Collected Wisdom

This is an edited summary of the Australian investment press: It includes investment newsletters, major daily newspapers and broker reports. The recommendations offered represent the views published in the other publications and may not represent those of Eureka Report. This article is general advice only which has been prepared without taking into account your objectives, financial situation or needs. Before acting on it you should consider its appropriateness, having regard to your objectives, financial situation and needs.

Downer EDI (DOW)

Infrastructure, mining and rail services group Downer EDI delivered the goods this week, reporting a 13% rise in net profit after tax (NPAT) for FY13 to $215 million and a 5.7% lift in operating revenue to $8.4 billion, despite challenging market conditions. Most rate this one a buy, given the strong result.

The reported numbers were generally above analyst expectations, giving some of the newsletters faith that the turnaround at the company hasn’t run its course just yet.

One source says Downer is in a good position to keep revenue steady and increase margins as stable cash flows and recurring revenue streams should help protect against a downturn in the sector. The improving balance sheet is another positive and could allow for acquisitions in the future, one says.

The rail group was the big disappointment, with earnings before interest and tax (EBIT) declining 22.7%. The long-awaited completion of the Waratah train project is expected in mid-2014, but there is still the potential for profitability to be hurt until that time, one source says. The group has already taken a $440 million loss against the $1.7 billion contract.

Looking ahead, it seems pretty likely that Downer will be affected by the tough environment. The company remains cautious on the outlook for both the sector and the economy, as is clear from the FY14 NPAT forecast, which is flat at $215 million.

Regardless, the investment press seems quite confident that management can weather the storm ahead. In the past 18 months the business has been de-risked and chief executive Grant Fenn has restored confidence and should continue to build positive momentum.

• Investors are generally advised to buy Downer EDI.

Virgin Australia (VAH)

Virgin Australia has now downgraded fiscal 2013 guidance for the second time in three months. The latest update saw guidance cut to a full-year loss of between $30 and $50 million. Given that the first-half pre-tax profit came in at $61 million, the new guidance implies a second-half loss of between $91 and $111 million.

The extent of the loss took the newsletters by surprise, given that in May Virgin was still talking about achieving a full-year profit rather than a loss. This one’s a sell, the newsletters say.

The newsletters are mostly concerned about the ongoing impact of the extremely competitive environment in which Virgin operates. It all boils down to the customer base. As Qantas and Virgin duke it out, looking to outdo each other at every turn, returns for both will come under continued pressure. When it comes to flying, customers care most about price, which promises to hit the bottom line of both airlines. Rising oil prices and a falling Australian dollar means both are hitting the customer with increases to fares and fuel surcharges. This will certainly do passenger volumes no favours. Yesterday’s outage of its Sabre booking system can’t have helped either.

At the moment, Virgin commands just 25% of the market share. The newsletters want to see this rise, but Jetstar is performing extremely well in the leisure market and Virgin needs to up the stakes.

The newsletters remain concerned about the weak balance sheet. Excluding off balance sheet items, gearing exceeds 90%. Cash flow is tight due to additional aircraft purchases and no dividend is on the cards yet.

The investment press is looking for profit in fiscal 2014 and code-sharing and alliance agreements should be of continued benefit. Still, there’s not a lot to like about the airline right now and turbulence looks set to continue for some time.

• Investors are generally advised to sell Virgin Australia.

PanAust (PNA)

PanAust’s record ore production at its Phu Kham copper mine in Laos was offset by cash costs hitting a new high in the quarter. At the latest update, the group reiterated copper guidance for the year and tipped a 10% rise in gold production. The newsletters still think there’s more good than bad here, and rate it a buy for those looking for copper exposure.

Production growth is expected for both the Phu Kham mine and its other big project, the Ban Houayxai gold mine. Diversifying into gold production means the group has reduced earnings risk, with gold sales now accounting for about a third of revenue.

The business is well run and the ungeared balance sheet means it is protected to an extent against weaker copper and gold prices, the newsletters say.

The group’s long history in Laos gives it a significant advantage over competitors in the region, but with both mines just 25 kilometres apart, there is substantial geopolitical risk. Expansion into Chile through the Inca de Oro copper project reduces this risk and increases the potential for new production from 2015.

Stronger production in the second half, as well as the recent completion of capital projects and lower expenditure, has the newsletters expecting free cash flow to rise sharply in the near term.

The newsletters seem confident that dividends are sustainable due to the steady mine performance and stronger cash flows.

• Investors are generally advised to buy PanAust.

Iluka (ILU)

Iluka Resources has been granted four exploration tenements in Sri Lanka and will acquire PKD Resources Ltd, the holder of another exploration tenement.

The size of the acquisition impressed the newsletters, since the tenements host 56 million tonnes (Mt) of heavy mineral (HM) grading at 8.2%, compared with its existing position of 122Mt at 6.5%.

The upfront cost of $5 million is minimal, and while the resource may be highly competitive in terms of scale and grade, there are many elements yet to be determined, the investment press says.

The problem is that the estimates are based on a 100% ownership basis, but regulations on foreign ownership restrict the holding of a foreign entity in a Sri Lankan mining company to 40%. Iluka said approval for up to 100% could be granted, but there’s certainly no guarantee of this. There are also elements of downstream processing that need to be clarified before a mining licence will be granted. So lots of unknowns here, which is why the investment press rates it a hold.

The latest acquisition of a large, long-life sulphate ilmenite deposit gives the company welcome exposure to the sulphate pigment market. But one source notes that price and volume pressure on its chloride business is likely to continue given the softer market for the pigment in China as sulphate pigment production takes over.

Iluka is financially sound and management has put a strong focus on returns on capital, but the valuation is looking a little stretched, the newsletters say.

• Investors are generally advised to hold Iluka.

iiNet (IIN)

iiNet has just snapped up South Australian internet provider Adam Internet for a cool $60 million. The deal takes iiNet’s total number of broadband subscribers to 900,000 and means it now controls about 30% of the South Australian market and 15% of the national market. Not bad for a second-tier telco. The newsletters are keen on iiNet but say it’s looking a bit pricey right now and rate it a hold.

iiNet’s acquisition will have been a blow to Telstra, the newsletters say, since the market leader had its sights firmly set on Adam before the ACCC shot down its offer just two weeks ago. Telstra’s offer was the same as iiNet’s but the competition watchdog was concerned that Telstra would use Adam as a low-cost provider, directly competing with other low-cost providers like iiNet and TPG Telecom.

Looking ahead, and forecast 2014 revenue for Adam is $55 million, while earnings before interest tax depreciation and amortisation (EBITDA) are expected to come in at $11.5 million. Brokers estimates on FY14 earnings are quite different, with one expecting the acquisition to add about 4% to FY14 earnings and another seeing earnings fall between 1-5% in FY14-15.

One thing’s for sure; iiNet is ramping up its market share ahead of the NBN rollout, which will force Telstra to compete on price. One source wants to see it start to focus more on organic growth and cutting costs. Watch this space.

• Investors are generally advised to hold iiNet.