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.

Iluka (ILU). Iluka’s share price took a tumble last week (May 8) when the mineral sands miner downgraded expected zircon sales volumes from 450,000 tonnes to 400,000 for full year 2012. However, far from seeing this as a red flag, the investment press sees a buying opportunity for a healthy business with a little volatility, but a big emerging market upside.

Iluka’s earnings in FY12 won’t be the $1 billion that was the consensus estimate six weeks ago, but $750-$800 million with a good dividend and a clean balance sheet is not something to sniff at. Even with rising costs, fluctuating prices from short-term demand issues, and a growing capex spend of more than $250 million, there’s serious advantages in this business.

Here’s why: the demand profile of mineral sands (of which Iluka mainly produces zircon, rutile and synthetic rutile) is still developing, and markets are small at the moment. But demand has vast potential that showed in 2011, and, importantly, can and has ramped up much faster than supply. Iluka’s Jacinth-Ambrosia mine in the far west of South Australia, in the Eucla basin, officially opened in 2011 and is the major global zircon mine with the capacity of roughly 25% of total worldwide demand.

While scaled-back zircon production due to temporarily lower demand is currently hurting revenue, higher grades of ore are being preserved at Jacinth-Ambrosia (by mining less-rich surrounding deposits), which extends the mine life and puts the company in a better position to produce more, cost-effectively, when demand picks up.

While further exploration currently underway is not expected to match the strength of that mine, incremental, lower-quality discoveries are still believed to be viable. In addition, the miner has 40,000km of leases to explore. All this is helped by the fact that mineral sands mining is cheap – low numbers of employees and simpler equipment keeping aggregate production costs at $670 million, on close to $2.3 billion of expected revenue – and because Iluka is a possible future takeover target.

While Iluka investors should be tolerant of volatile prices due to fluctuations in demand, here’s a well-managed miner with no debt and a globally significant resource that appears to have just been oversold.

• Investors are advised to buy Iluka at current levels.

Super Retail (SUL). One of the few impacts this year’s federal budget may have on equities is to fill the pockets of low- to middle-income Australia with about $2 billion of cash in carbon tax compensation and the schoolkids’ bonus. If anything, this should be mildly positive for retail, particularly in the hard hit discretionary retail sector which is sorely in need of some positivity.

One place some of this discretionary retail cash could end up is Super Retail, the surprisingly strong (compared with the rest of retail) owner of Super Cheap Auto, BCF, and Rebel Sports chains.
Super Retail is deeply discretionary, with a pitch to low-price outdoor leisure activities and home handyman-type tinkering. And yet, despite being caught squarely in the middle of a tough industry at a tough time, earnings growth continues to be strong.

In calendar 2012 to April 28, Super Retail has seen like-for-like sales growth of 3% in its Auto/Cycle division, 2.3% from Leisure and 3% from its Sports division. The latter is Rebel Group, which Super acquired last year, where sales have stayed surprisingly robust amid weakened consumer spending and online competition.

There’s one view of this that says “this can’t last”, and that such resilience will go the same way Seven West Media’s did in the similarly lacklustre media sector, but there’s another that lauds Super Retail’s sound management, organic growth, strong supply chains, experienced customer service and engaged customers. Gearing is moderate, with net interest cover of 8.85%, and both net profit and dividends (fully franked) rising for the past two years, and expected to rise for the next two.

It would still be naïve to think the volatile retail market and the headwinds of the deleveraging consumer and the mighty internet could pass Super Retail by, but it appears to have its shutters bolted more tightly than others against those winds.

• Investors are advised to hold Super Retail at current levels.

Singapore Telecommunications (SGT). You might remember from a few months back that SingTel laid out plans for a long-overdue corporate restructure, and a fortnight ago some of the implications of that restructure (750 redundancies at Australian subsidiary Optus) were made startlingly clear. For investors, however, the company’s full-year result released last week, as well as its increased site-sharing with Vodafone, are further evidence the company – which owns Optus in Australia – is meeting expectations for growth and stability.

First, to the headline numbers: SingTel’s full-year profit increased 4.3% to $S3.99 billion ($A3.18 billion), while revenue lifted 4.2% to $S18.83 billion. On the Singapore side of things, more post-paid mobile customers and some pay-TV bundling drove growth, while for Optus, post-paid mobile subscribers also grew, with margins steady at 26%.

Guidance is provided along the lines of that aforementioned restructure, with “low single digit” revenue growth for the consumer and ICT divisions. Less income from mobile terminations in Australia for the consumer division is expected to be mitigated by new customers and improved yields. The third 'Digital L!fe’ division anticipates start-up losses, but whole-of-group EBITDA is expected to remain stable. EBITDA in FY12 gained 1.9% to $S5.22 billion.
In addition, Optus announced an extension of its site-sharing agreement with Vodafone-Hutchison Australia on May 3. This adds 1,000 new mobile sites to the Optus network, with half of these still to be constructed by 2015, and is seen by the investment press as a significant step towards a 4G network rollout, where Optus has lagged behind Telstra.

SingTel poses some risks for investors, not least in that it is majority-owned by the Singaporean government, with only 3% of its capital base in ASX CHESS Depository Interests. There is also a lot of capex required in network development here and in Singapore – as well as changing fibre broadband landscapes in both countries – but for the time being, things appear to be on track at this telco.

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

Cochlear (COH). Cochlear’s share price has risen steadily since its deeply troubling product recall in September last year, which saw a tumble of more than 30% in a just a few days, and the investment press has begun to assess the longer-term impact of this as it nears its pre-fall price level once again.
The company is one of the few serious major listed stocks on the Australian market outside of resources, energy and finance, and has got there through the strength of its product – hearing implants – and its reputation, which was previously unblemished. The newsletters note that once a person receives a Cochlear implant, they tend to stay with the brand for life, because it is a significant surgical process to change brands.

However, with six months passed since its Nucleus 5 CI500 recall, reputational damage to the brand appears to be minimal. The failure rate of the implant peaked in October and has fallen since, with cumulative failure at 2.4% in February. In its most recent half-year report, sales rose 2.9% despite the recall, and CEO Chris Roberts said minimal market share had been lost.

There are risks for Cochlear from growing competition, and much of its strength is derived from that 60% market share. While this has been countered in the past, low-priced competition does pose a threat. On April 30, the company advised a patent infringement had been filed in the US District Court in Dallas. While the company has said it believes the allegations are without merit, and will fight them, it highlights another of the risks in the scientific innovation sector.

However, the newsletters agree Cochlear has recovered well from what appears to be a one-off reputational issue, and has returned to trading near what they consider to be fair value.

• Investors are advised to hold Cochlear at current levels.

Perpetual (PPT). The funds manager that seems to be the source of perpetual concern triggered more of it in the investment press last week, as third-quarter funds under management figures showed those funds walking out the door.

When Geoff Lloyd took over as the firm’s third CEO in 12 months in February, it was apparent this was a company struggling with direction and strategy. His predecessor, Chris Ryan, left Perpetual after less than a year and with a strategy that underwhelmed the investment press, but his exit only served to increase uncertainty. In addition, it followed highly-regarded equities chief John Sevior’s departure in 2011.

The loss of Sevior goes some of the way to explaining the outflow of funds from Perpetual, and the newsletters expected these to increase with the opening of his new boutique firm (with Treasury Group managing director David Cooper) in the second half of this year.

According to last week’s announcement, $800 million left Perpetual’s funds in the quarter to March 31, and the newsletters highlight that the $3.7 billion of net outflows in the three quarters of this financial year so far are already greater than the 2008 full year – amid the global financial crisis. This has been offset by the 8% increase in Australian equities over the quarter (so total funds under management actually rose by $800 million in the quarter), and lower interest rates may encourage investors to buy Perpetual’s equities funds, but a buoyant sharemarket can’t exactly be counted upon.
The real problem for Perpetual, however, is not John Sevior taking a few institutional investors with him, or the pending strategic review from yet another chief executive, but the structural issue of demographics.

As the population ages, Perpetual’s oldest and largest retail funds are being drawn down for living expenses – a turnaround from accumulation to redemption – and there’s not really a quick and easy way to fix this. Cost reductions, and the potential sale of the Corporate Trust division are suggested, although full-year profit is still anticipated to fall for FY12.

Some in the investment press are concerned, but still hoping for a turnaround under Lloyd, while others are downright sceptical that turnaround will, or even can, happen.

• Investors are advised to sell Perpetual at current levels.

Watching the Directors

The biggest splash of the week came from Webjet (WEB) non-executive director Steven Scheuer, who sold 1 million shares in the company for just over $3.45 million. At $3.451 each, the trade looks good compared with the company’s closing price today of $3.18. Webjet is preparing to start bundling flight and hotel packages in the second half of 2012, and has seen its share price improve 27.7% in the year to date.

Some way behind this was Bullabulling Gold (BAB) non-executive director John Lawton, who disposed of 1.99 million shares in off-market trades for $785,000, or 39.4c each. Bullabulling, which listed on the ASX in March, closed today at 22.5c, off a high of 40c in early April.

On the buying side, former leader of the National Party and new Whitehaven (WHC) chairman (since the Aston Resources merger) Mark Vaile bought 8,600 shares worth $40,850, while fellow new director Christine McLoughlin bought 11,000 shares at $4.66 and $4.71 a share, for a total of $51,633.10. Whitehaven is currently in the midst of a takeover bid for Coalworks (CWK), of which it already owns 17.3%.

There was also movement to be found amid the small-cap energy stocks, as Intra Energy (IEC) non-executive director William Paterson bought 1.05 million shares at 28c each, or $293,438, while non-executive director Clive Hartz sold 523,604 shares for 30c each, or $157,081. The former uranium explorer turned east-African coal miner is seeking to expand to meet electricity demand in the countries surrounding its mine in Tanzania.