Aussie Picks and Shovels from Australian Edge

Part two of our look at the "Income wonders from down under"

By Travis Johnson, Stock Gumshoe, October 5, 2011

If you’re just joining us, we’ve been working on identifying the Australian stock picks teased by the new Australian Edge newsletter from Roger Conrad and David Dittman — that first note is here, with the lead-in about their general “invest in Australia” theme, and they teased us with eight “income wonders from down under” that they think are good buys so we looked at the first few of them here in yesterday’s article.

It looks like the focus of the letter will not be on the high-flying resource companies of the “lucky country,” but on the “picks and shovels” companies that either benefit from the general strength of the economy or provide services to the natural resources businesses that generate most of Australia’s exports. Yesterday’s picks were a utility, a natural gas transport firm, and a telecom giant — so what are the rest of the “income wonders?” Let’s dig into their brief little clue blurbs and see what we can find, one at a time:

“INCOME WONDER #4—One of Australia’s largest natural gas distribution companies, with more than 21,000 km of pipelines and distribution serving over a million consumers. With 90% of revenue derived from domestic and small industrial customers, this company’s cash flows are highly predictable and support a yield of around 8%.”

Into the Thinkolator it goes … and the result? This is Envestra (ENV in Australia, EVSRF on the pink sheets). Never hear of this one before, but it looks like a pretty pure play on gas distribution — they have some larger transmission pipelines, but their primary asset is the distribution network (which is around 21,000 km) that reaches about a million customers in South Australia, Victoria, Queensland, New South Wales and the Northern Territory. And yes, the share price is teensy (about 65 cents) and trading is quite light on the pink sheets, but this is a reasonably large and stable company with a market cap near a billion dollars.

They have outsourced the operation of these networks to one of the much bigger companies we talked about yesterday, APA Group, so they don’t spend much money on employees or operations (APA owns a piece of Envestra, and also gets a management fee). It looks like they operate exclusively in regulated areas, so although they do carry a fair amount of debt they seem to be able to manage it fine and pass through any cost increases … so it’s a pretty clean investment in a long-lived asset, with a yield that is currently about 8.5%.

I don’t know the company history, but it looks like they probably had too much debt a few years ago — that’s usually the reason when you see a stock whose share price abruptly collapsed in 2007-2009, and the stock chart tells a story of a rebuilding company in the couple years since then. You can buy APA Group, the larger and much more diversified operator, for about the same yield so I don’t know what the argument would be for buying the smaller and more “vanilla” Envestra, but perhaps one of our Aussie readers can supply more details on the relative appeal of the two firms.

Moving on!

“INCOME WONDER #5— Spread across a 2,700-km footprint, this company operates at every point along the agricultural supply chain, from storage to exports to domestic distribution. They operate storage capacity for more than 20 million tons of grains and oilseeds, and are capable of hauling four million tons of grain annually with 20 contracted trains. Another high-yielder, with more than double the dividend of the average S&P company.”

This one, sez the Thinkolator, is GrainCorp (GNC in Australia, GRCLF on the pink sheets), another billion-dollar company that has fairly light trading in its US pink sheets-shares. GrainCorp is basically built on their big elevator network, not unlike the Canadian/Australian Viterra that I’ve written about before — they buy grain (mostly wheat in this case) from farmers, store, and sell, and also use their distribution network to sell supplies to farmers. They’ve also been investing pretty heavily in malting, which has been a regional focus as Asian beer consumption has grown but which has also been a bit of a contrarian investment in the last couple years due to flagging developed world beer sales.

GrainCorp does have a decent dividend, they paid 30 cents last year and are on track to pay at least something similar this year (they’ve paid out 20 cents so far, the final dividend has generally come in December). That gives a trailing yield in the neighborhood of 4% — better than the S&P, to be sure, though not dramatic (to be fair, agricultural stocks in general tend not to pay high — if any — dividends). As with Viterra and other grain storage, distribution and export companies, their performance depends in large part on volume — Australian wheat in their part of the country had a bumper harvest this year, but there have certainly also been very bad years with drought and/or floods, and if the grain isn’t produced there’s not much of a way for them to generate their “toll” income for processing, moving or storing it.

Next?

“INCOME WONDER #6—This company is focused on the niche marketing of its high-energy coal products, and exports around 65% of its production to Asia. They operate three mines and hold large interests in new exploration projects, as well as 100% ownership of an export ship-loading facility.”

In a piece of fortuitous timing, it looks as though this one must be (the clues are a bit thin, so certainty ain’t quite 100%) New Hope Corp. (NHC in Australia, NHPEF on the pinks), a pretty big ($5 billion or so) coal company. They do indeed export about 65% of their coal to Asian customers, which is not unusual for an Australian coal company, and they do operate a couple coal mines in Queensland and own the common-carrier bulk handling export port. And they’re profitable, with a similar trailing PE ratio (around 10 or so) to big international operators like Peabody (BTU).

But the most important news came after this teaser started running a couple days ago, and before I started writing this morning: New Hope announced today that they have received takeover offers from several parties and are beginning a “formal process for potential bidders” — which, as you can imagine, drove the share price up smartly. The stock went up about 15% today, so at this point you’re specu