Collected Wisdom

PORTFOLIO POINT: This is a sampling of the week's best research notes. In a world of too much information, we hope our selection helps you spot the market's key signals.

Wesfarmers. Perth-based conglomerate and owner of the Coles supermarket chain is set to transfer 45 of its stores and eight attached liquor stores to independent grocery retailer FoodWorks. The stores were regarded as underperformers, requiring considerable capital expenditure. The $35 million deal is broadly seen as a step in the right direction by the management as it aims to rebuild Coles as a serious challenger to market leader Woolworths.

One newsletter says the divestment shows Wesfarmers is now focusing on profit and not volume. Another plus for Wesfarmers is that the transaction will allow it to work on generating more profit from its core supermarkets, which have a greater upside potential.

According to one stock picker, the group's Coles store portfolio is improving and, with retailers usually keen to build market share, Wesfarmers’ willingness to shed some of theirs for enhanced profitability shows management is prepared to think outside the box in a bid to become more profitable.

Although stock pickers see medium-term value in the conglomerate’s stock, they are quick to concede the FoodWorks transaction will have no real bearing on Wesfarmers’ overall earnings. Coles may still have some way to go before catching up to Woolworths in the grocery game, but the consensus is that the Coles turnaround is gaining traction.

• Investors are advised to buy Wesfarmers shares at current levels.

David Jones. Staying in the retail space, upmarket retailer David Jones upgraded its earnings guidance last week to growth of 20–30% for the second half and 8–12% for the full year. The guidance implies full-year earnings of about $150 million and easily exceeds the previous guidance of 0–5% growth.

However, stock pickers are mixed on what the better-than-expected numbers mean for the retailer, with some saying that the stimulus-driven profit upgrade is not really much of a surprise and the real test will come when the stimulus well runs dry. David Jones management has certainly refrained from getting overexcited, with chief Mark McInnes saying the results aren’t a return to the boom times and are more indicative of the business managing to contain both its costs and its margins.

One stock picker adds to the downbeat tone saying that despite the surprise profit growth guidance, it is increasingly unlikely that the company will be able to sustain the performance given how stretched the valuation looks against the forecast of weaker retail spending that lies ahead.

Another concurs, saying that David Jones’ current share price is factoring in a very strong economic outlook that isn't entirely realistic and that the stock will start to lose its appeal once the euphoria about the recent positive retail sales data dies down. The retailer has so far managed to ride out the crisis, but with discretionary retail sales expected to deteriorate through the September 2009 quarter, the stock could come under renewed downward pressure.

• Investors are advised to hold David Jones shares at current levels.

Qantas. Qantas has downgraded orders for its fleet, cancelling the delivery of 15 Boeing 787s and delaying the delivery of another 15 aircraft, which will reduce some of the pressure on the flying kangaroo’s balance sheet, giving many stock pickers reason to cheer.

However, with May traffic stats showing a decline in profit margins, some of them are also pointing out the greater risk that is now associated with airlines in general. One newsletter says the lower fleet orders will reduce group capital expenditure by about $3 billion, but the downgrade will delay the many of the airline’s highly anticipated initiatives.

While the lower traffic numbers may have already been factored in by management when they cut their full-year profit forecast by 80% and jettisoned almost 2000 staff, the recent entry of US carrier Delta Air Lines into the lucrative Australia-US route will certainly not be welcomed by Qantas, especially as demand for international travel remains weak.

The one thing in Qantas’ favour is that its management is continuing to prudently manage costs and capacity says one stock picker, who adds despite the impact of swine flu and general weakness in demand, Qantas stock represents good value and is well positioned to bounce back as market conditions improve.

Another stock picker says the airline is being priced more on an asset-based valuation rather than earnings potential, and although the valuation gap is closing the stock is still the best pick in the sector.

• Investors are advised to buy Qantas at current levels.

Cabcharge. Payment services provider Cabcharge has found itself in a tussle with the ACCC for alleged anti-competitive behaviour. With Cabcharge shares falling more than 20% since the competition regulator started proceedings, investors are getting edgy.

The ACCC alleges Cabcharge breached the law by refusing to allow suppliers of rival EFTPOS terminals to process Cabcharge’s charge card transactions. It has also been accused of supplying taxi meters and fee schedules free or below cost to damage or eliminate competing suppliers.

However, stock pickers and newsletters don’t seem to share the apprehension, with most saying that the legal action should not have too big an impact on the market leader’s earnings. One newsletter estimates that if Cabcharge were to lose 20% of its charge card business, earnings per share would fall about 8%; another sees a loss of about 10%. Both agree that investor anxiety will weigh on the stock in the near term but overall the company is sound and still offers good value considering its dominance.

A win for the ACCC would undoubtedly strain the company's cash flow but there is still considerable doubt whether the regulator will succeed. Even if it prevails Cabcharge’s dominant market position should not be affected.

• Investors are advised to hold Cabcharge shares at current prices.

Tatts Group. The $107 million Oz Lotto super draw has come and gone and although most punters were left empty handed, the hysteria associated with the draw has certainly boosted the prospects of gaming and waging operator Tatts Group.

One stock picker says the stock is trading at a 13% discount and is expected to generate compound annual earnings per share (EPS) growth of 7% over the next three years. With a fully franked dividend yield of 8.3% (which is fully covered by free cash flow) Tatts offers good value in the gaming sector.

Tatts derives about 16% of revenue from lotteries and one stock picker points out that the earnings benefit from that area are muted, with the recent string of jackpots boosting Tatts’ full-year earnings by no more than 2%. However, although the lottery margins are slender, one newsletter points out that the company’s pokies operations are performing well.

Tatts has been a clear beneficiary from the government stimulus payments going down the slots, with pokie revenue improving 5% in May, adding to the 8% and 7% improvement in March and April respectively.

The company was widely seen as the front runner in the $600 million privatisation of the NSW Lotteries. However, with the sale put on hold until September, Tatts may now have to set its sight on the Victorian wagering licence (now held by Tabcorp), Tote Tasmania and the Victorian gaming monitoring licence, according to one stock picker.

Tatts Group and Tabcorp are both set to lose their Victorian gaming licences in 2012 as part of the controversial decision to change the industry structure, and the changes will have an impact on Tatts’ earnings. With $700–800 million in surplus balance sheet capacity and a further $400–500 million in undrawn facilities, the company has more than enough firepower to pursue growth in the medium term.

• Investors are advised to buy Tatts Group shares at current levels.

Watching the directors

Week to July 3

• Mirvac, like the rest of the embattled A-REIT sector, has had to rely on an expensive equity issue to keep its operations on the straight and narrow. After trading for as much as $6.30 in December 2007, the property owner and developer has been forced to raise $1.1 billion at $1 a share. Investors who dug deep to top up their holdings will no doubt be interested to hear of some big sales at boardroom level. Documents lodged with ASX show managing director Nicholas Collishaw sold 283,937 shares held indirectly for $320,849 on-market on June 30. Separately, executive director Adrian G Fini indirectly sold considerably more stock than his colleague, dumping 1,133,208 securities worth $1,290,107 on-market on June 24 and 29.
• Origin Energy chairman Kevin McCann has opted for more skin in the game by acquiring another 10,000 shares for $144,210 on-market on June 29. He directly holds 3,458 shares and indirectly holds 273,924 shares.
• Kagara chairman Kim Robinson sold 6,844,566 shares for $4,693,908 on-market between June 25 and June 30. He indirectly holds 11,445,971 shares. Director Joseph Treacy sold 1,000,000 shares for $700,000 on-market between June 26 and June 30. He holds 2,329,865 shares.
• NIB Holdings managing director Mark Fitzgibbon, the brother of former Defence Minister Joel Fitzgibbon, was granted 631,071 performance rights for a nil consideration on June 30.
• Fortescue Metals Group director Russell John Scrimshaw bought 150,000 shares worth $566,218 and sold 150,000 shares worth $1,411,950 pursuant to the settlement of a zero cost collar loan on June 26.
• Metgasco managing director David Johnson exercised 4,480,575 options worth $1,299,367 and bought 2,600,000 shares worth $1,170,000 on and off-market on June 30.
• Austock Group managing director Timothy David Boyle bought 2,000,000 shares on June 30, 2009 via employee share plan. He indirectly holds 3,078,920 shares.
• Diatreme Resources director Andrew Tsang bought 287,410 shares on-market for $41,948 between June 26 and 30. He directly holds 28,671,700 shares and indirectly holds 3,287,410 shares.
• Mirabela Nickel Ltd director Nicholas Poll bought 400,000 shares for $240,000 on June 30. He holds 3,400,000 shares and 1,200,000 options.
• Programmed Maintenance Services managing director Christopher Glen Sutherland was indirectly allotted 31,250 shares worth $85,000 via his executive service agreement on June 29. He directly holds 450,000 performance options and 180,000 performance rights. He indirectly holds 577,832 shares.
• Macquarie Bank Ltd director Richard Sheppard bought 5,825.14 units worth $5,825 as a result of an income distribution and sold 873.77 units worth $874 as a result of tax on income distribution on June 22 and 23. He holds 47,098.88 units.
• South Boulder Mines Ltd directors David Hughes and Terrence Grammer were indirectly issued 1,000,000 options on July 3.
• Kangaroo Metals Ltd director William Shire indirectly sold 250,000 shares off-market on July 2.
• Dominion Mining Ltd director Peter Alexander directly sold 150,000 shares on-market for $676,650 on July 2.
• MGM Wireless Ltd director Mark Fortunatow transferred 500,000 shares off-market on June 30. He indirectly holds 38,085,903 shares and 5,500,000 options.

nRecent directors' trades worth more than $200,000
Date	Company	ASX	Volume	Price	Value	Action
26/06/09	Primary Health Care	PRY	153,549	5.27	$809,203	Buy
24/06/09	United Group	UGL	43,205	9.731	$420,415	Buy
24/06/09	PPK Group	PPK	1,079,958	0.257	$277,545	Buy
12/06/09	Magellan Financial Group	MFG	947,239	0.5	$473,620	Buy
02/06/09	Primary Health Care	PRY	155,000	5.27	$817,050	Buy
28/05/09	Diatreme Resources	DRX	11,000,000	0.14	$1,540,000	Buy
27/05/09	Bass Metals	BSM	1,000,000	0.2	$200,000	Buy
22/05/09	Clime Investment Mgt	CIW	1,306,350	0.28	$366,198	Buy
15/05/09	Westfield Group	WDC	50,000	9.75	$487,500	Buy
14/05/09	Bow Energy	BOW	430,000	1.079	$463,884	Buy
01/05/09	National Australia Bank	NAB	13,049	20.72	$270,337	Buy
29/04/09	Washington H Soul Pattinson	SOL	57,000	9.63	$549,035	Buy
29/04/09	Primary Health Care	PRY	81,703	4.12	$337,197	Buy
28/04/09	Thakral Holdings	THG	2,400,000	0.25	$601,980	Buy
24/04/09	Ascent Pharmahealth	APH	1,546,875	0.16	$247,500	Buy
17/04/09	Primary Health Care	PRY	82,712	4.57	$377,711	Buy
09/04/09	TSV Holdings	TSH	2,660,000	0.11	$292,100	Buy
08/04/09	West Australian Metals	WME	3,500,000	0.15	$525,000	Buy

Source: The Inside Trader