There have been few sectors that have been spared in the recent equity rout. However, it has been the high PE and high ‘quality’ names that have bared the brunt of investor selling. Darling stocks like CSL, REA Group and Smart Group have shed around 15% of their price in just 3 months. So, has appetite for growth and momentum waned or will this prove to be blip on their journey higher?
In this episode of Buy Hold Sell Roger Montgomery from The Montgomery Fund and Ben Rundle from NAOS share views on the current valuations of these high quality stocks and they each offer up one quality stock that they believe investors have now put ‘on sale’.
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Panel: Matthew Kidman from Centennial Funds is joined by Ben Rundle from NAOS, and Roger Montgomery from The Montgomery Fund.
Matthew Kidman: Welcome to Buy Hold Sell. My name's Matthew Kidman, and today I have Ben Rundle from NAOS and Roger Montgomery from Montgomery Funds, and the market route has given us opportunities. Or has it? Some quality stocks seem to be a lot cheaper than what they were. Ben, bellwether for Australian quality stocks, CSL: buy, hold or sell, came off 20-odd percent?
CSL (ASX: CSL)
Ben Rundle: I think it's a hold. I think it's an incredibly high quality company, and a lot of the earnings inside CSL have come from the company not issuing any shares, which hasn't diluted shareholders. It's purely internally…
Matthew Kidman: They bought back a lot.
Ben Rundle: ... and they bought back shares along the way. They spend a huge amount of money on R&D, which has been very fruitful for them in the past. The valuation is just eye-watering, though, so I can't own it, so I'm going to say hold.
Matthew Kidman: Right. CSL. Ben would love to own it but it's too expensive. Buy, hold or sell, Rog?
Roger Montgomery: We sold at $120, thinking it was expensive, and then it went to over $220.
Matthew Kidman: And you bought it back?
Roger Montgomery: No. The market is willing to pay for three CSLs for the growth of one, effectively, and we value the business as a sort of ... If it never grew again, it's probably worth 30 or 40 billion dollars. Market was willing to pay over $100 billion for it. You say you often joke, Matthew, that I don't like mining businesses. I think this is the highest-quality mining business in Australia. It mines and refines blood and it does a brilliant job and it's got great product development. It's got low exploration costs. It is extremely high quality. Just too expensive. So I agree with Ben, and unfortunately, it has to be a hold.
REA (ASX: REA)
Matthew Kidman: All right. One of your favourite subjects: real estate. REA. Juggernaut in the field. Came off a long way. Probably 25%. Buy, hold or sell?
Roger Montgomery: Look, again, very high-quality business. There are two scenarios where this business suffers. Scenario number one, very sharp fall in property prices, 20/30 percent fall in property prices. Not good for it. Or a very prolonged route in property that would be bad for it as well because it effects listings. But absent that, I think it is actually reasonably priced at the moment, probably fair value. So you could buy it or you could sell it at this level, it doesn't really matter.
Longer term, I think the opportunity is that the 7.3 billion dollars that's been spent each year in the last couple of years on residential real estate marketing, they collect a bigger proportion of that over time away from real estate agents by offering real estate agents more value, the real estate agents then pay for that. So I think long term it's an excellent business. I'd love to the share price fall another 15 or 20 percent to buy it so it's at a hold at the moment.
Matthew Kidman: All right, we'll try to organise that. Ben REA, we know it's quality.
Ben Rundle: Yeah, it is very high quality. I mean the key thing about REA is that they just have such great pricing power because of their dominant position in the market. I'll say hold on as well on valuation. I would like to own it. I think if it pulls back much further you can, but for now just given evaluations it’s a hold.
Smart Group (ASX: SIQ)
Matthew Kidman: Alright, let's go to salary packaging, novated leases, Smart Group. Market darling went from zero to half billion dollars virtually. Buy, hold, or sell?
Ben Rundle: I think with the pullback you can buy a Smart Group. I think they obviously have exposure to car sales which have been incredibly weak in Australia, but the novated part of the market is weathering that storm okay for the time being. They are also pushing in to further penetrate their current customer base which is showing early signs of success and it's a very high-quality management team. You're buying on about an eight percent free cash flow yield at the moment with a strong balance sheet. So I think it’s a buy on the pull back.
Matthew Kidman: Rog, Smart Group? You smart enough to buy or sell it?
Roger Montgomery: I'm going to take a completely opposite view to Ben and that is I think it's a sell. It was only in 2013 that the then Prime Minister Kevin Rudd called salary packaging and novated leasing a rot and I think if Labor wins the election you need to be worried that they might. I think if Labor wins the election, we might find that the outlook…
Matthew Kidman: Too much risk in the political…
Roger Montgomery: Exactly too much political risk and so for me it's a sell.
Matthew Kidman: Alright give us something high quality, it’s come back in the valuation range that you’d want to open the bag…
Challenger (ASX: CGF)
Roger Montgomery: Challenger’s come back for good reason. There's a delay to the implementation or the hard implementation of the income for retirement products, CRPR, and I think that's justified, that's pushed the price down to about 10 dollars now. The problem is that the demographics aren't changing, and we also keep in the back of our mind knowledge that David Murray and the financial system enquiry back in 2014 actually suggested mandating a proportion of people superannuation to be put into lifetime annuities. So at the moment we've seen long term annuities sales come off and we've also seen this delay to, what I think is appropriate legislation for them. That's temporary it's not permanent and so at around 10 dollars I think it's good value.
Matthew Kidman: Okay Ben? Something out there that's just quality that you just can't give a miss at the moment.
Reece (ASX: REH)
Ben Rundle: I think Reece. It's come back probably 20 percent from its highs. It's a company that has been listed for 40 odd years. Management have an exceptional track record. They've made a very rare acquisition which, typically when a company makes a large acquisition offshore alarm bells ring but with the track record they've got and the fact that the business that they bought does such a lower margin in the core Reece business I think the management team will be able to execute on that and we will see a rebound from the current share price.
Matthew Kidman: It might be quality but these two gentlemen they love buying at the right price.
You can access more insights from Ben Rundle via the NAOS Podcast I Did it My Way listen to the first episode here with guest Michael Heine, to subscribe join our investment community.
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