Collected Wisdom

This week we look at APA Group, Spotless, Nine Entertainment, Metcash and Recall Holdings.

Summary:  Newsletters maintain their positive stance towards APA Group after its earnings downgrade due to it mostly being related to timing issues, but have slashed their forecasts for Nine Entertainment in response to its earnings cut. Elsewhere, Spotless is highlighted for its attractive medium term outlook and yield, the bad news is finally out for Metcash after it scrapped its dividend and Iron Mountain’s sweetened takeover bid for Recall looks appealing for retail shareholders, analysts say.

Key take-out: APA is executing on its strategy to grow operating cash flow, with lower revenue being offset by lower debt, analysts say.

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.

APA Group (APA)

Worse than expected earnings guidance from APA Group for FY15 hasn’t discouraged most analysts about the outlook for the gas infrastructure company.

Shares in APA fell 3.6 per cent to $8.74 last week (June 4, 2015) after the company cut full-year earnings guidance to $810-825m, below consensus expectations for $866m and its previous forecast of $816-873m.

The downgrade was part of APA’s announcement that it had completed the acquisition of the Queensland Curtis LNG (QCLNG) pipeline at a final price of $US4.6bn, with the first full-year earnings before interest, tax, depreciation and amortisation (EBITDA) contribution expected to be around $US355m.

Analysts say the reduction in earnings guidance can be explained by the timing of the acquisition: the purchase was completed with less than a month before financial year’s end when it was originally expected to be finished with 1-2 months left.

The majority of analysts call APA Group a “buy” after the update. They say the timing of the transaction is largely immaterial to the rationale for buying the QCLNG pipeline and for the overall investment thesis for the stock.

APA is executing on its strategy to grow operating cash flow, with lower revenues being offset by lower debt, they say.

Further, QCLNG provides surplus capital that will help APA pursue investment opportunities such as with the Northern Territory (NT) pipeline and the South West Queensland Pipeline (SQWP).

However, several analysts highlight that any investment decision on APA Group revolves around the long-term view for interest rates. One publication which is bullish sees low interest rates as here to stay.

However, another publication is more cautious on APA Group because utility stocks tend to underperform in a rising interest rate environment.

While it sees scope for the company to increase dividends in the years ahead, it doesn’t think this will be enough to offset the decrease in the stock’s valuation given it doesn’t have the same regulatory hedge that some other utility stocks have.

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

Spotless Group Holdings (SPO)

Spotless offers investors an attractive, growing dividend yield at a share price which is currently trading at a discount to major peers, investment houses highlight.

Their analysis comes after Spotless announced the conditional acquisition of Utility Services Group (USG) last week (June 2, 2015). USG has annual services revenues of $200m, which amounts to roughly 7 per cent of Spotless's estimated revenues of around $2.7bn for FY15.

Spotless is a provider of integrated facility services in Australia and New Zealand. It was bought and then de-listed by private equity firm Pacific Equity Partners in 2012 before returning to the market in June last year at an offer price of $1.60 to 1.75. It closed on Tuesday at $2.18.

While the purchase price of the USG acquisition wasn’t disclosed, analysts estimate an acquisition enterprise valuation of $50-60m and say it will be internally debt funded.

The acquisition provides Spotless with access to a new base of utilities clients and exposes it to an outsourcing trend which is likely to accelerate as the sector privatises, like in NSW, analysts say. Spotless will also be able to cross-sell other services to its new utility customers.

Most analysts call Spotless a “buy” following the purchase. They highlight that, on average, the stock has traded at an 18 per cent discount to peers since listing. This gap has widened further since the recent decline in the share price from a peak of $2.47 in April.

Moreover, Spotless has dominant market positions, good revenue visibility thanks to long-term contracts that range between five to 10 years and excellent diversification with no one customer making up more than 5 per cent, analysts say.

Spotless is well placed to deliver on its prospectus guidance and generate ongoing earnings growth over the next few years due to the outsourcing trends and contract wins, analysts say.

The consensus forecast dividend yield is 5.1 per cent in FY16 and 5.4 per cent in FY17.

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

Nine Entertainment Group (NEC)

Three investment houses have cut their recommendations on Nine Entertainment in response to the media company lowering its full-year earnings guidance last week.

Yesterday the stock plunged 16 per cent to $1.665 – its lowest point since listing in December 2013 – after Nine announced that it now expects EBITDA in the range of $285 to $290m, below previous guidance for $311m.

“This reduction in earnings reflects a softer than anticipated free-to-air advertising market in the second half which is now expected to be in low single digit decline, driven by particularly soft conditions in May and June,” the company said in the statement.

With four publications dropping their calls in the past month, consensus is far less optimistic about Nine. More analysts now rate the stock as a “hold” than as a "buy".

Analysts who remain bullish point to Nine’s balance sheet strength (particularly after the sale of Nine Live), dominant content (albeit with weaker ratings), the ability to reduce costs as content deals are renegotiated and to the company being a potential takeover target or acquirer.

They also say Nine has valuation support at current levels at a price-earnings multiple of 11 times, especially since the $640m in proceeds from Nine Live are likely to enable further share buy backs, a higher payout ratio and diversification away from the television business.

But others say cracks are emerging in the market: The free-to-air prime time audience declined 7.5 per cent in the first 15 weeks of 2015 and more of the younger audience are switching to digital delivery platforms.

Competition from other broadcasters has heightened as well. One analyst believes another reason for the downgrade is the loss of ratings share to Ten Network, while Seven’s rating share remained broadly flat.

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

Metcash (MTS)

Metcash’s decision to scrap its dividend and potentially float its automotive business will bolster the balance sheet, but the wholesale distribution business still faces an extremely challenging environment, newsletters say.

Shares in the company plunged 18 per cent to $1.14 – their lowest levels in 14 years – on Thursday last week when it was announced that a final dividend for FY15 won’t be declared and dividend payments in FY16 will be suspended. Metcash also announced a $640m non-cash impairment.

“While we are making progress with the group’s strategic priorities, the food and grocery pillar is operating in an increasingly competitive environment,” said chief executive Ian Morrice.

The move comes after Metcash announced in May it was investigating the potential initial public offering (IPO) of its automotive business, with the proceeds to be used to invest in the group’s balance sheet and businesses.

The last time Collected Wisdom covered Metcash in April most analysts warned the company was failing to execute on its transformation plan and advised to exit the stock.

With the bad news now in the open, more analysts believe the risks are fully reflected in the share price but are still divided between calling the stock a “hold” or “sell”.

Publications which remain bearish say Metcash is structurally challenged, with IGA’s market share continuing to deteriorate despite reducing prices in the efforts to match competitors. Further, Aldi is expected to enter South Australia and Western Australia – which currently make up around 50 per cent of profit – by 2016.

But others say the dividend cut and automotive IPO will provide enough of a buffer to reduce the need for a dilutive capital raising in the medium term. Provided Metcash can cut its costs and stabilise earnings at an EBIT margin of 1.8 per cent, the stock should find valuation support.

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

Recall Holdings (REC)

Newsletters are advising Recall shareholders to accept Iron Mountain’s sweetened takeover bid.

The document management company announced to the market yesterday (June 9, 2015) that it had entered into a scheme implementation deed for Iron Mountain to acquire Recall for an enterprise value of around $3.4bn.

“Our shareholders stand to benefit from the transaction’s significant synergies and the potential future share price of the combined company as well as the additional cash payment,” said chief executive Doug Pertz.

Shares in Recall lifted 3.2 per cent to $7.25 on the day of the news.

On top of the original 0.1722 Iron Mountain shares for each Recall share, shareholders will also receive $US0.50 in cash for each share. Iron Mountain will establish a secondary listing on the ASX to allow Recall shareholders to trade its shares.

Alternatively, Recall shareholders can choose to receive $8.50 in cash for each share, but this is capped to a maximum of $225m.

With Recall’s share price trading at around $7.17, offer is attractive for smaller retail shareholders given the cash offer for the first 5,000 shares, one publication says.

Another publication agrees, advising its clients to opt for cash then script. It says that it is unlikely a third party will show interest and start a bidding war and expects the takeover to be completed by late 2015.

On the other hand, analysts agree with Pertz that shareholders should see increased value from synergies, economies of scale, an improved growth profile and more geographic diversity.

However, analysts also caution that the deal remains subject to regulatory approval.

  • Investors are generally advised to hold Recall Holdings at current levels.

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