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Commodities Trading Ideas & Charts

Fletcher Building materials businesses possess many strong brands

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At the group level, however, returns are below the cost of capital, as the firm has made poor acquisitions in adjacent segments and new geographies and suffered execution issues in the construction division. This has overwhelmed the positive impact of an unprecedented building cycle in Australia and New Zealand which peaked in 2018. Following the substantial losses sustained in its construction segment, Fletcher has taken corrective action–divesting its global Formica business and backing away from commercial construction projects which led to significant losses. But we’d like to have seen a more comprehensive restructure, involving a marked reduction in the group’s level of diversification. We’d advocate for Fletcher to re-focus the group’s attention on its businesses which are well positioned competitively. The potential for management to create value for shareholders is maximised when it’s free from the distraction that comes with the ownership of a plethora of disparate businesses.

The company operates across seven divisions: building products, distribution, steel, concrete, construction, residential and development, and Australia. We forecast improving EBIT margins across most divisions, with the most pronounced improvement in building products and Australia, but aren’t confident ROICs can sustainably remain above cost of capital. Nonetheless, strong brands, dominant market share in key categories, and control of distribution should help to sustain pricing and margins in the building products division, which generates around 6% of group revenue and 20% of adjusted EBIT. We see steady growth in revenue and slight margin expansion, resulting in mid-single-digit EBIT growth over the long term.

Financial Strength

With the balance sheet awash with liquidity, Fletcher also announced a NZD 300 million share buyback. With the cyclical revival of residential construction activity in New Zealand and Australia, we think the return of cash to shareholders is well-timed. With the buyback to commence in June 2021, we anticipate the lion’s portion of share repurchases will occur in fiscal 2022. Upon conclusion of the share buyback, we forecast leverage–defined as net debt/EBITDA including IFRS 16 lease liabilities–of 1.4 times at fiscal 2022 year-end, near the midpoint of Fletcher’s through-the-cycle leverage target of 1-2 times and up from 1 times at fiscal 2021 year-end. As such, significant debt covenant headroom exists relative to Fletcher’s leverage covenant, which is calibrated at 3.25 times net debt/EBITDA. While further capital expenditure will be allocated to Fletcher’s new plasterboard facility–with total project spending of an estimated NZD 400 million—other nonessential capital outlays have been pared back in order to minimise cash outflows in fiscal 2021. Management anticipates NZD 230 million in capital expenditure in fiscal 2021. We forecast full-year dividends of NZD 0.27 per share, reflecting a 70% payout of net income–near the top end of Fletcher’s targeted 50%-75% payout ratio.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Shares Small Cap

Nine’s Estimates Updated for News Supply Deals with Digital Giants

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We see competitive intensity continuing, preventing any sustained improvement in Nine Network’s margins. The same is true for digital division, which operates in the equally competitive digital advertising space. However, Nine Entertainment has a strong balance sheet and is a high cash-generating business. This provides management with significant flexibility, allowing it to invest in marquee television content, diversify into digital businesses, and engage in capital management initiatives. The group has been executing admirably to date and culminated in the merger with Fairfax (consummation in December 2018), using mostly Nine shares as consideration.

Key Investment Considerations

  • Despite boasting a portfolio of entertainment-based divisions, Nine Entertainment’s key asset is Nine Network, a free-to-air television business that operates in a structurally challenged industry.
  • The group has a strong balance sheet, giving management the luxury to invest in content and emerging delivery platforms to fortify the current revenue base.
  • Benefits of the merger with Fairfax hinges on synergies management extracts from the combined entity. We forecast cost savings of AUD 62 million, but this may be conservative, given the potential upside from collaboration and savings on news-gathering resource rationalisation.

Company Profile

Nine Entertainment operates Nine Network, a free-to-air television network spread across five capital cities, as well as in regional Northern New South Wales and Darwin. It also owns Australia’s third-largest portfolio of online digital properties, one that reaches more than 60% of the country’s active online audience. The merger with Fairfax combines Nine’s top-ranked TV

network and the second-largest newspaper group, topped with a collection of quality digital assets in Nine Digital, subscription video on demand operator Stan, and Fairfax’s 59%-owned Domain. It ensures the merged entity remains relevant in the eyes of audiences and advertisers.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Shares Small Cap

Sales Surge at O’Reilly Automotive Inc

The firm has profited from increases in miles driven and average vehicle age as well as the benefits of its expansive distribution network in ensuring part availability, leading to adjusted returns on invested capital that have grown more than

900 basis points since 2010, to 22% in 2019 (before a pandemic-related surge led to a 30% 2020 mark).

With a strong operational record and national presence, O’Reilly features a highly productive infrastructure, with strong margins despite investments in service and high levels of part availability. While other chains have attempted to adopt a similar dual-market approach, we believe O’Reilly’s expertise and customer relationships give it an advantage that will take time for peers to match. This should keep O’Reilly’s relative positioning strong among the national retailers as the industry consolidates, with large-scale participants like O’Reilly increasingly favored due to their ability to provide hard-to-find parts to commercial (and, to a lesser extent, DIY) customers more quickly, reliably, and efficiently. We estimate the firm should achieve meaningful share growth in both segments, to 12% in DIY and 8% in commercial from 10% and 6% before the pandemic, respectively, over the next decade.

While O’Reilly’s operating margins grew from 13.6% in 2010 to 18.9% in 2019 (pandemic-fueled cost leverage led to a 20.8% 2020 mark), we see room for expansion as it leverages fixed costs and as house label products gain increasing acceptance and adoption. The strength of its brand, coupled with its cost advantage, should enable the firm to foster new and deepening relationships with its customers by providing a better standard of service, protecting O’Reilly’s results from competitive threats from smaller and like-sized peers. Although the pandemic’s sales surge should ease in mid-2021 as vaccination rates rise and comparisons become challenging, O’Reilly’s long-term strength remains rooted in its competitive advantages.

Company Profile

O’Reilly is one of the largest sellers of aftermarket automotive parts, tools, and accessories, serving professional and DIY customers (41% and 59% of 2020 sales, respectively). The company sells branded as well as own-label products, with the latter category comprising nearly half of sales. O’Reilly had 5,616 stores as of the end of 2020, spread across 47 U.S. states and including 22 stores in Mexico. The firm serves professional and DIY customers through its store network, and also boasts approximately 765 sales personnel targeting commercial buyers.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Small Cap

Link Administration Holdings Ltd

The acquisition of U.K.-based Capita Asset Services in 2017 reduced the proportion of revenue from Link’s Australian businesses to around 60% of group revenue. We expect the key earnings driver for both the U.K. and Australian businesses to be cost reductions over the next three years, underpinning an EPS CAGR over the next decade of around 10%.

  • Link benefits from high customer switching costs and relatively low marginal costs, which underpin its narrow economic moat rating. The capital-light business model should enable returns on invested capital to comfortably exceed the weighted average cost of capital.
  • We forecast EPS to grow at a CAGR of 10% over the next decade, driven by revenue growth and margin expansion from acquisition-related synergies.
  • Questions remain around earnings growth drivers beyond planned cost cuts. Link may use acquisitions to drive earnings growth, but this strategy has associated risks.

Link Administration has created a narrow economic moat in the Australian and U.K. financial services administration sectors via its leading positions in fund administration and share registry services. Client retention rates exceed 90% in both markets, underpinned by inflation-linked contracts of between two and five years. The capital-light nature of the business model should enable good cash conversion, regular dividends, and relatively low gearing. Earnings growth prospects are supported by organic growth in member numbers, industry fund consolidation, and continued outsourcing trends.

The company was formed via numerous acquisitions made since 2005 under the ownership of private equity firm Pacific Equity Partners, banks and AMP, which have a reasonably low probability of outsourcing. The remaining 30% comprises a combination of government-owned entities and relatively small superannuation funds, which are likely to have outsourcing lead times of months or years.

Bulls Say

  • We expect Link’s EPS to grow at a CAGR of 10% over the next decade, driven by a revenue CAGR of 5% per year, in addition to cost-cutting and operating leverage.
  • Our base case assumes Link’s Australian fund administration market share grows by 2.5 percentage points to 32.5% over the next five years.
  • The capital-light nature of the business model should enable regular dividends, and low financial leverage creates the opportunity for debt-funded acquisitions.

Bears Say

  • Both superannuation fund administration and share registry services are reasonably commoditized, and sizable competitors exist in both segments.
  • Link’s core businesses may struggle to grow meaningfully beyond low- to mid-single-digit growth rates.
  • Superannuation fund administration and registry services have become more efficient as a result of increasing use of software and automation of processes. However, this raises the prospect of disruption by new software-based solutions.

Source:Morningstar

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Funds Funds

Federated Hermes MDT Small Cap Growth R6

The team is experienced at the top. Dan Mahr joined MDT in 2001 and became lead manager of this fund in 2008. He is responsible for the model and research and draws on seven managers/analysts. Frederick Konopka also became a manager in 2008 and handles portfolio construction and trading for the team.

The fund’s approach is differentiated. MDT looks to group companies into different baskets producing various streams of alpha potential using valuation, growth, momentum, and quality indicators. By using classification and regression tree analysis, the team can test thousands of potential combinations of factors based on 30-plus years of U.S. stock data to find the best mixtures of alpha using a three-month investment horizon. For example, the model could forecast positive alpha from low price and low debt, but also high price and stable business, which a standard linear regression model can’t do.

Still, such a short investment horizon can be difficult to implement. It leads to annual portfolio turnover that can be lofty and varies greatly. Over the past five years, turnover ranged from 188% to 227%, well above the 59%-66% range for the typical small-growth Morningstar Category peer. The portfolio’s holdings have varied from 150 to 250, suggesting some opportunities may be too illiquid and costly to pursue unless they’re spread out across more holdings.

Since Mahr became lead manager in August 2008, the Institutional shares’ 11.9% annualized return through April 2021 lagged the small growth category’s 12.2% gain and the Russell 2000 Growth Index’s 12.2% rise. The fund has performed better since the team’s 2013 process switch to multiple decision trees, but the fund’s high volatility has kept its risk-adjusted results in line with the index. Investors should consider other options.

The fund’s absolute and risk-adjusted returns lag the Russell 2000 Growth Index during lead manager Dan Mahr’s tenure. Since Mahr took over in August 2008, the Institutional shares’ 11.9% annualized return through April 2021 trailed the small-growth category’s 12.2% gain and the Russell 2000 Growth Index’s 12.2% rise. It has done so with more volatility than the benchmark, resulting in subpar risk adjusted performance measures, like the Sharpe ratio. Most of the fund’s underperformance has come during market turbulence. Mahr’s Aug. 31, 2008,start date means he took over amid the credit crisis, and the fund barely edged the benchmark through that period’s March 9, 2009, bottom. The fund lagged the bogy’s ensuing trough-to-peak (April 23, 2010) performance by 26.6 percentage points, annualized. The fund has performed better since the team’s 2013 switch to using multiple decision trees for regression analysis, though. Its 16.8% annualized gain through April 2021 bested the index’s 16.1%. However, the fund’s elevated volatility has caused the fund to struggle in market pullbacks, such as late 2018’s correction. It also underperformed in 2020’s first-quarter coronavirus driven pullback. That volatility has helped it advance in market rallies and has captured 102% of the market gains during that span.

SOURCE:MORNINGSTAR

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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ETFs ETFs

Schwab US Large-Cap Growth ETF

The index weights stocks by market cap, which channels the market’s view on the relative value of each holding. This is an efficient approach. Large-cap stocks attract widespread investor attention, so they tend to be priced reasonably accurately. Market-cap weighting also helps curb turnover and the associated transaction costs, with help from comprehensive index buffers. Index buffers improve diversification as well, allowing stocks to wander into value territory without trading them immediately. So, although this portfolio does not overlap with its value counterpart like most style index funds, it holds blend stocks like Home Depot HD and Costco COST that aid diversification. Its value-growth tilt mirrors the large-growth Morningstar Category average. The fund’s sector allocation approximates the category average as well. Market-cap weighting gives the fund a slightly larger-than-average market-cap orientation, but that shouldn’t affect performance much. Overall, this portfolio mimics the contours of the category norm, which accentuates the fund’s cost advantage and should help it outstrip its category peers. Mimicking the category average portfolio has caused this fund to look somewhat concentrated. At the end of April 2021, its 10 largest holdings represented more than half the portfolio. Tech stocks comprised about 44% of the portfolio. Investors may pause at this concentration, but it reflects the state of the large-growth market and shouldn’t translate to volatile category-relative performance.

This fund has posted terrific returns, outpacing the category average by 2.21 percentage points annually over the 10 years through April 2021, with comparable volatility. A low cash drag, best-in class fee, and favorable exposure to communications stocks have driven much of the outperformance. This fund relies solely on the market’s sentiment to weight its portfolio, so it does not shy away from stocks its active peers may consider overvalued. That has worked out well in the communication services sector, where the most richly valued firms have performed among the best.

Taking larger than-average stakes in Netflix NFLX and Alphabet GOOG, for example, proved to be a winning approach, as the companies have continuously exceeded steep expectations over the past decade. Unlike many of its active peers, this fund is always fully invested. This aids performance during market rallies but can hinder it in turbulent stretches. The fund has held up well, though, capturing only 94% of the category average’s downside and 104% of its upside over the past decade. This fund’s greatest performance edge is its fee. At 0.04%, its expense ratio ranks among the cheapest in the category, and low turnover leads to low transaction costs.

Source:Morningstar

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Commodities

Downer EDI Ltd

But the fair value impact of the earnings declines is countered by boosted cash levels from the asset sales. It should be noted the company still provides no earnings guidance for fiscal 2021 given uncertainty around coronavirus.

Our unchanged fair value equates to a fiscal 2025 EV/ EBITDA of 6.2, P/E of 14.5, and dividend yield of 4.1% on a reinstated 60% payout. We now assume a 5-year EBITDA CAGR of 5.9% to AUD 945 million by fiscal 2025, and a midcycle EBITDA margin of 7.4%. The margin forecast is above the 5-year historical average nearer 6.5% and first half fiscal 2021’s 6.0%. This anticipates a recovery from Spotless Group which recorded a 6.4% margin in first-half fiscal 2021, down from levels nearer 8.0% prior to fiscal 2020.

At around AUD 5.60, Downer shares have more than doubled from sub-AUD 2.60 March 2020 lows, and are now only somewhat undervalued. Downer is exiting mining in pursuit of more capital-light and government-backed revenue business models in urban services including in operating, maintaining, servicing, and supply. If mining cools as per our thesis, Downer could be viewed in a more favourable light by a market currently enamoured with mining.

Downer finished December 2021 with net debt of AUD 1.1 billion excluding operating leases–improved on June 2020’s AUD 1.5 billion–gearing ND/(ND+E) at a comfortable 28%, down from 36% six months prior. We now estimate net debt at around AUD 550 million, following the latest round of asset sales, ND/(ND+E) at just 15%. This would have net debt/EBITDA at a conservative sub 1.0. But Downer says its optimal capital structure is net debt at 2-2.5 times EBITDA, meaning capital returns and acquisitions could feature.

In the June half to date, Downer has undertaken combined asset sales of AUD 605 million, of which proceeds of AUD 476 million have so far been received. This includes sale of Open Cut Mining West for over AUD 200 million, sale of Downer Blasting Services for AUD 62 million, sale of plant and equipment to Byrnecut at Carrrapateena mine for AUD 70 million, sale of 70% of laundries for AUD 155 million, and sale of the Otraco tyre management business to Bridgestone Corporation for AUD 79 million.

Remaining noncore assets on the block including Mining Open Cut East and hospitality with the sale process underway. Downer currently has AUD 36.2 billion of work-in-hand, equivalent to a healthy three years of revenue at current rates. The most recently announced is a AUD 900 million eight-year contract to operate and maintain Sydney Northern Beaches buses through Downer’s 49% participation in the Keolis Downer joint venture.

Profile

Downer operates engineering, construction, and maintenance; transport; technology and communications; utilities; mining; and rail units. But the future of Downer is focused on urban services, and mining and high-risk construction businesses are being sold down. The engineering, construction, and maintenance business has exposure to mining and energy projects through consulting services. The mining division provides contracted mining services, including mine planning, open-cut mining, underground mining, blasting, drilling, crushing, and haulage. The rail division services and maintains passenger rolling stock, including locomotives and wagons.

Source:Morningstar

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

WiseTech Global Ltd – Share Price Jump

The narrow economic moat, which is based on switching costs, and strong annual client retention rate of around 99%, should protect earnings from competition as the business grows. We expect revenue growth and the scalable business model to drive margin expansion, and we forecast an improvement in the EBIT margin from 19% in fiscal 2020 to 33% by fiscal 2030. However, we expect ongoing investment in capitalised research and development to cause weak cash conversion for the foreseeable future.

Key Investment Considerations

  • WiseTech to continue growing quickly as its global software-as-a-service logistics platform replaces legacy and in-house software, and we forecast a revenue CAGR of 13% over the next decade.
  • WiseTech had an annual customer retention rate of over 99% in each of the four years to fiscal 2016, which we expect to continue for the foreseeable future.
  • WiseTech founder Richard White retains significant influence over the company as its CEO and largest shareholder.
  • WiseTech has a narrow economic moat based on customer switching costs, as evidenced by a very high customer retention rate of over 99% for the past four years. The economic moat should protect returns and
  • margins from competition.
  • WiseTech’s revenue is expected to continue growing strongly over the next decade as its logistics software platform replaces in-house and legacy software solutions. A high degree of operating leverage should create even stronger EPS growth.
  • The capital-light business model should enable the balance sheet to remain debt-free, with operating cash flow covering research and development spending and dividend payments.
  • WiseTech competes against much larger competitors, such as SAP, Oracle, and in-house developed software of the major logistics companies.
  • Cash conversion is poor due to reinvestment in the business, meaning the company must achieve earnings growth to justify this investment.
  • Disclosure is not as extensive as we would like, and the founder, major shareholder, and CEO Richard White arguably creates key-person risk.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Property

Vicinity Centres– Support Long-Term Earnings

Vicinity’s assets are high quality but have exposure to tourism and luxury consumption, leaving earnings vulnerable to coronavirus shutdowns and economic thrift. Some assets have redevelopment potential, including the addition of apartments, hotels and offices. Vicinity’s AUD 14 billion of directly and indirectly owned malls are skewed to larger shopping centres. By official classifications, it has about 22% in super-regional, 29% in regional, 16% in CBD, 19% in subregional, 12% in outlets, and 1% in neighbourhood centres.

Key Investment Consideration

  • Vicinity Centres is more sensitive to the economic cycle than most other retail REITs due to its exposure to tourism, CBD, and luxury spending.
  • About half of Vicinity Centres’ portfolio is in Victoria, and about 16% in CBDs, mainly Melbourne, Sydney, and Brisbane. So far, these areas have been the most affected by the coronavirus. The remaining portfolio is diversified around Australia.
  • Exposure to food, beverage, entertainment, and service based tenants increased since 2015. These categories are less prone to e-commerce competition but vulnerable to thrift, border closures, the absence of CBD workers, and social distancing.
  • Vicinity is arguably the REIT most exposed to an economic and health recovery. Should a effective treatment for COVID-19 be developed, Vicinity would likely outperform other REITs as conditions normalise. OVicinity has the strongest balance sheet of the large and high-end mall operators listed in Australia, so the risk of another dilutive equity raising is low.
  • Vicinity has substantial development opportunities, including the Bankstown and Box Hill town centres, Chatswood Chase upgrade, and apartment developments at The Glen.
  • Even if regulations on distancing and borders return to normal, consumers have already begun to form new habits, including working from home, shopping online, and thrifty shopping habits.
  • Vicinity has about a fourth of its leases up for negotiation in fiscal 2021, meaning it is more exposed to the economic downturn than rival REITs.
  • Vicinity is much more exposed to border closures and work-from-home trends due to its substantial reliance on tourism and luxury spending, and CBD office workers.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Dividend Stocks Shares

Vocus Group Ltd – Spin Off Business

Closeup of a stock market broker working with graphs on digital tablet at office. Rear view of stock agent reading bad report and graph. Back view of multiethnic businessman analyzing fall sales.

The February 2016 merger between these companies transformed the enlarged Vocus into a full-service, vertically integrated player with the necessary ammunition to materially lift its share in all segments of the Australian and New Zealand telecommunications markets. However, the group has been beset by integration and execution risks, leading to a string of board and management changes. Under new management, the turnaround is now progressing solidly.

Key Considerations

  • Vocus’ extensive fibre network infrastructure has the potential to materially lift the company’s share of the corporate and small business telecommunications markets.
  • Vocus’ Australian retail unit faces margin pressure in the National Broadband Network, or NBN, era.
  • Vocus is well and truly past the “fix and repair” stage, and is on the “shed and grow” phase of its journey, with network services clearly identified as its core unit longer-term.
  • Vocus owns and operates an extensive fibre network that drives attractive economics in its fibre and Ethernet business and provides a durable competitive advantage.
  • The marriage of Vocus’ infrastructure and M2’s strong salesforce has the potential to materially lift the company’s share of both the corporate and the small business markets.
  • Vocus’ presence in the New Zealand telecommunications market is underappreciated by investors and is a fertile source of growth.
  • The merger with M2 has exposed Vocus to the margindilutive NBN regime.
  • While steps are being taken to improve in these areas, it is abundantly clear Vocus has bitten off more than it can chew with its recent spate of mergers and acquisitions, with reporting and technology systems woefully inadequate for what is a major player in the telecom big leagues.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.