Collected Wisdom

This week we look at South32, Aristocrat Leisure, Independence Group, Suncorp and ALS.

Summary: Most newsletters are calling South32 an excellent opportunity for investors after the BHP spin-off listed last month, as they are again for poker machine maker Aristocrat Leisure following another set of stellar results. Elsewhere, Independence Group has paid a premium for a quality asset in the acquisition of Sirius Resources, Suncorp may not be able to achieve its ambitious return on equity target and ALS may be nearing an inflection point in its earnings cycle, analysts say.

Key take-out: Analysts believe South32 is undervalued in the context of its strong balance sheet, its cost reduction program and its attractive yield.

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.

South32 (S32)

Most analysts like the outlook for South32 after the BHP spin-off listed last month, highlighting its variety of cash generative assets and opportunities to reduce costs.

Shares in South32 debuted at $2.13 per share on May 17. They have since risen to $2.19 as of Friday’s close, putting the company’s market capitalisation at $11.6 billion.

Since then a number of major investment houses have initiated coverage on South32, with most rating the stock as a “buy”. On average, they forecast a 12-month price target of $2.55 on the stock, 16.4 per cent above current levels.

Analysts think the stock is cheap in the context of the company’s strong balance sheet (with no debt), its cost reduction program – which they estimate should around drive up to $500m in savings by the end of FY16 – and its attractive yield.

At the current share price South32 is trading at a forecast price-earnings multiple of 11 times and a yield of 3.4 per cent in FY16 and 4.7 per cent in FY17. The dividends won’t be fully franked, however, as the company didn’t gain any franking credits from BHP.

Nevertheless, one publication says the yield could be much higher – at around 8-10 per cent for South32’s first year – as management seeks to reward patient investors while it undergoes the capital reduction program. The publication tips this to come in the form of a share buy-back.

But analysts also warn investors South32 has limited volume growth options as most of its assets are steady-state businesses with long mine lives. There is some speculation that management will look to mergers and acquisitions, but analysts are sceptical this will happen within the first 12 months given the focus on internal improvements.

And while the assets provide exposure across a unique mix of commodities and are diversified across geography and currency, their quality is below the majors like BHP and Rio Tinto – deterring conservative investors – and they may be pressured at spot prices.

South32 is primarily exposed to aluminium and alumina, with the remainder almost equally split between manganese, coal and base metals. Most analysts see spot prices improving for South32, however, with five of the commodities arguably trading at troughs in the cycle.

  • Investors are generally advised to buy South32 at current levels.

Aristocrat Leisure (ALL)

Analysts continue to forecast stellar growth for Aristocrat over the next few years thanks to the poker machine maker’s latest acquisition and underlying improvements in the base business.

Last week the poker machine maker reported that first-half net profit leapt 66.8 per cent to $110.1m compared to the previous corresponding period, beating expectations. Revenue surged 73.5 per cent to $685m.

“Clearly, the acquisition and successful integration of VGT has been a significant factor in our performance half on half, but our results also reflect accelerating operational momentum across key markets and metrics,” said chief executive Jamie Odell.

Management forecasts second-half net profit after tax and before acquired intangibles (NPATA) to be broadly in line with the first half.

As with the last time Collected Wisdom covered Aristocrat Leisure in March, newsletters overwhelmingly rate the stock as a buy.

At a price-earnings multiple of around 16 times, analysts say the company remains an attractive investment because of its high growth profile. Generally they estimate a compound annual growth rate (CAGR) of 34-37 per cent up to FY17, largely driven by the VGT business.

VGT has transformed Aristocrat Leisure into a more predictable business that generates stronger cash flows with a higher percentage of recurring revenue (up to 47 per cent from 22 per cent in the previous corresponding period).

While the focus is to pay down debt with free cash flow for the foreseeable future, Aristocrat could release up to a 60 cent special dividend by FY17 after its net debt to EBITDA position reaches the desired 2 times level, one analyst highlights.

Shares in the company jumped 6.5 per cent on the day to $8.38, but have since fallen to Friday’s close of $7.80. They have climbed more than 50 per cent over the past 12 months.

  • Investors are generally advised to buy Aristocrat Leisure at current levels.

Independence Group (IGO)

Independence Group has made a generous offer to Sirius Resources shareholders in the $1.8bn acquisition of the nickel miner, but has also purchased a world-class asset in the process, newsletters say.

Under the deal, Sirius shareholders will receive 0.66 IGO shares for each Sirius share and 52 cents per share in cash – representing a split of 88 per cent and 12 per cent respectively. They will also keep the company’s non-nickel assets via a spin-out called S2, where they are entitled to 1 share for every 2.5 Sirius shares.

Though this looks to be a good deal for Sirius shareholders, it’s much less so for IGO shareholders, newsletters say. Not only have their shares fallen 17 per cent to $4.85 since the bid was made – reducing the value of the transaction to around $1.5bn – but they will also be heavily diluted.

Analysts don’t expect the deal to be EPS accretive until at least 2018, but see earnings increasingly sharply beyond FY21.

Despite the negatives, analysts say there are a number of compelling reasons for this offer and recommend investors “hold” onto IGO shares.

Firstly, IGO’s existing Long and Jaguar mines are short life assets with only two years of reserves remaining. Sirius’s flagship nickel-copper mine, Nova, has a 10-year plus mine life which should start production in 2017 – filling the gap in the company’s production schedule.

Secondly, Nova is expected to be one of the lowest cost nickel mines in the world with an all-in sustaining cash cost of around $2.10/lb.

Lastly, the deal moves IGO’s weighting back to nickel away from gold. One publication highlights that prior to the deal nickel accounted for about 30 per cent of its valuation for IGO while gold made up around half thanks to Tropicana – IGO’s quality gold asset. After the deal, nickel rises to 60 per cent and gold falls to around 20 per cent.

For one newsletter this is a good change because it sees significantly more upside for nickel prices than gold prices over the next two years.

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

Suncorp (SUN)

Newsletters are mixed over the outlook for Suncorp after attending the financial services group’s investor day last Wednesday.

The financial services company again showed how adept it was in removing efficiencies across the group, initiating its third significant cost and efficiency program in the past five years. An investment of $75m is being made in the ‘optimisation’ program in the aim to save $170m in efficiency benefits in 2018.

The savings are expected to come from improving the efficiency of processing claims, motor vehicle repairs, home repairs, procurement, technology and business intelligence.

“I am confident that as we maximise the value of our strategic assets and deliver on the next wave of projects we will see Suncorp achieve a sustainable ROE of above 10 per cent,” said chief executive Patrick Snowball, who is handing his position over to Michael Cameron later this year.

A number of “buy”, “hold”, and “sell” calls have been published since the investor day, with the point of contention being how well Suncorp can sustain margins and protect market share in a soft premium rate environment.

One analyst bullish on Suncorp says it is better positioned than Insurance Australia Group (IAG) and QBE to hold its margin thanks to its additional focus on cost savings and innovation initiatives.

As another analyst says, there aren’t too many companies that have driven structural change across supply chains like Suncorp has with smash repairs, parts procurement and home repairs.

Further, Suncorp is more than diversified with 35 per cent of its earnings outside general insurance, it trades at a 25 per cent discount to the market at a price-earnings multiple of 13 times for FY16, and it generates a yield of 7 per cent.

But other analysts disagree. Several are sceptical the company can achieve its ROE target because they believe these further savings will only offset some of the margin pressures and losses to market share, particularly in personal insurance.

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


Analysts have become more mixed about the outlook for ALS following the mining services company’s latest full-year results.

Underlying net profit after tax fell 21 per cent to $135.4m compared to the previous corresponding period, while operating revenue edged upwards 3 per cent to $1.42bn. A dividend of 10 cents per share was declared, franked at 25 per cent.

“Market conditions are unlikely to change in the short term and management remains focused on ensuring our operating model and strategies are aligned to market conditions,” said chief executive Greg Kilmister.

While earnings themselves contained no surprises – the company had already released quarterly and unaudited full-year results – they did have widely different implications for analyst recommendations.

There are now a range of “buy”, “hold” and “sell” calls for ALS, unlike the last time Collected Wisdom covered ALS in December last year (when the stock was overwhelmingly rated as a “sell”). On balance, however, consensus is to “hold” ALS.

The main area of contention is whether the company is about to reach an earnings inflection point and if its better outlook is already captured in the share price.

Two publications argue ALS is approaching such a point, with trends showing a strong second half in the life sciences division (partly thanks to growing market share) and improving organic growth rates in most divisions.

Despite timing risks, investors need to be set in ALS before the cycle and sentiment turns so they can be rewarded, one analyst highlights.

But others says that while EPS appears to be at a low point, the 35 per cent share bounce since the trough in late April more than adequately captures this. And while activity levels may have stabilised, competitive markets may mean that pressure on returns continue to linger.

More analysts are looking for harder evidence the tide has turned before they become bullish. There is still sustained pricing pressure, intensifying competition and challenged end-markets to deal with, they say.

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

Directors’ trades

  • Caltex chief executive Julian Segal has sold 276,000 shares in the fuel supplier and retailer at $33.158 each, realising a total of $9,151,706 from the trade. Caltex shares have climbed 50 per cent over the past year.
  • Also on the selling side, Nanosonics non-executive chairman Maurie Stand has offloaded $6,043,983 worth of scrip in the biotechnology company at $1.83 per share.
  • Elsewhere, chief investment officer of Platinum Asset Management, Andrew Clifford, netted $5,582,722 from selling 759,050 shares in the fund management company at $7.355 per share.

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