Think big, go smalls!
Uncapped 100 - Australia's most interesting small cap stocks
|Small cap stocks covered by the Uncapped team|
|Code||Name||Rationale||Market cap ($m)||Total return 1-year (%)||Sector (GICS)|
|ACR||Acrux||One of the most successful Australian biotechs in recent history. Widely held by instos.||446.28||-16.07||Health Care|
|ACL||Alchemia /Australia||One of the few biotechs with revenue stream. Good pipeline of oncology treatments.||192.98||8.18||Health Care|
|AOH||Altona Mining||Noteworthy copper play with Xstrata pull-out of Roseby project in Australia and the good ramp up of its Finnish project.||77.17||-46.3||Materials|
|AMA||AMA Group||Good turnaround story but under the automotive services group is radar of most.||125.34||42.6||Consumer Discretionary|
|AMM||Amcom Telecommunications||Well covered junior telco but good candidate for core holding.||507.46||67.55||Telecommunication Services|
|AZZ||Antares Energy||Liquid with good insto support. Already in production with exploration upside in Texas.||126.22||-8.33||Energy|
|ARP||ARB Corp||Well covered but good candidate for core holding due to quality management.||836.07||16.18||Consumer Discretionary|
|AAD||Ardent Leisure Group||Widely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.||806.95||54.67||Consumer Discretionary|
|AJA||Astro Japan Property Group||Strong leverage to Japanese economy makes this an interesting stock to watch.||245.32||20.13||Financials|
|AUB||Austbrokers Holdings||The insurance broker is a strong performer. Widely held and well liked by small cap investors.||726.05||64.43||Financials|
|AEU||Australian Education Trust||Well performing childcare centre property owner. Good yield story and outlook.||276.36||43.37||Financials|
|BDR||Beadell Resources||Will be a very big FY14 for miner as it has to prove it aims to produce 200,000 ounces of gold a year.||737.17||0.81||Materials|
|BGA||Bega Cheese||Corporate interest in Australian food companies makes the cheese maker worth following.||663.65||152.81||Consumer Staples|
|BGL||BigAir Group||The wireless microcap has gained strong following over past year or two but is often overlooked by investors and the press.||142.69||60.59||Telecommunication Services|
|BNO||Bionomics||One of the larger cancer treatment developers in this market.||288.51||123.53||Health Care|
|BOL||Boom Logistics||Crane hire group is riding out the downturn in construction. It's widely held by instos and is very liquid.||87.06||-38.33||Industrials|
|BRU||Buru Energy||Substantial size but not often covered by press. Widely held with good insto support.||498.27||-40.57||Energy|
|CAA||Capral||An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose.||92.29||-2.5||Materials|
|CCV||Cash Converters International||Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.||463.60||26.13||Consumer Discretionary|
|CWP||Cedar Woods Properties||Property developer with good ROE and earnings growth track record.||519.39||75.56||Financials|
|CUV||Clinuvel Pharmaceuticals||Interesting skin disorder treatment developer that has done reasonably well over past year||59.24||-3.13||Health Care|
|CLV||Clover Corp||One of the star performers in 2012. Operates in growing but relatively stable niche.||78.46||-7.79||Health Care|
|CLH||Collection House||In similar space as Credit Corp. Strong stock performance has attracted a following and the stock appears to be well placed to run further||217.86||84.77||Industrials|
|CKF||Collins Foods||One of the few food franchise listed companies.||157.17||50.13||Consumer Discretionary|
|CKL||Colorpak||The small cap packaging company has grown via acquisitions over past few years.||69.31||56.26||Materials|
|CCP||Credit Corp Group||Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.||455.32||42.91||Industrials|
|DTL||Data#3||Well respected IT company that receives little press coverage.||177.07||6.71||Information Technology|
|DRM||Doray Minerals||Widely held by instos. One of the more favoured gold explorers by brokers.||98.60||-17.26||Materials|
|DWS||DWS||Will be a big beneficiary if governments start spending on IT again.||201.19||7.38||Information Technology|
|EBT||eBet||Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.||50.88||230.34||Consumer Discretionary|
|EML||Emerchants||Trying to change way corporates and governments disburse cash with its trackable and controllable debit card offering. If company can get $1 billion in loaded value on cards, the stock will surge.||67.32||440||Financials|
|ESV||Eservglobal||Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage||128.26||157.5||Information Technology|
|FGE||Forge Group||One of the better performers in its industry. Good track record and potential core holding.||387.76||16.68||Industrials|
|GEM||G8 Education||Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.||942.95||136.67||Consumer Discretionary|
|GXY||Galaxy Resources||Good upside potential if it can get its problem-prone Jiangsu plant back on track. Won't be easy to right this ship.||62.46||-80.83||Materials|
|GHC||Generation Healthcare REIT||One of the more interesting REITs. Income is more defensive than typical property stock and its greenfield expansion gives it earnings growth potential.||120.88||35.51||Financials|
|GID||GI Dynamics Inc||Largely forgotten by investors but could attract attention this year as it looks to gain US approval to use its intestinal liner on diabetics.||322.71||47.77||Health Care|
|GXL||Greencross||Acquisitive veterinary group. Good profit growth and share price performance, but gets little press.||238.35||102.51||Health Care|
|HSN||Hansen Technologies||Operates in a high potential/growth industry but is not covered by press or brokers.||174.22||34.25||Information Technology|
|HZN||Horizon Oil||One of better regarded small energy stocks that doesn't receive much media attention.||432.63||-11.3||Energy|
|IMD||Imdex||Drilling company is well supported by instos and should benefit from any rebound in exploration activity.||159.43||-41.57||Materials|
|IMF||IMF Australia||Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.||264.77||25.72||Financials|
|IFM||Infomedia||Interesting tech play in the car parts market. Strong share price gain but gets little air play.||182.97||84.1||Information Technology|
|IPP||iProperty Group||Worth watching as it is trying to be the REA Group of Asia.||336.49||106.11||Information Technology|
|JIN||Jumbo Interactive||Innovative small cap facing off industry dominated by giants. Worth watching to see if it can carve out a profitable global business.||111.57||43.53||Consumer Discretionary|
|KOV||Korvest||The construction products and services supplier has been hit by project delays and deferrals. But its relatively high yield could give it some support.||51.13||-8.32||Industrials|
|LGD||Legend Corp||Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.||71.34||0.62||Information Technology|
|LCM||LogiCamms||Strong price performance and reasonable valuation attracting interest.||135.24||84.72||Industrials|
|MTU||M2 Telecommunications Group||Amazing growth story and well run company. High free float and strong insto support.||1,133.05||72.32||Telecommunication Services|
|MXI||MaxiTRANS Industries||Transport equipment maker posted good interim result. Has appealing yield and growth.||210.67||25.32||Industrials|
|MYX||Mayne Pharma Group||Sizeable generic drug maker with interesting board members.||402.87||197.92||Health Care|
|MMS||McMillan Shakespeare||One of the best performers since the GFC, but ongoing risk of change to FBT rules is hanging over the company.||967.32||4.17||Industrials|
|MCP||McPherson's||The personal care and household products supplier had been relatively insulated from volatile discretionary spend and online threat, but its latest profit warning shows it's not immune.||119.65||-21.47||Consumer Discretionary|
|MLB||Melbourne IT||A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.||133.40||4.52||Information Technology|
|MRM||Mermaid Marine Australia||Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.||870.12||19.57||Industrials|
|MNW||Mint Wireless||Huge market potential if the mobile card payment solutions provider can gain market traction. Management aiming for $1 billion in transaction value a year.||131.26||1811.77||Information Technology|
|MOC||Mortgage Choice||Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.||364.12||83.38||Financials|
|MYS||MyState||Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.||425.43||40.47||Financials|
|NAN||Nanosonics||A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.||218.14||58.1||Health Care|
|NEA||Nearmap||A stellar performer with an Interesting business that offers high quality aerial maps to companies & government.||172.99||1428.57||Information Technology|
|NTC||NetComm Wireless||Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.||30.89||84.62||Information Technology|
|NWT||Newsat||Potential large cap if it can launch its own satellite in 2015.||295.62||0||Telecommunication Services|
|NXT||NEXTDC||The cloud computing company is an IT sector darling. Fairly widely held and followed.||491.20||25.63||Telecommunication Services|
|NHF||NIB Holdings /Australia||Only listed health insurer. Widely held. Good performer.||1,071.17||41.06||Financials|
|NWH||NRW Holdings||One of the better regarded mining & civil contractors with good track record in delivering on projects.||394.63||-23.5||Industrials|
|OTH||Onthehouse Holdings||Alternative small cap to online property leader REA Group. It is trying to use more timely housing data as a competitive edge against REA.||63.69||30.31||Consumer Discretionary|
|PGC||Paragon Care||Emerging hospital equipment supplier that has been ignored by market.||19.27||134.54||Health Care|
|PFL||Patties Foods||Illiquid stock but has suite of well recognised consumer brands. Defensive yield.||191.22||-12.98||Consumer Staples|
|PEN||Peninsula Energy||Widely held by instos and large free float. It's the only uranium miner on the list.||71.21||-34.72||Energy|
|POH||Phosphagenics||Sizable biotech with a game changing FY14 year ahead. Good insto following but questions of poor audit and governance standard could dog company.||137.76||-12.9||Health Care|
|RCG||RCG Corp||The footwear retailer is one of the best performing consumer stocks as online competition is not a big threat. Company has a good yield as well.||186.33||86.28||Consumer Discretionary|
|RCR||RCR Tomlinson||Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?||504.41||114.83||Industrials|
|RKN||Reckon||Fierce competition for cloud base accounting software puts it in firing line.||301.04||3.8||Information Technology|
|REX||Regional Express Holdings||Well run airline that is overshadowed by Virgin and Qantas.||113.94||-15.16||Industrials|
|RFG||Retail Food Group||Owns a number of well know franchise brands. Widely followed by instos.||597.15||47.32||Consumer Discretionary|
|RIC||Ridley Corp||High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.||263.18||-19.37||Consumer Staples|
|RUL||RungePincockMinarco||IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.||84.81||42.86||Industrials|
|SAR||Saracen Mineral Holdings||Emerging gold producer that is widely held by instos. Hitting milestones and looks cheap. Key asset is close to gold majors, which makes it a potential takeover target.||142.86||-50.52||Materials|
|SHV||Select Harvests||Noteworthy for turbulent past and exposure to soft commodity market.||247.45||278.8||Consumer Staples|
|SLX||Silex Systems||Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.||408.61||-31.43||Information Technology|
|SIV||Silver Chef||Strong jump in the share price of the equipment financing group has attracted a good following.||238.78||79.35||Industrials|
|SRX||Sirtex Medical||A shining star in the biotech space and one of the best performing stocks in 2012. Great product (liver cancer treatment) and bright outlook.||691.54||14.45||Health Care|
|SFH||Specialty Fashion Group||In early stages of turnaround. Can the women's apparel retailer sustain the momentum?||173.01||71.86||Consumer Discretionary|
|SPL||Starpharma Holdings||Noteworthy for its good pipeline of innovations. Well run, widely followed.||253.62||-44.22||Health Care|
|SGN||STW Communications Group||One of few companies able to benefit from online shift. Widely held and good insto support.||629.97||57.8||Consumer Discretionary|
|SEA||Sundance Energy Australia||Analysts have a favourable take on the oil & gas explorer, but stock is still under radar of most. Sundance provides exposure to prospective Eagle Ford shale.||506.56||39.49||Energy|
|TAN||Tandou||The only direct equity exposure to cotton prices. Also trades water rights and receives little press.||70.15||17.75||Consumer Staples|
|TGR||Tassal Group||Salmon farmer is finally turning a corner with an improved harvest strategy and growing demand for product.||479.08||137.79||Consumer Staples|
|TFC||TFS Corp||The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.||212.51||102.46||Materials|
|TSM||ThinkSmart||Potential turnaround story worth keeping eye on.||63.30||81.4||Financials|
|TGA||Thorn Group||One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.||376.71||35.34||Consumer Discretionary|
|TGS||Tiger Resources||Future lies in its Kipoi copper mine expansion in the Congo but miner is fully funded with DRC govt holding 40% stake in tenement. Next 12mths will be interesting.||266.53||8.22||Materials|
|TOX||Tox Free Solutions||Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.||438.64||18.4||Industrials|
|UML||Unity Mining||Growing Tassie gold producer with high free float. Valuation looks compelling too.||42.82||-54.81||Materials|
|UBI||Universal Biosensors Inc||Well regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.||109.12||-32.07||Health Care|
|UXC||UXC||Company has turned corner and enjoyed re-rating. What's next?||299.73||11.59||Information Technology|
|VOC||Vocus Communications||Telecom stocks are in favour but Vocus is one of the least covered||217.91||49.6||Telecommunication Services|
|WDS||WDS||Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.||126.65||55.06||Industrials|
|WBB||Wide Bay Australia||The building society is trying to turn its fortunes around. Also worth watching for its exposure to Queensland housing market, particularly around major resource projects.||214.17||-8.05||Financials|
|YTC||YTC Resources||Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.||69.66||4||Materials|
|Source: Eureka Report, Bloomberg|