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Should I Take Part in Capital Raising?

Richard Hemming


Today Under the Radar Report talk's about five ASX stocks that are doing a capital raising and what ASX investors should do.

Are capital raising good for investors?

The broking community is busier than ever because ASX companies have never raised more capital at any one time, but is capital raising good for investors? The answer is, only sometimes. As Under the Radar Report keeps saying, it’s a stock picker’s world for investors more than ever, as COVID-19 crashes its way through the economy.

Five stocks doing a capital raising

Below, Under the Radar Report examine the latest capital raisings: Breville (BRG) and the mortgage broker Australian Finance Group (AFG). We’ll also cover last week’s profit results from Commonwealth Bank (CBA), the car leasing specialist Eclipx (ECX). We round off with a comment on the property sector, following the Stockland (SGP) third quarter update.

Capital raisings in Australia

The vast majority of ASX companies doing capital raisings are forced by inadequate balance sheets, having been weakened over time by heavy dividend distributions owing to the Australian taxation system’s favourable treatment of franking credits.

Which stock are doing capital raisings in Australia? 

Leading kitchen appliance manufacturer Breville is raising $104m, $95m from institutions at $17 a share, representing a 9% discount to its price prior to the announcement. Breville’s shares are now trading just below $20, so this represents a handy turn thus far. The retail share purchase plan is capped at $10m and is at the same price.

Why is Breville raising capital?

From what we can see the raising was primarily required to refinance $373m of debt facilities, but the company says it’s also for working capital needs to enable sales growth and international expansion into the Middle East; as well as for capex and R&D. Post the raising, Breville will have net cash of $10m.

Breville is a quality ASX listed company but expensive 

Breville is a quality ASX listed company that is achieving great things on the world stage. It also looks expensive, trading on forecast PE multiples of well over 30 times, although these are based on COVID-19 distressed condition. Based on historic earnings, it still looks expensive, trading on 27 times.

How resilient is Breville?

Investors pay for growth, but how resilient is this ASX listedcompany? Under the Radar Report would argue not as resilient as the market’s valuation suggests. One of our associates relies heavily on a Breville bread machine for all his doe needs. It probably cost A$70 and three years later it still works fine. The product is too good! Breville services the consumer durable market, whereas clearly in the COVID-19 world consumer staples are the winners. Bank those entitlement profits!

AFG business impacted by COVID-19 

As for AFG, we’re nervous about anything associated with residential lending and a mortgage broker is at the coal face. The ASX listed company is seeking $60m in a deal underwritten by Macquarie. The company is offering new shares at $1.15 to raise $15m and another $45m via a rights issue. The discount was 17% to the prior close, but its shares traded at $3 prior to the COVID-19 crisis. Wow!

What will AFG funds be used for?

The majority of funds will be used to strengthen balance sheet. Remainder to invest in technology and growth opportunities. Under the Radar Report prefer the majors banks. Shadow/non-bank lenders are at a greater disadvantage to major banks in terms of access to funding and funding costs. Get out of AFG when you can.

Bank's are historically good value 

CBA delivered its third quarter result this week, which we’ll expand upon in next week’s Blue Chip Value Report. Under the Radar Report like the banks because they are historically good value; you would have to go back to the early 90s to see them cheaper.

Divergence in bank valuations 

What we’re seeing, however, is a divergence in their valuations and on our numbers. CBA looks the most expensive; its valuation is within 10% of our price target; this is probably because we’re excluding from our valuation a final CBA dividend. Overall though, the banks’ balance sheets are stronger than they’ve ever been and they benefit from government assistance, although CBA’s CET1 (tier one capital) position was weaker than expected, which is a concern and which we’ll talk more about.
 
At the other end of the scale there is the Eclipx (ECX) salary sacrifice business. You couldn’t get more financial engineering than this business. It’s WeWork for cars. There are so many great opportunities to buy quality companies that we won’t say any more.

Can Stockland (SGP) withstand COVID-19​?

At the quality end of the spectrum is the Australian listed property trust flagbearer Stockland. But is its business able to withstand the ravages of COVID-19? We would say not without more damage.

What does Stockland's third quarter update shows?

The group’s third quarter update showed the weakest monthly net deposits in residential on record. Moreover, there is huge uncertainty relating to asset values, in contrast to its fixed debt amounts, which are all too certain. Rental negotiations are the biggest factor and gearing (debt/debt plus equity) is probably over 30%, which is above its 20-30% target range, indicating a capital raising is on the cards (why miss out on the fun?).

Problem areas outnumber positive areas

Looking at it simply, they’re the biggest in Australia, but residential is a problem; retail is a problem; offices are a problem; warehouse is a strength. Problem areas outnumber positive areas.
 
If you hold property trusts or developers that are leveraged to residential and offices the game is changing rapidly. Would anyone pay $750k for a studio apartment in Macquarie Park?
 
Others we're more interest in the sector include those leveraged to the industrial sector; most specifically those involving distribution. It’s an online world these days.

Property trusts we're more interested in 

Centuria Industrial Trust (CIP) which owns warehouses but has lowered its distribution guidance, which puts it on a yield of close 7%. There is tenant risk, so it’s still buyer beware. Goodman Group (GMG) is more of a developer if industrial estates and is global; hence more growth orientation. This business is a property fund manager and has reaffirmed earnings and distributions for June. It trades on a 2% distribution yield though; so you’re paying up for it!

Buying any security for its income stream is more dangerous than ever

All property trusts have tenant risk and in the wider market, this is mirrored by income from all companies. Dividends/income paid in the past will bear little relation to the foreseeable future. Buying any security for its income stream is more dangerous than ever.
 

About the Author

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (AFSL: 409518). The author does not own shares in any of the stocks mentioned.

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