Lonsec comments on major out-performers:

ORG (-1.5%) shares were steady after being de-rated by the market over the December quarter. ORG was de-rated from a premium P/E to a market P/E after a profit downgrade from AGL Energy spooked the market. Lonsec is not aware of any material issues with ORG, operationally or strategically. Origin Energy offers a quality exposure to the growing energy industry in Australia and NZ and is best thought of as a vertically integrated utility with exploration and production assets. Lonsec expects 10-15% pa earnings growth over the next few years and is happy to maintain the holding.

TCL (-3.5%) has come under pressure in-line with the infrastructure sector. Lonsec likes Transurban and Asciano because both defensive qualities in that they are both owner/operators of quality infrastructure assets and are expected to generate solid growth in cashflow over the long-term. Transurban is not sponsored by an Investment Bank and thus does not pay management fees to a controlling shareholder and is not obliged to participate in ‘deal flow’.

Transurban is Australia’s largest toll-road owner and operator and has plans to expand into the US via a wholesale investment fund called DRIVe. Transurban’s recent acquisition of Sydney Roads Group (SRG) gives the Group a major interest in five of Sydney’s most important motorways. Transurban expects to achieve major cost savings by running each road as a centralised network. Further upside is expected from a significant pipeline of new projects in Sydney that connect to the Transurban network. In addition, two new projects in Melbourne – the Tullamarine/Calder interchange and the Monash/City Link/West Gate project are both expected to substantially increase traffic and revenue on City Link in coming years.

Transurban’s gearing is moderate compared to many infrastructure companies. Its gearing ratio (debt/EV) is currently 40% while interest cover is 2.0x. Transurban maintains an A- credit rating on senior debt and a BBB+ corporate credit rating. The vast majority of debt (76%) is locked in at an average fixed rate of only 6.57% with an average weighted maturity of 8.4 years.

TAH (-5.9%) retreated less than the market as the stock is now starting to look fairly cheap on investment fundamentals. Broker consensus is for EPS of 95 cps and DPS of 94 cps which puts it on a forward P/E of 14.8x and yield of 6.7% ff. Tabcorp has solid recurring cashflows from three key divisions being Gaming, Wagering and Casinos. The exclusive Star City Casino licence was recently rolled over for another 12 years while negotiations on Victorian gaming and wagering licence renewal post 2012 are still progressing. Tabcorp is currently undergoing an operational review to improve efficiency after a spate of takeovers over the past 5 years. The recent equine horse flu outbreak in NSW and QLD came at a bad time for the company but on a positive note the underperforming NSW racing industry is likely to be more open to much needed review and restructure after recent losses. Lonsec notes that the new Federal Government may pose some risk to Gaming regulation (which is currently State based) - Lonsec is monitoring developments closely.

Lonsec comments on major under-performers:

AIO (-21.4%) has been beaten up as investors shun geared infrastructure assets. Lonsec view is that AIO is an operator/owner of quality port and rail assets that should offer good long-term growth prospects. The relatively high gearing structure of 60% Debt/Debt+Equity and 2.1x interest cover is the main concern for the market. This gearing level was not unusual at the time the company de-merged from Toll but now the market is very risk-adverse. Lonsec believes that the best way for AIO to achieve a re-rating in the share price is to reduce gearing levels via asset sales (eg Brambles stake) and/or equity injection (perhaps from Middle-east investment funds?). A reduction in gearing to say 40-50% is likely to be well received by the market. At current levels, AIO is valued at 5.2x forecast EBITDA of $700m which looks to be too cheap for high growth/ high barrier to entry assets like Port and Rail infrastructure. Lonsec recommends investors BUY but admits a catalyst is needed from management.

CBA (-16.4%) suffered a rapid de-rating in line with the finance sector which fell 13% during January. Rising costs of wholesale funding and rising loan rates are expected to lower banking margins and slow credit growth over coming quarters. At the same time, market volatility is likely to reduce earnings from investment markets. Of all the major Banks, Lonsec believe CBA is best positioned to etch out earnings growth over the medium to long-term. It has the highest retail deposit base (the lowest cost source of funding) representing 54% of its funding mix and it has the largest exposure to the Australian Wealth Management sector (16% of Group earnings). While CBA maybe penalised in the short-term for greater exposure to Wealth Management (from Cominsure, Comsec and Colonial/First Choice), Lonsec has a positive view on the sector (mainly due to growth in Superannuation) over the medium to long-term. CBA is a long-term BUY.

AMP (-15.6%) also suffered in-line with the finance sector as investors became concerned about future investment market income. Such sell-offs are really based on short-term concerns about investment markets. AMP has transformed itself over the past five years from a life insurer into a leading player in the Australian Wealth Management sector. AMP is well positioned in the Australian WM sector with a strong brand, wide financial planner network and good quality funds management products. While AMP is certainly not immune to investment market volatility, the business is in great shape and the balance is strong with low gearing of 10% and high interest cover of 17x. AMP states that is has no material exposure to possible mono-line insurer downgrades (stemming out of the US) and no direct exposure to sub-prime mortgages.

The investment fundamentals of AMP are compelling:

However, investors should note that AMP’s key driver is AUM. A +/-10% movement in Australian equities is expected to affect profit by +/- $40m while net funds inflow is also a key variable. Net funds inflows should continue to rise based on expectations of at least 10% pa growth in the retirement savings market. AMP is targeting growth in operating earnings of 10-12% pa over the next five years with an 85% dividend payout ratio. On-going capital management initiatives will continue where surplus capital is identified. AMP is considering increasing its debt levels to fund an on-market share buy-back but won’t go ahead until debt markets settle down. AMP is Lonsec’s preferred play on the long-term growth expected in the Australian WM sector due to rising incomes, compulsory super contributions and tax incentives to grow retirement savings via superannuation. Investors should look to pick up AMP on any weakness in the local sharemarket. A $7-$8 target range seems good long-term value.

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