Price target increased

Bradken (BKN)

Chart: Share price over the year to versus ASX200 (XJO)


Share Price: $8.35

Price target: $10.25

Broker Calls: Buy – RBS Australia, Outperform – Macquarie,  Buy – Merrill Lynch

P/E: 17.73

Market Cap: $1.35 billion

To bet on Bradken, you’re betting on the continuation of the mining and resources boom because the engineering services provider and rail equipment manufacturer has hitched its wagon to the China train. Managing director Brian Hodges noted specifically that Bradken is driven by China’s growth, and he saw no signs of an economic slowdown in China. Others may disagree.

Record spending in the mining sector and strong performances from competitors in the sector, such as Caterpillar, meant that the market was expecting a lot from Bradken’s recent earnings result. Although the company has seen orders flowing in at a historically high level in the past six months (as to be expected), analysts were a tad disappointed with its half-year numbers given the magnitude of mining spend at the moment. Net profit came in at $43.05 million for the half year to December 31, up 65.6% on the same period a year earlier. Net profit guidance for the 2011/12 financial year remains unchanged, with growth in the range of 35% to 40%. Bradken’s order book is already sufficient to meet its FY12 guidance, brokers say.

Bradken is on track to become a global mining services provider with recently expanded foundry operations in China, North America and Australia. To meet an increase in demand for its cast steel products, Bradken purchased Canadian foundry Norcast, West Australian-based WPS and AOA in NSW. The $222 million acquisition of Norcast and AOA in July 2011 makes Bradken the largest global supplier of cast steel mill liners. The new foundry in Xuzhou, China, also enables Bradken to boost capacity and revenues in the future.

The worry for investors is that hefty capital expenditure to pay for expanded foundries is upping debt levels – currently around $497 million. Net debt to equity is now around 66%, which is high and ROE and ROA have been falling, not rising, over the past few years.

According to most brokers out there, let the good times roll. Almost all brokers surveyed have a buy on Bradken at the moment, with price targets ranging from $8.49 (Macquarie), to $10.25 (RBS Australia). Although most brokers noted that interim earnings were lower than expected – market conditions are buoyant, and the company’s recent acquisitions mean that new products and capacity will hit the market in FY13.

Clive Briggs, at RBS Morgans, with a buy on Bradken notes: ‘We believe the drivers of an expected stronger second half include integrating the Norcast business, the rollout of the GET (ground engaging tools) product range and organic growth. BKN’s full year 2012 guidance is premised on the execution of existing work rather than the need to fill its order book. As market focus gradually shifts to full year 2013, we note a very reasonable forward valuation – 7 times earnings before interest and tax.’

Upgrades & Buys

Harvey Norman (HVN)

Chart: Share price over the year versus ASX200 (XJO)


Share Price: $2.08

Broker Calls: Buy – Deutsche Bank, Neutral – JB Morgan

P/E: 8.78

Market Cap: $2.21 billion

What, a buy recommendation on Harvey Norman? A new analyst covering Harvey Norman at Deutsche is a contrarian indeed. The analyst picked up coverage on Australia’s largest electronics retailer and upped the stock’s price target from $2.20 to $2.80. Harvey Norman shares have been in freefall since September 2010, when the stock was trading at around $3.88. Over the past few weeks it has been ticking up, up 8% in a month.

Harvey Norman still takes out 12th spot in the top shorted stocks in Australia, however. And as you’d know if you follow the shorts, the shorters have a good handle on stocks that are heading south.

There are rumblings that Harvey Norman could be an attractive target for private equity following the move on Pacific brands by US private equity firm KKR. As conditions in Australia’s retail sector get gloomier each day, Deutsche Bank thinks that some of our biggest players may seek a lifeline out. Harvey Norman, David Jones and possibly Myer (although it has underperformed since listing in 2009) are likely candidates for private equity, says Deutsche, with returns more appealing than Billabong and JB Hi-Fi, for example, which would not be as attractive to buyers. It’s the extensive property portfolios of Harvey Norman and David Jones that would attract buyers, according to Deutsche. Interestingly, it’s the Deutsche analyst that placed a Buy on Harvey Norman.

The other big news surrounding Harvey Norman is the possible purchase of Dick Smith electronics. Woolworths is offloading the chain, and Harvey Norman, with 22% market share, is the most obvious buyer in sight. Gerry Harvey, however, adamant that he won’t be opening any more stores in Australia may not want the added pressure of Dick Smith, especially considering the dismal outcome of purchasing of Clive Peeters.

The risk with investing in Harvey Norman is whether or not the company can exact a turnaround, or whether the structural changes in the retail industry (the growth of online, increased competition from offshore retailers, and the fallout in consumer spending) makes Harvey Norman’s franchise model redundant – like putting a square peg in a round hole. Macquarie Bank thinks so.

Macquarie Securities argues that Harvey Norman’s franchisee fee structure is “unsustainable” within a climate of severe discounting of low margin products. The broker notes that Harvey Norman’s franchisees’ cost of doing business (CODB) is presently higher than the gross margins charged a rival JB Hi Fi. It’s also concerned about the company’s build up of unsold inventory.

Shawn Uldridge, William Shaw Securities has a sell on Harvey Norman. ‘Even though the share price is low, the internet has forever changed the retailing sector. HVN has high fixed overheads in its premium retail space. Consumers are browsing in shops then finding the best deal online. Sell and invest elsewhere. The shares were priced at $2.08 on February 9.’


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