Alpha POWER Shares (Lonsec) Portfolio - October 2008
Alpha POWERS Portfolio – October 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:
WOW (+2.2%) has outperformed the market by over 30% over the past year, truly exhibiting its defensive qualities. First quarter sales to 5 October 2008 were up 10% to $12.8bn and WOW maintains a FY09 sales target of 8-9% with NPAT expected to grow by 9-12%, subject to macroeconomic conditions.
Woolworth’s key long-term performance targets are:
- Sales growth ~ 8-9%
- EBIT growth > Sales growth (due to cost savings)
- EPS growth > EBIT growth (due to capital management)
- CODB reduction of 20bps per annum
- Maintenance of targeted credit ratings (A-)
WOW has $2.2bn in debt and $6.2b in net equity leading to a moderately low gearing ratio of 26% (D/D+E). WOW has suspended buy-back activity to preserve capital in the current economic environment.
The market expects WOW to generate FY09 eps of $1.48 and dps of $1.03 which suggests the stock currently trades on a forward PER of 17.3x and yield of 4%. Investors should look to BUY below $25.
TLS (-1.4%) has outperformed the market by nearly 40% over the past year. It’s 5 year transformation program is on-track and with major capital expenditure behind it, the next two years are expected to deliver an increase in free cash flow from $4bn to $6-7bn by 2010. If TLS achieves this, the dividend will be comfortably maintained and possibly increased depending on TLS investment plans.
One project that could require a large amount of capex is the National Broadband Network (NBN) with tenders due by Nov 26. The financial crisis has put TLS in the box seat, as competitors will find it hard to fund the estimated $5bn required on top of the Federal Govt’s $4.7bn contribution. There is a risk that some of TLS’s infrastructure assets could be split from the company if a competitor or a public solution to the NBN is determined. At this stage, the financial crisis has improved TLS’s hand and it is playing tough, threatening to not lodge a bid for the NBN unless the Govt. guarantees that it won’t be split.
Lonsec notes that TLS has plenty of options, even if it doesn’t participate in the NBN, as it already has cable laid in most major cities and its NEXTG mobile network is already capable of impressive wireless broadband speeds. Some brokers suggest the shares may fall to $3.50 if the NBN decision goes against it but TLS shares already trade around $4.00, so the downside is not catastrophic. Lonsec believes there is plenty of water to go under the bridge as yet and that the global financial crisis has certainly put the ‘ball back in Telstra’s court’. Lonsec remains comfortable holding the stock, given its utility style cashflow and strong balance sheet, and expects it will continue to outperform the market in the short to medium-term. BUY under $4.00.
Comments on major under-performers:
GPT (-42.3%) (note: the Alpha put option has limited most of this downside)
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.
AMP (-22.5%) fell heavily during October as the sharemarket is now down over 50% and will put obvious pressure on its investment income in the short to medium term. AMP also conducted a surprise capital raising during early November, raising $400m to replace maturing debt. AMP has a strong capital position with gearing of only 13% and interest cover of 13.5x. Despite investment income being down, it continues to perform well from an operational point of view. AMP is now well positioned to make select acquisitions amongst a distressed financial sector which will improve its market positioning for when investment markets improve.
AMP is in the Core portfolio because it is the largest superannuation provider in Australia with more than $129bn in assets under management. Notwithstanding short-term equity market weakness, the long-term outlook for the retirement savings market is positive due to bi-partisan support for a superannuation system that is attractive and acts as a tax effective savings vehicle for Australians. AMP expects the market to triple in size over the next decade, with expected average growth rates of more than 10% per year.
AMP is well positioned in the Wealth Management industry with two core business units being AMP Financial Services (operations spanning financial planning advice and various financial products) and AMP Capital Investors (investment management). AMP is the leading superannuation provider in Australia and is number 2 in the retirement incomes market.
AMP is well placed to ride out the current volatility in financial markets because it is now in good shape operationally and has a strong balance sheet. While earnings may dip in current bearish market conditions there will also be numerous opportunities for AMP to grow organically (by growing planner numbers, increasing productivity and gaining new investment mandates) and by acquisition. AMP has a growth strategy that aims to invest in distribution and enhanced products and services to drive long-term growth. Management aim to double the value of an investment in AMP every five years. Investors should look to buy AMP at current levels.
WPL (-17.9%) retreated as the oil price continued its rapid descent, falling from US$100 bbl to US$69 bbl by the end of October 2008. The oil price is currently trading around US$49 bbl and Woodside has since declined to the $29 level, a level not seen since 2005. WPL seems to offer a good long-term buying opportunity for exposure to the forecast rising demand for energy, particularly gas energy.
Woodside’s 3Q08 production report was in-line with expectations with 2008 production likely to meet its target 81-84m barrels of oil equivalent.
Woodside is investing substantial capital into a major LNG project called Pluto situated offshore WA, near the North West Shelf. 2008 Capex will be close to A$5.5bn of which Pluto accounts for $3.3bn. Woodside also has other significant gas reserves offshore WA (Browse) and in the Timor Sea (Sunrise) that can be commercialised in the future. Pluto is about 30% complete, Browse site location is expected to be announced before Christmas and Sunrise development concept selection is expected in the 1H09.
Chart: Woodside’s potential production upside
As you can see from the chart, Pluto once commissioned, will lead to a substantial lift in production and will be followed by Browse and/or Sunrise. This sort of major gas production upside is the reason that WPL should be targeted as a core portfolio holding.
WPL production should significantly increase from 86mmboe to over 100mmboe in the next few years as Pluto comes on-line. It has potential to reach 120mmboe as the Pluto trains are built and commissioned.
Lonsec/AH currently expects WPL to generate CY08 EPS of $3.50 and CY09 EPS of $2.80 which suggests that it is only on a 10x FY09 earnings at current levels.
Lonsec remains positive on the medium to long-term outlook for oil and gas, particularly LNG, due to declining global production of oil and gradual transition over to gas fired energy due to lower carbon emissions (1/3 the carbon emission of coal per MW of electricity produced). Demand for LNG is likely to increase significantly in the years ahead – the recently announced ConocoPhillips CSG to LNG JV with Origin Energy is clear evidence of that. Investors should look to BUY WPL for exposure to rising gas production and expectations that oil and gas prices will continue to rise over the long-term.
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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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