Collected Wisdom

Buy Crown, hold Flight Centre, Amcor and Caltex, and sell Cue Energy, 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.

Crown (CWN). How do you like the chances of a company with good cash flows from developed businesses, strong upside from Asian exposure, and the potential for lucrative growth via acquisition? The investment press sees this and more in Crown, and recommends taking a punt.

Crown, which operates casinos in Melbourne and Perth, as well as investments in casinos in Macau, is the vehicle through which chairman James Packer is building a stake in Echo Entertainment (EGP). Echo is a spin-off from Tabcorp, that owns casinos and licences in Sydney, Brisbane and the Gold Coast, and Crown owns roughly 10% – the maximum it can under NSW and Queensland gambling laws without approval. Crown has requested approval to raise its stake above 10%, but only to a maximum of 25%, and would be barred from buying more than 20% in practical terms because of takeover legislation.

In addition, Malaysian casino group Genting has also built a similar sized stake, and appears to be looking to move toward 20% as well, if approved.

The newsletters believe it is therefore unlikely Crown will launch a full takeover of Echo, at least in the immediate future, but that if it did a $2.5 billion equity raising would be on the cards, and net debt to EBITDA would more than double.

Potentially more interesting for investors are the Macau assets, where Crown has a 33% stake in Melco Crown – a joint venture with two casinos, a gaming machine business, and another major casino property in the works. Growth in Macau remains very strong – between 30% and 80% revenue growth in 2010 and 2011 – and despite increasing capacity with new casinos opening in this immature growth market the demand from China is still strong.

What's more, the investment press sees this asset as completely overlooked in Crown’s share price – and that on forecast earnings for the Australian casinos the company is trading at a steep discount.

In short, if Crown gained control of the Star City casino in Sydney through Echo, and Macau continues to grow at even a fraction of the current pact as Asia's gambling hub, then the company can look forward to strengthening what is already a strong, low-debt, compelling business.

  • Investors are advised to buy Crown at current levels.

Flight Centre (FLT). An update to full-year profit guidance for the past financial year has Flight Centre toward the top of its previously provided range and an expected rise of 15-18% on the previous year. While the numbers look good at the moment, and the travel agent seems to be making the right moves in regards to the threat of online growth, investors should be wary of potential headwinds around the corner.

Profit before tax is expected to be between $285 and $290 million, and the growth comes off several years of strong growth previously. Net profit is strong, earnings per share are expected to be just short of $2, and the grossed-up dividend yield is expected to be in the range of 7%. Despite general consumer caution, corporate demand appears solid and increasing focus on this business – with higher margins to make up for airfare price-war commission squeezes – is evidently seeing some success.

While slightly softer spending on travel is expected given ongoing global financial uncertainty, outbound Australian tourism remains in a strong position. The real threat, as for many traditional 'bricks-and-mortar’ store networks, is from the internet.

Flight Centre has now provided more information about the shift to allowing full online capacity for its services – but at the same time has indicated plans to grow the sales force by roughly 10%, adding 1,000 new staff members. The newsletters view the company’s ability to manage this shift as essential, but the policies do appear contradictory at present, as the online bookings may cannibalise store offerings.

However, Flight Centre has a commanding lead position among travel agents in Australia and makes a decent portion (32%) of its earnings offshore, increasing diversity. For a company reliant on discretionary consumer spending, in a rapidly changing e-commerce environment, Flight Centre seems to be holding up well.

  • Investors are advised to hold Flight Centre at current levels.

Amcor (AMC). There’s an episode of The Simpsons where the children are dismayed to learn their school excursion will be taking them to a cardboard box factory – and while packaging may not be the most immediately interesting product, it has served Amcor well as a highly regarded defensive stock.

One of the strengths of Amcor’s business is diversity. Providing packaging for food, healthcare, and tobacco products across the world, it has plenty to fall back on in cyclical or geographical downturns. It has just improved that diversity even further, albeit in a small way, with the acquisition of Wayne Richardson Sales in Australia, which distributes packaging to small and medium-sized enterprises. WR will add between 1-2% in revenue to the Australian business.

Amcor also has some significant and ingrained competitive advantages – including the size of the company. Scale and capacity can be leveraged well, and Amcor has raw material purchasing power as well as widespread expertise and intellectual property to produce complex products.

In terms of market positions, Amcor is also served well by limited competition. Glass, cans and boxes in Australia are mature and limited markets, as are the European and US pharmaceutical markets where Amcor also has a strong presence.

Through the acquisition of Alcan in 2009, Amcor dominates the western world’s tobacco packaging market, which constitutes roughly 10% of revenue. Despite changes to packaging branding legislation in Australia, and potentially overseas in the longer term, this should not affect the underlying production of the packaging, and the expertise can be used in confectionery and other similar items.

North American assets are also a major part of Amcor’s performance, with two implications. First, through small acquisitions and a targeted strategy the company has niche areas of strength and is the clear market leader in hard plastics – such as beverage bottles. Second, it is set to benefit from any correction in the AUD/USD exchange rate thanks to this exposure.

The company pays regular dividends, though unfranked, and with a solid product mix and wide exposure the newsletters like it very much as a point of relative safety in a rough market.

  • Investors are advised to hold Amcor at current levels.

Caltex (CTX). Australia’s only listed petrol refiner and distributor released its first-half profit guidance last week, and stunned some of the investment press with a massive expected 65-80% jump in Replacement Cost of Sales NPAT.

The newsletters are also quick to point out that this kind of an increase is an example of just how volatile earnings in the petroleum industry can be, with outside supply and demand factors, such as the oil price and currency shifts, greatly affecting performance.

Margins were stable for the first half, and transport fuel production increased in volume by more than 10%, which chiefly drove the strong uptick.

Sales of premium retail fuel and diesel were strong for the half, and total sales for transport fuels pushed higher, but a downward trend in sales of standard, unleaded petrol continues.

Strong volume growth across many products seems favourable, but investors should recall the recent hefty write-downs to both Caltex’s Lytton and Kurnell refineries, and the expected plan to decommission Kurnell as a refinery in the coming two years and convert it to an import terminal.

Like many energy-intensive downstream industries, such as steel, petrol is not competing economically with overseas producers from Australia. The size of refineries in Asia and the Middle East are often almost as large as the entire Australian industry combined, and maintaining production at current levels is unviable. A focus on those aforementioned premium products to drive margins could see Caltex remain adequately profitable here, but it is a changing beast.

Regardless, Caltex is viewed as a well-established business that, while going through a tough transition, can still post big profit numbers with demand for fuel staying strong.

  • Investors are advised to hold Caltex at current levels.

Cue Energy (CUE). A drilling update on June 28 has killed market sentiment for this up-and-coming energy play, and the newsletters think the time has come to get out.

The drilling of the Banambu Deep-1 exploration well in permit WA-389-P was a high-risk project, with BHP taking a 40% interest and Woodside a further 25%. However, Cue advised that after early positive signs the well was not producing, and despite the fact the contribution from the majors has reduced the financial impact of the failure, the newsletters note this is the second prospective well that has turned up dry for Cue, and these were the best hopes for the company.

A day later it also provided an update dry drilling results at its Naga Selatan-1 well in Indonesia, where it holds a 40% interest, and said it had concluded its drilling campaign for the Mahakam Hilir PSC with no commercial discovery.

Cue’s oil and gas production is actually increasing, however, and with a bit of cash on the books there are certainly more exploration targets that could see Cue take off. Its Indonesian and PNG operations are reasonably good assets, but the newsletters believe there is just not enough there to justify holding past a second failed project when there’s nothing of the same potential quality in the pipeline.

There are always potential sudden discoveries, and the share price decline of 40% in the past three months suggests it may be slightly oversold, but the investment press think this one isn’t worth the risk.

  • Investors are advised to sell Cue at current levels.

Watching the directors

Director trades were a little thin on the ground this week – though a few shifted things around for tax purposes with the new financial year. Of course, this is not counting Gina Rinehart’s sale of 86.5 million Fairfax (FXJ) shares at 58c a piece, where she wants to be a director but isn’t '¦ yet.

Also selling was Kingsrose (KRM) executive director Timothy Spencer, who sold 200,000 shares for $225,700, or roughly a sixth of his holding. Tim Treadgold recently covered Kingsrose in a column on gold stocks as part of a very limited club with margins above $1,000 an ounce.

There was a bit of a buying spree at Avanco Resources (AVB). Chairman Matthew Wood led the charge picking up more than 2.8 million shares for $151,843. Also buying was Avanco managing director Anthony Polglase, who paid $16,923 for 307,692 shares, while executive director Simon Mottram bought 1 million shares for a total of $54,120 and then another tranche of 366,974 for $19,991. Non-executive director Colin Jones rounded out the purchases, buying 512,120 shares for $29,703. Avanco shares are down 33% year-to-date, but a positive exploration update from its Brazilian copper mine at the end of June has seen the price lift more than 25% since the announcement.

Atlantic (ATI) executive chairman and managing director Michael Minosora finally paid up for a $10 million share placement that required a special extension under ASX listing rules and was expected to be concluded almost a month ago. Atlantic, which operates the Windamurra vanadium mine in Western Australia, had a $40 million capital raising in March, including Minosora’s placement at 88c a share. The share price has tumbled 60% since the start of the year, and closed at 50c today, amid ongoing concerns about the viability of the Windamurra mine.

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