Alpha POWER Shares (Lonsec) Portfolio - November 2008
Note: Recommendations made within Lonsec Model portfolios may differ from other research published by Lonsec.
Comments on portfolio:
Lonsec runs a top-down high conviction investment philosophy that has seen the Lonsec Core model portfolio deliver strong out-performance over the past eight years. The portfolio developed for the Alpha Powers product is also based on Lonsec’s top-down themes and is high conviction. Where it differs is the focus on income from both dividends and option writing. As a result the Alpha Powers portfolio has a bias towards large-cap stocks that can generate good income (either through dividends and/or option premium). The mix of stocks is deliberately diversified across resources (BHP), energy (WPL), financials (CBA, WBC, AMP), industrials (TLS, TAH, ORI, WOW) and property (GPT). These stocks should generate a good combination of dividends, option premium and capital growth over the medium to long-term. Obviously, in the short-term market conditions have been very bearish hence the portfolio has been up against it since inception but Lonsec is confident that the mix of stocks is right, for the medium to long-term.
Lonsec comments on major out-performers:
GPT (+31.8%) (Note: the Alpha put option has limited the downside below $1.08)
GPT recently conducted a $1.6-$1.9bn capital raising to pay down debt and reduce gearing levels to 29%. Post the capital raising, dpu will fall to 7.2cpu and the NTA will fall to $2.09 per unit. GPT estimates that if all of its $1.9bn in equity in the BNB Global JV Fund is lost, its NTA will fall to $1.56. If the quality Australian property portfolio is then devalued by 30% (under a worst case scenario) the NTA would fall to $1.07.
This suggests that investors in GPT can have a fair degree of confidence that the NTA of GPT is somewhere between $1.07-1.56. Lonsec notes that SGP recently took a 12.7% strategic stake in GPT at a VWAP of $1.07. It is likely that SGP will be interested in parts or all of GPT’s quality Australian property portfolio. It may lodge a scrip bid for GPT once there is less uncertainty around the value of its international assets.
Lonsec recommends that investors continue to HOLD GPT units.
BHP (+10.8%) In late November 2008, BHP called off its 3.4:1 scrip bid for Rio Tinto. The market took this as good news for BHP shareholders but bad news for Rio shareholders. Clearly, the global financial crisis and resultant global economic slowdown has markedly changed the outlook for commodities since the bid was originally announced, many months ago. In particular, the short-term outlook for Aluminium has taken a turn for the worse which suggests that Rio has seriously overpaid for its debt funded US$38bn purchase of Alcan last year. Rio is now saddled with US$42bn in debt and faces a significant write-down of its assets and a major reduction in cashflow from 2008 onwards. This could put RIO’s gearing and interest cover ratios under stress and the market clearly expects a capital raising.
For BHP shareholders, a high risk transaction has been removed leaving the company to take advantage of its strong balance sheet and internal growth opportunities. It is possible that BHP will come back with another bid for Rio but it will most likely wait for greater clarity on the outlook for global economic growth and for Rio to fix its balance sheet. It is not known exactly what the European Commission requirements were but BHP has suggested that iron-ore and metallurgical coal divestments were required. These might have been deal breakers but probably not; it is more likely that the fall in commodity prices and Rio’s debt were the main problems.
On BHP’s outlook, BHP generated US$2.75 in EPS during FY08. Your Lonsec portfolio manager estimates that EPS could fall to US$2.00 over FY09 and US$1.75 by FY10. At current exchange rates that is equivalent to A$3.00 for FY09 and A$2.65 by FY10. That suggests the market is currently pricing BHP at around 10x FY09 earnings and 11.3x FY10 earnings. That seems fair given the prospect of global recession reducing demand for commodities offset somewhat by the strength of BHP’s balance sheet and its various options to make strategic acquisitions to grow earnings. With BHP pulling out of the RIO bid, the threat of a BHP scrip overhang is removed and the share price should be firmer. Lonsec still holds a favourable top-down view on natural resources and energy given the emergence of China and India is expected to continue and infrastructure spend by the developed world should also increase in coming years. Investors should also note that the weaker AUD helps buffer the recent falls in commodity prices. BHP provides an excellent exposure to key commodities iron-ore, coal, copper, oil and gas. Look to BUY below $25.
Comments on major under-performers:
ORI (-17.0%) Orica has retreated in-line with the market over the past year. A major $900m capital raising conducted in August this year has put the company in a position of strength with gearing (D/D+E) reduced to 19%. However, the increase in shares on issue coupled with generally falling asset valuations has seen ORI retreat to the $16.50 level.
At 30 Sept 08, ORI generated NPAT of $572m leading to fully diluted eps of $1.58. That implies ORI trades on a historical PER of 10.4x. At this stage, the company still expects FY09 NPAT to be higher than in FY08. Broker consensus is for a NPAT of $670m. Your portfolio manager believes that a slowdown in the global mining industry will actually reduce earnings but the fall in the AUD will help buffer some of this fall. The interest bill will also be lower over FY09. On balance, a flat result should be expected, so ORI seems to be trading at a fair value of 10x earnings.
While the economic cycle is currently trending down, Orica is in a strong position to survive and prosper over the longer-term. The company is well managed and is a global leader in the supply of commercial explosives and blasting systems, tunneling and underground mining, industrial and retail chemical products. Accordingly, Orica is focused on the global mining and infrastructure sectors. Lonsec retains a favourable long-term view on these sectors and has chosen Orica as a lower risk play on this theme than the developer/contractors which run much thinner margins and have lumpy revenues. So far this strategy is working well with ORI outperforming most of the developer/contractors. Investors should look to BUY under $17.00.
IMPORTANT NOTICE: The following Warning, Disclaimer, Disclosure and Analyst Certification relate to material presented in this document published by Lonsec Limited ABN 56 061 751 102 ("Lonsec") and should be read before making any investment decision.
Warnings: Past performance is not a reliable indicator of future performance Any express or implied recommendation or advice presented in this document is limited to "General Advice" and based solely on consideration of the investment and/or trading merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the recommendation or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek further advice on its appropriateness.
Disclosure as at the date of publication: Lonsec does not hold the product(s) referred to in this document. Lonsec’s directors, officers, representatives, and their associates, may hold the product(s) referred to in this document, which may change during the life of document, but none receives or gains any other benefit as a consequence of the recommendation or advice presented in this, this document. Lonsec considers such holdings not to be sufficiently material to compromise the recommendations or advice, and the Analyst at the time of publication is not aware of any holdings. Lonsec receives brokerage or other benefits (e.g. application fees) for dealing in financial products and its associated companies or introducers of business may directly share in the brokerage or benefits
Analyst Certification: The analyst(s) certify that the views expressed in this document accurately reflect their personal, professional opinion about the financial product(s) to which this document refers. The analyst has an interest in shares referred to in this report but Lonsec considers such holdings not to be sufficiently material to compromise the recommendations or advice.
Disclaimer: This document is for the exclusive use of the person to whom it is provided by Lonsec and must not be used or relied upon by any other person. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information that has not been verified by Lonsec. The conclusions, recommendations and advice contained in this document are reasonably held at the time of completion but are subject to change without notice and Lonsec assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, Lonsec, its directors, employees and agents disclaim all liability for any error or inaccuracy in, or omission from, the information contained in this document or any loss or damage suffered, directly or indirectly by the reader or any other person as a consequence of relying upon the information.
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