important informationIntelligent Investor Share AdvisorPO Box Q744Queen Victoria Building NSW 1230T 1800 620 414F 02 9387 8674info@intelligentinvestor.com.aushares.intelligentinvestor.com.au

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, AOG, ARP, ASX, AWC, AWE, AZZ, COH, CPU, CSL, DWS, EGG, FWD, ICQ, JIN, KRM, MAU, MIX, MQG, NBL, NST, NWS, OFX, PTM, QBE, RMD, RMS, RNY, SLR, SMX, SRV, SWK, SYD, TAP, TEN, TME, TPI, USD, UXC, VEI, VMS, WDC, WES and WRT. This is not a recommendation.

in tHiS iSSUE

LatESt HEaDLinES

ioof Holdings: result 2014

This financial services group has reported another solid result,

from itself as well as its new acquisition, SFG Australia … (2)

Sydney airport: interim result 2014

Strong retail revenues and international passenger growth underpinned a respectable interim result for Australia’s busiest airport. Few noticed … (3)

Caltex: interim result 2014

The transformation of Caltex is on track and will build a better business, says Gaurav Sodhi … (4)

m2: result 2014

Earnings growth of 36% is impressive for any company, let alone one with a dividend yield of 4%, but the challenges for M2 lie ahead … (5)

Santos: interim result 2014

The investment phase of Santos’s transformation is almost complete. Now bring on the cash flow … (6)

platinum asset mgmt: result 2014

The recovery in markets gave a massive boost to this fund manager in 2014, but there are positive signs under the bonnet as well … (7)

Vision Eye institute: result 2014

Vision’s profit jumped 20% but the doctors continue to take a larger slice of the pie – at the clinic and in the courts … (8)

flight Centre: result 2014

Flight Centre is going back to where it all began, on the top deck of a double-decker London bus … (9)

Spark infrastructure: interim result 2014

Vision’s profit jumped 20% but the doctors continue to take a larger slice of the pie – at the clinic and in the courts … (10)

alumina: interim result 2014

Ignore the result. Industry conditions are finally improving and Alumina’s share price is finally recovering … (11)

ContEntS

StoCkS in DEtaiL

StoCk aSx CoDE rECommEnDation paGE

Alumina AWC Hold 11Caltex Australia CTX Hold 4Flight Centre FLT Hold 9Ioof Holdings IFL Buy 2M2 MTU Hold 5Platinum Asset Mgmt PTM Hold 7Santos STO Hold 6Spark Infrastructure SKI Sell 10Sydney Airport SYD Hold 3Vision Eye Institute VEI Hold 8

StoCkS in briEf

StoCk aSx CoDE rECommEnDation paGE

ARB Corporation ARP Hold 12Coca-Cola Amatil CCL Hold 12Insurance Australia Group IAG Sell 13SomnoMed SOM Hold 13

fEatUrES

Blue sky at Qantas? 14

ExtraS

Ask The Experts 15Blog links 16Twitter links 16

rECommEnDation CHanGES

Insurance Australia Group downgraded from Hold to SellM2 Group downgraded from Buy to HoldSantos downgraded from Buy to Hold

portfoLio CHanGES

There are no recent portfolio changes

wEEkLY rEViEw | ISSUE 399a | 23–29 AUGUST 2014

SHAre AdvISor 2

As ever, cash conversion was excellent, with free cash flow of $120m representing 98% of the pre-amortisation net profit. Pro forma net debt is now $67m, up from $9m at June 2013, the increase reflecting the difference between the $77m shelled out for SFG and the balance of free cash not paid out as dividends (which totalled $104m – a payout ratio of 90%).

In terms of the outlook, IOOF promised more of the same, in ‘the expectation of a stable regulatory environment’, with operating efficiencies and further acquisitions expected to play a role.

tabLE 1: ifL pro forma rESULtS

ioof SfG pro ioof pro 2014 2014 forma 2013 forma 2014 +/– (%)

rEV. ($m) 427 158 584 393 49

Ebita ($m)* 171 56 227 148 53

npat ($m)** 123 39 162 109 49

SHarES (m) 232 n/a 300 232 29

EpS (C)** 53.1 n/a 53.9 46.9 15

DpS (C) 47.5 n/a 47.5 42.0 13

frankinG (%) 100 n/a 100 100 n/a

finaL DiViDEnD 25 cents fully franked, ex date 22 Sep

* Underlying; ** Underlying and before amortisation

The stock is up 8% since Taking the wraps off IOOF on 23 Jun 14 (Buy – $8.28) and we recommend that review for a more detailed description of the business. That puts the stock on a multiple of 17 times the 53.9 cents of pro forma earnings per share just announced and 16 times the consensus forecast of 57.3 cents for 2015. That’s enough to encourage us to nudge our Buy price up from $9.00 to $9.50. BUY.

Note: Our model Income Portfolio holds shares in IOOF.

It didn’t appear in its accounts – because the acquisition didn’t complete until last Wednesday – but the most notable thing in Friday’s results from IOOF Holdings were the provisional numbers from SFG Australia.

kEY pointS

nIOOF and SFG both slightly ahead of expectations

nFurther efficiencies and acquisitions likely

nIncreasing Buy price; BUY

SFG’s underlying net profit rose 19% to $39m – giving a price-earnings ratio of 17, based on the $664m IOOF ultimately paid for the company (68m new shares plus $77m cash). Together, the combined group would have made $162m in 2014, or 53.9 cents per share compared to the (slightly better than expected) 53.1 cents that IOOF actually made. However, management expects the deal to enhance earnings per share by 8% by 2016.

To achieve this, it will undertake a ‘merit-based review of staffing requirements’ (reduce staff numbers), ‘review material contracts’ and ‘unify and reprice major suppliers’ (make good use of its increased clout with fund managers) and ‘consolidate its property footprint’ (close down surplus offices). Given IOOF chief executive Chris Kelaher’s track record, though, the biggest gains will be had from merging clients onto fewer, more efficient investment platforms.

SFG finished the 2014 financial year with $31.0bn of funds under management, administration or advice (FUMA), ahead of the $28.3bn at June 2013 and the $30.5bn when the two companies presented their scheme of arrangement in May. On these funds, the company made a gross margin of 51 basis points, compared to 48 last year, to give it revenues of $158m, up 18%. Expenses rose by a slightly lower 17%, to give a 19% increase in underlying earnings before interest, tax and amortisation (EBITA) to $56.0m.

For its part, IOOF itself had another good year, with $1bn of net flows onto its platforms and $1.4bn onto its flagship platforms. With the benefit of asset price increases, FUMA rose by 9% over the year to $95.9bn. On this, the company made a gross margin of 41 basis points – in line with 2013 – but cost increases of only 4% resulted in a 15% increase in EBITA to $171m.

IOOF Holdings: Result 2014This financial services group has reported another solid result, from itself as well as its new acquisition, SFG Australia.

James Carlisle • 25 AUGUST 2014

ioof HoLDinGS | ifL

PRICE AT REVIEW $8.95

MARKET CAP. $2.8bn

12 MTH PRICE RANGE $8.02–$9.82

BUSINESS RISK Medium

SHARE PRICE RISK Med–High

MAX. PORTFOLIO WEIGHTING 5%

OUR VIEW bUY

rECommEnDation GUiDE

SellAbove $14.00

Hold

buyBelow $9.50

$8.95

The most notable thing in Friday’s results from IooF Holdings were the provisional numbers from SFG Australia.

Weekly revIeW3

The Government and media says it’s a bottleneck; Sydney Airport will buckle under the pressure of 70m passengers trying to squeeze through its gates in 2030. Sydney itself will then grind to a standstill; a second airport must be built.

Colour us sceptical.

kEY pointS

nGood result; retail spending strong

nSecond airport doesn’t make sense

nCompetitive threat overstated; Hold

The rationale for a second airport seems to be booming international travel. International passenger numbers have grown relentlessly for decades. Indeed, the six months to 30 June were particularly strong with growth of 5% helping to boost Sydney’s aeronautical revenues 6% to $236m. Rising incomes in developing nations will ensure strong international passenger growth continues for decades to come, but that doesn’t mean Sydney Airport is in any way facing capacity constraints.

Total passenger numbers have risen 50% since 2000, but the actual number of planes flying in and out of the airport has increased only 5% over that time to 327,000 flights per year. Sydney Airport is allowed up to 500,000 so there’s plenty of room to increase the number of flights.

LESS LEG room

It’s not flights but the number of passengers per flight that has accounted for the increase in passenger numbers. Airlines are buying larger aircraft like the A380, and the growing number of budget carriers cram 30–50% more seats onto the same aircraft relative to a full-service airline. The number of budget passengers has nearly tripled since 2008 and there are now four international budget airlines with services to Sydney, yet they still account for only around 10% of flights.

Besides squeezing on more passengers per plane, budget airlines also tend to use the airport’s infrastructure more efficiently given their strong cost focus (see Sydney Airport: Result 2013 from 27 Feb 14 (Buy – $4.02)).

Sydney Airport is not short of space to deal with the extra passengers in any case. The airport served 38m passengers over the past 12 months and sits on 907 hectares. The master plan for London’s Heathrow, by contrast, caters for 130m on roughly 1,600 hectares – twice Sydney’s current passenger density. It’s not that Sydney Airport is run inefficiently, it just has a lot of land up its sleeve for development.

What’s more, Macquarie (which distributed its 19% stake in Sydney Airport to its shareholders in January) estimates that, assuming a $5bn development cost for a second airport at Badgery’s Creek, airlines would have to pay landing fees twice those at Sydney Airport for it to be financially viable.

Given the choice between an airport 10km from the CBD and one 50km away charging twice as much, we don’t expect the second airport to be much of a threat.

So, if a second airport isn’t needed and probably wouldn’t stack up financially, why is the Government so intent on building one? It could be politically motivated or a desire to break up Sydney Airport’s monopoly – but it may not even achieve this, given the company’s right of first refusal to build any second airport.

tabLE 1: SYD intErim rESULt

Six montHS to 30 JUn 2014 2013 +/– (%)

paSSEnGErS (m) 18.6 18.2 2

aEronaUtiCaL rEVEnUE ($m) 236 224 6

rEtaiL rEVEnUE ($m) 125 116 7

propErtY rEVEnUE ($m) 96 96 7

Car parkinG rEVEnUE ($m) 66 63 6

totaL rEVEnUE ($m) 568 538 6

EbitDa ($m) 460 433 6

nEt opEratinG rECEiptS pEr SECUritY (C)

11.5 11.0 5

DpS (C) 11.5 11.0 5

DiV. YiELD (%) 5.3 5.1 n/a

frankinG (%) 0 0 n/a

Despite all of this, the government is now in consultation with Sydney Airport and we’ll have to wait and see where it leads. If the project does go ahead, though, it’ll be at least another two years before ground is broken and more than a decade before the first runway comes online. Even then it’s unlikely to take much away from growth at Sydney Airport.

Investors have little to fear.

aUStraLia’S bESt rEtaiLEr

All the talk of the second airport overshadowed the result’s big surprise – who’d have guessed one of Australia’s top-performing retailers this half would be the world’s oldest commercial airport. Retail revenue grew 7% for the six months to 30 June, reflecting an impressive 13% increase in the amount each passenger spends.

Sydney Airport: Interim result ‘14Strong retail revenues and international passenger growth underpinned a respectable interim result for Australia’s busiest airport. Few noticed.

Graham WitComb • 26 AUGUST 2014

SYDnEY airport | SYD

PRICE AT REVIEW $4.41

MARKET CAP. $9.8bn

12 MTH PRICE RANGE $3.69–$4.47

BUSINESS RISK Low

SHARE PRICE RISK Low–Med

MAX. PORTFOLIO WEIGHTING 7%

OUR VIEW HoLD

rECommEnDation GUiDE

SellAbove $6.00

Hold

buyBelow $4.00

$4.41

Who’d have guessed one of Australia’s top-performing retailers this half would be the world’s oldest commercial airport.

SHAre AdvISor 4

(Hold – $4.39) and have risen 39% since we upgraded the stock in The ’high yield & safe’ mini-portfolio on 1 Feb 13 (Long Term Buy – $3.18). The company expects to pay a final unfranked distribution of 12 cents, on top of the 11.5 cent interim distribution already paid, to give an annual total of 23.5 cents and a yield of 5.3%. HOLD

Note: Our model Income and Growth portfolios own Sydney Airport securities.

Disclosure: Staff members own securities in Sydney Airport, but

they don’t include the author.

The performance was attributed to several small changes working together. New products and changes to store layouts played a part, as did an increasing flow of Chinese passengers, who tend to spend more. China is now the airport’s second-largest international market behind New Zealand. International passengers also have longer wait times before their flights, so there’s a little extra dallying around the retail precinct.

Sydney Airport’s securities are barely changed since Sydney Airport downgraded to Hold from 23 May 14

Caltex: Interim result 2014The transformation of Caltex is on track and will build a better business, says Gaurav Sodhi.

Gaurav sodhi • 26 AUGUST 2014

CaLtEx aUStraLia | Ctx

PRICE AT REVIEW $28.26

MARKET CAP. $7.5bn

12 MTH RANGE $16.87–$28.26

BUSINESS RISK Med–High

SHARE PRICE RISK Med–High

MAX. PORTFOLIO WEIGHTING 5%

OUR VIEW HoLD

rECommEnDation GUiDE

SellAbove $30.00

Hold

buyBelow $19.00

$28.26

As always with Caltex, the headline number confuses more than it illuminates.

The headlines suggested bad news – job cuts and refining losses – but the real story was rather good. Caltex is successfully morphing from a capital pig into a reliable retailer and the market is starting to appreciate that change. Although underlying results were within expectations, the share price jumped 7% following their release.

kEY pointS

nIgnore headline numbers

nRefinery conversion on track

nMarketing business still strong

As always with Caltex, the headline number confuses more than it illuminates. The company carries enormous volumes of oil as inventory – about $2bn worth – that it must revalue as oil prices move, creating regular non-cash charges we need to adjust to get an idea of how the underlying business is performing. Doing so suggests profits were stagnant at $173m.

Our job isn’t done there, because the adjusted profit figure includes results from the company’s refining business and its marketing business. With the refining business undergoing a restructure, the performance of the marketing segment and the Lytton refinery are the most important numbers in the result. They impressed.

Earnings before interest and tax from the marketing business rose 8% to $393m. As we explained in Caltex: A fuels errand on 22 Oct 13 (Buy – $18.68), falling petrol sales are being offset by rising premium and diesel volumes, which are higher margin for Caltex. That trend continued: petrol volumes fell 2% but volumes of premium petrol rose 4% and diesel volumes increased 7.5%. Volumes of jet fuel were up 11%.

Although diesel volumes are affected by mining activity, most of the increase is due to the retail market as

consumers substitute diesel for petrol engined cars. The fuel marketing business is a stable one that generates high free cash flow and offers reinvestment opportunities at decent rates of return. It is, in other words, nothing like the refining industry which has long been associated with Caltex.

rEfininG LoSSES

On a replacement cost basis (which adjusts for movements in inventory value), the refining business reported a loss of $65m for the first half. Although this includes some one-off costs, it was primarily due to lower margins which stripped $111m from the result. Margins are notoriously hard to predict and largely outside management control.

tabLE 1: Ctx intErim rESULt

Six montHS to 30 JUn 2014 2013 +/– (%)

rEportED npat 163 195 (17)

UnDErLYinG npat ($m) 173 171 1

opEratinG CaSH fLow ($m) 205 244 (19)

EpS (C) 64 63 1

DpS (C) 20 17 18

YiELD (%) 1.3 1.1 n/a

frankinG (%) 100 100 n/a

With Kurnell changing from a refinery to an import terminal, the Lytton refinery will soon be the company’s sole refining asset. It was significant that Lytton performed splendidly and did not detract from profits. Lytton reported EBIT of $40m. For our valuation we’ve assumed that, on average, it breaks even so this was a decent outcome.

A key benefit of closing Kurnell will be lower capital expenditures and the release of huge levels of working capital that can improve cash flow. Although forecast capital expenditures are higher than average, this is only to pay for the conversion of Kurnell and should fall in

Weekly revIeW5

years to come. Combined with higher cash generation, it should allow Caltex to pay sustained high dividends once the restructure is complete.

Investors got a taste of that with an 18% increase in dividends to 20 cents per share (fully franked, ex date Sep 5). By 2016, when the Kurnell conversion is complete, Caltex will look very different to the business we see

today. The quality of its marketing division will no longer be obscured by an awful refining business. Although the share price has increased 30% since Caltex warns of lower profit from 1 Jul 14 (Hold – $21.64) and 51% since our initial buy recommendation, we’re not quite at our sell price yet. HOLD.

M2: Result 2014Earnings growth of 36% is impressive for any company, let alone one with a dividend yield of 4%, but the challenges for M2 lie ahead.

James Carlisle • 26 AUGUST 2014

m2 | mtU

PRICE AT REVIEW $7.11

MARKET CAP. $1.3bn

12 MTH PRICE RANGE $5.29–$7.27

BUSINESS RISK High

SHARE PRICE RISK High

MAX. PORTFOLIO WEIGHTING 4%

OUR VIEW HoLD

rECommEnDation GUiDE

SellAbove $10.00

Hold

buyBelow $6.50

$7.11

Since M2 listed in 2004 it has increased earnings per share tenfold – a compound rate of 30% a year.

It’s impressive for any company to increase earnings per share by 36% in a year, as M2 Group managed in 2014, but it’s spectacular for a stock offering a prospective fully franked dividend yield of over 4%.

kEY pointS

nEPS up 36%; pre-amortisation EPS up 41%

nCash flow recovered from first half

nDowngrading to Hold

The performance is no flash in the pan either. Since M2 listed in 2004 it has increased earnings per share tenfold – a compound rate of 30% a year. Size hasn’t been an impediment, with growth of 34% a year over the past five years.

And you can’t say the earnings aren’t real because they’re substantially backed by cash: in 2014, free cash flow came to 95% of earnings per share.

Despite the performance, investors begrudgingly marked the shares up by a few cents. So why is the market so unimpressed? The first clue is probably in that amortisation number – not of itself, but because it points to the company’s acquisitive past. It’s done a great job of buying up smaller competitors, culminating in Dodo and Eftel in 2013, consolidating customer lists and cutting costs, and the market is concerned that it’s running out of companies to buy.

Without significant further acquisitions, the company will have to rely more on its existing rag tag of businesses, 47% of whose revenues came from Fixed Voice services in 2014.

Worse still, 30% came from business voice services which are under particular threat from Voice over IP telephony and the NBN (have you ever thought how few of your office phone lines are actually being used at any one time?).

Even so, Fixed Voice services in operation (SIOs) rose 6% to 773,000 in 2014, while average monthly revenue per user (ARPU) was stable at $52.

The next biggest contributor, with 24% of revenue, is the area of telecommunications next most at risk – fixed broadband. You wouldn’t know it from the numbers, though, with SIOs rising 17% to 482,000 while ARPU rose from $41 to $44.

Mobile, with 12% of revenue, arguably has better prospects – as an industry at least – but it performed worst in 2014, with SIOs falling 11% as ARPU rose from $29 to $31. The performance picked up in the second half of the year, though, after the (belated) release of the company’s new 4G plans.

makinG a bUnDLE

Management’s strategy is centred around cross-selling among its 1.6m services in operation. Over 90% of its broadband services, for example, are bundled with voice, which helps to increase margins and makes customers more sticky. But M2 doesn’t stop at communications and a particular focus at the moment is electricity.

tabLE 1: mtU 2014 rESULt

YEar to 30 JUn 2014 2013 +/– (%)

rEVEnUE ($m) 1,024 681 50

UnDErLYinG npat ($m) 93 58 60

UnDErLYinG EpS ($m) 52 36 42

pEr 14 20 n/a

DpS (C) 26 20 30

DiV. YiELD (%) 3.7 2.8 n/a

frankinG (%) 100 100 n/a

finaL DiViDEnD 14.5c fully franked, ex date 7 Oct

In all, M2 had 93,000 energy customers at the end of June, up 66% from a year before, and they contributed the highest ARPU, at $116 – down slightly from $120 in 2013 and more than double the ARPU of M2’s Voice, Mobile and Broadband businesses. Energy contributed 10% of revenues in 2014 and management expects strong growth to continue.

SHAre AdvISor 6

2.5% of revenue. Analysts, though, are evidently sceptical and the consensus at this stage is for pre-amortisation earnings per share to grow by 14% to 58.7 cents.

With the stock up 19% since Correction to M2 dividend forecast on 30 Jul 14 (Buy – $6.00), that puts it on a forward (pre-amortisation) price-earnings ratio of 12 and a free cash flow yield of 6.4%.

On the face of it, those are appealing numbers, but we’re wary of the poor outlook for such a large portion of the company’s core business. We’ve nudged up our risk ratings to account for this, particularly given the higher share price, and with the stock now well past our Buy price of $6.50 we’re downgrading to HOLD.

Note: Our Growth and Income portfolios own shares in M2 Group.

The cash flow statement showed a marked improvement from its shock following the acquisition of Dodo (see M2: Interim result 2014 on 20 Mar 14 (Buy – $5.99)), with flat working capital despite the deferred commission liability being reduced by a further $10.5m (in line with expectations), on top of the $20.1m reduction in the first half. About $15m remains to be extinguished in future periods.

Overall, free cash flow came to $50.8m in the second half (103% of the $49.5m pre-amortisation net profit), up from $12.9m in the first half (29% of pre-amortisation net profit).

SCEptiCaL

Management guided towards 8-9% revenue growth in 2015, 15-20% net profit growth and capital expenditure of

Santos: Interim result 2014The investment phase of Santos’s transformation is almost complete. Now bring on the cash flow.

Gaurav sodhi • 26 AUGUST 2014

SantoS | Sto

PRICE AT REVIEW $15.09

MARKET CAP. $14.4bn

12 MTH RANGE $13.11–$15.79

BUSINESS RISK Low–Med

SHARE PRICE RISK Med–High

MAX. PORTFOLIO WEIGHTING 6%

OUR VIEW HoLD

rECommEnDation GUiDE

SellAbove $20.00

Hold

buyBelow $15.00

$15.09

The early start to the PNG LNG project, of which Santos owns a 13% stake, is an example of the change that this once sleepy gas producer is undergoing. The project will produce about 7m tonnes of LNG a year, all of it at oil-linked prices. Although PNG LNG made only a small contribution to the half year result – volumes rose just 2% – revenue rose 25% partly because oil and LNG attract higher margins than gas.

kEY pointS

nPNG LNG starts early

nConcerned about GLNG returns

nShare price up, downgraded to Hold

This is, in a microcosm, the change that management is trying to engineer across the business. Long a producer of low margin gas, Santos has chased oil and LNG projects to lift margins. When the Gladstone LNG (GLNG) project is complete in 2015, about 70% of output will be linked to oil prices. That means higher production will lead to a disproportionate increase in profit.

That has been known for a while which is why Santos has been on our buy list. What was unclear before this result was what management intended to do with higher cash flow. Dividends appear to be part of the answer. The company raised the interim dividend by a third to 20cps (fully franked, ex date Aug 27) and noted it would pay more as cash flow improved.

Unlike, for example, Woodside, Santos has ample development projects to replace and grow output. Dividends will surely rise but they are unlikely to match

the payout ratio of Woodside and the company won’t shut its wallet as peers have done.

worriED aboUt GLaDStonE

The company’s capital expenditure was noteworthy for its diversity. The largest portion, almost $800m, was spent on GLNG and another $150m on completing PNG LNG but Santos also spent almost $450m on projects in the Cooper Basin. In contrast, Western Australian fields received just $30m of investment.

tabLE 1: Sto intErim rESULt

Six montHS to 30 JUn 2014 2013 +/– (%)

proDUCtion (mmboE) 25 24.5 2

UnDErLYinG npat ($m) 258 250 3

opEratinG CaSH fLow ($m) 744 629 18

EpS (CEntS) 26 25 3

DpS (CEntS) 20 15 33

frankinG (%) 100 100 n/a

The attention lavished on the Cooper Basin is significant. It’s a lot of money to spend on aging fields that, only five years ago, were thought to be in decline. There are two objectives being pursued: Santos believes the Cooper Basin has a lot more life yet and it is desperately trying to find new gas to fill its Queensland LNG plant.

We’ve long argued that GLNG is short of gas. Santos and its partners have already bought some third party gas but, with drilling results less than spectacular, more is likely. The expenditure at the Cooper Basin could almost be classified as a GLNG expense.

Weekly revIeW7

priCE mattErS

This highlights a potential pitfall at GLNG: if wells continue to disappoint, expensive gas will have to piped to the plant to fulfill contracts, reducing margins. Like Woodside’s Pluto, GLNG could ultimately deliver plenty of cash but a poor return on capital. We are therefore cautious about paying too much for Santos today and stick strictly to our recommendation guide.

The market greeted these results enthusiastically but they were merely average. Production was flat this year with PNG LNG offsetting declines in other fields, but that will

soon change. Over the next two years, output should soar closer to 80m barrels of oil equivalent (boe) from just over 50mmboe today. As that potential nears, so does the prospect of higher profits and dividends.

That prospect, rather than approval of the interim results themselves, explains the market’s reaction and why, despite rising 10% since Santos: Result and upgrade (Buy – $13.72), we remain interested. With the share price creeping above our recommendation guide, however, we are downgrading to HOLD.

Platinum Asset Mgmt: Result 2014The recovery in markets gave a massive boost to this fund manager in 2014, but there are positive signs under the bonnet as well.

James Carlisle • 27 AUGUST 2014

pLatinUm aSSEt mGmt | ptm

PRICE AT REVIEW $6.29

MARKET CAP. $3.4bn

12 MTH PRICE RANGE $5.28–$7.74

BUSINESS RISK Medium

SHARE PRICE RISK High

MAX. PORTFOLIO WEIGHTING 5%

OUR VIEW HoLD

rECommEnDation GUiDE

SellAbove $8.00

Hold

buyBelow $5.50

$6.29

When we reviewed Platinum Asset Management’s 2013 result, we wrote that shareholders would have to wait a bit longer for improved investment returns to show up in the company’s financial results, and in 2014 they duly did.

kEY pointS

nProfits surge due to higher average FUM

nFund flows and performance also positive

nShares getting cheaper but risk of Neilson leaving

With markets sustaining higher levels throughout the year, compared to 2013 which began in a bear market, average funds under management (FUM) rose 33% to $22.3bn, and management and administration fees saw a similar rise, of 32% to $285m. On top of this came $27m of performance fees (of which $24m was recognised in the first half), compared to $5m for 2013. Overall, operating revenue increased 41% to $313m.

Expenses rose 20% to $59m, mainly due to higher staff costs, which is fair enough because if you don’t pay some decent bonuses in the good years, you won’t keep good staff. Kerr Neilson, however, denied himself, explaining that ‘as the controlling shareholder, I feel there is no need for me to participate in [the new] profit-sharing pool or to receive a performance bonus’. Of course it’s peanuts to him, but that doesn’t stop many others.

Headline earnings per share rose 44% to 32.4 cents. Excluding performance fees and normalising for a low (27%) tax rate, earnings per share would have been 28 cents. We’ll opt for about 30 cents as an underlying figure.

Beneath the bonnet the signs were positive as well, with net inflows of $238m (excluding distributions). Platinum certainly seems to have turned the corner on fund flows, with net inflows into its managed funds in all but two of

the past 12 months (excluding distributions).

Performance has also picked up, particularly for funds with little hedging. Out of eight funds, only two are now behind their benchmark over five years: the ($61m) Platinum IT fund and Neilson’s own, the ($10bn) Platinum International Fund.

We find this reassuring for a couple of reasons. First of all, we have confidence in the International Fund’s management – at least while Kerr Neilson sticks around. And second, because of what it says about the depth of Platinum’s investing expertise, thereby allowing some hope for when Neilson does decide to hang up his calculator.

Un-amEriCan

Neilson commented that the MSCI World Index had developed a significant skew towards the US – a weighting of 49% despite the country accounting for less than 20% of global GDP – due to the ‘early recovery of the US economy and good earnings growth’. By contrast, he said, Platinum had moved its funds away from the US to cheaper markets, so that ‘if our traditional pattern holds, fallow years should be followed by strong outperformance’. We don’t doubt it.

The share price is barely changed since FUM’s up for fund managers on 26 Jun 14 (Hold – $6.24) and, despite the surge in earnings, it’s up only 2% from a year ago. The difference is that then it was in the top half of our Hold range, whereas now it’s closer to the bottom.

With a price-earnings ratio of 21 based on our underlying earnings figure, the stock is beginning to look quite cheap but, despite the apparent strength in depth, we continue to be mindful of the risk of Kerr Neilson leaving. HOLD.

Note: Our model Growth and Income portfolios hold shares in Platinum Asset Management.

Disclosure: Staff members own shares in Platinum Asset

Management, but they don’t include the author.

SHAre AdvISor 8

Dr Unger believes this prevented him from selling his stock, which proceeded to lose 60% of its value, due to his possession of inside information. Dr Unger is also suing the company over a loan Vision provided him for the purchase of stock.

Vision denies the allegations and has launched a counterclaim to pursue Dr Unger’s repayment of the debt. In any case, we hope the proceedings are settled soon as legal costs more than doubled this year to $2m, taking 10% or so straight off the bottom line.

CaSH maCHinE

Despite litigation troubles and doctors pressuring for a higher share of earnings, Vision continues to throw of prodigious amounts of cash. Interest payments fell from $6m to $2m due to a reduced net debt and lower interest rates. This helped increase free cash flow some 40% to $16m.

However, this figure includes one-off insurance claim proceeds of $2m and we suspect is also flattered due to the company temporarily underinvesting in equipment in order to reduce debt. The sustainable level is probably something closer to underlying net profit see Table 1. The medicine seems to be working, though, with net debt declining to $27m from $40m in 2013, and the company has announced its first dividend in four years.

tabLE 1: VEi 2014 rESULt

YEar to 30 JUn 2014 2013 +/– (%)

rEVEnUE ($m) 111 107 3

UnDErLYinG Ebit* ($m) 19.0 19.7 (4)

UnDErLYinG npat* ($m) 11.9 9.6 24

EpS (C) 7.1 5.7 25

DpS (C) 1.3 0.0 n/a

DiV YiELD (%) 1.7 n/a n/a

frankinG (%) 100 n/a n/a

finaL DiViDEnD 1.25c fully franked, ex date 5 Sep

*Excluding goodwill write-offs and insurance proceeds

Vision has also spent $6m of its free cash to buy the property underlying its clinic in Box Hill, Victoria, which it plans to renovate next year. The company is also looking to expand its network by purchasing new clinics. We think the time is right, necessary even, given the balance sheet is now under control and that the doctors’ pressure on margins shows no sign of abating. We continue to be cautious, however, of management’s ‘exploration of other

For a company to earn outsized profits over the long term, it needs what Warren Buffett calls a ‘moat’ – a sustainable competitive advantage. The width and depth of that moat ultimately depends on five factors: the industry’s barriers to entry; the intensity of existing competition; the threat of substitute products; and the bargaining power of customers and suppliers.

kEY pointS

nDoctors continue to pressure margins

nHigh legal costs hurt profit, offset by lower interest payments

nCheap, but need larger margin of safety; Hold

Vision Eye Institute scores well on four of these factors but, ironically, Australia’s largest network of ophthalmology clinics has almost no control over the supply of ophthalmology services – its doctors do.

At each contract renewal, the doctors have pushed for a larger share of profits (see Put Vision on your watch list from 2 Oct 13 (Hold – $0.72)). This year was no exception. The company’s gross profit margin fell from 45% to 43% and underlying operating earnings fell 4% to $19m for the year to 30 June due to the cost of paying doctors increasing faster than revenue.

Revenue increased 3% to $111m, thanks to a 7% rise in operating theatre revenue. New doctors joined the network in Victoria, which led to more surgeries being performed in the state. However, this was more than offset by a volume decline in NSW due to doctors working fewer hours.

Vision’s doctors performed 6% more cataract surgeries this year, which was in line with the industry as a whole. Untreated cataracts affect roughly 1.5m Australians aged over 55 – nearly one in three people of that age group. And an ageing population means demand for ophthalmic procedures will outpace population growth for several decades to come.

LitiGation

Vision is fighting two legal battles: one against a previously employed doctor for breach of contract, dating back to 2009, and a separate case against the company’s founder, Harry Unger, which commenced in the middle of last year.

Dr Unger, who was chief executive until 2007, alleges Vision breached continuous disclosure laws in 2008 in relation to a private equity group’s offer to buy the company and the sacking of its then chief executive, Neil Rodaway.

Vision Eye Institute: Result 2014Vision’s profit jumped 20% but the doctors continue to take a larger slice of the pie – at the clinic and in the courts.

Graham WitComb • 27 AUGUST 2014

ViSion EYE inStitUtE | VEi

PRICE AT REVIEW $0.72

MARKET CAP. $117m

12 MTH PRICE RANGE $0.56–$0.86

BUSINESS RISK High

SHARE PRICE RISK Very High

MAX. PORTFOLIO WEIGHTING 2%

OUR VIEW HoLD

rECommEnDation GUiDE

SellAbove $1.00

Hold

buyBelow $0.60

$0.72

Australia’s largest network of ophthalmology clinics has almost no control over the supply of ophthalmology services – its doctors do.

Weekly revIeW9

healthcare opportunities’ – we’d prefer it focus on growth and improvement of the existing business.

Excluding the insurance proceeds and last year’s goodwill write-off, underlying net profit rose 24% to $11.9m, giving earnings per share of 7.1 cents. All things considered, that’s a very good result but, given the boost was mostly due to lower finance costs, it’s unlikely to be repeated next year unless the company’s top line manages to outpace the shrinking margins.

The stock has fallen slightly since Your small-cap healthcare portfolio from 8 Jul 14 (Hold – $0.76) but is up 24% since we first upgraded it in Vision upgraded to Speculative Buy on 1 Mar 14 (Speculative Buy – $0.58). The multiple of 10 times 2014 earnings is far from expensive and we’re sticking with HOLD.

Note: Our model Growth Portfolio owns shares in Vision.

Disclosure: Staff own shares in Vision, but they don't include

the author.

Flight Centre: Result 2014Flight Centre is going back to where it all began, on the top deck of a double-decker London bus.

James Carlisle • 27 AUGUST 2014

fLiGHt CEntrE | fLt

PRICE AT REVIEW $46.34

MARKET CAP. $4.6bn

12 MTH RANGE $43.23–$55.65

BUSINESS RISK Medium

SHARE PRICE RISK High

MAX. PORTFOLIO WEIGHTING 6%

OUR VIEW HoLD

rECommEnDation GUiDE

SellAbove $60.00

Hold

buyBelow $40.00

$46.34

Overshadowing this morning’s annual result from Flight Centre is the news that it is returning to its roots with the acquisition of 90% of Topdeck Tours for up to $42m (an implied value for the whole of £26m, or about $46m).

kEY pointS

nAcquisition of Turner’s first business, Topdeck Tours

nFlight Centre’s result in line with guidance

nDisappointing outlook, for 5–8% growth in 2015

Flight Centre founder, 15% shareholder and managing director Graham Turner famously started Topdeck in Earls Court, London, in 1973, with an old double-decker London bus to take (what we would now refer to as) backpackers around Europe.

With money, experience and confidence gained from this enterprise, Turner launched Flight Centre nine years later. Topdeck was sold a few years after that, although Turner bought back into the company in 2003 and will be selling a 4% stake to Flight Centre.

The purchase fits with Flight Centre’s strategy to develop more of its own products, and the price is a reasonable-looking 6.5 times Topdeck’s 2013 earnings before interest, tax, depreciation and amortisation of £4m. Topdeck will sit alongside Back-Roads Touring, another UK coach operator of which Flight Centre owns 67%. Both will continue as stand-alone businesses, although ‘there will, of course, also be synergies’, which sounds to us a bit like having your cake and eating it, but we’ll take their word for it.

The annual result was in line with the update delivered in June (see Flight Centre delivers mild profit warning on 11 Jun 14 (Hold – $46.29)) and the preliminary results announcement on 25 July, with underlying profit before tax rising 10% to $377m. However, the market

was disappointed with guidance for only 5–8% growth in 2015, and sent the shares down a couple of per cent.

The anticipated slower growth was blamed on ‘ongoing volatility in Australian leisure’, but management was confident that healthy demand would return in due course, helped by falls in air fares.

In fact, the company said we were at the ‘dawn of a Golden Era of Travel’ with cheaper fares, more choice, greater comfort and less flying time. Adjusted for changes in the average wage, the $1,800 cost of a return flight from Sydney to London in 2014 compares to the equivalent of $9,000 in 1980 and $130,000 in 1947. Get ‘em while they’re hot.

tabLE 1: fLt 2014 rESULt

YEar to 30 JUn 2014 2013 +/– (%)

rEVEnUE ($m) 2,245 1,986 13

UnDErLYinG pbt ($m) 377 343 10

UnDErLYinG npat ($m) 264 240 10

UnDErLYinG EpS ($) 2.62 2.42 8

pEr 18 19 n/a

DpS ($) 1.52 1.37 11

DiV. YiELD (%) 3.3 3.0 n/a

frankinG (%) 100 100 0

finaL DiViDEnD 97c fully franked; ex date 17 Sep

The stock is up slightly since 11 June and is trading on a multiple of 18 times underlying 2014 earnings per share of $2.62. That’s not expensive for a business of this quality, particularly given its strong cash flow, but we’d want to see a cheaper price before buying. HOLD.

SHAre AdvISor 10

GrowinG painS

The underlying regulated asset base (RAB) increased 3% to $8.9bn before debt, of which Spark owns a 49% share.

All Australian power networks are facing fewer opportunities to grow their regulated asset bases due to a crackdown on ‘gold plating’ and solar power reducing peak demand – the few times in a year that contribute almost all of a network’s profit (see Electricity disrupted – Part 1 and Part 2).

The Australian Energy Regulator (AER) has also changed various guidelines for how it calculates what networks should earn over a five-year regulatory period, and these will make it harder for Spark to increase profits and distributions following the next regulatory reset which occurs on 1 Jul 15 (see Storm brews for Spark Infrastructure on 24 Sep 13 (Hold – $1.60)).

Spark has continued to deleverage at the asset and corporate level which is encouraging, with net debt to RAB decreasing from 79% to 78%. Management is targeting 75% in 2015.

tabLE 1: Ski 2014 intErim rESULt

Six montHS to 30 JUn 2014 2013 +/– (%)

nEtwork rEVEnUE* ($m) 1,139 1,127 1

nEtwork EbitDa* ($m) 718 703 2

totaL inComE ($m) 152 156 (3)

UnDErLYinG EarninGS** ($m) 140 121 15

DpS (C) 5.8 5.5 5

DiV YiELD (%) 5.9 5.7 n/a

frankinG (%) 0 0 n/a

intErim DiViDEnD 5.75 cents, unfranked, ex date 1 Sep *100% ownership basis

**Net profit plus interest paid on stapled security Loan Notes

Spark’s share price is flat since Electricity disrupted – Part 2 from 31 Jul 14 (Sell – $1.90). The board declared an unfranked interim distribution of 5.75 cents (ex date 1 Sep), and reaffirmed its expectation for a full-year total of 11.5 cents, up 5% over the previous year, for a forecast yield of 5.9%.

Despite the healthy yield, an enterprise value 1.4 times the regulated asset base is on the expensive side, especially given the regulatory risks and declining electricity volumes. We’re sticking with SELL.

At this rate, Spark Infrastructure would do well to give up on electricity distribution and go into the investing business. The company’s underlying earnings increased 15% to $140m for the six months to 30 June, though this was entirely due to the increasing value of financial instruments.

kEY pointS

nPoor underlying result

nElectricity volumes declining

nRegulatory risks; Sell

A few months ago Spark purchased derivative contracts that entitle it to a 14% stake in DUET Group, which owns various gas and electricity distribution assets (see Spark buys stake in DUET from 20 May 14 (Hold – $1.88)).

Though Spark has said it doesn’t intend to make a takeover bid, DUET’s share price increased some 13% following the announcement. This caused an unrealised gain of $23m on Spark’s derivatives which more than offset a 3% decline in Spark’s share of profits from SA Power Networks and Victoria Power Networks to $152m for the half-year.

Despite regulated price increases of around 10%, on a wholly owned basis the revenue at Spark’s networks increased just 1% to $1,139m compared to the previous corresponding period, while earnings before interest, tax, depreciation and amortisation (EBITDA) increased 2% to $718m.

Total revenues at the South Australian network increased 2% to $520m while EBITDA was flat at $360m. Regulated revenue notched up 5% due price increases; however, this was offset by a 14% decline in unregulated revenue which includes asset rentals and services provided to competitor networks.

Revenues for the Victorian network increased a paltry 1% to $547m while EBITDA was up 4% to $358m. The 10% increase in regulated prices only just offset a 25% decline in unregulated revenue and lower electricity use.

Volumes at SA Power and Victoria Power fell 3% and 5% respectively due to the increasing use of solar power. Nearly one in four South Australian houses now have rooftop solar, among the highest penetration rates in the world.

Spark Infrastructure: Interim result 2014Vision’s profit jumped 20% but the doctors continue to take a larger slice of the pie – at the clinic and in the courts.

Graham WitComb • 27 AUGUST 2014

Spark infraStrUCtUrE | Ski

PRICE AT REVIEW $1.94

MARKET CAP. $2.9bn

12 MTH PRICE RANGE $1.54–$2.02

BUSINESS RISK Low

SHARE PRICE RISK Medium

MAX. PORTFOLIO WEIGHTING 6%

OUR VIEW SELL

rECommEnDation GUiDE

SellAbove $1.90

Hold

buyBelow $1.45

$1.94

All Australian power networks are facing fewer opportunities to grow their regulated asset bases.

Weekly revIeW11

Twice a year every year, Alumina ceremoniously releases results. Every year, we ignore them. There are few businesses whose results are less important than this one because Alumina is merely a holding company whose sole asset is a 40% stake in AWAC, the world’s largest producer of bauxite and alumina.

kEY pointS

nResults don’t reflect asset performance

nNew pricing structure improving outcomes

nIndustry conditions getting better

Alumina’s revenues reflect dividends it receives from AWAC, not the earnings power of its stake in those assets. That’s just as well because the results were awful. The statutory loss of US$47m included a US$79m charge for a restructure at the Point Henry plant. Excluding this, underlying profit was a more respectable US$26m, but equally as irrelevant.

More important was the performance of AWAC where earnings before interest, tax, depreciation and amortisation (EBITDA) fell 93% to US$119m but, again, that sum was sullied by the Point Henry restructuring. Excluding that charge, underlying EBITDA fell a more respectable 5% as prices and volumes fell. Those negatives were offset somewhat by lower costs, with AWAC closing high cost production to slide further down the alumina cost curve.

Although alumina prices fell, it was significant that the newly created alumina spot price was above the old aluminium linked price. A key reason for upgrading the business in Alumina: lousy business, hot opportunity (Speculative Buy – $1.44) and why stuck with Buy when prices went lower (see Alumina: for the bold and the patient (Speculative Buy – $0.645)) was the expectation that a new pricing structure would improve margins.

GEttinG bEttEr

AWAC has now moved over 60% of contracts onto the new pricing benchmark, a move that has added to profits. The new regime is more stable and better reflects alumina

production costs. By 2016, 80% of contracts should reflect the new pricing regime and contribute to more stable revenue.

With major projects in Brazil and Saudi Arabia almost complete, capital expenditures have halved and AWAC should be able to lift dividends to Alumina in future periods. The market has anticipated this, along with improving industry conditions, and pushed up Alumina’s share price – it’s up over 50% this year. Members have had a mixed experience, those following our initial recommendation are up just 6%. Those who got in at lower prices are up over 130%.

tabLE 1: awC 2014 intErim rESULt

Six montHS to 30 JUn 2014 2013 +/– (%)

Stat. nEt profit (US$m) (47.4) (2.4) n/a

UnDErLYinG nEt profit (US$m) 26.8 36.6 (27)

awaC aLUmina proDUCtion (mtpa) 8 7.9 (1)

EpS (C) (1.7) (0.1) n/a

DpS (C) 0 0 n/a

frankinG (%) 0 0 n/a

CaSH from awaC 54.2 28.9 88

awaC EbitDa 345.6 364.8 (5)

With Alumina’s balance sheet in fine condition – net debt is just $130m – and industry conditions slowly improving, things are getting better for this beleaguered business and dividends could resume next year. It is no longer dirt cheap but neither is it expensive. With the price up 22% since Alumina: Result 2013 (Hold – $1.23), we’re happy to HOLD.

Disclosure: The author, Gaurav Sodhi, owns shares in Alumina.

It was significant that the newly created alumina spot price was above the old aluminium linked price.

Alumina: Interim result 2014Ignore the result. Industry conditions are finally improving and Alumina’s share price is finally recovering.

Gaurav sodhi • 28 AUGUST 2014

aLUmina | awC

PRICE AT REVIEW $1.50

MARKET CAP. $4.2bn

12 MTH PRICE RANGE $0.94–$1.62

BUSINESS RISK Med–High

SHARE PRICE RISK Very High

MAX. PORTFOLIO WEIGHTING 2%

OUR VIEW HoLD

rECommEnDation GUiDE

SellAbove $2.50

Hold

buyBelow $1.20

$1.50

SHAre AdvISor 12

CoCa-CoLa amatiL : intErim rESULt 2014natHan bELL, Cfa

CoCa-CoLa amatiL | CCL

PRICE AT REVIEW $9.04

REVIEW DATE 27 Aug 2014

MAX. PORT. WEIGHTING 7%

OUR VIEW HoLD

At $9 Coca-Cola Amatil’s share price is back to levels not seen since the GFC, as the company’s interim result was every bit as bad as expected. In Australia revenue fell 0.5% to $1,364m compared to the same period last year, but with slightly higher volumes failing to offset lower prices operating profit slumped 14.1% to $227m.

This is by far the company’s most important division, but Indonesia – widely touted as the company’s future growth engine – barely produced an operating profit as costs exploded due to the fall in the Indonesian Rupiah. In case there was any confusion, Coca-Cola is no longer blessed with abundant pricing power.

The Alcohol and SPC Ardmona businesses are as much a management distraction as anything else, but more concerning is the unprecedented competition facing the core Coca-Cola business. People are becoming increasingly health conscious while competitors are dropping their prices. Private label sales are increasing and Woolworths and Coles are using their market power to demand lower prices as they simultaneously consolidate the grocery, liquor and service station industries.

In its best jargonese the company has laid out a comprehensive list of priorities to increase profits. Our best interpretation reveals some key factors; Costs will be cut – a clear sign that top-line growth will be limited; Marketing must address health issues and attract teenagers; The variety of serving sizes and packages will increase; New products must be found and marketed; and the company must retain its premium market position in bottled water through its Mount Franklin brand.

New chief executive Alison Watkins will announce further details on her strategic review in due course and you can expect a slight improvement in earnings in the second half, but that will still mean a big fall in earnings from last year. We’re in no rush to get involved given the company’s competitive position is deteriorating, so with the share price falling 8% since Coca-Cola Amatil loses its fizz from 11 Apr 14 (Hold – $9.76) we’re sticking with HOLD.

arb Corporation: rESULt 2014natHan bELL, Cfa

arb Corporation | arp

PRICE AT REVIEW $12.97

REVIEW DATE 25 Aug 2014

MAX. PORT. WEIGHTING 6%

OUR VIEW HoLD

We downgraded ARB Corp on 21 May 13 (Sell – $13.49) as its strong share price and high valuation made little allowance for the carnage we expected in the resources and mining services sectors. While share prices in those sectors have indeed been savaged, ARB’s share price is recovering as strong exports help offset reduced orders from vehicle manufacturers.

tabLE 1: arp 2014 rESULt

YEar to 30 JUn 2014 2013 +/– (%)

rEVEnUE ($m) 298 292 2.2

Ebit ($m) 55 55 0.0

nEt profit ($m) 43 42 0.5

EpS (CEntS) 58.7 58.4 0.0

pEr 22.1 22.2 n/a

DpS (CEntS) 29 28 4

DiV. YiELD (%) 2.2 2.2 n/a

frankinG (%) 100 100 n/a

finaL DiV. $0.16, fully franked, ex date 8 Oct

Total sales only increased 2.2% over the past year, but if the company continues to develop new products at home and abroad this should eventually offset any short-term cyclical concerns such as Australia’s slowing resources sector. Following years of development the company has released the Ascent Canopy for the Ford Ranger dual cab, with versions for other popular models to be released over the next year.

Despite profits increasing 13% per year over the past decade, the company’s market value is still below $1bn leaving plenty of room for growth as four-wheel drive accessory sales increase around the world. Over the next decade the company will expand its sales and marketing teams and distribution network to ensure its market leading products are as prevalent abroad as they are in Australia. That requires a long-term outlook and money, neither of which are an issue for this cashflow machine.

ARB is one of the few Australian companies that you could conceivably buy and hold for decades, but we’re prepared to wait for a cheaper price before upgrading. That may come as Australia’s massive energy and resources developments wind down over the next couple of years, but with the share price increasing 10% since ARB Corp: Interim result 2014 from 26 Feb 14 (Hold – $11.78) we’re sticking with HOLD.

Stocks in Brief

rECommEnDation GUiDE

SellAbove $14.00Hold

buyBelow $9.00

$12.97 rECommEnDation GUiDE

SellAbove $11.00Hold

buyBelow $8.00

$9.04

If the company continues to develop new products at home and abroad this should eventually offset any short-term cyclical concerns.

Weekly revIeW13

inSUranCE aUStraLia GroUp: rESULt 2014natHan bELL, Cfa

inSUranCE aUS. GroUp | iaG

PRICE AT REVIEW $6.45

REVIEW DATE 26 Aug 2014

MAX. PORT. WEIGHTING 6%

OUR VIEW SELL

Insurance Australia Group’s (IAG) performance has been remarkable since the string of natural catastrophes in 2011. Chief executive Mike Wilkins has cut costs and disposed of the problematic UK businesses, revealing a first class insurance business enjoying a period of minimal claims and strong premium pricing that reflects its market position as one third of an oligopoly to rival that of the big four banks. The share price has responded in kind, increasing 132% since its low of $2.79 in November 2011.

tabLE 1: iaG 2014 rESULt

YEar to 30 JUn 2014 2013 +/– (%)

rEVEnUE ($m) 9,779 9,498 3.0

inSUranCE profit ($bn) 1,579 1,428 10.6

UnDErLYinG inSUr. marGin (%) 14.2 12.5 n/a

nEt profit ($m) 1,233 776* 59

EpS ($) 54 50 8.0

pEr 11.9 12.9 n/a

DpS ($) 0.39 0.36 8.3

DiV. YLD (%) 6.0 5.6 n/a

frankinG (%) 100 100 n/a

finaL DiV. $0.26, fully franked, ex date 8 Sep

*Includes losses from UK business

IAG doesn’t look expensive trading on a price-to-earnings ratio of 12 and a 6% fully franked dividend yield, but therein lies the trap. The time to buy insurance companies is during periods like 2011 when claims explode following a series of expensive natural catastrophes and the price-to-earnings ratio is high becuase earnings have collapsed. It’s usually the same time that investors make any excuse not to buy insurance companies, such as blaming global warming as the reason for the increase in natural catastrophes while overlooking the fact that such periods lead to more people spending a lot more to protect their belongings.

IAG’s results show we’re currently at or near a peak in the insurance cycle. Premium growth is slowing following three years of strong growth and margins are at or near record levels as the benign claims environment produces reserve releases. We wouldn’t underestimate Wilkins’ ability to create plenty of value from the recent acquisition of Wesfarmers’ insurance business, which has made IAG top dog in commercial insurance, but we’re prepared to wait patiently for the next great buying opportunity when Mother Nature strikes.

IAG is a far better business than it was prior to Wilkins’ arrival, but with the share price approaching $6.50 we’re taking advantage of Mr Market’s ebullience even if it means leaving some value on the table (this was a key lesson from our experience with QBE Insurance). The insurance industry is notoriously cyclical, so with the share price increasing 5% since IAG confirms profit guidance from 24 Jul 14 (Hold – $6.14) we’re downgrading to SELL.

SomnomEDGrEG Hoffman

SomnomED | Som

PRICE AT REVIEW $1.88

REVIEW DATE 25 Aug 2014

MAX. PORT. WEIGHTING 2%

OUR VIEW HoLD

Europe is sleeping a little more soundly this year thanks to a small Australian company called SomnoMed. We introduced the company with a positive recommendation in SomnoMed: A future mini-ResMed? on 5 Feb 14 (Speculative Buy – $1.33). The review laid out the big-picture for the business, which treats sleep apnoea through the manufacture of custom-made oral appliances (fancy mouthguards). The company’s recent full-year results showed that the case remains on track.

Unit sales in Europe exploded by 41% while sales in the larger US market grew by 12%, though the rate was 18% in the second half and management expects to maintain a pace closer to that mark for the coming year. Several European markets are embracing this kind of treatment as a first line, compared to Australia and the US where the first line is continuous positive airway pressure (CPAP) treatments from the likes of ResMed and Fisher & Paykel Healthcare (see Shoptalk).

SHoptaLk

Somnomed’s mouth guards are usually replaced every 3–5 years, but for those that grind their teeth (a condition known as bruxism) it might be closer to 2.5–3 years. Though the costs are comparable over the long term with CPAP treatments, the competitive edge (vis-a-vis CPAP) is in compliance (fewer people stop using oral appliances than CPAP over time) and portability. But they only really compete in moderate sleep apnoea cases – CPAP wins severe cases hands down.

In Sweden, more than half of all new patients are now treated with oral appliances rather than CPAP machines. And Holland is heading in that direction, too (45% this year, up from 35% last year). Overall this year revenue rose by 40% to $26m, helped along by a softer Australian dollar (overall unit sales were up 21% for the year).

rECommEnDation GUiDE

SellAbove $6.50Hold

buyBelow $4.00

$6.45

rECommEnDation GUiDE

SellAbove $3.50Hold

buyBelow $1.75

$1.88

AG doesn’t look expensive trading on a price-to-earnings ratio of 12 and a 6% fully franked dividend yield, but therein lies the trap.

SHAre AdvISor 14

SomnoMed is currently expanding into new markets including Italy, the UK, Spain, Portugal and Korea.

SomnoMed shares are up 13% since SomnoMed SPP on 4 Aug 14 (Hold – $1.67) and we’ve raised our recommendation guide slightly given the company’s continued business success. HOLD.

Management expects unit sales of 55,000 for the coming year (up 27%) with revenue of $32.5m (up 25%). Our expectations are a little more modest (management has a history of slightly over-promising) but this remains a company growing at more than 20% per year, which is a rare beast in a sputtering first-world global economy.

Negative headlines and popular scorn shouldn’t be automatic buy triggers but they should pique our interest.

Blue sky at Qantas?Gaurav sodhi • bloG post • 29 AUGUST 2014

The reaction to Qantas’ results has been universally savage. Everyone agrees the airline is doomed, that sensible investors should avoid the company and avoid the sector. No less than Warren Buffett himself has proclaimed he would never buy an airline. Pessimism and discomfort surround the business. This is, in other words, perfect hunting ground for contrarian investors.

Negative headlines and popular scorn shouldn’t be automatic buy triggers but they should pique our interest. Sure, Qantas is a poor quality business in a lousy industry. But there is a price for everything.

So, how could things get better at Qantas?

Start with the loss. The tear inducing headline loss was $2.8bn, the largest in the company’s history. This included asset impairments of $2.5bn but, even at an underlying level, last year’s $186m profit fell to a $646m loss. The headlines, so far, seem well deserved.

What went wrong? The international business lost almost $500m in earnings before interest and tax (EBIT). And although it regularly loses money, this year’s loss was double last year’s. There are no easy remedies. Since 2008, competitors have increased seats by 44% in international routes forcing prices and revenue lower. Selling or shrinking the international business seems to be the only way to stem losses.

The domestic business operates some of the most profitable routes in the world, last year generating EBIT of $365m. This year, a price war devastated profits to just $30m, 90% lower. Qantas’s derided strategy to claim 65% market share is blamed but it’s not an act of irrationality – it is to deter competition.

If competitors believe they can access juicy margins, they will. Qantas has to convince them it will wear any loss to prevent them making profits. Game theory, not silliness, is at play. Either rational pricing will return to restore profits or they will be permanently lower. We can’t know which of those outcomes will take place but a return to normality could see segment profits rise 10-fold. In my view, management is acting sensibly.

Jetstar recorded an operating loss as a result of the price war but this is its first operating loss in a decade and is unlikely to be permanent. The frequent flyer business is the most profitable, generating EBIT of $286m, 26% higher than last year. This is the airline’s best asset.

There is a possible path to recovery, however. Floating Jetstar, shutting or shrinking the international business, a return to rational pricing and a float/sale of the frequent flyer business could all benefit shareholders. These are unlikely outcomes but they are possible. There is, therefore, some option value in Qantas.

All this doesn’t mean Qantas is worth buying – I don’t think the price is quite low enough – but writing it off and swearing never to buy is behaviour we should exploit rather than emulate. We may get our chance.

Weekly revIeW15

ozforEx’S aDDED VaLUE

Thank you very much for your comprehensive coverage of OzForex (OFX), James. I really do like the sound of this company and I’m just about to pull the BUY trigger but I am concerned about it’s medium-term viability. For well over a decade we have been able to transfer funds from one bank account to another via internet banking for free, albeit just within Australia. In this age of rapid globalisation, surely it’s only a matter of time before the banks across the globe upgrade their systems to tack a country code on the front of the bank account number to allow international transfers just as easily as domestic transfers? MasterCard and Visa seem to have worked it about by processing international funds transfers from our bank accounts to foreign merchants whenever we purchase something overseas without the need for a service provided by the likes of OzForex. Am I’m showing my ignorance as to the value-add this company provides or could this be precisely why the owners headed for the exits? Mike C

25 Aug 2014 – James Carlisle: First of all I must stress that I can’t give personal advice, so all of the following is just my general view on the stock.

The big difference between a local transfer and an international transfer is, of course, that the latter involves a currency trade, and that’s where OzForex adds the value. The transfer itself is nothing; but to get $A into $US cheaply and efficiently definitely is something – just like any other trade, the counterparties will want to know that they’re not being ripped off. That involves some effort and, for relatively small trades, banks have (presumably) not found it to be worth their while – hence why they build themselves in such a fat margin of safety (at the cost of the customer). (And don’t think that Mastercard and Visa do it for free – you’ll get a lousy rate from them, and then there’s all those ’overseas transaction charges’.)

OzForex gets past this because it has developed technology that essentially piggybacks off the international currency market – offering reasonable rates and hedging them (where necessary) until settlement. This automation enables a better rate and it also lets the customers know their rate before they transact. All of this is currently beyond the banks (at least

for small customers – for big customers doing wholesale trades it’s a different story).

What I’m expecting over the medium term is more consolidation, so that the payments specialists are dealing with larger amounts, offsetting more directly between customers (ie someone sending A$ is offset against someone receiving A$) and further reducing fees. There’s no reason I can see why OzForex shouldn’t play a part in this process, either as buyer or target, or more likely both, but it could be a bumpy ride!

SEEk pEr VS traDE mE

Hi James, Interested in your thoughts on paying a ~17x P/E for TME versus a similar multiple for Seek (SEK). SEK P/E based on last twelve months EPS appears around the same ballpark. Growth prospects within TME are expected to be muted in FY14. Management does expect some further growth in FY15. SEK appears to have stronger growth prospects with revenue and earnings all set to grow in the double digits, as well as a number of international markets in which to expand into. You have noted that you don’t rate jobs advertising as highly from a competitive/business model standpoint, however I just get the impression that TME is a dominant player with fewer growth prospects. Is it just a matter of rating the quality of property/motor earnings higher than jobs? Andrew T

25 Aug 2014 – James Carlisle: Where are you getting your PER for Seek, because I’m getting almost double that! The EPS just announced for 2014 for Seek was 53 cents (excluding significant items), giving a PER of 32. Even looking forward to the consensus for 2015 of 62 cents the PER comes to 27. So that’s the difference right there – if I could buy Seek on a historic PER of 17 I’d do so like a shot – come to think of it, I did exactly that in July 2012!

Ex DiViDEnD DatE

I am new to share trading and wanted to ask if you hold a share (that provided dividend payment) and sold it on the day it went ex, do you still receive the dividend payment for that share?

22 Aug 2014 – Graham Witcomb: The ASX explains how dividends are paid here. The ex dividend date occurs two business days before the company’s Record Date. To be entitled to

a dividend a shareholder must have purchased the shares before the ex dividend date. If you sell on the ex date, you are still entitled to the dividend, however it’s likely the share price has fallen by the same amount as the dividend to account for the fact that the person you’re selling to will not receive it.

tECHniCaL anaLYSiS

Could I please know if there is merit in using technical analysis when entering and exiting a stock? If so, what key technical measures should be used? In this day and age, can we just rely on one method when trading/ investing in stock (i.e. just fundamental or just technical).

22 Aug 2014 – Graham Witcomb: I’d say in this day and age, not only can you rely on one method when investing, but must – and that method is value investing by fundamental analysis. Technical analysis differs from value investing in that it relies on the immediate past to predict the future. Volumes, prices, charts etc. are types of data that are easily and more efficiently analysed by computers. Whenever you make a trade, it’s important to remember that you are up against an army of banks and hedge funds with incredible resources at their fingertips to invest in software, engineers and analysts to pore over the same data you see (and more) and execute in fractions of a second – what are the odds you or I can beat them at that game? There’s nothing to say an edge can’t exist in technical trading, but the odds you’ll be able to act on it before other market participants have spotted it are extremely low.

Value investing, on the other hand, is about psychology and that’s something that can not only be improved with education, but will actually give you a significant advantage over computer driven traders that buy or sell mindlessly. Humans have a string of biases that mean stocks tend to become either overvalued or undervalued relative to their intrinsic worth. That is, the underlying value of a company doesn’t fluctuate nearly as much as its stock. At II, we value the company and then wait for the market to offer us a favourable price, usually because people have oversold it out of short-term fear or a temporary problem. Patience is our enduring advantage. My suggestion is focus on buying high quality companies at sensible prices, and don’t worry about timing your way in and out.

Ask the Experts

SHAre AdvISor 16

the sector weightings don’t expose us to too much risk. Risk isn’t just a product of weighting, though – it depends on what that weighting is towards!

inVEStinG Link

I think this article may be worth sharing with subscribers It has some elements of the Tulip Mania of the 1630s plus highlights the difference between investing for a return and speculating on future prices. Michael M

28 Aug 2014 – Gaurav Sodhi: Thanks, Michael.

pro-mEDiCUS too SmaLL

The Weekend Australian did a brief item on Pro Medicus. It looks interesting, seemingly substantial expansion and profits to come. Might you consider running an analysis please?

25 Aug 2014 – Nathan Bell, CFA: Unfortunately the stock is too small for us to cover but it seems the company is in a sweet spot with its latest product picking up a key customer or two. Given its small size it could well be worth doing your own homework, but the difficult part is assessing the competition as the medical software industry isn’t an industry many of us know much about.

SirtEx

Are you planning to review Sirtex Medical (SRX) in the near future, the recommended sell price on 14/3/14 was 17.5 it is now 20.9 a worthy investment for those who had purchased already. Is it worth investing now though? or are they at there peak.

22 Aug 2014 – Graham Witcomb: We’ll be doing a detailed review of Sirtex in the coming weeks. Please note, however, that we have removed the price guide intentionally from Sirtex due to its rapid growth (see Holding on to Sirtex).

wHY DoES CSL HaVE a LowEr portfoLio Limit?

Why do you recommend a maximum portfolio weighting of 6% for CSL while the likes of RMD and COH get a limit of 7%? Surely CSL is a very high quality company that deserves a decent chunk of one’s portfolio – at the right price of course, i.e. maybe not right now, but I’m asking in general. Thanks and keep up the great work.

22 Aug 2014 – Graham Witcomb: Thanks for the compliment. You’re right that CSL is a high-quality company, as are RMD and COH. The main reason CSL has a slightly lower portfolio limit is

pErLS Vii rEViEw

Can you give your opinion on the new CBA PERLS being offered.

22 Aug 2014 – Nathan Bell, CFA: Hi June and to everyone that’s interested in the PERLS VII securities. Chris Joye has saved us a task, clearly pointing out why we prefer the ordinary shares to these hybrids, albeit both securities are expensive and neither currently offers a margin of safety. These hybrid securities should in no way be considered a substitute for deposits.

portfoLio wEiGHtinGS

As a new subscriber, I’m liking the research – thanks. I’m exploring the income portfolio and comparing it with what I have, with the plan of slowing adding to mine more of yours. I notice you have three companies which seem to overlap, and give quite a large tilt to financial management – Perpetual, Platinum, and IOOF. Why?

27 Aug 2014 – James Carlisle: First of all a word of caution – our model portfolios aren’t meant to be replicated because they’ll always own stocks that are in the Hold phase (perhaps even close to being sold) and therefore won’t reflect our best ideas at any given point in time. The idea is that they give an idea of what a sensible portfolio might look like, how you might go about building and managing one and what can be achieved by doing so. Also bear in mind that our advice can only be general and the same opportunities won’t suit everyone, so you need to apply our advice to your own circumstances.

So, having said all that, the purpose of a portfolio is of course to hedge your bets among different opportunities – most shares overlap a bit, given that they’re shares and they participate in the performance of the Australian economy. By splitting our money between three companies (3% or so each) in the wealth management sector we’re able to have a bigger exposure to that sector than if we put it all in one company – individually companies in this sector can be quite risky so we wouldn’t want to have as much as 10% in one. And 10% doesn’t seem like too much for what is an attractive sector, relatively unthreatened by the internet and will solid long-term growth prospects supported by compulsory super. Bear in mind also that our weighting in banks is very low, so our overall weighting to ’financials’ is relatively low.

This isn’t really how we see things, though – rather we start from the other direction, by aiming to get our best ideas into the portfolios over time and then making sure that the individual positions (first and foremost) and then

due to its complexity. There are many more moving parts in the pharmaceutical industry, and in CSL in particular, than the medical device industry, which translates into a slightly higher level of uncertainty in our valuation. It’s worth noting that our portfolio limits are not a ’one size fits all’, they are more a starting point from where you can make your own adjustments to factor in your personal circumstance. To better understand how we think about portfolio limits, and what weightings might be appropriate for you, check out Nathan Bell’s article Why I can afford mistakes (and maybe you can’t). All the best, Graham

timE to SELL notHErn Star?

Is it time to sell NST. In the recent months, the stock has gone gang busters after its two mine purchases. Its production appears to be going to plan if not better and it maintains a decent recovery price. But how much is too much for the flourishing stock? Jerome M

28 Aug 2014 – Gaurav Sodhi: It’s a question I’ve been thinking about a fair bit too, Jerome. Northern Star has more than doubled since we recommended it and it has by far been the best performing miner in the sector. The share price appreciation is a response to good news. As you say, production and exploration results have been very good suggesting higher prices are justified.

Gold prices are still fairly low and, should this change, we could see higher prices yet. Gold miners are, however, notorious for announcing bad news. Perhaps the best strategy is to keep portfolio limits in place. We’ve recommended about 5% in the gold sector and no more than 2% in a single exposure.

bLoG LinkS

Coke is no longer it

How I learned to love Caltex

Steering clear of Scentre Group

Rio and BHP build new global iron ore cartel

twittEr LinkS

Why value investors avoid stocks with high multiples

Interesting Joel Greenblatt profile in Barron’s

Great blog post from Toby Carlisle on What The Original Mad Man David Ogilvy Can Teach Investors