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.

Crown (CWN). It wasn't long ago that Collected Wisdom last looked at Crown, and while a lot has happened in a short space of time the view of it as a good-looking company with strong prospects hasn’t changed.

There are four main developments to look at – the announcement of a major new expansion in Perth, full-year earnings results, a $525 million debt raising, and chairman James Packer’s sale process of Consolidated Media and what that means for Echo Entertainment and Crown’s planned Sydney Barangaroo dream.

On the Perth expansion, the newsletters are united in support. Crown’s general plans for expansion, targeting Asia’s high rollers and the elite ‘six star’ hotel-type customers, appear sound while reasonable growth in general revenue at the Perth, Melbourne and Macau casinos show a strong base to work off. The Perth incarnation of Melbourne’s Crown Towers will cost $568 million, but the value it will bring is expected to make this worth the effort.

The complex hybrid note issue was more of a surprise, and some took it as a sign of a coming full bid for Echo. But others see it as a more opportunistic raising while corporate hybrid issues are becoming commonplace. Either way, if successful the raising will provide a little more debt flexibility and help pay for some of the developments and refurbishments.

As for Packer, the ACCC has granted approval for News Corp to go ahead with its bid for Cons Media, and that could free up roughly $1 billion for him ahead of any Crown equity raising. Such an event would likely presage a larger move on Echo, though Crown’s intentions there, along with Malaysian group Genting, remain very unclear.

Crown’s full year net profit was up 22%, in line with guidance and expectations at $415 million. EPS was up more than 25%, and this was with Melbourne revenue lower as upgrades there disrupted business. As that work completes, costs will fall and performance is expected to improve further.

In all, despite a 5% rally in the Crown share price this month, the newsletters see this as justified by the strong future being put in place and the potential for the company to be Australia’s dominant casino player – and a major presence in the global casino game.

• Investors are advised to buy Crown at current levels.

Commonwealth Bank (CBA). It’s been a healthy earnings season for the big banks this year, and Commonwealth led the charge with a record $7.1 billion cash profit and a generally stronger looking business in the face of global uncertainty.

Some of the ‘four pillars’ are more equal than others, and with NAB weighed down by its UK businesses the other banks are looking stronger. Commonwealth is particularly rewarding investors thanks to the combination of the latest bank rally – bank stocks are outperforming the index by more than 10% this year, as resources stocks underperform by about the same – and improved returns to shareholders. The final dividend of $1.97 contributed to a 4.4% increase in dividends for FY12, and the interim payout for the coming half has been “tweaked” up from roughly 60% to 70%. This improvement gives Commonwealth a very attractive dividend yield of 6%-7%, and that’s before the benefit of franking credits.

Balance sheet strength is another positive for the bank, and tier 1 capital under Basel III is now at 9.8%, ready for the new regulatory regime in the coming year. Deposit growth was impressive at 8%, while credit grew a very reasonable 5% given the conditions, and bad debts fell sharply. The $850 million of bad debt provision pales in comparison to Commonwealth’s $350 billion loan book, which is relatively conservative and appears strong. Return on equity was above 18%, which, while lower, is still stunning, and above the 15%-16% of its peers. Deposit funding is at a record high of 62% of total funding, which is important in light of shrinking wholesale markets from an imploding euro.

If the euro holds, however, Commonwealth is also well placed to benefit from a macroeconomic improvement, especially in credit conditions. Some on the investment press view the share price as a little inflated, and have generally unanimously moved from ‘buys’ to ‘holds’ as it nears estimates of reasonable value and tests some longer-term technical highs. But in the shape the full-year results reveal it’s in, Commonwealth Bank looks as good as it ever has.

• Investors are advised to hold Commonwealth Bank at current levels.

OZ Minerals (OZL). As discussed a fortnight ago with Newcrest, the weakened copper price and flat gold outlook have cast a pall over producers, but the investment press interprets this as an opportunity to buy.

Interim profit was down 37% on last year, in line with forecasts, as cash costs for copper production are on the rise at the same time as the copper price achieved fell by more than 10%. But production guidance stands and the cost base for both copper and gold allows for steep further price declines before it becomes a real problem. There is, of course, substantial upside for gold as well if things go pear shaped in the global financial system, either as a result of a China hard landing or a European crash landing.

OZ is also set to benefit from a fall in the Australian dollar against the greenback, which may not be immediate but is near-unanimously viewed to be inevitable. The company would also stand to benefit from any delay to the massive BHP Olympic Dam project, where any negative sentiment created in the outlook for the resources sector would be offset by freed up labour and construction equipment in South Australia.

Most of all though, OZ, like Newcrest, stands to benefit from the constrained supply of both its major resources in coming years as copper discoveries dwindle and the acquisition of the Carrapateena mine adds to the company’s production base. Exploration in Chile and Argentina is pushing ahead and the cost of that exploration is low.

OZ’s share price has fallen about 30% year to date, almost 10% in the last month, and along with the rest of the Australian resources industry it is in a bit of a rut. But for investors willing to bear some risk, with due caution given to the short mine life at the main operating mine, OZ could provide great exposure to two of the more attractive hard commodites.

• Investors are advised to buy OZ Minerals at current levels.

JB Hi-Fi (JBH). After a rotten year for the music and electronics retailer, assailed from all sides by the move to digital music downloads, the broader shift to online retail and poor cyclical consumer spending conditions, the newsletters are still holding out some hope for JB Hi-Fi.

Net profit for the full year was above expectations – particularly the expectations of the traders who had shorted more than a fifth of the shares on issue ahead of the earnings report – at $104.6 million, a decline of about 22%. Second-half comparable sales held flat after a 3% decline in the first half, which suggests something of a floor in terms of retail conditions. The result indicated good profitability remains for the group in spite of the weaker spending. A 7.3% dividend yield, grossed up, didn’t look bad for investors either.

CEO Terry Smart raised a key point on JB’s fortunes compared with the broader market: “Challenging trading conditions have driven competitors with higher cost bases out of the market, enabling JB Hi-Fi to continue to grow both its store network and market share.”

Some in the investment press see a possible spike from the government’s carbon tax assistance, as well as generally improving retail spending in the past six months, although 2013 is not expected to be a great year. JB’s guidance is for a 1% decline in like-for-like sales, though new stores will drive growth, and a redesigned website will see the battle continue to be fought in the movement of retail online.

If online growth can get meaningfully above the paltry 2% or so of earnings it contributes now, JB could benefit from its size and brand name advantage, but its large store network is structurally restrictive. That said, better sales online could significantly improve margins – which at JB’s low price point are tight – and with the company’s performance elsewhere holding flat its size and relative willingness to adapt could see it weather the various storms.

Investors are advised to hold JB Hi-Fi at current levels.

Domino’s Pizza Enterprises (DMP). The investment press is often wrong about the prospects of companies, suggesting things might move one way when they end up moving the other. But while this may the case in the short term, it’s usually based on some sound reasoning. With Domino’s, the newsletters’ insistence that the stock is heavily overbought and due for a correction has been consistently rebuffed with strong growth and surging earnings. But it can’t go on forever.

Domino’s share price is up 9% in the past three months, 22% in the past six months and 53% in the past 12 months. Throughout that time the investment press has both recognised the strength and potential that low-cost quick-service restaurants have in economic downturns, but also the sheer unsustainability of double-digit earnings growth and EPS growth at or above 20% in consecutive years.

All the signs do look good for the pizza maker. Net profit – $26.9 million for the full year just reported – shows no sign of slowing as up to 80 new stores are added to the network and the potential expansion in Europe where Domino’s operates (in France, Belgium and the Netherlands ) is far greater than the Australian market. However growth here is still on the cards. What’s more, the threat of online has been completely neutered and turned in Domino’s favour as online sales move to the majority of total Australian revenue, accounting for an expected 55%-60% in 2013.

So what could go wrong? Several things, according to the newsletters. If food and materials input prices rise, as expected, this could push margins – something McDonald’s experienced in its weaker full-year results earlier this month. In addition, wheat prices are soaring. Also, consumers are fickle, and fast food is a fast-moving business.

To date, product innovation from Domino’s has been good, but it may not last forever. Then there is the aggressive growth and expansion, which carries exponentially increasing risk if not managed correctly, and the risk that improving general economic conditions would trigger a move away from fast food – as seen in previous recoveries.

In their previous forecasts, the newsletters had been highly sceptical that Domino’s could maintain double-digit growth for another year, and they were proven wrong. But they remain sceptical, if not more so, that the company will do it again.

• Investors are advised to sell Domino’s at current levels.

Directors Trades

Director trades have been all but absent for the past fortnight as lock-ups from earnings reporting season limit the action. However one show of faith worth mentioning comes from JB Hi-Fi (JBH) chief executive Terry Smart, who splashed out a total of $193,848 buying 20,000 shares in the company (implying about $9.69 a share) following the release of better-than-expected full-year earnings. The company’s share price has been hit hard this year, falling more than 35% from more than $16 a share in December to its close today at $9.46.