-Consolidates Melbourne presence
-High earnings margins, returns
-Well placed to grow Asian share
 

By Eva Brocklehurst

IPH Ltd ((IPH)) continues to expand, with its latest acquisition being the Melbourne-based Callinans patent and trade market assets for $11.5m. The acquisition will be funded by scrip and cash and, while accretion is not material to FY16 earnings, it signals to brokers the company's ability to consolidate the sector.

Callinans will be merged with the Fisher Adams Kelly acquisition and the entity will be renamed Fisher Adams Kelly Callinans. The combined business will have a strong presence in Brisbane and Melbourne and lines up with the company's Spruson & Ferguson office, based in Sydney, to provide a strong presence on the east coast.

Brokers consider IPH is well placed to grow in the region, given its dominant intellectual property services based in Singapore and Australia and an ability to leverage multinational clients.

Deutsche Bank believes the acquisition of Callinans is a minor positive as it increases the Australian patent market share while expanding the domestic footprint and broadening the client base. The broker assumes a transaction earnings multiple of around five times, implying 2.2% earnings accretion in FY17. Deutsche Bank notes there is significant further capacity on the balance sheet and retains a Buy rating on valuation.

The new merged entity is the right decision, in Morgans' view, as it provides a stronger focus on corporate clients and consolidates the Melbourne business. The company's goal of 25% domestic market share is now in view, with the share estimated at 21% on the back of the latest addition.

The acquisition price includes potential earn-out payments of $6m, based on a proportion of FY16 earnings from key clients compared with FY15, as well as assumptions around employee entitlements. This will be funded by $5.5m in up-front consideration and the first $4m earn-out will be paid by 50% scrip and 50% cash. Scrip components are escrowed for two years.

For Morgans, IPH ticks most investment boxes, with high earnings margins, solid earnings growth, high returns on equity and strong cash flow conversion. Morgans has moved its rating back to Hold from Add on the back of the acquisition but would become a buyer again on share price weakness.

Macquarie, yet to update for the latest acquisition, also has a Neutral rating. FNArena's database has one Buy and two Hold ratings. Target is $7.13 which suggests 3.6% upside to the last share price. Targets range from $6.20 (Macquarie) to $8.00 (Deutsche Bank).

Bell Potter, not one of thee eight stockbrokers monitored daily on the FNArena database, believes the business is high quality and situated in a structurally growing industry. The broker has a Buy rating and raises its target to $7.90 from $7.00.

There should be front-end synergies with the company's Asian platform as approximately 70% of Callinans' client base is offshore. The broker take the opportunity to strengthen medium and longer term growth estimates in the belief that IPH will be able to grow market share in Asia more quickly than previously assumed. The net effect is an increase in FY16 and FY17 estimates by 1.9% and 3.2% respectively, with more material increases beyond.

See also, IPH Expansion Offers Significant Potential on September 24 2015.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

-Strong accretion from acquisitions
-More balance sheet capacity
-Focus on brownfield conversions

Gateway Lifestyle ((GTY)) is expanding, adding another two NSW estates to its portfolio following the Cobb Haven acquisition in July. The latest two are the Myola Lifestyle Resort at Jervis Bay and the Terrigal Sands Lifestyle Village.

Management expects the acquisitions to be accretive to FY16 earnings and brokers observe additional upside from excess balance sheet capacity. The price paid per site compares favourably to industry averages, UBS notes. There are operational synergies at Terrigal given the close proximity to existing parks. UBS upgrades FY16-18 forecasts by 1-3% and its estimates now sit 7.0% above prospectus for FY16, because of the strong underlying momentum and the accretion from recent acquisitions. UBS retains a Buy rating and $2.75 target.

Brokers believe Gateway Lifestyle is well placed to participate in further sector consolidation, with a conservative balance sheet. Macquarie flags the surplus debt capacity of $127.5m that existed at the June 2015 results. There were eight parks under due diligence as of August 2015, with two of these now executed.

UBS calculates that, taking gearing to the mid point of management's 25-35% range, with an ingoing yield of 7.5-9.5% and 8.0% weighted average cost of capital, Gateway Lifestyle can generate additional annual earnings of $8-12m. The main drivers are growth in site rents and manufactured home sales as well as opportunities form converting existing sites. The company is advantaged by a capital efficient funding model, low levels of gearing while operating in a highly fragmented industry.

The Myola park, acquired for $5.4m with an initial yield of 8.4%, provides a conversion opportunity for a manufactured home estate over the next 5-7 years, with 30 existing sites and potential for the remaining "annual" tenants to be converted into another 140. The prospectus forecast is for a gross profit per house of $98,000 on development, which signals to Macquarie the park will be very accretive on conversion. The Terrigal site, located 1km for the beach, is a mature park with 198 occupied manufactured homes at a passing rent of $160/week. This was acquired for $8.5m at an initial yield of 8.2%.

Having listed on the ASX in June, Gateway Lifestyle has delivered a 20% total return, with the stock up 15.4% since Moelis initiated coverage. Further share price appreciation is expected but the broker reduces the rating to Hold from Buy with a target of $2.48. Moelis leaves estimates unchanged, given around $25m in acquisitions were assumed for the first half of FY16. So far, since IPO acquisitions have totalled $26m.

Gateway Lifestyle is the largest in the Australian domestic manufactured home market, with parks in NSW, Queensland and Victoria under its belt. It now has over 2,200 sites in its development pipeline. Industry fundamentals are underpinned by the favourable demographics, including an aging population, financial pressure on retirees and housing affordability. The company is intent on converting mixed use residential parks rather than making greenfield acquisitions, Macquarie observes. This strategy provides the cash flow benefits in the form of existing short-term site rentals. The broker retains an Outperform rating and notes that the price target of $2.83 is based on Gateway investing its undrawn bank facilities into new parks.

See also, Gateway Lifestyle Offers Potential In Affordable Homes on June 30 2015

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

-Asian platform leverage
-Long standing blue chip clients
-Benefit from weaker AUD
 

By Eva Brocklehurst

IPH Ltd ((IPH)) is busy on the acquisition trail, having acquired three businesses since its ASX listing last November. The latest two, Pizzeys Patent and Trade Mark Attorneys, have been bought for $73.3m with a potential earn-out capped at $13.3m.

The acquisitions are attractive, in Bell Potter's view, as Pizzeys is one of the fastest growing intellectual property (IP) firms in Australia. The acquisition will give IPH a dominant market share of 20%. Pizzeys has recently become the fourth largest filer of patent applications at the Australian Patent Office.

The majority of Pizzeys' clients are US based. The broker believes there is a significant opportunity to leverage IPH's Asian platform and broaden the Pizzeys service offering to include that region.

Deutsche Bank also considers the company well placed to capitalise on a leading position in Asia-Pacific IP services. This market has favourable medium-term dynamics with ongoing global investment. The broker is attracted to the company's cash generating ability and strong growth profile. Moreover, the balance sheet offers more potential for M&A.

The company offers a wide range of services for the protection, enforcement and commercialisation of intellectual property. It has a leading position in the secondary patent application filing market in Australian and Singapore. The long life cycle of IP provides revenue predictability and annuity-style earnings. Longstanding relationships have been forged with blue chip clients.

Deutsche Bank initiates with a Buy rating and $7.85 target. The broker forecasts a 21% 3-year compound growth rate, reflecting low single digit organic growth in Australia and low double digit growth in Asia. This should be bolstered by recent acquisitions. IPH remains a beneficiary of the declining Australian dollar, with 85% of revenue derived in foreign currency.

Risks? The company operates in a highly regulated environment so potential changes are a concern, although there are none on the horizon. Deutsche Bank also cites acquisition pricing and integration risks, particularly given the company grew organically before its IPO and acquired three businesses after listing. IPH is targeting further M&A to support growth.

Bell Potter updates its models for the latest acquisition, believing the transaction is well structured with the use of 50% scrip escrowed for two years. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, upgrades growth estimates for FY16 and has a Buy rating and $7.00 target, raised from $6.20.

Morgans observes Pizzeys has even more leverage to a falling Australian dollar than IPH and increases post-acquisition earnings estimates by 6.0% and 8.0% for FY16 and FY17 respectively.

Pizzeys has offices in Canberra and Brisbane and is predominantly dealing with in-bound work from US based IP associates. It has operated for more than 15 years and its acquisition enhances the IPH strategy of consolidating the highly fragmented IP market. Morgans also suspects significant synergies exist in systems and offshore operations.The acquisition follows Fisher Adams Kelly, which was acquired for $26.5m earlier this year.

Despite the strong share price performance since the IPO, Morgans believes the stock has a number of catalysts and is well placed to leverage its superior IT platform and Asian business. Also the push into the cloud should help reduce overheads over the coming year, which will flow straight to the bottom line.

Macquarie also believes Pizzeys can offer more leverage to a depreciating Australian currency and assumes the business operates at margins closer to the Asian business of IPH (50%) as opposed to the domestic business (39%).

After revising FY16 forecasts up by 17% to account for the acquisition and currency assumptions, Macquarie raises its target to $6.20 from $5.00 and retains a Neutral rating. The broker is attracted to the IPH business model but, at a 50% premium to the small cap industrials index, considers the stock fully valued.

FNArena's database has two Buy ratings (Deutsche Bank and Morgans) and one Hold (Macquarie). The consensus target is $7.04, signalling 3.3% upside to the last share price.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

-Cash flow steps up
-Capital management?
-US now the mainstay
 

By Eva Brocklehurst

Incitec Pivot ((IPL)) has enhanced confidence in the outlook at the Louisiana ammonia plant being constructed in the US. The company updated North American investors with a tour of the plant and those brokers present welcomed the chance to update forecasts and expectations. Confidence in timing, costs and outlook has improved.

UBS finds Louisiana compelling, raising earnings forecasts for FY16-17 by 5.0% to incorporate the initial contribution from Louisiana ammonia in the September quarter next year. FY15 estimates are also raised, by 3.0%, to reflect higher Phosphate Hill volumes. UBS previously assumed a drag from the Dyno Nobel explosives business but the presentations highlighted the strong position it holds in its key end markets.

Major capital expenditure is now largely complete at Louisiana and net debt has peaked. The company appears set to generate annual free cash of around $700m per annum which, all else being equal, suggests to UBS the potential for capital management by the end of FY16.

Any negatives are reasonably well known, in Deutsche Bank's opinion. The company is also highly leveraged to the depreciation in the Australian dollar with every US1c move down enhancing pre-tax earnings by around 1.7%.

The negatives are mostly surrounding Australian business, with pressures on volume and margin in explosives and lower gas supply at Moranbah. The company has expressed confidence that the reduction in gas supply to Moranbah should not persist beyond 2016.

In terms of explosives, the company believes the effect of the mining downturn should be limited, as explosives are just 5.0% of total mine production costs. Nevertheless, Deutsche Bank suspects reduced demand for higher value products and services will have an impact, as this has been a provider of earnings growth over the past five years.

In contrast, the North American market is still short on ammonia and gas is in abundance. Macquarie observes Incitec Pivot has first mover advantage in terms of cost, risk and time in the ammonia market and is well positioned to capture the gas-to-ammonia arbitrage.

Coal production in North America declined in the second half, impacting the explosives business. Despite this, Macquarie highlights the company's forecast for Dyno Nobel US dollar earnings to be roughly in line with the prior corresponding half. This should be achieved via cost cutting and price rises in ammonium nitrate.

The Dyno Nobel exposure to US end markets is in the coal, mining and quarry & construction segments. While headwinds from coal and mining are well known, the company remains more optimistic about quarry & construction. Strong growth is expected on the back of road and infrastructure projects.

Nonetheless, the Louisiana earnings contribution is expected to be the main driver of the outlook for the company, with the variables being natural gas and ammonia prices. Macquarie calculates, even when including the decline in global prices for both natural gas and ammonia - which are linked to oil, the economic proposition at the facility still compares favourably.

Citi was reassured by the update, believing the main variables that surround the Louisiana plant were comprehensively addressed. Structural issues should keep the US market dependent on imports and this supports the market economics, in the broker's view. With gas prices likely to be lower for longer this makes the project highly attractive, with Citi estimating a 4-year pay-back.

Citi also suspects a capital return might come sooner than is widely expected. Of note, the US explosives business has faced material volume and cost pressures but, brokers believe, this has been broadly offset by higher average prices and efficiency programs. Incitec Pivot will become heavily leveraged to the US, with 50% of group earnings and two thirds of cash flow after FY17 emanating from that region. 

FNArena's database has four Buy ratings, one Hold and two Sell. The consensus target is $4.15, which signals 12.4% upside to the last share price.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

-Activity trends weaken
-Segment selection crucial to value
-Positives in NBN, transport infra
 

By Eva Brocklehurst

Raising of equity capital among junior and mid-tier miners is a signal for their exploration partners, engineers & contractors, given exploration activity lags the capital raisings by several months.

UBS notes, globally, these miners undertook 72 capital raisings for such purposes in June. This figure is down on the prior month's total of 91, and the prior corresponding June (110).  In value terms this was a reduction of 55% on June 2014 and raisings were well below the run rate over the past six months.

That is the backdrop. After some months of stability it now appears a further leg down in the activity trend has occurred. Australian equity raisings among these miners were down 71% year on year in August. The outlook for those which service the industry appears weak.

ALS ((ALQ)) recently commented that minerals testing orders were strong enough heading into the first quarter of 2015 but have since deteriorated. Drilling services operator, Boart Longyear ((BLY)), is likely to weaken further should current trends continue, UBS maintains.

Goldman Sachs is also finding little light at the end of the tunnel. The earnings downgrade cycle continued in the engineering and contracting sector in FY15 and the broker reduces FY16-18 forecasts on increased commodity price volatility, slowing global growth and the unrelenting pressure associated with capex discipline and resources cost deflation.

There is ample evidence of lower capital investment among miners and a deferral of project sanctioning. This is consistent with the cyclical transition to exploiting resources from a period of resources investment, the broker attests.

Goldman Sachs prefers CIMIC ((CIM)), which has a Buy rating from the broker on share price weakness, given its exposure is more weighted towards the preferred domestic infrastructure segment. The company is a market leader in major Australian project work. Goldman has a Sell rating for WorleyParsons ((WOR)) and ALS, given ongoing commodity-related headwinds, particularly in the case of oil engineering for WorleyParsons.

The broker also downgrades its sector-relative rating for Seven Group Holdings ((SVW)) to Neutral from Buy. The company's outlook is heavily leveraged to depressed mining capex and oil price volatility, as well as challenges in the traditional media market.

A ray of light is proffered by Ord Minnett. The broker has been bearish for several years towards the sector but, having endured a substantial sell-off, it may now be the time to change to a bullish view, at least in terms of some of the better players in the sector.

The broker assumes the market will buy the sector once it realises most of the earnings decline has occurred, re-rating some of the stocks that trade on very low multiples. This is critical, as the broker warns there are some stocks which remain seriously challenged. Consolidation is expected to occur and good balance sheets will provide some companies with options that could be future catalysts for the stocks. 

Ord Minnett also finds signs that miners are no longer attempting to reduce contract margins, because some operators are almost at the point of going to the wall. Work levels have stabilised and the positives on the horizon include work from the NBN roll out, transport and greater outsourcing from government.

Ord Minnett singles out Mineral Resources ((MIN)), which has been sold off heavily despite its FY15 results being in line with expectations. The broker believes FY16 consensus estimates need upgrading and retains a Buy rating and $6.30 target.

Another stock is RCR Tomlinson ((RCR)), Buy rated with a $2.50 target. The company has a record order book worth $1bn, being well placed to grow its power business. Decmil ((DCG)) remains a value play, having substantial property which could be sold and, with a market cap of $167m, trading at a 32% discount to its assets, in the broker's view. Ord Minnett has a Buy rating and $1.60 target.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

-Addressing accounting concerns
-ASIC clearance a re-rating chance
-Weak cash flow conversion in H1
 

By Eva Brocklehurst

Brokers have welcomed the enhanced disclosure by lawyers Slater & Gordon ((SGH)) in the FY15 results. The report was complex as the company elected to change its accounting policies regarding revenue recognition, work in progress and acquisition accounting.

The company is being proactive in addressing transparency concerns and cash flow, which Deutsche Bank finds encouraging. Queensland continues to be adversely affected by regulatory changes and increased competition, while Victoria and NSW were strong. In the UK, the results were better than Deutsche Bank anticipated.

Management highlighted increased brand awareness and a strong increase in new cases, with a shift in mix towards higher value, significant injury work. Deutsche Bank switches its valuation methodology to a cash earnings multiple from a discounted cash flow basis. The broker considers this a prudent decision, given market concerns around cash conversion. As a result the broker's price target is reduced to $5.00 from $8.00. Deutsche Bank finds the valuation attractive and retains a Buy rating.

Morgans was pleased with the extra disclosure. While there has been no actual conclusion to the Australian Securities and Investment Commission (ASIC) investigation, the regulator has said it welcomes the decision to reclassify certain items as non-current, noting the company's early adoption of AASB15 - revenue from contracts with customers.

The broker acknowledges the sustainability of earnings is the biggest risk ahead but believes there are a number of catalysts which could support a re-rating such as ASIC signing off on the accounts, an update on accounts at the October briefing and AGM commentary. Moreover, with the stock trading on a FY16 enterprise value/earnings ratio of 5.5x, Morgans believes the risks are well priced in at current levels.

UBS remains an outsider, suspecting the ASIC investigation poses the risk of further, more material, accounting policy changes. Upon conclusion of this review the broker believes the company will need to demonstrate strong cash conversion to justify its accounting policy. There are a number of issues with respect to the accounts UBS has an issue with, such as reconciling management's income statement to the unaudited statutory accounts.

As management has suggested the first half will be weak in terms of cash flow the broker anticipates evaluating a regular flow will take 12-18 months. UBS assumes 50% conversion of reported earnings to free cash flow, down from 60% previously. The broker has a Neutral rating.

Macquarie was pleasantly surprised by the changes in accounting and the results broadly met expectations. The three changes are not expected to affect performance, rather they are considered cosmetic. The broker observes the stock has been heavily sold over recent months, as the market took on board the sizeable PSD acquisition and the ASIC inquiry.

Macquarie believes increased disclosure will go a long way to soothe concerns. Moreover, near-term multiples are not considered demanding. The broker expects cash flow conversion will improve over time, with greater UK exposure and changes in business mix as well as operational improvements. Still, Macquarie flags the fact that cash flow in FY16 is expected to be weighted to the second half.

FNArena's database has three Buy ratings and one Hold. The consensus target is $5.73, suggesting 66.3% upside to the last share price. Targets cover a wide range, from $3.10 (UBS) to $7.52 (Morgans).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

-Undemanding valuation
-Leading position in Oz/NZ
-Diversified customer base
 

By Eva Brocklehurst

Spotless Group ((SPO)), which provides facilities maintenance, has bettered prospectus and broker forecasts in FY15. Earnings were strong across most sectors with new contracts and acquisitions in the mix.

The company continues to benefit from the growth in aged care as well as a strong government maintenance sector. Resources remains the most subdued area in which the company operates, with base & township revenue below several broker forecasts. The commercial & leisure segment also slowed as a result of a deliberate move away from single service cleaning contracts.

Valuation is undemanding, in Macquarie's opinion, as the stock is trading at a 25% discount to global peers. When assessing the stock the broker takes into account the company's smaller size, Australasian concentration and short life as a recently re-listed company. This is countered by strong earnings margins and positive growth outlook, as well as a leading position in Australasian facilities management.

Macquarie forecasts 8.4% earnings growth in FY16, supported by acquisitions. This accelerates to 12.0% in FY17 as acquisition margins improve. The company has ample capacity for acquisitions and believes there is 1-2% further margin available over time. Spotless is currently bidding on an enlarged contract with Rio Tinto ((RIO)) and an outcome is expected by December.

There were some negatives in the report, with a delay in the NZ government laundry contract resulting in a 4.0% revenue shortfall in that area. Higher depreciation expense is expected in FY16, reflecting a full year of defence contract mobilisation. Still, the base business should benefit in FY16 from a full year of NSW and Queensland defence contracts, Macquarie maintains.

UBS assumes 6.2% profit growth in FY16 with incremental contributions from acquisitions and new contracts. The broker remains more cautious about margins, despite the success to date in expanding these. UBS forecasts an earnings margin of 10.8% in FY16. The broker remains attracted to the growth potential, strong industry position and the diversified, high-quality customer base.

Deutsche Bank also favours a more cautious margin outlook, lowering estimates to allow for the inclusion of lower-margin AE Smith installation revenue. The broker also assumes lower net working capital requirements. All up, the impact on FY16 means forecasts for 10% profit growth, with a robust 5.0% dividend yield.

Outside the resources sector, the environment is favourable, Citi observes. Earnings are stable and the competitive intensity favours this company as a scale player with back office synergies and a strong operating track record.

Furthermore, a dividend can be funded at an assumed long-run 75% pay-out and still provide head room for acquisitions without affecting covenants. The broker highlights the potential for net debt to grow by $600m in FY16 before debt covenants are threatened.

FNArena's database shows four Buy ratings. The consensus target is $2.28, suggesting 22.1% upside to the last share price. Targets range from $2.17 to $2.45. The dividend yield is 5.8% and 6.4% on FY16 and FY17 forecasts respectively.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.