3 cheap ASX shares owned by top-rated funds
These companies could offer good value and have the stamp of approval from Morningstar Gold Medalist equity funds.
Mentioned: Investors Mutual Concentrated Aus Share (18953), Hyperion Small Growth Companies (4242), Dimensional AUS Value Trust - Active ETF (5840), Aurizon Holdings Ltd (AZJ), Domino's Pizza Enterprises Ltd (DMP), Woodside Energy Group Ltd (WDS)
Call me nosy, but I love looking at top ten holdings. I recently looked at the biggest holdings of Morningstar Gold Medalist rated funds, hunting for shares that also command a four or five-star Morningstar rating.
Criteria 1: Gold medalist funds
Morningstar’s Medalist ratings indicate which funds and ETFs Morningstar believes are likely to outperform a relevant index or peer group on a risk-adjusted basis over time.
Funds and ETFS are evaluated on three key pillars (People, Parent, and Process). These are coupled with a fee assessment before being ranked against other funds in the same Morningstar Category, which represents funds and ETFs that follow similar investment strategies.
Criteria 2: Four or five star stocks
A four or five star rating means our analysts think that a stock is trading at an attractive discount to our Fair Value estimate. These shares may represent an opportunity if they align to your investment strategy.
I wanted these stocks to be in the fund’s top ten holdings as per June 30th according to Morningstar's data. These positions may have fallen in value or been sold since then. But it was the best way I could think of to find cheap stocks with the seal of approval from high quality managers.
Unsurprisingly, none of Mark’s latest ASX shares to avoid made the cut. So, what did?
Aurizon ★★★★
Fair Value estimate: $ 4.70
Share price on July 31: $3.69
Economic moat: Narrow
As of June 30th, rail haulage firm Aurizon (ASX: AZJ) was a 9% holding in gold medal rated Investors Mutual Concentrated Aus Share fund. This value-oriented fund takes a bottom-up approach and targets companies with competitive advantages, quality management and steady earnings streams. Our research team see it as a top pick for concentrated value and quality exposure in Australian markets.
Aurizon is a narrow-moat business operating in efficiently scaled markets. Its rail operations hold significant cost advantages over other forms of bulk commodity transportation, though the industry is highly cyclical. Coal prices have recovered but downward pressure is likely to remain on haulage rates and volumes due to intense competition.
The coal-haulage market is highly concentrated, with few competitors and a few large customers. Aurizon holds major positions in the domestic coal-haulage market (70% market share in Queensland and 30% in New South Wales). Commercial contracts, which are typically five to 12 years in length, underpin defensive revenue with customer commitment to take-or-pay (around 60%), pass-through of rail network access fees, and annual consumer price index increases. These contracts have helped insulate the firm from volatility in coal demand and supply factors to date.
Aurizon's non-coal bulk-haulage operations are typically low-margin and extremely variable, with customers based in the volatile agricultural, manufacturing and mining sectors. While a relatively large operation, the contribution to group earnings is small. Aurizon's iron ore customers are typically higher-cost juniors. The long-term outlook remains challenging for these firms, despite recent iron ore strength, as low-cost majors continue to bring on new supply, despite China slowing. Aurizon's earnings from iron ore haulage could disappear over the medium term.
Aurizon's Central Queensland Coal Network, or CQCN, provides essential transport infrastructure for the main metallurgical-coal-mining region in Australia. The CQCN is leased from the Queensland government until June 2109, with competitor access and access charges strictly regulated by the Queensland Competition Authority.
Despite being highly regulated and needing large capital investment, the CQCN is a monopolistic rail system that provides Aurizon with highly predictable long-term revenue. Typically, regulated tariffs are the main source of Aurizon's revenue from the CQCN, with the access undertaking set every three to five years. However, until 2027 network tariffs are set under an agreement with customers.
Domino’s Pizza Enterprises ★★★★★
Fair Value estimate: $58.00
Share price on July 31: $32.49
Economic moat: Narrow
Our manager research team rate Hyperion’s Small Growth Companies fund as one of the top options for Australian investors seeking small-cap growth exposure. Our analysts note Hyperion’s ability to find businesses that have genuine long-term competitive advantages that can grow into large total addressable markets.
Hyperion has also shown a willingness to look past short-term trading or share price weakness and exercise patience with its holdings. This is a quality they've probably needed for their holding in Domino’s Pizza Enterprises (ASX: DMP) recently.
DMP is the Australian master licence holder of the Domino's Pizza brand. It also has operations in New Zealand, Japan, Singapore, Malaysia, France, Germany, Belgium, Luxembourg, Taiwan, Cambodia, and the Netherlands.
The company's shares fell in July after the company announced that it plans to close some poorly performing stores in Japan and France. And this was just the latest setback for shareholders, who have endured a torrid run stretching back to 2021.
As well as concerns about a weaker consumer, cost pressures have squeezed profitability across the food service business. This has reduced profits for Domino’s franchisees, hit store openings and reduced profits at company owned locations.
July’s announcement led Morningstar's Johannes Faul to reduce his store rollout forecast by around 4%, yet he still expects the company’s global footprint to reach some 5,900 stores by fiscal 2033 – up from around 3700 today. Faul also maintained Domino’s Narrow Moat rating, citing its strong global brand recognition and valuable intangible assets in the form of internally generated intellectual property.
Domino’s is a leader in restaurant logistics and has developed technology tools that build and maintain customer engagement and loyalty. Faul thinks its investments in streamlining its cooking and fulfilment process makes it the "go-to" location for individuals who covet the fastest and most reliable service.
Faul’s Fair Value estimate of $58 per share is considerably higher than current share price levels.
Woodside Energy ★★★★★
Fair Value estimate: $45.00
Price on July 31: $27.38
Economic moat: None
As of June 30, Woodside Energy (ASX:WDS) comprised around 6% of Dimensional’s Gold Medalist rated Australian Value Trust. Like other offerings from Dimensional, the Australian Value Trust employs factor tilts grounded in the research carried out by Eugene Fama and Kenneth French. From a starting point of the ASX’s cheapest 45% of stocks by book value, further value, size, and profitability factors are applied.
As Australia's premier oil player, Woodside Petroleum's operations encompass liquid natural gas, natural gas, condensate and crude oil. However, LNG interests in the North West Shelf Joint Venture, or NWS/JV, and Pluto offshore Western Australia are the mainstay, and the low-cost advantage of these assets form the foundation for Woodside. Future LNG development, particularly relating to the Pluto project, encompasses a large percentage of this company's intrinsic value.
Morningstar's Mark Taylor sees Woodside as being unique among Australian energy companies in that it has successfully managed the development of LNG projects for more than 25 years—unparalleled domestic experience at a complicated and expensive task.
Adding to Woodside's competitive advantages are the long-term 20-year off-take agreements with the who's who of Asia's blue chip energy utilities, such as Tokyo Electric, Kansai Electric, Chubu Electric, and Osaka Gas. These help ensure sufficient project financing during development and should bring stability to Woodside's cash flows once projects are complete.
Woodside's development pipeline is deep, enabling it to leverage the tried and trusted project-delivery platform as a template for other world-class gas accumulations off the north-west coast of Australia. Gas is the fastest growing primary energy market behind coal and the seaborne-traded LNG portion of that gas market grows faster still. Woodside is well suited to the development challenge. With extensive experience, it remains a stand-out energy investment at the right price.
Terms used in this article
Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.
Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.
Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.
Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.