12 blue chip buy - under the radar report

• CONTENTS •

1

99% of all financial news relates to the 40 to 50 biggestcompanies. So what about the rest? They’re Under the Radar.

Published by Under the Radar Report Pty Ltd 45 Evans Street, Balmain NSW 2041Telephone +61 2 9106 2167 Email [email protected]

Editor Richard Hemming Publisher Caroline MarkABN: 65147404662. AFSL: 409518.

www.undertheradarreport.com.au

In this Blue Chip Value issue we’re covering 12 stocks and we’ve done a portfolio revamp. Consumer stocks are under pressure and we’re adding and subtracting from the 25 stocks in our Blue Chip Value Portfolio, which continues to outperform due to its defensive bias.

As you can see from the stocks listed on the right, they cover a variety of sectors and in a number of cases we’ve changed our recommendations.

A key to many consumer stocks is the wealth effect and we spend some time explaining what it is and how it is impacting the earnings outlook for many companies. It is interesting to see what effect the investment decisions of big companies like Coles, Woolworths and Metcash has on their valuations. You might not see it immediately in the profit and loss, but it has a profound impact on the profitability of the business over time.

As we have said before, our valuation methodology frowns upon big “capex humps” where are a company is set to spend huge amounts.

The good news is that there are plenty of Blue Chips focused on maximising the returns from their existing asset base, which are the companies we tend to favour. n

CHANGING CONSUMER TASTES 02

We look at how the wealth effect impacts on the investment returns of retailers. The results are more surprising than you would think.

BLUE CHIP VALUE 03 PORTFOLIO PERFORMANCE

ASX BIG CAP ANALYSIS 05

Alumina (AWC) Buy

BlueScope Steel (BSL) Buy

Boral (BLD) Buy

Coca-Cola Amatil (CCL) Hold

Coles (COL) Sell

Lendlease (LLC) Hold

Origin Energy (ORG) Hold

Rio Tinto (RIO) Take $$$

Sydney Airport (SYD) Buy

Wesfarmers (WES) Hold

Woolworths (WOW) Hold

WorleyParsons (WOR) Buy

12 BLUE CHIP BUY HOLD SELLS

“As expectations continue to grow that interest rates might be cut, we’re comfortable having JB Hi-Fi (JBH) in the portfolio. Ironically, the diminishing wealth effect has had a positive effect on the electronic retailer. It’s all about expectations in the equities markets.” UNDER THE RADAR BLUE CHIP VALUE PORTFOLIO

Talking Big

Richard Hemming Editor

ISSUE 024 22 MARCH 2019

22 MARCH 2019PORTFOLIO

We consume out of our current income; but we also consume out of changes in our net wealth – the changes in the value of our house and the changes in the value of our financial assets. As these changes increase, we spend more. This graphic shows that we’ve been spending less as those values diminish, particularly house values. The wealth effect has gone into reverse. This is one of the reasons the RBA

has flagged that it may cut interest rates. Ever since the RBA indicated this, JB Hi-Fi (JBH) has outperformed the market. As expectations continue to grow that interest rates might be cut, we’re comfortable having this stock in the portfolio. Ironically, the diminishing wealth effect has had a positive effect on the electronic retailer. It’s all about expectations in the equities markets.

THE WEALTH EFFECTThe contribution to six-month annualised growth of the average household’s net wealth.

----- TOTAL HOUSING AND DURABLES FINANCIAL ASSETS LIABILITIES

PPT

30

20

10

0

-10

-2020102008 2012 2014 2016 2018

CHANGING CONSUMER TASTESIn our portfolio section we look at the changes we’re making to

our portfolio in consumer facing stocks. The graphic below gives you a big indication as to why we are making those changes and some of the nuances involved in maintaining our holding in one

of the portfolio’s top performers: JB Hi-Fi (JBH).

SOUR

CES:

ABS

; RBA

2BLUE CHIP VALUE

3BLUE CHIP VALUE


PORTFOLIO COMMENTWe are uncertain about Coles (COL) because it was parachuted into the portfolio due to its spin-off from Wesfarmers (WES). More importantly its 1H19 result delivered in February was soggy. It sounds like management has to reset the business model. It also sounds like Wesfarmers has been deliberately under investing and that the group will need big capex to catch

up, which is desirable for long-term sustainable growth but in the short-term will depress profitability. There is scope for the stock to de-rate. We don’t want to be in Coles but want exposure to consumer staples, which we have in Bunnings via Wesfarmers but having a defensive bias, we want more. Woolworths (WOW) fits the bill. On our model it looks good value, trading in line with its price target. It’s more

attractive than Coles, having spent a lot more in the past, and is preferable to Metcash (MTS) which is a much smaller third player. Our hunch is that while Coles is catching up, the group will have limited ability to engage in a renewed price war. We believe this will favour Woolworths. In our next portfolio rebalancing at the end of the quarter (31 March), Coles will most likely be replaced with Woolworths. n

BLUE CHIP VALUE PORTFOLIO

MODEL PORTFOLIO

ASX 200

108

110

106

104

102

100

98

96

29/0

1/20

18

29/1

2/20

17

28/0

2/20

18

31/0

3/20

18

30/0

4/20

18

31/0

5/20

18

30/0

6/20

18

31/0

7/20

18

31/0

8/20

18

30/0

9/20

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31/1

0/20

18

30/1

1/20

18

31/1

2/20

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31/1

/201

9

28/2

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9

94

Index Points

PERFORMANCE

DEFENSIVE VALUE ATTRIBUTES ARE DELIVERING OUTPERFORMANCE FOR UNDER THE RADAR BLUE CHIPThe portfolio has been outperforming the ASX200 since late August 2018 and we believe will continue to in 2019

4BLUE CHIP VALUE


NAME (CODE) SECTOR MARKET CAP $BN

DIVIDEND YIELD %

PORTFOLIO WEIGHT %

WESTPAC BANKING (WBC) FINANCIALS 91.3 7.10 8.27

COMMONWEALTH BK.OF AUS. (CBA) FINANCIALS 128.0 5.96 9.20

AUS.AND NZ.BANKING GP. (ANZ) FINANCIALS 75.0 6.07 9.14

NATIONAL AUS.BANK (NAB) FINANCIALS 70.1 7.85 8.40

BHP GROUP (BHP) BASIC MATERIALS 107.5 4.64 10.95

RIO TINTO (RIO) BASIC MATERIALS 34.0 4.36 5.89

SOUTH32 (S32) BASIC MATERIALS 19.2 5.94 2.93

BLUESCOPE STEEL (BSL) BASIC MATERIALS 7.3 0.71 1.05

ALUMINA (AWC) BASIC MATERIALS 7.4 12.14 0.90

COCA-COLA AMATIL (CCL) CONSUMER GOODS 6.2 5.52 1.29

JB HI-FI (JBH) CONSUMER SERVICES 2.8 5.68 0.24

WESFARMERS (WES) CONSUMER SERVICES 39.2 6.37 4.50

QANTAS AIRWAYS (QAN) CONSUMER SERVICES 9.1 3.91 1.01

COLES GROUP CONSUMER SERVICES 15.3 0.00 1.82

ASX (ASX) FINANCIALS 13.6 3.19 3.56

MEDIBANK PRIVATE (MPL) INSURANCE 7.6 6.73 2.25

LENDLEASE GROUP (LLC) INDUSTRIALS 7.1 3.74 1.07

AMCOR (AMC) INDUSTRIALS 17.2 4.20 4.11

TRANSURBAN GROUP (TCL) INDUSTRIALS 33.8 4.59 9.13

SYDNEY AIRPORT (SYD) INDUSTRIALS 16.8 5.05 4.19

DOWNER EDI (DOW) INDUSTRIALS 4.4 4.56 1.10

WORLEYPARSONS (WOR) OIL & GAS 6.7 1.57 0.38

TELSTRA (TLS) TELECOMMUNICATIONS 38.8 3.83 4.66

AGL ENERGY (AGL) UTILITIES 14.5 5.34 2.17

ORIGIN ENERGY (ORG) UTILITIES 13.0 2.68 1.81

1 MONTH 3 MONTHS 6 MONTHS 12 MONTHS

Model Portfolio 2.78% 12.37% 4.23% 10.17%

Benchmark (ASX200) 2.75% 11.81% 2.30% 8.81%

Value Add 0.03% 0.56% 1.94% 1.36%

PORTFOLIO PERFORMANCE - AS AT 15 MARCH 2019

22 MARCH 2019ASX BIG CAP ANALYSIS

ASX BIG CAP ANALYSISWe look in depth at 12 Big Cap stocks

ALUMINABauxite miner and alumina refiner

In FY18 (31 December year end) the company’s earnings were strong, as expected. Alumina declared a fully franked final dividend of US14.1 cents (A19.9 cents) bringing the total dividend for the year to US22.7 cents (A32.1 cents), up 68% on the previous year. The 33% increase in the alumina price more than made up for a 14% increase in production costs, which was driven by higher caustic soda prices. The dividend was underwritten by operating cash flow.

The company faces increasing costs, although if the alumina price stays at or around its current levels of close to US$400 per tonne, operational cash flow is sufficient to ensure that dividends are maintained. This is a big deal considering they have more than quadrupled in the past three years. The tight alumina market should be maintained due to the world’s largest mine Alunorte in Brazil operating at 50% of capacity, although this will ramp up during this year. The Trump trade talks should also have an impact (which if anything could be negative). n

RADAR RATING: For us Alumina is about dividends and at current levels the average yield on offer over the next few years is close to 8%, although there is a great deal of macro risk. The yield is still pretty good if you can get it, which you can. BUY.

BLUESCOPE STEELSteel manufacturer

When it goes your way in the steel industry, it really does go hard. Then again, when the winds reverse, you can literally go out of business. Just ask any long-term watcher of BlueScope Steel.

For 1H19 the company produced a record half year profit, boosted by its North Star steel producing operations in Ohio, to report NPAT of almost $624m, up $183m on the same period a year earlier. The company is not a big dividend payer, but paid out 6 cents (the same as last year) and is continuing a buyback of up to $250m in stock. Arguably of more importance, the group guided to FY19 EBIT being 10% higher than the prior year and better than expectations.

When you’re hot you’re hot, but for how much longer? A key to the future is North Star expansion, which is being considered pending an engineering report that is in its final stages. North America made up almost half the company’s EBITDA, while Australia contributed 38%. n

RADAR RATING: The company trades on a forecast PE of just under 10 times, reflecting the cyclical highs the company is taking advantage of, while its dividend yield is only 1%. We continue to believe that with its US expansion the wind will be at BSL’s back, plus it’s good value, based on our price target. BUY.

*FY19 Forecast

*FY19 Forecast

RADAR RATING BUY

ASX CODE AWC

CURRENT PRICE $2.60

MARKET CAP $7.5BN

NET CASH US$96M

DIVIDEND YIELD 7.7%*

RADAR RATING BUY

ASX CODE BSL

CURRENT PRICE $13.40

MARKET CAP $7.2BN

NET CASH $128M


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AWC - Share Price

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5BLUE CHIP VALUE

6BLUE CHIP VALUE


BORALBuilding products

The building material company remains one of the best positioned to profit from the infrastructure boom in Australia and the US and we regard its depressed 1H19 profit result as a buying opportunity.

For the six months to 31 Dec 2018, NPAT was down 6% to $200m despite sales climbing 5% to $2.93bn, although the company announced a small 0.5 cent increase in the interim dividend to 13 cents. Net debt was slightly higher than expected at $2.3bn. The lower result was partially due to declining concrete volumes in Australia (-8%) although prices held up; while other impacts were reduced volumes in the US due to heavy rainfalls and increased competition and a cyclical downturn in South Korea.

The highly visible CEO Mike Kane was optimistic about the Australian residential market, predicting that it would stabilise after a couple more years of depressed activity. The big areas of growth are in US residential and infrastructure. The company left FY19 guidance unchanged, predicting EBITDA ahead of FY18’s $1,056m. n

RADAR RATING: The stock looks good value, trading on a forecast PE of close to 10 times and a dividend yield of 5.5%, which is forecast to grow. There are many irons in the Boral fire, which gives confidence that overall growth can be achieved and the group is on track to deliver targeted synergies from its big US acquisition. BUY.

RADAR RATING BUY

ASX CODE BLD

CURRENT PRICE $4.72

MARKET CAP $5.5BN

NET DEBT $2.3BN


*FY19 Forecast

COCA-COLA AMATIL Asia Pacific beverages

The beverage giant continues to be a case of jam (or Coke) tomorrow. Coca-Cola Amatil reported a weak FY18 result that was largely as expected. Underlying EBIT and NPAT from continuing operations fell 6.5% to $635m and $388m respectively. The dividend was held at 26 cents, 50% franked.

This performance was due to the core Australian operation (59% of group EBIT), which reported an 8.8% decline in EBIT reflecting lower volumes and growth initiative costs. EBIT in Indonesia and PNG (13% EBIT) was down 6.4% on weak economic conditions in Indonesia and operational issues in PNG. The NZ & Fiji and Alcohol & Coffee segments continue to perform well.

Management view FY19 as another transition year as it progresses the cost cutting and reinvestment program with mid-single digit EPS growth from FY20 targeted. There was nothing in the result to change our view that this is a stretched target. n

RADAR RATING: A portfolio of leading consumer beverage brands and a record of product innovation puts CCL in a better position than peers to deal with changing consumer tastes and pressure from the big supermarkets in Australia. This plus good cashflow generation and a high (circa 80%) payout allow it to pay a healthy dividend. But the stock is not cheap and the FY19 outlook is weak so we would be looking to sell on share price strength. HOLD.

*FY19 Forecast

RADAR RATING HOLD

ASX CODE CCL

CURRENT PRICE $8.42

MARKET CAP $6.1BN

NET DEBT $1.3BN


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BLD - Share Price

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7BLUE CHIP VALUE


COLESSupermarket

Direct comparisons of Coles’ numbers with the prior year were difficult due to its demerger from Wesfarmers. And Wesfarmers’ shareholders received the benefit of dividends based on earnings in 1H19.

Coles’ group sales revenue was up 2.6% at $20.9bn, while EBIT was down almost 6% at $753m. Supermarkets were the star with sales up 4% and EBIT almost flat at $602m, while the main decline was at Express where EBIT fell almost 40% to $51m. Liquor produced 7% earnings growth on flat revenue. Express was impacted in 1H19 by sharply lower petrol volumes, which have led to the sale of the petrol retailing business to Viva. In future Coles will derive a commission on petrol litres sold.

Costs of doing business have increased, and these pressures are unlikely to abate. The company announced an investment of almost $1bn in new supply chain modernisation and automated distribution centres, with uncertain returns in a mature and potentially weak retail environment. n

RADAR RATING: Coles has only been independently listed since November, but is already raising capital expenditure expectations to maintain market share. The stock looks overvalued on our model. SELL.

*FY19 Forecast

RADAR RATING SELL (DOWNGRADE FROM HOLD)

ASX CODE COL


MARKET CAP $15.5BN

NET DEBT $1.2BN


LENDLEASEContractor

Back in May last year we stated how we liked Lendlease’s exposure to rising construction of public infrastructure. The problem is this exposure has first led to $500m in write-downs in its troubled Engineering and Services segment; as well as an estimated $450m-550m in “restructuring costs” in order to get out of the business altogether. This news has led to the loss of over $2.8bn in market capitalisation for Lendlease, which seems too harsh, but reflects the uncertainty about further infrastructure related write-downs and restructuring costs.

There are some positives emerging out of this, however. The first is the clear signs that despite the weakening residential housing market, Lendlease has built up a formidable global presence to offset this with a $74.5bn development pipeline. The group also has $34.5bn worth of assets under management generating big fees. The company has indicated that there are buyers emerging for its Engineering and Services division. The latter generates about $50m a year, which puts it on an estimated valuation of about $500m.

Finally, Lendlease remains profitable overall and its debt is not too onerous, at 15% gearing, which is at the bottom of its targeted range of 15-20%. For 1H19 Lendlease delivered NPAT of just under $15m and a dividend of 12 cents (down from 34 cents in 1H18), which was better than the losses most had expected. n

RADAR RATING: The risk is much higher for Lendlease than we had previously anticipated and although there is a great deal priced in, the company has not been clear enough about the extent of the problems in Engineering. HOLD.

*FY19 Forecast

RADAR RATING HOLD

ASX CODE LLC


MARKET CAP $7.0BN

NET DEBT $2.3BN


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COL - Share Price

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8BLUE CHIP VALUE


ORIGIN ENERGYEnergy gentailer

Origin’s business is both a beneficiary of high energy prices while also being the object of Government and regulatory interest, as those same high prices cause political backlash.

1H19 underlying EBITDA was up 20% to $1.7bn, leading to underlying NPAT of $592m and EPS of 33.7c, both up over 50%. Net operating cash flow increased to $754 million including a $276m cash distribution from ORG’s stake in Australia Pacific LNG. Debt was reduced, and dividends were recommenced with a 10 cent interim after a three year hiatus. Growth came from the integrated gas operations, while the energy markets division was largely flat, impacted by competition, consumer price stresses and lower volumes. n

RADAR RATING: FY19 guidance was in line with expectations at an underlying $3.3bn EBITDA, leading to 60 cents EPS, a PE multiple of 12.5 times. Management forecast a total full-year dividend of 20 cents. We like the stability of Origin’s business and competent management. Despite political noise around the industry and the fact that it looks expensive on our model, we would rather own Origin than not. HOLD.

*FY19 Forecast

RADAR RATING HOLD

ASX CODE ORG

CURRENT PRICE $7.47

MARKET CAP $13.1BN

NET DEBT $6.7BN


RIO TINTO Diversified miner

The top tier miner reported a slightly better than expected FY18 result with guidance largely unchanged. Strong cash generation and bumper dividends featured. Underlying EBITDA was only 2% lower at $18.1bn, despite divestments. Underlying NPAT was 2% higher to $8.8bn. The final dividend was raised 6% or US17 cents to a record US307 cents. A US243 cent special dividend is also being paid.

The board is displaying disciplined capital stewardship, sharing more of the spoils with shareholders rather than solely reinvesting in growth. We recall the disastrous US$38bn acquisition of Alcan in 2007 that nearly blew up the company. Cash from divestments and internal cash generation has seen US$13.5bn being returned to shareholders via dividends and buy-backs with respect to FY18. We expect this theme to continue. n

RADAR RATING: With a diversified portfolio of leading assets and healthy development pipeline underpinned by a strong balance sheet and good cashflow generation, Rio Tinto is well positioned to continue to benefit from the upswing in the resources cycle. But everything has a price and Rio Tinto looks expensive on our valuation model. We have milked the commodities boom well. It’s time to take some risk off the table. TAKE PROFITS. *FY19 Forecast

**Proforma 31 Dec 18 - adjusted for post balance commitments including dividends and buy-back.

RADAR RATING TAKE $$$ (DOWNGRADE FROM HOLD)

ASX CODE RIO


MARKET CAP $34.2BN

NET DEBT US$8.0BN**


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9BLUE CHIP VALUE


SYDNEY AIRPORTAviation

Sydney Airport reported a record full year result driven by record passenger numbers and strong performance in non-aeronautical segments (retail, property and parking) and cost containment.

FY18 revenue and EBITDA increased around 7% to $1.58bn and $1.28bn respectively. A modestly higher interest bill saw net operating cash receipts rise 9% to $861m. Full year distributions totaled of 37.5 cents. FY19 distribution guidance is 39 cents.

Passenger numbers were up 2.5% to 44.4m for the year with international rising 4.7% to 16.7m. Domestic traffic moderated recently but international is still relatively strong. Sydney Airport is more resilient to changes in passenger activity than an airline given that it is not directly exposed to airfare revenue, oil prices and has more diversified revenues. Non-aeronautical revenues represent over half of the total. Changes in interest rate expectations have a greater impact on the stock price. n

RADAR RATING: Sydney Airport is Australia’s largest and busiest airport. As the international gateway into Australia it is leveraged to growing tourism into Australia. Dividends should increase gradually over the next few years, as they have done in the past few years. The 5.4% dividend yield looks good, particularly in a declining interest rate environment. BUY.

*FY19 Forecast

RADAR RATING BUY

ASX CODE SYD

CURRENT PRICE $7.17

MARKET CAP $16.2BN

NET DEBT $8.4BN


WESFARMERSDiversified industrial

Wesfarmers has substantially restructured its operations over the first half, including the demerger of Coles and a few major disposals.

The company reported a 1H19 underlying increase in NPAT of 10.4% to $1.08bn from total underlying EBIT of $1.65bn. The divestments funded a substantial reduction in debt and allowed a special dividend of $1 in addition to the ordinary interim dividend of $1. Bunnings delivered a solid result and remains the key component of the business, contributing more than half of group earnings. Sales revenues increased 5% and EBIT 8%, while Kmart Group EBIT, which includes Target was down 4%. Officeworks reported 8% revenue growth and almost 12% in earnings. The industrial business was slightly down on the prior year despite much higher revenue, impacted by higher ammonia costs and contracting expenses.

Operating cash flow was almost $2bn with substantial debt capacity for acquisitions, but it is not yet clear which direction the company will take. n

RADAR RATING: Wesfarmers earnings profile is substantially more exposed to discretionary retail expenditure after the demerger of Coles and its valuation is not compelling. We are downgrading. HOLD.

*FY19 Forecast

RADAR RATING HOLD (DOWNGRADE FROM BUY)

ASX CODE WES


MARKET CAP $39.3BN

NET DEBT $324M


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10BLUE CHIP VALUE


WORLEYPARSONSEngineering contractor

The engineering group reported a stronger 1H19 result reflecting improved conditions, cost cutting and the full period inclusion of the UKIS acquisition. No specific guidance was given, however outlook commentary was bullish and an improved full year result is expected. Importantly, the company is on track to complete the US$3.3bn Jacobs ECR acquisition by March/April 2019.

The lastest acquisition brings potential significant strategic and financial benefits as Worley will become the global leader in the upstream hydrocarbons, chemicals and minerals and metals sector. The timing also looks good as the energy investment cycle looks to be on the upswing. However, this also brings increased risk. Worley is making a big bet as it assumes no material downturn in commodity prices and also brings integration risk.

For 1H19 underlying EBIT and NPAT were up 17% and 26% to $156m and $98m respectively on 11% revenue growth to $2.57bn. Operating cash flow halved to $21m but debt metrics are sound. The unfranked interim dividend was raised 2.5 cents to 12.5 cents. n

RADAR RATING: WorleyParsons’ earnings outlook is positive and will be further improved by the Jacobs ECR acquisition. But this it is not without risk. The challenge will be to manage a smooth integration and deliver touted benefits. BUY.

WOOLWORTHSSupermarket

Woolworths reported a 2.3% increase in sales revenue for 1H19 to $30.6bn, with a balanced result across all its continuing operations: Australian Food, Endeavour drinks, New Zealand Food, BigW and Hotels. At the EBIT level, an improvement of 4% in Australian Food to $937m offset deteriorations in Endeavour to $290m, a small loss at Big W, and marginal losses in Hotels and NZ for total EBIT of $1.441bn.

The group is selling its petrol business, which will help fund a return of capital of up to $1.7bn, around $1.25 per share. Increases in the cost of doing business in many divisions both in Australia and NZ cut into first half earnings, and these pressures will continue. n

RADAR RATING: We think that Woolworths is better positioned than is arch competitor Coles to meet the challenges presented by a subdued consumer market and increased competition nipping at its heels. A good stock for the portfolio. HOLD.

*FY19 Forecast

**Excludes $2.9bn cash proceeds from the capital raising earmarked for the Jacobs ECR acquisition.

*FY19 Forecast

RADAR RATING BUY

ASX CODE WOL


MARKET CAP $6.7BN

NET DEBT $784M**


RADAR RATING HOLD

ASX CODE WOW


MARKET CAP $40.0BN

NET DEBT $1253M


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31.000

30.000

29.000

28.000

27.000

26.000

11BLUE CHIP VALUE

22 MARCH 2019ASX BIG CAP ANALYSIS 22 MARCH 2019

WARNING: This publication is general information only, which means it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether a particular recommendation is appropriate for your needs before acting on it, and we recommend seeking advice from a financial adviser or stockbroker before making a decision.

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12 blue chip buy - under the radar report

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