26/04/2005 - 22:00

Tim Treadgold: Briefcase - BHP and Woolworths – what’s the deal?

26/04/2005 - 22:00

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Woolworths is trading on a prospective price/earnings ratio of 16.85. BHP Billiton is on 9.85. Can anyone explain the gap between two of Australia’s corporate icons because it is ridiculously wide?

Woolworths is trading on a prospective price/earnings ratio of 16.85. BHP Billiton is on 9.85. Can anyone explain the gap between two of Australia’s corporate icons because it is ridiculously wide?

In theory, and depending on your belief in the power of the PE (price-to-earnings ratio), it possibly makes one of those two a screaming buy and the other a screaming sell.

The buy, and you didn’t read it here ’cos Briefcase can’t give investment advice, is BHP. The theoretical sell is Woolworths – unless it can be shown that the odd man out is BHP because a single-digit PE for a market leader posting monster profits is a seriously interesting event.

Before delving too deeply into BHP v Woolworths a little explanation of the PE ratio might be useful for newcomers to the world of fundamental investment analysis.

A PE, as its name suggests, is a number derived from the price of a stock (in cents) and its earnings per share (also in cents).

The process is simplicity itself – divide the price by the earnings to arrive at a ratio.

The complexity comes in when you look at future year ‘forecast’ earnings, a process which involves a little bit of guess work, but provides a guide to future share price movement.

As you dig deeper you will find that certain categories of stocks have low PEs because they are seen as having erratic, or risky profit streams.

Others have high PEs because of their reliability.

Woolworths is obviously a reliable profit earner simply because we all have to eat, and it is Australia’s biggest food retailer. With a share price of $15.23 (at the date of this exercise) and earnings in 2004 of 70.1 cents it can seen that Woolworth’s ‘historic’ PE (last year’s) is 21.73 – 1,523 divided by 70.1.

The outlook, according to the consensus view of 13 stockbroking firms that follow Woolworths, is for a profit in the year to June 30 of $837 million, or 79.5 cents a share which, when divided into the current share price ($15.23) produces a prospective 2005 PE of 19.16.

Next year (2006), based on an earnings forecast of $948 million (90.4 cents a share), the PE comes out at 16.85.

In terms of value, that probably makes Woolworths a hold, rather than a buy, with more cautious investors drifting towards a sell situation because the PE is at the high end, even for a quality company.

If that’s the case, then what do we make of BHP Billiton, Australia’s biggest company, drifting into single-digit territory.

The historic BHP Billiton PE is 24.23, the forecast PE for the year to June 30 is 12.48, and the 2006 PE is that staggeringly low 9.85.

As far as Briefcase can see the single-digit PE is a result of the recent share price fall suffered by all stocks, and special concern about resource stocks that the best of the boom is over.

Perhaps that view is right. Booms do not go on forever. But when you look at the trend in profit forecasts, and the fact that China has not disappeared but will remain a voracious consumer of BHP Billiton’s iron ore, coal, copper and oil, then the single-digit status of the stock is hard to fathom.

The consensus view of 14 brokers who track BHP Billiton is that profit in the year to June 30 will come in at $US2.98 billion, rising in 2006 to $US3.76 billion, and then virtually steady in 2007 at $US3.65 billion (BHP Billiton reports in US dollars).

The profit trend is hardly a worry. In fact, the only real worry the directors of BHP Billiton face is what to do with the spare cash, and that probably means more share buy-backs and higher dividends, which makes a mockery of the market’s current assignment of a single-digit PE.

•••

Speaking of things hard to justify, it looks increasingly like Australia’s major newspaper groups are going to be forced into a fundamental re-think about how they treat the Internet.

The latest set of circulation figures were ordinary (verging on the awful), and made to look even worse because they came out a few days before the highly successfully listing of the Internet advertising leader, Seek Ltd.

While subscribers to the Seek float were posting handsome profits, traditional newspaper stocks were under pressure. Closest to home is WA Newspapers, which has eased back from a 12-month high of $9.07 reached on January 4 to trade now around the $8 mark.

WAN is not an orphan, though it is particularly interesting because it has been least enthusiastic about the Internet, and even operates a system of charging for electronic delivery of its flagship product, The West Australian newspaper, when many other publishers offer their products for free.

In fact, it is one of the great modern curiosities that you can buy a printed version of the daily paper for $1, or pay $4 for the electronic version, which has a cost base of zero, or thereabouts.

While print media publishers ponder their response to the net, a trip through the circulation figures is eye-popping. Sydney’s Daily Telegraph dropped an astonishing 6.6 per cent in the six months to March 31, and The Sydney Morning Herald was down 4.7 per cent. They are not just declines. They are a crash.

Closer to home, The West added 473 copies to its Monday-to-Friday sales (up 0.2 per cent) but lost 2,455 (down 0.6 per cent) on its most profitable day, Saturday.

If these were normal times no-one at WAN would be worried. But these are not normal times, as the tear-away success of the Seek float demonstrates, and as declining circulation at a time of rising population, and a booming state economy underline.

Briefcase may be wrong (yes, it can happen) but there must be a lot of newspaper executives chewing their pencils these days pondering what’s next with this beast they call ‘the net’.

•••

 “The salary of the chief executive of the large corporation is not a market award for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.” John Kenneth Galbraith

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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