Three more star stocks i like

A fund manager recently told me investing in this market felt like “flying blind”. Low earnings visibility made it near impossible to get a read on valuations.

The latest profit-reporting season, just finished, did little to clear the fog. About two thirds of companies in the ASX 200 did not issue, or continued to withdraw, earnings guidance.

The risk of prolonged restrictions in Victoria and tapering of government subsidies from late September is fuelling earnings uncertainty. Who can blame companies for not issuing guidance when the risk of ongoing COVID-19 breakouts and greater economic damage lingers?

The market rewarded companies that provided guidance. Of the 55 that did so going into the earnings season, nearly 80% posted a result in line with or more than 5% above Macquarie Wealth Management’s forecasts.

Simply, companies with greater clarity on earnings mostly beat market expectations. Many had share-price gains after their result.

Issuing guidance is no small thing. When companies disclose a range of expected earnings, they set market expectations. If that guidance is incorrect and adjustments are not disclosed, companies risk breaching continuous disclosure rules (and triggering shareholder class actions).

So, nervous boards ensured their company withdrew earnings guidance during the pandemic’s early stages and many have kept it that way. Across industry, there’s just too much uncertainty with COVID-19 on the economy and earnings.

I’m paying extra attention to companies that continue to issue guidance. Their confidence in the outlook suggests a strong business model, long-term contracts, recurring income or superior management in volatile markets.

If they were confident enough to issue guidance at the height of the COVID-19 pandemic, my sense is they will continue to have a strong FY21. Increased dividends were another good sign (I’ll cover that next week).

Here are three companies outside the ASX 100 that still have guidance in the market:

1. Nick Scali (NCK)

I have written favourably on the furniture retailer many times over the past decade for The Switzer Report. The well-run company continues to grow in good and bad markets.

Remarkably, Nick Scali is trading at a record high in the midst of a pandemic when some of its stores are shut and Victorian consumers cannot leave their homes to buy discretionary items.

The company reported underlying after-tax net profit of $42.1 million for FY20, beating guidance of $39-$40 million and matching the FY19 result. The final dividend rose 12%.

That’s an outstanding result given Nick Scali lost an estimated $9-$11 million in sales orders during temporary store closures in late March and April. Like many retailers, it has had supply-chain complications during COVID-19, reduced trading hours when stores re-opened, and it deferred two store openings. Yet earnings were unchanged over the year.

Retail bears learned a painful lesson with Nick Scali. Some consumers who still had a job spent money earmarked for travel on furniture. Others used their superannuation withdrawals to buy a new couch and pamper themselves.

Nick Scali sales orders soared more than 70% in May and June (on a comparable store basis against the same period in FY19) creating a record work pipeline.

Cost management was key. The retailer was eligible for JobKeeper wage subsidies (controversially, in light of its profits), achieved rental reductions from 85% of its landlords, and cut advertising spending. The company is well-positioned for a stronger retail recovery in 2021.

Nick Scali says profit for the first half of FY21 will be at least 50-60% higher compared to the same time in FY20. As most companies withdraw guidance, the company expects soaring profit growth (albeit because of a lower base in the first half of FY20 due to the Coronavirus).

A share price that has more than doubled since the March low reflects the company’s performance and outlook. Nick Scali is due for a share-price pullback or consolidation, but I have long thought it one the market’s best-run, highest-quality small-caps. The latest results, in a pandemic no less, confirm that.

Any sustained price weakness in Nick Scali would be a buying opportunity.

Chart 1: Nick Scali

Source: ASX

2. Arena REIT (ARF)

The owner of childcare and healthcare property has been one of my favourite niche Australian Real Estate Investment Trusts (AREITs) for years.

I like Arena’s exposure to the defensive sector and believe it is a better way to play the childcare sector than owning centre operators, given the industry’s inherent volatility.

Arena reported 29% growth in net profit to $76.6 million for FY20. The company’s net asset value rose 6% to $2.22 a security, and earnings and dividends per security were up a little.

In an AREIT market losing tenants or having to offer rent deferrals or reductions (especially in retail and commercial), Arena’s performance stands out.

All Arena properties, including in Melbourne, remain open. There could be weakness in childcare property demand if some operators close this year and next. Arena argues early-learning centres and healthcare are integral to Australia’s economic recovery – a point hard to argue with.

The company has a low gearing (14.8%) and only 9% of its FY21 revenue is unresolved with market rents being reviewed. About 20 childcare projects worth $112 million are in Arena’s development pipeline and the majority have settled.

Arena has guided for distributions of 14.4-14.6 cents in FY20 – up 3-4% on FY20. In a market where most companies are cutting dividends, Arena will appeal to income investors.

Chart 2: Arena

Source: ASX

3. ReadyTech Holdings (RDY)

I have mentioned the potential of education technology (edtech) several times in this report and have had a longheld positive view on IDP Education.

Edtech has fabulous prospects as more education at schools and in business is provided and assessed online. COVID-19 has sped up that disruptive trend as more people work and learn from home – and find it surprisingly convenient.

Edtech stocks Janison Education Group, 3P Learning and ReadyTech Holdings were highlighted in this column on August 13. 

ReadyTech, a software-as-a-service (SaaS) education provider, helps customers comply with regulatory and legislative reporting obligations, manage large numbers of students and manage payrolls. Many universities and TAFEs use ReadyTech software for student administration.

The company’s software also helps companies navigate compliance-rule changes that affect awards, annualised salaries, JobKeeper payments and other changes.

ReadyTech reported underlying earnings (EBITDA) of $15.6 million, up 21.5% in FY20. Strong revenue and cash-flow growth were other highlights.

The company said fourth-quarter FY20 business rose 55% compared to the same time in FY19. Some large contract wins boosted the result.

Like other innovative SaaS providers, ReadyTech benefits from high-margin, recurring revenue. Client retention was 95% in FY20 and 89% of all revenue was recurring.

ReadyTech said it expects FY21 revenue growth in the mid-teens and an EBITDA margin of 37-39%. Solid sales growth with high margins is a recipe to boost profits.

As I’ve written before, ReadyTech’s software is in a sweet spot of online education and compliance. The stock rallied after the result but at $1.80 is well below its 52-week high of $2.29.

Gains will be slower from here, but the market continues to underestimate ReadyTech’s potential and the prospects for listed edtech companies in Australia.

Chart 3: ReadyTech Holdings
 Source: ASX