Collected Wisdom

Buy Woolworths and Woodside, hold Bendigo & Adelaide Bank and Ansell, and sell Billabong, 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.

Woolworths (WOW). Years of steady, high returns can lull investors into a false sense of security, but no company is invulnerable to changes of fortune or to human error.

A profit warning from the UK’s largest and best-managed supermarket, Tesco, bumped Woolworths’ share price downwards last week by 2.5%. This led one newsletter to point out some interesting similarities between the two powerhouses that should prompt investors to pause a moment for thought.

Another newsletter focused on the Masters hardware stores, saying its concept has promise but there is a long way to go before we know whether it will be successful.

But first, Tesco is a high-margin supermarket and its profit warning has been put down to the 'Big Price Drop’ program and whispers that it’s letting product standards slip.

There is potential for Woolworths to follow this path if it doesn’t heed the lesson from its northern hemisphere peer: both companies operate in increasingly difficult market conditions; both got new CEOs during 2011; an exodus of senior executives followed the change at the top; and competitors are now viable rivals.

This doesn’t mean Coles is about to trounce Woolies or that the supermarket giant is on the way down in terms of value as a defensive stock, but it does mean it can’t afford to make a misstep, especially as it’s committed to entering unfamiliar arenas of hardware, and daily deals with the Door Buster website.

Woolworths’ less-experienced management is trying to make its way in a tough market, and the Tesco profit warning is an example of how easily a leading food retailer can make a mistake and fall from grace.

Meanwhile, the first seven Masters stores have opened and the question is whether their more female-friendly setup can reduce Bunnings’ 20% market share.

Bunnings captured the tradie and home improvement market, but Masters, with its inclusion of appliances, artwork and homewares is likely to be more attractive to women than its austere, concrete-floored rival. The newsletters’ logic follows that where women want to shop, men will stay longer and buy more.

The risks are that the core tradie buyer won’t abandon the store they know so well for the interloper, and that Masters is biting off more than it can chew by throwing down the gauntlet not only to Bunnings, but also to homeware retailers such as Harvey Norman, Reece and Freedom.

A nicer store with better presented merchandise will cost more so Masters won’t be starting out with Bunnings-level operating margins of 11.7%.

Despite these challenges, at no point do the newsletters suggest they’d downgrade Woolworths to a hold recommendation, but they do remind investors that, like any other stock, the pros and cons should be thoroughly considered before a decision to invest is made.

  • Investors are advised to buy Woolworths at current levels.

Bendigo & Adelaide Bank (BEN). Right now many investors are likely to be looking at their bank shares and thinking “Erk”.

Banks’ cost of funding – from both wholesale and local markets – is rising, demand for debt is falling, and the prospect of bad debts making a reappearance could be on the horizon. As one newsletter says, the longer Europe remains a financial basket case the more the global economy will be tossed in its wake, and Australia isn’t escaping the fallout.

Yet with that dire outlook in mind, the local banks are still some of the best-regulated and capitalised in the world and a regional upstart like Bendigo & Adelaide Bank (BEN) has some advantages (and some disadvantages) that the big four don’t.

Its biggest problem is that to win back investor trust, management has to stage a recovery in underlying earnings, and based on their December guidance this isn’t going to happen soon. The bank said it expects first-half cash earnings to be similar to those of the prior corresponding period (about $162 million), but that earnings growth between the second half of 2012-12 and the first half of 2012-13 is probably going to fall 7%.

On the other hand, the 60–70% dividend payout ratio isn’t going anywhere at the moment and its loan and deposit growth is faster than that of the big four.

The regional bank’s loyal fan base is an advantage that can’t be discounted. Bendigo & Adelaide Bank made itself the darling of country towns by moving into centres the big four banks had abandoned; the happy byproduct is that it doesn’t need to rely on wholesale markets for funding (sourcing all the cash it needs from retail customers and securitisation).

This produces different complications to those of the big four: increases in funding costs in Australia, such as pricier bond issues and higher term deposit rates, affect the bank but the benefits from surging consumer savings are more amplified.

Capital levels are very strong, especially after a $150 million share placement in December, and the investment press is expecting a local economic rebound in the next six months that will fuel retail spending and residential building activity, all of which will be a bonus for the bank.

  • Investors are advised to hold Bendigo & Adelaide Bank at current levels.

Ansell (ANN). Other companies are affected by all sorts of challenges but almost every comment on Ansell focuses on one thing: latex prices. This week we – refreshingly – have a change from the usual analysis of the global latex market as Ansell has moved into acquisition mode (although latex prices still make an appearance).

Ansell paid $US4.5 million for a 9.7% stake in Nasdaq-listed Lakeland Industries, a maker of fire-protective clothing. Ansell isn’t known for sitting on large investment holdings for long and because it is sitting on net cash, the newsletters expect an eventual takeover.

Despite the gripes of the Lakeland president and CEO (he was miffed that Ansell didn’t bother to let the board know it was about to pounce), this is a strategic move to expand Ansell’s product line from simply industrial and medical gloves, and condoms. It also expands Ansell’s business further into specialised, high-margin products just as it moves away from more price-competitive products such as examination gloves.

After that moment of excitement, we return to latex prices, but this time there is good news on the horizon.

For over 18 months, latex prices have been rising, cutting into Ansell’s margins as it tried to both pass on costs and absorb them. They’ve now dropped about 37% from the record highs of 2011 (now 6–7 Malaysian ringgits a kilogram, or about $1.80 to $2.10, from a peak above 10 ringgits, about $3.05).

The pullback came in mid-2011 and although prices are still high on a five year time frame, the sharp drop gives Ansell the flexibility of sinking higher margins back into the business or reducing prices to customers.

Add in good sales momentum and guidance for 6–12% profit growth and it seems Ansell investors can breathe a little easier at night now.

  • Investors are advised to hold Ansell at current levels.

Woodside Petroleum (WPL). Woodside was one of the most talked-about companies in the resources sector but Peter Coleman, who became CEO in May, has toned down the exuberant outbursts that characterised Woodside when Don Voelte presided.

Coleman’s more conservative approach is still drawing fire amid a solid outlook for oil prices. The latest media reports are sceptical about the announcement that the development of the two Xeres wells – two recently discovered sites that directors had hoped could supply gas to a second train from the Pluto find – are not going to go ahead right now, saying that it effectively confirms Woodside will have to buy in gas if it wants to go ahead with a second production plant for the offshore West Australian field.

The newsletters are more forgiving. They think the positive aspects of the fourth quarter production report are ensuring the company remains worthy of their $65-a-share price target (although the common consensus 12-month price target is around $44).

Woodside said sales fell by one million barrels of oil equivalent (mmboe) in the quarter and because of this revenue fell 6% to $US1.24 billion from the previous quarter. Still, that number was well ahead of expectations, and volumes were low because Woodside couldn’t get the gas out – it actually produced 1.6mmboe which was higher than expectations.

It’s negotiated a $US12.75mmboe LNG price, which is the highest price since the fourth quarter of 2008-09.

Coleman was also able to announce a nugget of news that will draw sighs of relief from investors too long used to hearing of projects delayed: the new North West Shelf Okha floating production storage and offload platform started a month ahead of schedule.

As for Pluto, the field that is either going to make or break Woodside, the estimated first cargo date is March and will contribute about half of the estimated full year output.

  • Investors are advised to buy Woodside Petroleum at current levels.

Billabong International (BBG). It’s not too late to sell. That’s the advice from the investment on this retail sector casualty.

In December, Billabong issued a trading update that immediately sent its share price plunging 44% to a depth from which it hasn’t quite recovered.

The reasons were management’s revelations that it expects earnings before interest, tax, depreciation and amortisation (EBITDA) to fall 23% to $70–75 million, and it’s planning a strategic capital structure review.

The review will look into all possible options to strengthen Billabong’s capital structure, and it’s only when a company is in dire straits that they do this – much like going to a debt consolidator to sort out your credit cards just before the debt collector turns up at the door.

Dividends are likely to be suspended in 2012 and about 10% of newly acquired Australian stores closed.

The decision to buy bricks and mortar stores and add retailing to the wholesale business was a bad move. Under different conditions it could have worked: having its own stores to control the placement of merchandise and prevent other brands being stocked might have saved it from a fate similar to PacBrands, where its products are being rejected by the likes of Kmart in favour of house brands.

But in reality, it has put more pressure on Billabong than it could handle. Owning a store means paying for staff, shop leases, maintenance and other expenses, and these have drained the company’s cash to the point where interest cover fell to 4.4 times in 2011-12 and potentially to 3.2 times in 2012-13.

It’s becoming increasingly obvious that consumers aren’t going to pay a premium for lifestyle brands any more and slowing sales is forcing Billabong to discount – an action that damages the brand as it encourages consumers to think they never have to pay full price for Billabong gear.

  • Investors are advised to sell Billabong International at current levels.
-Recent large directors' trades
Date Company ASX Director
20/01/12 Hyperion Flagship Invest HIP Emmanuel Pohl
06/01/12 Primary Health Care PRY Edmund Bateman
30/12/11 Gold One International GDO Barry Davison
30/12/11 Fortescue Metals FMG Neville Power
29/12/11 Kagara KZL Kim Robinson

Source: The Inside Trader

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