Tag Archives: Media

article 3 months old

Not All Media Stocks Are The Same

By Greg Peel

We know that all media stocks are not the same, because for years now they have been separated by the market into the “old media” world of newspapers, radio and free-to-air television and the “new media” world of the internet, cable television and digital media in general. Indeed, UBS notes that while the media sector on the Australian market is trading at an FY11 forward earnings price/earnings of 15.1x, that figure is split into 11.7x for “old” and 20.1x for “new”.

If you consider that the historical full-market average PE is 14x, you might say that old media looks undervalued and new media overvalued but that would be to ignore the underlying and now gradually maturing secular shift which pervades the sector, GFC or no GFC. In simple terms, metro newspapers are being replaced by digital versions as is analogue FTA-TV while classifieds are now the preserve of internet-based specialists and viewers are moving towards a view-on-demand basis instead of a TV guide basis.

And today's youth are never likely to read a newspaper at all in hardcopy and few even drag themselves away from the computer to watch tele, with rare exceptions such as Masterchef or sport. Gen Y is probably blissfully unaware mum and dad found their house and cars in newspapers classifieds once upon a time.

The secular shift is nevertheless not over, nor is it an overnight phenomenon. There are still enough tired old fools like me who prefer to spend half an hour each morning wrestling the seemingly seamless plastic wrap off my home-delivered Herald and to settle in of an evening to Spicks & Specks on ABC FTA-TV (albeit delivered via satellite re-send). That is why the old media companies and the new media companies have a PE split. The story ain't over yet.

But the story is now far enough down the track that it is fully understood by the market. There remains a PE gap because new media still have greater future earnings potential than old media, but among the old media stocks which have collective PE of 11.7x, and the new media stocks which have a collective PE of 20.1x, there are those which are over- or undervalued in their own right, at least according to analysts.

The recent earnings reporting season gave stock analysts a chance to assess how things are going.

UBS notes that on average, the sector delivered FY10 earnings 1% above consensus. But company managements were collectively cautious in their FY11 guidance, so forward earnings were downgraded by an average of 2%. Those stocks which surprised to the downside included APN News & Media ((APN)), Ten Network ((TEN)) and West Australian Newspapers ((WAN)) while surprising to the upside were Carsales.com.au ((CRZ)), Seek ((SEK)) and Fairfax ((FXJ)).

There is almost, but not quite, a consistent split here. As a purveyor of newspapers, magazines and directories, APN is a wrinkly. So is West Oz, but then its fortunes rise and fall with commodity prices (strong prices = mining boom = strong WA economy = lots of job and house ads). Ten is still a wrinkly despite making a late charge into digital channels, which are still FTA. Ten simply lives and dies on the strength of whatever franchise is working at the time, from Big Brother to Idol to Masterchef.

Carsales and Seek are clearly teenagers, albeit Seek is now so well established it's almost Gen X. And Seek's outperformance is currently due to its successful foray into education which has really little to do with media. Its online classifieds business is mature.

The odd one out is Fairfax, which is still very much an old media company. But the story of Fairfax is one of strong foresight but poor execution. The company moved into the digital space early by trying to sell the Fin Review online, but charged so much for access that the world stayed away in droves. Now, with thanks to rival Rupert Murdoch, the quiet shift is on towards charging out digital newspapers at a reasonable price. And Fairfax has remained in touch with its classifieds competition through its internet websites such as Drive and Domain.

Fairfax was almost written off in the GFC by the market, but has proven its critics wrong and bounced back with a vengeance. What is notable, nevertheless, is that old media undertook an extensive capital raising program in response to the GFC, and now balance sheets are looking rather healthy.

Which brings us to the core of media revenues – advertising. Here the lines are now blurred given the rise of practices such as viral internet advertising and television product placement to replace the newspaper ad or lengthy TV ad break. But anyone who has to constantly unwrap his Herald from not just stubborn cling wrap but also some wrap-around full-page spread, or has been forced to sit through the relentless and repetitive ad breaks in Masterchef, knows that old-style advertising is still alive and well and threatening to hang around for many a moon yet. Have razor blades ready when the Commonwealth Games begin.

Advertising spending is now back in earnest having vanished completely in the GFC. The strong numbers achieved in the second half of FY10 are already showing up as continuing in the first half of FY11. And as UBS notes, longer booking cycles are providing confidence that strength will indeed prevail. Such revenue, along with recapitalised balance sheets, has allowed media companies to reinstate their dividend payouts.

Yet managements remain cautious. They are cautious because there remains a global economic uncertainty which threatens to shut down ad spend once more if things go back to panic, and they are cautious because it was easy to show good earnings growth in FY10 over FY09 – given no one spent any money on ads in FY09 – but it will obviously not be possible to repeat those comparable numbers in FY11 over FY10.

Comparables always seem ludicrous to me, and a fall-back point for the unintelligent analyst or investor, but that's the world we live in.

Deutsche Bank expects all media companies to make incremental investment in their digital platforms in FY11 having shut down capex during the GFC. Just as to how this is accepted by the market is a case in point. Seek, for example, is expected by Deutsche to make the heaviest relative investment. But given this will be in its burgeoning education division, earnings growth potential renders such investment worthwhile. Ten, on the other hand, is throwing a lot of money into its new FTA digital channel Eleven, and into expanding its news service.

Analysts are concerned this might be good money going after bad. So far the big news around Eleven is that Neighbours – a show watched only by envious foreigners and lonely local diehards, and now a hundred years old or something – will move to a new time slot on the new channel. If that's the best we have to look forward to, goodnight. And the other risk is that Eleven simply fragments the Gen Y target audience of Ten, and offers yet more Simpson re-runs to fill in the blanks.

(I recently read that between FTA and cable, The Simpsons appears on Australian TV 53 times a week.)

Moreover, Ten's decision to pump more money into that which it has always shunned for the most part – news and current affairs – seems like an unnecessary addition to a crowded market (note ABC 24) and, again, anathema to the Gen Y audience Ten has so cleverly consolidated over the years.

If something new doesn't eventually come along to replace an over-flogged Masterchef when we're all over the cooking show concept, Ten is in big trouble.

But while this looks like new media winning and old media losing again, consider that UBS has today initiated coverage on the REA Group ((REA)) – once known as Realestate.com.au – with only a Neutral rating. While the business is sound on a medium-term view, say UBS, at 23x forward earnings the stock is simply fairly valued.

Indeed UBS suggests that on a PE basis, REA and Carsales appear the most expensive while Fairfax and APN appear the cheapest. But if you go another step down the ratio line, to PE over earnings growth (PEG), Newscorp ((NWS)), Austar ((AUN)), Seek and Fairfax are the more attractive and APN and West Oz Newspapers the least.

If I had a dollar for every time an analysts said News Corp was “compelling value” only to see Rupert buy into some other new fad (or old fad) at great expense, I'd be a very wealthy man. How's MySpace going these days?

As for Austar, the company has been able to shoot goals through what's know as ARPU but not through growing its subscription base (as is also the case with Foxtel). ARPU is average revenue spend per unit and basically reflects the fact existing customers are paying up for new channel packages and fancy hard-drive boxes which allow you to pause for a leak or fast-forward through ads (assuming you record first).

One wonders how Austar's satellite TV service will be faring by the time fibre cable reaches the bush.

Yet UBS has a preference for Austar, along with Seek, Austereo ((AEO)) and Southern Cross Media ((SXL)).

In the case of Austereo, it is considered that while radio is old media it will never die. We still listen to radio at the breakfast table or in the car, or in the shed when the finals are on, no matter how whizz-bang other digital offerings become.

As for Southern Cross Media, regional old media is also considered a stalwart. This also works for Fairfax after its 2006 acquisition of Rural Press.

Across all media companies, there exists the ongoing possibility of more industry consolidation and takeovers.

So the rule of thumb with media sector investment is don't just separate into old and new. One must consider whether the market is over- or undervaluing the pros and cons. And one must also take note of diversity or lack thereof, and that which is specifically driving earnings growth potential.

article 3 months old

Southern Cross Media Awaiting Re-Rating

By Chris Shaw

Southern Cross Media ((SXL)), which used to be part of the Macquarie empire as the former Macquarie Media Group, owns a collection of regional media assets spanning both the radio and TV markets that give the conglomerate exposure to more than 7.9 million Australians.

According to Citi, which today initiated coverage on Southern Cross with a Buy rating, this spread of assets gives the company good leverage to any improvement in advertising spending going forward. The assets are also well spread geographically, as Southern Cross's largest regional market is Southern Queensland at around 15% of total revenues.

The other attraction in Citi's view is now the assets are out from under the Macquarie umbrella, the complex financial structure including the likes of management fee has now been removed. This leaves Southern Cross management free to simply focus on operating its media assets.

In Citi's view, Southern Cross is now approaching the cash cow phase of operations, as on the stockbroker's numbers the radio and television operations together should generate a combined EBITDA (earnings before interest, tax, depreciation and amortisation) margin of 32.6% in FY11. At the same time, Citi expects a free cash flow yield of 11%, based on what the broker suggests are conservative forecasts.

This strong free cash flow should mean an increase in dividends, with Citi forecasting a dividend yield for Southern Cross of 4.9% in FY11. This implies a 50% payout ratio, something the broker expects could be lifted over time. As an example, an 80% payout ratio would see a yield of 8% on Citi's numbers.

The other scope for upside in Citi's view comes from potential merger and acquisition activity, as Southern Cross is attractive given it is a television affiliate network. The group holds 14 broadcast licenses and re-transmits programming content from both Ten Network ((TEN)) and Seven Group ((SVW)).

Nothing is expected in this regard short-term as Citi notes any M&A upside would require changes to existing media regulations, but such a process may soon be underway given the Federal Communications Minister, Stephan Conroy, has outlined an intention to reform the current laws starting in 2011.

In terms of risks, Citi suggests there are limited structural threats in the TV and radio markets, particularly in the regional markets that Southern Cross is operating in. This, combined with the completing of the restructuring process as the company extricated itself from the Macquarie stable, means a re-rating remains possible going forward.

In Citi's view the upcoming full year results due next month could act as a catalyst for the stock, as management will be able to present the core business to the market for assessment. Value will be the other catalyst as Citi estimates Southern Cross is trading on an EV/EBITDA multiple of 6.1x and offers an attractive 8.4% yield in FY12.

Citi is forecasting earnings per share (EPS) of 8.3c this year, rising to 16.3c in FY11 and 17.6c in FY12. These estimates compare to consensus forecasts according to the FNArena database of 13.3c in FY10 and 16.9c in FY11.

The database shows Southern Cross is rated as Buy five times and Hold once, this courtesy of JP Morgan. The average price target for the stock is $2.17, while Citi has initiated with a target of $2.10.

Shares in Southern Cross today are slightly weaker, down 0.5c at $1.695 as at 11.40am. Over the past year the stock has traded in a range of $1.575 to $2.31, today's price implying upside of better than 27% to the average price target in the FNArena database.

article 3 months old

Previewing FY10 Results And FY11 Outlook

By Greg Peel

Cash is king, says RBS Australia. The analysts recognise this line is a cliché, but in such uncertain times they suggest the “quality” of earnings results is just as important as the quantity. Quality is obviously a subjective measurement, but RBS believes quality can be quantified at least in part by a calculation known as a “cash realisation ratio”.

The analysts want to deploy CRR measurements given cashflow generation is a “unifying force” among companies that cuts through the noise of factors within company reports including one-off items, provisions, seasonal earnings bias and so forth. The CRR is measured as normalised profit after tax (NPAT) plus depreciation and amortisation divided by operating cashflow. It represents the “cash backing” of earnings and thus their quality, RBS suggests.

RBS has applied CRRs to its FY10 forecasts for stocks in the ASX 100 and will recalculate once all reports are in.

The top ten stocks on a CRR basis are Australian Worldwide ((AWE)), Oil Search ((OSH)), United Group ((UGL)), OZ Minerals ((OZL)), OneSteel ((OST)), Goodman Fielder ((GFF)), Myer ((MYR)), Alumina Ltd ((AWC)), Woodside ((WPL)) and DUET ((DUE)).

The bottom ten are MAp Group ((MAP)), Paladin ((PDN)), Intoll ((ITO)), BlueScope ((BSL)), Amcor ((AMC)), CSR ((CSR)), Sims Group ((SGM)), Westfield ((WDC)), JB Hi-Fi ((JBH)) and James Hardie ((JHX)).

BA-Merrill Lynch has been looking at the infrastructure and utilities sector. The analysts expect “very solid” six-month results. Assuming no more “debt events” (such as another European implosion for example), Merrills expects this sector to hold up well through any further market volatility, although it is not so clear as to whether this “defensive” sector can actually continue to outperform.

Those companies in the sector Merrills is looking to for “stand-out” results are AGL ((AGK)), Asciano ((AIO)), MAp Group, Transurban ((TCL)), Australian Infrastructure ((AIX)) and ConnectEast ((CEU)). The analysts particularly like MAP and AIO.

The analysts have these stocks trading at steep discounts to their discounted cash flow valuations, but note that price/earnings and other multiples do look high in comparison to other sectors. This may mean some resistance from the market, but Merrills considers them reasonable “in light of earnings security and likely growth”.

The broker warns, however, that AGL has outperformed the market by 6% since the beginning of June which limits its upside.

Morgan Stanley has considered another so-called “defensive” sector, being healthcare, but suggests regulatory risk undermines such defensiveness. MS has Ramsay Health Care ((RHC)) and Ansell ((ANN)) on Overweight ahead of reporting season believing the market may be too conservative in its earnings forecast consensus. ResMed ((RMD)) is the analysts' preferred growth exposure, but upside appears now to be capped, they suggest.

The new government initiative of pathology centre licensing is a negative for companies in that game, Morgan Stanley suggests. The analysts thus have an Underweight on Primary Health Care ((PRY)) and note that while less exposed, Healthscope ((HSP)) and Sonic Healthcare ((SHL)) remain “vulnerable”.

Morgan Stanley believes expectations for earnings growth for Cochlear ((COH)) are too high following a survey of the implant industry.

From defensive to offensive, or cyclical, Morgan Stanley has also run its ruler over the resources sector.

Companies which the analysts believe have upside risk to earnings results are BHP Billiton ((BHP)), Rio Tinto ((RIO)), OZ Minerals, PanAust ((PNA)), Equinox ((EQN)) and Newcrest ((NCM)). Companies with downside risk are Alumina, Iluka ((ILU)), Fortescue ((FMG)), Macarthur Coal ((MCC)) and Centennial Coal ((CEY)).

Morgan Stanley suggests management outlook from resource sector companies will tend to be on the conservative side given ongoing global uncertainty over European debt and Chinese slowing. The MRRT will no doubt crop up and the Chinese steel price will be seen as a lead indicator with iron ore spot prices now falling.

The analysts nevertheless expect improving share prices for mining companies over the course of the September quarter.

UBS has looked at the Real Estate Investment Trust sector. After considering upside and downside risk to results and guidance, the “always coming” office recovery, debt refinancing obligations, asset valuations, dividend payout ratios and the recovery of funds flow into REIT investment, UBS prefers Westfield and Goodman Group ((GMG)).

Moving on to FY11 guidance and analyst forecasts, UBS suggest margin expectations are a little optimistic. The analysts expect timing will be adjusted to suggest a longer than previously anticipated recovery, such that FY11 earnings forecasts across the market will need to come down by some 5%. UBS does not expect any “huge” downside.

On a sector distribution basis, UBS' strategists are Overweight the mining sector and the industrial cyclicals (media, selected consumer discretionary and selected mining services). They are Neutral on the banks but note banks will outperform in any market bounce.

At the stock level, the strategists' strongest growth/defensive ideas are ResMed, AGL and Crown ((CWN)).

While RBS is looking at cash realisation ratios to assess FY10 results, Deutsche Bank is using profit “run rates” to gauge the outlook for FY11 in the emerging companies (small industrials) sector.

A “run rate” is simply an extrapolation of a previous result. If company XYZ posted $100m profit in the first half of FY10, for example, then its run rate implies a full-year profit of $200m. But Deutsche is using forecast second half run rates to gauge expectations of first half FY11 earnings.

Run rates lose their value for certain specific sectors or stocks where seasonality is a major factor (Christmas for retail, for example). And for cyclicals in general, run rates are not taking into consideration troughs and peaks in cycles. But nevertheless, Deutsche notes most stocks in its coverage universe have run rates below current forecasts. Says Deutsche, “It appears that the market's expectation for earnings growth has improved over the calendar year to date, but remains slightly negative to FY11 earnings growth. If results prove to be closer to run rates than current forecasts, the analysts would expect downward pressure on the Small Industrials index.

Stocks with an FY11 run rate below current forecasts include Ardent Leisure ((AAD)), Crane Group ((CRG)), GWA International ((GWT)), Miclyn Express ((MIO)), Mermaid Marine ((MRM)), Realestate.com ((REA)), Salmat ((SLM)), Spotless ((SPT)), Swick Mining Services ((SWK)), Transpacific ((TPI)) and Wotif ((WTF)).

Stocks with run rates above consensus forecasts include Flight Centre ((FLT)), Bradken ((BKN)) and NRW Holdings ((NWH)).

Leaving off where we began, with RBS, the analysts have had a look at FY11 prospects for the construction and engineering sector.

The upshot is that the roll-off of government infrastructure stimulus coupled with delays to new resource projects in light of mining tax uncertainty have meant a risk to short-term performance. The sector does appear to be recovering, but the recovery is neither uniform nor linear, RBS suggests.

The analysts thus warn of downside risk to current FY11 forecasts in the sector but they nevertheless have a positive medium-term view, looking for performance on a three-year basis.

On that measure, the stocks RBS prefers in the sector are Downer EDI ((DOW)), Transfield ((TSE)), WorleyParsons ((WOR)), Monadelphous ((MND)), United Group, Leighton ((LEI)) and Boart Longyear ((BLY)).

FNArena will bring readers more broker previews as they come to hand.

article 3 months old

A Guide To The Australian Reporting Season

By Greg Peel

In the US, listed companies report their earnings results officially on a quarterly basis, with the great concentration being around the natural quarters of March, June, September and December. The June quarter season has just begun.

In Australia, reporting is required only on a half-year basis, although often companies will provide interim quarterly updates. The majority of Australian companies work off a June financial year, meaning December half results posted in February and full year-results posted in August. Increasingly, companies reporting in US dollars (many resource sector stocks for example) are working off a December financial year, meaning their August results are half-years and their February results full-years.

Then there are other companies, such as three of the big banks, which report on an “off” cycle to everyone else. But suffice to say, we are about to hit the major reporting season for the year. Next week and the week after will see the first handful of results, the second week of August sees a lot more, and thereafter comes the deluge. By September it's all over.

It is important for investors to appreciate that the market response to a result has nothing to do with whether or not a company posts a record profit, or a record loss. Responses will only be based on whether a company matched, beat or fell short of analyst forecasts. Every single day of the year, stock prices are building in earnings expectations. Thus an actual earnings result is only providing confirmation of market expectations, and affirmation of pricing, or otherwise. The inexperienced investor is often perplexed when BHP, for example, announces a record profit yet its shares fall on the day. The reason for the fall is usually that the market had expected an even bigger record profit, and thus is disappointed.

One must also not discount the “buy the rumour, sell the fact” effect. A stock may go for a run ahead of its results announcement on anticipation of an “upside surprise”, for example. If the result does surprise to the upside, the stock price can still fall as traders take profits on a successful trade.

Which brings us to the contradictory notion of “surprise”. Ahead of a results season, brokers will usually prepare lists of those stocks which their analysts believe may “surprise to the upside” or “surprise to the downside”. Your old English teacher would probably immediately ask “How can one expect something to surprise? Surely it cannot be a surprise if expected?” However, the butchered English simply reflects an analyst's view that perhaps market consensus is a bit conservative, for example, on a particular stock, and that it will find itself surprised by the result.

In the US, it's very easy to know immediately whether a result has “beaten the Street” or not given a very specific focus on earnings per share (EPS) and revenue forecasts and comparable results. In Australia, we tend to focus on the profit number. This is problematic, given profit results can be impacted by such things as tax changes, asset write-downs, depreciation charges and so forth. Analysts will often speak of a “messy” result, which is one which requires the report to be picked apart before the “real” performance can be gauged. It may not thus be immediately apparent whether the result is a “beat” or not. Sometimes an analyst needs a few hours to arrive at realistic opinion.

This also flows through to the important notion of result “quality” as opposed to “quantity”. The quantity of a result is simply the profit or earnings number which can be compared to last half and the same half last year, as well as previous management guidance and analyst forecasts. But let's say for example, that XYZ beat forecasts by a long margin, but did so because it closed and sold off several shops, slashed staff numbers, pared back inventory lines, brought forward tax losses, fully depreciated machinery – any such notion that suggests earnings were more about downsizing and less about growing revenues. Such a result lacks quality, because it paints a misleading picture of corporate growth.

Another example is banks which post solid trading profits from their proprietary desks in time of high market volatility. It's a good result in a quantitative sense, but not so in a qualitative sense given such volatility is unusual and such profits cannot be expected to always be repeated.

Quality or otherwise can take many forms.

Then having been hit with a series of numbers to interpret from the period past, the market will also take note of ongoing company guidance. Analysts do not only have FY10 forecasts running, they also have FY11 forecasts (and beyond) in their models. Guidance is just as important as the result.

For example, a company's accompanying statement to a result might be something like “We saw difficult trading conditions in FY10 but evidence in the past month or so suggests prices are firming and margins are increasing. We are forecasting an FY11 profit improvement of X”. Once again, the value of X is only important by comparison to analysts' FY11 forecasts, not as an absolute number. But if a company posts a weak result but sweetens it with better than expected guidance for the period ahead, that stock may still find buyers when selling might have been expected.

Note, however, that some companies may choose to provide only near term guidance, or, perhaps citing “uncertain global conditions”, provide none at all. There is no obligation, but the market does tend to assume by default that no news is bad news.

Just when you thought it was getting complicated, we must also consider the notion of “sandbagging”. 

Given it is always better for a company to beat market expectations than fall short, company managers will often understate their ongoing guidance, or even guidance updates they produce leading up to a result. This might strictly be called misleading disclosure, but such an accusation is hard to prove if management argues it was simply being “conservative”. By understating guidance, companies have a better chance of “surprising to the upside” when the true result is revealed. This is known as sandbagging.

Macquarie Group, for example, became known as a serial sandbagger back in its glory days before the GFC. Every half the bank would post conservative guidance and every result would blow that guidance away. But the market became so used to this game that analysts would simply take Macquarie's profit guidance and add 10-20% as a rule before declaring any “surprise”. So it helps not to become too transparent.

On the other side of the coin, some companies have been known to constantly miss guidance, leading to unexpected profit downgrades, which suggests they may be serial over-staters. As to whether this is deliberate or simply innocent evidence of rose-tinted glasses is by the by. Companies which do seem to overstate guidance are usually held in contempt and marked down for such “risk”.

So taking all of the above, the small investor must be wary of any knee-jerk reactions to profit results. BHP might report a record profit, but that does not necessarily ensure its share price will go up. Did the result beat analyst forecasts? Did the result beat company guidance? Was it a result of good quality? Was it a “messy” result? Was ongoing guidance positive? And was it more positive than FY11 forecasts suggest? All of these considerations must be made.

Often you'll see a stock price spike one way and then do an about-turn soon after, or even the next day. Stock analysts can tell you immediately whether a profit result was higher or lower than consensus, but before readjusting their views they will first tune into the conference calls held by management, pick through the details of the report, look at guidance, re-run their models and generally reformulate their outlooks. It may not be until the day after, or more, that an analyst decides, for example, to upgrade a stock to Buy.

So it's best for longer term investors to leave short term trading to the traders, and to wait for the dust to settle before considering portfolio adjustments.

Enjoy results season.

article 3 months old

Fairfax And The Big Short

By Greg Peel

The third most shorted stock in the ASX 200 at present is Newcrest Mining ((NCM)), with 4.6% of its market cap held as short positions by the market. The second is Perpetual ((PPT)) at 5.0%. But way, way out in front is Fairfax Media ((FXJ)) with 11.5% of its market cap held as short positions by the market, as reported by ASIC.

Analysts at Morgan Stanley are somewhat perplexed. Sure, the global media sector is undergoing structural change, such that the “old media” of newspapers and free-to-air television is being replaced by the “new media” of the internet and cable. But companies in the same boat, such as West Australian Newspapers ((WAN)) and APN News & Media ((APN)) are shorted by only 2.7% and 0.9% respectively. Indeed, there's not a lot of difference between these numbers and the short on new media company Seek ((SEK)), for example, with 0.7%.

And sure, Fairfax was in a some degree of trouble at the height of the GFC, causing the value of its hybrid debt issue to fall to 50 cents in the dollar. But the stock price, and the value of the debt, has since recovered reasonably well.

So why the big short? Morgan Stanley remains positive on Fairfax, suggesting that why structural issues remain the stock is currently undervalued. What the analysts do conclude is that with such a big short position in place, there is scope for heightened volatility in the movement of the FXJ price. If the shorts start to lose faith, an upside scramble could occur, they imply in a report this morning.

Wrong.

To understand why, lets look at second and third place. Now Perpetual is a company which has struggled to maintain funds under management as a result of the GFC. One might be able to conclude these are legitimate short positions from hedge funds, or maybe there's something going on between the whole wealth management play given the AMP ((AMP)) and AXA AP ((AXA)) thing. But let's leave Perpetual. Let's look at Newcrest.

The less experienced in the market immediately assume anyone short stock must be an evil hedge fund hellbent on screwing smaller investors. If this is the case, why Newcrest? You'd be hard pressed to find anyone at present who doesn't believe gold is in a secular uptrend. But then perhaps the secret lies in the age old trader takeover strategy – the one where you buy the target, in this case Lihir Gold ((LGL)), and short the suitor (Newcrest) as an offset. The strategy assumes a premium will be paid by the suitor for the target, thus overvaluing the target and costing the suitor. One price rises and the other falls, and you're a winner.

Is this evil? There are a plethora of “long-short” funds out there who don't even need takeovers to play such spreads. Maybe they think miners are undervalued and banks overvalued, so they buy miners and short banks, keeping a net zero exposure.

And then there are derivatives market-makers. No - they don't have to be evil either. If Joe Investor wants to buy put options as protection on his stocks, he has to buy them from someone. A proprietary market-maker will sell to Joe and then hedge his own risk by shorting an amount of stock. The market-maker is then short as a hedge, not as an attacking ploy.

So back to Fairfax. Remember that hybrid bond issue I mentioned? A hybrid begins life as a corporate bond, paying a coupon (in this case a good one) but it may be converted to an equity at a later date if the stock price rallies sufficiently. Hence such an animal is really a bond with a call option attached. Fairfax has long been an issuer of hybrids.

If you are a hedge fund, or maybe even a mutual fund or investor, you may like the idea of holding the bond part (Fairfax has never defaulted) but don't wish to be holding the equity exposure. What you can do is buy the hybrid and then sell an amount of Fairfax stock short to a level which reflects the risk of the embedded call option (this is known in market parlance as a delta hedge).

If the Fairfax stock price rises it stands to reason the bond price will also rise (less chance of default) and the value of the call option will rise. In order to hedge the increased equity exposure, more stock needs to be sold.

It is understood in the market that many funds have bought the Fairfax debt issue at cheap levels (high yield) assuming the company will not go under, while hedging out the equity exposure through short-selling.

The “big short” in Fairfax represents that hedge. Shareholders need not be concerned. Indeed, the last thing the shorts want to happen is for Fairfax to collapse.

What's more, if FXJ does shoot up, the shorts will need to sell more. If it falls, they will buy back. As long as they maintain a position in the bonds, they will actually act to reduce volatility, not increase it.

article 3 months old

Newspapers Miss Out In May Job Ads Bounce

By Rudi Filapek-Vandyck

ANZ's montly survey suggests the number of job advertisements rebounded in May, but the survey also revealed divergence between job ads online and in Australia's leading newspapers.

According to the survey, the total number of jobs advertised rose 4.3% in May to a total of 167,600 per week, seasonally adjusted, following a 1.2% drop in April.

Online advertisements increased by 5% to 158,400 a week but newspapers posted a 6.5% drop to 9,425.

In response to the survey, ANZ economist Katie Dean suggested May's job ad numbers ''suggests that employers remain confident about Australia's long-term prospects, despite the tightening of monetary policy in the first half of the year and renewed concerns about the global environment.''

article 3 months old

Earnings Downgrades To Drive Further Weakness?

By Chris Shaw

Over the past couple of weeks there has been an escalation of tension in the Korean Peninsula, further bank and credit problems in Europe and an apparent weakening of momentum in US leading economic indicators. Citi notes an increased level of despair in the global investment community.

At the same time, Citi notes some in the US market are trying to call a bottom, which implies the current bad news appears to be starting to be priced into equity markets. Valuation is certainly looking better but this doesn't usually signal an imminent rebound, Citi pointing out valuation is a necessary but insufficient condition to turn the tide of the market on its own.

Uncertainty remains an issue for GSJB Were, thanks to factors such as the proposed RSPT in Australia and sentiment flows surrounding China, though Citi's commodity analysts suggest the latest data indicates speculators have been taking profits but not aggressively shorting metal markets during recent turmoil.

There are reasons for this, as Citi points out demand indicators for developed economies remain robust, even in Europe, which should support commodity demand. As well, it suggests in China the concerns over the possible impact of a slowing in the housing market may also be overstated as housing accounts for only 10-15% of base metals demand.

With the increase in risk aversion, GSJB Were notes investors have temporarily shifted back to more defensive names, which also reflects concerns over the potential for earnings downgrades to increase as the focus shifts to FY11.

Such downgrades in the US are likely according to Citi, as the analysts take the view a trimming of earnings estimates for 2011 in particular still needs to be addressed. In other words, the upward earnings estimate revision trend needs to pull back from current levels. This process would create a setting from which an equity rally can be more sustainable.

As Citi notes, the market overall does appear reasonable value, as various analysis tools suggest equities are tending towards cheap at current levels. As an example the broker points to its highly correlated trailing P/E to bond yields and equity risk premium model, which currently implies the US S&P500 is more than 25% undervalued.

In Australia, Citi estimates earnings are currently around 17% below trend or “mid-cycle” levels, which reflects the 30% fall in earnings between February of 2008 and September of 2009. Given this, the broker suggests if global macro risk concerns weaken from current elevated levels the market would be entering a downturn with an earnings base with less downside risk.

The important point here is this would be in stark contrast to the 2008/09 recession, as at that time the earnings backdrop was one of peak cycle numbers that gave scope for massive cuts to estimates. On Citi's forecasts Australian equities should deliver 27% earnings growth in 2011 while consensus numbers suggest growth of around 25%.

Even if no earnings growth is delivered over the next 12 months, Citi estimates valuations on the market would be no higher than the long-run average of about 14.8 times earnings. This means for the market to start looking expensive earnings next year would now need to be downgraded by around 30%.

If only half the forecast earnings growth over the next year is achieved, which implies growth in earnings of 12.5%, the Australian market's forward price to earnings ratio would still only rise to 13.2 times. Citi regards this as still cheap relative to long-term historical averages.

The 800-pound gorilla is that equity market valuations also appeared cheap in September of 2008, just prior to the collapse of Lehman Brothers. This time around the issue is sovereign debt but rather than a sharp collapse, Citi sees this as a slow bleed issue, meaning it will be a headwind for equities through the next decade.

But for equities to take a another significant downward leg Citi suggests it would require a complete capitulation in all forms of confidence, something that would lead to massive earnings downgrades. But as such an extreme shock event is unlikely in the analysts' view it follows that equity market prices at present represent great value rather than a value trap.

Medium-term there are a number of factors Citi sees as supportive to earnings growth, including ongoing solid population growth, lower corporate gearing levels and an expectation of ongoing improvement in Australia's terms of trade.

These also supports the broker's view the Australian market offers value at current levels.

Given current market conditions and expectations GSJB Were's model portfolio is currently overweight the Materials, Commercial Services, Transport, Media and Retail sectors, while the broker is underweight the Banks, Insurance, REITs, Healthcare, Consumer Staples and Utilities sectors.

With respect to specific stock positions GSJB Were has its five largest overweight positions in ANZ Banking Group (( ANZ)), Wesfarmers ((WES)), National Australia Bank ((NAB)), News Corporation ((NWS)) and Qantas ((QAN)).

Its five largest underweight positions are Commonwealth Bank ((CBA)), Telstra ((TLS)), Woolworths ((WOW)), Westfield ((WDC)) and QBE Insurance ((QBE)).

article 3 months old

Tabcorp Good, REITs Bad, Economy Good Especially For Media

By Greg Peel

BA-Merrill Lynch's Australia Focus One portfolio is similar to GSJB Were's Conviction List in that it specifically selects “best buy” recommendations from among those stocks already rated Buy by the Merrills analysts. Today Merrills has added wagering company Tabcorp Holdings ((TAH)) to that list.

The broker believes Tabcorp is offering compelling value. The analysts' sum-of-the-parts valuation puts the stock at $8.00 compared with its current price of around $7.00, and another dollar of value is up for grabs, they suggest, if the company is successful in delivering on the wagering turnaround story and can achieve the targeted 13% return on Project STAR.

What's more, TAH is offering an 8% fully-franked yield which the analysts suggest can be maintained after the 2012 Victorian licence expiry.

If Tabcorp loses the Victorian licence in 2012, Merrills sees 60c worth of downside but at least that issue, which seems to have been hanging over the market since Phar Lap won the Cup, will have been resolved. There is also 40c of downside surrounding a settlement with Racing NSW over something to do with Tabcorp publishing race fields when it shouldn't.

But either of those factors could go the other way, and Merrills likes a bet.

GSJB Weres recently travelled to Asia to see if it could get anyone interested in having a bet on Australian real estate investment trusts (A-REIT) but found only rampant disinterest.

The A-REITs have been underperforming their global counterparts of late, “quite meaningfully”, the analysts note. But given investors require decent yields to draw money away from stocks and into property trusts, the A-REITs' lack of enticing distribution means no one wants to play.

To that end Weres has reduced its expected June 30 level for the A-REIT index (XJP) from 925 to 908 which would imply little capital upside from January 1. The analysts have moved the 925 target out to December 31.

But Weres doesn't mind having a bet and has been seeking REITs with sustainable earnings per share growth and an attractive price on a comparison with net tangible asset valuation. To that end it likes Goodman Group ((GMG)) and Stockland ((SGP)) along with Charter Hall Office ((CQO)) and Charter Hall Retail ((CQR)).

Weres doesn't like Westfield ((WDC)), Dexus ((DXS)) or GPT Group ((GPT)).

Citi likes the Australian economy in general, suggesting the analysts' own leading indicators are pointing to more upside to the recovery.

Among the positive “leads” are financial conditions in Australia (and in the US), the upward sloping yield curve, high levels of business and consumer confidence, encouraging plans amongst businesses for hiring and capital expenditure, strong commodity prices and strong Chinese industrial production.

The analysts are keeping an eye on Australian house prices, given the indicators are suggesting a “much needed” moderation but there's simply no sign of one just yet. Consumer lead indicators are overstating the strength of spending, they say, and signals are for moderate interest rate rises but mixed on the Aussie dollar.

Watch out for inflation pressure, suggests Citi, and note that upward momentum in both consumer sentiment and stock prices has likely peaked, meaning prices are not going to continue running as hard as they have.

But it's a different story in the advertising market, Citi finds, where everything is going gangbusters. Ad agencies have been raising their growth forecasts and Citi is now expecting market growth of 7.2% in 2010 and 6.4% in 2011. If there is one thing ad agencies like more than the recovery from a recession, it's an election year.

The bulk of the ad-spend is going into television with on-line continuing to benefit from the secular shift in ad placement. Radio has seen some renewed optimism but newspapers will lag, says Citi.

As a result, Citi remains positive on Fairfax ((FXJ)) and News Corp ((NWS)) while expecting Seek ((SEK)) to benefit from both increasing ad-spend and the shift to on-line.

The market has big expectations for the Ten Network ((TEN)) and West Australian Newspapers ((WAN)) but the broker believes the good news is already priced in. APN News & Media ((APN)) looks cheap but will lag in the ad recovery.

article 3 months old

Seeking Value Among Emerging Companies

By Chris Shaw

As brokers continue to look for pockets of value in the Australian equities market, Morgan Stanley has initiated coverage on an additional 10 emerging companies. These companies offer exposure to a range of industries including consumer, mining services, media and IT services.

The 10 companies are Automotive Holdings ((AHE)), Invocare ((IVC)), Mermaid Marine ((MRM)), Mineral Resources ((MIN)), Mitchell Communications ((MCU)), Navitas ((NVT)), Oakton ((OKN)), The Reject Shop ((TRS)), SMS Management & Technology ((SMX)) and Super Cheap Auto ((SUL)).

Out of these companies Morgan Stanley rates all as Overweight with the exception of Oakton, to which it ascribes an Equal-weight rating. The broker has an In-Line industry view, which suggests relative performance for the emerging companies universe will be in-line with that of broader market benchmarks.

Among the 10 companies, Morgan Stanley suggests on a risk-reward basis the three stocks with the most implied upside relative to base case valuations are Mineral Resources at 69%, Automotive Holdings at 28% and Mitchell Communications at 26%.

Applying bull-case valuations the results are a little different, as on this basis Morgan Stanley estimates the top three upside scenarios come from Minerals Resources and Automotive Holdings again at 141% and 61% respectively, while Navitas also makes the list at 65%.

Integrated mining services and processing company Mineral Resources is seen as expanding its operations in coming years, largely through higher volumes rather than higher prices. Also attractive to Morgan Stanley is the three businesses within the company have defensive characteristics, which suggests limited downside even when the resource cycle turns out less positive.

Morgan Stanley's price target for Mineral Resources is $13.00 and this is well above the $8.19 target of Macquarie, the only broker in the FNArena database to cover the company. Macquarie similarly rates Mineral Resources as Outperform.

For Automotive Holdings, Morgan Stanley suggests the market is likely to be attracted to the combination of a resilient business model delivering solid earnings growth, with upside for additional growth via both investment and acquisition.

To reflect its positive view on Automotive Holdings, Morgan Stanley has set its price target at $3.40, which compares to an average target according to the FNArena database of $2.90. The database shows the three other brokers with coverage all rate Automotive as a Buy.

The FNArena database shows only GSJB Were covers Mitchell Communications, rating it as a Buy with a price target of $1.15. Morgan Stanley's target of $1.10 is close to this, its forecasts calling for annual capitalised growth in earnings of 13% through to 2013.

The attraction of Mitchell, according to Morgan Stanley, is the company is Australia's largest media buying agency and offers a cheap exposure to strong growth in online advertising. On the broker's numbers Mitchell is trading at a 30% discount to the market.

In recent years Navitas has made a number of acquisitions and diversified its income streams, while also establishing an offshore presence in the education market. Morgan Stanley anticipates solid double-digit earnings growth and expects as the market becomes more comfortable with this outlook, it will be more willing to pay up for the stock.

Morgan Stanley's price target for the stock is $6.50, which is well above the average price target according to the FNArena database of $4.81. Of the seven brokers to cover the stock, only Macquarie rates Navitas as Outperform at present, compared to six Hold ratings.

Funeral service provider Invocare ((IVC)) is another stock offering defensive growth according to Morgan Stanley, while the strength of the business model should allow for earnings growth of solid single digits in coming years.

The other attraction for Morgan Stanley is the attractive yield, which is more than 5%. The broker has set its target at $7.00, broadly in line with the average target according to the FNArena database of $6.87. Seven brokers in the database cover Invocare, with three Buys and four Hold ratings.

Marine services group Mermaid Marine remains undervalued in Morgan Stanley's view, as the stockbroker sees additional upside as the group's fleet is expanded and renewed and the Dampier supply base turns into an earnings generative asset.

Supporting Morgan Stanley's expectation of solid earnings growth is Mermaid's exposure to the Gorgon development, which it expects will deliver better long-term earnings than the market currently anticipates.

Against a Morgan Stanley price target of $3.30, the FNArena database shows an average price target of $3.04, Mermaid receiving three Buy ratings compared to two Hold recommendations from those brokers covering the company.

IT service group SMS Management & Technology is viewed by Morgan Stanley as the best of breed player in the consulting and project delivery services sector, so deserving a premium relative to its peers.

SMS Management also offers leverage to an upturn in demand for IT services and has the ability to scale its business up and down to maximise profitability across the cycles. This supports Morgan Stanley's forecasts of 15% annual capitalised net profit growth through FY13, which underpins its $7.80 price target.

The FNArena database shows an average price target for SMS Management of $6.95, with three Buy ratings and one Hold recommendation.

Oakton is also in the IT sector but here Morgan Stanley sees annualised earnings growth of around 12%, with solid cash flows and an improving balance sheet likely to allow for growth in dividends as well.

What should hold Oakton back compared to SMS Management is recent contract cost overruns and ongoing Tenix litigation, meaning a turnaround in the business may take longer than expected. Along with its Equal-weight rating Morgan Stanley has a price target of $3.45, while the average target according to the FNArena database is $3.66. Overall Oakton is rated Buy and Hold three times each.

Retailer Super Cheap is expected to deliver double-digit earnings growth in coming years, Morgan Stanley seeing solid sales growth and efficiency gains as the major drivers. As well, Morgan Stanley sees the move into bike retailing as a likely value enhancing move, while upside is also on offer from market share gains in Auto Parts.

Against an average price target according to the FNArena database of $5.81, Morgan Stanley has a target of $6.75. The database shows Super Cheap is rated as Buy three times and Hold twice.

Discount retailer The Reject Shop has a number of growth options in Morgan Stanley's view, the ongoing store rollout program to be supported by improved efficiencies in sourcing and cost control.

With double-digit earnings growth expected, Morgan Stanley has set a target price of $19.00, while the average target according to the FNArena database is $17.03. The database shows three Buy ratings and two Holds.

Morgan Stanley's list of favourable emerging companies is somewhat different to others in the market, as JP Morgan's preference list is composed of Ausenco ((AAX)), Campbell Brothers ((CPB)), Norfolk Group ((NFK)), Retail Food Group ((RFG)), Salmat ((SLM)), TFS Corporation ((TFC)) and Tox Free Solutions ((TOX)).

Credit Suisse's top five emerging companies list also contains Campbell Brothers, along with Tower Australia ((TAL)), Pacific Brands ((PBG)), Virgin Blue ((VBA)) and PanAust ((PNA)).

article 3 months old

Regulator To Standardise Broker Ratings

By Greg Peel

The Australian Securities and Investment Commission has been charged with the task of reassessing and consolidating investment advisory compliance rules in the wake of the Global Financial Crisis. A similar process is being carried out in all developed economies as a result of a G20 finance ministers' commitment to move toward more regulatory consistency across the globe.

Areas of focus include the problem of “too big to fail” in regard to financial institutions, the problem of opaque over-the-counter financial derivatives, and the issue of government guarantees of bank deposits. But also high on the agenda is a need for further protection for the retail investor.

Last year ASIC commissioned a survey of Australian retail investors, focusing particular attention to those hard hit by the GFC and its subsequent impact on financial markets. The burgeoning self-managed superannuation fund pool of investors was an obvious place to start.

ASIC has been receiving details of the survey over the first quarter 2010, and has this morning released a memorandum citing one particular complaint from investors that came up in the survey time and time again. Investors find stock broker recommendations confusing and misleading, and in many cases money had been lost by following recommendations closely.

“Many participants were incensed,” suggested ASIC spokesperson April Tromper, “that some stocks in their portfolios were still under 'Buy' ratings with brokers even as they lost up to 60% in value. Many claimed to be confused by the meaning of 'Buy', 'Outperform' and other typical ratings and how they differed from one another.

“Most of all it seemed,” said Tromper, “that investors could not understand why one broker can say 'Buy' when another says 'Sell'”.

This is hardly news to FNArena, which often fields email inquiries of exactly the same nature.

There are three major ratings scales used by brokers in Australia as well as across the world, being Buy, Hold or Sell; Outperform, Neutral or Underperform; and Overweight, Neutral or Underweight. In the last case, Equal-Weight can also be used in place of Neutral. In some cases, variations of combinations are used.

To further confuse the issue, some brokers stretch their ratings to a total of five, thus including mid-tier ratings such as Accumulate or Reduce.

In each case, it is the intention of the broker, or stock analyst, to convey the same meaning. Buy, Outperform or Overweight all mean investors should hold a greater proportion of the stock in question than its index weighting suggests. Sell, Underperform or Underweight means hold less, and Hold, Neutral or Equal-Weight means hold the equivalent index weighting.

However, the average small investor does not hold a portfolio equivalent to, for example, the ASX 200, upon which these ratings are based.

It becomes more confusing when the concept of target prices are introduced.

“Yes it's true that sometimes we can apply an Overweight rating to a stock even when the trading price has already exceeded our target price,” said one analyst from a major house I spoke to this morning, who for obvious reasons wished to remain anonymous. “Occasionally we even confuse our institutional clients”.

It would be a littler simpler if all brokers stuck to one popular formula – one in which a Buy rating was applied if the traded price was below the broker's target price, Sell if above, and Hold if on or near. This is the usual process, and indeed some brokers trigger ratings changes by a purely objective price formula rather than any form of subjective view.

But this still does not resolve the issue of how a retail investor – the numbers of which were very strong ahead of the GFC in proportional share holding terms – is meant to resolve the different ratings used by brokers, or the instances in which one broker says Buy and another Sell for the same stock at the same time.

The proposal put forward by ASIC this morning is to standardise all broker ratings for the benefit of the retail investment community. ASIC was not yet specific on which system would be enforced, although the early suggestion is that Buy, Hold, Sell is the simplest to appreciate.

Furthermore, stock brokers would be required to register their ratings changes with ASIC ahead of the release of research reports and provide justification for that change by means of a new compliance document currently being drawn up by the regulator.

In a move that will most unnerve the sell-side community, ASIC also intends to mark those ratings changes against prevailing trading prices and track broker performances. In the case, for example, of a broker maintaining a Buy rating on a stock that is continuing to lose value, ASIC intends to take some form of punitive action.

“The system will be akin to the 'speeding ticket' system in use for listed companies,” explained Tromper, “in which companies are obliged to justify unusual stock prices movements and can be fined for breaches of disclosure regulations. Brokers unable to justify their stock ratings will also be subject to potential fines and possible loss of trading licence”.

ASIC further intends to issue “please explain” notices to brokers whose ratings on a particular stock do not match consensus, such as a broker who publishes a Sell rating when the great majority of peers is recommending Buy.

“It is a lack of consensus that confuses many retail investors,” Tromper suggests, “and ASIC believes it is in the interest of the investment community to increase compliance among the broking industry”.

The response to this memorandum from FNArena's contact at the major broking house cannot be printed, but suffice to say ASIC has a fight on its hands if it is to see these new rules passed into legislation. However, we are already aware that Australian banks are currently in fear of upsetting the government in an election year lest they incur the wrath of those campaigning. It would be popular with the electorate if policies were put forward for much greater bank regulation.

To that end, the broking community might also be best served by ceding to ASIC's wishes.