Update No. 13 – 26/06/11

EGP Fund No. 1 Pty Ltd. Up by 10.12%, leading the benchmark by 16.22%.

EGP 20.  The EGP20 index is Down by 13.28%, lagging the benchmark by 7.18%.

S&PASX200TR    The benchmark index is Down by 6.1% since April 1 launch.

This week I will nominate the constituents that will make up the EGP20 between July 1^stand December 31^st2011.  I will give a brief account of the first 10 this week and of the final 10 next week.

Now, the EGP20 has lagged the benchmark in its first 3 months of existence, such things will happen, I believe over the longer term, the constituents of this group will outperform.  Here again I give my usual caveat, that we are not licensed financial advisers and that if you are interested in any of the stocks mentioned, you should do your own research, or engage an advisor, the prospects of these stocks are identified (by my proprietary method) as having superior quantitative prospects, however, I have not undertaken the exhaustive qualitative research I undertake for the investments EGP Fund No. 1 Pty Ltd holds.  The constituents and a brief note about them:

1. OST – Onesteel.  Given the ongoing debate about the proposed Carbon Tax (again I attach my alternative carbon abatement solution, at the bottom of the ‘about us’ page, for those who would like to see a solution, but acknowledge the fatal (anti-competitive) flaws in the current proposals), it may seem ludicrous to include this stock as a likely out-performer.  Unlike the power-generation industry, the steel industry could be driven offshore.  Onesteel will face many challenges, but I believe that the business is well positioned to withstand, time will tell, but over the medium term, I believe OST will outperform the ASX200. People overlook advantages OST has, such as owning its own sources of iron ore. 
2. OMH – This company gets marked down by the market for various things, not the least of which include mining a less well followed commodity (manganese), which is trading at well off recent higher prices, operating in countries Australian investors are wary of (such as Singapore and Malaysia), and having a huge reliance on its major customer (China).  I still think 92c makes it so cheap as to give too much weight to all the various ‘negatives’.  Although OMH has produced ‘lumpy’ results, it has been consistently profitable and even managed to maintain good production when other Northern Territory miners were closed down (see ERA below).  They seem to communicate fairly well the state of affairs to their shareholders, without the value of the business being recognised in the share price.  Unless I’m missing something, I believe they should trade much higher in the not too distant future, perhaps not testing the all-time highs of $2.87 anytime soon, but well higher than now.
3. ERA – Energy Resources Australia remain in the EGP20, despite their poor performance over recent history (including this years flooding shutdown, but particularly since Fukushima).  The company has faced myriad challenges in recent history, but I think any sensible person must acknowledge the most logical, deployment ready solution to reducing CO² emissions through energy production is a nuclear one.  ERA stand ready to produce the uranium for this solution, absent the production problems of this year.  The forward prices of uranium have dropped in expectation of reduced demand, if I was inclined to buy any commodities (I am not as it is too speculative), uranium at under US$55 per pound would be worth considering.
4. OGC – Oceanagold.  I have stated previously my distaste for gold as an investment.  The sum total of gold mined in all of man’s history would make a cube with just over 20m sides, and have almost no other use than to admire (only about 10% of gold is used for industry, and I suspect this ‘industry’ includes people with gold teeth, by contrast approximately 80% of silver/platinum mined goes to industrial uses).  That said, who am I to question people’s motivations?  If people want to buy and own a useless substance, why not own a producer with good competitive advantages.  OGC are a low cost producer of Gold, who are about to produce a lot more at a much lower cost.  If they can come even close to getting the Dipidio project in the Philippines to perform to expectations, they will go from producing at about US$600 per ounce to less than US$400 per ounce.  The copper production at Dipidio alone will be profitable (i.e. cover all mining costs); the 100,000 ounces per year gold will be a bonus.  At current prices approximately a US$150m bonus (OGC are a AU$650m company at present).  As I said, undervalued if they get it even close to right.  Like all junior miners, there are risks, but at current prices, very little of the potential rewards being considered.
5. PBG – Pacific Brands Limited. Pacific Brands have been an unmitigated disaster since listing and earn a consistently anaemic ROE (6.56% last year).  As I have pointed out before though, you aren’t paying the same price for equity as those who originally stumped up; you pay the current market price.  No, for the price of 68 cents per share, you can get earnings which are forecast by the 6 analysts covering the stock that are forecast to be about 35c over the next 3 years.  The majority of the production facilities are in low-cost countries now, debt is sensible, the key challenges in my view are rising input costs (cotton etc.) and challenging retail conditions, but the majority of their brand-stable are household brands that should hold up through the cycle.
6. RSG – Resolute Mining Limited.  Resolute produce the 3^rdmost gold on the ASX, over 300,000 ounces per annum, with several good development prospects and some (potentially) even better exploration prospects.  For a relatively small company (about $500m market cap) RSG have been relatively consistent, with positive cash-flows for the last 10 years.  They would seem to have about 6 million ounces of the useless yellow-metal, marked down due to being a higher-cost producer & a good portion of the reserves being African.  The production cash-costs are forecast to decline and production to increase, on this basis, future earnings per share should be much higher, on this basis, the shares appear undervalued.
7. AGO – Atlas Iron Limited.  I have tried to find holes in the Atlas story, but they have done an outstanding job of bringing their various projects online.  They are generating an enormous and growing amount of cash each month.  To my way of thinking they have 2 key risks, firstly (obviously) a substantial slump in iron ore prices and secondly, that management gets involved carelessly in the inevitable consolidation in the sector and overpay for growth assets.
8. BOQ – Bank of Queensland.  I think BOQ has been unfairly marked down with their recent struggles.  I believe it is a case of the market over-reacting, treating a genuine one-off situation as ‘the norm’.  We need to remember that absent the flooding and cyclones Queensland had this year, that state economy (where the majority of BOQ income is generated) would be performing second only to W.A.  The big banks will be steadier, but I am confident we will look back in 5 years’ time and the TSR (total shareholder return) generated by BOQ will be better than the big banks.
9. SIP – Sigma Pharmaceuticals. The best performing of the April EGP20 nominations, up about 35% in 3 months.  Sigma looks to be one of those rare turnaround stories that are actually starting to turn.  That being the case, there is still a good amount of potential left in the price before it becomes so fully valued as to drop out of this list.
10. AIX – Australian Infrastructure Fund.  I have followed AIX for some time.  I think they seem to do things right that other infrastructure funds get wrong.  Based on the solid earnings they generate and the fact they pay dividends out of cash-flow (most infrastructure funds borrow to pay dividends higher than their ‘cash’ earnings), I think they will stably perform a couple of percentage points better than the market over the medium term.

The 10 that follow, I will go into further detail next week.

1. RIO
2. FXJ
3. BHP
4. APN
5. GNS
6. KCN
7. JBH
8. HVN
9. HIL
10. DOW

Again I must state, these are (my personal opinion) of the best of the ASX200 that we do not hold in EGP Fund No. 1 Pty Ltd, if I thought the stocks above were really outstanding opportunities, then they would not be in the EGP20, but held in our company.  I will meet with our auditor on 8 July to confirm the NTA per share as at 30 June, so until I have that confirmation, I will not make an update as to the NTA.  It is likely I will make my next update on 10/07/2011, which will outline the June 30 audited NTA and resume weekly NTA updates from that point forward.  Tony Hansen 26/06/2011