Collected Wisdom

This week we look at Asciano, Sydney Airport Holdings, Caltex, Pacific Brands and Kathmandu.

Summary: Analysts believe there’s good reason for the market to be wary about the takeover bid for Asciano with the terms of the proposal too unclear. Elsewhere, they agree Sydney Airport has struck an excellent deal over its five-year pricing for international passengers. Meanwhile, Caltex’s half-year earnings are better than expected, Pacific Brands are under threat from external challenges and the bid for Kathmandu looks opportunistic, analysts say.

Key take-out: Analysts urge caution around the takeover bid for Asciano but say there’s limited downside to the stock at current levels and the deal could be improved.

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.

Asciano (AIO)

The market appears to be wary about the terms of Brookfield Infrastructure’s $8.8 billion offer for Asciano – and for good reason, the investment press say.

Shares in the rail and ports operator leapt 17.2 per cent to $7.78 at the start of the month (July 1, 2015) after the company confirmed it had received a proposal from US-based Brookfield to acquire 100 per cent of its shares at an implied value of $9.05 per share. The board has engaged Brookfield on an exclusive basis.

The share price remains at a discount to the implied takeover price because the proposal may not progress into a firm offer and, moreover, because the terms of the proposal are unclear, analysts say.

The implied value of the offer comprises cash and scrip, but there’s no information about its composition – making assessing the value of the offer difficult. Newsletters warn investors to be cautious about the scrip component for two reasons.

Firstly, Australian investors may lose access to the $267m of franking credits in Asciano’s franking account. One analyst expects the offer to be improved by at least this amount (at about 27.5 cents per share), while another anticipates a special dividend as compensation.

Secondly, Australian investors will be swapping their scrip for an interest in a US-listed partnership and Bermuda-incorporated company with an external manager, Brookfield Asset Management.

Under this mode, which has largely been discredited in the Australian market, the manager is paid 1.25 per cent of Brookfield’s enterprise value. It also shrinks Brookfield’s apparent multiples of earnings, making the company appear cheaper.

Nevertheless, most analysts either call Asciano a “buy” or “hold”. While the deal looks opportunistic given automation at Port Botany has just been completed, it may be improved upon and there is limited downside to the share price, they say.

They point out price discovery has been established and Asciano has a promising outlook ahead as it continues to cut capital expenditure and grow dividends (see Collected Wisdom's last coverage of the stock).

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

Sydney Airport Holdings (SYD)

Sydney Airport Holdings has struck a good deal with the Board of Airline Representatives Australia (BARA) over the amount it charges international passengers over the next five years, according to investment houses.

The company, which owns and operates Sydney Airport under lease until 2097, has agreed to reduce charges by 0.7 per cent for FY16 before increasing them by 3.8 per cent for the four following financial years. In return, it is investing upgrades to increase capacity, efficiency and presentation.

Following the update most of the investment press call Sydney Airport a “buy”, with one publication upgrading its recommendation. They anticipate strong cash flows ahead thanks to the certainty from this agreement, along with lower funding costs as the debt portfolio rolls forward.

Despite the reduction in pricing for FY15, the pricing agreement is ahead of consensus forecasts and analysts have upgraded their earnings estimates significantly for FY17 and FY18.

International pricing is important to earnings; last year three quarters of aeronautical services revenue came from international passengers, with the segment itself accounting for 42 per cent of total revenues.

Domestically Qantas and Virgin are negotiating charges separately, but discussions are advanced and similar outcomes are expected, analysts say.

However, shares in the company have surged 8 per cent to $5.39 since the analyst responses and now trade just shy of the average 12-month target price of $5.53. Analysts expect a dividend yield of 5.1 per cent in FY16 and 5.5 per cent in FY17.

  • Investors are generally advised to buy Sydney Airport Holdings.

Caltex (CTX)

Analysts remain mixed over the outlook for Caltex shares following the oil refiner and marketer’s latest half-year unaudited results, but want more information in the face of the company’s overhauled business structure.

Net profit on a replacement cost basis (which doesn’t include oil price changes and aims to show underlying performance) lifted 45 per cent to $251m, largely in line with analyst estimates.

“Despite the competitive landscape in Australia continuing to be challenging, particularly in the business to business sector, the change in our business model is enabling us to capture opportunities as we optimise the integrated value chain,” the company said in the statement.

But the new reporting structure may be flattering marketing segment growth, analysts suggest. Underlying earnings before interest and tax (EBIT) grew 6.5 per cent in the supply and marketing division but, given that the first half of last year incorporated $72m in Kurnell refining losses, actual marketing growth is likely to be subdued or even in decline.

Analysts wait for more clarity on the makeup of the supply and marketing segment at the first-half results on August 24.

In the meantime, however, the consensus on balance is to “hold” the stock, with an average 12-month target price of $34.96 – 5.8 per cent above current levels.

Analysts bullish toward Caltex expect a total return of greater than 10 per cent thanks to capital management later in the year. One expects it in the first-half results given that its balance sheet is strong, M&A in New Zealand is no longer an option and there are no signs of BP’s Australian assets coming to market.

But while others acknowledge Caltex is a well-run business with a focus on business optimisation, they see risks to the growth outlook in the longer term. Its refining business is highly leveraged to volatile refining margins and the $A exchange rate – meaning earnings volatility remains a key risk.

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

Pacific Brands (PBG)

Analysts praise Pacific Brands’ turnaround strategy for the retailer’s better-than-expected earnings guidance for the full financial year, but warn that earnings are at risk in the following year from a lower $A.

Shares in Pacific Brands surged 47 per cent to 47.5 cents earlier this month (July 2, 2015) after the company reported that it now expects EBIT for FY15 to be between $63-65m – up to 13 per cent below its previous guidance of $57-63m. Group sales growth is expected to be 5.3 per cent and the balance sheet is anticipated to be debt free by the end of the year.

“The key contributing factors to the improved 2H15 results relative to the PCP have been the continued strong performance of Bonds and Sheridan retail, disciplined margin management and cost control and further action on corporate costs following the divestments,” the company said.

However, investment houses either call Pacific Brands a “hold” or “sell” following the re-rating despite the shares still being more than 15 per cent lower over the past six months.

So far the strategy has been asset divestments, offshore sourcing, brand rationalisation and cost savings – resulting in a much stronger balance sheet, they say. But the next phase revolves around delivering sustainable growth and relies on the Bonds and Sheridan brands continuing their push into retail.

This strategy will be difficult to accelerate due to a higher cost base and currency headwinds, analysts say. They forecast cost of goods sold (COGS) could rise as much as 20 per cent in the second half of FY16. While Pacific Brands is negotiating prices with retailers over the next four months, it has found it difficult in the past to pass on currency-induced COGS inflation in the past, one analyst says.

  • Investors are generally advised to hold Pacific Brands at current levels.

Kathmandu (KMD)

Briscoe Group’s proposed takeover offer of Kathmandu looks opportunistic and may need to be more appealing to shareholders to get approval, analysts say.

Late last month shares in Kathmandu jumped by a quarter to $1.57 after the adventure retailer received a takeover offer from Briscoe Group, a homeware and sporting goods retailer based in New Zealand.

Under the offer, shareholders will receive five Briscoe Group shares for every nine Kathmandu shares – representing 88 per cent of the offer – and cash of NZ20 cents per share.

Following the announcement most analysts call Kathmandu a “hold” and await more information, including the board’s yet-to-be-given recommendation.

The heavy scrip component is likely to be an issue because shareholders’ exposure will be altered from a specialty adventure wear retailer (with the potential for a turnaround) to a diversified retail group that’s listed in New Zealand and not on the ASX, they say.

The timing of the deal appears to be opportunistic to analysts, coming after a year of disappointing trading and coinciding with the new chief executive’s second day on the job.

That being said, it’s unlikely the turnaround of the business will be swift: The first half result showed a sharp deterioration in Australia and management is uncertain of the extent of structural issues within the business, they say.

One analyst takes the view that the offer doesn’t include any control premium or take into account synergies. As a result, it would be naïve to assume that a bigger cash consideration won’t be required to get the deal across the line.

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

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