Volatility in 2017

Thursday 8 December 2016 Volatility in 2017

Could November 2016 provide a clue for what to expect in 2017? Charlie Aitken is expecting volatility to be the key theme in 2017, and tells us why in his note today. Plus, he explains why he’s bullish on the outdoor advertising sector.

Also in the Switzer Super Report, Tony Featherstone updates the takeover targets’ list. It appears there are some headwinds for travel agent Flight Centre, increasing its chances of a takeover.

Sincerely,

Peter Switzer

Inside this Issue 02 Buy quality in volatility Be prepared by Charlie Aitken 05 Takeover targets – Online headwinds building for Flight Centre What to watch by Tony Featherstone 08 Buy, Sell, Hold – what the brokers say Upgrades and downgrades Buy quality in volatility by Staff Reporter 14 Professional’s Pick – Cleanaway (CWY) by Charlie Aitken Waste management and recycling 02 by ST Wong 16 Questions of the Week – Evolution Mining, CSL and Cochlear Reader queries by Questions of the Week

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before Switzer Super Report is published by Switzer Financial Group Pty Ltd AFSL No. 286 531 acting, consider the appropriateness of the information, having regard to the 36-40 Queen Street, Woollahra, 2025 individual's objectives, financial situation and needs and, if necessary, seek T: 1300 SWITZER (1300 794 8937) F: (02) 9327 4366 appropriate professional advice. Buy quality in volatility by Charlie Aitken

The ONLY certainty next year is VOLATILITY. With recent wage data out of the US continues to support the combination of populist political leaders and less the view that some inflationary pressures are building “monetary policy morphine” from Central Banks, the into 2017. ONLY outcome can be volatility. Inflationary pressure is bad news for long bonds. It’s I think November gave you a taste of things to come as simple as that and inflationary pressure is building in 2017. In November, Donald Trump was elected in the world’s biggest economy, the USA. President of The United States of America and the market implied chances of a 25bp rate hike from the US Federal Reserve moved to 100%. The result was unprecedented short-term volatility and major sector and stock performance divergence.

It’s worth remembering that at one stage in November, US equity index futures were halted limit down (-5%), in fact, the US S&P futures traded in a 9.3% range during the month. Kerb trading kicked in which only happens in periods of extreme duress. I’ve only seen US futures limit down three times in my 23-year career. However, less than 24 hours later, all those losses had been eradicated and capital losses started stacking up in bond markets.

Long bonds, as I have repeatedly warned you, did prove to be “return free capital risk”. Most major long If we then decompose the S&P500 (SPX’s) +3% bonds lost -6% in value in November and the total return since the US election by sector, a clearer capital lost in bonds in November was $1.7 trillion. picture of the drivers behind the US’s However, despite these capital losses, there remains outperformance emerges. Financials have accounted over $10 trillion of bonds in the world still for roughly half of the SPX’s gain since November 8, commanding negative interest rates. What this tells a far greater proportion than the sector’s 15% weight me is the bond bubble hasn’t burst yet, but the in the overall index (Chart 2). The 7% gain from balloon has been pricked. I remain very cautious on industrials, meanwhile, has made up another quarter all forms of long bonds. of the benchmark’s return.

My funds short position in long bonds were profitable The sizeable rally in financials seems appropriate, at for the month as were our shorts in equity bond least from a “fair value” perspective, given the proxies (healthcare, REITS, infrastructure). We significant move in the yield curve. The remain short long bonds and bond proxies feeling that outperformance from other US sectors, however, is bond yields will continue to head higher over the next more suspect. The outsized contribution from year. Along with the rebound in commodity prices, industrials stocks has been driven primarily by infrastructure specialists (+20% since Nov 8), while

Thursday 08 December 2016 02 copper miners like Freeport have also outperformed taken advantage of them. (+31%). Both groups have been buoyed by Trump-driven fiscal spending expectations. Yet both As an investor I must set the portfolio for 12, 18 and industrial stocks as a whole and copper mining 24 months from today. Buying high quality structural shares have historically been negatively affected by a growth stocks when they are “on sale” is a great rising dollar. Something’s clearly got to give. place to start.

Quality is rarely on sale and when it is you need to buy it. Price is what you pay, value is what you get. In all the stocks I mention above you are buying structural earnings growth at what I consider very reasonable prices (PEG ratios for FY17).

Peter Switzer always gets into me for owning “sin” stocks such as gaming, alcohol and casino operators, so today I thought I’d reinforce my very positive view on a “respectable” industry, outdoor advertising.

I am really, really bullish on the Australian outdoor advertising sector for 2017 and beyond. My fund has large investments in the two key players in the sector, APN Outdoor (APN) & Ooh Media (OML).

This is a classic example of an investment idea you can see with your own eyes in everyday life. If you’re like me you check to see which digital and static billboards have “APN” or “OOH” on them. When The stock and sector divergence has been stunning you do this enough, you realise these companies both globally and locally. have a wonderful duopoly and wonderful opportunity to generate strong shareholder returns as they However, we all need to remember this is a upgrade their signs from static to digital. macroeconomic view based rotation to cyclicals from defensives that arguably has gone too far. We are Tailwinds in the sector are strong yet the two major now seeing almost panicked buying of cyclicals and players in the sector trade on P/E discounts to the selling of defensive growth stocks. ASX200. That is unwarranted and they will revert back to P/E premiums in the months and years My very strong view is that investors have moved too ahead. The February results for both APO and OML hard and too fast on the cyclical stocks, bidding them should be the trigger for the start of that re-rating up, and moved too hard and too fast selling defensive process. or structural growth stocks as I call them. It’s worth noting that the outdoor advertising segment For example, in Australia, my fund used price is growing at double digits into the lucrative Christmas weakness in Aristocrat (ALL), Link (LNK), Star Group period. The Outdoor Media Association (OMA) has (SGR), Treasury Wine Estates (TWE), APN Outdoor announced that out-of-home advertising revenue in (APO) and Ooh Media (OML) to increase our Australia for November was $84.4m, +12.5% on the positions. We can see no fundamental change to the pcp. APO and OML are members of the OMA. earnings outlooks for these companies. In fact, in some we have upgraded our earnings forecasts. All For 2016, year-to-date media revenue is $709m, we can see is lower earnings multiples (P/E’s) for +15.8% vs pcp. Digital penetration of the category those structural earnings growth themes and we have continues to increase, accounting for 39.9% of total

Thursday 08 December 2016 03 revenue in 2016 YTD, up from 27.7% in the pcp.

Across all segments, Retail, Lifestyle and Other saw the largest growth in November. The growth in out-of-home advertising will continue. This is structural growth in my view. The outdoor advertising industry will continue to benefit from adoption of digital technologies, presenting new revenue opportunities and increasing returns. The key benefits from digitalisation include increased yield and effectiveness, increased addressable market size, increased consumer engagement interactivity as well as customer growth.

Next time you’re stuck on a motorway, have a look at who owns the digital billboard you’re most likely watching. I am of the view APO and OML will perform strongly in 2017 and I encourage you to consider an investment in both stocks.

Next week I’ll finish the year with a highly speculative trading idea to fill your Xmas stocking with.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Thursday 08 December 2016 04 Takeover targets – Online headwinds building for Flight Centre by Tony Featherstone

Would Flight Centre Travel Group be worth more in But Flight Centre’s recent growth has been below the hands of an international travel giant that can market expectation. Competitive threats are piling up invigorate the Australian company’s online offering? as local and international operators disrupt the industry and as the company potentially pays a price That question will occupy global travel groups and for its relatively late entry into mobile technology, private equity firms if Flight Centre’s share price such as Apps. keeps falling and its online presence, especially in Apps, disappoints. Growth in online travel bookings is not new. The market has long speculated that Flight Centre would Flight Centre has slumped from almost $55 in March lose market share to insurgent online operators. To 2014 to $31.65. The company’s earnings guidance its credit, the well-managed company has defied the downgrades, most recently in November, reinforced sceptics for much of the past decade. market fears that the move from shopfront travel retailers to online providers is quickening. That could change as technology reconfigures consumer behaviour in travel bookings. It was not so Chart 1: Flight Centre Travel Group long ago that consumers started booking domestic flights online and used bricks-and-mortar travel agents for recommendations and more complicated bookings.

Today, those recommendations often come from TripAdvisor and other international behemoths that provide holiday reviews. I’m sure many reading this column have used these and other sites to read customer reviews about a resort or travel package.

Source: Yahoo7 As consumers become ever more comfortable with e-commerce, they are booking larger holidays online Short sellers are betting that Flight Centre will follow and bypassing travel agents. Increasingly, they are the path of traditional media companies and using mobile travel Apps, on smartphones or department stores as it loses ground to online rivals. computer tablets, to search for holidays and book Were that to happen, its golden run could be ending. them.

Flight Centre is still a great business with a great Flight Centre’s strategy involves building a brand. It is highly profitable, has a growing “blended” travel offering that combines its massive international footprint and excellent balance sheet. network of stores with a strong online travel offering. Most companies would love its double-digit revenue This plan has merit as more consumers combine growth and $1.52 billion in global cash and online and offline resources to book their holidays. investments. But the strategy relies on a powerful online presence – something Flight Centre does not yet have.

Thursday 08 December 2016 05 Playing catch-up in planet of the Apps Adding online weapons

Flight Centre’s mobile technology strategy is Flight Centre could be a neat fit with a global online arguably its biggest weakness. App usage, highly travel giant that combines its online presence with the advanced in Australia, is a sticky business. Getting a Australian group’s vast shopfront travel network and spot on smartphone “prime real estate” (the front customer base. Greater consolidation in travel, an screen) – is critical. Consumers often stick to a dozen industry that relies on scale, seems inevitable. or two key apps, making it harder for new entrants to break through in App land. Flight Centre’s cashflow is another attraction. It expects FY17 total transaction value to top $20 Flight Centre’s App is number 45 in free travel App billion, with underlying profit of $320-$355 million. rankings, based on App Annie data. AirBnB, Debt is minimal. TripAdvisor and Booking.com have a spot in the top five. Skyscanner, Webjet and Trivago are in the top A predator would get a business with a rapidly 20 and Wotif.com is the 25th most popular travel App. growing presence in four of the world’s five largest travel markets, and a strategy to enter the top 15 In fairness, Flight Centre’s App, only released in markets by 2022. Flight Centre is also growing its October 2016, has already climbed 10 spots in the corporate travel business, with more than $6 billion in rankings and should rise further as it attracts user star turnover. ratings. Still, Flight Centre has given its online rivals a huge head start. The timing looks right for industry consolidation. The global tourism industry has terrific growth prospects Flight Centre’s new online brand, Aunt Betty, is as an ageing population travels more, and as the another gamble. Released earlier this year, the site coming boom in middle-class consumption in was designed to halt market share losses in domestic emerging markets drives new travel demand. holiday bookings. Launching a site that does not use the prominent Flight Centre brand, without an App, is Local companies, such as Webjet and the revitalised perplexing. Helloworld, have enjoyed stellar share-price gains this year, as have other stocks exposed to tourism Hopefully, Aunt Betty will be a huge success. But tailwinds. Flight Centre is going against the trend with playing catch-up with an unknown online brand, in an a negative 17% total return over one year. intensely competitive online travel market, could be a strategic error that Flight Centre can ill-afford, given Flight Centre’s growth slowdown is not only because its surprisingly low ranking in travel Apps. of structural factors, such as growth in online travel and the threat of Airbnb as more consumers use the History shows that companies late to online platforms “share economy” for low-cost accommodation. often struggle to catch up – or never get near the Shorter-term cyclical factors, such as airline leaders. Successful early entrants develop formidable discounting (which affected Flight Centre’s margins competitive advantages through their network size in FY16) and Britain’s proposed exit from the and scale. European Union (which affected sales in Flight Centre’s UK operations), have weighed on growth. Flight Centre could struggle to meet its total transaction value (TTV) growth targets if its online The market has mixed views on Flight Centre. Three strategy fails to gain traction. of 12 broking firms that cover the stock have a buy recommendation, seven a hold, and two a sell, based I suspect the market will ask more questions about on consensus analyst forecasts. A median price Flight Centre’s internal online capabilities. Nobody target of $33.37 suggests it is a touch undervalued. doubts it is a terrific shopfront travel retailer, here and The share-valuation service, Skaffold, values Flight overseas. But there’s not enough evidence yet that Centre at $43.25 in FY17. Flight Centre can become an online leader in travel.

Thursday 08 December 2016 06 Nevertheless, the odds favour Flight Centre heading lower rather than higher in the next 12 months as its online challenge intensifies. That might be the catalyst for a predator to swoop and get the share price flying again.

From a charting perspective, Flight Centre needs to hold above $30, a point of share-price support that has been tested a few times on its price chart in the past few years.

Either way, Flight Centre remains one of Australia’s best mid-cap companies and potentially a quality portfolio addition as better value emerges in the next six months.

Portfolio update

Some longstanding members in the Switzer Super Report are making big moves. South32 is up 174% and WorleyParsons has surged 106% over 12 months. Gains in Africa-focused gold explorer Perseus Mining and beaten-up online policy provider iSelect were other highlights.

The large materials stocks look overvalued – an argument I have made in recent editions of this report – but they keep their spot in the takeover portfolio for now.

Spark Infrastructure is another worth watching as the market pays greater attention to the sector’s takeover prospects after this month’s takeover bid for Duet Group.

Infrastructure is another worth watching as the market pays greater attention to the sector’s takeover prospects after this month’s takeover bid for Duet Group. Source: Morningstar (one-year return), Standard and Poor’s (S&P/ASX 200 total return). * assumes dividend reinvestment. Prices at Dec 6, 2016.

Thursday 08 December 2016 07 Buy, Sell, Hold – what the brokers say by Staff Reporter

In the good books from an accretion perspective.

Alumina (AWC) Upgraded to Accumulate from Beadell Resources (BDR) Upgraded to Buy from Hold by Ord Minnett B/H/S: 1/3/3 Neutral by Citi B/H/S: 2/0/1

Ord Minnett has increased its forecasts for coal, iron Citi commodities analysts have changed their view on ore and copper, while downgrading near-term gold commodities, now expecting 2016’s momentum is price forecasts. The broker also raises forecasts for likely to remain the dominant theme for 2017 and alumina. Spot alumina continues to look strong at 2018. US$325/t and presents upside potential to the broker’s earnings estimates. For gold producers in particular, the combination of flat prices in the Australian dollar and a pull back in The broker upgrades AWC to Accumulate from Hold share prices has inspired upgrades. Rating moved to and raises the target to $1.80 from $1.60. The Buy/High Risk from Neutral. upgrade is driven by a higher valuation and strong forecasts for free cash flow. BHP Billiton (BHP) Upgraded to Neutral from Sell by Citi B/H/S: 2/6/0 Bapcor (BAP) Upgraded to Buy from Neutral and to Add from Hold by UBS by Morgans B/H/S: 3/1/0 Citi commodities analysts have changed their view on commodities, now expecting 2016’s momentum is The company has lifted its offer for Hellaby Holdings, likely to remain the dominant theme for 2017 and to NZ $3.60, which is at the lower end of the 2018. independent expert’s valuation range. Price estimates have all gone up. The Board has stated it will not recommend the offer unless a dividend is paid, making use of its imputation See downgrade below. credits. Carsales.com (CAR) Upgraded to Neutral from Regardless of whether the Board endorses the offer, Sell by UBS B/H/S: 6/2/0 UBS believes it’s highly likely that Bapcor will attain at least a majority ownership. Given this likelihood, UBS upgrades to Neutral from Sell without UBS incorporates the business into forecasts. accompanying commentary. Target is $10.50.

Morgans now factors in the acquisition, but notes DUET Group (DUE) Upgraded to Neutral from there is some risk to Bapcor gaining full control. The Underperform by Credit Suisse and to Hold from broker acknowledges the company has been Reduce by Morgans B/H/S: 6/2/0 particularly accretive in recent years, which brings higher integration risk. The company has confirmed a non-binding offer of $3.00 from Cheung Kong infrastructure. Credit Suisse Nonetheless, the broker believes the deal stacks up observes the bid price is in line with the upper end of

Thursday 08 December 2016 08 recent transactions in NSW for Transgrid and The broker also removes the overhang from Ausgrid. ADM’s sell down of its stake and transfers coverage to another analyst. FY17 and FY18 earnings per The high initial offer reduces the likelihood of a share estimates are raised by 14% and 4% counter bid. The broker acknowledges some respectively. uncertainty regarding approval by the Foreign Investment Review Board. Independence Group (IGO) Upgraded to Neutral from Sell by Citi B/H/S: 1/4/1 Given the corporate activity, Morgans lifts its rating to Hold from Reduce. The broker does not factor Citi commodities analysts have changed their view on corporate activity into the target, including the commodities, now expecting 2016’s momentum is takeover premium that the company may be willing to likely to remain the dominant theme for 2017 and pay to gain control of the stock. The broker sets the 2018. For gold producers in particular, the target at the indicative bid price of $3.00. combination of flat prices in AUD and a pull back in share prices has inspired to upgrades. Cheung Kong may be attracted to the yield but also could merge its Victorian distribution networks with Japara Healthcare (JHC) Upgraded to Outperform DUET networks, the broker observes. Morgans from Neutral by Macquarie B/H/S: 2/1/1 expects cash flow supporting the distribution to materially fall away early next decade. After reviewing the aged care sector Macquarie upgrades Japara to Outperform from Neutral. Target Evolution Mining (EVN) Upgraded to Buy from is $2.50. Neutral by Citi B/H/S: 7/0/0 The broker believes the company is well placed for Citi commodities analysts have changed their view on the uncertainty inherent in the regulatory commodities, now expecting 2016’s momentum is environment, with more conservative gearing levels likely to remain the dominant theme for 2017 and and more generous staff costs per place. 2018. The broker expects the tight funding environment will For gold producers in particular, the combination of restrict earnings growth from places, which increases flat prices in AUD and a pull back in share prices has the importance of portfolio growth. inspired to upgrades. Rating moved to Buy/High Risk from Neutral. See downgrade below.

Fortescue Metals Group (FMG) Upgraded to JB Hi-Fi (JBH) Upgraded to Neutral from Sell by Neutral from Sell by Citi B/H/S: 2/4/1 Citi B/H/S: 3/4/0

Citi commodities analysts have changed their view on Citi analysts ask the question: Is JB Hi-Fi’s sales commodities, now expecting 2016’s momentum is growth sustainable? The combination of anticipated likely to remain the dominant theme for 2017 and slowing in sales growth and the incorporation of The 2018. Good Guys only results in minor increases to estimates. Graincorp (GNC) Upgraded to Outperform from Neutral by Macquarie B/H/S: 3/3/0 Luckily the shares are trading at a discount vis-a-vis the broader market ex-resources, and below the price A strong crop season and the latest receivables data target (unchanged at $27.20), so Citi analysts still suggest that the company is catching up after a upgrade to Neutral from Sell. delayed start to harvest and Macquarie lifts its forecast for FY17 receivables to 11.2mt and also Bottom line: JB Hi-Fi is expected to outperform a raises export expectations to 5mt. market (consumer electronics) that is facing

Thursday 08 December 2016 09 headwinds, in the analysts’ view. If the companies in Australia’s media sector could replicate their domestic models overseas, the broker New Hope Corporation (NHC) Upgraded to Neutral believes the upside would be material. However, from Underperform by Credit Suisse B/H/S: 1/2/0 market structures are also less favourable and competition is fiercer. Credit Suisse updates its commodity price forecasts for 2017, upgrading iron ore, thermal coal and copper Regis Resources (RRL) Upgraded to Neutral from prices by 22%, 25% and 23% respectively. Underperform by Credit Suisse and to Buy from Sell by UBS B/H/S: 4/3/1 While China has pushed up the price of thermal coal recently, a policy reversal is expected to lift local Credit Suisse observes management understands supply and cool prices into 2017. well its prospective ground at Duketon, and the operation has become a robust, cash generating Given recent developments with the new Queensland project. water legislation, the broker again defers the inclusion of the expansion of New Acland mine and assumes a Reliable commercial outcomes that are readily 12-month hiatus between depletion of stage 2 and the developed and quickly converted to cash flow are commencement of stage 3. being delivered, the broker notes.

Northern Star Resources (NST) Upgraded to UBS trims 2017 gold price forecasts to US$1350//oz Outperform from Underperform by Credit Suisse and remains bullish on gold. The broker notes it was B/H/S: 3/2/0 a volatile year for the company and remains drawn to the stock, although a premium valuation versus peers Credit Suisse observes the company’s exceptional was always difficult to appreciate. returns have been extracted from low-cost operating practice, an elevated Australian dollar gold price, and Nevertheless, with the share price pulling back and disciplined acquisitions. organic growth options turning into production growth, as well as a strong balance sheet, the broker expects The broker upgrades to Outperform from investor interest to remain high. Underperform, a valuation-based call given recent share price declines. Resolute Mining (RSG) Upgraded to Buy from Neutral by Citi B/H/S: 1/1/0 Regis Resources (RRL) Upgraded to Buy from Neutral by Citi B/H/S: 3/2/3 Citi commodities analysts have changed their view on commodities, now expecting 2016’s momentum is Citi commodities analysts have changed their view on likely to remain the dominant theme for 2017 and commodities, now expecting 2016’s momentum is 2018. For gold producers in particular, the likely to remain the dominant theme for 2017 and combination of flat prices in AUD and a pull back in 2018. For gold producers in particular, the share prices has inspired to upgrades. combination of flat prices in AUD and a pull back in share prices has inspired to upgrades. Rio Tinto (RIO) Upgraded to Neutral from Sell by Citi and to Outperform from Neutral by Credit REA Group (REA) Upgraded to Buy from Neutral Suisse B/H/S: 5/3/0 by UBS B/H/S: 6/2/0 Citi commodities analysts have changed their view on UBS suspects investors may not fully appreciate the commodities, now expecting 2016’s momentum is potential for Australian residential revenue to likely to remain the dominant theme for 2017 and re-accelerate in FY18, even without a rebound in 2018. volumes. Credit Suisse updates its commodity price forecasts

Thursday 08 December 2016 10 for 2017, upgrading iron ore, thermal coal and copper cash generation from the maturing Gwalia asset has prices by 22%, 25% and 23% respectively. been maximised and the life of the operation has been extended. Rio Tinto has recently revised the capital expenditure guidance and committed to a further US$5bn of free The challenge is now to replace the short life Simberi cash flow in productivity improvements over five asset with a value-adding acquisition. Credit Suisse years. The company has promised a minimum 2016 removes the Simberi sulphide contribution from dividend of US$1.10 and the broker assumes forecasts, with the recent strategic review indicating US$1.50. there are no plans to develop the project and no willing buyers in the current climate. Sandfire (SFR) Upgraded to Buy from Neutral by Citi B/H/S: 5/1/1 Whitehaven Coal (WHC) Upgraded to Accumulate from Hold by Ord Minnett and Buy from Sell by Citi commodities analysts have changed their view on Citi B/H/S: 4/3/1 commodities, now expecting 2016’s momentum is likely to remain the dominant theme for 2017 and Ord Minnett has increased its forecasts for coal, iron 2018. For gold producers in particular, the ore and copper, while downgrading near-term gold combination of flat prices in AUD and a pull back in price forecasts. The broker upgrades Whitehaven share prices has inspired to upgrades. Coal to Accumulate from Hold and the target to $3.30 from $3.00. Saracen (SAR) Upgraded to Outperform from Neutral by Macquarie B/H/S: 1/0/0 The upgrade is driven by a higher valuation and a strong free cash flow forecast. Ord Minnett Drilling at Thunderbox and Carosue Dam continue to recognises it is late in its call but estimates the stock return positive results, Macquarie notes. Confirmation will be net cash within a year. of thick mineralisation at Thunderbox is particularly encouraging as it supports the broker’s assumption Citi commodities analysts have changed their view on of an underground operation down the track. commodities, now expecting 2016’s momentum is likely to remain the dominant theme for 2017 and This confirmation, and Saracen’s recent share price 2018. Price estimates have all gone up. Whitehaven fall, leads Macquarie to upgrade to Outperform. Coal has received a double-whammy upgrade to Buy from Sell. South32 (S32) Upgraded to Buy from Sell by Citi B/H/S: 3/4/0 In the not-so-good books

Citi commodities analysts have changed their view on Bellamy’s (BAL) Downgraded to Hold from commodities, now expecting 2016’s momentum is Add by Morgans and to Hold from Buy by Ord likely to remain the dominant theme for 2017 and Minnett B/H/S: 0/2/1 2018. The analysts remain bearish on bulk commodities whose rallies are labelled “a fluke” on The company’s trading update and FY17 guidance the back of China changing its policies. were well below estimates. Morgans downgrades FY17 and FY18 net profit forecasts by 45% and 55% Price estimates have all gone up. South32 has respectively. received a double-whammy upgrade to Buy from Sell. The company’s second quarter has not been as St Barbara (SBM) Upgraded to Outperform from strong as expected. The company is also being Neutral by Credit Suisse B/H/S: 3/0/0 affected by regulatory changes in China, which is causing brands which won’t meet the December 31 Credit Suisse considers the company’s operational 2017 CFDA approval deadline to heavily discount and financial turnaround has been stunning. Free their excess stock.

Thursday 08 December 2016 11 Revenue for the year to November 20 2016 is up broker downgrades to Underperform from Neutral, as 24%, which compares with Ord Minnett’s FY17 the business needs to prove its earnings now that it is estimate of up 59.3%. FY17 EBIT margins are now trading almost on a market multiple where earnings expected to be below 20%, depending on the sales estimates for FY19 will be roughly flat versus FY16. channel mix. Japara Healthcare (JHC) Downgraded to Hold With momentum materially slowing, market from Add by Morgans B/H/S: 2/1/1 dislocation from regulatory changes, and the stock trading on FY17 price/earnings ratio of 20x post the Given the rally in the company’s share price, downgrade, the broker lowers its recommendation to Morgans downgrades to Hold from Add. Hold from Buy. After a period of uncertainty, the broker notes the BHP Billiton (BHP) Downgraded to Neutral from industry and the government have reached a broad Outperform by Credit Suisse B/H/S: 2/6/0 agreement with some of the measures outlined in the FY16 budget regarding funding cuts being Credit Suisse updates its commodity price forecasts moderated. for 2017, upgrading iron ore, thermal coal and copper prices by 22%, 25% and 23% respectively. The broker remains comfortable that current forecasts reflect the new arrangements. Underlying EBITDA is revised up 33% and 35% in FY17 and FY18 respectively. The broker notes BHP See upgrade above. has been widely criticised for under investing in its conventional oil business but has now sanctioned the Origin Energy (ORG) Downgraded to Neutral from Mad Dog 2 expansion and first oil is expected in Buy by Citi, to Underperform from Neutral by 2023. The company is also the winning bidder for Credit Suisse, to Hold from Add by Morgans and 60% of the block containing the Trion discovery in the to Hold from Accumulate by Ord Minnett B/H/S: Gulf of Mexico. 1/5/1

The stock has outperformed the Australian market by Citi has lifted its price target to $6.95 from $6.61 on 37% in the past year and is now at around fair value, the news Origin is looking to spin off its conventional in the broker’s opinion. oil assets through an IPO, while pulling back the rating to Neutral from Buy. See upgrade above. The analysts think the initiative is “OK”, but not game Downer EDI (DOW) Downgraded to Underperform changing. Debt will be reduced and the spin-off from Neutral by Credit Suisse B/H/S: 2/3/1 requires board approval without shareholders having their say, note the analysts. The company has been awarded the Sydney growth trains contract. The $1.7bn contract follows the Also, the analysts observe AGL Energy (AGL) is contractual close on the Victorian government’s $2bn currently trading at a comparable premium, but this high-capacity metro trains project. seems justified, in their opinion, because AGL has a stronger growth outlook and a stronger balance Credit Suisse takes the opportunity to review its sheet, even after the planned divestment. Citi thinks a assumptions, noting that the company has positioned meaningful multiple re-rating for Origin may take itself to diversify away from the challenged mining several years. and engineering construction sectors. Over 55% of revenue is now generated from servicing public Credit Suisse believes that the IPO of its conventional infrastructure customers in Australasia. upstream assets is strategically, and financially, the right thing to do. That said, the broker is baffled by a Despite raising the target to $5.30 from $4.70, the decision to sell to the equity market versus a trade

Thursday 08 December 2016 12 sale. Management to Sell from Hold. Apart from recent net funds outflows, the analysts are referring to increased The broker carries a value of $1.4bn for the assets competition for retail funds from the likes of Hyperion, noting that this is inclusive of the $350m in hedging Magellan ((MFG)) and ex-Platinum PM run, cost. This does not include remediation or corporate Antipodes. costs, which are either not disclosed or unknown, and both will reduce the net present value. As a result, Ord Minnett thinks the outlook remains challenging. The analysts have reduced estimates. Credit Suisse downgrades to Underperform from The 10% buyback should provide some downward Neutral, reluctantly, but notes the valuation is hard to protection, the analysts acknowledge, but at what measure and an IPO is unlikely to be materially share price level exactly? accretive to value. While the company will be a more investable business after this IPO, the broker believes Western Areas (WSA) Downgraded to Neutral the starting point share price is wrong. from Outperform by Credit Suisse B/H/S: 2/1/4

With the intention of fast tracking the de-gearing of its Nickel prices have risen strongly on the back supply balance sheet, the company is preparing to spin off restrictions. Nickel in stainless steel had also been its conventional upstream oil & gas assets via an IPO. stronger than expected. Credit Suisse maintains its price forecasts at US$5/lb in the first half of 2017 and Morgans values the combined assets at $1.5-1.7bn, at US$5.50/lb in the second half, increasing to Although recognises that the debt load, corporate US$6/lb in 2018. costs and offtake contracts will have an impact. The broker notes Western Areas has now completed Ord Minnett says that the spin out of its conventional a favourable offtake tender process which will result petroleum business partially addresses its immediate in a greater return from nickel produced in concerns regarding the balance sheet. While the sale concentrate versus the contracts that are due to proceeds could net as much as $3bn, the downside, expire in January 31 2017. the broker envisages, is that it removes the natural hedge for the gas retailing business. It also remains As the shares have rallied 60% since the beginning of to be seen what contractual or other arrangements the year the stock has become less attractive and the the company can make. broker downgrades to Neutral from Outperform.

Oroton (ORL) Downgraded to Sell from Neutral by Important: This content has been prepared without Citi B/H/S: 0/0/1 taking account of the objectives, financial situation or needs of any particular individual. It does not Citi has downgraded to Sell from Neutral, while constitute formal advice. Consider the reducing forecasts and pulling back the price target to appropriateness of the information in regards to your $2.05 from $2.40. Clearly, Oroton’s trading update circumstances. did not meet expectations.

Citi analysts observe the majority of weakness in sales was driven by the core handbag category and the exit of categories such as apparel, footwear and lingerie. Factory stores are under pressure from international competitors, they add.

Platinum Asset Management (PTM) Downgraded to Sell from Hold by Ord Minnett B/H/S: 0/1/3

Ord Minnett has double-downgraded Platinum Asset

Thursday 08 December 2016 13 Professional’s Pick – Cleanaway (CWY) by ST Wong

What is the stock? What do you like about its management?

Cleanaway (CWY). Management is not Cleanaway’s strongest point. There has been a high level of turnover in the past. Cleanaway is a major waste management and The current management team has made a promising recycling company and owns strategic landfill sites on start to re-orientating the company towards better the eastern seaboard. The company has made a discipline in capital resources and improving returns number of acquisitions in the past decade. In recent for shareholders. years, Cleanaway has sold its New Zealand business and other assets which were deemed non-core. What is your target price? Management has decided to streamline the company and to increase focus on improving the profitability of Based on current information, we have set a $1.20 the business. target price.

How long have you held the stock? At what point would you sell it?

We built a position in Cleanaway when the stock was The investment thesis is focussed on the company’s recently sold down to under $1.00. ability to defend and gain market share off its competitors while focussing on taking costs out of its What do you like about it? operations. Market share losses could indicate Cleanaway’s inability to gain traction on recent The medium-term outlook for waste management is initiatives to improve customer acquisition, or positive — we continue to generate more waste every heightened competition in the sector. Both have year, which we need to manage in an efficient and negative implications for Cleanaway’s profit margins. environmentally friendly manner. How much has it added (subtracted) to your Against this backdrop, Cleanaway holds a market overall portfolio over the last 12 months? leading position due to its extensive network of collection services and stations. Management has the The company is a relatively new position. opportunity to build on these assets by allocating capital and resources to gain market share and Where do you see the value? improve profitability. Recent profit results have been underpinned by good How is it better than its competitors? improvements in the company’s cash flows. As a consequence, Cleanaway’s gearing has declined to The sector is competitive and is susceptible to a comfortable level. This gives Cleanaway options to periods of heightened competition and large contracts consider acquisitions that would add scale to the will be won and lost. Cleanaway’s edge lies with its business. The potential upside from scale is positive assets: an extensive network of collection routes, for margins as a number of Cleanaway’s assets landfill sites and processing sites. operate on a relatively high proportion of fixed costs.

Thursday 08 December 2016 14 Source: Yahoo!7 Finance

Thursday 08 December 2016 15 Questions of the Week – Evolution Mining, CSL and Cochlear by Questions of the Week

Question: I’ve recently asked specifically about EVN, and generally about the softening of the gold sector’s prices.

Answer (By Paul Rickard): Evolution Mining (EVN) is a great gold producer – but it has no control over the price of its one commodity – gold.

With bond yields soaring, the gold price has been smashed.

I really don’t have a strong view on where the gold price is heading, except to say that I can’t see any compelling reason to buy yet.

Question: I am a little confused about two companies: CSL (CSL) and Cochlear (COH). Do you have any suggestions? Let it go or stay with it?

Answer (By Paul Rickard): The market is in a great hurry to find cyclical exposures, and healthcare is viewed unfavourably. The Australian market is not unique – we are following a lead out of the USA. Funds are rotating out of healthcare into other sectors.

CSL and Cochlear are great stocks, but the market feels that they are expensive.

My view is to stick with them – however, you might have to wear some pain in the short term.

Thursday 08 December 2016 16