Find below the last of the articles published at Macro Investor mid-December 2012. It is the top ten stock picks for 2013 from the Macro Associates’ team, balanced as always against fundamentals, allocations, risk and macro factors. With strong fundamentals and offshore exposure, all should do well in a post mining boom economy. Thus the portfolio is relatively “China-proofed”.
Moreover, the portfolio offers strong exposure to the few secular bullish trends that remain for investors: deteriorating worldwide demographics via health care, the fight for productivity in a world of gross industrial over-capacity and the few domestic demand strengths that are secure. This should also serve the portfolio well in the long term.
The forward-looking nature of the picks has already performed well with the portfolio returning 23% capital growth plus approximately a 5% p.a. yield versus 16.6% for the ASX200 since the current rally took off last August.
N.B. Be aware that the charts are six weeks old.
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It can be challenging enough to select a stock that should do well in the coming weeks or months, let alone ten stocks that should outperform across an entire year, but putting caution to one side we’ve attempted to do that with a selection of our favourite companies for the year ahead.
Since Macro Investor’s inception, we have had an unapologetic bias for stocks with strong fundamentals, low risk, resilient earnings and a business model geared towards providing useful goods or services to a wide market that’s not dependent upon the credit cycle. Unlike financial services and mining stocks (houses and holes), which are largely dependent on a credit boom in Australia, represented through high levels of real estate investment, and a credit boom in China, represented through high levels of fixed-asset investment, our preferred shares may not be the largest companies on the ASX, but they are nevertheless leaders in their fields.
Further, should either or both the housing boom and the mining boom continue to unwind – pulling the Australian dollar down with it – these companies will not only be relatively immune, but could do well due to their exposure to offshore earnings and the intrinsic benefit this brings in local currency terms. If that process takes longer, these are our most efficient companies and will still make headway against global competitors. Finally, those with high exposure to local demand are in defensive sectors such as food and government spending. 
Listed at end of this article are our suggested allocations for a portfolio comprising all ten stocks. Allocations have been calculated based on their respective margins of safety (if any) between the current share price and the FY2014 estimate of value, the probability of higher earnings arising from a lower Australian dollar and a greater weighting to defensive or “recession-proof” stocks like Coca-Cola Amatil (CCL) and Woolworths (WOW), which tend to do well in all economic climates due to the low-cost or essential nature of their goods and services.
It is, in short, a “China proof” portfolio. This portfolio is estimated to yield 5.1% in franked dividends with Cochlear, CSL and Ansell providing low to zero franking credits. It is considered relatively low-risk, of course, but as with all equities investing past performance does not indicate future returns and investors are always advised to speak to their licensed professional advisors before making any decisions.
Ansell Limited Ansell Ltd (ASX:ANN) provides health and safety protection solutions, with operations in North America, Latin America, Europe, the Middle East and Asia.
Ansell holds positions in the industrial and medical gloves market, as well as in the sexual health and well-being category. 
We covered Ansell on October 15, noting that the company’s emerging markets sales outlook – particularly in the Asia Pacific – looked buoyant and that the company could exceed consensus and FARM estimates of earnings and value should the AUD fall. We also noted that rubber prices could weaken in 2013, delivering additional margin alongside longer-term growth in demand for high-quality latex products, particularly in sexual health as condom use becomes the norm in developing countries. Based on this and a view that industrial stocks will attract a share market premium, we are bullish on ANN’s 2013 prospects notwithstanding its relatively low dividend yield.
Coca Cola Amatil Limited Coca-Cola Amatil (ASX:CCL) manufactures, distributes and sells carbonated soft drinks along with still and mineral waters, fruit drinks and flavoured milk drinks, holding the license to distribute Coca-Cola products throughout most of Southeast Asia. 
The company also rents and services commercial refrigeration equipment to food and beverage manufacturers. CCL is another brand-name, blue-chip and low-risk industrial stock we like, as we liked it in June, when we first profiled it prior to the newsletter’s launch. The company has benefited since then from a cyclical trend of capital moving away from the battered discretionary sector into staples and a continuing flight to safety.
As we did in June, we feel CCL’s core strength is the ability to leverage off the intangible value of iconic brands, supplying a wider range of products domestically and tapping into the burgeoning middle class in Southeast Asia, where it also has rights to distribute Coca-Cola products. It is from Asia that CCL has enjoyed a surge in top-line growth, which has also translated into an attractive dividend yield. Our concern, however, remains on the company’s ability to keep production costs low in Australia.
Codan Limited Codan (ASX: CDA) is a designer and manufacturer of remote area communications equipment and systems. The company’s product range is utilized by the international high frequency radio, satellite and terrestrial microwave communications markets – including defence industries – and also for television broadcasting.
CDA was another company we profiled in June, prior to our official launch, and we’re still bullish about its prospects. We have been pleased to witness its strong performance since coverage began and note that while its price has outperformed current estimates of value, it still trails FY14 targets. Unlike our other top-ten stocks however, CDA is a micro-cap and as such, has much higher price volatility, although average price is relatively stable. Balance sheet risk remains modest although increases in debt and serviceability need monitoring, especially on the back of recent acquisitions. The biggest risk, ultimately, remains CDA’s exposure to the commodity boom through sales of metal detectors alongside exposure to government defence and IT contracts, which are inherently unpredictable and could contract under forthcoming austerity measures.
Cochlear Limited Cochlear Ltd (ASX:COH) researches, develops, manufactures and markets cochlear implant systems for hearing impaired individuals. The hearing implant systems include Nucleus and Baha and are sold domestically and internationally. With exemplary financial metrics and a proven ability to spin off vast amounts of free cash-flow then reinvest them at high rates of return on equity – averaging over 40% p.a. for the last ten years – COH is undoubtedly one of our favourite stocks. Stability of high earnings power translates into ever increasing dividends, even though the nominal dividend yield always appears low by Australian standards. While reduced franking levels do not provide additional benefits for Australian shareholders, the dividend has increased four-fold in the last ten years.
While return on equity was a lot lower in FY2012, share market performance has been strong on the back of increased dividends and earnings per share.
And despite a well-publicised safety recall of a leading product, the Nucleus CI500 implant, leading in turn to a significant cost write-down, COH’s overall revenues have proven resilient. Investors should remember that COH has grown earnings at a 17% annual pace, with earnings forecasted to grow from 283c in FY12 to 402c in FY2016.
The balance sheet is, furthermore, in very good shape, with no net debt. COH’s major risk remains the large amount of constant capital expenditure on research and development required to maintain its competitive edge and the high Australian dollar, which to date has continued to impact on earnings. European and US earnings account for some 80% of COH’s profits. A downtrend in the AUD against the USD and Euro will assist COH’s share price performance in the long run.
CSL Limited CSL Limited (ASX:CSL) is a leading pharmaceutical and healthcare product provider with a global reach and a dominant member of the healthcare sector. It develops, manufactures and distributes paediatric and adult vaccines, infection and pain medicine, anti-venoms and immunoglobins.
CSL is another undoubted favourite, its strong performance vindicating our initial backing, supported not only be excellent fundamentals but a further buyback of up to $900 million, or 4% of its shares on issue.
Like COH, CSL’s earnings per share continue to climb on strong capital management and tight cost control. A low dividend yield and zero franking credits continue to be a major disappointment, despite a relatively high payout ratio, but income investors should be assuaged in the coming years with the scope for further dividends increasing. The risks facing CSL continue to be regulatory and competitive. Like COH as well, CSL must also maintain high capital expenditure costs to ensure an edge in developing new products.
Domino’s Pizza Enterprises Limited Domino’s (ASX:DMP) is a license owner of the fast food Domino’s Pizza brand, which covers Australia, New Zealand, France, Belgium, The Netherlands and Monaco. Another stock we covered early on, DMP is a highly successful food retailer, with high operating margins, positive cash flow and an ability to grow earnings. The major metric, Return on Equity (ROE) after early growing pains, is now settling in high teens/low 20% range, reflecting a strong business model.
Unsurprisingly, DMP has been rewarded in the market with its share price consistently exceeding value, albeit with high volatility. As a mid-cap company this could be a concern for more conservative portfolios, though in terms of revenue and business model we consider this a defensive stock notwithstanding its discretionary sector categorisation. DMP has no net long-term debt and has a good use of working capital, so balance sheet risk is very low. The main risks to the business are competition within the sector, and forex risk for earnings generated in Europe if the high AUD continues. DMP’s share price furthermore closely follows institutional earnings expectations, which must be managed.
Data 3 Limited Data 3 (ASX:DTL) is an information and communications technology company that provides a broad range of equipment, human resource management and software services to business and government customers. 
DTL, profiled by us in June and then again in September, has had a mixed year but we believe despite a challenging operating environment it trades at well below value and deserves closer inspection. The company’s potential for further appreciation is reflected in its very high return on equity, averaging 40% over 10 years, commensurate with most IT companies, but with only a small amount of intangibles on its balance sheet. While the increased ubiquity of smart business infrastructure and computer technology bodes well for IT services firms DTL’s biggest risk is continuing austerity in state government expenditure, with a reversal in ‘big project’ spending that has impacted all IT providers.
DWS Advanced Business Solutions Limited DWS (ASX:DWS) is a small IT company, headquartered in Victoria, that provides a wide range of solutions, primarily to corporate and government organizations. This includes program and project management, business analysis, application development, systems integration and data management.
Like DTL, DWS is an undervalued but high-quality IT services firm with similar opportunities and risks. Its dividend yield is a standout attraction – 11.7% at the time of writing – and its PE ratio is the lowest of our top-ten selection at 11.2 times.
Navitas Limited Navitas Ltd (ASX:NVT) offers educational services, including English language training, high school courses, university preparation, university programs, career advancement programs and settlement courses to students, professional and migrants. Profiled by us in August, NVT was an unconventional choice following several years of declining returns, but with a significant dependence on overseas students – an export profile that’s somewhat obscured due to the fact that teaching takes place in Australia – its core strengths, weaknesses, opportunities and threats are all Australian dollar-related. NVT has also had sweeping higher education regulatory reforms to contend with, depreciation expenses on its $289 million purchase of SAE Group and a downturn in many emerging market economies. 
The upside however is that NVT’s difficulties are now behind it, as expressed in the company’s recent share price performance, which has more than fulfilled our expectations. Further, the fact that the company delivered a 30% return on equity in such a tough years is testament to excellent cost control, strong management and a highly resilient business model.
It is our contention that when good times return to the sector – especially a sector where NVT’s weaker competitors have been cleaned out through reform – the company’s share price will rebound beyond what we otherwise consider a conservative estimate of intrinsic value going forward. NVT is a market leader in the private college space and should Australia once again become a preferred destination for international students – especially students from South Asia now that Australia has made significant steps to improve the sector’s reputation and perception of safety – the company should report a much stronger result in FY13 than is currently forecast.
Of course with education being a service that customers take some time to plan purchases of, especially international customers who need to arrange things like relocation and visas, there will be a time lag between a fall in the AUD and a likely rebound in NVT revenues, but as NVT has become something of a proxy, like CSL, for investors betting on the direction of the Southern Peso, the company’s share price is likely to lead earnings fundamentals anyhow meaning an entry at this point could be warranted.
Woolworths Limited Woolworths (ASX:WOW) is Australia’s category killer in retail, operating the countries largest food, groceries, takeaway alcohol and poker machine businesses. Its core business, Woolworth’s supermarkets, operates in a duopoly fashion alongside Coles. The company also operates BigW and is expanding into home improvement with its new “Masters” stores.
WOW was one of the first stocks we covered and it has well and truly been an out-performer, even if at times its share price has been very volatile for such a conservatively-managed blue-chip stock. WOW is nonetheless a dynamic company with a changing business model; the divestment of Dick Smith Electronics and the entry into big-box hardware are just two examples.
Moreover, while it is in many ways a company that makes, not takes, prices, it is still locked in a tight battle with key competitor Coles, owned by Perth-based conglomerate Wesfarmers (ASX:WES) and for several years in a pattern of resurgence. While outsiders may view the two as a cosy duopoly, like any company, WOW must constantly invest in innovation and best practice.
Having said that, as one of the most defensive companies on the ASX we believe it will continue to outperform when times are tough and continue to produce high quality earnings and strong dividend yields to investors at low risk. WOW is thus a most appropriate stock to conclude our top-ten list with.
