Banks, biotechs and BNPL – the fundamentals of the ASX-20

This article was produced by Livewire Markets and published in two parts on 15 and 19 April 2021.

Investors are spoilt for choice with the ASX-20. Everything is on offer from banks to supermarkets, miners to infrastructure. It is safe to say, the top 20 has changed dramatically in the first 21 years of the decade. Considering this, what will the ASX-20 look like in ten years from now? Will tech still reign supreme or will we see a new entry as influential as CSL? How can we account for the future?

Catherine Allfrey speaks to Livewire Markets about what makes a top Australian company and predicts what sectors we may see more of in the coming decades.

The Holy Grail – Sustainable earnings growth

Australia is a small market of 25 million people so to be a Top 20 company, a company is either part monopoly (TCL), have been a duopoly (supermarkets /WES/TLS) or an oligopoly (banks) or you’ve created a product that the world really wants! WaveStone’s stock-picking process uses a quality filter to look for companies that have a “Sustainable Competitive Advantage”. We look firstly at the internal attributes of success such as a company’s track record, why the company is #1 or #2 in their industry and how they have a successful strategy of engaging their employees, suppliers and customers to create sustainable earnings growth. Secondly, we use a form of Porter analysis to determine the industry conditions that a company operates in. These are always changing due to changes in consumer preferences, regulation and technology allowing new entrants into an industry. In the Top 20 the companies with the highest “Sustainable Competitive Advantage” are CSL, GMG, WES, MQG, TCL, APT and ALL.

The next big sector 

Let’s consider a larger presence to mean a higher market capitalisation, bearing in mind that the Top 20 stocks currently have a combined value of $1.4 trillion. If we take a ten-year view on iron ore, it may revert to the long-run price of US$60 due to slower Chinese growth and alternative African iron ore supply. Under this circumstance, the likes of BHP, FMG and RIO may not hold their current combined market cap of $440bn. The technology sector should have a larger presence due to Xero already knocking on the door of the Top 20 with a market capitalisation of A$20bn. Furthermore, if we can convince the Australian based billionaires Farquhar and Cannon Brookes to dual list Atlassian with a market capitalisation of US$55bn they would gain immediate entry into the Top 20! Also, the ongoing IPO activity is mostly technology-based and if companies like Canva come to market we could see a much larger technology sector and potentially another technology stock in the Top 20.

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Catherine Allfrey nominates one company that she believes will make its way into the top 20 within the next ten years, and one company currently there that will make its exit.

One overdue entry

One company which is a global champion taking a successful product from Australiasia offshore is James Hardie (ASX:JHX).

The company has built a 20% share of the exterior siding market in the US with its high performing fibre cement product. Housing stock in the US is ageing with 40 million homes more than 40 years old. We expect JHX to continue to grow market share in the Repair & Remodel (R&R) market as it innovates to become the industry standard for exterior siding, not just substituting vinyl which it has done so successfully but taking market share from wood, bricks and stucco as well. James Hardie acquired Fermacell in March 2018 to establish a platform in Western Europe to grow its share of the European exterior siding market. The company has a goal of turning this €300m revenue business with 10% margins in 2018 to a €1bn business with 20% margins by 2028. Given the levers they have to grow earnings per share over the next decade, we are quite confident that the company will be firmly in the ASX 20.

Waving goodbye to an old favourite 

We would expect Coles Group (ASX:COL) to fall out of the ASX 20 as it has been a COVID beneficiary. Home consumption over the past year has boosted short-term profits and therefore Coles’ market capitalisation.

The last year has resulted in persistent changes to the way we shop for groceries with online shopping having doubled over a one-year time frame. In fact, all of the growth in food retailing is now coming from online which has a lower margin. The risk for supermarkets is that we could see negative operating leverage in the store network, similar to what has happened to discretionary retailing in the last few years as spending shifts online. In addition, the lack of population growth through migration in the coming years, a highly inflated profit base from COVID-related spending in 2020 and the need to spend on its online strategy, we can’t see strong profit generation and cash flow growth relative to the ASX 20.

We don’t expect profit growth due to this high hurdle for a few years. Over the next ten years, Coles has geographically limited itself to Australia, so it is reliant on population growth, consumers making premium food purchases, taking market share and price increases for profit growth. New entrants into the Australian market like Aldi and Amazon have taken market share away from Coles and now consumers are increasingly shopping for groceries online which has increased sales but is not as profitable as in-store purchases. Whilst we expect Coles to grow on a 10-year view, it won’t be enough to stay in the Top 20.

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