Collected Wisdom

Incitec Pivot (IPL) ‘Tis the season to cancel or postpone large infrastructure projects, and the latest company to shelve an expansion in the name of saving money is Incitec Pivot.

The last time Collected Wisdom looked at the company, in June (see Collected Wisdom), the newsletters pointed out that 65 new ammonia plants were in the pipeline worldwide, including 23 in China, and that this was likely to put pressure on prices. As such, the decision not to proceed with an ammonium nitrate plant at Kooragang Island – where Orica (ORI) has already slated an expansion to its own plant – is a sensible one in terms of supply.

The newsletters anticipate a 5% dip to the full-year net profit as a result, but since the project had long been contingent on pre-committed contracts and demand the move was not entirely a surprise. The decision, as with several shelved expansions, has been ‘deferred’ for two years, however it is not expected to proceed then without a major change in the demand landscape.

Along with Orica, Incitec Pivot is a major explosives player in a very tight Australian market. In that respect it has a fairly safe and clear position, with known capacities. In its fertiliser business, lower achieved prices are expected to lead to a significant drop in earnings for the full year when reported in November. However, prices are expected to improve in the coming year as Incitec improves its margins from some of its inputs and demand rises with the high prices in soft commodities such as wheat and corn. Last week the company announced it would not to proceed with its fertiliser plants in Newcastle, but instead take steps to invest in the US (see Robert Gottliebsen’s article on Friday).

The newsletters are generally positive on the company’s outlook, approve of the decision on Kooragang, but are cautious of a prolonged downturn in the coal industry to which much of its ammonium nitrate is sold. Incitec Pivot remains a company with some unpredictability and volatility in the prices of its key input and output products, but it looks on track for a better year ahead.

• Investors are advised to hold Incitec Pivot at current levels.

David Jones (DJS) After a look at Myer last week indicated glimmers of hope for how a well-run department store’s results can look in a downturn, David Jones wasn’t quite so solid.

Full-year profit crumbled 40%, to $101 million, and sales dropped 5% to $1.87 billion. The result was in line with expectations, but those expectations were pretty poor, and some of the surrounding numbers aren’t great either. Whereas Myer lifted gross margins to 41.3%, David Jones’ gross margin fell from 39.1% to 37.5%. On the upside, operating cash flows rose 8% and the company is expected to continue paying dividends near a 90% payout ratio.

The major headlines, however, came from its review into the value of its property portfolio, long considered to be undervalued on the books and thus ripe for either redevelopment or private equity takeover action. The closest David Jones has come to the latter so far was the apparently spurious ‘bid’ at the end of June, which saw the share price spike and then come tumbling back down, prompting plenty of red faces, media speculation, debate over disclosure laws and an ASIC investigation. Investors should remember, though, that the stock did not completely return to its former level after the tumult, indicating some still took the underlying theory of a takeover seriously.

David Jones has now said an independent valuation indicated the properties worth $460 million in its books were actually worth more than $600 million, excluding development potential, and this is viewed as something of a flag trying to reignite interest from bidders.

While the revaluation attracted attention, the fact remains it revealed nothing the market didn’t already know and appreciate about the company. Nor would any redevelopment or sale of its properties change the underlying fundamentals of its business – which in the current retail environment don’t look great. The company lags even further behind Myer in the challenge of online retail, the newsletters see little improvement in the coming year for consumer sentiment, and price pressure will continue to squeeze. Until something real changes with the business, not just the potential numbers around its property portfolio, the investment press is staying away.

• Investors are advised to sell David Jones at current levels.

Washington H. Soul Pattinson and Co. (SOL) A truly diversified investment company, ‘Soul Patts’ (as it’s colloquially known) had an average year in 2012. The investment press doesn’t think this should discourage those in the stock, however, and remark it remains a conservatively managed company with a wide range of exposures.

Soul Patts has significant stakes in a range of listed companies, which does add transparency to its results through the year, although the newsletters note it is still very difficult to forecast accurate valuations.

Reported net profit for the year sank sharply, to $143 million, although the prior year’s $364 million profit was heavily inflated by the sale of Arrow Energy. Once this is stripped back, normalised or “regular profit” slipped 4.1% to $155 million on 20% increased revenue of $912 million.

New Hope Corporation, in which Soul Patts owns a stake just shy of 60%, had a reasonable year, although confidence in the coal sector is declining, and it contributed a lower-than-expected $100 million to the final result. Staying in the resources sector, the company has recently had a bid for gold and copper miner Exco Resources (EXS), which widens its exposure to the rarer, and more attractive, minerals.

Investment in TPG Telecom also underwhelmed, although the newsletters forecast net profit there to rise steadily in the coming two years, and increasingly contribute to Soul Patts’ profits in turn.

Essentially, with a broad base of exposure to mining, communications and pharmacies, the company has its fingers in enough profitable looking pies – in appropriately cautious and conservative amounts – to provide investors with a promising mixture.

• Investors are advised to hold WHSP at current levels.

TPG Telecom (TPM) Moving from TPG’s second-largest shareholder – Washington H Soul Pattinson has a 27% stake – to the company itself, the numbers are also looking better for the telco going forward.

One of the feted ‘second tier’ of communications companies (after Telstra and Optus), TPG is often included on lists of both potential takeover targets and bidders. After another year of good growth, the newsletters see the business as a key player to pick up earnings from the National Broadband Network rollout and it is also making inroads into fixed-line telephone bundle packages.

Revenue grew 15.4% for the year to $663 million, and the corporate division made up a greater part of this – growing a massive 139% in revenue over the year. The consumer division grew a modest 8% as well, with just shy of 600,000 total customers, and in the past three years the number of bundled phone and internet plans has grown from nothing to more than a third of total customers. Reported net profit improved 16% to $91 million, with a hefty one-off tax bill taking $23 million, while EBITDA grew 12% to $261 million.

TPG, along with peers iiNet (IIN) and Amcom (AMM) (see Collected Wisdom), has significantly outperformed the wider telecommunications sector in growth in FY12 and the outlook looks good with the coming of the NBN and the scramble for new market share.

However, the newsletters note that a less-than-50% dividend payout ratio has led to a poorer yield for investors than some other telcos and a price to earnings ratio bumping up near 14 is also on the pricey side. Nonetheless, it would be hard not to hold onto a company in a growing sector that has positioned itself, with a sound balance sheet, at the top of the second tier.

• Investors are advised to hold TPG at current levels.

Funtastic (FUN) In some rare positive news for the dismal-looking retail sector, the stock with the most up-beat ticker code on the ASX forecast a reasonable Christmas season ahead. While it’s a risky small-cap heavily reliant on the retail sector, the newsletters think it’s worth a look.

Funtastic distributes toys, sporting equipment and various licensed merchandise, most notably the popular LeapFrog junior computer devices and some Lego-branded accessories. The company released a very positive statement following its full-year results just ahead of the Christmas period, announcing a swing from a reasonably large loss to a very solid profit.

Net profit for the year to July 2012 came in at $10.4 million, up from a loss of more than $38 million the year before, and EBITDA was $20.2 million, from a loss of more than $29 million in FY11. Importantly, and of comfort to investors, is the repayment of $20 million of debt over the year as well, and a 19% reduction in costs coupled with a 14% improvement in gross margins. This is quite a few relevant statistics that are all heading sharply in the right direction.

Chief executive Stewart Downs says the company is “primed for a strong growth period ahead” and the company intends to commence paying dividends in 2013, up to 50% of net profit. The newsletters note this would equate to roughly a 9% yield at current levels.

With a leaner business, a few strong brands and expectations of a Christmas season at least in line with last year, Funtastic looks to be a small-cap to stock the stuffing with in coming months.

• Investors are advised to buy Funtastic at current levels.