Stewart Oldfield* says Australian individual shareholders are finding it harder to find listed companies that are successfully investing to ensure their long-term prospects.
The relentless search for yield by Australian individual shareholders has made it harder to find listed companies that are successfully investing to ensure their long-term prospects.
In the wake of the Global Financial Crisis and the end of the mining boom, capital expenditure plans of Australian listed companies other than financial companies almost halved as a proportion of sales as confidence about the outlook declined.
Lee Mickelburough, head of Australian equities at Janus Henderson Investors, says too few listed Australian companies have been investing adequately to ensure long-term growth.
Low interest rates and Australia’s taxation system have combined to encourage companies to pay out a high proportion of free cash flow as franked dividends, he said.
Despite there being a strong correlation between investing for growth and more sustainable earnings growth, Australian companies have been investing in their businesses far less than foreign counterparts.
We are left with too many companies with strong balance sheets but vulnerable to disruption from new entrants.
There are of course some high-profile exceptions on the local bourse.
Plasma group CSL said it spent $858 million on research and development (R&D) last financial year, which works out to be about 10 per cent of sales.
It has more than 1,400 scientists working on R&D.
In 2017, Cochlear invested $150 million, or 12 per cent of revenues, in R&D.
This year it is guiding towards between $160 million and $170 million of R&D spend.
The implant manufacturer has more than 300 engineers working on product innovation.
Last year respiratory device maker ResMed invested $192 million, or about 7 per cent of its revenues, in R&D.
Trading at hefty premium
Assisted by this level of investment, CSL and Cochlear are expected to lift profits by 30 per cent over the next two years, with ResMed expecting 16 per cent growth, whereas the broader industrial sector is expected to post 13 per cent growth over the same period.
Shareholders in each of these three companies have already done well.
Each stock trades at a hefty premium to market in terms of price to earnings multiples.
Based on Credit Suisse numbers, ResMed trades at 29 times forecast 2019 earnings, Cochlear trades at 40 times and CSL trades at 30 times.
This compared with an average of about 18 times for ASX 200 industrials.
The good news is that Credit Suisse says there are signs that a growing number of ASX companies are investing more — as measured by capital expenditure as a proportion of sales.
“Australian companies are on the verge of ending their four-year capex recession,” Credit Suisse strategist Hasan Tevfik says.
Australian listed companies ex financials have forecast a rise in the capex to sales ratio to 8.2 per cent for the year to June from 7.2 per cent last financial year, still a shadow of the near 14 per cent seen at the peak of the mining boom.
The trick of course is to identify companies that are yet to be fully rewarded by the market for the growth that their increased investment will produce.
Credit Suisse notes a strong correlation between share price growth and companies that are able to raise dividends and the capex-to-sales ratio at the same time.
Companies in a position to lift cap ex and dividends include AGL Energy, satellite owner Speedcast and online travel agent Webjet, says the broker.
Star’s bright prospects
Mickelburough also highlights increased investment by casino operator Star Entertainment Group as boding well for its prospects.
In February, Star flagged total capital expenditure in 2017–18 of between $450 million and $480 million, primarily due to capital works.
Star trades at 18 times forecast 2019 earnings.
Education specialist Claire Field says the investment community had not yet recognised the significance of the long-term commitment of Australia’s biggest education company Navitas to being a disrupter in education technology — beyond its existing business.
In 2016, Navitas said it would invest up to $10 million a year to secure its future against game-changing digital disruption.
“They have committed a good chunk of money and impressive executives to that business,” Ms Field says.
Navitas currently trades at 20 times 2019 expected earnings.
However, there are plenty of examples where investors have remained reluctant to embrace particular investment strategies even after an extended period.
Not all expenditure on growth initiatives will result in sustainable benefits and investors should be wary when mature companies — historically more focused on cost-cutting — announce ambitious new plans.
Jury out on Suncorp strategy
Suncorp Group CEO, Michael Cameron last year conceded he would need time to prove to investors that his “marketplace” strategy first flagged in 2016 would work.
The Suncorp Marketplace has been likened to an iTunes store of financial services — a one-stop shop where customers can use an app to do things like check personal finances and buy financial products.
Shares in Suncorp are trading at 15 times 2019 expected earnings, a discount to the broader market, and have not gained over the past 12 months.
Citi analyst Nigel Pittaway has said “the jury is still out on the marketplace strategy and there is a risk the market remains wary of it”.
Brambles is another company that is battling scepticism despite committing millions to long-term growth initiatives.
Brambles’ BXB Digital was set up as a business in early 2016, with a view to “apply technology to collect and transform data into services that track goods, optimise operations and improve supply chain efficiency”.
Shares in Brambles are trading lower than they were 12 months ago and at a discount to the broader market.
Unlike CSL, Cochlear and ResMed, it seems investors are not yet prepared to give Brambles the benefit of the doubt about its plans to secure its long-term future.
* Stewart Oldfield is a Director of Field Research and contributor to the Australian Financial Review.
This article first appeared at www.afr.com.
