Tuesday 1 September, 2015 The Cane Toad

Tuesday, 1 September 2015

Editorial - Let’s create, not curate

Global markets experienced some form of minor melt-down in August, owing to abating China growth and currency values, and linked to that, the fall in the oil price, to below US$40/barrel for the first time since 2009. As a result, the Australian ASX200 index fell 7.8% in August. (To escape the tur-moil, I am happy to recom-mend Spicer’s Clovelly Estate at Montville, which has one of the prettiest hotel car parks in the world – pictured – as well as fantastic food and uber-comfy rooms). But because of the turmoil, no one really paid much attention when on 14 August the boss of News Limited, Robert Thompson, deliv-ered the annual Lowy Lecture in Sydney. In that speech, he lament-ed the rise of the content aggregators (Facebook, Google, LinkedIn), and the demise of content creators. A triumph of curate over create, he pointed out, in reference to mainstream journalism. Here is a link to his impressive speech. (http://www.mediaweek.com.au/news-corp-ceo-robert-thomsons-the-lowy-lecture/) In equities, I see the same thing. Businesses everywhere are now curating and distributing content, not creating it, while the much of the so-called sell side, and most likely the buy side too, is left to with-er on the vine. And this matters, because in the end it affects the ability of Australian’s everywhere to live just a little more comfortably in retirement, or not. For without the creation of money making ide-as, which requires financial support of talented, well educated, often idiosyncratic, and sometimes expensive analysts, there will be a heightened race to the bottom of the financial ideas barrel, inhabited by index funds and the efficient market hypothesis! Which is cheap, but hardly Darwinian. You want your fund managers to reach for the stars of a share portfolio for the next decade or two? Good luck with that, when good analysts on all sides are sidelined by over-investment in distribution, at the expense of ideas. I suppose at least you’ll get beautiful quarterly reports, and world class internet acces-sibility, when you check the price of your index fund. So thanks Robert Thompson for reminding us that whether it’s in journalism, or investment research, good ideas are hard to come by, and require nurturing, with cash. Please enjoy this Toad as much as we enjoy bringing it to you.

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A Hunter Green Institutional Broking Publication AFSL number 235259

www.hgib.com.au

Inside this issue...

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

Transpacific Industries - Bad to Worse ....................................... 2

Flight Centre - Wild ride ....................... 2

G8 Education - Beacon of success in graveyard of failures ............................ 3

Suncorp - Dreaming of a Croatian sunset ........... 4

Mantra Group - Priced for perfection ............................ 4

Super Retail Group - Improvement gains traction ................. 5

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

August Market Summary ..................... 7

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

Attachments: QLD database TPI forecast FLT forecast GEM forecast MTR forecast SUL forecast

Issue 164

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150The Cane Toad Qld20 Accumulation Index

Tuesday 1 September, 2015 The Cane Toad

Transpacific Industries - Bad to Worse Jim Collins’ famous book ‘Good to Great’, reflects on the characteristics which allow companies to make the leap from being good to being great… unfortunately, in the Toad’s experience, it is more common to see companies go from good to bad, or now in the case of TPI, bad to worse. TPI’s important Cleanaway (CA) business posted anoth-er year of flat EBIT in FY15, despite the contribution from Melbourne Regional Landfill (MRL) in 4Q15, suggesting underlying weakness in 2H15. The key detractors from the result were Collections busi-nesses Commercial & Industrial (C&I) and Municipal, where revenues fell 1.6% and 8.6% y-on-y respectively, owing primarily to lower front-lift volumes. Recent industry data, which refers to an average growth rate of 5.2% for the Australian waste industry from FY11-FY15, confirms CA has lost share in that time. For context, CA increased revenues by 1.5% p.a. between FY11 - FY15. Meanwhile, Industrials EBIT fell 53% to $28.9m, driven by continuing tough trading conditions in minerals and energy markets. Cost control was poor, as margins fell 600bps, with the earnings decline in line with the fall in revenues. Management guided to improved earnings for Industrials in FY16, which, in our view, seems optimistic given the significant step down in EBIT from 1H15 to 2H15 com-bined with the recent fall in the oil price to new lows. The company provided a $165m-$190m guidance range for capex in FY16, consistent with levels it used to incur when it owned the large NZ waste business, alongside $59.5m in additional R&R spend. Based on our forecasts, this implies TPI will generate negative cash flow in FY16, meaning any dividends paid will need to be debt funded. We have downgraded our FY16 and FY17 EPS forecasts by 23.0% and 5.4% to reflect the weaker than expected performance from Industrials, as well as the updated guid-ance on costs and spend. Our DPS estimates have fallen more heavily than EPS owing to the lower than expected final dividend, combined with lower forecast group FCF generation. In our view, the lack of any meaningful FCF over the fore-cast period will limit the company’s ability to make signifi-cant acquisitions without additional debt or equity financ-ing, and reduces the prospect of higher dividends and/or potential for capital management initiatives. These con-cerns, combined with substantial headwinds for Industrials in the short term, and the lack of an improvement in earn-ings from Cleanaway, have prompted us to downgrade to a REDUCE recommendation. We unreservedly apologise to readers who may have followed our earlier advice to Buy the stock, when we briefly bought into the vision of sunlit waste uplands put about by the former MD. That

was a clear error by the Toad, and many more like that will see us in the cuisses de grenouilles soupe. Our SOTP valuation for TPI, which references our FY17 EBIT forecasts to reflect a full period contribution from MRL and synergy benefits post Clayton closure, has now dropped to $0.55 p/share, implying 19.7% downside to the current share price. At $0.69, TPI is a Reduce, trad-ing on a PE of 22.5x in FY16, falling to 16.9x in FY18, with a fully franked yield of 2.8%, rising to 3.3% by FY18. Flight Centre - Wild ride

An eerie silence lasts for just milliseconds before the car blasts backwards rocketing guests out of a 206m tunnel at rapid speed hitting up to 161 km/h in seven seconds flat. Riders soar 100m into the atmosphere dangling for several seconds of stomach-churning weightlessness at its peak before plummeting back to earth…only this time it’s face first….This is Dream World’s description of what it’s like to ride on its Tower of Terror. Over the last twelve months, Flight Centre’s share price has been the ASX’s answer to the Tower of Terror. Its terrifying ride started at $47 in Sep ‘14 before plummeting to $31 in Dec ‘14, soaring back to $47 by May, thudding back to $30 in Au-gust, and finally rocketing up over 20% during the past week to sit at $37. What a ride! Contrast the wild share price ride with the profit result that FLT delivered in late August. FY15 PBT, excluding the contribution from Top Deck Tours which was ac-quired early in the year, was $363.7m, down by a pretty unexciting and not unexpected 3.4% compared with FY14. The y-on-y decline in group profit concealed very strong performances from the core offshore jurisdictions of USA and UK, which achieved EBIT growth of 69% and 24% respectively. More than offsetting these gains was an 11% drop in Australian EBIT, which was impacted by a number of factors connected with subdued Leisure sales. Australian Leisure TTV grew uncharacteristically by just 2.0%, while total Aussie TTV grew by 4.9%. While not a bad result, the income margin (sales/TTV) was heavily impacted by consultant discounting and meant that sales revenue only rose by 1% in FY15, and was swamped by a 4.8% increase in operating expenses re-sulting in the heavy fall in Aussie EBIT. According to management trading conditions have improved (at least

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Tuesday 1 September, 2015 The Cane Toad

“if past history is an indicator of future performance, the outlook is indeed grim” [for Affinity]; and “even if there are stag profits on offer in the Affinity IPO, the lessons of the past temper our enthusiasm for its medium and longer term viability”. Well, we didn’t have to wait too long for our views to be fulfilled, as Affinity, after yet another downgrade, plunged to 49cps on 2 July, before closing at 54cps that day, be-fore G8 launched its 80 cps bailout package. And now with a welter of corporate activity underway at Affinity, which we prefer to leave to some of the most expensive brains in the country to deal with, we return to more familiar territory, and look at the impressive interim result handed down by G8 in August, where normalised EBIT for 1H15 was $54.3m, up a stunning 74%, driven by a 60% increase in average licenced places year on year, a 6.6% increase in the average daily fee, and impressive cost controls, as we have come to expect from G8. The only sour note of any consequence in the result was softer occupancies across the 70 WA centres acquired with the Sterling Education Group in 2014, which com-prise about 16% of the G8 portfolio, and where the Toad estimates occupancy rates were 3% to 5% below budget. Happily, G8 management also confirmed there are “clear signs of improvement in WA”, which may provide scope for upside to the Toad’s CY15 earnings forecast, given we have not forecast any such improvement in 2H15. So when we reflect on the G8 business, from the time current management reorganised and replaced most of the senior ranks at the listed Early Learning Services business in late 2009, we note that G8 has been a 10 times plus investment bagger, with the prospects of more solid earnings per share and share price growth to follow. This bright future would likely be enhanced if Affinity were in the G8 fold, but will happen anyway whichever the cards fall for the failing Affinity. G8 has cracked the Australian for-profit sector childcare code, mainly by dint of skill, hard work, a good product of course, but mostly because of fanatical attention to cost control. All this has so far added up to massively outsized returns to early and loyal shareholders. And compare this record of success to the listed childcare business fail-ures, disappointments and laggards in this list: ABC Learning, Affinity, Early Learning Services, Sunkids, Pep-percorn, Kids Campus, Childs Family Kindergartens, Hutchison’s...... Following G8’s solid interim result, the Toad’s DCF based valuation is $5.87 per share, and at $3.12, G8 is trading on a forecast CY15 PE of 12.9x and forecast fully franked dividend yield of 7.7%. With or without Affinity, these are very cheap multiples. G8 is a beacon of success in the Australian childcare industry graveyard of failures, and remains a Buy.

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for now) in 1Q with increased enquiry levels and the con-tribution from selling staff added in 4Q15, which is posi-tive. The outlook for Australian Corporate is positive with management flagging a number of recent client wins and targeting high single digit TTV growth in FY16. The company has provided PBT guidance of $380-$395m for FY16 implying growth of 4-8% vs FY15. We have fore-cast PBT of $394m, and expect a continued theme of off-shore earnings growth as the key earnings driver of group earnings growth, including a full year contribution from Top Deck Tours. With the offshore businesses continuing to perform strongly, the positive commentary on current Leisure and Corporate sales in Australia and improved outlook for op-erating margins imply a PBT outcome for FY16 PBT at the top of the company’s guidance range. Despite the shares rallying 14% since the result, FLT is trading at a 30% discount to retail peers on an FY16f EV/EBIT basis and at a 31% discount to our revised blended DCF and peer earnings based valuation. The share price ride over the last twelve months has been, at times, terrifying and completely out of sync with earnings performance which has been on the flat side of soft. So despite the real prospect of continued dramatic ups and downs for the share price, the Toad remains fo-cused on the prospects for earnings and cash flows which look reasonable, and valuation which continues to be cheap. At $37.01, FLT is trading on a forecast FY16 PE of 13.5x and fully franked dividend yield of 4.3%. It re-mains a BUY.

G8 Education - Beacon of success in graveyard of failures

Autopsy.io is a website that collects stories of start-up failure, with the aim of sharing the lessons learned with the whole community. The Toad should start a similar site for investors in listed childcare companies, having seen it flow but mostly ebb since Eddy Groves famously drew attention to the sector over a decade ago. For instance, our comments in the Cane Toad of November 2013 were truly prescient, when in relation to the upcoming Affinity float the Toad earned its keep and noted that:

Tuesday 1 September, 2015 The Cane Toad

So as Snowball sails off into a Croatian sunset, we value Suncorp at $14.49 per share, which is 12.9% above its current share price. At $12.83, SUN is trading on a FY16 PE of 12.3x, yielding 7.2%ff, and it remains a Buy.

Mantra Group - Priced for perfection

Over the years the Toad has accumulated scars from high-growth market darling stocks which have subse-quently endured a long period of savage PE contraction. And so when a company has paid a full price for some high profile assets, is benefitting from strong macro tail-winds, and is a consensus buy, with a share price having doubled in a little over 12 months despite only beating (EBITDA) prospectus by ~5%, the alarm bells start ring-ing. While MTR, in our view, remains a well-managed, high-quality company, the Toad believes, at this point, it is priced for perfection. MTR announced a cash NPAT of $36.2m for FY15, up from -$0.3m in FY14. The NPAT result was higher than forecast, mainly reflecting lower than expected income tax expense. The bulk of the improvement y-on-y was driven by a $41.4m reduction in net interest expense fol-lowing repayment of $335.7m of debt post MTR’s IPO in June ‘14. Management provided FY16 EBITDA guidance of $84m-$87m, implying growth of between 14.9%-19.0% y-on-y, which was consistent with our existing forecast of $85.2m. CBD (+$4.4m) and Central Revenue & Distribution (+$4.6m) drove the bulk of the 19.2% improvement in group EBITDA y-on-y, owing primarily to a full year con-tribution from properties added in FY14 as well as acqui-

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Suncorp - Dreaming of a Croatian sunset Full marks to team Suncorp for announc-ing its result way back on 4 August, before our market really hit the skids, and also for attending the traditional post result lunch at Mor-gan’s, complete with truffle and black garlic mash, calvero nero (aka cabbage in the real world) and artisan cheeses, as we bade farewell to highly regarded Suncorp MD, Patrick Snowball. To show how he has influenced the group since he began in late 2009, the Toad shows some statistics in the table below. Note the 48% lift in profit, and the $3.96 of divi-dends in that time. Total return from Suncorp since 1 July 2009 to date has been 157%, comfortably outstripping the ASX200 Accumulation return of 77% over the same time frame.

The Toad especially likes the careful attention to capital management at Suncorp since the wild old days of both the most senior Suncorp management, and capital man-agement, into the GFC. That stopped dead under Snow-ball, with a growing focus on a savage “costs out” pro-gramme (e.g. SMART shops), business rationalisation, and a refusal to sell the bad bank and the Life business at derisory prices, when the whole world it seemed was urg-ing this on. The important move to the non operating hold-ing company structure, which seems such an obvious thing to do with hindsight, was also finally completed un-der the Snowball watch. Meanwhile, up on Brisbane’s George St., senior manage-ment started talking to each other again, as well as to the outside world, people got happy (or sacked), and revenue grew, and even storms and tempests abated after a few years. Eventually even securities industry guys, including some with funny wigs, were invited to the corporate box, to enjoy the cold beer and warm hospitality of the head honchos feasting on Suncorp’s superior party pies. But now, down to business again, as the Toad reflects on the Suncorp valuation post the August “flash crash”, as one leading “old red” from the buy side referred to the market shenanigans in August. Here is our table capturing the highlights of our current valuation for Suncorp.

Suncorp financial history FY10 vs FY15

FY10 FY15 % chg

NPAT $m 814 1,167 43.4%

EPS $ 0.62 0.92 48.4%

DPS $ 0.35 0.91 160.0%

Shares on issue m 1,281 1,287 0.4%

Share price $ 7.92 14.61 84.5%

Total dividends paid over period $ 3.96

Suncorp Group (SUN): SOTP valuation

Gen. Insurance $m $11,957.8 implied PE 13.0x FY16 NPAT

Banking $m $4,693.0 implied PE 13.0x FY16 NPAT

Li fe $m $1,420.0 implied PE 12.0x FY16 NPAT

Sub total $m $18,070.8

Add surplus capita l $m $570.0 at 30 Jun 15

Total value $m $18,640.8

No. Shares m 1,287

Value per share $ $14.49

Current price $ $12.83

Discount % -11.4%

Source: HGIB

Tuesday 1 September, 2015 The Cane Toad

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positive features including 1) a 10.8% improvement in EBITDA from Rebel/Amart underpinned by 6.6% growth in LFL sales y-on-y; 2) 3.2% EBITDA growth in Auto; and 3) a recovery in LFL sales during 2H15. Management confirmed that sales in QLD were weak with regional QLD continuing to slow and SE QLD slowing during 2H15. We have forecast a 17% increase NPAT in FY16. We estimate the company will carry $12.9m of EBIT tail-winds into FY16 relating to Ray’s store closures, Workout World and Infinite restructuring and reduced group costs. These items account for approximately half of our fore-cast earnings growth. LFL sales for the first 7 weeks of FY16 are supportive with positive outcomes across Sports (+4.5%), Leisure (+10%) and Auto (+2.5%). Following the result, The Toad has made minor revisions to its EBIT forecast to reflect higher than expected group costs, and the consolidation of losses from the Infinite Retail business, and the Toad has also made heavier cuts to its DPS forecasts which reflect a reduction in pay-out to ~65%, in line with management’s comments at the result. We have forecast a return to earnings growth from FY16 for SUL following two disappointing years of relatively flat earnings. And whilst the FY16 earnings will reflect the tailwinds from recent business restructuring and reduced group costs, the FY15 result contained signs of improve-ment in the Sports and Leisure divisions, and sales per-formance so far in FY16 is supportive. Other factors which will provide earnings and cash flow benefits over the few years include the significant capex investment on supply chain and maturation of the Amart franchise in NSW and VIC. At $8.82, SUL is trading on a forecast FY16 PE of 14.0x, falling to 11.4x in FY18 and has a divi-dend yield of 4.9% rising to 5.7%. Our DCF valuation for SUL is $11.26 p/share which implies 15% upside to the current share price, and we maintain our BUY recom-mendation.

sitions completed in FY15. The EBITDA result was in line with company guidance and was 5.2% above prospectus forecast. Lower than expected corporate costs (-$1.8m) also aided the result. LFL EBITDA growth in CBD of 3.8% was broadly in with revenue growth of 3.6%, suggesting minimal operating leverage. The company highlighted weakness in the resource exposed cities of Perth and Brisbane as reasons for flat margin, although we note Brisbane should have benefitted from the G20 convention which occurred in 1H15. Resorts grew EBITDA y-on-y, but was slightly lower than expected. We have upgraded our FY16-FY17 EPS forecasts by 0.1% and 3.3% to reflect the acquisitions of Chevron Re-naissance and Mantra on Mary, which we assume will contribute from 2H16. We estimate the properties will be purchased for $38.5m (incl. associated real estate) and will generate annualised EBITDA of $5.5m, representing an EV/EBITDA multiple of 7.0x. For context, we note that the Chevron Renaissance MLR was purchased by the Picone group in 2009 for $9.0m. Except for these large buys, our underlying forecasts remain relatively un-changed. We continue to like MTR for its strong suite of brands, flexible operating structures, and good cash flow, howev-er, increasing multiples paid for MLRs and potential for further weakness in resource related areas tempers our positive view on the stock. This, combined with MTR now trading at a premium to both its international and domes-tic peers, and our DCF valuation of $3.30 p/share, means we maintain our REDUCE recommendation. At $3.41, MTR is trading on an eye watering FY16 PE of 19.8x, fall-ing to 16.1x in FY18 with a fully franked dividend yield of 3.5% in FY16, rising to 4.1% in FY18.

Super Retail Group - Improvement gains traction

Back in April, the Toad switched its view on SUL from RE-DUCE to BUY on the basis there were clearer roads ahead after a challenging couple of years. And the full year result that SUL delivered during the month, whilst messy, provided more evidence of improvement in Sports sales and margins and a rebound in Leisure sales. SUL reported FY15 EBIT of $170.2m (ex $29.0m of pre-tax restructuring and closure costs), which was flat vs pcp and in line with our forecast. The result was impacted by surprisingly large losses from Workout Work and Infinite Retail, and a sharp increase in unallocated costs and de-preciation expense. These items concealed a number of

Tuesday 1 September, 2015 The Cane Toad

jumped following better than expected FY15 results and outlook commentary. FLT is discussed in more detail elsewhere in the Toad. Corporate Travel Management (CTD) increased 3.0% over the month to close at $11.03, making it the third strongest performer in August. The stock’s rise coincided with the release of its FY15 results, which showed strong profit growth y-on-y, and manage-ment’s comments that acquisitions made through the year were performing to expectations.

On the downside, the worst performer in August was Technology One (TNE), which fell 11.8% to $3.52. The decline coincided with a significant sell-off in AUS and US technology companies in August, with the ASX Info Tech index down 15.8% over the month. G8 Education (GEM) posted the second heaviest decline in the CTI in August, falling 8.2% to end the month at $3.12. It was a busy month for GEM, with the release of its 1H15 results, an increased bid price for AFJ to $0.80 p/share, and a $0.90 p/share counter proposal for AFJ from Anchorage Capi-tal. GEM is discussed in more detail elsewhere in the Toad. Cromwell Property Group (CMW) was the third worst performing stock in August, falling 8.1% to finish the month at $1.03. The drop followed a solid perfor-mance in July. We note 173m shares (9.9%) were crossed at $1.00 p/share on the last day of the month.

Despite the ongoing turbulence in global markets, as well as the Australian share market which is a slave to them, we maintain our view that the constituents of the CT In-dex are well placed to continue providing outperformance to the broader Australia market over the medium to long term.

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AUGUST CANE TOAD INDEX WRAP

The Cane Toad Index (CTI) fell in August following its strong rise through July, declining 2.3% to close at 131.8 points. The CTI outperformed the broader market signifi-cantly with the ASX200 Accumulation Index falling 7.8% over the period. The CTI has now outperformed the ASX200 Accumulation Index in 53 out of the 104 months since inception, or approximately 51% of the time.

Of the CTI’s twenty stocks, a solid sixteen outperformed the broader market average in August. The strongest per-formance was from Virgin Australia (VAH) which rose 5.7% to close at $0.47. Early in the month VAH released its FY15 results, which showed a smaller loss relative to FY14, with management flagging a return to profit in FY16. In addition, later in the month the ACCC approved Virgin and Delta’s alliance for US-Aus routes. Flight Cen-tre (FLT) was the second strongest performer in August, rising 3.9% over the month to close at $37.01. The stock

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

DISCLAIMER: The information and opinions contained in this report have been obtained from sources believed to be reliable, but no representation or warranty, ex-press, or implied, is made that such information is accurate or complete and it should not be relied upon as such. Information and opinions contained in the report are published for the assistance of recipients, but are not to be relied upon as authoritative or taken in substitution for the exercise of judgement by any recipient, and are subject to change without notice. This report is not, and should not be construed as, an offer document or an offer or solicitation to buy or sell any investments. Except to the extent that liability cannot be excluded, HGIB does not accept any liability for any direct or consequential loss arising from any use of material contained in this report.

DISCLOSURE: HGIB and/or persons connected with it may effect or have effected a transaction for their own account in the investments referred to in the material contained in this report or any related investment before the material is published to any HGIB clients. On the date of this report, HGIB, persons connected with it and their respective directors and/or representatives and/or employees may have a long or short position in any of the investments mentioned in this report and may pur-chase and/or sell the investments at any time in the open market or otherwise, in each case either as principal or as agent. Additionally, HGIB within the previous twelve months may have acted as an investment/commercial banker or may have provided significant advice or investment services to the companies or in relation to the investments mentioned in this report. Contributors to the Cane Toad or their associates hold positions in Flight Centre, Tatts Group, Comet Ridge, G8 Education, Soul Patt’s, Brickworks, Villa World, Nomad, and Eureka Group.

WARNING: This report is intended to provide general securities advice, and does not purport to make any recommendation that any securities transaction is appropri-ate for any recipient’s particular investment objectives, financial situation or particular needs. Prior to making any investment decision, recipients should assess, or seek advice from their advisers, on whether any relevant part of this report is appropriate to their individual circumstances. If a recipient was referred to HGIB by an invest-ment adviser, that adviser may receive a benefit in respect of transactions effected on the recipients behalf, details of which will be available on request in regard to a transaction that involves a personalised securities recommendation. This report may not be reproduced, distributed or published for any purpose, unless authorised by HGIB.

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