During the previous quarter, some of our portfolio holdings experienced upgrades, which underpinned strong relative performance.
Notably, James Hardie (JHX), Aristocrat (ALL), Xero (XRO) and Telix Pharmaceuticals (TLX) stood out among the industrial companies that were upgraded, contributing to the portfolio's success amidst a turbulent period for the Australian market. We believe that these companies are entering earnings upgrade cycles and maintain a positive outlook for them.
However, we also observed some disappointing downgrades among what we consider our resilient growers – for instance, CSL (CSL) and IDP Education (IEL). In our view, these downgrades are isolated incidents and therefore present good opportunities to buy these stocks.
James Hardie (JHX) 3% - Macro Improving, Structural Drivers Material
James Hardie (JHX) has been upgraded following its full-year result. In the past 3 months, consensus earnings per share (EPS) was upgraded 2.6% and 2.7% for FY24 and FY25, respectively. A strong FY23 update, with stronger than expected 1Q24 guidance provided a positive surprise. The share price has risen 31% based on this news after looking oversold into the end of last year.
Why we think this is the end of the downgrade cycle
We now look closer to the end of the downgrade cycle for JHX. After three downgrades (and a slight miss) to JHX’s FY23 guidance, we think investors are starting to look through the immediate headwinds, focusing on the structural tailwinds for JHX.
Structural drivers still solid
The rising popularity of fibre cement sidings in housing construction at the expense of timber and other 'traditional' materials has proved to be a game-changer, enabling the company to take market share in the US building materials market. Despite enduring a challenging macroeconomic period, JHX has impressively managed to maintain flat earnings over the past 12 months, a remarkable feat given the prevailing market conditions driven by market share gains. Market share gains are likely to continue over the medium-term, in our view.
Building confidence
We have seen evidence of positive developments in the US housing macro environment. Market sentiment in the US housing market is improving, which is evidenced by the positive momentum of the NAHB housing market index this year to date. Mortgage rates, which rose significantly last year to ~20 year highs in October 2022, are also now stabilising. Additionally, US building permits are recovering. These factors collectively indicate a positive cyclical trend in the US housing market, which bodes well for JHX.
Aristocrat (ALL) 3% – New Growth Opportunities
After 1H23 earnings, ALL consensus EPS was upgraded 5.1% and 6.4% for FY24 and FY25, respectively, as analysts upgraded their land based gaming outlook.
With the recent acquisition of NeoGames (a Nasdaq-listed company) for $1.8 billion, ALL signalled its intent to move into the online real money gaming (RMG) market. Consensus for online RMG is effectively zero, providing another avenue for earnings upgrades in the next 12 months.
Online RMG underappreciated
We anticipate that the online real money gaming (RMG) sector, specifically Anaxi, will drive substantial improvements in Aristocrat's (ALL) earnings over the next 5-10 years. The current consensus forecasts for this segment appear to be overly cautious, potentially due to the sell-side's conservative approach, considering the relatively early stage of the online RMG industry and its evolving earnings base.
According to the consensus expectations, Anaxi's revenues are projected to reach a peak of approximately $350 million by FY30, after around 8 years of operation. To provide context, within a similar timeframe (between FY14 and FY20, spanning 7 years), ALL managed to grow the revenues of Pixel United from nothing to $2.4 billion in a comparable global market. Therefore, if ALL successfully executes its plans for Anaxi in line with our expectations, we anticipate significant earnings upgrades in the coming years.
Digital bottomed?
While the revenue of Pixel is gradually stabilising after experiencing a surge
in demand during the COVID lockdowns, there are signs of momentum shifting. In the latest 1H23 financial results, management indicated that Pixel's EBITDA (earnings before interest, taxes, and amortization) is expected to grow year-on-year (YoY) in 2H23. This guidance implies a growth rate of approximately 12% compared to 1H23, which will likely necessitate a combination of significant revenue growth or cost reduction measures.
Telix (TLX) 2% - Higher TAM, Acceleration of Sales
Telix Pharmaceuticals (TLX) has quickly evolved from a loss-making clinical stage biotech to a soon-to-be (come the FY23 full year result) highly profitable business. The rapid commercial success of TLX’s ILLUCIX product (a radioactive diagnostic agent for patients with prostate cancer) has significantly exceeded market expectations which has driven a number of both near-term and long-term upgrades to consensus earnings expectations this calendar year to date – including four upgrades from the Wilsons Healthcare Research team.
The earnings upgrades have been driven by both ILLUCIX’s market share gains and subsequent improvements to terminal market share assumptions for ILLUCIX, as well as gradual increases to estimates regarding the size of the PSMA imaging total addressable market (TAM). We see ample scope for a continuation of TLX’s earnings upgrade cycle from ILLUCIX, and from the launch of other products in TLX’s therapeutic pipeline including its kidney cancer imaging agent, TLX250-CDx (expected in FY24), among others.
Read the latest update from Wilsons Research on TLX here.
Xero (XRO) 2% – Balancing Growth with Profits
The latest financial year (FY23) results demonstrated robust volume growth, particularly in the UK where the volume growth exceeded expectations. This was complemented by steady price growth, leading to a favourable outcome overall. The results indicated progress in achieving a balance between growth and earnings, as evidenced by the pre-announced cost base adjustment through staff count reduction. This strategic move aligns with the goal of optimising the cost structure while pursuing growth opportunities.
Multiple levers to pull
Xero (XRO) has several key levers that can potentially surpass consensus earnings, positioning the company for continued growth and profitability.
- A significant opportunity lies in cost optimisation. Currently, approximately 80% of Xero's costs are attributed to growth-related expenses. As the business matures and reaches a more stable state, these costs are likely to decrease substantially, improving margins.
- XRO has the potential to substantially increase its average revenue per user (ARPU). Presently, XRO's ARPU stands at XRO's ARPU is ~NZ$38 per month, but the company offers a range of valuable features and services that can drive higher subscription fees (especially in ANZ). The consensus estimate for ARPU growth appears conservative, failing to fully capture the potential revenue uplift from the expanded suite of offerings.
- XRO remains underpenetrated in key markets such as the UK, Europe, and the US. Despite its substantial growth and success in its home market of New Zealand and Australia there is still ample room for subscriber expansion in these regions, providing upside to consensus.
CSL (CSL) 8.5% - A Rare Downgrade
CSL has received consensus EPS downgrades of ~4% for FY23 and ~9% for FY24 in the past month after providing a trading update to the market. In the announcement, CSL re-affirmed its FY23 NPATA guidance (18% NPATA growth in constant currency terms), although revised its FX ‘headwind’ assumptions higher from US$175m to ~US$230-350m. However, the key disappointment for the market was CSL’s FY24 guidance for NPATA of US$2.8-3.01bn, representing 13-18% growth (in constant currency terms).
This was broadly in line with forecasts from the Wilsons’ healthcare team although was markedly below consensus expectations, which were unrealistically optimistic on the speed of the recovery of Behring’s gross margins (currently weighed down by elevated donor fees and labour costs) from post COVID-lows of ~49% (in 1Q23) to pre-COVID levels of ~56%.
Reality check-up
Wilsons healthcare analysts’ NPATA (constant currency) forecasts for CSL are unchanged post the trading update.
Our investment thesis for CSL remains firmly intact, with recent downgrades from the street ultimately representing a ‘one-off’ re-basing of consensus earnings expectations to more realistic levels – rather than the start of an emerging earnings downgrade cycle. Looking forward, with the market’s expectations re-anchored, we see material earnings upside from expected product launches over the medium-term (in addition to the gradual recovery in Behring’s gross margins).
CSL’s R&D pipeline offers potential earnings upside in FY24 from HemGEnix, the first ever gene therapy for Haemophilia B; while in FY25 there is potential earnings (and valuation) upside from the debut of garadacimab, a monoclonal antibody designed to treat patients with hereditary angioedema; and CS112, a novel infusion therapy used to treat cardiovascular disease.
Wilsons research remains Overweight CSL with a price target of $345, and it remains a core Focus Portfolio holding with the recent downgrades being immaterial to our favourable fundamental view of the business.
IDP Education (IEL) 2% - Changes to Canada's Student Testing Framework
In the past month, consensus EPS forecasts for IEL have been downgraded by ~1% and ~9% for FY23 and FY24 respectively. The downgrades occurred on the back of news that Canada will open Student-Direct-Stream (SDS) visas to four new English test competitors, meaning IEL’s test will no longer be the monopoly player in this market. This is a negative (although not entirely unexpected) development as IEL will lose some market share to new entrants in the Canadian market. By way of comparison, when the UK market opened up to new competitors IEL lost ~10% of its market share.
Structural tailwinds intact
Importantly, we view this as a one-off adjustment to forecast earnings – as opposed to a persistent downgrade cycle for the business – noting that Canada is the last major market to open to new competitors. Most critically, our investment thesis remains intact with IEL remaining a market leader that is poised to benefit from the long-term structural tailwinds associated with rising university participation rates, increasing student mobility and the burgeoning emerging market middle class. Even following the downgrades, consensus forecasts are still pointing to EPS growth of ~20% p.a. between FY23 and FY25, which is attractive relative to IEL’s forward PE multiple of ~37x.
Written by
Rob Crookston, Equity Strategist
Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.
About Wilsons: Wilsons is a financial advisory firm focused on delivering strategic and investment advice for people with ambition – whether they be a private investor, corporate, fund manager or global institution. Its client-first, whole of firm approach allows Wilsons to partner with clients for the long-term and provide the wide range of financial and advisory services they may require throughout their financial future. Wilsons is staff-owned and has offices across Australia.
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