Tuesday 2 May, 2017 The Cane Toad

Tuesday, 2 May 2017

Aussie S-Bonds will save our kids

Here’s a thought for our elected leaders as they finish off preparations for next week’s federal budget. Take a page from the book of Woody Brock (US economist; author of American Gridlock, pictured left). In a recent interview with the Epoch Times, Woody said “we underestimate hugely the benefits of good, sound, rational public infrastructure invest-ment” [and] “you end up using mostly private sector money, my money, pension fund money, money doing nothing, unproductively sitting on the sidelines”. I agree, and have been discussing this for some time. So have others. We can’t just go on borrowing endlessly to finance our wants, with no prospect of payback. One prominent Sydney based surfing fund manag-er suggests an Aussie twist to the Brock model. They should be called Super Bonds. Here’s the plan. Right now, based on recent numbers, I estimate that of the $2.2 trillion invested in Aussie super finds, there’s around $200b invested in “cash”, and another $200b invested in “fixed interest” (see www.superannuation.asn.au). Lazy money. Unproductive money. So the government issues long dated infrastructure bonds, on sufficiently attractive terms to induce an investment switch away from at least much of the cash to them, but with the crucial twist that the bonds are only available for investment to local super funds. But there’s at least one big problem. Infrastructure spending in Australia has historically often amounted to little more than pork-barrelling. Take the NBN for instance, where highly respected Rocky ex-pat, and Telco entrepreneur, Bevan Slattery (pictured right), way back in 2010 rightly called “’bullshit’ on NBN economics”, and who now, at Superloop, calls for a $20b-$30b NBN write-off, to allow “fast and affordable” internet. Which means that along with the Super Bonds, there needs to be an in-dependent, Reserve Bank style supervisory Board, which is accountable to the taxpayer to ensure that the investment return exceeds the cost, and to put an end to the pork-barrelling, and I want to be there. Happy investing.

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A Hunter Green Institutional Broking Publication AFSL number 235259

www.hgib.com.au

Inside this issue...

Editorial................................................ 1

Soul Pattinson - The ultimate pub test ........................... 2

Tatts Group - Bidding war escalates ......................... 2

Technology One - Passing the torch ................................. 3

Mantra Group - Strange bedfellows, downgrades and takeover talk ............ 3

Michael Hill International - Growing pains for Emma & Roe .......... 4

Eureka Group Holdings - The punch you don’t see ..................... 4

Cane Toad Index Wrap ....................... 6

April Market Summary ......................... 7

Queensland Movers ............................ 7

Company Visits Register ..................... 8

Attachments: QLD database BKWSOL nil-premium merger TTS forecast & decision tree TNE forecast MTR forecast MHJ forecast EGH forecast

Issue 182

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160The Cane Toad Qld20 Accumulation Index

Tuesday 2 May, 2017 The Cane Toad

Washington H Soul Pattinson - The ultimate pub test

The Toad recently read that Winston Churchill said of Clement Atlee, that he was a very modest man with a lot to be modest about. Which made the Toad contemplate Soul Patt’s, a very modest company that also has a lot to be modest about. For starters, there’s $500m odd in stranded franking credits in the group, as well as a disas-trous foray into copper in North Queensland, which has cost shareholders over $300m, and counting. Not to men-tion the $217m that Soul’s dusted on KH Foods. And in normal circumstances, shareholders would be enti-tled to roll the Board for this modesty of performance, if that was their desire, but at Soul Patt’s that just impossi-ble. Why? Because Brickworks owns 42.7% of Soul’s, and Soul’s owns 44% of Brickworks, so Brickworks will always vote the way it’s instructed to vote, by its control-ling shareholder, Soul’s. And bear in mind that down at the Pitt St. HQ of Soul’s, it’s a Millnerathon, where despite the family owning just 9.2% of Soul’s, and 4.0% of Brick-works, it’s a family dominated Board, comprised mostly of rusted-on Millner family members, or their acolytes. Which is what in Queensland we’d refer to as a gerryman-der, which would certainly fail what we know as the Brekky Creek pub test. And now all this is being tested in a much fancier venue than the Brekky Creek (pictured), by a bunch of legal brainiac’s before Her Honour Jayne Jagot (by one account a modest woman with nothing to be modest about), in a hearing to figure out whether Soul’s or Brickworks, or both, have been oppressing their minority shareholders. Gather round folks, this Federal Court hearing is set down for two weeks, beginning on 22 May, in Sydney. And after trading around a 25% discount to asset backing for the last 5 years or more, Soul’s share price has lifted sharply over the last few months, mainly as the market has become aware, thanks to leading Aussie wealth, fund and trust business Perpetual’s talented and principled te-nacity in the Federal Court, that there are, finally, some genuine prospects that the Millnerathon may be entering its sunset period, to the great benefit of all minority share-holders in Soul’s and Brickworks. Perversely, Brickworks is still trading at a substantial dis-count to its asset backing, as the market fails to come to grips with the notion that its prospects are tied more close-ly to the success or otherwise of TPM, and New Hope, than to its brick or property development businesses.

Overall, despite all the stuff up’s that Soul’s shareholders have been hostage to, and in the shadows of the ultimate pub test later this month, both Soul’s and Brickworks re-main a Buy, at their current share prices of $18.84 and $14.73. Tatts Group - Bidding war escalates

Through April, the fireworks at TTS continued, with the KKR and the Macquarie led Pacific Consortium launching a revised offer for TTS on 19 April, for $4.21 p/share in cash. This compared with its late 2016 offer of part cash and part scrip, and reflected PC’s response to TTS’ Board stating that it could only consider an offer for the entire business. Then last Friday, the TTS Board deliv-ered its verdict on the revised proposal, again finding it ‘not superior’ to the TAH merger proposal, and thus denying the PC the right to due diligence. So then also last Friday, the PC said some version of, “see you later alligator” to TTS. The TTS Board supported its decision by referencing multiple factors, including the current market price of its shares (then $4.47), the current implied value of the pro-posed TAH merger (then $4.25), the potential for timing delays under the revised PC proposal, and the potential tax implications of scrip (i.e. CGT roll-over relief) vs the certainty of cash. Following this latest exchange, we have taken the oppor-tunity to review and adjust our decision tree valuation framework for TTS. The big changes that we made are firstly to take the low end of the implied TAH proposal off the table (our assessed low end is now $4.03 per TTS share), and secondly to increase the probability that the PC proposal will succeed, in the event the ACT does not approve the TAH merger, from 20% to 50%. Overall, this has increased our probability weighted valuation to $4.69 p/share (from $4.65 p/share). We have again attached our decision tree to the Toad to assist our readers. In our view, the probability remains high that further bid-ding activity emerges, and remind readers there are many other potential suitors outside of TAH and the PC, including William Hill, a UK betting mob which has al-ready invested around $800m in Australia, and Camelot (the Ontario Teachers’ Pension lotteries arm, which owns both the UK and Irish lotteries), GVC (which on 2 March announced a £320m - c. A$525m - bond issue), the Coates family, the wealthy UK owners of Bet365, Aussie punt mob Crown, or some other PE group, or maybe even Chinese buyers.

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Tuesday 2 May, 2017 The Cane Toad

and significantly increasing the scope of the work (~100% more than initially contracted) in a powerful return serve. More recently, TNE revealed that the BCC was not re-sponding to its efforts to resolve the issues. Elsewhere, TNE is set to release its 1HY17 results in May, having reaffirmed guidance of strong profit growth (10-15%) over the full year. Owing to the strong season-ality of earnings, the Toad has forecast TNE to deliver 1H17 NPAT of $7.9m (+7.9% on pcp), ramping up in the second half as contracts fall-in to $47.4m over the full year, representing NPAT growth of 14.6% on pcp, in-line with guidance. So as Ed Chung takes the leadership torch, and the busi-ness moves beyond this undeserved noise, the Toad re-mains attracted to TNE as it continues to roll out its highly scalable Cloud and Ci Anywhere products, which we ex-pect to provide accelerated sales growth and margin ex-pansion in coming years. At $5.46, TNE is trading on a forecast FY17 PE of 39.1x, falling to 29.0x in FY19 with a dividend yield of 1.8% rising to 2.3% (incl. special divs) and remains a BUY. Mantra Group - Strange bedfellows, downgrades and takeover talk

The February reporting season is already a distant memory for the Toad, and despite a cyclone which rav-aged the Queensland east coast in late March, and an endless run of long weekends that seeks to undermine the very foundations of business productivity, the Toad persevered and caught up with many of the high-quality management teams running listed companies across the Sunshine State since the results. We found one of these meetings, with accommodation operator Mantra Group (MTR), particularly useful given the changing landscape for the business, as well as the takeover rumours floated in the press during April. And while the Toad has no special insights about MTR takeo-vers, we did think it curious that the identity of the would-be acquirer continues to change, as the first two names proposed, Minor International and Accor, both denied having any interest. We also noticed the press release from MTR advising it was not in discussions with any po-tential buyers, as well as the MD selling approximately a quarter of his holding a few weeks before the takeover speculation emerged. As usual, our primary focus was on the business, and the potential for improvement from recently underperforming regions (Brisbane, Perth & Darwin) and further clarity about the apparent lack of operating leverage in Resorts in the first half. On this first point, the key takeaway was

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And so we believe TTS remains well and truly in play, despite last Friday’s rebuff (which stopped short of out-right rejection) of the PC, and based on our updated prob-ability weightings of the outcomes from ongoing corporate activity, we value TTS at $4.69 per share, 9.1% above the current share price, while the upside could be as high as $5.82 per share, a premium of 35.3%. Meanwhile, the downside is $4.05, a discount of 5.8% to the current share price. At its current share price of $4.30, TTS is on an FY17PE of 26.8x, falling to 24.2x by FY19, and a fully franked dividend yield of 4.0% for FY17f, lifting to 4.1% by FY19f. It remains a Buy.

Technology One - Passing the torch

When the Toad first met Adrian Di Marco at what the Toad described as its “poorly attended results briefing in Brisbane” way back in 2001, TNE was a top 10 Queens-land company, its stock traded on a PE of 29x, and Adri-an was guiding to 15-35% growth but “would be disap-pointed if they weren’t at the top of that range”. Fast forward over 15 years and TNE is still a top 10 Queensland company, its profit and share price have in-creased 5-fold and 6-fold respectively, and Adrian is still guiding to the top end of the range, and he actually looks younger now than he did in 2001. So it must have seemed an opportune time for Adrian to pass the torch to long serving and highly respected Chief Operating Of-ficer, Ed Chung, who will take over as CEO following the first half result announcement in late May. Adrian will remain highly involved as Executive Chairman, and pre-sumably move to a non-executive role sometime in the future. Meanwhile, earlier this year Technology One was served a curve ball by Brisbane City Council Lord Mayor Graham Quirk, who quirkily bypassed the typical avenues for dis-pute resolution and instead took to the media to air BCC grievances about cost blowouts and delays to the BCC IT replacement program (in which TNE is involved). In the press release (which has also quirkily since been re-moved from the BCC website), LM Quirk claimed that un-der the contract “the cost to Council was $122m over ten years”, but that snafus (the Toad is paraphrasing) could cost an additional $60m, which would take the total cost to $182m, plus there would be delays of up to 18 months. In other words, the BCC was upset, and a large finger was being pointed by the BCC at TNE. However, as TNE was quick to point out, the total contract value for TNE was only $50m, with the $132m balance instead associated with BCC staff and contractors. TNE added that the delays were due to BCC shifting strategies

Tuesday 2 May, 2017 The Cane Toad

nine months to 31 March, with LFL sales growth lifting marginally to 0.8%, from the 0.6% achieved in 1H17. The company’s new brand, Emma & Roe (E&R), opened two new stores in 3Q17, taking total E&R store count to 26 stores. LFL sales trends remained consistent with 1H17, with Australia relatively flat (+0.4% FYTD vs +0.2% in 1H17), and NZ down by 1.5% (1H17: -1.5%). MHJ said it will close four underperforming stores in AUS in 4Q17 (we have assumed they cumulatively contribute EBIT of $0.4m) and will open one store in AUS as well as one in NZ. Canada continued to be the shining light for the group, achieving LFL growth of 7.0% FYTD compared with 6.8% across 1H17, and posting total sales growth of 16.9%. Management has flagged a further six store openings for the region in 4Q17. The company’s smaller segments, the USA and Emma & Roe (E&R), posted softer results, with USA LFL sales declining 11.0% (1H17: -9.3%) and E&R LFL sales down by 1.0%. Given the investment made to expand the E&R network into NSW, the lower than expected average sales p/store outcome means in our view the segment is likely to generate a EBIT loss of around $6m for FY17, compared with our previous ex-pectation of ~$4m, and the FY16 loss of $2.4m. Taking into account these factors, as well as the recent moves in exchange rates (primarily NZD:AUD), the Toad has shaved its earnings forecasts for FY17-FY19, which has led to EBIT downgrades by us of 4.8% - 5.2% across FY17 - FY19. Nevertheless, we remain attracted to MHJ for its quality management, solid earnings growth profile and market leading position in mid-market jewellery retailing across Australia, New Zealand and Canada. The stock trades at a discount to our DCF valuation of $1.59 p/share, and its listed retail peers. At $1.21 p/share, MHJ is trading on an FY17 PE of 14.5x, falling to 11.1x by FY19 and a divi-dend yield of 4.1% ff in FY17, rising to 5.0% ff in FY19. It remains a BUY. Eureka Group Holdings - The punch you don’t see

Now it’s confirmed that Lang Park will host the showdown between eight-division world champ and future hall of famer, Manny “Pacman” Pacquiao (a tantalising $1.22 on Ubet), and Brisbane school teacher Jeff “The Hornet” Horn on 2 July, the Toad thought it apposite to reach for a boxing analogy for Eureka, because in stock analysis, as in boxing, it’s the punch you don’t see which is the one that does the most damage. And to our great regret Eu-

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that these regions have largely stabilised, but are ex-pected to remain subdued for some time, owing to signifi-cant increases in accommodation supply. On Resorts, the Toad learned that the weaker than expected leverage was driven by softer than expected occupancy in the Gold Coast across the peak season, owing mainly to higher cancellation activity and lower last minute bookings. An-other consequence, at least in part, of the Dreamworld debacle late last year. And as the Toad drove past Dreamworld over these endless long weekends, and glanced at the barely occupied carpark, it looks to us like this softness will endure through at least the second half of FY17 as well. So we have taken the opportunity to adjust our earnings forecasts to reflect lower profit contributions from Perth and Brisbane, as well as the Gold Coast, although we assume performance in this market shows some stability from April onwards. All up, the Toad has put through EBITDA downgrades of 1.3% - 2.8% across FY17-FY19. So, although we rate MTR’s management highly, and like the MLR industry generally, we remain cautious on the stock given the tepid outlook for growth in Brisbane and Perth, combined with the surprising underperformance of the important Gold Coast market in the middle of a tour-ism boom. With the Toad’s updated EBITDA forecast of $101.9m towards the bottom end of the company’s $101m-$107m guidance range, and below consensus of $104.6m, we maintain our Reduce recommendation. Our updated valuation of $2.75 p/share sits 2.5% below the current share price. At $2.82, MTR is trading on a FY17 PE of 16.7x, falling to 14.6x in FY19, with a 3.9% yield in FY17, rising to 5.1% in FY19. Michael Hill International - Growing pains for Emma & Roe

Earlier this year, formerly Whangarei, but now Murarrie based jewellery retailer Michael Hill International (MHJ) announced it had appointed its next CEO. As the last CEO, Mike Parsell, had served in the role for 16 years before he stepped down in August 2016, this was a signif-icant decision for the company. After an internal and ex-ternal search across six months, the Board announced that Phil Taylor, the acting CEO and former CFO of the business, had secured the position. Phil has been with the company since 1987, and was CFO from 2003. The company also released a quarterly sales update in April, reporting total growth sales growth of 5.5% for the

Tuesday 2 May, 2017 The Cane Toad

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reka’s first half result was one the Toad did not see com-ing. After a stellar run of earnings and share price growth over several years, underpinned by the consolidation the af-fordable rental retirement accommodation sector, Eureka has been doing it tough recently with its share price roughly halving since the beginning the year, a fall not helped by the announcement of a surprisingly disappoint-ing first half earnings result. Based on the result, it seems that “negative jaws” was the order of the day, with a num-ber of villages experiencing occupancy declines, and cor-porate costs accelerating, which when combined are le-thal to earnings in any company. However, since the end of the first half, there has been considerable management change. Former executive directors (and large shareholders) Greg Rekers and Kerry Potter have departed and well regarded Brisbane busi-nessman, Jeff Weigh, has been appointed CEO. Also, Robin Levison has moved from Executive to Non-Executive Chair of the company. The company has also initiated an on-market share buyback, under which the company has so far bought back about $0.5m of shares at an average of $0.38 per share. The Toad met with Mr Weigh recently and was impressed with his experience in managing similar assets, and his short-term priorities to improve the performance of the business. These priorities involve stabilising the problem villages in South Australia, getting operating expenses back in order, and monetising the attractive Terranora assets. In a presentation post the result, the company highlighted the current EBITDA run-rate of $9.1m, and $9.9m on an “optimised” basis (presumably through a mix of higher occupancies and better management of costs). In the face of the revised company guidance, as well as lower forecasts for company acquisition spend, to around $15m per annum from almost double that, we have down-graded our earnings forecast for FY17-FY19 by 8.8%- 24.6%. That said, if the new management can turn things around more quickly than we currently forecast, monetise Terranora, and accelerate acquisitions, there is plenty of potential for upside to our earnings forecasts. So while the recent past for EGH has been disappointing, the Toad is backing the new MD and his team to “weigh in” and get things back on track, and consider this out-come a far safer bet than “The Hornet”. At $0.37, EGH is trading on a forecast FY17 PE of 13.4x, falling to 8.9x in FY19 and it remains a BUY.

Tuesday 2 May, 2017 The Cane Toad

This report was produced by Hunter Green Institutional Broking Pty Ltd (HGIB), holder of an Australian Financial Services License Number 235259.

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