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3 growth stocks at reasonable prices

Glenn Freeman  |  18 Jul 2017Text size  Decrease  Increase  |  

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This diverse trio of ASX 200 companies in FMCG, advertising and healthcare represent quality companies trading at a fair price, according to Morningstar analysts. 


A move that will see Domino's Pizza Enterprises (ASX: DMP) secure full ownership of its Japanese operations is the latest news for this international pizza chain.

Holding the Australian master licence of the Domino's brand, it has multi-national operations in New Zealand, France, Germany, Belgium, the Netherlands, and Japan. The last in this list is currently part of a 75 per cent/25 per cent joint venture with private equity player Bain capital.

Pending final approval from Japanese authorities, Domino's is set to purchase Bain's stake in late August. Domino's intends to fund the estimated $84 million acquisition with cash and existing debt facilities, which "will not have a material impact on our intrinsic assessment," says Morningstar equity analyst Johannes Faul.

Japan accounted for around one-quarter of Domino's earnings before interest, tax, depreciation and amortisation in fiscal 2016, though this is trending downward against stronger sales growth in Europe, tipped to drop to 16 per cent by 2025.

Outside the US, the United Kingdom is its biggest market, followed by Mexico and Australia.

"The stock suits investors seeking exposure to the food and beverage sector. Australia can still increase its store base by nearly 50 per cent during the next few years," Faul says, noting potential growth prospects are even higher in Europe.

"The pizza market in Europe is highly fragmented, presenting significant opportunity for Domino's to take market share with an attractive value proposition, increased convenience to the customer, and a differentiated product offering."

He believes it could grow its existing European store base by around 1,500, to more than 2,300 outlets over the next decade.

Anticipating Domino's storefront footprint to double over the next five years, Faul says management is targeting store numbers in Australia, Europe, and Japan to reach 1,200, 2,600 and 850, respectively.

Morningstar assigns Domino's a narrow economic moat due to a combination of "intangible assets and cost advantages". Faul points to its strong global brand recognition, having been formed in the US in 1960 and now extending to more than 80 countries, with around 14,000 stores.

This is furthered by its technology assets and intellectual property, which drive customer engagement and loyalty, with around half its global sales sourced from digital channels. In Australia, its mobile app drives around 50 per cent of these digital sales.

Average earnings per share (EPS) growth of around 30 per cent is forecast over the next two fiscal years, and the stock was trading at a 7 per cent discount to Morningstar's fair value as of 17 July 2017.

Heading outdoors

Outdoor advertising company, APN Outdoor Group (ASX: APO), was also trading at a discount to Morningstar's fair value as at this date, 18 per cent undervalued. Average EPS growth of around 13 per cent is forecast over the next two years.

"APN Outdoor is well positioned to benefit from the positive dynamics driving the Australian and New Zealand outdoor advertising industry," says Brian Han, senior equity analyst, Morningstar.

Even as its attempted merger with competitor oOH!media was recently rejected by the Australian Competition and Consumer Commission, Han says the decision "does not impair our fundamental view of the group".

"We urge investors to focus on ... the fundamental value inherent in APN Outdoor as a standalone company."

These fundamental drivers of value include "the outdoor medium's increasing audience, improving audience tracking and accountability measures, and benefits of inventory digitisation".

Outdoor advertising holds an almost 5 per cent share ($678 million) of the total advertising market, up from 3.5 per cent in 2009. Han believes this growth trajectory will continue, with the Australian outdoor market share lagging that of the US (6 per cent), Canada (8 per cent) and the UK (7 per cent).

He views population growth and increasing density and higher traffic flow on major roads among major structural tailwinds supporting this growth outlook.

Some of the key challenges for advertising businesses--including difficulties of evaluating the effectiveness of the outdoor medium, and the "debilitating" impact of digital technology--are being effectively addressed by APN, according to Han.

The former has been turned into an opportunity, with the industry's launch of Measurement of Outdoor Visibility and Exposure (MOVE). The latter is an opportunity for outdoor advertising, with digital technology growth the facilitator, rather than the threat it is for other traditional media.

"We view these drivers as long-dated, and believe APN Outdoor will continue to exploit them," Han says.

Healthy outlook

In the healthcare sector, Ramsay Health Care (ASX: RHC) is a positive story. As Australia's largest private hospital operator, it is capitalised at more than $14 billion and operates 223 hospitals and day surgeries.

It was trading at a 16 per cent discount to Morningstar's value as at 18 July 2017, with forecast average EPS growth of almost 13 per cent.

"Continued market share growth in Australia would further confirm its competitive cost advantage and reinforce its ability to negotiate favourable terms with the insurance industry," says Morningstar healthcare analyst Chris Kallos.

"A significant investment program reinforces the scale and diversity of specialty medical services at its keynote facilities. Attracting the best industry specialists further differentiates these facilities."

On the domestic front, Ramsay's scale gives it considerable negotiating strength with private health insurance funds, providing reasonable pricing power.

"Scale also delivers operating efficiency through group procurement, centralised administration, and system integration," says Kallos.

Australian government regulation is further bolstering Ramsay's position, as people are encouraged to adopt private medical insurance through surcharges and rebates.

"Ramsay Health Care's private-care offering is clearly differentiated from the public sector, which is capacity-constrained and a haven for government bureaucracy and inefficiency," Kallos says.

It is also seeing strong international growth, particularly in Europe, where France's "fragmented industry and similar demographic trends to both the UK and Australian markets" presented an opportunity. France provides around 20 per cent of overall group revenue, and the UK provides 10 per cent.

The French election outcome was a positive for Ramsay, with Emmanuel Macron's centrist-leaning government more accommodative to private healthcare providers.

The long-term effect of Brexit on its UK operations, which have introduced some pressure, are still somewhat unclear, says Kallos. He anticipates a good earnings result in the upcoming reporting season, expecting management to deliver on its earlier guidance.

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Glenn Freeman is a Morningstar senior editor.

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