Alpha POWER Shares (Lonsec) Portfolio - May 2008
Note: ORG was replaced by GPT mid May on the high probability that the stock will be called away, by option expiry in late June 2008, due to its recent significant re-rating by the market.
Lonsec comments on GPT:
GPT has been sold down on general weakness in the LPT sector and on concerns about its European Property JV with Babcock and Brown. Suddenly, anything to do with Investment Banks is on the nose. The trust has moderate gearing of 36% but has higher ‘look through’ gearing of 47%, if its European Property JV with Babcock and Brown is included. Lonsec has had a close look at the JV and is comfortable that the JV debt is non-recourse to GPT.
The Babcock and Brown Global Property JV has a book value of $7.1bn and debt of $4.9bn (70% geared). The market has effectively discounted GPT’s equity in the JV to zero and then some more. GPT has got the message and has commenced discussions to wind up the JV in the near term rather than by FY10. GPT is still confident of receiving back its equity and a capital gain, depending on the sale price achieved for the property portfolio. A successful redemption of just the equity from the JV is likely to be a positive re-rating event for GPT given it is predominately a large diversified property trust with about 80% of its portfolio invested in Australia. GPT currently offers a yield of 10.1% and is trading at a 25% discount to its NTA of $3.86. Lonsec sees GPT as good value at these levels and believes it will provide a good combination of yield and capital growth that is well suited to the Lonsec Alpha Power Portfolio.
Lonsec comments on major out-performers:
SGB (+28.7%) In mid-May 2008, WBC and SGB announced an agreed all scrip merger of 1.31 WBC shares for each SGB share. The SGB Board recommends the merger subject to any superior proposal and an independent expert report on the merger. Full CGT rollover relief is expected. The merger would create Australia’s largest Bank with approximately 25% of the home lending market and a leading position in Australian Wealth Management ($108bn in FUA). The intention is that there will be no net reduction in Branch or ATM numbers. If the merger goes ahead, SGB shareholders will own 28.1% of the combined entity. The merged entity would have a strong AA credit rating and a larger balance sheet would should help lower the cost of capital moving forward – a major issue for the Banks in the short to medium-term.
WBC and SGB would overtake NAB and CBA to become Australia’s largest Bank.
Current market caps:
| CBA | $59bn |
| NAB | $54bn |
| WBC | $49bn |
| ANZ | $45bn |
| SGB | $15bn |
| SUN | $15bn |
| BEN | $3bn |
| BOQ | $2bn |
Key conditions:
- Due diligence over a two week exclusivity period (now complete)
- Independent Expert Report
- Regulatory approval
- Approval by SGB shareholders (75% under a scheme of arrangement)
- No material adverse change in company or market conditions
The merger is expected to be EPS accretive to WBC shareholders by year three. However, the major benefits of cost synergies and lowering the cost of capital are likely to be understated at this stage, as WBC does not want to pay too much. The key risk with Bank mergers is usually customer attrition but the intention to not reduce Branch and ATM’s will go a long way to reducing this risk ie all SGB customers will have access to Westpac Branches and ATM’s plus their existing Branches and ATM.
At first glance, the merger seems highly probable. The regulator may have some issues with NSW market share but it does not contravene the Government’s “four pillar” policy so it seems likely that it would be given the go ahead. The market price of SGB suggests the market thinks another higher bid could come. ANZ is unlikely to bid as it trades at a discount to WBC while CBA may hit market share hurdles in home mortgages. That leaves NAB as the only logical bidder but it may not be able to bid more than WBC as it too trades at a discount to WBC. It seems WBC is in the box seat but it still might be forced to pay more yet. Shareholders of WBC and SGB should continue to HOLD.
Possible ramifications of the merger:
- There is the possibility of CBA or NAB also bidding for SGB, so you might find that SGB trades at a slight premium to the merger ratio.
- WBC, CBA and NAB shares may start to struggle, in the short-term, if the market becomes concerned about a bidding war
- It is unlikely that any major would bid for SUN as it is predominantly an insurer (insurance makes up about 70% of earnings)
- However, it could lead to SUN possibly selling its Banking operation to a major (would come at a price)
- It is unlikely that any major would be interested in BEN or BOQ due to lack of scale
- AMP may also become a target but it is a play on AWM rather than Banking or Insurance and is probably too expensive for any of the Banks
WPL (+16.3%) There were two positive events and one negative event that affected WPL during the month. Clearly, the positive events have outweighed the negative event. The two positive events were:
- The oil price continued its upward march to a peak of US$134 a barrel during May; and
- BG’s revised takeover offer for ORG at $15.50 (that was subsequently rejected by ORG) highlighted 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.
However, there was some bad news in the May budget where the Federal Government announced that it was removing a 30-year-old tax exemption on the part of the North West Shelf operations that extract light crude oil from natural gas or gas condensate. The removal of the condensate exemption from the crude oil excise will allow the Government to claw back about $2.5 billion over the next four years from the NWS project owners. Lonsec’s estimate is that the annual impact to WPL’s NPAT could be around $100m or 15cps and represents a 5% reduction to our previous 277cps FY09 earnings forecast. However, an increase in Lonsec’s near term oil price forecast more than offsets the impact of the condensate excise. Lonsec now assumes oil at US$100/bbl in FY08 and US$90/bbl in FY09. Our FY08 and FY09 earnings forecasts increase 30% and 32% respectively to 354cps and 365cps. Our valuation rises 55 cents to $55.75ps and we retain a HOLD.
ORG (+11.8%) 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.
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.
Lonsec comments on major under-performers:
AMP(-6.3%) AMP’s 1Q08 fund flows were weak as expected. The first quarter tends to be the weakest and quietest period. MD Craig Meller says difficult market conditions are obvious but the group is well placed given its resilient business model, low cost ratio and diverse earnings streams. Meller says difficult market conditions are likely to remain for some time which could continue to dampen investor sentiment. The corporate superannuation business has won a number of recent tenders worth around $175m which should transition into 2Q and 3Q.
Valuations of AMP should contain premiums for high market shares, the strong brand, the large customer base, the industry´s lowest unit costs and especially the planner network, an enduring competitive advantage. We are optimistic about AMP´s long-term prospects given the demographic trends and compulsory superannuation contributions which support the asset management industry´s above-average growth. AMP is a leveraged equity market play, particularly on the All Ordinaries, because the market´s performance affects discretionary investments, the size of funds under management and thus management fees, and the value of AMP´s own investments. Other key risks are claims experience, reserve adequacy, policy renewal rates, new business levels and regulation.
We maintain our Buy recommendation below $8.40. Lonsec’s price triggers, earnings estimates and valuation all remain unchanged. Long term fundamentals remain solid despite short term fluctuations in fund flows from equity market volatility. AMP trades on a prospective P/E of 13.8x and a yield of 6.4% (85% franked).
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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© Alpha Structured Investments
Dr Tony Rumble
July 2007
