Collected Wisdom

PORTFOLIO POINT: This is an edited summary of Australia's best-known investment newsletters and major daily newspapers. The recommendations offered represent the views published in other publications and may not represent those of Eureka Report.

Commonwealth Bank of Australia (CBA). CBA’s first-quarter trading update came hard on the heels of interim results from the other big banks, giving investors the perfect sector wide view. One newsletter says the latest figures from CBA confirm the trends across the sector; bad debt charges are falling at a faster rate than anticipated but the growth in profits from financial markets have been underwhelming. Surprise impairments from the BankWest loanbook went against the trend but were offset by a decline in bad debts elsewhere in the business.

CBA’s unaudited March-quarter net profit came in at $1.5 billion, a 30% improvement on the previous corresponding period and steady with the December quarter. The result was in line with expectations and the lender only needs to repeat the figure in the current quarter to achieve the anticipated $5.9 billion full-year profit. The primary concern for the newsletters across the banking sector is rising funding costs and limited scope to raise interest rates above the RBA rate due to political pressure. CBA is no different.

Credit growth has recommenced but the rebound is slightly disappointing at present. The newsletters note CBA’s caution isn’t mere words; one says the bank has the most conservative business platform of the big four. The lender has the highest provisions set aside for risk-weighted a tier-one asset ratio of 9.2%, liquid asset balances steady at $89 billion and having completed funding arrangements for the entire 2010 financial year. CBA also has longer funding timelines than its peers and is thus better positioned for a tightening in credit markets, while the strong tier-one ratio leaves it well prepared for any tightening from regulators on balance sheet requirements.

• Investors are advised to hold CBA shares at current levels.

Sigma Pharmaceuticals (SIP). The newsletters could possibly spend their time better than examining the plight of a company with a market capitalisation of about $400 million while there are bigger fish to fry. But Sigma had a market cap of $1.5 billion just nine months ago. Since then its share price has plunged 67%. The reason was the writedown of $442 million in goodwill, most of which was related to the 2005 merger with Arrow Pharmaceuticals, a deal that was supposed to provide Sigma with market expansion and vertical integration.

Last month chief executive Elmo De Alwis, who had been with the company for the good part of a decade, announced he was stepping down. Now chief financial officer Mark Smith has followed and the newsletters wonder whether regime change is going to be enough to improve Sigma’s fortunes. The newsletters are sure that whoever the new CEO and CFO are, they’ll need quite a lot of turnaround experience because Sigma is still trying to find ways to meet its loan covenants and reduce its debt burden.

But the newsletters say Sigma’s problems extend beyond its past mistakes. The pharmaceuticals company is battling a federal government determined to improve the health system, which will impact on Sigma’s core operations. The new industry group Medicines Australia is aiming to slash $1.9 billion in drug prices over the next five years. The newsletters say this will hit both patented and generic drugs. If the changes go ahead, Sigma’s margins will come under even more pressure.

One newsletter said it’s not in the federal government’s interest to kill Sigma with its changes, so leniency might be adopted. But the newsletters agree that aside from this battle Sigma has too many problems that will take too long for investors to bother trying to recoup their losses.

• Investors are advised to sell Sigma shares at current levels.

Carsales.com (CRZ). Australia’s leading classifieds provider for cars, motorbikes and boats is confident that its EBITDA forecast for the 2010 financial year of $61 million is well within its reach. Carsales debuted on the ASX last year and the newsletters stress that this was one of the few recent floats that didn’t leave investors short-changed. Speaking at a conference recently, chief executive Greg Roebuck said he remains confident about the company’s prospects going forward and the newsletters are inclined to agree with him.

In fact, one newsletter expects Carsales to experience strong earnings growth for almost five years as advertisers continue to abandon print and migrate online. The newsletter cites comments from Hyundai’s marketing head, who says the debate is over and “print is dead”. The tremendous advantage of being an online advertiser is the operational leverage. Carsales can rake in additional revenue without a substantial increase to its costs. As one newsletter notes, in its first-half results the company delivered a 26% increase in revenue that netted a 48% increase in EBITDA.

Carsales isn’t idly sitting on its formula. One newsletter acknowledges the widespread success of its iPhone application that is not far from producing the same number of page impressions as the actual site. Carsales is continuing to lead the way in information technology innovation to ensure that rivals have a hard time muscling in.

The question the newsletters have to ask is where to next for Carsales? With cash flow building the prospect of an international acquisition is considered a possibility but the company has a stated preference of moving into accessories. This will test the company’s ability to move into specific markets rather than overarching areas such as cars or boats. Investors should not Carsales to provide similar customer numbers to specific markets, but it will nonetheless provide opportunities to generate more revenue from its existing customers.

With a price/earnings multiple of 27 times expected 2010 earnings, the newsletters think Carsales is looking pretty keenly priced.

• Investors are advised to hold Carsales.com shares at current levels.

SP Ausnet (SPN). This regulated utility and infrastructure stock gave the market a welcome surprise when net profit for the year to March 31 came in at $209 million, a healthy 9.4% above the expected $191 million. Stronger regulatory pricing helped lift group revenue 14% to $1.33 billion, while EBITDA rose an impressive 9.7% to $778.3 million. The final dividend came in at 4¢, to bring total dividends to 8¢ and a very imposing yield of 8.8%. The company expects to at least match these results in the coming year.

SP Ausnet, which is still 51% owned and operated by Singapore Power, focuses primarily on regulated assets. About 87% of the company’s investments are regulated, with the new end-to-end services provider Select Solutions the exception to the rule. All units performed well in the latest set of numbers. Electricity transmission revenue rose 7.9% to $531.3 million, power distribution revenue swelled an eye-catching 23% to $626.2 million, and gas distribution revenue gained 6.5%.

While all divisions are ticking over nicely, the company is engaged with the tax office over an $81 million claim. The tax office could reverse some of the payment but the company is standing by its claim and will respond to office’s request by the end of May. The newsletters are quietly confident that SP Ausnet will fend off the tax office without much trouble but even if it can’t, the penalty on the interest accrued by the $81 million increases franking credits. Who would have thought fighting with the tax office could have an upside?

The newsletters think the tax battle is a side issue that could distract investors from some serious value. With a price/earnings multiple of 11, SP Ausnet is favourably priced compared to one rival at 15, and this rival doesn’t come with that dividend yield. One newsletter points out that while some in the sector raised money to improve their balance sheets SP Ausnet had a prudent set of numbers. The only reason SP Ausnet raised $415 million about this time last year was to fund the growth that was out of its rivals’ reach. With healthy revenue starting to flow through thanks to those investments, the newsletters think the time is now for SP Ausnet.

• Investors are advised to buy SP Ausnet shares at current levels.

Incitec Pivot (IPL). The fertiliser and explosive maker’s significant exposure to the US market is providing some substantial currency headwinds as the Australian dollar holds its ground above US90¢. Still, the company managed to post a net profit of $132.4 million, which was 33% higher than the previous corresponding period, but after significant items the adjusted net profit actually fell 14% to $146 million. This is what the newsletters focus on and while it doesn’t sound appealing, Incitec gets a reasonably confident tick from its critics because of the immense challenge posed by currency differentials and lower prices for the commodities the company deals with.

The reason for the optimism expressed by the newsletters is the improvement in EBIT and EBITDA margins of 2.5% and 2.7% respectively. This is what helped cushion the impact of a 13% reduction in revenue to $1.28 billion. The impressive margin growth is largely due to Incitec’s cost-cutting and efficiency program, dubbed Velocity. While giving something as mundane as cost-cutting a name seems arbitrary to one publication in particular, results are results and the improvement to margins is not just a sign that fat can be cut for the good of shareholders, but a hint of good management. As chief executive James Fazzino said during a presentation, Incitec must do it’s utmost to deliver “good results in bad times and exceptional results in good times”.

So the question is how far away are the good times and what riches will they bring to patient investors? Conditions are expected to remain challenging for Incitec for the rest of the calendar year, but fertiliser demand is anticipated to improve soon as farmers begin to reinvest in soil nutrients, and a steady US recovery should strengthen demand for explosives.

But the attention is firmly on Incitec’s $935 million ammonium nitrate plant, Moranbah. The last time the newsletters touched base with Incitec, there was a strong degree of scepticism around the company’s completion target of the first quarter of 2012. At the time many newsletters described the timetable as ambitious, but curiously there’s no such scepticism now and Incitec is confident of hitting the target. Construction of the site is 35% complete and 90% of the output has already been contracted out. Moranbah sits very close to the gas supply in the North Bowen Basin, which will give it a compelling cost advantage over competitors. Incitec has spent $333 million on the project, but with another $500 million to go, the newsletters expect the company’s net debt to rise from $1.24 billion after falling 13% in the last half. The company has $1.14 billion undrawn in its $2.4 billion debt facility so there’s plenty of room to spare.

Despite the currency headwinds, Incitec has actually outperformed the benchmark index over the past 12 months by about 10%. With conditions starting to come around in the fertiliser and explosives market the newsletters think the company is beginning to come into its own.

• Investors are advised to hold Incitec Pivot shares at current levels.

Watching the directors

• BT Investment Management alternate director John Gareth Frechtling has sold more than 150,000 Westpac shares for $3.7 million at an average price of $24.76. The trades went through between May 6 and 10. Since then Greek debt jitters weighing on global sharemarkets have dragged Westpac shares down to $23.34. BT was spunoff by Westpac in 2007. While Frechtling picked up the shares by exercising incentive options, he retains just 245 shares in the company.

• Singapore Telecommunications non-executive director Simon Israel has almost doubled his stake in the telco amid niggling, endless speculation that Optus could be floated. Israel grabbed 150,000 shares at an average price of $S3.02 for $S453,000, or $A368,168.

• Miclyn Express Offshore non-executive director Nicholas Peterson has boosted his stake in the company by 100,000 shares at a $1.71, an outlay of $171,000. Miclyn, which provides service vessels to the offshore oil and gas industry, was launched on the ASX in late March at an issue price of $1.90. The stock was significantly underperforming the ASX 200 by May 6, but has since revived to be on level pegging with the benchmark since its launch. Peterson currently heads Macquarie’s industrial advisory unit across Asia.

• Nufarm non-executive director William Goodfellow has picked up 9907 shares at $6.75, for a total of $111,614. Goodfellow will hope that the trade ends up being a bargain after the company rejected an all-out bid at $12 a share from China’s Sinochem in July 2009, worth a total of $2.62 billion, in favour of a 20% bid from Japan’s Sumitomo. Goodfellow’s trade went through at $7.07, 70% beneath the Sinochem offer price.

Source: The Inside Trader