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Morningstar Equities ALZ, ARI, FPH, FPH-NZ, FXL, MGR, NAB

Morningstar Equities – ALZ, ARI, FPH, FPH-NZ, FXL, MGR, NAB, NWS, TAH, TLS,

Australand Property Group ALZ | FY12 result: Contracted rental escalations underpin growth
Morningstar Recommendation: Hold

ALZ’s FY12 operating NPAT was $142.1m, up 4.9% on FY11 and just ahead of previous guidance for 3-4% growth. Reported NPAT rose 27% largely due to a $51m revaluation of the commercial property portfolio. Guidance was for FY13 distributions of 21.5 cents, flat on FY12.
There was no additional information on the GPT offer, but ALZ is assisting Capitaland on its strategic review of its 59.3% holding. As Capitaland has said it intends to sharpen its focus on China and Singapore, a full or partial divestment of its majority stake in ALZ looks increasingly likely, probably in 1H13. We expect strong institutional interest in the commercial portfolio, but executing a transaction will be difficult as splitting the commercial portfolio from the rest of the business is likely to materially impact the value of the residential development business.

Arrium Limited ARI | OK, so there’s a bit of rust…
Morningstar Recommendation: Reduce

Arrium will take a AUD 474 million impairment against its intangible assets. The goodwill write-downs relate to the troubled Manufacturing and Distribution divisions. While the company is no longer called OneSteel, the business has not changed. Arrium still has large manufacturing and distribution divisions on the books. They may not be contributing much to earnings but from an asset value and revenue point of view, they are large. Combined group EBIT for fiscal 2010 to fiscal 2012 was AUD 1,102 million of which iron ore mining contributed AUD 1,160 million. The rest of Arrium’s businesses were loss-making! Yet gross assets for the non-mining businesses total a staggering AUD 7.2 billion at 30 June 2012.

Fisher & Paykel Healthcare Corporation Limited FPH . FPH-NZ| CMS delivers big price cuts: Minimal impact on the company
Morningstar Recommendation: Hold

The U.S. Centres for Medicare and Medicaid Services (CMS) last week announced new lower Medicare prices on a wide variety of medical equipment products, which will become effective from 1 July 2013. We think the impact on Fisher & Paykel Healthcare will be minimal and continue to expect underlying prices for obstructive sleep apnea (OSA) products to decline by 3-5% per annum for the foreseeable future. OSA represents 45% of Fisher & Paykel Healthcare’s revenue. Consequently we are not making any changes to our forecasts and fair value and our thesis is intact. Over the next five years we expect group revenues to grow by double digits (in constant currency terms) based on firm's strong market position in respiratory & acute care. We expect earnings to exceed revenue growth as favourable product mix and cost savings deliver operating leverage.

FlexiGroup Limited FXL | 1H13 Result: on track to meet full year guidance
Morningstar Recommendation: Hold

FXL reported a strong interim 2013 result. Cash NPAT was up 16% to $32.6m. Importantly the company reaffirmed its FY13 guidance of cash NPAT growth between 11% to 16%. Net portfolio income was up 16% driven by receivables growth. The cost to income ratio was unchanged at 43%. Costs were up 19% as costs associated with the Lombard acquisition and training costs associated with transitioning operations to Manila. Impairment expense was up 4% but the loss experience improved. Impairments as a percentage of average receivables improved from 3.0% in 1H12 to 2.7% in 1H13. 90-day plus arrears were flat on 1H12 at 0.8% of average receivables but up on 0.7% from FY12. In the result briefing management commented that the credit worthiness of consumer applicants was improving.

Mirvac Group MGR | New CEO clears the decks with $273 million impairment
Morningstar Recommendation: Reduce

Mirvac will take a $273.2m write-down to the value of its residential development projects, with 72% in Queensland and 27% in Western Australia. The impairment results in a reduction to net tangible assets of 5.9 cents per security.
Selected projects will be sold as undeveloped lots over FY13 to FY15, generating an estimated $89m in proceeds, and also removing the requirement to invest an additional $476m of capital into underperforming projects.
The write-down to Mirvac’s portfolio is not surprising, with new CEO Susan Lloyd-Hurwitz preferring to start her tenure with cleared decks.
We had also been forecasting Mirvacs’s residential development margins to contract in the years ahead. Our negative view reflected recent house price weakness, longer average holding periods and the fact that a material portion of Mirvac’s land banks had been acquired at top of the cycle prices.
We are supportive of the decision to systematically divest the underperforming projects as investing the additional $476m of capital to these projects is likely to be higher risk, with margins likely to be thin.
However, we see some bright spots for residential developers, with residential development volumes expected to gradually increase from current levels, reflecting improved affordability following successive RBA rate cuts and shortage of supply, particularly in Sydney. We believe Mirvac’s pipeline of inner city developments, particularly the 10.6 ha Harold Park site in Glebe will experience strong demand and robust margins.
Recommendation Impact
Following share price strength we move our recommendation from Hold to Reduce

National Australia Bank Limited NAB | Strong 1Q13 trading supports our positive view
Morningstar Recommendation: Accumulate

NAB announced a relatively clean 1Q13 trading update, but limited detail makes it difficult to fully gauge underlying performance. But key earnings drivers such as volume growth, margins and bad debts point to strong future earnings growth. The strong start to the year supports our positive view on NAB, and the bank is on track to an FY13 profit around $6bn. Unaudited profit for the three months to 31 December 2012 (1Q13) of $1.45bn is in line with our expectations, and is 4% higher than 1Q12 and an impressive 14% above the bad debt impacted 4Q12. The growth is due to strong retail loan and deposit volumes in the Australian franchise, higher revenue growth, improved customer interest margins and lower bad debts.

News Corporation NWS | Cable networks offset other 2013 headwinds; Sports takes centre stage
Morningstar Recommendation: Reduce

News Corp's fiscal second-quarter results were solid and driven by the cable networks (60% of total operating profit). A few smaller parts of the News Corp. empire are facing near-term headwinds (Sky Italia and the Fox network in the U.S.) which caused management to reduce its forecast for fiscal 2013 segment operating profit growth from low double-digits to a range of mid-to-high single digits.
We expect the shares to trade down based on the lower guidance, but looking beyond 2013 we see the cable networks getting a boost from investments in international sports as well has its wide-ranging channel lineups across the globe. Our 2013 EPS estimate was below consensus so we’re not making any near-term adjustments to our forecast, but we plan to boost our fair value estimate to around AUD 26.00 per share from the current AUD 23.00 based on more optimistic long-term profitability in the cable network segment.
Recommendation Impact
The proposed increase in fair value will likely lead to an upgrade from Reduce to Hold.

Tabcorp Holdings Limited TAH| The new Tabcorp’s first result: transitioning
Morningstar Recommendation: Hold

TAH announced first half fiscal 2013 reported NPAT of AUD 72.9 million, which includes a one-off gain from a GST refund and sale of equipment of AUD 22.9 million and loss on discontinued operations of AUD 21.6 million. The interim dividend was AUD 0.11 cps, fully franked. CEO David Attenborough provided only limited full year guidance noting first half revenue growth of 2% continued through January 2013.
A complex first half result, which can’t be compared to previous periods due to TAH’s transition to the new gambling structure in Victoria. In early first half fiscal 2013, TAH’s Victorian gaming licence expired, the new twelve year Victorian wagering and betting licence commenced and a new business, Tabcorp Gaming Solutions (TGS), was launched. But underlying NPAT of AUD 71.6 million was marginally below our expectations due to higher than anticipated wagering operating costs. Our forecast and fair value are under review.
Wagering now contributes 55-60% of total EBIT. In a highly competitive environment with restricted household expenditure on gambling, TAH’s Wagering EBIT was down 27.9% to AUD 91.3 million. The large fall in EBIT was due to the terms and conditions under the new Victorian wagering and betting licence, which commenced on 16 August 2012, being less favourable than the old licence, with TAH and Victorian Racing now operating on a 50:50 profit share basis. TAH’s Wagering operation also incurred high re-brading and technology costs, estimated at an additional AUD 7 million, during first half fiscal 2013.
The structural change in the Australian wagering market continued with strong growth in fixed odds betting and digital technology. TAH has maintained leadership in both fixed odds betting and digital wagering during first half fiscal 2013. TAH’s fixed odds revenue grew 28.4% to AUD 195.6 million and the company holds a 28% market share in national digital wagering.
TAH’s media and international EBIT increased by just 0.4% to AUD 27.5 million, Sky Racing revenue was up strongly on increased subscriptions but increased technology costs and contributions to the domestic racing industry ensured flat earnings. Keno’s EBIT was up 1.2% to AUD 25.6 million. Keno revenue was up strongly due to expansion into Victoria but higher technology costs and depreciation / amortisation changes resulted in only minimal earnings growth. The new gaming business, TGS, contributed EBIT of AUD 16.8 million and will potentially exceed full year EBITDA guidance of AUD 55 million by 5-10%.
Recommendation Impact
Our forecasts and fair value are under review. There is no change to our Hold recommendation.

Telstra Corporation Limited TLS | First half result in line with mobile leading the way
Morningstar Recommendation: Hold

Telstra's first half fiscal 2013 result was in line with expectations. Sales revenue grew 1% to AUD 12.53 billion, in line with our AUD 12.65 billion forecast. The result was again driven by mobile and the network, applications and services (NAS) division but public switched telephone network (PSTN) revenue was softer. The key highlight was Telstra’s ability to deliver both market share gains and increased profitability in mobile. Most product groups registered margin improvements with the exception of Sensis. Group EBITDA margin improved 150 basis points to 39.8% on lower labour costs. EBITDA increased 5% to AUD 4.99 billion. First half free cash flow was 17% lower at AUD 2.16 billion due to higher working capital as the NAS operation ramps up. Free cash flow guidance was maintained at AUD 4.75 billion to AUD 5.25 billion. First half fully franked dividend of 14 cents per share was in line with expectations and fiscal 2013 fully franked dividend guidance of 28 cents per share was reaffirmed. Investors have flown to Telstra in search of secure dividends, and would have expected nothing less than confirmation of a 28 cent dividend.

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