The Month In Review: March 2010
Patrick Stewart
Our bullish long term view of the market continued through March, especially in relation to China and the resources sector. There was plenty of action, with a takeover bid for Arrow Energy from Royal Dutch Shell and PetroChina bringing the sector back into the spotlight. Macarthur Coal Ltd (MCC) was the next to go, receiving a left field bid from New Hope Corporation Ltd (NHC), but considering NHC’s huge stockpile of cash, there was always a chance they would announce a big acquisition.
One company that will benefit from all the commotion and possibly have a second chance to show its credentials as a takeover target is Oil Search Ltd (OSH). After announcing that the PNG LNG project, in which it holds a 29% stake, has finalised the funding package for the entire project, the company finds itself right under the spotlight that is seemingly shining so bright on the sector. This is exactly what we needed considering the lack of near-term catalysts and we now expect only more action in the coming months.
Not wanting to miss out on the action, it was imperative that we moved fast on gaining more exposure. In the first few days of the month, we took up a holding in Bradken Ltd (BKN), a supplier of differentiated consumable products to the resources and freight rail industries. In the past, we have rarely recommended buying mining service companies compared to the mining companies themselves, despite the theme in the world becoming more reliant on outsourcing. During the GFC, many of these mining service companies were hit hard as mining activity died down and mining companies looked to cut costs even in continuing operations. So we saw significant revenue declines as well as margin squeezes, but there are strong signs that the worst has passed and the outlook has brightened significantly.
BKN, in its recent interim report, reported one of the strongest results relative to expectations. While revenues were down as expected, there were aspects of the result which both suggested that this is a higher quality company than the market previously expected, and that market conditions were improving. It’s come as no surprise then that BKN is currently 21% ahead of our $6.60 entry price.
Staying with the trend within the resources sector, we next bought Santos Ltd (STO) at $13.90 for its value and exciting prospects as another takeover target. With the press suggesting AOE would reject the offer from Shell and PetroChina, there was growing talk that STO looked like a logical target for the would-be predators. As it turns out, the board of AOE has agreed to a revised offer with the Shell/PetroChina joint venture and intends to accept the offer in the absence of further bids, though the likely further consolidation in the industry has given STO some solid backing. The company has ridden the wave of confidence in the market and has been relishing the rumours surrounding them directly. STO is a comfortable 6.5% ahead of our entry level.
There is little doubt that as time has passed, coal seam gas (CSG)-fed liquefied natural gas (LNG) is becoming a force. The rumour mill went into overdrive at the close of the month as speculators were predicting WPL as a likely bidder for STO due to the company’s already planned LNG plant in Gladstone, Queensland. After the press reports, both WPL and STO announced that there was no truth to the rumours, and while that doesn't rule a tie-up out of the question, we are inclined to believe that WPL is not looking at STO, although we do feel there are plenty of potential predators such as BP, which has apparently looked at STO in the past and has also been left behind in the CSG space. We continue to feel that STO stands out as a likely takeover target and the expected activity in the sector will be a positive for STO whether it remains independent or not.
Finally, on the buying side of things, an interesting opportunity presented itself in the form of Corporate Express Australia Ltd (CXP), offering an appealing arbitrage situation after it announced that it had agreed to a friendly deal with its major shareholder, the US giant Staples, whereby shareholders would receive $5.60 per share. So with the stock trading at $5.57, why would we recommend buying the stock? The first reason is the small chance that Staples increases its offer to ensure it gets to the 90% acceptance rate (one of the conditions to the offer), and secondly, the reason we feel the investment is so attractive is that Staples has agreed to have CXP distribute some of its large franking credit balance by paying a large fully franked special dividend. This decision is subject to a favourable ruling by the Australian Tax Office (ATO), so there is a chance that it will not eventuate, but the risk is worth taking considering members will not lose any money if the ATO knocks this on the head.
On to the selling, and things were a little less exciting. We exited Foster’s Group Ltd (FGL) mid month for a small profit. We got into FGL to gain exposure to an underperforming company with the potential upside of corporate activity, but as news broke that they had no intention of demerging, we felt the catalyst for holding was no longer evident, so exiting was our only option.
Two stocks that have long plagued our portfolio have been Brickworks Ltd (BKW) and Elders Ltd (ELD), remnants of the lucrative capital raising that became so familiar to us all in 2009. Taking full advantage of the strong market, we were able to fully exit BKW and partly ELD, as both trades finally exceeded the offer prices of their raising. We managed another small but effective profit on BKW, but were less fortunate with ELD. Taking into account the original buy price on ELD of 36.5c, even as the stock passed its offer price of 15c, we were still behind, but with any luck we will manage to break into profit soon enough. Having waited for the overhang, which was seemingly holding the pair back, proved the right move in the end, but to drop the ‘dead wood’ from our portfolio couldn’t come as more of a relief.