INSIGHTS

For some years, the New Zealand Herald has asked the major broking firms to nominate five companies on the NZX they think will do well in the year ahead. The tradition is an interesting way to gain some insights into what investment teams are expecting. Here, we outline the five stocks we picked for 2018, and why they fit nicely into our New Zealand equity investment strategy for the coming year.

But first, how did we do last year?

Our five companies were:

1. Contact Energy (+30.4%)
2. Fonterra (+14.3%)
3. Gentrack (+94.2%)
4. Mainfreight (+24.8%)
5. Restaurant Brands (+43.6%)

Of the eight participants in 2017, we came in third place with a respectable overall gain of 41.5%. This compares very well with the 23.7% return for the NZX 50. Our conservative approach rarely lends itself to coming first in a contest like this. To achieve that, you often need to take more risk than we are comfortable with. We make no apologies for that, as minimising volatility and sticking to quality are key tenets of our philosophy. Pleasingly, none of our five stocks suffered a negative return. Only two other participants achieved that. We also experienced the smallest variation between our best and worst performer, making for a very consistent set of returns. On balance, a satisfactory outcome overall.

Our brief thoughts on the backdrop for 2018

The economy is in good shape, although the pace of growth will slow this year as some of our tailwinds lose a bit of steam. We think it will be a more difficult year for investors, with higher volatility and more modest returns. Opportunities still exist, but investors need to be more selective. We’re targeting companies with a clear growth strategy, enough defensive attributes to withstand a slower economy, pricing power to handle an increase in inflation or interest rates, some international exposure in case we see the NZ dollar weaken, and a sustainable dividend yield.

We don’t expect a repeat of 2017 for the local sharemarket

The NZX 50 did 23.7% during the last year for this exercise, which is the best return we’ve seen in five years. Part of the reason for this is because NZ shares suffered a 13% correction in late 2016, so it’s a little misleading and much of this year was simply a rebound from that sell-off. However, it’s still a great performance and one that is certainly above the long-term average. Over the past 20 years NZ shares have delivered a return of 9.2% per annum, with two thirds of that coming from dividends. We think investors would be wise to expect something in the high single digit range (in terms of total return), rather than expecting another year that looks as impressive as 2017 was.

So what are our five stocks for 2018

a2 Milk (ATM)
It would’ve been nice to have picked a2 Milk this time last year, but few people saw such a staggering return coming. While some might recoil when looking at the share price chart for ATM, the fact is that a fair chunk of the gains have been driven by fundamental improvements in the business. In 2014 ATM generated EBITDA of just $3.6m, and in 2017 this increased to $141m. This is expected to grow even further, with EBITDA of more than $250m expected in the coming year. While the share price has had a stellar run, those sorts of gains in underlying earnings justify the move.

Mainfreight (MFT)
A great quality company with a strong record of earnings growth and shareholder returns. Two thirds of revenues are from offshore, including a reasonable exposure to Europe where economic activity has been exceptionally strong.

Meridian Energy (MEL)
MEL has very high quality assets, and is likely to be resilient during challenging economic conditions. This company has pricing power and an element of inflation protection, which makes the highly attractive gross dividend yield of 8.8% sustainable with steady prospects for growth.

Restaurant Brands (RBD)
A well-managed business that tends to perform well through all stages of the economic cycle. RBD has approximately 44% of revenues from outside New Zealand, which provides some insulation from a potentially slower economy, the benefit of any NZ dollar weakness, as well as a number of international growth opportunities.

Tourism Holdings (THL)
The tourism sector remains in very good shape, despite some capacity issues in places like Queenstown. THL is also a vastly different company than it was ten years ago, with management having made a lot of progress in reshaping the business and positioning it for growth. More than half the company’s revenue comes from outside New Zealand, so it also fits the bill for us in terms of global growth options and some international diversification.