Thursday 21 October 2010

'Avoid purchasing shares in QR National' - Investment adviser

A Queensland investment business is not recommending investment in the Queensland Rail share float.

A number of investment advisers have shared similar views, saying the price is too high. It's at odds with the State Treasurer's view.

Andrew Fraser says he's sick of "every two-bit fund manager" making comments about the float, most of them only wanting to buy the stock cheaper.

"No one wants to pay more but the reality is who signs on the dotted line and buys the stock," Fraser said.

Townsville-based investment adviser Axis, are informing their clients to avoid purchasing shares in QR National.

"We are not recommending it to our clients, however, we can obtain shares for you if you do want some," an email to AXIS customers reads. "We have been analysing all of the research on the QR float. The expected asking price of $2.50 to $3 is just too expensive. I’d be prepared to look at it again at $2."

Last week, Queensland Premier Anna Bligh and lead managers were in Brisbane preparing to launch a collection of rail assets bundled up into nice, shiny $7 billion package called QR National.

They quote Alan Kohlers Eureka Report...

"I was hoping to have a copy of the prospectus beforehand so I could ask some half-intelligent questions but it wasn’t released until the moment the conference started. I can only assume that this was to avoid the hard questions. Now I have had some time with the prospectus and the time to analyse it I can see why. Based on its contents and the way this float has been structured, QR National is one train that I am happy to let pass me by."

Kohlers says that despite the retail carrots and the strength of the company’s board and balance sheet, they don’t believe a $2.50 offer price is justified.

"At $3 they’re dreaming. I’d be inclined to revisit the subject again at $2. That represents a 2010-11 P/E of 17 times, falling to 13 times in 2011-12. It also means the yield is a respectable 3% rising to 4.1% in 2011-12."

"We're going to pass on QR National. If I want a railroad company, I can buy Asciano today, trading below QR National’s low-end valuation. There are plenty of growth stocks with China leverage from which to choose. Take Orica for instance. It sells explosives and other consumables to the miners. It’s trading on 13.5 times 2010-11. First-class mining contractors such as WorleyParsons at 17 times 2010-11, Leighton and Monadelphous on 16 times and UGL on 14 times are all cheaper."

At an asking price of $2.50 to $3, QR National has been valued at between $6.1 billion and $7.3 billion. Retail investors will pay a maximum of $2.80 a share and a discount of 10¢ a share to the price paid by institutions, however there are other incentives.

"That’s a price/earnings (P/E) multiple of 21–25 times for 2010-11, or a 75–100% premium to the ASX 200 market multiple of 12 times. Based on the growth the company has forecast, the multiple drops to 16.5–20 times in 2011-12. That is still a 65–100% premium over the market. The nearest comparable company, Asciano (AIO) – the owner of rival outfit Pacific National – trades on a multiple of 19.5 times for 2010-11 and 16 times 2011-12, which is equally difficult to justify," Axis say.

Axis said that over the past three years, capex has been running 140–340% higher than depreciation. Over the next two years QR National forecasts capex to reach $3.75 billion – that’s more than the past three years combined.

Nor is the dividend yield exciting: 2–2.5% in 2010-11; low 3’s in 2011-12. One reason for this is a low, 30–55%, payout ratio. The heavy capex program restricts the ability of the company to pay cash to its shareholders. The dividend is also unfranked. Tax allowances for capital expenditure mean that won’t change any time soon.

"The asking price straddles book value of $2.78. But that’s not a great value indicator as the return on equity even in 2011-12 is only 5.4% … you could get more than that from a bank deposit and take on zero risk in the process," Axis say. "In my opinion, a more appropriate return would be closer to 10%, suggesting either earnings have to double or shareholders pay a lot less than book value."

Coal volumes are the single largest factor impacting the bottom line. A 5% variance in volume impacts after-tax profit by 15–17%. The federal government’s new resources tax, which is scheduled to start in July 2012, is a threat to volumes. An even bigger threat is a future carbon tax.

That’s likely to decrease coal demand. It’s not easy being green.


KitchenSlut said...

I'm curious about some aspects in here as judging by the quotations the analysis is ultimately derived not from AXIS but from Mike Mangan at 2MG fund manager which is mostly available publically at businessspectator?

Mike, am wondering if you can tell me if this was acknowledged in the email from AXIS as we all know financial firms here in the north are not renowned for ethics? Plagiarism?

Andrew Fraser is correct as reported elsewhere that it is in the interests of fund managers and institutions to talk the price down.

However, Mangan has a good reputation for speaking his mind having previously been moved on from an analyst position at Deutsche Bank after posting negative reports on News Ltd with sell recommendations drew the ire of Rupert (but i had to say that so Syd wont sue!)

Disclaimer: KS has no financial interest.

Michael P Moore said...

The statements, KitchenSlut, are from the company communication. There was no reference to another party.