Collected Wisdom

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.

Downer EDI (DOW)

The majority of newsletters tell their clients to buy Downer EDI, despite the company losing a $360 million contract.

The mining services contractor announced last Wednesday (June 11, 2014) that its contract with BHP Billiton to provide pre-stripping work had been terminated almost two years early, reducing work-in-hand by $160 million in 2014-15 and $200 million in 2015-16. Downer says it will be entitled to compensation for early termination.

Shares in Downer EDI plunged 11.2% to $4.70 – their biggest one-day fall in three and a half years.

Though analysts are deeply mixed on Downer in response to the news, with several downgrading their recommendations, most have stuck with their buy calls.

While the loss of the contract is undoubtedly a hit to Downer – representing a cut of around 7% to work-in-hand – most sources believe the excellent management team is pursuing the right strategy in stabilising the business amid the mining services downgrade cycle.

Management can respond to a number of risks because of Downer’s robust balance sheet, sources say. Further, operating costs are set to be reduced as the company continues to work hard with key customers, including Fortescue Metals (FMG) and Karara.

But others who have downgraded their recommendations think Downer’s earnings from mining contracts will continue to be at risk. Downer’s largest customers are likely to terminate contracts early and instead source the work themselves, like BHP in this instance, or reduce the scope of their projects.

However, newsletters are more positive about Downer’s outlook in the longer term. Opportunities will open up for the company as it strengthens its position in markets including oil and gas, power, and maintenance for road and rail, one source believes.

The average target price for the stock is $5.16 following the news, 18.3% above Tuesday’s close.

* According to our value investor partners, StocksInValue, the intrinsic value for Downer EDI is $4.53. To find out more visit http://www.stocksinvalue.com.au/.

• Investors are generally advised to buy Downer EDI at current levels.

Flight Centre (FLT)

Flight Centre should be able to weather consumers’ reduction in discretionary spending better than others, newsletters say, after the travel group trimmed its full-year earnings guidance last week.

The company now anticipates underlying profit before tax (PBT) to be $370-380 million, at the lower end of its previous guidance of $370-385 million. Disappointing leisure travel results in Canada and a tougher trading environment in Australia were responsible for the slight downgrade.

Following the announcement, the investment press are almost evenly split between rating Flight Centre a buy or a hold. More newsletters, however, believe the news has been more than built into the share price after its 11% slide to $44.84 after the past month, and call the stock a buy at current levels.

While Flight Centre’s commentary is consistent with other companies in the discretionary spending space, such as Pacific Brands and The Reject Shop, the impact of the change in customer behaviour is much less, one newsletter says.

Flight Centre’s earnings are much more defensive, according to the source. Though earnings risk in the near term may cause earnings volatility, its earnings profile over the next year is assured thanks to a strong global brand, benefits of scale, growth through the corporate business in the US and employees with a strong performance culture.

The stock should also be supported by the company’s growing dividend yield, sources say. When franking credits are included, analysts on average expect a yield of 5.5% in 2014-15, lifting to 6.3% in 2015-16.

Lastly, sources say Flight Centre will benefit from any continued strength in the Australian dollar, with more Australians incentivised to travel overseas. And, as Adam Carr said last week, there’s a chance the dollar could reach parity by the end of the year.

* According to our value investor partners, StocksInValue, the intrinsic value for Flight Centre is $45.76. To find out more visit http://www.stocksinvalue.com.au/.

• Investors are generally advised to buy Flight Centre at current levels.

UGL (UGL)

UGL is trading off future value for a quick fix to its ailing balance sheet, according to the majority of newsletters.

On Monday the engineering and property services company announced that it had finalised the sale of DTZ, its property services business, to a consortium of private equity firms for $1.215 billion.

Net proceeds of $1-1.05 billion are expected from the sale, depending on final capital gains assessments, transaction costs and other sale adjustments.

Most newsletters view the sale as disappointing, and are advising their clients to sell the stock for several reasons.

For one, the sale price is well below where global peers are trading at, with an enterprise value to earnings before interest and tax (EV/EBIT) ratio of 8.3 times.

And while the sale does deleverage UGL – allowing the company to pay off its $619 million in net group debt – it removes any value from property services that could have arisen from a demerger instead.

Newsletters believe the market’s attention will now turn to the quality of UGL’s earnings in the second half of 2013-14, where the share price will be at risk from UGL’s persisting cash issues. One source anticipates a net working capital outflow of over $50 million during the period – representing the fourth year where operating cash flow lags behind reported profits.

That being said, it’s not all bad news for UGL. A key question for newsletters is what the company will do with its excess cash of around $400 million, as it could look for acquisition opportunities or make a capital return to shareholders. The company’s engineering division is also looked upon favourably by several analysts.

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

• Investors are generally advised to sell UGL at current levels.

Super Retail Group (SUL)

Shares in Super Retail Group lifted on Monday even though the retailer issued a profit warning, with investors expecting worse amid the downturn in consumer confidence and a warmer than expected winter.

The owner of brands Rebel Sport and Super Cheap Auto announced on Monday (June 16, 2014) that net profit for the full year is expected to be $107-109 million, an increase of 5% on the previous year but 5% below market expectations.

“This reflects the significant downturn in consumer confidence since the federal budget, particularly across the lower to mid income families who represent the group’s core customers,” the company said.

Shares in the company climbed 3.4% on the day to $8.32, and have since risen further to Tuesday’s close of $8.47.

The consensus is to hold the stock after the update, though several newsletters call Super Retail Group a buy.

Analysts more positive on the company say the external factors have been overplayed. They think the stock appears cheap, since it has plunged 36% since the beginning of the year amid three earlier downgrades, though they don’t anticipate it to outperform for at least 12 months when sales and margins improve.

But the majority of newsletters are reluctant to take a positive stance because they think more earnings downgrades are likely. Further, company specific matters, such as the problems with the leisure and sports divisions, will take a while to resolve, one source says.

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

• Investors are generally advised to buy Super Retail Group at current levels.

Echo Entertainment (EGP)

Echo Entertainment shares have climbed to their highest point in a year after the casino operator forecast earnings ahead of analyst expectations for the full year.

Echo anticipates earnings before interest, tax, depreciation and amortisation to climb around 10% to $430-435 million, above what analysts had pencilled in at $411 million on average. Net profit is expected to be $150-153 million.

The company attributed the upbeat forecast to its improved profit focus and its cost optimisation program, with operational expenditure predicted to be $870 million for the year, down from the previous guidance for $880 million.

The stock soared 7.6% to $2.98 in response to the news on Monday (June 16, 2014) and climbed another 2.7% on Tuesday. Since Collected Wisdom last covered Echo Entertainment as a buy in February, the stock has climbed more than 25%.

This time around, however, most newsletters are advising their clients to hold the stock following several recommendation downgrades.

The discount to which its share price trades to peers has narrowed to a level that reflects fair value, sources say. While most sources acknowledge that trading in the stock seems underpinned, they don’t think their clients should buy the stock due to the mid-term risks.

Echo Entertainment faces earnings risks from Crown’s entry into Sydney from 2019 and from uncertainty surrounding its redevelopments in Queensland.

For newsletters to take a more optimistic stance on the stock, they need management to prove they can deliver longer-term market share gains.

* According to our value investor partners, StocksInValue, the intrinsic value for Echo Entertainment Group is $1.46. To find out more visit http://www.stocksinvalue.com.au/.

• Investors are generally advised to hold Echo Entertainment Group at current levels.

Watching the Directors

• The largest trades were on the selling side this week, starting with David Leckie of Seven Group. The director and ex-chief executive netted $2,421,000 from offloading 300,000 shares in the equipment and media company at $8.07 each.
• Elsewhere, Louis Gries, the chief executive of James Hardie, sold 144,712 shares in the building products manufacturer for $2,077,720 at $14.358 each.