Income Report / Income Report; A cheap agricultural play, AMP - why it’s not cheap enough (MWY, AMP, AXLHA)

By Market Matters 19 September 18

Income Report; A cheap agricultural play, AMP - why it’s not cheap enough (MWY, AMP, AXLHA)

Market Matters Income Report 19th September 2018

The market is trading higher this morning thanks largely to a decent move back into the resource stocks – an area of the market that has been feeling the pinch in recent times. Fortescue Metals (FMG) leading the way up  ~3% followed by RIO +2.5% and BHP +2.2%. It’s typical to see those stocks that have been relative underperformers bounce most strongly. In terms of moves this calendar year, Fortescue is down ~30%, while RIO is off ~14% & BHP is off just ~9%, supported by capital management + in the case of BHP, its exposure to energy.

Source; Bloomberg

In terms of the MM Income Portfolio for the week, it fell by -0.17% in a stock market that fell by -0.29%. Eclipse (ECX) was the weakest link down by -5%. The portfolio is now up 1.93% this financial year, and +8.05% from inception vs the benchmark which is tracking at 1.19% & 6.63% respectively. The expected yield on the portfolio is ~7% inclusive of franking.

Midway (MWY) $3.12; A cheap way to get agricultural exposure, good yield and cyclical tailwinds

This was a stock mentioned in the Monday Q & A report, however MWY had gone into a trading halt and Shaw and Partners was involved in the placement of stock. That has now been done at $3.00 per share with 11.2m new shares being issued in the company at $3. The placement was oversubscribed and the two biggest shareholders took that opportunity to sell (into the institutional oversubscriptions) a total of 5.4m shares at the same price. That’s generally not a great sign however on this occasion it was to improve the free float (tradable shares) and they still own ~35m or ~48% of the company.   

In terms of a brief background, Midway is the biggest vertically integrated producer of high quality woodchips in Australia and they provide services to producers of pulp, paper and associated products here plus they also export internationally.  They’re reasonably new on the ASX having listed at the end of 2016 however the business has been around since 1980. They’ve got a market capitalisation of  ~$233m with about 52% of shares in the free float, which does mean there is some constraints around liquidity.

When thinking about a business like this, we want to see a large addressable market, good earnings now and solid growth expected for the future. MNY ticks these boxes with earnings expected to grow at low double digits over the next 3 years, providing good free cash flow and a strong yield along the way.

KEY POINTS

-          Underlying demand to outstrip supply in hardwood chips by 2020. China and Japan helping to drive this

-          Double digit earnings growth and attractive PE of ~12.5x plus a fully franked forecasted yield of ~6%

-          Good balance sheet and benefits from a lower Aussie Dollar

MM likes MWY below $3.00 as an income BUY – watch for alerts

Midway (MWY) Chart

AMP $3.17– is it cheap enough?

It’s hard to argue that AMP is not cheap, whether it be relative to peers or relative to its own history.  The price has fallen from a 12 month high or ~$5.50 to languish at $3.17 – a ~40% decline.

Turning back the clock, between 2013 and 2016 AMP garnered enough support to attract a decent premium to its peer group which is shown by the white line (AMP) being above the orange line (peers) and also by the second segment below being red, flagging it as expensive. By 2016 the shine was coming off and AMP was back to a sector average before gradually sliding lower ahead of the Royal Commission this year, which ultimately saw the price fall off the cliff, making it about two standard deviations cheap as shown by the green shaded below.

AMP relative to its peer group

Source; Bloomberg

Looking at AMP versus its own history tells a similar story, as you’d expect. Over the past 5 years its traded on 14.1x which is a bit below the market average but reasonable. The range between 2015 and 2018 was 13x at the low and 16x at the high and it ticked between those levels. Buy it on a PE of 13x and sell it on a PE of 16x was the trade. The share price followed suite tracking between ~$4 & ~$7 over that period. Right now AMP trades on 10x earnings making it about 40% cheap versus its peer group and about the same relative to its own history. Clearly it’s a BUY - right?

AMP’s historical PE bands

Source; Bloomberg

The multiple however, is only one piece of the puzzle. Getting the earnings side right is the more complicated part, particularly given the number of  variables thrown into the mix post Royal Commission. If we look at the graph of consensus earnings expectations, it’s clear that analysts have been working hard to downgrade AMP earnings from 2014 – which was when earnings peaked and so did the PE at around 17 times. Since then it’s been a slow deterioration in both earnings and share price to ultimately end up where it is today trading on a PE of 10.1x and a price of just $3.17

Source; Bloomberg

Ultimately, analysts will capitulate on this stock and cut hard, simply because they’ll get sick of being incremental about their assumptions. Assuming that happens, we could then look at AMP as a buy. We’ve seen a few do it already with our guy at Shaw and Partners along with Bell Potter cutting hard, and being bearish outliers with their price expectations – we think the rest will ultimately follow.

Source; Bloomberg

There are still a significant number of headwinds facing AMP largely around grandfathered commissions, the buyer of last resort (BOLR) facility that it has standing with its planners and of course potential restructuring charges, class actions and fines.

If they end grandfathered commissions like Westpac has done for their salaried planners it could costs them around ~$250m pre-tax according to Shaw. To give that number some context, it’s about 25% of the forecasted FY19 pre-tax profit.

The BOLR facility is an interesting one, and potentially a significant  unfunded liability for AMP. These arrangements provide for a financial planning practice to receive a payment of 4 times the revenue of that practice from AMP. If we assume the average payment per planner is $1M then the potential liability for AMP is $1.5B. It seems that AMP has no material excess capital so an impost like this would probably result in a capital raising and/or lower dividends.

The other key to all of this is around adviser numbers which underpins distribution. What adviser / planner will move to AMP given all the negative publicity?  It seems to us they’ll find it very hard to grow their planner base plus it will be difficult to retain existing. The industry is also facing greater educational requirements in the next few years which will require many to undertake further study. Combining all of the above, the 4 times revenue paid by the BOLR facility is suddenly looking pretty good!  

KEY POINTS

-          AMP is now extremely cheap relative to history  

-          However, significant earnings risk remains in the stock, and earnings will likely be under pressure for some time

-          The BOLR facility could be a significant unfunded liability

MM has no interest in AMP as an income play – yet

AMP Chart

AxcessToday Bond (AXLHA) $100.00 – Voluntary suspension

The MM Income Portfolio holds the AccessToday bond which is listed on the ASX. On the 12th of September, AxcessToday went into a trading halt  “To allow the board to conduct a detailed review of the company’s business strategy”.  A trading halt can only last for a maximum of 2 days then the company needs to go into voluntary suspension – which is now the case and will likely be that way until the 24th September according to the company. The announcement on the 14th said…The Managing Director (Peter Ferizis), being one of the co-founders of the business has resigned as one of the directors.  The Chairman - Kerry Daley and Director - Michael Sack have stepped into executive roles within the company, whilst a strategic review is undertaken.

The company has been very tight lipped since then with no further news or granular information given and the voluntary suspension is in place until the 24th of September. We have the bonds in the portfolio rather than the stock, however this is clearly a strange set of circumstances that are playing out. More information to flow in the next week or so.   

Conclusion (s)

We think Midway represents a good income opportunity below $3

We have little interest in AMP at current levels – seeing a price below $3 as likely

Have a great day!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

Disclaimer

All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 19/09/2018

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