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BHP/South32: Buy, Hold Or Sell?

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BHP/South32: Buy, Hold Or Sell? BHP/South32: Buy, Hold Or Sell? May 06, 2015 In This Week's Weekly Insights: - BHP/South32: Buy, Hold Or Sell? - MYOB: The Fun Has Only Just Started - Insurers: Only About Dividends? - Share Buybacks - Who's Doing It? - Rudi On TV - Rudi On Tour BHP/South32: Buy, Hold Or Sell? By Rudi Filapek-Vandyck, Editor FNArena Wednesday 6 May 2015 will be a pivotal day for investors in Australia. Shareholders in the Big Australian, BHP Billiton ((BHP)), will vote in favour of spinning-off, and listing as a separate entity, an amalgamation of less-desired assets under the umbrella-name South32. The decision will have an immediate impact in that: - BHP's own index weight (without South32) in Australia will fall behind all Big Four banks - BHP's estimated dividend yield will rise to circa 6% (and on some estimates the yield on South32 shares might turn out to be similar) - BHP's resources diversification will be limited to coal and iron ore, copper and energy (indeed, it can be argued South32 will become the largest diversified resources stock on the ASX) - Depending on price movements, BHP might genuinely start feeling constraints from high debt, and no growth in its core operations, triggering doubt/questions about sustainabilityFNArena of its dividends While all these consequences might attract investor attention, the question most asked in the weeks ahead is going to be: do I hold both shares, or do I sell at least one of them? And for the more short-term oriented market participants: are there strategies I can rely on to make a quick buck here or there? Let The Past Be Your Guide Luckily, for investors asking the questions, two stockbrokers -Macquarie and Morgan Stanley- have dusted off their data-analysis into stock market de-mergers, revealing there's quite a difference in share market performances post corporate de-mergers, depending on the time horizon. Those in favour of holding on to both shares with a longer term horizon will be pleased to read Morgan Stanley's research suggests the combined performance is one of index outperformance two years post the separation. As a matter of fact, the longer the separation disappears into the past, the larger the outperformance. However, Macquarie's detailed analysis from 35 demerger precedents shows there's more variation around the theme than there are exceptions to grammatical rules in the French language. Thus the question of what to do becomes immediately intertwined with: what is your horizon? In the immediate aftermath of the separation, concludes Macquarie, the spin-off is likely to see above average trading volumes and share price weakness kicking in. This is easily explained by the fact not every shareholder can or wants to hold on to the smaller, now independent spin-off. I've already seen analysts making suggestions UK shareholders will likely divest their shares upon listing, so South32 shares may well stay true to the historical pattern discovered by Macquarie. Separate Listing: First Comes Weakness The historical cut-off date is ten days, after which the separated unit starts to claw back and outperform. However, the research also suggests that on a six month timeframe the parent company is usually the better performer. No doubt there is some impact from the fact investors have little to draw confidence from regarding the newly listed entity. There's no history as an independent company. 55% of all spin-offs in the past made a positive debut on Day One. In the run up to the actual split, observes Macquarie, the parent company stock tends to appreciate, which is a new trend post-2010. Previoulsy, shares tended to weaken ahead of the event. Post split the performance quickly becomes market related and in line with broader macro-economic and market trends. Underpinning the value of the above observations is the high consistency between all 32 precedents, reports Macquarie, with not one single significant outlier. The underlying message from both pieces of research combined is thus: expect an underwhelming, if not weak performance in the first few months from soon to be separated South32, but on a two-year horizon the combined performance for both shares should be better than what BHP shares have done in years past (admittedly, that wasn't much). Macquarie researchFNArena also suggests it can take up to twelve months before shares in the separated entity find their own footing and start outperforming, though in the case of South32 any performance post demerger may well become heavily influenced by movements in commodity prices. But first a re-alignment of the South32 shareholder register needs to happen. UK-based Macquarie analysts estimate passive fund managers in the UK will sell their shares estimated to represent some 11% of all outstanding stock. In addition, some active funds in the UK and in Europe may join the selling. All up, up to 30% of South32 shares might be looking for another owner soon after listing. Potential For Take-Over Premium One question that can only be answered once we have an actual share price and a market-driven valuation for the South32 assets, is whether investors are going to take guidance from day-to-day commodity prices, from what appears to be a juicy looking dividend yield or from the fact that potential suitors might be circling the company? Fresh in the memory will be the example of Recall Holdings ((REC)) which was spun-off by Brambles in late 2013. True to form, the shares initially dipped below listing price, but then quickly recovered and soon traded at higher levels while analysts were contemplating whether the company genuinely had a future on its own or whether US-based Iron Mounting would come to shareholders' rescue. There was no stopping the rally from September last year onwards. Assuming everything goes ahead as planned, Recall is about to leave the ASX at a significant premium to its original listing price, only 1.5 year ago. Treasury Wine Estates ((TWE)) is also enjoying higher multiples because of constant take-over speculation. One other example in support of lucrative shareholder rewards ahead is Amcor's spin-off Orora ((ORA)) whose share price has almost doubled in a little over one year as a separate listing. Probably lesser known is that NextDC demerged Asia Pacific Data Centres ((AJD)) which in its first year post separation led a rather anonymous existence, but a sharp rally leading into 2015 has dramatically changed the performance of what should be a relatively solid dividend paying small cap stock. Other successful demergers include DuluxGroup ((DLX)) ex-Orica, Mayne Pharma ((MYX)) ex-Mayne Nickless and Origin Energy ((ORG)) ex-Boral. But demergers are by no means a guaranteed success. I think it's only fair to say the jury is still out on News Corp ((NWS)) while Aurizon ((AZJ)) was a wonderful stock to own between 2012-2014 but it is now suffering from investor angst about potential fall-out from the downturn in bulk commodities. Fairfax Media spin-off Trade Me ((TME)) looked like a certain winner at first, but its performance has been sketchy and underwhelming over the last two years. Stocks fully out of favour today include Pacific Brands ((PBG)), BlueScope Steel ((BSL)) and Arrium ((ARI)) - which were once part of Pacific Dunlop and BHP Billiton respectively. Maybe the closest reference to the upcoming South32 separation is Alumina Ltd ((AWC)) which in 2003 separated from Western Mining and instantaneously enjoyed a jolly good time on the back of the emerging Commodities Super Cycle. Until 2007. Post-GFC the shares have proven more popular with short-term traders in line with the performanceFNArena of the underlying base materials; alumina and aluminium. Important Dates May 6 - BHP shareholders vote on South32 demerger May 15 - Last day to buy BHP Billiton shares including an entitlement to South32 shares May 18 - South32 shares commence trading on the ASX on a deferred settlement basis May 19-22 - Determining entitlement to South32 shares for BHP shareholders May 26 - Normal trading of South32 shares on the LSE commences June 1 - South32 ADSs commence regular way trading in the over the counter market June 2 - Normal trading of South32 shares on the ASX commences MYOB: The Fun Has Only Just Started The largest new listing thus far in 2015 occurred on Monday and true to the hype surrounding this type of new offering, the share price proved in demand on the first day of trading. MYOB ((MYO)) shares on Monday closed at a 7% premium to the IPO price at $3.92. At first glance, the company has a lot going for itself, being Australia and New Zealand’s leading accounting software provider boasting not only a market share of 65%, but also 94% in recurring revenues at a profit margin above 40%. The latter is said to have remained stable in the past three financial years. The prospect of converting thousands of loyal customers onto the cloud further adds to the general attraction. This time is as good as any to remind investors the number one enemy threatening sustainable positive returns for shareholders on a longer term horizon is competition. Fierce competition. And competition in the form of listed peers Reckon ((RKN)) and Xero ((XRO)) should be plenty and tangible. With all three major players now listed on the ASX, investors will have the opportunity to follow the battle for local accountants and SMEs on ongoing basis. Not unlike how the listing of Medibank Private ((MPL)) effectively forced investors to pay closer attention to changing dynamics for health insurers, I believeFNArena post MYOB's listing investors will be paying closer attention to dynamics inside the world of accounting software.
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