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.
Fortescue Metals (FMG). A good definition of confidence would be betting against the almost self-fulfilling prophesies of short-seller Jim Chanos. And the investment press have no such confidence in Fortescue.
In widely circulated comments, Chanos reportedly said Fortescue was a “value trap”, propped up by an unsustainable level of debt and an expensive capex program that would come back to bite it if and when iron ore prices sank. Almost every analysis lends support to this.
As a simple starting point, Fortescue is much more vulnerable to the whims of the iron ore market than BHP or Rio, because it does not have the diversified commodity exposure of its larger rivals.
The majority of Fortescue's growth at the moment is coming from volume expansion, and this is both its strength and weakness. If iron ore demand stays high, big fish like BHP and Brazil's Vale will be ramping up production along with Fortescue, sending the commodity’s price down by estimates of about 30% to near the $100-a-tonne mark. If demand doesn't stay high, Fortescue will be competing with those same larger, low-cost, high-volume miners to generate the sales to pay for all that debt and capex.
Fortescue's balance sheet had $US3.7 billion net debt at the end of 2011, and a capex program of $1.5 billion in the pipeline, against a net profit that is predicted to decline this year from $1.64 billion to $1.4-$1.5 billion.
Production for the third quarter (to March 31) declined q-on-q due to poor weather, although Fortescue maintained production guidance of 55 million tonnes for the full year.
None of these risks on their own are particularly startling or deal-breaking, but taken together the Fortescue recipe doesn't look so tasty. It's only exposed to iron ore, and even among the Australian iron ore miners it's not the best placed. The potential for Africa to open up with high-grade, low-cost mines in the medium term doesn't help Fortescue’s case, and China's ongoing demand profile is far from certain.
As long as Asia keeps wanting huge amounts of iron ore at historically-inflated prices, Fortescue looks alright, but any part of that equation looks dangerously susceptible to change in the near future.
- Investors are advised to sell Fortescue at current levels.
Stockland (SGP). While the probability of a rate cut of at least 25 basis points is all but a given when the Reserve Bank meets tomorrow (May 1), the impact of that cut – notwithstanding whether the big four actually pass it on – is less clear.
Accordingly, the prospect of a rise in new housing activity is no sure thing. Data from the Housing Industry Association released today showed new homes sales fell to their lowest level for 10 years last month. Sales dropped by 9.4%, seasonally adjusted, in March, while multi-unit sales slumped 6.4% over the same period.
While today’s data, and the uncertain outlook around rates, doesn’t bode well for property developers, the newsletters like Stockland at the moment (it’s currently trading around the $3-a-share mark, with a roughly 8% dividend yield – well below its pre-GFC highs of more than $9). The company has a good diversification of commercial, industrial, residential and retirement communities – the latter being a solid prospect for future earnings growth as the demographics move in that direction.
The big risk with Stockland, of course, is the strength or weakness of the property market. The picture doesn't look good for new residential housing approval rates, and, while prices haven't tumbled, they are flat or retreating across most of the country. However, only 21% of Stockland's portfolio is in residential development, so even a drop of 25% (or more) that some predict for the housing market would not write-off the company. A further risk, however, is that a drop in prices may flow through to the retirement sector (20% of the portfolio), since the majority of retirees' funding comes from the sale of their existing home.
Stockland's retail portfolio is markedly different in makeup from its obvious point of comparison, Westfield, in that it has a much higher percentage of anchor tenants, such as supermarkets or low-budget department stores, and is located in more suburban regions. This provides greater protection from cyclical downturns, as more of the tenants are in essential food and services industries – a point that Stockland CEO Matthew Quinn has made on several occasions.
Property market risk aside, this is a company with admirably low gearing – 23% debt to tangible assets – and a clear diversified strategy. It's not pretty, but few property stocks are at the moment, and when housing activity recovers, Stockland looks to be well-placed to capitalise on it.
- Investors are advised to hold Stockland at current levels.
Seven West (SWM). Very few people would be labouring under the impression that Seven West had a very good week on the sharemarket. A 9% profit downgrade late on the afternoon before Anzac Day saw a very quick sell-off when trading resumed Thursday morning, dropping 22% to dive below $3 and ending what had until then been a strong run on a stock which seemed immune from the general media malaise.
Breaking down the company – which formed from a related-party merger of Kerry Stokes' television and print assets Seven and West Australian Newspapers in early 2011 – 61% of earnings are derived from TV, with newspapers and magazines providing roughly a third, and online the rest.
There are a multitude of problems here. The Australian advertising market, across both print and free-to-air TV, is in a slump. Seven's television ratings may be excellent, and The West Australian's newspaper circulation holding up, but this is not translating into dollars from a reluctant ad market.
The newsletters attribute last week's downgrade to a realisation that the increased cost of the AFL content free-to-air TV deal this year – almost doubling from $48 million to $95 million annualised – is not going to be met by sufficient extra ad-spending.
The other problem that has been consistently raised since the merger last year is debt. One of the outcomes of the deal was to saddle the previously debt-free West Australian Newspapers group with around $2 billion of Seven's debt – something institutional shareholder KKR, which still holds 12% of the company, was keen to do and something WAN shareholders accepted to diversify away from 'dinosaur' print media reliance. But now $1.8 billion of that debt remains, and while reduction is a priority it's also, at best, a pressure on dividends – and at worst, the path to a dilutive equity issue.
On the point of dividends, however, Seven West has been one of the stand-out stocks on the ASX. A fully-franked dividend of 30-36c is still expected for the full-year, equating to a yield of 10-12%.
The question for Seven West investors now is whether last week's share price plunge represents an overdue correction towards fair value for a debt-laden stock in a poor media market, or a knee-jerk jitter that may present a good buying opportunity for a high-dividend stock.
- Investors are advised to hold Seven West Media at current levels.
Woolworths (WOW). Another quarter of sales data from the supermarket giants, and another escalation in the fevered battle between Coles and Woolworths for the hearts and wallets of Australia's grocery shoppers.
While this competition melee may look good from a consumer perspective, it doesn't seem so attractive to shareholders, and Woolworths’ food and liquor same-store sales growth and total sales growth each saw steady declines over the past three quarters, linked clearly to price deflation. From inflation of 3.1% in the quarter to June 30 2011, subsequent quarters recorded 1%, -0.3% and -1.2%, respectively – and that's excluding promotions.
But, the newsletters point out, conditions are difficult and this shouldn't count too hard against a stock which has been very good to shareholders over the past decade, and has exceptional underlying business strength built up over years of dominance over rival Coles.
Interestingly, while Coles has recorded much stronger growth numbers in recent years (following its 2007 sale to Wesfarmers) as it plays 'catch up' to Woolworths, the latest quarterly results showed Woolworths gained market share across its business sectors.
Dividend yield is approaching 5%, and it's fully-franked, and the gap in real terms between Woolworths and Coles remains significant.
With weather permitting, a sustained high price of petrol, and adequate management of the pending flybuys consumer rewards assault on Woolworths' Everyday Rewards program, the company should be able to continue posting respectable (if subdued) growth, and solid dividends. The impact of the fledgling hardware business Masters is yet to be felt or fully understood, but this is also an aspect to watch – for better or worse.
It should also be noted that buying into rival Coles means Wesfarmers share ownership, and entails exposure to the other half of that business – the coal industry – where an entirely different set of considerations apply. For a deeper look at what the retail stoush means for investors, take a look at Robert Gottliebsen’s Clicks v bricks’: A retail war.
- Investors are advised that Woolworths is a long-term buy at current levels.
Kingsgate Consolidated (KCN). What do you do with a 4.3-million-ounce gold resource in Thailand? If you're Kingsgate, you ramp up mining as best you can and use the proceeds to grow dividends and buy more mines to reduce single-site exposure – a strategy the investment press quite likes.
This is a stock with significant risk attached to it, and risk that could come from a variety of sources, but it appears to be making all the moves in the right directions.
The Chatree gold mine in Thailand has a mine life of 14-20 years ahead of it, and is still increasing production with development that could more than double it. In addition, Kingsgate has acquired the Challenger gold mine in South Australia, as well as the Nueva Esperanza silver project in Chile and the Bowdens silver project in NSW. Group March-quarter production results were below market expectations but still increased 13.7% for gold and 25.8% for silver, and Kingsgate is expected to produce 300,000 ounces of gold next year.
The newsletters agree that while some risk is mitigated by the purchase of a range of mines in different countries and locations, significant risks remain. The underground Challenger mine particularly requires high grades of ore to pay for the rising costs of mining it, but these grades are being reported. The silver projects open the company up to the more fickle silver market, and both projects require a fair amount of cash expenditure.
An expensive quarter at Challenger drove the group’s production cost of gold up to the industry average of around $US600 an ounce, but with Chatree producing at $US459 an ounce, the previous quarter average of $US517 looks closer to normal.
Large decreases in the share price over the past year make this an attractively priced stock, with estimated fair values more than double its close at the end of last week of $6.04.
Kingsgate has a wide range of sizeable proven resources and growing production and revenue. There is risk in managing costs, but this is a company the newsletters say has a good dividend history; looks set to sharply increase profits and yields over the next two years; and can use its stronger Thai mine to offset any teething issues at its new purchases.
- Investors are advised to buy Kingsgate at current levels.
Watching the directors
Takeover target Thakral (THG) former director Jaginder Pasricha sold the majority of his 226,092 shares this week and resigned from the board. Mr Pasricha offloaded 190,000 shares for $139,650, or 73.5c each, but in doing so breached Thakral’s securities trading policy by selling during a closed period. The board said in light of the circumstances, no further action would be taken. Thakral is the target of a 70c per share bid from Brookfield Asset Management, which owns 38.6% of the company.
On the buying side, new Cockatoo Coal (COK) managing director Andrew Lawson stumped up $540,000 for 2 million shares in the company at 27c each. Cockatoo’s share price has slumped this week after six months of trading around 35-40c, and Lawson steps up as managing director after former MD Mark Lochtenberg became executive chairman following the resignation of Norman Seckold.
QR National (QRN) chairman John Prescott bought 27,000 shares for his family super fund, paying $3.678 a share, or just under $100,000, and taking his total holding to over 200,000 shares. QR this week announced it was considering partnering with Atlas Iron to create an independent, open-access rail network in the Pilbara.
Some big sellers of some very small caps also featured in director trading action this week. First, Hydromet (HMC) non-executive director Jeffrey Chen sold 44,924,000 shares for $2.16 million, or 4.8c each, and ceased to be a director as of April 20. Hydromet is the subject of an off-market takeover bid at 4.8c from Simon Henry, the company’s largest shareholder, who now holds 27.1% of the shares on offer. Bisan (BSN) director James Robinson sold his entire stake in the company (21,031,862 shares and options) for $630,000, at 3c each.