Under the Microscope – ALS Limited

In this section we place one stock under the microscope and give it the unconventional assessment.

ALS Limited (ALQ) – Is the former Campbell Brothers Limited. ALS Limited is one of the world’s biggest and most profitable testing companies. It also specialises in inspection, certification and verification services, head quartered in Brisbane, Australia. It services multiple industries globally and employs over 13,000 staff in over 65 countries and has been around for 40 years. The company initially provided laboratory services to the oil shale and mineral exploration industries but has since expanded its services. In the past, 60% of earnings were tied to commodity markets. But the end of the resources boom caused it to diversify into other industries such as industrial, environmental, food testing and asset maintenance. This has reduced its minerals exposure to 40%. The company operates in these four divisions:

  • ALS Life Sciences: Comprises four primary analytical testing areas: Environmental, Food and Pharmaceutical, Electronics, and Consumer Products.
  • ALS Minerals: Provides testing services for the global mining industry in four key service areas: Geochemistry, Metallurgy, Mine Site Services and Inspection. Mineral services cover the entire resource life-cycle from exploration, feasibility, production, design, development through to trade, and finally rehabilitation.
  • ALS Energy: Delivers quality technical solutions to the coal, and oil and gas industries through an expansive range of analysis and certification testing services supporting exploration, production and cargo shipment.
  • ALS Industrial: Provides diagnostic testing and engineering solutions for the energy, resources, transportation and infrastructure sectors.

Bulls

  • ALS has a strong brand, skilled staff and good relationships with large clients.
  • The company has diversified away from just minerals and energy (cyclical commodities). This helps offset any downturn in the market.
  • ALS now has exposure to food, pharma testing as well as inspection and certification markets.
  • It’s exposure to minerals and energy could once again provide upside earnings potential if there is another mining boom.

Bears

  • 40% of its earnings are tied to minerals and energy. Any severe downturn will hit the bottom line.
  • Lower demand for commodities will also mean scale benefits will start to dry up contributing to lower margins.
  • ALS charges a premium for quality work. Competitors may enter and undercut ALS on price.

Fundamentals

On fundamentals, the company is neither good nor bad. The company trades on a rather high PE of 41.72x but it is forecast to drop to 26.83x next year. ROE isn’t overly high, but it is stable and rising from 9.58% to 12.26%, which is the main thing. Dividend is low. EPS growth is 44% and high. Debt to Equity is at 63%, which isn’t bad. The intrinsic value is below the current share price, so some might argue that the stock is somewhat overvalued.

Broker Recommendations

  • Deutsche Bank has a Hold recommendation with a target price of $7.73. The broker says there is a definite recovery in minerals testing which is a positive for the company. Hold rating kept.
  • Macquarie has an Outperform recommendation with a target price of $7.80. The broker believes ALS’ guidance for 1H18 is a little conservative. It has also factored in acquisitions of $450m for Life Sciences. This means there will be a small increase to its forecasts.

Technical Analysis

Looking at the chart, ALS seems to have reversed and is sitting towards the upper end of its uptrend channel. Ideally you’d want to be buyng near the channel’s support line i.e. around $7.30. Of-course waiting for a dip that may never come is a hard game to play. So we recommend buying around the $8 mark. If this trend continues, over the longer term the stock will move higher.

Unconventional View:  We quite like the ALS Limited story. The company has a long and rich 40 year history that has enabled it to become a market leader in laboratory resting for the minerals and oil and gas space. It has a strong brand, skilled staff and is scalable across the markets it is exposed to. It also has strong relationships with large clients that give it a key competitive advantage. The company however recently completed the sale of its oil and gas business to Chicago-based Madison Industries for $109m. This gives it some $300m in the bank for bolt-on acquisitions that could boost returns for shareholders. Shares have been on a tear despite there being no notable news or upgraded broker reports. All indications point to a solid FY result which was later followed up with a 1H18 guidance upgrade. The company expects NPAT to be in the range of $70m-$75m up from $60m in FY17.

Overall we think ALS has built itself a great reputation around technical innovation, quality and a deep client understanding. We think it will continue to kick goals and its upcoming profit result should impress on the upside. At the moment the stock is sitting on 68 on the StockOmeter. That means it’s both its fundamentals and technicals are at a Buy. But as mentioned before the stock is looking a touch ritzy. Ideally you’d want to be buying on a dip. So we recommend buying around the $8 mark. If this uptrend trend continues over the longer term, the stock will move higher.

SEEK

In this section we place one stock under the microscope and give it the unconventional assessment.

SEEK (SEK) – Is a market leading website for job advertisements. The company runs an online employment classifieds platform providing in 12 countries with three main business divisions: SEEK Employment, SEEK Learning and SEEK International. It entails a strong portfolio of employment, education and volunteer businesses which span across Australia, New Zealand, China, South East Asia, Brazil, Mexico, Africa and Bangladesh. SEK receives over 450 million visits to its sites every month and has over 4 million job opportunities available at any given time and relationships with over 150 million candidates.

  • EMPLOYMENT: Provides online employment classified advertising services through the SEK website.
  • LEARNING: Markets, sells and distributes vocational training and education training courses in Australia.
  • INTERNATIONAL: JobsDB (South East Asia), Zhaopin (China), Brazil Online (Brazil) and OCC (Mexico).

SEK was founded by Andrew Bassat, Paul Bassat and Matt Rockman.

Bulls

  • First mover advantage. In Australia SEK has a monopoly position on the employment recruitment space. There is still significant opportunity for SEK to expand through volume and price increases.
  • New Corp and Fairfax have both been unable to disrupt SEK’s dominance. SEK now captures some 90% of total time people spend online looking for jobs. It dominates the Australian market.
  • Is expanding globally via acquisitions. This business offers strong upside growth potential. There is a low internet penetration in many of the countries it has exposure to. If one takes off, earnings could be substantially higher than that of Australia.

Bears

  • SEK’s business is ripe for disruption. Companies such as Livehire, Airtasker, Linkedin and other social media platforms are pulling business away from SEK.
  • The online job advertisement market could break apart due to specialist sites that offer differentiated industry opportunities.
  • The internet landscape can change rapidly. Whilst SEK has dominance, big tech firms such as Google or Apple can enter the job advertising space and cause disruption. 

Fundamentals

On fundamentals SEK stacks up OK. The StockOmeter ranking came in at 68 which is just shy from the Buy mark. The stock is trading on a PE of 16.97x which means it’s neither cheap nor expensive. SEK’s ROE is relatively high but is dropping which is a little concerning. Dividend yield is OK and debt is quite low. Intrinsic value is lower than its share price, which suggests the stock is overvalued. EPS growth is also positive. On fundamentals, we’d say the stock is fairly valued. 

Technical Analysis

On the chart, SEK looks to be in an up-trending pennant flag. The stock has held its uptrend support line for quite some time. We don’t think it will disappoint on the downside and break support. Instead we think it might bounce at around $15.50-$16.00. For that reason, we suggest investors buy at these levels. The stock is attractively priced and should continue to track along this uptrend support line.

Broker Views

  • Morgans has a Hold recommendation with a target price of $17.39. We broker has a positive view on SEEK. The company offers investors exposure to the global rising hiring cycle and the increasing migration of employment advertising to the online market. So far SEK has risen and responded to competitive threats.
  • Citi has a Sell recommendation with a target price of $13.75. The broker believes SEK is tied too much towards the Australian housing cycle. Job ads for architects have subsided a while ago. Citi sees this as a problem, hence the downgrade. 

Unconventional View: SEK’s August reporting season didn’t shoot the lights out. In-fact it missed expectations and its guidance was a little short of consensus forecasts. Australian & New Zealand Employment revenue was up 14% to $313.1m, EBITDA up 11% to $197.9m due to 4% vol growth. Seek International revenue was up 6% to $629. Zhaopin was flat, Brazil Online down 8% and Asia steady. Seek Education revenue up 9% to $109.4m. Its outlook guidance is for NPAT to be flat despite expecting revenue growth of 20-25% in FY18. EBITDA growth of approximately 10% and reported NPAT in the range of $220m to $230m. Its Chinese Online Zhaopin job portal has signed a deal with two private equity firms to privatise it and delist it from the NYSE. This is now complete. Zhaopin is the largest and most popular Chinese jobs portal, with about 36.9 million job postings in the year to June, 2016. SEK currently owns 61.2% of Zhaopin. Despite what has been a choppy market, SEK has held up quite well. Revenue is still growing and the company appears to be expanding internationally. But its market leading position in Australia is at risk of disruption from startups, social media such as Linkedin and other small players such as Livehire (LVH). What keeps us optimistic is its international exposure. Its Seek Asia and Zhaopin stake will be the main driver of growth going forward. Zhaopin already generates more revenue than the Australian business, $372.9m vs $355.9m. The company has said it will provide an update on its outlook at its AGM on 24 November.

With its Zhaopin venture, SEK is entering a new phase and growth channel. We think the move to privatise the Chinese jobs website was a positive one and the upside potential is huge. Zhaopin is now the most popular career website in China and it’s very probable that it will soon become a much bigger business than the Australian business. Its Australian business is mature so it’s all about Zhaopin. On fundamentals, SEK has really traded sideways for the last two years. But in that time its earnings have gone up. That means its PE has dropped from 32x earlier this year to roughly 16.97x. We like the SEK story and we think it’s trading at an attractive level, but we advise investors to hold off until the AGM in November. SEK will provide further clarity on its outlook and there will be ample time to buy then. Otherwise we think it’s a solid stock to have in your portfolio.

Under the Microscope – Computershare

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In this section we place one stock under the microscope and give it the unconventional assessment. Computershare (LHC) – Is an Australian-based administrative company that provides corporate trust, stock transfer and employee share plan services in a number of different countries. CPU is a global firm with offices in 20 countries, including Australia, the United Kingdom, Ireland, the United States, Canada, the Channel Islands, South Africa, Hong Kong, New Zealand, Germany, and Denmark. Computershare built its share registry business by successfully expanding into employee equity plans, stakeholder communications, corporate governance, fund services, class action administration, deposit protection and most recently, mortgage servicing. ​​They now manages over 125 million customers records worldwide with 16,000 staff across all major financial institutions.  

Bulls

  • CPU holds a 60% stake in the Australian share registration market and is the market leader. Link Market Services is its closest competito0r.
  • Economies of scale – CPU has a global footprint that gives it financial strength to undertake acquisitions, has transnational IT capabilities that also give it a competitive position and the ability to scale.
  • Sticky customer base and high retention rate – barriers to entry.
  • Low margin and stable recurring core registry revenue
  • Tailwinds – Increasing interest rates in the US and UK. CPU earns interest on client balances. Rising US dollar.
  • Its platform is competitive and highly scalable providing low cost growth opportunities globally.

Bears

  • Growth by acquisition has its limitations. The sheer size of Computershare means it cannot grow by the same amount every year.
  • Risk of start-ups disrupting the share registry industry.
  • Computershare will need to look for growth outside the share registry environment once acquisitions dry up.
  • Low interest rates around the globe is a headwind because Computershare earns interest on client balances.

Fundamentals

On fundamentals Computershare stacks up well. The StockOmeter ranking came in at 72 which is just shy from the Buy mark. The stock is trading on a PE of 26x which is near its PEhigh but isn’t overly expensive if you compare it to Link Market Services which trades on a PE of 32.65x. CPU’s ROE is stable and high reflecting its defensive stable recurring revenue, whereas LNK is forecast to fall from 35% to 18%. So on that basis, we’d say it’s attractively priced.Debt is a little on the high side due to recent acquisitions, but it’s not a problem due to high interest cover and good cash flow. Yield is thin but it isn’t really a dividend stock.

Technical Analysis
On the chart, CPU has had a very bullish short term rally. Shares have gone on a super run since the 3Q 2016 at $8.83 to $14.26 which is a good 60% rally. Can it continue? Going by technicals, if the stocks keeps to its support line and continues to trade with this bullish momentum, then yes it can. But we warn investors to be wary, that any disappointment and CPU could pull back to $9. 

 Broker Views

  • Morgans has an Add recommendation with a target price of $15.42. The broker says CPU has reaffirmed its FY17 guidance at its investor day. Both the US and UK divisions are on trach to hit their respective targets and margin income could become a slight tailwind.
  • Deutsche Bank has a Hold recommendation with a target price of $14.90. It likes the business but believes CPU does benefit from higher interest rates via its investments. But the broker is concerned about customer attrition in the core share registry business and thinks CPU is fairly valued at its current levels.

Unconventional View We conducted a site visit early in June at the company’s Abbotsford office. Whilst a great company in the making, the site visit was quite a boring affair. Computershare is basically a huge office with desks, computers and of course people. No real colour or vibe unlike say the iSelect or Medibank buildings. From what we’ve been hearing the company is an OK place to work but there are a lot of internal problems. A lot of interesting people but because of the lack of competition, there is little to no chance of being promoted. Complaints of too many project managers, and hierarchy. Bad communication amongst staff and a bit of micro managing is also prevalent. Besides all that, we’ve been keen followers of the stock since November last year. We said: “We are confident the company will continue to grow and retain its dominant market position. The chart is attractive. We suggest investors look to buy on the recent upside break out.” That was back when the stock was trading at $11.52. If you bought back then you’d be sitting on a 25% profit and no doubt you’d have quite a smile on your face. We certainly do. We got this one right. Our advice to those holding CPU – is probably lock in profits. Computershare has had a mammoth run since and is up 60% from its bottom to top, that’s $8.83 to $14.26. The turning point was the bottoming of the US and Australian interest rate curve. Bond yields have soared since the Trump election and the Federal Reserve has raised rates. Computershare is a beneficiary of rising interest rates. It acts as a tailwind for Computershare as it will benefit from higher interest on client accounts. These balances total US$16bn – so they are quite significant accounting for roughly an additional US$80m. Put that all aside – CPU is also a high quality defensive stock that has a highly scalable and competitive platform. It is a market leader in its industry and has a stick client base. All of these qualities make it a star stock. Its February profit result beat expectations. Revenue was up 7% to $999m, free cash flow was up 4% to $150m, NPAT was up a whopping 78% to $150.2m and its shares shot up 6% on the day. CPU confirms that will cut costs further by delivering between $85m – $100m of annualized savings. CPU held a recent investor day presentation where is confirmed its FY17 EPS guidance to be between 56-58c. The real catalyst for the stock, as you’ll see from the below chart is the expectations of further US rate hikes. A 1% uplift in average interest rates translates to a 20% uplift in profits. The yield curve has pulled back, slower jobs growth and overseas geopolitical events has prompted the Federal Reserve to keep rates unchanged and trim back its longer-term interest rate forecasts. Forecasts are for two rate rises this year, however some are now expecting that to be pared back to just one rate rise this year. Looking at the bond yield curve below, it’s pulling back. For that reason – if you hold CPU, we think now is the time to lock in profits. Otherwise those looking to buy, should buy on a dip. It’s simply too ritzy to buy now.

Under the Microscope – Lend Lease

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Company Overview Lend Lease (LLC) – Is an international property and infrastructure group withoperations in Australia, Asia, Europe and the Americas. LLC’s core lines of business are designing, developing, constructing, funding, owning, and co-investing in operating & managing property and infrastructure assets. The Property Development business involves the development of inner and outer urban developments, apartments, commercial offices, retail centres, healthcare facilities and retirement villages. New projects secured in Australia includes Sunshine Coast University Hospital project, New Bendigo Hospital, Lakeside Joondalup shopping centre redevelopment, City West Police Complex, Pacific Highway Nambucca Heads to Urunga upgrade and the second commercial tower at Barangaroo South. LLC has 25 residential and commercial projects and over 70 retirement villages in Australia; 2 projects in Asia; 11 projects in Europe; and 6 healthcare projects in USA. LLC is also constructing a number of apartment complexes such as: Studio Nine, No 1 Collins Wharf, The Yards, Toorak Park, Darling Rise, Waterbank, Melbourne Quarter and 888 Collins St.

Fundamentals
 

On the StockOmeter, LLC pulls up quite well. The reading is a clear buy on 81 points. This is because its PE is 12.84x which cheaper than the market and it delivers a decent ROE of 10.35% which is forecast to rise to 13.48%. Debt to equity is quite low and its EPS growth is Ok. Overall solid fundamentals. The company is in good financial health and has a decent yield. Technicals On the chart the stock has broken out on the upside and is looking attractive. The break out has triggered a bullish buy indicator. Traders should be buying at these levels. However, note – the stock has rallied quite a bit form its support line, so it is a touch expensive. Those wanting to buy should set a tight stop loss.

 Broker View

  • UBS has a Buy recommendation with a target price of $16.70. The broker says the opportunity in Australian construction is improving and there is medium term upside for the company’s Engineering & Services division.

Unconventional View We like the Lend Lease story and think it stands to benefit from the $75bn infrastructure funding package announced in the May budger. The package includes funding for rail, a second airport in western Sydney, highway funding and for Snow 2.0. All of these projects should provide a large increase in tendering opportunities for LLC. According to a Macquarie report LLC has significant revenue exposure to infrastructure development activity going forward. We think this provides upside potential for the stock.

 It was only a few months ago that LLC delivered a solid set of earnings results beating expectations and posting a strong half with $49bn in the development pipeline. The company posted a 12% rise in NPAT to $394.8m which was above an expected $342m. Construction margins have already ticked up to 2.7% are expected to rise even more. The company expressed confidence on the health of the settlement of apartment and housing. Buyers are 56% domestic, 21% Chinese and 23% from other offshore locations. Overall the solid result came on the back of a booming construction sector with investment and development businesses producing results which were more or less in line with the pcp. It was a strong half that was cheered by the market. Interim dividend of 33c. With a solid balance sheet, high levels of liquidity and access to third party capital we think it has the flexibility to fund major developments in the pipeline and capitalise on growth opportunities. In our view, LLC offers investors diversification opportunity for your portfolio via its international property and infrastructure assets. LLC trades on a PE of 12.84x and ROE of 10% which is forecast to rise to 13.48%. The company is in good financial health with an OK gearing level. Donald Trump as US president is expected, at the least,to provide a boost to economic activity, primarily infrastructure spending around the globe which will benefit many of LLC’s services. LLC is in prime position to put its hand up and take on growth because of its growing footprint and experienced management. On the chart the stock looks to have broken out on the upside of what looks like a pennant flag. We think the upside break out is a bullish Buy indicator. Investors should be adding LLC to their portfolio.

 

Under the Microscope – CSL

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Company Overview CSL Limited (CSL) is a biopharmaceutical company that researches, develops, manufactures and markets products to treat and prevent human medical conditions including coagulation disorders, viral and bacterial diseases, bleeding disorders and other diseases. The operational businesses include CSL Behring and bioCSL. CSL has manufacturing operations in the United States, United Kingdom, Germany, Switzerland Bern and Australia Parkville and Broadmeadows.

This week I attended a site visit at the CSL Behring Broadmeadows site. It looks after plasma protein therapeutics. It manufactures and markets a range of plasma-derived and recombinant therapies worldwide. Therapies are used to treat coagulation disorders including hemophilia and von Willebrand disease, primary immune deficiencies, hereditary angioedema and inherited respiratory disease, and neurological issues. It also manufactures immune deficiency product immunoglobulin (Ig). Immunoglobulin is a component of healthy human blood plasma. Some people are born with low levels of Ig in their blood or with an immune system that does not function properly. Such a condition makes fighting off germs and infections difficult. Immunoglobulin therapy replaces Ig that is present in an insufficient quantity. The body’s immune system can then work more effectively. Some of the products in the CSL Behring portfolio include Privigen, Hizentra and Carimune. The site is a 24/7 production facility that resembles the likes of a milk factory. There are numerous stainless steel tanks that are connected via intricate network of steel tubes. Like oompa loompa’s off Charlie and the Chocolate factory, workers are dressed head to toe in protective gear and scuttle around the factory floor. The place is absolutely spotless, including the ceiling. You could almost eat off the floor, it’s that clean. If there was anything contaminating the place, it was me.

Fundamentals

On fundamentals, CSL ticks almost all boxes. The stock does lose a few points because of its high PE of 34x, but that’s expected because of its ROE. It shouldn’t be a concern as the company has a very high, stable and rising ROE. Put simply, CSL is very profitable and continues to be. Its dividend is low and should be considered a growth stock. The company’s earnings are forecast to grow in line with industry rates. Overall this makes CSL a high quality, strong, defensive like growth stock. The only downside is that fundamental analysts consider the stock to be overvalued.

Broker Views – 4 Buys and 2 Neutral (Citi has highest target price of $148)

  • Ord Minnett has an Accumulate recommendation with a target price of $130.00. CSL recently hosted a briefing where the president of Seqirus (flu vaccine business) said the business remains on track to reach breakeven in FY18 as revenue is boosted by the roll-out of highervalue quadrivalent vaccines and operating costs are reduced. Ords sees potential for the performance of the division to exceed estimates this year in light of the relatively strong ‘flu season’ in the US.

Technicals Since CSL’s HY profit result, the stock has gone on a bumper rally rising from below $100 to $130 in the space of a few months. Whilst the stock is trading with bullish momentum, we all know what happens to high PE stocks when they disappoint. For any reason if CSL disappoints, it could easily pull back to $99 as it did earlier this year.  So we think CSL is for the traders not for investors. The downside risk is too great. For traders that buy at these levels, ensure you set a suitable stop loss to exit the minute there is a downturn.

 

Unconventional View I came away from the site tour more than impressed. The CSL Behring plasma facility was top notch. The amount of blood plasma that passed through the centre was mind boggling 800 kilolitres per year. By and far the plasma business is CSL’s main strength. Demand on average is around 6%-8% but it has been stronger. Plasma collection has been especially strong. Most blood plasma ends up at CSL via Red-Cross centres. CSL is cost-competitive given its manufacturing scale and broad range of plasma products that reduce unit production costs. The company spends big on R&D ($2.3bn) and has years of experience. It is truly a giant in its space, and is one of the three biggest players along with US Baxter International and Spanish Grifols. There three players account for 90% of the US market for immunoglobulin derived products. CSL is the lowest cost producer of plasma out of the three. Just two years ago it bought the Novartis influenza vaccine business for US$275m which was integrated with bioCSL to form Seqirus. It’s the world’s second largest influenza vaccine company and a major partner in the prevention and control of influenza globally. It is a reliable supplier of influenza vaccine for Northern and Southern Hemisphere markets and a transcontinental partner in pandemic preparedness and response. It operates state-of-the-art production facilities in the US, the UK and Australia, and manufactures influenza vaccines using both egg-based and cell-based technologies. CSL is in a unique position. Global plasma supply and fractional abilities are limited. A stable oligopoly exists between the three giants. There are huge barriers to entry for new entrants as the industry is very capital intensive. A plastic bag coated by plasma at atmospheric pressure is used to cultivate cells. Every single bag costs a staggering $12k-$16k. We think CSL will maintain this advantage and will continue to expand. With the Seqirus business, CSL will only strengthen. Seqirus is now the second largest influenza vaccine company in the world. With extensive research and production expertise and manufacturing plants in the US, UK, Germany and Australia, Seqirus is a transcontinental partner in pandemic preparedness. CSL’s is a stock that continues to deliver year after year. Its recent results were robust. Underlying NPAT was up 36% to US$806m thanks to blood fractionation. An interim dividend increased to US$0.64. CSL Behring remains the company’s core stronghold. It recorded sales up 18% to US$3.0bn boosted by rising demand for immunoglobulins. These help boost one’s immune system. The division manufactures three products Hizentra, Privigen and Carimune. Sales of Privigen were up 34%. Specialty Products were up 25%, and albumin sales increased 19%. For CSL’s business outlook, it expects solid ongoing demand particularly for immunoglobulins, specialty products and albumin. CSL is well positioned with the recent launches of its differentiated innovative recombinant coagulation factor products and it has consistently stayed one step ahead of demand by increasing the number of US collection centres by 18% a year. One of CSL’s competitive advantages is its constant, reliable source of plasma. With over 160 collection centres, it means there is enough supply of plasma so that manufacturing can keep up with increases in demand for antibodies, while its competitors struggle.

 The real question is: Would you buy CSL at these lofty levels? The short answer is “possibly”. When CSLwas trading around $80, you would have said it was expensive. It’s now trading at $130 and it’s still expensive. But that doesn’t mean it can’t continue along its solid upward trend and hit $200. Blackmores (BKL) did it back in 2015. It can. The sole reason we think this is possible is because CSL’s fundamentals are rock solid. Looking at the chart below, its EPS has been increasing. It not only has a competitive advantage, but it is one of the biggest players in its industry. It has a robust balance sheet and with an aging population the demand for its products will only continue to rise. It trades on a ROE of 43.39% which is forecast to rise to 49.83%. There was a point where the market was worried that Seqirus would turn out to be a lemon, but this proved wrong. Seqirus has turned around and has been one of CSL’s biggest bets that has paid off. The acquisition has boosted CSL to number two in flu vaccines in the US. This adds a powerful second earnings stream to CSL’s core plasma business. Since CSL’s HY profit result, the stock has gone on a monster rally rising from below $100 to $130 in the space of a few months. Whilst the stock is trading with bullish momentum, we all know what happens to high PE stocks when they disappoint, they drop like a falling bus. For any reason if CSL disappoints, it could easily pull back to $99. Whilst CSL has many defensive qualities, it’s a growth stock. It’s for the traders not for investors. The downside risk is too great. It’s not a stock you can simply set and forget. Its yield is also thin. For traders that buy at these levels, ensure you set a suitable stop loss to exit the minute there is a downturn. Otherwise jump on and enjoy the upward ride.

 

Under the Microscope – Catching a falling bus – Telstra

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In this section we place one stock under the microscope and give it the unconventional assessment.

Telstra (TLS) – Is  Australia’s  largest  network  provider,  and  has  worked  with  public  and  private enterprise to present new and competitive offerings to customers over the last 5 years.  Telstra’s  market  leading  position  for  the  technological  boom  in  terms  of  mobile  and computer  devices  puts  them in  a  very  good  position  to  capitalise on  the  high  demand  for such goods in the short- to mid- term. This week however shares were battered following news that TPG Telecom (TPM) had secured spectrum to build its own mobile network shaking up the entire mobile industry. It’s the biggest drop in three years but it really is just a continuation of what started two years ago. So the questions is, is Telstra still an income stock?

Bulls

  • Operates in an oligopoly where fixed line telecommunications products in Australia are primarily delivered by Telstra, Optus and NBN Co. Other brands are virtual network operators. In the mobile market there are now four main operators, Telstra, Optus, Vodafone Hutchison Australia and TPG Telecom.
  • It has 6.8 million fixed voice services and 3.5 million retail fixed broadband services.
  • Telstra has the largest and quickest mobile network with a customer base of 17.4m as at December 2016 including mobile broadband, along with over 500,000 wholesale customers. Optus has around 9.43m.
  • Pays a high dividend. Its recent decline in share price gives it an even higher yield which currently sits around 7.3% with a final dividend of 15.5. It’s a great stock for retirees looking for yield in a low interest rate environment.
  • Divestment  in  Chinese  online  car  sales  business,  Autohome,  resulted  in  $1.8 billion  profit, and the cash is expected to be reused for future acquisitions.
  • Telstra has more “mum and dad” shareholders than any other Australian company. This reduces the chance of short selling, manipulation or big institutions moving share prices.
  • Strong brand reputation. Was voted Australia’s most valuable brand in 2016.
  • $11bn of copper wiring compensation to come from the NBN.

Bears

  • Telstra’s services are regarded as the most expensive in the telco sector but its premium is justified by its wide coverage and high quality service. This competitive advantage is at stake. It could all be lost after Easter when the ACCC hands down its decision on whether all carriers will be forced to share their networks and customer roaming is declared.  The ACCC has the power to force other telco’s to use Telstra’s entire mobile network even in regional and rural areas. That means Telstra’s claim to fame having the best and biggest network, won’t matter anymore. It will be a game changer.
  • TPG Telecom has just entered the mobile space making an aggressive entry to an already competitive sector.
  • Is trying to push into Asia, which is already a flooded market in terms of mobiles and technology. Telstra recently pulled out of a proposed Philippines JV with San Miguel.
  • Fierce  competition  domestically  (from  competitors  such  as  Vodafone, Vocus, TPG Telecom  and  Optus)  will continue to put pressure on profits.
  • When NBN comes into fruition, profit margins will be squeezed.
  • Mobile revenues continue to show strong growth but it is slowing. Telstra needs to find growth options.
  • Recent  drop  outs  in  the  market  have  led  to  widespread  customer  dissatisfaction. Consequent forecasts are  predicting  an  8%  increase  in  customers  changing  their  mobile  service  providers,  up  to 19%.
  • Recent  below  average  trading  volumes  have  driven  prices  downwards  over  the  last  6 months.
  • As Telstra loses its monopoly in fixed infrastructure, there are signs the telco will face concerted pressure from operators like TPG Telecom and Vocus Communicationsin the post-NBN landscape.
  • Regulatory risk and technological change in telecommunications.

Fundamentals

 Telstra trades on a PE of 16x which is below its all-time high of 17.9x but slightly higher than its average of 14x. Its ROE is 25.11% which has come off from 30.1% which may be reflective of growing competition in the mobile market. Gross yield is currently 9.71%. The gearing level is manageable. The telco will receive $2.1bn from the sale of Autohome. Telstra’s balance sheet is OK. 2016 free cash flow was $4.8bn. NBN payments are expected to boost this figure. On the StockOmeter it is ranked at 69 which is a good score. The only downside is its technicals.

Technical Analysis
The chart looks horrible. What we’re seeing here is a falling bus. The stock is in freefall and is making lower lows with no floor in sight. It actually has been in downtrend since early 2015 and has drifted lower ever since then. Sure the RSI says it’s oversold, but with this bearish trend the chart says NO. 

 Broker Views

  • Citi has a Sell recommendation with a target price of $4.00. The broker says this is disappointing for Telstra. TPG are lifting the game and increasing pressure in the mobile space which has been Telstra’s game for quite some time. The task is getting harder and harder for Telstra. Target cut by 9%.

Unconventional View If we’ve ever seen a falling bus, this would be it. The Telstra bus is dropping out of the sky and we’re not about to stand in the way. The telco has been in downtrend since early 2015. It has been plagued with profit downgrades, numerous network disruptions, contracting margins, shrinking subscriber base and now TPG has entered the mobile race. Could it get any worse? Yes it could. Telstra has been long known for its core defensive qualities. It’s a reliable and safe stock for retirees looking for a consistent yield. In-fact that was the only reason mum and day investors bought Telstra, for its sexy dividend. But where’s that sexy dividend now? It’s not that sexy if you’ve lost 30% of your holdings. Let me explain. Let’s say for example you bought Telstra this time last year at $5.16. You will have collected two dividends worth in total 31c. Let’s subtract those two dividends and your cost base is $4.85. The current share price is $4.22. You’re down 13% in a year just to hold a stock that pays a dividend. If you had Telstra early 2015 when it was at $6.67, you’d be down 30%. The idea of holding a falling security just for its dividend is ridiculous.

What about now, Telstra is cheap?    

Shares have been absolutely hammered by around 8% which is a bit of an over-reaction. You may even see shares bounce back. But if you look at the chart Telstra has been falling straight for two years now. This decent started early 2015. Things smell foul in the Telstra camp. Back in June 2016 (click here) we said “Telstra has a bit of a problem. Despite being a cashed up and high yielding, where is growth going to come from? The telco recently abandoned its joint venture deal with San Miguel in the Philippines. But ever since the telco walked away, experts are questioning where will they find the next leg of growth?” And that’s the problem. We’ve never really liked Telstra for that reason. We think the days of Telstra being the all-conquering telco giant are coming to an end. Before TPG entered the foray, Telstra’s mobile numbers were on the nose. Now there’s a fourth competitor vying for market share and TPG are hungry. By winning the 700 Mhz mobile spectrum and with the right infrastructure in place, it can provide real cut throat price action to Telstra and Optus.They will launch a cheap bundled package that has a mobile strategy that will be complementary to its fixed-line business. TPG needs 500,000 customers for its mobile network to break even. It has over 2 million broadband subscribers. It’s a task they’ve got their eyes set on achieving and with David Teoh at the helm, they’ll do it. We haven’t even thought about the possibility of Vodafone and TPG merging. They’re pretty good friends apparently. Early this year Telstra dropped a bombshell when it announced a 14% profit drop to $1.8bn well below expectations. Shares have fallen 18% since its February profit result. 1H profit was hit by tough competition, adverse regulatory rulings and restructuring. Telstra added 200k mobile customers, 90k broadband and 300k NBN connections. If Telstra’s profit fell 14% last year because of what Andy Penn says was ‘intense competition on pricing’… it’s going to get a whole lot worse with the NBN coming in and TPG about to launch. Telstra’s EPS is 14.8c versus its 15.5c dividend. I think this is all pointing to one thing: A dividend cut. Sure Telstra has money, but it can’t keep paying out a massive dividend if its margins are getting squeezed. It is also making further investments into its 5G network. It needs to cut the very thing that keeps it popular because its earnings per share is dropping and soon it will have to fight off TPG. Cut the damn dividend and reinvest.

But there’s one more thing that has us concerned. Telstra’s services are regarded as the most expensive in the telco sector but its premium is justified by its wide coverage and high quality service. This competitive advantage is what makes Telstra, well Telstra because I can tell you it sure isn’t their call centre. But it could lose this when the ACCC hands down its decision on whether all carriers will be forced to share their networks and customer roaming is declared. This means the ACCC will allow other telco’s to use Telstra’s entire mobile network even in regional and rural areas. Anyone that lives in rural Australia will know that they can only get coverage if they’re with Telstra and they get absolutely rorted in the process. If roaming is allowed Telstra’s claim to fame for having the best and biggest network, won’t matter anymore. It will be a game changer. Even Telstra admits it will “lose revenue and market share” in both regional and metro areas because roaming will neutralise the coverage advantage that has justified significant investment in infrastructure that is uneconomic on a standalone basis. Goldman Sachs says Telstra stands to lose $546m in earnings as a result, the figure is the rent Telstra earns on its regional coverage. If this goes ahead the ACCC would set a fee that Vodafone, TPG and others would pay Telstra to use their phone towers. Telstra needs cuts its dividend and start reinvesting otherwise it faces margin pressure from intense competition. The NBN once fully operational it’s expected to take a further share of the industry’s profits. Margins will be squeezed. This makes it absolutely vital for Telstra to find other ways of making and mobile is the only answer. For it to remain competitive it needs to invest heavily in 5G. For that reason, we don’t think Telstra’s dividend will be maintained, it’s simply not sustainable. So if you’re buying Telstra because it’s a ‘safe’ high yielding stock, look past the yield and look for growth. It’s not a safe stock anymore. For those wanting to buy Telstra for growth because it’s cheap – Our best advice is not catch a falling bus, you’ll just get squashed. If you’re buying Telstra for a bounce, wait for it to bottom. There’s a long way back up, so you won’t forgo much by waiting for that convincing bounce. Trying to pick a bottom and you risk a dead cat bounce. Our message: Telstra just isn’t the animal it used to be. TPG and Vodafone are buddying up and the NBN is about to hit the streets. Telstra needs to cut its dividend and reinvest so that it can return to its former glory. This is the view of Unconventional Wisdom and not that of Sornem Private Wealth.

Under the Microscope – The Star Entertainment Group

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In this section we place one stock under the microscope and give it the unconventional assessment. The Star Entertainment Group (SGR) – Is Australia’s second biggest casino operator after Crown. Formerly Echo Entertainment Group, it provides leisure and entertainment services particularly in relation to casino gambling, entertainment and hospitality. It has casinos in New South Wales and Queensland, Australia. These comprise of hotels, apartment complex, night club, restaurants and bars. The Star features more than 20 food and wine options including award-winning dining at BLACK by ezard, Balla, Sokyo and Momofuku, a summer rooftop bar offering expansive views of Sydney harbour and the city skyline, along with two luxury 5-star hotel towers, serviced apartments, a 16-room day spa, an international designer retail collection as well as a world-class gaming facilities and international nightclub Marquee. Its premier casinos are Star City and Jupiter’s which is set amongst 7 acres of landscaped gardens and parklands.

Bulls

  • The company operates three of Australia’s most popular casinos with long-date licences.
  • It also has significant leverage to the Chinese middle class and tourism, especially in Queensland.
  • Top line margins are rising and above the industry average.
  • Star’s main rival Crown Casino was involved in a violation in strict Chinese gambling regulations that saw 18 of its employees arrested. This put the spotlight on Crown deterring China’s big gamblers. A positive to Star.
  • New competition has jolted the company out of complacency and has force it to become more innovative and efficient.

Bears

  • Competition from rival Crown is likely to be intense in each of the company’s operating markets. Losing market share can be costly and have implications for its bottom line.
  • Global headwinds and economic conditions can affect how gamblers both here and overseas spend.
  • Changes to regulation both local and foreign can become a negative headwind to casinos.
  • Costs required to defend the casino’s position in Sydney and QLD can be costly.

Fundamentals 

 On fundamentals Star looks OK. Its PE ratio sits at around 16.79x which is looking a touch expensive when compared to Crown (CWN). CWN is definitely cheaper trading on a PE of 7.79x. Both have similar ROE of around 8%. Crown also pays a higher dividend. The StockOmeter has given SGR a reading of 65 whereas CWN has a lower score of 57 because of its trend. Technical Analysis
The chart is looking OK. SGR recently bounced rather convincingly off its support line and is a bit below midway in its uptrend channel. That break out is a bullish buy signal. We think investors should be buying at these levels before the stock rises towards resistance. 

 Broker Views (8 buy recommendations)

  • Morgans (ADD $6.12) – The broker has a relatively positive view of the company despite what was a softer 1H. The Crown arrests also affected Star in a negative manner. But Morgans thinks the 2H will be a lot better as its capital works finish and its casinos are ready to grow earnings.

Unconventional View 

 A few years ago if you’d have asked me whether I would have invested in Echo Entertainment, I would have said no. Star City is basically an oversized RSL with a few pokie machines scattered around the venue. It serves in plastic cups, has hardly any gaming tables and violent brawls break out every few minutes. Great. Star City really is a far cry from Melbourne’s world renowned Crown Casino and its lush fine dining restaurants and megaclubs. But a lot has changed since then. Well Star City still doesn’t compare to Crown but SGR has been busy building new casinos and upgrading old ones. It’s all about Queensland. Star Entertainment won a casino licence for Queen’s Wharf Brisbane. It is also upgrading its Jupiter’s casino on the Gold Coast and Treasury Casino in Brisbane. The $3 billion Queen’s Wharf Brisbane Integrated Resort Development includes a major hotel, casino and residential complex. And this is the reason we like Star. Once it is fully completed, the project will become Brisbane’s iconic landmark. Not only will it bring people from around the country, but also from Asia. People from South Bank Melbourne will be looking at Brisbane’s South Bank in envy. It’s an architectural gem. There’s a skydeck that comes around and there’s a massive area for public space. It will literally transform Brisbane from a sleepy town into a bustling CBD. Looking from the top is a glitzy development featuring pools, a glass skydeck, ballroom, moonlight theatre and hotels. Queen’s Wharf is due to open in 2022. With it will come a stack of gaming facilities, 1000 new hotel rooms, 50 new bars and restaurants, retail space, a free and accessible skydeck 100m above William Street, 2000 apartments and a new pedestrian bridge to South Bank. This is a game changer and it is what Star needed to take it to the next level. To add to it the company is redeveloping its ageing Jupiters Casino in Gold Coast, which was long overdue. It will include a new $200 million-plus, 17-story tower will feature only the best in finishes and amenities, with in-room theatres, new restaurants, bars and entertainment facilities as well as 80 luxury suites each with a balcony and four bedroom super-suites with breathtaking ocean views. The tower is part of a broader plan to position Jupiters as a world-class resort, ready in time for the 2018 Gold Coast Commonwealth Games.

On to the numbers. Crown does look better fundamentally but in all honesty we like both. Whilst the numbers look better, our StockOmeter ranks Star higher because it incorporates the technical side. And looking at the chart, Star looks a lot more attractive at the moment. Crown is battling through a few issues but with its new Melbourne complex in sight and Barangaroo about to lift off, we have no doubt Crown will be back. Nevertheless we’re assessing Star here – So is it a buy? We think so. There are 8 broker buys at the moment and no Sells. You can’t get any better than that. Whilst the 1H was softer than expected most brokers agree that the 2H will be a strong one. The chart also The chart is looks ok as well. SGR recently bounced rather convincingly off its support line and triggered a bullish buy signal. We think investors should be buying at these levels before the stock rises towards resistance.