A positive outlook for an earnings recovery has led investment bank Morgan Stanley to choose a selection of blue-chip stocks from three market sectors — global leaders, the housing-led upturn, and resource game-changers. This outlook is based on the following investment themes:
- The falling Australian dollar
- Record-low interest rates
- Stabilising commodity prices and rapid volume growth
- Cost-cutting
- Improving non-resources growth
Global leaders: These companies benefit greatly from a declining Aussie dollar. In fact, if the foreign earnings of Australia's 15 largest multinationals experience a 10% currency decline, more than $1 billion is added to earnings for those stocks (or approximately 8% earnings upside). The stocks chosen in this category are Brambles (ASX: BXB), Amcor (ASX: AMC), Ansell (ASX: ANN) and James Hardie (ASX: JHX). Another tailwind for this group is the labor cost containment, arising from Australia's subdued labor market.
Australia's housing-led upturn: This group accounted for three of the 12 stocks and were also beneficiaries of the subdued labor market cost effect. A strong rebound in housing activity and a moderate improvement in consumer spending led to the selection of Stockland (ASX: SGP), Lend Lease (ASX: LLC) and James Hardie.
Resources boom game-changers: In general terms a 10% decline in the Aussie dollar, lifts profits for the sector by $6.25 billion. Specifically, for Rio Tinto (ASX: RIO), BHP Billiton (ASX: BHP), Fortescue Metals Group (ASX: FMG) and Santos (ASX: STO), the FY2014 net profit after tax impact is 11%, 8%, 12% and 14% respectively.
All of these stocks, along with Oil Search (ASX: OSH), are benefiting from low borrowing costs that increase free cash flow. One example is Fortescue, which has recently repaid US$3.1 billion of debt and refinanced much of its outstanding debt, saving an estimated US$300 million.
Looking ahead, in the short-term stronger global growth should help stabilize, and even lift commodity prices. At the same time, resource companies are increasing production. This is shown by the dramatically increasing iron ore export volumes and the projected boom in LNG export volumes in 2014-15.
Finally, by way of example, Rio Tinto exceeded its US$2 billion operating cost-cutting target, while also reducing exploration spending by more than US$1 billion.
Foolish takeaway
It is always instructive to look at potential investment themes and stocks that would benefit accordingly.
However, my personal preference is for stocks that are all-weather performers with company-specific tailwinds. Although very recent, the research seems to have been written prior to the emerging markets effect on world markets. On that basis, I would be wary of reduced world growth projections affecting resource companies. A wait-and-see approach to companies with significant earnings from those regions (such as Brambles, Amcor and Ansell) would also be prudent.
