Collected Wisdom

Buy AACo, hold Fortescue, Mermaid Marine and Myer, and sell Quickflix, the newsletters say.

Summary: Iron ore has soared, but investors in Fortescue are advised to hold.

Key take-out: Australian Agricultural Co is a long-term buy at current levels.

Key beneficiaries: General investors. Category: Portfolio management.

Fortescue Metals Group (FMG)

It’s been a merry Christmas and new year period for anyone in the iron ore sector, as prices of the base metal have jumped sharply and corresponding equities have rallied. Iron ore is close to $US160 a tonne again, though analysts vary on how long it could stay there, and is significantly improved from the $US86 a tonne of just a few months ago.

It also means that many are taking another look at Australia’s largest pure-iron ore play, Fortescue, and how its fortunes may have changed. Readers may remember in September (Collected Wisdom) when the spot price tumbled below $US90 a tonne, Collected Wisdom covered the newsletters’ calls to sell in the face of weaker production targets, significant debt to be refinanced, and the price plunge.

If it was only the iron ore price which had recovered since then, more scepticism may remain, but it appears things really are on a firmer footing for Fortescue on all three of those points.

Reports that some December iron ore shipments were delayed due to equipment problems were quickly and convincingly countered by the company, and production was running at 100 million tonnes on an annualised basis in December. The Solomon project has resumed expansion work, and the total production target of 155 million tonnes per annum has been restored.

There are also some fresh management appointees, including David Woodall as the new Pilbara operations director – a man described as one of Robert Friedland’s ‘key lieutenants’.

Then there is the debt, which was comprehensively and very cleanly dealt with in October with a large credit facility and the repayment of some less-favourable notes. The $5 billion deal took a large part of the market’s uncertainty away, and, combined with the generally stronger outlook for the miners, pushed the share price higher. Fortescue is up more than 20% in the past three months, briefly breaking above $5 for the first time since July, and while the iron ore price rise may not be sustainable, the newsletters argue it could be worth holding on while the sector swings back into favour.

  • Investors are advised to hold Fortescue at current levels.

Mermaid Marine (MRM)

Staying on the topic of a renewed appetite for resources, offshore oil and gas marine services company Mermaid has started the year on the right foot with a major long-term contract.

The company signed a $50 million five-year support contract with BHP Billiton Petroleum, with two one-year options for extension, which comes on top of a major joint venture announcement in December between Mermaid and Toll Holdings (TOL).

The newsletters like the signals that these contracts imply, and see the company heading for strong earnings growth as the offshore LNG construction boom takes root now and in the coming few years. The argument that Mermaid is geographically well positioned, with a base in Dampier, WA, to take advantage of the boom is strengthened by growing activity in the Browse Basin and North West Shelf.

Despite the limited time frame the construction boom work implies – the investment press sees much of it drying up by 2016 and 2017 – there is likely to be ongoing construction work and support services work for the industry. Australia is set to take its place among the top tier of energy producers, with gas reserves estimated to be on a level with Qatar and North America, and the development of this industry and the services attached provide an opportunity for investors. For now, the newsletters think Mermaid is worth sticking with.

  • Investors are advised to hold Mermaid at current levels.

Australian Agricultural Company (AAC)

One of the quieter stockmarket success stories of 2012 was the agricultural sector, which often slipped through the cracks of the yield chase and the troubles of the mining and retail sectors. But AACo remains a company with considerable experience and valuable assets, and – while the weather remains favourable – the newsletters like the look of it.

The chief headwind for the company is cattle prices, and a 10% fall in one key indicator since June is set to flow through to herd valuations, and the company’s net profit. However sales for the company remain strong, and the newsletters expect positive cash flow and an operating cash flow surplus. AACo said total cattle sales for 2012 were above 254,000, up from roughly 240,000 last year and 166,000 in 2010.

Weather has also been very good, with decent rains continuing to bring good pastures and grazing conditions. The past two to three years have seen a major shift for agricultural companies in this regard, and coupled with genetic and breeding improvements AACo now runs a much higher quality herd of cattle.

The ongoing fallout with Indonesia over the live cattle export ban is also a point to watch, however the newsletters note AACo has a high-quality stock with significant experience, and Australia provides a naturally appropriate landscape for cattle grazing – moreso than many nations where it exports to. The proposed Darwin abattoir is also viewed as a major positive, although an investment partner for the project is desired by both the company and the investment press.

  • Investors are advised AACo is a long-term buy at current levels.

Myer (MYR)

It’s tempting to believe the retail story at the moment is all about Christmas, or online channels, or ‘clicks and bricks’, or any number of headline grabbers. However some of the investment press make a compelling argument that it’s also about interest rates.

Myer is one of Australia’s main retail ‘names’, and it copped something of a battering on the market in 2012, as falling consumer confidence, weak retail growth (particularly in department stores), and the online structural change narrative took hold. But there are more positives for the company than initially meet the eye.

Aside from being a solidly profitable company, and paying a very attractive dividend yield above 8%, Myer has also been effective in stripping back discounting and promotional pricing. This sales tactic has hurt, rather than fostered, profitability in recent years and chief executive Bernie Brookes has stepped back from this at the same time as a viable ‘omni channel’ strategy is being put in place. The newsletters suggest it is too early to tell if this is achieving the desired results, but it does at least appear proactive.

The investment press also notes retail sales growth in Australia is above 3% – comparatively low compared with before the GFC, but hardly shrinking. Also, the combination of high household savings, lower rates easing mortgage pressure, and potentially improving consumer confidence sets up a nice playing field for the retailers heading into 2013.

Myer’s share price has rallied almost 20% in the past three months on these emerging positives, along with the wider cyclical market rally, and investors should look to hold on for the ride.

  • Investors are advised to hold Myer at current levels.

Quickflix (QFX)

The magic of the movies hasn’t quite made its way to online streaming film rental and subscription service Quickflix – but a $5 million lifeline has from Hollywood investor Alki David.

The once-promising microcap stock more than doubled on the news after Christmas, from 1.9c to a peak of 4.5c a share, but has since retreated. It remains well off the 15-16c highs of just a couple of years ago, when US online streaming company Netflix was trading at nearly $300 a share on the Nasdaq. It, too, has fallen sharply in the past two years and spent most of 2012 under $100.

The loan from David comes at the cost of an option that converts the loan balance into ordinary shares after six months at a 20% discount. This would substantially increase the company’s share base.

The newsletters are not entirely abandoning the company, which some still see as having serious potential – and it does boast the backing (for now) of popular US cable network HBO, and a recently signed New Zealand streaming deal.

But with a string of high-profile departures from senior positions at the end of last year – including HBO’s Henry McGee from the board, director Justin Milne, and chief executive Chris Taylor – the newsletters are not sticking around to watch the end of this particular picture.

  • Investors are advised to sell Quickflix at current levels.

Watching the directors

One person who’s making the most of the iron ore price rally is BC Iron (BCI) chairman Anthony Kiernan. He sold 200,000 shares in the company last week, a little under a third of his direct holding, for a total of $746,844.53, or about $3.73 a share. Given that BC Iron languished between $2.50 and $3 a share for much of the past two years, and has put on nearly 50% in the past six months as the iron ore price has recovered, the sale “for the purposes of personal portfolio balance” doesn’t seem like a bad deal. BC Iron closed today at $3.55.

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