Morningstar Equities Research

Morningstar Equities Research - DWS, TEL, TEL-NZ, GBG, DUE, KIP-NZ, SKI and, KMD, MIN, MND, WSA on price change

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DWS Limited DWS| Trading Environment Remains Challenging but DWS Starting to See Improved Demand
Morningstar Recommendation: Hold
Peter Rae, Morningstar Analyst - 0414300107
In a brief update, DWS said that trading conditions remain difficult but it is starting to see a number of positive signs. Staff numbers are materially lower than last year but utilisation has improved and new demand for services means the company is recruiting again in most regions. We make no changes to our forecasts or fair value estimate of AUD 1.30. We currently view the stock as fairly valued, trading at a slight discount to fair value. We continue to rate DWS as not having an economic moat because of the fragmented and competitive nature of the IT services industry. However, we believe the company is well placed to grow earnings once business conditions improve and we expect it to benefit from long-term growth in demand for outsourced services.

In first-half fiscal 2014 DWS reported a 19% decline in net profit after tax, or NPAT, reflecting lower demand for information technology, or IT, services from business and governments. Billable staff numbers fell from 535 to 479 during the six months and despite the lower staff numbers, utilisation fell from 75% in first-half fiscal 2013 to 72%. While headcount is still lower than last year, utilisation is up slightly in the second half. We had expected improvements in utilisation given the lower staff numbers and some improvements in demand. This should see the second half earnings before interest, tax, depreciation and amortsiation margin lift from the 19.8% level of the first half. The fact that the company is recruiting again sends a strong signal that conditions are improving and gives us comfort that earnings will recover in fiscal 2015. We retain our forecast for 15% NPAT growth in fiscal 2015.

Telecom Corporation of New Zealand Limited TEL-NZ| Telecom's Balance Sheet Capacity Post AAPT Sale Offers Medium-Term Capital Management Opportunity
Morningstar Recommendation: Hold
Scott Carroll, Morningstar Analyst - 02 9276 4423
The recent sale of AAPT has bolstered the balance sheet of Telecom New Zealand, or Telecom, with gearing levels now below long-term management targets. In the absence of a material increase in the dividend, Telecom will degear further in the medium term on our estimates. A strong balance sheet provides scope for Telecom to undertake new capital management initiatives within the next 12 to 24 months, assuming delivery of operational and cost saving targets.

We currently assume a small increase in annual dividend payment from NZD 0.16 per share in fiscal 2013 to NZD 0.17 by fiscal 2015 and NZD 0.18 by fiscal 2018. This is based on a 90% to 95% long-term payout ratio. With this dividend profile, Telecom will have a net debt to EBITDA, ratio of less than 0.8 times by fiscal 2015. By fiscal 2018 we estimate the ratio will fall to between 0.6 and 0.7 times, against a long-term internal target of 1.0 times. This implies capacity to allocate up to NZD 200 million for capital management. A share buyback is the most realistic option in our view given a special dividend would likely be unfranked.

Our narrow moat rating for Telecom remains. We believe the company has a scale and cost advantage in mobile and the ability to leverage its broad product suite to increase user spend. We believe it can successfully execute a strategy which aims to rebuild market share and entrench the brand over the long term. Strong customer gains in mobile during the past 12 months support our view, though there is a risk that a focus on market share sees margin pressure persist for longer than our forecasts suggest.

We have made small changes to our long-term earnings and dividend estimates. We retain our fair value estimate at NZD 2.90 per share, viewing the stock as slightly undervalued currently. Our AUD fair value estimate of 2.40 is based on an Australian dollar/New Zealand dollar exchange rate of 1.20, well above the current 1.08 rate.

Gindalbie Metals Ltd GBG| Gindalbie Metals Coverage Ceased
Morningstar Recommendation: Ceased Coverage
Gareth James, Morningstar Analyst - 02 9276 4583
We cease coverage of Gindalbie Metals as foreshadowed in our note of 18 March 2014. Gindalbie suffers from low-quality underlying assets, lack of an economic moat and stretched financial position. Uncertainty around the fair value is extreme. We maintain our view that Gindalbie has no sustainable competitive advantage and Karara's margins are likely very skinny at best. The consequences for Gindalbie could be dire. Since we turned bearish on the stock in September 2012, the shares have fallen by 85%.

Spark Infrastructure Group SKI| Spark Infrastructure Puts its Foot on DUET
Morningstar Recommendation: Reduce
Adrian Atkins, Morningstar Analyst - 02 9276 4508
We're surprised by Spark Infrastructure's acquisition of an effective 14.1% stake in DUET Group, and find the stated justifications fairly weak. In our opinion, heightened takeover activity and strong investor demand in the infrastructure space has pushed Spark, which has struggled on its strategy of buying assets, to put its foot on DUET. Spark may look to merge the two businesses in the future, though Spark has a smaller market cap and is cheaper than DUET on our numbers. DUET informed us Spark has not contacted it yet, and it hasn't had any approaches from other potential acquirers.

We make no changes to our forecasts or AUD 1.60 fair value estimate for DUET. We adjust Spark's forecasts to incorporate the stake in DUET, increased debt and the higher share count, but Spark's AUD 1.60 fair value estimate also remains. There's no change to our view that both Spark and DUET lack economic moats as excess returns are unlikely given the firms' returns are regularly reset to costs of capital. The harsh regulatory environment further reduces the potential for excess returns.

To help fund the acquisition, Spark is raising AUD 200 million in an equity placement to institutions at a price of at least AUD 1.75 per security, representing a 7% discount to the last traded price. This will cover less than half the acquisition cost with the remainder coming from debt. As this is a leveraged investment into a leveraged company, we disagree with Spark's view that this is a prudent funding mix.

Spark's corporate structure is relatively unattractive because of its minority stakes in underlying assets, and we question the merit of its acquisitive growth strategy. History shows companies often destroy value from acquisitions in the infrastructure space, and Spark is highly unlikely to find attractively priced opportunities at present given strong investor demand for infrastructure assets. With low costs of debt and equity, large global investors are willing to pay high prices.

Kiwi Income Property Trust KIP-NZ| Ongoing Economic Strength in New Zealand Should Continue to Push Up Kiwi's Property Values
Morningstar Recommendation: Hold

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