Big four, Telstra back in vogue for this fund manager
Sean Martin tells Morningstar why it’s time to rethink the fortunes of two pillars of the ASX.
Mentioned: ANZ Group Holdings Ltd (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank Ltd (NAB), Telstra Group Ltd (TLS), Westpac Banking Corp (WBC)
The big four banks and Telstra have been in the doghouse with value investors over the past couple of years, for justifiable reasons. The increasingly competitive landscape in the telco industry and regulatory concerns threatening financial institutions have spooked investors.
But for the first time in five years, Sean Martin, chief investment officer at Solaris Investment Management, says he's ready to bet on Telstra (ASX: TLS) again. He's also been stunned by the resilience of Australia's big four banks.
Martin told the Morningstar Investment Conference last week that his outlook had changed.
"Two, three years ago I would have said there's no chance that we were going to go in that direction," he said. "[Both stocks] have fallen a long way, and at the same time the market has gone a long way north. We find both those areas relatively attractive."
Martin said major shifts in the telco competitive landscape has made Telstra an attractive buy.
He said the "ban" on Chinese telco giant Huawei had hurt two of Telstra's competitors, Vodafone and TPG, who were ready to use Huawei technology for their 5G rollout.
"Telstra now has a lead on the back of that," he said. "TPG has now abandoned its mobile attack, so the industry structure for the first time in as long as I can remember has actually gotten a little bit better – and it's occurred while the balance sheet looks all right.
"It's not the sexiest idea we've ever put in the portfolio, but at these valuations levels for both the market and for Telstra with that dynamic – we're quite happy there."
Martin said he had been critical of Telstra's prospects because of the competitive landscape, but that this had since changed.
"TPG had a $2 billion assault on the mobile market; Vodafone – for 25 years threw good money after bad in this country and seemed addicted to losing money in Australia; and Singtel Optus was equally ferocious competition without much reward," he said.
"So that's a pretty ugly scenario for an incumbent to compete against."
Last year the Australian government blocked companies from building 5G networks using of equipment made by Technologies on national security grounds. This led to TPG in January abandoning the rollout of its own mobile telecoms network in Australia.
Then, last month, the Australian Competition & Consumer Commission inadvertently announced its decision to oppose the $15 billion merger of Vodafone Hutchison Australia and TPG Telecom, citing concerns that it would substantially lessen competition in the supply of mobile services.
Morningstar equity analyst Brian Han has been bullish on Telstra since early-2017, applying a target value of $4.60. The stock hit lows five-year lows of $2.62 in June 2018 but is currently trading around $3.62.
Han has long contended that long term Telstra will maintain its dominant market position in the industry.
"We do see Telstra maintaining its dominant market position in the telecom industry because it is investing to maintain its network advantage and we do believe longer-term there are potential for 5G to bypass the unsustainable economics of nbn and make it more profitable for Telstra to gain subscribers and customers."
Also speaking at the conference, Brad Potter, head of Australian equities with Nikko Asset Management Australia did not disagree with Martin's assessment of the telco industry, but said the shift wasn't enough for them to buy into Telstra.
"We sold out of Telstra when TPG announced they were moving into mobile – that was the last straw in that. Since we're struggled with the valuation with Telstra."
Big four shake off regulatory risk
The Big Four banks – Commonwealth Bank (ASX: CBA), National Australia Bank (ASX: NAB), Australia and New Zealand Banking Group (ASX: ANZ) and Westpac (ASX: WBC) – also features in Solaris's fund after previously being underweight.
Martin said he's been "stunned" at the "lack of disruption" which has occurred within the industry.
"Where are the fintechs? Where are the regionals? I mean these brands have been hammered more then they possibly ever have in our generation on the back of regulatory attacks and from the Royal Commission," he said.
"Our share of the major banks is now as high as ever."
Potter said his fund is also overweight the banks. Potter agreed the operating environment for the banks has markedly improved.
"Certainly the tail risk has been removed now that the we've got a Coalition government in place; the RBA looks like it's about to do a number of rate cuts which will help; and the fact that house prices declines have started to slow, which I suspect it will bottom out this year, is only a good thing," he said.
"Certainly, the tail risk has left in the meantime."
CBA, Westpac and NAB have been undervalued in Morningstar senior equity analyst David Ellis's view since mid-2018. Commonwealth is now trading within a range which he considers fairly valued but NAB and Westpac remain undervalued – 12 per cent and 11 per cent respectively. Westpac remains Morningstar's prefered major bank.