As Australia faces stubborn inflation and potential rate hikes, we delve into three robust stocks — CSL, Transurban, and NextDC — that have a history of weathering economic storms.
In this insightful Investor Spotlight, Dani and Kyle take a deep dive into the current economic landscape marked by stubborn inflation and potential rate hikes.
This cycle isn’t different
It remains to be seen whether Australia can dodge a recession. But with stubborn inflation and higher-than-expected wage rises from the Fair Work Commission, many economic experts are now forecasting the Australian cash rate to rise another 0.50% to 4.35% with another 25 basis point rate rise on June 6 when the RBA meets.
Discretionary retailers like Adairs, Universal Stores and Michael Hill are but a few companies downgrading earnings forecasts as the higher cost of living and elevated interest rates curb the consumers’ spending power.
As discussed last week, some companies can better manage the earnings cycle due to the nature of business and this week will be a deeper dive into three great Australian stocks with a proven track record.
CSL: A healthcare giant with stable earnings
CSL (CSL) is Australia’s largest biotech company with a $148 billion market capitalisation, ranking only behind CBA with a $162 billion value and BHP at $219 billion .
At the time of listing in 1994, CSL had a market capitalisation of $299 million and after adjusting for a share split in 2007, the stock price is now around $308 versus about $0.77.
For many investors, CSL has become a core staple holding. The company has grown sales revenues and earnings through strategic acquisitions and constantly investing in Research and Development.
As it stands there are four main operations: blood plasma, specialist blood products, CSL Behring, flu vaccines, CSL Seqirus and the recently acquired specialist iron drug company, Vifor.
Excluding the uncontrollable impacts of a pandemic on the blood collection business, CSL is typically a business that is not affected by externalities like rising interest rates.
The valuation is usually at the higher end of price-to-earnings multiples due to the perceived strength of earnings and cash flow generation. CSL also has a strong balance sheet, low levels of debt and is a post covid recovery play as well as a favoured stock pick by experts in the domestic healthcare sector.
CSL daily chart
Transurban: Toll roads and demographic tailwinds
Shifting gears, Transurban (TCL) is Australia’s largest toll road operator which builds and operates toll roads in Melbourne, Sydney, and Brisbane as well as Greater Washington in the USA and Montreal in Canada.
Like CSL, the group’s operations were severely impacted by the pandemic and lockdowns but 2023 is a return to earnings growth as Australians and Americans move on with their post covid daily lives.
Typically, toll road builders and operators are considered as sensitive to changes in interest rates due to the financials - high levels of debt to finance the build which is then paid off by the steady income streams once the roads are operational.
However, Transurban has a natural hedge against rising interest rates. The tolls are CPI (inflation) linked, meaning they are allowed to increase prices to offset rising finance costs. Most of their debt is long-dated and therefore not exposed to higher rates immediately, only when the debt is refinanced.
Transurban is also a longer-term play on Australia’s rising population and strong employment, which makes it one of the favourite stocks for those investors who like to receive a stable income stream as well as long-term capital gain.
Transurban is another stock that is expensive on a price-to-earnings basis, as investors usually consider the almost annuity-style dividend yield as the benchmark for how cheap or expensive the company is.
At current levels of a 4.2% projected yield for FY24 (as FY23 is almost finished), it ranks around the cash rate, which some investors may see as fully valued when considering the equity risk of owning shares.
Transurban daily chart
NextDC: Harnessing the potential of AI and cloud storage
NextDC (NXT) is the developer, owner, and operator of data centres in Australia with a $6.3 billion valuation. It was listed on the ASX in 2010. They recently raised $618 million through an equity offering at $10.80 per share to existing shareholders for targeted overseas expansion in Auckland and Kuala Lumpur and an accelerated fit-out of the third Sydney centre.
Data centres are what we effectively identify as the ‘cloud’. There are long-term structural growth trends as more and more businesses transition to off-premise data storage.
There is also an increasing demand for data storage capacity due to the embryonic AI trend, with an estimated US$1 trillion in upgrades in GPUs for the likes of the hyper scalers - AWS (Amazon), Azure (Microsoft) and Google Cloud, to allow for the more advanced AI software like ChatGPT.
NextDC currently doesn’t pay a dividend as all the cash flows are being deployed for long-term growth. At some stage, it will provide an annuity-style dividend income stream.
NextDC daily chart