This article was originally published on LivewireMarkets.com on July 14th, 2023

It’s been a remarkably volatile time in financial markets over the last 18 months in particular. Investors have been riding a wave that started with fresh highs for the index before the ASX 200 fell 13% in six months. Along the way, there have been astounding and outstanding share price moves.

This volatility, the ongoing fear of a global recession, and concerns over rising interest rates have created a notable shift in investor strategy. People want quality companies with recurring revenues, sturdy product offerings, and a strong track record for growth.

But too many people rushing into the same kind of trade can lead to disappointment. How quickly can we forget the Buy Now Pay Later craze of 2021, or the China reopening trade of earlier this year, or the Wall Street Bets/ASX Bets craze which saw investors pile into junk companies en masse?

We’re combining those two themes – rock-solid balance sheets and overcrowded trades – in today’s edition of Buy Hold Sell. Livewire’s Hans Lee is your moderator. He is joined by Andrew McKie from Elston Asset Management and Rob Crookston from WILSONS.

Together, they analyse three stocks that are widely perceived to have those rock-solid qualities and assess whether they have become overcrowded. As a bonus, the fund managers bring along one quality company of their own.

Note: This episode was taped on Wednesday 12 July 2023. You can watch the video, listen to the podcast, or read our edited transcript below.

Edited transcript

Hans Lee: Hello, and welcome to Livewire’s Buy Hold Sell. My name is Hans Lee. It has been a very volatile 12 months, least of all I need to tell you that. And because of it, investors have gravitated toward stocks with rock-solid balance sheets. But have some of these stocks also become crowded trades? Let’s probe those ideas right now with Andrew McKie from Elston Asset Management and Rob Crookston from Wilsons.

Aristocrat Leisure (ASX: ALL)

First company, Aristocrat Leisure. Andrew, it reported 27% net profit growth in its most recent earnings result, thanks primarily to its US operation. Is it a buy, hold or sell?

Andrew McKie (BUY): It’s definitely a buy for us. I don’t think it’s overbought at all. The business has done a great job. Management’s done a great job over the last few years to increase the amount of recurring revenue coming through, as well as diversify the business in terms of digital. So if we look at the Pixel side of the business, obviously there’s a bit of COVID flux. Digital did really well during COVID, but we’re seeing that now counterbalanced with land sales. You mentioned the US doing quite well and we think the balance sheet is pristine. We think the margins are great. The cash flow’s great. We think they’ve got optionality in terms of growth, whether they do buybacks or they’d look at additional acquisitions, particularly in digital. We really like the business. We don’t think it’s overvalued at the moment, and definitely a buy for us.

Hans Lee: Okay, a buy for Andrew. Rob, all the brokers love this stock. Citi, Morgans, Morgan Stanley, Macquarie, Ord Minnett all have it on outperform or buy. What do you think? Buy, hold or sell?

Rob Crookston (BUY): It’s a buy for us as well. Think about the land-based gaming, the traditional business, we like that. Greater recurring revenue than it has in the past. We like the digital business. We still think there’s a lot of growth to come from digital business over the next 10 years. What we really like is the online real money gaming opportunity for Aristocrat. So if you think of online real money gaming, which is slowly getting legalised in the US and you take the land-based gaming and the mobile gaming. Put them together and Aristocrat are perfectly positioned to go for this opportunity over the next decade. Then the acquisition in the last few months of NeoGames, gives them the tech stack to go after this. And as I said, they’ve got the IP already. Consensus at the moment really has zero embedded in it for online real money gaming. So the opportunity is there, it’s not priced in, I don’t think it’s crowded at 18x if the opportunity is ahead of them.

Hans Lee: Okay, interesting. So we’ve got a double buy to start the show. Let’s see if we can keep it up with Telstra. UBS recently upgraded this one to a buy, but it is on 22x earnings. Rob, buy, hold or sell?

Telstra (ASX: TLS)

Rob Crookston (BUY): It’s a buy for us. What we like is the resilience of the mobile plan business. It’s still a massive part of Telstra’s business. I can attest that mobile plans are a key part of everyone’s budgets. They probably didn’t used to be 20, even 10 years ago, but they are now. The industry has also got a lot more rational in terms of pricing. Optus and Vodafone have got a lot more rational in the way they’re pricing. That intense pricing competition we’ve seen for a long time has now dissipated. Now Telstra can increase their prices, and they have been over the last 12 months, and they can do that and keep their market share. That is key.

The third point is we’re hoping that management over the next couple of years unlock the value of the InfraCo business. At the moment it looks really undervalued, just in the group structure when we do a sum-of-the-parts analysis on Telstra. So if they can maybe divest some of that, like they did the towers business, then we’ll see the value of InfraCo, and that could rerate from there.

Hans Lee: Andrew, a lot of people think of Telstra as a great dividend payer. Five years ago though, Telstra had an 8% dividend yield. Now it’s about 4%. What do you think, buy, hold or sell?

Andrew McKie (HOLD): We’re a hold on Telstra at the moment. I agree with Rob, though. If we decompose Telstra into its predominant EBITDA groups, you’re looking at mobiles and you’re looking at InfraCo. They’re the real drivers of EBITDA. Mobiles, very much what Rob says. I can see why people like it. It’s defensive. They’ve got pricing power. People nowadays would probably go without eating rather than go without their mobile phones. So that’s clearly a great business longer-term. But if we also look at free cash flow, most of that goes into the dividend. If you look at the balance sheet, it’s okay. There’s not a lot of growth for us going forward. So on a relative growth basis and valuation basis, it’s a hold, with obviously a dominant market position in mobiles.

Hans Lee: All right. Well, speaking of eating and drinking. Third stock here, Endeavour Group, of course, the Woolworths spinoff, down 22% though in the last year. Andrew, is it a buy, hold or sell?

Endeavour Group (ASX: EDV)

Andrew McKie (BUY): It’s definitely a buy for us, Hans. Clearly not overbought, given the 12-month performance. If we look at retail, we love Dan Murphy’s, we love BWS and their store rollout. If you look at Dan’s, it has a dominant position. We call it the Bunnings of booze in Australia. We don’t see a lot of competition for Dan Murphy’s. They’re vertically integrating. 5.1 million users on the app. So we think that’s a great business. Admittedly rolling off a little bit from COVID, but that’s counterbalanced with hotels, which is very strong coming out of COVID lockdown. They’ve got a buying program as well for their pubs. It was under-capitalised in terms of ownership under Woolworths. So, an under-invested business, refurbishment, new pubs, which also then augments their retail strategy in terms of Dan’s and BWS rollouts as well.

So coming into tougher economic times, we think it’s more likely that would play into Endeavour Group’s core businesses. That people will entertain at home, which is say good for Dan Murphy’s and BWS. And they’re more likely to go out but maybe dial it back a bit, go to the pub rather than the Michelin Star restaurant, like you, Hans. So they still want to have fun, but just obviously aware of cost of living pressures there. So that helps Endeavour.

Hans Lee: All right. So, Endeavour there, a buy. And Rob, what do you think about this one? Buy, hold or sell?

Rob Crookston (SELL): It’s a sell for us. The valuation probably does look better but we just can’t get excited about a business that we think it’s going to grow as mid-single digits over the next couple of years. So really, it’s just too low a growth for us to get too excited. I see it maybe as a bit of value trap at the moment.

Hans Lee: Okay, interesting. So we’ve asked our fund managers as well to bring along one stock that they think has a rock-solid balance sheet and is not a crowded trade as of yet. Rob, I’ll stay with you. What did you bring us?

The Lottery Corporation (ASX: TLC)

Rob Crookston: The Lottery Corporation is our pick. I think it’s got a reasonable balance sheet, gearing is still below the guided range, and resilient cash flows. And really, that’s driven by the countercyclical nature of lottery sales. It’s capital light. CapEx is around about 5% of EBITDA. So we like that part of it as well. In terms of earnings, we think there’s a good story there, from moving from paper tickets to digital, and with that you’re getting margin expansion at the same time. So we’re thinking here you’ve got double-digit growth in what is a very resilient business.

Hans Lee: Okay, so The Lottery Corporation for Rob. Andrew, what’s a stock with a rock-solid balance sheet and is not a crowded trade?

Nine Entertainment (ASX: NEC)

Andrew McKie: We love Lottery Corporation as well, so I really agree with Rob there. But Nine Entertainment for us is one we think’s worth a look. Obviously from a macro perspective, people are concerned about ad spend. But if you look at the quality of the business since they’ve merged with Fairfax, those assets are very hard to replicate. Not easily to compete with in terms of broadcasting, publishing, Stan, Domain, the radio network. A very dominant position. They’ve done a great job of also converting to digital. So if we look at subscription, if we look at digital advertising revenue is now 50% of overall revenues, a lot more resilient than just ad spend. And so, although there’s market concern about ad spend, we think that’s the opportunity to acquire the stock at the moment. We think that they’ve got pricing power and subscriptions as well, and that the balance sheet is pristine. They’re currently buying back 10% of their stock. We see that continuing with free cash flow over the next five years. So yeah, rock-solid business for us.

Hans Lee: Okay. Andrew and Rob, thank you very much for your insights. And thank you for joining us. If you enjoyed that episode of Buy Hold Sell, why not give it a like, and you can subscribe to our YouTube channel as well as both the Livewire and Market Index websites. We’ll see you soon for another Buy Hold Sell.

If you would like more information, please call 1300 ELSTON or contact us.