Investment Matters

Company profit reporting season continues...

Company profit reporting season ramped up this week, with six holdings in clients' portfolios releasing their results for the six months ending 31-Dec-16.  


Challenger released a good result.   Cash operating earnings increased 8% (to $316m), as did normalised profit (vs pcp).  Earnings per share (EPS) increased 7.4%.

Challenger's main division, Life (annuities) increased its earnings by 7% to $267m.  Annuity sales grew strongly - up 34%, and new business tenor increased to 8.7 years (pcp 5.6 years).  Increased tenor = longer term returns / value for shareholders.

Challenger has expanded its annuity distribution network, with their annuities now offered to about two-thirds of Australia's financial advisors (including names such as BT, AMP and Colonial FirstState), and access to  about one-third of Australia's superannuation industry FUM.  New opportunities are also in play, such as MS Primary (partnering with a leading provider of AUD annuities in Japan).

Earnings from the company's Funds division decreased 5% to $21m, with lower performance fees from Fidante (boutique funds) and lower income from CIP (Challenger Investment Partners, a fund for institutional investors, global fixed interest and real estate).  Positively, Finante's FUM increased 9%, and CIP's FUM increased 11% vs 30-Jun-16.

The company remains well-managed, with corporate costs decreasing 3%.  Challenger's capital position remains strong, with Life having $0.8b of excess capital over regulatory requirements.  The company also reaffirmed FY-17 guidance, for Life cash operating earnings in the range of $620m to $640m.

We remain attracted to the long term opportunity that Australia's ageing population represents for Challenger.  We are, however, cognisant that it is trading at a higher valuation (certainly on some metrics, such as P/E) than we are comfortable with.  Strong growth in the outlook mitigates this concern to a large degree.



Aveo released a strong result.  Underlying profit increased 18% vs pcp, to $53.9m (vs pcp).   This was driven by the core Aveo retirement business, and assisted by contributions from the Freedom and RVG acquisitions.  EPS increased 7% - a lower percentage than profit due to the additional securities on issue (raising to support the acquisitions).

Operationally, Aveo achieved a record 621 total retirement unit sales in the half.  58 new retirement units were completed.  Portfolio turnover was 10.3% - within target.  Now the integration of RVG and Freedom has been successfully completed, the focus will turn to looking for the opportunities in these portfolios, as well as rolling the Aveo Way contracting model.

Looking into H2, Aveo expects 208 new units to be completed, and construction has started on a number of projects with FY-18 completions.  Additionally, a new 123 bed aged care facility at Durack is due for completion in H2.  Care and support services, including Freedom care and continuum of care, continue to be a focus - not so much for the $ return (low contribution to Aveo), more for the strategic benefit (e.g. attracting residents, quality of resident life).

As Aveo continues the exit of the non-retirement operations and sells down assets, profit from this division declined.  It was down 16% vs pcp.  Now only 16% of assets are non-retirement.

Guidance for FY-17 is for EPS of 18.3cps, a 7.6% increase on FY-16.  A final distribution of 9cps is expected (+7.5% on pcp).


Primary Health Care

Primary's result was messy, and somewhat disappointing.  It reflects a company going through significant change - including changes to contracting arrangements with GPs and associated flow through to the company's finances, and investment in the business e.g. IT / systems, IVF.

Underlying profit and EPS were flat, and are disappointing from the perspective of the margin being achieved.  Dividends were down vs pcp, but up very slightly when franking is included.

On a divisional level, Medical Centres was the problem child.  Revenue decreased 5% and earnings decreased 36% vs the pcp, to $26.9m.  GP costs and investment in new service offerings (e.g. occupational health, chronic care) impacted margins.  We expect new GP hirings to ramp up over H2 and FY-18, which will significantly improve margins (Medical Centres has a large fixed cost base).

The Pathology division increased earnings 1.0% to $51.3m.  Primary's smallest division, Imaging, increased earnings 58.9% to $14.3m.  This was driven by portfolio rationalisation and operating cost programs.

Assuming GP numbers increase as expected, and with investment in items such as IT and systems expected to moderate, Primary should have have reached its low from an operating perspective.  The company is also potentially the subject of a takeover offer.



South32's result delivered substantial growth, and it did surprise a little on the positive side.  Higher commodity prices, along with a focus on reducing operating costs, flowed though to deliver a US$479m increase in underlying earnings, and a US$626m increase in free cash flow.  Kudos to management for the effective management and operation of their various mine assets.

Production guidance was provided for H2 and FY-18, which looked positive overall.

Net cash now stands at US$859m.  The first interim dividend will be paid (the company listed only became stand-alone in May-15, following the split from BHP).  At US3.6cps it is a healthy increase on last year's final of US1.0cps.  With only one relatively minor acquisition on the cards, capital management may be coming in future periods (e.g. additional dividends, capital return).


Origin Energy

Origin Energy's result was mostly in line with expectations, with EBITDA (earnings before interest tax, depreciation and amortisation) at $1,145m - up $277m or 32% over the pcp.  Operating cash flow was ok, at $485m - up $27m over the pcp.

Underlying profit was, however, lower than expected due to higher financing costs, and depreciation and amortisation, both associated with the APLNG project.  (As Train 1 of APLNG is now complete and in production, financing costs associated with this asset are expensed rather than capitalised, and depreciation and amortisation are incurred).

Statutory profit was impacted by a significant writedown, of $1.9b.  The main component was associated with APLNG, with lower macro assumptions (oil price, exchange rate etc) impacting on the valuation.  The Browse Basin field was also revalued (-$558m) due to the probability of, and timing of, commercialisation of the asset.  There were also smaller writedowns associated with the assets to IPO'd, and Energia Austral SpA (a hydro JV in Chile).

The company has elected to focus in debt reduction, and therefore an interim dividend will not be paid.  Origin also confirmed its intent to proceed, in 2017, with the IPO of its conventional upstream exploration and production business, with the proceeds to be used to reduce debt. 

Guidance for FY-17 was a little stronger than expected, with the company upgrading its EBITDA forecast to $2,450m to $2,615m (was $2,3700m to $2,615m).  Underlying NPAT is forecast to be between $480m and $590m.


Centuria Industrial REIT

Centuria Industrial REIT (CIP)'s earnings were in line with expectations.  Underlying earnings and distribution per security were both 10.8 cents.  Net tangible assets per security increased 1.7% to $2.36.

Gearing is comfortable at 42.9% (42.2% post the Villawood asset settlement), but we assess Centuria should be looking to bring it down at this stage of the property cycle - when we look to the future for industrial (and office and retail) property, there is more risk than opportunity.

Portfolio metrics remain sound, with 95.1% occupancy and an average lease expiry of 4.3 years.

Centuria revised the FY-17 guidance down from 21.6cps for earnings and distributions (as released when 360 Capital was the manager), to 20.5cps - a 5% reduction.  The basis of the revision is longer assumed vacancies, higher interest costs on debt being refinanced in Jun-17, and no reinvestment of proceeds from non-core asset sales (de-leveraging instead).