Eureka Report's new stock approach

As we transition to Intelligent Investor's expert equities team, it's time to review some of Eureka's calls.

Trimming our coverage list

With all share research now provided by Intelligent Investor, we’re ceasing coverage on a number of stocks to allow us to concentrate on the most attractive opportunities.

As John Addis, editor-in-chief of InvestSMART, the new owners of Eureka and Intelligent Investor, noted today, all share research will now be provided by the ten analysts at Intelligent Investor.

You’ll soon have full access to the Intelligent Investor website at no extra cost but, until then, the Eureka home page will feature all new Intelligent Investor research. Our IT team is also working on bringing across all recommendations from the last 12 months.

Intelligent Investor covers over 150 stocks and currently has fifteen Buy recommendations. It also runs model Equity Income and Growth portfolios which have outperformed the All Ordinaries Accumulation Index by 5.7 per cent p.a. and 2.6 per cent p.a. respectively since inception in 2001.

Due to the long-term outperformance of Intelligent Investor’s model portfolios and a larger team of talented analysts, we’re replacing the Eureka Income First and Growth First portfolios with those from Intelligent Investor.

To that end, we’ve taken a fresh look at the stocks on Eureka Report’s coverage list and have decided to cease coverage on a number of stocks. This was also necessary due to the departures of senior analysts Simon Dumaresq and, more recently, James Samson.

Here’s a list of the companies we’re going to cease coverage on, along with some of the reasons why. Let’s start with the IT services companies.

IT services companies

The IT market has fragmented in recent years as companies increasingly use a range of specialised cloud-based solutions rather than relying on large root and branch projects. As a result, the work for consultants has been dwindling and they are increasingly having to reinvent themselves as service providers. Even here, companies are increasingly having to match prices with competitors in lower-wage countries (think India).

The other challenge all IT service companies face is that their major assets – their people – walk out the door each night. Worse still, they often don’t return the next morning, instead setting up their own company and taking many of their former employer’s clients with them.

One way in which Australian-based IT services companies have responded is through acquisition binges but, as Empired’s interim result showed, successfully integrating new companies is often difficult. Further, selling by Empired’s chief executive just before the November 2015 profit warning was a red flag in a business where management plays such a crucial role.

PS&C Limited just announced a profit warning, with management announcing that net profit could be up to 20 per cent below 2015 and that the final dividend would be halved. It’s always worth watching the actions of insiders and sales by a substantial shareholder in recent months was a red flag. That the company wasn’t required to pay deferred consideration also suggests acquisitions have been less profitable than expected.

DWS has fared better, with recent acquisitions proving successful. However, this doesn’t change our sceptical view of the industry and we think there are better opportunities elsewhere.

UXC was acquired by US-based Computer Sciences Corporation in March 2016, so it also joins the list.

G8 Education

Recent board changes and the appointment of a new auditor mean this expanding childcare business has eased corporate governance concerns. Yet we wonder why its former chief financial officer prefers developing and selling new childcare centres to G8, despite the greater risk involved compared to purchasing and managing established centres.

In relation to which, we note like for like peak occupancy for G8’s centres purchased in 2014 and earlier has either remained steady or declined based on the company’s 2015 result presentation. By contrast, the like for like average occupancies disclosed in the presentation accompanying its 2014 result painted a rosier picture.

Occupancy may come under further pressure as the supply of childcare centres increases faster than demand, although the impact will vary depending on the fundamentals of each local childcare market. All in all, we think G8 will find growth harder to come by and we see little value in the stock.

Netcomm Wireless

Netcomm Wireless has grown quickly and appears likely to continue to do so as it wins more business both here and overseas. Selling at fifteen times expected 2018 earnings, however, investors are already pricing in a lot of growth. As such, we don’t see a margin of safety at current prices.

Genera Biosystems

Speculative biotech stocks contrast starkly with Intelligent Investor’s conservative, value investing philosophy and Genera Biosystems is no exception. After years of losses, regular equity raisings and rising debt, it could hit the jackpot but it’s too speculative for us.

Sandfire Resources

This mid-tier copper miner’s Degrussa mine has a limited life expectancy, although its Monty deposit – owned in a 70/30 joint venture with Talisman Mining – appears promising. Moreover, its majority-owned Black Butte copper project in Montana should be ready for production in 2020 pending approvals, whilst other exploration efforts may prove as successful as its Degrussa find. Nevertheless, given the risk of delays and cost blow-outs in developing new mines and the company’s dependence on the copper price, it’s too speculative.

MGM Wireless

MGM Wireless is suffering as communication between schools, parents and pupils moves away from SMS-based communications such as its patented SMS-based system towards smart-phone based applications. Lacking any competitive advantage and now sporting a $6m market capitalisation, it really shouldn’t be listed on the ASX. The company may well overcome the resulting short-term decline in revenue as more schools use its recently released SchoolStar app but we don’t see any value at current prices.

Capitol Health

This expanding diagnostic imaging business has too much debt for us. Whilst fears over the Medicare Benefits Review are likely priced in to a great extent, we think there are better opportunities elsewhere.