Collected Wisdom

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.

AWE (AWE). AWE is a favourite of Eureka Report’s resources correspondent Tim Treadgold for its shale gas potential in Western Australia, but for some time it’s also been a speculative buy for the investment press, only for different reasons.

The market has long focused on AWE’s declining Tui field in New Zealand. This discovery was a supernova: emerging with a flash of light before quickly burning out. The newsletters point out that everyone knew this would be the case and it is the long-life Casino and Bassgas projects that will underpin AWE for many years to come.

But in the past couple of weeks, a number of factors have hammered home the fact that AWE has excellent potential. The first was that the WA environment minister granted approval to start testing for shale gas in the Perth Basin, and dismissed all appeals against the Environmental Protection Agency’s decision to allow hydraulic fracturing (fracking) at one well in three different tenements.

The second piece of good news was AWE’s return to profit after years of large writedowns. Fruitless exploration attempts were shut down by the middle of last year and the company reported an underlying half-year profit of $19 million, up from a $34 million loss in the prior corresponding period. Pre-tax and exploration earnings grew 18% while net operating cash flow shot up six times to $101 million (AWE’s market cap is $926 million).

A 7% dip in production was not reflected in the books, because higher oil prices meant revenue rose 17% to $158 million.

The sale of 11.25% of BassGas to Toyota Tsushu and all the shares AWE owned in Buru Energy were balanced by the purchase of two production-sharing contracts for the Ande Ande Lumut oilfield in Indonesia.

The Indonesian venture does expose AWE to exploration and sovereign risk, but it also allows it to reap some benefit from high oil prices. About half of AWE’s proven and probable (2P) and contingent (2C) reserves are liquids, and about 75% of 2P and 2C gas resources are uncontracted, meaning higher oil prices are going straight to the bottom line – as will gas prices pushed higher by increased offshore demand.

AWE is holding enormous potential if the shale gas adventure works out, but it’s also diversified enough to maintain its attractiveness if it doesn’t.

• Investors are advised to buy AWE at current levels.

REA Group (REA). The newsletters are unmoved by rumours of corporate activity at REA, as bored commentators suggest News Corp may sell down its majority stake or, alternatively, make a mop-up bid. In fact, the newsletters say the online real estate company – which is so dominant it is more popular than its next 15 rivals put together – is performing exactly as it should.

REA was one of the bright points on the earnings calendar this year, producing first-half revenue of $134.6 million (up 18% on the prior corresponding period), a 24% increase in EBITDA and a 32% jump in net profit.

These numbers are backed by a strategy that makes money in all kinds of markets. REA changed the way it charged for real estate ads in 2008 from a subscription model to a fee-per-ad model, keeping revenues rising even as the number of property agents thins out (the number of properties going up for sale or rent doesn’t fall just because the number of people selling them does). And in a weak property market, revenue still grows, because sellers are happy to spend more on ads to make their house stand out. REA says 48% of revenue from the residential side of the business now comes from this kind of value-added advertising.

Locally, the company is expanding and its position in the online real estate market should give it easy dominance over new areas of interest.

Commercial property and business sales advertising diversify REA’s revenue stream away from purely residential property, while associated websites – such as Home Ideas, designed to appeal to home renovators – will try to capitalise on REA’s already-large display advertising quotient.

The value of display ads rose by 17% in the half to $23.4 million, and if new sites like Home Ideas become popular, the value of those ads will increase considerably.

What’s more, REA Group has an extremely popular iPhone app, which is accessed over three times more often than its website proper. The trick will be finding a way to monetise that avenue without putting people off using it, so watch this space.

Internationally, REA owns real estate sites in Hong Kong, Luxembourg and, as of December when it moved to 100% ownership, Italy. The only site the newsletters commented on was the Italian www.casa.it, which moved from a pre-tax earnings (EBITDA) loss of $1.6 million in the prior corresponding period to a gain of $200,000. Italy isn’t expected to make a serious contribution to the bottom line in the near future, as most earnings will need to be ploughed back into the business for the next few years.

The main issue is News Corp’s 61.4% stake. It puts any shareholding in REA at the whim of the multinational’s latest aims and although the newsletters think a significant premium would have to be paid by News to gain full control, they also say this is an unlikely outcome at this stage.

The bright earnings and almost-monopolistic market position are factors highly in REA’s favour, but the investment press says it’s flying at fair value.

• Investors are advised to hold REA Group at current levels.

Customers (CUS). Australia’s largest ATM operator has a licence to print money (metaphorically speaking, anyway), but over-ambitious management can cause even the most prolific money tree to shed its leaves.

The first setback for Customers was a 67% fall in its half-year net profit, to $2.7 million. That was followed by CEO Tim Wildash’s decision to sacrifice himself, to be replaced by John Russell, a former general manager at AWB and Tabcorp, and director of KPMG.

The investment press agrees that Customers needed the change. The company’s chairman, Peter Polson, told one newsletter that Wildash – who founded ATM Solutions in 2001 before it was eventually taken over by Customers in 2007 for $132 million – had “overpromised and underdelivered”, and was better suited to an unlisted business environment.

Wildash was central to Customers’ growth, but a failed attempt on Asia and a slower-than-expected entree into New Zealand put unnecessary pressure on the business.

Structural changes in other sectors, such as retail, are additional headwinds affecting Customers and will be difficult to fend off.

For example, ATMs will be banned from pokie venues in Victoria from July 1 this year, with Customers having to remove 120 of its machines. These machines may only account for 2% of the company’s ATMs, but they make up 4-4.5% of revenue.

Moreover, the benefits from the 2009 RBA decision to let ATM operators set their own fees are starting to wane, as competition grows for the best sites and site owners start pushing for a greater share of the profits.

The shift towards online shopping and decline of bricks-and-mortar retail means people are making fewer transactions, while new technology such as Mastercard’s Paypass chip that makes cashless spending much easier is a constant threat.

Although there are growth opportunities available in terms of co-branding with banks and creating other automated services, the change at the top may not be enough to prevent the threat of structural change weighing on Customers’ ability to do business as it has in the past.

• Investors are advised to sell Customers at current levels.

Singapore Telecommunications (SGT). The announcement of a corporate restructure is raising some eyebrows among the investment press, but in a good way.

SingTel is going to divide its business into three units: group consumer, group digital life and group ICT. This, the newsletters say, is a long overdue development that will give it an edge against the Googles and Apples of this world, which are muscling in on mobile operators’ revenue base.

The plan is to dial back the focus on geographic boundaries and concentrate on products to give SingTel a strategic position in a mature market. It will be able to jump on new products and applications as the digital media and marketing sector grows, and it has the financial firepower ($S2.6 billion in the bank, no less) and wide Asian reach to take these opportunities ahead of rivals.

A diverse range of new products will also tie customers to SingTel far more strongly and reduce churn between different mobile providers.

However, this also raises some questions. Telecommunications marketing is still highly regional, and although it’s a step into the future to shift away from a direct focus on geographical delineations, the move will have to be managed very carefully to get it right and not alienate too many of Singtel’s 400 million customers.

It will also mean that SingTel is in a good spot to capitalise on movements to use fibre broadband networks in Singapore and Australia, as the new structure will allow the telco to adapt a broad range of applications across a number of different countries.

The divisions will have their own distinct areas to oversee. The Singapore and Australian consumer divisions will merge into one; group digital life will look after the development of digital marketing, applications and products; and the group ICT division will deal with corporate and government customers.

The only real downside (aside from the possibility of a badly managed transition), is that SingTel is majority owned by the Singapore government and its opaque earnings structure does make it more risky.

• Investors are advised to hold Singapore Telecommunications at current levels.

Amcor (AMC). Amcor has set its sights on the modern Eldorado of Asia, as it plans to spend $238 million buying flexible packaging group Aperio. The deal is conditional on an increasingly commercially-minded ACCC, and the newsletters approve strongly.

The deal is small – it will add just $350 million in revenue to a company that pulls in $12.5 billion a year – but it expands Amcor’s footprint by 13 extra manufacturing facilities spread across Australia, New Zealand and Thailand, lifting the flexible Asia-Pacific division from 21 facilities to 34.

The ability for Amcor to capitalise on strongly increasing demand in the region, yet also compete on price, means the sum of the parts of the Aperio deal is worth more than its face value. Management hopes to extract about $25 million in savings from it.

It’s also necessary on a global scale. Amcor is a market leader and its advantage is scale and the ability to innovate faster than its peers, but the packaging market is also highly competitive and there is little pricing power available to even the large players. Growing a base in Asia makes sense.

Small deals, however, have teeth that can cut both ways. Amcor is funding the deal from an undrawn debt pile of $873 million and as at December 31 it already had net debt of $3.5 billion and a net debt to equity ratio of 98.4%. So even though the purchase of Aperio is expected to provide rewards greater than the sum of its parts, there is a trade-off for investors looking at Amcor – extremely high debt levels.

• Investors are advised to hold Amcor at current levels.

Watching the directors

Since last Monday’s update, it’s been a week for sales with the latest large sell-down coming from Origin Energy (ORG) managing director Grant King. He sold 55,000 shares for $13.51 a pop, making $743,050 in total. The sale was from King’s directly held stake, which slid to 69,302 shares, but he still owns just over 1 million shares in Origin when the direct and indirect holdings are combined, worth about $13 million.

Matrix Composites & Engineering (MCE)’s Paul Wright may be a director of a small company, but last week he proved no stranger to big trades. Wright sold a mammoth $3.42 million stake in Matrix, a company with a $290 million market cap. The sale was of 1 million shares at $3.42 apiece from the only stake he owns, which is inside the Paul Wright Superannuation Fund. The fund now owns a mere 1.26 million shares in Matrix.

A $2.4 million sale by Atlas Iron (AGO) director David Hannon wasn’t quite balanced by fellow directors Kerry Sanderson and Jeff Dowling buying up lots of 30,000 shares each. Hannon let go of 750,000 shares for an average of $3.177 each (he split the sale over two lots) and now owns just over 2 million Atlas shares. Sanderson bought two lots of shares for her initial stake, 23,000 for $3.14 and 7000 shares for $2.99, which totalled $93,150. Jeff Dowling also undertook some dollar cost-averaging by buying 10,000 shares for $3.19 and 20,000 for $3.17. He now owns 57,000 Atlas shares at a total value of $95,300. Atlas has endured a week of interesting news, as its half-year net profit plunged 80%, yet it’s being touted as an obvious takeover target.

Judged entirely on the week’s director trades, Webjet (WEB) may not be the best place to store your money. Director Christopher Newman sold almost 80% of his stake down to 200,000 shares by dumping 700,000 for $3.11. He made a tidy $2.2 million in the process. CEO Richard Noon was also a seller, taking in $80,019 for the sale of 25,000 shares ($3.201 apiece). Noon is still the owner of 2.2 million shares, but has been a net seller this year.

-Recent large directors' trades
Date	Company	ASX	Director	Volume	Price	Value	Action
5/03/2012	Coca-Cola Amatil	CCL	Terry Davis	90,000	11.909	$1,071,765	SELL
5/03/2012	Petrel Energy	PRL	Alexander Sundich	10,900,000	0.05	$545,000	BUY
5/03/2012	Atlas Iron	AGO	David Hannon	750,000	3.151	$2,363,500	SELL
5/03/2012	Insurance Australia Group	IAG	Michael Wilkins	370,000	3.28	$1,213,246	BUY
2/03/2012	Trade Me Group	TME	Sam Morgan	525,680	3.17	$NZ1,666,217	BUY
2/03/2012	Engenco	EGN	Dale Elphinstone	1,345,924	0.81	$1,088,922	BUY
29/02/2012	Ivanhoe Australia	IVA	Peter Meredith	20,000	17.09	$C341,800	SELL
29/02/2012	Billabong International	BBG	Gordon Merchant	2,523,600	3.13	$7,898,111	BUY
28/02/2012	Roc Oil	ROC	Sidney Jansma	3,000,000	0.416	$1,249,200	BUY

Source: The Inside Trader