By James Dunn
With the February 2017 profit reporting season receding into the rear-view mirror, investors are still sifting through the good, the bad and the ugly. The season was generally strong, with overall results coming in better than anticipated. Broker Goldman Sachs says 46% of stocks beat their earnings per share (EPS) estimates, the highest number of “beats” since the global financial crisis – although 30% of stocks missed them.
Viewed another way, broker Credit Suisse noted that whereas on average analysts downgrade their earnings per share forecasts during results seasons by 0.9%, during this season they upgraded their second-half forecasts by 1.6%. On the basis of analysts upgrading of their dividend per share (DPS) forecasts in response to the December half results, Credit Suisse said it was “the best reporting season for dividends in over a decade.”
AMP Capital says the December-half profit reporting season left Australian listed company profits on track for a 19% rise for the June 2017 financial year, after two consecutive years of falls.
While there were some clear disappointments from the season, there were also some clear positives. Here are five of the latter, where analysts still see some value in the stocks.
South 32 (ASX code: S32)
- Market capitalisation: $14.4 billion
- Forecast FY17 yield: 5.2%, unfranked (at current exchange rates: company reports in $US)
- Analysts’ consensus target price: $3.15 (FN Arena)
- Implied upside: 16.5%
BHP Billiton spin-off South 32 reported an excellent half-year to December 2016, with a net profit of $US620 million ($804 million) in the half, compared to $US1.7 billion loss a year earlier, which was due mainly to asset write-downs. Earnings per share (EPS) came in at 11.7 US cents, up from a 32.9-cent loss per share the year before. South 32 benefited handsomely from the surge in metal prices in the latter part of 2016.
South 32 operates a portfolio of base metal and coking (steel-making) coal assets that BHP did not consider core assets. It has operations across three continents, with coal mines in NSW, alumina smelters and refineries in WA, South Africa, Brazil and Mozambique, the Cannington silver, lead and zinc mine in Queensland and manganese production in the Northern Territory, Tasmania and South Africa. Alumina/aluminium generates about 29% of underlying earnings, manganese ore 21% and silver/lead/zinc 26%).
The company’s interim result was expected to be strong given higher commodity prices, but it was better than expected, with aluminium and the Cannington operation particularly bountiful. Since the result Chinese government action to control pollution in northern China has also been positive for the company, with the recent announcement of proposed winter curtailment of activity in the aluminium/alumina and steel industries feeding straight into a rise in the S32 share price. Add to that the fact that manganese – which is already critical to the steel industry – is also becoming increasingly influential in clean energy and energy storage, and the planets are aligning nicely for South 32. Analysts mostly expect the second half of the financial year to be even stronger.
South 32’s share price has tripled in the last year, so there could be some profit-taking, but the company is raking in the free cash flow, and still looks cheap compared to commodity price forecasts.
NextDC (ASX code: NXT)
- Market capitalisation: $1.07 billion
- Forecast FY17 yield: no dividend
- Analysts’ consensus target price: $4.43 (FN Arena)
- Implied upside: 17.4%
Data centre operator NextDC also could not have had a much better reporting season: the stock posted a 39% profit jump, and was rewarded with a slew of analyst upgrades. Next DC operates five purpose-built data centres – in Melbourne, Brisbane, Sydney, Perth and Canberra – that offer secure co-location services to corporate, government and IT services companies.
NextDC hosts critical IT infrastructure – such as servers – for its customers, providing the data centre as a service. Whereas previously a company may have stored information on its own servers, the growing amount of data – combined with cheaper telecommunications – means it has become much more economical to store such data in the “cloud.”
Organisations are shifting their data into the cloud at an increasing rate, and NextDC’s results showed that it is at the heart of this move, and has further operating leverage to it. Demand is strong, NextDC’s costs are falling and this means cash flows are rising. It’s a great example on the stock exchange of a long-term play on a very strong business trend.
NextDC is not a dividend payer: it has sold its Sydney, Melbourne and Perth data centres into a real estate investment trust (REIT) called APDC Group, and that is the yield generator. NextDC does not own any of APDC Group’s equity – it leases its data centres from APDC on long-term leases. APDC Group is the only Australian listed REIT that owns data centre assets. According to FN Arena, analysts expect AJD to pay a 6.4% unfranked yield in FY17, and 6.5% in FY17.
- Market capitalisation: $408 million
- Forecast FY17 yield: 3.0%, fully franked
- Analysts’ consensus target price: $4.21 (FN Arena)
- Implied upside: 8.2%
In January last year, jewellery chain Lovisa brought out a profit warning after margins were squeezed by the weaker Australian dollar and sharp discounting, and the shares were hammered 46% lower. In a piece of unwanted symmetry, Lovisa’s net profit for FY16 also fell 46%, to $16.5 million – despite sales rising by 14.3%, to $153.5 million – and the company more than halved its final dividend.
It was a performance typical of a band of recently floated small-cap stocks, mainly in retail, that had become market favourites – but the downside of that status was that the market was always going to be savage if any of these delivered a blip in the expected story, as Lovisa did.
However, Lovisa shares recovered from their mauling, and the company rewarded that faith with a strong December 2016 half-year, reporting a 50% increase in net profit to $20.3 million, following strong sales (up 21%) and gross margin gains (up 1.8 percentage points to 77.8%), as Lovisa was able to raise its prices. Lovisa also benefited from its competitor Equip closing 120 of its stores.
Lovisa has a vertically integrated model, with its designers turning out a constant stream of new products, which are made for it in China, India and Thailand. As a discretionary fashion business it is exposed to the vagaries of the preferences of its younger customers: Lovisa needs to be “on-trend” at all times. It’s a model with an added degree of risk, but the market, in reinstating Lovisa so quickly after its early-2016 speed wobble, has shown a fair bit of faith in the company to manage it.
Lovisa opened 18 new stores during the period – taking its roster to 268 stores – with 44% of those outside Australia. The company’s latest expansion area earmarked is the UK, with seven stores already and plans for 15 by the end of the financial year. The model often cited by observers for Lovisa’s growth plans in the UK is Smiggle (owned by Premier Investments), which entered the British market just three years ago, but now has 90 stores, and plans to have 200 by 2020. Lovisa would aspire to similar growth, and while there is certainly great opportunity in the UK for it, the market will watch the expansion closely. But analysts see scope for a healthy gain from present levels, and a growing – but at this stage, below-market-average – fully franked yield.
Star Entertainment Group (SGR)
- Market capitalisation: $4.1 billion
- Forecast FY17 yield: 3.0%, fully franked
- Analysts’ consensus target price: $6.02 (FN Arena)
- Implied upside: 20.1%
Casino stocks have been on the nose since October, which saw Crown Resorts staff jailed in China amid a Chinese investigation into the “high-roller” market – in which Star Entertainment, operator of the Star casino in Sydney, the Treasury casino in Brisbane and Jupiters casino on the Gold Coast – also participates. But Star Entertainment posted a better-than-expected first-half result, more than doubling net profit to $141.8 million, on a revenue rise of 11%, to $1.2 billion. The company’s forward profit guidance was also seen as strong.
Revenue was affected by the uncertainty in the lucrative Asian high roller market: turnover from Star’s international VIP business dropped 27% in the last two months of 2016, after the detention of the Crown staff, amid Beijing’s crackdown on high-roller gambling promotions. Star was already shifting the focus of its international business away from relying on Chinese and Hong Kong clients, to develop the South-East Asian market: its sweet spot is gamblers who typically spend between $50,000 and $1 million per trip, and that market is growing.
Star is building the $2 billion Queen’s Wharf integrated resort project in Brisbane’s CBD, due to open in 2022, which incorporates its Treasury casino. Star is building a new $400 million, 700-room hotel and apartment tower near its casino.The company has also bought the Sheraton Grand Mirage on the Gold Coast to attract more guests. Analysts are highly positive on Star Entertainment, with the still-present share price beatdown after the Crown arrests making the stock look cheap, given its earnings growth prospects.
Vocus Group (VOC)
- Market capitalisation: $2.7 billion
- Forecast FY17 yield: 3%, fully franked
- Analysts’ consensus target price: $5.41 (FN Arena)
- Implied upside: 24.2%
Australia’s fourth-largest phone and internet provider, Vocus Communications, was pounded on the stock market back in November after it downgraded full-year earnings expectations at its annual general meeting. But the December 2016 half-year result was actually quite robust, with the telco reporting net profit of $47 million for the six months, up from $24 million a year earlier. First-half revenue jumped five-fold, to $888 million. Fully diluted underlying earnings per share grew by 26%, to 15 cents a share.
Even more welcome to investors was the fact that the company allayed concerns about its earnings prospects, reaffirming its recently revised guidance for annual underlying earnings before interest, tax, depreciation and amortisation (EBITDA) of $430 million–$450 million, on revenue of about $1.9 billion.
The company said the full-year result will be skewed towards the second half because of a higher earnings contribution from the company’s national fibre telecom network, Nextgen, further synergy benefits from its string of recent acquisitions – including the 2015 mergers with M2 Telecommunications and fibre-optic internet and data centre business Amcom – and solid earnings growth from its corporate and wholesale division. All divisions are looking at earnings growth and analysts expect full-year EPS growth of 30% this year and 34% in FY18. Vocus has not yet regained the full confidence of the stock market after November’s 28% fall, but analysts see this re-rating as being on the cards.
By James Dunn