Hunter Hall – Sell Half HHL around $12.63

Hunter Hall has handsomely rewarded those Members who followed our initial buy recommendation back in March 2001. The fund manager’s impressive investment performance has driven the strong share price growth through consistently increased funds under management (FUM) and fee revenue.

This trend has continued in the first half through to 31 December 2007, which saw FUM rise by 32% to $2.82 billion. And compared to the same period in 2006, first half net earnings expanded by 42.5% to $8.99 million.

Given the possibility of continued volatility in global stockmarkets however, such strong growth is unlikely to continue through the year ahead. In fact, management expect second half earnings to be some 20% below the latest result.

Longer term, the company’s strict value based investment philosophy should prove resilient in the face of tougher market conditions. Indeed, Hunter Hall share our view that the current period will present many excellent opportunities, laying the foundation for strong investment returns in the future.

From a charting perspective though, the January correction has interrupted the long-term upward trend. Although the stock has found near term support at $12, we believe further falls are possible. Given the possibility of continued stock price weakness, we believe the time has come to take some profits off the table. As such, we recommend Members sell half of Hunter Hall around $12.63.

Please note: Hunter Hall will be reduced in the Fat Prophets Portfolio as per our recommendation. However, the stock will trade ‘ex’ a 36.7 cent dividend on February 28. As such, depending on individual circumstances, Members may wish to delay reducing their exposure in order to receive the dividend.

Notwithstanding the potential for a weak stock price performance in the months ahead, we continue to like the business as a long-term investment. Accordingly, we will monitor the price action with a view to re-instating our exposure once downside risks have receded.

Platinum Asset Management – Hold PTM

As Platinum Asset Management’s share price performance suggests, 2007 has not been one of their better years. On a pro-forma basis, net earnings for the six months to 31 December fell 7.9% to $98 million.

As we have discussed in the past, Platinum’s reputation for delivering consistently strong investment performance has been tarnished over the last year or so. All but one of the fund manager’s investment products recorded negative returns for the 12 months to 31 January 2008.

The poor performance has led to a steady outflow of funds, as both institutional and retail investors have chosen to allocate their capital elsewhere. From $21.54 billion as at 31 December 2006, funds under management fell to $18.71 billion at the end of last month. And the trend is set to continue through to the end of February, following an additional $352 million outflow during the month.

Nevertheless, value investing is contrarian in nature and prone to periods of underperformance. Certainly, we do not believe that the currently weak investment performance is symptomatic of a fundamental deterioration in Platinum’s investment ability.

As such, we will continue to monitor the company’s stock price for a potential buying opportunity. On this front, the recent slowing of downward momentum is encouraging, however, it is too early to gauge whether a lasting low has been established.

Tox Free Solutions – Hold TOX

Tox Free Solutions reported a strong first half result last week. The company provides waste management services to predominantly the resources sector in Western Australia. Revenue of $15.9 million and earnings before interest, tax, depreciation and amortisation (EBITDA) of $6.38 million represent a year-on-year increase of 100% and 70% respectively.

Net profit growth was just 7%, to $3.1 million, however this was largely due to an income tax expense of $1.4 million, whereas Tox paid no tax in the previous corresponding period. For a growing company like Tox though, the operational profit figure is more relevant.

Tox focuses on EBITDA as a measure of operational performance, and on this front the outlook is positive. The company commented that it is ‘already on track to achieve, if not exceed, its forecast EBITDA of $13 million for financial year 2008’. We believe this will translate into net profit for the year of around $8.5 million, placing Tox on a PE of approximately 15 times 2008 earnings.

The company’s strong growth is being driven both organically and through acquisitions. Given the fundamental strength of the markets that Tox services (mining, oil and gas sectors), we believe its growth prospects remain solid.

Despite the positive outlook, Tox’s share price has suffered as investors have shunned ‘growth’ companies and small cap stocks in general. The relative illiquidity of the stock has also contributed to the price falls.

We believe the recent pullback puts Tox into the ‘cheap’ category. According to consensus estimates, the stock trades on a 2009 PE of just 11.5 times. In this market though, a cheap stock can get cheaper and before recommending the stock as a buy to Members, we’ll await confirmation of our bullish fundamental views from the charts.

On this front we’d prefer to see some more consolidation around current levels and a hold above the January low of $1.70. A rise above the $2 mark would be considered highly encouraging. As the 2008 financial year draws to a close, investors will begin looking to 2009 and the company’s solid fundamentals will come into focus (i.e. low price to earnings ratio and high return on equity).

Fone Zone – Hold FZN

Fone Zone unveiled a strong set of first half numbers today and reaffirmed full year guidance for strong growth in both revenue and operating profit. For the six months to 31 December, net profit after tax grew more than 200% to $6.2 million, while earnings per share increased by 197% to 4.6 cents.

Last year’s acquisition of Apple products re-seller Next Byte, as well as improved conditions in the Fone Zone business (mobile phone re-selling), led to the increased earnings.

Members will recall that Fone Zone suffered a horror fiscal 2007 due to Telstra’s heavy subsidization of 3G mobile phones. Combined with a lack of handset range, this savaged Fone Zone’s margins.

But as highlighted at last year’s AGM, margins are again improving following a return by Telstra to more normal mobile phone sales practises. Gross operating margins in the mobile phone business increased by 2 percentage points to 45%.

A concern is that the balance sheet shows current liabilities to exceed current assets. We have discussed this with management and they have acknowledged the need to manage their working capital position tightly. During the company’s growth phase, they continue to expect current liabilities to slightly exceed or match current assets.

Fone Zone reaffirmed full year guidance of $300–$320 million in revenue and $23.5-$24.5 million in EBITDA (earnings before interest, tax depreciation and amortisation). This should translate into net profit of around $11 million, which puts the stock on a forward PE of around 7.7 times.

Fone Zone declared a dividend of 2.5 cents, payable on 2 April.

Telstra – Hold TLS and TLSCA

Telstra posted a strong half yearly result last week, with operating earnings growth of 6.2% on revenue growth of 5.3%. While the numbers were hardly spectacular, they beat market expectations and raised the prospect of stronger than expected future growth.

Strength in mobile phones and broadband, driven by the Next G wireless network, were the highlights of the result. The smaller than expected decline (only 2.1%) in the fixed line network also impressed.

There is much to discuss regarding the Telstra result, including the progress of the transformation plan and the regulatory outlook. As such, we will provide in-depth analysis in next week’s report.

For the time being, we continue to recommend Telstra as a hold. The better than expected result, combined with a defensive earnings profile has seen Telstra become a market favourite in an extremely uncertain environment. As those who bought into T3 will know, this is in stark contrast to the prevailing sentiment of late 2006.

Avexa – Hold AVX

Given that Avexa’s primary product is still in the development stage, the first half loss of $17.3 million is certainly not alarming. In fact, in a positive indication the company’s operating cash consumption for the six months was below budget, at $9.9 million.

And with $66.6 million in cash on the balance sheet (having raised $79 million last year), the company is well able to finance the final stages of development for their primary product, Apricitabine (ATC).

ATC is an HIV treatment, which recently became eligible to enter the final stage of testing (phase III) prior to commercial release. Given that all HIV treatments to enter phase III in the past have gone on to commercial release, Avexa is tantalisingly close to gaining a share of the US$7 billion HIV market.

Despite this potential, the stock is well down on our initial buy price. Given the positive outlook for the company hasn’t changed, we put this down to the market environment. In nervous markets, stocks like AVX get hit the hardest.

Biota – Await buying opportunity

Last week, Biota announced a $5.5 million half yearly profit, on the back of an increase in Relenza royalty revenues and collaboration income. Relenza is a licensed product sold and marketed by Glaxosmithkline. While profit growth was strong, legal costs associated with litigation against Glaxo increased to $8.6 million from $3.4 million in the same period last year.

The result looked good, and was largely anticipated by the market, as evident in the stocks rally in the weeks prior to the result release. Admittedly, this rally took us by surprise. Given the hefty fall in the share price in recent months, we anticipated a period of base building and consolidation.

From a technical perspective, the momentum of the recent rally is waning, so we would not be surprised to see a pullback and further consolidation around these levels. We are scheduled to meet with management in mid-March to discuss the recent results. We will provide another update on the company then.

Austal – Hold ASB, await buying opportunity

West Australian ship builder, Austal, delivered net earnings of $29.9 million for the six months to 31 December 2007. The result represents an impressive 63% growth in comparison to the 2006 first half.

However, a significant factor in the earnings growth was an increased number of progress payments made to Austal during the period. This in effect has transferred a portion of second half revenues to the first half. As such, management expect second half revenues and earnings to fall.

In terms of the longer-term outlook, today we attended a briefing by senior management including Chairman John Rothwell and head of Austal USA, Bob Browning. The mood among management was upbeat and certainly reinforced our positive view on the company’s future growth prospects.

As we discussed last week, the defence business is the core growth engine with the potential for a second LCS order as soon as August this year. Certainly, based on anecdotal evidence Austal’s more flexible trimaran design is viewed favourably by the Navy in comparison to the competing monohull in development by Lockheed Martin.

Meanwhile, sales enquiries remain strong on the commercial side and there is the potential for a further extension to the recent ferry orders to service Macau.

QBE – Hold QBE

With the market firmly focussed on companies’ future outlook, any indication of potential weakness is being harshly treated. This point is highlighted by QBE, who today reported a 30% increase in full year net earnings to $1.93 billion. In contrast to the company’s history of over achieving however, the result fell short of expectations and the stock subsequently fell.

Under the direction of CEO Frank O'Halloran, the insurer has pursued a successful strategy of growth through acquisition in the past few years. As a result though, more than 70% of group earnings are sourced overseas, which has left QBE exposed to the stronger Aussie dollar.

In addition to currency exposure, the company expects the insurance margin to decline in 2008. This subdued outlook weighed on the stock today, with the share price falling over 10%. Our initial thoughts are that this is an over-reaction. We will review the result in depth over the next few days and provide a more detailed report in a subsequent issue.