Collected Wisdom

Hold Macquarie Group, GWA and McMillan Shakespeare, AGL Energy is a long-term buy, and sell Treasury Wine Estates.

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.

Macquarie Group (MQG)

Things are not entirely golden over at the ‘millionaire factory’ these days, as market volatility continues to hurt the half of the business exposed to it.

Profit lifted 18% in the first half of fiscal 2013, to $361 million, but the newsletters note this was a 15% decline compared with the immediately prior half. Earnings also missed market expectations, but the underlying feeling was broadly positive, as brokers lifted valuations and commentators expected cost tailwinds to end. Revenue fell 5% compared to 1H12, to $3.08 billion, or 17% half-on-half, reflecting a business bringing in less money and attempting to do more with it.

The investment press explain that earnings are playing out as could be expected, with the funds business performing the best and contributing almost 35% of group business unit earnings while the market businesses are dragging. Macquarie Securities, Capital and Fixed Income, Currencies and Commodities (FICC) businesses all improved many multiples of earnings compared with 1H12, but collectively declined 62% compared with 2H12. Macquarie securities reported a net loss of $64 million.

The newsletters like Macquarie’s declining costs and strong capital position, as well as the 4% increase in assets under management. Return on equity lifted but remains low, at 6.6%, but this is partly as a result of surplus capital, and the company is well into a roughly $750 million share buyback to rectify this.

The major risk continues to be the global investment environment, and Macquarie is seen as something of a bet on the markets. Over the past year it has performed better than the four big banks in terms of share price, rallying strongly when the market did from January to May, and then August to now. With Europe settling, signs of a US recovery, and tentative movements back into equities as a result of the search for yield, there are indicators markets may be stirring. And that’s good news for Macquarie investors – though it’s still cautious days yet.

  • Investors are advised to hold Macquarie at current levels.

AGL Energy (AGK)

It has been difficult to avoid the electricity pricing debate rumbling in the wings of state and federal governments, with all its associated gold-plating and carbon tax rhetoric, and perhaps AGL would have liked to avoid it. Changes to retail pricing in South Australia and Queensland are expected to cost the company $45 million in this fiscal year. But from an investment perspective, the view on the company is still very positive and the newsletters continue to recommend the stock.

Two news points for AGL emerged in the past week – it announced earnings guidance slightly below consensus expectations and it decided it would not proceed with the 1,000 megawatt Dalton gas power plant in New South Wales at this time, after putting the project on review for several months.

Guidance for underlying profit this year is $590-640 million, which while falling short of estimates suggesting a midpoint of about $635 million, the midpoint of $615 million would still be an improvement of nearly 30% on 2012. It seems investors had largely factored this in, and the share price has lost less than 4% since the announcement and AGM last Tuesday.

On the Dalton power plant, the decision is largely a factor of supply capacity remaining in surplus as a result of coal-fired power plants staying open. Government policy has the potential to change this at some point, however the political environment suggests it won’t be in the near term.

Fundamentally, AGL remains a dominant player in a partially-regulated industry. Sometimes this works in its favour, and sometimes, as with recent pricing announcements, it does not. But with more than a quarter of the eastern states market, growth in NSW customer numbers, and a strong collection of assets boosted by the Loy Yang acquisition (see collected wisdom in June/July?) the company remains attractive in the long term.

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

GWA Group (GWA)

A very pessimistic first-quarter trading update ahead of GWA’s annual general meeting last week has taken some of the steam out of the building products ‘revival’ narrative, but the newsletters see long-term value remaining in the company.

Sales are down 12% and EBIT is down 41% on the equivalent quarter last year, but the company said it did not expect this to be “reflective of the group’s full year performance”. GWA said in spite of falling rates and government stimulus, new housing was not expected to improve immediately, and there was a 6-8 month lag between new construction and the types of late-addition fixtures and fittings (typically for bathrooms and kitchens) that GWA provides.

Consumer confidence was pointed to as a factor impacting the business – a refrain heard across corporate Australia at the moment. GWA is cutting costs, and the newsletters expect the sales force to be cut, as well as margins to improve through offshoring manufacturing.

Housing approvals remain weak, but the view in the investment press is that this is unsustainable. Confidence will return at some point, and population growth and a generally full rental market suggest an uptick is coming eventually. GWA’s brands have some strength and familiarity, but cheap imports and the high Australian dollar also hurt. However, the trajectory of the dollar is steady at best, and many expect it to fall in the medium-term, which would help the company to some extent with growing competition.

GWA is a strong business, dealing with a tough broader market, but the newsletters suggest the very weak first-quarter update should not shy investors from the stock just yet.

  • Investors are advised to hold GWA at current levels.

McMillan Shakespeare (MMS)

As covered in Eureka Report last week (link to my Car article), it hasn’t been a bad year for automotive exposed companies in Australia. One of the more distant, but related, businesses is vehicle lessor and salary packager McMillan Shakespeare.

After another year of strong earnings growth in 2012, having reported a 25% increase to $54.3 million, the newsletters saw hints it would top $60 million in FY13 in the chief executive’s AGM address last week. Dividends last year lifted from 38c a share to 47c in total, though the company is still on a modest yield below 4% largely as a result of its near-50% share price improvement in the calendar year to date.

A major negative for the company is the general reduction in public service headcount – particularly in Queensland – where a large number of its remuneration and vehicle lease contracts are. However the company suggests the increased job losses are not material – and the much larger and more lucrative private sector remains a target for growth.

The company’s share price is off 2% in the past week, suggesting the market is hardly spooked by the potential headwinds, and the newsletters generally see this as a solid small cap in a profitable and scale-able niche, definitely worth holding onto.

  • Investors are advised to hold McMillan Shakespeare at current levels.

Treasury Wine Estates (TWE)

The Australian wine industry is recovering from a bit of a prolonged hangover from the rush of activity and glut of product in the 1990s and 2000s, and with its stable of well-known brands such as Penfolds and Wolf Blass Treasury is in the middle of it. Treasury was spun off last year from Foster’s, that largely unsuccessful experiment to mix beer with wine (something every university student has surely considered at one point, before deciding the better of it), and the demerger made each of the businesses more attractive in their own right – at least for a time.

Foster’s was picked up almost immediately, and is now owned by multinational brewing giant SABMiller, and Treasury’s share price has improved more than 40% since listing in May 2011. The newsletters now believe it’s looking peaky though, and that consumer spending weakness is trickling through to wine as well.

Treasury softened its guidance to “mid-single digit growth” in fiscal 2013, after a weaker than expected first quarter in America and the US. The company said costs were increased by poor weather affecting production, and by setting up IT infrastructure following the demerger. First half underlying earnings are now expected to fall by 20% on the same period last year.

The risk for investors not being in Treasury is the potential that the company will fulfil its role as a takeover target, as did Foster’s. The investment press expects there is a high likelihood of corporate action at some point – the question is whether that’s enough now. With weak consumer spending, falling earnings, and a share price that’s supported by expectation of a takeover that does not appear immediately in sight, the newsletters are firmly staying away for now.

  • Investors are advised to sell Treasury at current levels.

Watching the Directors

At least one person is making hay while the sun shines again on the iron ore price. As Fortescue Metals Group’s (FMG) share price has recovered 15% in the past month and is sitting back above $4, non-executive director Kenneth Ambrecht sold 360,000 shares in the company for more than $1.5 million, or roughly $4.26 a share. It came to light last week that Fortescue applied to the WA government for royalty payment relief, and while the company pulled off an impressive financing pirouette recently it remains closely watched by analysts and investors for any wobbles in the iron ore price or otherwise.

Aftermarket car accessories and repairs outfit AMA Group (AMA) chief executive Raymond Malone took some profit as well, after a stellar year in which the company’s share price has more than doubled. Malone shifted 16 million shares for 28c apiece, or roughly $4.5 million, in a company that just three months ago was sitting at around 14c. He retains more than 77 million shares in the company, or roughly 27%.

On the buying side, embattled director and founder of Billabong (BBG), Gordon Merchant, has showed some faith in the company’s recovery after a horror year of takeover interest which has amounted to a large chunk of shareholder value destroyed. Merchant, who retained his board seat at least week’s AGM despite pressure, bought more than 900,000 shares in the company, for a total of roughly $750,000, or 84c each. The move looks good as Billabong shares have rallied since last week, closing today at 92c – although they remain well below the $1.45 indicative private equity bids that disappeared in the past month, and the $3.30 Merchant rejected earlier this year.

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