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 examines whether he'd buy up three heavily discounted ASX shares.
Cut or keep?
The Motley Fool: Let's examine three ASX shares that have been devastated this year, and see if you think each of these fallen stars is now a bargain to pick up or if you'd stay away.
The first one is Coles Group Ltd (ASX: COL), a value stock that's cooled off about 11% over the past six months.
Ray David: Look, Coles is an attractive stock to us. It's held in our portfolios and we think it's a buy.
It's quite a defensive business, as you know — consumer staples — and the supermarkets have also faced earnings headwinds from COVID. So the supply chain issues are labour costs, inflation, and the inflation regarding protective equipment. It's not like they were a huge beneficiary of COVID. Obviously you had a sales uplift but there was a significant cost uplift. Some of those costs will come out of the business which will support earnings.
The outlook looks pretty good for Coles relative again to the rest of the market where interest rates are going to have an impact on discretionary expenditure as well as building materials.
When we look at Coles' valuation, it's about 20 times earnings, [with] about a 4% dividend yield, which actually looks okay to us. And it trades at quite a big discount to Woolworths Group Ltd (ASX: WOW).
It trades at about a 25% discount to Woolworths. And Coles offers a similar earnings growth profile at 4% CAGR. Woolworths is only growing at 4% CAGR as well. So here you can buy the number two supermarket player at a discount to Woolworths which gives you the same growth, the same exposure to a defensive segment.
To us it's attractive. And where we get really excited about Coles is its cash generation is much better than Woolworths. Coles' capital expansion profile is in line with its depreciation, where Woolworths is actually spending about 1.3 to 1.4 times more [than] depreciation. It's putting a lot of money into online e-commerce in warehouse logistics. It implies Woolworths' valuation's at a bigger premium to Coles', yet it's growing at the same rate.
The other point on Coles is that about eight years ago, everyone was really concerned about Aldi being a disruptor to the market. If we [now] look at market share across Woolworths, Coles, and Aldi, it's largely stabilised. The big differentiator that Coles and Woolworths have against Aldi is that actually Coles and Woolworths have got a comparative advantage in online. They've been investing in online for the best part of a decade. Aldi's never going to do that. So we don't see any threat to the industry structure. The market share's pretty stable, so we quite like Coles.
MF: How about CSR Limited (ASX: CSR), which is down about 15% since April?
RD: CSR we don't hold in the portfolio but it's starting to look attractive given the sell-off in the market.
The management team have been quite good at taking investors through their facilities and they've had an investor day which showcased a lot of the surplus property within the business.
But if we step back, it's a building materials company specialising in plasterboard and mainstream bricks. It's a pretty good industry structure for those two segments of the market. CSR is number one with about a 50% to 60% share in plasterboard within masonry. Bricks [it's] a number two player, but they're both consolidated. We expect it's going to be a pretty rational industry.
The issue you have with CSR is it's largely exposed to construction of detached housing. As you go into a higher interest rate environment, we think earnings are going to come under quite a bit of pressure.
Margins currently are about sort of 13%, 14% EBIT for the building materials business. In the past they've gotten down to as low as 8%. So we think earnings will come into a bit of pressure, which is why we don't own it in the portfolio.
But having said that, the market cap of $2.4 billion is backed by quite a bit of freehold property, like Ramsay Health Care Ltd (ASX: RHC). There's that surplus land there that's worth about $1.4 billion. If they can realise the value of that property, you're actually not paying a huge amount for that building materials business, even though earnings are about to fall off the cliff, effectively.
MF: So you would say it's interesting but not buying yet?
RD: Yeah, we'd say it's interesting. Like I said, it's not that expensive. It's not in our portfolio, but yeah, it's a stock we've got a watching brief on.
MF: The third one used to be called IOOF, and it's now Insignia Financial Ltd (ASX: IFL). The share price has more than halved from its pre-pandemic high.
RD: Insignia, for us, is a value trap and it's a stock we don't hold and we don't see ourselves holding stock even at these levels.
Think about what Insignia is — it's basically a wealth management platform business, which makes up most of its earnings. Insignia or IFL has been on the acquisition spree acquiring competing platforms such as the ANZ Group Holdings Ltd (ASX: ANZ) platform. But it's also an incumbent in the industry that's being disrupted by specialists like Netwealth Group Ltd (ASX: NWL) and Hub24 Ltd (ASX: HUB).
And Netwealth and Hub24 are gaining shares at a pretty fast clip relative to these incumbents such as Insignia. The reason why Netwealth and Hub are gaining share is that, unlike these incumbents, they're not saddled with legacy technology. They're not having to worry about integrating previous acquisitions. They've been quite nimble. They're able to roll out new features to the platform pretty quickly, which is why they've got better net promoter scores, better customer service scores, and that's why they're winning in terms of net flows.
So Insignia, to us, it's a declining business. We think it's a technology business, [but] it's legacy technology. And you never really want to own legacy technology when there's new tech, new competitors with better technology that are disrupting you and they're lower cost.
The other reason why we've been cautious on Insignia is, while it looks cheap on 12 times earnings, if you look at the balance sheet, there are about half a billion dollars of remediation provisions still there which are yet to be paid out. That's a liability. Also, they've flagged to the market that there'll be close to $100 million of integration charges as they integrate previous acquisitions.
So as a shareholder, the cash flow returns are going to be well below reported earnings, and that's on top of them losing market share. So for us, [it's] a value trap. Not a company we would be interested in putting in the portfolio.
