Alpha POWER Shares (Lonsec) Portfolio - June 2008
Alpha POWERS Portfolio – June 2008
Note: SGB was replaced with WBC in early June on the high probability that the stock would be called away, by option expiry in late June 2008, due to its recent re-rating by the market. WBC keeps with the theme of Retail Banking (less risky than the big corporate lending banks in ANZ and NAB) and exposure to Superannuation (BT). If WBC acquires SGB then the story will be even better, as WBC will be the largest major bank (which will bring synergy and cost of capital savings) and it will have a dominant position in retail banking and superannuation to rival CBA.
Lonsec comments on major out-performers:
WPL (+3.9%) continues to perform well as the oil price continued its upward march past US$140 a barrel and BG came back with an off-market takeover offer for ORG at $15.50, highlighting the rocketing value of gas reserves as an important ‘clean’ energy source. WPL production is 70% gas (natural gas and condensate converted into light crude oil, LPG and LNG) and its huge reserves are nearly all gas reserves offshore WA, Victoria and NT.
Woodside 1H08 production was 36.5mboe with the company targeting CY08 production of 80-86mboe. It seems the company will (once again) struggle to meet production targets but the rising oil price (and gas price) has more than compensated. It should be noted that most oil and gas companies are struggling to meet production targets and in fact many have declining production profiles. Woodside stands out as it should be able to actually grow production over time as it has a good pipeline of major LNG growth projects including Pluto (offshore WA), Browse (offshore WA) and Sunrise (Timor Sea). Consensus earnings per share for CY08 are $3.77 but increase to $5.80 by CY10. The main risks to these forecasts are the price of oil & LNG and project capital costs blowing out. Lonsec recommends a BUY under $61.65
ORG (+3.3%) On 30 April 2008, Origin announced that BG Group Plc, a global integrated gas major, had approached the company with a proposal to acquire all of the shares in Origin at a cash price of A$14.70 per share. The takeover offer was at a 40% premium to ORG’s last closing price before the offer.
Origin commissioned advice from various experts including a reserves expert on Coal Seam Gas and an expert on LNG markets. Based on this work, Origin negotiated an improved offer of A$15.50 from BG but then decided to reject the offer. BG has since come-back with a direct off-market offer to Origin shareholders at the same price of A$15.50 per share.
In reviewing the offer, the Origin Board had the benefit of considering two new important developments:
- The receipt of a new CSG reserve estimate that doubles ORG’s 3P reserves from 4,578 to 10,122 PJ and identifies prospective resources up to 17,947 PJ; and
- The announcement of the Petronas investment in the proposed Santos Gladstone LNG plant.
“The increase in ORG’s reserve and resource base confirms Origin’s pre-eminent position as the largest holder of CSG reserves and resources in Australia and demonstrates Origin’s unparalleled record of converting resources into reserves” the company said.
“The Santos announcement establishes a new and higher benchmark for the value of CSG and, along with the proposed BG LNG project, demonstrates confidence in the use of CSG for LNG production. It is particularly relevant to the valuation of Origin’s CSG interests, which includes acreage covered by and adjacent to the acreage being acquired by Petronas.”
Mr Kevin McCann, AM, Chairman of Origin, said, “The Board of Origin has given careful consideration to all of the relevant information available to it, particularly the substantial increase in the company’s CSG resource base and the demonstrably higher value now placed on CSG resources.
“Directors have been mindful of the certainty that a cash proposal provides for shareholders. However, based on these recent developments, the Board has decided that the revised proposal does not adequately reflect the greater value that will be available to shareholders by not accepting this proposal.”
“Directors believe, having developed the largest 2P CSG reserves base in Australia, that responding to the many approaches the company has received from third parties will best accelerate the commercialisation of these resources and create increased value for shareholders.”
Clearly the Petronas $2.5bn investment in Santos proposed LNG plant in Gladstone has increased the valuation and confidence in converting CSG into LNG. Origin has far superior reserves and resources to Santos and will obviously pursue similar plans. With the advent of carbon emission trading, LNG is going to become an important alternative to coal powered energy in the near future.
Why should Origin hand over this upside to another company? Clearly the Board believes the upside is worth far more than $15.50 per share. The Origin Board has shown good form in the past in rejecting a proposal to merge with AGL about 2 years ago. While there maybe some disappointment from ORG shareholders in the short-term, one must only look to Shell’s bid for WPL at around $14.00 (that was subsequently knocked back by the Treasurer) as a good example of why investors should not be too focused on short-term gains. The global move into cleaner burning fuels is not likely to go away in the future. The price of natural gas in the form of LNG is likely to continue to rise as oil reserves deplete and coal energy becomes more expensive due to carbon emission taxes.
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.
ORG shareholders should continue to HOLD pending further direction from the Board of ORG. Clearly, BG is prepared to test shareholders mettle given current market conditions. While BG may try to paint a more somber picture for Origin, it is still worth noting that nonetheless they are back again with a hostile bid. There must be compelling value in Origin that BG can see.
Lonsec cautions against being too hasty or panicky. Origin can mitigate much of the risk that BG is talking about by bringing in a major LNG JV partner (Woodside for example). This battle may take months to pan out and another company may take a blocking stake in Origin as yet. Lonsec holds a positive view on the Energy sector, particularly Gas plays, and WPL and ORG are the best major gas plays in the market. HOLD.
Lonsec comments on major under-performers:
WBC (-14.0%) fell as the global credit crunch continued to deepen since the first rumblings in the US sub-prime mortgage market around August last year. Credit spreads have spiked sharply higher while many corporate debt markets have become illiquid.
While Australian Banks have little direct exposure to US sub-prime mortgages, they do source about 30% of their capital from (previously cheap) foreign debt markets while many of the Banks’ corporate clients have also been adversely affected by tightening credit conditions. To summarise, the negative effects of the global credit crunch on the Australian Banks are:
- The cost of capital (especially from overseas debt markets) has risen substantially;
- The seizing up of securitisation markets means the Banks have had to bring off-balance sheet funding vehicles back onto their balance sheets thus constraining their capital adequacy;
- Some highly leveraged corporate clients may fail leading to an increase in bad debts; and
- Falling equity markets and a decline in credit growth will hurt earnings in the short-term.
On the positive side, Australian Banks seem to have generally good quality loan portfolios and good capital positions relative to their overseas peers and many borrowers will have to return to the Banks for debt financing given equity and corporate debt markets are so volatile and expensive.
The Banks should stabilise at the point where they have secured their capital positions, allowing them to take advantage of market conditions and increase market share. Recent global bond and hybrid issues by the Banks is evidence that the Banks continue to work hard on raising capital.
Lonsec has selected CBA and WBC as its preferred Banking stocks as both have a bias to Australian Retail Banking (not corporate and international banking like ANZ and NAB) and both are well positioned in the Australian Wealth Management market which has good long-term prospects because of Superannuation. So far this strategy is proving very effective with ANZ and NAB the two worst performing major Banks over the past year.
TAH (-12.7%) In May 2008, the Victorian Government announced changes to the industry structure for gaming in Victoria. Under the new industry structure, hotels and clubs will directly hold gaming machine licences, effectively ending TAH’s and TTS’s duopoly operating Victoria’s slot machines post 2012. TAH is currently focusing on adjusting its business plan to maximize its returns from the Victorian Gaming Business leading up to 2012. In addition to lodging an application with the Northern Territory Government for a racing and sports wagering licence, TAH is also planning on submitting applications for the renewal of its Victorian wagering and Keno licences (Single Licence Structures) post 2012. Following the renewal of a 12 year exclusive licence to Star City by the NSW Government, TAH is pledging $300m to the redevelopment of Star City in 2009. As a part of its plans, TAH is expected to expand the main gaming floor, upgrade and expand its restaurants and bars and build a new 300 room hotel.
The near future is set to present many challenges for TAH with the after effects of smoking bans in the Eastern states and the uncertainty regarding its Wagering licence renewal in 2012. TAH’s Victorian Gaming revenue will cease by 2013 however, its impact is mitigated by the diversified business base TAH has developed over recent years. TAH has indicated that it will challenge the state government’s decision not to refund the original $597m Gaming licence fee. In the short term, management’s guidance is for flat earnings over the next 12 months, with an attractive fully franked forecast yield of 9.7%. The sustainability of the dividends will largely depend on the board’s future strategy. Nevertheless, at current levels the cautious outlook appears to be priced in. Lonsec awaits an update on company strategy moving forward.
Note: Recommendations made within Lonsec Model portfolios may differ from other research published by Lonsec.
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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.
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