Key Points:

  • We recently updated our TAA/DAA outlook and are now positioned for recession.  We recommended a weight of 3/10 in Growth assets and 4/10 in defensive assets with our highest weight 7/10 in cash (TAA Updated Q3 2022 – 15 September).  Equities are unlikely to retest their peak early in the year and there is still considerable downside, in our view.  Nonetheless, Australia is one of our preferred equity markets late-cycle and we look under the bonnet for those investors exposed to the Australian market.
  • Stocks can get into trouble not only due to high leverage in a rising inflation and interest rate environment.  Sticky lease contracts and other short-term obligations can become problematic with a recessionary decline in revenue.  A good record of cashflow generation during the ups and downs of the economic cycle provides some comfort as well.  Of course, a starting point of low debt also makes it easier to ride out the bumps.  We have identified 45 stocks in the ASX 200 universe (ex REITS and financials) that may struggle when the recession takes hold.
  • Consumer discretionary and Industrials are the at-risk sectors.  QAN, FLT, and CTD were down for the count during the pandemic and are barely back on their feet.  QAN has high debt and low quick and current ratios, while FLT and CTD have track records of poor cashflow generation and low interest cover.  Alcohol and gaming stocks such as SGRTLCEDV, and TAH have a high-risk score due to poor quick and current ratios.  WOWCOL has low quick and current ratios, but the nature of these businesses means that revenue growth is likely to be relatively stable and cashflow generation has been generally good.
  • Of the defensive names, CNU, TLS, EVT, and APA attract red-flag scores.  However, TLS and APA hedge their interest rate exposure, while EVT hedges its interest rate exposure occasionally.  EVT has long-term leases that may make it challenging to cut costs when businesses and consumers are under pressure from high interest rates.  APA management indicates that a 100bp increase in floating rates on their debt would lower equity reserves by $A41.2m.