We continue this week with the last of the top ten, namely FMG, WOW and TCL. Looking at the key highlights and Sid Ruttala's notes around each.
Fortescue Metals (FMG.ASX)
Firstly, credit where it's due, the CEO (Elizabeth Gaines) has done a stellar job in turning around the business, cutting debt and costs. From a numbers perspective, a record EBITDA of $8.38bn USD ($10.99bn AUD) and NPAT of $4.25bn USD ($5.85bn AUD). More importantly, the free cash flow continued to grow in double digits. From a yield perspective, the company's 100c p/s was certainly above the market expectations and represents a 77% payout ratio.
In terms of capex and additional projects, the two majors in the pipeline are Eliwana and Ironbridge. This is in addition to Pilbara Energy Connect which aims to decrease the firm's carbon footprint by investing in hybrid solar-gas transmission infrastructure. Currently, capex stands at approximately $1.96bn USD for 2020 with guidance of $3.4bn USD in 2021. Although this does represent a substantial increase, it puts the company in a strong position for the future with my expectations being a substantial decrease (i.e. 50-60%) post-2021.
Red Flags & Risks: The biggest red flag is the current share price at $18.25 AUD per share, this represents a substantial premium to NAV and even small fluctuations in the price of ore could lead to amplified downside risk from a valuation perspective. That said, from a cost-discipline and management perspective, I could not find fault (not for lack of trying). The biggest metrics to watch going forward will be steel production in China (and thus the trade relationship that underpins it) and the infrastructure pipeline both domestically and abroad. We would guess that there will be a fair amount of infrastructure spending in the coming years given the need for stimulus globally.
My Expectations: Personally, I remain bullish about iron-ore spot prices, even with the possibility of Brazil coming back online, due to the amount of fiscal stimulus that is being touted across the planet as mentioned above. This is pure-play on exposure to that growth trend. Though the security remains overvalued from a historic perspective, Fortescue is one great Australian business that fits well into a portfolio despite the downside risk (mainly due to the substantial run in the share price).
Dividend Yield: The current dividend yield stands at an exceptional 9.6% assuming a price of $18.37 AUD.
On a nominal basis we don’t expect this to stay put through the next FY due to the upcoming elevated capex. Over the long run, we expect the company to maintain a consistent payout ratio (above 70%).
Not surprisingly, Woolworths was one security that effectively behaved as a hedge during the Covid-19 market sell-off. That being said, it remained consistently volatile calendar year to date, the share price returning 2.29% since January. Amidst the lockdowns and stay at home trends, there has been a spike in home consumption increasing the volumes but reducing the frequency (i.e. large bulk orders and less frequency in orders).
This is one security that has been on my radar ever since Amazon’s entry into the market in 2017. Despite the doom-and-gloom type hype associated with the move, WOW has been adapting and growing it’s business consistently. Online sales growth came in at 69%, a stellar result that equated to 100% of the sales growth which stood at 8.1%. Normalised EBIT came in at 8.8% (assuming the exclusion of the hotels since this was an exogenous event, we would exclude this particular metric in assessing management). Australian Food continues to grow in the high single digits with the NZ business growing at a double-digit rate.
What has been pleasantly surprising was the inventory turnover which was pushed down to 37 days and indicates that management has been forecasting in a reasonable manner. The lower than expected capex was surprising and, though taken well by shareholders, is not a positive (in this author's opinion at least).
Red Flags & Risks: Management seems to be disciplined when it comes to cost management and balance sheet discipline but there is uncertainty around the divestment of Endeavour and the profitability of same-store sales. If the Endeavour divestment is done at a reasonable valuation, it could put some cash in the pockets of shareholders though. Big W somewhat surprisingly beat my expectations, though I believe it would be better off sold rather than remaining a part of the broader group.
The competition from pure-play online retailers could put downward pressure on profit margins (including price deflation). The competition could also come in the form of convenience stores. The key will again be in the delivery, turning existing stores into effective distribution centers (DCs). What caught my eye in this instance was the partnerships with Sherpa, Uber and Drive Yellow for last-mile delivery, a problem that remains the single biggest headache for retailers both in Australia and globally.
My Expectations: Not a growth play but rather a play on the balance sheet (bottom line as opposed to top-line). Much will be dependent on continuing to increase inventory turnover, reinvestment in IT and last-mile delivery. The business’s competitive advantage could also come from regional areas where existing store-presence gives them a head-start on online retailers (i.e. stores as DCs). The divestment of Big W along with Endeavour would make the business much more manageable and focused in my view.
Dividend Yield: The current yield stands at 2.5% assuming a share price of $37 AUD.
This is likely to stay consistent at around $1 AUD per share (give or take 0.2c) for the foreseeable future as the business continues to reinvest in order to keep up with competition and margin pressure.
Transurban is one company that sits on the frontline for the Covid economy and not in a good way. Government lockdowns and policy responses have meant that all major markets have been impacted including Montreal, Melbourne, Sydney and to a greater extent Washington. Numbers-wise, EBITDA stood at $1.89bn AUD, representing a decrease of 6%, while revenues were down approximately 3%, coming in at $2.492bn AUD. Of this, the North American operations represented a less than stellar figure of $154m AUD. Traffic restrictions across key regions, including Melbourne, are likely to take a further toll on the company. July traffic declined more than 25% in fact with the biggest negative coming from Citylink being down close to -48%.
That said, while the current situation does seem rather gloomy, TCL remains relatively well-capitalised though debt and gearing has continued to increase to 35%. What is more interesting is the pipeline of additional projects, the more attractive of these being the M6 extension, M12 Motorway, in Washington (with the announcement of the Capital Beltway Accord) and Montreal set for a toll increase of 14% (A25).
Red Flags & Risks: Much of the businesses immediate future will be contingent upon the whims and vagaries of government policy as well as economic conditions, mostly Covid-19 related. What was been surprising is the resilience of commercial and large trucking haulage. It will be incumbent upon management to win additional business in North America where the groups best prospects for sustained growth are likely to come. From a macroeconomic perspective, the business depends upon the urbanisation of populations which, from a long-term secular growth perspective, could start to decline or at the very least slow somewhat as a result of the pandemic. We have seen signs, especially in North America and to a lesser extent Australia, of a move out of the city for opportunities in regional or suburban areas or, in a pandemic-accelerated trend, even the same opportunities but with the option to work from home. For those interested please feel free to look at the dislocations in the San Francisco property market, with increasing movements of populations away from the main city.
In the shorter term, the bigger concern for me was the slight but still telling increase in costs, of 2.3%, despite the fall in earnings. I would have liked to see this remain flat.
My Expectations: The business will focus on expanding its North American footprint going forward, especially with the likelihood of fiscal stimulus being directed toward the upgrading of existing infrastructure as well as build out of new projects. Similar trends are likely in Australia as governments are forced to stimulate growth. TCL, while currently seeing some short-term pain, will benefit substantially from these catalysts as long as they win net-new contracts. Management does have a proven and consistent track record when it comes to this.
Earnings growth will remain less than stellar in the short-run unless we see traffic levels revert to something near pre-covid levels, which in my opinion may take longer (at least eighteen months) than many seem to expect. Over the medium-to-long run, given the likely additional infrastructure pipelines across all the geographies that the group operates, there are catalysts in the form of net-new wins or contracts. So, for the more patient long-term investors it might pay to stay invested as long as the expectation is not for a quick turnaround.
Dividend Yield: 3.6% assuming a share price of $13.97 AUD.
I expect the payout ratio to be consistent and the nominal dividend to remain around 50c p/s for the foreseeable future. Over the long-run (I’m talking 3+ years) I would expect to see this grow in the mid-to-high single digits. This is based on my assumption that traffic volumes won’t return to a normal or pre-covid level for at least the next eighteen months and the fact that any additional contracts would require capex and put upward pressure on the cost base.
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