Chart of the week: Blue chips look expensive, more opportunities in smaller caps
This week's chart comes from the Australian equity market outlook for Q4.
Mentioned: ANZ Group Holdings Ltd (ANZ), CSL Ltd (CSL), IGO Ltd (IGO), Mineral Resources Ltd (MIN), New Hope Corp Ltd (NHC), Santos Ltd (STO), Telstra Group Ltd (TLS), Whitehaven Coal Ltd (WHC), Woodside Energy Group Ltd (WDS)
This week's chart comes from Morningstar's latest Equity Market Outlook report. The 60 page report delvs into the market and economic outlook, valuation overview for the Australian market and a deep dive into our top picks for each sector.
One chart from our Equity Research team focuses on the performance of the Small Ordinaries (the top 101-300 companies by market capitalisation) against the top 20 stocks by market capitalisation in Australia.
The rally of the top 20 reflects materials rallying the stimulus news. Iron ore leaped to USD 110 per metric ton at the end of September, from USD 90 only weeks earlier and well above our long-term assumption of USD 70 per metric ton.
Accordingly, the materials sector, dominated by iron ore miners, trades at a 5% unweighted premium to fair value—not as expensive as financials, but still overvalued. But some of our resources coverage still looks attractive, including lithium plays IGO IGO and Mineral Resources MIN (we recently wrote about MIN here).
Energy trades at the biggest discount of all sectors, roughly 25% below fair value. Coal miners Whitehaven WHC and New Hope NHC look cheap, as do Woodside and Santos STO, the latter trading at almost half our fair value estimates.
The divergence between large and small caps is stark. The 20 largest stocks on the ASX, which account for almost 60% of the benchmark S&P/ASX 200 index, trade at a premium of nearly 12%. Very few large caps trade at a discount, except for Santos STO, Woodside WDS, Telstra TLS, and CSL CSL.
ANZ ANZ is the only major bank close to fairly valued. For small caps, almost 40% of our coverage trades in 4- or 5-star territory, and most fall outside the S&P/ASX 100.
In 2022, when recession fears were building, many smaller names were cast off in a flight to quality and still haven’t caught up to their larger peers. We think this end of the market can do well if the Reserve Bank of Australia can take some of the economic risk off the table by sticking a soft landing.
