Alpha POWER Shares (Lonsec) Portfolio

Alpha POWER Shares (Lonsec) Portfolio - August 2009

Note: Recommendations made within Lonsec Model portfolios may differ from other research published by Lonsec.

Alpha POWERS Model Portfolio Change

11 August 2009

Remove TAH 10.0%

Tabcorp is Australia’s largest gaming entertainment company with leading positions in Casinos, Wagering and Gaming. Tabcorp has been trading around the $7.00 level after raising $387m in equity and $284m in a listed bond issue. Tabcorp stands to lose about 24% of its EBITDA from 2012 but still has a considerable earnings base up to and post this date. Tabcorp’s attention post 2012 is likely to be on its wagering and casino businesses (especially Star City in Sydney). Since losing its Victorian gaming licence (expires 2012), Tabcorp has implemented a three phase corporate strategy to 1) focus on operational improvement; 2) drive performance in and growth in each core business and 3) prepare for transition to the post 2012 environment

TAH was removed from the portfolio on 11/08/09 after going ex-dividend. Lonsec is exiting the position as the recent company result painted a picture of a company under significant headwinds in each of its three key businesses. While the negative outlook for pokies was well known, it now seems the Wagering business is coming under pressure from on-line bookmakers and racing industry re-structure. There is a risk the stock could drift lower, despite its high yield, as there are significant risks to revenue over the medium term. In addition, State Governments are moving into budget deficit and are likely to keep increasing gaming taxes.

Include FGL 10.0%

Fosters is under new management and has recently announced the operational separation of the Australian beer and wine business. The operational separation of the two businesses is expected to release cost savings of $100m pa from FY11 after incurring once off restructure cash costs of between $130-$165m.

Fosters retains 52% market share of the Australian beer market which has been growing at 5-6%pa (in revenue terms) because of consumers moving away from packaged beer toward higher value premium beers, low-carb beers and mid strength beers. The Wine business looks to have stabilised at around 20% of EBIT and the industry looks to be past its cyclical lows.

Despite its recent misadventures in Wine, Fosters remains a very profitable business with strong recurring cashflows. It runs EBIT margins of 27.5% and generates return of equity of 19%. It has relatively low levels of debt with strong interest cover of 8x. Lonsec expects earnings growth to come mainly from Australian beer and business re-structure and sees no reason why the dividend cannot be at least maintained.

Comments on major outperformers:

AMP (+13.2%) recently reported its interim report for CY09.

Key Points:

Underlying 1H09 profit of $367m, down 16% (above market forecasts of $342m)
Reported 1H09 NPAT $362m, down 1% on pcp
EPS $0.18
DPS $0.14 (50% franked)
ROE 31.6%, down from 40.5%
Capital reserves now 2.4x the minimum regulatory requirement
Gearing modest at 16%, interest cover high at 10x
AUM $104.1bn (down from $117.1bn at pcp)

Outlook

“AMP is investing to reshape the business in anticipation of potential regulatory change and changing consumer preferences, from a position of significant strength. This investment involves a series of important change programs, including initiatives to unbundle fees from products and supporting planners to operate on a fee-for-service basis. We are also offering more competitive and targeted products to different customer segments, and sourcing more of AMP Capital’s net cashflows internationally, particularly from Asia,” said Mr Dunn.

Short-term outlook

Economic and market outlook improving
Regulatory environment set to change, creating challenges and opportunities

Medium to long-term outlook

Attractive outlook for Australian, NZ and Asian markets underpinned by:

Ageing demographics
Mandatory superannuation regime in Australia
Saving initiatives in NZ
Economic, social and political developments in Asian markets

Comments:

The interim result exceeded expectations and AMP’s capital position looks very strong. Perhaps the only disappointment was that the level of dividend franking has dropped to 50%. AMP intends to increase franking income as its taxable profits recover.
From here, AMP has significant operational leverage to improving market conditions. As a top 3 player in Australian Wealth Management (AWM) with AUM of $104bn and a market cap of $12.3bn, it is in a strong position to reshape the business in anticipation of regulatory change.
An important message from the result is that AMP is not just looking to protect the business but is actively looking for growth opportunities. A key plank in its growth strategy is balance sheet strength to allow flexibility to respond to changing conditions. AMP has $1.1bn in surplus capital and continues to operate its DRP (75% underwritten) to raise further capital.

AMP has some short-term regulatory hurdles to overcome but improving market conditions will help mitigate the impact and the long term outlook for the AWM industry remains very robust. AMP continues to manage its costs very tightly and has a five prong plan for growth, as follows:

Grow planner capacity and broaden distribution;
Expand into Asia through AMP Capital Investors;
Grow HNW customer segment;
Reshape AMP Capital Investors into a top performer; and
Build balance sheet capacity for growth

Based on the 1H09 result, AMP looks on track to deliver CY09 EPS of around 38cps and DPS of 0.28cps. If market conditions continue to improve, it is highly likely that AMP could deliver on broker consensus expectations for EPS of 42cps in CY10 which implies the stock trades on forward PER of around 14.6x and yield of 5.1% (based on a 75% payout ratio). Given NAB’s renewed interest in the AWM space (acquisition of Aviva, JB Were) it is likely that AMP will retain at least a market multiple of 14-15x earnings. Lonsec recommends an Accumulate under $6.40.
WBC (+12.4%) recently released an update on its June quarter 09 result.

Key Points:

Unaudited cash earnings of approximately $1.1bn
Total lending up by 1.3%
Mortgage lending strong but business lending softer
Deposit growth strong, up 2.3%
Impairment charges $865m (up from $811m in the March quarter)
Increased impairment charges are coming from Aust. commercial lending and NZ portfolio
However, the rate of increase is unlikely to be repeated in coming quarters
Strong Tier 1 capital ratio of 8.2%
Collective provision to credit risk weighted assets of 1.33% (up from 1.25% at March 09)

Outlook:

CEO Mrs Kelly said: “The third quarter has shown some early encouraging signs of improvement. In particular, stronger business and consumer confidence and better than expected growth in China are assisting the Australian economy. At the same time, however, we believe it appropriate to remain cautious, recognising the pace of any recovery is likely to be slow, and that we still face some challenges particularly on the unemployment front.”

“The Westpac Group remains in sound shape, with strong provisioning, capital and funding. Westpac continues to make good progress on its strategic agenda, which is centred on significantly enhancing service delivery to customers and deepening relationships. The merger with St.George Bank is progressing particularly well, with both revenue and cost targets exceeding initial forecasts. Both customer and employee engagement remain high.”

Mrs Kelly said: “The third quarter has been a period of transition and the Group has maintained its business momentum and delivered another solid performance. I am particularly pleased with how all our businesses continue to work constructively with customers.”

Comments:

An encouraging update with cash earnings on track to meet FY09 IRESS broker consensus expectations of ~ $4.5bn. Impairment charges have moved up again in the June quarter but WBC seems to be taking a prudent approach (WBC conducted an extensive review of its portfolio and loan watchlist this quarter) and expects the rate of increase to slow from here. Impairment charges are due mainly to its commercial lending portfolio of unlisted companies and NZ. The consumer lending portfolio continues to experience only a small rate of delinquency. Lonsec notes Westpac has a strong balance sheet with a Tier 1 capital ratio of 8.2% and an additional buffer of 1.33% coming from the collective provision. WBC retains its AA credit rating which ranks it amongst the top 12 Banks in the world in terms of credit quality.

The trading update confirms Westpac is on track to generate Sept FY09 cash earnings of around $4.5bn or EPS of $1.53 per share and DPS of $1.14 (75% payout). That implies WBC currently trades on a forward PER of 14.8x and yield of 5.0% ff. However, earnings are expected to lift considerably in FY10 as the asset impairment charge recedes and investment income improves. The current IRESS FY10 broker consensus forecast is cash earnings of around $4.9bn or EPS of $1.67 per share implying that WBC trades of a FY10 PER of 14.8x. Lonsec recommends investors Accumulate under $24 ahead of the FY09 result, due late October.

Comments on major under-performers:

TLS (-3.7%) looks like a value play at these levels with a high dividend yield and low PER. However, the fixed line business represents about $20bn or half its $40bn market cap. The Government wants TLS to structurally separate its fixed line assets so that the NBN can acquire them. Subsequently, TLS will not be able to compete against the NBN and will become another customer, just like Optus or any other retailer.

Lonsec holds major reservations over TLS’ ability to secure adequate compensation for its assets. This then leads to concerns about its financial structure in the future. Lonsec is also concerned that TLS’ fixed line margins will materially shrink, post implementation of the NBN. Remember, TLS will hold a passive equity stake in the NBN without any management control. It will be a retailer like the other Telco providers.

It is possible that TLS will be adequately compensated with a portion in cash. However, given the harsh negotiating tactics employed by the Government so far, Lonsec would prefer to wait this one out before assessing again later. Lonsec expects the stock to range trade between $3.00-3.50 over the short term but has potential to drift lower over the medium term. Lonsec has removed TLS from the Lonsec Core Model Portfolio but continues to hold the stock in the Lonsec POWERS portfolio. This is because the Alpha option overlay works well with a range trading high yielding stock and should be able to generate significant income from dividends and option premium. The bought put position acts to mitigate any concerns about the stock drifting lower.

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.

Lonsec Limited ABN 56 061 751 102
AFSL No 246842
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