Collected Wisdom

Buy AACo and Navitas, hold Westfield Retail Trust and Boral, and sell CSG, 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.

Australian Agricultural Company (AAC). For some time now the investment press has been confident about Australia’s largest cattle grower, AACo. Although it smacked of a risky contrarian play after the ban on live cattle exports to Indonesia in June, they’ve stuck by the recommendation.

With its 600,000-plus head of cattle and six million hectares spread over 20 properties, AACo isn’t everyone’s cup of tea (only patient, risk-tolerant investors should consider it) but judging the company by numbers alone it’s done well in the past year and the next is expected to be just as good (bar more drastic weather or political events).

It reported 2011-12 pre-tax earnings (EBITDA) of $58.1 million, up a whopping 41% on the previous year, and net profit of $10.5 million, up from $904,000 in fiscal 2010.

Further, the drag on earnings did not come from the ban on live cattle sales to Indonesia but from lower wholesale beef prices. AACo lost a contract with Chefs Partner, and the Japan earthquake and competition in Korea from the US meant lower revenue from this sector. But as demand from Japan is beginning to recover and the US sell-off due to drought is not sustainable, this shouldn’t be as much of a problem this year.

Four elements saved AACo’s results from being buffeted too much by those disturbances this year: good seasonal weather conditions, higher trading activity, higher beef prices (to $961 a head from $946 in the previous year), and an improvement in herd quality.

But in farming, conditions can change very quickly so while the company is benefiting from its efforts last year when conditions were good, there is no sign of management relaxing.

The focus for 2012 is to sell about 120,000 head of cattle to generate positive cash flow and drop gearing from 51% net debt to equity. Plenty of grass should mean robust natural increase in cattle numbers and promote good weight gains. Plans to build a meat processing facility in the Northern Territory – close to its Asian market – are waiting on government approvals.

  • Investors are advised to buy Australian Agricultural Company at current levels.

Westfield Retail Trust (WRT). Considering the sorry state of the retail sector, it’s a wonder that so few newsletters have taken a look at the retailers’ listed landlords yet.

The biggest and highest quality retail landlord in Australia has to be Westfield’s spin-off retail trust, which owns most of the local assets and derives its income from rental fees – a great business while rents are still going up but vulnerable in the years when they begin to fall.

The newsletters have identified a trend. Retailers have been lifting their profit margins for years – making shopping more expensive for in-store customers – but it’s the landlords who have been reaping the extra profits.

A key problem is that with a quick Google search on their phone customers can find out how much more they’re being stung by buying a product in-store rather than online. The logical consequence of this is that companies drop prices, close shops, and push more of their products into online stores. Ultimately landlords are stuck with more and more hard-to-fill empty spaces, which in turn drags down the desirability of their whole site.

So after years of rent increases, the negotiating power is returning to tenants.

All of this leads to one question: as the risk of lower rents, longer vacancies and consequently lower revenue grows, why should an investor buy Westfield Retail Trust? The group controls all development projects, which means the trust has no way to expand its income away from rents, and it faces slowly declining revenue over the next decade as retailers shift more of their offerings online or negotiate more affordable rents to stay in the Westfield malls.

Then again, such a big sea change won’t happen quickly at Westfield malls, nor will the outcome be quite so drastic as for other retail property funds because it owns the premium sites everyone wants to be in.

Westfield owns prime sites such as Bondi Junction in Sydney and Southland in Melbourne, which aren’t just shopping centres, but entertainment destinations in their own right, and attract high-end brands and include drawcard department stores Myer and David Jones.

This provides some insulation from a collapse in rental rates, but the structural change that the retail sector is undergoing suggests that a future of lower rents and therefore lower income is inevitable for Westfield Retail Trust.

  • Investors are advised to hold Westfield Retail Trust at current levels.

CSG (CSV). As Facebook gears up to an IPO investors might be tempted to start looking at local prospects in the notoriously unpredictable technology sector, but all new investors should heed the warning presented by CSG.

There are dozens of sub-sectors within IT, and CSG operates in one of the more competitive ones as it provides IT and software-related services and print services to companies. It’s also a highly cyclical area, as companies spend more on IT when they’re doing well but are quick to cut that budget as soon as the market gets a little sour.

CSG is not doing well at combating the slump in demand for its services. It issued a profit downgrade for the six months to December 31, and expects an almost 50% fall in first half 2012-13 net profit from the prior corresponding period, to between $9 million and $11 million.

Expectations of a stabilising print business in Australia have been dashed, as have hopes of better sales in New Zealand and an earnings recovery as delayed South Australian government contracts begin.

The newsletters reckon that the mysterious takeover offer last year and an over-ambitious acquisition strategy are behind CSG’s downfall.

First, CSG listed on the ASX in 2007 after some big acquisitions and it has pursued this method of growth ever since. Whenever a company takes over another there’s an ever-present risk that it won’t integrate the new business into its existing operations well. A $31 million deal at the end of 2010 is where the newsletters suspect CSG first started to go wrong.

CSG bought the subcontractor rights over Canon’s print dealerships in Australia and a bungled transition process is believed to be behind its poor performance since. Managing director Denis Mackenzie has stepped down and will be replaced by the former head of technology solutions, Julie-Ann Kerin.

Second, CSG sat through four months of indecision from September when a still-unnamed bidder offered $1.20 a share for the company, which was only rejected in December. The process cost it $2.1 million, a sizable sum for a $155 million company.

Poor transparency and a surprise capital raising in April didn’t help matters.

Things might improve as new managing director Kerin and a fresh CFO take the reins, but the incumbent Mackenzie (who is the largest shareholder with 20.5%) will be back on the board by July, and no one would be surprised if, after the latest challenge, further write-downs follow.

  • Investors are advised to sell CSG at current levels.

Navitas (NVT). After a year of ho-humming over Navitas, the investment press is again backing the pre-university education provider.

In saying that, things aren’t going as swimmingly as some of the newsletters suggest. Disappointing enrolments in Australia and the UK offset decent earnings growth in Canada and Singapore, and the first half-year results for newly acquired SAE prove that Navitas paid too much for the digital media education business.

The SAE acquisition did help boost sales revenue by 17.5% and net profit by 5%, but enrolments have been flat instead of the 10% increase management used as a reason for the acquisition, and the rights issue used to fund the $289 million purchase diluted earnings per share by 5.4% to 9.4¢.

But it can’t be all bad because Navitas has a buy tag attached to it.

Navitas’ position in the industry is a key reason for the love it’s getting from the newsletters: it has built excellent relationships with agents and students, and strong partnerships with quality universities around the world, creating very high barriers to entry for any interlopers.

And because of the work Navitas has put into these relationships, it is one company that is benefiting from growing demand from Asia for a Western education. As the middle class grows in countries such as Indonesia, Thailand and China, more and more students (and their parents) want the benefits of a tertiary education in the world’s leading universities – most of which are in the West.

On the financial side, Navitas generates a lot of cash and has low costs, which is what is seeing it through the downturn in enrolments.

This downturn isn’t expected to last because although the strong dollar will put some people off, it’s the visa situation in Australia that deter most. Investors will see the difference when the Knight Review recommendations are implemented, allowing students to work for two to four years after graduation, although these benefits will come at the end of 2013-14. Changes to visa rules in the UK will also mitigate the sliding enrolments there too.

  • Investors are advised to buy Navitas at current levels.

Boral (BLD). The building products company is continuing to reposition itself in Asia with its latest sale.

Boral sold its Indonesian Construction Materials business to Siam Cement Group for $US135 million. One newsletter says it’s a good thing the company is sticking to its game plan of mastering the Asian plasterboard market and selling non-core assets, but pointedly also says that the outlook for construction in Indonesia is very good and so demand for products made by the now-sold business are in demand as well.

But Boral must keep an eye on costs. It is able to lift prices to cope with cost increases or lower sales but it also has very high capital spending costs, which restrict it from paying out too much in dividends or making many acquisitions.

This indicates that last year’s $600 million purchase of the other half of an Asian plasterboard joint venture won’t be repeated in a hurry. Neither analysts nor newsletters think this price was justified either, so Boral will have to make the wholly-owned unit work hard to get the expected payoffs.

Fingers will be crossed that this deal in Asia does work out, because the building products division is also not looking healthy. Management let the cat out of the bag in the guidance for first-half results for 2012-13 when they said net profit would be $65–70 million. Back in November at the AGM, CEO Mark Selway said it would be “broadly similar to the second half of 2011”, which was $83 million.

The inference is that softening residential property in Australia and a stagnating US market is beginning to punish Boral’s bottom line.

  • Investors are advised to hold Boral at current levels.
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Source: The Inside Trader

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