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Every month – rain, hail or Black Swan – our astrologically-minded buds at Morningstar put together a Best Stock Ideas list overseen by Johannes Faul, Morningstar’s director of equity research. The intention is to highlight Australian (and New Zealand) companies which are ideally positioned at attractive discounts vs. the equity team’s assessed fair values.
In this series Johannes offers a few monthly morsels for the Alpha hungry.
Johannes Faul told Stockhead this week that the attractive discounts are out there right now on the ASX because – more often than not – ‘quality taking some hits too’ when the market corrects like this.
“I’ve been focussing on ASX retailers,” Johannes says.
“ASX retailers, and retail businesses elsewhere as well, have been under obvious pressure as consumers struggle with rising costs and interest rates. Many businesses themselves are also having a daily grapple with high costs.
“But for some, cost pressures are easing,” he adds. “Steep declines in global food commodity prices bode well for fast-food restaurants. We also expect e-commerce growth to start to gain traction in fiscal 2024.
“Amid these challenges there are some undervalued opportunities in the retail sector.”
Rightio.
Here’s a couple Johannes suggests we consider.
Domino’s Pizza was just added to Morningstar’s October Best Ideas list. But it’s probably worth first recalling how the year started for DMP, because the March Quarter and H1 entire was a standout disappointment.
Johannes says Domino’s saw some very high cost inflation, which forced management to increase pricing.
“However, the increase was such that demand dropped off and clipped their earnings of that half.
“As we said at the time, that was a temporary phenomenon and DMP has adjusted. However, its volatile share price tends to reflect short-term challenges with the business – currently tackling higher costs from wages and ‘inputs’ such as the appetising ingredients that makes these pizzas.
“It’ll continue to be a growth company and continue to roll out stores internationally underpinning their intrinsic valuation,” Faul says.
“DMP has very long-term master franchise agreements with the US franchisors, which means it’s effectively the franchisor in the jurisdictions in which it operates. That system works in the way that Domino’s franchisees pay a royalty based on their top-line sales to Domino’s Enterprises. So, Domino’s itself is mainly concerned about driving top-line growth within its network, within the multiple countries it operates in. So, that’s a key concern.”
At the same time, obviously, Johannes says Domino’s wants to grow the store network ‘quite dramatically’ over the next 10 years.
“And that means it has to have incentives in place or make it appealing for its franchisees to open up more stores or new franchisees to join that business – so, again, Domino’s wants top-line growth, the franchisees like to see the bottom-line grow, their profit grow.
“That’s something which needs to be managed and that’s what Domino’s CEO Don Meij has been managing really for 21 years and they’ve been improving for most of the last decade.
“So, DMPs’ fair value is $68 per share, which basically means there’s a lot of upside, in our opinion, at its current share prices.
“Now, what underpins that was significant store growth in Europe and Japan, so in their key overseas markets where it’s had a history of success.
“Domino’s has been taking market share for many, many years in the domiciles in which it operates, not just from independently-owned quick service restaurants but also compared to other chains.
“It’s a viable franchise network for all because it shares the earnings potential of the brand with its franchisees. This ensures that the franchisees remain lucrative and are incentivised to open up new stores, which then drives top-line growth.
“We believe the market is overly discounting Domino’s significant long-term growth potential. In the end, This is a high-quality company with long-term growth outlook and we still see a bright future and those shares are undervalued at the moment.”
Kogan is another one of Morningstar’s top picks and is also under-appreciated by the market, according to Johannes.
“We believe that share price weakness is due to a material decline in sales and earnings from boom-time levels. The market appears more cautious than us on Kogan’s ability to expand margins, or its long-term growth, which we expect to be underpinned by a structural shift to e-commerce.
“Basically what we’re expecting to happen with Kogan is for their sales growth to reignite.
“They went through a period of extraordinary sales growth during the lockdowns and that unwound following the reopening of the economy. And now, we’re still seeing their sales declining year-on-year, but that momentum is slowly turning around.
“So, what we’ve seen in the last quarter is that their sales growth, while still negative, is not as bad as it was, if you like.”
Johannes says Morningstar believe that KGN’s sales growth will start going positive again.
“So, they’ll grow sales coming into fiscal 2024 and that will be the catalyst for their EBIT margins, for the profit margins to come back to where they were before COVID.
“We expect revenue growth to reignite as consumer spending moves to online and for margins to expand, as operating expenses normalise. Revenue is also supported by growing Kogan First subscriptions platform.
“Despite a challenging macroeconomic environment, recent trading for KGN is encouraging.”
This story does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.
The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.
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