Seven Group: Result 2012

For the year ended 30 June 2012, Seven Group reported trading revenue of $4.5bn, up 41%, and earnings before interest, tax, depreciation and amortisation (EBITDA) of $630m, up 50%. Underlying net profit (which ignores $167m of after tax significant losses—particularly influenced by a revaluation of its stake in Seven West Media) increased 38% to $343m. It was a good result.

All of the revenue growth and the great bulk of the profit growth came from the company’s ownership of WesTrac Australia. This business experienced 57% revenue growth to $3.5bn and 88% EBIT growth to $387m. WesTrac’s bounty came from expansion in the coal and iron ore mining sectors over 2012. But the recent sharp curtailing of mining industry expansion should be cause for concern. The business’s earnings have also become more cyclically-exposed over the year, with recurring product support revenue falling from 45% of total revenue in 2011 to 36% in 2012.

Seven West Media provided a contrast. On a 100% ownership basis, EBIT fell 14% to $474m, with both print and television disappointing. The stock, which is listed, has been hammered in recent months, leading to the substantial revaluation of Seven Group’s 33% stake in the accounts, from $962m at June 2011 to $638m a year later. The current market value of the stake is lower again, with the Seven West share price continuing to slide since 30 June.

Directors declared a fully franked final dividend of 20 cents, bring the yearly total to 38 cents, up 6%. The stock look quite cheap superficially, on a PER of 8 and a fully franked yield of 5.0%. But there is a huge cyclical component to earnings here that has us concerned.

Whichever way you cut it, Seven Group is hitched to the economy of China. Its biggest business, WesTrac, directly through mining sales, its television assets via exposure to the Australian economy generally, newspapers more directly through the Perth market. And it also owns a big stake in Agricultural Bank of China, which was written down from $297m to $238m over the course of the year. Renowned short seller Jim Chanos has, at least until recently, held a prominent short position in the bank. We’re concerned about this overall China dependency and are pretty convinced leaner times are already here. We’ve also never been fans of the group’s corporate governance. The current price is not cheap enough for us to overlook these issues. AVOID.

Of course, we can’t just avoid Seven Group TELYS4, a preference share we first recommended in 2008 and haven't yet sold. Though it’s been far from a disaster with the inclusion of dividends, given our time again we wouldn’t buy the security. It’s the sort of instrument that, were it to float today, we’d pan the offer and its fine print. But we’re not paying float prices here and, given the discount to face value, the instrument does offer an attractive running yield, which equates to 9.9% or, expressed as a floating rate, the 6-month bank bill rate plus a margin of 6.4%. While it’s under no obligation to continue doing so, management has thus far paid every dividend due in full and on time, and at the current price the preference shares remain a slightly uncomfortable HOLD.

Note: The model Income portfolio owns Seven TELYS4 preference shares.