Ask A Fund Manager
The Motley Fool chats with the best in the industry so that you can get an insight into how the professionals think. In this edition, Schroders portfolio manager Ray David picks the two ASX shares he would buy right now, although he actually mentions three.
Hottest ASX shares
The Motley Fool: What are the two best stock buys right now?
Ray David: Two favourites, and these make up two big positions of the fund.
The first one is Ramsay Health Care Ltd (ASX: RHC). Ramsay is the largest provider of private hospital services in Australia and France, and also third largest player in the UK.
During COVID, private hospitals were hit hard by elective surgery cancellations and also had cost blowouts because of nurses having to isolate. And then Ramsay having to effectively backfill those nurses with high-cost agency staff. So you had revenue declining and costs going up and profitability really took a hit.
But that's all behind us now. We think the outlook for elective surgery volumes looks really strong because there's quite a big backlog. And those cost headwinds associated with COVID are really abating. So we expect Ramsay to deliver pretty strong earnings growth in '23 and '24 that's well above market growth.
In addition to that, during the pandemic, Ramsay invested over $2.7 billion to upgrade its facilities and expand its facilities, which it really hasn't had any benefit from. So it's positioned quite well to come out of this COVID period with extra capacity to cater for the backlog.
In the longer run, they've got positive demographic trends. So they've got increasing healthcare utilisation, [an] ageing population, and pretty strong support [from] the government for a private healthcare system.
Outlook looks really strong and the valuation looks incredibly cheap.
What really highlighted how cheap the stock was, [private equity firm] KKR came in and bid for the stock around $88 per share and it really shone a light on Ramsay Health Care's freehold property.
[Ramsay] basically owns a significant or most of all their Australian properties — hospital sites. Based on our analysis, we think if you were to spin off the property, that accounts for about $30 a share compared to the stock where it's trading in the mid-$60s.
So it's a company that's got strong tailwinds and a good earnings outlook and there's a big property freehold there that's supportive of the valuation. Management have recently announced that they are looking at freeing up some of those properties for sale and lease back some of the tier-three properties. We think it's a pretty good investment right now.
MF: It's interesting you mentioned Ramsay as a stock to buy because earlier you mentioned healthcare as one of the sectors that might be overvalued?
RD: That's right. Yeah, Ramsay has probably been one of the poorest-performing healthcare stocks over that three-year period compared to the big names like CSL Limited (ASX: CSL) and ResMed CDI (ASX: RMD). Mainly because Ramsay was a COVID loser because of all those issues it faced.
MF: Your second buy?
RD: The second one is News Corporation CDI (ASX: NWS).
It's got about a $10 billion valuation but, to us, it's probably one of the highest-quality businesses on the ASX.
If we look at News Corp's key assets, it's mainly digital media assets, and the print exposure is quite small and modest. The largest asset that New Corp holds is the 61% holding in REA Group Limited (ASX: REA), which is listed realestate.com.au. That's the number one property classifieds portal in Australia. They've got around a 70% market share and they've got significant amount of pricing power. They're effectively putting up prices by high single-digits, but there's new products that they're rolling out, which they call Premier Plus. It's going to add another 6% to revenue growth.
So it's a really monopoly-type business that's got high returns on capital, high margins, generates a lot of cash flow, and News Corp owns 60% of [REA], which forms part of the News Corp valuation.
MF: Whenever a fund manager picks News Corp and mentions the REA ownership, readers often ask why wouldn't they just own REA?
RD: We own REA in the fund as well.
If you back out REA's 61% holding from News Corp, basically you're implying an earnings multiple of six times for the rest of the other assets. And those other assets are just as good quality.
News Corp also owns the Dow Jones business, which is basically the Wall Street Journal, a flagship newspaper. That business has been growing its top line by low double-digits, and about 70% of that revenue is now digital. So it's not as exposed to the traditional advertising cycle as what newspapers used to be.
And the Journal's a fantastic masthead. The costs are well under control because unlike a Spotify Technology SA (NYSE: SPOT) or a Netflix Inc (NASDAQ: NFLX) where you have to acquire third-party content, the Wall Street Journal creates all its own content through journalists, such as yourself, for example.
The third large business within News Corp is the HarperCollins book publishing business. They are basically the second-largest publisher globally. And it's a pretty stable business. Book sales have been growing at three to 4% per annum, and that's even with audiobook growth and ebook growth. Physical books are still in high demand, but the kicker for HarperCollins is 60% of the revenue comes from the back catalogue. That's titles that have been published many, many decades ago. So it is like an annuity revenue business.
When you back out News Corp's holding of REA, you're actually getting HarperCollins and the Wall Street Journal for about six times earnings. And there's a whole heap of other businesses that they own which aren't that material, such as Foxtel and the Australian newspapers. But the other two businesses are high quality.
For us, it's undervalued. It's got a good balance sheet. The management team and board have recognised a disconnect between their view of valuation and the market price. Governance is improving and they're looking at ways to increase shareholder value.
MF: I am slightly surprised that your fund owns REA because we think of Schroders as the flag bearer for value investing. Investors don't typically think of REA as a value stock.
RD: Yeah, REA, we recently added to the portfolio. It would've been the third quarter of last year. So it got down to a level of just over $100 or under $100. The stock had really been belted.
What we saw was a multiple which wasn't cheap by any standards, but a pretty decent discount from its historic valuations. And we saw a pretty strong growth profile relative to the rest of the economy.
So we haven't owned it for long, but there was a moment there in the market sell-off where REA was getting sold off progressively with the rest of the tech sell-off. And to us, REA is a great business. It makes its own in cash. It's pretty durable, which is why it's made its way into the fund.
