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Rudi’s View: IPH, G8 Education, And NextDC

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Apr 19 2018

In this week's Weekly Insights (this is Part Two):

Investing In Oil Price Momentum, And Other Twists
-Conviction Calls
-G8 Education, A Yield Trap?
-NextDC, An Update

-Willem Buiter, Myth Buster
-Rudi Talks (updated)
-Rudi On TV
-Rudi On Tour

[Note the non-highlighted items appeared in part one on the website on Wednesday]

Conviction Calls

By Rudi Filapek-Vandyck, Editor

Fund managers at Wilsons have increased exposure to BHP ((BHP)) and to BlueScope Steel ((BSL)) recently, while waving goodbye to Sydney Airport ((SYD)) and to Macquarie Atlas Roads ((MQA)). However, the big deal occurred over at stockbroker Morgans where some of the model portfolios have given up on IPH ltd ((IPH)), with the holding having seriously failed to live up to expectations.

Let's call it a value trap, shall we?

Those responsible for the investment still called it a "difficult decision", given apparent value in today's beaten down share price, but they decided that switching into Bank of Queensland ((BOQ)) ahead of the interim results release was a better way to play the current context. Interestingly, Morgans has also nominated four candidates that might be added in case of further share price weakness: Link Administration ((LNK)), Australian Finance Group ((AFG)) -still erroneously referred to as AFG Group- Rio Tinto ((RIO)) and Aristocrat Leisure ((ALL)).

IPH ltd listed on the ASX in late 2014 and at first enjoyed buoyant investor sentiment which took the share price to $9.30 by late January 2015, but it has been relentlessly downhill since. Recently, the shares have traded range bound around the $3.50 price level, not far off from prices seen at the time of the IPO now 3.5 years ago.

The company's market updates have on multiple occasions unimpressed the market, with further share price losses the result. Over at stockbroker Morgans, the experts concede "Ultimately our confidence in IPH's management, and to a lesser extent its business model, have taken a knock following recent results falling short of expectations".

Morgans' Growth Model Portfolio has been topping up on Apollo Tourism & Leisure ((ATL)) and Motorcycle Holdings ((MTO)), while selling Seek ((SEK)) and CYBG ((CYB)). Preferred yield/income plays are Aventus Retail Property ((AVN)), Viva Energy REIT ((VVR)) and Centuria Industrial REIT ((CIP)).

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Analysts at Morningstar Australia (previously known as Huntley's) have selected 11 companies as their Best Stock Ideas. Investors should note, the Morningstar methodology has a firm bias towards intrinsic value, with selected stocks all trading well below what Morningstar calculates they're worth.

The 11 selected ideas are: Aveo Group ((AOG)), Bapcor ((BAP)), Brambles ((BXB)), Contact Energy (NZ listed), Domino's Pizza ((DMP)), Healthscope ((HSO)), MYOB Group ((MYO)), QBE Insurance ((QBE)), Ramsay Health Care ((RHC)), Telstra ((TLS)), and Westpac ((WBC)).

G8 Education, A Yield Trap?

If there is one important lesson to be learned from investors' disastrous Telstra ((TLS)) experience over the past three years it is that dividend sustainability trumps yield, which is why sticking with a company, no matter how large, that is only able to retain its dividend over a long period of time, is fraught with danger, because the day might arrive when the dividend can no longer be maintained and that also implies a much lower share price.

Telstra shares peaked at $6.70 on February 3, 2015. On Friday, they closed at $3.10 for a total share price decline of nearly -54% in a little over three years. That juicy looking dividend has come with one mighty burden. Hopefully, those investors still holding Telstra shares today have learned a few valuable lessons along the way.

For what it's worth: experts such as Martin Crabb, CIO over at Shaw and Partners, are now suggesting here might be a buying opportunity, because "everything has a price". Prospective dividend yield is for 7%+, plus franking.

One other stock that has followed Telstra's example in recent months is G8 Education ((GEM)), generally liked by income seeking investors but not so by others, hence why the share price has fallen from around $4.60 in October last year to a low of $2.40 in early April. That makes for a painful -48% loss in less than seven months.

All of a sudden Telstra doesn't look that bad.

But don't be mistaken; the reason behind G8 Education's share price weakness is similar. The share market is anticipating lower dividends, not only for FY18, but also for FY19. Unfortunately, and this in contrast to what happened to market consensus forecasts for Telstra post 2015, this is not yet reflected in FNArena's consensus forecasts available through Stock Analysis on the website.

We don't know how, why or when exactly stockbroking analysts will start updating their view and the underlying numbers, but most forecasts are for a cut to 20c from 24c in each of the three previous financial years, to be followed by a swift return to dividend growth. Not so with RBC Capital and Morgan Stanley who both updated their numbers recently.

The key take-away here is that the above mentioned recovery in profits, cash flows and dividends is likely to be pushed out further into the future and FY19 is more likely to see a total dividend of 18-19c, say those analysts. If correct, this still represents a juicy yield of 6.9%+, plus 100% franking, but the point here is this still leaves a major gap with the 9.2% represented by the 24c shareholders got accustomed to.

The latter, of course, easily explains the fall in share price. The key question for investors and for shareholders is now: have we seen the bulk of the stock de-rating?

The sharp fall in share price, further exacerbated by a capital raising in between, and the still-high implied yield on the downwardly revised numbers suggest the answer might be affirmative. This requires no more bad news or pushing out further the anticipated recovery. With most analysts yet to succumb to the new trend set by RBC Capital and Morgan Stanley, however, the shares might see more selling pressure emerging on the back of further analyst updates.

G8 Education is likely to provide market guidance during Friday's AGM this week. In addition, a new child care funding regime will be in place from July onwards and the communis opinio is that the new framework should be more favourable for operators such as G8. Shareholders will be hoping this is the case, meaning G8 Education doesn't have to follow Telstra's lead all the way to yet another dividend cut in a few year's time (which is widely anticipated for Australia's largest telco, unless current management can miraculously withstand sector pressures and stage a sustainable come-back before then).

As they say, sometimes, in the movies: hope is not a good strategy.

NextDC, An Update

Let's be brutally honest about this: too many investors, both professional and retail, have been focusing on finding value among (apparently) cheaply priced equities during a time when the share market was making a decisive swing in the opposite direction.

As should be clearly visible today on backward looking share price charts, many stocks including AMP, Brambles, G8 Education, Healthscope, Telstra, IPH ltd, the major banks and Vocus Communications certainly looked "cheap", but they have essentially gone nowhere fast, if not become "cheap-er" as time passed by.

In contrast, share market investors, as a collective, developed an almost insatiable appetite for secular growth stories with manageable risk. The past four years have been tough on those naively buying into cheap looking, out-of-favour, low growth companies while pampering those investors prepared to join the growing fan bases of companies like CSL, Orora, a2 Milk, Altium and Aristocrat Leisure.

Cloud hosting infrastructure provider NextDC ((NXT)) is very much part of the latter group, as illustrated by the observation its share price has multiplied by a factor 6x since listing in late 2010. The bulk of these gains occurred since 2015. That's when I got interested.

My interest was fueled by my macro-view that global growth will likely remain lower than pre-GFC, with household budgets globally post-2014 consistently under pressure, and in such an environment it is best to seek out reliable, high quality, multi-year growth stories that don't carry too much risk.

NextDC had the potential to meet the sought after profile, but given it still was an early stage business, I was most concerned about getting on board too soon. Given the business model consists of spending billions on infrastructure first, and then attracting customers and filling up the capacity, it goes without saying that, as the business matures, the overall risk profile becomes more acceptable for conservative investors like myself.

In the end there were three additional factors that pulled me over the line: management was highly regarded inside the industry, demand and demand projections were very strong for possibly the decade ahead, and National Australia Bank had done due diligence and agreed to providing additional capital via bank loans and corporate bonds.

You can criticise the banks for many things, but when they are being invited to lend money to an unknown, early stage, non-profitable entrepreneurial enterprise, their response is likely to be rigid, conservative, and with a lot of eye for details.

I am still a happy shareholder today and intend to use the latest capital raising to buy additional shares. NextDC's existing facilities are ranked among the highest quality, worldwide. Management has consistently over-delivered. The obvious black spot is a public dog fight with the new owners of the properties that shelter its data centres, but there's no immediate threat for disaster.

Most importantly: demand for cloud services and for data, and thus for data hosting facilities, continues to grow strongly and is expected to continue doing exactly that for years into the future. There is no better proof than the cloud hosting businesses built by market leader Amazon. These have been consistently growing at double digit percentages (look it up).

In between the global corporate mastodons, like Amazon, Microsoft, Oracle, et cetera, sit independents like NextDC, which play a niche role in providing "neutral" service both to corporate customers, to telcos, and to other providers of cloud hosting services. There is a strong business case for such non-aligned service providers with demand growth strong and extra capacity commanding billions of upfront investment.

As with every other business, competition is the fiercest enemy of shareholders, but do we really have to worry today about price deflation and discounting when demand growth remains strong and capacity is in constant catch-up mode? That too is the message that stands out from NextDC's latest capital raising.

To quote from the presentation slides that have been posted on the ASX website in support of the capital raising: "NextDC continues to experience very strong demand for its premium data centre services, which has increased the Company's confidence in the size and nature of the long-term demand for its data centre services".

Ultimately, the key message here to investors is: don't stare yourself blind on Price-Earnings (PE) ratios and/or (absence of) dividend yield. It's growth and how this translates into added shareholder value that ultimately defines your happiness as an investor and shareholder.

Rudi Talks

Audio interview about joining this year's upward momentum in oil&gas stocks:

http://boardroom.media/broadcast/?eid=5ad5708d03600639530e914f

Last week's udio interview about seasonality in the share market, and whether this year might be different:

http://boardroom.media/broadcast/?eid=5acd7619f0a61473eeeeedef

Rudi On TV

This week my appearances on the Sky Business channel are scheduled as follows:

-Monday, 7.30-8pm, with Peter Switzer
-Tuesday, 11.15am Skype-link to discuss broker calls
-Thursday, noon-2pm

Rudi On Tour

-Presentations to ASA members and guests Gold Coast and Brisbane (2x), on 12 & 13 June
-ATAA members presentation Newcastle, 14 July
-AIA National Conference, Gold Coast QLD, July 29-August 1
-Presentation to ASA members and guests Canberra on August 3
-Presentation to ASA members and guests Wollongong, on September 11
-Presentation to AIA members and guests Chatswood, on October 10

(This story was written on Monday 16th April and the first part was published on the day in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website. Part two will be published on the website on Thursday).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via the direct messaging system on the website).

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Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
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– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
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(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)  

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