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Tim Boreham
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+ About Tim Boreham

Welcome to the New Criterion, authored by Tim Boreham.

Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.

Tim Boreham has now joined Independent Investment Research and is proud to present The New Criterion, which will honour the style and purpose of the old column. These were based on covering largely ignored small- to mid-cap stocks in an accessible and entertaining manner for both retail and professional investors.

The New Criterion will strive to continue the tradition in a weekly online format.

The column will not offer stock recommendations because we think readers can make up their own mind on the facts and opinions presented.

Our coverage will include both the industrial and mining sectors, including listed investment companies and IPOs. The stocks covered will not necessarily be of investment grade with sound financials. But they will have credible management and – at the very least – an interesting story to tell.

We hope readers will find The New Criterion both entertaining and informative.

Is Zircon a diamond in the sand?

Friday, November 09, 2018

While resources pundits regard copper as the commodity most reflective of the world’s economic strength or otherwise, the more obscure zircon arguably is an even better guide.

On zircon’s recent price strength, investors shouldn’t be fretting about a global recession or – more pertinently – a Chinese downturn.

A component of mineral sands, zircon is used widely in ceramics (as a tile whitener) and for heavy-duty industrial applications, such as nuclear reactor liners and jet turbine blades.

It’s also used to make artificial diamonds and is even being talked about as a future battery metal material.

With the depletion of some of the bigger deposits and with few new finds of note, the zircon price is on a tear: up from a recent low of $US950/t ($1340/t) in mid 2016 to $US1650/t now.

Australia is the biggest zircon producer, accounting for 35% of global output, followed by South Africa with a 28% share. Consultant TZMI expects zircon demand to grow by 2.8% a year to 2026, from the current 1.2 million tones. At the same time, supply is expected to decrease by 4.3% a year.

 “It’s a good time to be in the zircon business,’’ says Diatreme Resources head, Neil McIntyre. “We see constrained supply: mines are maturing so there’s a strong window for new projects to meet that shortfall.”

The earnings turnaround is already apparent at Iluka Resources (ILU, $8.98) our biggest mineral sands producer, which posted a June half net profit of $126m, compared with an $81m loss previously.

But after years of development and promises, three other local minnow developers are poised to become producers at the right time.

Peaking the excitement scale is Sheffield Resources (SFX, 85c), which for a small cap is in the enviable position of fully owning Thunderbird, one of the biggest mineral sands discoveries in the last three decades.

On the Dampier Peninsula in northern WA, Thunderbird is rated as a 680 million tonne resource, with 76.8mt of heavy mineral sands, mainly zircon and ilmenite (from which the paint pigment titanium dioxide is derived).

Thunderbird is close to being ‘go’, at least for the $463m first stage:  a $US175m debt facility has been arranged – although it’s non binding at this stage – and the Northern Australian Infrastructure Fund is chipping in $95m.

Management is currently negotiating an engineering, procurement and construction contract, which is expected to be fixed price in order to minimise risk.

The company targets production by the December quarter of 2020, with initial output of 122,000t, increasing to a substantial 809,000t by 2025.

A bankable feasible study in March ascribed a net present value to Thunderbird of $US507m, but that was when rutile traded around $US1380/t.

Meanwhile, Image Resources (IMA, 12c) last week announced commissioning of its full-owned Boonanarring mineral sands project in the North Perth basin, 80 kilometres north of the capital.

For mineral sands, the region is like what Kalgoorlie is for gold: both Iluka and US titanium giant Tronox in the area, which lies on an ancient beach. And the project’s proximity to Perth means the project will be a cheaper drive-in drive-out than a costlier and less hospitable fly-in fly-out one.

“The company has been working diligently over two years to move a company into production,” Image chief Patrick Mutz told the recent Australian Microcap Investment Conference.

Indeed, If Image can get its ducks in a row – and they look to be falling in place – Boonanarring could be producing by as early as Christmas, based on a simple dry shovelling operation.

The company is fully funded, not only to complete construction but we have the funds for the working capital through the commissioning to ramp up to positive cash flow.

Rutile is the key ingredient in mineral sands, which in Image’s case means an exotic mix of zircon, rutile, leucoxene and ilmenite.

While zircon will comprise 30% of the heavy mineral concentrate produced, it is expected to account for three quarters of the projects revenues.

On paper at least, the project economics look compelling.

Updated in June, the bankable feasibility study values the project (net present value) at $235m, with a project cost of $52m and a payback period of 13 months.

The project is forecast to produce earnings before interest of tax of $278m over the life of the project, although zircon’s further price strength mean these numbers could be conservative.

The company envisages annual output of 220,000t of heavy mineral sands, containing 60,000-70,000t a year of zircon.

In comparison, Iluka expects to produce about 335,000t this year.

Overall, Boonanarring is rated as a 19.8mt resource, grading 7.2% heavy minerals.  As Mutz proudly notes, that’s more than twice the grade of a typical deposit globally.

“In addition, there’s very little trash heavy mineral (in the concentrate),” he says. “Heavy mineral content is not all saleable and sometimes (the saleable content) can be as low as 30%”.

Still in WA, Diatreme Resources (DRX, 2c) is further down the evolutionary curve with its Cyclone project in WA’s Eucla Basin, also a well-known mineral sands address.

But once again, Diatreme could be timing its run with a Winx like perfection.

Diatreme expects a long-awaited definitive feasibility study, presumably confirming the robust economics of the 80,000 tonnes a year (of zircon) operation, to be released “imminently”.

Only one of three discoveries of size over the last decade, Cyclone is rated as a 138mt deposit at an average grade of 2.3%.

Management has targeted production by 2020, with a 10mtpa operation sustaining a 14-year mine life.

The mine is based on slurrying the ore to a wet concentrator plant, trucking the produce to the Forrest rail siding on the transcontinental rail line and then freighting it to Port Pirie.

“As we enter the final stage of the bankable study, we are looking at options for offtake and venturing or processing in China,” McIntyre says.

Diatreme is not just a mineral sands story: it owns a silica sands project in Far north Queensland, Cape Bedford, which is expected to start mining the 21mt resource as a simple quarrying operation.

Down the road from the world’s biggest silica mine, the Mitsubishi owned Cape Flattery, Diatreme will tap the buoyant demand for these sands in construction, notably high end glass.

Both Image and Diatreme management argue their shares are undervalued, given the progress their companies have made. “We’ve been in an orphan period in which no one cares about you because you are spending money but don’t have anything to show for it,” Mutz says.

Sheffield shares have retreated sharply after hitting $1.20 in early October, despite talk that Thunderbird would make for better economies if it were in the hands of a major.

In other words, Sheffield is a takeover target.

In the case of all three stocks, investors should be aware that once a developer turns miner and starts digging dirt, the shares tend to underperform because the stock is being valued on the drudgery of reality rather than blue sky.

Pundits who believe in the minerals sands story could well consider Iluka: rather than revelling in the buoyant prices, the shares have slumped 30% since late August because the company’s costs guidance for the calendar 2018 year were higher than expected.

Iluka’s $3.65 billion market cap compares with $218m for Sheffield, $123m for Image and $23m for Diatreme.

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.
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How about a beer?

Friday, November 02, 2018

Gage Roads (GRB) 9.9c

The Perth-based boutique brewer’s CFO, Marcel Brandenburg, hesitates when asked to define what a ‘craft’ beer actually is.

“It’s a contentious issue,” he told a recent annual Australian Microcap Investment Conference. “In the US, they try to define it by the size of the brewery.

“In Australia, we define it more by flavour profile, anything that has a hoppy, floral taste profile.”

A simpler definition is any brew made in a smaller batch-style facility, no matter the level of floral hoppy after tones. But the contentious aspect is that six of our top 10 selling ‘boutique’ brewers are now owned by the big guys.

This includes the top three: James Squire (Lion, owned by Kirin of Japan), Yak Ales (Foster’s owner Anheuser-Busch) and Little Creatures (Lion/Kirin). In 2015, Asahi of Japan picked up Mountain Goat and in 2017 beer wannabe Coca Cola Amatil snapped up Feral Brewing.

For Gage Roads, it’s a case of bucking the trend, winning back its independence after buying out its 25% owner Woolworths. Two years into its five-year proprietary brand strategy, Gage Roads has made inroads into transforming its business from a contract brewer for the grocer to pushing its own higher-margin brands.

Founded in 2004, Gage struggled for critical mass before the 2009 deal with Woolworths delivered enough volume to justify building what’s now WA’s biggest brewing facility.

The trouble is, there wasn’t a lot of profit in contract brewing, while Gage’s higher margin own brands – sold exclusively through Woolworths – had become the country’s fifth biggest craft brand.

But the only way for Gage to take care of its own destiny was to win back its independence — and the ability to sell through other channels including Coles, pubs and restaurants.

Two years ago, management bit the stubbie lid and bought out Woolworths’ 25% stake.

Over three years, Gage hopes to get its own brands – including its eponymous Gage Roads, Single Fin Summer Ale, Alby and Breakwater Pale Ale – to 70% of sales compared with about one-third of sales in the 2016-17 year.

Having invested $27m on German brewing and packaging equipment, Gage Road’s jewel is a state-of-the art brewery with capacity of 17 million litres a year, of which 12 million litres is currently deployed.

The $4.9bn, 1.2 billion litre a year Australian beer market in essence has been flat for years, growing at a 2% clip. But craft now accounts for 11% by value and 5% by volume and has grown at a 16% compound annually in the last three to five years.

Based on the US craft beer experience, Brandenburg says there’s plenty of room to grow. But given the top eight brands here account for 89% of the growth, the key is to have recognisable brands with a strong shelf presence.

Hipsters also won’t pay through their pierced noses for the boutique experience: on Gage’s reckoning, a case of grog won’t sell if it costs more than $62 per case, or $22 per six pack.

Rather than spending millions on billboards and other advertising, Gage Roads has tied up key venues and events in exclusive beer supplier arrangements.

These include Perth’s new Optus Stadium and NIB Stadium, Fringe World (WA’s biggest outdoor event), Cricket Victoria and the Rugby Sevens competition.

In June this year, Gage Roads acquired the Broome-based brewer Matso’s from the Peirson-Jones family for $13.25m cash, plus 35m Gage Roads shares over three years based on performance hurdles.

Matso’s is famed for its mango and ginger beers, which aren’t exactly everyone’s taste but are high selling, high margin products nonetheless. The added benefit for Gage is these lines don’t compete with its own beers.

Brandenburg dubs the acquisition, which is expected to boost earnings per share by 35% this year, as a no brainer.

 “We had made their product under contract so carried the operational risk, so all we are doing here is on boarding the brand and capturing the brand owner’s margin.”

The Matso’s buy has boosted Gage’s earnings per share by 35% to date and no doubt is a key contributor to Gage’s recent share price strength.

Joyously, Gage Road’s dash for freedom has helped the bottom line, with the company reporting a 2017-18 net profit of $2.06m, up 3% on revenue of $33.2m (up 22%).

“We are now at a point where we feel we can match it with any supplier,” Brandenburg says.

Having traded at 7.5c a year ago, Gage shares hit 14c in early September but have since drifted to around the 10c level for a market capitalisation of just over $100m.

The dilemma for management and employees, who account for 23% of Gage stock, is what to do when one of the beer multinationals comes a knockin’.

Broo (BEE) 10c

Unpatriotically, Gage and Chinese aspirant Broo are the only ASX-listed beer exposures after Lion Nathan and Foster’s Group fell into foreign hands some years back.

Broo got investors frothy in November last year when it announced a partnership with a mob called the Beijing Jihua Information Consultant, to market and distribute Broo’s beers in China for seven years.

Under the take or pay arrangement, Jihua will take 1.5 billion litres at a fixed rate per litre, generating aggregate revenue for Broo of $120 million. The first three years’ revenue is accrued and then paid to Broo at the end of this period.

Broo shares spiked about 30% on the news (to 39c) but the gains were short lived, probably as investors remembered that the difficult Chinese market proved an expensive failure for even the deep-pocketed Foster’s and Lion.

Broo listed in mid October 2016 at 20c a share.

On Friday, Broo reported September quarter distribution volumes of 19.2 million litres, which implies there’s still work to do to get to that 1.5bn litre run rate.

Broo makes Broo Premium Lager and Australia Draught, both emblazoned with a garish kangaroo emblem. To suit Chinese tastes, the alcohol content was lowered and the bitterness toned down.

Broo’s brews will be marketed as premium (rather than boutique) drops, priced similarly to the offerings of other foreign devils, such as Heineken and Budweiser. The company plans to market Australia Draught aggressively in the on-premises tap market, which Grogan describes as one of the most lucrative in the world.

Locally, Broo also has ambitious plans to build a $95m green-friendly brewery on land acquired on the outskirts of Ballarat for $2m in early 2017. Green principles, such as minimal water and chemical usage, work nicely with the hipster-oriented craft beer theme.

With a 480 million litres capacity, the brewery would be one of the biggest in Australia and would also involve contract brewing. The site would also incorporate an Australian beer museum and a “cultural engagement hub”, which come to think of it sounds awfully like a pub.

Broo owns the hip Sorrento Brewhouse and Mildura Brewery Pub and both look like decent cash cows, delivering most of Broo’s 2017-18 revenue of $2.58 million.

Broo’s September quarter report showed revenue of $646,000 and a $1m loss. Broo lost $4.43m last year and $3.4m in 2016-17 and has chewed up $12.5m over the last five years.

 With a September cash balance of $832,000, Broo clearly needs a deep-pocketed backer to realise its green dream.

Meanwhile, Broo expects first revenues from the Middle Kingdom to trickle in in November 2020.

Tim Boreham edits The New Criterion. tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.
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Bunker down with these D-E-F-E-N-C-E stocks

Friday, October 26, 2018

Given the current swooning stock market, there’s plenty of talk about defensive stocks, but, in the case of some of our listed defence suppliers, that concept has a more literal hue.

In theory at least, suppliers to the military machine should be as resilient as grocers or utility companies because defence expenditure globally continues to increase no matter what the economy – or the Dow Jones — is doing.

With Canberra splurging $200 billion on extra defence spending over the next five years (including long-term contracts for frigates and subs and the $5.2 billion Land 400 vehicle program), perhaps now’s the time for investors to be bunkering down with the handful of ASX defence exposures.

As in warfare, there are winners and losers in the defence supply game: some of them are shooting blanks and some are still recovering from their past travails.

1. Xtek (XTE, 50c)

An example of the latter is the Canberra based Xtek (XTE, 50c), which supplies (or intends to supply) small unmanned aerial systems (drones), ballistics, body armour and helmets to the Australian Defence Force and other friendly parties.

Xtek chairman and 13% shareholder Uwe Boettcher says the outlook is also bright for defence suppliers because of new rules mandating 50% local content in any supply deal (this involves getting in the good books of the lead contractor).

Defence minister Christopher Pyne is also focused on defence exports and has told our high commissions to have a dedicated person pushing our defence wares (to friendly countries, of course).

Xtek’s armoury of goodies includes techniques to make body armour 30% stronger and much lighter than the standard issue version and helmets to withstand a bullet from an AK-47.

Xtek in 2017-18 reported revenue of $17.3m and a net profit of $139,000.

Most of the turnover derived from a contract with Aerovironment of the US to be exclusive local supplier for the drone manufacturer.

As agency work, it’s high turnover but low margin. But maintaining the fragile devices is much more lucrative, and given Xtek already does the maintenance, it’s in pole position to win a long-term maintenance contract from the military bods.

 What would such a deal be worth? Mr Pyne in August last year announced a $100m contract through Xtek to acquire and maintain the birds. 

Of this amount, $42m has been expanded on the drone acquisitions, with most of the remaining $58m likely to be spent on maintenance. 

Xtek’s second great hope lies with its own mapping software called Xatlas, which converts video feed from drones to real time maps.

For example, a drone flies over an enemy territory and then again in hour, the updated map can detect a change in the sniper’s position.

That sounds handy.

Xtek this month received its first order, from the Australian Defence Force. The deal worth a humble $70,000 is more a case of the military testing the software in view of a more material contract.

Xatlas is also expected the software will be sold by Aerovironment – which moved 25,000 drones last year – as an optional extra.

In the meantime, Xtek is talking to 15 international customers about potential armour supply deals, while testing of it polyethylene helmets is being funded to the tune of $1m by the US military.

The equipment is based on the company’s XTclave autoclaving technology, which involves ultra light and strong composites being made under extreme pressure.

“We are sufficiently confident about these discussion to build a fully fledges factory to make commercial quantities,” chimes Boettcher.

The facility will have a vaunted capacity of 40,000 armour plates capable of generating $20m annually from a global market worth $US3.5bn.

Xtek has guided to $26m of revenue this year, $20m of which is contracted. But as the fine print says, this excludes any potential drone maintenance or armour plating revenues.

Now backed by instos including Kentgrove Capital and Alto Capital, Xtek has come a long way since three years ago, when Boettcher was forced to lend the company $500,000 to stay afloat.

2. Electro Optic Systems (EOS) $2.83

The hitherto obscure entity is best known for its facility that tracks objects in space, notably harmful debris, for both defence and commercial applications.

But Electro Optic Systems is fast emerging from under the radar in a different capacity: manufacturing a range of remote controlled weapons systems with improved “lethality” to ensure that friendly forces can outgun the enemy.

Crucially, the soldiers can operate the guns, while safely bunkered in the vehicle.

Unlike most of its ASX tech peers, EOS is starting to make serious money.

In August, EOS won a pivotal contract to equip remote weapons systems for the second phase of the Land 400 program, which involves the army procuring 211 armoured combat reconnaissance vehicles.

The top brass have also specified the EOS systems for phase three of the Land 400 program, which involves the army buying 450 infantry fighting vehicles by 2024.

The win was a prestigious one, but in reality 95% of EOS’s output is exported. With the hardware denominated in $US, EOS has no problem with the falling Aussie dollar relative to the greenback.

EOS reported $620m from committed contracts at end of first (March) quarter, growing to $800m by the end of the September quarter.  Management expects sales of $900m by the end of the calendar year.

Revenue wise, the company expects to turn over close to $100m by the end of 2018, rising to $180m next year and $275m by 2020.

Profit-wise, EOS expects to post $10m this year, having recorded a $5m surplus in the first half. Based on the contracts in hand, management is confident enough to forecast $20m next year and $27m by 2020.

The company currently has $58m in cash and will not need to raise funds unless new orders are received

Based at the company’s $30m tracking facility at Learmonth in WA, the space tracking side is expected to become profitable in the first half.

3. Quickstep Holdings (QHL, 7.5c)

As a supplier of carbon fibre parts to the Joint Strike Fighter (JSF), Quickstep shares should have had a supersonic trajectory but like our fleet of F-35s, they’ve been grounded.

The JSF contract, via lead contractor Northrop Grumman, is augmented by a deal with Lockheed Martin to provide wing flaps for C-130J/LM-100J Hercules aircraft until late 2019.

It’s hard to pin down what’s amiss, but a revolving door of CEOs hasn’t helped. Philippe Odouard, who now heads Xtek, was replaced by Dave Marino, who re-focused the company on specialty high-performance car parts.

Having decided that car executives were even harder to deal with than military brass, Marino was replaced in favour of Mark Burgess.

Quickstep grew its revenue from $51.9m to $59m in 2017-18, with ebitda of $1.2m and a net loss of $2.9m, compared with a $6.7m deficit previously.

Quickstep shares have marked time over the last year but have lost 67% of their value over the last five years, much to the chagrin of long-term shareholders, including Washington H Soul Pattinson.

Tim Boreham edits The New Criterion tim@independentresearch.com.au

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A tale of two stocks

Friday, October 19, 2018

1. Rectifier Technologies (RFT) 2.9c

Rectifier isn’t building more charging facilities as such but it is playing a low-key role in solving a related problem: the time it takes to charge a vehicle.

Rather like a dead-flat battery, the previous sub 1c zombie stock has sparked back to life, after a series of contracts with Tritium Pty Ltd, which is rolling out fast charging stations on German autobahns for a consortium of car makers called Ionity.

A key investor in the unlisted Brisbane based Tritium is energy entrepreneur Trevor St Baker, who as the part owner of a coal mine has his position nicely hedged. Billed as the most powerful in the world, the 475 kilowatt Tritium stations will charge a typical electric vehicle with 150 kilometres of range within five minutes.

In contrast, the most powerful charger currently used by Tesla is 120KW, with a charging time of about one hour.

Rectifier doesn’t make the fast chargers but it beat several offshore rivals to provide the rectifiers, gee-gaws that convert alternating current (AC) into direct current (DC). The devices are known as such because they ‘straighten’ the currents to run in only one direction.

As with a laptop or a phone, cars can’t be plugged into a socket without a DC conversion.

Established in 2001, Rectifier provides a range of electrical devices, for use in applications including submarines and drones. But the unfolding EV market is re-shaping its once-battered fortunes.

In June, Rectifier got a $6.6m binding order from Tritium for its modular units and at the time told shareholders to expect more orders. Sure enough, in early October Tritium lobbed a further order for another $US3.4m of the gadgets. 

CEO, Yanbin Wang, expects demand for fast chargers from both the big charging stations and the home market. 

 “We have not started popular sales but we believe more and more people will go this way,” he says.

Rectifier started in 1980 by a group of engineers based on automatic DC switches for telephone exchanges. 

Supported by contracts from the then Telecom Australia, Rectifier had a few good years but, like Nokia, didn’t invest in the next big thing.

The company listed in 1994 but by 2010 the stock traded at the lowest allowable value of 0.1c.

Wang got involved in 2005 after the company went to China – where the company had a good reputation -- in a desperate search for new investors. A Chinese entity, Pudu, took a 15% stake and remains Rectifier’s biggest shareholder.

“But in 2010 the company still didn’t have enough money for salaries,” Wang says. “It had borrowed from every shareholder and director and had no plans to pay them back.”

Unusually for a small tech play, Rectifier is profitable, having generated a $612,000 surplus in the year to June 30 2018, on revenue of $8m.

 “We are only a few months in (to the 2018-19 year) but we are already seeing an increase in sales, all from EV charging,” Wang says.

Redflow (RFX) 8.3c

With a $60m market capitalisation, the heavy-duty battery maker can be viewed as the poor man’s Tesla, which still bears a $60 billion worth, in spite of the dope inhaling Elon Musk’s missteps in recent times.

Despite the hype around renewables and stored energy, Redflow is the only ASX-listed battery producer * with investors preferring to punt on the raw ingredients, such as vanadium and lithium.

As a result, Redflow shares are trading near record lows, despite opening a new factory in Thailand that will ramp up output and improve efficiencies.

One reason is that in the tech sphere, punters prefer blue sky over the drudgery of commercialisation.

Another is that having been around since 2010 and listed since 2015, Redflow is not a shiny new thing. “We have been going for a wee while,” says CEO Tim Harris. “A couple of times we got a little ahead of reality but … we are in the right place at the right time.”

Redflow has also done what it said it would do, in its quest to perfect a better battery for tough operating conditions.

Called zinc bromide flow batteries, Redflow’s units can work in 50 degree temperatures and are guaranteed to retain 100% of their discharge capacity (10 kilowatt hours) for 10 years.

 Unlike lithium batteries, there’s no risk of them catching on fire and they thrive on long usage periods of more than four hours. Another advantage is that because the batteries are heavier, they don’t contain inherently valuable ingredients and they’re not nicked as much as the lithium-ion ones.

 “Think of lithium-ion as the sprinter, we are the marathon runner,” Harris says. “Our batteries actually like hard work.”

Rather than focusing on the consumer market – a la Tesla Walls – Redflow targets specialist uses, such as telco towers (to replace lead acid batteries) and off grid applications, such as mining and wind and solar farms.

In the company’s biggest order to date, worth $800,000, New Zealand’s Hitech Solutions committed to use the batteries for a new digital network in Fiji.

The batteries are also used to provide peak capacity for Adelaide’s heritage listed Darling Building.

Having previously manufactured in Mexico, Redflow recently cut the ribbon at its new factory, Chinburi, a free-trade zone 110 km south west of Bangkok.

As well as saving on costs – Mexico isn’t quite the low cost regime it used to be – the Thai migration takes Redflow closer to its target markets in the Asia Pacific and southern Africa.

“It gave us a little bit more control over the supply chain,” Harris says, adding the company is delighted with the quality of the batteries.

The Thai factory churned out 78 units in August, with a forecast uptick to 150 in December. Depending on demand, the factory can produce up to 250 a month.

Redflow generated a modest $1.775m of revenue in the 2017-18 year (up 29%), for a loss of close to $12m (down 7%).

Given the batteries sell for around $US8,000 each, producing at a clip of 250 a month. That’s a decent step up – although not enough to render the company cash flow positive after R&D costs. 

In a changing of the guard, 15% shareholder “technology evangelist” and former NBN Co director, Simon Hackett, will step down from the board at the next AGM.

The Internode founder remains in a new role of “systems integration architect” so his talents are not lost to the company.

Redflow raised $18.1m of equity in early 2018 and $14.5m in mid 2017. As at June 30, the company had $17.7m in the bank.

Harris, meanwhile, is confident the shares will receive the jump start that Redflow shares need.

 “As with the relaunch of any major commercial product, it will take some time to gain traction but we are pleased with progress to date.”

*With a similar market cap, Novonix (NVX, 54c) comes close. As well as owning a graphite mine, the company sells battery testing equipment and is developing graphite based anode materials.

Tim Boreham edits The New Criterion Tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.
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3 sporty stocks

Friday, October 12, 2018

1. Cogstate (CGS, 57cents)

In the contact sports’ sphere, concussion is fast evolving from an acceptable workplace risk to a multi-billion dollar headache for sports organisations and, more pertinently, their insurers.

With several former AFL players looking on, a recent investor presentation in Melbourne showed video of several sickening head on collisions in AFL, NRL and American football matches.

The really disturbing aspect was that in every case, the victim played on until it was blatantly clear he was not at all right. 

While some of the footage related to a more rough and tumble bygone era – and the old timers in the room could attest to the more cavalier attitude — some of the vision was contemporary.

US studies suggest that half of all concussions go undiagnosed, with the players unconscious in only 7.5% of cases. 

While the long term effects of cumulative head knocks remains in dispute, past players are queuing to sue clubs and code administrators for breach of duty of care.

In the US, a study found that 110 out of 111 National Football League players showed signs of chronic traumatic encephalopathy, a degenerative disease caused by repetitive head trauma.

Not all players suffered known concussion in their career, which means the problems could be more widespread than thought.

The NFL recently struck a $US1 billion settlement but some pundits reckon the ultimate cost could be double that. Here, players suing for concussion-related damage include Brownlow Medallist, John Platten, former Essendon premiership player, John Barnes and former Newcastle Knights, winger James McManus.

Which brings us to Cogstate, a cognition appraisal specialist, whose Cognigram concussion test is used by numerous elite sports bodies globally on match days.

Here, it’s mandated by the Australian Football League and the National Rugby League.

In truth, Cognigram is only a small part of Cogstate’s activities, which are more about assisting third party clinical trials for conditions such as Alzheimer’s disease and dementia, Parkinson’s disease, schizophrenia, autism and epilepsy.

Cogstate provides services to 14 of the top 15 pharmaceutical companies (as measured by research spend).

Of Cogstate’s $30 million of revenue last year, only $400,000 was attributed to the healthcare (Cognigram) division, which lost $1.9m. 

But the period marked only the first full year of Cognigram’s commercialisation, with the device approved by the US Food & Drug Administration in July last year and then by European authorities this year.

Cogstate overall is modestly profitable, making $106,000 last year. The company has guided to a stronger net profit in the current year, albeit with the current (first) half affected by $2 million of non-recurring restructuring costs.

Naysayers might note that Cogstate has been around for a while now, having listed in 2004. But that hasn’t deterred the company’s long-term shareholders — including the Myer family and the Dolby family of sound-system fame – from hanging in there in the hope of a knockout performance.

2. Catapult Group (CAT $1.08)

The sports ‘wearables’ innovator is a classic example of a tech company rising from nowhere, but then overshooting the mark valuation-wise. 

In a little over a decade, Catapult has become the world’s biggest supplier of devices to track the vital statistics of athletes, such as speed, movement and positioning.

Operating mainly in the professional (elite) sector, Catapult has tied up clubs and leagues from most of the key code: 1800 clients across 35 sports in all. Most of the devices are sold by subscription, which brings in steady annuity revenue.

Catapult turned over $76 million in the 2017-18 year, up 26%. But its growth has not been all organic, with the company shelling out $80 million in late 2016 to acquire the Boston-based video analytics house XOS Technologies. 

Smaller acquisitions include the Canberra based GPS Sports, Ireland’s Playertek (wearable analytics) and SportsMed Elite and Baseline (artificial intelligence).

During the year, it launched Playr, a device for the 20 million strong ‘prosumer’ (keen amateur) soccer market, capable of detecting 1,250 movements per second.

But solid profitability remains elusive to date for Catapult, with a 2017-18 net loss of $17.4 million (compared with $13.6 million previously) and underlying ebitda of $1 million ($2.9 million previously).

This year, the company expects double-digit annual recurring revenue growth and expects to generate “positive cash flow at group level” by 2021.

Catapult shares have retreated to one-quarter of their peak value of $4 in August 2016 (which followed a $100 million share raising to fund the XOS purchase).

But the stock is also twice as high as its December 2014 listing price of 55 cents and bears a $210 million market capitalisation. So the glass is either half full, or half empty.

3. Impression Healthcare (IHL) 1.7 cents

Do sport and cannabis mix?

The country’s biggest mouth guard provider is trying to take a bite out of the sports market, having recently won the exclusive rights from the AFL to use the colours and logos of all 18 clubs.

In February, Impression signed a similar deal with the NRL pertaining to its Gameday mouth guard brand and it’s in discussions with a large retailer to distribute both products.

Impression’s product enables users to take an impression of their chompers at home, with the finished mouth guards mailed to them.

Impression also has a “preferred practitioner” arrangement with 70 clinical dental clinics, including those under the banner of the listed Pacific Smiles.

As for the cannabis bit, Impression last month signed a letter of intent with AXIM Biotechnologies to secure local distribution of the US pharma company’s present and future cannabinoid therapeutics.

The link is oral health, with potential products including cannabis infused toothpaste and mouth rinses.

The list of ASX minnows without any intent of entering the “pot stock” sector diminishes by the day.

As with so many start ups with a good idea, it’s been a case of too few incomings and too many outgoings for Impression since back door listing in late 2016. Impression reported 2017-18 revenue of $1.01 million – albeit 259% higher – and a net loss of $2.9 millions.

The skinny end-of-year cash balance has since been supplemented with $145,000 of debt funding and the company is in the throes of a $735,700 rights raising.

The Gameday mouthguards sell for between $69 and $129, which is dearer than an inferior ‘boil and bite’ specimen at $10 to $90, but cheaper than a dentist fitting, which could cost up to $600.

Impression also sells higher margin mouthguards for sleep apnea (snoring), bruxism (teeth grinding) and teeth whitening.

Impression’s initial board included John Worsfold, but a year later the Essendon coach had bailed out to focus on his day job.

But not to worry: the mouthguards are still being spruiked by ‘Gameday Ambassadors’ Gary Ablett jnr, Rory Sloane (AFL players) and NRL legend Jonathan Thurston.

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.
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Old King Coal

Friday, October 05, 2018

While the robust revival of thermal coal prices has surprised the carbon sceptics and renewables zealots alike, the even more spectacular performance of coking (metallurgical) coal has played out to largely empty auditoriums.

Steel blast furnaces may be one of the most carbon-belching activities, but otherwise coking coal is not seminal to the spirited but circuitous debate about whether Old King Coal really has had its day.

Things go better with coke

The other reason for coking coal’s shy profile is that when it comes to steel production, flirtier cousin iron ore steals the headlines. Yet for every tonne of steel produced, about 600-750 kgs of coking coal (converted to coke) is required.

Relative to thermal coal – and there’s plenty of that black stuff – decent coking coal deposits are much scarcer.

To date, investors haven’t exactly been spoiled for choice when it comes to pure-play coking coal exposures. BHP Billiton (sorry – BHP) is the world’s biggest producer, via the BHP Mitsubishi alliance (BMA) in Queensland.

Similarly BHP spin off South 32 (S32, $3.90) is a meaningful producer from the Illawarra region, but not relative to its total size.

But with coking coal prices edging back to near record levels, some smaller plays are sniffing the winds of opportunity. The interest is squarely focused in Canadian province of British Columbia, the Toorak of met coal addresses along with Queensland’s Bowen Basin.

At the junior end, ASX aspirant Montem Resources is passing the Mountie’s hat around for $20m in an IPO to revive an open cut project in the Crowsnest Pass geological precinct straddling Alberta and British Columbia. In its second attempt at an IPO, Montem plans to list in mid October.

Gina Rinehart’s Hancock Prospecting recently splurged $69m for a 19.9% stake in Riversdale Resources, which owns the Grassy Mountain project just down the road.

Montem has acquired six tenements, four of which previously have been mined, with a total tonnage of 160 million tonnes.

But the initial focus is on Tent Mountain, which produced up to 1973 1983 and still retains a mining permit. “We have some work to do to get the coal quality information up to date and complete a feasibility study for it,” Yeates says.

 While Tent Mountain is subject to a definitive feasibility study, Montem is working on a presumed $130m capital cost for a 1.5 million of tones per annum (mtpa) operation (a conveniently proximate railway would whisk the produce to the port of Vancouver and on to the hungry Asian mills).

Yeates notes that Canada’s giant Teck Resources produces 26mtpa from three mines in the region at a cost of $C90/t ($85/t, loaded on to the ship).

 “At the moment there’s a huge cash margin in excess of $US100 ($138) a tonne,” Yeates says. “We do our numbers on a more conservative but it has the potential to be a real cash generator.”

Other aspirants are lapping at Montem’s coal-dusted heels, with Jameson Resources (JAL, 17.5c) winning funding support for its Crown Mountain project in British Colombia’s Elk Valley Coal Field.

At a similar stage to Tent Mountain, Crown Mountain is costed at $US281m of start up capital for a mine producing 1.7 mtpa over 16 years.

“Coal prices assumed are significantly lower than (the) current market,” the company says.

Jameson’s financial backer is the ASX-listed NZ producer Bathurst Resources (BRL, 11c), which is stumping up $C4m for a current exploration program. In what’s expected to emerge as a 50-50 joint venture, 

Bathurst, which accounts for 2.2 mtpa of output in NZ, also has the option to fund $C7.5m in non-exploration activities and eventually chip in $C110m to build the open-pit mine.

Lower down the development curve, Pacific American Coal (PAK, 5.1c) is running the drill bit on its Elko coking coal project, also in the fecund Crowsnest field.

The ground is currently rated as a 257mt resource, but further work aimed at honing this estimate has resulted in “significant amounts of coal”.

Closer to home, Bounty Mining (B2Y, 30.5c) re-listed in June, having raised $18m to acquire the mothballed Cook Colliery and coal handling plant near Blackwater in the Bowen Basin.

The mine operated up to March last year, when an “inundation event” forced the hand of owner Caledon Coal. The venture was placed in care and maintenance, while Caledon Coal went spectacularly bust.

Bloody Queensland weather!

Backed by Chinese interest, Bounty plans to expand the mine’s output to 2.2mtpa across four operating areas.

Bounty CEO chairman and CEO Gary Cochrane was founding director of Queensland producer Millennium Coal, while director Rob Stewart once headed Whitehaven Coal.

With little prompting they would point to Rio Tinto’s $2.9bn sale in March of its 80 percent stake in the Kestrel mine, also in the Bowen Basin. In 2017 Kestrel produced 5.1mt of saleable coal, 4.25 of the hard coking variety.

For investors who like to think big, late in September the US based Coronado Coal said it would pursue a $4.6bn float on the ASX, thus exposing investors to its Curragh coking coal mine in Queensland (acquired from Wesfarmers) as well as three mines in Virginia.

The company is seeking to raise up to $1.2bn, which is not chump change given about 20 percent of Coronado’s output is untrendy thermal coal.

 “Demand from Asia for met coal, particularly from emerging economies, is expected to be strong and Coronado will be a key supplier to this growth market,” Coronado Chairman Greg Martin says.

Of course, the coking coal story ultimately prospers or founders on steel making trends. The World Bank forecasts current year steel production of 1.548 billion tonnes, compared to last year’s 1.535bt and on par with record 2014 levels.

The drivers include China’s Belt and Road economic colonisation policy and India’s desire to more than double steel output to 300mt by 2030.

The better coking coal (and iron ore) is especially in demand because China has been relocating steel mills to port areas so they can access the premium seaborne stuff, thus reducing pollution.

On the demand side, Japanese and Korean steel producers understandably are keen to diversify their reliance on BMA and Teck.

Yet another variable is the dispute between rail operator Aurizon (formerly Queensland Rail) and the Queensland Competition Authority over Aurizon’s maximum allowable revenue.

A poor result for Aurizon could constrain the state’s coal exports and put further pressure on prices.

As with thermal coal, the post GFC met coal story hasn’t exactly played out as expected. But when does any commodity follow the rules?

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Investing in a listed valuation company

Wednesday, October 03, 2018

Does a housing downturn bode well or poorly for the only pure-play property valuation firm listed on the ASX?

Conventional theory goes that if there are fewer property transactions, there’s less need for valuation services. But then again if (or when) interest rates rise, there’ll be more borrowers looking for better deals and more demand for bank valuations. The same applies if things turn gnarly and bank foreclosures increase. 

Landmark White (LMW) is taking no chances and is diversifying its business to government and insurance jobs. Landmark’s recent full-year numbers show its residential valuation work falling from 67% to 53% of revenues, but this is partly attributed to last year’s $23m cash/scrip acquisition of rival MVS National.

Landmark chief, Chris Coonan, reckons the measures adopted by the bank regulators (and the banks) themselves may already have done the trick and stabilised the Sydney and Melbourne residential markets.

“(The measures) are working and it is good,” he says. “The market was getting too high and if it didn’t happen we would have had some trouble in the future.

 “It’s hard to see a lot of mortgage stress given the (value) of properties has gone up considerably and overall the economy is looking quite strong.”

Landmark posted a $4.1m net profit – up 155%. There’s no sign of management waving the white flag, with current year guidance increased to earnings per share of 6.16c, 13% higher than last year’s 5.44c.

The company hasn’t missed a dividend in 19 halves, paying 4.6c (fully franked) in the 2017-18 year. Assuming a similar payout ratio, the company currently trades on a yield of 9%.

Landmark shares have steadily declined from 75c a year ago, bearing in mind the company raised $20.5m at 60c apiece to fund the MVS purchase.

This decline implies opportunity for investors convinced the property sector is in the mild and organised decline it had to have.

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.
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Stiffening market doesn’t soften listed builders

Friday, September 28, 2018

Most listed builders reported improved profits and increased activity, but the question is how they will fare if credit conditions continue to tighten and the currently robust employment trends weaken?

Whatever the case, they’re likely to fare better than the developers in the more speculative and more definitively oversupplied apartment sector.

The key bricks and mortar participants are the Singaporean controlled, AV Jennings (AVJ, 67c), the Victorian-centric Simonds Group (SIO, 41c), the Queensland oriented Villa World (VLW, $2.09) and the fellow banana-bending Tamawood (TWD, $4).

Simonds CEO Kelvin Ryan puts some context around the downturn. “It’s gone from breakneck crazy to very busy,” he says of the Victorian market.

In the context of the NSW market, AV Jennings is sipping from a glass half full. “Our view is this softening isn’t such a bad thing as it will lead to the market being more sustainable in the long run, both in terms of acquiring sites as well as our ability to produce and sell land and housing.” CEO Peter Summers says.

Traditional housing, he says, should remain supported by strong population growth and stable employment.

The companies’ results didn’t give too much inkling of looming issues, with profits if anything crimped by delays in development approvals that have deferred revenue until the current year.

Simonds, the second biggest operator behind the unlisted Metricon, reported a 48% profit boost for the full year to $6.8m, with 2,500 house starts relative to 2,391 previously.

The 69 year-old entity (which remains controlled by the Simonds family) is in repair mode, given its insipid share performance since listing in 2014 at $1.78 apiece.

 In 2016, the inexorable share decline prompted patriarch Gary Simonds and the Roche family to mount a privatisation bid at 40 cents a share, but major shareholders snubbed the proposal.

Under CEO Ryan, who clocked in last March, the company has launched a multi-pronged improvement program that has included reducing debt and gaining better traction in its non-Victorian markets of NSW, Queensland and South Australia.

Simonds is also developing a “unique” financing product to convert the curious display home visitors into firm buyers. For the millennials  (for whom sampling artisan beers in a boutique inner city brew house is a more attractive away to spend a Saturday afternoon), the company is honing other channels such as 3D modeling.

Ryan reckons that in the buoyant Victorian market developers got lazy and stalled on design innovation. “There really hasn’t been much technology change in the way houses are built,” he says. “We see a real opportunity with building techniques, especially green ones.”

For Simonds, it’s a case of ‘get bigger or get out’ and that means gaining traction in its non-Victorian markets. The company has been in the Queensland market for 15 years, but last year still only accounted for 255 starts out of 25,000 in the detached market (in Melbourne the company accounted for 2,000 of an addressable market of 38,000).

Villa World chalked up 2017-18 earnings of $43.6m, within its guided range of $42-44m and 15% better than previously.

The company also sold 1678 lots, 39% higher than the previous 1,207.

If anything, Villa World’s current year guidance of $40m (10% lower) results from delays in key projects, including two in Melbourne. But management says the number also assumes “general consumer confidence is maintained, interest rates remain low, credit conditions do not deteriorate and the first home buyers’ grant scheme remains intact.”

 Villa World says it is “well positioned with diversity in terms of our products and our markets with significant development properties now selling across major growth corridors in three states.”

Broker Baillieu Holst is more sanguine, trimming Villa World’s earnings forecasts by 15% between 2019 and 2012. “We believe that the slowing down of the credit approval process for home buyers and weakness in housing prices and demand may have had an impact,” the firm intones.

AV Jennings also cited “planning and production delays” on key projects for a 12% reported net profit decline to $45m, but in underlying terms earnings were flat.

In Victoria, laments Summers, the company has been slugging away in a strong market – albeit with some softening – but “hasn’t been able to get the value of work to a physical stage where it can be reflected in the accounts.”

This implies a pipeline of work that will support current year earnings.

Meanwhile, the Brisbane-based Tamawood attributed a 4.5% profit decline (to $8.69m) to factors unrelated to a housing downturn.

These include inclement weather and customer delays in receiving credit approvals, a side effect of the banking Royal Commission.

Tamawood, which operates under the Dixon Homes brand, also cites a margin squeeze in the Sydney market because of delays between contracts being signed and the land being registered.

Tamawood acknowledges the market is slowing and is taking remedial action, such as reviewing its house design and specifications. But once again, there’s no sniff of a bricks and mortar Armageddon.

While Simonds doesn’t pay a divided, Tamawood, AV Jennings Villa World are yielding 6%, 7% and 9% (we stress that this is based on the 2017-18 earnings rather than current year expectations).

If the conventional rule book plays out, the discounted valuations are justified. But it’s also possible that a reversion to more sensible market conditions will coax timid first home buyers back into the market.

Of course, the tempting yields become a dividend trap if the great Australian dream enters a nightmare phase.

Tim Boreham authors The New Criterion

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense
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Come hell or high water

Friday, September 21, 2018

The dry conditions in many of the key farming regions highlight the importance of water security for our listed agricultural plays. When it comes to water rights, some are in a better position than others

With the parched conditions lingering in some key farming regions, it’s becoming a case of the water “haves and have-nots” for the key listed agriculture plays. 

The cost of temporary water rights on the spot market has more than tripled in the last 12 months and, not surprisingly, they’re keeping a keen weather eye on weather spring rains to eventuate to alleviate what could become a crisis for many growers.

“The market is very concerned at the moment,” says water expert Richard Lourey of Sauber and Co, who notes record low rainfall in central and north-west NSW.

“Everyone is worried about how dry it is and everyone is concerned about whether they will be able to get their allocation.”

Some contend that financial (non-grower) buyers have been pushing up the price of rights, creating resentment in low-return sectors such as dairying. Others argue that as these rights holders lease the rights temporarily to growers, the water is still available.

What’s for certain is that in the ‘real’ world, demand for water is unprecedented because of the rollout of water intensive nut and fruit orchards and cotton growers buoyed by the high prices for the commodities.

So how are the listed agri plays likely to fare?

For the time being, Duxton Water (D20) is on the right side of the equation because it has a book of almost 44,000 megalitres of rights, mainly permanent and predominantly in the ‘high security’ category, which means they are more likely to receive their full annual allocation.

Currently about half these rights are leased to growers but the fund expects this portion to rise to 70-80% “due to the expected increase demand for water supply solutions.”

In its June half commentary, Duxton says that with the January to June period one of the driest on record, many irrigators drew down on their carry over reserves from last year, forcing them to wade back into the market (in some cases, this action was needed to avoid fines for overuse).

In the meantime, many farmers haven’t covered their requirements for the 2018-19 growing season, with many of them forced to bring forward irrigation to September or October. “This is likely to increase demand in the allocation market through summer and autumn as irrigators finish summer crops and support their permanent plantings towards harvest,” Duxton says.

The Chris Corrigan –chaired Webster (WBA) is the biggest private owner of water rights – 200,000 megalitres — but is also a prolific grower of walnuts, almonds and cotton.

So Webster may have plenty of water, but it also has plenty of orchards and crops to quench. The company recently sold a cotton property called Bengerang for $132.7m, thus reducing its irrigated land from 24,500 ha to 15,000 ha. Development work at two properties will increase this coverage back to 20,000 ha in the current financial year.

“The company remains well positioned to grow its operations, further supported by our investment in water which continues to underpin our business,” Corrigan declares.

For Select Harvests (SHV), the country’s biggest listed almond grower, it’s a case of being alert and not alarmed. One again, Select has sizeable water rights worth $51m, but needs to slake the thirst of three million trees across three properties in southern NSW, northern Victoria and SA.

Select is not yet wading into the heated spot market in the hope that its springs and aquifers will suffice for the key growing period between November and May.

“Water is our biggest macro concern,’’ says CEO Paul Thompson. “But we don’t know the impact of entitlement allocations or where the market will settle.”

Select is also using field technology to reduce usage. For instance, it measures sap moisture rather than soil wetness for a more reliable gauge of watering requirements.

Select has held off watering until the evening to save water (and energy) costs  - a tip that any inner urban gardener could have imparted.

Then there’s Select’s landlord Rural Funds Management (RFF), the biggest ASX-listed landowner with 44 properties valued at close to $800m.

In theory Select’s tenants (which also include Treasury Wine Estate, Baiada Poultry and Olam) bear the climate risk. Still, with 93,000 megalitres of water rights valued at close to $50m, Rural Funds can ensure there’s enough water to support the cropping activities.

In a major non-irrigated diversification, Rural Funds recently bought five feedlots in NSW and Queensland from cattle giant JBS Australia for $149m.

While the evidence points to water rights surging further, there are a number of unknowns apart from the likelihood of precipitation and whether snow in the highlands melts under the sun or is washed downwards by rain (the latter produces more water).

On the demand side, intensive water users, such as rice and cotton growers, may do the sums and decide it’s not worth planting a crop this year. If that’s the case, they may sell their entitlements and cause the water price to tumble (as has happened before). 

This luxury of not growing doesn’t apply to orchards, which need to be kept alive, come hail or shine. Some pundits reckon that because of the proliferation of such permanent crops, farmers will struggle to secure temporary seasonal allocations in coming years.

Not surprisingly, Duxton Water shares have risen 18% since mid June. While its water rights are on the books at $95m – 40% higher than a year ago – the fund cites a fair market value of $120m.

The company has net tangible assets of $1.27 a share, which means the stock is trading at a slight premium to this intrinsic worth.

While Duxton shines, the weather concerns have pushed Webster shares down 13% since hitting a record high of $2.02 in mid June, despite a walnut crop that looks like being the second best on record.

Webster’s water rights are in its books at $222m but valued at $360m (directors view even this number as conservative).

Select Harvest shares have declined 30% from last June’s two-year high of $7.45 a share.  Select should benefit from a bigger crop – an expected harvest of 15,700 tonnes compared with a poor 14,100t previously (bearing in mind the harvest has only just begun).

Pricing is also improving because of persistent drought in California, which supplies 90% of the world’s almonds.

For investors punting on the big dry continuing, Duxton is the obvious play, as the bourse’s only pure play water rights play. However the troubled Blue Sky Alternative Investments (BLA) holds $258m of water rights in its Blue Sky Water Fund.

On a cautionary note, the water rights market is notoriously complex, often illiquid (ironically), poorly regulated and thus open to manipulation.

If the heavens open in the right locations, water again will become a buyers’ market.

Currently, the Southern Oscillation Index, the guide to likely El Nino dryness or La Nina wetness – is at a neutral setting. So in theory it could go either way.

Tim Boreham authors The New Criterion

tim@independentresearch.com.au 

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.
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Not sexy but a good show

Friday, September 14, 2018

If there’s a clear winner from the murky swamp of revelations uncovered by the banking Royal Commission, it’s the provider of independent administration and investment platforms for the financial advisory industry.

The listed alternatives — (HUB24 (HUB), Netwealth (NWL) and Praemium (PPS)) —  could never be mistaken for ‘sexy’ companies. 

But when it comes to the recent earnings season, they were among the better performers, as advisers migrate in droves from the conflicted bank-owned platforms.

What’s the history?

First adopted in the 1980s, platforms were developed as a simple way for investors to hold, acquire and administer assets. For intermediaries such as brokers and financial advisers, they help to streamline advice implementation in an era of elevated regulatory requirements.

Post the Royal Commission revelations, having a platform owned by the manufacturers of the investment products is as acceptable as dwarf tossing or third world slavery.

The banks (and AMP) still account for about 80% of the market. But most of the banks have got the message and are offloading their wealth platforms as fast as they can find a buyer offering a half-decent price.

How did HUB24 report?

Given this backdrop, HUB24 reported a 129% in underlying net earnings to $5.4 million, with funds under administration surging 51% to $8.3 billion.

Revved-up management also declared a maiden 3.5 cents a share dividend and increased its guided funds under administration to $19-23bn in 2021, compared with earlier guidance of $12bn by 2020.

HUB24 now accounts for 12% of total industry flows and as of March 31, accounted for close to half of new flows.

CEO Andrew Alcock says advisers for some years have been looking for an uncompromised choice of products to offer clients. “The Royal Commission has just expedited that.”

Lest investors get too excited, the platform industry is also fragmented and very, very competitive.

Another competitive threat is that once bifurcated from their tarnished owners, the bank’s former wealth operations will operate with the ‘independent’ cachet.

But Alcock contends they still will be product manufacturers and in any event will not have invested adequately. “When they’re stand alone, they’ll be behind the pack,” he says.

“All up, in the last 10 years, we’ve spent $60m to $70m (on product development) and this year will spend $7m.”

So what can go wrong? 

The pachyderm in the room is rival BT’s recent decision to slash the pricing of its Panorama platform.

In July, BT cut its administration fee to 0.15% of assets, with a $540 a year flat accounting fee. For a holder with an average account of $400,000, this equates to a 42% cut.

Rivals argue that the reductions are ‘headline’ only, with variations for specific products.  “I think our pricing is very competitive,” says HUB24’s Alcock. “It’s not just about pricing, it’s about features and functionality.” (Because it provides a tailored service for individual clients, HUB24 doesn’t publish a universal rate card).

What’s happening at Praemium?

Over at Praemium, group revenue grew a healthy 22% to $43.2m, with profit (ebitda) rising 40% to $8.8m.

Praemium operates in Britain as well as here and if anything, the Old Dart performance brought down the batting average with a negative performance.

As with HUB24, Praemium investors can’t complain about local inflows, up 45%. In particular, self managed accounts inflows rose 69% to $2.2bn.

Shaw and Partners highlights Praemium’s forecast compound annual ebitda growth of 17% over the next five years, with double digit earnings per share growth over the next three years.

And the ASX newcomer Netwealth?

Not to be outdone, Netwealth reported a 73% surge in full-year profits to $29m, on 36% revenue growth to $83m.

Netwealth also reported funds under advice of $18bn, up 41% and 18% above prospectus forecasts (the company listed in November last year at $3.70 a share).

Netwealth is winning 22% share of fund inflows, but still only accounts for 2% of the overall market.

“Netwealth has made a large impact in a short amount of time,” opines Pengana Capital’s Steve Black. 

“Through updated technologies, elegant user experience and by providing financial planners with the ability to manage their clients’ money, report and charge for additional services, this relatively new platform is positioning itself as a welcome alternative to the tired staples offered by the big banks.”

If there’s a bum note, Netwealth’s revenue margins fell 12% to 0.53%. Profit margins are likely to remain flat as the company re-invests in the business.

HUB24’s margins also came under pressure in the second half and are expected to come under further pressure from larger new clients (such as dealer groups) typically demand – and receive — a discount.

Netwealth is still a family affair, as it 53% controlled by the Heine family (Michael Heine and son Matt are joint managing directors).

They have no plans to sell down.

As with growth stories, the seemingly unfettered potential of the independent platforms comes at a price: factoring in some generous earnings growth for this year, the shares are trading on ritzy earnings multiples.

Netwealth, HUB24 and Praemium bear market valuations of $1.78bn, $830m and $340m respectively.

But who said quality is cheap?

Given the master trust, wrap and platform market is now worth more than $800bn and growing at a 12% per annum clip, there’s plenty of room to grow, barring some radical remediation by those stale incumbents.

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

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