James Frost July 6, 2011 PORTFOLIO POINT: Austock has a renewed focus on private wealth and its daring strategies are getting attention.
If you ever needed proof that Tony Smith (right) loves a bargain just, ask him about Austock?s new headquarters.
As the new head of private wealth tells it, they acquired the space from a national regulatory body that had fitted out the entire floor with the latest in boardroom gadgetry and high-speed connectivity before staffing it with just six people.
Needless to say as soon as the bean counters in Canberra caught on, they relegated the gang of six to more modest accommodation, making the vast office available. Austock snapped it up and with the change of address came a change of focus ? back to their private broking roots after years of concentrating on corporate finance for small and mid-sized companies.
With ex-Merrill Lynch CEO Paul Masi now at the helm, the company is clearly making a play for high-net worth clients with a multi-tiered offering of advice, research and execution.
Following excellent calls from their strategy team to deploy cash into the market after the Japanese crisis and take it out as the ASX approached 5000, we?ve reproduced their latest list of ?preferred stocks? in the table below.
It?s interesting for two reasons. First, because it?s the kind of material that is usually reserved only for their top-tier clients; second, because it contains a lot of new ideas including brave calls on blue-chips and high-conviction assessments on stocks outside the realms of normal broker research. -Austock's preferred stocks ASX 50 Price P/E Yield Market cap ANZ Banking Group $21.85 10.59 6.30% $56b BHP Billiton $44.45 13.41 2.10% $142b Crown Limited $8.97 20.6 4.10% $7b Incitec Pivot $3.90 14.3 2.40% $6b Map Group $3.39 NA 6.20% $6b National Australia Bank $24.96 12.1 6.50% $54b Newcrest Mining $38.15 26.5 0.80% $29b Origin Energy $15.38 NA 3.20% $16b Qantas Airways $1.99 15.4 NA $4b Suncorp Metway $8.05 16 4.40% $10b Rio Tinto Limited $83.60 11.6 1.30% $36b Transurban $5.20 NA 5.20% $7b Woodside Petroleum $40.92 20.4 2.70% $32b Woolworths Limited $27.69 16.3 4.30% $33b x Mid Cap 50 Boart Long Year $3.94 21.6 1.40% $2b Connect East $0.45 NA 4.40% $2b Oz Minerals $13.44 NA 0.50% $4b Tatts Group $2.36 24.6 4.40% $3b Ten Network $1.13 8.4 5.30% $1b Transfield Services $3.50 31 4% $2b Downer EDI Limited $3.86 NA 4.20% $2b x Small Ordinaries Carnarvon Petroleum $0.20 11.5 NA $134m FKP Property Group $0.67 14.3 3.60% $800m Gerard Lighting $0.93 8.2 5% $164m Matrix Composites & Engineering $7.88 18 0.60% $600m Mineral Resources Limited $12.20 14.6 2.30% $2b Pacific Brands Limited $0.68 NA 4.60% $633m RCR Tomlinson Limited $1.71 12.7 1.80% $225m Slater & Gordon $2.27 12.2 2.30% $339m Western Plains $0.89 NA NA $220m
Smith?s views on the market are unequivocal, perhaps a consequence of spending many years in the no-nonsense world of institutional broking. When asked about a lack of exposure to the food and beverage sector he deadpans ?Don?t like it?; while gaming operator Tattersalls is economically described as ?An easy get?.
That?s not to say he?s short on words. As our half-hour chat on his preferred stocks stretched out to the full hour, he was upfront about the companies he was happy to be fully invested in, such as the mining services companies Mineral Resources and Decmil.
In contrast with the heady rush to secure development contracts in our resource states, Smith is also bullish on the prospects for Australian infrastructure stocks. Transurban, in particular, is singled out for attention as ?fantastic?; and Austock?s analysts? forecast distributions to double in the next five years.
It makes for interesting conversation when industry professionals are happy to talk at length about opportunities outside the top 50 stocks while recognising the role blue-chips play in long-term wealth creation strategies.
When it comes to owning banks, Smith currently prefers ANZ and NAB but he is also pragmatic when he (perhaps jokingly) adds ?Buy the one you bank with. They?ve been ripping you off for years and you might as well get something back.?
Because as he explains, real value is found in the turnaround stories. In unloved stocks. In underutilised assets. Just like their new headquarters.
The interview
James Frost: Tell me a bit about your philosophy behind stock selection and portfolio construction.
Tony Smith: We are not like your regular broker, who is just interested in getting you to turnover stock. We?re about building long-term wealth. So how do we do that? Our view is that so many people are out there trying to make money that they completely forgot the first rule of investing, which is not to lose money.
That means being in the top 50 stocks. You need to pick and choose because there?s no point in just buying the index but you preserve your investment capital by being in the top 50. We still believe that not everyone gets that, so we do structure portfolios with that in mind.
Once we?ve achieved that we look to add outperformance ? or alpha ? through stocks outside the top 50. When we?re looking at these stocks we want to see three things: it must have good management; it must have a business where we can see growth; and it must have good cash flow.
Your list of preferred stocks has a big emphasis on the miners and mining-exposed industries. How comfortable are you with that?
We invest according to where the dollar comes from and not because we are overweight or underweight a sector. So, it?s very easy in this environment to find yourself exposed to mining and mining services. For a lot of investors that means big positions in BHP Billiton (BHP) and Rio Tinto (RIO). We see that in the next six months that mining is one of the few plays where there are dollars being spent. The question is how you go about managing that risk.
Well let?s explore one of those risks like the capital expenditure bottleneck that is pushing out projects and pushing up prices. How do you manage that exposure?
Typically we will focus on the front end of the mining services spend. This means companies like Decmil (DCG), who are in there first building camps, because we know that they are going to get paid. After that you?re looking at companies like Mineral Resources (MIN), who are in there straight after building the crushing facilities because they?ve got to build the plants.
We?re all aware of these huge capex figures being bandied about but we?ve seen contracts in the past where the purse strings start to tighten at the back end of the contract and the last ones to turn off the lights are getting screwed on margins. So we?ve been avoiding that kind of tail risk, which you have typically found with companies like UGL (UGL), for instance.
Tell me about some of the other smaller resource companies in your preferred list.
A company that we?re very comfortable with at the moment is WPG Resources (WPG).
That?s the old Western Plains Group with iron ore deposits in the Woomera, isn?t it?
Yes. If you have a look at it, it stayed pretty steadfast throughout the recent turmoil in markets after the capital raising at 68?. The reasons we like it is because it?s got good management and it?s got some very good assets, but some of the assets are tied up in the Woomera prohibited area, which is in the process of being released.
We like WPG because the particular grade of their assets is superior to the rest of the market. We also think it?s priced for the asset they?re going to produce and you have optionality on the prohibited area. So if we go back to those three things we look for ? good management, good business and good cash flow ? we can see the cash flow coming so we?re comfortable in buying it.
There?s another small energy stock in your list I?d like to hear your thoughts on: Carnarvon Petroleum (CVN).
They?ve got cash flow. We like their Phoenix asset in the North-West Shelf. They have assets in Thailand that spit out cash flow, and I like operations that are self-funded. I don?t like people coming back to the market all the time. So we were happy to hold some short-term pain on the basis of what they might do with Phoenix, which is in a very prospective area with all the majors around it and they?ve found themselves with this piece of land right in the middle. So we think that that?s a valuable asset and they should be in a position to know just how valuable that is towards the back end of this year.
I?d like to change tack for a moment and consider a large cap exposure like Woodside, which has suffered quite a bit following project blowouts.
We believe that the problems at Woodside will be fixed. With energy assets we try and put ourselves three to five years down the track and consider how it is going look in an environment that is a little more certain, when cash is easier to come by. So where our competitors might only be looking six months out, we are happy to take the long-term view and we believe that at some point Woodside will be a standalone asset ?
What do you mean by that ? that they will take ownership of all their projects or they will be sold to someone?
They?ll be sold to someone. At some point the market will see that there are opportunities and that there is value waiting to be unlocked and they will have the means to do it. When that happens, whoever is running the numbers at the time will see that Woodside is one of those opportunities.
Are you happy to acquire Woodside at current prices?
From a long-term perspective we are happy to acquire Woodside on the basis that it may continue to slip another 50?, $1 or $5. We are not prepared to be fully invested in something where we cannot see the catalysts we need, so in the case of Woodside we would be happy to put half in.
What are you happy to be fully invested in right now?
Mineral Resources.
That?s the $2 billion mining services company we were talking about earlier.
That?s right. That?s a company we have been following for quite some time. Earlier this week Fortescue awarded them the $1 billion Christmas Creek 2 contract and we expect to hear more good news from Mineral Resources in the future.
I notice that you?re not recommending much in the way of food and beverage exposure.
Correct.
Why is that?
Don?t like it. Haven?t liked retail for some time. I don?t see any reason to buy a sector I don?t like. We have started playing Woolworths on the basis that the problems with the floods would see some food inflation, which is an environment that has typically been good for supermarkets. We choose Woolworths over Wesfarmers because that revenue growth would have been offset by its exposure to coal.
But on the other hand you are recommending a considerable exposure to gaming.
That?s right, love Crown. Whenever Crown spends money on their domestic assets you typically see a pull through in revenue pretty quickly. Compare that to, say, Tabcorp, which spends a lot of money on what is essentially maintenance capex. Crown?s domestic assets are blue-chip and as such I believe they are insulated from the problems of the real world, if you like.
Tatts is just a fantastic company. CEO Dick McIlwain and CFO Ray Gunston are very easy to talk to and very transparent. The company pays a good dividend and they work damn hard to make sure that there are no surprises. Every time Tatts buys another asset the market says ?Oh, they paid too much? but in hindsight it?s turned out to be a good price. It?s an easy get.
I notice that infrastructure is well represented as well. What?s your thinking there?
We think because of the de-risking post GFC infrastructure is looking a lot better. In the early days, it was a lot about paying back capital that you?ve actually put in. Today we see them as cash flow generators. Transurban (TCL) has done some fantastic work over the past 10 years and our analyst has them doubling their distributions over five years. So if you?re talking about capital preservation, I can?t see what will go wrong now that they have all refinanced.
Connect East is another company that has fixed itself up. We still believe that consensus earnings and outperformance of consensus earnings drives prices. There are a lot of things that could go right for Connect East, and single entity companies like them usually don?t last too long in the market. Transurban will have to buy them at some stage, only simply because they?ll run out of roads to buy in Australia ? and its a natural fit.
MAp Group is another infrastructure play we like. It?s throwing off a nice yield and from the perspective of returns it?s probably one of the best airports I?ve ever been too. They?ve got $1.7 billion in cash, or they will have soon, and the market cap is $4 billion. There are a number of things that have held that stock back but history tells us that all these things sort of get worked out.
To finish up, one of the last notes I read from Austock talked about investigating the possibilities of margin lending. Do you want to elaborate why?
Yes, very much so. We went pretty hard overweight following the Japanese disaster when equities tanked and then started taking money out towards the end of that month when the ASX headed back towards 5000. We then moved to go into cash and we?ve been fairly negative on the market since the end of March.
So it might look to some people that we got that horribly right but what we want to educate our clients about is that although we are working through a number of risks, we?re probably going to get another opportunity where investors can investigate the idea of actually leveraging ourselves into this market because it will be ideally the bottom of the double dip.
So when that happens, we want people to be in a position to be able to act. We like investors to have a choice because if they?re not across leveraged margin lending when it?s pertinent to use it, then they will miss the opportunity. So we?re certainly not suggesting for people to take out margin loans right now because we still like cash, but my experience is that when there is a rally and you think there?s three months to go you?ve probably already missed the boat.
What are the signs going to be that the momentum is behind the market again for the short to medium term?
The signs will be when we stop hearing noise out of the banking system, wherever that may be. At the end of the day, whether we like it or whether we don?t, the banks will dictate growth, and while we continue to have no confidence in the banking system at the moment through Europe, we?re not going to get any growth. No one feels good about being in the US and there is a lack of patriotism that we used to see there.
We might have to wait until August 2, when Obama is hoping to get his debt refunding package through. I?m not going to be quite convinced we?ve owned up to the problems of the GFC until then. Lots of people are doing it tough but it appears not to have got through to those who control the purse strings and until they actually own up to them we?re just going to trade sideways.
CMV Price at posting:
$3.48 Sentiment: None Disclosure: Held
