Collected Wisdom

Buy Newcrest and Rio, sell Myer, but hold Bank of Queensland and James Hardie, the newsletters say.

Summary: Analysts rate Newcrest and Rio as buys, but recommend selling Myer while Bank of Queensland and James Hardie are holds, the newsletters say.

Key take-outs: As gold producers follow the gold price down, analysts are seeing long-term value in the quality low-cost producers. The newsletters argue that Newcrest remains the most undervalued gold stock.

Key beneficiaries: General investors. Category: Portfolio management.

This is an edited summary of Australia’s best-known investment newsletters and major daily newspapers. The recommendations offered represent the views published in other publications and may not represent those of Eureka Report.

Newcrest (NCM)

Everyone’s suddenly talking about gold – why did it fall, what is it really worth, is it comparable to Bitcoin and what about the impact of ETFs? All interesting questions, but for equities investors there’s a much bigger one: What does it mean for the gold miners? The newsletters think it means a buying opportunity for the better producers, and the leader of the pack is Newcrest.

With the gold price dropping by roughly $US200 an ounce in the past 10 days, near-term earnings are set to take a hit. It should go without saying that the high-cost gold producers are going to be under the most pressure as margins are squeezed.

But the newsletters argue Newcrest remains undervalued – even with the price squeeze. Earnings and cash flows will of course take a hit in the immediate future, and less cash may see projects shelved across the board, but Newcrest is traditionally a very low cost producer and has a lot of room to move. Even if the gold price fell by the same amount again, to average about $1,200, long-term value is still seen in the company.

The share price is down 25% for the month, and the newsletters see a buying opportunity on the dip. Investors prepared to take a slimmed down dividend if cash flow is strained may be rewarded by the company’s cost advantages, exploration potential and diversification in copper.

One interesting statistic noted is that non-investment use of gold (that is, jewellery and industrial use) has shrunk from 84% of total demand to 53% in just eight years, amid strong investor appetite for gold-backed ETFs and net buying from reserve banks . That means more speculation, and with it more price uncertainty as investor sentiment takes the box seat. For those who can bear the bumps, though, Newcrest remains an attractive prospect.

  • Investors are advised to buy Newcrest at current levels.

Rio Tinto (RIO)

The ‘other’ big Australian didn’t have its best quarter, despite clocking up record production in the iron ore business which rose 6% on the previous corresponding period. Commodities generally may be moving out of favour, and Rio’s share price has had a poor quarter, but the newsletters are backing Rio as a rock solid ‘buy’.

Compared with the previous quarter, 4Q12, most of the key numbers slipped. Iron ore production was down 7%, copper down 9%, coal down 11% and alumina down 16%. Despite this, the forecasts for the year are all on track and the newsletters note there wasn’t too much out of the ordinary except the US Bingham Canyon copper mine disruption. But compared with the same quarter last year the improvements are strong. The Pilbara iron ore mines are up at full capacity and guidance for 265 million tonnes of iron ore in the 2013 fiscal year remains unchanged.

Copper production is recovering after a volatile couple of years, and the massive Oyu Tolgoi mine in Mongolia is due to reach commercial production this half. Uranium is also at reasonable levels compared with corresponding quarters, after heavy rains last year stifled production.

Essentially the investment press sees the diversity and experience of Rio Tinto as key positives, and the first-quarter production numbers as strong enough to help build a good year. It views the prospect of a China hard landing as increasingly unlikely, and with its GDP target of 7.5% over the coming years expected to be pursued with force Rio is in place to benefit.

  • Investors are advised to buy Rio Tinto at current levels.

Bank of Queensland (BOQ)

The next bank in line after the ‘big four’ swung back to profitability in the half, and the newsletters found more good news upon digging deeper into the numbers.

When Collected Wisdom looked at Bank of Queensland in October last year (click here) – following its report of a full-year loss – we noted bad debts were piling up for the lender as the Queensland economic picture deteriorated.

Since then, two things have changed to brighten the picture: the gradual opening of global wholesale funding markets and a much faster-than-expected recovery in bad debts.

The first point has swung the funding picture back into favour for smaller banking competitors, who have been unable to properly compete with rates offered by the big banks with high credit ratings. The second comes as management tightened up lending and bad debt charges fell 18% on the previous half and 82% on the first half of 2012.

Retail deposits also improved, and have been on a steady healthy rise over the past five years. Dividends are expected to increase in line with recent rises, and estimates for the 2013 fiscal year give BoQ a 6% yield – and that’s after the 30% share price rise in the year to date.

The newsletters also note the purchase of Virgin Money Australia, for $40 million in cash and scrip, which currently runs at a loss. BoQ expects it to be EPS accretive by the second year of acquisition, and has bought it to access a brand attractive to younger customers and young families. The deal will also improve geographic diversity, cutting the total Queensland customer base down close to 50%.

  • Investors are advised to hold BOQ at current levels.

James Hardie (JHX)

James Hardie is no stranger to lawsuits and unfortunately for investors it’s got another one on its hands. The New Zealand Ministry of Education has launched a representative action (essentially a class action) against two subsidiaries there over leaks in school buildings allegedly caused by some defective fibre cement.

The stock dropped sharply on the announcement last week, but bounced back today to close at $9.68, recovering most of its losses. Apparently several thousand NZ school buildings are affected, but James Hardie said in a statement to the ASX it is “not able to assess what proportion of the claim relates to the Companies or comment about the validity and/or any financial impact of the claim”.

This presents an investment dilemma. On the one hand, the investment press argues the case puts the expected May $US0.35 dividend at risk and introduces yet another legal minefield for the company. On the other hand, the US housing recovery is beating expectations (with more than a million new homes started in March) and Australia’s construction market is starting to show positive signs as well. The company has $160 million of cash on the balance sheet too, and no debt, which leave it room for flexibility at a time like this.

It’s a tough call, but the newsletters think there’s enough puff in the housing rebound to justify holding onto the stock – at least until further information on the dividend and the lawsuit’s impact comes to light.

  • Investors are advised to hold James Hardie at current levels.

Myer (MYR)

What can investors do about the unfortunate position Australia’s venerable department store finds itself in? Crushed between a small population with high wage costs, and the global buying power of the Australian dollar in an internet age, the newsletters say the recent run-up in the stock presents an opportunity to sell.

The ‘retail recovery’ narrative and sales numbers that weren’t completely awful have propelled the stock more than 55% higher in the past six months, and more than 40% in 2013 alone. But the newsletters believe there’s too much uncertainty and too few barriers to entry for competitors to have confidence in Myer’s sustained value.

Online is a major concern, with spending now above 5% of retail spending and rising. The UK has already seen online spending rise to 11%, and there’s no reason to think Australia won’t be there soon. Myer’s percentage of online sales remains tiny (though fast growing), and seen as likely comparable with David Jones at less than 1%. But there are other costs. Labour costs, shop leases and the cost of doing business in Australia generally has risen noticeably in recent years, and the increased international competition means it’s tough for local retailers to offset those with prices.

The newsletters argue the entry of established major brands like Zara and Top Shop will only exacerbate the pain, as Myer’s traditional buying power advantage (which served it so well for a century) is dwarfed. It has been a pleasant period for Myer shareholders, and the investment press thinks it may be time to take advantage of that and pocket some of those gains.

  • Investors are advised to sell Myer at current levels.

Watching the Directors

One man apparently unfazed by the gold price dip is Panterra Gold (PGI) executive chairman Brian Johnson, who picked up an additional 4,725,800 shares in the company for a total of $453,677 or 9.6c a piece. The price of gold currently sits at roughly $US1420 an ounce after a week of extreme volatility. Panterra closed at 9.2c.

Meanwhile on the selling side, Beach Energy (BPT) chief executive Reginald Nelson (described by the Australia newspaper as a “doyen of the industry”) has been shifting shares in the company en masse the past week. After selling a total of 970,000 shares last week for just over $1.4 million, he announced the sale of a further 330,000 over last Wednesday and Thursday for a total of $460,980. Beach closed today up almost 2% at $1.40 – a tiny fraction above the $1.39725 average Nelson shifted the batch of shares for.

Finally, most of the time when a director files an ASX statement notifying their disposal of half a million shares it means a tidy windfall. But occasionally not. Fortescue Metals (FMG) non-executive director William Rowley declared he was 500,000 shares lighter in the company this week, after ceasing to hold an interest in the trustee of his charity the Rowley Foundation. The stake would be worth $1.91 million on today’s closing price of $3.82.