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.

Telstra Corporation (TLS). After spending the better part of a year negotiating with the government over how large a pile of cash Telstra would receive under the national broadband network (NBN) deal, the telecommunications giant has now outlined what it plans to do with it.

With the expectation of excess free cash in the range of $2-3 billion over the next three years, the newsletters strongly support the plan to grow franked dividends in the medium term. Share buybacks haven't been ruled out, but current management don't seem overly keen and no long-term commitment to such a move has been made.

Telstra has a new chief financial officer, Andy Penn, coming on board to replace the long-serving John Stanhope, and while he may have a lot on his plate with the arrival of the NBN, he could hardly have been handed a better balance sheet and set of cash-flow projections.

Dividends for Telstra shareholders are currently locked in at 28c fully-franked for both the 2012 and 2013 financial years – estimated to provide a yield of more than 8% – and may grow in 2014.

With the size and pace of Telstra's free cash position depending largely on the NBN rollout schedule, it's easy to mistake uncertainty or risk in that project with risk for Telstra. But the deal with the government provides a significant protective buffer for the company, as it will still get infrastructure access payments if the rollout is ditched, as well as the right to operate its existing business where the rollout doesn’t use it.

The compensation deal for the gradual disconnection and migration of Telstra's copper network looks as lucrative now for shareholders as it did when it was announced, and the company's plan for distributing the cash seems both prudent and positive.

• Investors are advised to buy Telstra at current levels.

Bank of Queensland (BOQ). How does a low-growth small fish with an illogical dividend payout rationale and bad debts sound as a potential investment? Not great? The investment press doesn’t think so either.

Bank of Queensland, commonly known as BOQ, has some things going for it – new management, a better focus on risk, stricter loan-writing standards – but for the next few years, those changes are going to struggle to cut through the expected continuance of bad debts from low-quality Queensland property loans.

The regional bank told the market that it made a $91 million first-half loss, down from a $57 million profit in the prior corresponding period. Now, everyone knew this was coming, but when it was first suggested in March it completely took the market by surprise. The reason behind the sudden drop was an increase in bad debts to $328 million, from $134.4 million.

This rise in bad debts caused tier one capital to fall to 6.4%, which was one spur for the highly dilutive, non-renounceable, deeply discounted $6.05-a-share rights issue closing April 24. The other spur was the maintenance of a 26c interim dividend payout. Given the size of the sudden bottom line loss, there’s good reason to question why this payout is happening at all – especially as it’s funded by the rights issue (in which, by the way, shareholders receive no compensation if they don’t take up their rights).

To top it off, the newsletters don’t see the bad debt news dying down for at least a couple of years, and they cite Suncorp as evidence. The Queensland bank took the writedowns on its own bad property debts early, in fiscal year 2009, and has only just stopped feeling the pinch to its earnings from that medicine. The continuance of a frail property market in the Sunshine State is going to draw out BOQ’s pain even longer.

• Investors are advised to sell Bank of Queensland at current levels.

Fleetwood Corp (FWD). Where once was a caravan and caravan accessories company, now stands a mining services business at the start of a resources-funded road to money-making heaven.

Fleetwood got into mining accommodation with the 1500-room Searipple Village in Karratha, which catered mainly to Woodside employees. When the oil and gas major lowered its room requirements last year, however, Rio Tinto jumped on the newly-empty rooms, proving how secure the sector is for operators. Moving to the other side of the country, Fleetwood will now build a 1000-room temporary village for the Gladstone Regional Council to address the dire shortage of accommodation in the nascent gas region.

The contract is to build, own and operate the village for 10 years, after which time it’ll be removed. The aforementioned undersupply of rooms, as gas workers flood into the region, means Fleetwood will be able to charge a premium for its accommodation in a region where housing prices are already high, and be sure that any dip in demand from one company will be quickly replaced by another.

One concern is that Fleetwood hasn’t yet released the financials behind the deal, such as costs and room rates, but the newsletters are confident in Fleetwood’s track record of only taking up conservative, 'safety-first’ tenders.

They’re assuming costs of about $80-90 million, and rates that will add about $12 million a year to pre-tax earnings. With $13 million in the bank as at December last year, funding the project isn’t going to be a problem and it should start paying for itself pretty quickly, as Fleetwood expects to have the first 350 rooms built by the end of the year.

Fleetwood invested in its mining services arm just in time, when it bought BRB Modular in 2010, a manufacturer of prefabricated buildings for the public sector. It not only gave Fleetwood a toehold in Queensland, but negated the downturn in caravan sales as retirees – the main buyers – began to rein in their spending.

• Investors are advised to buy Fleetwood at current levels.

Westfield Retail Group (WDC). Unafraid to take some active steps toward emerging – and potentially more lucrative – markets, Westfield has sold some more of its American assets to the tune of $US1.1 billion.

US outfit Starwood Capital Group has picked up a 90% stake in seven shopping centres for $1 billion, while another, undisclosed, buyer paid $US147 million for a centre in California. Starwood's $1 billion for 90% is roughly in line with 100% of book value, and the Californian centre's book value was $114 million, so Westfield picked up a premium on each.

While Westfield hasn't spelled out what it will do with the proceeds, the newsletters are generally positive on the sale, which continues a strategy moving away from relatively low-yielding locations to emerging markets, particularly Brazil.

While the sales are expected to dilute Westfield's funds from operations measure by 2c a share, some suggest the impact could be offset by a continuation of the group's share buyback, which is currently set to lapse in March 2013.

While Westfield has seen a strong return to profitability in the past two years, one of the biggest issues facing the group is the inescapable structural weakness of the retail industry at the moment. Spending is conservative and the sharp pace of growth in online retail will do no favours to the commercial retail property sector that growth is sapping.

Successful diversification into less mature markets may be at least a partial answer to these problems, but such a move comes with increased risk.

Overall, the asset sales are consistent with the strategy of the group and the price at which they were sold is promising for the remaining assets.

• Investors are advised to hold Westfield at current levels.

Santos (STO). Santos is at the centre of the coal seam gas boom in Queensland and although it’s agreed the benefits are going to flow from 2015 onwards, in the meantime high costs (with little production) are going to take their toll.

Santos sold 40% of its Gladstone stake to Malaysian giant Petronas in 2009, and since then has had no debt on its balance sheet. It also has a 20-year gas sales contract already locked in. Production should lift from 50 million barrels of oil equivalent (mmboe) to 80mmboe by 2020.

The move towards lower carbon-dioxide emitting fuels is expected to underpin part of the rise in gas prices over the next few decades, despite the huge amount of supply due to come on stream by 2020. The company also has 1.4 billion boe in its 2P reserves and its projects are on the doorstep of Asia, the region where demand for fuel is expected to explode.

But before this wonderful future takes hold of Santos, the next few years are going to be a time of capital spending supported by dwindling production elsewhere, and continued fears over whether the US gas market is going to undercut the local one in international markets.

Production in the Cooper Basin is still providing decent returns, but the fields the gas is coming out of are fragmenting into smaller sites. US natural gas prices fell below $2 mmbtu (million British thermal units) recently and the spate of requests to the Department of Energy to start gas exports could bring down international prices, from the $20mmbtu price that many projects have been budgeted on.

The big issue, however, is that coal seam gas is a largely untried technology in Australia, and while the sums being spent on the Gladstone plants (about $50 billion) mean that tech will be made to work, no matter what, hiccups along the way pose potentially expensive traps for Santos.

While these issues will be worked out in time, Santos’ share price is going to be affected by the rumours and investor tremors in the duration.

• Investors are advised to hold Santos at current levels.

Watching the directors

Australian Power and Gas (APK) non-executive director Richard Poole bought a hefty swathe of shares in the company this week, picking up 2.83 million at 49.2c each. The trade was worth $1,391,400 and follows his purchase of more than 850,000 shares in the company late last year. Poole now owns 27,885,167 shares, the vast majority indirectly through Arthur Phillip Nominees Pty Ltd, on behalf of Fontelina Pty Ltd.

On the other side of the coin, Tox Free Solutions (TOX) non-executive director Michael Humphris sold 750,000 shares for just under $2 million this week, at $2.66 per share. Tox, a hazardous industrial waste management company, has seen a strong improvement in its share price since the start of the year, rising more than 30% from about $2.10 to a high of $2.87 this month. The sale follows the disposal of 50,000 Tox shares by Humphris in mid-March, for $131,219.

Meanwhile, at gold explorer Octagonal (ORS), chairman Ian Gandel bought 4.7 million shares through Abbotsleigh Pty Ltd for 15c a share, or $705,000. The rest of senior management also got in on the action – managing director Anthony Gray’s super fund bought 100,000 shares for $14,030 and CFO Ian Pamensky indirectly acquired 61,667 shares for $9,250.

-Recent large directors' trades
Date	Company	ASX	Director	Volume	Price	Value	Action
19/04/12	Intra Energy Corporation	IEC	Clive Hartz	1000000	0.03	$300,000	SELL
17/04/12	Australian Power & Gas Company	APK	Richard Poole	1180000	0.48	$566,400	BUY
12/04/12	Crusader Resources	CAS	David Archer	750000	0.897	$672,975	SELL

Source: The Inside Trader