Perpetual / Fosters Underperform.

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Perpetual / Fosters Underperform
October 31st. 2007 - Australasian Investment Review – (AIR)

Listed investment manager, Perpetual, got caught by the credit freeze, it’s also been caught by the sharp surge in resource stocks since August that has left the broader market behind (with the exception of isolated stocks like JB Hi-Fi).

It’s not alone: Argo Investments, another listed investment company (but of a different sort with just one portfolio unlike PPT’s many funds and products) is in a similar position, caught short and underperforming.

Perpetual fell $2.10 to $73.76 yesterday, a fall of 2.7% compared to the half a per cent fall in the wider market.

As the graph shows, comparing the performance of Perpetual and ASX 200 reveals Perpetual’s recent and substantial under performance.

Perpetual generates fee and other income from the funds, so it is not a straight comparison, but there’s definitely a set against the company in the eyes of some investors.

Shareholders were told at the AGM in Sydney yesterday that first half earnings are expected to rise by 10% per cent, from $68.8 million in the first half of 2006-07. That’s down on the original forecast of 15%.

Perpetual chairman, Robert Savage, said the forecast would have been higher had not recent credit market volatility resulted in below benchmark performance in the company’s exact and enhanced cash funds.

The softer performance was due mostly to small unrealised losses arising from the revaluation of credit securities.

“Excluding the impact of losses borne by Perpetual in respect of these funds, the forecast result for the first half of the current year would be a 15% increase over the prior half year,” he said.

“The forecast is subject to fluctuations in the markets, particularly in Australia.”

That exposure of Perpetual to the credit markets was a bit of new news for some shareholders as the company had not been notable in revealing its position during the freeze and its fallout.

Chief executive and managing director, David Deverall, said the company’s year to date had been impacted by the crisis in the global credit markets.

“While events of this nature are very unusual, they have had an impact on Perpetual’s income business and on our corporate trust business, both of which transact in the credit markets,” he said.

“The credit crisis is a timely reminder of two core investment principles which are at the heart of Perpetual’s investment philosophy, those being the importance of diversification and a focus on quality.”

Mr Deverall said Perpetual was poised to deliver another good result for shareholders in fiscal 2008.

Mr Savage said also that Perpetual stood by its decision to retain a near 15% share interest in Tasmanian timber group Gunns Ltd, which is about to start construction on a controversial pulp mill project in the Tamar Valley.

“Your board and members of Perpetual’s executive committee respect the investment decisions taken by our fund managers on behalf of our investors … and their right to independently select stocks in line with their mandate to grow and protect the savings of Australians,” he said.

“Gunns is one of those investments.”

The Gunns investment was raised by some green activists who were outside the meeting but had mostly forgotten to get proxies so they could speak. One activist asked a couple of questions and then left.

There was also discussion of the disclosure of the salaries and other remuneration of the company’s top fund managers, several of whom made major coups for the company’s funds over the past few months, mostly notably Rinker where a profit of around $1 billion was booked on the Cemex takeover.

Fosters Group shareholders meet in Melbourne today and some will no doubt be a bit grumpy.

The company too has been left behind as the resources boomlet powers away, but there are other concerns for the big liquor group.

From the point of view of some investors and analysts it’s a serial underperformer: the graph of the ASX 200 and the FGL share price shows that.

The Fosters share price is around 9% down on what it was at the start of the year, so management and the board can’t blame the under achieving on this ‘resources fad’.

Analysts at investment bank, Merrill Lynch, are of a similar bent.

They put a big sell recommendation on Foster’s Group ahead of its AGM, describing it as valuing destroying.

They further said that the company needs to break itself up, and quickly, to avoid any further loss of value.

The analysts said that a combination of the low wine vintage this year, caused by the drought, prospects for another poor vintage in 2008 and the rising Australian dollar, would see the company’s earnings from wine, especially in the US, plunge in the current financial year.

The recommendation sent the shares down at the opening to a low of $6.25 yesterday morning. They closed 2c higher on $6.32 in a down market, so that is some small comfort for shareholders.

“Foster’s performance since the Southcorp acquisition supports our assessment that around $2bn to $2.5bn of shareholder value has been lost as a result of the purchase. And we anticipate that even more value will be lost by continuing to pursue the current strategy of combining a beer and wine business,” Merrill’s said.

“Our view is that Foster’s needs to break itself up to avoid further loss in shareholder value.

“And although the value of the break-up may not differ significantly from the current share price, it would prevent further capital being lost in the future.

“This poor return to shareholders has occurred in a period in which Foster’s has sold off many assets (around $1.5 billion) – meaning that Foster’s as a company has become a shell of its former self. Such assets that have been sold include global brand names, the Wine Clubs and Services business, key breweries, and winery assets.

“The problem facing Foster’s is managing its earnings after a very low V07 – which reduced volumes and increased costs. Combined with the higher A$, Australian Wine looks troubled. We estimate that annualised EBIT for Foster’s Wine will fall by $150m-$200m due to the low V07 – and could be more if V08 is lower again.

“We foresee Foster’s share price falling to $5.50/share if it continues operating in its current form.

“However, if the businesses are split up in the short term, we could see the company fetching possibly $6.60/share. But in 12 to 18 months time, the break-up value could fall to $5/share. We maintain our SELL rating”.

And that’s tough comment, but the evidence is in the relative performance of the FGL share price and the ASX 200, even discounting for the recent resources surge. Much of the pressure on the FGL share price has come as the Aussie dollar has risen from March onwards.

Shareholders will be hoping for an update on the dollar’s impact at the AGM.

Copyright Australasian Investment Review.
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