Why backing a sector is not always the right way to play it
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The trend to date for investors has been to jump into stocks purely because of the sector they’re in.
A case in point is the mad dash by retail investors to get into stocks that started making and selling masks and hand sanitisers when the COVID-19 pandemic hit.
Tech has also been a favourite with investors thanks to the booming work-from-home trend and the hastened rise of telehealth and e-commerce that resulted from global lockdowns and the need for physical distancing.
On the opposite end of the spectrum, investors abandoned those in the travel and tourism sector as demand pretty much evaporated overnight.
Morningstar analyst Brian Han believes it’s important to look at a company’s liquidity and competitive environment ahead of the broader industry outlook.
Investors need to assess a company’s ability to capitalise on opportunities that present themselves in the post-COVID economy.
“I think in the current environment liquidity and balance sheet are your most important attributes,” Han told Stockhead.
Han stood by Morningstar’s decision to add Flight Centre. This is because the company’s liquidity left it well placed to capitalise on the pent-up demand for travel.
“I don’t know when industry will go back to pre-COVID levels but what I do know is this: there is pent-up demand for travel,” he said.
“Until that pent-up demand gets realised, in the meantime most important is liquidity.
“I do feel Flight Centre, with about $1.1bn of liquidity … have enough to see through this whole malaise.”
This amount could sustain them for 14 months even if transaction volume stayed at 10 per cent of pre-COVID levels.
“One positive is that, what this pandemic has done is going to get rid of smaller competitors in that space. So when everyone comes out on the other side, I think there’ll be less smaller competitors for Flight Centre,” Han said.
“And at the same time, this pandemic has forced them to rationalise their brick and mortar network much more quicker than they wanted to.”
Another company added to Morningstar’s list was annuities provider Challenger (ASX:CGF).
Annuities work like pensions, providing investors with a secure income stream from a lump sum investment.
Han says Challenger made the list because a promising opportunity awaited and it was well placed to capitalise.
Morningstar noted that as baby boomers retire, $70bn in funds would move from wealth accumulation to the retirement phase.
Challenger’s current annuity sales captured less than 5 per cent of this.
“Older investors get risk averse and there is an appeal to having a secure annuity stream as opposed to getting bumped by day to day activity in the stock market,” Han told Stockhead.
“That’s another attraction for Challenger’s business model especially for older people who are counting on dependable earnings streams for their retirement.”
In the past several months, the small cap telco sector has seen a boom that was relatively affected by COVID-19.
On the other hand, large cap Telstra has fallen 20 per cent and Morningstar removed it from its “Best Stock Ideas” list.
“I think people gravitate towards the smaller players in the telco space because the market is getting frothy despite the pandemic,” Han said.
“When the market gets frothy people go for upside, and as a smaller player your upside is much larger than an incumbent. I think that could explain why some of the smaller players are doing so well.”
While Morningstar thought competitive intensity in the mobile market would ease, the opposite has happened.
“Telstra recently put through a mobile price increase across all its plans and Optus and Vodafone have not followed, so it shows you that competitive tensity is not letting up at all,” Han said.
Another disappointment for Han was that Telstra was delaying its $2.5bn cost cutting program
“That’s not good news for our investment thesis on the company, especially at a time NBN continues to rip out earnings and the pandemic itself is hitting Telstra’s earnings,” he said.
“So when you wrap all of that up and look at all the results from the telcos’ reporting season, Telstra’s near-term earnings outlook is probably the least defensive-like among all of the telcos in our coverage.”