Collected Wisdom

Buy Cabcharge, hold Sigma and OrotonGroup and sell Campbell Brothers, 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.

Cabcharge (CAB). Taxi-fare processor Cabcharge is back in the competition regulator’s headlights, this time over card surcharges, but this is not deterring the investment press. They say the latest scrap indicates that although Cabcharge isn’t one for conservative investors, its near-monopoly over the sector creates long-terms benefits.

The Reserve Bank is in the final stages of consultation over surcharging standards. At the moment, Cabcharge imposes a 10% fee on any non-cash or non-Cabcharge chit transaction – basically every credit or eftpos card payment – and the RBA is investigating what level of fee is appropriate for merchants to charge to recoup some of their costs.

Then again, Cabcharge still holds all the, ahem, cards if it is forced to lower its fee. When Visa demanded that the company lower the fee on its cards in 2000, taxis simply stopped accepting those cards until the company backed down. There is also the fact that Cabcharge is the industry giant: if it is forced to stop or drastically reduce card surcharges, it will be emerging competitors who suffer most.

This is not the first tiff Cabcharge has had with the regulator. In 2010, the ACCC won its case that Cabcharge breached the Trade Practices Act by not allowing its corporate cards to be used in taxi fare terminals installed by rivals.

But Cabcharge isn’t the gorilla in the playground for nothing. It’s going from strength to strength, with underlying net profit for full year 2011 up 11% to $34.6 million and an increase in its dividend, from 10c to 17c. It’s constantly improving the technology taxis use, with contactless terminals to be fully activated by the end of March, and an integrated payment platform to be rolled out this year, making transactions faster and fares easier to calculate.

Cabcharge’s venture into bus services is also paying off, with a 37.6% increase in revenue last year coming from new routes and a better network in metropolitan Sydney, Victoria and the Hunter Valley.

Cabcharge is involved in the rough and tumble, often-opaque world of taxi companies, but it’s also the Seek or REA Group of taxi-fare processing and will remain the dominant market player for some time to come.

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

Campbell Brothers (CPB). Campbell Bros operates ALS Laboratory Group, which undertakes global testing services for the minerals, coal, food and pharmaceutical, environmental, and tribology (analysis of equipment fluids) sectors. This business aligns Campbell Bros mainly with the cyclical mining sector (59% of earnings in the first half of 2012) and provides 95% of group earnings.

But since the announcement of those first-half results, Campbell Bros has spent $39 million on UK businesses Eclipse Scientific Group and Ireland-based Advanced Micro Services. Both give the Australian company more exposure to the food and pharmaceuticals sector (a diversification the newsletters greatly approve of) and boost Campbell Bros’ presence in a sector that is set to get bigger.

One newsletter points out that as demand for food grows, and as the world’s population increases and becomes more urbanised, food, pharmaceutical and water testing is going to be a swiftly growing sector. We are already seeing it in China: after the melamine milk scandal and last year’s revelations of cooking oil being scavenged from road-side drains, Chinese people are quickly realising that there is a dire need for food safety and tighter regulations.

The acquisition will lift Campbell Bros’ position in Europe and was funded by debt, at a time when the resources side of the business can easily carry a higher load. But the newsletters don’t like the look of 41% net debt to equity and think any further deals are likely to be funded by dilutory equity raisings.

The basic fact the investment press doesn’t like is that Campbell Bros’ share price has risen 38.6% in the last year and its PE stands at a premium 25 times – far higher than is warranted, the newsletters say, for this company and its operations.

So an investment in this company depends on what you think about the future: can food and mining services underpin further growth? Or is the company just too pricey in such an uncertain market? The newsletters think the latter.

  • Investors are advised to sell Campbell Brothers at current levels.

OrotonGroup (ORL). 'Getting it’ – when 'it’ is online retail – is dividing Australian merchants into those who saw the future a while ago and those who think they can forecast accurately but are really just trying to read the tea leaves.

Oroton is one of the few retailers which not only realised after 2008 that being constantly on sale would cheapen the premium brands it manages (Oroton and Ralph Lauren), but that having an online marketing channel would be essential.

Overseas experiences have already demonstrated that establishing an online retail strategy is hard work to start with, but the payoff is exponential. At the low end of the spectrum, Marks & Spencer is producing online sales of 5.6%, while luxury fashion retailer Neiman Marcus is generating 16.3% of sales via the internet, proving that being able to directly source products and use the established supply chains and distribution networks (the stores) to create a single sales structure, rather than two distinct and unlinked parasitic businesses, is one key to being a success retailer of the future.

For Oroton, online sales grew another 70% for the first half of 2012, compared to the same period in the last financial year. Overall, sales lifted 13.4% (and remember, apparently consumers aren’t spending on discretionary items right now), and net profit hit $16.1 million.

But the main driver of this leap in profitability is the strategy launched last year to venture into Asia. The first six of 60 stores planned throughout the region have been established and although the company is remaining cautious, demand for luxury goods among the growing moneyed middle-classes of Asia should offset any weakness in Australia.

  • Investors are advised to hold OrotonGroup at current levels.

Sigma Pharmaceuticals (SIP). Since the newsletters flagged the arrival of 'new Sigma’ in December last year, it’s gone from a loss-making portfolio liability to a straight cash cow, reinstating the dividend and paying out a 1.5c special dividend.

And how has Sigma gone from being one of the dogs of the market, after the disastrous 2005 merger with Arrow Pharmaceuticals, to a corporate revival story? By management proving, with hard figures, that it’s capable of the action the company so badly needed.

Full-year results were as follows: a $50.3 million net profit compared to a $73 million loss in the year before; fully-franked dividends are back on the table, starting at 2c; operating cash sprang from $45 million to $146 million; and most importantly, cash in the bank was $144 million – something of a novelty for a company that in 2010 sold its whole generics business to South African firm Aspen to stave off the debt collector.

The threat of Pfizer cutting out the middle man and supplying pharmacies directly doesn’t seem to be having the hugely destructive effect expected either. Last year, the investment press was almost certain that by cutting wholesalers such as Sigma out of the sale process for Pfizer-made drugs, the foreign pharmaceuticals maker was taking away a large chunk of revenue.

But it appears that Pfizer’s attempt to create its own distribution network is not working so well, with anecdotal evidence piling up that rural pharmacies are receiving crucial drugs later than the within-24 hours a Community Service Obligation supplier (such as Sigma) is financially rewarded for.

Still, there are headwinds that are out of management’s control. The federal government is determined to cut health care costs, with the next round of cuts due on April 1 to be in the region of 23%. It’s also being particularly slow in recommending new drugs to go on the Pharmaceuticals Benefits Scheme (PBS), one of the main sources of Sigma’s revenue.

The ever-present threat that supermarkets will be allowed to sell prescription drugs is a worrying one for investors in the wholesaler. Sigma relies on pharmacies having an effective monopoly over the country’s (legal) drug trade as it supplies them. Were local business giants Woolworths or Wesfarmers allowed to muscle in on this trade, they could severely undercut pharmacies not aligned with the duopoly and this would force a new revolution in Sigma’s business model.

Nevertheless, management is showing that it has what it takes to turn a business on the brink around. Sigma may have sold the exciting generics business and live on now as a boring wholesaler, but provided the pharmaceuticals landscape doesn’t change too drastically in the near-to-medium term, it could begin to return to the pre-2005 glory days.

  • Investors are advised to hold Sigma Pharmaceuticals at current levels.

ResMed (RMD). On the face of it, ResMed looks like another Cochlear: expensive, cash-rich and another Australian health care company that is taking the world by storm. The newsletters say there is less to like about the sleep apnoea products maker, though.

ResMed released its December quarter results to the world and showed just how lucrative it can be to find a niche in borderless health care sectors. Revenue grew 9%, net profit was up 6.1%, and the company has $500 million of cash on its balance sheet, despite a $104.1 million share buyback. It could, of course, reduce this hefty cash balance if it started paying dividends.

Although it sells CPAP (continuous positive airway pressure) machines for $2000 apiece, it’s the cheaper replaceable accessories that are the underlying money-makers. Mask sales were strong and flow generator sales in the US were back at 4% growth.

In saying this, these products are also threatened by some competitive pressures, and each year ResMed needs to increase sales volumes in order to resist the slow deflationary creep.

ResMed’s products are positioned at the premium end of the market and because of their undisputed health (and hence economic) benefits, the company is relatively insulated from cuts to health care budgets. However, as one newsletter points out, sleep apnoea is often the result of dietary and lifestyle choices. For example, the company admits that it’s middle-aged, obese men who smoke and drink to excess who are more likely to suffer from the condition, and in a world of constrained government budgets, these people can be seen as less 'in need’ than, say, a person with diabetes.

In Australia, Medicare doesn’t fund ResMed’s products and private health insurance is grudging about covering them, although health funds in the US – the larger and considerably more profitable market – are more generous.

In saying all that, ResMed has only conquered a tiny portion of the available market, estimated at anywhere between 7-20% of the global population. It’s a leader in its field and the 7% spend on research and development should ensure that it remains there for some time yet.

  • Investors are advised to hold ResMed at current levels.

Watching the directors

Lycopodium (LYL) director Lawrence Marshall took advantage of the 20% surge in the company’s share price this year, to chip off 200,000 shares from his holding last week. Marshall sold out at $6.97 a share (making $1.4 million), which was 50c below where Lycopodium’s stock surged to in Monday morning trade. He still owns 1.94 million shares. Mining services is widely considered to be the sector to watch this year – although not if you’re an adherent of Michael Feller’s analysis (see today’s lead article).

Following the large sale by Mineral Resources (MIN) chief Peter Wade last week, director Mark Dutton followed with a $6.2 million sell-down. This was about 97% of his total stake and leaves him with 15,000 shares, after the sale of 485,000. Dutton is a private equiteer and sits on the board of WA private equity manager Banksia Capital.

Breaking the recent selling flood, there was large buying in personal care products minnow Symex Holdings (SYM) last week. Director Alan Johnstone bought $656,038 worth of the stock, totalling 6.3 million shares and bringing his stake to almost 30 million securities, while non-executive chairman Peter Robinson made two separate transactions of 950,000 shares each, bringing his stake to 3.1 million shares. Both purchases cost him $99,750.

Ramsay Health Care (RHC) director Patrick Grier made a cool $656,976 last week when he sold 35,740 shares in the private hospital operator on market. The per-share price was $18.33 and Grier now owns 22,376 shares. Grier was once the managing director and CEO of Ramsay, before retiring in 2008.

-Recent large directors' trades
Date Company
ASX
Director
Volume
Price
Value
Action
22/03/12 Symex Holdings
SYM
Alan Johnstone
6247983
0.105
$656,038
BUY
22/03/12 Ramsay Health Care
RHC
Ian Grier
35740
18.38
$656,901
SELL
22/03/12 Sedgman
SDM
Russell Kempnich
1000000
2.25
$2,250,000
SELL
21/03/12 Imdex
IMD
Bernie Ridgeway
220370
2.89
$636,870
SELL
21/03/12 Westside Corporation
WCL
Angus Karroll
1000000
0.45
$450,000
SELL
20/03/12 Dart Energy
DTE
Nicholas Davies
1000000
0.345
$345,142
BUY
19/03/12 CI Resources
CII
Lip Sin Tee
787000
0.55
$433,950
BUY

Source: The Inside Trader