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GWA Group Ltd – Earnings Likely to Recover

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But competition is heating up with new entrants such as Spain’s Roca eyeing the fast growing Asia Pacific region including Australia and have achieved access to local distribution channels. We expect GWA’s margins to come under pressure as the brand portfolios of recent Australian market entrants garner greater

brand awareness.

Key Investment Considerations

  • GWA’s brand strength and leading market share in bathroom and kitchen fittings create enduring competitive advantages. However, competition is heating up.
  • The COVID-19 outbreak represents a significant shock to the Australian economy. We anticipate a sizable contraction in 2020 Australian housing starts. But the dip in construction is expected to be relatively short-lived, with a recovery commencing in early 2021.
  • The outsourcing of vitreous china and plastic manufacturing activities to suppliers in Asia has significantly reduced operating leverage. Operating margins are expected to remain stable through the cycle.
  • Caroma’s strong brand awareness should preserve GWA’s market share and economic profits. OThe Methven acquisition may provide access to growth opportunities in the U.K. and continental Europe.
  • GWA’s outsourced manufacturing model increases the variability of the firm’s cost base, steadying margins through the cycle.
  • Global industry leader Roca has big ambitions for the Asia-Pacific region. While off a low base, Roca is enjoying strong growth in Australia.
  • The top-of-cycle acquisition of Methven introduces execution risk. Value will be destroyed if deal synergies are not fully realised.
  • Falling Australian house prices could affect the typically more resilient renovation and replacement market segment near term.
  • Following the sale of its door and access systems business, GWA Group now operates through a single business division: water solutions. We think this division has competitive advantages that warrant a narrow economic moat rating for the group. Brand strength is high, with Caroma in particular resonating in both retail and wholesale channels in Australia.
  • Established distribution channels, including strong relationships with market-leading plumbing retailers, also help to maintain market position and prices. GWA has strong market positions in most products and is particularly dominant in toilet suites. A long history, since 1941 in Caroma’s case, has allowed it to build its presence.

 (Source: Morningstar)

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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 Shares

Harvey Norman Holdings Ltd– Overestimating Upside

Yet, these factors are unlikely to alter the long-term outlook for most retailers. Rather, we expect consumer spending growth will prove relatively weak, while shifts between categories and sales channels could test retailers in the medium term.

The S&P/ASX 200 Consumer Discretionary index has rebounded by some 75% since the recent lows on March 23, 2020, after it collapsed by 45% in just over a month amidst the global equity rout. The discretionary retailing sector was initially much more severely hit than the overall market. In the past, discretionary spending has proven to be procyclical and it was singled out as highly exposed to the impending recession and widespread shutdowns, with these risks further exaggerated by supply chain concerns.

However, unlike the overall domestic equities market, the S&P/ASX 200 Consumer Discretionary index has nearly fully recovered and is just 3% shy of its February 2020 highs. In contrast, the broader Australian market is still down 13% versus its all-time February highs. While our discretionary retailing coverage screened as materially undervalued in March 2020, when we identified Myer, Super Retail and Premier as 5-star investment opportunities, the pendulum has now swung too far the other way.

However, this growth was unevenly distributed because of various restrictions on mobility and gatherings introduced either by federal and state governments or self-imposed by health-conscious consumers. The travel and restaurant industries, as well as fashion retailers, have been amongst the most impacted as consumers redirected their spending to other categories. Clear winners have been liquor, hardware and consumer electronics and home appliances retailers

 (Source: Morningstar)

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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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Iluka Resources Ltd – Exposed to Mineral Sands

The long life Sierra Rutile operation is the key source of rutile but lacks a cost advantage. It may come in time as the company expands and builds scale economies. The new Cataby mine bolsters zircon output and maintains feedstock for the production of synthetic rutile. Iluka’s 20% ownership of Deterra Royalties brings exposure to the high-returning iron ore royalty over BHP’s Mining Area C. It is the sole moat-worthy asset but comprises less than 10% of our fair value estimate.

Key Considerations

  • Iluka’s shares are undervalued with demand set to recover from coronavirus-inspired lows. Disruption to other suppliers is likely to see prices remain resilient despite lower demand.
  • As a large producer of both zircon and high-grade titanium dioxide products (rutile and synthetic rutile), Iluka has some ability to flex output to meet either weak demand and strong demand.
  • Reserve life is moderate at around 10 years but Iluka has a sizable resource base which covers at least 25 years of production at 2018 rates. We expect resources to convert to reserves as Iluka clears feasibility and technical hurdles.
  • Iluka is an industry leader with relatively high grade zircon and rutile deposits. Supply can be withheld to defend prices and margins in times of weak demand.
  • Management has improved company fortunes with a strong focus on returns on capital. Demand for zircon is likely to be bolstered by new applications such as chemicals and digitally printed tiles.
  • Iluka has some diversification. The revenue mix is approximately half from zircon and half from highgrade titanium products. Geographically, revenue is split between North America, Europe, China and the rest of Asia.
  • Mineral sands markets are relatively small. Sales volumes can go through periods of significant demand weakness, such as in 2008-09 and 2012-16.
  • The largest single source of demand for zircon is China, accounting for nearly half. China could throttle back on fixed-asset investment-driven growth, which may see subdued zircon sales volumes and prices. OThe Jacinth Ambrosia deposit is very high-grade, with a large component of high-value zircon. Reserve life is less than 10 years and it will be nearly impossible to replicate the returns and competitive position once depleted.

 (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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Global stocks

Insurance Australia Group – Unexpectedly Large Provision

There is continual pressure from competition on revenue and margins, with premium rate increases generally only covering recent claims inflation. Large insured events occur without warning, and claims trends are largely beyond management’s control in the short term. Reinsurance protection and quota share agreements do help mitigate risks but come at a cost and mean profit sharing. In addition to more-stable fee-based income, quota share deals have the added benefit of releasing capital. We agree with management’s decision to exit Asia with a focus on profitability in its core markets.

Key Investment Consideration

  • Insurance Australia Group, or IAG, is a custodian of well-known brands in Australia and New Zealand. Despite its size and market share, competitors with low-cost digital strategies, or a focus on select regions or products, prevent IAG from exerting pricing power one would expect with its associated scale.
  • The strategic relationship with Berkshire Hathaway reduces uncertainty and IAG shareholders should benefit with less volatile earnings and dividends.
  • Brand recognition and confidence claims will be paid are helpful in acquiring and retaining customers, but competitors have shown these are not insurmountable barriers.
  • Insurance Australia Group is a general insurer with around AUD 12 billion of annual gross written premiums, operating in Australia and New Zealand. Stakes in a Malaysian and Vietnamese insurer are the only remaining remnants of an abandoned Asia growth strategy. Insurance Australia Group is a custodian of well-known heritage brands which include NRMA, CGU, SGIO, SGIC, Swann Insurance in Australia and State, NZI, AMI, Lumley in New Zealand.
  • The firm’s underwriting discipline, productivity initiatives, and focus on profitable growth, will see returns consistently return its cost of capital.
  • IAG has collectively removed downside risk from 32.5% of its business while retaining exposure to earnings upside via profit share arrangements.
  • A benign claims environment with a lower incidence of major catastrophes considerably boost underwriting profits.
  • A strong balance sheet and good earnings momentum will see consistent dividend growth and surplus capital returned to shareholders.
  • Competition increases and wins market share from incumbents, such as IAG, by offering lower premiums, regardless of the impact on short-term profits and returns.
  • The Asian growth strategy was disappointing, and we endorse the recent sale of operations in Thailand, Indonesia, and India.
  • A higher incidence of large claims events from major catastrophes will reduce profitability to the extent dividends are cut materially and the insurer needs to raise capital.

 (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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Global stocks Shares

InvoCare Ltd– Earnings

The number of deaths is highly predictable, creating a reliable revenue source. Historically, growth has been driven by price increases, growth in the number of deaths, small organic market share gains, and a boost from acquisitions of small private businesses at relatively low prices. Nonetheless, year-on-year variations in the death rate can cause some short-term earnings volatility. InvoCare typically trades on a high forward price/earnings ratio; however, we believe a premium valuation is justified, given the stable, growing revenue and returns consistently above its cost of capital.

Key Investment Considerations

  • InvoCare usually trades at a high price/earnings ratio, reflecting defensive earnings, strong cash flow generation, and a high dividend payout ratio.
  • Fluctuations in the number of deaths per year and changing product mix dynamics can result in volatility of underlying earnings.
  • The increased reinvestment in the business should support margin improvement while ensuring the business is well placed to capitalise on rising death rates.
  • InvoCare is the largest provider of funeral, cemetery, and crematorium services in Australia, New Zealand, and Singapore. It has a number of well-known, highly respected brands and significant market shares that underpin our
  • wide economic moat rating. InvoCare has a history of resilient and rising revenue and earnings, free cash flow and dividend-per-share growth. The company consistently generates returns above its cost of capital.
  • Steady growth in the number of deaths underpins our positive long-term view on InvoCare’s earnings outlook. Growth in the number of deaths has averaged about 1% in Australia and in New Zealand over the past 60 years. The latest estimates from the Australian Bureau of Statistics and Statistics New Zealand project the annual growth in the number of deaths to increase progressively and peak at around 2.8% in Australia and 2.3% in New Zealand by 2034, before slowing back to around 1% by 2055.
  • InvoCare consistently generates return on invested capital above its weighted average cost of capital, reflective of its market position, reputation, and strong brand equity.
  • Steadily growing industry volumes are relatively immune to economic factors and will accelerate as the population increases.
  • InvoCare faces no significant national competitors in Australia. This relative market strength and InvoCare’s participation in the slow consolidation of the industry should deliver high-quality earnings.
  • Beyond brand management, reputation risk in particular is high, given the importance of personal recommendations to winning new business.
  • Advances in medicine and changes to assumptions for life expectancy, coupled with changes in assumptions regarding birth and death rates, could negatively affect expected cash flows.
  • An extended economic downturn could see more price-sensitive customers spend less on funerals.

 (Source: Morningstar)

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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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Worley Ltd

Worley says its strategic transformation is accelerating as it increasingly supports customers moving to a low-carbon future. While traditional business continues to be an important part of Worley’s activities, sustainability is providing a higher rate of future growth and margin. The company says its work backlog at end of March 2021 had increased to AUD 14.1 billion, from AUD 13.5 billion at December 2020’s end, with activity levels on long-term projects returning and key project awards in both sustainability and traditional services. Sustain ability focused work comprises 29% of current aggregated revenue, but a considerably higher 45% of the factored sales pipeline (upcoming work). In the half to December, Worley delivered AUD 1.2 billion in sustainability revenue at more favourable margin.

Worley characterises the global market size for sustainable design to 2035 as approximating USD 4.5 trillion per year, of which its addressable share is estimated at 10%-20%. And for decarbonisation investment, its addressable share is estimated at 3% to 15% of a total USD 1.5 trillion annual spend. It’s a big market for a company with current annual revenue approximating just AUD 10 billion.

And despite having a similar risk profile to other services– not lump sum turn-key–sustainability activities have more favourable gross margins. This reflects their technically complex nature involving technology integration and modification to existing facilities, with often challenging logistics requiring expertise in scaling-up. This provides opportunities to embed automation and digital solutions. Worley is accelerating its digital technology to create high value solutions and drive margin improvement including in artificial intelligence and machine learning.

At around AUD 10.70, Worely shares are up 75% on March 2020 lows, and are currently only somewhat undervalued, in 3-star territory. Our fair value estimate equates to an unchanged fiscal 2025 EV/EBITDA of 7.2, a P/E of 15.4, and dividend yield of 4.9%. We still assume a five-year EBITDA CAGR of 9.5% to AUD 1.15 billion. Our 9.2% midcycle EBITDA margin assumption betters the five-year historical average to June 2020 of 7.2%. In addition to the historical period including COVID-19 imposts, improvement reflects both cost-outs and higher assumed sustainability margins.

Worley achieved run rate cost synergies from the ECR acquisition of AUD 190 million in April 2021, already factored in our base-case valuation. We mention this completed program simply in recognition of form–the program being completed on time and at considerably greater magnitude than the original target of AUD 130 million. Future cost-outs are to come solely from operational savings targeted at a total AUD 350 million by June 2022. Worley said it had banked approximately 70% of these on an annualised basis at the December 2020 mark. We estimate this leaves around 1.0% of EBITDA margin improvement left from this source. The balance of our forecast margin improvement can be expected to come via the return of volumes post-COVID over which fixed costs can be disbursed, and via higher margins from growing sustainability activities.

At end December 2020, Worley’s net debt excluding operating leases stood at AUD 1.2 billion, (ND/(ND+E)) 18.4% and annualised net debt/EBITDA of 2.4. Net debt/ EBITDA was somewhat elevated, reflective of the AUD 4.6 billion ECR takeover. We estimate current net debt little changed, but project sub-1.0 net debt/EBITDA by as soon as fiscal 2022 and an unleveraged balance sheet by fiscal 2025, all else equal. This includes assumption of a 75% payout ratio for a prospective plus 6.0% unfranked yield from fiscal 2023.

Source:Morningstar

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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

Vocus Group Ltd

M2, on the other hand, is an infrastructure-lite but sales force-heavy consumer-focused telecom entity. Its stellar growth has also been driven by many acquisitions.

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.

  • 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’ Scheme of Arrangement with MIRA/Aware Super Consortium

We recommend shareholders of Vocus vote in favour of the proposed scheme of arrangement with Voyage, a vehicle owned 50/50 by Macquarie Infrastructure and Real Assets Holdings, or MIRA, and Aware Super. The recommendation is based on the following reasons. First, there have not been any competing interests for Vocus since MIRA’s AUD 5.50 offer was first proposed on Feb. 8, 2021. No left-field utility companies have come along with visions of “bundled plays”, and no right-field upstarts have come along with “funny paper” hoping to turn it into hard assets (as is occurring in other sectors).

In fact, the Vocus board is fully on board with the scheme, at least 15.6% of the voting interests are in the bag (Janchor with 9.3%, MIRA/Aware Super with 6.3%), and we do not see any reasons for other major institutional shareholders to dissent. Second, as pointed out in our prior research, MIRA/Aware Super’s AUD 5.50 per share offer is generous. It is at a significant premium to our AUD 3.50 stand-alone assessment for Vocus, and represents a ritzy 12.7 times underlying EBITDA for the past 12 months, or 11.6 our forecast fiscal 2021 EBITDA. The independent expert’s report, unsurprisingly, also agrees, declaring the offer to be within its AUD 4.98 and AUD 5.60 valuation range. Third, Vocus shareholders should cherish the straightforward, uncomplicated nature of the high-premium bid.

It is AUD 5.50 per share in cold, hard cash right now, as opposed to remaining as shareholders of a listed entity competing in the turbulent and NBN-infested waters of the telecom industry, with no certainty as to when or if Vocus’ value may ever exceed AUD 5.50 in the future.

Bulls Say

  • 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 sales force 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.

Bears Say

  • The merger with M2 has exposed Vocus to the margin dilutive 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.

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Dell Technologies Benefiting from Heighted PC Demand as It Expands Its Cloud Offerings

Although Dell Technologies has substantial exposure to commoditized markets and carries considerable financial leverage, we believe synergistic opportunities across its brands should drive success as businesses migrate to hybrid cloud IT infrastructures. Dell Technologies’ business centers around PCs and peripherals, servers, storage, networking equipment, as well as software, services, and financial services. Its brands include Dell, Dell EMC, VMware, SecureWorks, and Virtustream. The company returned to the public market in late 2018 through a reverse merger of the VMware tracking stock, DVMT.

The company’s largest revenue streams of commercial PCs and servers are in cutthroat pricing environments that rely on services and support to generate profit. We expect the overall PC market to continue consolidating toward an oligopoly and for consumer-based profits to come from high-end and gaming PC sales. While storage is a challenging marketplace, we believe flash-based arrays and hyperconverged infrastructure provide avenues for rampant growth. We posit that the company’s majority ownership of VMware and other cloud-centric software brands provides growth catalysts as firms augment hardware with software-based solutions. After the acquisition of EMC, we view Dell Technologies as an end-to-end IT infrastructure provider that is supplementing hardware prowess with emerging software and cloud-based solutions. We’re optimistic about its ability to upsell VMware and other cloud-based solutions, especially in high-growth areas of hyperconverged infrastructure and software-defined networking, but we do expect competitive markets to challenge the company’s overall profitability.

We think that Dell Technologies’ debt burden may affect its ability to invest in the development and sales of future innovative products. Public shareholders have very little influence on the company’s strategy and rely heavily on CEO Michael Dell and Silver Lake Partners making value-accretive decisions.

Fair Value and Profit Driver’s

Our fair value estimate of $80 per share is consistent with an enterprise value/adjusted EBITDA of 10 times and adjusted price/earnings of 10 times for fiscal 2022.

We project that Dell Technologies’ revenue will rise at a five-year revenue compound annual growth rate of 2%. By product line, we project the ISG segment to slightly grow, which includes storage and servers. We model a low single-digit five-year CAGR for storage, primarily driven by flash array demand, data proliferation, and software-defined networking. We model CSG to be flattish in the long run, which includes PCs.

We project VMware growing around the high-single-digit or low-double-digit range due to strong demand for VMware’s hybrid cloud ecosystems and networking solutions, in addition to cross-selling opportunities. We expect the other businesses (SecureWorks and Virtustream) to contribute revenue growth during the same time period due to cloud-based software adoption across IT and security teams.

In our view, Dell Technologies should be able to maintain gross margins in the low 30% range, up from the mid-20% range in fiscal 2018 and fiscal 2019 through increasing product cross-sales and upsells, especially through adding software suites. In our view, Dell Technologies has substantial cross-selling and upselling opportunities as well as collaborative development efforts that will lower operating expenses as a percentage of revenue. We model operating margin to remain in the mid-single digits over our explicit forecast.

Dell’s Company Profile

Dell Technologies, born from Dell’s 2016 acquisition of EMC, is a leading provider of servers and storage products through its ISG segment; PCs, monitors, and peripherals via its CSG division; and virtualization software through VMware. Its brands include Dell, Dell EMC, VMware (expected to be spun off toward the end of 2021), Boomi (expected to be sold by the end of 2021), Secureworks, and Virtustream. The company focuses on supplementing its traditional mainstream servers and PCs with hardware and software products for hybrid-cloud environments. The Texas-based company employs around 158,000 people and sells globally.

Source: Morningstar

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.