Collected Wisdom

Newsletters warm to Metcash’s potential, but worry about Primary Health Care’s ability to grow and its debt load.

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.

Metcash (MTS). Metcash has come through a gruelling 17 months to buy 80 Franklins supermarkets for $190 million, a small sum in the grand scheme of things but it has the potential to be well worth the battle in the long-run.

In short, the competition regulator thought the acquisition would give Metcash too much power in the independent grocery wholesale sector, but the High and Federal Courts agreed that in terms of the bigger picture, a larger third player on the Australian grocery scene was an eminently sensible idea and rejected the ACCC’s theory that there was another “potential” buyer waiting in the wings to pick up the stores.

Independents should benefit, as a larger wholesale “umbrella” company will allow them to compete on discounts more easily with the Woolworths/Coles duopoly.

Pre-acquisition, Metcash delivered a 1.7% increase in first-half revenue to $6 billion despite the hesitant market sentiment, and it expected 2012-13 earnings per share to rise in the mid-single digits. More stores will give the company opportunities to lift this.

And no retailer can miss the still-cautious consumer outlook but Metcash is taking several steps to tackle this. One is to position its IGA stores as independent of the big two and highlight their differences, and the creation of IGA Fresh two years ago with later deli and bakery additions is also helping. The Fresh category has grown from being 65% of total sales to 95%.

Metcash also owns and operates the Mitre 10 hardware chain. It has renewed the sponsorship of Channel Nine’s The Block DIY renovation series, and even though Woolworths has just launched its Masters hardware chain and Wesfarmers is investing heavily in Bunnings, the investment press thinks Mitre 10 has what it takes to be a viable third alternative as independents are squeezed out. Although it’s in the early stages of rejuvenation, Mitre 10 has potential to take a much larger piece of the $12 billion DIY home renovation market.

  • Investors are advised to buy Metcash at current levels.

Primary Health Care (PRY). Primary, which operates 24-hour medical centres and pathology services, has been on the newsletters’ list of stocks to sell for a significant period of time.

The last time we covered Primary, federal Health Minister Nicola Roxon had just announced $550 million in budget savings in pathology funding over four years. This is great for the government but terrible for companies like Primary, which rely on that funding to subsidise their business model.

Primary’s pathology unit, Symbion, constitutes about 40% of its profits, with the medical centres making up another 40%, radiology 15% and health technology 5%.

A new memorandum of understanding from the government will also limit pathology revenue growth to 5% a year from July next year. One newsletter points out that in Australia the industry is already highly efficient so any extra gains from cost-reduction programs will be negligible.

The pull-back in pathology funding and the squeeze on margins in that division will offset a come-back in the medical centre business. Government changes in 2009 to how it funds medical centre services dampened demand in 2010, but customer visits have been rising this year as people get used to higher fees. Attendance levels are up 14% in the four months to October 31, compared to the prior corresponding period.

The biggest concern, however, is the amount of debt Primary is carrying, going into the next few years of lower margins. It rolled over $1.2 billion of bank debt in October and extended the maturity profile to between three and five years. Some are lauding this as proof that times are looking up for Primary, but you should remember the saying that if you owe the bank thousands, you have a problem, but if you owe the bank billions, it’s the bank that has the problem. It was certainly in the lenders’ interests to refinance that debt while appetite for corporate liabilities is relatively benign.

  • Investors are advised to sell Primary Health Care at current levels.

Starpharma Holdings (SPL). Buying into R&D healthcare stocks is fraught with risk and has cost Australian investors considerable sums in the past. But Starpharma is one the investment press has been persuaded to dip their toes into, and a capital raising two weeks ago inspired them to review their reasoning.

Starpharma is involved in dendrimer chemistry and has projects under way in both the medical and agrochemical sectors. Its most advanced project is Vivagel, a gel that prevents sexually transmitted infections (STIs) such as HIV and herpes, and treats and prevents bacterial vaginosis.

A “significantly oversubscribed” placement raised $32 million, while a $3 million share purchase plan is under way but the most interesting aspect is that M&G Investments, Prudential’s UK and Europe arm with over $320 billion of funds under management, is now a major stakeholder with 6.7%. M&G is also the largest shareholder in Ansell and Australian stem cell technology wunderkind Mesoblast.

The money will fund Phase 3 clinical trials for the Vivagel bacterial vaginosis treatment (the STI trials are a little further behind, at the Phase 2 stage) with the European Medicines Agency, after reaching a similar deal with the US Food and Drug Administration in October.

Starpharma expects to start and finished the trials next year and will, if successful, partner the product with a major industry player. It has already done deals with SSL International, owner of the world’s largest condom-maker Durex, and Okamato, the leading Japanese condom-maker, which plan to launch Vivagel-coated condoms in 2012.

The Vivagel bacterial vaginosis condoms won’t provide that much revenue but they will raise awareness of the company and its operations. It will be the STI coating that will be the big cash generator, and although a commercial product is estimated to be about five years away, it’s the one to watch.

Starpharma’s agrochemical work to improve the potency of glyphosphate. and medical project combining dendrimers with cancer drugs to improve tumour targeting and potency, and reduce toxicity, have partnerships with Eli Lilly and GlaxoSmithKline. Both are funding the developmental stages and are waiting to distribute the finished product.

Without a commercial product on the market yet, it is these partnerships and major shareholders that show Starpharma is on the right track. As well as keeping an eye the progress of the company’s R&D, investors should be looking out for who else might be interested in this promising little company.

  • Investors are advised to buy Starpharma Holdings at current levels.

Sigma Pharmaceuticals (SIP). A share price chart for pharmaceuticals wholesaler Sigma tells a detailed and (if you’re still holding the stock) depressing story. You can see the phenomenal growth from the time of the ASX listing in October 2002 until late 2005, when it merged with promising generics maker Arrow Pharmaceuticals. The deal was expensive and in hindsight, disastrous, as Sigma’s share price fell from a $13.78 high to 65¢ at the close on Friday.

The good news is that new management – although untested – is focusing on transparency, strategies to improve profits and contingency plans to offset structural shifts in the industry. The newsletters cite this as a positive feature of the company, but you have to wonder why such basic, obvious steps weren’t being taken before now.

Sigma has strong discretionary sales, such as cosmetics and over-the-counter medicines, and sales to pharmacies are hitting about $4.2 billion a year. It also assists with the marketing for groups such as Amcal and Guardian, which encourages those pharmacists to buy just from Sigma. These are two areas that it may be able to leverage to lift that profit line.

And then there is the push-back by pharmacies against Pfizer’s decision to supply them directly. Pharmacies don’t receive the volume discounts they get from wholesalers and say, particularly in rural areas, that Pfizer isn’t delivering essential drugs fast enough. This is allaying fears the investment press had earlier in the year of Sigma losing market share to the dominant market player.

However, without the manufacturing and generics business that it sold to South African company Aspen Pharmacare this time last year, Sigma has gone from having growth potential to being a “boring” general pharmacy products supplier with no substantial upside available.

This is the greatest concern that the newsletters have: now that its operations have been cornered into one competitive market, Sigma is highly vulnerable to government moves to cut healthcare spending.

There is a suggestion that it is likely the ban on the supermarkets operating their own pharmacies will be lifted, and Woolworths and Wesfarmers certainly have enough market heft to bypass wholesalers and be formidable competitors.

Changes to the Pharmaceutical Benefits Scheme (PBS) will start to cut into Sigma’s profits from April next year as there will be a 23% minimum price cut for about 180 generic drugs. This will apply to about 30% by value of Sigma’s sales, and it may respond by cutting volume discounts to pharmacies (and hope that others do the same).

Even though Sigma is still near record share price lows, the newsletters don’t see enough promise in its future to veer from their long-held 'sell’ call.

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

Iress Market Technology (IRE). Iress provides market data and share trading systems for people who dabble professionally and casually in equity markets, and it’s on the brink of expanding into the UK wealth management software sector.

There are several reasons that spring to mind as to why this shouldn’t be a good idea, but on a closer look it makes a lot of sense for the company.

The latest step into the UK was to choose the country’s biggest financial advice distributor, Sesame Bankhall Group (SBG), as the supplier of Iress’ XPLAN software. SBG has 12,000 direct and indirect advisers in its network and it will pay fees from 2013.

This push into the UK doesn’t come out of the blue. Iress already operates in Canada and South Africa as well as Australia and New Zealand, and the management team for the new region is experienced and will draw on lessons learned in the other four countries.

There is long-term growth available in the UK because at the moment Iress’s all-in-one technology will be competing against software that is less functional and forces financial advisers to use more than one system to organise products and services for clients.

The UK regulatory environment is also inviting optimism, as the Retail Distribution Review could provide the same kind of growth options that have developed in Australia.

Iress has no debt and the offshore operations (not including New Zealand) proffer growth above the mature Australian market.

However, cost pressures from developing Australian operations and the expansion into the UK, and ultimately Asia, will narrow margins in the coming years. Weakness in Australia and New Zealand markets are headwinds that are weighing heavily on revenue, leading newsletters to downgrade their earnings forecasts for the next two years. And even though competition in Australasia is not high, this is not a possibility that should be ignored over the long-term.

  • Investors are advised to hold Iress Market Technology at current levels.

Watching the directors

Computershare (CPU) non-executive chairman and founder Christopher Morris sold 349,000 shares last week, just after he asked shareholders in his new baby, Car Parking Technologies (CPT), to pay $10 million to fund the cash part of an acquisition it’s making. Morris made $2.9 million from his Computershare sale, which would go a long way to funding part of the CPT share placement. Morris owns 45.4 million Computershare shares, so the sell-down was not significant in the grand scheme of things – just profitable.

Salmat (SLM) director and co-founder Peter Mattick has peeled a small number of stocks out of his super fund. Although 49,950 shares doesn’t sound small, compared to the 36.2 million he still owns via the fund, and 513,071 in his own name, it’s not a substantial amount. The stake sold for $110,130, or $2.20 a share. In total, he still owns 23% of the company. Mattick co-founded Salmat in 1979 and has had lead roles on the board ever since, before winding back his involvement from 2009.

Mermaid Marine (MRM) director Mark Bradley joined the charge last week to sell high value shareholdings. He sold one million shares for $2.85 each, for a $2.85 million collect, and has 573,819 shares left over. Bradley said the sell-down was part of “reorganising” his personal share portfolio. He last made a director transaction in September 2010, when he halved his shareholding by 1.5 million shares.

Troy Resources (TRY) director Frederick Grimwade led the buying charge last week, though compared to the sellers it was a drop in the ocean. Grimwade bought 20,000 shares for $4.46 each, a total of $89,176. The purchase brings his holding to 40,000 directly owned shares. A lawyer by trade, Grimwade has sat on a variety of boards involved in mining and agriculture, as well as roles in investment funds Fawkner Capital and Colonial First State Investments.

-Recent large directors' trades
Date Company
01/12/11 Campbell Brothers
Gregory Kilmister
01/12/11 Adelaide Energy
Peter Hunt
01/12/11 Adelaide Energy
Neville Martin
01/12/11 Salmat
Peter Mattick
29/11/11 Mystate
Miles Hampton
29/11/11 Mystate
Miles Hampton
28/11/11 Mermaid Marine
Mark Bradley
25/11/11 Bow Energy
Stephen Bizzell
23/11/11 Fortescue Metals
Neville Power
23/11/11 Sihayo Gold
Gavin Candle
21/11/11 WPG Resources
Robert Duffin

Source: The Inside Trader

-Takeover action, November 28-December 2, 2011
Date Target
1/12/20112 Adelaide Energy
Beach Energy
23/11/11 Anvil Mining
Minmetals Resources
Lock up deal on 40.1%. Ext to Dec 9.
30/11/11 Contango Capital Partners
Contango Micro Cap
01/12/11 Gold One International
BCX Gold Investments
21/11/11 Laguna Resources
Kingsgate Consolidated
23/11/11 Macarthur Coal
Peabody Energy
FIRB Clearance. Ext to Oct 28.
18/07/11 Mintails
Seager Rex Harbour
16/11/11 MSF Sugar
Mitr Phol Sugar
29/11/11 National Hire Group
Seven Group
24/11/11 NSX
Financial & Energy Exchange
14/10/11 Signature Metals
12/05/11 Sphere Minerals
Schemes of Arrangement
02/12/11 Adamus Resources
Endeavour Mining
Shareholders and court approve.
22/07/11 Austar United Communications
ACCC raises competition issues.
01/12/11 Bow Energy
Royal Dutch Shell/PetroChina
Vote Dec 21. Cleared by ACCC.
29/08/11 Auzex Resources
Bullabulling Gold
See GGG Resources - 50/50 merger.
30/11/11 Coal & Allied Industries
Rio Tinto/Mitsubishi
Shareholders and court approve.
25/11/11 Flinders Mines
Magnitogorsk Iron and Steel Works
Vote Mar 1.
02/12/11 Foster's Group
Shareholders and court approve.
29/08/11 GGG Resources
Bullabulling Gold
See Auzex Resources - 50/50 merger.
01/12/11 Rock Building Society (The)
01/11/11 Souls Private Equity
Washington H Soul Pattinson
Vote Dec 14.
11/10/11 Sundance Energy
Hanlong Mining Investment
Reverse Takeover/Scheme
21/09/11 Bondi Mining
World Titanium Resources
WTR to nominate 8 out of 9 directors.
Backdoor Listing
14/09/11 Consolidated Steel
CFT Holdings (HK)
12/08/11 Millepede International
Cool D'Fine
Marine HVAC provider. Vote mid-Nov.
Foreshadowed Offers
27/09/11 Bannerman Resources
Sichuan Hanlong
Conditional proposal. Talks continue.
05/10/11 Charter Hall Office REIT
Macquarie Capital consortium
Indicative offer. Further due diligence.
10/08/11 Cooper Energy
Unnamed parties
Preliminary talks.
29/09/11 CSG
Unnamed party
Indicative offer.
07/10/11 CSG
Other unnamed parties
Expressions of interest.
17/10/11 Customers
Unnamed party
Non-binding discussions.
25/05/11 MacarthurCook Property Securities
P-REIT (BlackWall)
05/10/11 New Hope Corp
Unnamed parties
Proposals invited.
06/06/11 Pulse Health
Unnamed party
Expression of interest.
01/12/11 Spotless Group
Pacific Equity Partners
Revised proposal.

Source: News Bites

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