Beware the ?Brokers' Trap'

Remember Goodman Fielder (GMF) before Graeme Hart arrived? It did not seem to matter who was hired to revitalise Goodman, the owner of some of Australia's best-known food brands including Meadow Lea and Uncle Tobys. There was always a reason why none of the restructurings worked out as planned.

And so it was that the chairman had to explain and defend new plan after new plan at the annual shareholder meetings. This went on for years, until Graeme Hart came along, bought the business, turned it around, sold some assets and re-listed the remainder on the Australian stockmarket.

Hart turned the company into a classic example of how to make money from the stockmarket: by utilising other people's failure.

The diversified industrial conglomerate Nylex (NLX) is in a similar position as Goodman Fielder was before Hart bought in. Management announced recently that yet another restructuring plan is in the pipeline. Negotiations with house bankers and potential financers are being held to provide management with the funds necessary to keep the old and battered ship afloat and give it a much needed refurbishment.

For loyal shareholders, however, it is again another plan to turn things around, with promises that have been made so many times before. And like Goodman Fielder, Nylex owns several iconic Australian brand names, in its case, Gardena and Esky. The main difference is that it would seem rather unlikely that Graeme Hart, or another smart company doctor, will come along and buy the suffering shareholders out to take advantage of this chain of long lasting management failures.

Nylex, the former Austrim Nylex, appeared to be on the right path again after reporting losses of $94.3 million and $49.5 million for the past two financial years. Leading equity brokers such as Merrill Lynch, Smith Barney Citigroup and Credit Suisse, went along with management's enthusiasm regarding the progress achieved and put a Buy recommendation on the shares.

As any savvy stockmarket investor knows, potentially large gains are to be made from successful turnaround stories. Judging by the emails we have received over the past few weeks, quite a few investors saw the opportunity and jumped on board.

Unfortunately, things again turned out worse than scheduled and management is in negotiations with potential providers of debt to secure the future of the company.

Management is trying hard to persuade investors and shareholders that Nylex won't end up as another Henry Walker Eltin but few would take the bet the company won't. Nylex's share price reached a high of 44¢ in early 2005, when market enthusiasm regarding a successful turnaround was very much alive, but crashed to 2.9¢ a few weeks ago. It has since recovered to about 5¢.

And those securities analysts that joined in with management's confidence and enthusiasm have started to abandon the stock. Aspect Huntley was the first to cease coverage in December. Smith Barney Citigroup ceased coverage in May. Credit Suisse is still contemplating following suit. All the Buy recommendations have been replaced by Sells. Valuations on the stock have been brought back to 4¢. Even if management manages to keep Nylex alive, the future for shareholders who bought their shares as late as last year seems dire by all accounts.

Securities analysts, regardless whether they work at the leading international stockbrokers, are not always right. In fact, they can be collectively wrong.

Take News Corp (NWS) as an example. The 10 leading stockbrokers and equity researchers in Australia that are monitored by FN Arena on a daily basis ranked News Corp as one of the highest recommended stocks in the Australian sharemarket throughout 2005. Yet the share price barely moved and even ended the year down slightly.

At FN Arena we call it the Brokers' Trap. There can be eight or nine of them putting a Buy recommendation on the shares, and a price target that suggests double-digit returns should be up for grabs, but investors who follow the advice instead see a negative return.

It's the old criticism of the industry that takes guidance from a company's intrinsic value while not giving sufficient weight to the many barriers that lie ahead and may prevent the value from being reached. News Corp is a fine example of this. Is Alumina Limited (AWC) another one?

Alumina Limited's share price is back under $7 again. Most brokers will tell you that it’s time to buy again. Most of them have already calculated an intrinsic value of $8.50–9. Eight of the 10 experts we monitor rate the stock a Buy with only GSJB Were and Aspect Huntley sticking to a Neutral.

So why is the market not jumping on the shares? Because the outlook for alumina and aluminium is very much in doubt. Even if Alumina's share price is arguably too cheap, investors don't like buying into something that does not have a clear future upside. For all we know, Alumina's future may consist of sharply lower prices for alumina and aluminium; not a very attractive proposition to spend your money on.

China, the big supporter of today's bull trend in metals and commodities, is a net exporter of alumina and the availability of bauxite, the basis for alumina and aluminium, seems to be increasing while past shortages in alumina smelting have been addressed as well.

On UBS's latest assessment, if aluminium prices were to remain at their present levels, the market consensus estimate for Alumina Limited's earnings for this year would increase by about 11%. But until there is more clarity on what exactly will happen to the metal's spot prices over the coming months, investors are likely to prefer the sidelines instead.

It's probably a safe bet to assume that Alumina Limited will remain one of the highest recommended stocks in Australia until then.