Alpha POWER Shares (Lonsec) Portfolio - March 2008
Stop Press: two changes executed during late March 2008 – Asciano (AIO) removed and replaced with Orica (ORI) and Transurban (TCL) removed and replaced with Woodside Petroleum (WPL). Lonsec is seeking to reduce highly geared exposures and replace with quality mining services and energy exposures. |
Lonsec comments on major out-performers:
SGB (+8.0%) recovered during the month after being harshly dealt with during February.
St George is predominantly focused on the Australian domestic market with a material Australian Wealth Management business which represents about 14% of group earnings. The Bank is well managed and has a leading ROE (23%) and a low cost to income ratio (43%). St. George is a fair bit smaller than the majors with a market cap of about $13bn compared to the majors which range from $40bn up to $50bn. Lonsec expects that St George’s smaller size will make it easier to generate organic growth while its retail banking focus should also help it avoid much of the corporate debt problems that are starting to emerge. That being said, the Bank does source about 30-40% of its funding from off-shore where funding is increasingly hard to get on favourable terms. St George may have to underwrite a few more DRP’s yet to get itself out of trouble. The stock is currently on a yield of 6.7% (ff) and the company continues to target 10% growth in EPS over FY08 (subject to market conditions). Lonsec views the stock as excellent long-term value at these levels.
ORG (+4.9%) recovered well during the month on rising energy prices. Origin is well placed in the Australian and NZ energy sector and is best viewed as a vertically integrated electricity and gas distributor. Origin is investing heavily in the production of gas to fire new electricity generation for the Australian market. Gas is cleaner burning than coal and is therefore expected to be a key fuel in future years. Origin is maintaining guidance for at least 15% earnings growth over FY08.
WOW (+1.6%) managed to recover well after going ex-dividend during March. Woolworths is a key consumer staple play that offers ‘defensive qualities’ due to its large recurring cash-flows from food, liquor and petrol retailing. Woolworths has also diversified into hotels with acquisitions of ALH, BMG, MGW and Taverner Group. More recently the company has expanded into New Zealand with the acquisition of Foodland Australia NZ supermarkets, trading under the Progressive Supermarkets banner.
Lonsec comments on major under-performers:
AIO (-19.5%) the stock has obviously caught out many who were focused on the rail and port assets (like the Lonsec Portfolio Manager) and not the growing gearing levels of the company. Indeed, most brokers still maintain a BUY on the stock. Three things happened over Dec, Jan and Feb 08 that caused Lonsec to change its view on the stock:
- The company confirmed that earnings are actually trending down (due to issues in the rail business);
- The company’s interest cost is trending up (due to $4.5bn in debt on balance sheet and deteriorating debt market conditions); and
- The company confirmed that is has invested $590m in new rail stock for expansion into Queensland without confirming any new Queensland coal haulage contracts. Indeed, at the time of writing there is still no confirmation on any new contracts. With flooding in the Qld area reducing coal volumes, in the short to medium-term, one must ask will there ever be a contract?
All in all, with debt markets continuing to deteriorate during 2008 and a global slowdown looming, Lonsec took the tough decision to exit the stock at around $5.00 on Feb 27. Since that date, the stock has fallen to a low of $3.33 and now trades around $4.00. Lonsec’s portfolio manager firmly believes that if EBIT continues to trend down and interest costs continue to trend up, there is a clear risk that the company will struggle to roll over debt financing come FY10 and its bankers will end up owning the rail and port assets. For this reason, Lonsec took action and exited the stock.
BHP (-9.5%) fell during the month on a “Sell Resources, Buy Financials” theme that prevailed because of a short-term return of confidence in financial stocks post the Fed’s rescue of Bear Stearns. There was also nervousness in the market that the ‘de-coupling’ theory behind Asia may not hold as the G7 economies faced a synchronised slowdown. Expectation for a large increase in iron ore and coal prices have since seen a rapid recovery in BHP shares.
TAH (-7.3%) The Victorian Government has announced significant changes to the Victorian Gaming and Wagering industry post 2012. The implications of the changes are:
Gaming – post 2012 pubs and clubs will be able to own, operate and maintain gaming machines directly effectively cutting out the operating licences of Tatttersall’s (Tatts) and Tabcorp. Pubs and clubs will be able to bid directly for gaming licences, with a 10 year term, subject to a limit of 35% market share.
The Vic Govt is also denying that it has to pay $1.2bn in compensation to Tatts and Tabcorp (about $600m each) under the terms of the original licencing agreement.
Post 2012, Tabcorp will lose about 28% of its EBIT from Vic gaming while Tatts stands to lose about 40%.
Wagering – a single wagering licence will be offered for tender post 2012. The current JV with the racing industry will be removed. The Vic Govt plans to compensate the Victorian Racing Industry for this change, under changes to the conditions of the new wagering licence post 2012.
Tabcorp currently holds the licence with the Vic racing industry and will have to re-tender for this licence. Vic wagering currently represents 10% of Tabcorp EBIT.
Keno – will be offered as a single, specific licence, with distribution to be expanded to include all venues with a liquor licence and wagering service.
Tabcorp’s current earnings base is:
| Vic Gaming | 28% |
| Wagering | 29% (10% is Vic wagering) |
| Casinos | 43% |
| Total | 100% |
By FY13 the Vic Gaming earnings will cease while the Vic wagering earnings will be subject to a successful outcome in tendering for the new wagering licence and the conditions of the new licence. The $687m in compensation for loss of licence is now likely to be subject to a legal battle with the Vic Government. These are the clear negatives of this announcement.
The positives are:
- Tabcorp will continue to earn cashflow from Vic gaming until the end of FY12.
- Tabcorp will likely reduce its capex in the Vic gaming business moving forward, as the business will most likely move into run-off mode.
- Most analysts had Tabcorp bidding $1.2bn for the new licence, the need for that outlay will now be removed.
- Tabcorp could get about $100m for the sale of its gaming machines, depending on its future strategy in the sector.
- Without the gaming assets, Tabcorp becomes a more logical target for Crown which is looking for Casino acquisitions, or maybe Tabcorp and Tattersalls would consider merging?
- S&P is maintaining a BBB+ rating on Tabcorp’s balance sheet given the $1.2bn payment for licence renewal is not required
S&P said: “While the loss of the licences are negative for Tabcorp’s earnings and business diversity beyond 2012, the company will now not have to fund a gaming licence renewal payment, and can manage its expenditure within that business with an eye to its 2012 closure. Tabcorp will need to decide whether it wants to remain involved in the Victorian gaming business beyond 2012 in some capacity. “The reduced earnings from Victorian gaming will slightly weaken the company’s business diversity, however, its impact is mitigated by the broader business base the company has developed over recent years.
“Standard & Poor’s will continue to monitor the impact of the Victorian Government’s announcement and will discuss Tabcorp’s business response with the company. We do not envisage that the ‘BBB+’ rating on Tabcorp will be affected by the announcement, although we cannot rule out a rating change as the situation unfolds and Tabcorp’s commercial reaction emerges.”
Conclusion
While the Tabcorp valuation is likely to fall by 15-20% as a result of the loss of Vic gaming earnings from FY13, there is the potential of high short-term dividend yields up to then. Tabcorp current dividend is 94cps, so its current yield is 8.9% fully franked. The level of future dividends will obviously depend on its future strategy.
Lonsec also feels that the Vic Govt’s hard-line on the $687m compensation payment maybe just an opening position, that it fully expects to be tested in the courts. It would look better, politically, if the Govt fights before handing over any money to Tatts and TAH. That being said, it shouldn’t be assumed that Tabcorp will eventually get the money either.
The vital question is; what does Tabcorp plan to do post FY12 when it loses the gaming revenue? The answer to this question will become clearer over the coming weeks. Lonsec feels investors will be in a better position to make an assessment then. Most of the damage is done for now, continue to HOLD.
 | Lonsec Limited ABN 56 061 751 102
Published by Participant of ASX Group
Level 22, 500 Collins Street, Melbourne, 3000 - P.O. Box 46 Collins Street West, Victoria, 8007
General Inquiries: (03) 9623 6345 Dealing Room: 1800 649 518 Fax: (03) 9629 6990
|
© Alpha Structured Investments
Dr Tony Rumble
July 2007
