Collected Wisdom

Sell Harvey Norman, hold Ausdrill and Fisher & Paykel, buy Woodside, while Clean Seas Tuna is a high-risk buy.

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.

Harvey Norman (HVN) The Australian retail industry is in trouble, and despite Gerry Harvey’s public proclamations of relative strength and endurance, the newsletters don’t see much reason to keep holding onto his company given the rocky road ahead.

Full-year net profit for the electronics and appliance big box retailer fell 32%, to $172.5 million, as revenue fell 10% to $1.79 billion. Dividends for the year totalled just 9c, a 25% drop on FY11, and EBIT was down by a similar percentage.

The problems are threefold for the company – margins, consumer confidence and the internet. These factors, in order, present short-, medium- and long-term concerns. Harvey says the closure of WOW Sight and Sound, Dick Smith and Retravision Victoria stores is causing a glut of cut prices, and while he may have a point this is at least a limited problem and likely to actually be a boon to the business in the long run. The elimination of weaker competitors through the downturn has been a refrain from Harvey Norman to date, but the bigger problems lie in discretionary spending and the shift online.

The investment press notes that this uncertainty remains unaddressed by the company’s full-year results presentation. Instead, the newsletters expect weaker consumer discretionary spending for a sustained period – at least a couple of years – and for the structural shift online to continue and become more essential and permanent.

Harvey Norman is on the back foot when it comes to online, and though the “omni-channel” is being spruiked now the division still only represents a tiny couple of per cent of total sales. Harvey has been publically reluctant to go ahead with it at all.

The one strength for the company is its store ownership, which gives it about $2 billion of property assets on a market cap of roughly the same. While some of the investment press suggest that may be grounds for a speculative buy on takeover potential, the market for big leveraged private equity buyouts isn’t great at the moment and, in any case, David Jones (with its even more favourable valuable CBD property assets) would surely be first in line.

The fact is, the longer it pushes on with a big-box physical retail strategy in a weak consumer environment, with corresponding sinking profits, the less attractive Harvey Norman becomes. Relying on the property industry to hold up or a suitor to jump in and break it up is cold investor comfort indeed.

  • Investors are advised to sell Harvey Norman at current levels.

Ausdrill (ASC) As much of the mining services sector takes a battering in lieu of a reduced investment outlook due to weakening commodity prices, Ausdrill stands out with a subtle but important variation – it is exposed mainly to gold.

As Tim Treadgold (and myself) have pointed out (Iron ore’s golden carrot) recently (ETFs the path to gold), the precious yellow metal is in a good patch while investors rush in to combat potential inflation from Eurozone bond buying and QE3. As a result, the secondary industry around supplying its miners is enjoying some of the flow on effects, and Ausdrill – which derives roughly 60% of revenue from gold producers – jumped almost 5% on Friday following Ben Bernanke’s stimulus announcement.

Obviously, however, there’s the other 40% to worry about and while the newsletters note the company has a steady stream of work and several long-term contracts in Australia and Africa, Ausdrill’s fortunes do depend on the continuation of drilling demand. A key positive for the company in this regard is its exposure to ‘name brand’ miners such as BHP, Rio, Barrick, AngloGold Ashanti and OZ Minerals, which lessens the risk that service providers to the smaller miners face being squeezed at the margins.

In spite of an at-best-cautious outlook from drilling competitor Boart Longyear, Ausdrill has maintained guidance for 15% revenue growth in the coming year, though competition is expected to tighten. This is also weaker than the company’s stellar record of revenue growth – 26% compound over the past seven years – but still strong. Negatives include the high spending on equipment that hire businesses must deal with, and an increased debt burden that some of the newsletters find excessive.

For the most part however, the investment press views Ausdrill as one of the safer ways to retain some exposure to mining services via the current gold upswing, and are holding on.

  • Investors are advised to hold Ausdrill at current levels.

Clean Seas Tuna (CSS) A hair’s breadth (or a fish scale’s breadth) away from being a true ‘penny’ stock, Clean Seas has been a rough ride for investors. But there’s hope yet for the South Australian tuna farmers.

After a decline of almost 80% in its share price this year, the company was looking as appetising as dead fish, which is precisely its problem. Clean Seas breeds and grows kingfish and the valuable Southern Bluefin tuna, attempting to meet the growing demand for seafood in a farmed sustainable way. However, its kingfish had been dying from disease, and the delicacy and difficulty of growing SBT to full size in captivity has eluded the company to date.

A corner may have been turned, though, after the company released an upbeat operational update last week outlining healthier kingfish and encouraging breeding behaviour from the tuna as the company prepares for another crack at raising them in sea pens over the summer.

Clean Seas shares doubled on the news, from a close of 1.6c last Tuesday to 2.3c on Thursday. CEO Craig Foster said the tuna broodstock is “already showing encouraging courting behaviour”, and that “cash reserves are as forecast and we have managed to sell significant surplus assets”. The company has trimmed staff numbers significantly in 2012, roughly halving the number of employees, and could boost its financial position through flagged interest from several companies to take on a ‘core investor’ role.

The newsletters generally see this as a much-needed collection of good news. Having long seen the potential in the lucrative Asian market for valuable SBT, the successful farming of this fish would be hugely positive for Clean Seas. While this goals seems to have been ‘almost there’ for several years, the latest updates have the newsletters once again willing to take a punt.

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

Fisher & Paykel Appliances (FPA) Takeover activity has been quiet recently – the recent Freehills Public Mergers and Acquisitions report found deals were at the lowest level since 2009 and activity was coming in volatile ‘bursts’ – but there’s some life emerging with a bid for Fisher & Paykel.

The New Zealand company (also listed on the ASX) saw a share price gain of about 10% last week on the news that Chinese appliance maker Haier, already its largest shareholder, had made an approach to the next three largest owners for roughly 50% of the company. Haier currently has roughly 20%.

Haier last week announced it intended to make a full takeover bid for the shares in Fisher & Paykel it does not own at a price of NZ$1.20 in cash, subject to certain conditions. This is good news in the current less-than-exceptional retail environment, noting that the company’s last results report in March recorded a 55% profit drop for the year.

A company update to the market indicated earnings had improved slightly since its last result, and net debt has fallen also. Dividends are also expected to be paid this fiscal year, and growth in the US and Canada is expected to offset some of the weakness here and in the home market of New Zealand.

As one of the only ways for investors to attain appliance exposure, the company may be missed, but it’s easy to see that Haier has been working towards greater control and an eventual takeover as the company has been distributing Fisher & Paykel products in China and working closely with the firm for several years. This appears to be a logical takeover, and if it does go through holders of Fisher & Paykel could see some deserved reward in a tough time for the industry.

* This report has been corrected from an earlier version, which had referred to earlier newsletter speculation of a possible takeover bid for Fisher & Paykel.

  • Investors are advised to hold Fisher & Paykel at current levels

Woodside (WPL) The big name in Australian oil and gas has been discussed several times in Collected Wisdom this year (Collected Wisdom July 23), as the massive Pluto LNG project comes online and signifies one of the major resources development areas for the coming decade. However, recent profits for the company disappointed some, and missed much of the investment press’s expectations. In spite of this, the newsletters argue this shouldn’t deter investors, and there’s still a compelling argument to buy Woodside while it’s as cheap as it is.

First-half net profit fell 2% on the prior year to $US812 million as overall increased costs and volume reductions outside of the Pluto project wiped out the small gains (roughly $80 million) the project on its own contributed after start-up costs.

Essentially, the cost of producing a barrel of oil in Australian dollars has been sharply and steadily rising for the past three years for Woodside, and while prices and volumes are both up for the half that’s hampering the overall picture.

However, cash flow is improving, underlying profit increased 4.5%, and the costs associated with setting up Pluto will be diminishing going forward.

Production target guidance has been lifted by 6 million barrels of oil equivalent and LNG is the one sector of the resource boom that most analysts agree is nowhere near over yet. Chevron’s sale of its Browse Basin stake to Shell is also seen by the newsletters as good for Woodside, with either more Browse gas for Pluto or James Price Point proceeding.

For investors concerned by the flat profit, or weaker-than-expected 65c interim dividend, the message is clear – there is tremendous long-term growth and profit to be gained from gas off the WA northwest, and Woodside is in prime position to take advantage of it.

  • Investors are advised to buy Woodside at current levels.

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