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6 great businesses at attractive prices

Glenn Freeman  |  10 Oct 2017Text size  Decrease  Increase  |  
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These moat-rated companies in the telecommunications, financial services and healthcare sectors remain appealing even in an ASX 200 index widely regarded as overvalued.


Telstra (ASX: TLS) occupies a significant position in the ASX and the portfolios of many investors. However, various factors including the rollout of the National Broadband Network (NBN) and increasing competition--including from the likes of TPG Telecom (ASX: TPM)--present strong headwinds. Its share price has taken a substantial knock in recent months, most recently in response to its August half-yearly profit results.

At the same time as Telstra announced $3.9 billion in profits for the 2016/17 fiscal year, CEO Andrew Penn flagged the company's reassessment of its dividend policy. This is a marked shift from its historical practice of paying almost all profits in dividends, to paying between 70 per cent and 90 per cent.

"CEO Andrew Penn said the change is 'about setting the business up for success in the future ... which will bring it more in line with global peers and local large companies,'" according to AAP reports.

Morningstar senior equity analyst Brian Han believes shareholders shouldn't be overly concerned, having factored this altered dividend payout ratio into his assessment of the business some months ago. He also remains confident Telstra can plug the revenue gap created by the NBN--estimated at between $2 billion and $3 billion.

"The group has the financial firepower to meet this challenge, further aided by NBN compensation payments. We clearly believe the stock is undervalued, and we certainly think a 22 cents per share dividend is sustainable, given the conservative payout [in FY17] and the strong balance sheet," Han says.

Telstra was one of several companies Han and his colleagues Chris Kallos and David Ellis, senior equity analysts covering healthcare and financial services, respectively, discussed at the Morningstar Individual Investor Conference 2017 last week.

Another of these is Vocus Group (ASX: VOC), which has a four-star Morningstar rating and is regarded as holding a narrow moat. Having traditionally been an infrastructure-heavy, corporate customer-focused telecom services provider, its February 2016 acquisition of M2--one of several in recent years--added a consumer-focused boost to the group.

Vocus booked a net loss of $1.46 billion for FY17, "after making heavy write-downs on goodwill for some of its acquisitions and abandoned paying a dividend to redirect funds to projects and debt reduction," according to AAP reports. Han trimmed his fair value estimate (FVE) for Vocus by 38 per cent following the FY17 result.

"It is little wonder that the board has instituted a dividend holiday that is likely to continue until the second half of fiscal 2019, given the capital expenditure hump in the near term," he says. However, Morningstar remains comfortable with Vocus' balance sheet and management's focus on cash flow management.

CommBank still appeals

Though it has been buffeted by negative media reports in recent months, Commonwealth Bank of Australia (ASX: CBA) continues to hold a wide economic moat. David Ellis believes it remains in a strong position, despite increasing regulatory and compliance risk, and the bank features in Morningstar's latest Australia & New Zealand Best Stock Ideas, which is available to Premium subscribers.

Ellis notes the bank "has experienced a horror two-month period with the AUSTRAC anti-money-laundering allegations, a potential shareholder class action, the announcement the CEO is to retire no later than 30 June 2018, and the APRA inquiry."

In response, the share price has fallen around 11 per cent, and in early August, Morningstar dropped its stewardship rating for the bank to standard from exemplary. "But we believe the share price fall is overdone and the stock price offers an attractive entry point. In our view, the regulatory and compliance issues do not detract from the bank's strong competitive advantages that underpin our wide economic moat rating," Ellis says.

He highlights the bank's "robust balance sheet, dominant market positions, strong profitability, solid organic capital generation, and sound loan book" as particularly attractive characteristics.

Ellis also maintains his positive view on the narrow-moat-rated global general insurer QBE Insurance Group (ASX: QBE). "Over the short term, we expect more earnings volatility, but from 2018 we forecast steady and consistent earnings growth. We believe in the QBE turnaround story based on improving macro momentum with a long-awaited upturn in global insurance rates," he says.

Healthcare remains robust

Two healthcare stocks discussed at the conference also feature in the Best Stock Ideas list for October 2017: Ramsay Health Care (ASX: RHC) and Healthscope (ASX: HSO), which both hold narrow economic moats.

Ramsay is a global hospital group operating 223 hospitals and day surgery facilities across Australia, the UK, France, Indonesia, and Malaysia. Domestically, it is also the largest and most diversified private hospital operator.

According to Chris Kallos, this scale is "a sustainable competitive advantage that drives both cost advantage and a reasonable level of pricing power in negotiations with private health insurers".

"We believe government policies designed to support private health insurance membership, combined with current inefficiencies of the public hospital system, protect private hospitals from major funding related disruptions," he says. Ramsay's increasing push into community pharmacy further extends its reach into chronic disease management, which Kallos notes "is a growing area given the ageing demographic".

"We also think Ramsay's centralised procurement strategy, leveraging the global purchasing power of the group, bodes well for margin expansion," he says.

Healthscope's less diversified business has earnings largely driven by the domestic hospital portfolio and, as a result, is more reliant on the "timely completion and ramp of its ongoing brownfield projects". As such, the slower-than-expected volume increases at several Victorian sites disappointed at the full-year result. It also saw a share sell-off in response to management's suggestion that problems could persist into the first half of 2018.

"Nonetheless, at current levels, we consider the shares significantly undervalued," Kallos says.

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Glenn Freeman is a senior editor at Morningstar.

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