Metcash Limited (MTS) is a marketing and distribution company operating in the food and other consumer goods sectors.

MTS is divided into four business units: IGA Distribution, Campbell’s Wholesale, Australian Liquor Marketers and Mitre 10. All of the business units are full owned by MTS with the exception of Mitre 10, which is 50.1% owned.

Last year, MTS completed a takeover of New South Wales supermarket chain, Franklins. The deal was finalised after the Full Court dismissed the ACCC’s appeal to block the merger on the 30th of November.

Margin squeeze

The domestic supermarket industry is dominated by Woolworths and Wesfarmers-owned Coles, with MTS coming in at a distant third.

Significant price deflation has crimped profit margins across the industry, but MTS has been hit harder than its bigger rivals.

Based on semi-annual figures, MTS’ EBITDA margin has contracted over 20% between November 2009 and November 2011.

In that same time, Wesfarmers and Woolworths have seen their EBITDA margins rise 5.4% and 1.7%, respectively.

There may be many other reasons behind the discrepancy, but it is apparent that MTS is struggling to keep up with the aggressive discounting being implemented by Wesfarmers and Woolworths.

Business restructuring

In early April, MTS shocked investors by announcing a $34 – $43 million restructuring charge related to the consolidation of its businesses and the closure of 15 regional Campbells Cash & Carry (Campbells) branches.

Additionally, MTS will book a $75 – $90 million non-cash restructuring charge related to the underperformance of two JVs in Queensland.

The write-downs followed a disappointing 1H12 for MTS, in which its underlying profit rose just 1.4% on-year to $116.6 million.

Campbells was the most disappointing business unit, with EBITA decreasing 35% to $16 million and EBITA margin dropping 73 basis points (bps) to 1.2%.

IGA Distribution – the largest of all the business units – saw its EBITA rise only 0.8% and EBITA margin slipping 5bps to 4.73%.

Outlook

Conditions for supermarket retailers like MTS have been terrible over the past two years and things are unlikely to turn around in a hurry.

MTS is in the unfortunate position of having to contend with two industry behemoths in Coles and Woolworths.

Metcash: Stocks To Watch

These companies have been forced into aggressive price discounting in order to attract customer sales, and this has come at a huge cost to MTS’ margins.

In response, MTS has looked to streamline its business through consolidation and the closure of its Campbells branches.

However it will be a stock to watch as there are questions as to whether more write-downs may be needed down the track if trading conditions deteriorate further and/or price deflation continues to cut into MTS’ margins.

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Weekly Buy Recommendations: Crown (CWN)

Crown (CWN) manages a variety of gaming and entertainment facilities, including, bars, restaurants, nightclubs, cinemas and retail outlets. It also develops hotels and conference centre facilities.

The company wholly owns and operates two integrated resorts; the Crown Entertainment Complex in Melbourne and Burswood Entertainment Complex in Perth. Mr James Packer currently owns a 48.09% stake in the group.

CWN also has an interest in several different projects including:

• 33.65% interest in Melco Crown entertainment, which is based in Macau
• 50% interest in online gambling site Betfair
• 24.5% interest in Cannery Casino Resorts in the US
• 50% interest in Aspers Holdings (UK) which operates three regional casinos in Newcastle Swansea and Northampton

The company also recently increased its stake in Echo Entertainment to 10%.

Latest Results

CWN’s 1HFY12 results were impressive considering the challenging consumer environment.

The company reported normalised NPAT of $211.6 million, which was an increase of 28% on the prior corresponding.

CWN’s Australian casinos reported revenue growth of 10.7% to $1,387.9 million, with normalised EBITDA up 5.2% to $362.4 million.

A breakdown of the two main facilities showed that Crown Melbourne’s normalised EBITDA added 3.7% to $269.4 million, whilst Burswood EBITDA gained 8.7% to $116.6 million.

The company declared an interim dividend of 18 cents, which equates to a health yield of over 4%.

CMJ and Echo Entertainment

Today it was reported that James Packer will sell his controlling stake in Consolidated Media Holdings (CMJ).

Whilst it is just a rumour, a takeover is looking like happening sooner rather than later given CWN’s increased 10% stake in Echo Entertainment (EGP).

EGP’s assets include Sydney’s Star City and Jupiter’s Hotel and Casino in Queensland; however it is Star City that would be the most appealing to CWN.

Star City is CWN’s major, if not only, rival in the highly coveted VIP segment. A merger of the two companies would alleviate any pressure aggressive competition would have on the segment’s margins.

Looking forward

CWN”s results speak for themselves, they were able to grow earnings in a tough consumer environment.

The reported move of James Packer selling his controlling interesting in CMJ has already sparked further takeover rumors in regards to EGP.

Mr. Packer also increased his own personal stake in CWN from 46% to 48.1%, showing his confidence in the company.

We believe that the takeover of EGP would be seen as a positive move for CWN.

As such we think CWN is a stock to watch in the coming months.

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Weekly Buy Recommendation: Telstra (TLS)

Telstra Corporation Limited (TLS) is a provider of telecommunications and information products and services, arguably best known as Australia’s dominant telco company.

Its principal activities are the provision of telephone lines; national local, and long distance, and international telephone calls; mobile telecommunications; data; internet and on-line; wholesale; telephone directories; and pay TV.

TLS owns a 50% stake in Foxtel while Newscorp (NWS) and Consolidated Media Holdings (CMJ) hold 25% each.

Results confirm turnaround

TLS’s 1H FY12 results showed a return to EBITDA growth after years of stagnation. EBITDA grew 3.7% to $4,750 million when compared to the $4,580 million in FY11.

Total revenue climbed by 1.1% to $12,419 million, whilst operating expenses declined 1% to $7,751 million over the same period.

One of the major earnings drivers for the company is its mobiles products; revenue was up 10.9% to $4,393 million year on year. Revenue from this product line alone makes up of one-third of TLS’ revenue.

The growth in Mobiles is impressive, especially when considering EBITDA margin of 34% was considerably higher than Optus’ 25.9% and Vodafone & Three’s 16.3%.

TLS has the only 4G network in Australia and with many new mobile phones being designed with 4G capabilities, the company can continue to experience strong growth in this market.

$11 billion NBN booty

Earlier this month TLS finalised its definitive agreements with NBN Co and the government for its participation in the NBN rollout.

The agreement will provide the company with approximately $11 billion in post-tax net present value over the long term life of the agreement.

The $11 billion includes compensation from the government for decommissioning its copper network and allowing the NBN to use some of its infrastructure.

In a strategy update on April 19^th, TLS said it expected to generate $2 – $3 billion in free cash flow over the next three years, subject to the NBN roll out schedule and market conditions.

TLS also said that it didn’t have the franking capacity to increase dividends before 2014 and that it had no immediate plans for a share buyback.

Arguably a better longer-term share price driver for a company is the implementation of a dividend increase over a buyback.

A dividend increase signals confidence in the long-term prospects of a company, and that TLS’ management has recognised this is a positive thing for shareholders.

Widening yield differential signals positive outlook

TLS is currently trading on a forecast yield (28c for FY12) of over 8.5%, fully franked. This is equivalent to 12.1% pre-tax.

TLS has been able to maintain a 28 cent per share dividend since FY07 and has forecast the same amount for FY12 and FY13.

Given the healthy sums of cash TLS is generating and following this month’s strategy update, we would anticipate a dividend increase from 2014.

When considering the next likely move in interest rates is down, we believe income-oriented investors will increasingly prefer TLS’s dividend yield over potentially lower interest rates on their savings accounts.

As such we think TLS is a stock to watch in the coming months.

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Weekly Share Tip: Buy on KAR

Karoon Gas Australia (KAR) is focused on identifying, exploring and developing acreage that is highly prospective for oil and gas.

The company currently has three focus areas – the Browse Basin (Western Australia), Tumbes Basin (Peru) and the Santos Basin (Brazil).

Santos Basin

KAR has a 100% equity interest in five oil blocks in the Santos Basin, offshore Santa Catarina in Brazil.

The Basin has a history of oil discoveries, and importantly, KAR anticipates that new fields within its acreage can quickly be brought to production due to relatively shallow water depths and their proximity to existing infrastructure.

A three-well drilling campaign will begin later this year, and KAR is currently in the process of farming out some of its equity interest. KAR expects to complete the farm-outs in the coming quarter.

A farm-out will not only help fund KAR’s drilling campaign, but the strong interest it is receiving from prospective farm-in partners appears to validate the significant production potential of the block.

Browse Basin

KAR’s Browse Basin drilling campaign holds long-term promise for the group, this despite a year of contending with regulatory and operational delays.

KAR’s joint venture partner is ConocoPhillips, which holds a 60% stake in the project and is its operator.

The drilling campaign, likely to start this month, will see five to eight wells drilled initially.

The campaign will attempt to define the size of the resource, but pre-drill estimates of proven reserves (P-90) are 3 trillion cubic feet of gas.

Although funding risk is always a concern with gas explorers, KAR had $266.6 million at the end of the December quarter.

When factoring in the proceeds from likely farm-outs of its various projects, KAR expects to have sufficient capital to complete all drilling activities.

This implies a very low likelihood of KAR having to sell down more equity in the Browse Basin Project and/or announce a capital raising.

Outlook

KAR has emerged as an exciting oil and gas explorer, with several promising drilling campaigns about to get underway.

The group is sufficiently funded to complete its Browse Basin drilling campaign, and there is hope the drilling will lead to a sizable defined resource in the near future.

Regarding its South American operations, KAR anticipates reaching a farm-out agreement in the coming quarter.

This will not only improve its cash position but pave the way for the commencement of its Santos Basin drilling campaign.

We expect KAR to be a stock to watch in 2012, and see further upside for its share price.

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Atlas Iron (ASX:AGO) is an emerging iron ore producer and explorer.

With a growing number of high quality iron ore projects and one of the largest landholdings in the lucrative Pilbara region, AGO is now one of the area’s largest iron ore producers.

The company has a significant number of direct shipping ore (DSO) projects in WA. DSO projects are those that are in close proximity to ports, which helps to significantly lower capital costs.

One of the more recent ones, the Mount Dove DSO Project, is expected to contribute to AGO’s shipping tonnes later this calendar year.

Iron ore in spotlight

Iron ore miners have been in focus over the past few weeks due to a combination of factors. Among these is the improving prospect for iron ore.

We don’t believe the current spot price around $142 a tonne reflects what is still a favourable supply/demand dynamic for Aussie miners.

The European debt crisis forced some of the higher cost iron ore miners to cut back production last year.

This is likely to ensure the iron market remains in a supply deficit for a few more years yet, which not only supports prices but provides an opportunity for low-cost producers like AGO to fill the breach.

Also, the Glencore/Xstrata merger proposal has thrown the spotlight on pure play iron ore miners. Given the commodities giants’ lack of iron ore assets, the merger may encourage existing iron ore companies to either consolidate or potentially be the subject to an offer.

Output hit by cyclone

For the December quarter, Atlas Iron reported an 11% quarter-on-quarter fall in iron ore mined.  This was due to Tropical Cyclone Heidi, which impacted mining operations and damaged the Utah Point ship loading facility at Port Hedland.

As a result, AGO downgraded its FY12 production target to 5.5 – 5.7 million tonnes, from the previous 6 million tonnes.  However cash costs were within AGO’s targeted $42/ton-$45/ton range for FY12.

AGO, like other iron ore miners, suffered from a fall in iron ore prices during the quarter. However it also positioned itself to take advantage of a recovery in prices.

The company moved from quarterly pricing of its contracts towards shorter term reference points. This means it is more directly exposed to spot prices, which have trended higher in recent months.

Outlook

Despite last quarter’s operational issues, AGO managed to grow its cash pile from $373 million to $380 million.

With strong operating cash flows and competitive cost of production, AGO has significant capacity to fund development projects such as the Mt. Dove mine.

Although AGO faced a number of headwinds in the December quarter, we think it is well placed to take advantage of a recovery in iron ore prices. Atlas Iron (AGO) is an emerging iron ore producer and explorer.

With a growing number of high quality iron ore projects and one of the largest landholdings in the lucrative Pilbara region, AGO is now one of the area’s largest iron ore producers.

The company has a significant number of direct shipping ore (DSO) projects in WA. DSO projects are those that are in close proximity to ports, which helps to significantly lower capital costs.

One of the more recent ones, the Mount Dove DSO Project, is expected to contribute to AGO’s shipping tonnes later this calendar year.

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At the start of a new year traders and investors alike invariably look to the potential that the new horizon brings.

After a tumultuous 2011, this year that sentiment is even more pronounced as market participants put the last 12-months in their rear-view and look to better times ahead.

At Australian Stock Report we don’t particularly care for long dated predictions about the market as a whole – too much can change too quickly.

We are prepared however, to outline a few stocks that will make for interesting reading in 2012.

Below is a list of stocks to watch in 2012 and a brief outline as to why we think so.

QR National (ASX:QRN) / Asciano (ASX:AIO) – Both companies operate in the transportation industry and are highly leveraged to the mining sector. While they are in competition with each other, both can prosper with the mining boom likely to drive industry revenue. QRN and AIO are likely to experience strong growth from the Queensland area as the state’s coal output moves back into full swing after last year’s floods caused havoc with production.

ANZ (ASX:ANZ) – Our bank of choice is ANZ. While we can’t see an extreme decoupling in price between the big four over the next year, ANZ is our preferred exposure to this sector. ANZ has the second lowest P/E based on current earnings and has a dividend yield approaching 7%, which should provide some support for the stock at this level. The company also has the most exposure to the growing Asian region and one of the lowest exposures to the slowing domestic residential market.

BHP Billiton (ASX:BHP) / Rio Tinto (ASX:RIO) – These mining giants are poised for growth in 2012. Both companies were weighed down last year as the market factored in the effects of a possible hard landing in China. It is becoming more evident however, that any slowdown in the Chinese economy will be akin to a soft landing instead. The other factor that could buoy the mining giants is increased commodity prices due to the likely introduction of further monetary stimulus by the US Federal Reserve.

WorleyParsons (ASX:WOR) – Worley’s provides professional engineering and management services to the energy, resources and complex process industries. The company has significant leverage to the energy sector, specifically through its hydrocarbons (compounds founds in crude oil) division. The company will benefit from any oil supply/demand imbalance that drives up prices. Indeed, some analysts are predicting the price of oil will increase dramatically due to the political unrest in the Middle East. Higher oil prices will encourage the big oil companies to ramp up capital expenditure to the benefit of WOR. The company also has demonstrated an ability to land contracts with the major oil players, evidenced by its recent contract win for the Chevron project in Indonesia.

Saracen Mineral Holdings (ASX:SAR) – On the smaller side of the market, Saracen is a mid-tier WA gold producer that was added to the S&P/ASX 200 on the 28^th of December, 2011. This company has forecast gold production of between 120,000 -130,000 ounces of gold a year, which was reaffirmed in a recent update. Saracen is also trying to expand its business with $35 million of capital expenditure planned for the current financial year. The capital expenditure is substantial for a company of SAR’s size, but a strong net cash position of $58 million significantly reduces the funding risk.

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WorleyParsons (ASX:WOR) provides professional engineering and management services to the energy, resource and complex process industries.

It offers a broad range of services, from feasibility studies to design and project services, and is exposed to a number of sectors.

The group is a leader in its industry and has established long-term relationships with a number of blue-chip companies.

Despite facing obstacles in FY11, WOR was able to grow its profit and revenue, with the Hydrocarbons business driving the result.

Moreover, WorleyParsons is ideally placed for the future, as the lure of high energy prices is likely to drive demand for its services from the bigger oil companies.

Hyper about Hydrocarbons

The majority of WOR’s earnings are in the Hydrocarbons (oil and gas) division.  WOR’s leverage to the energy market is a key attraction, particularly as demand for oil and gas is expected to strengthen due to emerging market growth.

The oil supply/demand imbalance (dwindling oil supplies vs. growing energy demand) is only expected to worsen due to this growth.

The lure of energy price appreciation is likely to encourage oil companies to ramp up capex spending, which puts WorleyParsons in an ideal position to accelerate its contract win rate.

WOR has had a positive start to 2012, winning two major contracts in January.  The first was a US$115 million contract with ExxonMobil, and the second was a US$180 million contract with Chevron (split with a 50/50 JV partner).

LNG is the future

The big oil companies have recognised that the world is moving towards more unconventional sources of energy such as LNG.

There are a number of massive projects being undertaken throughout Australia, and WOR has had a hand in some of the key ones such as Pluto and Wheatstone.

WOR’s experience in developing LNG projects, coupled with the established relationships it has with its blue-chip clients, makes it ideally placed to benefit from this increased focus on alternative energy.

Outlook

As the global growth engine continues to shift from developed economies to the developing regions, there will be increased demand for commodities.

As mining companies look to meet this demand, there is going to be a significant increase in capex activities over the coming years.

This will strengthen the market for WOR’s services, providing it with plenty of growth opportunities, especially in the hydrocarbons space.

WOR is in a sound financial position and is expected to continue the positive earnings momentum into FY12.

Based on one year forward earnings, WOR is trading at a more than 50% premium to the industry average.

Whilst this may appear to suggest the company is overvalued, we feel the premium is justified when considering WOR’s relatively stronger growth prospects, cash flow generation and a five-year average return on equity of over 20%.

The long-term relationships WorleyParsons has fostered with its blue-chip clients is likely to yield considerable benefits for the company, particularly as miners look to capitalise on rising commodity prices as well as the world’s shift to alternative energy sources.

We believe that WOR is poised for growth, and is defiantly a stock to watch for 2012.

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Australian Stock Report presents the 2012  Portfolio Review.

Have you ever wanted to know what the “must-have” stocks are that should be in your portfolio? Do you know what 2012 has in store for the markets? Our Panel Does! Come and hear them present a review of your portfolio!

Here’s how the Portfolio Review works: List 5 stocks from your portfolio, or in which you are thinking of investing. Our panel of experts will tally the requests and select the 12 most popular stocks (and a few of their own) to thoroughly analyse and present their results live at the Review. The experts will then host a Q & A session to discuss current market valuations, trends, and their expectations for local and international markets in 2012.

Even if you don’t get all of your picks reviewed, you’ll get the benefit of comprehensive research on no less than 12 of the most interesting stocks on the Australian share market for 2012: What to buy, what to hold, and what to get rid of!

The Panel consists of:

Geoff Saffer
Head of Corporate Research
Australian Stock Report
Fundamental Analysis

Carl Capolingua
Head of Education
Australian Stock Report
Technical Analysis

Kel Butcher
Professional Trader, Author, Trading Coach
World Markets

Your 2012 Portfolio Review Ticket Includes:
>> a copy of Kel Butchers’ latest book
>> sumptuous buffet lunch
>> refreshments on arrivals

Portfoio Review Locations and Dates:

Sydney - Saturday, February 18, 2012 @ Sir Stamford at Circular Quay, 93 Macquarie Street.

Registrations: 8:30 AM, Duration: 9:00 AM – 13:30 PM. Click now to reserve your seat.

Melbourne - Saturday, February 25, 2012 @ Crowne Plaza, 1-5 Spencer Street.

Registrations: 8:30 AM, Duration: 9:00 AM – 13:30 PM. Click now to reserve your seat.

Brisbane - Saturday, March 3, 2012 @ Brisbane Convention & Exhibition Centre, cnr Merivale & Glenelg Streets.

Registrations: 8:30 AM, Duration: 9:00 AM – 13:30 PM. Click now to reserve your seat.

Perth - Saturday, March 10, 2012 @ The Studio Room, Level 2, Burswood Convention Centre
Bolton Ave & Great Eastern Hwy.

Registrations: 8:30 AM, Duration: 9:00 AM – 13:30 PM. Click now to reserve your seat.

Tickets for the Portfolio Review are only $44 (single) of $66 (double). Click now to learn more about this must attend event.

James Hardie Industries (ASX:JHX) is a leading international building materials group that produces a wide range of fibre cement building materials used in the exterior and interior of residential and commercial buildings.

The company is also the largest seller of home siding (imitation wood) in the US, and produces fibre cement in the US, Australia, New Zealand and the Philippines.

Approximately 80% of JHX’s sales come from the housing industry, and the majority of this exposure is via the US housing market.

Although the US property crash has been a millstone on JHX, recent evidence suggests the market may have turned the corner.

JHX focus on efficiency and market share gains has placed it in an advantageous position to benefit from increased US housing activity.

US housing recovery

Although the US housing sector has been in a well established decline for much of the past five years, recent evidence is pointing to a long-awaited recovery.

Among the relevant housing indicators for James Hardie are housing starts and building permits.

Housing starts measure the number of new monthly building constructions, whilst building permits are more of a leading indicator in that they measure the number of new monthly residential building permits.

Since May 2011, both these indicators have been steadily rising in a sign Americans are beginning to take advantage of the country’s record low interest rates.

Furthermore, we see this momentum continuing due to the slowly strengthening US jobs market and the Federal Reserve’s pledge to maintain low interest rates until the end of 2014.

Operating results

In late November, JHX reported a 1Q12 net operating profit of US$41.2 million, which was double its result in 1Q11.

Despite reporting low demand, James Hardie was able to achieve its profit on the back of operational improvements such as a reduction in fixed costs, as well as an increased share of the fibre cement market.

This increased market share, positions JHX well in the event of an acceleration of the US housing recovery.

Outlook

JHX forecast FY12 net operating profit of US$126 – US$140 million.  Although management was cautious about the outlook for US housing, recent data points to a noticeable pickup in this industry.

With US employment inching higher, housing affordability high and the Fed committed to a record low interest rate environment, there are enough incentives to drive continued improvement in residential construction activity.

We at Australian Stock Report believe that a focus on cost control and increasing market share has placed JHX in a strong position to leverage off any US housing recovery.

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QR National (ASX:QRN) is Australia’s largest rail freight operator and the world’s largest rail transporter of coal from mine to port for export markets.

QRN is a provider of specialist rail engineering, construction and maintenance services in Australia, operating a network of five terminals and more than 40 depots across five states.

The company not only transports minerals but agricultural goods, and is a significant transporter of grain.

Since being privatised by the Queensland government in November 2010, QRN has been a stock to watch with a large percentage of retail shareholders.

QRN has faced some major headwinds since listing, principally the early-2011 flooding and cyclone in that state.

However, the company proved its resilience by managing to record a healthy FY11 underlying profit despite the impact to coal volumes from the floods.

The expansion into the WA and NSW markets also positions the company well for future growth.

Profit shines despite floods

QRN delivered an FY11 net profit of $349.5 million, which compared to a $36.8 million loss a year earlier when it was still owned by the Queensland government.

QR National faced a number of difficulties last year due to the Queensland floods, yet still managed an 11% lift in revenue and a 35% rise in underlying EBIT.

The growth in earnings was achieved due to the company’s focus on cost management and better revenue quality (more customer-focussed contracts).

With a net gearing ratio of less than 10% at the end of FY11, QRN’s balance sheet was in strong enough shape financially to pursue growth initiatives.

Volumes down, but significant growth potential

The Queensland floods had a big impact on QRN’s coal haulage volumes, and the company is yet to fully recover from the damage.

The slow recovery in Queensland coal volumes necessitates an ongoing focus on cost initiatives as well as pursuing new growth opportunities.

The company has recognised the importance of that second point, and is looking to expand its presence in the NSW Hunter Valley coal region and WA’s lucrative iron ore market.

QRN recently signed an iron ore haulage contract with the Karara Iron Ore Project, which is expected to deliver $900 million in additional revenue over the next ten years.

That is not say QRN has forgotten its core Queensland market.  Asciano and QRN recently signed a multi-year deal with Rio Tinto to haul millions of tonnes of coal from its Queensland mines.

Importantly, this deal will leverage QRN’s $1.1 billion project to expand the Goonyella-Abbot Point rail network link.

Outlook

QRN’s management has thus far proven its ability to grow earnings in periods of turbulence.

A focus on improving operational efficiency paid dividends for the company in FY11, and given the slow recovery in Queensland coal haulage, we would look for similar diligence this year.

Along with cost initiatives, QRN is positioning itself for growth via the Goonyella-Abbot Point project and its expansion into the WA and NSW mining industries.

In our view, the positive momentum will translate into more near-term growth for QRN.

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