The Walt Disney Co.

For a change of pace, this month we take a look at, in our view, one of the most interesting media companies in the world. Disney, or The Walt Disney Company is known throughout the world for its theme parks and children’s cartoons. Yet the company is so much more than that in 2019. Disney may be the most important media company in the world given its ownership of leading brands, dominant position as a content provider and global scale.

Businesses

Disney’s businesses are extremely diverse and include both traditional and modern networks including sports broadcaster, ESPN, ABC, FX and the Disney Channel. They also own a growing portfolio of Walt Disney theme parks and more recently cruise ships that offer families a unique holiday experience. Disney’s recent strength, however, has been in their Studio Entertainment division through which they identified the true value in the video-on-demand would be owning content rather than platforms. It is this unit that owns both the traditional Walt Disney studios, which includes movies like the Lion King and Aladdin, as well as the two most dominant franchise of all-time, being Marvel Studio’s and Lucasfilm. For the uninitiated, Marvel owns the content and has delivered several dozen super hero movies including the Avengers, Thor and Guardian’s of the Galaxy, whilst Lucas Film controls the all-time Stars Wars and Indiana Jones’ franchises. Finally, the company recently completed the acquisition of Twentieth Century Fox from News Corporation further extending their dominance. More recently, Marvel have announced an expansion to deliver their contact directly to consumers, similar to Netflix, with the global launch of both a Disney+ and ESPN+ streaming service just around the corner.

Financials

The company has been riding a wave of record revenue on the back of titles including this years Avenger’s: End Game topping the all-time list for ticket sales. The fourth quarter of 2019 was no exception with revenue of $20.25bn (up from $15.2bn) however the resulting earnings per share was impacted by the Fox acquisition, falling from $1.87 to just $1.35 this year. Management blamed the underperform of Fox Studio’s which can be taste driven and many years in the making for the earnings reduction of 0.60 cents per share compared to 0.35c expected. The release of Avengers and Toy Story 4 were not enough to offset the disaster that was XMEN: Dark Phoenix. Disney’s largest segment is however their television networks and theme parks which added revenue of $6.71bn and $6.58bn after years of capital expenditure adding new themes including a dedicated Star Wars park.

Outlook

Disney’s only loss-making business, it’s direct-to-consumer streaming services offer the greatest potential in our view. The company recently acquired the popular Hulu streaming platform and is in the process of launching a dedicated sports streaming service, ESPN+, around the world as well as taking back control of their historic content database and launching a Disney+ TV and move subscription platform. This comes at an interesting time for the industry with many consumers now rationalising their subscriptions in light of diluting quality. The fact in Disney’s favour, however, is that they own two of the most valuable commodities in media. The first being live sports that consistently attracts strong advertising revenues and which is only becoming more popular. And the second is the quality of content and the ability to leverage this not into movies but into TV shows, theme parks, products and experiences. We understand ESPN is about to begin renegotiating its position with various cable TV providers and given its importance as an anchor to these services will result in better than forecast sales.

Given the potential growth and market position you would expect Disney to trade at a substantial premium to market, yet it’s historical P/E is only around 21 times earnings even with the stock up 24% this financial year. Much cheaper than the 90x hat Netflix trades on.  It offers a yield of 1.3% and has aggressively been buying back stock at every opportunity.

Costa Group Holdings (CGC)

We may be wired differently to the rest, but when we see companies fall by 20% or more in a day out interest is automatically piqued. Whether it is the need to search for a discount, or something contrarian in our blood, we tend to see value in these ‘fallen angels’. And with interest rates at an all-time low, markets and most importantly individual companies trading at stretched valuations, there seem to be more and more of these every month.

This week a client reached out and put some very simple words forward, being that the basis of education relating to economics and financial markets is still reliant on the ‘rational man’ concept. That being markets will react rationally and price in all relevant information at all times. Yet anyone who has been involved in investing at any time over the last 100 years knows this is simply not the case, investing is an inherently emotional pursuit and these emotions regularly result in mis-pricings.

This month we were surprised at the reaction to Costa Group’s earnings downgrade and weaker outlook for its many markets, with the share price falling 25% and reaching multi year lows.

Who is Costa Group?

Costa is Australia’s leader grower, packer and marketer of fresh fruit and vegetables with five core business lines: berries, mushrooms, tomatoes, avocados and citrus fruit. In fact, it is the number one producer of blueberries, raspberries, mushrooms, glass house tomatoes and citrus in Australia. That is some sort of monopoly.

Costa was traditionally reliant on the production of berries and citrus but post it’s listing in 2015 the company has invested substantially to diversify its earnings base, as has been seen in the revenue chart below:

The Costa business model is based around having a 52 week production cycle and diversifying its earnings base sufficiently to ensure a poor season for one type of fruit does not impact the business as a whole. This has been extended to overseas investments including Morocco and China, the produce from which is delivered directly into Europe and China respectively. This is going someway to remove the reliance on the major supermarkets who purchase 75% of Costa’s production.

So, what happened?

Anyone who shops at Woolworths or enjoys some blueberries on their morning muesli would have seen it coming. The price of both blueberries and avocados in 2018 dropped substantially selling for as little as a few dollars a punnet, and that was only the start of the problems for Costa.

The company was hit by a quadruple shock, with poor weather in Morocco resulting in its production being sold into Europe at the peak of supply, meaning lower prices were received. Next, the Australian mushrooms experienced an unseasonably warm growing season and the expanded growing centre was still waiting for commissioning which impacted production. Then raspberries were impacted by poor quality and fruit flies were detected in their citrus plantations. It couldn’t get much worse.

Yet it was still a shock when the company reiterated its previous guidance at the end of May and investors capitulated. The company confirmed that revenue was down 2.4% and EBITDA would fall 42% to $35.3m for the financial year. They indicated that the results for the full calendar year of 2019 would be in line with the previous year but below previous expectations due to the combination of events listed above. However, they clearly indicated that avocados, tomatoes and blueberries had not been impacted, which represent a majority of their revenue base.

Our view

We think Costa is a case in point as to why agricultural and food production companies have had such a difficult time on the ASX and in other listed markets. Costa is an example of a high-quality company, with great long-term assets and production schedule, but which became overvalued due to the exuberance of short-term investors. The company operates in a weather dependent industry, therefore, poor seasons will occur regularly and the companies annual profits will be volatile. This appears to have been misunderstood by the market.

As a smaller company, valued at $1.3bn we think Costa has some merit. The company is nearing the end of a significant capital expenditure cycle, having upgraded and planted out more of its core blueberry, mushroom and tomato plantations, costing some $200m. It continues to derive strong margins of around 14% from these business lines and delivers leverage thanks to its fixed lease agreements for the underlying properties.

We believe the various issues are cyclical and simply part of owning an agricultural company. Management have done a lot of work to diversify the business which will hold them in good stead moving forward. The company currently trades on a forward price earnings ratio of just 16x, which is a discount to most Australian food companies and most importantly much lower than global beers like Calavo Growers (25x) and Scales (18x).

Webster’s Ltd

With Australia’s water markets an election issue, we would be remiss not to provide an update and our view on one of Australia’s largest water rights owners, Webster’s Ltd (WBA). WBA is the combined Tandou entity, chaired by one of Australia’s most experienced business people, in Chris Corrigan, who stepped down from the booming Qube Holdings group to focus on this sector.

At last report, WBA holds just over 150k mega litres of water rights across the eastern Seaboard, but primarily in the Murray Darling Basin; noted by James Dunn as Australia’s largest water region. The group has operations across the east of Australia, including Tasmania, with around 20,000 irrigable hectares of property at any one time under management or ownership.  The groups biggest crops are in cotton, walnuts and almonds, with livestock including lambs a growing share of their business. The company has the ability to produce as much as 180,000 bales of cotton each year and currently delivers 90% of Australia’s annual walnut crop (that’s some sort of monopoly). Yet by far the company’s largest asset is it’s substantial water rights holdings which are carried at a book value of $162m on their balance sheet but which many experts believe are worth in excess of $350m at the present time. Given WBA’s market capitalisation is just $545m, the horticultural and agricultural assets nearly come for free to shareholders.

WBA was caught up in a 4 Corners report in 2017 which made allegations regarding the company’s water use, ownership and intentions following the purchase of the Tandou cotton farming properties in NSW and the associated water rights. Such was the coverage of the report that management saw fit to put out a press release, highlighting in their words ‘fabrications’ and lack of research undertaken in this ‘hack job’ by the ABC. Effectively, the reporters and several land owners were suggesting that Webster’s had breached various obligations regarding its use, storage and ownership of water. The company stands by its stated goal, which is to ‘own a wide range of water entitlements……and convert these entitlements into more valuable horticultural and agricultural products’.

WBA is coming to the close of a period of transition, which began when the company decommissioned the cotton farm operations at Tandou, due to concerns about the availability of water from the Menindee system, and converted the property to livestock farming of lambs.

The group also sold another cotton farming property, Bengerang, for $132m in 2018, to a series of private investors and pension funds. This and more recent decisions to purchase further almond and walnut orchards in the Riverina district in NSW has seen the company sharpen it’s focus on the region where they have the greatest competitive advantage. For the 12 months ending 30 September 2018, the company remains reliant on the Agricultural division, which included cotton, wheat and livestock, for $153m in revenue and $43m in profit, and the Horticultural division delivering $53m and $10m in profit respectively. Unfortunately, comparisons to previous years offer little value to the substantial land sales and change of strategic direction that have occurred.

Whilst some may question the best use of limited water in Australia, there is no doubt that cotton, almonds and walnuts offer some of the great return on investment for farmers particularly in export markets. The walnut orchards alone deliver a profit margin of around 20%, with WBA delivering the second highest yields on record in 2018 and selling prices increasing 17% globally. As with all agricultural businesses, there was some weakness in the 2018 crop due to non-pollination events, however, management’s recent decision to divest a number of non-core properties has allowed them to continue to invest in further plantings, as well as purchase additional and surrounding properties. The company’s walnut operations, which are vertically integrated, are one of the few Australian monopolies still available to investors to take part in.

Where many agricultural investors go wrong, is in over-leveraging their business and not maintaining sufficient diversification of their income. WBA is well placed on both areas, first, their gearing ration is just 28.5% after using the sale proceeds to reduce debt, and secondly, their income is spread across annual crops, like cotton, and perennial crops like walnuts and almonds, which once producing provide a consistent income. This has more recently been complemented by a move to increased livestock capabilities following the purchase of 50,000 hectare property for lambs at Backpaddle. Following the recent transactions, PSP Investments, a global pension fund, own some 19% of the property, and Chris Corrigan himself 13%; this provides important support for further capital raisings and asset purchases.

Overall view

In our view, the change in direction of WBA comes at an opportune time and offers an excellent entry point for investors. The company trades expensively on a Price-Earnings ratio of 30x, however, this is muddied by the combination of a transition year for the company’s finances and the fact that some 60% of the company’s shares are owned by insiders. Continued improvement in 2018-19 operations, which have been highlighted by management should see earnings grow strongly in the years to come.

We believe some level of valuation premium is reasonable given the monopoly position in walnuts and the large water, relatively high security, water entitlements. Outside of BlueSky’s Water Fund, which trades at NTA but offers limited liquidity, WBA is one of the few true water investments left in Australia. We believe the company will continue on its expansion into perennial crops where is has a competitive advantage and is likely to do through further capital raisings. The strategy being undertaken is not unlike that of Harvard Endowment, which has spent many years buying up pristine Napa Valley property in order to take ownership of the water located underneath. For this reason, we would not be surprised to see further pension fund interest in the company’s assets. Given Qube Holdings strong turnaround, we would not expect someone like Chris Corrigan to walk away to waste time in WBA unless he sees real opportunity in the sector.

It’s a buy for us.

Long Table – LON (ASX)

We’ve all tucked into an expensive, yet incredibly delicious Maggie Beer ice cream before, and there is no doubt we have all had our share of smashed avocado with a flat white in one  of Melbourne and Sydney’s many respected cafes. Well, an investment in Long Table may offer a chance to profit from these trends.

Long Table has been around for some time, but is only just coming into its own as a ‘House of Brands’. The company is well known for being the 48% owners of the Maggie Beer brand, and recently agreed to purchase the remaining 52% for just $10m as it seeks to ramp up its sales growth. Long Table also owns a number of little- known, but growing brands including Saint David Dairy, which is a micro-dairy based in Fitzroy, Melbourne, and Paris Creek Farms, a bio-dynamic, organic dairy in South Australia. Through these acquisitions and business lines the company has delivered a near fully vertically integrated business model.

Leading the charge is  Laura  McBain, who left her lucrative position as CEO of Bellamy’s Australia, the infant formula producer, to run this fledgling company. Laura is well connected to the Tasmanian agricultural scene and the fact that someone of her experience and stature, not to mention the pay cut, would join a small company like Long Table, bodes well for the future.

As with Webster’s, the company is coming to the end of a period of transition after it appears too little attention was placed on the efficient operation and distribution of the Maggie Beer brand. Maggie Beer’s long-established career offers Long Table the ability to leverage off the respect she has in the public and industry, and the high quality synonymous with her name. The Maggie Beer brand spans various products, focused around home entertainment, including pate’s, pastes, jams, ice cream, and more recently cheese. Interestingly, Maggie’s recent book, a ‘Recipe for Life’, offers recipes that can help reduce the risk of dementia, and are likely to form part of an eat-at-home line to be offered by Long Table in the future.

Alongside Maggie Beer, is Saint David Dairy, located on St David Street in Fitzroy, Melbourne. The area is the heart of hipsters and the branding could not be more authentic. There is a proven trend that hipsters are willing to pay more for authentic products, and the business has been focused on supplying award winner butters, milks and yoghurts to Australian restaurants and independents for some time. Whilst only a small part of the business, the sector and revenue is growing (up 31% in the first half to $3.6m) via the corporate support of the Long Table Group. The gross margin is also strong at 61%. The final business is Paris Creek Farms, located in Meadows and producing a series of milk, yoghurt and cheese for the domestic market. As with  Saint  David,  the  brand is authentic, local and organic, branded ‘food for purists’, as management seek to capitalise on restaurants need to identify the source of their products and consumers wish to support smaller businesses. The company saw revenue fall 6% in the first half, delivered a gross margin of 42% and a loss of $1.8m as they reset their pricing across Australia.

The first half of the 2019 financial year has been a difficult one, involving a great deal of consolidation and corporate activity. Saint David was acquired during this period, Paris Creek was re-branded, and the Maggie Beer purchase was finalised. The highlights came from Paris Creek, which now supplies over 500 stores and has began a rollout with Metcash, whilst Maggie Beer sales are expected to deliver earnings of at least $1.7 to $1.9m. The company announced a $13m capital raise to fund the Maggie Beer acquisition, with only $4.0m being raised placing pressure on the business in the short-term. For the first half Group Revenue was $23.1m, with $11.5m coming from Maggie Beer and $8.0m from Paris Creek. The former produced a profit of $1.482m, the latter a loss of $1.802m and St David $692k.

Whilst the results were not particularly great given the period of transition, the opportunities are substantial  with  a  lot of low hanging fruit available to an astute management team. With 100% of Maggie Beer now owned, management  have  been able to create efficiencies by having these products produced by Paris Farms, reducing input and staff costs substantially. They have also integrated the Maggie Beer sales team into the business who will now expand their product line to include both the other key brands. The Paris Creek brand struggled somewhat due to an ill- fated decision to offer non-standard milk and yoghurt lines, which added cost to production and confused consumers; this has since been rectified. St David, which remains possibly, is also entering a ramp up phase,  with   management   looking   at expansion opportunities in Sydney and expanding their reach of independent stores and cafes and introducing a number of non-milk-based products, like almond and soy, which are part of an incredibly fast growing market.

Overall view

At a market cap of just $35m, an investment in Long Table isn’t for everyone, however, it may offer great returns for those willing to be patient. The company is well capitalised with trade payables of just $4.4m, however Good Will from the purchase of Maggie Beer represents one of the largest assets   at $41m. An investment in Long Table at this point is a bet that the company can ramp up both sales and margins on under  a more professional and experienced management team; with the odds likely in your favour. Given the size of the company, we would expect further capital raisings to be announced as further acquisitions are identified, with a improved cost control likely to see the losses turn into gains sooner rather than later.

The company’s high-quality products, which claim to be Barista approved, are positioned to give the discerning Millennial consumer with the warm feeling that they know the cows producing their milk are happy, or which farms they are supporting. An expansion into non-dairy products, like almond and soy milk, exposes the company to a fast-growing sector that should add to returns. Whilst it may be a while down the road before the company rewards shareholders, it’s a very interesting speculative opportunity  in  the  midst  of  a turnaround.

Webster’s Ltd – WBA (ASX)

With Australia’s water markets a common thread throughout this issue, we would be remiss not to provide an update and our view on one of Australia’s largest water right owners, Webster’s Ltd (WBA). WBA is the combined Tandou entity, chaired by one of Australia’s most experienced business people, in Chris Corrigan, who stepped down from the booming Qube Holdings group to focus on this sector.

At last report, WBA holds just over 150k mega litres of water rights across the eastern Seaboard, but primarily in the Murray Darling Basin; noted by James Dunn as Australia’s largest water region. The group has operations across the east of Australia, including Tasmania, with around 20,000 irrigable hectares of property at any one time under management or ownership. The groups biggest crops are in cotton, walnuts and almonds, with livestock including lambs a growing share of their business. The company has the ability to produce as much as 180,000 bales of cotton each year and currently delivers 90% of Australia’s annual walnut crop (that’s some sort of monopoly). Yet by far the company’s largest asset is it’s substantial water rights holdings which are carried at a book value of $162m on their balance sheet but which many experts believe are worth in excess of $350m at the present time. Given WBA’s market capitalisation is just $545m, the horticultural and agricultural assets nearly come for free to shareholders.

WBA was caught up in a 4 Corners report in 2017 which made allegations regarding the company’s water use, ownership and intentions following the purchase of the Tandou cotton farming properties in NSW and the associated water rights. Such was the coverage of the report that management saw fit to put out a press release, highlighting in their words ‘fabrications’ and lack of research undertaken in this ‘hack job’ by the ABC. Effectively, the reporters and several land owners were suggesting that Webster’s had breached various obligations regarding its use, storage and ownership of water. The company stands by its stated goal, which is to ‘own a wide range of water entitlements…… and convert these entitlements into more valuable horticultural and agricultural products’.

WBA is coming to the close of a period of transition, which began when the company decommissioned the cotton farm operations at Tandou, due to concerns about the availability of water from the Menindee system, and converted the property to livestock farming of lambs. The group also sold another cotton farming property, Bengerang, for $132m in 2018, to a series of private investors and pension funds. This and more recent decisions to purchase further almond and walnut orchards  in  the Riverina district in NSW has seen the company sharpen it’s focus on the region where they have the greatest competitive advantage. For the 12 months ending 30 September 2018, the company remains reliant on the Agricultural division, which included cotton, wheat and livestock, for $153m in revenue and $43m in  profit, and  the  Horticultural  division  delivering $53m and $10m in profit respectively. Unfortunately, comparisons to previous years offer little value to the substantial land sales and change of strategic direction that have occurred.

Whilst some may question the best use of limited water in Australia, there is no doubt that cotton, almonds and walnuts offer some of the great return on  investment for farmers particularly in export markets. The walnut orchards alone deliver  a  profit margin of around 20%, with WBA delivering the second highest yields on record in 2018 and selling prices increasing 17% globally. As with all agricultural businesses, there was some weakness in the 2018 crop due to non-pollination events, however, management’s recent decision to divest a number of non-core properties has allowed them to continue to invest in further plantings, as well as purchase additional and surrounding properties. The company’s walnut operations, which are vertically integrated, are one of the few Australian monopolies still available to investors to take part in.

Where many agricultural investors go wrong, is in over-leveraging their business and not maintaining sufficient diversification of their income. WBA is well placed on both areas, first, their gearing ration is just 28.5% after using the sale proceeds to reduce debt, and secondly, their income is spread across annual crops, like cotton, and perennial crops like walnuts and almonds, which once producing provide a consistent income. This has more recently been complemented by a move to increased livestock capabilities following the purchase of 50,000 hectare property for lambs at Backpaddle. Following the recent transactions, PSP Investments, a global pension fund, own some 19% of the property, and Chris Corrigan himself 13%; this provides important support for further capital raisings and asset purchases.

Overall view

In our view, the change in direction of WBA comes at an opportune time and offers an excellent entry point for investors. The company trades expensively on a Price- Earnings ratio of 30x, however, this is muddied by the combination of a transition year for the companies finances and the fact that some 60% of the companies shares are owned by insiders. Continued improvement in 2018-19 operations, which have been highlighted by management should see earnings grow strongly in the years to come. We believe some level of valuation premium is reasonable given the monopoly position in walnuts and the large water, relatively high security, water entitlements. Outside of BlueSky’s Water Fund, which trades at NTA but offers limited liquidity, WBA is one of the few true water investments left in Australia. We believe the company will continue on its expansion into perennial crops where is has a competitive advantage and is likely to do through further capital raisings. The strategy being undertaken is not unlike that of Harvard Endowment, which has spent many years buying up pristine Napa  Valley  property  in  order  to take ownership of the water located underneath. For this reason, we would not be surprised to see further pension fund interest in the company’s assets. Given Qube Holdings strong turnaround, would not expect someone like Chris Corrigan to walk away to waste time in WBA unless he sees real opportunity in the sector.

It’s a buy for us.

 

Under the Microscope – Boral Ltd

The Australian residential property market has been a major talking point in recent months, as the long awaited correction gathered pace. As many readers will be aware, a great deal of the economy relies on the residential property sector, from construction and building supplies companies, to entertainment and retail stores who benefit from the ‘wealth effect’ higher property values provides. The recent weakness has seen many associated sectors fall off heavily on the back of investors expecting lower profit growth; yet know that these corrections don’t impact all companies the same way and some can become oversold. In this edition of Under the Microscope, we try to determine whether Boral Ltd (BLD) is good value or has further to fall. As a note, Boral’s share price has fallen from a 12-month high of $8.22 to just $5.10, or 38%.

What is Boral?

The company was founded in 1946 as a group of investors sort to manufacture bitumen for the expanding Australian economy. Boral is an international building products and construction materials group with three divisions; Boral Australia, a construction material and building supplies business; USG Boral, an interior linings joint venture in Asia, Australia and the Middle East; and Boral North America, a growing building product and fly ash business in the US. The company acquired the US-based Headwaters for US$2.6bn in FY2017 as it attempts to expand its international footprint and reduce its reliance on the Australian building cycle.

Why Boral? 

Boral is among a handful of dominant building material players in Australia and has benefited from the recovering US economy through its acquisition of Headwaters. Management have been diversifying the business in recent years with revenue spread across Boral Australia ($3.59bn), USG Boral ($1.58bn) and Boral North America ($2.14bn). The Boral Australia business is Australia’s largest construction material and building product supplier focused around concrete, asphalt, cement, roof tiles and timber. Road, highways, subdivisions and bridges (RHS&B) represent 36% of revenue, following by non-residential and detached dwellings at 16% each; meaning the business is well diversified and not as reliant on residential property as the share price fall suggests. The USG Boral JV is a growing international business focused on the supply of plasterboard and internal linings across the growth economies Asia, with most revenue coming from Australia (37%) and South Korea (23%). The Boral North American business offers direct exposure to the US housing cycle, with around 80% of revenue coming from new and existing residential property, but a growing portion (13%) being sourced from infrastructure spending. It is the North America business that has been the key source of recent weakness, with a recent earning downgrade blamed on poor weather in the US.

Which Bucket does it fit in? 

We believe BLD meets the requirements of the Value Bucket as it offers substantial earnings growth and currently trades at a heavily discounted valuation compared to this potential. The company has been sold off by close to 40% on the back of poor weather, but more so, concerns about their exposure to the US and Australian housing cycle. Yet, a closer look at Boral’s financials indicates that less than 50% of their total revenue comes form Australian and US residential housing construction, and they are in fact more directly exposed to the infrastructure spending boom than any company in Australia. The company has an oligopolistic position in the Australian concrete and infrastructure market but trades on a price-earnings ratio of just 12x and offers a 50% franked yield of 5.4% (6.6%). As a comparison, similar but less attractive competitors, Adelaide Brighton (16x) and Wagner’s (22x), trade on premium valuations but offer less exposure to the announced increases in infrastructure spending and more to the volatile residential property sector.

How do the financials look?

Boral announced a strong result for 2-18, with EBITDA up 47% on the previous year to $1.056bn and net profit up 38% to $473m. This result was supported by a full year of contributions from the Headwater’s business and hence appears stronger than it otherwise may be. Looking more closely, revenue in the Boral Australia division increased 9%, with scale supporting a 15% increase in division profit to $433m. From a macro view, further strength is supported by a 15% increase in the RHS&B building that occurred in 2018 and 13% in non-residential construction that is expected to continue. USG Boral detracted from performance in 2018, with income from the JV falling 9% and EBIT 10% down to $194m, as higher input costs and competitive pricing in Asia impacted on returns for the business. That being said, the business continues to grow from its small beginnings with EBIT now up 80% from day 1. The Boral North America delivered ahead of proforma expectations, reporting EBITDA of $368m compared to expectations of $345m and synergies from the acquisition are 10% ahead of their stated target. The result would have been stronger if not for adverse weather conditions impacting on construction projects. The strong results across the board resulting in a 20% increase in earnings per share and 10% to the dividend for the financial year.

Broker views

The broker views on Boral are quite strong, with five buys and two holds from those who cover the stock and most have a target price in the $7’s suggesting upside of around 40% from its current level.

Wattle Partners view

The view of the Investment Committee is that BLD has been oversold due primarily to a misunderstanding of their revenue exposure. As all investors would know, mis-pricings can occur from time to time continue for extended periods, offering patient investors excellent opportunities. In Boral’s case, it appears that investors have assumed the company is more reliant on the Australian residential property sector, and subsequently that they have extrapolated a short period of US housing weakness into the future. US home building rebounded late in 2018, with November housing starts up 3.2% and building permits up 5.0%, with indications that rate hikes may be on hold likely to support further growth. As part of their ‘downgrade’ management reported expected growth in the North American business to be 20% in 2019, high single digits in the Australian business and 10% in the USG Boral joint venture.

In our view, BLD offers investors exposure to a company expected to continue growing earnings at a high single digit rate over the years ahead. The company is supported by three major tailwinds, firstly, the substantial pipeline of approved and funded infrastructure projects that require their concrete, bitumen and other material inputs (see the chart) as well as a renewed recovery of the US housing market and continued growth in Asian construction.

The companies US divisions are well placed to benefit from the stronger US economy and higher wages growth, which will contribute to higher property prices and greater spending on renovations. Management noted in 2018 that the supply of concrete and cement is likely to come under pressure in 2019 offering the potential for higher prices and greater profits. The US operations have benefitted from the announced corporate tax cuts whilst the future sale of land around existing quarries and operations in Australia may result in the payment of special dividends or other capital management initiatives. The property division has consistently delivered incremental profits to the business through a combination of rezoning and selling previous property assets or buying and redeveloping properties for their own use.  Importantly, in a competitive sector Boral has committed $425m to capital expenditure focused around upgrades at their various plants and quarries around Australia and North America. Finally, the merger of Boral’s US JV partner, USG with Knauf, has triggered Boral’s option to buy 100% of this business, which will be determined based on the fair value which is expected in early 2019.

To summarise, in a world of overvalued, high growth, low profit technology companies, Boral may provide the complete opposite to investors; a profitable, diversified and growing business leveraged to the infrastructure cycle, that trades at a substantial discount to its fair value.

A few head scratchers

As with every reporting season, there were quite a few headscratchers on both the analyst and management side for investors to deal with.

Bingo Industries (BIN): Fund manager darling Bingo Industries shocked the market by announcing a substantial downgrade to profit guidance of $108-112m, or 20% growth from its rubbish collection business. The share price was punished as a result, but after being pitched the IPO some time ago, we couldn’t quite understand how this type of business could manage to consistently deliver 20% profit growth every year. Management indicated that softening residential construction, following house price falls, and a slowdown in developments had hit profits heavily, after suggesting they were immune just a few months ago.

Bank of Queensland (BOQ): As predicted by most in the industry, it has been the smaller banks more impacted by the Royal Commission and APRA prudential measures, as BOQ reported a substantial higher cost of capital and profit falling to $165m from $182m in 2018. Their net interest marhin fell to 1.93% from 1.97%, one of the lowest in Australia, and CET 1 capital is just 9.1% in what must be a concern for the regulator.

IOOF Ltd (IFL): We cant’s quite work out what’s happening at IOOF, after seeing several staff members facing criminal charges, the company that has acquired one financial advisory business after another (including Shadforths) announced remediation provisions of just $5-10m. This pales in comparison to the banks and AMP. They highlighted that the cost to review all their advice will be around $30m but that only 10% of revenue produced by their adviser network comes from grandfathered commissions. We struggle to believe this is accurate and suggest some further negative news is coming in the future. At the same time, the company reporting NPAT of $100.1m, up 5.8% on the first half, and confirmed it would proceed with the purchase of ANZ’s Pension and Investments business.

Afterpay Touch Ltd (APT): APT delivered another solid headline result, with underlying sales on their platform increasing 147% to $2.3bn, yet the company failed to deliver a profit. The company appears to be the buy now pay later provider of choice for retailers, however, the quality of its customers may leave something to be desired. Some 17.6% of income is presently being sourced from late fees and the company continues to avoid the use of credit ratings checks. The strength of the business model appears to be driven by offering credit to those who are unable to control their spending, hence the huge levels of growth and increasingly lower quality of their retail partners. Yet following recent political questioning the company has now indicated it will seek to improve its lending standards; is it giving up growth?