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1 Weekly Recommendation, Target Price, Earnings Forecast Changes

2 The Oil Search Buy Argument

3 A-REITs: Focus On Earnings Growth

4 M2 Telecom Acquires Businesses And Risk

5 Orica Detonates Concerns Over Earnings

6 Goldman Reports Spark Rio Confusion

7 TPG Rings Up Strong Subscriber Growth

8 Sweet Spot Stocks: Telecoms Prove Their Mettle

9 Breville Brews Potential Despite Keurig Loss

10 David Jones Transforming But Going Where?

11 Metal Matters: Steel, Iron Ore and Base Metals

12 Uranium Market Tighter Than Most Think

13 Time To Buy Silver?

14 Metal Matters: US Dollar, Copper And Iron Ore

15 Greenback On The Launch Pad

16 The Global Recovery Is Really Underway

17 Weekly Broker Wrap: Europeans Home In On Oz Infrastructure

18 The Short Report

FNArena Weekly http://www.fnarena.com/membership/pdf_weekly.cfm

1 of 49 23-Mar-13 5:55 PM

19 SMSFundamentals: Growth And Yield In Direct Industrial PropertyInvestment

20 Dow Trend Still To The Upside

21 Treasure Chest: Drums Speak Of Perseus Re-Rating

22 Resources: In Need Of A Catalyst


2 of 49 23-Mar-13 5:55 PM

Stories To Read From FNArena www.fnarena.com

1 Australia

By Andrew Nelson

Upgrade and downgrade activity by Australia’s major international brokers picked up a little bit last week. TheFNArena Database shows that there were six upgrades made last week versus nine downgrades and while therewere more significant upward EPS forecast revisions than downward, significant consensus price target cutsoutnumbered the increases.

Atlas Iron ((AGO)) was upgraded to Buy from Sell by Credit Suisse on the back of a strong December quarterproduction report that saw the broker lift its FY13-14 EPS forecasts by 66% and 18% and price target to $5.40 from$5.20. Sentiment in the FNArena Database is positive, with more than 17% upside to the consensus price target.

Aurizon Holdings ((AZJ)) was lifted to Buy from Hold by JP Morgan. Shares were trading at an 8% discount to thebroker's valuation and it notes the company has limited exposure to domestic macro conditions. Recent railcontract wins have also added to the valuation picture. The broker also upgraded Aurora Oil & Gas ((AUT)) to Holdfrom Sell on news the company plans to raise debt to fund its recent acquisitions, rather than equity. The brokernotes the planned US$250m note issue will fill the funding gap and give the company a buffer to accelerate fielddevelopment or make further acquisitions. Broker sentiment for both stocks is positive.

JP Morgan’s final upgrade last week was on Australand Property ((ALZ)), which went to Hold from Sell, the brokernoting the share price has underperformed residential developer peers by around 15%. At the same time, JP Morganalso reduced the valuation discount it applies for the residential business. Broker sentiment is positive.

Credit Suisse boosted Fortescue Metals ((FMG)) to Buy from Hold. The broker re-modelled its case after the selldown of the minority stake in the port and rail infrastructure, assuming the company will attract $3.3 billion for a35% stake. CS reasons earnings will improve slightly, but the major benefit is the lower gearing ratio, which CreditSuisse foresees reaching 49% by end of FY14. This should enable Fortescue to be re-rated investment grade, thinksthe broker. Broker sentiment remains positive.

Our last upgrade was enjoyed by OZ Minerals ((OZL)), which was lifted to Buy from Hold by CIMB, who cited strongcash flow and recent share price underperformance. The broker believes the company should generate strongoperating cash flow from Prominent Hill over the remainder of the mine life, despite being a bit sceptical of theplans to extend underground given the volume of ore required to justify it.

Of the downgrades, CIMB dropped its call on CSR ((CSR)) to Hold from Buy. The company put out an update lastweek and guided for a net profit of $32m-$34m, 30% below the broker's previous estimates, which were pretty muchin line with consensus. The damage was done by an underperforming Viridian glass business, which is unsurprisinglybeing restructured yet again. Weaker than expected numbers for property and aluminium also didn't help. The callwas ultimately made on valuation grounds, the broker looking for some more clarity and a better entry price beforetaking a more positive stance. The Sentiment Indicator in the FNArena Database shows a negative read.

David Jones ((DJS)) was cut to Sell from Hold by Deutsche Bank, the broker pointing out the share price has runbetter than 26% so far this year and is now looking way too expensive on a 12-month PER of 16.8x, which is a 10%premium to the broader market. Sentiment for the stock is negative ahead of the company's interim profit reportthis week.

Fletcher Building ((FBU)) was downgraded to Sell from Hold by Citi after a new analyst took the reins. Citi’s newman pointed out that while the share price seems reasonable versus peers, it is still expensive given shares trade ata better than 10% premium to the broker's valuation. Sentiment for the stock is still positive post the downgrade.


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Citi also lowered Karoon Gas ((KAR)) to Hold from Buy after adjusting its valuation to account for a changed view ofrisk in the company's exploration portfolio. Karoon's Browse, Brazil and Peru prospects are now seen as speculativeby the broker.

Myer ((MYR)) had a busy week last week, downgraded to Sell from Hold by Citi and to Hold from Buy by both UBSand Credit Suisse. Citi liked the focus on costs and noted there was some sales growth on offer, but the broker isconcerned the improvement has come on the back of more discounting and a lower-margin sales mix. A lowermargin outlook and the fact the shares have run 42% this year are what tipped the broker to Sell. Both UBS and CSalso liked the look of the result and are reasonably optimistic on the outlook, but like Citi, they think shares haverun too far too fast. Sentiment has moved into negative territory on the downgrades.

National Australia Bank ((NAB)) was dropped to Hold from Buy by Citi, the broker concerned about the recent rallyin the share price. BA-Merrill Lynch downgraded Premier Investments ((PMV)) to Sell from Hold, noting the stock isovervalued at current levels after having significantly outperformed peers since the FY result last September, whileoffering a yield of only 4.8% versus a peer average of 5.9%.

Lastly, Credit Suisse downgraded Sigma Pharmaceuticals ((SIP)) to Hold from Buy, noting the 1H result fell a bitshort and that the rising costs of goods is concerning. Operating cash flow was strong and given the broker sees thecompany as being in a state of significant internal change, this is definitely a good thing and should help support theshare price. But a merely supported share price doesn't warrant an Outperform call, said CS.

There was only one greater than 5% revision to consensus price targets and that was seen by Aquarius Platinum((AQP)), whose average target was boosted by 18.3% last week. CSR’s average target price was boosted by 4.9%,while Karoon Gas’ average target is 4.4% lower.

There were a number of significant revisions to consensus EPS forecasts, the largest of which was seen by CSR, withforecasts down by 34.6%. Discovery Metals ((DML)) earnings estimates were dropped by 31.9%, with Citi panning theFebruary production report. Macquarie Atlas Roads estimates were down more than 28%, Perseus Mining ((PRU)) is13% lower and Qantas ((QAN)) is down by 12.3%.

There was only one significant earnings increase of note and that was a 17% increase enjoyed by Silver LakeResources ((SLR)). CIMB initiated coverage with a Buy call last week, saying that since the merger with Integra andthe commissioning of Murchison, the company is now set to produce around 170-190koz of gold in FY13 with a goalof taking output to 400kozpa.

Note: FNArena monitors eight leading stockbrokers on a daily basis and the tables below are based on data analysisfrom the week past concerning these eight equity market experts. The eight experts in casu are: BA-Merrill Lynch,Citi, Credit Suisse, Deutsche Bank, JP Morgan, Macquarie, CIMB (formerly RBS) and UBS.

Total Recommendations Recommendation Changes

Broker Recommendation BreakupSecurities,Citi,Credit<*br*>Suisse,Deutsche<*br*>Bank,JP<*br*>Morgan,Macquarie,UBS&b0=99,151,82,81,89,70,112,96&h0=79,152,119,105,137,107,124,138&s0=64,24,38,46,16,49,38,27" style="border:1px solid #000000;" />

Broker Rating UpgradeDowngrade Order Company Old Rating New Rating Broker 7 CSR LIMITED Buy Neutral CIMBSecurities 8 DAVID JONES LIMITED Neutral Sell Deutsche Bank 9 FLETCHER BUILDING LIMITED Neutral Sell Citi 10KAROON GAS AUSTRALIA LIMITED Buy Neutral Citi 11 MYER HOLDINGS LIMITED Neutral Sell Citi 12 MYER HOLDINGSLIMITED Buy Neutral UBS 13 MYER HOLDINGS LIMITED Buy Neutral Credit Suisse 14 NATIONAL AUSTRALIA BANKLIMITED Buy Neutral Citi 15 PREMIER INVESTMENTS LIMITED Neutral Sell BA-Merrill Lynch 16 Sigma PharmaceuticalsLtd Buy Neutral Credit Suisse [Due to technical problems the table above is incomplete. We apologise]Recommendation Positive Change Covered by > 2 Brokers Order Symbol Previous Rating New Rating Change Recs 1AGO - 13.0% 13.0% 26.0% 8 2 FMG 25.0% 38.0% 13.0% 8 3 AZJ 38.0% 50.0% 12.0% 8 4 SLR 67.0% 75.0% 8.0% 4 5 EVN 60.0%67.0% 7.0% 6 6 AQP 20.0% 25.0% 5.0% 4 Negative Change Covered by > 2 Brokers Order Symbol Previous Rating NewRating Change Recs 1 BWP - 50.0% - 67.0% - 17.0% 3 2 KAR 100.0% 83.0% - 17.0% 6 3 PMV 33.0% 17.0% - 16.0% 6 4 CSR -25.0% - 38.0% - 13.0% 8 5 NAB 38.0% 25.0% - 13.0% 8 6 STO 88.0% 75.0% - 13.0% 8 7 DJS - 38.0% - 50.0% - 12.0% 8 8 FBU25.0% 13.0% - 12.0% 8 9 AQG 75.0% 63.0% - 12.0% 8 10 SGT 57.0% 50.0% - 7.0% 6 Target Price Positive Change Covered


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by > 2 Brokers Order Symbol Previous Target New Target Change Recs 1 AQP 1.023 1.210 18.28% 4 2 CSR 1.826 1.9164.93% 8 3 BWP 2.055 2.113 2.82% 3 4 PMV 6.368 6.517 2.34% 6 5 NAB 28.770 29.339 1.98% 8 6 AZJ 4.254 4.333 1.86% 8 7EVN 1.652 1.675 1.39% 6 8 FMG 5.143 5.214 1.38% 8 9 AQG 5.451 5.516 1.19% 8 10 DJS 2.390 2.403 0.54% 8 NegativeChange Covered by > 2 Brokers Order Symbol Previous Target New Target Change Recs 1 KAR 8.628 8.243 - 4.46% 6 2SLR 3.017 2.925 - 3.05% 4 3 STO 15.569 15.381 - 1.21% 8 Earning Forecast Positive Change Covered by > 2 BrokersOrder Symbol Previous EF New EF Change Recs 1 SLR 24.767 29.075 17.39% 4 2 OSH 10.912 11.283 3.40% 8 3 SKI 15.32515.625 1.96% 7 4 QBE 100.357 100.761 0.40% 8 5 ORL 65.668 65.908 0.37% 5 6 AZJ 20.011 20.073 0.31% 8 7 PTM 22.60022.657 0.25% 3 8 IIN 34.851 34.894 0.12% 7 9 SGT 17.986 18.005 0.11% 6 10 CTX 159.432 159.598 0.10% 6 NegativeChange Covered by > 2 Brokers Order Symbol Previous EF New EF Change Recs 1 CSR 9.425 6.161 - 34.63% 8 2 DML11.057 7.532 - 31.88% 4 3 MQA 4.733 3.400 - 28.16% 6 4 PRU 17.129 14.843 - 13.35% 7 5 QAN 11.465 10.053 - 12.32% 7 6AQG 49.280 44.858 - 8.97% 8 7 EVN 13.913 13.497 - 2.99% 6 8 STO 60.838 60.338 - 0.82% 8 9 ANN 100.789 99.968 - 0.81%7 10 GMG 32.000 31.764 - 0.74% 6 Technical limitations

If you are reading this story through a third party distribution channel and you cannot see charts included, weapologise, but technical limitations are to blame.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this storycontains unashamedly positive feedback on the service provided.


5 of 49 23-Mar-13 5:55 PM


2 Australia

By Andrew Nelson

The FNArena Database shows six Buy calls and two Hold calls and nearly 14% upside to the consensus price targetfor oil & gas explorer/developer Oil Search ((OSH)). According to the database, consensus for full-year earningsgrowth next year (2014) is pegged at 78.9%, while dividend growth is pencilled in at nearly 48% (off a low yield).Looking at these numbers it almost seems the obvious question is why are two brokers at Hold, not why are six atBuy?

It all comes down to the valuation model employed by the broker. More specifically it comes down to how brokersvalue the optionality the stock offers.

JP Morgan, at Hold, sees a 75% chance of a third production train at PNG LNG, while Citi, who downgraded to Holdat the end of February, sees an 80% chance of a 5tcf third train and also cites many potential exploration catalysts.Still, the broker sees prospects like Mananda, Taza, and the Gulf of Papua as being relatively high risk and ascribeslittle value to them. Despite the lack of speculative valuation support, Citi calls Oil Search the best value, top pickin the sector, while JP Morgan’s call is based on a sector-relative valuation.

That’s the simple story of why there are two Hold calls. The six Buy calls will take a little more explaining.

Analysts from CIMB seem to hold one of the biggest crushes on the stock and believe there are nowhere near theamount of unanswered questions that brokers like Citi and JP Morgan see. CIMB calls Oil Search a simple but goodstory, citing a better than 15% free cash flow yield when, not if, Train-3 comes on line in 2018. What’s more, withExxon running the operation, the story is enhanced.

The broker points out that on many levels, the Oil Search investment case is also a fairly cheap play on Exxon Mobiland its ability to deliver and operate a major project. So even if PNG LNG T3 is risked at 80%, Exxon trades atcurrent 10.9x, so it is cheap way to play the what is the biggest operator in the global game.

The real question to CIMB is whether Exxon will want to own Oil Search post start-up at PNG LNG?

One of the keys for the company going forward will be maintaining the sustainability of the currently strong levelsof free cash flow on offer. If the company is able to remain disciplined, then there isn’t really that much to tax thebalance sheet other than PNG LNG. Most other projects, like Taza, are low cost, so even if they do fall over, thebroker doesn’t see much value destruction.

Another thing supporting the broker’s appreciation of the Oil Search story is that the rest of the big caps in thesector either look a lot more expensive, or present much greater capital risks. On current numbers, Oil Search’sFY18 PE ratio is less than 5x, free cash flow yield is in excess of 15% and the long-term earnings potential isimpressive, says CIMB.

It may take a while for the market to appreciate all of this and share price appreciation may be slow in coming,but it will be a steady climb over the coming years until the stock begins to be priced more on earnings and moreimportantly, cash flows.

CIMB’s view is pretty much the same story told by most other brokers, although with a few variations.

BA-Merrill Lynch is much more relaxed about risk profile, feeling increasingly confident about start-up timings andcapex budgets. The broker notes the pipeline has now passed Kutubu, which is the source of commissioning gas.Komo is nearing completion and all of the heavy lifting has been completed at the LNG plant.

Operationally, FY production forecasts were maintained at the recent profit result release and what’s more, all of


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the oil sold in 2012 has been replaced by increased reserves in 2013 after a 24% increase in contingent resourceswas posted with the result at the end of February. This has the broker thinking the company couldn’t be in bettershape prior to first LNG production. Again, cash flow is strong, which will support ongoing exploration anddevelopment.

There is one problem seen by the broker. Even though a resource increase has made, and the PNG LNG expansionalmost a certainty, Merrills thinks Exxon probably won’t green light the development until drilling at Hides iscompleted, so a final investment decision (FID) is unlikely in 2013.

Credit Suisse agrees on first LNG in 2014 and sees capex needed to get there as easily covered. Given the type ofresource increases being booked at sites like P’nyang, the broker is very confident enough resource can be found tosoon underwrite Train-3. The broker calls it “the best LNG project among Australian majors”.

Goldman Sachs notes the stock trades at an unwarranted 18% discount to the broker's valuation. Goldman expectsthe project will enter front end engineering and design (FEED) on Train 3 in 2013, with more good news to comeover the year ahead. Drilling at Hides, offshore Gulf of Papua and in Kurdistan are all likely to offer valuationupside, although this will put some strain on the capex budget.

This pretty much sums up Macquarie’s opinion as well, the broker noting that with continued solid progress beingmade on a number of fronts and what seems to be a seemingly conservative budget for the PNG LNG development,all the market should get in the year ahead is positive drilling news and more support for the valuation case.

Analysts at Deutsche Bank are very upbeat on the increased resource estimates at Pn'yang, proving there are morethan enough unallocated gas opportunities in PNG to support a third train. The broker, like the rest, sees a run ofdrilling catalysts in the Gulf of Papua and Middle East/North Africa, which should increase growth prospects. Morethan enough to keep an undervalued stock at Buy.

Lastly, UBS pretty much sees Train-3 as a done deal and thus believes other catalysts, of which there are quite afew, will drive the share price this year. Drilling at Taza in Kurdistan, Semda in Tunisia and in the Gulf of Papua allkicking off in the first half this year. Taza may well contain 250-500 mmbbl. Mananda oil resources in PNG havebeen upgraded from 12.5 to 30 mmbbl, with an appraisal likely to commence drilling next month.

Thus the existing oil business itself, plus Train 1 and 2 at PNG LNG underpin the share price, with a 50% riskweighting on Train-3 and 44c per share for the 2013 exploration drilling program is more than enough to supportUBS' Buy call.



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3 Australia

-Narrower capex margins seen for REITs -Cap rate compression potential is there -Preference for earnings growthmaintained -Underperformance but downside limited

By Eva Brocklehurst

There's an emerging dynamic from presentations by management of various Australian real estate investmenttrusts (REITs), in the wake of earnings season. Goldman Sachs found the return from capital expenditure againstasset capitalsation rates is looking lower than in the past.

The cap rate is the ratio of annual income that can be derived against the book value of the asset. A narrowing ofthe comparison with the cost of investment in expansion and development potentially reduces the profit marginand can increase the development risk. The narrower margin limits upside opportunity, which has typically beenavailable from unrealised development profits on capex works. Generally, it has always been presumed thatdeveloping and expanding a property would deliver a healthy yield on the expenditure versus the property caprate.

Or, put another way, this returns a consistent profit on cost by REITs for the development risk being taken.Re-development has also resulted in a higher yield on incremental investment compared with buying additionalproperties, where taxes such as stamp duty come into play. Goldman notes there is now a reduced margin for errorand demand for specialty stores, in the case of shopping centres, is currently the weakest in a decade.

So, does this mean investment returns in property re-development is more risky? Or are there enough mitigatingfactors to counter the narrower margin? Goldman analysts suggest several factors could be combining to underpinthe narrower margin. These could include owners looking for opportunities to expand on low premiums but stillseeing the benefit of upgrading assets. Also, development works could be used as a trigger for shifting the asset caprate lower by repositioning the property. There could also be limited opportunities for acquisitions.

Looking at the cap rate specifically, Goldman notes cap rate compression is being anticipated in the market. Thebroker finds limited evidence so far this is actually happening. On the asset side, there are short and medium termheadwinds to lifting property values. These include new supply hampering rental growth in the office sector, highoccupancy and low margins for tenants in the retail sector, and lower barriers to entry in the industrial sector. So,the risk of valuation upside from potential lower cap rates could be offset by lower rent in the analyst's opinion.Moreover, the market does not appear to be actually pricing in cap rate compression to stocks yet. Goldmansuspects the market may be, at this stage, differentiating between REITs with earnings growth potential and thosewith short-term earnings headwinds.

Morgan Stanley has emerged from discussions with REITs and believes the outlook for cap rate compression is a bitmixed. What can be generally said, in keeping with Goldman's view, is there's little expectation for downside risk toasset values. Whilst it was generally acknowledged that asset values were well supported, the point is whether amoderating rental outlook across office and industrial markets would offset any cap rate compression with regardto driving asset values up. In the end, the broker suspects the potential for cap rate compression is higher for officeand industrial than retail REITs, purely from the point of higher average starting yields in each sector. Whilst riskprofiles do differ between office, industrial and retail, Morgan Stanley expects greater appetite for assets andtransaction activity will translate into the office sector seeing the bulk of cap rate compression.

UBS finds fundamentals have been sufficiently rebased and compression is around the corner. The broker believesthe appetite for yield along with transactional evidence illustrates cap rate compression is likely to occur this year.The broker expects 10-30 basis points of cap rate compression across prime office property as well as net assetappreciation over the next 12-18 months. Nevertheless, earnings upside from acquisitions enables the broker to bemost favourably disposed to the office REITs. The broker's pick across the office REITs is Dexus Property ((DXS)),


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given its quality of income, earnings growth and potential earnings upside.

On the shopping centre side of things UBS retains a preference for Westfield Retail ((WRT)), reflecting a higherquality portfolio. Whilst cap rates remain supportive of existing valuations in the higher quality regional shoppingcentres, the broker is cautious about a sharper deterioration in comparable net operating income. Income andrental growth is expected to remain soft as sales struggle to grow, particularly across specialty apparel.

Morgan Stanley finds attractive dividend yields from the REIT sector had been a major supportive factor inperformances in the past 18-24 months. But the yield premium investors get from REITs against the ASX is now atan all time low. With many REITs now trading around the level of net tangible assets, the broker believes the focusneeds to be on earnings growth potential, and thus stock preferences favour REITs that can supplement rentalincome with active earnings streams (such as funds management or development).

The wide spread of Australian commercial property cap rates to the 10-year bond rate also has analysts' attention.Market participants (including REITs) and some REIT investors cite the spread between Australian commercialproperty cap rates and the 10-year bond rate as a potential driver of cap rate compression within Australia'scommercial property markets, according to Goldman. Now, this could lead to a valuation uplift at the directproperty level. There may be some merit here, particularly in the case of a good property, but the analysts cautionagainst taking this too far across the property sector.

Macquarie has noted that, for the first time since mid 2011, the spread between the average REIT dividend yieldand 10-year Australian government bond yields is back at the 10-year average. Rising bond yields have historicallyresulted in REIT underperformance against the broader ASX market. Macquarie's equity strategists are becomingmore positive on the growth outlook. These factors will likely result in REIT underperformance in the near term.

Nevertheless, there's underperformance and underperformance. Macquarie believes the downside is limited.Several REITs should see a modest acceleration of earnings growth into FY14/15 as lower debt costs and corporatecost savings support underlying property fundamentals. For Macquarie, CFS Retail ((CFX)), Charter Hall ((CHC)),Investa Office ((IOF)), DXS and GPT ((GPT)) are going higher and these are the preferred exposures. Least preferredare Westfield ((WDC)) and Stockland ((SGP)). WDC is trading on the highest PE multiple with limited near termgrowth and offering the lowest free cash flow and dividend yields in the sector. In terms of SGP, the broker expectsmedium term residential sales targets are likely to be downgraded at the third quarter update in May.



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4 Australia

-Acquisitions ahead of wholesale renewal -Gains more bargaining power -Risks heightened -Is there too much debtinvolved?

By Eva Brocklehurst

In a previous story (Doubts over M2 Telecom's Growth Rate) we noted broker views that M2 Telecommunications((MTU)) needed to deliver better organic growth or pursue more acquisitions. Well, the company has obliged. M2has acquired Dodo Australia and made an offer for Eftel ((EFT)). Eftel is a telecommunications reseller as is Dodo.Dodo also resells other services, such as gas and electricity.

CIMB finds the new acquisitions a bit of a mouthful, coming just nine months after Primus was acquired. Thebroker's key concern is whether the amount being paid for Dodo ($204m) and Eftel ($44m) will adequately addvalue. The company expects the acquisitions to be 20% accretive to earnings in FY14. The acquisitions will take netdebt to around $302m in June 2013, nearing three times the broker's earnings forecasts for FY13. The companyexpects to pay this down to 1.8 times in FY14 and still maintain a dividend payout of 70% of net profit afteracquisition.

As an aside, the FNArena database shows consensus dividend yield based on FY13 forecasts of 4.5% with 5.4% forFY14. For CIMB, reducing debt, improving earnings and maintaining payout is the risky bit and means M2 has to relyon a good relationship and wholesale agreement with Telstra ((TLS)). The broker pointedly remarks that theseacquisitions could make or break the company.

The company's growth projections from the acquisition would take FY14 earnings to around $165 million. To CIMBthis appears unrealistic, given organic growth has been flat. The broker believes it would require about 6% organicrevenue growth post-acquisition and about 30% incremental earnings margin, supported by acquisition synergies. Toachieve this would require a smooth transition in operations and high customer retention rates as well as a lift inbundled sales. Despite the acquisitions, Macquarie believes that share price outperformance in the longer-term willbe reliant on the company's ability to achieve better organic growth.

Macquarie was surprised by the acquisition of a consumer business, given the company's focus on the small-mediumenterprise market and the intense competition for the consumer dollar. The broker notes that, unlike M2's iPrimusconsumer business, which is positioned at the top end of the market, Dodo is low cost and only differentiates fromcompetitors on price. The business has posted very strong organic revenue and earnings growth over the past fewyears but does not provide any infrastructure and has established wholesale agreements with Telstra and Optus((SGT)). So there's little prospect to move customers to the Primus network. The positive for Macquarie is theenhanced buying power that may be possible once wholesale agreements come up for renewal in 2014.

For Citi, the diversification in the business model should lower risk, but then it also dilutes the focus on the highermargin business. Citi noted that peak debt was 2.1 times FY12 earnings following the Primus acquisition, so payingthat down to 1.8 times in FY14 takes it off the peak in historical terms. The broker just wants to see more of whatDodo and Eftel are about before judging the merits of the acquisitions. Citi currently rates M2 a Buy, the only Buyof the three rating the stock on the FNArena database. Macquarie has a Hold rating and CIMB has a Sell. CIMBbelieves the stock is overpriced, given the aforementioned risks. The consensus price target is $4.73, revealing 4.7%downside to the last traded share price.

It's just that the debt is being loaded up at a time when the company is vulnerable to negotiations with Telstra,CIMB maintains. In mobile, M2 resells Optus and the broker understands that arrangement is also under review. M2may be planning to switch this customer base to Telstra, CIMB surmises. Regardless, the additional customers andtraffic should give the company more bargaining power. Maybe Telstra will value the arrangement enough toconsider offering good terms. Time will tell.


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5 Australia

-Earnings impact from weather, Minova -Brokers downgrade forecasts -But there are some positives -Hope in futurestrategy

By Eva Brocklehurst

The flooding of Australia's east coast coal fields this year, in particular the duration of the wet in NSW, has causedOrica ((ORI)) to reduce forecast explosives volumes and mark down earnings expectations by $10-15 million. Thecompany advised of the earnings impact in an investor conference yesterday and also flagged ongoing weakness inthe Minova business, which supplies consumables and services to the mining industry. These were the two mainnegative implications from the briefing, but brokers took heart from the fact that the company did not downgradefull-year profit guidance.

The market's negative share price reaction to Orica's news was overdone as far as JP Morgan is concerned. Thebroker has still downgraded forecasts for FY13 earnings but believes the majority of this will come from the lowvaluation Minova business. To put this in context, a 23% reduction in the broker's forecasts for Minova reducesgroup earnings forecasts by 2%. The downgrade for explosives earnings is weather related and, therefore, shouldrevert to mean in FY14. JP Morgan notes a lot of the volume reduction was in the Hunter Valley, in anticipation ofthe impact as the big wet moved south. In all, the broker considers the valuation impact on the stock is minimal.The broker suspects some analysts might be using the first half 2012 earnings and deducting $10-15m without addingback lost production margins from the Kooragang Island plant shutdown in FY12. That could understate the outlookfor FY13 earnings as a result.

Minova is suffering from weak demand in both Australia and the US as well as price competition. For Macquarie,the business may be just 4% of earnings but has taken away much of the prior growth expectations. Macquarie nowexpects a 56% decline in Minova's full year earnings as opposed to Orica's expectations of 20%. Macquarie sees apositive in the big wet. These situations increase demand for high margin emulsion product and there is potentialfor the earnings to be made up later in the the year. On balance, the broker notes the key will be non-recurrenceof Kooragang Island outages that took $90m out of the earnings equation previously. It just depends, when lostearnings are added back in, how much is negated by the Minova deterioration.

Deutsche Bank is quite upbeat about the future, believing the $10-15m figure is conservative and the impact couldbe lower, around $6.5m on estimation. The broker also highlights the company's restructuring progress with Minova.This will be completed in FY13 instead of FY14 as initially planned. Okay, conditions continue to be difficult inunderground coal mining but the broker believes the company is well placed to benefit from a recovery in miningactivity and suspects the market is not taking into consideration the company's strategy on operationalimprovement.

UBS is positive about the outlook for domestic explosives volume growth but cautious about the maintenance ofmargins after five years of strong growth. The supply/demand balance is becoming less favourable and when this iscombined with increasing customer pressure it suggests to the broker that domestic margins have peaked. Thislimits the scope for earnings upside. UBS has also disagreed with Orica's target of an 18% contribution from theBontang ramp-up, and new Burrup and Kooragang Island projects from FY16 and FY18 respectively. This is becausethe capital costs are high. The broker suspects the industry will not be able to support the higher ammoniumnitrate prices that are required for these projects to achieve targeted returns in the years followingcommissioning. UBS has downgraded its recommendation to Hold from Buy.

For BA-Merrill Lynch it is clear Minova is challenged, but there is some light at the end of the tunnel. Oricaindicated mining services is growing market share and increasing penetration in mine site services. Furthermore,Orica has maintained over 80% of its own contracts up for tender and won over 57% of new contracts, globally, thatwere previously held by competitors. The stock is the broker's pick in the sector as it retains significant leverage to


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continued growth in explosives volumes in Australia and Asia. There is also margin expansion from convertingcommodity ammonium nitrate volumes to higher value mine site services.

Morgan Stanley takes a different tack: the news is ushering in the beginning of a downgrade cycle. Morgan Stanley,which does not feature on the FNArena database, rates the stock as a Sell. A number of negative structural factorsare coming into play and the broker believes the stock is expensive, given the risks. For Morgan Stanley, thecompany may not have altered its guidance but implies it could be forthcoming. The broker was below consensusfor FY13-15 earnings forecasts and is now 7-13% below. Why is Morgan Stanley so bearish? The client base is seekingcost savings while there is a rising cost base. Import parity prices are falling and placing pressure on the company'ssupply and services margins. In particular, Morgan Stanley cites the risk in Indonesia from exposure to Chineseimports, noting 15% of Orica's Bontang volumes are directly exposed and contracted volumes are likely moving intoa softer pricing environment.

There's no Sell rating on the FNArena database. Just six Buys and two Holds. The consensus target price, from arange of $26.60 to $31.50, is $27.93, showing 14.5% upside to the last share price. The stock shows a 4% dividendyield on consensus FY13 earnings forecasts.


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6 Australia

By Greg Peel

Last night Goldman Sachs global stock analysts in London downgraded iron ore producers BHP Billiton ((BHP)) toNeutral from Buy and Rio Tinto ((RIO)) to Conviction Sell from Neutral.

This morning the Goldman Sachs local resource sector analysts in Sydney downgraded their share price targets forthe two majors and for pure-play Fortescue Metals ((FMG)), but maintained previous ratings of Buy for BHP andNeutral for both Rio and Fortescue.

Why the contradictions within the same broking house?

The clue lies in statements within each of the separate reports. The global report suggests “No escaping US$80/tiron ore; on relative valuation [Rio moves] onto Conviction Sell list”. The local report says “[BHP, RIO and FMG] arestill appropriately positioned within our Australian stock coverage universe”.

It is important for smaller investors to understand that in providing stock recommendations, brokers, andparticularly large houses, are speaking to equity fund managers who, by default, must hold an equity portfolio.Indeed, equity fund managers only hold an equity portfolio, thus it is only the make-up and weightings of stocks inthat portfolio that can be managed. Equity fund managers cannot decide to sell stocks and buy bonds instead, forexample.

Hence when brokers offer Buy, Hold or Sell ratings, or equivalents such as Outperform, Neutral, Underweight etc,those ratings are intended to be relative and not absolute. They are relative to a particular benchmark portfolio,which may be the Australian resources sector, or the ASX 200, or an MSCI international share index, et cetera.

The downgrades to BHP and Rio from Goldman’s global equities team were sparked by a decision by Goldman’scommodities research team to downgrade their price forecasts for iron ore. The price downgrades represent aback-flip from the commodities analysts, given last year their view was one of iron ore recovering following thedownturn in prices in the second half of 2012 led by a decline in marginal-cost Chinese domestic production. Lastnight the broker reported “domestic production has surprised us on the upside recently”. Add to this an increase inChinese scrap recycling and lower than previously expected steel production and the analysts have decided theirearlier forward price forecasts look too ambitious.

Seaborne ore (from Australia and others) will still be in demand in China, Goldman believes, but with supplyincreasing globally, particularly from the likes of BHP, Rio and Fortescue, an oversupply down the track has alwaysbeen on the cards. An oversupply would lower prices but there would always be a price floor, given marginalChinese domestic production would be forced to shut down at too-low prices, reducing net supply. Given greaterthan expected domestic production in early 2013, increased scrap usage and lower than expected steel production,Goldman now sees the oversupply threat sending the market into surplus by 2014, earlier than previously assumed.

Goldman has thus reduced its average annual iron ore price forecasts by 3% in 2013 to US$139/t, by 11% in 2014 toUS$115/t, and by 9% in 2015 to US$80/t. Reduced commodity prices lead to reduced earnings forecasts forcommodity producers and reduced target prices for their shares. Within a global portfolio of stocks, and bearing inmind that BHP and Rio are both large-cap global companies, Goldman Sachs’ global team has downgraded BHP toNeutral and Rio to Conviction Sell. A “Conviction Sell”, as opposed to just a “Sell” means the broker is particularlyconvinced. These ratings are relative within said global portfolio.

Within a local portfolio of Australian stocks, Goldman has retained Buy on BHP and Neutral on Rio and Fortescue.This implies a recommendation that an Australian equity fund manager overweight the fund’s holding in BHP butretains an index weighting for the other two.


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Locally, Goldman prefers BHP over Rio given Rio has the greater exposure to iron ore production within its ownportfolio of commodity production ventures, while BHP offers a more diverse commodity base, particularly with itslarge oil & gas exposure. At an iron ore price of US$80/t, Fortescue will struggle under the weight of debt andhigher costs than the legacy majors. The analysts believe, however, that FMG’s intended sale of a stake in its portand rail infrastructure will alleviate the pressure by reducing costs.

Locally, Goldman analysts also point out commodity prices can be quite volatile.

Locally, Goldman has reduced its 12-month price target on BHP by 2% to $41.00, on Rio by 9% to $64.00, and onFortescue by 13% to $4.10.



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7 Australia

-Strong subscriber growth -Margin risk but earnings compensate -Potential growth in acquisitions -Potential capitalmanagement

By Eva Brocklehurst

TPG Telecom ((TPM)) pleased the market with first half results showing strong subscriber growth in broadband andmobile. What brokers are really seeking is as to how the company can differentiate itself in the hotly contestedtelecommunications sector. Dividends and capital management are important too, of course.

Management provided no guidance on dividends but CIMB expects the payout ratio to be similar to FY12, at 37%.The broker previously forecast a payout ratio of 45% but notes management plans to focus on paying down debt.The first half dividend payment was 3.5c.

Going forward, CIMB finds risks in the increased price competition in the fixed broadband market. TPG is up againstM2 Telecommunications ((MTU)) and that company's recent acquisition of Dodo Australia, another player in thelower value end. Other risks include those of continued margin pressure in the corporate division and slowerrevenue growth. Mobile margins declined during the half because of lower pricing. CIMB notes TPG is in the processof negotiating the mobile reselling agreement and there could be a risk to margins as Optus ((SGT)) is reviewingchannel partner agreements to improve profitability. Having taken note of risks, the broker still believes TPG hasample balance sheet capability to pursue strategic acquisitions. Nevertheless, at current levels, growth is largelypriced in. The broker prefers iiNet ((IIN)) given the higher free cash flow yield, scope for cost cutting and corporateactivity.

Goldman Sachs hailed TPG's ability to win share in the consumer and corporate segments without sacrificingprofitability. The key issue ahead is capital allocation. Will it be acquisitions? TPG has announced a $10minvestment in Cocoon data to develop cloud-based applications. Will it be capital management? Goldman notes thebalance sheet potential for such but accepts the company is focused on paying debt. Morgan Stanley finds strongfree cash flow places the company in a position to increase the dividend, make a small strategic investment andpay down debt.

The big event ahead, the laying out of the National Broadband Network (NBN), presents both risks andopportunities for TPG in Goldman's opinion. The opportunity exists in the increasing ability to tap into the marketwith the structural separation of Telstra ((TLS)) and an improved regulatory environment. The risks are inincreased competition and margin erosion from higher costs. For Morgan Stanley there is more opportunity for TPGif the NBN is delayed by 18 months. The broker estimates TPG's value could be 7% higher. Why? Extended increasesin organic market share of over 1% per annum for an additional two years, with construction delays pushing costincreases down the track.

Morgan Stanley views TPG as a winner in the NBN space but does not factor this into the base case. Still, the brokerlikes the stock and rates it a Buy for three reasons. These include on-net subscriber migration and organic marketshare growth as well as the attraction in any delay in the NBN. The third reason is the potential to participate inindustry consolidation, i.e. acquisitions. Morgan Stanley believes up to $477m in aggregate value can be achievedin the industry with further consolidation in the small telecom space. This is the broker's point of differentiation forTPG against iiNet.

Macquarie notes the company has something up its sleeve. TPG previously was going strong on internet protocoltelevision (IPTV), flagging delivery of linear channels and video on demand. A year later that's not the priority.Instead there's an important project in the wings with further details to come over the next three to six months.The broker is waiting. Meanwhile, Macquarie likes the free cash flow generation, ongoing consumer broadbandgrowth and scope for acquisitions. Gearing has fallen to $75m and the broker expects the company to be in a net


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cash position by the end of the year. While management has stayed mum on returning excess capital, the brokernotes the possibility of further network investment or acquisition.

TPG offers value for Credit Suisse. The broker likes the defensive 12% earnings growth for the next three years andis looking for management to use the balance sheet potential to unlock significant shareholder value. The brokerwould not be surprised if the payout ratio was increased. Credit Suisse views the 15% stake in Cocoon as aninvestment to fund a start-up company and at the same time acquire product development for the core business.TPG has indicated it does not intend to increase its stake. TPG is the broker's preferred stock in the sector.

For Citi, the subscribers are the key and there's healthy growth there. Citi has upgraded the stock to a Buy, viewingearnings growth as outweighing margin risk. Citi believes the business deserves to trade at a premium to its peers.On the FNArena database there are three Buy recommendations and two Hold. The consensus target price is a neat$3.00, suggesting 3.9% upside to the latest share price. The dividend yield on FY13 earnings estimates is 2.7%.



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8 Australia

By Rudi Filapek-Vandyck, Editor FNArena

Three types of Australian listed stocks have proved an absolute boon for loyal shareholders and investors in thepost-2008 era: reliable dividend payers such as Telstra ((TLS)) and the Big Four Banks, All-Weather Performers suchas Woolworths ((WOW)), Amcor ((AMC)) and CSL ((CSL)) and stocks experiencing an operational sweet spot,generating strong profits and shareholder returns along the way.

All three categories have one key characteristic in common: they are able to generate satisfactory returns evenwhen risk appetite retreats or economic momentum wanes. Last week, we opened this new series with an inauguralupdate on All-Weather Performers, see story "All-Weather Stocks: MND And BKL In The Red". This week we take alook into stocks we think are experiencing an operational sweet spot. Note that we intend to make this aninteractive exercise: readers are encouraged to nominate stocks they believe should be added to our updates. Sendyour nominations to [email protected] and we will follow up and consider.

At the basis of all this lays my research since late 2007 which earlier this year led to the publication of "Make RiskYour Friend. Finding All-Weather Performers", an eBooklet which to date is exclusively available to paying FNArenasubscribers (if you haven't received your copy as yet, send an email to [email protected]).

The eBooklet argues that successful investing is closely correlated to minimising and managing risk. Hopefully theframework we are creating with these regular updates will assist subscribers in executing successful, long terminvestment strategies.

Next week we will zoom in on sustainable dividend payers.

It has to be pointed out that no company, regardless of its quality or credentials, can ever claim 100% immunityfrom hardship or headwinds. But some companies can take an unexpected kick against their shins much better thanothers. Probably the best example was this week provided by Breville Group ((BGR)), which had been explicitlynamed as a Sweet Spot Stock in the eBooklet.

Breville Group shares put in an ab-so-lu-te cracker of a performance throughout calendar 2012, but this year thegoing has proved a little tougher because of the pending loss of a distribution agreement with Keurig in theCanadian market. Investors don't like negative surprises, even when it's not management's fault, and the shareprice has been re-set at a lower trading range than where the shares started at the beginning of the year.

However, ask most brokers that cover the stock and none of them sees more than a temporary setback for whatremains one of the stronger growth stories in the Australian manufacturing space. Because of the share pricere-set, the dividend yield has jumped to 4.9%. Alas, because of the loss of the Canadian sales next year, reportedgroup profits are expected to suffer, that year, and thus it is more likely than not there won't be an increase individends next year. Underlying sentiment is expected to remain supportive though as most analysts (if not all ofthem) remain of the view that this company still has plenty more years of strong growth ahead.

Breville Group is missing from today's list of selected Sweet Spot Stocks (maybe we should create a bench stockscan "come off" or be "sent to" - something to consider before the next update) but on the list aretelecommunication companies Amcom Telecom ((AMM)) and iiNet ((IIN)) and it is only because of our own oversightthat the list does not also include TPG Telecom ((TPM)) and M2 Telecommunications ((MTU)). Clearly, the telecomsector is experiencing a purple patch ahead of the federal government sanctioned National Broadband Network(NBN) roll-out in Australia and this week's reported results and announced acquisitions in the sector once againproved just that.

Here's an easy to make observation: companies that are enjoying the wind in the sales find it much easier to report


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positive surprises, all else being equal. Otherwise, it's not a genuine failure when expectations are very high andthe result misses by an inch; the market won't ignore the fact that the result was still solid and strong. The sameconclusions applied this week as did during the February reporting season. We will make a mental note to also addTPG Telecom and M2 Telecom to our list by the next update.

We published two stories on the sector this week that may be of particular interest:

- TPG Rings Up Strong Subscriber Growth

- M2 Telecom Acquires Businesses And Risk

Meanwhile, take a look at what has been happening to the share price of Ainsworth Gaming ((AGI)); the company isstaring at a breather this year with profit growth anticipated to turn negative, but investors have so far put a firmbid under the share price. Market logic? Maybe confidence in FY14's resumption of growth is too high to allow theshare price to become genuinely cheap at this stage?

Another high-flyer so far this year is Collection House ((CLH)) but then double-digit profit increases are anticipatedto remain on the menu. Most performances for the stocks on the list look pretty impressive. ResMed ((RMD)) shareshave been rejected at the $4.60 price level. There's some chatter in certain corners that margins might come underpressure because of changing market dynamics in the US. Certainly something to keep an eye on.

Otherwise, spare a few moments to admire the performance of Technology One ((TNE)) shares post 2008. Readers,this is an IT stock! While nobody was paying attention, Technology One has become the benchmark for consistentperformance in the Australian IT sector. A Price-Earnings ratio of 20 suggests investors are looking over theirshoulders when making investment decisions this year. Share price performance thus far beats the index in 2013 butprofit growth is expected to remain at low double-digits in the years ahead.

Maybe what Technology One shares are suggesting is that the main danger for known and proven performers in theAustralian share market is the fact that valuations can run up too far? Wesfarmers ((WES)) is probably anotherexample of this (equally on a PE of 20 but with a slower growth profile).

Attached is a file (see top of this story) with share price performances for 13 stocks which we believe deserve tocarry the label "In The Sweet Spot". The list will be a little longer by the time we publish the next update. You cannominate your own candidates via [email protected]

If you do download the file: the first row of data for each company is the share price at the start of each calendaryear, the second row is the difference with the previous year's share price in percentage terms. So no dividends areincluded and each percentage thus refers to the share price performance in the previous year. All this remains verymuch work in progress and we intend to add, amend, expand and refine in future updates.

All feedback welcome at [email protected] or via Editor Direct on the website.

Technical limitations




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9 Australia

-Keurig distribution to end -Growth potential still strong -UK a key market going forward

By Eva Brocklehurst

Appliance manufacturer Breville Group ((BRG)) has confirmed the Keurig brand distribution agreement in Canadawill cease from June 2013. The company had flagged the possibility at the time of the first half results and, forbrokers, the confirmation removes an uncertainty and they can get down to evaluating the company's trajectory.Brokers find growth potential greatest in the US and Asia as well as the UK. Home base Australia is likely to bemore modest.

On the back of the announcement, Macquarie expects Breville to take a restructuring provision in the second halfand scale down the Canadian infrastructure over the coming year to fit with the remaining Breville electricalbusiness. The question will be how much of the operating cost infrastructure was shared with the existing Canadianoperations and what can be eliminated. Macquarie is upbeat about the Keurig loss, believing the remainingearnings streams from the Breville brand are of higher quality. The broker flags the strong growth prospects in theUS and solid sales in Asia and Europe. Moreover, the company will launch the new Nespresso range in mid 2013.

Goldman Sachs has downgraded earnings forecast to take into account the loss of Keurig revenue and the reductionin scale in the Canadian operations. This is offset by a rise in the price/earnings premium the company has to thebroker's small industrials coverage. Goldman believes the removal of uncertainty over Keurig will actually result ina higher P/E rating for the stock. Strong growth in underlying earnings, favourable international prospects and ahealthy balance sheet means the broker is not bothered by the loss of the Keurig revenue.

For CIMB the stock continues to offer reasonable value given the growth proposition is market penetration ratherthan overall system growth. The broker flags a net cash balance of $50m by the end of FY14 and wonders whethercapital management is a possibility, should the share price remain at current levels. A buy back of up to 5% ofshare on issue at the current price could cost the company $35m and still leave the balance sheet debt free.

One thing the broker does foresee is that there are trailing overheads unaccounted for from the Keurig closure andthese could take six to 12 months to eliminate. CIMB has allowed for $6m in trailing costs. Despite gaining marketshare and signs of an improving operating environment, CIMB has factored in only modest top line growth inAustralia, about 2-3% for FY13-14 with a slight margin decline, despite Breville edging away form the competitivelow end of the market.

UBS had already adjusted forecasts for the Keurig loss scenario and has reduced North American earnings forecastsby 22% for FY14. While the news of potential one-off costs with the Canadian restructure could still impactsentiment, the broker hastens to add the company still has significant growth potential internationally. UBS is yetto add in value for the UK opportunity, which should be launched in three months.

Breville intends to launch a premium range into the UK market, starting with 17 high-end units under analternative brand. UBS notes critical mass could take some time but there is no reason why the region could not bea meaningful contributor to the company's business. The broker envisages that, should UK penetration reach justone fifth of that in Australia, Breville's earnings would be raised by 6%, assuming similar 10% margins. This is thestory the broker expects investors to focus on going forward. On this rests the broker's Buy rating.

On the FNArena database there are three Buys and one Hold for Breville. The stock carries a dividend yield of 4.9%on FY13 consensus forecasts. The consensus target is $6.12, from a tight range of $6 to $6.30, with 12.7% upsidesuggested to the last share price.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story


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contains unashamedly positive feedback on the service provided.


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10 Australia

-Focus on margin expansion -But at the expense of sales growth? -Broker sentiment divided on turnaround

By Eva Brocklehurst

David Jones ((DJS)) is transforming. For brokers it's not a moment too soon, as department stores have beenplagued by a soft consumer environment and a need to respond to new trends in shopping. In its first half resultsthe company has flagged progress with its strategic plan, reducing costs and expanding margins. Earnings wereahead of expectations for the half but sales growth was not. What pleased was the increased margin. Whatconcerns brokers? A lot of things. Most importantly, a lack of sales momentum.

There's no Buy rating on the FNArena database. Two brokers have downgraded ratings to Sell in the wake of theresults. There are five Sell ratings. There was one upgrade to Hold - JP Morgan, and there are three Hold ratings.The consensus target price is $2.73, suggesting 11.5% downside to the last traded share price. A dividend yield of5.5% is reflected in consensus earnings forecasts for FY13.

David Jones is concentrating on improving quality sales. The company has decided to pursue more private labelbusiness, increasing this to 10% of sales against the current 3.5%. To reinstate the retailer's stamp on quality andhigher margins, sales growth will be affected as the store exists music, DVDs and games. More store space will beallocated to fashion/beauty and home. Some home categories such as electrical are on the exit plan and storeswith the wrong demographics will be closed. Macquarie has noted that the company did not specify any closuresand, as all stores are profitable, doubts the retail footprint will actually be reduced. The broker suspects theplanned review of expiring leases, something all retailers do at the time, is just a shot across the bows to thelandlord. Macquarie flags the planned opening of seven stores over the next few years, with four of these by endFY15.

The broker finds David Jones trading at a premium to domestic peers and, given a loss of around $25 million infinancial services business in FY14, the company will have to move ahead forcefully just to maintain ground.Macquarie dismisses the strategic plans regarding margin expansion, omni-channel retailing, credit cards andproperty as not having enough focus on sales growth. In terms of credit cards, Macquarie believes the number ofcards issued needs to be boosted as does the spending rate on the cards. The broker observes that the DJS/Amexcard relationship is hampered by the fact that customers tend to view it as a "special occasion card" rather thanthe preferred card.

CIMB is concerned there are no big cost savings identified in FY14 to offset the decline in financial servicesearnings. The broker hails the improved margins but notes there is little opportunity for earnings growth without acyclical recovery. The broker believes increasing the footprint of fashion/beauty and exiting certain areas may bealright but argues that this undermines the place as a full service store that the company has treasured.

JP Morgan has gone the other way, finding there are enough reasons to be more confident in the future direction ofthe company. Reasons include more detail on the quality sales focus and drivers of gross margin expansion.Earnings growth is coming closer too. Although financial services earnings should halve in FY14 the broker isconfident that FY15 will produce the improvement in department stores necessary to be a bigger driver of futureearnings. Moreover, the share price performance was poor over the past 12 months but has improved a bitrecently. Signs, in the broker's view, of an impending turnaround.

There's comfort to be had in the progress being made on the strategic plan but for Deutsche Bank the big concern issales decline, particularly as other retailers are showing some improvement. Like Macquarie, the broker believesgross margin improvement, while helpful, doesn't compensate for sales growth. Deutsche Bank agrees that apremium department store should not be leading the market with discounting, but sales declines are not part andparcel of that. Moreover, management was coy about how the current quarter's sales were going, providing more


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uncertainty. Another thing, Deutsche Bank ponders whether increasing private label percentages may cannibaliseexisting branded sales.

Morgan Stanley (not a contributor to the FNArena database) has decided the consensus is too bearish. The brokernow has a Buy rating on the stock, believing the dividend yield is sustainable and will rise with improved grossmargin. All the parts of the strategic plan coming to fruition should be enough to turn the company around after along downgrade cycle, in the broker's view. In Morgan Stanley's words: we would prefer to own the shares beforesigns of the turnaround emerge as when they do they will likely be capitalised into the share price.



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11 Commodities

-Steel pressures iron ore prices -Oz miners still strong, ready for upgrade -Price at US$80/t makes mid capsmarginal -Base metals still diverge

By Eva Brocklehurst

Standard Bank analysts have paused to explain the sudden drop in iron ore prices, some 16%, to US$133 tonne sinceFebruary 20 latest spot US$134.60/t). The focus is on China, of course, and the large steel industry capacity thatexists. The analysts note China's steel industry association (CISA) forecasts the country has over 960 million tonnesof installed steel capacity compared with an output rate of 716mt last year. This suggests utilisation rates ofaround 74.5%. The remaining capacity needs to maximise returns from the start of each new year as end-userdemand ramps up from the end of March, when the northern construction season emerges out of the winter.

What happened this year was an excess of steel output occurred from January and sent Chinese steel warehouseinventories soaring towards 21m tonnes more recently. For Standard Bank analysts this meant Chinese millsreturned from the new year holidays with a need to de-stock at a time when they were expecting rising demandand pricing momentum. Moreover, recent policy prognostications from both the central bank and the governmentmade the steel mills and consumers even more jittery. How much steel should consumers buy and how much shouldmills produce? The end result, according to the analysts, was steel prices falling around US$20/t for long steel, andas much as US$60/t for flat steel.

So, despite low iron ore inventory levels at the ports and poor availability of fresh ore deliveries, steel mills had toenact a raw materials boycott over the past month. This reminds the analysts of the time last year when iron oreprices plunged from US$135/t to US$87/t. It appears steel versus raw material margins are aligning and steelinventories are starting to clear and the analysts expect iron ore prices will once again rally in the June quarter.Iron ore swaps are forecasting a price of US$129/t for Q213 but the analysts believe this price is a bit low.

For CIMB the iron ore price movement translates to something simple for Australia's miners. Focus on costs. Thebroker believes the miners are cum-upgrade unless prices continue to decline sharply. In this environmentFortescue Metals ((FMG)) is the more vulnerable, with higher gearing and higher costs. In the broker's view FMGwill need to differentiate itself from Mount Gibson ((MGX)) and Atlas Iron ((AGO)) on margins.

Despite some bearish sentiment over the iron ore price, the broker believes the quick recovery from last year'sprice fall remains at the forefront of the investor mindset. CIMB suspects investors may wait until the June quarterto assess but notes year-to-date prices are averaging US$150/t CFR, signalling earnings updates are likely, givenconsensus prices are around US$129/t for the first half. This implies prices need only average US$113/t during theJune quarter.

CIMB has also taken a closer look at margins for the large and mid cap iron ore producers, setting iron ore finesprices at levels of US$120/t, US$100/t and US$80/t to judge where any difficulties might lie. The majors, BHPBilliton ((BHP)) and Rio Tinto ((RIO)), benefit from having lower cost operations. Their healthy margins areexpected to continue even in a lower iron ore price environment. Rio is viewed as having the lowest cash costs ofthe five iron ore miners reviewed. At US$100/t there's pressure on the more vulnerable, such as FMG. CIMB doesnote that FMG's cash costs are expected to reduce to around US$40/t over the next year or so.

Taking the lower iron ore fines price of US$80/t, the mid caps - FMG, AGO and MGX are marginal. This shows theimportance for these miners of reducing costs and maintaining healthy balance sheets in case of any sustainedperiod of depressed prices. On the other side of the square, the broker estimates Mount Gibson receives the highestselling price across the hematite iron ore miners, given the 64% reserve grade at Koolan Island and 59.5% atExtension Hill, combined with a moisture content level of around 3%. Fortescue and Atlas sell material with a gradein the 57-59% range with moisture levels of 9% and 7.5%, respectively, so they suffer materially on the price


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received per wet tonne.

Meanwhile, base metal prices have been erratic. BNP Paribas analysts note the rally from mid November 2012petered out by February. A quarterly price gain for base metals, overall, for the first quarter is still expected, ofaround 5%. Copper is expected to underperform the others as 2013 takes hold. Copper's supply constraints areexpected to ease and, for the analysts, this is significant in a highly priced market. Signs are still encouraging for2013.

Apart from faster economic growth in emerging countries and cyclical restocking in China, it seems unlikely thatEuropean metals demand will fare as badly as it did last year. BNP Paribas analysts expect world base metalsdemand growth will re-accelerate in 2013 to 5-6%, comprising 8-9% in China and around 3% in the rest of the world.

Differences in performance among the metals should be less marked than in 2012 and aluminium demand isexpected to outrun copper. The analysts note demand was distorted last year by Chinese stockpiling, albeit not aonce-only occurrence. This affected copper and tin and high imports led to a build in inventory in China. TheChinese overseas buying of refined metal may therefore be modest in 2013. The analysts at BNP Paribas find thesupply-side differences amongst the base metals quite pronounced. Reported stocks of aluminium, nickel and zincare higher than copper, lead and tin. Moreover, the tying up of inventory, both LME and unreported, in financingdeals has done more to raise physical premium than to prop up LME prices.

For new supply, at one extreme is tin, where the scope for production to grow in 2013 is very limited. The analystsexpect tin production will fall short of demand for the fourth year in a row. Lead may soon fall short as well.Current supply-constrained copper is moving further away from this position. The difficulties of the copper miningindustry are far from over, according to the analysts, but a combination of new mines, expansions and improvedperformance at some operations should finally deliver strong production growth in 2013-15.

The other end of the spectrum is aluminium, where smelter capacity stays strong. Here too lies nickel, whereoutput surged around 30% between 2009-12. Some problems at new plants and Indonesia's changed policy may limitpotential for more rapid production growth but the metal is not expected to fall short. The analysts emphasiseforecasts are highly sensitive to the world economic trajectory because they assume a sharp pick-up in metalsdemand growth. Copper would be most exposed to a deterioration in economic and demand prospects andaluminum would be least exposed.



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12 Commodities

By Andrew Nelson

Uranium prices have been fighting an uphill battle ever since the Fukushima disaster shut down all but two ofJapan’s fifty nuclear reactors. Spot prices for the commodity have fallen around 70% from the peak around $US135a pound in 2007, while many other minerals have seen prices rise. Yet analysts are increasingly of the opinion themarket is much tighter than most realise and there has been too much focus on Japan and the risk of their facilitiesremaining closed.

Toro Energy ((TOE)) chief executive Vanessa Guthrie says that 2013 will be the year the supply and demandequation turns in favour of the uranium industry.

''Uranium is almost through the bottom of the cycle and we are starting to see some return of interest, even ifthat's not yet investment in the sector,'' she said.

This is borne out by comments from Energy Resources of Australia ((ERA)), who recently advised that current pricesbelow $US50/lb were preventing new projects from entering production.

One of the most likely supportive factors for a uranium price recovery is China. After Fukushima, many were of theview that China would stop work, but it is slowly becoming apparent the country is determined to move away fromwhat is a massive dependency on coal. Nuclear energy is an obvious answer.

China’s economic planning agency was told this week that Chinese nuclear power production would grow by 20%this year. According to a report in WA Today, the Chairman of the China Guangdong Nuclear Power Groupconfirmed China would install an additional 3.24 gigawatts of nuclear power this year, taking capacity from around12 gigawatts to just shy of 16 gigawatts.

The news won’t send shock waves through the market because it was pretty much expected, but it is still a tangiblesign there is life in the market and new demand being added.

The World Nuclear Association has already reported that China has 51 more uranium plants on the drawing board.No one can really guess as to the timing of the approval processes that will be needed to kick off these projects,but you can bet Australian uranium miners like Paladin Energy ((PDN)) and Toro Energy are on tenterhooks.

Analysts at Credit Suisse expect demand for uranium to be weak enough to keep the price below $US48 until atleast June, but after that, who knows. It seems the Japanese government is at least talking up the prospects ofrestarting more reactors, but at the same time the government is intent upon establishing new standards, whichwill likely prevent any reactor restarts this year.

Conversely, WA Today reports that Canada's Cameco, the third biggest uranium producer globally, says that Japanwill have eight reactors up and running by Christmas.

At the same time, there are a number of issues that are continuing to tighten the supply side of the picture. Thearrangement between the US and Russia that converts old nuclear weapons into fuel for nuclear power ends thisyear. That’s around 10% of supply coming off the market. Then you have BHP Billiton's ((BHP)) decision to mothballthe Olympic Dam expansion, one of the world's biggest uranium reserves.

In the meantime, industry consultant TradeTech saw a continuation of the recent steady activity in the uraniumspot market last week. There were five transactions involving some 800,000 pounds of uranium, withintermediaries, utilities, and producers the buyers, while intermediaries and producers were the sellers.

TradeTech notes that at this point, supply and demand are pretty finely balanced, with neither sellers keen to drop


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prices nor buyers keen to offer any more. As such, TradeTech’s Weekly U308 Spot Price Indicator stayed put at US$42.25 per pound last week.

There was one deal transacted in the term market last week for delivery beginning in 2016. There was no newdemand, although TradeTech notes there are a few utilities on the sidelines that are expected to join the termmarket over the next few weeks. The one purchase and talk of new demand did little to alter term prices, withTradeTech’s Mid-Term U3O8 Price Indicator standing pat at US$46.00/lb and the Long-Term U3O8 Price holding firmat US$57.00/lb.



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13 Commodities

By Jonathan Barratt A lot has occurred with regard to sentiment towards gold over the last week. Inflation datafrom the US have been helpful towards our bullish call. Inflation, we suggest, is on the pick up as cheap moneycontinues to flood the market. Inflation in the US and China is close to reaching the targeted band imposed bythese countries Central Banks as such it will be interesting to see the reaction once it hits. Which we think will besooner rather than later. It is interesting to note that even with the strength in the USD that gold has managed agood come-back from its low at US1550. This is a bullish sign as normally the inverse relationship that gold has withthe USD should have seen the metal retest the lows. As a result of its recent gains we can suggest that withprospects of inflation picking, the ongoing EU sovereign debt crisis with Cyprus and concerns on how Central Bankswill reduce stimulus measures should inflation pressures persist, which we think they will, this presents a goodfundamental base for the metal. As at last week's Bulletin we looked for a test of US1600 and this has ben realized.The daily close above this level sets it in motion further gains

We were token long in the market at US1568 and our new position at US1593 looks good.

If the price of gold has moved too far to establish longs then silver may be an alternative. It is interesting to seethat silver has failed to move on with gold so it needs to play catch up. A break above US29.30 potentially opensthe way for further gains.

Chart Point - Gold:

Technically, the picture for gold remains positive. As we have bounced off the low at US1550, held US1600 and thepotential for a test to the topside US1640 is well on the cards. Momentum indicators remain supportive the metal.Any stop can be placed below US1550. It is a little away from the market at the moment however this is the safestplace.

Chart Point - Silver:

As can be seen from below silver has not moved. Look for a break above US29.20.

Edited by Jonathan Barratt, Barratt's Bulletin is a weekly subscription newsletter that provides expert analysis ofcommodity markets, global indices and foreign exchange movements. Click here to take a no obligation 21-day trialto Barratt's or to learn more visit www.barrattsbulletin.com. Content included in this article is not by associationnecessarily the view of FNArena (see our disclaimer).

This report is not, and should not be construed as, an offer to buy or sell, or as a solicitation of an offer to buy orsell, products, securities or investments. This report does not, and should not be construed as acting to, sponsor,advocate, endorse or promote products or any other products, securities or investments. This report does notpurport to make any recommendations or provide any investment or other advice with respect to the purchase,sale or other disposition of products, securities or investments, including, without limitation, any advice to theeffect that any related transaction is appropriate for any investment objective or financial situation of aprospective investor. A decision to invest in securities or investments should not be made in reliance on any of thestatements in this report. Before making any investment decision, prospective investors should seek advice fromtheir financial advisers, take into account their individual financial needs and circumstances and carefully considerthe risks associated with such investment decision. Find out why FNArena subscribers like the service so much:"Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.


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14 Commodities

-US dollar rallies, metal prices fall -Copper production to rise strongly -Iron ore oversupply could be earlier-Arrium's fortunes rest heavily on iron ore

By Eva Brocklehurst

Improving US economic fundamentals and a rally in the US dollar has provoked Macquarie into looking at how aprolonged dollar bull market would play out for commodities. If, and the analysts emphasise the If, a bull market isin train this would mean weaker US dollar prices for precious and base metals. This does not automatically meanthe prices will diminish in terms of other currencies. Macquarie analysts suspect the changed dynamics of the USdollar could make the negative impact less pronounced, at least for metals prices ex gold.

Macquarie analysts have looked at the historical cycles for the US dollar in terms of metal prices and, for anythingnot produced in the US, there is a negative correlation for metals prices with a rising US dollar. But other factorscan outweigh the currency. For example, a bear period for the US dollar occurred in 2002-2008. Then the US dollarprice of metals rose as expected, but so did the euro price of those metals (except palladium). Why? Supply anddemand were such that weak mine supply and strong Chinese demand reinforced the impact of a weaker dollar andoffset the negative impact of a stronger euro.

Recently, with the US dollar rising on resurgent economic optimism, the improved sentiment may also boost metalsprices and actually offset the impact of the stronger dollar. Euro metal prices could also perform very strongly. Theanalysts note the exception remains gold as it is often bought as a safe haven so the price could be hit by the USdollar gains and better economic circumstances.

Putting speculation on the dollar aside, copper prices could come under scrutiny with production in 2013 lookinglike turning around. Copper and gold production over the last few years has shown the worst downward trend of themetals but Macquarie, having reviewed the top mines across the world, is of a view that copper will reverse. Ofthe top ten mines producing in 2005, the analysts note that Antamina and Los Pelambres are the only ones thatproduced more in 2012. More mines are having output re-jigged, with Escondida the stand-out case after outputmore than halved between 2005 and 2011. Macquarie is more confident that a recovery in output witnessed in late2012 can be consolidated in 2013. Hence, 2013 should deliver strong gains from the top mines of 2005 and Macquarieexpects this will make up a large part of the 5% global copper mine output growth that's forecast.

Will that recent iron ore price weakness continue? Goldman Sachs has shifted to call a more neutral view on ironore, ratcheting down the forecast to US$139/t from US$144/t for 2013. Longer-term the analysts are bearishbecause of more robust domestic Chinese production and an expected surge in seaborne supply.

Steel production growth in China has slowed recently and Goldman expects that to remain below GDP growth ratesin the future, as the Chinese economy matures. Moreover, steel scrap availability should increase at the expense ofprimary steel production. On this basis, global iron ore demand is forecast to revert to historical rates of 2% perannum, which compares with the 8.8% in 2002-12. The analysts are not so sure, now, that Chinese iron oreproduction will decline. Previously, small, high cost mines were expected to be displaced by lower cost seabornesupply. Now, continued investment in large scale mines is seen offsetting the loss of marginal mines and mayimpinge on import demand.

There are important implications for seaborne iron ore producers, Goldman maintains. The top four - Brazil's Vale,Rio Tinto ((RIO)), BHP Billiton ((BHP)) and Fortescue Mining ((FMG)) deliver around 67% of seaborne supply growthover 2013-15. After threshing the numbers, Goldman has brought forward expectations of an iron ore oversupply to2014 from 2015. The analysts are not stating outright that supply will exceed demand, rather that the supply sideneeds to take note of current growth projections. Even so, the magnitude of potential oversupply could force asignificant downsizing in the sector.


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Furthermore, no other growth market is likely to emerge to take the place of China in seaborne iron ore demand.India's steel sector has not relied on imported ore to date and annual production volumes are only a fraction ofChina's. Goldman finds the iron ore industry highly concentrated with weak producer discipline. Seaborne demandgrowth is slowing to average 3%, while seaborne supply is still running at 7.3%. The analysts believe the most likelyoutcome is prices overshooting on the downside and staying below the marginal cost of production for long enoughto balance the market.

Goldman has reviewed iron ore and steel stocks and found Arrium ((ARI)) the most wanting. Earnings estimates areseen peaking earlier than previously assumed, in FY14. The revised iron ore outlook puts prices broadly in line withthe broker's estimate of cash costs for Arrium in FY16. This will more than offset any recovery in steel operations inFY15 and FY16. The broker has recently downgraded Arrium to Hold. The implications of the iron ore revisions areless drastic for BlueScope Steel ((BSL)) and Sims Metal ((SGM)), with the former is not involved in iron ore and thelatter dealing in scrap, diversifying the risk.

Without a near-term improvement in the domestic steel business, BA-Merrill Lynch, too, finds the fortunes ofArrium rest heavily on the iron ore price. The broker believes the company can deliver a ramped up capacity of12mtpa of expected sales by July but the additional tonnage is likely to be sold into a lower priced environment.BA-Merrill Lynch weighs iron ore at 80% of earnings forecasts for Arrium in FY13. The broker is not expecting Arriumto make inroads into its debt balance in the near term and expects volatile trading. Risk is weighted to thedownside, tied to iron ore price weakness. BA-Merrill Lynch has rated the stock as Sell.



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15 Currencies

By Andrew Nelson

With most now growing increasingly confident the US economy is finally waking from its long slumber and settingoff down the road to economic recovery, investors are asking questions about the implications for the US dollar.Analysts at Forex.com have some answers and one is that the dollar will put on a strong show this quarter on theback of the slow but steady recovery in US economic indicators.

With the greenback once again emerging as the growth currency of choice there are many emerging opportunitiesin the FX market. Some of these include a continuation of recent USD/JPY strength and GBP/USD weakness,especially over the course of the June quarter.

The analysts note that a running greenback would likely make life a little harder for the Aussie dollar, which isstruggling under the pressures of slowing growth at home and the slow recovery in China that is expected torebound, but to a lower base of growth rate. That’s the first piece of good news for Australian investors.

The next piece is that Forex.com also sees a good chance of shares maintaining their recent momentum, extendinggains further over the quarter. US share indices the Dow and the S&P 500 have both reached ore very nearlyreached record highs in the March quarter, as we know, but the analysts believe we could also see Hong Kong'sHang Seng, the German DAX index and the Eurostoxx 50 actually start to close the gap with their US counterparts.

The team further believes that once this upswing takes hold, there could well be a shift back to value onceinvestors become a bit more comfortable. It all adds up to Forex.com predicting the next few months could be areal “sweet spot” for US investment markets, especially if the Fed keeps monetary policy loose, as expected, andthe economy continues to accelerate.

The problem with this dream scenario is that there’s a good chance things may start to head back south for a whileas we get closer to the September quarter, given a solid recovery implies an end to the quantitative easing thatmany investors have taken to use as some sort of security blanket.

Also helping the USD outlook are the woeful conditions still abounding in the UK and Europe. The analysts see theUK entering a triple-dip recession, which would heap pressure on the pound. In fact, Forex.com sees a good chanceof the Sterling falling to its lowest level since the Financial Crisis there in 2009.

This quarter is also an important one for the eurozone. The southern countries in the zone are becomingincreasingly more vocal in their opposition to austerity. Italy is still rudderless and we have the prospect of someugly measures being taken in Cyprus, which could set some unpalatable precedents.

The analysts note that any one of these could provide the spark that lights the fuse of a falling euro and worse, theresurgence of the sovereign crisis that we had all hoped was put to bed. And we all know if this plays out, like it ornot, we’re in for another rough ride as global volatility levels surge and spike.

These views have given birth to some predictions from Forex.com:

Forex now expects the USD/JPY uptrend will continue through this quarter regardless of what the Japanese do,instead of believing the main driving factor will be developments in the US and at the Fed. In Q2, the analysts seeUSD/JPY pushing as high as 100.00.

As far as the EUR/USD goes, Forex.com predicts it will grind its way back the mid 1.20s once it has become patentlyclear that a bullish stance for the euro is unsupportable.

The green shoots of what we all hope will be a continued recovery in Japan and the US is certainly supportive of a


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"risk back on" mindset, but Forex.com warns investors need to be careful, especially given the good chance Italywill again be sucked back into the sovereign crisis.

A re-slowdown in China is also possible and that would also cause volatility to jump and that’s not even mentioningthe economic impact it would have on Australia and subsequently, the Aussie.

Despite the woeful outlook in the UK, the team does predict the FTSE will likely buck the UK economic trend andfollow US markets higher. The team also thinks relative valuations could see the German DAX outperform the Dow.

The ongoing monetary and economic uncertainty is likely to be of no assistance to gold bugs, with Forex.compredicting the yellow metal will remain range bound as long as concerns about global inflation pressures remain onthe back burner.

Given a flat outlook for gold, the analysts see a good chance copper may overtake the gold/silver ratio as abarometer for global economic growth. And lastly, the analysts think the spread between UK and US oil willcontinue to narrow given US energy demand continues to be met domestically.



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16 Economics

-The US to drive the global recovery - Europe to improve - China to firm - Italy not that big a risk

By Andrew Nelson

The global economy is finally on the road to full recovery, with positive conditions only accelerating over the yearsahead. That’s something you have probably wanted to read for quite a while now and what’s even better, this isthe admittedly qualified opinion of economists at Danish financial house Danske Bank.

Danske expects the euro area will remain in difficult circumstance for a little while longer, but it should also see agradual return to slow, but at least positive, growth sometime reasonably soon. China, too, is starting to step onthe pedal again, with signs the gradual slowing over the past couple of years is coming to an end.

The problem with the China story is not that the economy isn’t recovering, but that it is recovering to what will bea re-based growth rate that is lower than before the slowdown. Danske also expects Japan will rebound this yeartoo on the back of Abenomics, but there still remain some dire risks for Japan in 2014, say the economists.

Thus China and/or Asia won’t be driving the recovery, neither will emerging markets be providing the main motiveforce as has been the case over the past few years and Europe, while recovering, will only be of limited use. Surethese regions will help and also assist in shaping the size and ultimate velocity of the recovery, but they won’t besitting in the driver’s seat.

Pushing this recovery forward will be the economy that has almost always sat in the global driver’s seat over thepast century, the United States. Because, says Danske, 2013 will be the year the US economy really takes off. Thebank notes fundamentals in the private sector are improving, the housing market is showing some steady, if not yethealthy, signs of life and the business caution of the last few years has generated a significant level of pent-updemand for investments.

Sure, there will be intermittent bouts of fiscal contraction and these will undoubtedly weigh on growth, but anyfiscal drag will be no greater than last year and this year the fundamentals are looking way better, says Danske.

This is all before we get to the real power plant of the US economy, the US consumer. In the short term, Danskeexpects US consumers will remain on the sidelines a little longer as the tax hikes and lower government assistancelevels implied by the failure of the sequester start to flow through. Still, Danske expects this will only have atemporary impact, with the underlying growth recovery theme remaining intact.

This should take us out to the end of 2013 and at that point we should see consumers really chiming in. The Danishbank is expecting to see improvement in the labour market in the next few quarters, which should allow the Fed tobegin relaxing the pace of balance sheet expansion by the December quarter this year. This would mark the officialturning point after which the Fed may start thinking about rate rises again. Although, Danske doesn’t expect theFed to start lifting rates any time before March quarter 2015.

At the same time, the Bank of Japan is stepping up asset purchases and Bank of England is expected to do so, whileDanske expects the European Central Bank (ECB) to keep rates low for a very long time. This will of course lendsupport to the US effort.

The main risk to this playing out comes from the Old Countries, with a renewed flare-up of the euro crisis not onlypossible, but easily imagined. Something as innocent as a slowdown in Germany, or France, could light the fuse,although it’s more likely to be ignited by financial chaos in Italy, Spain, or hey, even Cyprus.

But to be fair, the ECB has put in a back-stop that Danske thinks will keep the plates from at least sliding off thetable. And if we’re honest, the fiscal situation has improved somewhat in the broader euro area after what have


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been a few years of consolidation.

Danske thinks the most likely European implosion story that could hurl the recovery off the tracks is Italy. Thecurrent political situation is in a state of flux. There is no government and the economic outlook worsens everyday, which means bond yields keep creeping higher. It is almost unthinkable to the bank that Italy won’t have tocome cap in hand for money, although at the moment the populist politicians are dead against it.

Then it all blows up and we’re right back to where we were with the Greece thing, only ten times worse becauseItaly is an actual economy. Danske thinks an Italian crash could cause a substantial widening of peripheralsovereign spreads and in turn, a 10%-15% correction in global stock markets on the revival of eurozone break upfears.

But Danske’s crystal ball tells it that this would then force Italy to sit down with the European Stability Mechanism(ESM) and the ECB to take advantage of the Outright Monetary Transactions (OMT) program. Italy then steadies theship, there is renewed optimism in financial markets and we’re back to the good news story above.

Lastly, the Danish bank also sees scope for an even stronger than expected US recovery on a big rebound in thehousing market and more generally, on decreasing levels of uncertainty. This would in turn release the flood gateson some very high levels of pent-up demand. Such an outcome could trigger a positive feedback loop pushing USgrowth rates to upwards of 4%-5%. If that happens, then BOOM goes the global economy.



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17 FYI

-Europeans target Aust Infrastructure -Yield versus growth in infrastructure stocks -Pressure on retailer marginscontinues -General insurers, transport outperforms -Who gains with media reform proposals?

By Eva Brocklehurst

Offshore competitors are circling. Citi has observed that European companies seeking growth are increasinglytargeting Australian infrastructure projects. The broker lists Impregilo, Salini, Acciona, Bouygues, Balfour Beatty,Ansaldo and Obrascon as targeting Australian rail, road, water and power projects. The most exposed, overall, tothis increased competition are Leighton Holdings ((LEI)) and Lend Lease ((LLC)). Citi believes Acciona's winning bidon Brisbane's $1.7bn Northern Link road project could be a test case for the Europeans' ability to undercutAustralians on price and make a profit.

In resources, competition from international companies is greatest in LNG. Europeans have not actively targetedresource infrastructure projects to date, limiting involvement to mostly maintenance services. That could change.Citi finds the most exposed stocks in this respect are Monadelphous ((MND)), Downer EDI ((DOW)) and UGL ((UGL)).Orica ((ORI)) and Incitec Pivot ((IPL)) have enjoyed the mining boom mostly free from international competition butthis too is expected to change. Citi notes the construction of the nitrates plant in Western Australia's Pilbara marksthe first major investment in domestic ammonium nitrate production from an international producer,Norway-based Yara International. Orica is partnering with Yara and Apache.

Aurizon ((AZJ)) is BA-Merrill Lynch's top pick in the infrastructure sector, given balance sheet leverage and costcutting potential. Asciano ((AIO)) will benefit from new grain and coal contracts and Transurban ((TCL)) will bedriven by steady traffic and toll increases. TCL, AZJ and Qube Logistics ((QUB)) are considered to have thestrongest 5-year compound annual growth rate.

The broker divides infrastructure companies into two broad camps. Companies such as Asciano and Sydney Airport((SYD)) will show growth over the next three years as economic conditions improve, but these more cyclical stockstend to offer a lower yield as capital is reinvested. On the flip side is DUET ((DUE)), Spark Infrastructure ((SKI)) andSP AusNet ((SPN)) which, being regulated utilities, have more defensive cash flow and offer higher yields. Forexample, on the FNArena database consensus forecast FY13 dividend yields are 6.8% for SPN, 6.6% for SKI and 7.5%for DUE. In contrast there's AIO (1.9%) and AZJ (2.4%). SYD appears to be the exception to the rule, showing a 6.9%yield.

Some of these stocks, such as AIO, SYD and Australian Infrastructure ((AIX)) are more leveraged to GDP and thegeneral economy. In contrast, the steady utilities such as DUE, SKI and SPN have more subdued growth profiles andexposure to the improved economic conditions. On Merrills' 5-year measure, QUB (14%), AZJ (10.5%), AIX (10.6%),TCL (10.3%) and AIO (8.85%) offer the strongest distribution growth. Although the regulated utilities currently havethe highest yields in the sector, there appears to be little growth in distributions. The 5-year measure shows 3.3%for SKI, 2.9% for DUE and 1.5% for SPN.

Overlapping infrastructure for some stocks is transport and here Aurizon shines again for the broker. It is one oftwo notable structural turnarounds in the transport sector. The other is Qantas ((QAN)). Transport stocksoutperformed the market in February, up a weighted average of 8.1% versus the ASX 200 at 5.4%. Asciano and TollHoldings ((TOL)) were the key stocks for Merrills, up 15.7% and 17.7% respectively in the month. The broker puts theoutperformance of TOL and AIO, as far as the financial results are concerned, largely down to margin expansionrather than top line growth and notes organic growth remains muted for each of Brambles ((BXB)) AIO, TOL andVirgin Australia ((VAH)).

There's been much talk about retailer margins. Citi finds Australian retailers seem reliant on gross margins toprotect earnings. For FY13, most retailers are approaching record margin levels but the broker believes it can't


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last. Myer ((MYR)) and David Jones ((DJS)) are perhaps best placed to protect gross margins through greater privatelabel sales and use of clearance outlets. Price discounting swings from season to season and, in Citi's view, the risein FY13 gross margins reflects fewer discounts.

The other factor at play is price harmonisation, which can actually raise margin percentages but comes at theexpense of sales growth. There are downside risks as new entrants and online shopping break down that marginadvantage. Overseas retailers have responded to gross margin pressure in a range of ways such as private labels,clearance channels and service income. This is the sustainable path and where David Jones and Myer seem wellpositioned to leverage these gains. Other retailers may pursue the same opportunities but, in Citi's opinion, willonly manage to offset natural margin pressure.

Credit Suisse notes general insurers have continued to outperform the market in recent months. They are nowtrading at a price/earnings premium to their five-year historical average. A slight premium is justified with thepositive outlook continuing, albeit at a slowing pace. Despite QBE's share price being up significantly in recentmonths, it remains the broker's preferred pick in the sector. The broker supports the actions taken by QBEmanagement and expects a continuation of underlying earnings improvement in coming years.

Insurance Australia ((IAG)) has recently widened the gap to Suncorp ((SUN)) on a price/earnings basis, a premiumthe broker considers appropriate. This is because IAG has most upside leverage to the local general insurancemarket and less downside risk from unpredictable natural peril events. Credit Suisse expects a slowdown inpremium rate increases, a reduction in investment income and adjustment to new APRA capital requirements toplay out for these stocks over the next one to two years. This week new media reforms were proposed by theCommonwealth Government and, understandably, received a lot of press. Legislation is expected to be presentedto the parliament within the next two weeks. The easy bit, and that which the Coalition is likely to approve, is areduction in licence fees and mandating Australian content quotas. The Coalition intends to oppose a mediaadvocate appointment, public interest test in relation to media mergers and a statutory press standards body. Aparliamentary committee will be established to discuss potential abolition of the 75% audience reach rule while theAustralian Communications and Media Authority (ACMA) will consider program supply agreements in determiningcontrol of free-to-air television. The Australian Law Reform Commission will to be asked to look at the possibleimplementation of a tort for invasion of privacy.

If a quick resolution is reached regarding the abolition of the reach rule, this will be added to the current package.Summarising the potential implications for the media, Credit Suisse notes a positive for Southern Cross Media((SXL)) and Prime Media ((PRT)), which would both benefit from reduction in licence fees and the opportunity ofabandoning the reach rule. Abandoning the audience reach rule would enable Ten Network ((TEN)) or Nine Networkto take over SXL and Seven West Media ((SWM)) to take over Prime.

On the neutral fence is TEN and SWM, as the potential abolition of reach rules would be countered by theintroduction of a public interest test, statutory press standards body and increased regulation of supplyagreements. In Credit Suisse's wholly negative camp is News Corp ((NWS)), if a public interest test, press standardsbody and increased regulation of supply come about. Fairfax ((FXJ)) and APN News & Media ((APN)) are also in thenegative camp because of the possibility of a public interest test and statutory press standards body.



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18 FYI

By Andrew Nelson

The shorting and short covering of equities on the Australian market remained at fairly sedate levels in the weekfrom the 6th to the 13th of March. Just two stocks saw their short positions come off by more than 2 percentagepoints (ppt) over the week, while only one stock saw its short interest increase by more than 1ppt.

Analysts from CIMB report that shorting interest has increased a bit across the gold sector. The broker notes twodriving factors for this: a run of weak operating performances booked over the February reporting season and amacro trade out of gold on signs of a building US recovery. Gold is not alone, with the broker also noting thatshorting has picked up in infrastructure and steel, while levels are still high in discretionary retail.

Media stocks are moving the other way, with CIMB noting a decrease in shorts over the past few weeks, while shortcovering has also been noticed in the transport, energy and building materials sectors.

The biggest increase to a short position over the week in question was booked by Billabong ((BBG)), with shortslifting a fairly subdued 1.04ppt from 1.81% to 2.85%. CIMB downgraded its call on the stock towards the end ofFebruary, noting if the company is not bought it will be forced into yet another capital raising, a likely unpalatableproposition for the board. The broker also sees limited upside prospects, pointing out the company's main sourcesof disappointment, Europe and the Nixon JV, are unlikely to recover in the medium term. Sentiment in theFNArena Database shows a negative skew for Billabong.

Shorts in Slater and Gordon ((SGH)) came off 2.82ppt from 2.84% to 0.02%. The stock did exactly the opposite lastweek when shorts went up 2.82ppt from 0.02% to 2.84%. The company’s 1H report at the end of February came inahead of expectations on both the earnings and dividend lines. The beat was enough to see Macquarie lift itsearnings forecasts. The broker did keep its Hold call in place, citing a pretty affordable looking valuation that isoffset by the unpredictability of cashflow conversion in the litigation game. Sentiment for the stock in the FNArenaDatabase is still neutral.

Sundance Energy ((SEA)) saw its short position decline by 2.52ppt from 3.51% to 0.99%. BA-Merrill Lynch was upbeaton news last week the company had bought 7,812 acres in the volatile oil area of the Eagle Ford at a good price.The broker thinks the purchase will form the core of Sundance's ramping up of production to 5,000 barrels of oilequivalent per day (boepd) over the next 15 months and sees plenty of further upside potential. Sentiment for thestock is positive.

Even though the move was less than the normal 2% for inclusion, we’ll give a mention to SingTel ((SGT)), its shortposition down 1.78ppt from 3.96% to 2.18% after coming off by a similar amount last week. BA-Merrill Lynch notedjust last week that the company had announced a strategic review for Optus' satellite business, with optimisingshare holder value the company's stated goal. BA-Merrill Lynch points out this could end up turning into a 2%-6%special dividend if the holdings are sold down or listed. Sentiment is positive for the stock.

That brings us to the monthly movers table, which holds a bit more to discuss. Shorts in Macquarie Atlas Roads((MQA)) are up by 2.54ppt from 0.88% to 3.42%, UBS noting at the beginning of March the stock had underperformedsince the February result. In the broker's opinion, the market is favouring the extrapolation of a low short-termdividend yield and ignoring the cash flow implications of one-offs in FY12-13, particularly from Eiffarie. Sentimentis positive.

Shorts in Alumina ((AWC)) are down 2.21ppt from 6.94% to 4.73% over the month in question. The last run of brokercommentary on the stock was over the last week of February, post the FY report. Credit Suisse upgraded to Hold,saying the loss was not as bad as expected and the outlook remains similar, i.e. CS is still pencilling in a modestimprovement this year. BA-Merrill Lynch, at Buy, sees a big increase in bauxite imports to China coming given the


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Indonesian ban from 2014 likely to leave China short of bauxite. Sentiment for Alumina is positive.

Harvey Norman ((HVN)) saw its short position retrace 2.13ppt from 10.73% to 8.6%. Brokers all reviewed thecompany’s 1H result at the beginning of this month and the general opinion was that it was not as bad as feared. JPMorgan even ventured that January sales were strong, although it is nowhere near convinced the company’soutlook is mending. The opinion was echoed by Macquarie, who in not at all convinced by the companyperformance, but is increasingly expecting a retail recovery at some point down the track. Broker sentiment forHarvey Norman is negative.

Our last significant monthly moves were posted by Bathurst Resources ((BTU)) and Sundance Energy. Shorts inSundance were down 1.96ppt from 2.95% to 0.99% over the course of the month in question, while Bathurst wasdown 2.01ppt from 5.89% to 3.88%. Credit Suisse noted back at the beginning of February that Bathurst’s Decemberquarter sales beat the broker by 20% on a 54% quarter on quarter increase, with an improvement in Takitimuthermal coal sales delivering the upside. The broker did have to push back first production from Escarpment bynine months or so, which means another net loss is expected in FY13. Still, the change did little to affect thebroker’s overall case and Outperform call. Sentiment for the stock is positive on straight buys in the FNArenaDatabase.

Changes to the Top 20 most shorted stocks list are very few in number. There were three or four position swaps,but none more than a position or two, while there was only one change to the list’s composition. Gryphon Minerals((GRY)) dropped off the list from the number seventeen spot, while Gunns ((GNS)) has joined at number 20.

Lastly, analysts from CIMB are seeing some good opportunity being provided by Seek ((SEK)). The broker notesshorts have dropped 1.3% from a six-month high of 6.2%, while the risk of a big earnings downgrade is fading. Thebroker now expects a strong earnings bounce at some point as employment conditions improve.

Top 20 Largest Short Positions Rank Symbol Short Position Total Product %Short 1 JBH 19196994 98947309 19.40 2 FXJ386277666 2351955725 16.42 3 ILU 60237740 418700517 14.39 4 MYR 77395244 583384551 13.27 5 PDN 101426631836969286 12.12 6 DJS 61777652 531788775 11.62 7 FLT 11218000 100289792 11.19 8 MTS 92706460 880704786 10.53 9LYC 194072954 1960801292 9.90 10 MND 8170746 90663543 9.01 11 KCN 13637392 151828173 8.98 12 TRS 232218026092220 8.90 13 CSR 44760256 506000315 8.85 14 HVN 91965801 1062316784 8.66 15 COH 4525373 57040932 7.93 16ACR 11543647 166521711 6.93 17 BRU 18653382 273912685 6.81 18 BKN 11464211 169240662 6.77 19 WSA 13250115196843803 6.73 20 GNS 52741216 848401559 6.22 To see the full Short Report, please go to this link

IMPORTANT INFORMATION ABOUT THIS REPORT

The above information is sourced from daily reports published by the Australian Investment & SecuritiesCommission (ASIC) and is provided by FNArena unqualified as a service to subscribers. FNArena would like to makeit very clear that immediate assumptions cannot be drawn from the numbers alone.

It is wrong to assume that short percentages published by ASIC simply imply negative market positions held by fundmanagers or others looking to profit from a fall in respective share prices. While all or part of certain shortpercentages may indeed imply such, there are also a myriad of other reasons why a short position might be heldwhich does not render that position “naked” given offsetting positions held elsewhere. Whatever balance ofpercentages truly is a “short” position would suggest there are negative views on a stock held by some in themarket and also would suggest that were the news flow on that stock to turn suddenly positive, “short covering”may spark a short, sharp rally in that share price. However short positions held as an offset against anotherposition may prove merely benign.

Often large short positions can be attributable to a listed hybrid security on the same stock where traders look to“strip out” the option value of the hybrid with offsetting listed option and stock positions. Short positions may formpart of a short stock portfolio offsetting a long share price index (SPI) futures portfolio – a popular trade whichseeks to exploit windows of opportunity when the SPI price trades at an overextended discount to fair value. Shortpositions may be held as a hedge by a broking house providing dividend reinvestment plan (DRP) underwritingservices or other similar services. Short positions will occasionally need to be adopted by market makers in listedequity exchange traded fund products (EFT). All of the above are just some of the reasons why a short position maybe held in a stock but can be considered benign in share price direction terms due to offsets.


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Market makers in stock and stock index options will also hedge their portfolios using short positions wherenecessary. These delta hedges often form the other side of a client's long stock-long put option protection trade, orperhaps long stock-short call option (“buy-write”) position. In a clear example of how published short percentagescan be misleading, an options market maker may hold a short position below the implied delta hedge level andthat actually implies a “long” position in that stock.

Another popular trading strategy is that of “pairs trading” in which one stock is held short against a long position inanother stock. Such positions look to exploit perceived imbalances in the valuations of two stocks and imply a “netneutral” market position.

Aside from all the above reasons as to why it would be a potential misconception to draw simply conclusions onshort percentages, there are even wider issues to consider. ASIC itself will admit that short position data is not anexact science given the onus on market participants to declare to their broker when positions truly are “short”.Without any suggestion of deceit, there are always participants who are ignorant of the regulations. Discrepanciescan also arise when short positions are held by a large investment banking operation offering multiple stock marketservices as well as proprietary trading activities. Such activity can introduce the possibility of either non-countingor double-counting when custodians are involved and beneficial ownership issues become unclear.

Finally, a simple fact is that the Australian Securities Exchange also keeps its own register of short positions. Thefigures provided by ASIC and by the ASX at any point do not necessarily correlate.

FNArena has offered this qualified explanation of the vagaries of short stock positions as a warning to subscribersnot to jump to any conclusions or to make investment decisions based solely on these unqualified numbers.FNArena strongly suggests investors seek advice from their stock broker or financial adviser before acting upon anyof the information provided herein.





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19 SMSFundamentals

SMSFundamentals is an ongoing feature series dedicated to providing SMSFs (smurfs) with valuable news,investment ideas and services, in line with SMSF requirements and obligations.

For an introduction and story archive please visit FNArena's SMSFundamentals website.

By Greg Peel

[Note: Unless otherwise stated, all tables are courtesy of Charter Hall Research]

Asset Class Performance

When assessing the performance of asset classes for longer term investment, comparisons will invariably use astock index as the proxy for "equities". In the case of Australian equities, the benchmark is usually the ASX 200, andto be meaningful the accumulated index (including dividend yield) is used. While there is no real alternative tousing such a benchmark as the proxy, few longer term investors will actually hold "the ASX 200" but rather will holdsome individually selected portfolio of stocks. The ASX 200 is heavily weighted to only seven of two hundred stocks-- two big diversified miners, four big banks, and one big telco. If an investor does not hold a weighting of all theseseven stocks in their own portfolio, immediately the ASX 200 index becomes a poor proxy for "equities"performance.

This is very much the case at present. The most recent leg of the wobbly four-year rally off GFC lows has beendriven by solid yield-paying stocks, such as the aforementioned banks and telco, while the big miners have well andtruly been left behind. Holding the right stocks in your portfolio over this period would have thus provided a muchbetter "equity" performance than the ASX 200, and considerably better than holding the wrong stocks. We could gofurther and suggest a portfolio that over the right period of time has held all of the "right" stocks in weightingsgreater than the ASX 200 (such as some of the more spectacular mining services stocks, or the online classifiedstocks for example) then as a SMSF you'd already be thumbing through brochures for luxury yachts.

Such a performance would no doubt have involved a fair bit of portfolio management, and not so much "set andforget". Not all SMSFs whish to be, or feel experienced enough to be, so active an investor. The great number arecontent to hold a passive "balanced" portfolio on the assumption that, over time, diversification will provide asolid risk/reward balance, and on the assumption that there's better things in life to do in employment/retirementthan watch the stock markets all day. On that basis, the ASX 200 is still the best proxy to use for “equity”performance comparison.

Having said that, now observe this rather interesting table:

Here we see an x-axis of 15-year compound return for various asset classes, and a y-axis of the long term volatilityof those returns. Return is obviously important, but volatility of return is also very important. Consider, forexample, that your stock portfolio held all the 30 Dow Jones Industrial Average stocks in 2007 and still does in 2013.Ignoring a couple of constituent changes in that time, your net result over the period is flat (plus dividends) giventhe Dow is now back at its 2007 highs. Not a bad result for a GFC. But if you’d sold in late 2008 in panic, and werelooking to perhaps buy back in 2013? Volatility of returns is very important with regards to investor psychology. It isalso fundamental when one considers that an elder brother who reached retirement and cashed in his super in late2006, and a brother two-years younger who did the same in 2008, would now be the Prince and the Pauper.

There are ostensibly four asset classes marked on the above table, although for reasons which will become clearerlater, the table highlights industrial property as a subset of general Australian property. The other three areAustralian government bonds, listed Australian real estate investment trusts (A-REITs), and “equities”, as


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benchmarked by the ASX 200. The higher up the x-axis the greater the compound return on that asset over 15years. The further right on the y-axis the greater the volatility of those returns. With a dive of 50% from 2007-09and a subsequent partial rebound, the ASX 200 is clearly the most volatile.

This table shows clearly that direct investment in property has provided not only the least volatile returns over 15years, but also the highest returns at around 10%. One usually expects a trade-off of return against volatility, albeitif your 15-year period includes a stock market crash of the magnitude we have recently seen, the figures will bedistorted.

Also quite notable is A-REITs have proven a disappointment on both counts, suggesting direct property has been the“best” investment over 15 years and listed property funds have been the “worst”. Seems strange, until you considerA-REITs can be sold in panic with the flick of a keyboard, just like shares, and property can’t be, and that the fall inA-REIT prices beginning late 2007 was greater than that of general shares through to 2009 given excessive gearing.

Now, it is important to note at this point that over 15 years, the make-up of the ASX 200 has changed several timesand some stocks have bitten the dust. The figures here for A-REITs does not include those that went under after2007, and there were several. Direct property doesn’t “go under”, but direct property investment funds andsyndicates have certainly done so in the period. The above table cannot be taken as gospel, but rather as a bestproxy comparison.

If we narrow down the return comparison from 15 years to the period September 2007, just before the then CreditCrunch sent A-REITs spiralling, to the end of last year, another picture emerges. We might call this "the GFCperiod":

Fixed interest is clearly the winner, reflecting extensive RBA interest rate cuts over the period. From here, thescope for further cuts is limited and the scope for rate hikes is increasing. Despite a decent rally of late, equitiesare still under water. And despite an even more pronounced rally of late, the damage done to A-REITs in the periodwas just too severe. Direct property again stands out.

The table further highlights the relative risk/reward benefits of a direct property allocation in any longer terminvestment portfolio. Let’s look at another one:

Leaving aside for now the volatile equity and A-REIT classes, we see here a comparison of returns over a decade ofprime property investment against bonds (5-year), the SMSF's favoured post-GFC investment of bank term deposits(3-year), and the RBA cash rate. Term deposits have clearly been a cracker of an investment for SMSFs, post-GFC,but returns are now waning, particularly following last year’s RBA cuts. By contrast, direct property has largelysailed on through.

Direct Property Investment

Direct property investment can loosely take three forms: your residence, a separate residential or a commercialproperty which you let, or an investment in a direct property investment syndicate or managed fund.

In the case of your residence, this only becomes an “investment” for yourself, other than your children, if yourintention is to one day sell the family home and trade down to something else. Usually we would exclude yourresidence under the label of “investment property”. As far as direct brick & mortar investment is concerned,investments here might range from one flat to a block of flats, or a factory or warehouse and anything beyond,depending on your means. For those on lesser means, tapping into the returns on offer from property investment inlarger residential or commercial assets means becoming an investor in units of a syndicate or fund. Syndicates,again, are usually for the more wealthy, so let’s cut our discussion down to direct property funds.

A comprehensive explanation of direct property funds is available by sourcing an FNArena article from 2011,Unlisted Property Trust Investment.

The important feature of direct property fund investment is, as indicated by the tables and graphs above, a steadyreturn over time. Most direct funds involve investment over several years, which would suit an SMSF anyway, butinvestors are not locked in and can exit at any time. Direct funds are nevertheless unlisted, so cannot be traded ona secondary market as can REITs.


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A steady return does not necessarily imply no risk, but rewards do not come without some level of risk. A lack ofsecondary trading market is one reason volatility of returns is reduced in unlisted funds which, as we have seen, isnot the case for shares, and not the case for listed REITs which are effectively traded as shares. High-yield sharesand REITs have provided a fabulous trading opportunity over the last year or so but only because they were soknocked down in the first place. All REITs suffered sell-offs beginning in 2007 which sent their listed valuationsdown to below, and in some cases well below, the net tangible asset (NTA) value of the properties in that REIT'sportfolio. Impressive rallies for favoured REITs in recent times is largely a reflection of that gap back to NTA valuebeing closed, now that the GFC dust has settled somewhat.

REITs have mostly now returned to more benign yield levels, thus limiting the scope for further sharp rallies invaluation. Offshore funding for banks is now returning to more benign levels of cost, reducing the pressure onAustralian banks to compete for deposits. On low RBA cash rates, bank term deposit rates have begun to wane.Fixed interest investments such as bonds have largely run their course on increased valuation, given limited scopefor further RBA cuts.

The share market, on the other hand, might just be looking good. But the rally-back to date has mostly been drivenby high-yield stocks, the valuations for which are now becoming stretched. If the ASX 200 is to continue upward, aswitch out of defensive yield and into cyclical risk is inevitable. Yield-seekers may thus be looking at capitalunderperformance ahead.

All the while Australian total superannuation fund assets are growing, not just in absolute terms but also as apercentage of Australia’s GDP:

If we consider a "default" domestic super fund portfolio to be weighted as in the following table, we can concludethat there is likely a growing demand for direct property fund investment:

From June 2002 to June 2012, the assets of Australian super funds grew by an average compound rate of 10.46% asthe Australian GDP grew by 3.07%. “With an approximate 10% allocation to property that is looking to be increasedby a number funds, prime quality [assets] may become increasingly difficult to attain should superannuation fundscontinue to post comparable growth rates from this exceptionally large $1.46trn asset base”, suggests property fundmanager Charter Hall ((CHC)),

SMSFs thus looking to find an alternative to bank deposits and/or an overweight to defensive yield stocks to driveportfolio growth in a more risk tolerant market would be well served by considering direct property investment asa proportion of a balanced portfolio. Investors already holding defensives or REITs on high entry yields willcontinue to enjoy such yields, but those yet to enter are now running into yield compression.

Yield compression occurs when the price of the underlying asset rises against the same value of dividend/coupon,ensuring a lesser annual yield on investment. High yield Australian stocks and REITs have all seen substantial pricerises recently and government bond prices are reaching the last hurrah of what has effectively been a thirty-yearrally from the bad old days of double digit interest rates.

While commercial property held by REITs and unlisted property funds is sourced from the same pool of assets, REITshave been able to rally sharply in price in recent times for the simple reason REIT prices were so knocked downpost 2007. Yield compression could not kick in until prices closed the value gap to NTA, but the compression is nowoccurring. Unlisted funds could not come under attack from panicked investors, hence yields on unlisted funds haveremained relatively more stable over the GFC period.

As the demand for investment property grows through weight of funds under management and lack of attractiveinvestment alternatives, the greater will be yield compression ahead for unlisted property funds.

The Argument For Industrial Property

Commercial property funds are divided into three classes: retail, office and industrial. Clearly all relative sectorsof the Australian economy have suffered as a result of the GFC, through consumer deleveraging, loss of jobs in theservices industries, and the decline of the Australian manufacturing sector. The strength of the economy post-GFChas been dominated by mining and energy development.


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Spending in mining has begun to peak and spending in energy will peak in the next two-three years. While progresshas been slow, the focus of the economy is now shifting away from the resource sector and back to “non-mining”sectors through easier monetary policy from the RBA and a slow return to risk appetite in the global economy.Retail spending has begun to pick up. Service industries have begun to re-employ. While the manufacturing sectorin Australia may never recover from what is now a structural shift in the value of the currency, manufacturing isonly one sub-sector of that which we call “industrial”. The following table shows total return by property assetclass in 2012. As we can see, industrial returns were only just pipped by office returns:

Despite the strongest 2012 result, office returns began to soften towards the end of the year. On the other hand,the take-up of industrial premises improved towards the end of the year. A recent survey by JP Morgan found thebulk of fund managers expecting industrial to be the top sector over 2013. Historically, industrial rentals have astrong relationship with the performance of the share market. With a strong result in 2012 (ASX 200 rising 14%), anuplift in industrial rental growth appears likely, suggests Charter Hall.

The mining and energy industries may be at or near peak development spend, but this simply means the resourcesector will now transition from a period of strong growth to strong production. Rental growth on properties withinall three classes across Australia was a feature of 2012, but the stand-out state capital was Perth. Oversupplymeant Brisbane did not perform quite so well, but supply has since decreased notably, suggests Charter Hall.

Property rentals in the high population states of NSW and Victoria have underperformed rentals in the “emerging”states over the past decade, yet institutional investors have remained steadfastly overweight industrial property inNSW in particular over the period. Old habits are hard to break. Indeed, Charter Hall points out that the industrialweighting to NSW is almost double that warranted by the weighting of the NSW economy within the Australianeconomy.

In short, if we assume an ongoing softening of global fear, improvement in the global economy, and a return to riskappetite, the Australian non-mining economy should also start improving to fill the gap left by the decline in themining economy. The RBA believes the early signs are positive, and hence has not decided to cut interest rates in2013 so far.

At this stage of the cycle fund managers expect the industrial property sector will offer greater growth potentialahead than retail or office. Overweight investment in the legacy states of NSW and Victoria suggests fund managerswill be looking to diversify their property portfolios into the other growing states.

While investors may be put off by a longstanding association of manufacturing with “industrial”, manufacturing isonly one sub-sector under the “industrial” banner. The slow decline of manufacturing is being rapidly now offset,for example, by the rise in the sub-sector of “logistics”. The demand for distribution centres and other logistics-related property is being driven by the rise in on-line commerce.

Charter Hall is one property fund manager offering unlisted direct property investment funds. There are manyothers. The successful subscription of Charter Hall’s direct industrial fund DIF 1 in 2011 has led the manager to openfor investment DIF 2 with an equity raising period closing end-2014 and a funds target of $200m. DIF 2 will target anaverage 8% per annum distribution yield with a total rate of return on the fund over seven years of 12%. Minimumretail investment is $10,000.

To date DIF 2 has acquired two properties – the Australia Post Distribution Centre in Melbourne and the ColesDistribution Centre in Perth, with a nod to logistics and diversification into WA.

For more information, readers are advised to contact Charter Hall.





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20 Technicals

Bottom Line 19/03/13

Daily Trend: Up Weekly Trend: Up Monthly Trend: Up

Technical Discussion

.... they continue to read as higher price levels being more than achievable over the coming months. And historicalhighs at that.' Well our long awaited projection that historical highs were going to be attained here [ in the DowJones Industrial Average] have now been met. Via a strong spike higher on the 5th March, and then follow throughfrom there. There has been some overall volatility entering other Global Indices of late though. And this hascertainly been a reflection of indecision coming into the market place post the ongoing strength that has beenwitnessed over the past 5 months or so.

Looking at the DJIA chart, it is clear that such volatility is not matched to the other major Indices. Yet there is aslight illusion here as well as the fact remains that U.S Futures markets have in fact been volatile in the nightsession , yet to this point in time have tended to settle before the cash markets have opened 10am New York time.I'm not going to draw any conclusions from this outside noting the potential for volatility, and therefore the needto remain vigilant over the coming weeks. And to step away from getting too complacent. Price has just probedinto historical highs after all.

There is a great trading pattern that we are going to keep a close eye on, that has the potential to unfold over thecoming weeks. And that is a congestion pattern, in the form of a symmetrical triangle or something similar,evolving shorter term, on and above the all time high price zone. Such a pattern would have trend continuationwritten all over it. It aligns our Elliott Wave count as well that is presently calling for a higher degree Wave-4 tostart kicking into gear shorter term, post the completion of the 5-wave subdivision we are presently watching aspart of the Wave-3. If this is a Wave-3 unfolding as proposed, it has now extended nicely up to the 1.618 x W1extension target circa 14330, with price recently breaking even higher above 14500. An indication that a Wave-4consolidation phase could be near. So if this does unfold as expected, for the overall move to indicate it still hasmore upside left in it, a resting phase on or above the all time high price zone around 14200, would certainly havea lot to like about it.

Trading Strategy

Nothing to do here for now from a trading stance outside keeping an eye on a potential Wave-4 consolidation phasetaking shape shorter term that unfolds within a bullish formation as outlined above. If price complies to our wishes,then this will be our next trading opportunity to run with a Wave-5 move higher. My only concern would be if pricestarts to fail via a convicted move below the wave-iv of a lesser degree circa 13784. A push that would be wellbelow the typical 38.2% retracement zone, and therefore a level that would start raising some alarm bells.Remaining bullish till then.

Re-published with permission of the publisher. www.thechartist.com.au All copyright remains with the publisher.The above views expressed are not FNArena's (see our disclaimer).

Risk Disclosure Statement

THE RISK OF LOSS IN TRADING SECURITIES AND LEVERAGED INSTRUMENTS I.E. DERIVATIVES, SUCH AS FUTURES,OPTIONS AND CONTRACTS FOR DIFFERENCE CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDERYOUR OBJECTIVES, FINANCIAL SITUATION, NEEDS AND ANY OTHER RELEVANT PERSONAL CIRCUMSTANCES TODETERMINE WHETHER SUCH TRADING IS SUITABLE FOR YOU. THE HIGH DEGREE OF LEVERAGE THAT IS OFTENOBTAINABLE IN FUTURES, OPTIONS AND CONTRACTS FOR DIFFERENCE TRADING CAN WORK AGAINST YOU AS WELL


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AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. THIS BRIEF STATEMENTCANNOT DISCLOSE ALL OF THE RISKS AND OTHER SIGNIFICANT ASPECTS OF SECURITIES AND DERIVATIVES MARKETS.THEREFORE, YOU SHOULD CONSULT YOUR FINANCIAL ADVISOR OR ACCOUNTANT TO DETERMINE WHETHER TRADINGIN SECURITES AND DERIVATIVES PRODUCTS IS APPROPRIATE FOR YOU IN LIGHT OF YOUR FINANCIALCIRCUMSTANCES.

Technical limitations If you are reading this story through a third party distribution channel and you cannot seecharts included, we apologise, but technical limitations are to blame.



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21 Treasure Chest

By Greg Peel

Mining in West Africa is an exercise fraught with risks, from the uncertainty of government policy to the difficultyof servicing equipment in remote parts. Gold explorer/producer Perseus Mining ((PRU)) has seen its share pricealmost halve over the past six months, which is a lot more than the pullback in the gold price over the periodwould imply.

Perseus has operations and developments in Ghana and the Cote d’Ivoire. In Cote d’Ivoire, the company’spromising Sissingue development has been held up for several months due to uncertainty over the government’sfiscal policy – whether or not it would impose a super profits tax – but it is the operating Edikan mine in Ghanawhich has caused Perseus the most grief.

The crusher required to process ore at Edikan has quite simply had a case of the gremlins, confounding theengineers. With problems persisting, Perseus’ gold production has fallen well short of guidance. A ray of light wasshined, nevertheless, at last month’s interim profit result releases and operational update. The gremlins had finallybeen identified. New parts were on their way.

The crusher was shut down for four days in February to replace the parts and the first week of operation thereaftersaw a return to 58% capacity. This doesn’t sound all that healthy, but as JP Morgan notes it’s a big improvement onthe December quarter’s 44% capacity. While management warned at its interim result that previous full-yearproduction guidance would not be met, the good news is that the crusher is now on a path back to re-achievingnameplate capacity.

Of seven brokers in the FNArena database covering the stock, six took a Buy or equivalent rating into the resultrelease and made no change thereafter. The thumping of the PRU share price was enough to provide a bufferagainst any further delays on full production at Edikan. Now that the crusher is on the mend, JP Morgan hasdecided the stock has plenty of scope to re-rate further than its initial bounce as it becomes clear the crusher isindeed back working properly.

JP Morgan also notes the current Perseus share price is offering little value for the Sissingue project, but it is nowexpected the government will scrap its plans for a super profits tax (someone probably pointed out how successfulone had been in Australia) and resort to a sliding royalty regime instead. JPM is assuming a top royalty rate of 6.5%to replace the previous flat rate of 3.5%, before sliding, and even on those numbers the broker considers Sissingueto be as a good as a “free option” in the current share price.

Perseus thus boasts a 3moz plus gold reserve to support what is low-cost gold production now Edikan is recovering,an option on Sissingue and a further Ghanian deposit at Kayeya. JP Morgan considers the current price to be “anattractive entry point” and has thus upgraded its rating on PRU to Overweight from Neutral.

That just leaves BA-Merrill Lynch with a lonely Hold in the database. Merrills suggested last month the Sissinguefiscal uncertainty prevented a more positive stance. The consensus price target among brokers in the database is$2.47, suggesting almost 50% upside.

The USD gold price has strengthened a little this last week or so, but clearly PRU has some re-rating potential toexploit before leverage to the price of gold again becomes the major earnings driver.



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22 Weekly Analysis

By Rudi Filapek-Vandyck, Editor FNArena

It is a truth not universally acknowledged by both investors and market commentators that resources stocks arebest bought when ultra-cheap. Certainly history seems to make this case.

These are very confusing times, to say the least. According to many a market commentator, we are in the earlystages of a multi-year bull market for equities, yet those equities closely correlated with risk and risk appetite arelanguishing in the background, abandoned and ignored by most of the funds flowing into equities this year.

Meanwhile, the safest options available in the share market together with solid dividend payers remain at thecentre of share market action. Who wants to own a high risk, small cap miner when Telstra ((TLS)) still offers morethan 6% in fully franked dividends plus the prospects of capital management in the years ahead, seems to be thegeneral, dominant view.

As shown on the chart below, which compares share price action of Westpac ((WBC)) and BHP Billiton ((BHP)), thedivergence between banks and resources stocks started to get traction in September 2011 (21 months ago) and thegap has today widened to some 50% between the two.

Not only does the gap appear incredibly wide, it also ignores the fact that BHP still has performed much better thanmany others in the resources sector. Which is why the chart below is equally interesting as it compares the AllOrdinaries against Small Industrials, the Small Ords and Small Resources index -in that order- and guess what? Theperformance gap between the All Ordinaries and Small Industrials hardly registers, but the Small Resources indexhas by now underperformed the broader index by 50%!

There we have that dreadful number again: minus 50%. It's tough to be a resources bull in the post-2007 era, bullmarket or not.

Maybe investors can draw solace from the fact that last year when the relative performance of the Small Resourcesindex widened as much as it has today, a relative catch up rally emerged from the battlefield, twice (!) throughoutthe year.

Firstly, let me draw everyone's attention to the wide disparity that has opened up in the sector since late 2010.Since then, stocks like OZ Minerals ((OZL)), Paladin Energy ((PDN)) and Western Areas ((WSA)) have graduallydeflated to share price levels as low as we've seen them post 2007, while others added a few months, or evenlonger, of solid performances in line with the share market in general. Take a look at a share price chart for OilSearch ((OSH)), or BC Iron ((BCI)), or Sirius Resources ((SIR)) and the first observation is: gap? What gap?

Maybe the most logical conclusion to draw from all this is there's no longer a general trend for resources stocks as agroup. Iron ore stocks still performed well until September last year (though BC Iron has kept on performing since).Energy stocks have now consistently outperformed miners. Large cap miners have significantly outperformed thevast majority of their smaller cap nephews.

Most of the above still suggests a catch-up rally, at some point, for the beaten down metals and minerals sectorseems but logical. We had two such rallies in 2012, why would 2013 be any different?

Longer term, however, the outlook remains murky at best. Analysts from UBS and from Macquarie recentlyreturned from visits to China and their observations essentially confirmed just that. The Chinese steel industry hasbeen too enthusiastic in ramping up production since late last year and is now confronted with too much steel leftas inventory. Worse, steel manufacturers in the country have signalled they want to see lower prices for iron oreand intend to keep inventories of iron ore at lower than usual levels. Traders in China are worried about whatmight happen in the second half of the year when additional supply will start hitting the market.


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The biggest reversal, however, is happening in the copper sector as more analysts are increasingly turning lessbullish on the metal. Copper's main problem, so to speak, is the same one as for iron ore: increasing supply. OnMonday, analysts at Deutsche Bank printed a sentence that would have surprised most market watchers: "copper isstarting to look more similar to aluminium than many would have ever thought possible". Copper is today stilltrading at a 30% premium to the marginal cost of production. Deutsche Bank analysts are concerned that as themarket for copper will see more supplies becoming available, that premium will be gradually eroded.

If Deutsche Bank's prediction proves correct, the current premium can halve in years ahead (to 10-15% level); thisimplies a copper price of US$6,300/tonne versus circa US$7700/tonne today. This will not go unnoticed.

Yet analysts at JP Morgan had been going through all kinds of variations in price scenarios last week and theyalways ended up with Net Present Values above today's share prices for both BHP Billiton and for Rio Tinto ((RIO)).One major difference with smaller, single commodity producers is, of course, that the major diversifieds can cutmore costs from longer life, larger mining operations. Regardless, this assessment still leaves unanswered whetherinvestors now think these majors should trade at lower multiples or not, since prospects for runaway earningsgrowth seem to have dissipated and propping up earnings growth via cost cutting remains a low quality exercise,even though potentially effective in the short term?

Most experts and analysts will also ensure us the overall risks to China's growth and its appetite for commodities isquite low in the years ahead. However, analysts at the highly regarded BCA Emerging Market Strategy recentlyreported credit expansion in China has in their view reached unsustainable levels with non-public debt to GDPexpanding from 120% to 190% over the past four years. According to the BCA report, most of these transactions takeplace behind several layers in order to hide the true levels of credit expansion and banks are accomplices to theseschemes. The research states some major Chinese companies are operating under unsustainable leverage levelsand will likely crumble at some point. Of course, it will be up to the central government to bail out both localgovernments and corporations, and they do have the necessary means to do so, but can anyone imagine the shockwaves such an outcome would trigger around the world?

Always good to remember: do not put all your eggs into the resources basket (that seemed okay pre-2007, but it'llnever again be okay since)

Bottom line 1: it's much better to buy BHP shares closer to $30 and Rio Tinto closer to $50; just look at the priceaction over the past six years

Bottom line 2: only pursue with the correct risk assessment

Bottom line 3: we need a much better environment to make any bounce more than a temporary phenomenon.Where's that global, synchronised re-stocking? It's still on its way, maintains UBS strategist Julian Garran - see storyfrom four weeks ago: "Commodities Due For An Upside Surprise"

Bottom line 4: yesterday's downturn by definition creates a more fertile environment for a pick-up tomorrow.That's how supply and demand balances interact for commodities. If we extrapolate this principle into the futurethen the outlook for nickel, zinc and lead will prove better than for iron ore, crude oil and copper. Note there's stillno sign of life for uranium and thermal coal continues to look abysmal. There are promising signs for mineral sandsproducts.

Bottom line 5: at times like these investors end up being heavily short the sector (not just for gold) and we all knowwhat that means: any rally can be of considerable strength.

Now, where is the catalyst?

(Answer: no doubt, it's in China, somewhere, but where? And when?)

(This story was written on Monday, 18th March 2013. It was published on that day in the form of an email to payingsubscribers at FNArena)

DO YOU HAVE YOUR COPY YET?


48 of 49 23-Mar-13 5:55 PM

FNArena has published my latest e-Booklet "Making Risk Your Friend. Finding All-Weather Performers". Thise-Booklet (58 pages) is offered as a free bonus to paid subscribers (excl one month subs). If you haven't receivedyour copy as yet, send an email to [email protected]

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculationsare provided for educational purposes only. Investors should always consult with their licensed investment advisorfirst, before making any decisions. All views are mine and not by association FNArena's - see disclaimer on thewebsite)

****

Rudi On Tour in 2013

- I will present and contribute during the 2013 National Conference of the Australian Technical Analysts Association(ATAA) at the Novotel in Sydney's Brighton Beach, June 21-23

Interview on Radio

- I will be interviewed about my recent eBooklet "Make Risk Your Friend. Finding All-Weather Performers" thisSunday, March 24, between 10-11am. The program is called Ringside, on Radio Northern Beaches, 87.7fm & 90.3fm /www.rnb.org.au/stream


49 of 49 23-Mar-13 5:55 PM

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