Collected Wisdom

Hold Virgin, Seek and Amcom, buy Iluka and sell WorleyParsons, 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.

Virgin Australia (VAH) Quite a few of the companies that reported average (or worse) earnings in the past fortnight at least had generally weak sectors to fall back on. But Qantas’ multi-million dollar loss (see last week’s Collected Wisdom) is all the more stark in light of the strong performance of its major competitor.

Recovering from a loss of more than $60 million last year, Virgin posted a net profit of $22.8 million and underlying earnings of $82.5 million. Revenue was up just shy of 20% at $3.9 billion and the business in general improved as Virgin took valuable business-class market share from Qantas.

This was achieved in spite of rising fuel costs – up from $900 million last year to $1.04 billion – and heavy competition in the sector, as well as staff costs rising by $100 million.

One of the keys to turning Virgin around has been the overhaul of its Velocity frequent flyer program, which in addition to partnering with more companies and international airlines has been introducing upgraded ‘lounge’ facilities in major Australian airports. The Qantas rewards program brings in a tidy sideline of cash for the company, and Virgin is starting to emulate that success with membership growing 24% in the year. This has come at the same time as the company erodes Qantas’ dominance in domestic business travel, as Virgin focusses on the much more profitable margins and yield, rather than capacity.

The newsletters also note that Etihad’s acquisition of a further 5% of the airline will likely lend some support to the share price in the short term, and the increase in code sharing agreements and international partnerships is helping Virgin to grow without excessive capital expenditure. Simplification of the fleet is also expected to minimise capex – a major cost black hole for airlines – as the company has phased out the E170 planes in favour of E190s, and is gradually retiring its B737-700s in favour of B737-800s. Along with the cabin re-fits and terminal refurbishments the changes to both the front-end and behind-the-scenes elements of the aircraft are delivering benefits.

Two years into the three-year “game change” plan, Virgin looks to have delivered on many of its objectives, and is genuinely achieving a profitable turnaround. If this can be maintained, Qantas will have even more to worry about from its main competitor in FY13.

  • Investors are advised to hold Virgin Australia at current levels.

Seek (SEK). After a year of solid growth and a 35% profit increase, Seek continues to be a company the newsletters are happy to hold.

The online job advertisement market is concentrated in Australia, and in the decade that Seek has been around it has held onto a massive majority of market share and grown significantly. In its full-year results statement, CEO Andrew Bassat said Seek has five times the market share of its nearest competitor and online classifieds were now 84% of all job ads.

Dividends for the full year were 17.3c, a 3c rise on last year, EBITDA rose 43% to $193.6 million, and net profit came in at $131.7 million. This figure is all the more impressive based on revenue of $442.3 million, which indicates the low overhead costs and strong margins Seek enjoys thanks to the online platform.

These good looking figures are helped by the fact the company also has a positive plan for the future, branching out from providing job advertising to helping with resumes, job matching and education. It has jumped on the mobile transition, which should not prove challenging for the versatile online company, and is moving into emerging economies overseas through joint ventures. China, Brazil and Mexico all helped to add more than a fifth of earnings for the company, particularly the Zhaopin business in China which reported 70% EBITDA growth.

Seek has demonstrated the power of online businesses to be both disruptive to traditional models and also highly profitable. Though a weakening in the Australian jobs market in the event of a prolonged global economic malaise would hurt the core business, the combination of its dominant market position and growing other revenue streams should be able to see it through.

  • Investors are advised to hold Seek at current levels.

Amcom Telecommunications (AMM). Away from the NBN-funded success of Telstra (TLS) this year, the second tier of Australian telcos has enjoyed a prosperous year of growth, mergers and profit in its own right. Amongst these is Amcom, a WA fibre communications business aimed at corporate customers.

Amcom links fibre cable connections, what’s known as ‘last mile’ services, as well as data centre management and IT services for companies and moving into cloud computing. The share price is a casual 40% higher for the year to date, and while it is still small this is a company with a lot going for it.

EBITDA for the year rose 18% to $34 million, with a net reportable profit of $28.4 million. Revenue soared 55% for the year to $136 million, and revenue growth over the past few years has been stellar – rising 38% in FY11.

As Tom Elliott has suggested, this year is seeing increasing consolidation among smaller telcos and Internet Service Providers (ISPs) as the fibre revolution takes hold. Amcom bought IT services company L7 Solutions in the year for about $15 million, and in just seven months it added a percentage point or two to full year profit.

Amcom itself is a potential takeover target as well, and the potential for more activity in this sector is clear. As the NBN continues to roll out, in whatever form under whichever government, it’s still clear that fast broadband, fibre and internet communications will represent and important element of Australian economic growth in the coming decade. A profitable company with a record of growth and low debt is therefore not something the newsletters can find much to argue with.

The recent share price rally has put it in the territory of record highs, and some of the technical analysis of the stock has it bumping against upper resistance levels, so it’s not quite a ‘buy’ on valuation metrics – but it’s still a company with plenty of potential and a good looking balance sheet.

  • Investors are advised to hold Amcom at current levels.

Iluka (ILU). About 10% of Iluka’s stock is shorted at the moment, making it one of the most shorted companies on the ASX. After a dismal May to July run, where the share price fell almost 50%, some investors are evidently expecting the slide to continue – but the newsletters disagree.

Iluka produces mineral sands – a quick way to say zircon and titanium-based products called rutile and synthetic rutile – which are used for all sorts of things like paint colouring, precision engineering, solar cells, ceramics and refractoring. The company says demand generally follows GDP, so the general global slowdown, and that of China, is hitting Iluka as many other resources companies at the moment. A sales volume update in July took almost $3 off the share price in one hit, as the company made it clear demand had fallen away and reduced guidance accordingly.

That said, first-half results were in good shape, and the thing about mineral sands is that supply is highly constrained as well. This reduces some of the commodity price risk other miners face at the moment, but has also recently sent prices very high. Net profit for the company was up 88% to $274.4 million on the corresponding 2011 half, on 16% increased revenue. Capex is being cut back to save while demand is weak, and development has been delayed.

However the newsletters view all of this as a well-managed company using its strength to invest and grow counter-cyclically. The company is versatile, so can quickly ramp up production when needed, and operates with very low debt. Earnings per share almost doubled for the half, and the dividend rose 5c compared with the prior corresponding half to 25c.

This is a company with a good supply of a limited product, a strong balance sheet, and the ability to invest in technology and exploration while short-term demand is weak. The medium-term outlook remains excellent, however, and the newsletters see the recent months of price decline as a real opportunity to buy.

  • Investors are advised to buy Iluka at current levels.

WorleyParsons (WOR). Full-year underlying profit at the mining services conglomerate lifted 16%, but in missing most analyst expectations the company raised some eyebrows in the investment press looking to its future.

First the good points – more than two thirds of WorleyParsons revenue comes from the oil and gas sector, which compared with other boom-time commodities such as coal or iron ore is looking rosy, or at least rosier. The company’s $7.4 billion of revenue is also diversified across a lot of countries around the world, though this is something of a plus and a minus for risk.

On the other hand, investors will recall how quickly things soured from exuberance in early 2011 around mining services stocks to the current cloudy outlook. Shares in WorleyParsons have lifted about 2-3% in the past three months – a period when its most comparable peers overseas Amec and John Wood also lifted more than 20%. But with EBIT missing the mark, and the company’s growth, in the words of its chief executive, “subject to the market for our services remaining strong”, it is highly exposed to any resources slowdown.

For investors, it seems to come down to how deep a believer you are in the ongoing boom. The newsletters note that margin improvements and strength from the hydrocarbons side of things is offsetting weakness in minerals, metals and chemicals. Problematic and expensive overruns on some contracts also hit the company in the past year, and the possibility of further projects delays and cost blowouts on a fairly opaque order book are a risk. But it’s worth noting how quickly the positive sentiment around iron ore evaporated when supply massively increased at the same time demand slightly eased, and there is potential for LNG to encounter a similar fate. There is also management risk as long-serving chief executive John Grill leaves at the end of the year. The investment press doesn’t necessarily think WorleyParsons is a bad company, just that there is an optimism to its outlook that may not be justified by ongoing contracts and profit margins, and the recent rally may prove a nice time to get out.

  • Investors are advised to sell WorleyParsons at current levels.

Watching the Directors

A couple of big moves defined the week for director-watchers. As he did in June Fortescue Metals Group (FMG) chairman Andrew ‘Twiggy’ Forrest forked out for a hefty couple of parcels of shares. Picking up 5 million shares for $3.71 apiece, followed by another 5 million for $4.02, the Western Australian billionaire paid a little less than $40 million to continue building his stake. Fortescue has dropped 11% off its share price in the past five days, as the spot iron ore price plummeted below $US100, and closed today at $3.56.

On the other side was iiNet (IIN) chief executive Michael Malone offloaded 4 million shares owned indirectly through his investment vehicle for $3.30 each, making a cool $13.2 million. The internet service provider closed at $3.48 today, down from the $3.60 just prior to the sale. iiNet recently posted a full-year underlying profit increase of 12% and Malone retains 18 million shares, or just over 11% of the company.