14/03/2012 - 10:33

Second stringers deliver first-rate portfolio

14/03/2012 - 10:33


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There are some first-rate local stocks out there if you look beyond the headlines.

POTENTIAL: WA's proven performers and those with big potential.

There are some first-rate local stocks out there if you look beyond the headlines.

THERE are two ways to buy a Western Australian investment portfolio. 

The first is to acquire shares in the obvious suspects, the handful of national leaders with a Perth head office; Wesfarmers, Woodside and Fortescue Metals Group are top of that list.

The other way is to apply the ‘we try harder’ slogan of the Avis car hire business and hunt for hidden treasures among smaller WA-based companies that can produce better returns because they really do have to outperform the big companies to attract attention.

It is in what might be called the second 11 (to borrow a cricket term) that a first-rate portfolio of stocks can be acquired on the ASX to broadly reflect WA business, and which generally offer more attractive investment returns.

Stocks that will play well in a second 11 WA portfolio include: BWP Trust, a Wesfarmers associate that owns many of the properties housing Bunnings hardware warehouses; the mining and engineering support company NRW Holdings; and the telecommunications service provider iiNet.

Those three stocks are just the start in looking for companies that do not always attract headlines, but which are running profitable businesses and paying solid dividends, or offer the potential for capital gains as they develop their projects.

Other possible members of a WA second 11 include: Decmil (a resource sector builder); Buru (an oil explorer); Imdex (an oil sector service provider); Peet (a residential property developer); Silver Lake (a gold miner); Alkane (a rare earths developer); Marengo (a copper project developer); Iron Ore Holdings (an iron ore asset trader); and Matrix (an oil sector service provider).

More on each of those stocks later, but first a technical reason why smaller companies can generate better investment returns.

The price-to-earnings, or PE ratio, is a simple and accurate tool for comparing the financial performance of companies in different businesses. It is calculated by dividing the share price of a company (in cents) by its earnings (also in cents).

The easiest way to work out a PE ratio is to use historic data, such as earnings over the past 12 months divided by the current share price. Most stockbrokers prefer to use a projected PE because it might reflect future performance – if they are able to accurately estimate the future earnings, which can be a bit tricky.

Wesfarmers, for example, is on an historic PE of 17.4 – a share price of $29.13 divided by earnings per share last year of $1.67. The company’s projected PE is around 15.5, a ratio derived from brokers assuming the company will earn around $1.87 per share in the current financial year.

Because the projected PE requires a degree of guesswork it is, for this second 11 exercise, best to use historic ratios with Wesfarmers on the 17.4 demonstrated above and Woodside on 18.7. 

Both the Wesfarmers and Woodside PE ratios are higher than the second 1, an indication that investors expect both companies to boost earnings substantially this year; or it could be that both companies are overpriced.

BWP on 14.5. NRW on 15, and iiNet on 12 have ratios that indicate more modest profit expectations; or it could be that they represent better investment value.

Another reason smaller companies have lower PE ratios is that they are considered to be in a higher-risk category because of their size, and because being smaller can make it harder to acquire the number of shares wanted and, more importantly, harder to sell. Smaller in most cases means less liquid.

An interesting test of the risk/reward estimation implicit in a PE ratio is to compare Wesfarmers at 17.4 with BWP at 14.5 and consider the questions of risk, because Wesfarmers does have some risky business units, including its coal and chemicals divisions. 

BWP simply harvests rents from Australia’s most successful hardware chain.

Following is a closer examination of the WA second 11.

1) BWP Trust (ASX code BWP)

Market capitalisation: $934 million

Perhaps operates the simplest business of any ASX-listed company. BWP Trust owns the sites on which stand 61 Bunnings Warehouse stores, and a number of other Bunnings-related businesses (showrooms), and development sites.

The property portfolio is spread across Australia, with an emphasis on Victoria where property assets account for 38 per cent of rental income. Each of WA, NSW and Queensland accounts for between 18 per cent and 19 per cent, with the rest from South Australia and Canberra.

Last year, BWP units outperformed the overall stock market, essentially by opening and closing at the same price of about $1.72. That might not seem like a sparkling performance, but it is when everything else is falling. The trust also paid out 11.98 cents – a handsome per unit dividend from a profit of $49.8 million.

Because it is a property owner and does not own the Bunnings business it has little to fear from the entry of Woolworths into the hardware business, and might even benefit from higher prices for commercial properties as Bunnings and Woolworths compete for warehouse sites.

2) NRW Holdings (NWH)

$990 million

One of the quiet achievers of the resources sector, NRW started life in 1994 as a Kalgoorlie civil construction and equipment hire firm. Today it operates across the country servicing most parts of the mining industry from iron ore in WA to coal in Queensland.

Recent major contracts include work for FMG on its railway and port, and as a supplier to the BMA coalmining joint venture of BHP Billiton and Mitsubishi.

The existing client list of NRW reads like a who’s who of the Australian resources sector, and includes: OM Holdings at its Bootu Creek manganese mine; Gindalbie Metals at its Karara iron ore project; Rio Tinto at its Western Turner Syncline project; and as a contractor to Macmahon Holdings and the WA Government’s Main Roads department on civil engineering works.

NRW earned a net profit of $45.3 million from a record $610.4 million in revenue generated in the half-year, and doubled its dividend for the period to eight cents a share.

The future looks bright. The company has won its first major oil and gas contract (on Chevron’s Wheatstone LNG project), and a three-year extension on a contract with Rio Tinto on its Simandou iron ore project in Africa.

3) Buru Energy (BRU)

$608 million

The comeback vehicle for Eric Streitberg, one of Australia’s most successful oil explorers, Buru has made what looks to be a successful conventional oil discovery inland from Derby in the Canning Basis, and has attracted strong international interest in its search for unconventional hydrocarbons – shale oil and shale gas.

Remote and expensive, the Canning has long been rated as one of the best locations for significant onshore oil and gas production, but has largely failed to deliver apart from the occasional small discovery such as the Blina oilfield in the 1980s.

Buru, backed by Japan’s Mitsubishi and the big aluminium and alumina maker, Alcoa, believes it can unlock the wealth of the Canning, and has made a good start on that plan. 

Mitsubishi has teamed with Buru in the hope of future LNG production from the Canning. Alcoa has a gas supply agreement in the hope of pumping gas from the Canning south to its alumina refineries.

However, the real appeal is what comes next as new drilling and extraction technologies are applied to the region’s conventional and unconventional exploration targets.

4) Peet (PPC)

$256 million

Heavily oversold after a poor couple of years, Peet has been hit by uncertainty among property buyers spooked by tougher bank lending rules, rising interest rates, and a widespread belief that property values are more likely to fall than rise.

The worst, however, is almost certainly behind the company, which expects earnings in the current financial year to be at the upper end of its profit guidance forecasts – between $15 million and $20 million.

Consumer confidence is the key to a sustained revival in the stock, which has been in a downtrend since early 2011 but which has also shown improved recent stability around the 80-cents mark recently. 

Peet management argues that there is a structural imbalance between housing supply and demand across Australia, which can be seen in low levels of construction activity and a tightening rental market. 

When recovery starts, Peet believes it will be a beneficiary of an increase in house building.

5) Decmil (DCG)

$455 million

A builder and civil engineer with deep roots in the resources sector, Decmil suffered a share price slump in 2011 but has started 2012 strongly thanks to a growing order book.

Profit of $13 million in the half year to December 31 was down slightly on $14.1 million earned in the previous corresponding period, with revenue sliding from $233.7 million to $210.9 million.

Management reported that 2012 started with a solid workload, which has continued to grow. “Current business activity and forward work-load levels remain healthy and are anticipated to result in stronger second half sales revenue and earnings than those in the first half,” Decmil said in its half year filing at the ASX.

“The value of new projects and contract extensions secured during the first half of the financial year was approximately $280 million, which reflects the group’s strong market position and relationships with high quality clients.” 

6) Silver Lake (SLR)

$803 million

Arguably the pick of the WA gold miners, Silver Lake is a case study of how to develop a gold business where others have failed – aided to a large extent by the high gold price.

Profit in the half to December 31 rose by 185 per cent to $17.2 million, thanks to a 66 per cent increase in revenue to $67.6 million.

Good as that looks today, the real interest in Silver Lake lies in its expansion plans. All revenue currently comes from a series of mines south-east of Kalgoorlie. A second mine and processing centre is under construction in the Murchison district, and a third possible centre is being examined on the south coast.

Over the next few years, Silver Lake plans to lift gold production to 300,000 ounces by 2014, and potentially add copper to its metal inventory if drilling at the Hollandaire target in the Murchison continues to deliver the strong results it did last year.

7) Imdex (IMD)

$510 million

A supplier of drilling mud and other fluids to the mineral exploration and oil-drilling industry, Imdex has survived a number of downturns in its life, but now looks to be on a solid upward growth trajectory.

Net profit in the December half rose by 88 per cent to $22.7 million, from revenue that rose by 46 per cent to $139.9 million. That performance encouraged management to lift the interim dividend by 86 per cent to 3.2 5cents a share.

The minerals division was the star performer in the latest half-year, according to Imdex’s half-year statement, up 52 per cent to $124 million.

“Growth in our minerals division ... was the key driver for the group’s revenue growth and reflected continued strength in global drilling activity and increased mineral exploration expenditure,” the company said.

8) Marengo Mining (MGO)

$240 million

WA-based but very PNG-focssed, Marengo is in the final stages of planning a major new copper mine with powerful Chinese associates.

When developed, the Yandera mine will produce around 100,000 tonnes of copper a year, plus 15,000t of the steel-hardening mineral, molybdenum, and useful amounts of gold and other metals.

With a price tag estimated at $1.8 billion, Yandera is a heavy lift for a small company, but Marengo should be able to hit its ambitious construction and production targets thanks to the deal with China Nonferrous Industries.

The next few months are critical for Marengo. 

It has been conducting a furious drilling campaign at Yandera, which has boosted the already world-class resource at the project, and should release a detailed feasibility study around mid-year, all steps in a potential re-rating of a stock that is attracting interest from major international investment funds.

9) iiNet (IIN)

$497 million

A rare telecommunications success for WA, iiNet is the brainchild of Michael Malone, who has been a thorn in the side of the telco majors for the past decade, delivering what they promise – good service to customers.

Sounding simple, but hard for big companies such as Telstra and Optus to do, high service standards have attracted an Australia-wide following for the internet and voice services of iiNet.

Despite operating in an intensely competitive industry, iiNet lifted net profit by 17 per cent in the December half-year to $14.4 million, from revenue that rose by 11 per cent to $365 million – with the fine margin in telco services on display in those numbers.

Mr Malone appears happy to continue growing iiNet, but a time will come when one of the telco majors moves to buy iiNet’s customer base. When that fat cheque is waved it will be hard for shareholders to refuse, though while waiting for a big takeover payday the company is paying solid dividends, including the latest interim of six cents a share, up 20 per cent.

10) Iron Ore Holdings (IOH)

$282 million

One of WA’s more successful participants in the iron ore industry, Iron Ore Holdings is a business that might never ship a tonne of the mineral, preferring to sell its discoveries to bigger miners in what might be called a ‘bird in the hand, worth two in the bush’ management technique.

During the past two years, IOH has sold iron ore tenements to Rio Tinto and Mineral Resources, and recently entered into a sales deal with FMG. On the flipside of the asset sales, IOH is also a buyer of iron ore tenements.

Trading in tenements has been highly profitable for IOH, which reported a profit of $28.8 million in the December half, compared with a loss in the previous corresponding period of $10 million.

Asset trading will produce lumpy results, but the principle of taking cash today rather waiting several years can work well in the cyclical commodities world.

11) Alkane Resources (ALK)

$357 million

WA-based but with an increasing focus on gold and rare earth assets in NSW, Alkane has three important projects approaching their commercialisation points.

First cab off the rank is expected to be the small Tomingley gold project near Dubbo in western NSW. Budgeted to cost $95 million to develop the mine is forecast to produce 50,000 ounces of gold a year, but at a relatively high $942/oz.

The importance of Tomingley, however, is that it restores Alkane as a producer, and sets it up for bigger projects, including its world-class Dubbo rare earths development, and other possible goldmines at McPhillamys and Bodangora, assets which might also be sold as the company clears the decks for the game-changing rare earths development.

Dubbo is attracting interest from rare earth customers around the world, primarily because it represents a non-Chinese source of the unusual elements in the rare earth family, which are used extensively in electronics and other technologies.

12th man) Matrix Composites and Engineering (MCE)

$232 million

A specialist supplier of materials to the offshore oil and gas industry, Matrix’s share price was hammered by investors during 2011, with the company slipping to a loss of $6.4 million in the December half year.

Despite the loss, which was partly the result of revenue timing and costs associated with building a new facility at the Australian Marine Complex at Henderson, south of Fremantle, Matrix is confident of a return to profits thanks to a $US120 million order book and strong demand for its products.

In its half-year report to the ASX, Matrix listed a number of challenges, including the need for its new syntactic foam plant to achieve design capacity by June, and the financial burden of the high value of the Australian dollar against the $US. Highlights in the first half included a record $US700 million “quote book”, the $US120 million order book, and $US46.5 million in new contracts.


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