Collected Wisdom

Buy Origin, hold New Hope and Caltex Australia, and sell Brambles, 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.

Brambles (BXB). Any view of Brambles depends on your perspective on the US dollar and whether you’re comfortable investing in a very complicated company. The newsletters had nothing but praise for Brambles’ half-year results, but cautioned that it’s a capital intensive global business operating in a not-so-hot global economy.

Sales revenue for the six months to December 31 was $US2.366 billion and up 32% on a constant currency basis. Earnings before interest and tax (EBIT) shot up 22% to $US385.1 million and earnings per share lifted 14% to 14.2 US cents. Disappointingly, despite all of this growth the interim dividend remained at 13 Australian cents.

The healthy figures were supported by rapid growth in Asia, Turkey and Latin America.

The Americas CHEP pallet business was behind much of it, as the Canadian and Latin American sides of that operation sent EBIT up 28%. The Better Everyday cost-cutting programme didn’t hurt either, and it’s expected to help Brambles make some good savings in the future.

Pallets Asia-Pacific grew revenue by 8% thanks largely to the expansion into Asia and India. Both are still small operations but their rise has been swift and profitable.

The RPC, or reusable plastic crates division, is another area that is expected to grow strongly in future, and in the last half sales revenue lifted by 15%.

The downside was Pallets Europe, Middle East and Africa (EMEA). Sales revenue rose 3%, but inflation is setting in for fuel and timber (remember, most pallets are wooden) and the capital costs of expanding in the region are catching up.

Capital expenditure increased to $US480 million, from $US359 million, thanks to an increase in contract wins needing to be supported. This has, however, also lifted net debt to $US3.174 billion. Some of this debt should be paid down by the sale of document management division Recall (which reported a very healthy half, with EBIT up 21%).

The case the newsletters are making is that investors should take their money now, while Brambles is in a good patch, and let the economic storms that will inevitably roll around the world this year affect other people’s investments.

  • Investors are advised to sell Brambles at current levels.

Origin Energy (ORG). Utilities are supposed to be solid, boring companies and providers of safe returns, but Origin is neither an ordinary utility nor a 'boring’ prospect for capital gains.

Since the company listed in 2000, CEO Grant King has gathered together a portfolio of assets that minimises Origin’s dependence on the spot National Energy Market, and thus insulates it from paying too much when demand peaks. These assets, which include gas-fired stations and black coal power, are flexible, as they can be cranked up or turned down quickly, in contrast to Victoria’s Loy Yang A station, for example, which must be constantly going.

Furthermore, the much-derided $3 billion purchase of Country Energy and Integral Energy from the NSW government last year is paying off already. There were many suggestions that Origin overpaid for the assets, but King had the last laugh at the half-year results announcement because the pair were partially responsible for the 42% rise in revenue to $6.5 billion.

One newsletter reveals how the assets fit in with King’s portfolio collection: the output of these black coal plants can, as stated above, be increased or decreased quickly and provide a greater footprint in the NSW market.

The elephant in the room is the Australia-Pacific LNG (APLNG) development in Queensland. The potential of this project hasn’t been priced into Origin’s share price yet – probably because it’s only due to start production in 2015 – but the facts indicate that it’s going to be an enormous asset for the company.

One newsletter points out that Origin owns the most coal seam gas reserves of any company in Australia and management is no stranger to the exploration side of gas production (even though that segment was the worst performer in the half, with EBIT touching $67 million after scheduled shutdowns at Kupe and Otways). The $5 billion cash injection from ConocoPhillips as part of the APLNG joint venture should become part of a payout to shareholders of about 60% of profits.

And then there is the fact that the project will expose Origin to the rise in gas prices, as large volume sales to foreign buyers inevitably force up domestic prices.

The big picture is that Origin has an enviable portfolio of current energy assets that are not only generating decent returns, but will insulate it from the spot market, and also has an asset whose potential hasn’t been fully recognised by the market yet.

  • Investors are advised to buy Origin Energy at current levels.

New Hope Corporation (NHC). The sale process is over, but there is a bigger problem on the horizon for cashed-up coal miner New Hope, and that problem is politics.

First of all, this week the board called off the $6 billion auction that it started in October. At the time, some expressions of interest and a rowdy major shareholder in Perpetual '” it wants the 60% cross shareholding with chairman Robert Millner’s Washington H. Soul Pattinson and Brickworks broken up '” meant the smart thing to do was to open the company’s books up to potential bidders and see what happened.

Unfortunately for Perpetual (the newsletters suspect the board isn’t quite as disappointed), no one made an offer that beat management’s vision for New Hope’s strategic or growth potential. New Hope’s shares sank on the news, but sprang back to sit around their 2011 highs of over $5.40.

But it’s local politics that will determine New Hope’s near future. Its main mine, Acland, is in prime farmland about 140 kilometres west of Brisbane, but stage three expansion plans are in danger as community backlash against miners in Queensland gains traction. Alan Jones is leading the charge and has the Liberal-National Party (LNP) on side, which is promising to introduce legislation to protect prime farmland from resources projects if it wins the next Queensland state election '” something it’s widely favoured to do.

Although the benefits of further investment in the community, higher employment and increased taxes from New Hope should theoretically win over the new state government, there is a chance that the Acland development plans will be derailed and you can guarantee the market will not like that news.

However, New Hope deals in one of the hottest commodities right now '” thermal coal '” and it owns its own port, which is a very handy asset when the Eastern seaboard coastline is hemmed by a queue of ships waiting to pick up their loads of Australian gas, ore or precious metals.

New Hope also has $1.5 billion of cash sitting on its books. This means many are expecting a special dividend to be paid out and even though this will cause the share price to sink a little, it won’t harm the company’s ability to pay for development plans.

  • Investors are advised to hold New Hope Corporation at current levels.

Spark Infrastructure Group (SKI). Although boring companies are often the ones analysts don’t want to cover, they will often make some of the best returns. Spark Infrastructure definitely falls into this category, because there’s nothing interesting about selling electricity off existing wires and power poles.

And because of this, those who’d bought into the electricity distributor this time last year have made about 33.5% (that’s capital growth and dividends combined).

Last week, Spark announced its results and said its net profit grew 2% to $82.6 million, while its full-year dividend (it operates on a calendar year) would be a slightly higher than expected 10c a share. In the year to March 2, its share price rose by 21% to hit $1.35.

Because its industry is so predictable, Spark is able to forecast dividends and profits years out – something that analysts sneer at when other companies attempt to do the same. Spark said dividends would grow between 3% and 5% between 2013 and 2015. One newsletter was pleasantly surprised by the earlier-than-expected upwards movement in the distributions, as it points out that smart meter installations and network reinvestment are going to chew up a lot of money freed up by the 2010 reduction in capital structure and last year’s management internalisation (which reduced costs from $8 million per year to about $5 million)

Half the reason why Spark is such a good defensive company is because it operates in a heavily government-regulated industry, where pricing is reset every five years. This means it’s not going to shoot the lights out, but it’s also not going to go bust unless something goes badly awry.

Still, power distributors were able to negotiate higher tariffs until 2015 and Spark will see an extra $213 million in revenue over the period as customer tariffs rise by 9.5%.

However, there are risks and these lie in capital expenditure. Spark’s revenue comes from its half shares in South Australia’s ETSA, Melbourne city provider CityPower and Western Melbourne power supplier PowerCor. The latter, and its local rivals, are facing a $500 million investment in remote-controlled safety devices to prevent power lines from sparking another Black Saturday-type fire and PowerCor has only just got off the hook from legal action over the 2009 bushfires after its insurer stepped in and capped total liability at $5 million.

  • Investors are advised the Spark Infrastructure Group is a long term buy at current levels.

Caltex Australia (CTX). The strong dollar isn’t just sending retailers into turmoil – Caltex, Australia’s largest and only listed oil refiner, is facing similar headwinds.

However, it’s also creating a plan to alleviate the pressures and to capitalise on its role as diesel-supplier-in-chief to the resources sector.

At its results announcement last week, Caltex CEO Julian Segal explained that the company is writing down and reviewing refineries, because enormous plants are being built across Asia by cashed-up competitors, some of which individually have similar capacity to the entire refining industry in Australia. Segal thinks supply will outstrip demand after 2013.

Add in the fluctuating risk of a 'stronger for longer’ dollar, which is a factor in the 15.6% margin reduction for domestic refining, and you have a strong case to do what has long been expected: that Caltex will ultimately close all of its refineries and import fuel instead.

This exposes the company to the vagaries of the fuel market, but Caltex already has a very strong marketing business – one that is being boosted by increasing sales of jet fuel and diesel – to base such a move on.

Net profit was at the higher end of guidance, at $264 million, and supporting this was an 18% increase in revenue from the marketing division, which has its own pre-tax earnings of about $700 million a year and a network of 1800 service stations.

Not only is Caltex investing in extra jet fuel and diesel storage capacity – infrastructure expansions in Gladstone, Port Hedland, Adelaide and Sydney are either complete or due to be up and running by 2013 – but closing the refineries would free-up $100-150 million from maintenance costs.

With iron ore production set to double over the next five years, Caltex’s marketing business will benefit from the huge demand for diesel. Its ever-weakening refining arm may be proving to be a dead loss, but moves are afoot to address this.

  • Investors are advised to hold Caltex Australia at current levels.

Watching the directors

It was widely reported last week that Billabong International (BBG) director Gordon Merchant lifted his stake in the company to 15.8% in order to fend off what he sees as low-ball bids from private equity. The details were lodged today with the ASX and the transaction involved just over 2.5 million shares for a total of $7.9 million ($3.13 each). The stake went straight into his superannuation fund and increases his total holding to 40.3 million shares.

And in another case of a former founder extending their roots, Trade Me Group (TME) director Sam Morgan spent $NZ1.7 million on 525,680 shares in the company proper, surprisingly for the first time. This is in addition to the 1.56 million shares he owns in Fairfax and purchased on the New Zealand stock exchange for $NZ3.17 each. Morgan started Trade Me aged 23 in 1999, after trying in vain to buy a heater for his Wellington flat online.

Cochlear (COH) CEO Christopher Roberts sold off 98,243 shares last week in three lots in order to pay off financing he’d placed over each. The total sale was worth $6.1 million (with the three lots being sold for $61.74, $61.29, and $63.16 a share, respectively) and Roberts is left with 513,169 shares with financing in the form of options over them, and 715,803 shares owned in total. The problem with directors using shares as collateral for debt is that often they own sizeable amounts of company stock, and any personal liquidity problems can drive down the share price if a sale is forced.

Northern Star Resources (NST) director Michael Fotios led the selling last week with a $30.7 million exit. Fotios and Investmet, a company he is a director of and has a substantial interest in, sold 34,101 shares for 90c each. Neither owns any shares in Northern Star now, although Fotios retains a five million share stake via another company.

-Recent large directors' trades
Date Company
24/02/2012 Mineral Resources
J Ricciardo
23/02/2012 Pharmaxis
Denis Hanley
22/02/2012 GBST Holdings
Joakim Sundell
21/02/2012 GWA Group
Peter Crowley

Source: The Inside Trader

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