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Investing
Investors are wary of some defensive stocks, but not all
April 24, 2008
Brendon Lau, ShareAnalysis
The worst share-market rout in over five years has sparked investor interest in sectors traditionally seen as "defensive" and less affected by the current turmoil. However, not all traditionally defensive sectors have performed well.
Utilities have underperformed the broader market since the sub-prime meltdown. This may have surprised some as the sector was the best performer during the last bear market, rising 3% when the S&P/ASX 200 tumbled over 20%. Also, the sector delivers the highest dividend yield (although it is mostly unfranked) and is usually regarded as a stable investment, as the demand for electricity and gas is usually unaffected by economic cycles.
This time round, however, investors have been spooked by the sector's relatively high gearing and low interest cover. While investors have good reason to shun anything to do with debt and leverage in this ongoing credit crisis, painting all utilities with the same brush is a mistake. This is because stocks in this space are not only structured very differently, but the type and nature of the assets they hold and their debt covenants vary greatly.
This means the risk profile of each utility could be vastly different and some utilities have been unfairly sold off.
Another factor working against the sector are our high interest rates. In the last bear market, interest rates were between 4.25% and 5%, now cash rates are 7.25% and investors can get a return of between 7% to 8% on a savings account. This reduces the appeal of the sector, which by our calculations is yielding around 9%. But there are utility stocks that have good growth potential, and these are the ones we would recommend.
Some healthcare stocks might be better placed to weather the anticipated economic slowdown, although a stronger Australian dollar has the potential to negatively impact those with overseas operations. One negative for the sector is its meagre dividend yield of around 2%. Also, the strong outperformance of the sector over the last few months has largely eroded the upside potential as many healthcare stocks are approaching fair value. Ramsay Health (RHC) is the only BUY we have in this space.
We feel there are better opportunities in the telecommunications space despite the headwinds facing the sector, such as declining growth of PSTN (public switching telephone network), regulatory risks and stiff competition. Telstra's (TLS) credible 1H08 result was encouraging, though, as it highlighted the growth potential of broadband and 3G.
TLS has fallen significantly since the beginning of March 2008, likely due to global macro effects and possibly the sell-off of some T3 instalment receipts ahead of the upcoming final payment date. In light of its share-price decline and its stronger than expected 1H08 result, we have upgraded TLS to a BUY with a 12-month target price of $5.18 (Technical Recommendation: BUY).
Singtel (SGT), the owner of Optus, is another telco we are bullish on. Although the government's decision to cancel OPEL was a setback for SGT, the company holds significant growth potential due to its presence in a number of emerging markets like India and Indonesia, where the penetration rates for mobile and broadband services are still in their infancy.
This higher growth potential is not without higher risks, as highlighted by the recent intervention of the Indonesian Commission for Supervision of Business Competition over Temasek Holdings' investments. But with the uncertain global economic conditions and investors looking to emerging markets to sustain global growth, the potential rewards for SGT currently outweigh the risks.
Recently, SGT posted a positive 3Q08 result with its underlying NPAT for the quarter up 21.7% to S$931M. We have updated our model to reflect the 3Q08 result and this has moved our EPS forecasts slightly in FY08 (-1%) and FY09 (+3.9%). The cancellation of the OPEL contract has no impact on our valuation, as we had not factored that into our model. We have a BUY on SGT (Technical Recommendation: HOLD for now, buy on anticipated weakness over next week or so).
Brendon Lau is the editor of ShareAnalysis, a premium retail investment service offered by Aegis Equities Research. Click here for your free trial.
More articles from this edition of CompareShares:
Investing: Where the wealthy stash their cash
Investor Profile: A mother's phenomenal trading success
Investing: Investors are wary of some defensive stocks, but not all
Currency: Australian dollar targets - US$1.0100 in 2008
Companies: Mortgage stress could grip 1m Aussies
Economy: May interest rate hike 50/50: economists
Inflation: Inflation a reminder of pressures: Swan
Super: Future Fund boss sees equity cash chance
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions. |
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