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HT&E Limited (ASX: HT1)

  • Additional cost savings, notably a large reduction in corporate overhead expenditures.
  • The ATO and HT1 are anticipated to reach an agreement in the near future.
  • Changes in media ownership rules could lead to more corporate activity. Upside to the valuation of Soprano (25% interest) 
  • Initiatives for capital management that are still in progress.
  • A solid financial statement.

Key Risks

  • Decline in advertising dollars (radio and outdoor), particularly if Australia’s retail industry is under stress.
  • The structure of radio is being disrupted.
  • Increased tender competition from large players.
  • With worldwide expansion, there is a danger of poor execution.
  • The tax liabilities of the Australian Taxation Office materialize at a higher level than expected by the market.
  • Hong Kong could detract from the group’s performance (Corona virus or protests escalate).
  • Lockdowns relating to Covid-19 are being reintroduced around the country.

1H CY21 group results 

HT1 had a great first half of the year, owing to a solid market recovery. Core revenue increased by 18.2 percent to $109.9 million, underlying EBITDA increased by 55.9% to $30.4 million, underlying EBIT increased by 139.5 percent to $23.7 million, and NPAT increased by 352.8 percent to $16.3 million. On a like-for-like basis, group sales increased by 21%, owing to higher consumer confidence and advertising spend in Australia and Hong Kong. Higher cost of sales (ongoing investment in digital audio capability) and the resumption of marketing and certain discretionary spending that were deferred to the pandemic in the pcp drove up operating costs (up +9% vs pcp, or up +12% on a similar basis). The Board reinstated the dividend and announced a fully franked interim dividend of 3.5cps vs. zero in the PCP due to strengthening market circumstances.

Company Description  

HT&E Limited (HT1) is a media and entertainment company with operations in Australia, New Zealand and Hong Kong. The Company operates the following key segments: (1) Australian Radio Network (ARN) – metropolitan radio networks including KIIS Network, The Edge96.One and Mix106.3 Canberra; (2) Hong KongOutdoor (Cody) – Billboard, transit and other outdoor advertising in Hong Kong, with over 300 outdoor advertising panels and in-bus multimedia advertising across 1,200 buses; and (3) Digital Investments – digital assets including iHeartRadio, Emotive and Conversant Media.   

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Oversupply Issues Are Behind Inghams, but Mix Shift to Drag in the Near Term

competition in poultry is intense. Poultry is largely commoditised, and Inghams possesses limited opportunity to differentiate its products, leading to our view that the firm lacks a sustainable competitive advantage required to award an economic moat. Further, Inghams’ customer base is highly concentrated, with the majority of its total sales comprising five customers, including supermarket giants Woolworths and Coles, and quick-service restaurant KFC. Population growth, relative affordability, and changes in consumer preferences have driven chicken consumption to all-time highs in Australia and New Zealand. 

Per capita chicken meat consumption in both Australia and New Zealand has steadily grown at a low-single-digit CAGR over the last decade. Chicken remains the cheapest meat by a significant margin, with the per-kilo retail price of chicken less than half that of pork, lamb, and beef. This price advantage is supported by favourable production dynamics, notably chicken’s superior food conversion ratio, or FCR. The chicken industry remains highly efficient in translating feed into live weight for production, with producers able to convert feed at a rate that is about 1.5 times more efficient than pork and 4 times more efficient than beef. The chicken FCR, measured by kilograms of feed required to produce one kilogram of meat, has fallen from over 2.5 in 1975 to less than 1.8 today.

Financial Strength 

Given relatively high lease-adjusted leverage, and slim operating margins, we rate Inghams’ balance sheet as weak–stronger than poor as we do not see risk of a dilutive capital raising. Net debt/EBITDA improved in fiscal 2020 to 1.2 at June 30, 2021, due principally to earnings recovery and tighter capital expenditure amid COVID-19 uncertainty over the year. This is down from 1.8 in fiscal 2020 and 1.3 in fiscal 2019 following the capital return and share buyback over fiscal 2019. Given heavy investment into automation and operational efficiency, capital expenditure requirements have been elevated, peaking at AUD 106 million during fiscal 2019 at 4% of revenue. 

Our fair value estimate for Inghams to AUD 3.70 from AUD 3.60 due to the time value of money boost to our financial model. Inghams’ fiscal 2021 underlying net profit of AUD 87 million matched our estimates and was at the top end of management’s guidance range. Inghams declared a fully franked final dividend of AUD 9 cents, bringing the full-year distribution to AUD 16.5 cents per share, implying a payout ratio of 71% of underlying EPS. Government-imposed shutdowns shift poultry demand from restaurants to retail, creating inefficiencies as Inghams is forced to adjust production lines. 

Poultry producers struggled to keep up with pantry-stocking and panic buying in March and April 2020, but this sales momentum was not maintained, and the poultry industry entered fiscal 2021 in oversupply. The chicken industry remains highly efficient in translating feed into live weight for production, with producers able to convert feed at a rate that is about 1.5 times more efficient than pork and 4 times more efficient than beef–leading to cost-efficient processing and a smaller environmental footprint. We expect low-single-digit growth in annual per capita chicken meat consumption to 53kg by fiscal 2026, before moderating as chicken consumption approaches saturation.

Bulls Say’s 

  • Inghams benefits from a consumer trend toward protein-rich, fresh, easy-to-prepare meals.
  • Per-capita chicken meat consumption continues to rise as chicken enjoys a relative affordability advantage compared with other meats, such as beef.
  • A shift in Inghams’ sales mix to value-added products could enhance margins.

Company Profile 

Inghams is the largest vertically integrated poultry producer in Australia and New Zealand. The firm enjoys a number-one position in Australia with approximately 40% market share and a number-two position in New Zealand with around 35% share. Inghams supplies poultry products, notably to major Australian supermarkets Woolworths and Coles, and quick-service restaurants McDonalds and KFC. Sales are heavily skewed toward poultry, which includes the production and sale of chicken and turkey products.

(Source: Morningstar)

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Bega Cheese’s Strength isn’t Strong Enough to Justify a Financial Moat

Competitive pressures from branded peers, niche operators, and private label products and a reliance on powerful supermarket customers will weigh on Bega’s ability to increase prices, leading to potential market share and margin deterioration. Despite the firm’s strategic shift toward a more diverse product offering, we expect dairy products to continue to represent the majority of Bega’s sales over the next decade, exposing the firm to commodity pricing and volatile input costs.

In November 2020, Bega entered an agreement to acquire Lion Dairy and Drinks from Kirin Group for AUD 534 million with the deal expected to be finalized in January 2021. Revenue from the branded segment, which includes spreads and grocery products and Lion’s Dairy and Drinks portfolio, to expand at a CAGR of 7.4% to fiscal 2025, underpinned by new product innovation and bolt-on acquisitions. Historically, Bega Cheese has made limited investment in its brands, particularly in Australia where Fonterra is the licensee of the Bega brand, however since acquiring the spreads and grocery business in 2018, marketing spend as proportion of revenue has increased to 3% from 1% and it to remain the higher level.

Bega Cheese’s Supply Chain and Manufacturing

At least 70% of Bega’s energy consumption is from fossil fuel generation. But these risks are immaterial to our unchanged AUD 5.00 per share fair value estimate and high uncertainty rating. Bega Cheese already operates in a highly competitive market, with a largely commoditized product offering and high private label penetration in key categories. Bega Cheese’s supply chain and manufacturing is heavily reliant on water, exposing the company to increased water costs and community backlash from inefficient water use.As pressure mounts to reduce global carbon emissions, there is the potential for a reintroduction of regulated carbon pricing in Australia, however, this is not factored into our base case. Extreme weather events such as droughts and bushfires may result in higher input costs, margin deterioration from reduced production volumes, disruptions to the supply chain and increased scrutiny on resource use. Climate change risk may lead to extreme weather in the short term or changing climate patterns longer-term impacting its supply chain and input costs. Management is certainly diversifying Bega Cheese’s product offering and building out the branded business through acquisitive growth in recent years

Financial Strength

Bega’s balance sheet will be stretched following the acquisition of Lion Dairy and Drinks, with pro forma net debt/EBITDA on a post AASB 16 basis deteriorating to 3.3 (from 2.3 pre-acquisition). Bega funded the acquisition through a AUD 401 million equity raising and AUD 267 million of new and extended debt facilities. The balance sheet to gradually deleverage as synergies are delivered, earnings improve and noncore assets are divested, with net debt/EBITDA falling to below the firm’s target of 2 by fiscal 2024. Bega will continue to explore potential bolt on acquisitions and partake in industry rationalisation. While the timing and scale of further acquisitions is uncertain, Bega has the capacity to pursue smaller acquisitions while maintaining a dividend payout ratio of 50% normalised EPS.

Changing Consumer Trends

  • Bega is shifting investment to the spreads and grocery business, which we view as less commoditised and higher margin than dairy, with strong niche positions in Vegemite and peanut butter
  • External factors outside of Bega’s control, such as the weather, can adversely impact supply and demand dynamics. This can impact commodity prices, inputs costs and the firm’s supply chain and lead to volatile earnings
  • Changing consumer trends toward dairy-free and vegan diets could lead to declines in per-capita dairy and cheese consumption, weighing on the majority of Bega’s earnings

Company Profile

Bega Cheese is an Australian based dairy processor and food manufacturer of well-known brands including Bega Cheese and Vegemite. On a pre-acquisition of Lion’s Dairy and Drink’s basis, the firm generated approximately 70% of sales from its domestic market, with the remainder from exports to over 40 countries, predominately in Asia. Bega Cheese operates two segments: the branded segment which produces consumer packaged goods primarily sold through the supermarket and foodservice channels and the bulk segment which produces commodity dairy ingredients primarily sold through the business-to-business channel.

(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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Genworth will find it Challenging to Grow its LMI Business In the face of Slow Credit growth and Increased Competition

Arch Capital Group received Australian Prudential Regulation Authority, or APRA, approval to enter the market in 2019 and announced it would acquire Westpac’s LMI business in 2021. This marked increased competition for Genworth and QBE in Australia.

LMI protects a lender against a potential gap between the outstanding loan amount plus costs and the sale proceeds from the mortgaged property. While it’s the lender who is protected and decides whether to purchase LMI, the premium is paid by the borrower. Low growth in high loan/value ratio, or HLVR loans, due to low system wide home loan growth, as well as banks being more risk-averse after the Royal Commission and tightening of lending standards is expected. An economic backdrop where Australians are holding historically high levels of home-loan debt, and wage growth is low, makes strong credit growth and a significantly stronger appetite for loans with higher LVRs unlikely.

Key Investment Considerations

  • Higher-risk home loan exposure means Genworth is very sensitive to the Australian economy, particularly employment and house prices. In a downturn, it faces the likely lower premiums, higher claims and reduced investment returns.
  • The full-recourse nature of Australia’s home loans reduces potential claims risks and in a benign economy it has proved profitable, earning profits in all but two years of its roughly 50-year history.
  • A sound balance sheet means there is the prospect of further capital-management initiatives.

Financial strength

Genworth is regulated by APRA to maintain a certain prescribed capital level, or PCA. Genworth’s PCA is driven primarily by its LMI concentration risk charge (which is mainly based on its probable maximum loss based on a three-year economic or property downturn of an APRA determined 1-in-200 year severity level) and insurance risk charge (the risk that net insurance liabilities are greater than the value determined by the actuary). Genworth targets a regulatory capital base of 1.32 times-1.44 times its PCA, which it has been consistently above. The PCA as at March 31, 2021, is a healthy 1.63 times.

Bulls Say

  • Fiscal and monetary stimulus cushion the economic downturn in Australia, resulting in a rise in

delinquencies but allows Genworth to remain profitable and continue to generate profits over the longer term.

  • A sound balance sheet provides the capacity to continue to institute capital management initiatives, including special dividends and buying back more shares.
  • The recent relaxation of some macro-prudential measures and low cash rates may spur lenders to issue more investor and HLVR home loans, which Genworth is well positioned to benefit from.

Company Profile

Genworth Mortgage Insurance Australia listed on the Australian Securities Exchange in 2014 after its U.S.-based parent, Genworth Financial Inc. (NYSE: GNW), sold down its stake. It has since exited. With a history spanning over 50 years, Genworth Australia is a provider of lenders’ mortgage insurance, or LMI, in Australia. In Australia, LMI is predominantly purchased on loans with a loan/value ratio, or LVR, above 80%. LMI protects a lender against a potential loss (gap) between the outstanding loan amount and sale proceeds on a delinquent loan property. LMI does not protect the borrower, however the premium is paid by the borrower. It’s regulated by the Australian Prudential Regulation Authority, or APRA, which requires it to meet minimum regulatory capital requirements.

(Source: Morningstar)

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Vornado Should Benefit From New York’s Office Recovery

The company now generates about 90% of its net operating income from New York City. While the focus is certainly on premier office properties, Vornado continues to invest in high-quality retail. Around 60% of companywide NOI comes from New York office properties, with New York retail generating around one fifth of total NOI.

In contrast with its New York office REIT peers, Vornado has made a concentrated bet on developments in the Penn District submarket just east of the Hudson Yards megaproject. The new development should have positive knock-on effects by increasing foot traffic and rents, as the project adds activity to a once-drab slice of Manhattan. Despite investor concern about oversupply in the region and the spectre of a massive rise in remote work due to the coronavirus pandemic, New York will remain a hub for global talent in the long run. With its enviable roster of blue-chip office and retail tenants, Vornado should benefit from healthy rent collections despite the coronavirus crisis.

Vornado only owns two non-New York properties in well-located central business districts in Chicago and San Francisco. In San Francisco, 555 California Street has benefited from healthy tech office demand in a supply-constrained region. In Chicago, the Merchandise Mart has likewise performed well, emerging as a hub for tech office users in the Midwest. With the completion of the Art on the Mart digital exhibition in 2018, the building is set to continue to benefit from its great location and iconic status within the Chicago office market.

Financial Strength

We view Vornado’s balance sheet as a slight concern, with the firm carrying more debt than many of its already bloated office REIT peers. We forecast 2021 debt/adjusted EBITDA to be around 11 times, with adjusted EBITDA/interest of 3.4 times. We forecast debt/EBITDA to decline gradually over the next 10 years. As a real estate investment trust, Vornado Realty is required to pay out at least 90% of its income as dividends to shareholders. Vornado’s 2020 dividend payout represented an elevated 110% of its funds from operations figure, although this is slightly obscured by acute COVID-related cyclicality.

Company’s Megaproject

Vornado’s well-located portfolio of office and retail assets attracts the highest-quality tenants. Developments near the Hudson Yards megaproject should pay off as the company benefits from increased property values in that region. Vornado’s Chicago and San Francisco properties represent some of the best assets in those markets.

Company Profile

Vornado owns and has ownership interest in Class A office and retail properties highly concentrated in Manhattan, with additional properties in San Francisco and Chicago. It operates as a real estate investment trust.

(Source: Morningstar)

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Canopy Offers Attractive Investment Exposure to the U.S

Portrait of Vietnamese young stock broker talking on the phone with coworker

Although we expect the medical market to shrink as consumers turn to the recreational market, we forecast more than 10% average annual growth for the entire Canadian market through 2030, driven by the conversion of black-market consumers into the legal market and new cannabis consumers.

Canopy also exports medical cannabis globally. The global market looks lucrative, given higher prices and growing acceptance of cannabis’ medical benefits. Exporters must pass strict regulations to enter markets, protecting early entrants like Canopy. Partially offsetting the global markets’ potential for Canadian producers are threats of future production from countries with cheaper labor— the single largest cost. However, many Canadian companies have pulled back expansion plans given ongoing cash burn. We forecast around 15% average annual growth through 2030.

Besides hemp, Canadian companies typically have no U.S. operations, given legal limitations. However, Canopy has a standing deal to acquire Acreage Holdings, a U.S. multistate operator, immediately upon federal legalization. We thought Canopy paid a good price and acquired an attractive option for an accelerated entry into the U.S. Canopy also owns 27% of U.S. multistate operator Terrascend on a fully diluted basis. The U.S. market is murky, with some states legalizing recreational or medical cannabis while it remains illegal federally. We expect that federal law will be changed to recognize states’ choices on legality within their borders. Based on our state-by-state analysis, we forecast nearly 20% average annual growth for the U.S. recreational market and nearly 10% for the medical market through 2030.

Constellation Brands owns 38.6% of Canopy with additional securities that could push ownership to 55.8%. We see the investment as supportive of developing branded cannabis consumer products while also providing a funding backstop and foothold into the U.S. non-THC market.

Company Profile

Canopy Growth, headquartered in Smiths Falls, Canada, cultivates and sells medicinal and recreational cannabis, and hemp, through a portfolio of brands that include Tweed, Spectrum Therapeutics, and CraftGrow. Although it primarily operates in Canada, Canopy has distribution and production licenses in more than a dozen countries to drive expansion in global medical cannabis and also holds an option to acquire Acreage Holdings upon U.S. federal cannabis legalization.

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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Kellogg Company Benefited From Pandemic-Related Gains

Stock market information

Kellogg’s dividend growth has been modest over the past five years, at an annualized rate of 2.9%. However, Morningstar analysts anticipate a higher rate going forward: “We forecast Kellogg will raise the shareholder dividend in the mid-single-digit range annually on average during the next 10 years.”

In their Best Ideas report, the analysts made the following case for the stock, which trades at an 18% discount to fair value: “Kellogg has benefited from pandemic-related gains in the retail channel (which drives 90% of its sales) as consumers continue to spend more time at home. Even before the pandemic, we thought Kellogg was taking steps to profitably reignite its top-line trajectory: abandoning direct-store distribution in favor of warehouse delivery, divest-ing noncore fare and stock-keeping units, and upping investments in its manufacturing capabilities and brands.

Although we expect more muted gains over a longer horizon, we think the company is using the current backdrop to sharpen its edge.

“We believe actions to expand its category exposure beyond cereal (with 50% of sales now from on-trend snacks versus 20% from North American cereal) will prop up its sales growth potential longer term. Further, we like the changes to its pack formats to include more on-the-go offerings, which should allow for increased penetration in alternative outlets. We also think recent acquisitions (including smaller, niche startups like RXBAR) afford the opportunity to grease the wheels of Kellogg’s innovation cycle to more nimbly respond to ever-changing consumer trends as they relate to health and wellness and taste.”

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The Pinnacle at Backing and Growing the Right Horses

This allows Pinnacle to benefit from earnings upside as its affiliate boutiques grow in scale and realise operating leverage. A well-known brand and extensive diversification (across managers, asset classes and client cohorts) strengthen Pinnacle’s ability to attract and hold on to FUM across market cycles. Regardless, capital intensity is higher than pure-play asset managers. Dilution from capital raisings, increasing leverage and deploying capital at low rates of return are risks.

Key Investment Considerations

  • Pinnacle’s reputation as a quality growth partner for high performing boutique managers helps attract high calibre asset managers and investors seeking varied investment solutions. Diversity in asset classes, boutiques, and client cohorts provide stability in FUM growth across market cycles.
  • We anticipate ongoing growth in demand for Pinnacle’s solutions due to the increasingly competitive and regulated funds management landscape.
  • Earnings prospects are strong. Notably, there are upsides from the scaling of fixed costs as affiliate boutiques grow in scale, new money from increased distribution and new boutique additions.

Company Profile

Pinnacle Investment Management Group is an Australian-based multi-affiliate investment management firm. The principal activities of the firm are equity, seed capital and working capital, and providing distribution services, business support, and responsible entity services to a network of boutique asset managers, termed as “affiliates.” Apart from deriving revenue from its services, Pinnacle also earns a share of profits from its affiliates via holding equity interests in them. The business is growing rapidly with number of boutiques and FUM more than doubling to 16 and circa AUD 71 billion in December 2020, respectively, from seven and AUD 23 billion in December 2016.

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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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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.

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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.