Update No. 22 – 28/08/11

There was a flood of profit announcements this week, I will briefly focus on 4 that are members of the EGP20 and discuss one that is not.  The funds holdings did not quite keep pace with the markets bold upward move this week, but we still have half of our holdings yet to announce and I expect there could be some good news from a couple of our largest this week.

First to the one that is not, Amcor Limited (AMC) announced this week a profit if 45.9 cents per share, I will ignore NPAT and other metrics for reasons I have discussed over the preceding weeks.  Its share price this week moved almost in-line with the market; however, it trades at about a P/E of about 14.8, which is approximately a 25% premium to the broader market, which should indicate significantly superior prospects – let us examine that.  Those who like the stock would point out AMC have substantially grown ROE over the last 10 years, from an average FY02-04 of 7.77% to a FY09-11 of 12.97%.  The reason for the improved ROE is simple, in the same periods, average equity shrunk from about $4.5b to about $3.6b, but long-term debt more than doubled to over $3b – ROC improvement, therefore has been much more modest, simply replacing equity with debt.  Those like me, who prefer to think (as I have posted previously about here) about return on the price paid for equity would be more interested in EPS.  Over the same period, EPS grew from an average of 39.8c to an average of 41.9c, I don’t know about you, but with inflation, EPS growth of 0.52% per annum over 10 years is probably not enough.  Interestingly, despite negligible EPS growth, AMC has returned 6.5% p.a. in total shareholder return over the last 10 years, of which only 0.2% has been in capital growth – makes you happy for Australia’s high dividend pay-out ratios…

Other concerns for me would include the falling cash-flows, FY02-06 saw cashflow per share of $5.15 for AMC but FY07-11 saw only $3.73, to my view, a business as mature as this should have improving cash-flows, at least stagnant and certainly not a 28% decline (Telstra using the same periods grew theirs by 18% despite a fall in EPS in the same period). AMC are forecast (not by me – analyst consensus) to grow EPS by about 27% over the next 2 years, interestingly TLS are forecast (again – not by me) to grow theirs by 19.9% in the same period, yet AMC trades on a P/E of 14.8 and TLS on 11.8x.  One of those numbers is either too high, or one is too low; I’m inclined to think the former.  I could go on, but just thought I’d share some thoughts, it astounds me how much unjustified faith the market will place in a company which has failed for so long to deliver anything.  JB Hi-Fi trade on roughly the same P/E as TLS and significantly lower than AMC, without any deep analysis, basic instinct should tell you which of those three businesses is most likely to look back in say 5 years and to have grown EPS at the fastest rate.

To the 4 EGP20 stocks – reporting this week were Hills Holdings Limited (HIL), Australian Infrastructure Fund (AIX), Fairfax Media Ltd (FXJ) and Pacific Brands Limited (PBG).  Now three of the four shot much higher on announcements that, to me, provided little more than a confirmation things were about as expected.

HIL actually reported a loss, while SP went from $1.01 at last Fridays close to $1.225 at this weeks close, so something in the result sparked hope.  HIL (unfortunately for them) have interests in steel-making (which is not the place to be in Australia at present…), these were substantially the cause of the write-off, the ORRCON business had assets, inventories and plant written down heavily, write-downs totalled $108.8m for HIL, which are HUGE for a business with a market cap this small (about $300m), the positive for investors is it leaves only $49m of intangibles on the balance sheet (not much left to write off).  I think HIL are at (or very near) the bottom of a cyclical low, I expect revenue will probably stabilise in FY2012 (barring some new crisis), NPAT will grow marginally and with the buy-back, EPS will be something like 12 or 12.5 cps, and could be as much as 15 cps in FY2013 if things continue to improve.  If that eventuates, the stock would seem to be pretty cheap even with the big jump this week; one concern is that it must be close to being replaced in the ASX200, which could spark short term price declines as index-huggers re-balance.

PBG also announced a loss, SP went from 63.5c at last Fridays close to 69c at this weeks close, so again, there were sufficient positives taken out of the report.  The write-downs leading to the announced loss, however, were flagged 6 months ago. Underlying EPS of 11.1 cps leave the company even with a large spike this week trading at about 6.3x earning.  Benjamin Graham tells us a business that is likely to earn the same EPS in perpetuity should trade at about 8.5x.  Although I think EPS growth for PBG will be muted, I don’t think it will decline, which is the way the stock is being priced.  PBG are generating solid cash, though unlike HIL, they still have over $1b in intangibles, which is pretty big for a company with a $650m market cap, but when you look through their stable of brands and consider their cash generating power, it is probably not an unreasonable figure.  With the continued pay down of debt and eventual increases in dividends, yield alone is likely to force PBG higher, I maintain my opinion this stock should outperform over the next few years.

AIX – I know infrastructure and real estate are unpopular at the moment, but the assets AIX own are truly outstanding collection of reasonably priced infrastructure assets with great growth potential, notwithstanding Athens Airport (probably not going so well, what do you think?) which makes up less than 4% of the portfolio.  This group of predominantly Australian airports, ports and some German airports are very good and in my view likely to perform very well in the coming 5 or 10 years.  The NTA of $2.85 is not overstated in my view (especially when compared with a current share-price of $1.80), and while I don’t think AIX will blast substantially higher in the very short term, I think there is a good chance of it consistently outperforming the market as cash-flows and the value of the underlying assets move steadily higher, coupled with a closing of the gap between price and NTA.  If I were CEO, I would reduce dividends and increasingly buy-back shares as the best way to add shareholder value and capitalise on the disparity between NTA and share-price.  At current prices AIX is trading at less than 16x cashflow and only 5.2x FY2011 EPS, if we assume cash-flow grows at 5% p.a. and asset values at 2.5% (both quite conservative, given the placement and quality of the assets), then the ‘repeatable’ earnings for FY2012 would be somewhere in the order of $140m, leaving AIX trading marginally below the Benjamin Graham, zero growth multiple of 8.5x (8.2x actually), when actual growth is unlikely to be less than about 7.5% in my view.  Pretty cheap for a fairly defensive asset I reckon.

FXJ A $655m impairment to intangibles, wow, still carrying $5.26b of intangibles on the balance sheet, double wow… Serves to remind investors of the earning power intangibles such as newspaper mastheads (used to, at least) have.  Given that FXJ trade at a market cap of $1.95b, the market is implicitly writing of a lazy couple of billion more of those intangibles.  The underlying performance of FXJ was actually pretty good, it is generating a lot of cash and despite the last 12 months being much tougher than the preceding 12 months, the underlying performance was roughly flat.  As I have said before FY2011 is in my view going to be the cyclical bottom for advertising/media and FXJ don’t really even need to grow their earnings to be cheap, but I suspect they have some growth left in them.

I have criticised the many ASX companies who were in very strong financial positions through FY2009, yet sat on cash when their share-prices were clearly and ridiculously under-priced, the boards of HIL and PBG are to be commended for recognising the mis-pricing of their stock and acting in the interests of long-term holders, buying back stock, I do find it interesting how a buy-back announcement almost always causes a very sharp re-pricing of a stock though, do buyers really need their opinions validated this way? Aren’t there highly paid equity analysts keeping the market ‘efficient’? – Tony Hansen 28/08/11

EGP Fund No. 1 Pty Ltd. Down by 2.79%, leading the benchmark by 5.27% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 5.38%, leading the benchmark by 17.13% all-time (April 1^st2011).

EGP 20.  The EGP20 index is Down by 8.89%, lagging the benchmark by 0.83% since July 1^st.  Since inception the EGP20 is Down by 19.49%, lagging the benchmark by 7.74% all-time (since April 1^st2011).

S&PASX200TR  The benchmark index is Down by 8.06% since July 1^st. The benchmark is Down 11.75% all-time (since April 1^st2011).