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Re-opening: Twin trends drive quality ASX stocks and infrastructure

Hunger for earnings growth certainty is driving valuation of quality companies and infrastructure businesses as investors set up portfolios for the re-opening, says Pendal equities analyst Anthony Moran

“PEOPLE are seeking certainty in an uncertain world,” says Pendal Australian equities analyst Anthony Moran.

“We’re seeing people willing to pay bigger premiums than we’ve ever seen before for the certainty of strong earnings momentum or the multi-decade earnings certainty of infrastructure.”

The recent ASX company reporting season shows investors are willing to pay a premium for companies with good operating momentum.

They are betting a demonstrated ability to perform well amid the pandemic disruptions means a company will be able to power out of lockdowns and deliver strong growth over the coming 12 months, Moran says.

Rising input prices have been a feature of the pandemic. Supply constraints from manufacturing disruption and a shortage of freight capacity have paired with strong demand to drive prices higher.

“One of the implications for portfolio construction is to be aware of stocks that have measures in place to manage those risks or have pricing power,” says Moran.

He highlights building materials companies James Hardie Industries (ASX: JHX) and Fletcher Building (ASX: FBU) as particularly good examples. The momentum they took into the pandemic has served them well in coping during the disruptions, he says.

“For Hardie, it was about having availability of products when their competitors didn’t — and having a strong brand and having invested a lot in customer relationships.

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“For Fletcher, they were kicked around for years by cheaper importers as they held on to being a domestic manufacturer. Now the shoe is on the other foot because of the supply interruptions hurting imports.”

These trends are likely to persist, Moran says. Companies with strong operating momentum will continue to perform well, since strong underlying demand will continue to buoy sales, he believes.

Search for stable, long-duration assets

The second big trend underpinning the market is the urgency with which big superannuation and pension funds are searching for stable, long-duration assets.

This is driving a flurry of takeovers in the infrastructure sector and pushing valuations to all-time highs. It’s led by multi-billion-dollar bids for companies such as Sydney Airport (ASX: SYD), Spark Infrastructure (ASX: SKI) and AusNet (ASX: AST).

“It’s fascinating because we’re seeing unlisted money willing to pay a materially lower cost of equity than the listed markets. They say they have a longer-term time frame. We would say they have got too much money trying to find a home.”

Moran says only particular types of companies are attractive to the big super funds: “It’s got to be long-dated, it’s got to be a hard asset and it’s got to be ESG [Environmental, Social and Governance] friendly.”

How can investors play these twin trends?

Moran says the key is to hold a diversified portfolio and not get too caught up in the interest-rate driven games played by institutional investors.

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“It’s about recognising there are different kinds of opportunities and you can make money in all sorts of ways in any given market.

“You want to have a balanced approach. If all you have in a portfolio is these stocks, the moment you get a switch in the market momentum away from growth and quality towards value, that could whip against you extremely quickly.”

It’s not a theoretical concern. A sustained lift in inflation, higher GDP revisions and rising interest rates could all potentially shift the dominant market view, says Moran.

The answer is to find exposure to stocks where there is a chance that earnings momentum will pick up as lockdowns pass or where there are clear catalysts to close the valuation gap, he says.

About Anthony Moran and Pendal Focus Australian Share Fund

Anthony Moran is an Australian equities investment analyst with more than 15 years of experience in a range of local and international sectors. His sector coverage includes Australian Industrials and Energy, including Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure. Anthony is a CFA Charterholder and holds bachelor degrees in Commerce and Law from the University of Sydney.

Pendal Focus Australian Share Fund is Crispin Murray’s flagship Aussie equities strategy. It is a high-conviction equity fund with a 16-year track record of strong performance in a range of market conditions. The Fund features our highest conviction ideas and drives alpha from stock insight over style or thematic exposures.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal Focus Australian Share Fund here

Contact a Pendal key account manager here

This article has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and the information contained within is current as at September 22, 2021. It is not to be published, or otherwise made available to any person other than the party to whom it is provided.

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