Weekend Takeaways 21/02/2014

Transcription

1 Weekend Takeaways 21/02/2014

2 Eco blog Given the number of profit releases this week, economic news was mercifully light. Locally, the RBA was a firm hold with its interest rate guidance. Unchanged rates through the year are based on balancing a modest rise in the inflation rate, higher unemployment, a relatively robust housing market, a cautious corporate sector and likely fiscal constraint in the upcoming budget. The AUD pushed back up over US90c, capturing the stable outlook for rates here against recent weak economic data out of the US. This is likely to be temporary, and unless there is a meaningful shift in the outcome, the AUD can be expected to track lower over the year. The wage price index for the December quarter came in at an annualised 2.5%, the lowest since the data series began. While it is welcome news for the inflation outlook, it will impact on consumption growth unless households add to their debt from already high levels. Further, Australian wage growth has for some time been relatively high compared to other developed nations; the payback now being felt in uncompetitive manufacturing industries. In keeping with the somewhat unusual circumstances of today s economic environment, Japan s disappointing GDP growth at 1% annualised has been met with further easing measures by the BoJ, resulting in a fall in the Yen and a rally in the Nikkei. Export growth was well below expectations, while domestic data was largely in line, albeit recognising the pull forward of spending due to the impending rise in sales tax in April. Efforts to imbed reasonable GDP growth in Japan have yet to be rewarded. China s new loan growth surprised on the upside, causing renewed concerns on the level and quality of lending in the country. The data for PAGE 2 Weekend Takeaways 21/02/2014

3 January may be affected by the timing of the Lunar New Year and the February figures across a board range of metrics will be keenly awaited. The HSBC PMI initial read continued the weak indicators of activity in China, with the index falling from 49.5 to At this point it would not be unusual to see the authorities undertake a mini stimulus, but it will be constrained by the already high apparent credit growth. Exceptional conditions are also being called for in the US. Following a pattern of well below expected growth in most metrics, weather is once again being blame for a sharp drop in housing, with starts falling 16% in January. The tea leaves suggest that weather has almost certainly played a big part in US data in recent times, yet regions unaffected by the forces of nature have also been weaker than forecast. As the months unfold, there will be a lot of focus on what the cause of a potential slowdown in momentum in the US could be. Taper and higher mortgage rates? Slow growth in employment and wages? Lack of credit growth and a subdued corporate sector? Or just a reality check that economic growth in indebted, relatively mature nations is going to be more subdued that the optimists expect? PAGE 3 Weekend Takeaways 21/02/2014

4 Australian Companies Ansell (ANN) Sonic Healthcare (SHL) Amcor (AMC) With a substantial number of companies reporting this week, we have concentrated on those we follow closely or where the results provide broader insights to economic and corporate developments. Ansell (ANN) fell short of expectations with poor organic sales growth of only 1%, with acquisitions taking the headline to 9%. New product launches only made up for the deterioration in core business. In additional to a broad geographic spread, at face value the group has an attractive mix of products, with its exposure to defensive healthcare, as well as cyclical industrial gloves. The group has made numerous acquisitions in recent years, yet appears unable to cement a competitive advantage. While the analyst community has mixed views on the outlook, fund managers appear less willing to give the company the benefit of the doubt, with the stock softening in the days after the result. The offset is a moderate valuation of 15x FY14 earnings (albeit with a low tax rate) alongside the prospect for a respectable second half as raw material prices move in its favour and management regroups behind new products. In the search for reasonable priced industrial stocks, ANN does past the first screen, but has too little credible growth to make its way into our model portfolio. Sonic Healthcare (SHL) is another company which has thematic appeal. However government restrictions on funding pathology and radiology have made it for tough to deliver the kind of momentum investors expect from the sector. Once again, in the result both revenue and profit were below expectations and the PE of 17x FY14 appears rich in the context of the growth profile. Amcor (AMC) in its new guise, without the Orora (ORA) operations, is now a global packaging company and reported profit will be substantially determined by the exchange rate. The chart below shows the splits for the first half year: Source: Amcor PAGE 4 Weekend Takeaways 21/02/2014

5 The result was a visible demonstration of the currency impact: 19% profit growth before interest and tax in A$ translated to only 3% growth in constant currency terms, and the stock was marked back after the release, notwithstanding management holding to full year guidance. We recognise that AMC is not a high growth company, but it has a low risk, diverse operational base generating dependable free cash flow. This cash flow is being selectively applied to acquisitions or returned to shareholders. Investors should appreciate the trade-off: higher growth from new business will limit payouts and high payouts are likely to be accompanied by modest profit growth. We recommend accumulating the stock on any weakness. Wesfarmers (WES) At face value, the Wesfarmers (WES) profit result was uninspiring, with recurring EBIT essentially flat. Improving profits at Coles, Bunnings, Officeworks and Chemicals were offset by declines at Target, Resources (coal) and Industrial and Safety. Stock analysis focuses heavily on the Coles operations, debating whether it can reach the equivalent profit levels achieved by its supermarket mirror, Woolworths (WOW), as this is an easy concept to embrace. In our opinion, Coles will struggle to match Woolworths given some structural disadvantages in their store network and a much lower liquor profitability. Instead, we look to a restructuring of the asset base to provide further valuation support to what is otherwise an expensive stock, trading on 20X FY14 and with likely low double digit EPS growth in FY15. WES has some good, well run businesses that however have little long term growth; we nominate the Industrial and Safety division and the Resource assets. It s hard to mount a case WES shareholders are keen on Chemical and Fertiliser as well; implicitly we are suggesting shareholders would be better off with a retail conglomerate rather than this unrelated mix. The impending sale of the insurance operations may be a first step, though management is unsurprisingly unwilling to publically suggest a round of asset realisation. The appointment of the outgoing head of Coles supermarkets to a roving strategic role implies WES is looking for acquisitions - another possible guide to a change in direction. The profit improvement and share price have come a long way from the acquisition of the Coles business (at what was clearly an excessive price) and the emphasis is now moving to the low gearing on its balance sheet. While we support holding WES as a core Australian equity, at this point we cannot see what will drive outperformance. We therefore recommend adding on weakness only. Super Retail Group (SUL) Super Retail (SUL) had preannounced its profit for the half earlier this year, guiding to low growth due to implementation issues at its distribution centre, higher depreciation and moderating same store sales growth. The result, with net profit up 1.1%, was therefore expected. Sales momentum, however, has picked up a little and management expressed PAGE 5 Weekend Takeaways 21/02/2014

6 confidence in their ability to achieve gross margin and good cost outcomes for the second half. We continue to recommend Super Retail as our preferred pure retail portfolio holding. Its mix of Auto, Leisure (outdoor) and Sport are all doing well in global retail, it will be less affected by online than other segments, and store locations can be outside of shopping centres, providing greater flexibility and lower costs to operations. Woodside Petroleum (WPL) Santos (STO) Woodside Petroleum (WPL), for the time being, remains a resource company with limited capacity for earnings growth through higher production volumes. In the short term, shareholders will benefit from a much higher rate of dividends (which have been enhanced further recently given that they are declared in $US), however in the absence of growth projects, in future years production will begin to be challenged by natural oil field decline. Outside of fluctuations in the oil price, earnings growth this year was expected to come from the repricing of a large part of its contracts associated with its Pluto LNG facility, however the timing of this benefit appears to have been pushed out further than previously expected, given it will be a staged ramp-up. Our preferred exposures in the energy sector remain Oil Search (OSH), Santos (STO) and Origin Energy (ORG). In contrast, STO is much better placed at present to deliver production growth over coming years, particularly from its key LNG projects at Gladstone in Queensland (GLNG) and in Papua New Guinea (PNG LNG). These projects are closing in on their completion dates, and, given their capital-intensive nature, the impact on STO s cashflows once they commence production is even more profound. The chart below highlights this expected production growth. STO s full year result to December was below expectations, however this appears to be largely attributed to higher interest costs. Source: Santos PAGE 6 Weekend Takeaways 21/02/2014

7 Origin Energy (ORG) ORG provided a mixed earnings result, with a much weaker than expected profit from its energy retailing business offset by a better result in its production portfolio. Energy retailing was expected to be weak this half, as a result of the unseasonably warm winter, general market decline from energy efficiency and increased number of solar panels used by consumers, as well as some margin compression from discounting in the prior period. Looking at each of these problems, the warm weather should be a temporary issue; overall market decline is expected to reverse as household consumption levels out and population growth continues; while recent indicators have been positive for a better retail market (including reduced churn rates) which, in this half, was affected by the lagged impact of lower pricing levels. While this was expected to be a difficult period for the company and broader industry, the outlook is more promising. A more stable retail environment, the prospect of deregulation in NSW and Queensland energy markets, the progress towards first gas at its APLNG project and higher east coast gas pricing are all potential catalysts/events that should work in ORG s favour. We have recently added ORG to our model portfolio. Breville (BRG) Treasury Wine Estates (TWE) Breville s (BRG) net profit was marginally below the previous year due to the loss of a distribution arrangement in the US. Elsewhere, the group achieved reasonable growth in its assortment of household appliances and appears to have successfully launched itself into Europe. While highly priced on 22x PE for FY15, the prospect of growth from a diverse product range across geographies and no debt adds up to an appropriate small holding in a portfolio. The Treasury Wine (TWE) result confirmed the poor trading conditions and execution by the group. To summarise what management would hope to put behind them as quickly as possible - the Australian business mishandled efforts to reduce discounting and lost share; the Asian division felt the impact of lower gift giving in China, but also appears to have done little to enhance its standing there; and in the US, loss of share in the middle market was not offset with any meaningful cost reduction. For the higher risk investor, the question is now whether there is upside from here. A new CEO has been brought in with global consumer food experience. This will unlikely lead to early results, as much work will need to be done on brand positioning and customer relationships. The other aspect is the asset value, in particular high quality wines where the group has been building stock rather than releasing wines to retailers who subsequently made very high margins. Unless the group does come under offer from a strategic buyer, the path to higher profit will take time. Our view is that greater execution and possibly the sale of the US assets could result in substantial upside, but any investor should be aware the risk is high and visibility low at this time. PAGE 7 Weekend Takeaways 21/02/2014

8 BHP Billiton (BHP) BHP Billiton followed up on Rio Tinto s (RIO) result last week with a first half result that exceeded expectations, with an underlying profit of US$7.8bn, up 15% on the previous year. Costs were again the focus, with the company highlighting that it has achieved $4.9bn in annualised cost and volume efficiencies in the past 18 months broken down as US$1.8bn in operating cash costs, a US$1.6bn reduction in exploration and business development, and US$1.5bn in productivity gains. Given the solid performance, the main gripe of investors was a lack of any meaningful increase in the dividend, which was raised by 3.5% - although we note that this is consistent with the company s recent practice of lifting the interim dividend to the previous year s final dividend. With profitability improving and capital expenditure declining, this has resulted in a significant increase in the company s free cash flow and a stronger balance sheet, which should again be evident at the end of the financial year. Inevitably, attention has again turned to the company s ability to undertake capital management initiatives, either in the form of buybacks or special dividends. While large institutional investors are likely to push the company with regard to returning capital to shareholders, BHP has made it clear that this won t be considered before the company s full year results and only when it has a confirmed solid A credit rating. The chart below shows BHP s capital returns to shareholders over the last 8 ½ years, with buy-backs correlated with periods of rising commodity prices. The difference this time is that commodity markets are reasonably subdued, with excess capital generated by lower capital expenditure and cost out: Source: BHP Billiton PAGE 8 Weekend Takeaways 21/02/2014

9 Seek (SEK) Seek (SEK) had the most impressive share price reaction to its result this week, with the stock up as much as 22% intraday, before closing 18% higher. While the result was better than market expectations, the focus was on the acquisition of the remaining 78% of JobStreet that it did not own, via its Seek Asia vehicle. JobStreet is an online employment website operating in Malaysia, Singapore, Indonesia, Philippines and Vietnam. The deal got the tick of approval by investors and analysts, with Seek s combined businesses now the clear market leader in South East Asia. Seek has successfully diversified its business from its core Australian employment website in recent years, with the company s earnings growth largely driven by acquisitions in its international employment website and education businesses, as shown in the chart below: Source: Seek This has allowed the group to grow its profitability over time, despite dealing with a weaker employment market in Australia. These international businesses are typically far less mature than Seek s domestic market, with a much greater opportunity to grow through higher levels of internet penetration, migration of print to online and general economic growth. While this acquisition should add a further leg of earnings growth to the group, we believe that recent share price performance has captured most of this upside, and so are hesitant to add at current levels. PAGE 9 Weekend Takeaways 21/02/2014

10 Two stocks with a similar thematic, Asciano (AIO) and Aurizon (AZJ), showed the benefits of their leverage to Australian coal mining volumes. Asciano (AIO) Aurizon (AZJ) Crown (CWN) AIO s underlying profit was up 6%, although the company is currently experiencing mixed conditions across its businesses, with good growth in its coal haulage business offsetting a more benign environment in ports and intermodal rail. With the latter two more closely tied to Australia s economic growth and trade, AIO is currently undertaking a significant cost reduction and efficiency improvement program, which was initially targeting $150m in savings to FY16. Good progress has been made to date, and the company has extended this program further, and is now looking for $300m in cumulative sustainable cost savings by FY18. Cost out has been key in growing AZJ s profitability since it was floated by the Queensland Government just over three years ago. The company has delivered material savings through driving more efficient operations and a large decline in its overall workforce numbers, with 22% of staff accepting voluntary redundancies in that time. As a result, AZJ is well on its way to achieving a 25% EBIT margin in FY15. While AZJ has been successful in achieving greater take or pay protection in its contracts as they have been rolled over in recent times, at present it is still exposed to potential shorter-term volume declines, either from poor weather or industrial action. Both companies have their appeal, however we have AIO in our model portfolio given its more appealing valuation and sustainable longer-term growth from its ports and rail businesses. We will expand and compare the two businesses in a note post-reporting season. At a headline level, a 29% increase in normalised (that is, adjusted for an average win rate at the group s casinos) sounded like a fairly solid number for Crown (CWN). The increase in profitability was entirely generated by a more than doubling in the contribution from its interest in Melco Crown (which currently operates two casinos in Macau and is developing a third), however the performance of the group s Australian casinos disappointed. Similarly to recent commentary from other Australian casino operators Echo Entertainment (EGP) and SkyCity (SKC), CWN reported that trading in the domestic market has been impacted by weak consumer sentiment. While this trend was certainly evident in CWN s result, the key miss for Crown Melbourne was the drop off in VIP, or high-roller turnover, which was down 33% on last year. CWN s VIP business has in recent periods performed admirably in the face of increased competition from new casino developments overseas, and as a result, this period it was cycling some tough comparable figures. At present, the opportunity from further growth and expansion from Melco is outweighing the short-term concerns we may have of Crown Melbourne s VIP, however this is something that we will be closely monitoring. PAGE 10 Weekend Takeaways 21/02/2014

11 Brambles (BXB) A stock that we have recently added to our model portfolio, Brambles (BXB), provided a more encouraging outlook for future growth, with management citing moderately improving economic conditions in its key markets of North America and Western Europe. Despite this, volume growth in its key pallets business appeared to be consistent with more recent periods, albeit with a marginal improvement in organic growth figures: Source: Brambles BXB is targeting constant currency sales growth of 7% for the full year, with profit growth of 11% assisted by further efficiency gains. With the company now free of the divested Recall (REC) business, the market is looking for BXB to deliver high single-digit earnings growth over the next few years. For the domestic investor, this growth rate is likely to be higher when translated back into $A. On a FY15 P/E multiple now of around 18X, the stock is not necessarily particularly cheap, but nevertheless provides upside exposure to global economic conditions. Suncorp (SUN) Suncorp s (SUN) result was the first full half year period following the resolution of the bad bank of the company a non-core portfolio of corporate and property loans, the majority of which was sold to Goldman Sachs last June. While a small residual portfolio still remains, the sale of these assets was important for SUN, as it reduced this ongoing risk given the losses that the book had incurred. As a result, the market has turned its attention to the now sound capital position of the company, which was demonstrated by a 40% increase in its interim dividend. Investors could be rewarded with further dividend increases and/or special dividends in coming periods, with SUN now sitting on around $1.2bn of capital in excess of its operating targets. PAGE 11 Weekend Takeaways 21/02/2014

12 SUN s result itself was a little on the weaker side, with a good figure from its insurance arm, driven by top line growth and an improving insurance margin. While better than previous periods, the banking result was held back by the residual bad bank assets, although this should drop off in coming periods. SUN remains a turnaround story trading at a significant discount to the broader banking sector and is one of the key overweights in our model portfolio. National Australia Bank (NAB) Remaining on the banking sector, National Australia Bank (NAB) provided a quarterly trading update today, with falling bad and doubtful debts again pivotal in contributing to a 7% increase in profit. On the key measure of revenue growth, NAB is underperforming the broader market. Aside from a more attractive valuation compared to its peers, however, central in our investment case for the stock and its overweight position in the portfolio is the potential for upside should it divest its UK operations. Recent promising economic data from the UK could give rise to a more attractive price received if it decided to go down this path. Reporting season concludes next week, with the following companies reporting: CTX, BSL, FLT, IFL, OSH, QBE, RHC, AGK, LLC, IRE, SYD, WDC, WRT, WOR, WTF, NEC, PPT, QAN, JHX and WOW. PAGE 12 Weekend Takeaways 21/02/2014

13 Important Disclaimer The content of this document has been prepared without consideration of specific client investment objectives, financial situation or needs. Thus, before any investment decision is made based on this document, an Escala Partners Limited ( EPL ) investment adviser should be consulted. This document is based on information from reliable sources, no representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented. Any conclusions, recommendations and advice contained here in are reasonably held at the time of completion but are subject to change without notice. EPL does not accept any responsibility to inform you of any matter that subsequently comes to its notice, which may affect any of the information contained in this document and assumes no obligation to update and reissue this document following publication. EPL, its directors, employees and agents disclaim all liability for any errors in, or omission from, this document or for any resulting loss or damage suffered by the recipient or any other person as a consequence of relying upon this document. EPL may receive commissions, underwriting and management fees from transactions involving securities referred to in this document. EPL, its directors, employees and agents may from time to time hold interests in the securities referred to in this document. This document is a private client communication and is not intended for public circulation or for the use of any third party. Escala Partners Escala Partners Ltd. Level 19 / 90 Collins Street Melbourne Victoria 3000 Contact Telephone: information@escalapartners.com.au Web PAGE 13 Weekend Takeaways 21/02/2014