Weekly Reviewn 27 February 2015

Virtus: Interim result 2015This Australian leader has its eyes on Ireland … p3

Santos: Result 2014 All eyes are on the imminent start of the second LNG project … p5

Carsales: Interim result 2015They missed recent earnings expectations – but it was for the best of reasons … p7

Stock Article

Quote, please??

FeaturesThe risky reach for yield - Exhibit A 32

Stock Articles company asx code recommendation page

Caltex Australia CTX Sell 15Macmahon Holdings MAH Hold 9

results

Austbrokers Holdings AUB Hold 30BWP Trust BWP Hold 18Carsales.com CAR Buy 7Hansen Technologies HSN Hold 28Medibank Private MPL Sell 22NIB Holdings NHF Hold 22Santos STO Buy 5Servcorp SRV Hold 21Sirtex Medical SRX Hold 16SMS Management SMX Hold 26Virtus Health VRT Buy 3Vision Eye Institute VEI Hold 24Wesfarmers WES Hold 11

Extras

Q&A 33Intelligentinvestor.com.au links 33Twitter links 33

Recommendation changes

company From to co. From to

Austbrokers Buy Hold DWS Buy SellCaltex Australia Hold Sell Macmahon Holdings Spec. Buy HoldCarsales.com Hold Buy Medibank Private Hold Sell

Portfolio changes

portFolio company Buy/ sell date no. oF shares price Value ($) Growth Caltex Australia Sell 26 Feb 15 390 $36.48 $14,227.20

n Intelligent Investor Share Advisor | PO Box Q744 Queen Victoria Building NSW 1230 | T 1800 620 414 | info@intelligentinvestor.com.au | intelligentinvestor.com.au/shares

disclaimer This publication is general in nature and does not take your personal situation into consideration. You should seek financial advice specific to your situation before making any financial decision. Past performance is not a reliable indicator of future performance. We encourage you to think of investing as a long-term pursuit. copyright© The Intelligent Investor Publishing Pty Ltd 2014. Intelligent Investor and associated websites and publications are published by The Intelligent Investor Publishing Pty Ltd ABN 12 108 915 233 (AFSL No. 282288). disclosure As at date of publication, in–house staff of Share Advisor held the following listed securities or managed investment schemes: ACR, AGI, AOG, ARP, ASX, AWC, AWE, AZZ, BYL, COH, CPU, CSL, DWS, EGG, FWD, HSN, ICQ, JIN, KRM, MAU, MLD, MQG, NST, NWH, NWS, OFX, PTM, QBE, RMD, RMS, RNY, SCG, SLR, SMX, SRV, SWK, SYD, TAP, TEN, TME, TPI, UXC, VEI, VMS, WES and WFD. This is not a recommendation.

Weekly Review • 27 February 2015

Contents

n Weekly Review | Intelligent Investor Share Advisor 3

Results

While most mana gements k now how to buy a business w ith other people’s money, some have f ig ured out how to actually run a business on other people’s money. IV F provider Virtus Health generates cash so quickly it actually sells and delivers its product before the company has even paid its suppliers.

Key Points

•Lowcapitalrequirements•Cyclevolumesunchanged•Foreignoperationsontrack

In contrast to, say, HarveyNorman, which must buy its inventory, put it on the shelf and then wait for a customer to swipe their credit card, Virtus’s clients are required to pay for their IVF cycle before the eggs are collected and the company has to shell out on drugs, tests, and doctors. In the meantime, Virtus holds on to the cash, and, as a consequence, the company has what’s known as negative working capital.

Ordinarily, having negative any thing isn’t a good thing, but with working capital it can be. Virtus is effectively ‘borrowing’ $10m from its customers to help fund its grow th – and it doesn’t have to pay them any interest.

The company’s ambitious expansion plans make this cheap form of funding more important than ever.

Vir tus recently boug ht I V F Sunshine Coast in Queensland for $1.2m and paid $16m for a 70% stake in Tasmanian-based provider TasIV F, which has its main laboratory in Hobart, and consulting clinics in Launceston and Devonport.

The company is also expanding overseas. Virtus’s new clinic in Singapore received its f irst clients in January and is expected to accommodate 350 IV F cycles a year. However, the start-up costs of building the $3.5m facility took a chunk out of the company’s net profit for the six months to December, which fell 1.5% to $16.7m.

Virtus’s Irish operations are also tick ing along nicely, w ith the addition of two new clinics. The integration of recent addition Sims IV F is on track with the number of cycles up 25% and the operating margin increasing from 20% to 22% due to various cost-cutting initiatives.

Normally we’re cautious of overseas acquisitions but the Irish expansion shows potential. Sims IV F has a 25% share of the Irish market, which has grown at roughly 5% a year since 2010.

However, this may u nderstate its tr ue g row th potential: 1,642 IVF cycles are performed in Australia per million people, whereas just 750 are performed in Ireland. This large discrepancy is most likely due to a lack of government funding. If this changes at some point in the future, there could be a significant

Virtus: Interim result 2015AssistedreproductionisontheriseandthisAustralianleaderhasitseyesonIreland.

GrahamWitcomb• 25 February 2015

VirtusHealth(VRT)Price at review $7.51Market caP. $600m12 Mth Price range $6.90–$8.93business risk Mediumshare Price risk MediumPortFolio weighting 5%our view Buy

Recommendationguide

Buy Hold Sellbelow $8.00 above $12.00

$7.51

4 Intelligent Investor Share Advisor | Weekly Review n

Results

Virtus Health generates cash

so quickly it actually sells

and delivers its product before

the company has even paid its

suppliers.

However, IV F requires a lot of technical know-how and Primary doesn’t have a track record. Recruiting doctors is also a slow process, so it will be difficult for Primary to grow rapidly.

Nonetheless, we expect Virtus will need to defend its 45% market share and find it hard to raise prices materially in the medium term. Furthermore, there’s a good chance the entrance of Primary will mean more competitive bidding when it comes to acquiring new clinics, which would take some shine off Virtus’s staggering returns on capital.

Table1:VRTinterimresult

six months to dec 2014 2013 +/– (%)

No. of cycles 7,646 7,618 (0)

ReveNue ($M) 114.5 101.4 13

NPAT ($M) 16.7 16.9 (2)

ePs (ceNTs) 20.7 21.2 (2)

INTeRIM dIvIdeNd 13.0c (up 8%), fully franked, ex date 31 March

Still, in ten years’ time, there will almost certainly be more assisted reproductive procedures taking place than there are today, and it’s hard to see Virtus’s place as the market leader being dislodged any time soon.

Management expects ‘ low to mid teens’ grow th in net profit for the 2015 financial year. Virtus’s share price has barely changed since Virtus expands in Tasmania on 7 Dec 14 (Buy – $7.31) and trades on a forward price-earnings ratio of around 17. That’s no steal, but it’s still a fair price for great business. BUY.

Note: Our model Income and Growth portfolios own shares in Virtus.

increase in demand – although given Ireland’s large budget deficit we aren’t holding our breath.

DomesticgrowthTotal revenue increased 13% to $114m for the six months to December, mainly due to a 17% increase in pre-natal diagnostic testing in Australia and two months’ contribution from the Sunshine Coast clinic.

The st rong revenue g row th d isg u ises a more discouraging f igure – the number of cycles barely budged at 7,646 for the half, though the overall IV F market was also f lat.

Management put it down to the slowing Australian economy, which is a reminder that Virtus is a more cyclical business than other healthcare companies, such as hospital operator RamsayHealthCare. Having a child is often a very high priority, but clients’ funds aren’t limitless and IV F is expensive.

What’s more, the proportion of cycles from Virtus’s low-cost offering – The Fertility Clinic – is on the rise. This suggests affordability is becoming an issue, which w ill make it harder for Virtus to increase revenue through price rises alone.

PricingpressureIn fact, there’s good reason to think that downward pressure on prices might increase over time. Primary Health Care entered the market in July 2014 with its f irst low-priced clinic in Sydney and it has plans to roll out more.

Around 80% of IV F clients are referred by GPs and Primary has Australia’s largest network of GPs with around a 15% market share. Assuming it favours its own offering, it could capture a good 10% or more of the IV F market.

n Weekly Review | Intelligent Investor Share Advisor 5

Results

Following the dramatic slump in oil prices investors expected impairments in Santos’s full-year results – and they got them. The largest f igure presented was the $2.3bn that Santos slashed from the value of some Cooper Basin fields and undeveloped coal seam gas projects. Interestingly, Gladstone LNG (GLNG), the project that caused the most concern, escaped without impairment.

Key Points

•PNGLNGstartsproduction•GLNGontrack•Anoptionontheoilprice

That is a result mostly of aggressive accounting from Santos. Management could have written down assets from GLNG as its neighbour, BG, has done but it has clung to higher oil price assumptions, suggesting prices of US$70 a barrel next year. Although it’s a view we happen to agree with, there is a case for being more conservative.

The impairment – or the lack of one – was the only surprise. Otherwise, the results were as expected.

Production volumes rose 6% to 54 million barrels of oil equivalent (mmboe), with PNG LNG contributing new output; about 50 LNG cargoes have already been filled and the project is ahead of schedule.

Revenue, which rose 12% to over $4bn, benefited from average recorded oil prices of $114 a barrel so oil revenue will be savaged next year. Santos earned about 50% of its revenue from oil last year, higher than average because of high oil prices. As LNG projects are completed, about 75% of revenue is likely to be oil-linked so persistently low oil prices will eventually hurt profits.

Some of that pain can already be seen from results in the WA business, which reported a 35% fall in operating profit to $635m. Profit from the Cooper Basin was, as always, steady and reliable. We expect returns from the Eastern Australian business to rise as gas prices increase from next year.

Table1:STOresult2014

year to 31 dec 2014 2013 +/– (%)

PRoducTIoN (MMboe) 54.1 51 6

ReveNue ($M) 4,037 3,602 12

sTAT ebIT ($M) (1,447) 886 (263)

uNdeRlyINg NPAT 533 504 6

uNdeRlyINg ePs (c) 54 51 6

dPs 35c, fully franked, ex date 25 Feb

Santos: Result 2014 OneofSantos’stwoLNGprojectsisnowoperational.Alleyesareontheimminentstartofthesecond.

GauravSodhi• 24 February 2015

Santos(STO)Price at review $8.15Market caP. $7.5bn12 Mth Price range $6.96–$15.32business risk Med–Highshare Price risk Med–HighPortFolio weighting 4%our view Buy

Recommendationguide

Buy Hold Sellbelow $10.00 above $16.00

$8.15

6 Intelligent Investor Share Advisor | Weekly Review n

Results

The Asian business was the star this year w ith operating profit soaring 130% to $743m ref lecting the start of PNG LNG which alone contributed $500m in additional revenue.

DebtanddividendsDespite operating cash f low rising 13% to $1.8bn, Santos still drew down another $2bn of debt, taking total net debt to $7.5bn, a frightening sum. With lower oil prices sure to crimp cash f low next year the business is looking to sell assets and infrastructure to raise cash. Debt will peak shortly but should decline as GLNG cash starts to f low.

There was nothing in this result to change our view that Santos is stressed but cheap. We presented detailed estimates of potential cash f low for the business in Santos: under fire or under water on 17 Dec 14 (Buy – $7.58) and recommend reading that review.

Fancy modelling simply confirms what investors already k now: that oil prices w ill determine the future for Santos. That leaves the investment case an easy one. Oil price bears – and there are many smart folks in that camp – can steer clear. For the bulls, Santos is an attractive option on the oil price. BUY.

Fancy modelling simply confirms

what investors already know: that oil prices

will determine the future for

Santos.

n Weekly Review | Intelligent Investor Share Advisor 7

Results

Carsales’ share price went on a wild goose chase following its interim results last Wednesday, initially falling 7% before recovering to close down only 1%.

Key Points

•EPSgrowthlowerthanexpectedduetomarketinginvestmentinStrattonFinance

• Internationalbusinessesgrowingquickly•Corebusinessstrong•UpgradingtoBuy

The initial fall was presumably a knee-jerk reaction to the company increasing earnings per share by only 6% compared forecasts for 10% grow th – and the recover y due to recognition of the fact that the earnings shortfall was for a very good reason, aggressive marketing investment in newly acquired Stratton Finance.

GrandambitionsCarsales paid $60m for a 50.1% stake in Stratton in July last year, w ith the ver y sound strateg y of increasing its long-standing customer’s exposure over its sites at the same time as helping to sell cars by providing f inance for buyers. Carsales clearly has grander ambitions for the business, judging by the 41% increase in sales and marketing expense, apparently pretty much all due to Stratton.

We love to see companies making shrewd acquisitions and investing in them rather than just cutting costs – which brings us to Carsales’ burgeoning portfolio of international businesses for which it also has grand ambitions.

The South Korean SK Encar and the Brazilian Webmotors are already profitable and appear to performing well, w ith revenue up 38% and 24% respectively, alongside improved operating metrics (particularly Webmotors). iCarAsia is at an earlier stage and Carsales’ share made a loss of almost $2m in the period. iCar also recently announced a write-down on its Mobile123 site in Indonesia, due to increased investment pushing back its expected shift to being cash f low positive.

Table1:Carsalesinterimresult2015

six months to dec 2014 2013 +/– (%)

ReveNue ($M) 150.9 112.3 34

ebIT ($M) 70.8 62.0 14

NeT PRofIT ($M) 46.7 43.9 6

ePs (c) 19.6 18.5 6

INTeRIM dIvIdeNd 16.2c fully franked (up 10%), ex date 23 Mar

Carsales: Interim result 2015Theonlinecarclassifiedssitemissedearningsexpectationslastweek–butitwasforthebestofreasons.

JamesCarlisle• 23 February 2015

Carsales.com(CAR)Price at review $10.17 Market caP. $2.4bn12 Mth Price range $9.35–$12.61business risk Mediumshare Price risk Med–HighPortFolio weighting 6%our view Buy

Recommendationguide

Buy Hold Sellbelow $11.00 above $15.00

$10.17

8 Intelligent Investor Share Advisor | Weekly Review n

Results

The performance of the core local business was much as expected, with private revenue up 16% on the prior period, largely driven by price rises, and dealer and data services up 20%. The dealer channel, however, is the biggest contributor and grew only 8%, while display advertising increased revenues by 3% ‘ in a challenging environment’.

CarssellingquicklyNew cars listings fell to about 35,000, from 43,000 in the prior period (and over 50,000 in the one before), due to the much-publicised bans by some car manufacturers on dealers listing their new cars. Dealer used car listings also fell 4% and Private l ist ings sh ran k about 12% , but the lat ter wa s apparently largely due to cars selling more quickly (‘a very positive consumer metric’).

Carsales retains its local dominance, with 5.5m site visits in January, compared to 2.4m for Drive.com.au and 1.6m for Carsguide.com.au (according to data from SimilarWeb). Crucially, though, the levels of engagement is much higher for Carsales than for its rivals: almost half the traffic comes to it directly instead of via searches, ads and links on other sites (compared to 14% and 12%); only 19% of visitors leave

the site after visiting only one page (compared to 61% for the others); and the average visitor spends 11 minutes on the site per visit (compared to about 2 or 3).

As ever, free cash f low came to about 90% of net profit. However, the money spent buying Stratton Finance pushed net debt up from $150m in June to $201m in December. The interest bill is covered more than 20 times by operating profit.

The higher costs associated with Stratton Finance mean Carsales will probably only make around 43–44 cents for the full year (up from 40 cents), compared with previous forecasts of about 46 cents. With the stock down slightly since our update on the f irst quarter, that amounts to a price-earnings ratio of about 23, which looks attractive given the strong cash generation and growth prospects. We’re raising our Buy price to $11 and upgrading to BUY.

Note 1: Our model Growth and Income portfolios hold shares in Carsales.

Note II: Carsales’ ASX code has been changed to CAR (as of 25 Feb).

We love to see companies

making shrewd acquisitions and investing in them

rather than just cutting costs

n Weekly Review | Intelligent Investor Share Advisor 9

Stock Article

MacMa hon wa s supposed to generate $1. 2bn in revenue over a f ive-year period from work on Fortescue Metals’ Christmas Creek iron ore mine. It was the contractor’s single largest project and a key lynchpin in our investment case when we included MacMahon in our mining services mini portfolio (see Is it time to buy mining services? Part 3).

Key Points

•LostkeyChristmasCreekcontract• Indiscussionwithbanksaboutfunding•DowngradetoHold

In a f lash, the company announced this morning that it had lost the contract, triggering a 40% collapse in its share price. This is not a case of the market overreacting to mildly bad news with a devastating sell-off: this is seriously bad news for the business.

The premature contract loss w ill mean the loss of $780m worth of revenue over the nex t three years, enough to force an immediate restructure. Management has already slashed revenue forecasts (for a second t i me) t o $ 6 0 0 –70 0 m a nd is i n discussions with banks about the company’s debt.

MacMahon currently carries $169m of debt and has $124m in cash on the balance sheet. Although

net debt is relatively low at just $45m, the sudden loss of so much revenue means banks can demand repayment.

The bu si ne s s now ha s 9 0 d ay s t o c omplet e negotiations w ith banks and, if that goes badly, another 60 days to repay them. Quite suddenly, MacMahon, which has been in business for half a century, could fall over. With enough work on hand, banks should allow a sensible restructure of debt but sense is often lost in the scramble for dollars.

The loss of Christmas Creek is a shock. Fortescue has decided to aggregate contracts to a single supplier, a move it says will save it as much as $19m a month on the project. MacMahon has just become the latest – and most surprising – victim of the iron ore price slump. It will have to dramatically shrink its cost base and successfully renegotiate with banks to survive.

For all the downside, the business remains cheap with significant contracts still on the books, including work at the Tropicana gold mine which MacMahon will lead until 2022 although, as we have

MacMahon loses Christmas Creek MacMahonhasabruptlylostitsbiggestcontracttotalling$780mofrevenue.

GauravSodhi• 23 February 2015

In a flash, the company

announced this morning

that it had lost the contract,

triggering a 40% collapse in its

share price.

MacmahonHoldings(MAH)Price at review $0.04 Market caP. $50m12 Mth Price range $0.03–$0.14business risk Highshare Price risk HighPortFolio weighting 1%our view hold

10Intelligent Investor Share Advisor | Weekly Review n

Stock Article

seen, contracts aren’t worth much in this industry. The downside has increased but low portfolio limits offer some protection.

There are a few lessons to draw from this. Firstly, this is an absurdly lousy industr y. Order books and contracts aren’t guarantees and producers are always better placed – in booms and in busts – than contractors. Our foray into the sector might end OK but, to date, it has been disastrous with MacMahon down 60% since our first recommendation. Bottom feeding has been costly so far.

Some investors may w ish to crystalise a tax loss but we are willing to wait through the discussion with banks. In the meantime, we’re downgrading to HOLD.

This is seriously bad news for the

business.

n Weekly Review | Intelligent Investor Share Advisor 11

Results

Was R ichard Goyder rig ht to buy Coles Group seven years a go? Wesfar mers’ latest ha l f-year results suggest the answer is a resounding ‘yes’. The company’s original businesses – with the noteworthy exception of Bunnings – produced interim profits that might charitably be described as ‘uninspiring’.

Key Points

•ColesandBunningsrepresentmorethan75%ofWesfarmers’value

•Bothareworthmuchmorethanseveralyears ago

•Alargeacquisitionwilllikelycomeeventually

Just 9% of earnings came f rom the company’s Resources, Chemicals, Energy, Fertilisers, Industrial & Safet y businesses. Bet ween them, Coles and Bunnings produced 72%, while the remaining retail businesses accounted for 19%.

With 91% of f i rst-ha l f ea r n i ngs com i ng f rom sel l ing st u f f to consu mers, Wesfar mers look s less a cong lomerate and more a retai ler. That prospect has caused some commentators to ask: Does the company need an acquisition to restore diversification? You’ll probably be able to guess our answer to that, but before we get onto it, let’s take a look at the result.

Removing the effect of businesses that were sold (such as insurance), Wesfarmers reported operating revenue up 4% to $32bn. Earnings before interest and tax (EBIT) rose 6% to $2.1bn and earnings per share (EPS) was up 10% to $1.21.

It’s pleasing to see EPS rising again, reversing the four-year decline of 2007 to 2010 (see Wesfarmers versus Berkshire from 16 Apr 12 (Hold – $29.51) for the back story). Free cash f low was $1.4bn, or about $1.23 per share – more than enough to fund the fully franked interim dividend of 89 cents (ex date 24 Feb), up from 85 cents.

ColesWesfarmers continues to deliver on its turnaround of Coles: EBIT rose 7% to $895m in the first half and has now doubled since 2008.

While much hard work has been done in-store – with 64% of stores now in Coles’ new format – there is further potential. In particular, Coles’ supply chain and liquor business lag behind Woolworths.

So do operating margins, which rose from 5.1% to 5.3% during the half (food and liquor only). Indeed, they’re unlikely to reach Woolworths’ 8.0% margins because Coles is choosing to lower prices instead of fattening margins.

Wesfarmers: Interim result 2015 WesfarmershasdoneagreatjobwithColesandBunningsandthiswasborneoutinitslatestresults;there’slikelymoretocome,butthisisborneoutinitsvaluation.

JamesGreenhalgh• 25 February 2015

Wesfarmers(WES)Price at review $45.49 Market caP. $47bn12 Mth range $40.33–$46.69business risk low–Medshare Price risk MediumPortFolio weighting 8%our view hold

Recommendationguide

Buy Hold Sellbelow $35.00 above $50.00

$45.49

12Intelligent Investor Share Advisor | Weekly Review n

Results

This is ‘pain now, gain later’ management behaviour, and exactly the way to build long-term value. It’s also partly why Woolworths was dow ngraded to Hold in What’s Woolworths worth?. With its price reinvestment strateg y, Coles is l ikely to end up attracting more customers, which will ultimately force Woolworths to respond by cutting prices itself. Paradoxically, Woolworths’ world-leading margins are now a weakness, not a strength.

Table1:Wesfarmers’interimresult

six months to dec 2015 2014 +/– (%)

ReveNue* ($M) 31,970 30,743 4

ebIT* ($M) 2,076 1,960 6

NPAT* ($M) 1,376 1,271 8

ePs* (ceNTs) 120.7 110.2 10

INTeRIM dIvIdeNd 89c (up 5%), 100% franked, ex date 24 Feb

*fromcontinuingoperations

Coles has become a f irst-class business with good profit growth momentum, so it deserves a premium valuation (see Table 2). While our ‘high’ multiple of 16 times 2014 historical EBIT looks steep, it equates to a forecast 2016 price-earnings ratio of about 20. It recognises that Coles is now worth a lot more than Wesfarmers paid, as well as the valuation we ascribed to it on 16 Apr 12.

HomeimprovementBunnings is another first-class business, with EBIT increasing 10% to $618m in the first half and having doubled since 2007.

Bunnings has clearly been fortifying itself against Woolworths’ Masters for several years. At the results presentation, Bunnings managing director John Gillam highlighted that the division has spent $3bn on capital expenditure since 2010.

Some of this has funded store openings, w ith 40 Bunnings to open in 2015 and 2016, as well as another 70 sites in the pipeline. Masters has struggled to obtain good sites, particularly in important markets like Sydney.

While store openings depress margins in the short term, Gillam explained that ‘greater brand reach’ – code for grabbing the best sites before Masters – has been vital. It’s clear that Bunnings’ lead over Masters is virtually insurmountable, as predicted in Wesfarmers to win hardware battle back in 2009. Like Coles, Bunnings has also been investing in lower prices to attract customers.

As with Coles, Bunnings is worth considerably more than on 16 Apr 12. At multiples of 12-16 times 2014 EBIT, we value Bunnings at between $11.7bn and $15.7bn (see Table 2).

Officeworks,TargetandKmartL et ’s t u r n now t o the rema i n i ng bu si nesses , remembering that in total they’re worth less than a quarter of Wesfarmers’ total valuation. Officeworks, the company’s office supplies business, has proved itself a consistent performer and the latest half was no exception, w ith EBIT rising 19% to $50m. Its $1.6bn ‘high’ valuation in Table 2 represents about one times sales.

The d ivergence bet ween Target and K mar t in recent years is noteworthy. Target’s fall from grace has been spectacular. In 2009 its 10% operating margins looked too high (see Wesfarmers finds solace in stability); now its 2.5% margins look too low. K mart is the reverse: after underperforming for years its 9% margins now look unsustainable. Discount department stores, being mature and cyclical assets, don’t deserve premium prices and our ‘high’ valuations for Target and Kmart equate to 0.6 and 0.8 times sales respectively (Myer currently trades at somewhat less than 0.4 times sales).

Resources,WesCEFandIndustrial&SafetyAs we suggested in Coal: A dark future ahead on 11 Jul 12, it’s been a dark few years for coal and we don’t see it getting any better. While the company’s Resources div ision has produced average EBIT of $250m over the past f ive years, low coal prices saw prof it fall 41% to just $35m in the f irst half. Wesfarmers once valued this division at $5bn but a ‘high’ valuation of $2.6bn now seems generous.

The Chemicals, Energ y and Fertilisers (WesCEF) division has produced reasonably stable earnings and a decent return on capital in recent years, but EBIT fell 14% during the f irst half. Industrial and Safety fared even worse, with profit down 32%. It’s hard to escape the conclusion that both divisions might suffer as the resources boom peters out, so high valuations of $2.4bn and $1.4bn are similar to those from 16 Apr 12.

ValuationMaking allowance for corporate costs (and adding back the value of other assets), deducting net debt, then dividing by 1,143m shares on issue gives a valuation for Wesfarmers of between $29 and $44 a share.

This is ‘pain now, gain later’

management behaviour, and exactly the way

to build long-term value.

n Weekly Review | Intelligent Investor Share Advisor 13

Results

With the share price sl ig htly above ou r ‘ hig h ’ valuation, investors clearly have conf idence in Wesfarmers’ future. The conf idence seems well-placed. Management has significantly increased the value of Coles and Bunnings over recent years – by enough to justify the high price it paid.

Despite this, Wesfarmers would likely be trading at a higher share price had it not piled up the debt to buy Coles – forcing it into two dilutive capital raisings. Our back-of-the-envelope calculations suggest an ex-Coles valuation range of $39 to $59 a share. Whilst that’s now history, it’s a salient reminder of how debt-fuelled acquisitions can destroy value.

So should Wesfarmers make another acquisition to restore diversif ication? With t wo f irst-class businesses in which it can deploy capita l , the answer is no. Wesfarmers is certainly not short of opportunities and in 2014 spent $1.5bn improving the already strong market positions of both businesses.

Whatever we think, a multi-billion dollar acquisition seems inevitable. Wesfarmers looked at hospital operator Healthscope before it f loated, and Orica is another possibility. Whatever target Richard Goyder chooses, though, he’s unlikely to be as cavalier with debt finance as he was in 2007.

Wesfarmers has undoubtedly done a great job with Coles and Bunnings and there is likely more to come, but some of that is already encapsulated in our $44 per share ‘High’ valuation, which implies multiples for those businesses of around 20 times 2016 net profit. We’re prepared to allow a small management premium – despite our reservations about further acquisitions – but it’s hard to justify a share price much above $50, which is where our Sell price remains. As before, we’d start to get interested in buying the stock below $35. HOLD.

Disclosure:StaffownsharesinWesfarmersbutnottheauthor,JamesGreenhalgh.

Table2:Wesfarmersvaluation

diVision 2014 1h15 low high low high eBit eBit multiple multiple Value Value ($m) ($m) on 2014 on 2014 ($m) ($m) eBit eBit

coles 1,672 895 12 16 20,064 26,752

buNNINgs 979 618 12 16 11,748 15,664

offIce suPPlIes 103 50 10 16 1,030 1,648

TARgeT 86 70 15 25 1,290 2,150

KMART 366 289 6 9 2,196 3,294

ResouRces 130 35 5 20 650 2,600

Wescef 221 95 7 11 1,547 2,431

INdusTRIAl & sAfeTy 131 50 7 11 917 1,441

less coRPoRATe/oTHeR (122) (26) (1,400) (1,400)

ToTAl 3,566 38,042 54,580

less NeT debT (4,508) (4,508)

coMPANy vAlue 33,534 50,072

vAlue PeR sHARe ($) 29 44

A multi-billion dollar

acquisition seems inevitable.

14Intelligent Investor Share Advisor | Weekly Review n

Stock Article

The investment case for Caltex was a simple one: what appeared, in agg regate, to be an average business was in fact a combination of a great business and a lousy one. The announced closure of the lousy business would lift the good one from obscurity and transform Caltex for the better.

Key Points

•Nowadecentqualitybusiness•Pricenowreflectsquality•Timetotakeprofits.Sell

We made the buy case in Caltex: a fuels errand (Buy – $18.68) and, with the business’s transformation now complete and the share price up 93%, it’s time to take profits and look for the next opportunity.

Banishing a stock from your portfolio – especially one that has been so generous – is always hard. That is particularly true in this case because Caltex is a much better business today than when we bought it. The company’s full-year result confirms that there have been no gremlins in the change from a refiner to a retailer and that a decent business is now in place.

ProfitadjustmentCaltex reported headline profits of just $20m but that number needs adjustment before it accurately ref lects changes in the business. Caltex holds

billions of dollars of fuel as inventor y, t y pically two months’ worth of supply. That supply has been bought at one price and sold, after several months, at another. Movements in currency and crude oil prices impact profits but don’t ref lect underlying business performance.

Caltex, like all refiners, adjusts for movements in oil prices to report profit on a replacement cost basis. On this measure, net profit rose almost 50% to $493m helped by a stronger refining margin as a result of lower oil prices. This was the ref ining div ision’s f inal hurrah because refining revenue will all but disappear and, from next year, Caltex will be a fuel marketing business. That being the case, it’s useful to examine results from the marketing business alone.

MarvellousmarketingHere, earnings before interest and tax rose 6% to $812m. As they have for many years, fuel volumes fell 1% but the drop was more than offset by a seemingly never ending rise in sales of premium fuel which now makes up 29% of total fuel sales.

Margins continued to march higher, rising from 4.4c per litre to 5.1c per litre. Some of this increase was a result of petrol stations withholding the impact of lower oil prices. Eventually, competition will force petrol stations to pass on sav ings so we expect margins to fall slightly.

CaltexAustralia(CTX)Price at review $36.48 Market caP. $9.9bn12 Mth range $20.95–$37.70business risk low–Medshare Price risk low–MedPortFolio weighting 6%our view sell

Recommendationguide

Buy Hold Sellbelow $26.00 above $35.00

$36.48

Caltex: Time to sell? Full-yearresultsconfirmthatCaltexhaschangedfromalousybusinesstoadecentone.Thesharepricesuggestseveryoneknowsit.

GauravSodhi• 26 February 2015

n Weekly Review | Intelligent Investor Share Advisor 15

Stock Article

Although these appear to be excellent results, they match our forecasts almost exactly. We expect the marketing division to make about $890m by 2016 and then grow modestly with inflation. Today’s share price, however, implies an EBIT multiple of over 12 times which translates to a likely PER of about 18. That’s a rich price for a business with limited growth prospects.

This highlights a key risk . Hav ing succeeded in turning the business around, management is keen to grow it. The only way to do that is by acquisitions. With limited room from reg ulators to buy f uel stops, Caltex has hinted it will look at other types of retail, away from fuel. Stepping away from its core competency could be dangerous.

The counter argument is that, having improved the business substantially, management now deserves the benefit of the doubt. Perhaps future acquisitions will generate strong returns. The other point to note is that Caltex will pay 40-60% of profits as dividends and, with $1bn of franking credits to use, the business could distribute a lot of cash to shareholders.

Let’s say Caltex sticks to a 50% payout ratio on future profits. That implies dividends of about $1.15 per share, up from 70c today. That still equals a yield of just over 3% at the current price, not enough to get excited about.

ThecaseforsellingWhichever way you cut it, Caltex is fully priced today and important risks remain. Foremost among them is the structural shift in fuel demand. With engine efficiency increasing every year and car ownership rates falling the world over, it is possible that fuel sales have already peaked and electricity, rather than petrol, will power ever more vehicles. We don’t want to hold Caltex at premium prices whilst an existential threat hangs over it.

Margins have doubled over a decade to support grow th but they won’t double again. High petrol margins have been driven by grow ing premium fuel sales which, we suspect, rely on regulations supporting ethanol fuels. If reg ulations were to change, a substitution from premium to regular fuels could lower margins again. We fail to see why diesel fuel margins remain so high and they are vulnerable to falls.

We’re willing to accept those risks at a lower share price but not at the current one. We would, however, revisit the business at lower prices or if management can establish revenue growth.

In many ways, Caltex has been a textbook example of value investing: the market failed to correctly price the transformation of the business, allowing us to exploit that mispricing. That opportunity has gone. A growing dividend and steady cash f lows should deliver returns of about 5–6% from here. For some, that will be enough.

For the risk involved, we don’t think it is. Just as we ex hibited prudence w ith the buy call, we should likewise show prudence when selling. Caltex is now a decent business but everyone knows it. At today’s price, we’d prefer to deploy profits elsewhere. It’s time to SELL.

Note: We are selling 390 shares from the Growth Portfolio at $36.48 to raise $14,227.

In many ways, Caltex has

been a textbook example of value

investing: the market failed

to correctly price the

transformation of the business,

allowing us to exploit that mispricing.

16Intelligent Investor Share Advisor | Weekly Review n

Results

As Mae West once said, ‘too much of a good thing can be wonderful’. Sirtex Medical has now posted 42 consecutive quarters of growth, and its latest interim result didn’t disappoint.

Key Points

•Stronggrowthindosesales•Netprofitup58%•Maxportfoliolimitof3%;Hold

Sales of the company’s main product, an internal radiotherapy for liver cancer known as SIR-Spheres, increased 26% to 4,950 doses for the six months to December due to the therapy’s growing acceptance in the medical community. Higher prices per dose and the lower Aussie dollar helped increase revenue 37% to $80m.

Sirtex spent $12m this half on clinical studies that it hopes w ill further improve acceptance among doctors. The largest of the studies, SIRFLOX, is due to present its preliminary results next month and, if SIR-Spheres are considered an effective first-line treatment, could greatly expand the number of doses sold (see Sirtex targets growing market from 14 Mar 14 (Hold – $15.56)).

Because most of Sirtex’s costs are fixed, 30 cents of every additional dollar of revenue fell straight to the bottom line, pushing net profit up 58% to $18m in the six months to December.

US&UKThe number of treatment centres using SIR-Spheres in the US increased 17% to 453, which helped increase sales in the region by 28%. The country now accounts for just under 70% of total sales.

For better or worse, Sirtex increased the price of treatment by US$1,000, which is noteworthy given that a single dose already cost upwards of US$15,000. It’s a sad reality but most patients are willing to pay whatever it takes to gain an extra few months of life, which gives Sirtex significant pricing power.

European dose sales increased 28% mainly due to expanded funding by the UK’s National Health Ser v ice (N HS) u nder the new ‘Comm issioning through Evaluation’ program, which was established to help rei mbu rse pat ient s u ndergoi ng novel therapies.

Sirtex: Interim result 2014Pricerisesandexpandedpatientreimbursementhavedrivenanotheranotherrecordresultforthiscancerspecialist.

GrahamWitcomb• 24 February 2015

It’s a sad reality but most patients are willing to pay whatever it takes

to gain an extra few months of

life, which gives Sirtex significant

pricing power.

SirtexMedical(SRX)Price at review $34.64Market caP. $2bn12 Mth range $14.50–$36.23business risk Highshare Price risk very HighPortFolio weighting 3%our view hold

n Weekly Review | Intelligent Investor Share Advisor 17

Results

The NHS expects around 220 patients per year to be treated with Selective Internal Radiation Therapy as part of the program and we expect SIR-Spheres to treat around half of those g iven its current market share.

2020visionManagement outlined its v ision for Sirtex over the next five years. Its f irst priority will be to ‘ fully exploit’ SIR-Spheres by expanding their use as a first-line treatment for liver, kidney and other cancers. The company is also researching various alternative applications for the ‘nanoparticle’ technology used in SIR-Spheres, though it didn’t go into detail.

Furthermore, management said it would pursue acquisitions that come w ith ‘commercial ready technology’. Sirtex has a pristine balance sheet and a $50m cash pile, so it has the f inancial f irepower to make some bold moves on the acquisition front. However, we’re war y of acquisitions at the best of times – and especially so when management’s track record, impressive as it may be, is limited to commercialising a single product. The possibilities are endless, and so are the risks.

Sirtex’s share price has increased 55% since Sirtex: Result 2014 on 2 Sep 14 (Hold – $22.30) and is up over f ive times since we f irst upgraded the stock in Sirtex enters remission on 8 Nov 10 (Speculative Buy – $5.90).

The company continues to look expensive by most measures – but a few more years of 50%-plus earnings growth would justify even today’s price. A lot hinges on the success of SIRFLOX and given the vast range of possible outcomes, we’ll only know in hindsight whether it was worth holding on.

Table1:SRXinterimresult

six months to dec 2014 2013 +/– (%)

ReveNue ($M) 80.4 58.6 37

gRoss PRofIT ($M) 67.8 49.3 37

NPAT ($M) 17.7 11.2 58

ePs (ceNTs) 30.5 19.5 56

INTeRIM dIvIdeNd 14.0c (up 17%), fully franked, ex date 3 March

Sirtex hasn’t let us dow n yet but it ’s inherently difficult to pin down a valuation for such a rapidly growing business so we recommend you continue to lock in profits as the price rises and maintain a maximum portfolio weighting of 3%. HOLD.

The company continues to look

expensive by most measures

– but a few more years of 50%-plus

earnings growth would justify even today’s

price.

18Intelligent Investor Share Advisor | Weekly Review n

Results

The share price of BW P Trust (BW P) has increased 32% since we upgraded it in Bunnings upgraded to Buy for a total return of 42% in barely a year. That’s a ridiculous return for such a predictable and widely covered business, and shows the power of low interest rates on share prices.

Key Points

•BunningsWarehouseperformingstrongly•Marketrentreviewspositive• IncreasingSellpriceinrecoguide

A listed security is never a substitute for a term deposit, particularly those protected by a government guarantee. But we’d much rather own BW P than have our money tied up in a term deposit, as we’re expecting interest rates to fall further and its rents are protected against inf lation. That’s why we’re bumping up the Sell price in the recommendation guide by 10%, but you must be mindful of the risks.

With 81 of its 84 properties leased to Wesfarmers’s Bunnings Warehouse, the continued success of the hardware chain is the major attraction – and the major risk – for investors in BW P. While the share prices of most retailers have been crushed lately, hardware retailer Bunnings produced a remarkable 9.1% growth in same-store sales. Clearly Masters isn’t providing much competition just yet.

It’s important to remember that Bunnings Warehouse is virtually the trust’s sole tenant, so if the business crumbled for some reason rents and distributions would dry up. That’s a highly unlikely scenario in our view, but you should still consider taking profits as the company’s share price increases to control your portfolio limit in case something changes.

The trust’s like-for-like rental growth was 2.7% for the 2014 calendar year, down from 3.8% in 2013, which included many more rent rev iews. A lthough the 13 rent reviews concluded recently produced average rent increases of 8.8%, only 10% of its properties are subject to rent reviews in each of the next four years. Rental growth, unlike Bunnings’ own sales growth, should be modest.

NewCompetitionWith Wesfarmers planning to open 20 Bunnings Warehouses in 2015 the trust w ill have plenty of acquisition targets, but because it distributes most of its prof its as div idends you must be prepared for intermit tent capital raisings. For the rig ht property, that isn’t a problem. More concerning is that competition for sites is increasing, potentially raising prices for new purchases.

BWP Trust: Interim result 2015TheriskofowningBWPTrustisrisingwiththeshareprice,butit’sabetterbetthantermdeposits.

Jon Mills• 24 February 2015

BWPTrust(BWP)Price at review $2.88 Market caP. $1.9bn12 Mth Price range $2.26–$3.10business risk lowshare Price risk low–MedPortFolio weighting 6%our view hold

Recommendationguide

Buy Hold Sellbelow $2.35 above $3.30

$2.88

n Weekly Review | Intelligent Investor Share Advisor 19

Results

The success of BW P, and low interest rates, is at tracting competitors. Char ter Ha l l recently raised $235m to help add to its current portfolio of six Bunnings stores. Management highlighted that rival purchasers recently paid cap rates of around 6.5% for several properties in Melbourne and Sydney, which is higher than the average value of the trust’s properties despite their inferior quality.

Furthermore, Bunnings has recently vacated four poor performing stores. Although it’s required to pay rent until the leases expire – which means we don’t expect a significant reduction in BW P’s 99.4% occupancy level in the medium term – BW P must eventually find new tenants. If they pay lower rent, asset values could fall.

Net tangible assets (NTA) has been increasing in recent years but mainly because capitalisation rates have been falling; they declined again from 7.71% to 7.41%, suggesting investors are simply bidding up prices as interest rates fall. The trust now trades at a 32% premium to NTA.

Table1:BWPTrust:Interimresult2015

six months to 31 dec 2015 2014 +/– )%)

ReNTAl INcoMe ($M) 70 57 23

boRRoWINg exPeNse ($M) 13 9 44

dIsTRIbuTAble PRofIT ($M) 49 43 14

dPs (c) 7.67* 6.83 12

geARINg (%) (see NoTe 1) 23 19 21

NTA ($) 2.18 2.02 8

*unfranked,exdatealreadypastNote1:Gearing=netdebt/(totaltangibleassets-cash)

An estimated second half distribution of 8.1 cents will bring the 2015 total to 15.77 cents per share, for an unfranked 5.5% yield. We’re getting closer to selling, but for now we’re sticking with HOLD.

Note: The model Income Portfolio owns shares in BWP.

A total return of 42% in barely a year … shows

the power of low interest rates on

share prices.

20Intelligent Investor Share Advisor | Weekly Review n

Results

Servcorp has a relatively straightforward business model. It rents office space on medium-term leases (from one to 10 years), f its it out as serviced offices, and then rents these out monthly. It adds value in the services it can provide – postal addresses, receptionists, meeting rooms and, increasingly, technology.

Key Points

•PBTup30%overprioryear,butonly1%overprevioushalf

•Accountingquirkwillknockabout5%offPBTthisyear

•Growthisslowing,butsharesnotoverpriced

Simple enough. But in terms of financial reporting, it can get very complicated and, after the switch at last year’s interim result from ‘mature’/‘immature’ f loor to ‘ like-for-like’ reporting, we now have something new to worry about – fixed rent increases.

Accounting standards require that where a lease contains f ixed increases, these must be ‘straight-lined’ across the term of the lease. This has the effect of bringing rental expense from the back end of a lease to the front, but it takes no account of the fact that Servcorp should itself be able to increase rents over the years.

In the past the impact from this has apparently been insignificant, but the company has just entered 10 new leases with fixed increase clauses and it’s now making a big difference, so management has chosen to spell it out.

Growth slowingThe anticipated impact over the next 10 years is shown in Chart 1. For 2015, it breaks down as $1.1m for the first half and $1.2m for the second. And finally we’re getting to the punch line, because without this impact the company looks like it has all but stopped growing. First-half profit before tax (PBT) may have been up 30% on the first half of 2014, but it was only up 1% sequentially. And management’s guidance for full-year PBT growth of ‘not less than 15%’ implies second-half sequential growth of (not less than) 2%.

If we add back the impact of f ixed rent increases, though, the f irst half of the current year is up 7% sequentially and the second half should increase (not less than) 3% (see Table 1). These numbers are less than we’d have expected given the fall in the Australian dollar (about 80% of Servcorp’s revenues are earned offshore) and they’re a lot lower than Servcorp has achieved during its rapid expansion over the past few years, but they’re better than 1% and 2%.

Servcorp: Interim result 2015Thisservicedofficebusinessisstilltickingalong,althoughgrowthhasmoderatedafterfiveyearsofrapidexpansion.

JamesCarlisle• 24 February 2015

Servcorp(SRV)Price at review $6.07 Market caP. $60012 Mth Price range $4.20–$6.11business risk Highshare Price risk HighPortFolio weighting 4%our view hold

Recommendationguide

Buy Hold Sellbelow $4.50 above $7.00

$6.07

n Weekly Review | Intelligent Investor Share Advisor 21

Results

Allowing for a bit of management wiggle-room, in fact, and the grow th may be more like 7% and 5%. Bear in mind also that as the impact of the f ixed rent increases reduces over the next seven years, it will add about $0.5m (around 1%) to reported PBT each year.

Chart1:Fixedrentincreaseimpact($AUD)

Source: Servcorp half year results, Dec 2014

$1.5m

$0.5m

-$0.5m

-$1.5m

-$2.5m

FY ’1

5FY

’16

FY ’1

7FY

’18

FY ’1

9FY

’21

FY ’2

0FY

’22

FY ’2

3FY

’24

Now this is al l ver y convenient , of course, and it’s always smart to take a step back when there’s this degree of f inancial manoeuvering and look at the overall picture. The picture here is that Ser vcor p mana gement has proved itsel f to be smart and candid over the years and still owns more than half the company, so it has little reason to gild the lily.

Sydney,PerthweakE l s e w he r e i n t he r e s u lt , l i k e -for - l i k e (L F L) occupancy increased to 80% from 79% last June and 78% the previous December, but is still some way from management’s target of 82–85%. Stand-out performances came from North Asia (LFL PBT up 43%) and Europe and the Middle East (LFL PBT up 59%), while Australia, NZ and South-East Asia disappointed, with LFL PBT falling 35% due to a management restructure in Malaysia and Singapore and weak performances in Sydney and Perth.

The full-year guidance should translate to earnings per share of about 32 cents, which would be about 19% up on 2014. But the growth rate is slowing and we’d guess that 2016 will probably only bring about 10%.

Table1:ServcorpPBTadjustments

h114 h214 Fy14 h115 h215 Fy15

PbT($M) 15.1 19.4 34.5 19.6 20.1 39.7

seq. gRoWTH (%) 0 28 25 1 2 15

fIxed ReNT Adj. ($M) n/a n/a n/a 1.1 1.2 2.3

AdjusTed PbT ($M) 15.1 19.4 34.5 20.7 21.3 42.0

seq. gRoWTH (%) 0 28 25 7 3 22

The stock is up 8% since Servcorp: Result 2014 on 2 Sep 14 (Hold – $5.68) and has almost doubled since our last Buy recommendation on 25 Jun 13 (Buy – $3.08). That puts it on a forward price-earnings ratio of about 19, which is no longer obviously cheap, but nor is it overpriced for a quality company that should keep growing, albeit at a more sedate pace.

Table2:Servcorpinterimresult

six months to dec 2014 2013 +/– (%)

oP. ReveNue ($M) 124.5 113.7 9

PbT ($M) 19.6 15.1 30

NPAT ($M) 16.0 11.8 36

ePs (c) 16.3 12.0 23

INTeRIM dIvIdeNd 11c (up 22%), 20% franked, ex date 3 Mar

Keep in mind our maximum recommended portfolio weighting of 4% and consider tak ing some prof it i f you’re reach ing those levels. Other w ise, we recommend you continue to HOLD.

Note: Our model Growth and Income portfolios hold shares in Servcorp.

Disclosure:Theauthor,JamesCarlisle,ownssharesinServcorp.

Servcorp management has proved itself to be

smart and candid over

the years and still owns more

than half the company.

22Intelligent Investor Share Advisor | Weekly Review n

Results

I n the lea d up to it s $5.7bn f loat , Med iba n k Private was trumpeted as a cost-cutting stor y. Management pitched that it could use Medibank ’s scale and negotiating power to push down the cost of healthcare, reducing claims, while at the same time strip out operating costs.

Key Points

•MedibanklosingmarketsharetoNIB•Administrativecost-cuttingsuccess•Fullypriced;DowngradingMPLtoSell

True to its word, Australia’s largest private health insurer reduced administrative costs as a proportion of premiums received from 9.2% to 8.0% for the six months to December, and management confirmed Medibank is on track for a full-year profit of $258m.

Still, two numbers in the interim result worry us – probably the same numbers that caused the stock to dive 8% immediately after the result was released, though it has now recovered somewhat.

The f irst is that while Medibank ’s prof it margin increased slightly to 4.6%, the underly ing gross margin fell from 13.6% to 13.4%. The company may be successfully cutting fat on the administrative side of the business, but it’s losing ground when it comes to managing claims.

Medibank pays out roughly 86 cents in claims for every dollar of premium it receives, so reducing claims and

the actual cost of healthcare is far more important than administrative expenses – but it’s easier said than done.

Doctors are paid for each service, so they deliver as many as possible, while healthcare providers, pharmaceutical companies and medical dev ice makers are out to increase their ow n revenue by negotiating higher prices.

Furthermore, just two companies, Ramsay Health Care and Healthscope, control nearly half the private hospital industry. Medibank has 3.9 million members so Ramsay and Healthscopecan’t walk away from the negotiating table; but neither can Medibank.

Australia’s other listed health insurer, NIB, had a similar experience in the six months to December, with its gross margin falling from 16.6% to 16.5% due to a 17% increase in payouts for hospital care.

LapserateNonetheless, Medibank and NIB are usually able to pass on rising costs to members through regulated premium increases, which is why the companies have relatively stable margins and revenue growth.

In recent years, however, premiums have been grow ing faster than wages, mak ing affordability an issue. And that brings us to our second concern: the proportion of members who let their Medibank policies lapse during the half increased from 4.6% to 5.0%, causing the number of policyholders under the core brand to fall 1.5%.

Medibank & NIB: Interim results 2015MedibankisstilllosingmarketsharetoNIB,butcostcuttinghasmadeitaleaneroperation.

GrahamWitcomb• 23 February 2015

MedibankPrivate(MPL)Price at review $2.47 Market caP. $6.8bn12 Mth Price range $2.08–$2.59business risk Mediumshare Price risk MediumPortFolio weighting 5%our view sell

NIBHoldings(NHF)Price at review $3.66 Market caP. $1.6bn12 Mth Price range $2.51–$3.82business risk Mediumshare Price risk MediumPortFolio weighting 5%our view hold

Recommendationguide

Buy Hold Sellbelow $1.60 above $2.40

$2.47

Recommendationguide

Buy Hold Sellbelow $2.60 above $3.80

$3.66

n Weekly Review | Intelligent Investor Share Advisor 23

Results

The overall market is still growing, so it follows that Medibank is losing market share. This undermines its negotiating position with the hospitals, though it is still the largest insurer with a 29% share. Declining policyholder numbers are also an anchor on revenue, which increased just 3.7% to $3.3bn for the half-year.

Table1:MPLinterimresult

six months to dec 2014 2013 +/– (%)

ReveNue ($M) 3,270 3,149 4

gRoss PRofIT ($M) 408 383 6

NPAT ($M) 151 137 11

ePs ($) 5.5 5.0 11

Growth in the company’s cheaper AHM brand offset the loss of policyholders in the core Medibank brand, but this has a few drawbacks. For one, the cost of acquiring a new A HM customer is higher as the brand relies heavily on brokers, which take a 30% cut of the f irst-year’s premium. As AHM products become a larger slice of Medibank ’s business, all things being equal, margins will decline.

Secondly, it suggests people are downgrading from the Medibank brand to cheaper products, which makes it harder to grow the top line.

Finally, A HM’s lapse rate of 14.5% is nearly three times that of Medibank as a whole, which suggests a lack of customer loyalt y and means it w ill be more difficult to upgrade members to high-margin products in future years.

It’s also easy to see where ex-Medibank customers are going. NIB’s market share has increased every year for the past 14. Policyholder numbers increased 1.5% in the six months to December, and its lapse rate of 5.7% is far better than AHM’s despite a similar target customer.

NewnormalMedibank ’s management said it ‘expects health insurance industry headwinds to continue with rising healthcare costs challenging affordability for customers, resulting in further product downgrades and churn’. NIB’s management echoed the sentiment saying high rates of customer switching is the ‘new normal’.

What’s more, the Reserve Bank ’s recent decision to reduce interest rates to their lowest level since the 1960s will hold down returns from both insurers’ i nvest ment por t fol ios , so thei r u nder w r it i ng results are more important than ever. Medibank ’s investment income fell 33% this half. While NIB’s increased 21%, if you strip out the $5.5m earned

from selling its stake in Pacif ic Smiles Group, the underlying result was down 12%.

The health insurance industry is in the midst of a regulator y overhaul, w ith many proposals, such as the removal of ‘risk equalisation’, favouring NIB and its younger member base (see Medibank IPO: prognosis negative from 3 Nov 14 (Hold – $2.00)).

Ironically, if Medibank achieves its cost-cutting goals and increases its profitability, the Government may be even more tempted to let claims growth outstrip premium rises – squeezing Medibank ’s margins – to ensure health insurance remains affordable for older voters. And as the Government no longer has an equity stake in Medibank, it has little to lose.

BottomlineMedibank is a high-quality company but it’s still underperforming its peers – NIB’s revenue increased 9% this half, with a profit margin of 5.1%, due to price rises and the increase in policyholders, including an uptick at its small New Zealand business for the first time in 10 years.

Table2:NHFinterimresult

six months to dec 2014 2013 +/– (%)

ReveNue ($M) 802 735 9

gRoss PRofIT ($M) 132 122 8

NPAT ($M) 41 40 4

ePs (ceNTs) 9.4 9.0 4

INTeRIM dIvIdeNd 5.5 cents, fully franked, (up 5%), ex date 3 March

Policy dow ngrades, the loss of market share and declining gross margins make it hard to imagine long-term earnings grow th for Medibank above 5% a year. But the stock is up 14% since Medibank jumps 7% on debut from 25 Nov 14 (Hold – $2.14) and now trades on a forward price-earnings ratio of 26. Consistent with the prospectus, the board expects to declare its first dividend of 4.9 cents in September and maintain a payout ratio of 70-75%, for a forecast yield of around 2.8%. There’s no margin of safety at today’s price so we’re downgrading to SELL.

NIB’s management expects net profit at the lower end of its $75–82m range for the 2015 financial year and, with the stock up 12% since Medibank IPO: prognosis negative from 3 Nov 14 (Hold – $3.27), its forward price-earnings ratio comes to about 20. We’re closer to selling than buying but, for now, we recommend you HOLD.

In recent years, premiums have

been growing faster than

wages, making affordability an

issue.

24Intelligent Investor Share Advisor | Weekly Review n

Results

The ability to remove a lens distorted by cataracts and substitute it with an artificial one is more than half a century old. But recent technological improvements are simplifying and speeding up the surgery.

Key Points

•Cataractsurgeriesandinjectionsup•Refractivelasersurgeryiscyclical• Expansionintomedicalclinicsaddsrisk

In earlier years, inserting a new lens meant cutting a f lap in the eyeball more than a centimetre across. Now, the use of injectable lenses and tiny ultrasound probes has reduced that incision to less than 2mm. Wounds heal faster, the process is less traumatic and a typical patient can be in and out of the clinic in less time than it takes to bake a cake.

Sti l l , u ntreated cat aracts af fect roug h ly 1. 5m Australians aged over 55 – nearly one in three people of that age group – and an ageing population means that number is all but certain to grow over time. Australia’s largest network of ophthalmology clinics, Vision Eye Institute, performed 7% more cataract surgeries this half, which was ahead of the 4% growth achieved by the industry as a whole.

The number of eye injections increased 16%, also well above the market’s grow th of 11%. This was partly a result of increases in doctor availability in

Queensland as well as an expansion of the service in two Victorian clinics.

Unfortunately, the growing volume of injections and cataract surgeries was offset by a 12% decline in laser eye surgeries. A large proportion of Vision’s surgeries are to prevent blindness; however, laser surgery, which accounts for 8% of revenue, is usually performed to correct issues that a patient could alternatively manage using glasses, which makes it relatively discretionary.

The procedure doesn’t come cheap, either. At around $3,000 per eye, patients think twice before getting it done in difficult economic times. Revenue from laser surgery tends to be volatile and is tied to the health of the overall economy, so we don’t expect this division to show significant improvement any time soon.

NewdoctorsOperating theatre revenue, however, increased 4% and total revenue was unchanged at $55m. New doctors joined the network in Victoria, which led to more surgeries being performed in the state. However, this was partly offset by a volume decline in Queensland due to the departure of three doctors, which together accounted for around $1.9m in revenue.

Vision Eye: Interim result 2015Anuptickincataractsurgerieswasn’tenoughtooffsetasharpdeclineinlasereyecorrections.

GrahamWitcomb• 26 February 2015

VisionEyeInstitute(VEI)Price at review $0.63 Market caP. $110m12 Mth range $0.56–$0.82business risk Highshare Price risk  HighPortFolio weighting 3%our view hold

Recommendationguide

Spec. Buy Hold Sellbelow $0.60 above $1.00

$0.63

n Weekly Review | Intelligent Investor Share Advisor 25

Results

The ability for a doctor to walk away and take their revenue with them means that they tend to push for a larger share of profits at each contract renewal, causing Vision’s gross margin to gradually drift downwards (see Put Vision on your watch list from 2 Oct 13 (Hold – $0.72)). Increased profit sharing continued this period but margins are starting to stabilise, which suggests we may be approaching the level that balances both parties’ interests.

Underlying net profit increased 8.5% to $6.7m after excluding one-off insurance claim proceeds of $2m received in the previous corresponding period. All things considered, that’s a decent result but the increase was entirely due to lower finance costs as the company used its cash f low to pay down debt. Net debt was reduced from $27m to $13m, a huge improvement on the $100m the company carried just five years ago.

Growth strategyVision completed a $10m capital raising in October, which increased its share count by 10% and was unfortunately restricted to institutional investors. The company is using the proceeds to fund the construction of a new day surgery in Victoria and intends to purchase other ophthalmic day surgeries as they become available.

More worrying is that management ‘continues to consider a number of prospective medical centres where there is a geographic and operational f it’. We’d prefer management focus on the growth and

improvement of its existing eye clinics, rather than branch out into unrelated areas where it has little experience.

Vision’s share price is unchanged since Vision completes capital raising on 17 Oct 14 (Hold – $0.64) and the stock trades on an undemanding price-earnings multiple of 9.

Table1:VEIinterimresult

six months to dec 2014 2013 +/– (%)

ReveNue ($M) 54.9 54.9 0

ebIT* ($M) 10.3 11.8 (11)

NPAT* ($M) 6.7 7.5 (11)

ePs* (ceNTs) 3.9 4.5 (14)

*2013resultincludes$1.9mofone-offinsuranceproceeds

However, Vision’s Southport Day Surgery w ill be leaving the network in early 2016, which means it will be difficult for the company to maintain its current earnings without strong grow th in revenue at its other clinics. Management said it would update the market when it could ‘reliably quantify the impact’.

Nonetheless, management increased its forecast for 2015 operating earnings to $25–26m and we’re sticking with HOLD, for up to 3% of your portfolio.

Note: Our model Growth Portfolio owns shares in Vision Eye Institute.

We’d prefer management

focus on the growth and

improvement of its existing eye clinics, rather

than branch out into unrelated

areas where it has little

experience.

26Intelligent Investor Share Advisor | Weekly Review n

Results

In distinct contrast with DWS last week, everything was going the right way in SMS Management & Technology’s latest half-year result. The utilisation of its consultants rose from 81% to 84%; contracts won during the period rose 21% to $212m; revenue rose 15%; and operating and net profit both rose 48% (ref lecting the operating leverage inherent in these businesses due to relatively fixed labour costs).

Key Points

•Operatingprofitup48%•Shifttomanagedservicescontinues• Cashflowweak–apparentlymostlyduetotiming

In distinct contrast with DWS last week, everything was going the right way in SMS Management & Technology’s latest half-year result. The utilisation of its consultants rose from 81% to 84%; contracts won during the period rose 21% to $212m; revenue rose 15%; and operating and net profit both rose 48% (ref lecting the operating leverage inherent in these businesses due to relatively fixed labour costs).

No wonder then, that since we recommended SMS and DWS in IT Services under a cloud last year, SMS shares have risen 14% while DWS’s have slipped 12%. It just goes to show the benefits of taking a portfolio approach to this kind of sector, where the winners can be hard to pick – although that portfolio is now

SMSManagement(SMX)Price at review $3.70Market caP. $260m12 Mth range $3.12–$4.44business risk Med–Highshare Price risk  Med–HighPortFolio weighting 3%our view hold

Recommendationguide

Spec. Buy Hold Sellbelow $3.50 above $5.00

$3.70

down to one follow ing our Sell recommendation on DWS.

ShifttomanagedservicesSo, with the benefit of hindsight, what’s been the difference? Well the key, of course, is that SMS has been winning more work. But you make your own luck and SMS has helped itself by embracing the shift towards more managed services work and less design work.

We’ve previously been slightly sceptical of this move – tantalised to a degree by the higher margins of design work. However, we’re coming to accept the view that the f lexibility of cloud-based solutions means there will be less of the root-and-branch design work.

Up to 1999, SMS got 90% of its revenues f rom design work, but this was down to 36% in the 2014 financial year and should fall to 31% in 2015, almost hitting management’s medium-term target of 30%. Managed services have come from just 2% in 2013 to an expected 25% in 2015, with a target of 35%.

The trends are all in the right direction, w ith an increasing proportion of new contracts relating to managed ser v ices work. Indicium, the cloud-based mana ged ser v ices prov ider acqu ired in 2013 is performing particularly well, resulting in an additional $4.4m being paid in consideration – which is f ine by us.

SMS Mgmt: Interim result 2015ThisITconsultanthasreportedasharpturnaroundsinceitsdisastrous2014andtheomensarepositive.

JamesCarlisle• 26 February 2015

n Weekly Review | Intelligent Investor Share Advisor 27

Results

‘The business has made good progress to expand into the managed services space,’ said new chief executive Jackie Korhonen, a former IBM veteran who arrived this month after six years at Infosys, where she was senior vice president and country manager of Australia and New Zealand. ‘This not only provides increased diversity of service offerings, but also reduces the dependency on traditional service lines and geographies.’

LeadingindicatorThe st ron gest sect ors were I n for mat ion a nd Communications Technolog y (ICT) and Financial Services, which increased revenue by 56% and 23%. Both these areas benefited from a strong half from M&T Resources, the company’s IT recruitment business which increased revenue by 16% to $42m and operating profit by 60% to $2.4m. This bodes well as the company has previously described this business as a leading indicator of demand.

The major blot on the resu lt was that EBITDA (earnings before interest , ta x, depreciation and amortisation) was entirely munched up by an $11.5m increase in working capital, to give a $0.3m cash outf low. The working capital increase was partly due to ‘$7m of expected customer receipts not collected until [the] week following cut-off ’, which we’ll take at face value. The cash performance was also weak

in the 2014 full-year results, but we’re happy to let things cycle through for at least a year before getting too concerned. It will, however, be a focus for the 2015 full-year numbers.

Table1:SMSinterimresult

2014 2013 +/– (%)

ReveNue ($M) 176.4 153.5 15

ebIT ($M) 12.7 8.6 48

NPAT ($M) 8.6 5.8 48

ePs (c) 12.1 8.0 51

INTeRIM dIvIdeNd 7c (up 40%), fully franked, ex date 18 Mar

The company looks like it’s well on its way to making about 26 cents in earnings per share for the full year and, w ith the price falling 4% since SMS reports contracts surge at AGM on 23 Oct 14 (Hold – $3.89), the stock is on a price-earnings ratio of around 14. That continues to look attractive, although it doesn’t provide quite enough margin of safety for an upgrade. HOLD.

Disclosure:TheauthorownssharesinSMSManagement&Technology.

The trends are all in the right

direction, with an increasing proportion of

new contracts relating to

managed services work.

28Intelligent Investor Share Advisor | Weekly Review n

Results

For empire-builders in the corporate world, failure is all too common. In the tech sector, it’s especially so. Hopes run high, price tags even higher, and the ‘synergies’ never seem to materialise.

Key Points

•BannerCISintegrationontrack•Earningspershareup20%•PayTVcontractwins

But , when mana gement is conser vative in its assumptions and unwilling to overpay, acquisitions can also pay off handsomely. Hansen Technologies’ latest interim result is a case in point.

Last year, Hansen bought Banner CIS, a North American billing software provider for water utilities. The company serves 46 municipal customers across 30 US states, which pay a monthly management fee with a contractual yearly escalation. The business accounts for 10% of Hansen’s revenue.

What’s more, it can take several years to build a new billing system and millions of dollars, so mu n icipa l it ies a l most never s w itch sof t wa re providers. Banner CIS has significant pricing power, which makes for juicy margins.

Management never shared the details but given our estimates of incremental earnings we doubt the company paid a price-earnings multiple of more than

HansenTechnologies(HSN)Price at review $2.19 Market caP. $350m12 Mth range $1.15–$2.25business risk low–Medshare Price risk  MediumPortFolio weighting 4%our view hold

Recommendationguide

Spec. Buy Hold Sellbelow $1.60 above $2.50

$2.19

10, which is a steal for such a high quality business (see Hansen: The next Computershare? from 8 Jan 15 (Hold – $1.73)).

Thank s mainly to the Banner CIS acquisition, Hansen’s revenue for the six months to December increased 19% to $49m, while operating earnings were up 42% to $16m. The company’s operating margin increased from 27% to 32%.

PayTVOther recent acquisitions are also tick ing along nicely. In 2013, Hansen boug ht pay T V bil l ing operator ICC, which now makes up 25% of total revenue. The acquisition demonstrates Hansen’s knack for growing its business slowly at the edges rather than branching into unrelated areas, as acquisition-hungry managements so often seem to do.

Table1:HSNinterimresult

six months to dec 2014 2013 +/– (%)

ReveNue ($M) 49.2 41.2 19

ebITdA ($M) 15.9 11.2 42

NPAT ($M) 8.8 7.2 22

ePs (ceNTs) 5.3 4.4 20

INTeRIM dIvIdeNd 3.0c (unchanged), 83% franked, ex date 3 March

Hansen: Interim result 2015TheacquisitionofaUSbillingsoftwareproviderpropelledHansentoarecordhalf.

GrahamWitcomb• 27 February 2015

n Weekly Review | Intelligent Investor Share Advisor 29

Results

Hansen had no direct experience in Pay TV; however, f rom a bi l l ing perspective, pay T V customers resemble Hansen’s existing telco clients. Telcos and Pay TV operators are increasingly having to calculate complex bills that bundle fixed-line, mobile, internet and pay TV products sent to a growing number of devices – laptops, iPads, mobiles etc. The exploding product variety and constant churn of special offers requires more frequent updates and adaptive billing software, which is Hansen’s specialty. Management said: ‘our increased focus on sales and marketing is gaining further traction with new contract wins in the utilities and pay TV industry’.

Hansen earns around two thirds of its revenue in foreign currencies so the lower Aussie dollar has benefited the company when translating its foreign earnings for reporting. However, the company has several overseas offices and its costs are relatively wel l matched to revenue, so it doesn’t impact profits and margins directly. Nonetheless, net profit increased 22% to $8.8m, while earnings per share were up 20% to 5.3 cents.

Management expect full-year revenue above $95m with an operating margin of 25–30% and believes the company ‘can achieve a result towards the top end of that range if trading conditions remain favourable’.

The share price has increased 27% since Hansen: The next Computershare? from 8 Jan 15 (Hold – $1.73) and 44% since Hansen upgraded to Buy from 29 Oct 14 (Buy – $1.52). The stock trades on a price-earnings ratio of 21 and dividend yield of 2.8%, but, with a clean balance sheet and stable growing cash f lows, we’re happy to HOLD.

Note: Our model Growth and Income portfolios own shares in Hansen Technologies.

Disclosure:TheauthorownssharesinHansenTechnologies.

Last year, Hansen bought

Banner CIS, a North American billing software

provider for water utilities.

30Intelligent Investor Share Advisor | Weekly Review n

Results

Austbrokers’ interim result produced no surprises as the company recently announced a profit downgrade (see Austbrokers profit downgrade from 23 Jan 15 (Buy – $8.78). Underlying net profit fell 15% for the six months to December due to lower premium prices and one-off expenses related to recent acquisitions. Insurance premium prices have fallen by up to 30% recently, which reduced the commissions earned by the company’s insurance brokers.

Key Points

•Lowerpremiumpricesreducedbrokercommissions

•Severalrecentacquisitions•Downgradingtohold

We’ve been wa r n i ng for some t ime that h ig h insurance margins for companies like Insurance Australia Group and Suncorp are unsustainable as we’ve reached the peak of the insurance cycle that started after the string of natural catastrophes in 2011. Austbrokers clients are mostly small and medium sized businesses, and the result would’ve been much worse had the company not acted quickly to increase policy volumes to offset the lower margins in the brok ing business. With cl ient nu mbers increasing 4.3% overall broking revenue fell just 1%.

AustbrokersHoldings(AUB)Price at review $9.06Market caP. $550m12 Mth Price range $8.21–$11.25business risk low–Medshare Price risk Med–HighPortFolio weighting 5%our view hold

The compa ny ’s Aust a gencies busi ness, w h ich u nder w r ites n iche i nsu ra nce product s t a i lor made for clients, fared better with a 21% increase in commissions to $21m, helping to increase the company’s total revenue 6% to $98m. Like its rival Steadfast, Austbrokers is investing heavily. Expenses increased 35% to develop new IT systems and hire senior managers.

Table1:AUBinterimresult

six months to dec 2014 2013 +/– (%)

ReveNue ($M) 97.6 92.2 6

NPAT* ($M) 12.5 14.6 (15)

ePs* (ceNTs) 20.2 24.7 (18)

INTeRIM dIvIdeNd 12.0c (unchanged), fully franked, ex date 9 april

*Beforeamortisationofintangibles

The company has also increased its budget for acquisitions to $45m and made several purchases, including a 50% interest in Western Australian broker Nexus Risk Services and a 75% stake in niche offshore energy agency Asia Mideast Insurance and Reinsurance (AMIR). The acquisition costs impacted the result but they’ll add to profits in the second half.

Austbrokers: Interim result 2015Thisinsurancebrokerhasbeenhitbylowerpremiumprices,butithasactedswiftlytomitigatethepain.

GrahamWitcomb• 26 February 2015

Recommendationguide

Buy Hold Sellbelow $9.00 above $15.00

$9.06

n Weekly Review | Intelligent Investor Share Advisor 31

Results

Insurance brokerage

profits are a resilient source

of recurring revenue, as

businesses that operate without

insurance are asking for

trouble.

build on the strength of our businesses to diversify our income generation, remain focused on our core ‘owner-driver’ business model and to continue with the programme to build our Group management and systems. As our products and services mix and systems capability continue to expand, this w ill underpin grow th across our business div isions building value for our partners and for our clients across Australia and New Zealand.’

Insurance brokerage profits are a resilient source of recurring revenue, as businesses that operate without insurance are asking for trouble. Somewhat ironically, the thing that worries us most about this stock is just how prof itable it is. As a colleag ue ment ioned recently, the compa ny ’s ret u r n on equit y cou ld get chopped in half and it wou ld still be a good business. Unfortunately it wouldn’t justify the current share price, and we’re cognisant that Steadfast’s acquisition plans could inf late

acquisition prices and reduce returns across the industry. That means we’re sticking closely to the recommendation guide.

The stock has increased 3% since Austbrokers profit downgrade from 23 Jan 15 (Buy – $8.78) and management reiterated that it expects net profit to increase between 0% and 5% for the 2015 financial year. Austbrokers currently trades on forward price-earnings ratio of around 16, but with the share price above $9 we’re downgrading to HOLD.

Note: Our model Income and Growth Portfolios own shares in Austbrokers.

32Intelligent Investor Share Advisor | Weekly Review n

IntelligentInvestor.com.au

Think long and hard about the

downside before committing

a greater percentage of

your wealth to growth assets.

The re a ch for y ield i s t he proce s s by w h ich individuals, and sometimes whole markets, take on a little more risk than wanted in the hope of achieving a little higher return. It’s a particularly tempting carrot at the moment, with bank account and term deposit rates at historical lows.

We’ve warned against the temptation regularly. If you can’t afford the forgone few percent in income because of lower interest rates, can you really afford the 20%+ hit to your capital if you buy riskier assets and they tank?

“Because I can’t live off 3%” just isn’t an adequate rationale for taking on more risk.

It might, however, be wrong to be black and white about it. After all, just because central bank policy is forcing your hand, doesn’t mean it’s not right to take on a little additional risk in response. Throughout history, people who believed that their cash, sitting in a bank account earning interest, would maintain purchasing power were regularly disappointed. Rates are currently set low with the indirect aim of eroding that purchasing power.

But we reiterate the call for investors to be cautious about reaching for yield, especially unconsciously. Think long and hard about the downside before committing a greater percentage of your wealth to growth assets.

No such caution was evident in George Cochrane’s recent piece for Fairfax, titled What to do with a term deposit. The first dear reader explained a classic reach for yield temptation, and Cochrane simply encouraged ‘R M’ to set up the ladder and start climbing. I find Cochrane’s entire answer irresponsible, in particular the third and fourth paragraphs:

However, with rates dropping, many investors are compensating by abandoning term deposits and looking to the sharemarket or to balanced funds, a move which I would favour at the current time.

Many balanced and diversified super funds offered by reputable fund managers are offering double-digit compounding returns over the past three years and although past performance is no necessary guide to future returns, I would like to think that the next three years offers similar returns in such funds.

My concerns?

Firstly, there is little more than a hat tip to risk.

Secondly, we need to banish the use of present tense language from discussions about historical return—‘are offering’ desperately needs to be replaced with ‘have returned’.

Finally, Cochrane’s inference of double-digit annual returns over the next 3 years from a balanced fund is quite likely to disappoint. With bond yields already down in the cellar, equities will probably have to generate well over 10% annual returns for a balanced fund to achieve 10% p.a. over the next three years. I’d generously put the probability at less than 30%.

I’m not licenced to offer individual financial advice. Because of that, I’m not allowed to provide financial advice to blog readers. I think that’s right and proper. In contrast, and based on barely 200 words of background information from R M, George Cochrane is allowed to provide such advice in the newspaper. I don’t think that’s right, even on occasions when the advice isn’t rubbish.

This post originally appeared on the Forager Funds blog.

The risky reach for yield - Exhibit AWithinterestratesatrecordlows,thereismuchtemptationtolooktowardspotentiallyhigheryieldingproducts.GarethBrowndiscussestheassociaterisks,andcallsforinvestorstoexercisecaution…

Gareth Brown • 25 February 2015

n Weekly Review | Intelligent Investor Share Advisor 33

Q&A

GRBupdateAny chance of an update on your views of Ga ge Roads g iven the heav y price falls of late? Trying to gauge if there’s a turnaround opportunity here or not. I guess its a question of if the operational i s s u e s t h e y ’r e s u f f e r i n g f r o m a r e t empora r y or i f it ha s p er ma nent ly impaired the value of the business.

23 Feb 2015 – GregHoffman: I’m holding and possibly buying more. I’d fully expect the operational issues to be sorted out in the medium term and the bigger worry is Woolworths (which I’ve w ritten about in previous analysis). At this price, the potential gains are significant enough to keep me very interested, while mindful of the risks.

M2SellpriceI notice that M 2 Communications is nearing the Sell price you identif ied, just wondering if your recommendations remain the same since the last review?

19 Feb 2015 – JamesCarlisle: Well there’s still a bit to go - thankfully, because if/when the price gets to $10 we’ l l have a toug h decision to make. It’s one of those stocks that seems to keep going up and it can make you look a bit silly for selling (like we did in our model portfolios at $7.50). But you have to draw the line somewhere and for us that’s $10 at the moment (corresponding to a forward PER of about 19). Bear in mind, though, that we’ ll be tak ing a good look at the interim result – due on Monday 23 Feb – and could very easily adjust the Sell price on the basis of that.

InvestingabroadBefore d i rectly pu rcha sing oversea s s h a r e s , I w a nt e d t o a s k a b o u t t h e mecahnics of tax. A friend told me that it was relatively easy for ind iv iduals or companies but for a self mana ged superannuation funds with a corporate trustee, it was very difficult. This did not seem to be an option that the USA had considered. In the end, after many hours of frustration, he sold the overseas shares. Do you have any advice?

19 Feb 2015 – Nathan Bell : I hate to be so unhelpful but I have no knowledge that will help you. I have a SMSF and that’s all I understand, perhaps to my detriment, so I’d either get to work on google or hunt down a specialist that can help you. I’d hate to think that an administration issue stopped you from what making what could be a vital decision to protect and grow your wealth.

If anyone has information on this issue please let us know and we’ll publish it for everyone’s benefit.

GoldETFsThanks for the great analysis and advice! There was an interesting article on gold in last weekend ’s Weekend Australian investment pages by James Kirby entitled ‘Gold investment the best refuge from currency wars’. He was pretty convincing that gold acts as a protection against both inf lation and def lation. As a result I’m considering buy ing some gold or gold ETFs. Have you analyzed this as an option over gold mining shares? I’d love to hear your thoughts on how best to buy gold direct, and on which gold ETFs are better than others. It seems this could be a better way in the present environment to hold some percentage of allocated cash reserves, rather than in cash accounts or term deposits.

20 Feb 2015 – GauravSodhi : It’s a little old now but thisarticle explains the basic of gold ETFs. There are two products that spring to mind: GOLD is an ETF linked to real unallocated gold (the metal cant be loaned out) that sits in a London vault. It does charge a highish fee but is a good quality gold exposure, although keep in mind it is linked to the AUD price of gold, not the USD price. PMGOLD is the Perth Mints own ETF and is backed by gold from the Perth Mint. It is also a safe exposure and allows conversion to real gold if you hold enough units. The fee is lower but so is the liquidity in the ETF and it is exposed to the AUD gold price. Those are the only two local ETF options I am aware of. For real gold, see the Perth Mint webpage.

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