weekly review | ISSUE 362a | 16–22 February 2013

CONTENTs In this issue STOCK REVIEWS Hush, and hear Amalgamated’s charms STOCK ASX CODE Recommendation PAGE Greg Hoffman Amalgamated Holdings AHD Long Term Buy 2 Greg Hoffman explains why this owner of hotels, cinemas and a skiing stock UPdates resort may be just the ticket for those looking for a steady, growing ARB Corp ARP Hold 3 dividend. (p2) Amcor AMC Avoid 4 ANZ Bank ANZ Avoid 5 Who wants golden dividends?; Blog links ASX ASX Hold 5 Australand ASSETS AAZPB Sell 6 Gaurav Sodhi BHP Billiton BHP Hold 7 Below is a list of Doddsville and Bristlemouth blog articles published BlueScope Steel BSL Hold 8 by our analysts this week. (p25) Boart Longyear BLY Avoid 8 Brambles BXB Avoid 9 ASX half-year result BWP Trust BWP Long Term Buy 9 Coca-Cola Amatil CCL Hold 10 James Carlisle Infigen Energy IFN Hold 11 Competition and weak market sentiment took a bite out of ASX’s InvoCare IVC Hold 11 revenue in the first half, but today’s result left plenty of room for IRESS IRE Hold 12 optimism. (p5) Monadelphous MND Avoid 13 NAB CPS NABPA Avoid 14 Platinum Asset Management PTM Hold 15 BHP half-year result ResMed RMD Long Term Buy 16 Gaurav Sodhi Rio Tinto RIO Hold 17 Good results were only part of the story, with management preparing Sunland Group SDG Hold 17 the business for a different world. (p7) Sonic Healthcare SHL Hold 18 Servcorp SRV Hold 19 Sirtex Medical SRX Hold 20 IRESS full-year result Suncorp Group SUN Hold 21 Jason Prowd Tassal Group TGR Hold 21 A growing market for its wealth management software failed to offset Treasury Group TRG Hold 22 lower demand for its market data products both here and abroad. Village Roadshow VRL Hold 22 Jason Prowd revisits the case for IRESS. (p12) Woodside Petroleum WPL Hold 23 features Platinum half-year result Doddsville blog | Who wants golden dividends? 24 James Carlisle extras Platinum ticks all the boxes as an excellent business in an attractive Blog article links 25 sector, but we’ll have to be patient for another entry point. (p15) Multimedia links 25 Twitter links 25 PORTFOLIO CHANGES Ask the Experts Q&As 25 BUY/ nO. OF PRICE VALUE Important information 26 PORTFOLIO STOCK DATE seLL shARES ($) ($)

RecomMendation changes Income Australand ASSETS Sell 20/2/13 100 $96.60 $9,660.00 Amalgamated Holdings upgraded from Hold to Long Term Buy Income ResMed Buy 20/2/13 2,300 $4.22 $9,706.00 Australand ASSETS downgraded from Hold to Sell NAB CPS coverage initiated with Avoid Suncorp upgraded from Avoid to Hold Intelligent Investor Share Advisor

Blue chip industrial | Greg Hoffman

Hush, and hear Amalgamated’s charms

Greg Hoffman explains why this owner of hotels, cinemas and a skiing resort may Key Points be just the ticket for those looking for a steady, growing dividend. Attractive collection of entertainment assets with growth potential Too many companies love to ‘sell the sizzle’, making upbeat presentations and Conservatively financed and managed with 5% full announcements, delivering glossy annual reports explaining why the company is worth franked yield more than the sum of its parts. Upgrading to Long Term Buy Usually, it’s bulldust designed to obscure the ugliness of the numbers. Amalgamated Holdings, owner of hotels, cinemas and a ski resort, doesn’t shout or gild the lily. But the performance is of a high quality for those prepared to listen. Table 1: Ahd’s businesses Amalgamated has long owned the historic State Theatre site in Sydney. In 2005 it Hotels Type/location acquired the ‘Mick Simmons’ building behind the theatre for $12.5m. A year later, Gowings 4 star leisure and business Retail went into administration and Amalgamated swooped, purchasing the Gowings hotels, Australia wide buildings, adjacent to its two other holdings, for $68.6m.

A quick examination of the accounts shows three random property assets. But as 4.5 star design hotels, Monopoly players know all too well, the purchase of three adjacent properties delivers the Sydney/Gold Coast/Port Douglas option of building a lucrative hotel. Under the stewardship of chairman Alan Rydge and his Cinemas team, that’s what Amalgamated has done. The achingly hip and popular QT Hotel was launched in September last year, featuring

Australia 200 rooms from $325 a night. That’s an example of the company’s modus operandi: patient, conservative, and creative. The same patient, strategic approach is also evident in Rydge’s personal property Australia portfolio. In 1960, Alan Rydge’s father bought a property in Sydney’s Point Piper. Through

patient acquisitions, the family now owns six adjoining properties in the exclusive suburb.

Australia Like father, like son

‘Alan Rydge is no rebel’ said the Sydney Morning Herald in 1986 after he took over as

Germany chairman of Amalgamated following his father’s death in 1980. ‘Sir Norman could never be accused of over borrowing, which was, in his vocabulary, a bit of a dirty word. Asked Other businesses then if he would change anything, young Alan replied firmly: “I don’t think so.”’ Alan stuck to his word. The company currently boasts a net cash balance of $16.5m; Ski resort, NSW debt of $46.8m is more than offset by $63.3m in cash. That’s an extraordinary position for such an asset-rich company, especially one that’s spent more than $60m developing a designer hotel in Sydney in addition to funding the requisite land acquisition (the company Theatre, NSW made an equitable 1-for-5 rights issue in 2009 rather than borrow the money). So Amalgamated Holdings is a rarity; a company that’s overseen with a genuinely

Cinema equipment supplier conservative eye to the long term. Comfort can also be drawn from the diversity of the company’s assets. Cinemas are the group’s main revenue and profit engine. In Australia and New Zealand, Film processing equipment Amalgamated owns and operates 72 cinema sites, mostly through its Event Cinemas joint venture with Village Roadshow. These produced more than $75m in profits in 2012, boosted by an $18.6m contribution from the group’s German cinemas. Wildlife park, NSW Film quality and general economic conditions affect this business but even in a downturn it should remain comfortably profitable. And the German operation offers a little currency hedge; an opportunity to benefit from a lower Australian dollar should it ever fall. Amalgamated also operates 47 hotels, largely through the Rydges brand. Hotels don’t generate as much profit as the cinemas business—just $26.5m in 2012—but this division contains hundreds of millions of dollars in asset value (the hotels themselves) and a large part of earnings are, in effect, rental payments, which should be valued more highly than operational earnings.

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Owning and operating hotels also delivers a powerful ‘informational advantage’ that substantially lowers acquisition risk. Through the GFC, Amalgamated opportunistically Amalgamated Holdings | AHD acquired several hotels that it previously managed on behalf of other owners (including Price at review $7.76

Babcock & Brown). Review date 21 Feb 2013 Amalgamated also owns (via a long-term lease) and operates the Thredbo Alpine market cap. $1.2bn Resort in the NSW Snowy Mountains. Profits here depend on bumper snow falls but a 12 mth price range $5.80 —$7.99 contribution of between $10m and $20m can be expected each year. There are also a number of investment properties and other smaller businesses that we’ll explore in a future business Risk Low–Medium review. For now, let’s focus on the juicy, reliable yield. Share price risk Medium Given the company’s track record, conservatism and diversity, annual returns of 9% max. portfolio weighting 4% seem a reasonable expectation. Our View Long Term Buy Based on its fully franked dividend yield of 5%, the lion’s share of returns (7.1% of the 9%) will therefore come from dividends and franking credits (see Franking credits made Chart 1: AHD dividends per share simple, issue 320). To boost returns to 9%, Amalgamated needs growth of just 2% per Cents year—less than the Reserve Bank is targeting for inflation. 40 For a business that carries no debt and reinvests almost a quarter of its profits each 35 year, that’s a very modest hurdle. The ride may not be totally smooth over the years but 30 2% is quite achievable, and 5% well within reach. 25 Amalgamated’s appeal and strength lies in its diversified operations, conservative 20 financial settings and the stewardship of Alan Rydge and his long-serving managing director 15 David Seargeant. We’ll shortly be interviewing David Seargeant, at which time we’ll publish 10 a more numerical analysis. But the case is already well made. 5 The share price has risen 15% since our comparative review on 10 Dec 12 (Hold— 0 $6.76) but in this environment that’s a fair price for a high quality blue chip. ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 If a 5.0% fully franked yield with the prospect of modest growth appeals, then Source: Capital IQ Amalgamated Holdings is the epitome of a LONG TERM BUY below $8 (or $8.15 before the stock goes ex dividend in the first week of March) for up to 4% of your portfolio. ahd recommendation guide This isn’t a stock for investors seeking 15%+ returns but risk averse income investors Long Term Buy Below $8.00 may find their appetite whetted. Amalgamated is not in the habit of shouting its charms, but is all the more attractive for it. Hold Up to $11.00 Sell Above $11.00 Disclosure: Interests associated with Greg Hoffman own shares in Amalgamated Holdings.

Stock updates

Half-year result ARB Corp | James Carlisle

ARB is a high-quality company, but it’s priced for near-perfection and today’s interim result was somewhat underwhelming. ARB Corp | ARP Price at review $12.39 Going up against a period affected by supply disruptions from the Japanese Tsunami Review date 21 Feb 2013 and flooding in Thailand, ARB Corporation’s first-half was always going to look pretty good. Max. portfolio weighting 5% But in the event, it’s somewhat underwhelming. Net profit growth of 14.5% (to $20.9m) and revenue growth of 10.0% (to $147.1m) Our View Hold are healthy figures. But they’re only around the 10-year averages for this company, of 16% and 13% respectively, so they hardly make up for the growth of only 2% each seen in the first half of the 2012 financial year. Earnings per share followed net profit up 14.5%, to 28.8 cents, from which a fully franked dividend of 12.5 cents will be paid (up 13.6%).

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Hitting capacity Management cited the high Australian dollar and capacity constraints in the local market as negative factors. Table 1: ARB’s half-year result The high Australian dollar is not something the company can control, although it can H1 2013 h1 2012 Change (%) mitigate its effects by diversifying its cost base, as it has done in the past by building the

Revenue ($m) 147.1 133.8 10 factory in Thailand. Perhaps it’s time to build a factory in the US, which might also alleviate the capacity constraints. Net profit ($m) 20.9 18.3 14 As it stands, management noted in today’s results announcement that construction Free cash flow ($m) 10.7 11.5 –7 of a warehouse and factory were completed in Thailand during the half and that further EPS (c) 28.8 25.2 14 investments were being made in Australia and Thailand in order to increase capacity. This Interim DPS (c) 12.5 11.0 14 explains the uptick in capital expenditure during the half to $7.7m, compared to $4.7m in the first half of 2012, and the 7% fall in free cash flow to $10.7m. But ARB makes very high returns on capital employed (of about 42% in 2012) and we’re pleased to see it making the necessary investments.

Mining slowdown The bigger worry is that the mining slowdown may be having an effect. That’s not necessarily a concern in itself, but it might suggest that the company’s excellent performance arp recommendation guide in recent years may have been helped by some significant tailwinds. Those tailwinds may, Long Term Buy Below $8.00 in turn, have been baked into a share price which, on a price-earnings ratio of nearly 20

Hold Up to $14.00 times forecast earnings, looks pretty steep for a manufacturing company. The stock is up 16% since 24 Oct 12 (Hold—$10.71), taking it past the relevant trigger Sell Above $14.00 in our price guide, but we’re very reluctant to let go of such a high quality company, so we’re cutting it a little more slack and edging up our price guides. The stock is, however, on watch for a potential downgrade should the price get too much higher or the long-term growth prospects show signs of faltering. Note also our 5% recommended maximum portfolio weighting: if your holding is much beyond that it might make sense to take some money of the table now. Note: The model Growth portfolio owns shares in ARB Corp. Disclosure: Staff members own shares in ARB Corp, but they don’t included the author, James Carlisle.

Amcor | James Carlisle

Amcor has reported a 16% rise in interim net profit to $238m on sales that slipped 1% to $6,035m. The company was keen to point out that before significant items the net Amcor | AMC profit was $322m, but we’re not buying it. Amcor has reported significant items in each of Price at review $9.19 the past five years, of between about 30% and 50% of earnings before the items, with Review date 18 Feb 2013 an average of 40%. I suppose we should be grateful that they don’t call them ‘one-offs’,

Our View Avoid although one suspects that’s just so they can keep doing it. Other ‘lowlights’ from the half-year results are the earnings before interest and tax margin of 8.8%, up from 8.5% in the comparable period but still very low, and the net debt of $3,774m, up from $3,551 six months earlier, to give a net debt-to-equity ratio of 110%. The net interest bill was covered five times by EBIT, but only 2.4 times by free cash flow before the dividend payment. All this sits alongside poor returns on capital employed, which came in at 11% in the 2012 year and look like being similar this year.

Table 1: Amcor’s significant items FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 h1 2013

Net profit pre significant ($m) 369 361 409 570 635 322

Net profit post significant ($m) 259 212 183 357 413 238

Significant items ($m) 110 149 226 214 222 84

Significant items as percentage of profit (%) 30 41 55 37 35 26

You can take your pick in what to blame for the rise in debt, whether it’s the $96m capital expenditure, the $204m increase in working capital or the $241m paid out in dividends (all out of operating cash flow after tax and interest of $592m). Oh, and the $42m of cash significant items. None of it looks too good, though, and it makes the dividend look

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vulnerable—and it only provides a yield of a bit over 4% at current prices in the first place. The current share price doesn’t look too attractive against earnings either, with a price- earnings ratio of just over 16 times consensus earnings for the current year. If you knock the earnings back by 30% to account for the perennial significant items, then you get up above 20 times. And it’s not even as though these are depressed earnings. 2013 is expected to be the company’s second most profitable year ever (significant items aside), and its most profitable since 2002. The market is tipping growth of around 10% each in 2014 and 2015, but at these prices and, given the risks, that doesn’t come close to balancing the value equation. The stock is up 21% since we reviewed the 2012 full-year result on 12 Sep 12 (Avoid—$7.63), and we would now add bells to that recommendation. AVOID.

ANZ Bank | Nathan Bell, CFA

ANZ has announced its first quarter update for 31 December 2012 (ANZ has a 30 September year end), with cash profit increasing 6.2% to $1.53bn. The result can’t be ANZ Bank | ANZ judged without the detail released with the half-year results, but the company cited volume Price at review $27.89 growth in Asia and good cost control for the result. The net interest margin remained flat, Review date 15 Feb 2013 although it fell slightly if you exclude the more volatile results from the Global Markets Our View Avoid division. This is consistent with Commonwealth Bank’s recent interim result where an improved global economic outlook helped stabilise financial markets. Holding back some of the Reserve Bank’s interest rate cuts is helping offset the cost of attracting deposits and bad debts aren’t currently a problem, though the tailwind from lower bad debts and provision releases has largely drawn to a close. The share price has increased 10% since ANZ, Asia and accounting shenanigans 29 Oct 12 (Avoid—$25.25) and we’re sticking with AVOID.

Half-year result

ASX | James Carlisle

Competition and weak market sentiment took a bite out of ASX’s revenue in the first half, but today’s result left plenty of room for optimism. ASX | ASX Price at review $36.59 On the face of it, today’s interim result from ASX was pretty rough, with operating Review date 21 Feb 2013 revenue down 3.3% and earnings down 2.5%, but it was better than it looked and allows Max. portfolio weighting 5% plenty of optimism for the future. For starters, the comparative period included the worst (so far) of the European Our View Hold sovereign debt crisis, with associated volatility, which led to a 17.2% increase in derivatives revenues. For the recent half’s derivatives revenues to only fall 2.3% from those levels is a decent effort.

Improving sentiment The comparative period also saw little effect from Chi-X (save for ASX’s pre-emptive price cuts), which opened for business at the end of October 2011. In the recent half Chi-X took 3.5% of value traded and that, combined with the weak sharemarket activity levels accounted for the 18% fall in cash market volumes. That’s in line with the ‘gloomy scenario’ we outlined in ASX: Competition cuts in—Pt 3 on 28 Nov 12 (Long Term Buy—$29.32). We still think the average over the next 5 years is more likely to be the 8% annual fall in our middling scenario (closer to the performance in the second quarter as we’ll see shortly), or perhaps somewhat better given the improving sharemarket sentiment. Which brings us to the revenue breakdown. The overall revenue fall of 5.6% in the half comprised an 8.8% fall in the first quarter and a 2.8% rise in the second quarter, due to improved performances in listing and issuer services, derivatives and technical services, helped no doubt by the improved sentiment.

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The improvement in sentiment has continued in the second half—indeed some might say it’s gone into overdrive—which should help the company achieve the 4% growth it needs over last year’s second half in order to make the consensus forecast for the full year earnings per share of 195 cents.

Table 1: ASX’s quarterly revenue breakdown Q1 2013 Chng from pcp* (%) q2 2013 Chng from pcp* (%)

Listing and issuer serv. ($m) 33.7 3.4 39.9 10.8

Cash market ($m) 27.9 –25.2 27.0 –9.1 The improvement in sentiment has continued in the Information serv. ($m) 15.1 –13.2 15.5 –9.9 second half … which should help Technical serv. ($m) 12.1 8.0 12.5 9.6 the company achieve the 4% Derivatives ($m) 48.3 –9.4 46.0 6.4 growth it needs. Austraclear ($m) 9.6 6.1 9.5 8.9 Other ($m) 3.7 –9.8 3.9 0.0

Total ($m) 150.4 –8.8 154.4 2.8

*prior corresponding period

Interesting developments The company also welcomed the decision to leave its cash market clearing monopoly intact for another two years and drew attention to several developments made during the half which should help future earnings. These include: more flexible capital raising rules for small and mid-cap companies, retail access to Australian Government bonds within 6–12 months, faster data services, data hubs in London and Chicago to add to the one asx recommendation guide already established in Singapore, a clearing service for OTC derivatives to be introduced buy Below $30.00 ‘by mid-2013’, and a new collateral management service for Austraclear. Long Term Buy Up to $35.00 The company will pay a full franked interim dividend of 87.9 cents, down 5.3 per cent Sell Above $50.00 on the prior period, but up 3.3% on last year’s final dividend (ex date 4 March). The share price is up slightly since we upped our price guides on 11 Feb 13 (Hold— $36.10) following Wayne Swan’s decision on ASX’s clearing monopoly. The new guide suggests an upgrade to Long Term Buy if the price moves convincingly below $35, and that still looks about right. HOLD. Note: Our model Income portfolio owns shares in ASX. Disclosure: The author, James Carlisle, own shares in ASX.

Australand ASSETS | Jason Prowd

Australand ASSETS have provided an annualised return of 20% since An opportunity in Australand’s ASSETS from 29 Jul 09 (Buy for Yield—$67.00), around double the All Australand ASSETS | AAZPB Ordinaries Accumulation Index. Those who followed the later recommendation (see Price at review $96.60 21 May 10 (Buy for Yield—$83.00)) would still have generated returns of 15% per year.

Review date 20 Feb 2013 These equity-like returns from an income security were possible because we bought at a large discount to face value; when the risk-reward equation had swung in investors’ Our View Sell favour. This highlights our general approach to income securities: at face value they are rarely attractive, and explains why we’ve avoided the spate of recent bank hybrid issues. Success with the ASSETS follows similar results with Goodman PLUS, Dexus RENTS and Southern Cross SKIES. Each have since been sold for a handsome profit as prices rose and the margin of safety contracted. Until recently the ASSETS continued to trade at enough of a discount to fair value to warrant holding on, while also collecting a 9%+ distribution. Now, as interest rates have fallen so has the ASSETS’ income. At the same time, though, the demand for income- related products has risen. This dynamic has helped propel the ASSETS price up 4% since 9 May 12 (Hold—$93.10). We’re using the market’s enthusiasm as a chance to exit. Pending corporate action at parent Australand has also prompted action. A deal may lead to redemption of the ASSETS at face value, but not necessarily. Depending on the structure of any deal it is legally possible for the ASSETS to remain with Australand even if it sells its investment portfolio. This would leave the ASSETS secured by a far riskier and

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smaller development business. That would increase the risk of the ASSETS, and no doubt send the market price lower. Although this is possible, we’ll admit it’s unlikely. Still, considering that capital gains from here are likely to limited we don’t think it’s a risk worth taking. We’re downgrading aazpb recommendation guide the Australand ASSETS to SELL. buy for yield Below $88.00

Note: As result we are selling 100 units from the model Income portfolio for $96.60, hold Up to $96.00 netting the portfolio $9,660.00. This cash is being put straight to work by buying 2,300 Sell Above $96.00 shares in ResMed at $4.22 each, for a total consideration of $9,706.00. Whilst ResMed provides a current yield of only 1.6% (unfranked), this is a business with vast growth potential which should help boost future income, and help drive overall growth within the portfolio. Disclosure: Staff members own shares in ResMed, but they don’t include the author, Jason Prowd.

Half-year result

BHP Billiton | Gaurav Sodhi

Good results were only part of the story, with management preparing the business for a different world. BHP Billiton | BHP Price at review $38.69

Only in a mining business can halving profits be proclaimed an outstanding outcome. Review date 20 Feb 2013 BHP Billiton’s interim result was one such example. Revenue for the half year fell 14% to Max. portfolio weighting 3% US$32bn while reported net profit fell 58% to US$4.2bn. On an underlying basis, that is, excluding US$1.4bn in asset writedowns due to falling commodity prices, net profit fell by Our View Hold a still substantial 43% to US$5.7bn. Asset writedowns in periods of falling prices aren’t unusual and BHP’s nickel and alumina Table 1: BHP’s half-year result operations took the brunt of the burden, reflecting dire conditions in those industries. From H1 2013 h1 2012 Change earnings per share of 107 US cents, down 43%, a fully franked 57 US cent dividend was (%) declared, up just 4%. Rev (US$bn) 32.2 37.5 –14 Once again it was BHP’s iron ore and petroleum divisions delivering the bulk of profits; Underlying NPAT (US$bn) 5.7 10.0 –43 iron ore contributing US$4.1bn and petroleum generating US$3.1bn of net profit. The Op. cashflow (US$bn) 6.4 12.3 –48 struggling aluminium and nickel division lost another US$285m in underlying earnings Underlying EPS (USc) 106.8 188.7 –43 to accompany the US$66m loss generated this time last year. With more than US$8bn in operating assets tied up in aluminium and nickel, the division is likely to be broken up DPS (USc) 57 55 4 and sold at some stage. Franking (%) 100 100 n/a

Second glance On first inspection, the controversial entry into US shale production appears a failure; almost US$25bn of assets generated an underlying loss. Yet that conclusion is too hasty. BHP will spend US$4bn punching wells this year, 80% of those in oil rich areas of the Permian Basin and the Eagle Ford shale, where returns on capital can reach up to 100% in the best locations. BHP may have bought Petrohawk for gas but it will make its fortune out of oil. We expect profits from the division to grow steeply over time with production from petroleum growing at 10% a year for the next decade. Although production volumes rose in almost all commodity groups, this was more than Only in a mining offset by lower prices. Volume growth generated US$435m in additional earnings before business can halving profits interest and tax (EBIT) but falling prices stripped US$5.4bn from the EBIT line. Only base be proclaimed an outstanding metals generated higher EBIT, a result of stable prices and exceptional copper output. outcome. Average iron ore prices fell by 28% during the half year, wiping US$3.5bn from EBIT. Although they have rebounded since, the company confirmed that new, low cost supply will enter the market in the years to come. As prophesised in Iron ore: this time it’s (not) different on 15 Nov 10, the great iron ore boom will end. BHP will conclude its enormous investment in the sector in anticipation of lower prices.

Legacy That hasn’t happened yet, however. The company generated just US$6bn in operating cashflow during the period but it spent twice that sum completing expansion projects, mostly in iron ore, copper and oil. Aggressive production growth will be the lasting legacy of outgoing chief executive Marius Kloppers. New chief executive Andrew Mackenzie, steeped in Rio Tinto and BP conservatism,

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has signalled a more sedate approach. As in the rest of the industry, capital expenditures will fall and we expect free cashflows will start to rise from next year. bhp recommendation guide The big unknown is what happens in petroleum. That business will devour cash in the years to come; if rates of return approach our expectations, the company will do fine. If Long Term Buy Below $33.00 not, BHP might have a ‘Rio moment’ of its own. We’ve upgraded our recommendation hold Up to $50.00 guide slightly to account for falling expenditures. BHP’s share price is up 18% since Sell Above $50.00 Iron ore: Trumpets and warning bells on 13 Sep 12. For now, HOLD.

BlueScope Steel | Gareth Brown

BlueScope Steel’s results for the half-year ended 31 December 2012 were, as expected, messy. Both volumes and revenues fell more than 15%, but that was chiefly caused by BlueScope Steel | BSL the wise decision to get out of the export business in the prior financial period. Headline Price at review $4.35 ‘profit’ improved from a half-billion dollar loss in the comparable period last year to a loss of

Review date 19 Feb 2013 $12m, while the underlying operations eked out a small net profit of $10m. Operating cash flow improved from an outflow of $151m in the same half last year to an inflow of $44m. Max. portfolio weighting 2% The turnaround continues but directors have behaved sensibly in not declaring an interim Our View Hold dividend until a surer footing is certain. Part of achieving that surer footing, the Coated Products joint venture transaction with Nippon Steel & Sumitomo Metals Corporation, has Table 1: bsl’s half-year result ‘now obtained almost all of the regulatory approvals that are required’ and is expected to H1 2013 H1 2012 Change close by the end of March. The deal will leave BlueScope close to debt free. (%) Having upgraded the stock to Hold on 21 Dec 12 (Hold—$3.42) but before we had Volume (mT) 2.15 2.66 –19 a chance to take a more in-depth look from a buyer’s perspective, the stock went on a Sales ($bn) 3.7 4.4 –17 tear—rising 27%. Our interest has been muted somewhat, but we still intend to take a

Reported net profit ($m) –12 –530 n/a closer look soon. HOLD.

Underlying net profit ($m) 10 –136 n/a

Interim dividend Nil Nil n/a Full-year result

Boart Longyear | Gaurav Sodhi

There is little to like about the world’s largest supplier of drill rigs. Boart Longyear | BLY

Price at review $1.95 Boart Longyear’s full-year result confirmed the end of the mining boom. Revenue for

Review date 18 Feb 2013 the full year fell marginally to just over US$2bn, generating net profit US$68m, a 57% fall from last year largely due to the inclusion of US$68m worth of restructuring charges. Our View Avoid From earnings per share of 15 US cents, down 57%, a partly franked dividend of 10 US cents (ex-date unknown) was declared. Worryingly, operating cash flow fell 68% to Table 1: Boart Longyear’s result US$64m while the company spent almost US$280 on capital expenditure. 2012 2011 Change (%) Boart is the world’s largest supplier of drill rigs. Although the business is notionally exposed to the supply, rather than the price, of minerals, the demand for drilling depends of Rev (US$m) 2,011 2,020 <1 the exploration budgets of miners. That, in turn, is entirely dependent on commodity prices. NPAT (US$m) 68.2 159.9 –57 Boart cannot escape its fate as a cyclical business that lives and dies by the commodity cycle. Op. cash flow (US$m) 64.2 197.7 –68 In recent times, the cycle has been particularly cruel. Although commodity prices have EPS (USc) 15.0 35.1 –57 recovered from last year’s lows, miners have been frightened by the prospect of a bust. The DPS (USc) 7.4 9.8 –24 largest have tightened their exploration budgets by choice, focusing on operating efficiencies

Franking (%) 15 15 n/a to raise volumes. Smaller miners have had lower exploration budgets forced upon them. By choice or design, the industry is spending less on exploration and the prospect for drilling intensity has deteriorated. For Boart, this presents a problem. The company derives 75% of its revenue, and the bulk of its profits, from drilling, and the utilisation rates on rigs fell from 75% in 2011 to 69% in 2012. Utilisation rates, determined by industry exploration budgets, contribute to wildly volatile profits. Over the past five years, net profit margins have swung from -8% in 2006 to 3% last year. A competitive, cyclical business like this one should, ideally, carry little or no debt. That hasn’t been the case historically and it isn’t the case now. Although net debt has fallen from over US$1.2bn in 2006 to US$512m today, it’s still too high, with operating cash flow covering cash interest payments a dangerously low 2.2 times.

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It’s easy to assume that all the bad news in the financials is also reflected in the share price, which has fallen from highs of over $4 a year ago. The business, for example, boasts a valuation which is currently below book value. But a closer inspection of its assets suggests it’s far from cheap. From assets of US$2.2bn, deferred tax assets and intangibles comprise over US$600m and inventories another US$530m. This is, in other words, a poor quality balance sheet. To tempt us, the price would have to fall to well under tangible book value. Failing that, there is no compelling case to buy or hold. AVOID.

Brambles | James Carlisle

Brambles has reported a 12% rise in earnings per share to 20.1 US cents for the six months to 31 December on a 4% rise in sales. On a constant currency basis, the rises Brambles | BXB were 16% and 6% respectively. Price at review $8.61

That’s a decent performance given the weakness in the global economy and it backs up Review date 21 Feb 2013 a strong 2012 full year, in which earnings per share grew 18% on a constant currency basis. Our View Avoid There was also an improvement in cash generation, with free cash flow of $177m in the period compared to an outflow of $95m in the prior half, but it still wasn’t enough to cover dividend payments of $210m. Brambles is a globally dominant business, but it involves a huge capital base, spread across the world in the form of pallets: they’re expensive to produce and maintain and they’re easy to lose. This means relatively low returns on capital (of 15% in the period, up from 1%), at least for a globally dominant business, and high levels of capital expenditure—of US$949m in the 2012 financial year, for example, compared to operating cash flow of US$1,089m. The share price is up 28% since 27 Aug 12 (Avoid—$6.73), putting it on a forward price-earnings of almost 19. Today’s result looks reasonable, but the thorn is still prominent in the company’s side and we’d need a much lower price to consider an upgrade. AVOID.

Half-year result BWP Trust | BWP BWP Trust | Jason Prowd Price at review $2.27

Review date 20 Feb 2013 It’s steady as she goes for this owner of Bunnings Warehouses. Max. portfolio weighting 5% BWP Trust reported a decent result for the half-year ended 31 December. Revenue Our View Long Term Buy rose 8% to $54.0m, which followed through to distributable earnings of $37.4m, also up 8%. An unfranked interim distribution of 7.0 cents per unit will be paid on 26 February to Table 1: BWP’s half-year result those who owned the stock prior to 31 December 2012. H1 2013 H1 2012 Change By all accounts BWP is a boring property trust—but don’t let that put you off. (%)

The income from its core property portfolio increases broadly in line with inflation—in Revenue ($m) 54 49.8 8 the period just ended like-for-like rent increased 2.4%—but total returns are enhanced by Distributable Profit ($m) 37.4 34.5 8 developing existing sites and acquiring new ones. During the half BWP purchased a Bunnings Warehouse property at Gladstone on a DPS (cents) 7.00 6.63 6 Like-for-like rent starting yield of 8.8%. And since 31 December, it has announced the purchase of land at 2.4 3.3 -0.9 growth (%) Wallsend and Albany, plus the redevelopment of the site at Rocklea. Together, transactions Net debt to total like these should help propel total returns into the high single digits. 21.7 18.9 15 assets (%) BWP Trust remains an excellent investment option for those seeking inflation-protected income. The current yield of 6% (unfranked) alone remains ahead of term deposits, Occupancy (%) 100 100 n/a Avg capitalisation and that’s without allowing for capital growth. Risks are minimal, with net debt a very 7.91 7.81 1 rate (%) manageable 22% of assets. The security price is basically unchanged since The ‘high yield & safe’ mini-portfolio from 1 Feb 13 (Long Term Buy—$2.34), which provides a more detailed background for interested investors. The investment case remains unchanged. bwp recommendation guide

LONG TERM BUY. Long Term Buy Below $2.35

hold Up to $3.50

Sell Above $3.50

9 Intelligent Investor Share Advisor

Full-year result

Coca-cola Amatil | James Carlisle

Hampered by December’s trading update, the beverages company has largely Coca-Cola Amatil | CCL missed out on the recent market rally, but today’s result shows sound performance Price at review $13.93 across the business.

Review date 19 Feb 2013 Coca-Cola Amatil has largely been left out of the recent market rally, trading up only Max. portfolio weighting 3% 2% since our update on its interim result on 25 Aug 12 (Hold—$13.75) after putting in Our View Hold solid gains in the first half of last year. It wasn’t helped by a negative trading update in December, but today’s full-year result shows that the most important parts of the business Table 1: Ccl’s full-year result are performing well. Revenue rose 6.2% to $5,097m, while earnings before interest and tax grew 3.1% to Year ended 31 Dec 2012 2011 Change (%) $896m and net profit before significant items rose 5.0% to $558m. Underlying earnings

Revenue ($m) 5,097 4,801 6 per share rose 4.6% to 73.4 cents, bang in line with guidance and forecasts. The Australian non-alcoholic beverages business performed okay, with revenue growing EBIT ($m) 896 869 3 5.1% to $3,028m, although price discounting saw the EBIT margin slip from 21.1% to Underlying net profit ($m) 558 532 5 20.7% leaving EBIT up only 3.3% at $627m. Underlying EPS (c) 73.4 70.2 5 But the standout performer was Indonesia and PNG where the EBIT margin went the DPS (c) 59.5 52.5 13 other way, from 10.4% to 10.6%, giving a 16.8% rise in EBIT to $103m on revenue that rose 12.1% to $948m.

Rotten tomatoes New Zealand saw EBIT fall 11.8% due to bad summer weather and the weak economy. But the main area of disappointment was SPC Ardmona, which has been left vulnerable to cheap imports by the strong Australian dollar and has also seen a shift from tinned to fresh fruit on account of price falls in the latter. The company took a $188m charge in respect of SPC Ardmona in the year, including a $100m writedown on inventory. This was offset by one-off gains of $53.2m. In the medium term, growth plans focus on the development of the alcoholic beverages business. The company has entered a beer manufacturing joint venture with privately- On an earnings basis, the owned Casella Wines, with production due to start in December 2013, and has signed an stock looks highly priced but not exclusive agreement to distributed Rikorderlig cider from January 2014. extravagantly so. Investments in the Project Zero efficiency program and in Indonesia and PNG led to an increase in capital expenditure in 2012 to $465m, but this is expected to reduce ‘to an average of $350m–420m per annum over the next three years’, with 2013 expected to be at the top end of that scale. Even with the higher than usual capex, however, net debt was reduced by $110m to $1,633m, and the net interest bill was covered 8.0 times by EBIT, up from 6.8 times in 2011.

Good-looking yield A final dividend of 32.0 cents will be paid, up 4.9% but only franked to 75%, and the company declared a special dividend of 3.5 cents, apparently to make up for the lower franking, although we’d prefer to see debt further reduced. In all, dividends for 2012 amounted to 59.5 cents, an increase of 13.3%. ccl recommendation guide The company said it expected to pay out about 75% of earnings in 2013, which would Long Term Buy Below $12.00 mean about 61 cents based on the current consensus forecast for earnings per share of hold Up to $17.00 81.5 cents: a yield of 4.4% at the current share price. That’s a good-looking yield for a company that should at least grow earnings along take part profits Above $17.00 with the economy and, although the dividend is not quite covered by free cash flow, that should be rectified as capital expenditure falls over the next couple of years. On an earnings basis, the stock looks highly priced but not extravagantly so, on a price- earnings ratio of about 19, falling to 17 for 2013. We’ve increased our price guides a little and the stock is closer to an upgrade than a downgrade (just), but for now it remains a HOLD.

10 Weekly Review | Issue 362a

Half-year result

Infigen Energy | Gareth Brown

Greater production and higher average prices from its Australian assets boosted Infigen’s interim results. Infigen Energy | IFN Price at review $0.29 In the half year ended 31 December, Infigen Energy’s 24 wind farms in Australia and Review date 22 Feb 2013 the United States produced 2,161 gigawatt hours (GWh) of electricity, up 4% on the Max. portfolio weighting 3% prior corresponding period, helped by a full contribution from the Woodlawn facility and windier average conditions in Australia. The US assets experienced, on average, weak wind Our View Hold conditions and that trend continued into January. Should the concept of a gigawatt hour mean little to you, that production generated revenue of $134.2m in the half, up 7%. Lower average prices in the US were more than Table 1: Ifn’s half-year result offset by higher Australian electricity prices, particularly in NSW and South Australia, after H1 2013 h1 2012 Change (%) the introduction of the carbon tax on 1 July 2012. Earnings before interest tax, depreciation and amortisation (EBITDA) increased 14% to $70.9m. The group’s net loss improved to Production (GWh) 2,161 2,083 +4 $27.8m, but this figure is less meaningful than the net operating cash flow, which lifted Revenue ($m) 134.2 125.7 +7 9% to $23.0m. EBITDA ($m) 70.9 62.2 +14

That cash flow was all applied to paying off debt, and gross debt fell $30m to $1,039m Net profit ($m) (27.8) (35.2) +21 but a reduction in cash balances of $16m, to $110m, partially offset this. The company Operating cash 23.0 21.1 +9 expects to pay off a total of $55m over the full financial year to 30 June 2013. The group flow ($m) announced a cost review and organisational restructure, aiming to reduce operating costs by $7m per annum from the 2014 financial year onwards. We reassessed our stance on the group’s debt and downside protection back in Infigen: A broken thesis of 2 Oct 12 (Hold—$0.28), and it’s important that members who still own the stock fully grasp this issue. No longer do we consider the stock ‘heads I win, tails I don’t lose too much’, though some partial downside protection remains. It’s probably lower risk than most High Stakes recommendations, but it’s speculative nonetheless. Those not comfortable should consider taking their profits and moving on. Otherwise, HOLD for now. Note: The model Growth portfolio owns Infigen shares.

Full-year result

InvoCare | James Carlisle

It’s a good business that can raise prices at the same time as increasing market share in a growing market, but unfortunately this fact isn’t lost on other investors InvoCare | IVC Price at review $10.01 A pick-up in the number of deaths in the second half of 2012 has helped InvoCare Review date 19 Feb 2013 to a 17% increase in underlying net profit to $43m, on sales that rose 15% to $369m. Underlying earnings per share rose a slightly slower 13% to 38.8 cents, due to the issue Max. portfolio weighting 3% of shares to fund the acquisition of Bledisloe in late 2011. Our View Hold Excluding Bledisloe, the underlying profit would have risen 12% on a 5.8% increase in sales. Annualised cost savings of $3.5m have now been achieved at Bledisloe and its earnings before interest, tax, depreciation and amortisation margin of 18.8% compares with 26.7% for the rest of the group, so further improvement is likely.

Table 1: Breakdown of InvoCare’s 2012 full-year result Group excl Growth excl Bledisloe tOtal Overall Bledisloe Bledisloe (%) GROwth (%)

Sales ($m) 299.3 5.8 69.3 368.7 14.9

EBITDA ($m) 80.0 6.3 13.0 93.0 13.7

EBITDA margin (%) 26.7 0.1 18.8 25.2 (0.3)

Underlying net profit ($m) 38.9 11.7 3.6 42.5 16.7

Underlying EPS (c) 35.5 7.5 3.3 38.8 12.3

DPS 34.0 14.3

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Strong brands As well as the increased number of deaths, InvoCare was able to increase its market share slightly (putting the overall number of funerals performed up by 1.5%) at the same time as pushing through price increases that saw the average revenue per funeral rise by 4.3%. It’s a good business that can raise prices at the same time as increasing market share It’s a good business that in a growing market, and it reflects the price inelasticity of the funeral market, as well as can raise prices at the same time the strength of InvoCare’s brands. as increasing market share. On a statutory basis, net profit was up 65% due to weak investment performance in 2011. The company collects payments in advance for funerals and invests the money—very conservatively—and takes the difference between the investment return and the expected cost of providing the funerals through the profit and loss account each year. In 2012, the company almost broke even with the expected costs rising $17.7m while the investments returned $17.6m. In 2011, on the other hand, a increase of $15.5m in expected costs was much higher than an investment gain of only $2.1m, leading to a loss of $13.4m.

Valuation stretched Operating cash flow rose 21% to $53.2m and $34.8m of that was left after capital expenditure, just covering the dividend payments of $34.4m. Net acquisition costs of $6m ccl recommendation guide meant that net debt rose slightly to $217m, compared to equity of $152m. However, the Long Term Buy Below $7.50 high returns on that equity meant that the interest bill was covered five times by earnings hold Up to $12.00 before interest and tax and more than twice by free cash flow. We’d expect to see earnings per share growth in the high single digits over the long take part profits Above $12.00 term, although the high payout ratio may need to drop a little at some point given the high debt levels, meaning that dividend growth might be a little lower. To this you can add a current dividend yield of about 3.4%, which isn’t quite enough to interest us, even for such an attractive business. On an earnings basis the valuation looks more stretched, with the stock trading on a multiple of 26 times 2012 earnings and about 23 times the consensus forecast for 2013. The stock is up 11% since 4 Sep 12 (Hold—$8.99). HOLD.

Full-year result IRESS | Jason Prowd

A growing market for its wealth management software failed to offset lower Key Points demand for its market data products both here and abroad. Jason Prowd revisits Disappointing full-year result, as overseas the case for IRESS. businesses falter The business still well above average IRESS’s full-year result failed to impress. Net profit fell 9% to $54.4m, from slightly higher Growth may be lower than initially expected revenue of $206.7m. However, excluding the amortisation on sunk software development costs, earnings before interest tax and amortisation (EBITA) was down only 2% at $60.1m. A 24.5 cent final dividend was declared, bringing the annual total to 38 cents (90% franked, IRESS | IRE ex date 5 March). Price at review $ 8.10 In 2010 we upgraded IRESS due to its excellent cash generation and on the basis that Review date 22 Feb 2013 its dominant position at home and planned overseas expansion would lead to further

Max. portfolio weighting 3% earnings and dividend growth. Nearly three years on, the share price is down slightly (although dividends would mean investors are slightly ahead). Earnings and dividends Our View Hold have similarly been flat. These are hard times for a company that’s used to generating 15%-plus growth, so what, if anything, has fundamentally changed?

Australian business steady Table 1 presents a numerical overview. The core Australian financial market data business has been steady. That’s no surprise: the finance industry has been laying off staff, making it hard to maintain the number of licences, let alone increase prices. And with IRESS commanding the majority of the market, we were never expecting outstanding growth. Modest growth is still possible but is dependent on a pick-up in equity markets. Judging from ASX’s recent result we may be headed that way. Its newer wealth management business has continued to have success, winning new

12 Weekly Review | Issue 362a

clients and increasing profit, which rose 15% for the year just ended. Here an increasingly complex regulatory environment and lack of other options is helping IRESS. We’d expect Table 1: IRE’s summary financials this division to continue to grow revenue and profits in the mid-single digits. 2009 2010 2011 2012 If we’ve overestimated IRESS’s abilities, it hasn’t been on the home front. Revenue ($m) 171.4 183.0 204.5 206.7

EBITA ($m) 39.9 56.5 61.5 60.1 Canucks drag on performance EPS (cents) 34.2 40.0 32.6 30.7 Overseas, however, it hasn’t been smooth sailing. The company’s expansion into Canada has proved more difficult than expected, and the full-year result extended the frustration FCF per share (cents) 55.8 57.1 37.5 43.2 expressed half-way through the year. For the full year, profits fell 23% to $6.2m. DPS (cents) 32.0 39.0 41.5* 38.0 Its single-product focus in Canada makes the division vulnerable to demand Franking (%) 100.0 100.0 85.6 90.0 fluctuations from sell-side brokers. Competition has been tough, as larger operators such Divisional results (net profit $m) as ThomsonReuters undercut IRESS’s pricing. A weak equity market hasn’t helped either. This Australia (Fin mkt) 56.6 58.9 56.3 54.2 has made winning large clients difficult, and hampered growth. Longer term, management Australia 16.9 18.6 20.3 23.4 plans to expand its offering in Canada to make it less reliant on sell-side brokers. (Wealth manag.)

South Africa too, has presented mixed results. There it sells wealth management Canada 7.0 7.8 8.2 6.3 software and, since 2011, financial market data, thanks to its acquisition of Peresys. Its wealth South Africa 2.5 2.2 7.2 6.5 management business suffered over the past year with profit falling 31%. The financial UK n/a n/a n/a –3.0 data business, though, continues to perform strongly, with profit up 6% in 2012—although it wasn’t enough to offset the losses in wealth management. South Africa’s market is Asia –0.2 –1.7 –1.5 –4.0 significantly smaller than Australia’s, but here too we see significant potential for growth. Shares on issue (m) 123.8 126.0 127.0 128.6

UK opportunity *Includes special dividend of 2.5 cents IRESS has also expanded into Asia and the UK. These are both long-term projects. Three years in, its Asian business is still making losses. It’s hard to gauge the potential for success in Asia, but there’s no obvious reason why IRESS shouldn’t be able to turn a profit from the region. Management has also capped total investment in Asia at $4m per The UK expansion is year, which is a prudent approach to expansion. a more recent development The UK expansion is a more recent development and presents a significant opportunity— and presents a significant with a potential market for wealth management software twice that of Australia. It’s a opportunity—with a potential sensible move, and fits management’s measured approach to expansion. It’s early days but we can see this division contributing meaningfully to future profits. It recently signed market for wealth management Towry—a medium-sized financial advisor—as a client, which bodes well for the division’s software twice that of Australia. progress. Over time, the UK business could grow to equal that of the Australian wealth management arm.

Quality remains, growth more subdued At home, IRESS has a stable financial markets business, coupled with a growing wealth management division. Elsewhere it’s proved tougher to bank profits than we expected, but ire recommendation guide we still expect decent growth from this business: somewhere in the order to 5%-10% a Long Term Buy Below $6.00 year in a more buoyant equity market environment. hold Up to $9.50 IRESS remains an above-average business that’d we’d buy at the right price. For now, take part profits Above $9.50 though, with the share price up 14% since our update on the interim result on 27 Aug 12 (Hold—$7.11) we’re happy to bide our time. HOLD.

Full-year result Monadelphous | Gaurav Sodhi

Despite another excellent result, the markets high expectations weren’t met.

Despite releasing yet another sensational interim result, shares in Monadelphous swiftly fell 6% as expectations overshot reality. Revenue rocketed 47% for the half year to $1.3bn Monadelphous | MND while net profit rose 38% to $79.1m despite margins margins dipping from 6.5% last year Price at review $26.35 to 6.1%. From earnings per share of 88.6 cents, up 36%, a 62 cent dividend was declared Review date 20 Feb 2013 (fully franked, ex date 4 March). As usual for this business, a large $126m net cash pile Our View Avoid sits on the balance sheet, a mark of management’s conservatism. The result was difficult to fault, yet that’s exactly what the market did. Too much growth had been baked into the share price and it was promptly deflated. This is a classic lesson in why even high quality businesses need to be purchased at reasonable prices. Only

13 Intelligent Investor Share Advisor

operating cash flow disappointed, falling 37% to $43.3m. Collecting cash is a vital metric for Table 1: Mnd’s half-year result an engineering business as they can book revenues on maturing projects without collecting H1 2013 h1 2012 Change (%) cash. The cash shortfall appears to be caused by the timing of contract payments and it’s Rev ($m) 1,289 880 46 something to watch in the full year result.

NPAT ($m) 79.1 57.5 38 Despite the downturn in mining activity, it was rising sales that propelled profits higher. Expansions in LNG and iron ore projects lifted revenue from the dominant engineering Op. cashflow ($m) 43.3 68.4 –37 construction division an astonishing 71% to $877m. The maintenance division registered EPS (c) 88.6 65.4 35 only modest revenue growth although it did win the lucrative 6.5 year maintenance contract DPS (c) 62.0 50.0 24 for BG’s Queensland Curtis Island LNG project. Infrastructure remains a small part of the Franking (%) 100 100 n/a business, representing just 7% of revenue, but grew 50% this year. Management have hopes the division can diversify earnings away from mining in the future. That is a sensible aim because today, the company is at the mercy of mining investment. LNG construction will peak in 2014/2015 and coal and iron ore expansions are unlikely to match the recent past. This year could be the last of leaping profit growth. Yet with a larger base of mining assets now in operation, maintenance contracts could still drive profits higher even with lower mining investment. We’ve underestimated the dominance of this business. A relentless string of major contracts wins and financial results that tower over its peers suggest Monadelphous does indeed boast a competitive moat. Yet the cyclicality of the business is inescapable. With the mining investment boom now subsiding, profit growth will, at best, slow. The market has not priced this outcome into the share price which still trades on a hefty price to earnings ratio of 17 and we’d rather lose potential dollars being conservative than the real thing. The share price is up 10% since 21 Aug 12 (Ceased Coverage—$23.83) and we recommend you AVOID.

NAB CPS | James Carlisle

NAB has finally jumped at the chance to raise cheap equity from willing punters, with the launch of NAB Convertible Preference Shares. It’s a preference share, so it’s different NAB CPS | NABPA in form to Westpac Capital Notes, launched earlier in the month, but it’s almost identical Price at review N/A in substance.

Review date 19 Feb 2013 Like Capital Notes, the dividend payments are quarterly, the indicative margin is 3.2% to 3.4% above the 90-day bank bill swap rate and mandatory conversion occurs (hopefully) Our View Avoid in March 2021. It also includes the ‘non-viability trigger event’ (in addition to the ‘capital trigger event’) and can be written off if conversion isn’t possible. Which is better? It really comes down to your choice of Westpac or NAB. You’d be hard-pressed to find two more closely matched offers. Our recommendation is to avoid both but, if you are interested, be sure to read our Westpac Capital Notes review. Of course if you’re interested it begs the question why you haven’t already loaded up on ANZ CPS 3, Westpac CPS, CBA PERLS VI or Westpac Capital Notes? NAB will no doubt get their issue away but, with the volume of issuance, it’s hard to imagine that anyone keen on bank convertibles isn’t full to the brim already. Over on Intelligent Investor Super Advisor we’ve compared the new NAB CPS to these and other options—the best of which, for most people, would be a suitable balance between term deposits and some of the relevant bank’s ordinary shares. In investing, it’s usually best to keep things simple. AVOID.

14 Weekly Review | Issue 362a

Half-year result

Platinum Asset Management | James Carlisle

Platinum ticks all the boxes as an excellent business in an attractive sector, but we’ll have to be patient for another entry point. platinum asset mgmt | ptm Price at review $5.30

Fund management companies have some of the simplest accounts: they have a pile Review date 22 Feb 2013 of money on which they earn a percentage fee, and they have salaries, marketing, rent Max. portfolio weighting 5% and some admin fees to pay. If you take one from the other, you’re left with a profit (and you probably won’t be far from the cash flow). Our View hold In Platinum Asset Management’s interim result, the pile of money averaged $15.2bn (down 6.2% from an average of $16.2bn in the prior period), the fees came to $102.7m (down 6.6% from $110.0m) the costs were $19.4m (down 4% from $20.2m). That left an operating profit of $83.4m (down 7.2% from $89.9m). After some interest and tax, net profit fell 7.0% to $62.4m and earnings per share fell the same amount, to 11.2 cents. An unchanged fully franked interim dividend of 8 cents was declared, payable on 18 March.

Jumpy markets, fleeting performance, fickle investors It all seems so simple. Except it’s not, because the key factor—the future development of the pile of money—is so hard to pin down. Markets can be jumpy, performance can Table 1: Ptm’s half-year result be fleeting and investors can be fickle. So much so that guessing the level of funds H1 2013 H1 2012 Change (%) under management even a few years’ hence is nigh impossible—let alone the long-term projections necessary to make a reasonable stab at valuation. Mgmt fees ($m) 96.0 104.5 –8.1 And yet fund managers have wonderful business qualities, converting almost all their Perf. fees ($m) 1.7 0.3 564.4 profit into free cash and with favourable long-term industry dynamics from compulsory Amin. fees ($m) 5.0 5.3 –5.2 superannuation. We’d love to find some good ones to buy. Revenue ($m) 102.7 110.0 –6.6 So what are the qualities we should look for? First, we need to find a fund manager Expenses($m) 19.4 20.2 –3.9 with an investment approach that should be successful over the long term. For us that EBIT ($m) 83.4 89.9 –7.3 means a skillfully applied value investing approach (Platinum scores a resounding tick on this measure). Second, we need it to have a reasonable handle on costs (again, a big tick Net interest ($m) 5.0 6.2 –19.5 given the operating margin of 81% in the half). Gains/losses on inv. ($m) 0.1 –0.9 –106.4 Profit before tax ($m) 88.4 95.2 –7.2 The hard sell Tax 26.0 28.0 –7.4 Our third criteria is an ability to sell the message and thereby pull in the funds under Net profit 62.4 67.2 –7.0 management. This is where Platinum has fallen down over the past few years. It absolutely EPS (c) 11.1 12.0 –7.0 smashed the market in the aftermath of the global financial crisis, building on years of outperformance, but somehow funds under management never saw the benefit. No doubt Interim DPS (c) 8.0 8.0 0.0 its refusal to pay commissions to financial advisers is part of the story, but this problem will be reduced when such commissions are banned from July this year. There’s an upside to not pushing the story too hard, though, because the harder you sell, the more you pull in marginal investors, and they’re the first to leave when times get Chart 1: PTM’s funds under tough. By contrast, if investors come directly to you, for your investment approach and managment long-term performance, then they’re likely to cut you more slack. ($bn) Platinum’s funds under management peaked at $22.2 billion back in February 2007 25 (shortly before its flotation in May that year, which is further demonstration of Kerr Neilsen’s investment nous). They fell to $13.6bn during the GFC, but that was mostly down to 20 market performance, and they have since edged back to $17.3bn. There has been no rush for the exits. 15 10 Buying when others are fearful Notice that underlying market performance is not on our list of criteria. We’re very 5 confident of the sharemarket’s ability to capture the economy’s wealth generation over 0 the long term, but we don’t think its movements can be predicted in the short term. So Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 the answer here is just to take the status quo and add an appropriate long-term growth Source: Platinum Asset Management rate each year. Right now, that’s probably only about 5% per year (to give total returns in the high single digits after dividends). For the broader market, however, short-term market performance most certainly is a swing factor—and that’s what provides the opportunity: when markets have been going

15 Intelligent Investor Share Advisor

up, as they have been recently, investors appear to factor in a continuation of that—as they do when markets have been falling. Putting it all together, our approach is to find fund managers with the right skills and investing approach, a handle on costs and preferably an ability to get their message across—then buy them when others are most fearful. We got this wrong when we recommended Platinum soon after its float, on 23 May 07 (Long Term Buy—$7.90), when others were not fearful in the least. But we continued to ptm recommendation guide back the company during its darkest hours (see FUM’s down for fund managers on 24 Jul buy Below $3.40 08 (Buy—$2.94) for example) so hopefully members had the opportunity to average down.

Long Term Buy Up to $4.00 More recently we’ve moved back to Hold and, with the stock up 5% since 5 Feb 13 (Hold—$5.05) that continues to the be the right recommendation, although we’re raising sell Above $7.00 our Sell price further to reflect the improved status quo (FUM has risen further this year and Platinum’s fund performance has also improved). We’re hopeful of further opportunities to buy this excellent company, but markets will probably need to have a wobble first. HOLD. Note: Our model Growth and Income portfolios own shares in Platinum Asset Management. Disclosure: Staff members own shares in Platinum Asset Management, but they don’t include the author, James Carlisle.

ResMed | James Carlisle

He’s been at ResMed for 12 years, after a career in management consultancy and in biotechnology, and oversaw sales growth in the Americas of 30% over almost two years ResMed | RMD in charge of that region. So there’s no reason to suppose any nepotism in the appointment of Mick Farrell to replace his father, Peter Farrell, as chief executive of the company. Price at review $4.21 So much so, that it only got a brief mention in the press release, and that’s fair enough. Review date 21 Feb 2013 The company should put Mick forward as his own man. We just give the relationship Max. portfolio weighting 5% higher billing as it’s a natural question to ask. As well as his previous roles at ResMed and Our View Long Term Buy in consulting, Mick Farrell has a first-class engineering degree from the University of New South Wales. More than anything, we’re delighted to see an internal appointment—of an engineer—to the role. The same can be said of 11-year ResMed veteran Rob Douglas, who will become president and chief operating officer. Douglas joined ResMed in marketing, but has since rmd recommendation guide been chief of global supply operations and chief operating officer of the Asia-Pacific region. buy Below $3.50 He also has a first-class degree from the University of New South Wales, except that it was in electrical engineering rather than plain engineering. Long Term Buy Up to $5.00 The changes will take effect from 1 March and Peter Farrell will stay on until the end of take part profits Above $8.00 the year as executive chairman, to help with the transition, at which point he will become non-executive chairman. The stock is up slightly since 31 Jan 13 (Long Term Buy—$4.15). LONG TERM BUY. Note: Our Growth and Income portfolios own shares in ResMed. Disclosure: The author, James Carlisle, owns shares in ResMed.

Full-year result Rio Tinto | Gaurav Sodhi

A poor result masked important strategic changes that herald the return of the Rio Tinto | RIO old Rio Tinto. Price at review $70.29 Rio Tinto reported a statutory loss for the first time in its long corporate history. Lower Review date 15 Feb 2013 commodity prices contributed to a 16% fall in revenue to US$51bn and previously flagged Max. portfolio weighting 4% asset writedowns ensured the US$2.9bn loss recorded for the full year compared to a Our View Hold US$14bn profit last year. On an underlying basis, that is, excluding the asset writedown, net profit fell a mere 40% to US$9.3bn. As an act of penance, Rio increased dividends substantially, from 145 US cents last year to 167 US cents (fully franked, ex date 6 Mar). Rio used the historic loss to declare changes in strategy. New chief executive Sam Walsh

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has pledged a renewed focus on costs, renounced excessive ambition and emphasised shareholder returns as a key measure in decision making. Acknowledging past misdeeds, Walsh appears to be returning the company to its conservative roots.

Hidden losses The damage done by the Alcan acquisition is easy to understate because of booming iron ore prices. If poor judgement about aluminium’s future almost bought down the Table 1: Rio’s full-year result business, Chinese steel demand has saved it. Without the remarkable iron ore boom, Rio 2012 2011 Change would surely have failed. (%) That boom is now subsiding. Falling iron ore prices tore US$3.6bn from the bottom Rev (US$bn) 50.9 60.5 –16 line even though volume expanded considerably. Capital expenditure peaked this year Underlying NPAT (US$bn) 9.3 15.5 –40 at US$17.4bn as Rio completed Pilbara expansions and development of the giant Oyu Op. cashflow (US$bn) 16.5 27.4 –40

Tolgoi mine. EPS (USc) –161.3 303.5 n/a With operating cashflow falling 40% to US$16.5bn, Rio was free cashflow negative for DPS (USc) 167 145 15 the year. As iron ore output expands to 360m tonnes in 2015 and capital expenditures fall away, free cashflow should rocket higher. Franking (%) 100 100 n/a The iron ore division generated about 90% of profits while aluminium made a mockingly low $3m contribution and will be partly divested and wholly forgotten in time. Copper remains a key business but we have doubts about returns from both Escondida and Oyu Tolgoi, Rio’s primary copper mines. The first is aging, struggling to maintain output while the second is struggling for liberty from government control and is yet to be tested. Both rio recommendation guide are capital intensive and Rio may be reluctant to feed cash indefinitely. Long Term Buy Below $60.00

Despite the poor result, the strategic change at the company is encouraging. Marginal hold Up to $80.00 output expansions, cavalier adventures and wild risks are being abandoned for cost control sell Above $80.00 and efficiency gains. Shareholders will see the benefits of this approach over time as free cashflow rises which is why we’ve adjusted our recommendation guides up. We still, however, expect lower iron ore prices and hence are demanding a larger margin of safety before buying. The share price is up 7% since Resurrecting Rio from 18 Jan 13 (Hold—$65.98) and we’re sticking with HOLD.

Half-year result Sunland Group | Jason Prowd

Our thesis for buying this Queensland-based property developer is progressing nicely, Jason Prowd unpacks the latest result. Sunland Group | SDG Price at review $1.24 Sunland’s development revenue rose 30% to $77.4m in the half-year ended Review date 19 Feb 2013 31 December and net profit increased from practically zero to $8.4m (although the latter Max. portfolio weighting 3% was boosted by a $6.2m tax benefit related to the recent sale of the Palazzo Versace Hotel). From earnings per share of 4.4 cents, a special 2.0 cent dividend was declared (fully Our View Hold franked, ex date 4 March) to return a small portion of the proceeds from the recent $68.5m sale of the Palazzo Versace Hotel. This result represents welcome progress of the investment case we originally set out in Pouncing on downtrodden developers on 22 Jan 10 (Long Term Buy—$0.78): that Sunland’s ill-fated Dubai expansion was weighing temporarily on shareholders’ minds, as were broader concerns about the property industry. Over time we expected Sunland to leave Dubai and renew its focus on the Australian business, improving profits and enabling the resumption of dividends. With this half-year result Sunland appears headed in the right direction. Since 2010 it has extricated itself from Dubai, and in the process gained complete ownership of the Palazzo Versace Hotel (it previously owned 50%). It sold that asset in 2012 for $68.5m, close to book value. Meanwhile its development business has ticked along and, despite sales tallying only 111 this half, down from 219 in the previous period, management has flagged an improved second half with revenue expected to reach $100m. The company has also bought new sites at Point Cook in Melbourne and Kellyville in Sydney, for $37.8m combined, which will help keep the development pipeline stocked.

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Buyback adds value Reasonable operational performance has been coupled with savvy capital management. An ongoing buyback has reduced shares on issue from 320m in 2009 to 190m today. As the shares have been trading at a large discount to asset backing this has added tremendous value for shareholders. Indeed, whilst other developers have faced shrinking net tangible assets (NTA), Sunland has increased its NTA per share by 4% to $1.86 over the half. The buyback continues, with ambitious plans to reduce the share count by a further 40m shares, which will sdg recommendation guide further boost NTA, although as the stock price rises this become a less attractive use of capital. speculative Buy Below $0.75 This activity means Sunland no longer possesses net cash and debt will likely increase hold Up to $1.50 further as the buyback and new site purchases continue in 2013. Still, with net debt to equity hovering around 5% we remain comfortable, but watchful. Little was also said about sell Above $1.50 the outstanding legal issues relating to its foray into Dubai, but we expect the group to be able to meet any legal costs that may arise. Sunland has returned 62% since our original recommendation. Despite that, the current share price remains at a 33% discount to NTA. The share price is unchanged since we increased our recommendation guide prices on 4 Feb 13 (Hold—$1.25), as is our recommendation. HOLD.

Half-year result Sonic Healthcare | Jason Prowd

Revenue growth in Australia and Germany was offset by a weak performance in the US. Still, Sonic remains a stable, above-average business.

Sonic Healthcare | SHL Sonic Healthcare managed to increase profit by 9% to $155m in the six months to Price at review $12.93 31 December, from revenue that increased 6% to $1,733m, but the share price fell 9%

Review date 20 Feb 2013 on the news. Such is the consequence of missing guidance. Management also ratcheted down full-year earnings growth expectations to the lower end of ‘5% to 10%’. A slightly Max. portfolio weighting 5% higher 25 cent per share dividend was declared (45% franked, ex date 1 February) from Our View Hold earnings per share of 39.5 cents. The weaker than expected performance was lead by the key US market, which makes up 21% of revenue. Revenue there fell 2% to $367m due to the less buoyant economic conditions—resulting in forgone or delayed pathology tests. Superstorm Sandy also didn’t help, wiping around 5% off the region’s earnings on its own. Management expect US results to stabilise as it ekes out costs savings from the business and ‘Obamacare’ helps widen the pool of those with medical coverage, albeit within a tighter fee environment.

German promise Sonic’s German operations showed more promise, as expanded market share helped it increase revenue 8% to $265m. As with other developed markets, the Government is shl recommendation guide keen to reduce the growth in pathology spending by outlining a new stricter funding regime. long term buy Below $11.50 At home, Sonic is also facing tougher regulations. Revenue grew 5% to $520m, and hold Up to $17.00 it remains the largest part of the business, generating 31% of revenue. Sonic is currently take part profits Above $17.00 integrating the recently acquired Healthscope business and expects margins to improve. Operations in Switzerland, the UK and Belgium performed well during the half, but make up less than 10% of Sonic’s business. Sonic Imaging (its radiology business) and IPN Medical Centres (its network of private general medical practices) increased revenue 6% and 15% respectively, and together make up 22% of Sonic’s business.

Scale benefits Running pathology clinics remains a profitable, cyclically immune business, but the general theme is clear: governments need to reduce health spending, making easy revenue growth more difficult to come by. Expansion by acquisition remains an attractive option due to the scale benefits of this business—but we remain mindful of Sonic’s debt load and were pleased to see an increase in interest cover this period to just shy of 8 times. All up, Sonic’s share price is down slightly since 19 Sep 12 (Hold—$13.16), and it remains a comfortable HOLD. Expect a more detailed review after reporting season. Note: The model Growth portfolio owns shares in Sonic Healthcare.

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Half-year result

Servcorp | James Carlisle

The story behind Servcorp’s big expansion has been delayed a little, but it’s still progressing well and we continue to expect a happy ending. Servcorp | SRV Price at review $3.32

As at last year’s AGM, Servcorp is sticking to its full-year guidance, despite what Review date 20 Feb 2013 management described as ‘aggressive price competition’. Max. portfolio weighting 3% In fact they’ve increased it, but only cosmetically. The company has reduced the Our View Hold depreciation rate it uses for leasehold improvements from 15% to 10% a year, resulting in an extra $3m of profit before tax per half. So the full-year profit guidance is now for $33m instead of $27m. Management said the change ‘more accurately reflects the actual life of a Servcorp floor, and also more closely aligns Servcorp’s depreciation policy to the industry standards’. Fair enough. It’s fine for companies to make adjustments like this, so long as they don’t make a habit of it, and Servcorp doesn’t. But it has no effect on cash flow.

Tough targets Before the accounting change, net profit before tax rose 15% to $9.3m. After the accounting change, profit before tax was $12.5m, so the company will need to make more than $20m in the second half of the 2013 financial year to meet its restated guidance— about 50% higher than the $13m we estimate it made in the second half of 2012 after the accounting change. The regional breakdown To be fair, this breakdown is exactly what management was saying at the AGM and was somewhat contrary to what they have always been very candid in the past. So, whilst noting a degree of caution, we’ll one might expect, with good take the guidance at face value. news coming from the USA and The other main concern was cash flow, at which we raised an eyebrow at the time of Europe and bad news closer the AGM. The company’s unencumbered cash position was $92.3m at that point, down to home. from $95.8m at the end of June, and it has now fallen to $87.1m. The culprits are a tax payment that was higher than the actual tax charge (which should even out over time) and a $5m increase in capital expenditure to $12.0m. As we wrote at the time of the AGM, cash flows can be lumpy in this business and that appears to be the case here. Presumably the extra capex is what’s needed to get the floors opened in time to make the profit guidance, so come the next set of results we’ll hopefully have killed two birds with one stone.

USA nears maturity The regional breakdown was somewhat contrary to what one might expect, with good news coming from the USA and Europe and bad news closer to home. The US business is now cash neutral. Revenue rose 53% to $5.7m and the overall loss was cut from $6.1m to $2.9m. Management still expects the ‘USA business as a whole to mature at the beginning of the 2014 financial year’.

Table 1: Servcorp regional breakdown H1 2013 h1 2012 Change h1 2013 h1 2012 Change Revenue ($m) Revenue ($m) (%) Net profit/ net profit/ (%) (loss) (loss)

Aust & NZ 27.2 26.8 1.5 5.7 6.7 –15.0

China 10.9 10.7 2.3 1.1 1.5 –25.9

S–E Asia 9.9 10.0 –0.3 1.8 2.8 –34.0

Japan 24.5 26.0 –6.0 3.1 3.1 2.0

Europe 7.8 7.3 6.4 0.2 –0.9 n/a

Middle East 12.1 10.6 14.2 2.0 1.2 66.1

USA 5.7 3.7 54.4 –2.9 –6.1 n/a

Other 0.5 0.5 14.9 –0.1 –0.1 96.4

Total 98.6 95.5 3.3 11.0 8.2 33.8

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In Europe, occupancy rose in both Paris and London, sending revenue up 3% to $7.1m. Profit before tax on mature floors was $0.6m, while $0.4m was lost on immature floors. The Australian business, however, was hit by the loss of four major clients in the first half, leading to worse than expected performances in Sydney and Perth in particular. Overall profit before tax fell 15% to $5.7m in the half, despite a slight increase in revenue. Immature floor losses in Australia were steady at $1m.

Happy ending Virtual office revenue was 28% of total group revenues of $98.6m, in line with the prior comparable period, and management said it was ‘satisfied’ with its performance. srv recommendation guide The stock is down 3% since we downgraded to Hold on 29 Nov 2012 (Hold—$3.42), Buy Below $2.50 putting it on an undemanding price-earnings ratio of about 13 times current year earnings long term buy Up to $3.20 assuming it hits guidance—with plenty of growth still to come. The story behind the company’s big expansion has been a bit delayed, but it’s still take part profits Above $5.00 progressing well and we continue to expect a happy ending. HOLD. Note: The model Income and Growth portfolios own shares in Servcorp. Disclosure: Staff members own shares in Servcorp, including the author, James Carlisle.

Half-year result Sirtex | Jason Prowd

Fast-growing companies rarely rise in a straight line. Jason Prowd outlines why Sirtex Medical | SRX we’re still backing Sirtex following a less than impressive interim result. Price at review $9.93

Review date 20 Feb 2013 Sirtex Medical posted another record half of dose sales, which rose 31% to 3,522 for the half-year ended 31 December. This translated into revenue of $46.0m, up 25% for Max. portfolio weighting 3% the period, and net profit of $7.8m, a rise of 28%. Earnings per share followed suit, rising Our View Hold 26% to 13.6 cents. As in the previous year, no interim dividend will be paid (although a final dividend of 10 cents was paid during the half, up from 7 cents in 2011). Table 1: Comparison of SRX’s It might seem strange then the share price has fallen 16% since the announcement. recent half-year results Table 1, helps explain why. While all the metrics were extremely positive on a half-on-half H1 2013 h2 2012 h1 2012 h2 2011 basis, they were mostly lower than the preceding half. Expenses rose above our expectations as Sirtex ramped up its marketing spend in the key US market. A slight rise in the Aussie Dose sales 3,522 3,443 2,698 2,652 dollar didn’t help either. Revenue ($m) 46.0 49.8 36.8 38.9 Still, the result remains decent—just not mind blowing—and it doesn’t affect our Net profit ($m) 7.8 11.0 6.1 10.8 longer-term view of the company. The general trajectory of sales remains up, and the rise Free cash 8.3 8.9 1.5 3.5 from minnow to giant is rarely a straight line. flow ($m) The company’s key SIRFLOX study, which aims to provide evidence that SIRS-Spheres R&D ($m) 4.9 4.3 4.2 1.8 can work as an earlier stage treatment for liver cancer, has recruited 90% of the required EPS (cents) 13.6 19.9 10.8 14.2 participants. Clinical research is a slow and costly process with results not due till 2014. But DPS (cents) 10.0 n/a 7.0 n/a if successful it could significantly expand Sirtex’s potential market. We’re more than happy

Franking (%) 100 n/a 100 n/a to accept lower profits now in return for much higher profits in the future. The promotional bent of the company irks us slightly, and it’d be wrong to think of this Cash balance ($m) 50.1 49.0 39.7 42.9 situation as low risk—especially now that the share price has almost doubled since we first recommend the stock in Sirtex enters remission from 08 Nov 10 (Speculative Buy—$5.90). Despite that Sirtex remains somewhat of an anomaly in the biotech sphere: it’s cash flow positive, it pays a dividend and it boasts net cash on its balance sheet. It appears srx recommendation guide expensive on a current earnings basis but that is the wrong way to look at a fast-growing speculative Buy Below $7.50 business like this, with (hopefully) years of growth ahead. Earnings could easily increase hold Up to $15.00 many times from here, and we’re not keen to move on just yet. take part profits Above $15.00 The share price ran up towards the end of last year but is back where it was when we last updated on the company on 18 Oct 12 (Hold—$9.99). To reflect the progress made so far we’re increasing our recommendation guide prices. HOLD.

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Half-year result

Suncorp Group | Nathan Bell, CFA

Fewer losses from natural disasters have more than offset continuing losses from Suncorp’s ‘bad bank’. There’s finally some light at the end of the tunnel for Suncorp Group | SUN loyal shareholders. Price at review $11.45

Review date 21 Feb 2013 The turnaround at Suncorp orchestrated by chief executive Patrick Snowball is nearly max. portfolio weighting 4% complete. With bad debts and losses from natural disasters falling, further shareholder friendly moves are a distinct possibility. Our View Hold Turning to the interim result, profit for the general insurance business—which includes familiar brands such as AAMI and APIA—more than tripled to $564m compared to the same period a year earlier due to a benign claims environment. A $144m profit from the ‘good bank’ was almost perfectly offset by the $143m loss from the ‘bad bank’, while Suncorp’s life insurance business is struggling; profit fell 62% to $51m. Including $42m of acquisition amortisation costs, overall profit increased 48% The general insurance to $574m. Cash earnings per share increased 41% to 48 cents and a fully franked interim business was clearly the hero, dividend of 25 cents was declared, up from 20 cents (estimated ex date 28 March). with gross written premium General insurance the hero increasing 10% to $4.2bn. The general insurance business was clearly the hero, with gross written premium increasing 10% to $4.2bn largely thanks to home insurance premium increases. The division holds over a billion dollars in excess capital, but another special dividend (for example) is unlikely until at least the end of the financial year. Suncorp had already used up a large part of its annual reinsurance protection in the seven months ending in January, so a sudden increase in claims from a natural disaster could substantially reduce the capital buffer. The bad bank is now down to just $3.4bn in assets, with $1.6bn impaired (down from $2.3bn). Assets are expected to fall to $2.7bn by the end of the calendar year, potentially allowing for a return of capital to shareholders. Low interest rates, high employment and falling bad debts are creating a favourable environment in which to unwind the problem loan portfolio. Aside from low investment returns due to low interest rates, Suncorp’s general insurance business is firing on all cylinders and the share price has increased accordingly. Value sun recommendation guide hounds will likely need a string of natural disasters before the share price offers a decent long term buy Below $9.00 margin of safety. hold Up to $15.00 Upgraded following turnaround sell Above $15.00 As the company is in the best condition it’s been in for some time, we’re increasing the prices in the recommendation guide. We’re still a long way from a positive recommendation, but despite the share price increasing 27% since Suncorp: Result 2012 from 30 Aug 12 (Avoid—$9.05) we’re upgrading to HOLD.

Half-year result Tassal Group | Gareth Brown

Domestic sales growth led to improved profits. But the recent stock price rise has further tempered our enthusiasm. Tassal Group | TGR Price at review $1.85 Salmon farmer Tassal Group recently announced its results for the half-year ended Review date 21 Feb 2013 31 December. Revenue, rising 6% to $135.0m, translated into a heftier 22% jump in max. portfolio weighting 2% net profit, to $15.8m. The company actually sold slightly less salmon by volume during the half, cutting exports to near zero but with offsetting domestic market growth (and at Our View Hold higher average prices). The improvement in free cash flow highlighted on 18 Dec 12 (Hold—$1.40) continued, with operating cash flow up 16% to $22.2m and capital expenditure on plant, property and equipment falling 18% to $13.3m for the half year. It’s a trend management expects to continue, with annual capital expenditure likely to run at about $20m-$23m over the next

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few years. The interim dividend was increased 13% to 4.5 cents but it remains unfranked Table 1: Tgr half-year result because the company hasn’t paid any meaningful tax bills during its existence—a quirk H1 2013 h1 2012 Change explained last review. (%) As also explained last review, we have mixed feelings about the stock. It has a Revenue ($m) 135.0 127.6 6 commanding market share and is heavily protected against foreign competition by Australia’s EBITDA ($m) 33.3 29.0 15 strict quarantine laws. But the business has historically been a capital hog (thought his may Net profit ($m) 15.8 13.0 22 be changing), paid little tax (often a red flag) and is exposed to the threats of Amoeba Interim dividend (c) 4.5 4.0 13 Gill Disease and fish kills, both linked to rising summer sea temperatures in Tasmania. The company experienced significant fish kills in the 2011/12 summer at its south eastern sites, Franking (%) 0 0 – and brought forward harvest from those sites by two months as a new strategy (meaning smaller fish sizes). Its expansion plans in Macquarie Harbour are at least in part to protect tgr recommendation guide against these issues, but only time will tell whether problems take hold there too. long term buy Below $1.20 The stock has risen 32% since 18 Dec 12 (Hold—$1.40) and is now trading at a small premium to its net tangible assets of $1.82 per share. The stock is getting closer to hold Up to $2.00 the $2.00 suggested downgrade price in our recommendation guide, but we’ll stick with sell Above $2.00 HOLD for now.

Treasury Group | James Carlisle

Today’s interim result from Treasury Group goes some way to justifying its portfolio approach to the fund management business, but raises other concerns. Treasury Group | TRG Although the implosion we feared at Orion Asset Management appears to be gathering Price at review $6.25 pace, with funds under management (FUM) dropping from almost $5bn to around $3.5bn,

Review date 21 Feb 2013 this was more than offset by FUM rises of about $1bn at each of RARE Infrastructure and Investors Mutual, to about $5.6bn and $3.4bn respectively. max. portfolio weighting 3% Total FUM rose 8% in the period to $17.0 billion and underlying profit after tax increased Our View Hold 7%. The interim dividend was raised 21% to 17 cents, fully franked (ex date 28 February). Our main gripe was the apparently selective disclosure, or at least the selected emphasis. trg recommendation guide Much detail is provided about the fund inflows and margin improvement at RARE and Investors Mutual, but Orion, by contrast, seems to be have been swept under the proverbial speculative buy Below $5.00 carpet. In the circumstances, more rather than less about Orion might have been appropriate. hold Up to $8.00 The commentary also appears to flit between changes in FUM and fund flows as suits best. sell Above $8.00 It doesn’t provide a lot of confidence, but for the time being the market’s rising tide is lifting all fund managers (well, except Orion). The market liked the result, sending the stock up about 4% today. That puts it up 45% since 23 Aug 12 (Hold—$4.30) and there’s enough good news to overcome our concerns about the commentary. We’re nudging up our price guides and sticking with HOLD.

Half-year result Village Roadshow | Gaurav Sodhi

A hot summer, and a couple of blockbusters helped Village deliver an excellent village roadshow | vrl interim result. Price at review $4.40 Village Roadshow’s interim result was superb. Net profit rose 18% to $34m, off a Review date 22 Feb 2013 mere 2% increase in revenue, thanks to earnings growth from each division and lower max. portfolio weighting 3% head office costs. This equated to earnings per share of 22.3 cents, from which a 13 cent Our View Hold dividend was declared (fully franked, ex date 28 February).

Theme parks & cinemas blazing Thanks to a hot summer and innovative events such as ‘fright nights’, the company’s Gold Coast theme parks attracted a record 2.8m visitors during the half. This helped boost operating profit 6% to $26.7m. In the US its two water parks generated steady attendance and eked out a small improvement in operating profits. Development of a new water park in Sydney’s west and a development/management agreement in China should help boost the division’s profits in future periods.

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That same hot weather also drove punters indoors, which combined with a good selection of recent movie releases such as Skyfall, Madagascar 3, and Twilight: Break Dawn Table 1: Village’s interim result 2 helped increase the cinema division’s visitation 1% to 12.3m. H1 2013 h1 2012 Change (%) In an industry where total visitor numbers have trended slightly lower over the past decade, this is a welcome sign. Management claims it has been winning market share from Op. rev ($m) 480.0 470.1 2 rival Hoyts as cinemagoers increasingly opt for premium options, such as Event’s ‘Gold Net profit ($m) 33.5 28.3 18 Class’ lounges. Divisional earnings increased 14.1% to $18.6m. EPS (cents) 22.3 20.1 11

Even those who headed to Hoyts helped Village’s result thanks to its distribution licence DPS (cents) 13.0 12.0 8 over Warner Brothers content in Australia. Here earnings were stable at $29.9m. Franking (%) 100 0 n/a Finally, the company’s off-balance sheet investment in film and music producer Village Debt to equity (%) 47.5 49.8 –2 Roadshow Entertainment Group (VREG) literally paid its first dividends: $2.5m for the half thanks to its $100m of preference shares, acquired through the recent recapitalisation and Divisional results (EBIT) which pay a 5% coupon. Theme parks ($m) 26.7 25.2 6 Following its recent recapitalisation, VREG is ramping up production, enabling it to make Cinemas ($m) 18.6 16.3 14 around six to eight films a year and spread the risk of any one project. Upcoming releases Film distrubtion ($m) 29.9 29.8 0.3 include: The Great Gatsby and All You Need Is Kill. If future releases are successful we Corporate.other ($m) –12.1 –15.8 -23 could expect far more than $5m a year to flow from this business.

Shareholder focus At a corporate level it was pleasing to see overheads fall 6% to $9.6m during the half. Shareholders shouldn’t expect too many more gains from here. Village also announced that key shareholders Village Roadshow Corporation (controlled by directors Robert Kirby, John Kirby and Graham Burke), Robert Kirby and Graham Burke vrl recommendation guide have sold nearly 11m shares via an institutional sale to help increase Village’s free float. long term buy Below $3.80

Following the sale Village Roadshow Corporation will remain Village’s largest shareholder hold Up to $5.50 with around 44% of the outstanding stock. This is the final step towards becoming a more sell Above $5.50 shareholder—and market—friendly company, following the implementation of a sensible dividend policy, and it may lead to inclusion in the ASX300. This renewed focus on shareholder friendliness has helped propel Village’s share price up 16% since Village Roadshow: A profitable ride? from 06 Dec 12 (Long Term Buy—$3.80) and 3% since we downgraded to Hold on 14 Jan 13 (Hold—$4.27). Like one of Village’s movies, the story is unfolding nicely so far, and considering the share price rise we’re very content to HOLD. Disclosure: Staff members own shares in Village Roadshow, but they don’t include the author, Jason Prowd.

Full-year result Woodside Petroleum | Gaurav Sodhi

An excellent result prompts an important question. After Pluto, what next?

A better than expected contribution from the Pluto LNG project helped Woodside Petroleum post splendid full year results (it has a calendar year end). A 31% increase in Woodside Petroleum | WPL production to 85m barrels of oil equivalent (mmboe) drove a 30% increase in revenue to Price at review $37.81

US$6.2bn. Reported net profit jumped 98% to US$2.9bn, although this included a one-off Review date 21 Feb 2013 gain of US$974m from the sale of equity in the Browse gas field. On an underlying basis, max. portfolio weighting 4% net profit rose 25% to US$2.1bn. From underlying earnings per share of US$2.53, up 21%, Woodside will pay US$1.30 in fully franked dividends (ex date 25 February). Our View Hold Pluto has been a remarkable achievement. No project in LNG history has gone from discovery to production as fast. None have been as expensive either. We maintain that, without expansion, the project will earn horribly low returns on capital. WPl recommendation guide Pluto is, however, generating piles of cash; operating cash flow jumped 55% to US$3.5bn and capital expenditures fell from US$3.6bn last year to US$1.9bn this year. With Pluto long term buy Below $35.00 complete, and Browse and Sunrise unlikely to see development anytime soon, capital hold Up to $50.00 expenditure will remain far lower than it has been over the past five years when US$15bn sell Above $50.00 was poured into expansion. This bodes well for free cash flow and dividends. Debt levels have already fallen substantially, from US$5bn in 2011 to under US$2bn in 2012. A persistent problem is Woodside’s poor reserve replacement. All oilfields have finite resources which deplete with production. Woodside has to spend cash on exploration

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and development of new fields or face a slow decline. It has certainly been spending, but Table 1: Woodside’s result without success. 2012 2011 Change Over the past three years Woodside has replaced just 88% of what it has extracted. (%) Consequently, the company had more reserves in 2009 than today. Management have Production (mmboe) 84.9 64.6 31 dedicated almost US$500m to new exploration to alter this, with newly acquired ground Revenue (US$bn) 6.3 4.8 32 in Myanmar and Israel being an immediate focus. Woodside has an awful track record Underlying NPAT (US$bn) 2.1 1.7 25 overseas so we’ll be watching progress with interest.

Underlying EPS (USc) 253 209 21 Under the leadership of Peter Coleman, Woodside is generating plenty of cash and, crucially, willing to deploy that cash conservatively. It is a far better business than under DPS (USc) 130 110 18 the watch of his predecessor. Our previous criticism of the business centred on overly Franking (%) 100 100 n/a aggressive ambitions that have now been sedated. We’re upgrading our recommendation guide to reflect falling debt and higher free cash flow. With the share price up 10% since 4 Dec 12 (Hold—$34.29), it’s squarely on our radar. HOLD.

Doddsville blog | Gaurav Sodhi

Who wants golden dividends?

Since reaching lows of less than US$300 an ounce 12 years ago, the price of gold has rocketed. Last year gold peaked at over US$1,900 an ounce and, despite recent falls, still ONLINE COMMENTS sits above US$1,600 an ounce today. If you thought a soaring gold price would propel the craig said: It’s a fabulous idea. Dividends shares of gold miners higher, however, you’d be wrong. paid in gold would get great interest. Gold equities have performed miserably over the course of the gold boom. Since I feel like a barbary coast pirate already. 2003, S&P’s Global Gold Index Fund (XGD), a measure of gold equity performance, has Will they send the gold in the mail or will we risen just 42% while the most popular gold ETF, listed on the New York Stock Exchange go to the annual meetings dressed up with as GLD, has increased almost 250% over the same time. cutlasses and peg-legs and get a couple of A given rise in the gold price should translate to a larger percentage increase in company those directors to walk the plank? profits so gold equities should have performed better as the gold price increased. That’s Damien said: Interesting. I wonder if the the theory, anyway. In practice, investors have been reluctant to pour capital into gold ATO would class a distribution of bullion as miners, and for good reason. income or a return of capital? If it’s capital Gold miners have been awful businesses. As the gold price has increased, producers then it may improve the after-tax returns for have chased increasingly marginal production instead of passively collecting higher margins. the investment (pending the 50% discount is applied). Costs escalation, political risks, geological constraints and declining orebodies have all contributed to poor industry performance. Investors have lost patience with miners and matt said: Hi Gaurav, speaking of which, was chosen ETF exposure instead. That’s why the GLD ETF is more than 2.5 times larger than just wondering if you have ever looked into Barrick, the biggest goldminer on the planet. Investors have given up on miners. Medusa mining (sorry I know you guys get this type of question a lot!) The industry has at last recognised investor dissatisfaction. Producers are increasingly forsaking marginal production growth and are at last focusing on returns. To differentiate Mainly seems to have no debt, low cost (quoted I think at less than $300 / ounce) themselves from ETFs, miners are increasingly promising regular dividend payments, some an annual dividend and plans for increased even suggesting payments made in gold. output over the next couple of years? If you accept that gold is a currency, not a commodity, and investors want exposure Many thanks! to gold in order to escape the dominance of fiat currency, then paying dividends in gold rather than in the currency investors are fleeing makes some sense. Whether it will change perceptions about the industry is another matter. First published online 19 Feb 2013 at our Doddsville blog.

24 Weekly Review | Issue 362a

Blog links

Below is a list of Doddsville and Bristlemouth blog articles published by our analysts this week.

Bristlemouth blog | Can Lloyds TSB Be As Good As CBA?

Gravy Train blog | Fixing our ‘not so super’ system (Part 2)

Multimedia links

Below is a list of podcasts and videos published to the website during the past week Doddsville podcast | The economics of advertising, Buffett’s new buy and Venezuela

Twitter links

Below is a list of this week’s article links posted by our analyst team to our Twitter page. Is Google studying Apple’s playbook? Company may launch retail stores in the U.S. RT @CFAinstitute: Nassim Taleb and Daniel Kahneman: Black Swan Shows Fragility under Heavy Weight of Anchoring. ‘I still do not believe that the Chinese “recovery” is for real’. Value Stocks Are Hot—But Most Investors Will Burn Out . Only a poor producer complains about the competition. Improve your own product! A warning for Australian banks? Moody’s downgrades Canadian banks over consumer debt exposure. How 300,000 yuan and shark’s fin soup can buy IPO approval. The realities of doing business in China. The are some surprisingly low corporate tax rates in many parts of Europe, especially smaller countries. Has the secretive Renaissance Technologies lost its touch? Sierra Leone’s leading psychiatrist believes that tea addiction is becoming a serious threat to the country’s society.

Ask the Experts

Please note that the member questions below have undergone minimal or no editing and appear essentially as they do online.

The other thing is that we have to move our price guides upwards Woolworths sale price at regular intervals, to reflect the opportunity cost—in other words, What would a sell on WOW be? Would it be above $36.60? if you’d targeting a return of 10% and you’re getting a dividend yield Your range only states a Hold position. of 3%, then you’d be expecting the share price to rise by 7% a year 22/02/2013, James Carlisle: There’s limited data we can put into over the long term. the recommendation guide, the prices themselves are necessarily Also, given the inevitable imprecision of all this, the hold range vague and we’re trying to provide a message. for a stock is likely to be much more than 10%—more likely once So the point with Woolworths is that it’s the sort of core holding you’d bought a stock you’d be looking to hold on until it had risen at that once bought, we’d be reluctant to sell, so by saying ‘Hold’ above least 30% (plus that 7% a year). $33, we’re trying to get that message across. If we said Sell above a Given that Woolies is such a steady performer, if you take that certain price, then it would seem like we had it in mind for the stock target, you’ll end up with a Sell target that’s far beyond the stock’s usual to reach that point, which we probably don’t. volatility. So rather than set something up that might look like a target,

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we’re more inclined to just cross that bridge if and when we get to it. best online retailers, and have no physical stores. Over the next few That’s broadly how the thinking behind it goes (I think). But to try years I expect a hybrid online/offline retailing model to become to fend off allegations of a cop out I’ll say that the sell price would be increasingly popular; one where most sales are completed online, and well past $36.60. Almost certainly it would be above $40 and most a smaller portion through a few strategically located stores. Here Apple likely closer to $45. Even then I think we’d more likely move to Take provides a useful example. Around 15% of its sales are conducted Part Profits rather than Sell—although I repeat that we don’t really through Apple stores with the remainder completed online or through expect the stock to get that far (and remember you’d need to add up other retail partners. to about 7% a year for the opportunity cost). 4. Again, I’m not sure I agree. Whilst ABS data shows that around Having said all that, it probably is a bit of a cop out—and when 25%–30% of online sales are currently transacted through overseas I next review the company (the interim result is due next week) I’ll websites, according to a recent NAB report they are growing at twice the give some thought to putting a sell or take part profits number in. rate of local online sales (~40% verse 20%). That suggests to me that international online stores are becoming more, rather than less, popular. Your point about price transparency is a really good one. The issue Is online retail a real threat? for me is that even if only a small portion of total retail sales move Just a comment or two concerning Jason’s recent review online, online retailers have an inherently lower cost base, which will of JB Hi-Fi, and perhaps also relevant to his recent review of help drive down total industry profits. Australian retailers. That is why I suggested that the ‘game has moved online’. I tend As far as I can tell from the available stats: to think about it like this: if you were going to start a new retailer 1. The proportion of retail sales performed online are still a tomorrow, it would most likely be online. In the electronics sector it very small proportion of that executed in physical shops. would more likely copy Kogan’s model, rather than a traditional bricks 2. Electronic goods and furniture lag other sectors substantially and mortar chain like JB Hi-Fi. To me, the difference between most (though I concede that electronics in isolation may reveal a retailer’s existing model and what you might do if you started a new different story). business tomorrow is telling. 3. International experience shows that the most successful I also agree that scale and marketing matters. I’m just not convinced online shops are those that include physical shops, by far. that traditional retailers have as great an advantage as what you’re 4. Australians prefer to do their online shopping from implying. A typical traditional speciality retailer spends around 15%- Australian sites, by a substantial proportion. A trend that is getting 30% of revenue on staff and occupancy costs. This puts them at a stronger, despite the strong AUD. very significant cost disadvantage to the online only retailers, where From the above, I fail to conclude that the ‘high street shop’ that figure is closer to 10%. This means online retailer can operate is an endangered species. from a much smaller base, whilst still being cost competitive. Additionally Jason, I am baffled by your assertion that “ … the Also, scale and distribution efficiencies have varying significance game has moved online...”. What I see, more than anything, is depending on the product category. It matters more for low cost, that the game has changed because of price transparency. What bulky items (e.g. groceries)—where distributing them represents a gives you a moat when there is price transparency? Scale and large portion of the total costs—rather than small, high value items marketing. How can the pure online players, in Australia, have (such as TVs or perfume). the scale when they don’t have the sales (as per my itemised Plus, it’s not the case that, on the whole, local incumbent retailers comments)? Incidentally, how does an online entrant differentiate have any real scale advantage (again this differs across categories). itself to get that scale? The rules have change? Yes. The rules of There are extremely well resourced online only retailers—such as competitive advantage haven’t. Mariano C eBay or Amazon. Plus, whilst a ‘JB Hi-Fi’ may be large on a national 16/02/2013, Jason Prowd: Thanks for the interesting comments scale it’s tiny compared to a ‘Best Buy’, for example. Mariano. I’ll take each of your propositions in turn, then make a few Retail, mostly, is about providing goods people want for as cheap a general comments. price as possible. In that context online only retailers have an inherent 1. Yes, that’s correct. Only around 5% of Australian retail sales cost advantage, and over time will hollow out the profits of traditional are made online, but they are growing at around 15%-20% a year, retailers. Traditional retailers, with higher cost bases, will either have if it continues at a similar clip by 2023 at least 20% of all sales will to demonstrate a benefit for the high prices they charge—which I be made online. argue will be difficult—or adapt their cost bases to match their new 2. Yes, that’s partly right. In the US, around 15% of electronic goods competitors. It’s certainly possible, and I don’t doubt some current and appliances are purchased online, Australia is a tad behind that. And, incumbent retailers will survive, even thrive, over the next decade, but I’d expect that percentage to increase significantly over the next few years. on the whole I think the traditional retail industry is underestimating 3. I’m not sure I agree. eBay and Amazon are, arguably, the world’s the significant changes to their businesses models that are required.

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