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A New Baddie In Town

High debt levels is the new baddie in the frontier town called capitalism. Investor, judge, jury and executioner vigilantes are riding out of town any stock with a whiff of “badness” for a quick desert execution and burial.

Investors pull the trigger first, and ask questions later. Perception is often viewed as reality for possible capital raisings.

But like many spaghetti westerns, (the Cisco Kid – and no that’s not a router!) the perception of badness, like gearing can be one dimensional and myopic.

Seven Group Holdings (SVW) was put, recently, on a horse by investors for a last ride out of town. Investors believed SVW was too highly geared, post a capital raising by its 33% owned affiliate Seven West Media, The SVW share price was barreled to a near low of $6.50 in the past two weeks.

Net debt (SVW) stands around $1.7 billion. But what is hiding behind the metaphorical beard stubble and bad ass attitude, is a raft of solid, profitable business assets, with debt/earnings cover of just over 3 times.

Further redemption for SVW is the proposed IPO of partly owned (46%), privatised Coates Hire, (estimated $500 -$700 mln) and possible sale of SVW’s Consolidated Media Holdings (CMJ) which could book a profit of more than $300 mln. If proceeds are ploughed back into working capital then net debt levels could fall significantly. A capital raising becomes redundant, particularly as EBITDA (earnings before interest, tax and depreciation) is expected to rise over the next two years to nearly $800 million.

SVW, as well, has a significant listed investment portfolio – about $400m (believed to be 100 million Telstra shares), which it may choose at some point to sell and book profits. It also has a $258 million (current market) investment in Agricultural Bank of China. ABC is one of China’s big four banks, and the investment is a demonstration and commitment to the Chinese government of Westrac doing business there.

Broker’s price estimates range wildly for the stock – $7.35 (already there at $7.40) to the high $10’s. This is partly due to expectations of what will happen with Chinese GDP growth and its implications for the Australian mining industry. Some analysts apply a valuation discount of up to 25% to a conglomerate corporate structure.

The Cisco to SVW’s Pancho sidekick, is the US based Caterpillar. SVW operates a CAT franchise in Northern China, and in NSW and WA, Australia. Caterpillar reported strong quarterly results last week.

Revenues, globally, up 22% to a record USD$17.4 billion and operating profit up from $1.6 billion to $2.6 billion. Based on forecast annual Caterpillar revenue of $69 billion, the US market values Caterpillar at 0.8 times annual revenue and 8-9 times annual expected earnings. Compare this with CAT’s main competitors Joy Global (1.2 times annual revenue) and Komatsu (1.6 times annual revenue) and CAT and by default SVW, looks cheap at around 0.5 times.

SVW recently bought Bucyrus Australia for $400m, complementing CAT’s machinery, adding 148 unique model configurations to its product range, particularly for coal mining. Bucyrus is expected to be earnings accretive in 2013 and produce between $600 and $650 million in revenue.

When you consider that Westrac in both Australia and China, along with Bucyrus, contribute over 60% to Seven Group Holdings valuations, it doesn’t take too much imagination to see the company’s assets divided in the future into two distinct public companies “Caterpillar “ and “Other”.

In the “Other” category is Seven West Media – Channel 7. The valuation of SVW had been on a downward trajectory since the merge of Seven’s media assets with the West Australian Group.

The SVW capital raising appears to have stabilised market concerns about the media company’s gearing levels. Seven has been the top rating commercial network over key demographics.

The most recent SWM presentation suggested profit could be up between 20 and 30% on the 2011 result of $204 million.

For my money SVW in the low $7.00’s is a good investment

Hey Cisco. Hey Pancho!

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