Collected Wisdom

This week we look at Fortescue Metals, Iluka Resources, Insurance Australia Group, OZ Minerals and Challenger.

Summary: The newsletters are bullish on Fortescue Metals, despite the iron ore miner falling short of third-quarter production forecasts and expectations it may not meet its full-year guidance, and the majority also like Iluka Resources, even after its fall in quarterly revenue and production. Insurer IAG is generally seen as a hold, as is annuity provider and fund manager Challenger, however views are more divided on copper and gold miner OZ Minerals.

Key take-out: Company analysts say the appeal for Fortescue lies in its ability to deliver iron ore in the longer term while reducing its costs of production and gearing.

Key beneficiaries: General investors. Category: Shares.

This is an edited summary of the Australian investment press: It includes investment newsletters, major daily newspapers and broker reports. The recommendations offered represent the views published in the other publications and may not represent those of Eureka Report. This article is general advice only which has been prepared without taking into account your objectives, financial situation or needs. Before acting on it you should consider its appropriateness, having regard to your objectives, financial situation and needs.

Fortescue Metals Group (FMG)

Fortescue Metals Group may find it difficult to deliver on full-year production guidance after its quarterly iron ore output fell short of analysts’ forecasts, according to the investment press.

The company announced last week that it shipped a record 30.8 million tonnes of iron ore for the March quarter, 59% above the previous period but below expectations for 32 million tonnes.

To meet its full-year guidance of 127 million tonnes, Fortescue will have to ship 41.6 million tonnes in the fourth quarter. This will require a run-rate of 166 million tonnes in the June quarter – a difficult task given the likelihood of ramp-up issues, newsletters say.

“The mining, rail and port operations have demonstrated the required sprint capacity to achieve this target,” Fortescue said.

Despite being sceptical, newsletters overwhelmingly say Fortescue is a buy at current share price levels. Even if the company does miss guidance for 2013-14, they say that it doesn’t really matter in the scheme of the iron ore miner’s overall investment thesis.

The appeal for Fortescue lies in its ability to deliver iron ore in the longer term while reducing its costs of production and gearing, sources say. Indeed, the company has wiped $US3.1 billion of debt off its balance sheet since November 2013, in line with its strategy to rapidly reduce debt.

Analysts on average forecast Fortescue’s share price to be $6.25 in 12 months, 17.5% above yesterday’s close. Most are confident the iron ore price – a key driver for the share price – will remain high when considering the continued growth in the consumption of steel in China.

* According to our value investor partners, StocksInValue, the intrinsic value for Fortescue Metals Group is $8.21. To find out more visit http://www.stocksinvalue.com.au/.

  • Investors are generally advised to buy Fortescue Metals Group at current levels.

Iluka Resources (ILU)

Shares in Iluka Resources plunged last week when the mineral sands miner reported a fall in revenue and production for the first quarter of 2014.

Total mineral sands production dropped by 18.6% to 221,200 tonnes and mineral sands revenue slipped 6.6% to $130.7 million compared to the same time last year, missing analysts’ forecasts.

The company’s stock fell 6.8% to $9.11 on Wednesday – the biggest one-day fall in almost two years.

Following the announcement, newsletters are split between buying and holding Iluka shares, but more advise their clients to purchase the stock at current price levels.

Though the investment press largely trimmed their earnings forecasts in response to the news, they believe Iluka is moderately undervalued when considering it is trudging through a deep cyclical low and that the company will benefit from pricing power when demand begins to recover.

“During the first quarter Iluka observed numerous positive on-ground market indications regarding a likely recovery in demand for both zircon and high grade titanium dioxide feedstocks during 2014,” the company said.

One source says the second quarter of the year will be telling, as Iluka needs to translate these encouraging signs of demand into orders. If it doesn’t, full-year production guidance is at risk.

Another source says Iluka is well positioned to capitalise on the potential global recovery in housing construction, since tiles require zircon and paint needs rutile.

With the balance sheet still in good shape, newsletters expect Iluka’s dividend to lift this year. Consensus forecasts are for the half-year dividend to lift 20% to six cents per share.

* According to our value investor partners, StocksInValue, the intrinsic value for Iluka Resources is under review. To find out more visit http://www.stocksinvalue.com.au/.

  • Investors are generally advised to buy Iluka Resources at current levels.

Insurance Australia Group (IAG)

Newsletters came away comforted that IAG’s core Australia Direct business can stem its market share losses to competitors after attending the company’s strategy briefing on Tuesday last week.

Australia Direct, which accounts for over half of IAG’s insurance profit and 48% of its gross written premium, has been battling an increasingly competitive market in the personal general insurance space, particularly in the key motor and home divisions.

“Our strategy is to deliver a superior customer experience, coupled with low operating costs,” said chief executive Andy Cornish.

IAG also reaffirmed its guidance in 2013-14 in the presentation, with Cyclone Ita unlikely to have a material impact. The company still anticipates GWP growth of 3-5% and a reported insurance margin of 14.5-16.5%.

The vast majority of newsletters say IAG is a hold, with the latest update providing a high level of earnings certainty for the second half of the year. The most severe risk to IAG’s share price is a reduction in the company’s retention rate, but the new strategy should stop that from happening.

IAG has created a valued insurance offering where Australia Direct can confidently reduce discounts in its loyalty discount structure and instead focus more on the policy count per customer, one source says.

But the company now has lower earnings growth prospects, newsletters say, which justifies the stock’s price-earnings multiple of around 12 times, below its five-year average of just under 17 times.

On the other hand, newsletters highlight IAG’s attractive dividend yield of 5.9% this financial year, not including franking credits.

* According to our value investor partners, StocksInValue, the intrinsic value for Insurance Australia Group is $4.77. To find out more visit http://www.stocksinvalue.com.au/.

  • Investors are generally advised to hold Insurance Australia Group at current levels.

OZ Minerals (OZL)

Newsletters are divided over the outlook for OZ Minerals after the copper and gold miner beat guidance in the first quarter of 2014.

OZ Minerals told the market it produced 18,182 tonnes of copper for the three months to March 31, substantially above its guidance for 15,000 tonnes. Gold production was also strong at 33,792 ounces.

The absence of an unpleasant surprise was a welcome development, newsletters say, given the two downgrades late last year that saw the company’s shares fall 40% in two months.

The investment press are largely split between those who believe the results signal a year of recovery for the stock after the troublesome 2013, and those who think it was an anomaly. At current share price levels, however, most believe the stock is mildly undervalued and rate it as hold.

Sources more optimistic expect OZ Minerals to turn a profit this year. Though they anticipate a weaker second quarter because of the heavy rain and power outage in early April, they have lifted their full-year production forecasts as production efficiency in the Malu open pit mine improves, leading to lower costs.

But those more cautious say upside to the share price in the short term hinges on positive results to prove OZ Minerals’ project pipeline, with an upgrade to the Malu reserve and the delivery of the Carrapateena pre-feasibility study expected in the second quarter.

The amount of cash spilling out of the company also concerns one newsletter. It disputes management’s earlier claim that the cash balance will be largely unchanged between 2013 and 2014, and anticipates a lower-than-expected cash balance in June to trigger a fall to the share price.

* According to our value investor partners, StocksInValue, the intrinsic value for OZ Minerals is under review. To find out more visit http://www.stocksinvalue.com.au/.

  • Investors are generally advised to hold OZ Minerals at current levels.

Challenger (CGF)

Shares in Challenger have surged to a record high after the annuity provider and fund manager released its third-quarter results last week.

Challenger, which is Australia’s largest annuity provider, lifted its forecast for retail annuity net growth book to be at the upper end of its previous guidance for 10-12%, marking the company’s second upgrade in three months.

“Retail annuity sales continue to be propelled by our product innovation and a rising number of baby boomer retirees,” said chief executive Brian Benari.

Challenger’s other business, funds management, recorded net inflows of around 2% for the quarter, supported by $500 million of net flows into its Fidante Partners business.

The stock jumped 9.8% to $6.72 over two-days following the news, putting the total share price gain at 67% over the past 12 months.

The majority of newsletters advise their clients to hold Challenger shares after the rise in the share price. For most analysts, the slight increase of earnings in Life (the annuity division) offset a small decrease in fund management earnings.

On average, analysts forecast the one-year target price to be $6.51 in 12 months, 4.8% below yesterday’s close.

Several newsletters say Challenger is becoming more compelling as an investment, particularly since its shares have been relatively flat since the half-year results. However, for them to take a more positive view, they need more clarity on the company’s annuity products.

Sources say that for the stock to rerate to a price-earnings expansion above 10 times, more earnings certainty is needed into the medium and long term.

* According to our value investor partners, StocksInValue, the intrinsic value for Challenger is $4.84. To find out more visit http://www.stocksinvalue.com.au/.

  • Investors are generally advised to hold Challenger at current levels.

Takeover Action April 10-23, 2014

DateTargetASXBidder(%)Notes
17/04/2014Bullabulling GoldBABNorton Gold Fields0.00
17/04/2014Cape AluminaCBXMetroCoal57.23
22/04/2014Challenger Diversified Property GroupCDIChallenger69.00
06/11/2013Energia MineralsEMXCauldron Energy0.00Ext to May 1
24/01/2014Genesis ResourcesGESBlumont Group0.00
15/04/2014Leighton HoldingsLEIHOCHTIEF60.02
28/02/2014Merlin DiamondsMEDBlumont Group0.00
09/04/2014Reef Casino TrustRCTAquis Casino Acquisitions 76.03
23/04/2014Westside CorporationWCLLandbridge Group Co3.20
Scheme of Arrangement
07/04/2014Atlantic GoldATVSpur Ventures0.00
09/04/2014David JonesDJSWoolworths0.00Vote June
17/12/2013EnvestraENVAPA Group33.00Vote May
17/03/2014Murchison MetalsMMXMercantile Investment CompanyVote June
31/03/2014Nexus EnergyNXSSeven Group Holdings0.00
24/02/2014Sierra MiningSRMRTG Mining0.00Vote April
27/03/2014SteriHealthSTPCatilina Nominees47.00Vote May
10/03/2014TriAusMinTROHeron Resources0.00Vote June
Foreshadowed Offers
23/04/2014Australand PropertyALZStockland19.90Indicative proposal
19/03/2014Crowe Horwath AustralasiaCRHAnchorage Capital Partners0.00Indicative proposal
Source: NewsBytes