Collected Wisdom

This week we look at Macquarie Group, South32, Boral, Sonic Healthcare and Duet Group.

Summary: The outlook for Macquarie Group is divided following the investment bank’s latest earnings upgrade, while it is unanimously positive for South32 after the BHP spin-off released its first quarterly report. Meanwhile, investors shouldn’t get too caught up in Boral’s earnings upgrade, Sonic Healthcare faces a difficult Australian pathology market and Duet Group’s acquisition of Energy Developments relieves some pressure around its ability to deliver distributions, analysts say.

Key take-out: Several analysts struggle to see Macquarie Group running higher after its share price climb this year, but others say momentum should continue to surprise on the upside.

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.

Macquarie Group (MQG)

Analysts agree Macquarie Group has made a strong start to the year but are divided about whether the investment bank’s future growth is already reflected in the share price.

At its AGM last week, Macquarie reported that contributions from both its annuity-style and capital markets facing businesses for the first quarter of FY16 were significantly up on the same period last year.

“While the impact of future market conditions makes forecasting difficult, we currently expect the FY16 combined net profit contribution from operating groups to be up on FY15,” the company also said.

Analysts highlight this compares with previous guidance for profit to be “slightly up” – a meaningful upgrade to earnings from management. In fact, it is especially positive because commentary at the AGM is usually benign as it is too early to move full-year guidance based on the first-quarter performance, one analyst remarks.

However, the recommendations are almost evenly divided between “buys” and “holds” after the AGM with an average 12-month target price of $88.80 – 8.9 per cent above current levels.

While the momentum is undeniable, several publications struggle to see Macquarie rising significantly higher at the moment given it has already climbed 40 per cent this year and trades at a FY16 price to book value of around 1.8 times.

But others say Macquarie’s diversified business is well placed to take advantage of further strong market conditions in the medium term, whether in asset finance, capital markets, securities trading, banking or funds management.

One of the main areas of disagreement is whether performance fees at the funds management business will continue to provide further growth. The division was a big factor in the group’s earnings upgrade thanks to an uplift in performance fees, with management guiding its profit contribution to be “up on FY15” compared to previous guidance for it to be “broadly in line with FY15”.

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

South32 (S32)

Analysts maintain South32 offers investors compelling value at current price levels despite the company delivering a mixed quarterly report.

In its first quarterly result since spinning off from BHP two months ago, South32 announced weaker-than-expected production for its aluminium and alumina assets but stronger-than-anticipated coal production. Elsewhere, an increase in manganese ore volumes was offset by lower manganese alloy and nickel production.

“The curtailment of aluminium production at Alumar and manganese alloy production at Metalloys demonstrates our commitment to maximise financial performance per share, rather than volume,” said chief executive Graham Kerr.

Kerr’s commentary failed to encourage the market, with the stock drifting from $1.83 to $1.79 on the day of the news (July 22, 2015). It is now around 25 per cent lower than its peak of $2.37 in late May.

As with the last time Collected Wisdom covered South32, investment firms overwhelmingly rate the stock as a “buy”. They say that South32 offers good value at current levels given it has a clean balance sheet and leverage to a cyclical upswing in commodity prices.

They forecast an average 12-month price target of $2.94 and a dividend yield of 3.4 per cent for FY16 and 5.1 per cent for FY17.

Though aluminium/alumina failed to impress for the quarter, they are commodities that analysts generally have positive price assumptions for in future periods. At around 50 per cent of South32’s FY15 EBITDA, the segment is central to the stock’s valuation.

Analysts say South32’s financial results in August will be crucial as they are the first forum in which management can reveal its plans for its cost and capital expenditure savings. As one publication says, this company was created on the premise that its assets would operate more efficiently under a leaner structure.

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

Boral (BLD)

Investors shouldn’t get too caught up in Boral’s recent earnings upgrade given that the better full-year earnings appear to be driven more by property sales than by operating earnings, according to most investment houses.

The building products and construction materials company announced last Wednesday (July 22, 2015) that it expects net profit to be between $240-250m – beating consensus expectations by 15-20 per cent.

“This result is being underpinned by a number of factors including strong earnings in June and higher than expected property sales,” Boral said in the statement.

But several analysts think most of the gain has been from the $44m after-tax in property sales which they consider to be “lower quality” earnings. While there does appear to be some outperformance across the business segments, it looks minor given that the company flagged operating earnings to be “broadly in line with divisional outlook commentary” that it had originally provided in May.

The market didn’t get too excited with the news either; the stock edged upwards from $6.38 to $6.46 on the day. Indeed, Boral’s share price rise of 23 per cent this year appeared to have already captured the upbeat announcement, analysts say.

Most investment firms call Boral a “hold” following the earnings upgrade. Many believe that with domestic housing approvals at arguably record levels and construction materials pricing on major infrastructure projects already committed, the company will need to look to its US division to beat expectations once again.

The US earnings recovery is likely to be uneven in FY16 because costs will be added back into the business, one analyst says. Another analyst with more optimistic assumptions, however, takes note of management’s comments about June earnings. If the earnings originated from the US, it could be indicative of strong growth in FY16.

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

Sonic Healthcare (SHL)

Sonic Healthcare is overcoming a difficult Australian pathology market by diversifying offshore, but the risks remain too high for most analysts to be optimistic about the stock’s outlook.

The pathology, medical centre and radiology provider said last week (July 20, 2015) that EBITDA guidance for FY15 is now anticipated to be $730m, below its previous projection for $762m.

Earnings were hit by lower patient volumes in the fourth quarter, costs associated with opening more pathology collection centres and Medicare rebate changes, including funding restrictions for vitamin D/B12 and folate testing.

Sonic Healthcare also set EBITDA guidance for FY16 of $850-875m, around 6 per cent below consensus forecasts.

Investment firms are extremely mixed over Sonic Healthcare after the downgrade, with a range of “buys”, “holds” and “sells”. Most analysts, however, see the stock at close to fair value after its fall from a peak of $23.63 in mid-July to Friday’s close of $20.67.

Analysts who are optimistic say the fundamentals remain intact and the revisions don’t change the company’s strong growth prospects amid sustainable industry growth in the medium to longer term. The changes will cycle through come November, meaning that they shouldn’t continue to drag on the business, one analyst says.

Others point to ongoing risk that the Australian government changes regulations and brings about a reduction in collection centre rents. There is also an active review of the Medicare Benefits Schedule (MBS), with recommendations to be delivered by the end of calendar 2015.

That being said, if Sonic Healthcare can continue to expand via acquisitions to more stable pricing geographies, such as Switzerland or the private UK market, this would be well received by the market, one analyst says.

  • Investors are generally advised to hold Sonic Healthcare at current levels.

Duet Group (DUE)

Duet Group’s $1.4bn acquisition of gas producer Energy Developments (EDL) enables it to cover more of its distributions with free cash flow – markedly improving the investment case for the stock, most analysts say.

Last week (July 20, 2015) Duet launched a takeover bid for Energy Developments at $8 per share, representing an enterprise value to EBITDA multiple of 8.8 times for FY15 (below Duet’s 10.5 times). The bid will be funded by a $1.7bn equity raising comprising of a $550m placement and a $1.1bn rights offer.

With more than 85 per cent of EDL’s shareholders already on board, the takeover is likely to be approved in the absence of a superior offer, analysts say.

Recommendations for Duet are mixed following the acquisition, but on balance are for investors to “hold” the stock.

The last time Collected Wisdom covered Duet back in November last year, analysts were negative about the outlook because they feared the company couldn’t sustain its distribution policy. Though the acquisition of EDL doesn’t enable Duet to fully cover its distributions, it is cash flow accretive and alleviates some of this pressure.

The purchase also lowers Duet’s gearing levels, with management forecasting them to drop to 61 per cent from 71 per cent, and offers Duet higher growth. EDL owns a portfolio of remote power stations in Australia as well as clean energy generators in Australia, the US and Europe.

However, EDL’s assets also increase the risk profile for Duet due to its single-customer remote generation assets, analysts say. Before, Duet was exposed to monopoly-type assets with dominant market positions.

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

*Collected Wisdom will be published in future on Wednesday.

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