Stock: Hastings Diversified Utilities Fund
Market Cap: $94m
When an entire sector gets demolished by investors we like to search for opportunities where the ‘baby has been thrown out with the bathwater’. Or in other words, hidden gems, deemed guilty by association, for simply having similarities to companies that have wronged investors. With share prices mauled by selling in late 2008, listed infrastructure was one such sector that piqued our interest.
Pioneers including Macquarie Group and Babcock and Brown had previously made millions by opening up the sector to everyday investors. They became adept in placing unique infrastructure assets in specially created listed companies, which in late 2008 accounted for around 40% of the sector. Ironically, these Babcock and Macquarie satellites became poster children for the sector’s woes. There was nothing wrong with their underlying assets. Instead problems arose because of the unsustainable nature of their capital structure.
Surprise, surprise, when the credit crunch hit, they found themselves carrying too much debt.
The real ‘irk’ for shareholders must have been the discovery that these companies were not the defensive, high yielding stocks that they were made out to be. Most infrastructure stocks turned out to be guilty of paying ‘financially engineered’ dividends, which typically rely on the unsustainable practice of funding shareholder payments through debt.
Where should dividends instead come from? Profits. But surprisingly, we found that only 30% of companies in the sector paid dividends out of operating cash flows in late 2008. Amongst this more conservative minority, we therefore searched for any ‘diamonds in the rough’.
Within our shortlist, our analysis suggested that no company offered clear capital growth opportunities. That left only one reason for investing in the sector – yield. With interest rates being cut around the world, the case for defensive high yielding investments has been improving. Finding companies that fit this bill is another matter. Infrastructure and property trusts were previously regarded as the ‘go to’ sectors in times like these. Their assets are typically subject to inelastic demand, which should protect income during softer economic periods. But as many shareholders have unfortunately learned, debt has become the dominating factor.
After scouring the infrastructure sector, no stock jumped up as a compelling value opportunity, but Hastings Diversified Utilities Fund (HDF) did stand out from the crowd. With below average debt levels, and a relatively high, cash flow funded dividend yield, we recently flagged the stock as one of the better quality members of sector. Its assets included gas pipelines in Australia and Water Utilities in the UK. The management team – Hastings Funds Management (owned by Westpac), garnered a conservative reputation. But given the potential for additional downside pressures to impact share prices in the sector, we held back from making a recommendation on the stock until the risk to reward proposition improved. There’s little point in chasing yield if your capital is at risk, and our assertion that the share price faced further downside pressures has rung true – in a big way!
Since our last report, the share price has collapsed, breaking through the all important $1.80 support level and falling as low as 29c – 90% below its all time high!
So what went wrong? And if Hastings was regarded as one of the higher quality members of the infrastructure sector, what does this mean for the others?
In short, the market has lost confidence in management following several tactless disclosure slip-ups and an ill timed ‘performance’ payment to themselves. In December all seemed well when management forecast a slight increase to distributions (dividends) for 2009. Given their conservative reputation and HDF’s relative outperformance to date, a 14% yield appeared pretty much ‘in the bag’ for shareholders….or was it?
The new year was marred by companies slashing dividends left, right, and centre. Therefore shareholders can be forgiven for needing additional ‘comfort’ over the security of their dividend income. So when management glossed over the topic of distributions in their half year report in late February, HDF’s share price started to crumble. And then, March 5th saw the company drop a bombshell. Seemingly out of nowhere, management released revised 2009 guidance that distributions would tumble to 12c a share, a 57% decrease from the previous year’s 28c.
Following this revelation, the integrity of management has been shot. After paying themselves a handsome performance fee for their ‘management prowess’ in 2008, management revealed that the Fund is in a less comfortable financial position than widely thought. In short, gearing pressures have emerged and looming repayment deadlines may force asset sales in what is clearly a buyers market.
The dividend reduction was a response to these pressures, but naturally shareholders should be questioning whether their best interests have been looked after. With the subsequent abrupt share price decline occurring on record volumes, remaining shareholders are no doubt wondering whether this is the ‘smart money’ that they too should follow?
But on the other hand, the stock is now trading at just 21% of its net tangible asset backing, and remaining shareholders questioning their faith could be risking an exit when the real value is starting to emerge. Omen or opportunity…?
We will be keeping members informed about whether Hastings ‘quality’ tag has been tarnished beyond repair. As for the rest of the infrastructure sector? We don’t expect the Hastings saga will do its peers any favours when it comes to winning back investor sentiment.
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Tim Morris is an analyst at wise-owl.com, one of Australia’s leading independent stockmarket research houses. Click here for your complimentary report.