Industrials

Austal - Hold ASB

As the recent stock price action indicates, West Australian shipbuilder Austal has faced a number of challenges recently. Foremost amongst these was the cancellation of their second Littoral Combat Ship contract late last year, which increased uncertainty surrounding the potentially lucrative project. Despite the setback though, the company is in sound financial health and the core commercial ferry business remains strong. Meanwhile, the US Navy is expected to announce a preliminary contract award later this month for the Joint High Speed Vessel project. Austal is a leading contender for the contract and a win would provide a welcome boost to the stock.

Australian Pharmaceutical Industries – Hold API

We recommended API as a ‘special situation’ last year and despite the company making progress in getting the distribution business back on track and growing the Priceline retail pharmacy business, the stock price has failed to respond positively. We suspect this may be due to investor concerns about the ability of API to fund the Priceline growth strategy. With a rollout plan of around 50 stores annually, this growth places demands on the group’s cash position. However, the stock price looks close to bottoming and we believe the worst may now be behind API. Of course, further share price deterioration will see us reassess this viewpoint.

AV Jennings – Sell AVJ

Our initial buy on AV Jennings was based on a favourable chart structure and the potential for a turnaround in the NSW housing market. However, the stock price has since broken down and we believe there may be an extended period of consolidation before any improvement occurs. Given this outlook, and the uncertain nature of the recovery in NSW housing, we recommend cutting losses and selling the stock. We will continue to monitor AVJ’s fortunes and consider a re-entry into the stock if appropriate.

Babcock & Brown Capital – Sell BCM

With concerns about global credit markets likely to persist for some time, the highly geared BCM will continue to struggle. We sold half of our exposure a few months ago and now believe the best course of action is to sell the remaining stake. While we feel BCM continues to represent good value, high debt levels should keep investors wary. Moreover, news of falling house prices in Ireland could have future ramifications for BCM’s primary asset, Eircom. The telco benefitted handsomely from the growth in Ireland’s housing stock.

Brandrill – Hold BDL

Brandrill is a small company providing drilling services to the iron ore and coal mining industries. The stock is trading slightly above our initial entry point and has been relatively unaffected by the recent market volatility. We attribute this to BDL’s attractive valuation. On our estimates, the company trades on a 2008 PE ratio of around 12 times. While investor nervousness may keep the stock tracking sideways in the near term, the long term outlook for the mining services industry remains robust, and Brandrill should continue to benefit.

Fone Zone – Hold FZN

Following the announcement of the Next Byte acquisition (re-seller of Apple products) last year, and an upbeat presentation and forecasts at the AGM in late October, FZN’s share price has retreated. Given the lack of material announcements from the company since the AGM, we put the share price deterioration down to concerns about the company’s debt levels. Next Byte was funded with a mixture of equity and debt, and gearing has increased. This obviously increases the risk profile of the group. But with FZN trading on a 2008 forecast PE of around 8 times and dividend yield of over 7%, the low price accounts for the higher risk.

Foster’s Group - Hold FGL

After massively increasing their exposure to the wine industry through the 2005 Southcorp acquisition, Foster’s has struggled to generate acceptable returns on their investment. This fact has weighed on both profitability and the stock price, despite the more robust earnings of the non-wine business. And while the wine division offers significant upside, the Australian drought and strong Aussie dollar represent considerable headwinds. In our view though, the potential for a predator to break-up the business into separate wine and beer divisions provides downside protection to the stock price. In the meantime, we will continue to monitor the progress of CEO Trevor O’Hoy’s multi-beverage strategy.

GRD - Hold GRD

GRD has been caught up in the general market sell-off, despite the engineering business continuing to announce contract wins and the prospect of a strategic review, which could lead to the break up of the engineering and global renewable divisions. GRD announced in early December that it had appointed Morgan Stanley to assess options for a potential restructure of the group “in order to assure that shareholder value is being maximised”. We welcome the move as it recognises GRD’s share price does not reflect the value in the group.

Orica - Hold ORI

After delivering a solid full year result in November, Orica’s management went a long way towards justifying their decision to knock back a private equity bid early last year. Even so, given the consensus 2008 price to earnings ratio of around 17 times, the market is clearly anticipating further growth. This is certainly possible, through the release of synergies as recent acquisitions are integrated. However, any slowdown could result in a revision of the market’s outlook for the company. As such, while the stock will remain held in the Fat Prophets Portfolio, we will closely monitor future developments.

Salmat - Hold SLM

The recent HPAL acquisition offers strong growth potential for Salmat. In fact, expectations are for annual synergies of between $10 and $15 million once the integration is complete. Comparing these cost savings to the company’s current earnings of around $28 million underlines the upside potential. And with positive early indications for Salmat’s “pre-shop” internet service Lasoo, the company remains on track to deliver on our growth expectations.

SP Telemedia – Hold SOT

We fell into a value trap with SP Telemedia. Given the company’s prospects, the stock looked cheap when we initially recommended it and the charting structure also looked favourable. However, following the sale of its media assets and the return of some cash to shareholders, the stock price has fallen significantly. With Telstra dominant in the sector, smaller players have found it difficult to build a scalable business, and SOT is suffering from this problem. While having been an extremely disappointing recommendation, we aim to continue holding as we feel the low stock price accounts for all of the current uncertainty.

Telstra - Hold TLS and TLSCA

We remain content to hold Telstra. The company’s transformation plans are slowly and successfully being implemented and the benefits should offset any weakness from the traditional fixed line business. Telstra looks fully valued, trading at just under 16 times 2008 forecast earnings. However, the stock could turn out to be cheap if a break up or operational separation occurs at some stage. Such a scenario could unfold during 2008 should there be continuing problems with building a high-speed broadband network.

As a reminder to holders of T3, the second instalment ($1.60) is due in May this year. We would anticipate a considerable amount of volatility around this time as investors reassess their weighting to the Telco following the investment of additional funds.

Tox Free – Hold TOX

Tox Free Solutions continues to trade in a consolidation range following its sharp appreciation early in 2007. Essentially, investors are waiting for earnings to catch up to the share price. And judging from recent management updates, TOX should achieve this without too much trouble. In a presentation given at the AGM in late November, it is evident that TOX’s business continues to perform well. We believe the company will beat its forecasts for the year, justifying the premium the stock currently trades on.

Based on 2008 consensus forecasts, TOX trades on a PE of around 19 times, which falls to around 14 times 2009 forecast earnings. Given the industries that TOX operates in, we are confident in the group’s longer term growth prospects.

Biotech

Avexa - Hold AVX

Aussie biotech Avexa recently announced the initiation of final trials (phase III) for its anti HIV drug, apricitabine. In a further positive, all but one of the patients involved in the phase IIb study have opted to continue with the drug. The move to final testing is especially significant because from a historical perspective, all HIV drugs to reach phase III have gone on to commercial release. And should Avexa continue this trend, the company stands to secure a share of the US$7 billion HIV market.

Members should be aware that apricitabine could still fail, which would be a major setback for the company. Nevertheless, the risk of failure reduces with the completion of each stage of testing.

Biota - Sell BTA around $1.05

This has been a disappointing recommendation. Despite the huge potential of the anti-viral drug zanamavir (licensed to GlaxoSmithKline and marketed as Relenza) the stock price continues to deteriorate. Furthermore, this is happening as the date for mediation with Glaxo approaches. Biota is confident the claim against Glaxo (for inadequate marketing of Relenza) will be successful, however, the deteriorating stock price is telling us otherwise. Apart from the initial recommendation, our biggest mistake was to buy the dip. Although a difficult decision, we recommend selling the stock and sitting on the sidelines for now. We will continue to follow the Biota story and will alert Members if the situation changes.