Morningstar Equities

Morningstar Equities

Auckland International Airport intends to seek shareholder and court approval to return NZD 454 million of capital to its shareholders. The firm argues it has a less efficient mix of equity and debt than in the past and the capital return provides an optimum debt-to-capital ratio. If successful, shareholders will receive NZD 3.43 per share for every 10 shares held. Around NZD 181.6 million of the distribution will be treated as a capital return which will not attract any tax in New Zealand, while the balance of NZD 272.4 million will be treated as dividends and will be fully imputed at the 28% tax rate for New Zealand shareholders. Foreign shareholders will receive a supplementary dividend to compensate for the lack of imputation credits. Consequently, the return is more tax-efficient than declaring a one-time special dividend, especially for New Zealand shareholders. It equates to NZD 0.343 per share, or nearly three times the forecast annual dividend of NZD 0.12 per share. The company pays 100% of adjusted net profit after tax as dividends and that policy is unlikely to change any time soon. However, given the capital return will coincide with the firm's fiscal 2014 final dividend payment, shareholders will not receive a final dividend for 2014 should the capital return be approved.

We are leaving our fiscal 2014 forecast unchanged but reduce our fiscal 2015 forecast to NZD 157 million, from NZD 172 million, reflecting the additional borrowing cost to fund the capital return. However, our earnings per share forecast is largely unchanged given the 10% reduction in share capital. The reduction in share capital boosts our fair value estimate to NZD 3.50 per share from NZD 3.15 per share. At the current price, the company's shares are fairly priced. The stock has had a good run as investors seem to be enticed by the firm's defensive characteristics and reliable dividends. We reiterate our wide Morningstar Economic Moat Rating reflecting the firm's monopoly status.

Graincorp Limited GNC| Australian Government Bans ADM Takeover of GrainCorp
Morningstar Recommendation: Hold
Peter Rae, Morningstar Analyst - 0414300107
Australian Treasurer, Joe Hockey, has banned Archer Daniels Midland, or ADM, from taking over GrainCorp. Hockey rejected the takeover on national interest grounds given GrainCorp's significant share of the eastern Australian grain handling infrastructure. Our forecasts and AUD 10 fair value estimate are unchanged.

We have always thought GrainCorp shares would fall if the takeoever did not proceed. The shares are currently trading at a discount to fair value and could continue to do so in the short term as hedge funds and other holders that were expecting the takeover to proceed exit. If ADM also exits this would place additional pressure on the share price. ADM is required to hold its 19.85% stake until 31 December 2013. In its release following the Australian Treasurer's announcement, ADM said it would work closely with GrainCorp to maximise returns on its investment and create value for both companies. This indicates it may remain on the register and work with GrainCorp to identify possible joint venture opportunities. The Australian Treasurer also said he is open to ADM lifting its stake to 24.95%. ADM may take the view that it may be allowed to acquire 100% of GrainCorp at a later stage.

GrainCorp's earnings remain volatile and dependent on favourable grain crop conditions. Volatility has reduced in recent years with the diversification into malt and edible oil processing, but in fiscal 2013 the grain storage and logistics businesses still contributed 45% of earnings before interest, tax, depreciation and amortisation, or EBITDA. Given the earnings volatility, we attach a high uncertainty rating to our fair value estimate and require a higher discount to fair value before purchasing the stock. Despite its ownership of strategically important grain handling and storage infrastructure in eastern Australia, we do not consider GrainCorp has an economic moat, as it has failed to generate returns above its cost of capital across the cycle.

Precinct Properties New Zealand Limited PCT-NZ| Muted New Supply in Auckland Keeps Precinct On Track to Hit Guidance
Morningstar Recommendation: Hold
Tony Sherlock, Morningstar Analyst - 02 9276 4584
At its annual general meeting earlier this month, Precinct left its fiscal 2014 dividend guidance unchanged at NZD 5.4, up 5% on the prior year. Management painted an upbeat outlook for rents, particularly in Auckland. We see the portfolio as well positioned to benefit from the stable economic conditions. The portfolio's 60% weighting to Auckland bodes well as minimal additions to Auckland supply supports high occupancy and solid rental growth during the coming two to three years. Unfortunately rent growth from reletting is likely to be muted in fiscal 2014 given rents were roughly 1.8% below market rates at August 2013.

We have adjusted our forecasts for the unit purchase plan, which added NZD 12.5 million in additional capital. Our fair value estimate is unchanged at NZD 1.00, with the stock broadly fairly valued at current levels. We retain our narrow Morningstar Economic Moat Rating, with the moat underpinned by the strong end-user demand to operate out of premium premises in the most desirable locations.

Precinct flagged NZD 230 million of the portfolio was considered non-core, with the business taking steps to divest these assets in an orderly manner. We expect the assets most likely to be sold are office towers in Wellington. Precinct is expected to focus capital on the Auckland waterfront area, an area it has been strategically developing as Auckland's premium business location. We expect some earnings dilution from the disposal program as yields on the Wellington assets average 8.0%, compared with 7.1% for Auckland. However, the effect is likely to be largely neutralised by growth in underlying rents and likely reductions of borrowing costs from 5.6% at June 2013.

Chorus Limited CNU-NZ| Placing Chorus's Fair Value Under Review
Morningstar Recommendation: Under Review
Peter Rae, Morningstar Analyst - 0414300107
With the New Zealand government unable to gain support in parliament to overrule the regulator's final pricing on wholesale broadband, we are placing Chorus under review. Our previous fair value estimate and recommendation were based on the government intervening and applying wholesale prices in the discussion paper released post the draft decision. We see the government stepping in as likely, but the form of intervention is uncertain. Possible scenarios include a capital injection by the government and amending the fibre rollout schedule, deferring capital expenditure commitments. Given the turn of events we are likely to lower our fair value estimate.

Infratil Limited IFZ| Energy Assets Lower Infratil's Core Earnings in the First Half, Guidance Remains Intact (corrected)
Morningstar Recommendation: Hold
Nachiket Moghe, CFA, Morningstar Analyst - 64 9 915 6776
Our previously published note did not contain the revised Australian dollar fair value estimate.

Infratil released results that were in line with our expectations and management guidance. Underlying earnings before interest, tax, depreciation and amortisation, or EBITDA, decreased 3.4% to NZD 285 million as a result of lower earnings from Trustpower and Infratil Energy Australia. Operating cash flow increased by a whopping NZD 274.6 million, reflecting dividends from Z Energy and lower working capital requirements. However, higher investments, especially in Trustpower, dramatically lifted capital expenditure to NZD 228 million from NZD 148 million. Post balance date, the firm invested in aged-care operator Metlifecare by acquiring a 19.9% stake at NZD 148 million. Consequently, management lifted its capital expenditure guidance from between NZD 580 and NZD 645 million to between NZD 650 and NZD 170 million. The partial sale of Z Energy also prompted management to lower its EBITDA guidance to between NZD 500 and NZD 540 million from between NZD 520 and NZD 560 million. This reflects flat earnings for Trustpower and a reduction in Infratil Energy Australia's earnings due to higher wholesale electricity prices.

We maintain our fair value estimate of NZD 2.50 per share which is consistent with our discounted cash flow valuation. However we are raising our valuation on Infratil's Australian listed entity from AUD 1.57 to AUD 2.20 to reflect the significant rise in the New Zealand dollar. We could see a significant churn in Infratil's portfolio such as was witnessed in the first half, as the firm seeks to acquire value-accretive assets.

Fisher & Paykel Healthcare - Downgrade due to price change
Auckland Airport - Upgrade due to price change
Metcash - Upgrade due to price change
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