Australia has set an example for other economies of the world, by managing the COVID-19 crisis through well-devised plans and continuous support to businesses and individuals. While the traces of COVID-19 are expected to remain for a considerable amount of time, the Australian government has succeeded in restoring some stability across the country. However, the recent GDP numbers a tough period, owing to the closure of businesses, minimal movements, reduced trade, and bilateral tensions. The combined effects of COVID-19 and the government’s response to the crisis led to unprecedented economic consequences. The below section provides a detailed picture of the GDP numbers in the second quarter.
Decline in Q2 2020 GDP: During the second quarter of 2020, Australia’s GDP contracted by 7% on the previous quarter, owing majorly to the impacts of COVID-19. In comparison to the prior depict a different tale due to the impact of corresponding quarter, GDP contracted by 6.3%. Some of the hardest-hit components of the GDP, comprised of Accommodation and food services, transport postal and warehousing, rental hiring and real estate services, and administrative and support services. Notably, the contribution from these components declined in the range of 15% - 39% on the previous quarter. Accommodation and food services witnessed the largest decline of 39%. While food and beverage services suffered a setback due to venue closures and restrictions on operational capacity as per the pandemic containment measures, a prolonged period of travel bans resulted in a decline in accommodation.
Positive Contributors to GDP: Among the positives, there were mining, financial and insurance services, public administration and safety, education and training, etc. The contribution from the mining sector increased by 0.2% on a quarter on quarter basis and by 1.1% on the prior corresponding quarter. Increase in mining came on the back of a 1.4% uplift in iron ore mining due to increased global demand as activity levels began to increase. Moreover, other mining reflected a rise of 2.5% due to robust gold and copper production volumes. Financial and insurance services witnessed an increase of 0.7% on the previous quarter and an uplift of 3% on pcp, backed by a significant rise in deposit balances as businesses and households increased liquidity in response to the pandemic. Education and training increased by 0.4% and 2% on a QoQ and pcp basis, respectively.
GDP Components (Source: Company Reports)
Trade Surplus in July: In July 2020, Australia recorded a trade surplus of $4,607 million, with total goods and services credits of $34,496 million. While exports of all the goods and services declined during the months, exports of non-monetary gold increased by 53% to $1,252 million. Notably, net trade contributed 1% to Q2 GDP, which can be attributed to exports of gold and minerals like iron ore.
Overall, GDP during Q2 2020 was positively impacted by a contribution from mining, finance and insurance, education and training, and exports of gold. Going forward, the increase in industrial activity across the globe is expected to further increase the demand for mining services. As the economies reopen and adjust to the new normal, the demand for education and training, accommodation, travel services, healthcare, etc., will drive the economy towards a better future. Moreover, the resilient demand for iron ore, gold, retail, health, and other essential services will continue to keep the economy from falling apart.
Key Risks: Amid the current scenario, the economy is threatened by the risk of another outbreak, which can hinder the recovery process. The current situation in Victoria due to a second outbreak is a testimony to the fact that a country-wide relapse can cost too much to the community and the government. Moreover, Australia’s battle with the virus so far has been protected by continued financial support from the government, which may not be able to keep the economy intact if the current economic conditions continue for a prolonged period of time.
Considering the positive contribution from mining, gold, finance and insurance, etc., and the key risks stated above, let us have a look at few stocks which retain a potential for further growth and possess a decent financial position to manage the potential impacts of COVID-19.
1. Insurance Australia Group Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)
(M-cap: A$ 10.98 Billion, Annual Dividend Yield: 6.32%)
GWP Growth in Line with Guidance: Insurance Australia Group Limited (ASX: IAG) is engaged in the underwriting of general insurance and related corporate services and investing activities. The company recently announced the financial results for the year ended 30th June 2020, wherein it reported Gross Written Premium (GWP) growth in line with guidance. GWP for the year came in at $12.135 billion, up 1.1% on the prior corresponding year. Underlying margin during the year was impacted by a softer second half due to higher reinsurance costs, lower interest rates, and a decline in the performance from commercial long-tail classes in Australia. During the year, the company exited its investment in India and made a post-tax profit of $326 million. Net profit after tax for the year came in at $435 million and dividend for the period stood at 10 cents per share.
Outlook: Amid the COVID-19 scenario, the company introduced several measures to support customers and suppliers and is focused on achieving customer-led growth through leveraging the data, customer reach and brands to enhance the core insurance business. The company is assessing opportunities as customers prefer a shift towards the digital channel during the pandemic. Although the management did not provide any guidance for FY21 due to current economic uncertainties, the business seems to be well-equipped to rise through the challenges and take advantage of opportunities in the post-COVID period.
The recent GDP numbers indicate a positive contribution from the finance and insurance segment, as businesses and individuals aimed for higher liquidity. During FY20, the company’s CET1 capital position remained comfortably above the benchmark. The company maintained a strong performance in the New Zealand market and witnessed an improving trend in Australia. Therefore, the resilience of IAG’s business due to the inevitable demand for finance and insurance related products is a relevant factor to count on while making an investment decision.
Key Risks: The business is exposed to insurance risk arising from inadequate underwriting or product pricing, insurance concentration risk by locality or segment, or inappropriate claims management. Reinsurance risk arises from a lack of capacity in the reinsurance market, insufficient reinsurance coverage, inadequate recovery management, etc. Moreover, the business is also exposed to the risk of adverse movements in market prices of equities, derivatives, interest rates, etc.
Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)
P/E Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
A-VIX vs IAG (Source: Refinitiv, Thomson Reuters)
Stock Recommendation: In the last three months, the stock has corrected by 23.39% on ASX. Despite the impact of market volatility on the price, the stock of the company retains a potential for growth on the back of growing demand for finance and insurance services and improved conditions in IAG’s markets. We have valued the stock using the P/E multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). Hence, we give a “Buy” recommendation on the stock at the current market price of $4.790, up 0.842% on 7th September 2020.
2. Mount Gibson Iron Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)
(M-cap: A$ 870.17 Million, Annual Dividend Yield: 4%)
Significant Increase in Revenue: Mount Gibson Iron Limited (ASX: MGX) is a metal and mining company that produces and sells high-quality direct shipping grade iron ore products in Australia. During the year ended 30th June 2020, the company’s total iron ore sales stood at 4.9 million wet metric tonnes. Revenue from ordinary activities came in at $452.3 million, up 56% on the previous year. NPAT for the year came in at $84.2 million. During the year, the company generated an operating cashflow of $160.1 million, against FY19 operating cashflow of $59.4 million. The company declared a final dividend of 3 cents per share, payable on 24th September 2020.
Outlook: For the Koolan Island Operation, the company is planning for increased mining movements to substantially complete the planned elevated waste stripping phase of the life-of-mine plan within the next 12-18 months. FY21 sales for the Koolan Island are expected between 1.8–2.1 Mwmt at a cash cost of $60-65/wmt FOB. For the mid-west operations, the company cited low-grade sales guidance of 1.0-1.2 Mwmt at a site cash cost of $40-45/wmt FOB in 2020/21. Development decision for the Shine Iron Ore Project expected in the current quarter. Group iron ore sales and cash cost guidance stand at 2.8 – 3.3 Mwmt at $60-65/wmt.
The rising demand for iron ore and favourable prices in the past few months depicts a decent outlook for the Australian iron ore players. During Q2 2020, the mining sector made a positive contribution to GDP numbers and is expected to play a decent role in economic recovery, going forward. With a resilient asset profile, the company seems to be well-positioned to capture the increasing demand for iron ore and drive business growth in the long term.
Key Risks: Travel and operating restrictions due to the outbreak of the global pandemic from March 2020 posed several challenges for the company. Going forward, the growth in business will be dependent on the extent and duration of these challenges. Further, the company is exposed to the risk of adverse movements in currency, particularly USD, as its iron ore sales receipts are predominantly denominated in the US dollar. The company’s operations are also exposed to the risk of fluctuation in iron ore prices.
Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)
EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
A-VIX vs MGX (Source: Refinitiv, Thomson Reuters)
Stock Recommendation: In the last three months, the stock has given positive returns of 6.38% on ASX and is currently trading slightly below the average of its 52-week trading range of $0.542 - $1.035. The stock has demonstrated a remarkable performance despite the market uncertainties. This can be attributed to the recognition of mining as an essential service by the government and the recent optimism around iron ore demand and prices. Going forward, as economies reopen and demand rises further, the company is expected to see further growth in business and financial performance. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). Hence, we give a “Buy” recommendation on the stock at the current market price of $0.765, up 2% on 7th September 2020.
3. Ansell Limited (Recommendation: Hold, Potential Upside: Low Double-Digit)
(M-cap: A$ 4.69 Billion, Annual Dividend Yield: 1.95%)
Strong Operating Cash Flow: Ansell Limited (ASX: ANN) is a world leader in providing superior health and safety protection solutions that enhance human well-being. The company recently announced its FY20 results for the year ended 30th June 2020. Sales for the year came in at US$1,613.7 million, up 7.7% on pcp. The company reported organic growth of 13.4% in the Healthcare segment and 1.3% in the industrial segment. EBIT for the year came in at US$219.7 million, up 8.3% YoY and 21.0% on a constant currency basis, driven by growth in sales, transformation benefits and net favourable raw material costs. NPAT came in at US$158.7 million, up 5.2% on pcp. The period was characterised by strong operating cash flow of US$191.7 million with cash conversion of 117.7%. Full-year dividend increased by 7% to 50 US cents per share.
Outlook: The company possesses a resilient brand portfolio which will help it during the current challenging times. Due to lower rates on cash invested, the company expects FY21 net interest expense for FY21 to be in the range of US$19.5 million - US$20.5 million. FY21 EPS is estimated between 126 – 138 US cents. Due to strong growth in Exam/Single Use, Chemical, Surgical and Life Science, and weakness in Mechanical, the company expects a mixed outlook for its Strategic Business Units throughout FY21. FY21 capital expenditure is expected between US$95 million – US$105 million. Organic growth is expected to be substantially higher than the target range due to price and volume increases.
Amid the COVID-19 environment, the company’s business model seems to be a resilient one due to the nature of the products being offered. The government has taken several initiatives to support the healthcare industry and provided relief in the form of resumption of activity due to the importance of healthcare services during such critical times. Moreover, households are also expected to continue spending on their health and safety, which, in turn, will benefit the business in the sector. Henceforth, the healthcare sector remains a key contributor to the overall economic well-being of the country.
Key Risks: The company’s growing global presence exposes it to geopolitical risks and regulatory risks. Due to international exposure, the group is also exposed to risks of foreign currency fluctuations. A changing distribution environment such as e-commerce, customer concentration, and increasing input costs, represent other potential challenges for the business.
Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)
P/E Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters), *1 USD = ~1.37 AUD as on 07-September 2020
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
A-VIX vs ANN (Source: Refinitiv, Thomson Reuters)
Stock Recommendation: In the last six months, the stock has given positive returns of 27.37% on ASX. The stock of the company has depicted a robust performance and is currently inclined towards its 52-week high. Considering the ever-increasing demand for healthcare services and the need for ANN’s products in the current COVID-19 scenario, we are of the view that the stock retains further potential for growth. We have valued the stock using the P/E multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). Hence, we give a “Hold” recommendation on the stock at the current market price of $36.240, down 0.549% on 7th September 2020.
4. Newcrest Mining Limited (Recommendation: Hold, Potential Upside: High Single Digit)
(M-cap: A$ 25.18 Billion, Annual Dividend Yield: 1.16%)
Strong Free Cash Flow: Newcrest Mining Limited (ASX: NCM) is a gold mining company that owns and operates a portfolio of predominantly low-cost, long-life mines. During the year ended 30th June 2020, the company produced 2.2 million ounces of gold at an AISC of US$862 per ounce. The company invested in future growth opportunities and reported a statutory profit of US$647 million alongside, up 15% on the previous year. Notably, investments during the period included payment of US$1.3 billion to acquire Red Chri for increased exposure to Fruta del Norte and an additional ~US$400 million to boost organic growth and support exploration activities. Free cash flow during the period amounted to US$670 million. The company declared a fully franked dividend of US17.5 cents per share, to be paid on 25th September 2020.
Outlook: For the year ended 30th June 2021, the company expects group production in the range of 1,950 – 2,150 moz of gold and 135 – 155 kt of copper. While the production guidance assumes no interruptions from COVID-19, the company has set aside some costs related to managing the pandemic impacts during FY21, expected to be in the range of US$30- US$40 million. Total group capital expenditure is expected to be between US$1,060 – US$1,240 million.
During July 2020, exports of non-monetary gold increased by 53%, resulting in a trade surplus. Notwithstanding the impact of COVID-19 on the global economy, gold is regarded as a safe-haven when the markets are on a wobbly ground. Considering the industry dynamics and the resilient nature of the business, NCM seems to be well-positioned to achieve accelerated growth in the coming years.
Key Risks: Some of the key risks for the business, include foreign exchange fluctuations, changes in commodity prices, increased costs and demand for production inputs, and general economic conditions. In addition, challenges with respect to obtaining necessary licences and permits and diminishing quantities or grades of reserves may impact operations.
Valuation Methodology: P/CF Multiple Based Relative Valuation (Illustrative)
P/CF Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters), *1 USD = ~1.37 AUD as on 07-September 2020
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
A-VIX vs NCM (Source: Refinitiv, Thomson Reuters)
Stock Recommendation: In the last six months, the stock has given positive returns of 9.82% on ASX. The stock of the company has performed decently over the past few months and retains potential for growth as the company continues to invest in organic growth initiatives and exploration. We have valued the stock using the P/CF multiple based illustrative relative valuation method and arrived at a target price of high single-digit upside (in percentage terms). Hence, we give a “Hold” recommendation on the stock at the current market price of $31.250, up 1.264% on 7th September 2020.
Comparative Price Chart (Source: Refinitiv, Thomson Reuters)
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