4 ASX shares that could be vulnerable to an August surprise
Any missteps this reporting season could be costly for these shares, which have all risen to lofty valuations.
ASX reporting season is just around the corner, and investors can expect some larger than usual daily moves in stock prices as a result.
This is because earnings releases often cause markets to quickly reassess a company’s share price.
This will generally happen if the results make the market’s previous take on the company look too optimistic or too pessimistic.
In this article, we’re going to look at four ASX shares where our analysts think the market is overly optimistic, as judging by the large premium these shares trade at to Morningstar’s Fair Value estimates.
This isn’t to say these companies won’t announce stellar earnings and see their share prices rise further. That can and does happen. This also isn’t a call to sell the shares. That would involve several other considerations, such as taxes and your strategy.
All I’m saying is that these shares seem to be shouldering heady expectations at recent valuation levels. And as a result, could be vulnerable to any less-than-perfect news emerging during August’s reporting season.
Let’s start with a company that has been richly valued for quite some time.
Pro Medicus (PME)
- Moat rating: Narrow
- Fair Value estimate: $50 per share
- Star rating: ★
Pro Medicus sells radiology imaging software, mainly to academic hospitals in the United States.
Sales of $180 million in the past twelve months are more than 20 times higher than they were at the time of its IPO in 2000. Combine that with a healthy growth outlook, and PME has blossomed into one of the ASX’s best performing shares of all time.
At a forward price-to-earnings ratio of over 200 times, however, it wouldn’t be outrageous to suggest that Pro Medicus is priced to perfection.
Our analyst Shane Ponraj’s Fair Value estimate of $50 per share bakes in assumed earnings per share growth of 22% per year over the next five years. So at recent prices north of $300 – more than six times Shane’s Fair Value – what is the market expecting?
If history is a guide, Pro Medicus may well deliver another stellar result. But if it doesn’t, the huge burden of expectation placed on the shares may come home to roost.
HUB24 (HUB)
- Moat rating: No moat
- Fair Value estimate: $31 per share
- Star Rating: ★
HUB24 is a leading provider of investment administration software. It offers portfolio administration, investment management, and managed account services to financial advisors and other clients including SMSF members.
By offering more functionality and better service, specialty upstarts like HUB24 and Netwealth were able to prize significant market share away from asset managers like AMP and Insignia that traditionally provided these functions.
HUB24 and co gained further momentum after the Hayne Royal Commission soured sentiment towards many incumbent firms in the Australian financial services industry.
Against this backdrop, HUB has grown revenues steadily for many years through a combination of market share gains and acquisitions. And it has eventually delivered handsome long-term returns to shareholders after a rocky start to publicly listed life.
Figure 1: HUB24 share chart since IPO. Source: Morningstar
Our analyst Shaun Ler’s Fair Value estimate of $31 per HUB share bakes in 18% per year growth in underlying profit over the next five years. But with a recent share price above $105, markets seem to be expecting a whole lot more.
You can read more about Shaun’s thoughts on HUB24 and its peer Netwealth in this recent research note.
Wesfarmers (WES)
- Moat rating: Wide
- Fair Value estimate: $58 per share
- Star rating: ★
Wesfarmers and its subsidiaries need little in the way of introduction. Its two biggest brands, Bunnings and Kmart, are household names.
Despite being forecast by Morningstar to grow revenues at just 4% per year over the next five years, WES trades at around 33 times estimated forward earnings with a forward gross dividend yield of 2.4%.
In other words, Wesfarmers shares appear to be priced for levels of growth that seem unlikely. They also trade at a 45% premium to our analyst Johannes Faul’s $58 estimate of Fair Value.
Such a racy valuation could land short-term investors in hot water if Wesfarmers fails to match the market’s expectations. Yet despite our concerns over valuation, it is worth noting that we continue to view Wesfarmers as a high quality and well-run company.
Wesfarmers’ Wide Moat rating from our consumer sectors analyst Johannes Faul stems mostly from scale advantages at Bunnings. Meanwhile, a Capital Allocation rating of Exemplary speaks to decades of largely shrewd investment (and divestment) decisions.
Now for another household name with shares that look materially overvalued according to our analysts.
Qantas (QAN)
- Moat rating: No moat
- Fair Value estimate: $9 per share
- Star rating: ★★
At first glance, Qantas doesn’t sport as racy a valuation as Wesfarmers, Pro Medicus or HUB24.
As I write this, Pitchbook data has the shares on a forward price to earnings ratio of nine and a trailing enterprise value to EBITDA ratio of around five.
Despite this, Qantas still trades in materially overvalued territory according to our analyst Angus Hewitt. The shares recently changed hands at 20% premium to our his $9 per share estimate of Fair Value.
Why the disconnect?
Angus sees a classic case of investors thinking that abnormally good industry conditions will continue in what is a highly cyclical business.
Angus also thinks that markets are betting that the current duopoly with Virgin Australia in domestic flights will persist.
Angus thinks that this is unlikely over the long-term, and a new entrant or weakening in demand could see pricing and margins at Qantas soften.
Sure, the good times could roll on. But any signs that the cycle or competitive environment is worsening could narrow the gap between Qantas’ share price and Angus’s significantly lower estimate of Fair Value.
Keep up to date this reporting season
August will see the vast majority of ASX listed companies report their latest results to shareholders.
For a long-term take on developments in the companies and industries our analysts cover, subscribe to our daily email for our latest reporting season articles.
