Collected Wisdom

Buy Brickworks, hold Crown and Lend Lease, and sell QR National, 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.

Brickworks (BKW). Perversely, it’s a construction industry stock that the newsletters have on this week’s wish-list. But Brickworks is no mere building products supplier: it’s the biggest brickmaker in Australia and has a couple of legacy investments that are helping it to fend off the downturn in housing starts.

On the face of it, Brickworks has been struggling in recent times. It posted an 18.8% decrease in normalised net profit for the first half, and earnings per share dropped 19.3%. Its biggest earner, the building products division, saw revenue slump 11.6% and EBIT plunge 36%.

These numbers are due mainly to Queensland’s housing rebuild taking much longer than expected to kick off, and a reversal in the decline in housing starts and prices failing to appear. The latter isn’t expected to eventuate in the coming half either.

But there are positive signs amid the gloom. The decline in approvals and starts for detached housing – a form of building that uses a high proportion of bricks – shows that it’s not a drop in demand for bricks as a building product that is behind the poor results, but rather the weakness in housing demand. All states reported falls in housing starts to decade-lows and most of the EBIT fall was actually due to starkly lower building levels in WA and Queensland.

What saved the day was Brickworks’ legacy land and development sector. Even though EBIT fell 35%, as no land sales were closed in the period (nor are any deals expected for the next half), the division has solid rental income from tenants who like the well-located assets.

Brickworks’ 42.72% stake in Washington H. Soul Pattinson was another reason why net profit didn’t fall further. Returns from that investment grew 11% to $41 million, and the value of the holding increased 4.2% to $1.38 billion, compared to July 31 last year.

Brickworks is at the lower end of the building cycle, but is being handily kept afloat by its outside investments. Indications are that it’s not the company’s products that are on the nose, but the sector as a whole.

  • Investors are advised to buy Brickworks at current levels.

QR National (QRN). Few Australian stockbrokers liked QR when it listed in November 2010, and how wrong they were proved in the months afterwards. But 18 months on, it seems the concern about QR not being the infrastructure stock du jour is leaching into the investment press, although not for the reasons outlined by grumpy brokers.

Lower volumes and industrial relations are beginning to affect QR’s earnings. The railway owner recast its prospectus forecast EBIT from $578 million to $540-580 million in February, and has since been hit by several unfavourable factors.

The industrial relations spat at BHP Mitsubishi Alliance mines is dragging down QR’s transported coal volumes, and with relations between miners and their employees’ unions not expected to thaw any time soon, QR may have to sideline more of its 2300km of wholly-owned tracks, 700 locomotives and 16,000 wagons.

Right now, QR is asking some employees to take leave and redeploying others by bringing forward maintenance schedules, but if more of its customers are affected by strike action, as well as the constant upwards pressure on wage costs, QR might be hit by a double whammy of lower volumes for itself and lower margins for its customers.

Meanwhile, QR has only one major competitor – Asciano’s Pacific National – and is exposed to iron ore mining in WA and some non-coal freight in Queensland. Heavy capital spending until 2013 should support strong earnings growth on paper, but it will also lead to a sharp rise in debt (QR entered the public world with $500 million in debt, compared to a market cap of $6.8 billion). The other problem is that if China’s soft landing does begin to bite this year, QR and its majority exposure to the mining sector is going to feel the pressure from both this slowdown and from its customers, who are dealing with softening demand and higher wages.

  • Investors are advised to sell QR National at current prices.

Crown (CWN). There’s no doubt that James Packer has plans for the Australian casino sector, but does this make Crown a good investment for the average punter? Perhaps, but it depends on your perception of the risks and benefits of the gambling industry.

On the whole, the landscape for Crown appears benign: its only competition in Australia is Echo Entertainment (which many suspect it’s trying to take over, or use to fund a very expensive project in Sydney); social and political pressure means it’s highly unlikely there will ever be more than one casino licence granted in one city, creating state casino monopolies; and even when times are tough, people will still have a flutter – and everyone knows that the house always wins.

As a result, Crown posted some healthy first-half results, with VIP revenue growing 10.6% in the WA Burswood casino, and 34% in Crown Melbourne, thanks to the retail and gaming floor refit. It has an under-geared balance sheet and is reeling in Asian punters now that the gloss of the new casino in Singapore is washing off.

However, even though it might seem like a business with a licence to print money, the sharks are circling.

Casinos are expensive businesses to operate. Furnishings need to be kept up to date and maintained, gaming tables and poker machines need to be regularly modernised, and the benefits of having a geographic monopoly in each state is somewhat outweighed by the sin taxes levied by governments. All of this eats into extra revenue from refits and higher numbers of VIPs.

Meanwhile, although the above figures show that VIP revenue (the source of about 35% of the total) is growing strongly, a slowdown in China or the appearance of more interesting casinos elsewhere (as happened in Singapore last year) could weigh on earnings. In contrast to the VIP take, first-half main floor revenue lifted by just 5.5%.

The threat of losing sporting events such as the Grand Prix is worrying, because tourists will be harder to attract, and online gambling is assaulting all Australian betting companies which rely on a punter’s physical presence.

These considerations are probably at the forefront of James Packer’s mind too, as he creeps up the register of rival Echo. The plan is to create a hotel-casino complex on Sydney’s Barangaroo site, near Echo’s Star casino, and spread the one licence across two locations – one for the average gambler and the other exclusively for high rollers. This would mean there’d be one casino operator in Australia capable of taking on foreign upstarts in Singapore and Macau.

One newsletter doesn’t think this scenario is likely to happen in the near future, because not only does Crown have to win over the regulator in order to lift its stake past 10% and take over Echo, but it has to negotiate with a relatively passive NSW state government to stretch the licence over what would really be two venues. It will also have to break some local planning restrictions, and negotiate with Lend Lease, the Barangaroo developer and owner of 99-year rights to developments on the piece of land Crown would need to build on.

  • Investors are advised to hold Crown at current levels.

AMP (AMP). The wealth management industry may appear to be under siege, but if you look at the bare numbers, it’s hard to see how a sector with such an incredible amount of money flowing into it can stumble too far.

AMP’s share price over the past year suggests that it’s underappreciated, but with $88.8 million in retail funds under management (18.7% of the entire market) it’s one of the giants of the Australian wealth sector. The takeover of AXA hasn’t done it any harm either, as savings for the year to December 31 came in at $55 million after tax, much better than the forecast $30 million.

The drawn-out takeover process also more than tripled AMP’s adviser network and it appears the fear that the long-running rivalry between AMP and AXA planners hasn’t caused a mass exodus either.

Furthermore, any discussion around wealth management in Australia cannot ignore superannuation and the $1.3 trillion (and growing) funds in the kitty. Lifting compulsory contributions to 12% is only going to speed the growth of this enormous sum and the big fund managers can’t help but benefit, given the lack of interest most people who aren’t Eureka readers show for their retirement funds.

And although the Future of Financial Advice reforms are going to create a problem for all wealth managers, AMP’s sheer size will insulate it from many of these challenges. For example, it’ll be more expensive per adviser for smaller, independent companies to implement many of the reforms, and requirements to remove commissions for new investments will curtail many businesses’ income streams.

AMP, however, has already launched its low-cost product and moved all of its advisers onto a fee-for-service platform. This combination of scale (and especially the ability to make changes ahead of regulatory requirements), and an expected influx of money from extra super contributions has the investment press quite pleased with this wealth management behemoth.

  • Investors are advised to buy AMP at current levels.

Lend Lease (LLC). Lend Lease, like Brickworks, is suffering from the cyclical downturn in the construction sector, but the property developer has to contend with delays in overseas recoveries as well.

The property developer sources most of its earnings from Australia, but one newsletter points out that although 64% of divisional revenue comes from local projects, it accounts for 85% of net profit, as margins on US and UK construction are eaten away by the drawn-out slowdown.

Not only is the expected recovery in these regions not happening as soon as forecasters had hoped, but increased competition and decreased contract wins are further cutting into slim margins.

The investment press also points out that the Barangaroo project, while individually important as the company’s largest development, is not as material to Lend Lease’s bottom line now as it will be in the eight to 10 years after the first tower is built. That timeline is liquid, because Lend Lease won’t be breaking out the diggers until it has at least 70% pre-sales and leases locked in.

Meanwhile, slowing residential development in Australia is going to balance the strong returns Lend Lease makes in its infrastructure arm.

The newsletters foresee the resources sector and government bodies, such as defence, being big earners in the next few years, with growth only limited by Lend Lease’s ability to find skilled and unskilled employees.

On the flip side, residential building starts and approvals have sunk and with the RBA unlikely to move interest rates down (and if it does, there’s the question of whether the banks will), combined with household deleveraging that’s proving far more persistent than many thought, there are few reasons for this sector to swing upwards.

  • Investors are advised to hold Lend Lease at current levels.

Watching the directors

The stampede for the exits at Mineral Resources (MIN) continues, with executive director and founding shareholder Chris Ellison selling down $41.4 million worth of stock, following Mark Dutton’s and CEO Peter Wade’s sizable charge out the door. Ellison let go of 3.45 million shares at $12 each, reducing his stake to 27 million. Mineral Resources company director Bruce Goulds was not able to provide a comment before publication on why four of the five board members have sold down substantial stakes in the past five weeks.

But Paperlinx (PPX) independent director Lyndsey Cattermole is prepared to back the direction she and her fellow directors are taking the ailing company in. Cattermole put up $199,955 last week (9.9c per share) to buy 2.02 million ordinary shares. She now owns 2.25 million shares, which puts her somewhat at odds with the company’s hybrid owners, who are alleging that their rights as higher ranking debt holders are being trampled on in favour of shareholders. Fellow director Michael McConnell wasn’t quite so keen, buying an initial stake of 1000 shares at 8.6c each – that’s $86 in total, not including brokerage.

Kingsgate Consolidated (KCN) told the market that managing director Gavin Thomas’ disposal was due to a loan he’d used to exercise 2.5 million employee share options in June 2010. Thomas is still a significant shareholder, with 1.9 million shares, but his portfolio is now 700,000 shares lighter while he – temporarily at least – is $4.5 million richer.

Over at civil engineer Seymour Whyte (SWL), CEO Brian Riggall sold off 2 million shares and director and founder John Seymour sold 1 million. The sales netted them just over $4 million ($2 a share) and $2 million ($2.01 share), respectively. Riggall’s holding now stands at 2.5 million shares, while Seymour still owns 18.06 million.

-Recent large directors' trades
Date Company
ASX
Director
Volume
Price
Value
Action
29/03/2012 Ramsay Health Care
RHC
Ian Grier
22376
19.4
$434,094
SELL
27/03/2012 Mineral Resources
MIN
Chris Ellison
3447815
12
$41,375,462
SELL
27/03/2012 McMillan Shakespeare
MMS
John Bennetts
250000
10.49
$2,623,583
SELL
26/03/2012 Washington H. Soul Pattinson and Co
SOL
Thomas Michael Robert Millner
40000
13.71
$548,348
BUY
26/03/2012 Tag Pacific
TAG
Gary Cohen
1664500
0.23
$383,230
SELL
26/03/2012 Kingsgate Consolidated
KCN
Gavin Thomas
700000
6.395
$4,476,712
SELL
23/03/2012 Seymour Whyte
SWL
John Seymour & Brian Riggall
1000000
2.01
$2,009,604
SELL

Source: The Inside Trader