The Point

Midcap case study: Lithium producer Allkem is well positioned for a rebound in lithium prices

Among Australian mid-cap stocks, few companies get more media attention than lithium producers.

And as last week’s announced merger of ASX-listed Allkem and New York-listed Livent shows, they’re getting plenty of corporate attention as well.

What does the mooted $16 billion merger tell us about the lithium market, particularly in the wake of a price fall since late last year?

“Our view is that there is a rebound coming in lithium prices,” argues Pendal investment analyst Jack Gabb, citing higher demand for electric cars and an end to destocking in China.

Pendal holds Allkem shares in Pendal Midcap Fund and Pendal Horizon Fund.

One of Allkem’s advantages is its diversification of products, says Jack.

“It’s majority lithium carbonate but also has exposure to spodumene and lithium hydroxide. That’s all three lithium products while other producers are picking one or two.”

Brenton Saunders: ASX mid-caps offer exposure to fast-growing sectors such as battery metals

Australia finally has a national strategy to “encourage greater use of cleaner, cheaper-to-run electric vehicles”.

The new ALP policy, alongside similar plans around the world, should help boost demand for “battery metals” such as lithium, produced by a range of ASX-listed miners.

What’s the best way to get exposure to quality stocks in this sector?

Pendal PM Brenton Saunders argues in favour of Aussie mid-cap portfolios.

Mid-cap portfolios are typically less concentrated and offer access to fast-growing industries such as cloud computing, medical innovation and battery metals.

Medium-sized companies tend to offer higher earnings growth than large-cap companies, often with less risk than small caps, says Brenton.

Brenton manages Pendal MidCap Fund, which invests in the 100 biggest companies outside the ASX50, with market caps ranging from around $1 billion to $10 billion.

“It’s really the sweet spot of corporate Australia. It’s a very useful addition to any balanced portfolio.”

Brenton and Australian lithium industry pioneer Ken Brinsden explained the opportunities in a recent webinar.

Aussie equities: What we can expect from earnings in the second half

Australia’s economic cycle has gone on longer than expected – and it showed in the recently ended ASX earnings season.

Somewhat surprisingly, most parts of the economy are still in reasonably good shape despite a string of interest rate rises.

The strong jobs market is a factor, helping prop up consumer spending.

“But the expectation is that higher interest rates will likely hurt earnings in the rest of the financial year,” says Brenton Saunders, who manages Pendal MidCap Fund.

“Across the market as a whole, revenue beats were pretty widespread even though many companies missed earnings forecasts at the bottom line. Revenue beats were much higher than profit beats.

“We saw profit margins reduce and that relates to higher costs. In many cases, despite high product price increases, costs increased at a faster rate, resulting in margin pressure.”

What does Xi Jinping’s consolidation of power mean for investors?

Confirmation of Xi Jinping’s third term as China’s leader wasn’t surprising, but his apparent control is greater than most expected.

It appears Xi’s main aim is to turn the “successfully achieved moderately prosperous society” into a “modern socialist society”.

“This is seen as part of China’s ambitions to be an independent technology powerhouse and to project power and influence,” says Pendal’s Brenton Saunders.

“This may suggest the economy remains on a relatively austere pathway by historical standards. 

“The potential for China’s property market remains muted. Material stimulus is unlikely beyond the short term.”

That’s a headwind for economic growth and demand for steel-making materials, Brenton says. “Iron ore and coking coal stocks are most exposed to the trend long term.

“But China’s strategic pivot to technology, grid investment and electric vehicles should benefit base metal and lithium-producing companies in the long term.”

Turning point for shares: what to watch

Waiting for a market inflection point?

We asked Aussie equities portfolio manager Brenton Saunders which signs he’s watching.

“One is the Chinese macro-economic outlook,” says Brenton, who manages Pendal MidCap Fund. “It’s unclear, despite some attempts at stimulus, that they are addressing the right areas to reverse that market in any kind of meaningful way.

“Energy policy has also changed gears. We’ve had rumoured sabotage of Russia’s gas pipelines to Europe. That almost assures Europe will have a tougher winter.

“The OPEC agreement to cut supply is the last thing the US Fed wanted and will come as a headwind to getting inflation under control.”

On rates, we may see more rises than the market’s expecting, “and likely higher for longer”.

“We still think we need an earnings downgrade cycle to put a bottom in this market – especially in discretionary retail and possibly commodity cyclicals.”

ASX earnings season: the big talking points

ASX-listed companies posted better-than-expected full-year earnings, though the averages hid a wide variation in individual results, says Pendal’s Brenton Saunders.

Revenue and dividend “beats” outpaced the misses by around 1.3x. But forward earnings guidance was negative on average.

Inflation, interest rates, labour availability and trade working capital increases were the big talking points in a reporting season that was complicated by a shifting global macroeconomic environment.

“Look for stocks that are either beneficiaries of the move higher in interest rates or those whose business are not overly geared to higher rates and have been heavily sold off year to date,” says Brenton, who manages Pendal MidCap Fund.

The mid-June rally benefitted oversold discretionary retail and long-duration, profitable tech companies, he says.

“It’s very much an alpha kind of environment, where staying across stock specifics is not only useful — it’s an absolute necessity.”