Collected Wisdom

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.

Echo Entertainment (EGP). Having just emerged from a trading halt due to a significant capital raising, but at the same time facing possible takeover interest as both James Packer and Malaysian casino group Genting build stakes, Echo is facing interesting times. Taking it all into consideration, the newsletters like the company and its major assets – and are recommending investors hold on for the ride.

Echo was demerged from Tabcorp last year, and owns the Star casino in Sydney, as well as the casinos in Brisbane, Townsville and the Gold Coast – four out of Australia's 13 total.

The recent accelerated renounceable entitlement raised about $450 million for the company at $3.30 a share – a significant 27% discount to the $4.49 last closing price before that. Packer, who owns Crown casinos in Perth and Melbourne, maintained his stake of just under 10%, and Genting is understood to have been increasing its stake to near 8%. This takeover potential is naturally providing some share price support at the moment, which some of the newsletters see as holding it above fair value – but not by overly much. Rather, the use of the capital to reduce Echo’s debt is roundly applauded.

Echo also provided guidance last week for EBITDA of $348-393 million, the second trading update in a fortnight, and the weak consumer environment is hurting the short-term future of the entire casino industry. A hefty profit downgrade, including a $30 million hit from the Silk Star VIP business, may not do Echo any favours in a fight against a takeover, but many of the headwinds are being felt by the whole industry. Another potential short-term issue may be the departure of chairman John Story, and ructions at board level as Packer jostles for position.

However the company has one clear jewel and that's The Star. Currently holding the only casino licence in Sydney, with a very long term on its expiry (until 2093), it has just completed a redevelopment that is expected to both increase margins and lower costs as full use of the expansion ramps up. This, and the eventual culmination of any change in ownership, should see a stabler entity emerge, with a very powerful revenue base and the post-demerger takeover speculation dealt with.

• Investors are advised to hold Echo at current levels.

APN News and Media (APN). With the frenzy of focus on the media industry lately, much of the attention has been on restructures at Fairfax and News Limited, or prior to that on profit downgrades at Ten or Seven West. One company that has flown under the investment radar is APN, which has a collection of media assets in print, online, radio and advertising in Australia and New Zealand.

The share price, as one might expect of a media company at the moment, has been hammered – losing almost 25% in the past three months, and there are plenty of reasons for this.

Print publishing, specifically newspapers, are facing profound cyclical and structural difficulties. However, the regional, and less competitive, nature of APN newspaper assets gives it a better position than the metro dailies.

APN also just picked up brandsExclusive, an online 'shopping club’, paying $36 million for an 82% stake. The investment press is pleased with the fact that founders of that business will remain on the board with equity stakes, and with the cash-positive nature of brandsExclusive, but is cautious of the highly competitive e-commerce space. APN’s sale of half its outdoor advertising business freed up some debt headroom and allowed more growth flexibility.

Another positive is increased radio market share, and its joint venture Australian Radio Network has several commercial radio licences in the major eastern seaboard capital cities.

Mostly, though, the outlook is shaky for APN. Print and radio advertising revenue is falling at a rate that most media companies can’t replace with strong digital ad spending growth. Classified websites are eating away traditional revenue streams, and while regional publications are seeing more support there are no guarantees this will continue.
The share price is very heavily discounted at the moment, and there are still a lot of good assets here with potential for digital leverage, but a large part of that discount has just placed APN closer to where the media reality indicates it belongs.

• Investors are advised to hold APN News and Media at current levels.

OneSteel (Arrium) (OST). If there was a more uncertain and structurally shifting industry in Australia than media, it would be steel. The combined impact of a highly competitive international landscape, rising costs and falling demand from a weak Australian property and construction market has made something of a perfect storm.

The change in name reflects not only the fact that Arrium is diversified across some iron ore and mining consumables businesses, but also the desire to get away from being known as a 'steel company’.

What the newsletters point out, however, is that steel has a high cost of exit. The cost of redundancies and closures is high, the significant upfront capital is a major disincentive, and the workforce is both unionised and in a bit of a political spotlight thanks to the carbon tax.

What’s worse is that the company has tried to reduce its reliance of steel through a large, debt-fuelled bet on iron ore. This is both cash-costly to get running and reliant on demand, plus it takes net debt to $2.24 billion on a $1.24 billion market capitalisation.

If the solution to Arrium’s problems are iron ore, then demand and prices will have to stay high and there is plentiful competition in that sector even if this is the case. If the solution is a recovery in Australian property and construction, there would need to be more household debt headroom, and, again, competition is a major factor.

Finally, much of that hefty debt exposure is in US or Canadian dollars, which means if the Australian dollar continues to trend downward (which may be another flow-on from weaker iron ore prices), then that introduces further risk to the equation from exchange rates.

The move away from the troubled steel reliance may be admirable, but Arrium appears to have done this in a very risky and potentially problematic way.

• Investors are advised to sell OneSteel (Arrium) at current levels.

IOOF Holdings (IFL). The independent wealth manager has been trading broadly flat within a $5-6 range throughout this year, but improved funds under management, administration, advice and supervision (FUMAS) in the March quarter has led to renewed positivity on this company.

The buoyant equity environment in the earlier part of the year helped boost FUMAS to $110.2 billion – a 10% gain on the September quarter and a 4% gain on the December quarter. All the major segments reported positive net flows. Other positives include a cost-to-income ratio of just over 50% and 'sticky’ client platforms for both retail and corporate investors.

Much like Computershare, covered in Collected Wisdom last week, IOOF is favourably exposed to a general medium-term improvement in financial markets and is well placed to benefit from improved activity. The newsletters also note that a planned government-mandated increase to superannuation contributions will also help IOOF.

The company has also benefitted from – but is exposed to increased risk via – an acquisitive growth strategy. A merger with Australian Wealth Management and a buyout of Skandia are noted as successful transactions, and IOOF could be positioned as a potential takeover target now itself. Even if not, its management style and growing size make it a likely part of M&A activity on either side.

The obvious headwind is a weak current equity market, but with a growing financial advice business and a solid balance sheet, plus a subdued share price as a result of those market headwinds, this is company in a good position to make the most of a general economic recovery.

• Investors are advised to buy IOOF at current levels.

Incitec Pivot (IPL). Is Incitec a cheaply-priced company with production ramping up, or an over-priced cyclical risk play hitting a price ceiling on its key product? The investment press is certainly varied in where it lands on this question, but is generally holding on for now with a cautious eye on fertiliser prices.

Incitec Pivot makes fertiliser and explosives, with significant resources and agriculture exposure as a result.

Essentially fertiliser is reliant on ammonium nitrate production, and there are a few different considerations here. Firstly, there looks to be positive growth upside in FY13 as the Moranbah plant ramps up production. However, conversely, plans to build a competing plant at Kooragang Island, where Orica is planning an expansion, could see an oversupply going into the latter half of the decade.

A key criticism of the business has been the fallout from its $3.3 billion cash investment in US explosives giant Dyno Nobel, which it promptly had to write down by half a billion dollars and raise more than $1 billion in 2010 to pay down debt. Dyno had a strong first-half result this year, but US coal industry conditions appear shaky and power-generating coal accounts for 60% of Dyno’s North American ammonium nitrate volume.

The growth of demand in fertiliser is rising steadily, and growing population and food demand is unlikely to disappear soon, but the newsletters point out supply is rising at a faster pace: 65 new ammonia plants, including 23 in China, are scheduled to be built by 2014 – as well as 40 phosphate fertiliser plants. This will put pressure on prices.

Further to this, agriculture and resources are enjoying peak cyclical periods, but Incitec Pivot’s return on equity is about 11-12%, down from 20-40% in 2007-08.

However Incitec is making moves to reduce exposure to fertiliser to about 40% of revenue, and the explosives business has quite a strong underpinning in the pipeline of mining activity in Australia through the coming decade.

In all, Incitec Pivot is a business that will strongly benefit from the ongoing mining boom, as well as a falling Australian dollar, but investors should be wary of volatile international fertiliser price shifts as the supply landscape changes here and abroad.

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

Watching the directors

A large selling splash was announced to the market late on Friday last week, as Kingsgate Consolidated (KCN) managing director Gavin Thomas shed almost 733,885 shares for a total of more than $4 million. Kingsgate, a gold miner with a major Thai asset, recently sold its South Australian Gawler iron ore project 90% ownership to Iron Roads (IRD).

Selling continued at M2 Telecommunications (MTU) last week, following Vaughan Bowen’s hefty $8.6 million payday. This time it was independent non-executive director John Hynd selling, offloading 76,384 shares for about $3.38 each for a total of $257,942.

Much of the larger director sales this week were taken up by takeovers at both Nexbis and Eureka Energy, but in the big corporate names Westpac’s (WBC) deputy chairman John Curtis made roughly $100,000 selling 5000 shares at $20.49 apiece. Westpac, along with the other three major banks, was today named among the most profitable in the world by the influential BIS.

Buyers were strong in the energy industry this week. Australian Power and Gas (APK) non-executive director Richard Pool continued to up his stake (Poole most recently bought $1.4 million of shares in April) by more than 1.5 million shares, for a total of $783,136, while at Orpheus Energy (OEG) executive director David Smith bough 2.6 million shares for $334,000. Jupiter Energy (JPR) non-executive director Alastair Beardsall bought a third of a million shares for 43.5c each, or just under $145,000.

Finally John Seymour, a founder and non-executive director of road builder Seymour Whyte (SWL) which bears his name, bought 200,000 shares for a total of $213,280, or about $1.07 each. The share price took a sharp fall following an earnings downgrade on June 19, but was trending downward anyway – off more than 12% in the 30 days preceding that. Deteriorating margins are apparently to blame for a thin $8.7 million after tax profit, much of that from the first half.