Collected Wisdom

Get out of BlueScope Steel and get set with Wotif, the newsletters say.

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.

BlueScope Steel (BSL). There is no subtext to the newsletters’ analysis of BlueScope: they think this is a failing company operating in a failing local industry.

Global steel output is still below 80% of capacity (an indication that margins are low), the Australian market for steel is dismal, and once the $600 million capital raising is over BlueScope will go from having 772.8 million shares on issue to 3.35 billion – a big dilution for shareholders.

The elephant in the room is the fact that despite the capital raising, BlueScope still has no spare cash. It won’t be able to cope with a GFC Mark II – the kind Alan Kohler was hinting at in his latest Weekend Briefing – and there’s no indication there will be a change to the current situation of high dollar plus high raw material and capital costs plus unrelenting output in China.

The newsletters asked two questions about the capital raising: why did it take so long, and will $600 million be enough? The first question is almost irrelevant now as they don’t see management as being able to dig the company out of this hole anyway; as for the second: no, they don’t think it will be enough.

The raising will reduce debt by $557 million, which sounds great except that in the past four months net debt rose $487 million, so really it’s just taking the company back to square one.

Then there is the fact that the global steel industry is highly fragmented. Over three-quarters of all steel is made by producers that have less than 2% market share, meaning customers have many choices about who to buy from and, with low barriers to entry (sourcing capital and finding a site for a blast furnace), individual steel makers must have something else apart from the quality of their product to give them a competitive advantage.

The Australian dollar is one of the more obvious irritants as it’s making imports considerably cheaper than anything BlueScope can produce here. Iron ore got much more expensive when the miners moved to monthly pricing and BlueScope has to pay the price dictated to it and all other global steel makers, unlike those such as rival OneSteel, which has its own mine.

And then there is China. One newsletter hypothesises that the best outcome for BlueScope is for the local currency to fall, China to weaken and stop supporting its own local steel making operations, and for a construction boom to emerge in Australia. However, if the first two happen, it’s very hard to see the third being likely.

  • Investors are advised to sell BlueScope Steel at current levels.

Wotif (WTF). Wotif is caught at the intersection of the so-called two speed economy. The mining boom is driving up exports – and therefore the economy, the balance of trade and disposable income (for some), and with it the dollar, encouraging people to travel overseas. On the downside, this is encouraging people not to travel in their own country, where Wotif does most of its business.

Yet, over the past few years Wotif has been increasing its foreign outlets, particularly in Asia. The stable now includes and AsiaWebDirect, and estimates suggest that 93% of bookings made through these sites are from Australian customers, with 7% from clients in Asia.

But there are two key factors that will drive Wotif’s growth: the surge in booking accommodation online, to the exclusion of any other form; and the choice by Australians to do more international travel than take holidays at home.

Of the growth in online bookings, one newsletter estimates that Wotif has about 33% market share, with its leading competitor (run by Expedia) only 3% behind. It expects Wotif to keep its position as market leader, and says as more accommodation bookings are made online the company will see double-digit returns in this part of the business.

Wotif is less well positioned to deal with the second factor. Its business model is heavily skewed towards local leisure travel and it is necessary for Wotif to look seriously at expanding its foreign offerings, particularly in package holidays. It has said it plans to do this, so watch this space in 2012, when Wotif should begin to pick up some offshore momentum.

So as Wotif continues its movement into the online booking segment in foreign lands, there is also the possibility of it doing very well at home again, if the coming doomsday scenario in the global economy plays out. During the financial crisis, Wotif benefited from a decline in overseas travel as people chose to take their holidays at home as they worried over the state of the world. If a second financial crisis does eventuate, the combination of higher levels of household savings and fears over world affairs could benefit Wotif very well. If not, then it has a growing overseas arm to compensate.

  • Investors are advised to buy Wotif at current levels.

Oil Search (OSH). It was just November when we last reported on Oil Search: the newsletters had a buy recommendation on the stock, “provided its main PNG LNG project is not derailed by sovereign or development risk”.

Well, the feared sovereign risk is now a reality. Papua New Guinea (PNG) is a volatile country but generally very receptive to foreign resources projects. Two weeks ago it underwent another political overhaul, after the Supreme Court ruled that incoming Prime Minister Peter O’Neill’s ascension to power was unconstitutional and reappointed Sir Michael Somare.

There are reports of armed guards from both sides of the debate patrolling the streets as PNG hosts two prime ministers and two alternative governments, each with their own ministers and institutions.

While the newsletters think Oil Search is quite capable of handling any risks posed by political upheavals, it is still a foreign company operating in a country with now increasing sovereign risk.

However, as much as this reminds investors again that PNG is still very different to Australia, despite being its closest neighbour, they also need to remember that the government’s reach doesn’t extend much past the capital. Oil Search operates in the Highlands to the north of Port Moresby and construction of the massive PNG LNG project is on track to begin production in 2014.

The appreciating Australian dollar has been the cause of a $US700 million increase in the cost of capital, but aside from that Oil Search’s development of the projects under its purview is going well: more than 100 million tonnes of steel has been laid and offshore pipelines continue to be built.

The $US15.7 billion project will increase Oil Search’s output five-fold when it becomes operational, and because of this the newsletters are recommending investors hold their nerve while the local politicians fight it out among themselves.

  • Investors are advised to hold Oil Search at current levels.

Coca-Cola Amatil (CCL). It’s game-on for softdrinks bottler Coca-Cola Amatil now that SABMiller has effectively completed its takeover of Foster’s Group.

Coca-Cola Amatil was offered a very attractive deal to let SABMiller out of the Pacific Beverages joint venture. This deal involved Coca-Cola Amatil selling its 50% of the JV to SABMiller for $305 million (making a sizeable $165 million profit in the process, which wasn’t included in the recent guidance), and the right to buy all or part of Foster’s spirits and ready-to-drink businesses.

The proceeds from the Pacific Beverages deal will go through in the first quarter of 2012 and Coca-Cola Amatil will start to conduct due diligence on the Foster’s divisions it might want to buy at the same time. The company expects to spend about $100–180 million on these as an easy way to get into the alcoholic beverages sector.

Meanwhile, even though Coca-Cola Amatil signed a non-compete clause preventing it from operating in the Australian beer market for the next few years as part of the deal, it expects to return with gusto in 2014.

Coca-Cola Amatil’s recent guidance showed it expects a 4.5% increase in underlying second-half net profit, and that the cost-cutting program Project Zero (taking place between 2010 and 2014) and the Indonesian operations are still the areas that will generate most cash in the next few years.

But the future possibilities available from the deal with SABMiller are not yet on the newsletters’ collective radar as they’re far more concerned about the near to mid term.

Pepsi Schweppes is returning to the softdrinks market with vigour and raw material prices are rising. While Coca-Cola Amatil is protected to a large extent by the brand power of Coke, supermarkets are still putting huge pressure on all their suppliers to discount their products. These headwinds may be the negative counterweight for the coming gains.

  • Investors are advised to hold Coca-Cola Amatil at current levels.

Tatts Group (TTS). Tatts has just added Tasmania to the states in which it operates after buying Tote Tasmania for $103 million. While the ACCC still has to OK the deal, Tatts expects to have it put to bed by March.

Tote Tasmania will give Tatts a 50-year wagering licence (exclusive for 15 years), a no-cost option to extend it for another 49 years, and 26 shopfront TABs and 110 in clubs and hotels. Tatts wants EBITDA of $13 million from the retail wagering business in fiscal 2012-13.

The acquisitions will be funded via Tatts’ debt facility. Debt was $1 billion at the start of this financial year (net debt to equity of 40%) and although this would normally give the investment press cause for concern, they say the company has the cash flows to support it.

Tatts also has a presence in South Australia and Queensland, with Tabcorp owning the exclusive licences in NSW and Victoria. However, the wagering industry is undergoing considerable structural change as internet and phone betting remove the power of geographic monopolies and Tatts may be able to take some market share in the latter region if the cards fall its way.

In August the Federal Court ruled that corporate bookmakers could set up branded self-service kiosks in Victorian clubs and pubs. Tatts is ready to roll out its own terminals if an appeal against the decision is lost, and won’t suffer any similar competition in at least one of its markets as legislation prevents self-service terminals in Queensland.

In the meantime, Tatts will lose its Victorian licence in August 2012. The newsletters expect it to make a one-off $65 million profit on the sale of terminals to venue operators but they are quietly positive about Tatts’ chances of recovering the $598 million refund it says the Victorian government owes it for the loss of the licence. If Tatts wins the legal action it intends to pursue if the government doesn’t play ball, it’ll use the cash to pay down debt and maybe pay a dividend, too.

In South Australia, Tatts plans to bid for the state lottery business in 2012, which is worth about $310–330 million.

Yet while Tatts appears to be slowly creeping in on Tabcorp’s monopolies and gaining national market share, investors have to remember that the wagering and lotteries industry is in a great state of flux and if companies don’t adapt they won’t survive.

  • Investors are advised to hold Tatts at current levels.
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Date Company ASX Director
12/12/11 Adelaide Energy ADE Carl Dorsch
09/12/11 Aurora Oil & Gas AUT Peter Schoch
09/12/11 Aurora Oil & Gas AUT Frederick Molson
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Source: The Inside Trader

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