Rudi on Thursday

This story features MACQUARIE GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: MQG

There is more than one reason why this week’s shock demise of the Centro Properties ((CNP)) group makes for a very fitting end to calendar year 2007.

Let’s start with a brief, but nevertheless embarrassing, reference to all experts, commentators, stockbrokers and financial analysts who stated back in August this subprime mortgage-related problem would turn out nothing more than a storm in a cup of tea.

Less than four months later one of Australia’s flagship corporate success stories from the past decade is on the brink of collapsing under the weight of its debt and with no quick fix available. With mortgage lender RAMS Home Loans ((RHG)) hitting rock bottom in September, Centro Properties has now become Australia’s second large corporate victim due to the sheer unavailability of fresh debt.

And similar to RAMS, nobody saw it coming, including the securities analysts who cover the properties sector for the major stockbrokerages in Australia. Centro Properties shares hit their peak a little above $10 in May this year and as concerns about prospects for the US economy and subprime mortgage-related problems crept into the market, the shares gradually ground lower.

By the end of November the shares had fallen below $6. Time to buy? Yessum, said the property team at Citi. In the second week of November Citi decided to upgrade Centro Properties to Buy for the simple reason that the shares had become too cheap and the value on offer had become  too obvious to ignore. At least that’s what the team at Citi thought at the time.

To be fair to Citi, colleagues elsewhere didn’t think there was anything wrong with Centro’s business model or highly geared balance sheet either. JP Morgan had an Overweight rating on the stock at the time and its property specialists equally argued that investors were overlooking the obvious value on offer. Credit Suisse had upgraded to Neutral on the same premise.

Two weeks later  the team at UBS conducted another in-depth analysis which did lead to some serious cutting in the broker’s valuation and price target for the securities. But as UBS’s target “only” declined from $9.50 to $7.07 the analysts didn’t see any reason whatsoever to change their Buy recommendation.

Surely investors would come to their senses eventually.

Soon analysts at other brokerages would start cutting back their estimates and valuations as well, but nobody suspected the downfall of the highly leveraged Centro Properties empire was so near. Until last week when analysts at Merrill Lynch sounded the alarm bells.

Merrills too had had another look into the Centro Properties business model with the team of sector specialists finally concluding investors fears would be proven correct.  On December 14 Merrill Lynch issued the first research report that publicly questioned the Centro Properties business model with the team stating it had lost all confidence. Forced asset sales were mentioned as a genuine possibility. The shares were downgraded to Sell. Unfortunately, for investors, by then Centro Properties shares had already gone into a trading halt and the next opportunity to actually follow Merrill Lynch’s advice would be on Monday – by then, however, the news had hit the street and everyone was selling.

Among the victims was Macquarie Group ((MQG)) whose team of property specialists had been rating Centro shares as Outperform before and throughout the share price decline from $10 to $6. It was only this week when Macquarie joined Merrill Lynch by publicly questioning whether Centro would be able to survive. The shares were downgraded to Sell with a price target of $0.92. Considering the broker’s target/valuation for the stock was still $9.54 on Friday last week, Macquarie’s revision must be one of the most spectacular ever witnessed in the Australian stock market, especially since we’re talking property management - not metals and mining.

Shareholders in the group can take some solace from the fact that this week’s research report by Macquarie analysts came with a special note:  “The Macquarie Group is a substantial securities holder of Centro Properties Group”.

UBS finally downgraded the shares to Neutral on Wednesday. Citi and JP Morgan still rate the stock as Buy, or in their terminology “Buy, High Risk” and “Overweight” respectively.  UBS and Credit Suisse are on Neutral. Merrill Lynch and Macquarie are on Sell.

For the record: prior to Merrill Lynch’s downgrade last week, four of these brokers rated the stock as a Buy – or as an equivalent of Buy. Only two had the stock on Neutral. And nobody seemed too worried about the high expansion pace, the highly geared balance sheet, the complex group structure or the lack of sufficient disclosure. (ABN Amro and Deutsche Bank are probably relieved they ceased coverage of the company sometime during the past eighteen months).

As such, Centro Properties can serve as the prime example of when not to follow stock brokers’ Buy recommendations, even when nearly all of them are of the same view. Look for the deadly signal “this stock has now become too cheap” and ask yourself whether there is an obvious reason why the shares should go up. “Cheap” should never be a reason in itself because, as again shown by Centro Properties this week, what seems cheap today can still drop further in value.

This is why shares of Macquarie Infrastructure ((MIG)) continue to trade some 40% below brokers’ valuations and price targets (yes, most rate it a Buy and they all mention the “cheap” clause) and it is for the same reason that ANZ Bank ((ANZ)) continues to trade at a relative discount to the other banks (all Buy ratings for ANZ are based upon this sector discount).

This brings us to the real reason why the demise of Centro Properties is a fittingly symbolic way to close 2007 for as the Australian share market should still post another strong investment return for the year, the number of fund managers that will have beaten the index this year will be very small. This year’s performance has almost entirely been driven by a small number of stocks, of which BHP Billiton ((BHP)) and Rio Tinto ((RIO)) represent the largest contribution to this year’s gain for the major share market indices.

This has been magnified throughout the year by continuous bloopers by market consensus expectations. Several of the worst performers this year have been among the highest rated stocks at one stage since December 2006. Think Perseverance ((PSV)), or Emeco ((EHL)) or Boom Logistics ((BOL)).

 In all cases research reports recommending investors should Buy the shares mentioned that one deadly signal – “the shares have become too cheap”.

Until reality hit the street.

Investors may want to take this lesson on board, and do some extra research, on the following list of sixteen stocks. These stocks are as at today, December 19 2007, the most highly recommended stocks in the Australian share market as defined by the FNArena Sentiment Indicator. This indicator is based on individual recommendations by ten major equity researchers in Australia.

All these stocks have either a perfect Buy score, or a near perfect score. They are all at least actively covered by five out of the ten experts we monitor daily.

Tassal Group ((TGR)) (Officially the highest rated stock for 2008)
Specialty Fashion ((SFH))
Domino’s Pizza ((DMP))
Galileo Japan Trust ((GJT))
Macquarie Capital Alliance ((MCQ))
Programmed Maintenance ((PRG))
Macquarie Group ((MQG))
News Corp ((NWS))
Caltex Australia ((CTX))
Babcock & Brown ((BNB))
Oakton ((OKN))
Macquarie Leisure Trust ((MLE))
Macquarie Media Group ((MMG))
Singapore Telecom ((SGT))
Norfolk Group ((NFK))

FNArena will take a break after this Friday, December 21. We will be back from January 10 next year onwards.

Best Wishes to you all.

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab Team of Greg, Grahame, George, Chris, Pat, Joyce, Sophia and Paula).

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