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Merck MRK High-Margin Drugs and Vaccines

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Management expects Organon, after it’s spun off in the second quarter, “to pay a meaningful dividend that will be entirely incremental to that of Merck.” It also intends to keep Merck’s payout ratio in the 47%–50% range. Based on consensus earnings for 2021 and 2022, Merck should be able to maintain solid dividend growth while remaining within that range.

“Merck’s combination of a wide lineup of high-margin drugs and vaccines along with a pipeline of new drugs should ensure strong returns on invested capital over the long term. Merck is well positioned to gain further entrenchment in immuno-oncology with Keytruda, which holds a strong first-mover advantage in the large first-line non-small-cell lung cancer market with excellent data. Also, we expect Keytruda to gain ap-provals in early-treatment settings, which should open up underappreciated sales potential.

“Merck’s vaccines look ready to drive further gains, led by human papillomavirus vaccine Gardasil, which continues to generate excellent clinical data. While the firm’s late-stage pipeline lacks several new blockbusters, we expect early-stage assets focused on cancer to move through trials rapidly.

Even though Merck faces some patent losses over the next five years, including diabetes drug Januvia, we expect new drug launches and gains from currently marketed products to more than offset generic competition.

Merck & Co., Inc., d.b.a. Merck Sharp & Dohme outside the United States and Canada, is an American multinational pharmaceutical company headquartered in Kenilworth, New Jersey. It is named after the Merck family, which set up Merck Group in Germany in 1668. Merck & Co. was established as an American affiliate in 1891. 

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Technology Stocks

Dell Posts Strong First Quarter and Capitalizes on Digitalization-Induced Demand

We are encouraged by Dell’s broad-based expanding addressable markets, as the company continues to benefit from accelerated trends toward digitalization, remote working and learning environments, and cloud-based infrastructure. We believe the secular trends of organizations accelerating the adoption of digitalization, cloud-based infrastructure, and facilitating remote working and learning environments, are aligned with Dell’s core capabilities, and the company is executing well. With shares trading in the mid- to high $90 area, we continue to view shares as slightly overvalued.

First-quarter revenue grew 12% year over year to $24.5 billion, led by CSG’s 20% year-over-year revenue increase to $13.3 billion. CSG continues to heavily benefit from high demand for computers to enable remote learning and work. CSG’s consumer business contributed significantly to the group’s success, up 42% year over year, capitalizing on ecommerce and digital entertainment accelerations. ISG revenue grew 5% year over year to $7.9 billion as demand for hybrid cloud solutions continues to increase. ISG’s growth was led by server’s revenue, up 9% year over year. VMware revenue increased 9% annually to $3 billion.

Guidance for the second quarter includes sequential revenue growth that is expected to be less than the historical 6% increase and a low- to mid-single-digit sequential decline in adjusted operating income as costs return after pandemic-related savings.

Dell continues to place emphasis on deleveraging its balance sheet, committing to a target of at least $16 billion in debt reduction for the full year. Management remains confident that the completion of VMware’s spin-off in the fourth quarter will help the company achieve an investment grade rating.

Dell Technologies Company Profile

Dell Technologies, born from Dell’s 2016 acquisition of EMC, is a leading provider of servers and storage products through its ISG segment; PCs, monitors, and peripherals via its CSG division; and virtualization software through VMware. Its brands include Dell, Dell EMC, VMware (expected to be spun off toward the end of 2021), Boomi (expected to be sold by the end of 2021), Secure works, and Virtustream. The company focuses on supplementing its traditional mainstream servers and PCs with hardware and software products for hybrid-cloud environments. The Texas-based company employs around 158,000 people and sells globally.

Source: Morningstar

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Dividend Stocks

Coach’s Enduring Popularity Provides Stability as Tapestry Establishes Its Acceleration Program

Due to the pandemic, all three of Tapestry’s brands suffered sales and operating profit declines in fiscal 2020, but its results are improving rapidly in fiscal 2021 as it implements its three-year Acceleration Program strategy to cut costs and improve margins.

Coach shares many of the qualities of other luxury brands per the Morningstar Luxury Brand Power Framework and, therefore, has the brand strength and pricing power to continue to provide a narrow moat for Tapestry. Coach struggled with excessive distribution and competition in the past, but we think Tapestry has turned it around through store closures, restrictions on discounting, and increased e-commerce, which has grown by triple-digit percentages during the pandemic. Further, we expect growth in complementary categories like footwear and fashion. We anticipate China to be a key growth region for Coach as, according to Bain & Company, Chinese consumers will compose 46% of the worldwide luxury goods spending in 2025, up from 35% in 2019. We forecast Coach’s greater China sales will increase to nearly $1.2 billion in fiscal 2030 (21% of sales) from $601 million in fiscal 2020 (17% of sales).

We do not believe the acquisitions of Kate Spade and Stuart Weitzman contribute to Tapestry’s moat. Spade was a natural fit for Coach as both generate most of their sales from Asia-sourced handbags. However, Spade merchandise is priced lower than Coach and lacks its international reach. Still, we think Spade can grow in both North America and Asia through store openings and new products, such as shoes (currently licensed). Tapestry has a stated goal of $2 billion in Spade revenue, which we forecast will not be achieved until fiscal 2030. As for Stuart Weitzman, while its women’s shoes achieve luxury price points, we view it as a niche brand (less than $300 million in fiscal 2020 sales) with fashion risk. Stuart Weitzman is struggling so much that Tapestry recently wrote off all the goodwill and intangibles related to its purchase and is downsizing its store base.

Real Value and Profit Maximisers

We are raising our per share fair value estimate on Tapestry to $43.50 from $40.50, which implies a fiscal 2022 P/E of 13 and an EV/EBITDA of 8. The COVID-19 pandemic forced the temporary closure of Tapestry’s stores and continues to affect consumer spending on accessories and apparel in some regions. However, Tapestry’s third quarter of fiscal 2021 was better than expected as e-commerce and strong sales in mainland China (up more than 40% as compared with two years earlier) partially offset store disruptions. Given this momentum, we have raised our fiscal 2021 sales growth and adjusted operating margin expectations to 14.7% and 19.0%, respectively, from 9.8% and 17.8%.

We now forecast adjusted EPS of $2.94, up from $2.64 previously. For fiscal 2022, we estimate EPS of $3.23 (up from our prior estimate of $2.80) on 7% sales growth.

Tapestry has started its three-year Acceleration Program to boost sales and profits. This program, which includes store closures and cost cuts, could reduce sales of Kate Spade and Stuart Weitzman in the short term. We project sales growth rates of 20% and 4.1% for Coach and Kate Spade, respectively, in fiscal 2021, but a decline of 7% on permanent store closures for Stuart Weitzman in Europe and Asia (excluding China).

We forecast selling, general, and administrative expenses as a percentage of sales for Tapestry of around 51% in the long term. While we expect the firm will achieve some expense savings under the Acceleration Program, we also think it will invest in advertising and other selling expenses to support each of its brands. As sales shift rapidly to digital channels, we expect only moderate increases in individual brand store bases over the next decade. We anticipate little or no store growth in North America, but some expansion in China and other international territories. At the end of fiscal 2030, we forecast Tapestry will operate 959 Coach stores (958 at fiscal 2020), 561 Spade stores (420 at fiscal 2020), and 173 Weitzman stores (131 at fiscal 2020). We have raised our long-term tax rate to 19.0% from 16.5% in anticipation of a possible increase in the U.S. corporate tax rate.

Tapestry Inc’s Company Profile

Coach, Kate Spade, and Stuart Weitzman are the fashion and accessory brands that comprise Tapestry. The firm’s products are sold through about 1,500 company-operated stores, wholesale channels, and e-commerce in North America (62% of fiscal 2020 sales), Europe, Asia (32% of fiscal 2020 sales), and elsewhere. Coach (71% of fiscal 2020 sales) is best known for affordable luxury leather products. Kate Spade (23% of fiscal 2020 sales) is known for colourful patterns and graphics. Women’s handbags and accessories produced 68% of Tapestry’s sales in fiscal 2020. Stuart Weitzman, Tapestry’s smallest brand, generates nearly all (98%) of its revenue from women’s footwear.

Source: Morningstar

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Dividend Stocks Shares

ViacomCBS Poised to Capitalize with Paramount+; International Streaming Expansion Key to Growth

The flagship service offers not only a strong on-demand library from the firm’s deep library but also access to CBS and its wealth of sports rights including the NFL and March Madness which helped to drive streaming growth over the first four months of 2021. With the recent renewal of the Sunday afternoon NFL rights, ViacomCBS now controls two of its most important sports rights into the next decade.

Like its larger peers, Netflix and Disney+, we expect that Paramount+ and Pluto will both benefit from international expansion. While the rebranded flagship service launched in 23 international markets in March including 18 in Latin America, the service has yet to launch in most of Europe, the largest non-U.S. market for Netflix, or India, the biggest international market for Disney+. Given the opportunity internationally and the relatively low guidance of 65-75 million subscribers by 2024, we think it’s likely that management raises the guidance in the next two years similar to the increase that Disney management made in December 2020.

In order to support the streaming growth, we project that ViacomCBS will continue to invest in content creation for the linear networks, theatrical slate, and the streaming platforms. Additionally, we expect that the firm will likely exceed its minimal target of $5 billion in streaming content spending as it ramps local language content to better compete with Disney+ and Netflix around the world. This spending will not help to drive subscription revenue but also ad revenue for both the lower-priced ad-supported tier and Pluto.

ViacomCBS Inc’s Company Profile

ViacomCBS is the recombination of CBS and Viacom that has created a media conglomerate operating around the world. CBS’ television assets include the CBS television network, 28 local TV stations, and 50% of CW, a joint venture between CBS and Time Warner. The company also owns Showtime and Simon & Schuster. Viacom owns several leading cable network properties, including Nickelodeon, MTV, BET, Comedy Central, VH1, CMT, and Paramount. Viacom has also built several online properties on the strength of these brands. Viacom’s Paramount Pictures produces original motion pictures and owns a library of 2,500 films, including the Mission: Impossible and Transformers series.

Source: Morningstar

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Technology Stocks

Narrow-Moat Splunk Continues to See Cloud-Transition Linked Uncertainty; Lowering FVE to $164

As a result, we are lowering our fair value estimate for Splunk to $164 from $212, but continue to view shares as undervalued at the moment. In spite of increased uncertainty, the cloud transition continues at a solid pace, with over 50% of software bookings coming from the cloud. We expect sustained cloud penetration, a growing robust product suite, and strong execution to lead to healthy long-term growth.

First-quarter revenue increased 16% year over year to $502 million. After several quarters of declines in the top line as a result of the cloud transition, accelerated adoption of Splunk’s robust product suite, as well as growing cloud traction have resulted in revenue growth once again. As cloud revenue is recognized ratably over time rather than up-front (as with term licenses), Splunk has been facing top line pressure for some time. This has been compounded by falling contract durations as a result of macroeconomic uncertainty and growing cloud demand. However, as we predicted, Splunk is now exhibiting growth in the latter part of the transition, and we expect this to persist in the future. First-quarter cloud revenue grew 73% year over year to $194 million, with cloud annual recurring revenue, or ARR, up 83% over the same period. This contributed to a 39% increase in total ARR. Even though management has withdrawn some long-term targets, healthy growth in cloud adoption has Splunk still on track to wrap up the cloud transition sooner than previously expected.

During the quarter, Splunk acquired TruSTAR, a cloud-based security threat detection and response solution. We believe this should augment Splunk’s security solutions by incorporating additional solutions into its already robust security product set and augmenting demand for the security buying center. The firm also rolled out the Splunk Observability Cloud, enabling businesses to use a unified platform to address a wide range of observability use cases. In addition, Splunk announced the appointment of Teresa Carlson in the position of President and Chief Growth Officer. In terms of guidance for the second quarter of fiscal 2022, management expects revenue between $550 million and $570 million, up approximately 14% at the midpoint. NonGAAP operating margins are expected to be negative 25%, reflective of the cloud transition and greater investments into the firm’s platform. While management did not provide full-year guidance, we expect the firm to successfully complete its shift towards the cloud and support healthy top-line growth in the future.

Splunk Inc’s Company Profile

Splunk provides software for machine log analysis. Its flagship solution, Splunk Enterprise, is employed across a multitude of use cases, including application management, IT operations, and security. The company has historically deployed its solutions on-premises, but the software-as-a-service delivery model is growing in popularity with Splunk Cloud.

The company derives revenue from software licenses, as well as cloud subscriptions, maintenance, and support.

Source: Morningstar

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Technology Stocks

Guidewire’s Cloud Is Gaining Steam; Initial Fiscal 2022 Outlook Is Constructive; Maintain $116 FVE

investment stockbroker risk analysis. Financial analysis using phone app and laptop. Market trading profit.

Overall, the firm saw 12 go-lives on 30 different products, with cloud momentum continuing. We continue to believe Guidewire turned the corner in terms of product development, customer references, and new deal activity beginning in the January quarter. We also get the sense the services business is once again on a smooth track. Management also provided a preliminary outlook for fiscal 2022 that was perhaps a little light on total revenues, which is likely due to conservatism and is fairly consistent with our model. We expect Guidewire will be the primary winner as the P&C insurance industry continues to modernize. We are maintaining our fair value estimate of $116 per share and see shares as increasingly attractive as the software group has sold off thus far in 2021.

Third-quarter revenue declined 2% year over year to $164 million, compared with the high end of guidance of $159 million and FactSet consensus of $158 million. Compared with our model, subscription and support was well ahead, while services were slightly ahead, and license lagged. Data and analytics remain strong. ARR grew 11% year over year to $538 million in the quarter, which is consistent with the firm’s full-year ARR growth outlook.

Based mainly on a better outlook for subscriptions and services, Guidewire raised its full-year guidance to $735 million and $17 million at the midpoints for revenue and non-GAAP operating profit, respectively, from $729 million and $6 million. We continue to see guidance as conservative, especially for operating profit and particularly given upside this quarter, and we note that our model is just under the high end of guidance.

Management also provided some preliminary guidance for fiscal 2022. Key points here include total revenue growth of 3% to 5%, non-GAAP operating margin expansion, and ARR growth of 12% to 14% from the midpoint of the fiscal 2021 outlook. We view this outlook as a conservative preview for next year that is largely consistent with our model–although we did lower our revenue growth outlook by approximately 150 basis points.

Non-GAAP operating margin was negative 9.9% in the quarter, compared with 3.4% last year, which was significantly better than the negative 17.2% at the midpoint of guidance. Higher revenue and a slower-than-anticipated pace of hiring drove overall margin upside. Despite better than-anticipated margins, the ongoing shift to cloud deals continues to pressure margins year over year. Ultimately, we see nothing within results that impact our long-term operating margin outlook and expect steady improvement over time. Granted, we still see continued margin pressure over the next several quarters due to the model transition.

Guidewire Software Inc’s Company Profile

Guidewire Software provides software solutions for property and casualty insurers. Flagship product InsuranceSuite is an on-premises system of record and comprises ClaimCenter, a claims management system; Policy Center, a policy management system including policy definitions, quotas, issuance, maintenance, and renewal; and Billing enter, for billing management, payment plans, and agent commissions. The company also offers insurance Now, a cloud-based offering, as well as a variety of other add-on applications.

Source: Morningstar

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Commodities Trading Ideas & Charts

Oil Market Update: Recovery progressing nicely.

Meanwhile, vaccination rates continue to rise in much of the developed world, where a nearly normal summer seems to be in the works. As such, our forecast for a full recovery in demand in 2022 looks safe.

At the same time, supply remains constrained. OPEC has reiterated its plan to bring back volumes in a measured way, which should allow for a resumption of Iranian volumes if a deal is reached to do so. In the United States, public companies have not shown a willingness to increase spending, meaning volume growth will remain tepid. The combined effect is a continued drawdown in inventories over the next 18 months. The market seems to agree, having pushed Brent prices back to $70/barrel. As supply typically lags demand, prices could be headed higher.

  • We have slightly lowered our 2021 demand forecast to account for India, but 2022 demand remains unchanged and above 2019 levels. In 2023, we expect record-high global oil demand of 101.7 million barrels a day.
  • At its June 1 meeting, OPEC+ reaffirmed planned supply additions of 350 thousand b/d in May, 350 mb/d in June, and 450 mb/d in July as it remains cautiously optimistic for a rear-end 2021 recovery.
  • The U.S. rig count increased in May to 372, twice the number in mid-August last year, but even with West Texas Intermediate crude prices approaching $70/bbl, further additions will be limited.

OPEC Wary of Pandemic Setbacks but Goes Ahead With Planned Increases

OPEC+ reaffirmed that it will proceed with the easing of production cuts that it proposed the meeting prior. The cartel will go forth with its planned additions of 350 mb/d in May, 350 mb/d in June, and 450 mb/d in July, while acknowledging pandemic-driven headwinds in many parts of the world. Members declined to adjudicate on production policy past July, but further upticks are likely (the group meets again on the first of the month). Despite vaccination shortages and mounting coronavirus cases throughout much of Asia and Latin America, OPEC remains cautiously optimistic for a rear-end 2021 recovery; its total oil estimate is unchanged from last month.

During April, the producers participating in the cuts produced 21.1 mmb/d, almost exactly in line with the combined target. These producers have held volumes flat for three straight months now, but the cartel expects to gradually ramp up output in the summer. De facto head Saudi Arabia is also expected to bump up its own production after enduring self-imposed incremental cuts. Overall, conformity with agreed production ceilings has been strong since the pandemic began, but it remains to be seen if OPEC members can be trusted to accelerate production at the agreed rate; historically, the cartel has struggled with producers willing to sacrifice group targets for their own benefit. We forecast an incremental 2.2 mmb/d and 4.2 mmb/d, respectively, in 2021 and 2022 from OPEC, Russia, and Kazakhstan combined.

Iran seem to be edging closer to a resolution as negotiations in Vienna motor onward and are optimistic that an agreement can be reached by August. If so, Iranian production, which has steadily increased in the past six months, could see the floodgates burst open. However, this sentiment was tempered by the International Atomic Energy Agency, which chastised the country in a June 1 report for failing to explain undeclared nuclear material at multiple locations. Iranian output fell over 1.5 mmb/d when the current sanctions came into effect, so an agreement could materially boost supply in the region. We’d argue, though, that the rest of OPEC would be willing to make sacrifices to accommodate these volumes (despite Iran-Saudi tensions). Otherwise, the cartel’s progress reducing inventories since the peak of the pandemic would be quickly undone, and the market would be thrown back into oversupply.

Source:Morningstar

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Technology Stocks

Hewlett Packard Enterprise Co

HPE posted broad-based strength and a bounce back to annual growth, aided by the year ago quarter being the worst impacted by the pandemic. While we expect HPE to benefit with its shift toward offering its portfolio as-a-service and believe it is well positioned in certain higher growing IT segments, core solutions potentially facing strong headwinds makes us cautious about sustained, long-term growth.

Sales expanded by 11% year-over-year as IT infrastructure spending ramped up behind digital transformation efforts. Intelligent edge grew 20% annually, led by switching and wireless strength, and Aruba as-a-service offerings rapidly expanded and have become a meaningful part of HPE’s overall annualized recurring revenue, or ARR. High performance compute and mission critical series grew by 13% year over year and ended the quarter with a book of over $2 billion in awarded contracts. Compute expanded by 12% year over year, while storage grew by 5% annually behind strong demand for all flash arrays, software storage management, and hyperconverged infrastructure demand. HPE’s as-a-service shift continues to ramp up momentum, with 41% year-over-year growth in as-a-service orders, and HPE’s $678 million in ARR grew 30% annually.

HPE guided to an adjusted EPS range of $0.38-$0.44. For fiscal 2021, the increased adjusted EPS range is $1.82-$1.94 and for free cash flow to be between $1.2 billion to $1.5 billion. We believe that HPE is well positioned for the growth in edge workloads and the need for consistent management across on-premises, clouds, and edge sites. With a growing mix of software and recurring revenue flowing into the business, we view the targets as achievable.

Profile

Hewlett Packard Enterprise is a supplier of IT infrastructure products and services. The company operates as three major segments. Its hybrid IT division primarily sells computer servers, storage arrays, and Point next technical services. The intelligent edge group sells Aruba networking products and services. HPE’s financial services division offers financing and leasing plans for customers. The Palo Alto, California-based company sells on a global scale and has approximately 66,000 employees.

Source:Morningstar

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks

Magellan Financial Group Ltd

While we don’t believe it will be immune from the structural trend of investors moving to passive investments, ongoing competition among fund managers and major institutions in-housing their asset management, we think it’s better placed than most active managers to address these headwinds. Magellan is moving beyond passively managing money, to implementing new initiatives such as product expansion to attract new money. There are prospects of stronger inflows, notably from Australia’s self-managed superannuation funds, the ageing demographic, and fee-conscious investors who were previously discouraged from investing with Magellan. However, continued strong performance will remain key.

  • Magellan has built a high-profile brand that it can effectively leverage to attract/retain client funds.
  • The firm is well placed to serve growing retail investor demand and win institutional mandates. In Australia, increasing superannuation balances supported by the ageing demographic and compulsory superannuation should expand demand for its products. Meanwhile, its established presence in the much larger U.S. and U. K. markets provides further growth opportunities.
  • A strong balance sheet, operating leverage, low capital demands, and strong free cash flow generation supports a high dividend payout ratio.

Magellan has unveiled FuturePay, its long awaited new fund catering to retirees seeking predictable income. Foreshadowed since fiscal 2019, we expect FuturePay to gain share from standard equity income funds and be used alongside annuities. Unlike the glut of equity funds that pay a percentage-based distribution from buying high-yield stocks, FuturePay feeds into Magellan’s Global Equities and Infrastructure strategies, and targets a fixed distribution per unit that’s indexed to inflation. Distributions are currently AUD 0.0203 per unit per month, equating to an annual yield of 4.3%.

Nonetheless, our fair value estimate retreats to AUD 56.50 per share from AUD 57.50, though shares remain undervalued. The earnings we forecast from FuturePay were offset mainly by higher expected future tax rates, and FuturePay cannibalising some flows into Magellan’s core, higher-margin funds. On the former, we note Magellan is an offshore banking unit, or OBU, enjoying low tax rates– currently 22.2%. The government’s proposed removal of the OBU regime will likely see it pay taxes closer to the corporate tax rate of 30% starting fiscal 2024.

FuturePay is the latest endeavour by Magellan to exploit underserved niches–here the retirement income market– which plays to its brand strength. We forecast FuturePay to capture 1% of the funds moving from the super to pension phase over the next five years–backed by Magellan’s established distribution reach, and reputation among investors, advisers and research houses. This is 75% less than what we project for annuity provider Challenger.

The proposition to investors is certainty in income stream. For advisers, this alleviates the hard work in ensuring a client has sufficient liquidity, especially in falling markets, which may compensate for having to go through more stringent best interest duty hurdles. For FuturePay, it does not have to pay out as much in distributions in rising markets, and can better top up its support trust. The support trust serves as a piggybank to support Future Pay’s monthly income payments in falling markets. FuturePay can also borrow funds from Magellan to meet its income payment obligations.

FuturePay will dampen Challenger’s annuity sales, or qualify as a retirement income product though. There will always be a need for assets with defensive asset allocation, such as annuities, that mitigate longevity risks. FuturePay does not guarantee income or capital, nor does it maximise social security benefits. Entry and exit fees, forgone contributions into the support trust, and the lack of ratings / platform presence are likely to limit its adoption in the near-term. Though, this will likely unravel in time as Magellan ramps up its distribution and advisers get more accustomed to the product.

Magellan’s recent growth initiatives–including FuturePay, which will see it deploy AUD 50 million into Future Pay’s support trust–suggest it is becoming more capitalintensive, with returns on capital forecast to average 57% over the next five years, versus 71% historically. Regardless, this is sensible capital allocation to defend and reinforce its competitive position.

Bulls Say

  • Magellan has built a strong intangible brand, supported by strong performance, which it can leverage to hold on to client funds, attract new money and charge premium fees.
  • Due to structural market trends and product expansion initiatives, the prospects for organic FUM growth is strong, notably from investors seeking to diversify exposure to international equities or gain a steady retirement income stream.
  • Aside domestic tailwinds from superannuation, Magellan’s distribution relationships in the much larger offshore markets of the U.K. and the U.S. should support growth.

Bears Say

  • The majority of Magellan’s earnings come from a few large funds, meaning it has a high reliance on key investment personnel and the performance of its main funds. Should key people leave, or its main funds underperform for a sustained period, outflows could be material.
  • There is increasing competition from other active international equity managers and new international equity funds from incumbents.
  • The firm faces fee pressure from the increasing popularity of lower-cost alternatives, such as index type products and ETFs.

Source:Morningstar

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General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Property

Lendlease Group Ltd – Has Valuable Assets

The strategy is to be vertically integrated, enabling Lendlease to generate income from each stage of the process: deal structuring and financing, value-add via planning approvals, developer fees, construction fees, and fund management fees if the assets are ultimately purchased by its property management platform.This strategy appears to be working well, with Lendlease able to leverage its successful track record in Australian projects into secure similar large-scale urban renewal projects globally. While Lendlease has managed development risk to date by securing presales and utilising third-party capital, shareholders could be exposed to capital losses if interest rates spike, or a sustained economic downturn triggers falls in the value of property assets.

Key Investment Considerations

  • Disclosure is opaque, making it difficult to see financial performance at a divisional level. High business complexity and long-dated earnings potential makes it difficult to estimate fair value precisely.
  • Construction is inherently cyclical and competition is fierce. Consequently, margin on large projects are thin, which means a firm can suffer large losses if it doesn’t understand or correctly price construction and design risks.
  • Earnings growth in residential development has been robust in recent years, but high Australian dwelling prices and rising supply will make this very difficult to sustain.
  • Lendlease Group is a diversified property and development empire. Operations have condensed from 40 countries in 2009 to less than 20 today, with key operational regions being Australia, North America, United Kingdom Like other diversified property owners and developers, Lendlease is increasingly using third-party capital on developments. This reduces pressure on its balance sheet, facilitates higher return on equity and reduces development risk, but the trade-off is lower potential development profits.
  • The Lendlease pipeline of major projects has expanded, but most are in an early phase of delivery, meaning the group has yet to reap full benefits from its vertically integrated businesses.
  • A solid balance sheet post raising equity in April 2020, and good access to third-party capital from its fundsmanagement platform mean that Lendlease likely benefits from a development-funding cost that is lower than those of most competitors.
  • With government balance sheets increasingly strained, and there being a desire to promote economic activity via construction, the public sector will return to private-public partnership models to fund long-term infrastructure, and other stimulus measures. Lendlease is well positioned to participate in this growth because of its expanding footprint and capable management.
  • With about a fifth of EBITDA derived from the construction division, a substantial portion of group operating earnings is nonrecurring. As such, a steady stream of work needs to be secured to maintain earnings. This is looking challenging, given constraints on the government budget, corporate constraints, and falling commodity prices.
  • Earnings in recent years were propped up by rising asset values and central bank cutting interest rates. Sustained and large falls in asset values could ensue if coronavirus shutdowns last longer than expected or recur, and this would hurt earnings, as asset values will decline and borrowing costs will increase materially.
  • Lendlease maintains a significant amount of capital in development projects. With property prices elevated across the globe, Lendlease has high exposure to a slump in residential and commercial property prices.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.