Foster’s Group – Sell FGL around $5.77

As we have discussed in the past, time is fast running out for Foster’s (FGL) to deliver satisfactory returns from their wine investments. With regards to this, in FAT360 we highlighted that a US slowdown could prove a significant headwind to the division’s already struggling profitability.

This morning the company released their first half results, which have done nothing to allay our fears. Operationally, the company looks to be travelling well, having benefitted from buoyant economic conditions during the reporting period.

Removing the impact of abnormal items such as asset sales, the company generated net earnings of $393.5 million for the six months to 31 December 2007. The result represents a modest 6% growth on the $371.5 million earned in the 2006 first half.

Our overall conclusion though is that the wine division is likely to continue generating sub-standard returns for some time. While the Australian wine division’s profitability improved considerably, wine sales in the Americas have already begun to slow.

Operational earnings from wine in Australia and Asia Pacific increased year-on-year from $55.5 to $82.1 million. However, the improvement was more than offset by the year-on-year decline in the US, where operational earnings fell to $98.3 million from $144.9. The weaker US dollar contributed significantly to the earnings decline, however even on a constant currency basis, US earnings fell by nearly 12%.

Management commented that weakness in US wine demand became apparent in November and December last year. Given our less than sanguine view of the US consumer, we would expect this weak demand environment to continue for some time, further delaying the recovery in the overall wine division.

In terms of the full year, management are expecting group earnings growth of approximately 10% on a constant currency basis. However, this raises the prospect of single digit growth should the Aussie dollar remain strong.

The company’s defensive qualities have led to the stock price holding up relatively well during the current period of volatility. We suspect this has something to do with the banks no longer being considered defensive, and funds managers re-allocating capital. However, with the likelihood of continued disappointment from the wine division, and risks that the Australian economy may cool in the next 12 months (from RBA rate hikes), we believe the risk/reward profile for Foster’s is no longer favourable.

Given these increased risks, the valuation appears stretched. Foster’s trades on a forecast PE of around 15 times, a premium to the market. Investors are now pricing defensive sectors at a premium! Moreover, Foster’s trades on a fully franked yield of around 4.4%, not particularly attractive.

Regarding the dividend, we are aware that Foster’s trades ‘ex’ a 12 cent dividend on 26 February, however that does not alter our decision to sell.

The prospect of a takeover or a breakup of the company may also be buoying the share price however holding on in the hope that this may happen is not a great strategy. We may be proven wrong, but we feel that better opportunities are emerging in the market. As such, we recommend taking the opportunity to lock in our profits and sell Foster’s Group around $5.77.

Sino Gold – Hold SGX

The company’s White Mountain project recently received a significant boost following an 81% increase in ore reserves, to 6.5 million tonnes at 3.8 grams of gold per tonne. The project’s measured and indicated resource now stands at 1.1 million ounces of gold, compared to previous estimates of 0.562 million ounces.

White Mountain is the company’s second major project, following the initiation of production at Jinfeng last year. The project is currently on track to begin commissioning of the processing plant in late 2008, eventually ramping up to annual production of 70,000 ounces.

Encouragingly, the project remains open to the northeast and at depth, with drilling to continue throughout the year. As such, the potential exists for further resource upgrades in the months ahead.

In other news, severe ice storms have restricted the delivery of coal to China’s power stations, forcing authorities to ration energy supplies in the region of the Jinfeng project. As a result, February’s production at the mine will fall below original forecasts of 12,700 ounces.

However, current expectations are for full power availability to resume around 21 February.

From a cost perspective, lower production volumes result in higher production costs on a per ounce basis. While the latest power disruptions will have only a short-term impact, Sino’s low cost profile is a major component of the miner’s valuation. As such, increasing power disruptions and/or higher energy costs could prove a future headwind.

And increased energy costs are certainly possible given the rising demands resulting from China’s industrialisation and the difficulties related to supplying coal to the nation’s power stations. However, the company’s access to China (potentially the world’s largest gold producer) and strong growth potential presently outweigh such longer-term concerns.

Meanwhile, a choppy triangle consolidation pattern is beginning to form on the charts. Such patterns often represent a temporary pause within the longer-term trend. In the near term, we anticipate further consolidation within this pattern, however once complete, given the resilience of the broader upward trend we anticipate prices will continue above $8.53 to new highs.

Babcock & Brown Japan Property Trust – Hold BJT

As we have mentioned previously, despite the hefty correction in BJT’s share price we like the Trust’s long term prospects. For this reason we are monitoring the stock closely for a buying opportunity. While the operational side looks solid, we are waiting for the charts to confirm our bullish view.

For the six months to 31 December 2007, the Trust generated net operating earnings of $31.6 million, up 17.5% on the 2006 first half. Driving the earnings growth were a number of property acquisitions during the year, in addition to rental increases across the portfolio. In fact, net property income increased by 28.6% over the period.

Turning to the balance sheet, gearing stood at a comparatively high 60.8%, as at 31 December 2007. However, following the recent asset disposals and repayment of debt, gearing should fall to around 55.5% by March.

Certainly, we remain comfortable with the Trust’s balance sheet given operating cash flows (based on secure rental income) cover the interest expense by around 4 times. Moreover, the Trust does not have any significant re-financing requirements within the next two years.

Meanwhile, as Members may recall, the Trust recently sold one of the original IPO assets at a 70% premium to book value. Subsequent to this, the Trust announced the sale of one of their retail properties, this time at a 35% premium to book value.

Last week we discussed the motivation behind the sales with BJT, who confirmed that both deals were entirely opportunistic. This was clearly the case for the initial sale, for which the 70% premium was simply too attractive to ignore.

The second opportunity arose after a leading Japanese retailer acquired BJT’s tenant and subsequently offered to buy the property. In addition to an attractive price, management also felt it would benefit future business to maintain good relations with the retailer.

From a valuation perspective, the Trust trades on a healthy 2008 distribution yield of more than 10%. Of this, unit holders will shortly receive an interim distribution of 6.33 cents per unit, scheduled for 29 February 2008. (The stock traded ‘ex’ the distribution just before Christmas). Management reaffirmed guidance for a distribution payment of 6.72 cents per unit for the 6 months to June 2008.

On the charts, BJT’s near term price action has been encouraging. As we discussed last week though, further evidence of a trend reversal is required before increasing exposure to the Trust.

Woodside – Hold WPL

Management recently announced the proposed acquisition (subject to regulatory and shareholder approval) of Royal Dutch Shell’s North West Shelf oil assets, offshore Western Australia. Woodside is the project’s operator, with the other joint venture partners being Chevron, BHP Billiton and Japan Australia LNG.

Although the assets are good quality, they represent non-core holdings to Shell, who are seeking to divest their interest in order to focus on the company’s Australian natural gas business.

Following the deal, Woodside's stake in the Cossack, Wanaea, Lambert and Hermes fields (shown below) will increase to 33.33%. Meanwhile, the company’s interests in the nearby Egret oil discovery and other exploration activity in the area will rise to 50%.

The acquisition will also boost Woodside’s proved and probable reserves by 21.3 million barrels of oil equivalent. At a cost of US$398.5 million, this equates to around US$18.71 per barrel, which compares favourably to similar industry deals elsewhere.

Moreover, the acquisition will be earnings accretive in the first year and is a sound approach to increasing reserves and production in our view. Particularly given the challenges faced by the world’s oil companies in replacing production.

Of course, as one of Australia’s most cyclone-prone areas, the North West Shelf isn’t short of challenges. Highlighting this, various operations in the region (including some of Woodside’s) have currently shut down due to Tropical Cyclone Nicholas. However, this is part and parcel of operating in the region and operations should resume in the near future.

From a charting perspective, Woodside has rebounded strongly over the past month, reducing near term downside risks. In the coming weeks, we anticipate volatile consolidation between major support at $43.75 and resistance provided by the January high of $52.40. Longer term, with the upward trend remaining intact we anticipate a continuation to new highs in time

Newcrest Mining – Hold NCM

Newcrest today released earnings for the six months to 31 December 2007, reporting a headline loss of $8.1 million compared to a profit of $37 million for the same period in 2006. However, the loss relates to the continued closure of Newcrest’s hedge book.

Last year, the company completed a $2 billion capital raising in order to remove their hedge commitments. The majority of the hedging has now been removed, with the final close-outs expected to be completed by mid-September 2008.

After adjusting for the hedge restructuring, Newcrest generated net earnings of $208 million and expanded gold production by 18%. The results are broadly in line with expectations and we therefore maintain our hold recommendation. We will provide a more comprehensive update in the weeks ahead.