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These 2 ASX sectors could be good bargains

Nicki Bourlioufas  |  10 Nov 2016Text size  Decrease  Increase  |  

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The Australian share market is trading at a premium to historical levels and is not yet in bargain territory, but there are two sectors that may represent some value.

 

The Australian share market is trading at a premium to historical levels and is not yet in bargain territory, though the telecommunication and healthcare sectors may represent some value, says Morningstar's head of equities research Peter Warnes.

While Telstra (ASX: TLS) and other telcos Vocus Communications (ASX: VOC) and TPG Telecom (ASX: TPM) have taken a hammering in recent weeks, the big banks have fared relatively well despite the general market sell-off ahead of the US election.

Some small caps have dropped significantly, many analysts say they are now returning to fairer value.

Morningstar's Warnes says, overall, the Australian share market isn't especially cheap despite the sell-off.

"Generally, the market is around fair value, or maybe at a slight premium to the value on the ASX 200. You've got price-earnings (PE) ratios across the ASX 200 at 16, or maybe slightly under, and historically that's not cheap, where the market is has been priced closer to 14. So, there aren't any obvious bargains," he says.

Given a PE ratio of 16, Warnes says the share market is trading on an earnings yield of about 6.25 per cent, and with a 10-year bond yield around 2.3 per cent, that leaves around 4 per cent for an equity risk, which isn't a very high premium.

"It's a risk-off environment, rather than a risk-on environment, due to the volatility in the market in the US, where nine consecutive days of losses for the S&P 500 last week was the longest losing streak in 36 years," says Warnes, who says the S&P 500 isn't cheap either.

"While markets didn't like the thought of a Trump victory, they weren't so excited by a Clinton victory either," he says.

Warnes expects 2017 to be a year when the US Federal Reserve raises interest rates after delaying the issue through 2016 and as the market adjusts to the Donald Trump victory and the likelihood of better economic growth and increasing inflation.

"The US market has been disappointed by the US Federal Reserve, which has squandered several opportunities to raise interest rates and reign in easy monetary policy, which has helped to elevate asset prices," Warnes says.

Locally, Warnes points to the telecommunications sector as being one possible area for bargains despite the rise in prices after the US election result.

"You probably got some bargains in the telco sector, including Telstra. The fall in Telstra's price means it is now yielding around 6.3 per cent, which grossed up for franking is about 9 per cent, and you would have to say that looks to be in bargain-ish territory," Warnes says.

"TPG and Vocus Communications have also fallen and may be getting to be good buys."

TPG shares tumbled in September due to heavy competition in the broadband market, and Vocus and Telstra fell too as their margins came under pressure with the rollout of the National Broadband Network (NBN).

Telcos are competing fiercely against each other to win new customers and are offering lower and lower broadband prices, denting revenue.

Telstra is trading well under Morningstar's fair value of $6.00 and so too is Vocus Communications, which is trading around $5.60, compared to an $7.40 fair value estimate.

TPG is also well below its $10,00 fair value estimate at a current level of around $7.20.

"In terms of other bargains, we haven't got many others out there in the stocks we cover," says Warnes, adding that the banks aren't necessarily cheap and have largely held their ground during the October and November sell-off.

CSL Limited (ASX: CSL) under $95 may be a good buy given it is well below Morningstar's fair value of $125. Ramsay Health Care (ASX: RHC) at under $70 is "getting bargain-ish," adds Warnes, compared to a fair value of $87.

Elsewhere, QBE Insurance (ASX: QBE) at under $10 is another possible buy for investors with Morningstar putting a fair value of $14 on its shares.

"It's claims were getting hit by falling bond yields and its portfolio of cash and short-term bonds is also reflecting low investment income from low yields. At under $10, QBE is very interesting and it's certainly moving towards an area or price where it might perk investors' interests," says Warnes.

Another less obvious buy is Village Roadshow (ASX: VRL), which is trading around $5.05, having been dragged down in recent weeks by the tragedy at Dreamworld and Ardent Leisure's (ASX: AAD) fall. Morningstar has a fair value of $6.50 on the stock, well below its current price.

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Nicki Bourlioufas is a Morningstar contributor.

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