Collected Wisdom

Hold Metcash and Invocare, sell BlueScope, while Billabong and Alumina are high-risk buys, 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.

Metcash (MTS). The supermarket retailer had a few surprises to add to its full-year results last week, which, while not overly impressive, have the investment press interested enough to hold on.

First, the numbers. Underlying profit lifted 2.4% to $263 million, while reported net profit slipped considerably, down 63% to $90 million, mostly as a result of costs associated with the well-publicised Franklins takeover and some other one-offs. Final dividend also increased to 16.5c, and revenue was up 2% to $12.6 billion.

Then there was the kicker, a $325 million institutional share placement and $50 million share purchase plan that few were expecting – with a chunk of the money to be used to buy 75% of after-market car parts distributor Automotive Brands Group for $72 million and the roughly 49% of Mitre 10 it doesn’t already own for $67 million. The ABG deal is apparently similarly structured to the way Metcash bought Mitre 10, with options to buy the remaining minority stake at various times in the future.

The newsletters are generally positive about the potential for the acquisitions, and the parts market is experiencing less trying times than the rest of the car industry. ABG is also retaining its founder and CEO Paul Dumbrell, which is generally a positive sign for acquisitions.

Consumer data suggests Metcash has and is expected to retain roughly one-fifth of grocery spending in Australia, and is an established 'third force’ to Woolworths and Coles. In hardware Mitre 10 is also improving quickly and is refreshing its brand image – however the introduction of Woolworths’ Masters chain this year will increase competition.

The share price fell sharply on Friday following the resumption of trading, but with a generally solid result meeting expectations in tough conditions, the newsletters are still all holding on for the time being.

  • Investors are advised to hold Metcash at current levels.

Billabong (BBG). It’s hard to tell what has upset the investment press more about Billabong recently – the fact it turned down a takeover offer at a price that now seems breathtakingly lofty in hindsight, or the fact it raised $225 million in a six-for-seven non-renounceable rights issue just a few months after saying it would not need to.

Billabong raised capital last week at $1.02 a share, after turning away TPG Capital in February offering $3.30 a share.

But, once that rage has subsided (along with various calls for founder and takeover bid-blocker Gordon Merchant to be removed from the board), one more relevant fact remains – that the share price of a company which is still expected to post roughly $75 million in net profit next month has now fallen more than 65% since the end of February.

The company has implemented some of the changes it requires, hiring former Target CEO Launa Inman to take the helm of the troubled retailer, and the sale earlier this year of 50% of its stake in the Nixon brand seems like a good deal now. Inman is expected to announce her plans for turning around the retailer in more detail, but her time with Target was a generally successful one and she brings much needed retailing experience to the former wholesaler.

Further to this, Gordon Merchant has issued something of a mea culpa. As reported, he “feel [s] bad about the whole situation” and would now be open to another private equity approach at a lower price. It is feasible that if private equity was keen at $3.30 in February, they may be keen for less than that in June.

Billabong still has a debt problem, and it is entirely reasonable to conclude the deep discount and timing of this capital raising has much to do with not breaching end-of-financial-year debt covenants. But even with a heavily dilutive share issue, and even factoring in expectations of declining revenue and weaker discretionary spending, and despite the less-than-impressive performance of the company since shifting from a wholesale to retail strategy, after all that the newsletters still see brand value. And, what’s more, they tentatively see it above the steep discount it’s currently trading it.

  • Investors are advised that Billabong is a high-risk buy at current levels.

Invocare (IVC). Funeral services company Invocare owns a string of dozens of funeral home and service brands in Australia, New Zealand and Singapore. And while it is often said with some negativity that there are only two certainties in life –death and taxes – you can at least rely on them for un-cyclical investment exposure.

The 'demand’, if that is the right word, for funeral services is fairly regular and steady – and rising despite the best efforts of modern medicine. The rate of death in Australia is rising (with estimates of about 1.5% per year through to the end of the decade) and, as a provider of recognised brands and the largest company in the market here, Invocare is the likely beneficiary of that growth.

The value of the stock as a stable and defensive play is apparent in its share price. In the past 12 months (the 2011-12 financial year), the S&PASX200 declined almost 10%, while Invocare rose more than 8%, closing on Friday at $8.06.

There is good financial reason for this, beyond just the inevitability of death. Revenue is up 27% for the first four months of 2012, though much of this was through acquisition of Bledisloe, and the company’s management says it believes there was “small gain in estimated market share”. Invocare said $3.5 million of merger synergies were also being delivered.

Invocare’s defensive status and price appreciation is, of course, viewed as one of the key negatives for new investors. Essentially there is a significant premium on this stock as a result of its clear and predictable growth profile. It is currently trading almost 20 times its consensus earnings estimates for the coming December half.

For those who do own Invocare however, the newsletters are positive on its business model, potential for steady growth and further acquisitions, and lack of correlation to many economic cycles.

  • Investors are advised to hold Invocare at current levels.

BlueScope (BSL). Last week Collected Wisdom looked at Arrium, formerly OneSteel (OST), where the newsletters were decidedly downbeat on its debt levels and outlook for how it was planning to sidestep structural issues in the steel industry. Well, opinions of BlueScope are generally even worse.

Steel is problematic because of both overcapacity in the industry as a result of the booming, and much lower-cost producers in China and also because demand is simultaneously slipping. A major construction or property recovery in Australia could see BlueScope benefit, but there are few who feel this is likely in the near term. A strong Australian dollar is doubly damaging, as it hurts margins for the company, but any improvement costs it more in its US-dollar denominated debt.

Debt reduction over the past three years as a result of three significant capital raisings totalling almost $2.5 billion is seen as a positive from the investment press, and BlueScope is in a slightly better position than OneSteel debt-wise (although not when maturities are taken into account). However, $796 million net debt on a market capitalisation of just over $900 million is not really a cause for celebration, and OneSteel is something of a low base to work off. Dividend payments in 2010 and 2011 have also eaten into capital, which were paid despite clearly deteriorating market conditions.

This is a business profile offering no guarantees there won’t be a further need to raise capital, and sticking around to wait and see doesn’t seem to hold a lot of upside. Unlike OneSteel, BlueScope does not have a relatively lucrative mining consumables business or risky iron ore play to fall back on. Instead, it appears to be looking for an improvement in the global price of steel – but for that to happen the dollar would likely rise with it, wiping out much of the benefit.

With losses widely expected, and extremely limited free cash flow, there doesn’t seem to be much reason to stay in BlueScope. What’s more, the newsletters were keen to sell before Friday’s 11% rally in the share price.

  • Investors are advised to sell BlueScope at current levels.

Alumina (AWC). On the other side of the coin to steel is aluminium, and while in many ways this sector has had an even harder time than steel in recent years, there are glimmers of hope from the investment press that better times lie ahead – for those willing to bear the risk.

The problem with aluminium is chiefly one of supply. There’s too much of it, primarily as a result of cheap production ramped up in China. This has allowed the price to remain supressed in a period where other commodities have appreciated significantly.

Aluminium consumption has also outstripped the growth of copper, despite being the same price a decade ago. Yet the copper price has appreciated hundreds of per cent since that time, while Aluminium remains at less than a US dollar per pound where it was in the early 2000s.

Alumina, with its primary business being a 40% interest in the world’s largest aluminium producer Alcoa World Alumina and Chemicals, is well placed to take advantage if China allows prices to improve. While this is no sure thing, the newsletters argue there is less for the country to gain from low prices now as production achieves self-sufficiency and the contract price cycle is changing. Also, much of China’s advantage is in labour costs, not materials.

Essentially, materials are getting harder to source for China, and Alumina sits much lower than the Chinese majors in the aluminium cost ladder. While currently low prices will see demand continue to grow strongly, Alumina could be in a position to pick up the first bite that China decides to set aside.

  • Investors are advised that Alumina is a high-risk buy at current levels.

Watching the directors

The big splash of the week has been from billionaire and Fortescue Metals Group (FMG) chair Andrew 'Twiggy’ Forrest, who has been buying up hundreds of millions of dollars of the company’s stock. In three tranches last week Forrest paid $60 million, $43.7 million and $29.1 million for a total of just under 27.8 million shares in the company, reporting to the ASX on June 26, 27 and 29. Now holding roughly a third of the company’s scrip, Forrest has bought almost $250 million of Fortescue stock in the past year. At the same time, Fortescue has launched a constitutional challenge in the High Court against the federal government’s Mineral Resources Rent Tax, on the basis of discrimination between the states.

Substantially smaller on the buying side, though sticking with the ASX top 50, was ANZ (ANZ) chairman John Morschel who bought 4,700 shares for just over $100,000 last week, or $21.32 apiece. ANZ shares have lifted 4% since Friday morning, to close today at $22.35.

Atlas Iron non-executive independent director David Hannon picked up almost a million dollars selling 500,000 shares in the company for $1.95 each. Atlas is currently in talks with Gina Rinehart’s Hancock Prospecting about a joint venture Pilbara rail project to compete with the iron ore majors BHP and Rio Tinto.

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