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6 large-cap ASX stocks that look relatively cheap

Nicholas Grove  |  04 Oct 2016Text size  Decrease  Increase  |  

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While P/E multiples may not be particularly helpful in gauging the attractiveness of large caps at the moment, there is a sub-set of ASX large caps that look cheap on a P/E basis.


The underperformance of Australian large-cap stocks vis-à-vis their mid- and small-cap counterparts since early 2015 has been widely reported, with falls in heavyweights Telstra (ASX: TLS), the big banks and the big miners weighing on the S&P ASX 200 Index.

Investors may therefore be wondering if large caps are now relatively cheap.

But as UBS pointed out in a recent note, P/E multiples are not particularly conclusive in determining the attractiveness of large caps when compared to mid and small caps, with the P/E multiples of large, mid and small caps all trading at a premium to their long-run average at this point in time.

However, there is a sub-set of large caps--banks, insurance and telcos--that look cheap on a P/E basis, UBS said.

"On a price-to-book basis, large caps do indeed look cheap relative to mid and small caps. In absolute terms, the P/B of large caps is low relative to its history, while mid and small caps trade at a premium," the wealth manager said.

UBS pointed out that the "very large-cap segment" of the market--the ASX 20 Leaders--does possess an appealing combination of a high dividend yield, moderate P/E and moderate P/B ratios.

And while earnings for this segment went backwards in fiscal 2016, expectations for fiscal 2017 are for a return to moderate earnings per share (EPS) growth of around 4 per cent.

"This is not hugely inferior to current expectations for mid caps, albeit risk factors such as potential for further bank equity issuance to bolster capital ratios and weak EPS revision trends in insurance and consumer staples continue to overhang the large-cap sector," UBS said.

"While a return to strong EPS growth is unlikely, if earnings performance does manage to revive to a moderately positive pace the sector is likely to attract renewed interest given its valuation appeal."

Below are six large-cap stocks--all of which have been assigned either wide or narrow moat ratings by Morningstar--that are currently trading at a modest discount to their fair values.

1) AMP Limited

AMP Limited (ASX: AMP) is one of Morningstar's preferred wealth managers, according to head of Australian banking research David Ellis.

This is a result of the company's strong market positions in a long-term growth industry, improving investment performance, a large distribution base, integration synergies and a strong track record in cost control.

"AMP is well placed to take advantage of structural advantages of a compulsory superannuation system, generous tax incentives and an ageing, increasingly wealthy population," Ellis said.

"Increasing complexity in superannuation and taxation rules will boost demand for financial advice, and AMP has the largest adviser network in Australia/New Zealand.

"Operational expertise, distribution and scale enable AMP to implement major regulatory reforms without materially affecting profitability."

2) Commonwealth Bank of Australia

Commonwealth Bank of Australia (ASX: CBA) is a lower-risk bank, according to Ellis, currently trading on an attractive dividend yield of about 5.5 per cent.

And despite industry headwinds, Ellis said CBA's conservative management, diversified revenue stream, and strong and stable balance sheet enable it to continue to consistently deliver solid financial results.

"Costs are under control, supporting earnings during a period of weak revenue growth. Improving economies of scale make ongoing gains in cost-efficiency likely," he said.

"Commonwealth Bank comfortably meets the current Basel III capital standards that came into force on 1 January 2016. We see no need for large dilutive equity raisings during the next three years."

3) Westpac Banking Corporation

Westpac Banking Corporation (ASX: WBC), Australia's oldest bank, is viewed by many commentators as possessing a key weakness in the form of its successful home-loan growth strategy, according to Ellis.

However, Morningstar argues that this is a key strength of the bank.

"Investor concerns, centred on the large exposure to residential mortgages, are overdone. The high-profile multi-brand franchise in Australia and New Zealand is slanted towards retail banking, but retains meaningful exposure to the wealth, corporate, and institutional sectors," Ellis said.

"We see solid earnings upside potential, with international investors continuing to focus too much attention on negative short-term issues."

4) QBE Insurance

Ellis believes QBE Insurance (ASX: QBE) is a stock that provides "attractive upside" because of the benefits from a major restructuring and consolidation undertaken in 2013-14.

"Financial results for 2015 and management guidance for 2016 confirm our view that the group is well on the way to a sustained and consistent earnings recovery after three years of financial and economic turmoil," Ellis said in a note.

"We expect the external detractors that caused so much damage in 2011, 2012, and 2013 to continue reversing in second-half 2016.

"The robust global business model is leveraged to a stronger US economy ... Major restructuring in the US operations will reduce premium growth, but boost the earnings recovery."

5) Telstra Corporation

Telstra is the dominant player in the Australian telecommunications industry, and the clear market share leader in domestic fixed voice, broadband and mobile services, according to Morningstar senior equity analyst Brian Han.

It is also likely that the telco will maintain these market-leading positions in the future, he said.

And while the telecommunications space is incredibly competitive, Han noted that Telstra has a significant competitive advantage via its extensive mobile and wireless networks.

"Telstra's mobile business benefits from a network quality advantage that underpins a 49 per cent subscriber market share position."

6) Woolworths

While Woolworths (ASX: WOW) has long been the largest supermarket company in Australia and has achieved strong EPS growth for many years, the entrance of discount supermarkets Aldi and Costco into the Australian market during the past decade has increased competition in the sector.

But despite this increased competition, Morningstar equity analyst Johannes Faul still considers Woolworths to be a very strong business, with competitive advantages stemming from its leading store network, low cost of doing business and buying efficiencies.

"We expect these attributes to enable Woolworths to regain sales momentum and lost market share," Faul said in a note.

"Woolworths' dominant position in the supermarket sector is entrenched, and coupled with first-class management, ensures it will maintain leadership in the sector."

More from Morningstar

• Telco shares tumble as competition intensifies

• What you need to know about listed investment companies


Nicholas Grove is a Morningstar journalist.

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