This week: ASX v Wall Street
FYTD: ASX v Wall Street
With Profit Reporting season ramping up, we switch our focus to reports from clients’ companies.
Over the week we had three companies report, all of which were in line or exceeded our expectations.
Here, There and Everywhere is a media and entertainment company. It operates the Australian Radio Network (ARN), which spans both regional (newly acquired assets from Grant Broadcasters) and metropolitan markets. HT&E’s radio stations include KISS 101.1 and Gold 104.3. The company is also building a strong digital media presence, as the Australian licensee of podcasting network iHeartRadio and holds outdoor advertising assets in Hong Kong.
The result (shares returned +8.2% on the day of announcement)
According to audience measurement provider GfK, radio audiences have continued to build in the post-pandemic period, as can be seen in the chart below:
Source: GfK Radio Ratings, HT&E
However, while listenership matters, what ultimately matters is whether this listenership translates to advertising revenue.
Pleasingly, in metro radio, HT&E’s advertising revenue grew by 5.5% and is now within 10% of pre-COVID levels, having made a strong recovery from the circa 30% fall seen in 2020.
During this recovery, the company has kept operating costs well controlled, which should mean a large percentage of revenue flows through to profit as advertising spending recovers further.
The company’s regional segment also showed strong revenue growth of 11%. As a reminder, the company broadened its regional presence through the purchase of Grant Broadcasters late last year (Grant’s footprint can be seen below).
The driver behind the acquisition was the opportunity to sell advertising across regional and metro radio to media agencies and national advertisers, as well as expand the presence of regional advertisers alike.
This half saw a strong mix of organic revenue growth and revenue growth from these initiatives, which gives us greater confidence that the company will achieve its medium-term revenue synergy targets.
We also saw good growth in Digital revenue (podcasting), with the launch of a new youth hip hop and R&B platform Cada. The company is targeting profitability for the Digital Segment within the next 2-3 years and is likely to be a strong source of growth.
The company has also continued to see good growth into the second half of the year, with the September quarter tracking 6-8% higher year on year.
However, what the presentation highlighted most of all is that shares in the company remain inexpensive. We are reluctant to dive into math too often, however we can’t help ourselves given how cheap HT&E is.
The company outlined that it expects to generate cash flows before dividends of $35-45m per year – a sum easily achievable even with current depressed earnings.
On Wednesday, HT&E was trading at a market capitalisation of approximately $400m. In our estimate the company holds around $145m in assets outside of its core businesses.
Therefore, if HT&E chose to, it could pay shareholders $35-45m in cash on their net $255m investment, or a free cash flow yield of 15%. There aren’t many investments that can return 15% in cash per year. Even taking into account the prospect of a weaker economic environment in the near term, we think this is far too cheap.
We were therefore happy that the company’s board wholly agrees with us, announcing a reinstatement of HT&E’s share buyback program (in effect, the company is buying back its own shares while they are cheap).
Origin Energy is an integrated energy provider that is involved in power generation, energy retailing (electricity and gas) and the production/export of natural gas (through the APLNG joint venture).
The result (shares returned -2.6% on the day of announcement)
As a reminder, Origin can be broadly thought of as two businesses, an export-focused LNG business (through its APLNG partnership) and a domestic energy and gas retailer, through its Energy Markets division.
While this may seem like an unusual pairing, years like FY-22 demonstrate why this combination forms a natural “yin and yang” for the business.
In what was a weaker year for Energy Markets, we saw incredibly strong oil and gas prices flow through to strong cash flows delivered by APLNG.
The combination of two businesses means that Origin’s balance sheet is now incredibly strong. We feel this, in addition to future cash flows, gives Origin the capacity to invest in the energy transition, not just have the assets it now has in place.
We discuss the performance of its two main businesses below:
Above: APLNG’s LNG facility on Curtis Island, QLD
Energy Markets (neutral)
Origin’s result highlighted the dramatic differences between the short-term impacts of change and the long-run consequences. The national energy market (NEM) is in the middle of structural change and short-term dislocation. There are many moving parts, most negative for short-term earnings, but we believe positive for long-run value creation.
Sharp rises in the cost of coal in the face of the war in Ukraine, localised floods and infrastructure outages found Origin at the wrong side of coal supply and rising short-term costs for a power plant that it plans to close in the medium term. That was the first problem.
But unfortunately for Origin (but good for consumers) there is also a lag between wholesale energy prices, and the amount household customers pay. The delay allows for fluctuations and market changes to settle before rising costs are passed on. In periods of low volatility, this has few costs, all of which can be easily managed.
However, in the past 4 months, for large parts of the day, and especially for some nodes of generation within the electricity network, the prices households are paying for electricity does not cover the cost of producing it, let alone pay for the upkeep and investment required.
Companies such as Origin Energy rely a mix of size, depth of customer relationships, and balance sheet flexibility to cope with short-term imbalances.
But the stock market didn’t appreciate the volatility reminder, especially when Origin was unwilling to give guidance for earnings in FY-23. Much like a child, the market prefers an unreliable forecast than no forecast at all – we believe the company did the right thing in treating investors like adults instead.
Now consider the long-term;
- Origin’s result highlights that despite volatility the electricity network is rapidly evolving for the better.
- Large scale wind and solar are generating increased power, at fabulously low costs which assists Origin, who are able to both purchase/build and contract electricity from these assets.
- The critical role for batteries (which Origin is looking to build) and gas peaking capacity (that Origin has a terrific supply of) to smooth out supply and demand is being reinforced.
- There are National Electricity Market (NEM) changes that are required to assist with the transition to an alternative generation mix, including long-mooted “capacity payments”. This period has highlighted the challenges consumers face in the form of high prices if the energy transition is not carried out in an orderly manner. As a provider of peaking and baseload capacity, we expect greater recognition of the critical role Origin’s assets still have to play over the coming years during this transition – a role that will have to be incentivised to ensure it is an orderly one.
As long-term investors, we were less focused on what next year’s earnings may be and are happy to trade short-term volatility for longer-term profits and returns.
Integrated Gas (APLNG) (positive)
FY-22 proved to be a boon to cash flows from APLNG. APLNG sells its LNG through a mixture of long-term contracts and spot (or on-market) sales.
The past year has been generous to energy producers. With oil prices staging a strong rebound cash has been flowing out of oil and gas projects worldwide.
APLNG was no exception, with Origin’s share of APLNG delivering $1.8 bn in operating profit, up 63% from the $1.1 bn in profit it achieved the year before. The joint venture achieved an average oil price of US$74/bbl compared to US43/bbl the previous year.
However, credit must be given to the strong performance of APLNG’s upstream gas assets, with decline curves (the reduction in the amount of oil/gas produced over time) performing much better than previously thought over the past few years. More gas, produced for longer from fields means relatively little has had to be spent to replace the gas that has been sold and has translated into strong cash flow for the project.
We continue to see Origin’s APLNG project as a strong counterweight to its Energy Markets business, producing substantial cash flow that has offset weaker earnings in Energy Markets and allows Origin the flexibility to take a long-term view on investment when many of its peers cannot.
Emeco is a mining fleet rental company with in-house maintenance capability. It has a strategy of purchasing mid-life assets and utilizing its maintenance capability to deliver high returns from these assets. Recently it has acquired an underground mining services company (Pit N Portal) as it looks to expand its operations and provide additional services to growth the return on its rental assets.
The result (shares returned +1.2% on the day of announcement, _4.3% for the week)
Emeco’s profit result was in line with the guidance it updated the market with not too long ago (in June).
Its rental business remains steady, with gross utilisation (assets on contracted rental to customers) remaining at 92% (vs 87% last year).
However, operating utilisation (that is, the number of hours this equipment is used versus the number of hours it is capable of operating) has yet to reach the levels the company expected. Operating utilisation is important as the number of hours equipment is used determines the revenue derived from customers.
The company put this down to COVID-related worker shortages that have meant its customers have not been able to utilise equipment as intensely as they otherwise would. With an improvement in labour availability, the company expects this to result in better earnings growth into next year.
Its underground mining business, Pit N Portal, saw an uptick in profit. However, it is underperforming its potential. The company has sighted its largest contract with Mincor, which is currently delivering sub-optimal returns on existing contract terms, given the inflationary environment. It expects to see a material improvement as this contract is renegotiated over the coming quarter.
What impressed us the most is the company’s renewed commitment to demonstrating its cash-generating capability. After a period of investment over the past few years, Emeco expects to focus on cash generation in FY-23, which, at the profit levels for next year that is has intimated should see it generate $60m+ in cash flow, relative to a share price of $450m (a free cash flow yield of more than 12%).
We see that as this is executed, the market will gain a greater appreciation of Emeco’s cash flow generation, which we have already seen this week with the movement in its share price.