Morgan Stanley’s top stock ideas ahead of the February reporting season

Investors are often intimidated by the research involved in using small and mid-cap companies in their portfolios. Typically, that's because it's far easier to stick to large-cap companies whose fortunes are well-documented.

That said, if you wanted to dabble outside the S&P/ASX 200, this could be a good starting point. Morgan Stanley has released their top conviction small and mid-cap picks ahead of the February 2023 reporting season.

Surprisingly, it’s a retail-heavy list, particularly given the high levels of inflation and rising interest rates we have witnessed in recent months, putting pressure on consumer spending. Retail demand and margins surprised on the upside in 2022, but Morgan Stanley believes that inflationary pressures and rising interest rates will dissipate savings buffers in 2023, and the advantages of reopening post-COVID will ease.

Despite this, the broker has high conviction in the earnings potential of these names - and there’s a high chance you know and use at least some of their products. As Warren Buffett says, invest in what you know.

In reverse order of preference, here they are.

#4. City Chic Collective (ASX: CCX)

The multi-channel plus-size women’s fashion retailer is rated as an equal weight by Morgan Stanley analysts, Joseph Michael CFA, James Bales and Chenny Wang. They believe it has long-term growth potential but will be challenged this year due to softening demand, increasing promotional activity (to encourage sales) and cost headwinds. They decreased the 12-month price target to $0.70 a share from $1.20.

City Chic is currently going through an earnings downgrade cycle and has been sold off hard over the past year. Morgan Stanley downgraded its rating for City Chic last November. It was not alone with Macquarie and Ord Minnett also dropping their ratings.

City Chic share prices v ASX200 for the past year

#3. KMD Brands (Formerly Kathmandu Holdings) (ASX: KMD)

The outdoor, lifestyle and sports retailer includes brands Kathmandu, Oboz and Ripcurl. Morgan Stanley downgraded KMD to equal weight from overweight due to the challenging consumer outlook and high levels of competition in outdoor and surf categories. It remains positive on the long-term outlook for the company due to resilient demand for its products and the potential for global expansion for its brands. Kathmandu is starting to gain traction in European wholesale channels. Further to this, the brands are benefitting from reopening and normalisation post-COVID (all of its brands were hit hard during the pandemic).

Morgan Stanley decreased the price target for KMD Group to $1.05 a share from $1.25.

KMD Group share prices v ASX200 for the past year

#2. Accent Group (ASX: AX1)

Accent Group is an Australian and New Zealand footwear and clothing retail, wholesaling and distribution company. It holds 19 brands (including The Athlete’s Foot, Skechers, Timberland, CAT and Dr Martens) with over 500 stores and 20 online platforms. Accent Group increased its exposure by adding apparel to its lineup with Glue Store and Stylerunner. While apparel can be more profitable, Morgan Stanley views higher risks in this approach and also expects Accent Group to encounter challenges in tighter consumer conditions. Morgan Stanley downgraded Accent Group to equal weight from overweight. It views opportunities ahead for Accent Group thanks to its resilient demand and a strongly aligned leadership team, along with the potential for opportunities in store roll-out.

Morgan Stanley increased the price target for Accent Group to $1.95 a share from $1.85.

Accent Group share prices v ASX200 for the past year

#1. Premier Investments (ASX: PMV)

Morgan Stanley’s top pick is speciality retailer Premier Investments, which includes brands The Just Group, Smiggle, Portmans, Peter Alexander, JayJays, Just Jeans, Jacqui.E and Dotti. It upgraded the company from equal weight to overweight, arguing that it is the best positioned of the retailers to manage the coming year thanks to its strong balance sheet and leadership team.

“We are attracted to PMV’s global expansion opportunity (via Smiggle), its long track record of beating market expectations (on apparel brand execution in the face of higher offshore competition, rent negotiations with landlords and scaling Smiggle and Petter Alexander) and capital management optionality (we see scope for more dividends/buybacks or highly accretive M&A),” said Morgan Stanley analysts Michael, Bales and Wang.

Morgan Stanley increased its 12-month price target to $30.50 a share (from $23.25).

Premier Group share price v ASX200 for the past year

It’s worth noting that this contradicts other analyst views which were outlined by Glenn Freeman in a recent article. He noted that Premier Investments had been downgraded by CLSA, Citi and JP Morgan.

This article was first published on Livewire Markets on Tuesday 24 January 2023.