Tag Archives: Telecom/Technology

article 3 months old

Oakton Turnaround Continues

By Chris Shaw

IT services provider Oakton ((OKN)) has struggled since the Global Financial Crisis, but the company appears to be turning around its performance after delivering a solid full year result of $20.2 million. Earnings largely met market expectations and according to UBS the quality of the result was good.

Of more importance to analysts is Oakton has started FY11 well, with order intake solid so far. BA Merrill Lynch notes order intake for FY11 so far is about 45% of the 2011 budget, a level higher than normal for this time of year.

According to UBS, the good start to the year reflects a focus on larger projects and managed services expansion, as well as improved client cross-sell ratios and a general pick-up in large ticket projects. This should drive some margin expansion in the broker's view.

Contract visibility has also improved in BA-ML's view, especially as Oakton has enjoyed some recent contract wins in the government space. The other favourable point, notes BA-ML, is the company is leveraging its offshore operations, which also has scope to boost margins.

Goldman Sachs agrees, estimating EBITDA (earnings before interest, tax, depreciation and amortisation) margins should improve from the 17% recorded in FY10 to around 20% by FY13 as revenues grow by around 10% annually.

There remain some issues in the view of Credit Suisse, as the broker notes while Oakton has picked up some market share in Sydney and Brisbane, the Melbourne and Canberra markets continue to perform below management's expectations. In the broker's view the outlook for government contracts also remains somewhat questionable.

Despite these concerns Oakton is expected to deliver solid earnings growth in coming years, Credit Suisse forecasting earnings per share (EPS) of 27.4c in FY11 and 33c in FY12. This compares to EPS in FY10 of 21.9c and implies increases to forecasts of 5.5% in FY11 and 11.6% in FY12.

Others in the market have also lifted earnings forecasts, with Goldman Sachs lifting its estimates by 2-3% to 25.5c in FY11 and 30.9c in FY12 and UBS to 26c and 30c from 25c and 28c respectively. Consensus EPS forecasts according to the FNArena database now stand at 26.5c in FY11 and 31c for FY12.

Post the result, the FNArena database shows ratings for Oakton are unchanged, the company receiving five Buy recommendations and two Holds. The average price target for Oakton has risen to $3.46 from $3.33.

In the view of BA-ML there is still good value on offer in Oakton, as at current levels the stock is trading at a discount to its global peers despite offering significantly better EPS growth in coming years.

Goldman Sachs makes a similar point as on its numbers Oakton is trading on a FY11 earnings multiple of around 12 times, which comes back to 11 times before legal fees related to ongoing arbitration with Tenix. This is too low a multiple for the earnings growth on offer in the broker's view.

But Credit Suisse suggests the risks still surrounding the stock are enough to likely limit any share price outperformance, so there is no change to its Neutral rating.

Shares in Oakton today are slightly weaker and as at 11.30am the stock was down 3c at $3.11. This compares to a range over the past year of $2.09 to $4.30 and implies upside of about 12% to the average price target in the FNArena database.

article 3 months old

Hutchison Shocks The Telco Sector

By Chris Shaw

Hutchison Telecommunications Australia ((HTA)) easily beat market estimates with its half-year result released yesterday, the result showing the company continues to benefit from the merger of the Vodafone and 3 Australia businesses just over a year ago.

The merger created VHA Australia, in which Hutchison has a 50% stake, and this business recorded strong subscriber growth in the period of 539,000 additions. This was well above market forecasts, as for example Citi had been expecting subscriber adds of around 350,000.

According to RBS Australia and BA Merrill Lynch the subscriber adds result implies VHA is taking some market share from others in the industry such as Telstra ((TLS)), particularly as growth in mobile handsets outstripped that of wireless broadband by a ratio of about 4-to-1.

But as Goldman Sachs notes, a closer look at the subscriber numbers offers some cause for caution as while for the six months as a whole the increase was significant there was a sharp slowdown in the June quarter to around 50,000 net adds compared to around 490,000 net ads in the March quarter.

RBS Australia estimates average revenue per unit (ARPU) for the six months declined by 3.7%, reflecting a lower contribution from the voice operations and an increased mix of lower value mobile broadband subscribers. The broker sees this result as reflective of aggressive price cuts in the market overall.

From the second half of 2009 to the first half of 2010, RBS Australia estimates Hutchison's share of VHA showed a profit turnaround of $132 million which reflects not only the subscriber growth being achieved but the delivery of cost synergies from the merger.

The other point made by RBS Australia is that the creation of VHA has delivered a mobile carrier with better scale, which is helping deliver an increase in margins. The broker estimates margins improved to 22% from 15% previously, with scope for margins to increase to 25% by the second half of 2012 when merger gains should be fully realised. Such merger gains will be important as Goldman Sachs expects VHA will continue to be a price leader in the industry, where competition is expected to intensify over time.

JP Morgan notes customer acquisition costs in the period were relatively stable at around $155, which is a solid improvement from $195 for the same period in 2009. An increase in acquisition costs is expected going forward as new products such as iPhone 4 and new Android phones are introduced in the second half of this year.

One positive for Hutchison is the increase in costs associated with these new products will also be felt by other operators in the market. These new products are also likely to increase the data demands of customers, so BA Merrill Lynch expects increases in capex for Hutchison as backhaul is upgraded to meet this demand.

Post the result brokers have revised earnings estimates significantly, though as Macquarie points out the changes come off a low base. In earnings per share (EPS) terms Macquarie has lifted its forecasts to 0.1c this year, 0.4c in 2011 and 0.8c in 2012, the latter two forecasts being increased by 143% and 19% respectively.

Citi has gone the other way and cut its EPS estimates by 36% this year and by around 7% in 2011 and 2012 to outcomes of 0.4c, 0.8c and 1.1c respectively, while Goldman Sachs has lifted its 2010 EPS forecast to 0.3c from minus 0.2c previously and lifted its 2011 estimate to 0.3c from 0.2c previously. Consensus EPS forecasts for Hutchison according to the FNArena database now stand at 0.4c in 2010 and 0.5c in 2011.

No broker has changed its recommendation post the interim result, meaning Hutchison is rated as Buy twice, Hold three times and Sell once. RBS Australia has one of the Buys, expecting a continuation of strong earnings growth in coming years thanks to the combination of market share gains and merger synergies.

BA Merrill Lynch however continues to have some concerns over debt levels within VHA and these are enough for the broker to retain its negative view. For Macquarie, which has a Neutral rating on Hutchison, the issue is while debt is reducing there are still no clear signs of when investors may see the company start to generate free cash flows.

The changes to earnings estimates associated with the interim result has had little impact on broker price targets, the FNArena database showing an average target now of $0.132c, down from $0.134 prior to the result.

Shares in Hutchison today are weaker despite a stronger overall market and as at 11.50am the stock was down 0.6c at $0.099. This compares to a range over the past year of $0.088 to $0.135 and implies upside of better than 35% to the average price target in the database.

 


 

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

The Overnight Report: Revenue Crunch

By Greg Peel

The Dow closed up 56 points or 0.6% while the S&P gained 0.6% to 1071 and the Nasdaq added 0.9%.

After Friday night's big fall, the Dow opened around 50 points higher. At that point the National Association of Home Builders released its industry sentiment index which showed a fall from 16 in June to 14 in July – the lowest level since April 2009. The Dow fell back to be slightly negative.

It is not clear why this number should be a shock, given recent US housing data have been nothing but poor. Wall Street nevertheless began to fight back, took some heart from earnings reports including that from construction services company Halliburton, which is embroiled in the oil leak mess. A good result had Halliburton shares up 6% and the rest of the sector following along.

News on the oil leak dominated the afternoon session. It had previously been noted that the oil field was seeping some 3km from the wellhead, and later it was noted there was also some seepage from the cap itself. But late news that the distant seepage in question was unrelated to this particular well provided some relief. The White House has given BP another 24 hours of test time to deal with the seepage at the well head.

Wall Street kicked to the close, but shortly after the bell the much anticipated result from IT giant IBM was released. As was the theme begun on Friday with all of Citi, Bank of America and GE, IBM beat on earnings but fell short on revenue forecasts, even though revenue was up 42% on the June quarter last year. IBM shares are down 4% in the after-market.

Then came competitor Texas Instruments, which matched earnings forecasts and missed revenue consensus by a whisker. But now in a negative mood, Wall Street wanted a clear “beat”. TI shares are down 6% in the after-market.

The IBM result does not bode well for the Dow tonight, given IBM represents 9.7% of the average. A 4% fall in IBM shares is 35 Dow points, and that's before you add in the likes of components Hewlett Packard, Intel and Microsoft with possibly sympathetic falls.

While the blue chips dominate the early reports in the season, the number of stocks reporting really hots up this week. So while IBM has provided a weak lead, tonight, both before and after the bell, reports will include those from Apple (second biggest US company by market cap after Exxon), Goldman Sachs, Johnson & Johnson (Dow), State Street, Bank of New York Mellon, Whirlpool and Yahoo.

Traders will buy one day and sell the next depending on each day's earnings reports. Clearly the investor is best served waiting for a trend to emerge. So far the trend is revenue misses, with the exception of Intel, but it's still early days.

The euro put in a strong performance last night, slipping only slightly against the US dollar despite some negative news. Last night Moody's downgraded Ireland's debt by one notch, and the EU and IMF suspended emergency funding to Hungary until such time as it can prove it is working to reduce its deficit. That emergency funding has been in place since 2008 – it is not recent as one might assume. But the Irish downgrade came as little surprise, and a kick in the backside for Hungary can also been seen as a positive.

The US dollar index was little changed at 82.67, and the Aussie little changed at US$0.8684. Gold, however, broker its backwards and forwards trend around the US$1200 mark last night by falling US$8.80 to US$1184.10/oz.

I have been suggesting lately that gold probably needs to go lower. The recent push to new highs above US$1250 was based on concern of risk in Europe, a reflection of the euros needing to be printed to finance the bail-out fund, and an assumption the euro would trend down to below US1.20 and perhaps even towards parity. But that hasn't happened.

Instead, the crisis in Europe appears to be abating and the euro has risen back to US$1.30. In the meantime, weak US economic data have swung the spotlight onto increasing confirmation of a deflationary environment in the US. Deflation is not good for gold. And while the US dollar has thus fallen recently, which should be positive for gold, unwinding of gold positions against the euro have been the leading negative factor. Between now and the fourth quarter, there is no support from Asian jewellery demand.

What may yet turn gold around is the possibility of renewed fiscal stimulus from a US government worried about housing and unemployment, or renewed monetary stimulus which the Fed is already discussing. This week Ben Bernanke makes his regular testament to both houses of Congress, so some clues may be provided.

Commodities were otherwise quiet last night, with oil falling US51c to US$76.54/bbl and base metals reflecting the summer wind-down as well as a flat dollar by moving very little.

The US ten-year bond yield pushed back up 4 basis point to 2.96% last night, but the IBM result may change that again tonight. While the company's revenue miss can be attributed to some extent to a weaker euro over the quarter, IT-spend from US companies is an important bellwether of economic health.

The SPI Overnight fell 3 points.

Watch out for the minutes of the July RBA meeting out today, a speech by Glenn Stevens, and a production report from Iluka ((ILU)).

[Note: All paying members at FNArena are being reminded they can set an email alert specifically for The Overnight Report. Go to Portfolio and Alerts in the Cockpit and tick the box in front of The Overnight Report. You will receive an email alert every time a new Overnight Report has been published on the website.]

article 3 months old

Micro Cap Rising Stars – BigAir

This story was originally published on July 08, 2010. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere.

Microequities is an Australian financial adviser specialising in in-depth research of listed "micro caps" - those companies of low capitalisation too small to register on ASX indices or to attract research coverage from leading stockbrokers. In June Microequities hosted its Rising Stars conference, at which selected companies presented their stories. FNArena was invited to attend, and over a period of time will provide conference highlights. This is the second in the series.

It is important to note that Microequities invites selected companies to present at the conference. Companies do not simply pay Microequities for the opportunity.

***

By Greg Peel

A few years ago I knew I was going to be moving house and this led to a decision to stop worrying about a fixed line internet connection and go with the new microwave service instead. The idea of being able to just set up my computer wherever I wanted with a guaranteed connection through my wireless modem seemed appealing to someone whose understanding of such technology could fit on a postage stamp.

So it was I dumped Optus and went with Unwired as my ISP. Despite the flexibility afforded by a wireless connection, I soon realised it was a big mistake. I was constantly pointing the modem in different directions to find a signal, my data speed was always much slower than the service had claimed, and drop-outs were commonplace. For an e-zine journalist it was not good enough, and I heard similar bad reports from friends. I soon returned to cable.

Unwired began to falter and was snapped up by new technology player BigAir ((BGL)). Big Air listed on the stock exchange in 2006 with plans to take on the big boys with its microwave internet and mobile phone services. Then along came Telstra ((TLS)) 3G. In the words of the company's co-CEO Jason Ashton, 3G slaughtered BigAir's retail services.

In retrospect, Ashton pointed out, the microwave technology was too new, too raw, and too underdeveloped at that stage. Realistically it was not yet viable. This explained my pioneering Unwired problems. Today, however, the technology is much better developed and far more sophisticated, providing faster download speeds through increasingly cheaper infrastructure, says Ashton. Now it is viable.

What is not, however, reliably viable is trying to play games with the big boys in the whole retail telecommunications space, with mobile now looking at 4G and with Telstra now on board for the big copper-fibre replacement ahead to create the National Broadband Network. In itself, the NBN and its intended FTTP (fibre-to-the-premises) rollout does provide other, far more viable opportunities. These lie in the business and wholesale markets.

BigAir has now finally extricated itself from its iBurst, as it was called, retail business. While iBurst contributed $1.5m in revenues and $0.5m in gross profit in FY09, it was costly to maintain. Without it, BigAir is expecting to deliver higher revenue and gross profit numbers in FY10 than in total in FY09 from the remaining business. The remaining business revolves around the establishment of CBD infrastructure to deliver high-speed wireless broadband within a city range.

The obvious thought here is why would CBD businesses be interested in paying for microwave technology when the rapid speed of fibre will soon be delivered by the NBN and while some fibre cables have already been laid?

The answer comes in three parts: speed of set-up, risk diversification and temporary installation.

In regard to the first part, for most an FTTP connection is still a long way off. Even concepts of a short way off mean streets being dug up and cable being laid, whether freshly or in replacement of copper. In the meantime, with its established network of microwave transmitters and receivers atop city buildings, and the simple process with which BigAir can either link in a new customer either using its existing network or by erecting a new dish where appropriate, BigAir can have city businesses operating on a dedicated high-speed broadband network in a matter of hours.

BigAir owns and operates the infrastructure end to end. There is no being held hostage by having to lease space on someone else's copper or fibre network. As for the actual internet service provision side of things, BigAir is now a wholesaler for 80% of its business. In this way it can let other ISP's worry about spending money on sales and marketing teams and by so doing keep the cost of the infrastructure, and the connection, highly competitive.

So that's the first part of the answer – businesses within a CBD can be set up with high speed microwave broadband in no time at all. Right now.

That's all well and good, but the next obvious thought is that while a microwave connection might suit in the interim, what happens when a business eventually has access to an FFTP network? Doesn't Big Air then risk being told thanks but see you later?

The answer here lies in one of risk diversification. Given Telstra had already begun replacing some of its copper with fibre in areas close to major exchanges before agreeing to join the NBN, some city businesses already have a much faster connection. But that has not stopped them also becoming BigAir customers and establishing complimentary microwave connections.

Sydneysiders will have not forgotten several episodes in the past couple of years which have caused the NSW State government much heartache. Those episodes have mostly involved some idiot with a back-hoe and a city map published in 1950 indiscriminately digging up city streets to service electricity/gas/phone lines and plunging entire sections of the CBD into darkness and/or cutting off phone lines and internet connections through severing a cable that wasn't meant to be there. Such indiscretions have then taken several hours to rectify, and for that time many businesses have been simply cut off from the outside world. It can amount to millions of prospective dollars being lost.

While one does not expect an idiot to be out there with a back-hoe every day, such episodes do serve to highlight a business's vital reliance in this day and age on its internet connection. Back-hoes are not the only potential cause of accidental disconnection (albeit one shudders to contemplate what the actual FFTP rollout period might bring), and it makes perfect business sense to have a back-up system just as a building might have a back-up generator for when the electricity is cut off.

A microwave connection can provide such a back-up, operating, as it does, in the vacant airspace above the skyscrapers. Recognising that some clients were opting for a Big Air connection as a compliment to another service, rather than just relying solely on BigAir for the internet, the company has since been aggressively targeting this growing market through its Back-up and Disaster Recovery services.

So that's the second answer. The third answer is one that may not immediately leap to mind.

One day a major listed construction company decided it needed to solve a problem. On every building site, the company would first establish a site office. While once upon a time such site offices might have contained little more than a table upon which to spread out blueprints and a kettle to make the tea, in this day and age site offices are sophisticated “offices away from the office” with computers a default requirement. And with a computer comes the need for an internet connection.

But a site office will only be in place for a finite amount of time until project completion. The actual structure might even have to be shifted about a bit on the site as construction rolls on. Clearly a fixed line broadband connection is neither practical in such a circumstance, nor cost effective. But it's little trouble and not particularly costly for Big Air to give the site a temporary dish and point it at an appropriate microwave transmitter.

And so was born another segment of Big Air's business – the temporary fast broadband connection. And it's not just limited to the construction industry. In recent times Big Air has provided temporary connections for the Sydney Fashion Week, the Australian Open Golf, and for the ambulance service at the Melbourne Cup, just to name a few.

Big Air spent FY07 losing money before it begun to wind down its original retail mobile services. Once those were on the way out the earnings graph turned positive. A comparison of the first half FY10 accounts to the first half FY09 accounts shows revenue up 40% to $3.3m, EBITDA up 68% to $1.45m and after tax profit up 122% to $625,000.

BigAir began establishing its rooftop infrastructure in the CBDs of NSW and three years ago was still NSW-bound. Rapid expansion into Victorian and South-East Queensland CBDs and Perth have since meant non-NSW revenues now exceed NSW revenues with more upside to come. The more than $1m required in capital investment has been fully funded from internal cashflows. BigAir has no debt on its balance sheet and as at June was holding $2.1m in cash.

The company is now the largest infrastructure-based Fixed Wireless business in Australia. On a half-year basis, the company's current revenue run-rate is $6.7m. Big Air estimates the addressable market size in the country is something like $1bn, so there's plenty of scope for upside. CEO Jason Ashton suggested BigAir's service is “quite” unique. Yes – bad English from a journalist's point of view but his point is that BigAir does have competitors in the space – maybe six – but they are not quite the same and they are not up to speed compared with BigAir.

Nevertheless, it is BigAir's desire to consolidate its position as the dominant player. It intends to take out its competitors.

In the past year BigAir has acquired six additional microwave base stations in Sydney, Melbourne and Brisbane, retained new wholesale channel partners and acquired additional resources and skills in the high-end licensed microwave market. The company has also appointed a new National Sales Manager with a solid 20-year track record in telecommunications.

The company has 88.5m listed shares outstanding which at 16.5cps suggest a market cap of $14.6m. At the time of writing the shares are trading at 17.5c. They were offered at 25c in 2006 and aside from its retail woes BigAir did not avoid an inevitable clobbering in the GFC, seeing its shares trade at under 5c at their nadir in early 2009.

For those with an interest in telecommunication investment, BigAir offers an opportunity outside the realm of the usual suspects, NBN rollout issues and fights over infrastructure leasing and pricing. Indeed, it offers a complimentary or diversified investment.

article 3 months old

Big Growth Numbers Projected For iiNet

By Chris Shaw

Internet service provider iiNet ((IIN)) is highly recommended on the Australian market, the FNArena database showing four Buy ratings and one Hold recommendation among the five major stockbrokers covering the company.

The positives views reflect a positive earnings outlook, with Morgan Stanley noting consensus expectations for earnings per share (EPS) growth for FY10-FY12 stand at a little more than 20% annually. Consensus EPS forecasts according to the database stand at 19.9c this year and 26.6c in FY11.

Morgan Stanley's forecasts for FY10 and FY11 are broadly in line with this at 18c and 26c respectively, but the broker takes the view EPS growth through FY13 is likely to be higher than the market expects at around 25%.

Acquisitions should assist in this regard, while Morgan Stanley also expects customer migration to the iiNetwork will boost group margins and profitability during this period. This outlook sees the broker initiate coverage on iiNet with an Overweight rating within an In-Line industry view.

Given its earnings growth expectations, Morgan Stanley suggests iiNet is cheap at current levels, as its forecasts imply earnings multiples of 11.3 times in FY11 and 8.8 times in FY12. This stacks up well against peers, as competitor TPG ((TPM)) is estimated to be trading on respective multiples of 15.8 times and 11.4 times in comparison.

Looking at iiNet broadly, Morgan Stanley sees a key attraction as the ability to add subscribers and margin simultaneously by moving new subscribers onto its largely fixed cost network. This is partly being achieved by acquisitions as the sector continues to consolidate, the March purchase of Netspace being the most recent example of this strategy.

The National Broadband Network offers some risks to iiNet in Morgan Stanley's view, largely as the company's core business relies on efficient access to assets it doesn't own such as the NBN in the future and Telstra's ((TLS)) last-mile copper network now.

But in Morgan Stanley's view iiNet is well placed to operate under the new structure as scale will be of greater importance, as will factors such as service, quality, brand and content. Each of these are relative strengths for iiNet in the broker's view.

Content is a good example, as the company has been conducting trials of internet TV service FetchTV. Earlier, JP Morgan noted while there wouldn't be any great financial benefit from re-selling the service, it would be another attraction for subscribers and so help reduce customer churn.

Management has set a medium-term target of 15% DSL broadband market share and Morgan Stanley suggests risk is to the upside in this regard given current market share stands at 12.4%.

The NBN should have some longer-term impact on margins for iiNet, especially if Telstra begins to compete more aggressively to reverse market share. But as the company can boost margins through migrating customers onto its network, Morgan Stanley expects iiNet should be able to withstand this increase in margin pressures.

Compared to a current share price of around $2.90, Morgan Stanley has a base case valuation on the stock of $3.76, so it has set its price target near this at $3.80. A bull case scenario where iiNet achieves market share of around 20% in fixed broadband implies a valuation of $5.54, while a bear case of a halving in margins and no further market share gains implies a valuation of $1.24.

Morgan Stanley's $3.80 price target compares to an average price target according to the FNArena database of $3.02, which reflects the stockbroker's above consensus earnings growth expectations.

Shares in iiNet today are slightly higher and as at 10.55am the stock was up 3c at $2.95. This compares to a range over the past year of $1.61 to $3.00 and implies around 3% upside to the average price target according to the database.

article 3 months old

Assessing the Telstra/NBN Deal

By Chris Shaw

Last Sunday Telstra ((TLS)) and the National broadband Network Company (NBNCo) signed a financial heads of agreement that will see Telstra migrate customers to the NBN and lease its infrastructure to that company.

The deal was valued at around $11 billion, $9 billion coming from NBNCo and $2 billion from the Federal Government. The market has generally viewed the deal as a positive outcome for Telstra, both financially and because it removes some of the uncertainty that has been overhanging the stock.

Credit Suisse suggests the deal is a win for shareholders as it provides enhanced regulatory certainty for the company. This is especially the case if the Labor Party is re-elected in the broker's view, as the deal means Telstra will avoid any scenario of increased regulation and the introduction of competing networks.

The deal was also at the top end of market expectations from a value perspective according to Credit Suisse, as speculation of the value of any deal had ranged between $8-$12 billion. Citi points out the agreement has yet to be finalised and there remain a number of hurdles, but Citi expects the deal will go ahead given its importance to both parties.

One advantage for Telstra in the deal, in Citi's view, is the $9 billion in cash payments for assets and customer migration. This means Telstra has locked in value for a fixed line business in structural decline, which Citi notes will help protect post NBN cash flows for the company.

As well, Citi suggests the cash can be used by Telstra for a number of options including the repayment of debt, capital returns or reinvestment in the retail business as the company attempts to retain or grow market share.

The disappointing element of the announcement for Bank of America Merrill Lynch was a lack of detail relating to the agreement. As an example, Telstra cannot advise how the $9 billion is being split with respect to customers transferred and infrastructure access. This means valuing the deal on actual cash flows is not yet possible.

The other issue for BA Merrill Lynch is the deal requires a number of conditions being met, meaning there are still some risks of the deal falling through. Given this uncertainty, the broker suggests the share price is unlikely to reflect the full value of the deal until it is actually completed, something that will also require shareholder approval.

BA Merrill Lynch estimates by assuming the full value of payments is received the deal would increase its valuation for Telstra to $3.85. But the current uncertainty with respect to the deal means Telstra shares are likely to continue to trade at a discount to this level, so the broker makes no change to its Neutral rating on the stock.

GSJB Were agrees and retains its Hold rating, suggesting maybe 50-75% of the agreement is likely to be priced into Telstra immediately. This equates to around 45-65c per share above its stand-alone valuation of $3.00.

In GSJB Were's view, the shares are likely to settle at the bottom end of a range of $3.45-$3.65, reflecting the ongoing share overhang from the Future Fund and the fact the NBN deal has not been finalised.

JP Morgan agrees with a Neutral rating, pointing out while the deal means Telstra has avoided a worst-case outcome there remains a lack of certainty relative to future earnings and free cash flows. As with BA Merrill Lynch, JP Morgan argues the lack of detail in the deal announcement means there is no basis to accurately assess the impact on Telstra of the transition to the NBN.

In the view of JP Morgan, Telstra is likely to need to transform from a high capex/high margin company to a lower capex/lower margin model. This implies great difficulty in currently estimating key long-term drivers of value such as future fixed retail share, future margins and future capex levels.

Others are more positive however, as the FNArena database shows Telstra is rated as Buy and Hold five times each. Credit Suisse is one of those rating the stock as a Buy, which is related to its $3.80 price target.

This assumes the current non-binding agreement is implemented, which Credit Suisse points out would remove much of the downside regulatory risk associated with Telstra. There is also value on offer at current levels, Credit Suisse estimating the shares are currently trading on a FY11 earnings multiple of 10.5 times and a gross dividend yield of 12.8%.

This is based on Credit Suisse's forecasts for earnings per share (EPS) of 31.2c this year and 31.7c in FY11. These compares to consensus EPS estimates according to the FNArena database of 31.3c and 31.9c respectively.

Citi also rates Telstra as a Buy, lifting its price target to $4.05 from $3.70 to factor in the agreement. While Citi agrees investors are likely to be concerned by the lack of details announced, the fact is more details will come over time and significant work has already been done in terms of bringing the deal to fruition. This increases the stockbroker's confidence the deal proceeds and supports its positive rating.

Citi's new target puts it at the top of the range according to the FNArena database, while Deutsche Bank is the low mark with a target of $3.15. The average price target according to the database is $3.66.

Shares in Telstra rose yesterday as the market first digested the news, but the stock has weakened slightly today in line with a lower overall market. At 11.35am Telstra was down 5c at $3.29, which compares to a range over the past year of $2.88 to $3.71. The average price target of $3.66 implies around 11% upside from current levels.

article 3 months old

Model Portfolios And Potential Earnings Surprises

By Chris Shaw

Debt issues in Europe continue to impact on investor sentiment but for UBS the combination of reasonable global growth expectations, expanding profit margins, low inflation, easy global monetary portfolios and attractive valuations is enough to remain positive on global and local equities.

In terms of its model portfolio UBS has made only minor changes as at the end of May, trimming its domestic defensive and US economy exposure given recent outperformance in favour of adding some cyclical and value positions.

Overall UBS remains overweight the Mining and Industrial Cyclical sectors while being Neutral on the banks. The bank position has come down from slightly overweight previously. The broker remains underweight Energy, REITs and Industrial Defensives.

Stock changes at the end of May were limited, UBS adding CSR ((CSR)) and Crown Limited ((CWN)) to its model portfolio and removing Woolworths ((WOW)) and Sky City Entertainment Group. Weightings have been increased in JB Hi-Fi ((JBH)) and Fairfax Media ((FXJ)), while there are now lower weightings in News Corporation ((NWS)) and Brambles ((BXB)).

According to UBS the fact domestic economic performance has been patchy, and given weak UK and European economies, there is an increasing risk of downgrades leading into August's profit reporting season.

Any such downgrades should be fairly contained in UBS's view, with a greater risk at the smaller cap end of the market. Overall it suggests earnings risk is more than priced into the market at current levels.

RBS Australia has gone a bit further into where the most likely sources of upside and downside earnings surprise may rest in the upcoming reporting season, basing its analysis on both quantitative and qualitative factors.

The screens used in RBS's analysis include a company's track record of earnings surprise relative to consensus estimates, the magnitude of earnings revisions over one month and a net revisions ratio. Other factors such as the dispersion of analyst earnings estimates is also considered.

Based on its analysis RBS suggests the S&P/ASX100 stocks most likely to deliver an upside earnings surprise compared to existing consensus estimates are Ansell ((ANN)), ASX, Boral ((BLD)), Cochlear ((COH)), Crown, Fairfax, Goodman Group ((GMG)), Telstra, United Group ((UGL)) and WA Newspapers ((WAN)).

Those in the ASX100 most likely to disappoint relative to current consensus forecasts according to RBS are Amcor ((AMC)), Alumina ((AWC)), AXA Asia Pacific ((AXA)), Boart Longyear ((BLY)), BlueScope Steel ((BSL)), Brambles, Nufarm ((NUF)), Sims Metal ((SGM)) and Transurban ((TCL)).

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

Small Caps With Upside

By Chris Shaw

Last week Morgan Stanley identified a number of smaller capitalised stocks it believed offered value and this week it has identified some more companies where it sees upside. The broker has initiated coverage with Overweight ratings on ASG Group ((ASZ)), Domino's Pizza Enterprises ((DMP)), Bradken ((BKN)), Fantastic Holdings ((FAN)) and Monadelphous ((MND)). In each case the rating compares to an In-Line industry view.

One attraction of ASG for Morgan Stanley is it offers a defensive exposure in the IT services sector from a majority of government clients. As well, there is leverage to operating expenditure rather than the more cyclical capex spending end of the market.

Earnings are therefore of a high quality, with Morgan Stanley expecting earnings to grow both organically and via acquisitions given a strong balance sheet. Net debt to equity currently stands at around 5% on the broker's numbers.

On Morgan Stanley's numbers the company should deliver a capitalised annual growth rate in net profit of 13% through to FY13, while return on invested capital is expected to rise from 4.2% now to 21.2% in FY12.

The company generates solid cash flow as evidenced by a free cash flow yield of 10%, so Morgan Stanley sees the current 4-5% dividend yield as sustainable. Its Overweight rating is accompanied by a price target of $1.60. Currently no brokers in the FNArena database cover ASG Group.

For Domino's Pizza it is the European operations that hold the key in Morgan Stanley's view, as the Australian operations are the solid base and Europe is the blue sky as the group's footprint is expanded.

This is important as Morgan Stanley suggests as the group expands its scale in the European market margins will improve, which in turn will support sustained momentum in system sales both overseas and in Australia.

Morgan Stanley's forecasts call for strong double-digit earnings growth in coming years, as evidenced by its earnings per share (EPS) estimates of 26c this year, 32c in FY11 and 37c in FY12. Consensus EPS forecasts according to the FNArena database stand at 26.2c this year and 31c in FY11.

The average price target for Domino's according to the database is $5.70, well below the Morgan Stanley base case target of $7.30. Under a more bullish scenario Morgan Stanley can justify a valuation of $8.60. FNArena shows Domino's is rated as Buy three times, Accumulate once and Hold twice.

Given the company offers exposure to the resources and energy sector through the supplying of various products and to freight via its rail division, Morgan Stanley likes the potential for Bradken given its expectation activity levels will pick up through FY11 and beyond.

Earnings in FY10 are expected to be flat but in FY11 Morgan Stanley expects growth of better than 30%. Further upside is expected in FY12, even assuming little increase in capital expenditure or acquisitions as volumes and revenues in the company's businesses should move higher as economic growth picks up. Its base case numbers suggest revenues increase by around 10% per annum over the next two years.

Morgan Stanley is forecasting EPS for Bradken of 50c this year and 66c in FY11, while consensus numbers according to the FNArena database are 51.4c and 62.7c respectively. Bradken is rated as Buy six times and Hold twice, with an average price target of $8.00. Morgan Stanley's target stands at $9.50.

As with Domino's Pizza, Fantastic Holdings is also looking to grow its store base, this while also looking at strategic acquisitions and investing in its supply chain capabilities. To Morgan Stanley this means the company is setting itself up to come through the current retail spending cycle with a bigger and much improved business and one that offers significant leverage to earnings.

On Morgan Stanley's numbers, Fantastic should generate robust double-digit growth rates, its forecasts calling for EPS of 25c this year and 29c in FY11. Consensus estimates according to the FNArena database stand at 25.5c and 30c respectively. The database shows two Buys and one Hold rating and an average price target of $4.77, while Morgan Stanley's target is $4.85.

Engineering group Monadelphous offers a premium exposure to Australia's resources boom in Morgan Stanley's view, as along with iron ore supply operations the company continues to expand in the oil and gas, coal, water and infrastructure markets.

This broadening of operations gives Morgan Stanley increased confidence growth can continue through and beyond the current strong resources cycle. Even allowing for a slight but steady erosion in operating margins, earnings should expand through at least FY12.

Morgan Stanley's EPS forecasts stand at 89c this year and 99c in FY11, while consensus forecasts in the FNArena database stand at 92.4c and 103.6c. The database shows the stock is rated as Buy twice and Hold five times with an average target of $15.86, while Morgan Stanley's target is $18.00.

Elsewhere in the smaller cap end of the market Macquarie has Boart Longyear ((BLY)) as one of its Marquee Ideas stocks given strong operating leverage to a recovery in the global minerals exploration spending cycle.

Recent comments from management indicate Boart is enjoying a strong turnaround in activity levels, leading Macquarie to suggest there is potential for revenue expectations to be upgraded at the company's annual meeting next month. The broker's numbers reflect this as Macquarie is forecasting revenue growth of 22% against current guidance of 15%.

Macquarie's target on Boart is $0.40, while the average target according to the database is $0.38. Including Macquarie's Buy the stock is rated as Buy six times, Accumulate once, Hold twice and Sell once.

The other stocks to make Macquarie's Marquee Idea's list are Commonwealth Bank ((CBA)), News Corp ((NWS)), Qantas ((QAN)), Rio Tinto ((RIO)) and Westpac ((WBC)). All are rated as Outperform except Westpac, which is rated as Neutral.