6 top-returning stocks of FY19

Mining and materials, financials, technology and other sectors feature in this list of Morningstar-rated ASX 200 companies that delivered the highest total returns in fiscal 2019.

Australian shares approached record highs earlier this month, as the All Ordinaries and S&P/ASX200 indices closed in on their previous high-water marks of 6593.6 and 6,533.1 points set in November 2007. They were each up just under 13 per cent in the year ended 30 June 2019.

Meanwhile, the S&P/ASX00 Accumulation Index – which Morningstar director of equities research Peter Warnes singles out as the best benchmark for measuring total shareholder return – has been breaking records for some time.

In the year ended 30 June, this index was up 11.5 per cent, slightly below the 13 per cent increase of a year earlier.

Source: Morningstar Direct

The stocks in the above table were identified using Morningstar's total return metric from our Direct database of companies under research coverage.

In addition to share price changes over the last 12 months, total return considers – where applicable – all income and capital gains distributions during the period.

In this commentary, we focus on six of the 10 stocks that stood out in fiscal 2019.

Comparing apples with kangaroos

There is an important caveat here investors should keep in mind: past performance is no guarantee of future returns. While this can sometimes be dismissed as a cliched disclaimer, Morningstar's head of equities research for Australasia Adam Fleck explains why it is so crucial.

"Historical returns are interesting, but they need to be compared and contrasted. The one- and two-star stocks in here - despite the fact they've done well over the last 12 months, doesn't necessarily mean they'll continue to do so," Fleck says.

He stresses the point that past performance has no bearing on Morningstar's equity analysis: "Our star ratings and past performance are about as related as apples and kangaroos."

Ore price takes Fortescue Metals Group to the top

Mining company Fortescue (ASX: FMG) tops this list of total returning stocks over the financial year, largely on the back of a buoyant iron ore price, which is benefiting from unusually strong demand.

Trading at a share price of $8.80 at 1pm Wednesday, it is still around 20 per cent above Morningstar's fair value estimate of $7.10, as set earlier this month.

"The global miners remain overvalued,” says Morningstar senior equity analyst Mathew Hodge.

“The sector trades at an average 10 per cent premium to our fair value estimates, versus a 20 per cent premium three months ago."

"We’ve raised our near-term iron ore forecasts meaningfully given higher spot prices, stronger near-term demand from China and potential for Vale’s supply issues to persist, but our long-term price is unchanged."

The deadly collapse of a Vale-owned tailings dam in south-eastern Brazil earlier this year also caused shortages, which pushed up the iron ore price. This subsequently led to share price gains for Fortescue over the past year, says Hodge.

Another price driver has been strong demand from China.

"China is again pushing infrastructure investment to stabilise soft economic growth, to the benefit of steel and iron ore demand.”

Steel production in China grew 10 per cent in the 12 months up to May 2019, while production elsewhere was flat.

Magellan’s reputation reaps dividends

Magellan Financial Group (ASX: MFG) comes in at second place, its share price having risen to $59.52, from $24.68 one year ago.

This uplift has been driven largely by the high growth of new investor money the fund manager attracted in the first four months of 2019.

In response, Morningstar lifted its fair value estimate to $37.50 a share in May, from $29.
At the time, Magellan's share price was trading at a price-to-earnings multiple of 22.5 times – which has lifted higher still to around 28-times since then.

"The firm’s proven ability to generate above-market returns, with relatively lower volatility and drawdowns than most competitors along with an effective distribution team has helped establish a strong reputation among investors," says Morningstar equity analyst Chanaka Gunasekera.

However, he points to the high PE multiple as proof this positive sentiment is already priced into the stock.

Gunasekera also points to a shift in new investor money, which has tended to be retail in the past but is expected to increasingly come from institutional sources.

"While we expect this mix in favour of institutional inflows should see a reduction in margins in fiscal 2019, this should be more than compensated by the enormous circa $12.45 billion increase in FUM from both net inflows and fund performance in the first four months of the year."

The following chart shows how a $10,000 investment in the three top-returning stocks from the table above would have performed over fiscal 2019, relative to the S&P / ASX200 benchmark.

Growth of $10k invested 1 July 2018 - 30 June 2019

Source: Morningstar Direct

Technology One surprises on the upside

In third position is software developer Technology One (ASX: TNE), whose share price has risen by more than 130 per cent since July 2018.

Morningstar equity analyst Gareth James believes this rally is unjustified, even considered alongside the progress Technology One's management has made after several considerable challenges during 2018. These included a contract dispute with Brisbane City Council, disgruntled former employees and the appointment of a new CEO.

At 1pm on Wednesday its share price was $7.74 - up 57 per cent from 12 months earlier. It is currently trading at a 25 per cent premium to Morningstar’s fair value estimate of $6.20.

"But Technology One remains a high-quality company and one with an enviable track record of growing profits and dividends, and we maintain our Exemplary Stewardship rating," James says.

He also highlights the company's customer retention rate of around 99 per cent and transition toward a software-as-a-service business model.

"This should not be underestimated, because recurring revenue is worth far more than revenue, which must be won from scratch each year," James says.

If Technology One has a weakness it is its ability to attract new customers, James says.

“However, this is unlikely to be an issue in the short- to medium term because the transition of existing customers to SaaS contracts should create savings for customers and increase the opportunity to upsell additional software modules."

Falling rates provide listed property tailwind

Other notable inclusions in this list are Charter Hall Group (ASX: CHC)  and Goodman Group (ASX: GMG). As listed property companies, they're generally regarded as defensive, income-generating stocks rather than growth plays – but falling interest rates have been a tailwind for them in recent months.

From $9.63 on 1 July, Goodman's share price has risen 57 per cent to $15.20 by midday on Wednesday.

Similarly, Charter Hall's share price of $11.69 at the time of writing is up from $6.69 a year earlier. A jump of 74 per cent.

But both are considered overvalued by Morningstar equity analysts, largely because they believe current share prices don't reflect the considerable risk posed by deteriorating global economic conditions. This would reduce demand for industrial property, and affect the pipeline of development projects and rental growth.

Telstra: undervalued outlier

Telstra (ASX: TLS) is the only stock on the list trading at a discount to Morningstar's fair value estimate.

The telecommunication giant's share price of $3.79 at midday Wednesday is slightly below the fair value estimate of $4.40 set by Morningstar's Brian Han in mid-March.

"Market scepticism regarding the sustainability of Telstra's dividends remains a roadblock to its shares reaching our $4.40 fair value estimate. We are not as concerned," Han says.

Conceding there is much "heavy lifting" ahead as Telstra seeks to transform itself, Han understands the negative investor sentiment, but not the scepticism around Telstra's ability to sustain dividends over the medium-term.

"Beyond fiscal 2022, we admit there is a leap of faith required,” he says.

"We have taken that leap and believe Telstra will be successful in cutting its underlying fixed-cost base by $2.5 billion, from the fiscal 2016 base of $7 billion to $4.5 billion by the end of fiscal 2022."