Collected Wisdom

Buy Ten, hold Orica and News Corp, and sell GWA, 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.

Ten Network (TEN). It looks like the investment press is playing with fire as they give a 'speculative buy’ tag to network underdog, Ten, just after it announced a stunning 70% crash in half-year net profit. But they have their reasons, it seems.

Ten dropped a bundle of bad numbers on the market last week: earnings fell 40%, operating revenue was down 11%, and net profit slid to $14.8 million from $49.5 million in the prior corresponding period (which was down 15.6% from the year before). All of which, by the way, was in the February guidance, so it’s not as though this came as a surprise.

The basis for the counter-intuitively positive response from the newsletters is that the future, if not the present, is looking as though it will work in Ten’s favour.

Advertising markets are flattening out (as opposed to falling, as they did all through 2011) and new CEO James Warburton says the network’s programming strategy is working out well. Ratings are starting to tick upwards, after major shareholders Lachlan Murdoch and James Packer (with support from Gina Rinehart) shifted the network from sports and news programming to reality shows, such as The Shire and Being Lara Bingle, and dramas such as NCIS and Hawaii Five-O.

This uptick won’t be parlayed into higher advertising for at least another year, because Warburton will need some solid figures in order to bargain for better rates and compete with star network Seven and still-strong Nine (although how long that can last, with private equity CVC fighting with hedge funds over the company’s $2.7 billion debt, is debatable). But all agree that this isn’t a quick 'fire some bods and cut some costs’ turnaround, despite the 12% cut in headcount that now-chairman Lachlan Murdoch has already made and the 2.4% taken out of both the TV business and the outdoor advertising arm EYE.

Warburton won’t be rushed and is setting the scene for a strategy that will take a couple of years to complete. Remember that he was the heir apparent at Seven, and his talent and knowledge will stand him in good stead against his former employer. He also has a board stacked with billionaires, who have the money and time to see a long-term strategy through, and won’t be looking for a short-term fix.

  • Investors are advised that Ten Network is a speculative buy at current levels.

GWA (GWA). Shareholders in bathroom fittings-maker GWA saw their investment flushed down the toilet last week when the company announced that sales figures are echoing like an empty chamber pot.

Because of its niche market, GWA is a bet on a residential building recovery – something that has to happen eventually, due to the simple fact that Australia’s population is growing and will need more houses and apartments as time goes by.

However, many clever people have bet on the top and bottom of housing cycles before and paid the price (see economist Steve Keen’s walk from Canberra to Mount Kosciusko after losing such a bet to rival Rory Robertson). GWA chief Peter Crowley was not going to make a similar mistake and said with the market remaining sluggish, a recovery “appears to be some time off”. He told the market that an expected 9% fall in sales would now be an 11% slide, while EBIT would no longer dip a mere 16%, but 20-25%.

GWA’s outlook was also dampened by rain on the east coast in March, making access to houses under construction difficult and causing demand to fade, while the removal of the solar hot water rebate cast a chill over Dux water heater sales.

On the upside, GWA operates in a not-particularly-competitive market and owns very strong brands, such as Dorf (taps), Austral (locks) and Gainsborough (doorware). It’s been restructuring the business since August last year, which will release some extra cash to pay down debt and get its sales margins back up, and it should be well positioned once the property market pops back up again, whenever that happens to be.

However, expect the current 8.5c dividend to be cut when GWA downgrades its guidance again, says one newsletter, as house price worries prevent people from renovating and sad-sack consumer confidence stops them from buying new houses.

  • Investors are advised to sell GWA at current levels.

News Corp (NWS). The focus on the ethical behaviour of Rupert Murdoch's News Corp is not likely to diminish in the near future, especially in light of new allegations of pay television service pirating in Australia and the UK. However, the investment press broadly agrees that the financial damage to News is not as severe as the reputational damage.

The company has been under fire since the Australian Financial Review’s Neil Chenoweth ran a series of articles about Israeli-based subsidiary News Datacom Systems’ payments to pay-TV set-top box hackers.

For all of News Corp's failings, the company still owns a significant group of very strong assets, underpinned by cable TV networks around the world and popular film and television offerings. Those pay TV networks generated 59% of News' operating income in its most recent quarterly results, with double-digit affiliate fee growth in international markets providing some very strong, if sometimes overlooked, potential windfalls for the company.

Problems in the publishing businesses as a result of a decimated print advertising market and the News of the World phone hacking scandal have been offset by a range of profitable assets in other media.

News Corp is also in the middle of a $5 billion share buy-back and there is plenty of scope for further share repurchases or increased dividends, although shareholders in News’ B-shares (those listed in Australia under the NWS code) have to remember that their interests are guarded by the Murdoch family, which owns 40% of the voting stock.

The key issue the latest pay TV hacking allegations raises is that of governance, and just how long the tenure of octogenarian CEO and chairman Rupert Murdoch will last.

Some believe the best thing for News Corp may be for Murdoch to go, allowing the departure of the outspoken mogul to work as a 'fall guy' for the organisation's less-than-squeaky-clean culture and act as a catalyst for change.

Whether this happens sooner or later – and whether the rule-bending suggested by the phone hacking scandal and the pirate TV allegations runs deeper within the group – may determine the direction this stock takes. For now, though, News’ other divisions are healthy enough to warrant allowing the local shares some slack.

  • Investors are advised to hold News Corp at current levels.

Programmed Maintenance Services (PRG). Programmed Maintenance Services operates across a range of industries and sectors and this week diversified a little further again, with an entrée into sports maintenance with the acquisition of Melbourne-based Turnpoint Group.

The relatively small debt-funded takeover was favourably received by the newsletters, and the $9.1 million price tag (excluding up to $2.9 million in incentives) on revenue of about $22 million and EBIT of $3 million won't hurt Programmed's financial position (it reported half-year profit in November of $11.6 million). The impact will be only around an extra 2% added to group revenue, and 5% EBIT, but the company expects the purchase to be earnings accretive by the end of its 2013 financial year, ending March 31.

Turnpoint maintains golf courses, racecourses and sporting facilities, which will add to the Perth-based Programmed's property and infrastructure maintenance division, alongside workforce and mining, and resources services divisions. Through Turnpoint, Programmed is looking to make the most of increased pressure on owners of sports venues to outsource maintenance and access more specialised equipment. Turnpoint's founder and CEO Ric Higdon will join Programmed's property division after the sale.

Since early March, Programmed's share price has improved significantly, with gains of close to 25% in the past month. Valuations of the stock have increased, although they still trail other maintenance service providers. Programmed has itself been a takeover target in the past from one of those other maintenance companies, Spotless, which failed in 2008 to buy the company for nearly $6 a share. Programmed closed last week at $2.45.

However, with the purchase of Turnpoint, the group looks to be making the right kind of strategic decisions to diminish the risk of a downturn in any one sector, and the decision appears financially sound.

  • Investors are advised that Programmed Maintenance is a long-term buy at current levels.

Orica (ORI). In general, there are two factors the newsletters take issue with when they look at companies they’re unsure about: the business itself, and the industry it operates in. In the case of Orica, it’s not the industry that is worrying the investment press (although that could bite the company in the future), but the way the business is run.

In short, Orica’s history of bad acquisitions and the continuing impact from these contributes to the quiet uncertainty around whether it can cope with the enormous plans it has laid for the future.

The industry it operates in couldn’t be healthier. Orica makes and sells explosives, and about a quarter of its business is in chemicals and underground mine stabilisation products. It really benefits from periods of high-volume mining, such as in the current environment, when the easy-to-find, high-grade copper and gold deposits have been exhausted and iron ore miners need to lift volumes to maintain their profit margins as prices moderate.

As the world’s largest explosives supplier, Orica has also built itself an excellent reputation. The $70-80 million it spends on R&D means it’s well ahead of industry competitors and the high quality of its explosives puts the products in demand in countries with stringent safety requirements (such as Australia). Orica therefore has significant pricing power.

Parts of the investment press are getting worked up about the speedy growth of competition, as presented in Australia by Incitec Pivot and Wesfarmers-owned CSBP. CSBP is building a new ammonium nitrate plant in WA, while Orica has just entered a joint venture to build a 330kt plant in Bontang, Indonesia, as well as new capacity in WA and Queensland, and Incitec Pivot has committed to more capacity in Queensland.

The extra volumes will bring down prices, but the bigger concern is that instead of sticking to the regions and industries they once operated in (Orica used to buy its ammonium nitrate from CSBP, and stuck to the East Coast along with Incitec Pivot), each company is now encroaching on the other’s turf, both geographically and technically.

However, the more pressing concern is Orica’s history of acquisitions for acquisitions’ sake. Minova, the stabilisation products business, was bought in 2006 for $857 million, followed in 2007 by the purchase of Exce Mining Systems for $775 million. Neither business has delivered the promised return and are tying up capital instead of contributing to the bottom line.

When Orica is raking in money from the surge in explosives sales, this doesn’t appear to be a problem, but with huge expansions in the works, having such a small part of the business requiring $1.5 billion in cash, yet only returning $100 million in EBIT, is a concern.

  • Investors are advised to hold Orica at current levels.

Watching the directors

James Packer made the biggest splash of the directors this week, buying almost $133 million of Crown (CWN) shares. The executive chairman acquired 15,250,723 shares through Cavalane Holdings Pty Ltd, taking his total to 350,311,967 shares – or 48.09% of the casino company. The buy takes Packer closer to taking majority control of the business through the 'creep’ method favoured by Kerry Packer. The push for Crown comes as Packer is also seeking permission to cross the 10% maximum ownership in Echo Entertainment, and break into the NSW gambling market.

Following the recent show of support by PaperlinX (PPX) independent director Lyndsey Cattermole, who recently bought 2 million shares at 9.9c each, the company’s chairman Harry Boon increased his stake by 229,000 shares at a value of $19,374. The shares were bought for 8.5c apiece and increased the chairman’s stake by nearly 12 times, to 250,000 shares. It’s been a big week for the troubled PaperlinX, with veteran CFO Tony Kennedy retiring as the company readies for a new phase of restructuring.

Amcom Telecommunications (AMM) managing director and CEO Clive Stein sold 266,000 shares for $279,300 last week, taking his stake to 504,334 ordinary shares. Based in Perth, the business data and internet service provider’s shares have increased more than 37% since the start of the year. Also at AMM, non-executive chairman Anthony Grist indirectly bought 100,000 shares for $105,500 through Oaktone Nominees, taking his stake to 9.3 million.

-Recent large directors' trades
Date Company
05/04/12 DSQ Holdings
Mark Loveys
04/04/12 Villa World
John Potter
03/04/12 Mastermyne
Andrew Watts
03/04/12 Mastermyne
Anthony Caruso
02/04/12 Acrux
Ken Windle
30/03/12 OrotonGroup
Sall Macdonald

Source: The Inside Trader

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