Monthly Strategic Outlook April 2013

T H E AU S T R A L I A N S TO C K B RO K E R
Patersons Securities Limited Monthly Strategic Outlook - April 2013

ABN 69 008 896 311
This months highlights... Macro: Whipsaw Market - Neutral View Industrials: Health Care Sector Reveiw - March 2013 Rare Earths: Weak hands create opportunity in a rare producer
IN THIS ISSUE...
Macro Investment Strategy Whipsaw Market - Neutral View . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Australian Outlook RBA benchmark rate stays at 3.00%; February retail sales surprise on upside . . . . . . . . . . . . . . . . . . . . . . . 8 Quantitative Focus Using a Multifactor Model to Identify Investment Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10
SECTORS
Banks Competition in the Australian Home Mortgage Space is Hotting Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13 Industrials Health Care Sector Review - March 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 Energy Oil & Gas: Oil prices rebound during March . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 Mining and Metals Gold The hurt continues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 Specialty Metals Rare Earths: Weak hands create opportunity in a rare producer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31
MONTHLY STRATEGIC OUTLOOK
All information and advice is condential and for the private information of the person to whom it is provided and is provided without any responsibility or liability on any account whatsoever on the part of this rm or any member or employee thereof.
Macro Investment Strategy

MONDAY 20 APRIL 2009 APRIL 2013
Andrew Quin - Research and Strategy Coordinator
WHIPSAW MARKET - NEUTRAL VIEW

Across the major global stock market indices the most positive technically remain the US indices, while Shanghai (China), the Nikkei ( Japan), and European Union (EU) markets, with the exception of the Swiss market, all look technically vulnerable. The US markets have been supported on easy monetary policy and a view that the US economy continues in recovery mode. With the US markets having reached record highs emphasis is naturally on the sustainability of the US recovery and company earnings going forward. In addition this places focus on US Federal Open Market Committee (FOMC) actions and the outlook for Quantitative Easing (QE) and the continuance of stimulatory economic policy to provide support for the market. This divergence in global markets, combined with a balance of supportive and resistance factors suggest the All Ordinaries (XAO) is set for a period of whipsawing a volatile, tight, ranging market.
Slow global growth, adds US economic emphasis

US stimulatory policy is only going to be reduced when there is clear evidence the US economic recovery is sustainable. If the US economy continues to improve reducing stimulatory policy efforts is inevitable. The rst move would be a reduction in monthly QE asset purchases. Under the distorted economic system now existing a reduction in asset purchases is the equivalent of a lift in interest rates. The FOMC has stated it will maintain stimulatory buying while the unemployment rate, currently at 7.7%, remains above 6.5%. Monetary policy needs to track proportionally behind the US economic recovery or growth will slow. Thus the FOMC are likely to maintain stimulatory policies for the foreseeable future, however this will not stop the stock market from trying to anticipate a change in policy direction. Commodities are mostly trading lower, particularly agricultural (grain) futures on favourable weather conditions. Although on balance combined with metals the commodity picture looks one of weakening global demand and an unwinding after expectations of a China economic bounce failed to materialise. With the top end yield play in Australia capital gain wise looking a little long in the tooth and the Materials sector lacking an upside catalyst, the local market is feeling some pressure. Recycling yield is still the main focus for superannuation focused investors on the Australian market with compounded yields still offering good returns relative to cash and the Australian property market. This remains a positive element despite, the now, reduced attraction on the capital gain potential side following the markets strong run.
Towards a volatile whipsaw market

The All Ordinaries (XAO) has scope to trade higher to ~5,150 if US 1QTR earnings surprise on the upside in coming weeks. However, relatively limited technical support exists below the 4,950 4,900 level, with support at 4,750, and 4,650 - 4,600. Thus a clear break of 4,950 4,900 would warrant protecting positions quite quickly for technical traders. While those with a fundamental view would need to see a deterioration in the US economic outlook to lighten positions, this requiring both a deterioration in the employment and housing outlook. Following the strong market move higher from November 2012 to the top of the 3.5 year trading range, we expect the XAO to set up a volatile tighter range as the market grapples with a lack of clarity on the US, Chinese and global recovery, and Japanese Bond market and North Korea pressures. We expect the Australian and US markets to be supported on the downside by an extension of stimulatory monetary policy, a basing in the Materials sector, and attractive yields (local), and to be blocked on the upside by strong technical resistance (5,000 5,200), lack of economic growth clarity, macro and socioeconomic stressors, and ironically the spectre that the FOMC may start to back off QE efforts in late 2013 early 2014. Though current estimates are for policy to be wound back in 2015. A view of the future could look something like the market in late 2009. A volatile whipsaw market suggesting traders will have to stay active to avoid neutral returns.
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Commodities Back to the future - Oscillation around the marginal cost of production
Materials and Commodities are messing with traders minds, as it is hard to separate what is actually happening from what traders want to happen. Metals look like they are going back to times when they traded just above and below the average marginal cost of production. Though iron ore, tin and copper all look to still be holding reasonable buffer margins, but the stock market is not a believer and is factoring in potential for a decline in prices going forward. This back to the future effect will return the stock market focus in regard to Materials companies towards grade and production costs. With China showing only lacklustre signs of growth, the hope for the Materials side now appears to be if the US can eventually drag the rest of the worlds economy higher, assuming its recovery continues. Chinese export import gures are released 10 April, these being one of the more accurate measures of Chinese economic performance. Of late they have tended to show a picture of reasonable exports lead by US demand, while imports, in part a reection of domestic activity, remain comparatively weak. Authorities in China are drying up liquidity and the country looks like it is still trying to absorb the excesses and a misallocation of resources following Global Financial Crisis (GFC) stimulatory policies.
Pulling the wool over your eyes?

What China, Japan and other central banks with their stimulatory policies and asset purchase programs have tended to forget, is that historically government directed economic growth and asset purchases have tended to result in signicant waste and a misallocation of resources. The GFC was a near structural failure of the nancial system, but subsequently governments have tried to prop up through asset purchases, and stimulatory policy a global economy where medium term demographics (China one child policy, Japan aging population, EU economic maturity) was likely to result in a partial natural decline in economic demand and output. Effectively resulting in a weak period, before wider global demographics and technology once again boost global growth performance. The global situation is not unlike when the Australian wool industry decided wool should not be sold below certain price levels and started to buy its own wool. This resulted in a huge wool stockpile, ending inevitably in tears. The global central banks are expanding their balance sheets with assets to support markets in the hope that private sector demand will lift, but like the wool industry perhaps they have set their oor prices too high distorting both production and global markets.
Japan continues to defy the economic laws of gravity recently signicantly expanding its asset purchase and stimulatory efforts. The country is targeting 2% ination to lift hard asset values and stop what has been a deationary spiral via simply more of the same policy that has not worked for 20 years. It is certainly an interesting experiment, but Japan has an aging population, strong competition from China and requires innovation to extract itself from such a downturn. But when do you hear support for innovation to aid competitiveness mentioned by central banks? At the time of writing Japanese Bonds are under pressure following the increased stimulatory moves. Central banks are trying to return to a world where signicant money was made buying assets that where then sold on to others at higher prices. Its a grand experiment. The US may just get away with it, because it is historically a country of signicant innovation, this assisting its competitive position. European Central Bank (ECB) efforts do seem to be sustaining a reduced risk prole in measures such as Credit Default Swaps (CDS) and periphery yields. The ECB has done a good job of acting as a back stop to demand, but the Eurozone remains in slow growth mode and it is essentially a trade-off between future economic growth levels and how long the ECB can support the Bond markets. The Japanese approach suggests a signicant amount of time, but perhaps not forever.
Again the world looks to the US

Right now the future of the global economy looks not to rest with China but once again on the US and the sustainability of its economic recovery. The US indices despite being at all-time highs still look attractive, with high liquidity levels and stimulatory policy remaining supportive. The FOMC has the US stock market back at record highs and they appear to want to keep stimulating the US economy until the property market and employment recovery looks sustainable. The US is moving closer to energy self-sufciency, technological innovation should start to ow more strongly through the system in coming years, and the S&P500 still has upside to catch up with long term Gross Domestic Product (GDP)/ination/dividend historical tracking. While there will of course be problems along the way, we maintain a positive view on the longer term US outlook. Alcoa kicks off 1QTR US earnings on 8 April with expectations for S&P500 company earnings to be 1.9%-3.9% lower against the same period a year ago. Earnings expectations are low for S&P500 companies this quarter. Currently the market expects earnings for Financials and Tech stocks to drag the earnings numbers lower before a later in the year rebound. It is vital that the US economy and stocks continue to perform, given alternative markets both lack upside catalysts and look technically vulnerable.
Outlook Whipsaw
The XAO is likely to range in a whipsaw pattern through what is commonly a weaker seasonal period for stock markets following the strong Christmas period. We are Neutral on the market on a month view, but still favour yield payers as defensives. At this stage we lack evidence for an upside catalyst in the Materials sector. We see the Materials sector as yet to base and are Neutral until we see a basing catalyst or technical reversal. The Materials sector is trading down as the market unwinds after the failure of the Chinese economy to bounce signicantly following the change of leadership and Chinese New Year. LME metals are yet to return to their trading bases. The Materials sector base is 9,000 (Current 9310). However, if US employment data is favourable a technical short term bounce of the sector could take place before base levels are hit. The market in the US has been supported on the US growth story and its continuance. This will add emphasis to the 5 April US NonFarm Payrolls (Consensus: 195,000, Prior 236,000) numbers, and housing numbers going forward. A signicant miss on US Non-Farm Payroll numbers would create the impression of a slowing in the US recovery picture which could result in a change in US market sentiment. However, a deterioration in the housing sector would be needed to complete a picture of the US economic recovery failing, and as yet this is not the case. However, if such a situation was to eventuate traders should lighten positions given alternative global markets and economies do not look strong. Concerns remain for both the Japanese and Chinese economies, while slow growth continues in the EU.
KEY DATES:
5 April US Non-Farm Payrolls. 8 April US 1 QTR Earnings season starts (unofcial). 10 April China Import Exports. 30/1 April/May FOMC meeting. 7 May RBA meeting. 19 May US Debt Ceiling extension.
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MONTHLY STRATEGIC OUTLOOK 5
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MARKET STRATEGY: April 2013: 1-Month: Neutral. 12-Months: Neutral/Bullish. The All Ordinaries (XAO) is trading down in what we expect to develop into a whipsaw trading pattern. US markets have touched record highs. US economic numbers remain mostly positive against a background of strong stimulatory policy. Chinese economic numbers are mixed, while EU credit risks as measured by CDS remain contained. Japanese Bond market and North Korea pressures are a market concern. The current belief that economic recovery is taking place will need to continue to be reected in economic numbers in the year ahead to maintain market support. Yields on the Australian market remain attractive. Chinese policy lacks aggression, probably due to stress in the shadow banking system and property market and this is pressuring commodity prices. The Australian economy is slightly underperforming on interest rate, government, offshore and dollar pressures. US, EU, UK and Japanese monetary policy is set at extreme stimulatory levels in an effort to lift demand. We maintain a yield and stock specic catalyst focus. We suggest long term holders ensure dividends are reinvested and so compounded through time. The twelve month technical target is 5,200.
Key theme The market is likely to long term range trade suggesting the need to recycle dividends, time, and trade positions. A specic stock focus is recommended. Testing range resistance.
12-Month view Neutral
Primary risks The sustainability of US growth
Technical (XAO 4,900) Support Resistance Near: 4,950 Medium: 5,000 Primary: 5,200
Sovereign credit risk and nancial structural Near: 4,900 pressures/ US Debt Ceiling negotiations/ Japanese Bond market Next: 4,750 1- Month view Neutral/Bullish Pressures on growth in China The pace and sustainability of global growth given high debt levels Neutral capital gains in a cyclical ranging market Next: 4,650-4,600
SECTOR Consumer Discretionary Consumer Staples Energy
WEIGHTING Index weight Index weight Index/Under weight Index/Over weight
COMMENT Interest rates, a weaker consumer outlook and pressure from internet purchases have taken some of the edge off the sector outlook. Technically upside momentum is coming out of the sector. More defensive than the Consumer Discretionary sector and offering some good yields. Technically upside momentum is coming out of the sector. The oil price continues to be heavily inuenced by OPEC, geopolitical factors and the global growth outlook. EU Iranian oil sanctions are also an inuence. Middle East and Northern African risk is oil price supportive. Technically the sector is ranging. Tight credit markets, margin contraction and loan book risks are negatives for the sector. Margin pressure, from tighter wholesale money markets, combined with a weak Australian property sector are primary inuencing factors in the market. However, yields remain attractive and RBA policy with a downward bias is of assistance. Technically upside momentum is coming out of the sector. Expected to benet long-term by the aging population and government support. Technically upside momentum is coming out of the sector. Australian dollar will hamper exports for some companies. Slow offshore demand will also drag. Technically the sector is testing resistance, with some momentum coming out of the market. Looks vulnerable to the downside. The Information Technology Index is stock specic. Technically the sector is just below resistance. Traders in the sector had anticipated a better performance by the Chinese economy by now, however this has not taken place causing the sector to sell off. China is continuing to signicantly drive metal demand. Chinese efforts to manage its economy remain the primary short term risk. Technically the sector is trading down looking for support. A short term technical bounce could take place if US employment data is favourable. We believe the worst for the sector is behind us and the majority of ASX 200 REITs are in good health and well set for the next upturn. Outside the ASX 200 investors still need to be cautious and selective, given many of these trusts have not recapitalised. We like the sector as a long term four year play for recovery with a good yield in the interim. Technically the sector is trending higher on a longer term chart, while some momentum is coming out of the market. The sector has regulatory, competitive and technological change pressures. Difculty predicting forward earnings adds sector risk. However, yields remain attractive. Technically upside momentum is coming out of the sector and it is ranging sideways. Many stocks in the Utilities sector are moving to more vanilla models and so the sector is in the midst of structural change. Avoid stocks with excess leverage and renancing risk. Yields make the sector attractive. Technically ranging.
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Financials
Healthcare Industrials
Index weight Index weight
Information Technology Materials
Index weight Index weight
Property Trusts
Over weight
Telecommunications
Index weight
Utilities
Over weight
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Australian Outlook
Tony Farnham - Economist
RBA BENCHMARK RATE STAYS AT 3.00%; FEBRUARY RETAIL SALES SURPRISE ON UPSIDE
RBA reiterates the appropriateness of policy accommodation and the scope for more cuts if required
The April RBA board meeting saw the bank keep its benchmark interest rate unchanged at 3.00%. Given its relatively relaxed view on the medium-term direction of Australias ination rate, the RBA overtly stated that scope still existed for rates to be further reduced should it be necessary to perk up demand levels. For the moment though the bank was happy to note that with ination expectations contained and with our GDP growth likely to be a little below trend over the coming year, an accommodative stance of monetary policy was appropriate. The bank stated that while global growth remained a little below trend, the downside risks had in its view reduced over recent months. Europe remained the proverbial y in the ointment with the RBA rates decision commentary blandly stating that the Continent remained in recession. On the upside though, the US continued to enjoy a moderate expansion and growth in China had stabilised at a fairly robust pace. Across the broader Asian region, the bank noted that growth was dampened by the earlier slowing in China and the weakness in Europe, but some signs of stabilisation were at least apparent. The RBA highlighted further improvement in global funding conditions for nancial institutions. It specically noted that long-term interest rates faced by highly rated sovereigns, including Australia, remained at exceptionally low levels and that borrowing conditions for large corporations are similarly very attractive. Share prices were, at the same time, substantially above their low points. However, the RBA also conceded that the task of putting private and public nances on sustainable paths in several major countries was still very much work in progress, meaning nancial markets remained vulnerable to setbacks. With regard to domestic economic developments the April RBA rate decision commentary stated that while the peak in resource investment was now close, there was more scope for some other areas of demand to strengthen in short, sector rebalancing rules OK! It specically stated that the 175 basis points of rate cuts implemented since late 2011 were having an expansionary effect on the economy and that further such effects would eventually emerge. The bank made mention of the moderate growth now apparent in private consumption spending a point reinforced by the recently released February retail sales data, which are examined blow. The bank warned though that any expectations households would go on a spending binge any time soon were wide of the mark. The RBA conceded that the near-term outlook for investment outside the resources sector was relatively subdued, but continued to hold out hope that a modest increase would become apparent over the coming 12 months. The much-anticipated revival in Australias dwelling construction sector remained a slow burn. On the costs front, the RBA remained relaxed about recent shifts in the Australian CPI and noted that labour costs were contained. In an additional positive, the bank had identied an increased focus on cost efciencies across the domestic business sector. And looking ahead it believed our ination would remain consistent with the target band of 2-3% underlying over the next 12-24 months. However, the RBA continued to show some frustration that the A$ remained quite elevated despite the observed decline in export prices. A still muted demand for credit was also seen as something of a surprise, although the RBA has for years now impressed upon both households and rms the merits of lower gearing.
Retail sales again surprise on upside, but unambiguous bounce in housing construction still to occur
Headline retail sales surged by 1.3% seasonally adjusted in February, well up on market expectations of around 0.3%. Adding to the joy, the already large 0.9% gain reported over the previous month was upgraded to 1.2%. All six of the broad retailing categories provided in this ABS-prepared release managed 1.1%+ advances across the month of February. However, putting things in perspective, the value of retail sales over the three months to February 2013 was just 1.9% above the total recorded in the corresponding period of late 2011/early 2012 and this would be much smaller again in ination-adjusted terms. While the retail sales revival marries up with the recovery seen of late in consumer sentiment, it does not correlate closely with the cries of pain still coming from many major and small retailers, who continue highlight the need to offer discounts to get consumers opening their wallets. What is more, even if the January/February bounce does reect reality, will it be long lasting? We wait with baited breathe for a meaningful package of individual retailer guidance statements on whether the robust January/February sales data does indeed approximate their reality.
The ABS also recently released its February building approvals stats which in our view were only satisfactory on the surface. Yes, the headline number was up 3.1% in February, above economists consensus forecast of 2.5%. However, digging deeper, the allimportant private sector houses segment edged 0.5% higher. And the approvals data were also patchy from a geographic angle, with SA enjoying an out-sized intermonth gain of 20%+, with the latter surge in large part driven by its public sector houses component (a jump that is unlikely to be reprised in March). The major disappointment was NSW, which booked a 7.7% intermonth decline.
Retail Sales Extend Their Early 2013 Revival
0.9 Mthly % Chg Mthly % Chg 5 4 Trend (LHS) 0.6 Seasonally Adjusted (RHS) 3 2 1 0.3 0 -1 0.0 -2
$B
Residential and Non-Residential on the Rise, but Renovations Still Lagging
$B
0.7 0.6
0.5 0.4
2 0.3 1 Residential (LHS) Non-Residential (LHS) Alterations/Additions (RHS) 0 0.2 0.1 0.0
Feb-03
Feb-05
Feb-07
Feb-09
Feb-11
Feb-13
Source: ABS, Patersons Research
We still expect further RBA rate cuts and/or additional mortgage rate reductions
The robust retail sales numbers had interest rate hawks salivating simply because they bolstered their thesis that the chance of another RBA increase is remote (assuming of course the data align with reality!) More immediately, the stats will have economists upgrading their current March 2013 quarter GDP projections. We nevertheless remain of the view that the RBA will cut rates further over coming months and this is without any downside shocks occurring in key overseas economies. While some wealth effects will ow from recent house price increases, the RBA rate cuts already in place and the modest bounce in our stock market over 2013 to date, we would be surprised if these are enough to deliver sustained gains in household spending. At the same time, the contribution by the all-important mining sector to medium term investment ows looks set to underwhelm and the A$ would be sticky downwards if offshore monies seeking safe havens continue to enter our market. In the background remains the potential for some slippage in consumer condence owing from political uncertainties ahead of the 14 September Federal election.
Feb-09
Feb-10
Feb-11
Feb-12
Feb-13
Source: ABS, Patersons Research
Quantitative Focus
Kien Trinh - Quantitative Analyst
USING A MULTIFACTOR MODEL TO IDENTIFY INVESTMENT OPPORTUNITIES

The success of quantitative stock selection strategies across markets has been well documented. Portfolios formed on the basis of various stock specic factors such as value, momentum, growth and yield have been found to earn excess returns across different types of markets. By studying the behaviour of specic stocks, their cycles, and characteristics during those cycles, it is possible to locate stocks that can outperform. Unlike fundamental investors who focus on a stocks industry, business, and specics of the companys management or nancials, quantitative investors evaluate the stocks statistics. The benet of quantitative models is that it can help investors screen a large universe of stocks into a portfolio of ideas which is more manageable. In addition, the systematic nature of quant models allows decisions to be objective. The main assumption of quantitative analysis is that patterns tend to repeat themselves. So which factors have done well? Last year, the factors which have performed well have been quality, yield and large caps. However, over the last six months, we have seen valuation factors show signicant outperformance. Interestingly value tends to perform well during a market trough (accumulation phase) while momentum based factors perform better near the market peak. Intuitively, valuation strategies tend to work poorly in periods of high risk aversion. Despite this, it is important to include valuation factors in our model because when value stocks begin to recover, they tend to rally strongly, especially after a prolong period of price declines. In fact, during this period, excluding value factors would signicantly impair the performance of the portfolio. We have developed a stock selection model by screening for stocks on factors which have historically generated a high correlation to excess return. To do this, we perform back-tests and assess the relationship between various factors on a stocks alpha over an extended period. For each test, companies in the universe are divided into quintiles (groups of ve) based on their rank on one or more investment factors. For example, a P/E ratio test would have stocks with the lowest P/E in the rst quintile while those with the highest P/E ratios would be placed in the fth quintile. Returns for all portfolios in each quintile are then calculated, averaged over a 30 year testing period, and compared to the average return over the same period for the overall universe. A strategy is said to have investment value if the top (rst) quintile signicantly outperforms the universe, the bottom (fth) quintile signicantly underperforms, and outperformance/underperformance is consistent over time. Our tests highlighted six key factors which stood out. The factors that provided the highest information coefcient in predicting excess return comprised of protability, price momentum, valuation, cash ow generation, capital allocation and earnings revisions (or earnings surprise). From a quantitative perspective, the most important factors are valuation, cash ow generation, protability and price momentum. Using this information, we can combine these factors to provide a powerful screening tool across the ASX300 universe. Valuation This factor eliminates companies that are not attractively priced and includes P/E, Intrinsic Value, Yield, Price to Book, and EV/EBITDA. Specic sectors respond differently to various valuation factors. For example Price to Book is useful for property stocks, EV/EBITDA is good for resource stocks and Intrinsic Value is ideal for industrial stocks. A widely known valuation strategy is the P/E ratio but tests reveal that is not strong and does not work consistently across market cycles or industries. The reason for this is bottom line earnings can be subject to distortion and earnings forecasts tend to lag sentiment. Generally speaking, companies with an EV/EBITDA below 9x tend to outperform over the longer term. Protability This factor works well because past protability often serves as a barometer of a companys potential future success eg. past earnings are often reinvested in the business to produce future earnings. The key factor for protability is return on equity as it measures the amount of income generated on an investment (equity). Investors should favour companies with an ROE in excess of 15%. Other protability measures such as ROA do not work as well. Cash ow Generation Free cash ow is operating cashows less capital expenditure. Capex is subtracted because it is nondiscretionary. Companies which do not maintain and expand plant and equipment cannot remain competitive. Unlike earnings or net income, cash ow is a tangible asset and cannot be easily manipulated. A company with excess cash has the nancial exibility to expand its business, pay distributions or repurchase shares. An ideal cash ow ratio is free cash ow to invested capital (ROIC). Companies which have a ROIC of 12% or more tend to outperform the market. Another ratio we look at is free cash ow per share which needs to be positive.
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Price Momentum This factor simply refers to the rate at which a stock goes up or down over a specied time period relative to the market. The success of momentum based investing is regarded as an exception to the efcient market hypothesis. Eugene Fama, refers to momentum as the premier unexplained anomaly. A simple way to measure price momentum is to consider the proximity of a stock to its 52-week high or low. Another technique might be to compare its shorter moving average with its longer moving average relative to the rest of the market. Stocks that scored a momentum ratio of 70% or higher tend to outperform. A few points to note: Certain factors work better than others in particular industries, so a more focussed sector based model may yield better returns than this model which is designed for the entire market. Although earnings growth is a primary driver of stock market returns (ie. high growth companies tend to outperform), earnings growth alone, is not predictive of future stock market returns. Rather it is the consistency of earnings growth which drives excess returns. Unprotable companies that are issuing large amounts of shares should be avoided. Application of analyst forecasts works slightly better than the application of trailing 12 months gures. Interestingly, nancial leverage ratios, such as debt to equity, do not work very well. However, this strategy was particularly useful during the nancial crisis but not so much now.
Most Attractive Stocks

Code TPM DLX MLD IIN CSL CLO TRS JBH MYR RMD Company Tpg Telecom Limited Duluxgroup Limited MACA Limited iiNet Limited CSL Limited Clough Limited The Reject Shop JB Hi-Fi Limited Myer Holdings Ltd ResMed Inc Price ($) 03.04.13 3.18 4.45 2.91 5.28 59.28 1.31 16.75 15.13 2.94 4.43 Sentiment Momentum 0.960 0.863 0.875 0.967 0.847 0.874 0.797 0.917 0.867 0.768 Valuation EV/EBITDA 9.1 11.5 4.2 5.6 17 .6 9.3 9.9 7 .7 6.6 14.1 Cash Flow Cash ROIC 10.7 11.9 9.5 8.4 9.0 13.9 19.1 22.3 14.5 60.4 Protability ROE (%) 21.9 47 .3 30.8 19.2 36.0 21.8 29.0 53.4 15.3 18.0 Quant Rank 0.98 0.97 0.96 0.96 0.95 0.94 0.94 0.93 0.91 0.91
ROIC = free cash ow to invested capital; ROE = return on equity; Quant rank has a maximum of 1
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Least Attractive Industrials

Code SLX BLY NUF VAH ARI MAH TEN BBG SGM RIC EHL CSR QUB MQA EGP TWE FKP WRT AZJ Company Silex Systems Boart Longyear Nufarm Limited Virgin Aust Holdings Arrium Ltd Macmahon Holdings Ten Network Holdings Billabong Sims Metal Mgmt Ltd Ridley Corporation Emeco Holdings CSR Limited Qube Holdings Ltd Macquarie Atlas Roads Echo Entertainment Treasury Wine Estate FKP Property Group Westeld Retail Trust Aurizon Holdings Ltd Price ($) 03.04.13 3.24 1.25 4.16 0.42 0.80 0.24 0.32 0.73 9.75 0.90 0.61 2.05 1.70 1.52 3.46 5.72 1.55 3.07 4.03 Sentiment Momentum 0.404 0.050 0.083 0.296 0.223 0.282 0.572 0.144 0.454 0.085 0.481 0.780 0.573 0.331 0.159 0.709 0.614 0.377 0.744 Valuation EV/EBITDA -80.2 3.8 6.1 5.6 5.1 3.0 16.9 6.5 10.6 7 .2 3.5 6.2 10.6 37 .2 8.6 13.2 18.2 16.3 8.8 Cash Flow Cash ROIC -14.0 -6.8 -7 .9 -9.9 -2.1 -0.5 -4.4 1.0 -0.3 1.6 -3.7 -5.3 -4.0 1.7 2.6 -3.1 0.7 2.5 -2.3 Protability ROE (%) -6.3 5.6 6.5 6.0 4.0 -3.3 0.3 2.3 2.3 6.0 7 .4 2.6 6.9 2.2 4.7 4.7 3.2 5.6 6.7 Quant Rank 0.14 0.15 0.18 0.19 0.22 0.23 0.26 0.27 0.30 0.31 0.31 0.32 0.32 0.33 0.33 0.34 0.38 0.38 0.39
Least Attractive Resources

Code IGO NCM AGO SAR SBM GRR OZL EVN GBG KCN WSA Company Independence Group Newcrest Mining Atlas Iron Limited Saracen Mineral St Barbara Limited Grange Resources OZ Minerals Evolution Mining Ltd Gindalbie Metals Ltd Kingsgate Consolidated Western Areas Ltd Price ($) 03.04.13 3.79 19.56 1.08 0.28 1.16 0.20 5.04 1.40 0.21 3.81 3.18 Sentiment Momentum -0.033 -0.054 0.017 0.017 0.055 0.013 -0.014 0.173 0.175 0.183 -0.028 Valuation EV/EBITDA 14.1 10.6 5.0 1.1 3.8 1.2 3.6 4.1 -26.1 5.1 6.1 Cash Flow Cash ROIC -12.2 -5.1 -8.4 -10.3 -6.1 -0.2 0.2 -10.4 -0.7 -4.6 2.7 Protability ROE (%) 4.1 4.9 3.9 6.6 5.4 2.0 2.8 7 .8 -1.3 6.6 4.6 Quant Rank 0.06 0.11 0.12 0.14 0.16 0.17 0.18 0.20 0.21 0.24 0.26
12
Banks
Tony Farnham - Economist
COMPETITION IN THE AUSTRALIAN HOME MORTGAGE SPACE IS HOTTING UP

The importance of the home loan sector to our Big-4 banks can not be over-estimated. Home loans account for upwards of 58% of these four banks respective loan books (both domestic and offshore), with Commonwealth bank of Australia (CBA) and Westpac (WBC) having around 67% of their global advances in housing-related term loans. Home mortgages share of regional bank loan books are even larger. Given this relative importance, any shifts in the competitive dynamics in this loan segment have ramications for Australian bank protability. Our view for some time now has been that sustained single-digit growth in Australian and NZ mortgage books will materially shorten the odds that our home loan providers will resort to more (1) aggressive pricing of their home loan products and (2) accommodative loan-to-valuation ratios. To not do so would risk a gradual slide in market share. Such a scenario increases the risk of some deterioration in credit quality especially if this fall away in lending standards is soon followed by softer jobs markets and some slippage in home prices across major capital city areas. We do not see the latter becoming a major concern in the immediate term. The RBA too noted in its March Financial Stability Review that while competition in the mortgage market had pushed some lenders to offer interest rate discounts and/or waive application fees, non-price loan standards have been broadly unchanged over the past six months. Macro and/or credit quality worries could nevertheless potentially come into sharper focus later in 2013 if the RBAs attempts to rebalance our economy are not a success and competitive pressures in the mortgage market intensify.
Amongst the Big-4 banks, NAB holds onto price-leadership-powered home loan market share gains
This potential for competition-induced margin contraction in the Australian mortgage sector must continue to be monitored by investors. The latest Australian Prudential Regulation Authority (APRA)-compiled market share statistics highlight the effects of the most recent sustained round of price competition in the Australian home loan market. The charts below, derived from the abovementioned APRA data show up the success of the NABs price leadership campaign in the mortgage space although it does not show the margin contraction that accompanied the initiative!
Loans & Advances - Big 4
27
Owner Occupied Home Loans - Big 4

32
% share
% Share
24
ANZ NAB
CBA WBC
28
ANZ NAB
CBA WBC
21
24
18
20
15
16
12
12
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Source: APRA, Patersons Research
Macquarie Bank and Yellow Brick Road attempt to create a fth pillar in home loan market
In late 2012 it became apparent that another major nancial institution, Macquarie Bank (MQG), was keen to wade into the Australian home loan market, in the process creating a so-called fth pillar in this sector. It looks like the bank is reprising its PUMA nancing vehicle of old, which was operating in the halcyon easy money days ahead of the Global Financial Crisis (GFC). This push is being done in partnership with mortgage originators, headed this time round by Yellow Brick Road Holdings (YBR).
Continued page 14
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Source: APRA, Patersons Research
13
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In November last year YBR announced the creation of some aggressively priced mortgage products. It intends launching additional banking and wealth management offerings further down the track. More recently, the company achieved record loan settlements during January 2013, with this total more than double that delivered in the rst month of 2012. This uplift indicates that YBR has gained traction via its heavily publicized Empower Home Loan product, which has a rst-year teaser rate. YBR noted that around three quarters of the January settlements total were renancings. From MQGs viewpoint, mortgages accounted for around 30% of total lending growth over its latest reporting period (the six months to September 2012). Looking at the APRA data, MQGs lending for housing (both owner occupied and investment) was $6.25B at the end of February 2013, more than double the total reported just 12 months earlier. Yes, all this is coming from a low base, but reports abound that the bank has materially beefed up the headcount of staff that liaise with mortgage brokers. The bank has also recently ramped up its marketing of MQG-branded home loans. This all makes sense when one considers the tough trading conditions being experienced in its traditional investment banking activities. Whether this new competitive threat has legs will be crucially dependent on the recent trend towards cheaper funding in the residential mortgage-backed securities market being long-lived. The cheaper this funding, the more scope is there for lenders utilizing it to more keenly price their mortgage product offerings. Banks on the other hand, with more reliance on relatively expensive term deposits, have less scope to play the pricing game (unless they opt to cross-subsidise or realise efciencies in other facets of their operations). The strategic response of Australias traditional listed banks will indeed be interesting.
We still prefer ANZ and WBC; investors over-exposed to banks should consider option strategies
We retain our long-held view that both ANZ and WBC appear better placed from an asset quality angle. These two banks also have the strongest capital positions under the Basel III regulatory regime. ANZ continues to differentiate itself from other Australian banks with a steadily growing Asian-based franchise. This said, ANZ will need to quickly demonstrate that the key man risk associated with the loss of its muchrespected head of International Alex Thursby can be quickly neutralised. The adjacent table outlines key dates in the upcoming reporting cycle.
Upcoming Bank Reporting Dates Result BOQ ANZ WBC NAB CBA 1H13 1H13 1H13 1H13 3Q13 Due 18-Apr 30-Apr 3-May 9-May 15-May Ex-Div 2-May 9-May 13-May 30-May na Record 8-May 15-May 17-May 5-Jun na Payable 27-May 1-Jul 2-Jul 16-Jul na
Upcoming Bank Trading Updates Source: Various bank announcements/websites
More generally, with bank share prices now up appreciably over the past year and their prospective dividend yield metrics now less enticing, some investors particularly those heavily over exposed to banks might want to consider some conservative options strategies. For those in the latter grouping with a view that bank share prices will track sideways from here a covered call strategy might be worth a look (making sure to protect pending dividends). For those concerned that bank prices could give back some of their recent gains, a bought put strategy may have attraction.
HIGHLIGHTED STOCKS
SECTOR WEIGHTING COMPANY ANZ Banking Group Ltd (ANZ) Index/Over Weight RECOMMENDATION ACCUMULATE COMMENT ANZ Banking Group announced an unaudited cash prot for the three months to 31 December 2012 of $1.53bn, up 6.2% on the same period in 2012 (rst quarter 2012: $1.49bn). Unaudited statutory prot after tax was $1.36bn. Revenue growth reected the constrained business environment. Reasonable volume growth, particularly in Asia, was offset by margin pressure in NZ and in the International and Institutional Banking division. The groups APRA Basel III CET1 ratio at 31 December 2012 was 7 .7% which equates to 9.7% on a fully harmonised basis, unchanged from the 2012 full year. Payment of the nal 2012 dividend had a 30 basis point impact towards the end of the quarter. The group had completed circa 50% of the 2013 full year term wholesale funding task by the end of December 2012.
14
Industrials
HEALTH CARE
Ben Kakoschke - Industrial Analyst
HEALTH CARE SECTOR REVIEW - MARCH 2013

Key Pharmaceuticals & Biotechnology News
CSL (CSL): re-afrmed guidance for FY13 NPAT growth of 20% Mesoblast (MSB): raises $170m at $6.30/sh, a 2.2% discount
Key Health Care Equipment & Services News

Resmed (RMD): Earnings marginally lowered after round two of US Government medical insurance competitive tender process Ramsay Health Care (RHC): Entered into a 50:50 JV to expand into Southeast Asia initially and eventually throughout Asia Sonic Healthcare (SHL): Expects FY13 EBITDA to be at the lower end of previous guidance of 5 - 10% growth
Recent Small Cap Contact

Antisense Therapeutics (ANP) To begin chronic toxicology study to support a potential future Phase IIb study of ATL1102 in multiple sclerosis patients Capitol Health (CAJ) Announced the acquisition of MDI Group, a specialist diagnostic imaging company with 11 clinics primarily located in the southeastern regions of the Melbourne metropolitan area, with expected EPS accretion in excess of 25% Our price target has increased to $0.17 per share (from $0.13) and we have maintained our Hold recommendation Mayne Pharma (MYX) Our price target has increased to $0.45 per share (from $0.42) due to a small reduction in risk rating to reect the Companys inclusion in the All Ordinaries Index and more investible size with a market cap approaching $300m However, our recommendation has reduced to Hold (from Buy) following the 30% price increase since our last report Figure 1: Summary of large cap key data
Company Code Price MC ($m) 646 29,459 1,936 617 2,102 3,882 1,139 2,495 6,527 6,785 5,518 860 EV* ($m) 623 29,891 1,637 569 2,308 3,941 1,248 3,521 7,444 6,092 6,989 818 FY12 88.2 31.4 36.7 16.6 24.5 22.3 21.3 27.8 23.9 17.3 16.8 PE (x) FY13 102.1 24.5 32.6 15.6 25.3 18.9 17.0 23.9 20.6 16.7 14.8 FY14 18.7 21.7 23.4 13.7 23.6 17.4 15.0 21.0 18.9 15.3 14.4 FY12 -87.2 8.8 48.0 6.3 -12.1 -1.7 12.6 14.8 35.7 6.9 2.3 EPS Growth (%) FY13 -13.6 27.9 12.4 5.9 -3.2 18.4 25.3 16.5 15.8 3.5 13.6 FY14 447.4 13.2 39.3 14.0 7.4 8.3 13.4 13.8 9.1 9.2 3.0 Dividend Yield (%) FY12 2.1 1.4 0.6 2.2 3.6 4.7 2.2 1.9 0.4 4.2 5.4 FY13 2.1 1.8 0.9 2.3 3.7 4.7 2.8 2.1 1.5 4.4 6.0 FY14 4.9 2.0 1.4 2.6 3.7 4.7 3.1 2.4 1.8 4.6 6.1
Pharmaceuticals & Biotechnology Acrux CSL Mesoblast Sirtex Medical Ansell Cochlear Fisher & Paykel Healthcare Primary Health Care Ramsay Health Care ResMed Sonic Healthcare Sigma Pharmaceuticals ACR CSL MSB SRX ANN COH FPH PRY RHC RMD SHL SIP 3.88 59.23 6.15 11.07 16.07 68.05 2.10 4.96 32.30 4.36 13.93 0.74
Health Care Equipment & Services
Source: Thompson Reuters consensus estimates, IRESS
* FY13 net debt forecasts used for EV
Continued page 16
15
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Figure 2: Summary of contacted small caps

Company Antisense Therapeutics Code ANP Rec Price ($) 0.01 MC ($m) 14.4 Net Cash ($m) 5.1 Potential Catalysts (0-12 months) ATL1103 Phase II trial results ATL1102 Phase II progress Global antisense transactions Potential Catalysts (12+ months) Major pharma licensing proposals Global antisense transactions In-licensing additional compounds
Capitol Health
CAJ
HOLD
0.175
75.2
(2.1)
Demonstrating MDI margin benets More gap-charging services Expansion of MRI incentives Further acquisitions Solid industry organic growth Potential takeover target Meeting FY13 guidance SUBACAP approval in Europe Relaunch of Kapanol in Australia FDA approval of Doryx News ow from pipeline of 17 products US launch Mayne Pharma products through Metrics distribution Launch of injectables in Australia
Mayne Pharma
MYX
HOLD
0.48
270.2
(11.5)
Source: Patersons
Sector Performance
Figure 3: 12-month index performance
180% 170% 160% 150% 140% 130% 120% 110% 100% 90% 80%
Aug-12 Apr-12 Jun-12 Jul-12 May-12 Feb-13 Mar-12 Sep-12 Nov-12 Mar-13 Jan-13 Oct-12 Dec-12
Figure 4: 5-year index performance

170% 160% 150% 140% 130% 120% 110% 100% 90% 80% 70% 60% 50% 40%
Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10
Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12
S&P/ASX 200 (XJO) S&P/ASX 200 Health Care (XHJ) Pharmaceuticals & Biotechnology (J3520) Health Care Equipment & Services (J3510)
S&P/ASX 200 (XJO) S&P/ASX 200 Health Care (XHJ) Pharmaceuticals & Biotechnology (J3520) Health Care Equipment & Services (J3510)
Source: IRESS
Source: IRESS
Figure 5: Monthly Pharmaceuticals & Biotechnology movers

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% -40%
Figure 6: Yearly Pharmaceuticals & Biotechnology movers

350% 300% 250% 200% 150% 100% 50% 0% -50% -100%
Source: IRESS
TIS PXS IVX NRT PAB ANP PRR GTG POH OBJ NEU MVP PBP AVH BIT MSB BNO AVX ACR SPL LCT CSL CUV VLA SUD ACL SRX CIR PBT CTE CDY CZD QRX PVA MYX VSC
Source: IRESS
PXS TIS PRR AVH POH IVX AVX CIR ANP LCT SPL ACL QRX OBJ BIT BNO MSB GTG VLA CZD PAB ACR PVA PBP CUV PBT NEU CSL SUD CDY NRT SRX MYX MVP CTE VSC
-50%
Sep-12 Dec-12 Mar-13
16
Figure 7: Monthly Health Care Equipment & Services movers

30% 25%
Figure 8: Yearly Health Care Equipment & Services movers

250%
200%
20% 15% 10% 5% 0% -5% -10%

-50% 50% 150%
100%
0%
-15% -20%
-100%
Source: IRESS
AJJ GID UNS OIL UBI SDI ADO ELX AHZ SOM ACG RVA IPD VEI NAN COH ITD HIN ONT PME OSP PHG PRY RHC API FPH ANN RMD SHL ISN CGS BRC SIP GXL CLV CAJ
Source: IRESS
Pharmaceuticals & Biotechnology Sector News

CSL (CSL) market cap $29.5bn (down 1% for month) CSL develops, manufactures and markets biopharmaceutical products. The blood plasma industry has consolidated into a few fullyintegrated global suppliers. Control of supply, scale of operations, and integration of services from blood collection to product manufacture gives CSL a competitive advantage difcult to replicate. Industry consolidation led to favourable pricing and lifted returns. The Companys human papillomavirus (HPV) vaccine offers a new stream of earnings, with royalty revenue from Mercks Gardasil and GlaxoSmithKlines Cervarix. Revenue of US$2.5bn was 7% above the pcp or 11% higher in constant-currency terms. EBIT rose 24% to US$786m. NPAT jumped 24% and exceeded guidance of 20%. EPS beneted from the share buy-back, rising an impressive 30%. The interim dividend was US50cps unfranked, up 33% on pcp. Revenue growth reects, among other factors, ongoing penetration of emerging markets and small market share gains in developed markets. Material operating efciency gains and higher margin sales mix drove up gross margins from 46.1% to 52.1%. The result beneted from some skewing of expenses to 2H13, in particular R&D. CSL re-afrmed guidance for full-year NPAT growth of 20%, suggesting EPS growth nearer 24%. Mesoblast (MSB) market cap $1.9bn (down 7% for month) MSB is a medical research and development company developing therapies that utilise Mesenchymal Precursor stem cells extracted from bone-marrow. The therapy is non-controversial unlike some other stem-cell therapies, while clinical trial results indicate a high probability of success. Large underserved potential markets include heart failure patients, bone-marrow regeneration in cancer patients and several orthopedic indications such as intervertebral disc repair. A potentially highly lucrative licensing deal with US biotech Cephalon (now owned by Teva Pharmaceuticals) provides strong endorsement of the technology platform. Product sales are unlikely before 2015 but additional revenue from partnering deals is likely before then. In March 2013, MSB raised $170m through an issue of new shares to existing and new global institutional investors, priced at $6.30 per share, a 2.2% discount to the stocks last traded price prior to the announcement. Following the issue the Company will have cash reserves of $332m. Cash raised will go towards: a Phase 3 clinical trial using Mesenchymal Precursor Cell (MPCs) for treatment of degenerative disease of the lumbar spine; a new Phase 2 clinical trial to broaden the indications for intravenous delivery of MPCs in the treatment of systemic inammatory conditions; optimisation of MPC manufacturing processes and increased product inventory staff and overheads. Acrux (ACR) market cap $0.6bn (down 4% for month) ACR is trialing a range of applications of its patented transdermal drug delivery technology. These include treatments for menopause, sexual dysfunction, nausea and a contraceptive application. All these markets are large, but in most instances patent lives are limited. The technology is validated with product already in market and trials are relatively cheap and of short duration. ACRs Axiron product, a testosterone supplement for men, is the subject of a high-value licensing deal with Eli Lilly. The Company posted revenue of $5.1m and PBT of $2.5m in 1H13. Importantly net operating cash ow turned positive - $2.3m compared with negative $4.5m. Since 30 June 2012 cash reserves fell from $28m to $19m, reecting an $13.3m dividend payment (8cps). ACR will pay another dividend in August 2013, which is expected to be 16cps. Dividends and capital gains do not attract tax as Acrux is a Pooled Development Fund (PDF). The Company indicated that Lillys level of rebates to drive sales is falling as a growing number of healthcare plans begin to cover the cost of the supplement. This was reected in net sales of Axiron jumping 49% from US$16m in the September 2012 quarter to US$23.9m in the December 2012 quarter, well above market growth of around 8%.
Continued page 18
IPD UNS OIL GID ADO RVA NAN UBI AHZ ELX BRC ISN PHG ANN ONT SHL COH SOM ACG SIP FPH OSP HIN API CGS RMD AJJ CLV RHC ITD PRY PME GXL VEI CAJ SDI
Page 17 continued
Sirtex Medical (SRX) market cap $0.6bn (up 2% for month) SRX has developed an effective treatment for liver cancer that involves the infusion of radioactive microspheres that selectively target liver tumours. Sales growth has become consistently strong despite the treatment still being used chiey as a last resort. Large scale trials in progress should signicantly promote use. Gross margins are in excess of 80%. Risks include weak intellectual property protection, SRXs limited resources, and single product portfolio along with the more generic risk of obsolescence. The Company delivered a very solid rst half result. A 31% surge in dose sales drove revenue 25% higher to $46m. NPAT rose 28% to $7.8m. Net operating cash ow increased 132% to $13.2m. There is no interim dividend. A 10 cent dividend was paid in October 2012, 43% above the 7 cent dividend in 2011. At the end of December 2012 SRX had net cash of $51m, up $10m on pcp and representing almost a dollar per share. The Company continues to look for worthwhile investments including additional product to sell via its established distribution network.
Health Care Equipment & Services Sector News

ResMed (RMD) market cap $6.8bn (up 2% for month) Sleep apnoea is a huge medical problem that can go unnoticed and untreated. RMD is helping lead the charge on sleep apnoea and should benet from strong growth for the long run by serving this huge potential marketplace. If the Company continues to up the innovation ante with new product introductions, including new airow generators, masks and nasal pillows, it should remain an inuential leader in this market for the foreseeable future. Operating margins are impressive, typically exceeding 20%. In 2012 RMD began paying dividends. The balance sheet has net cash. We think growth-oriented investors should consider buying shares of this narrow moat rm at a reasonable price. We undertake a closer look following the release of the results of round two of the US Government medical insurance (CMS) competitive tender process for supply of durable medical equipment. Around 35% of sleep disordered breathing equipment sales are covered by CMS. We understand this equates to 25% of RMDs sales in the Americas segment, which make up a little over 50% of its global sales. Instead of the 30% falls seen in round one, the price decreases were signicantly greater at 45 50% in round two. Our revenue forecasts already factored in a view that strained public and private nances in the developed world would constrain future growth. Competitive tender is one method of reducing spending. Given the extent of the price falls we have reduced our forecasts for the Companys US revenue growth from 12% to 10% in scal 2014 and from 10% to 8% in scal 2016 when round three of the tender process is likely to hit. Our calculation assumes RMD absorbs roughly one third of the 45 50% price falls, the dealers bearing the remainder. These changed assumptions result in the operating margin falling from 24% to 23% in 2017 and net income falling by around 5% by scal 2017. Ramsay Health Care (RHC) market cap $6.5bn (up 1% for month) RHC is a premier private hospital operator generating industry-leading margins. Strong cashow from the portfolio of quality hospitals is invested to enhance facilities. It has over 117 hospitals and day care facilities, 30,000 staff, manages over 10,000 beds and has annual revenue of over $3bn. The Company operates a decentralised control structure to empower operators. Many of the hospitals present natural monopolies for their region because of location, scale and reputation. Offshore expansion provides another leg of growth as RHC exports its business practices. In March 2013, the Company conrmed speculation it has entered into a 50:50 joint venture with Malaysian conglomerate Sime Darby Berhad (Sime) to expand its healthcare businesses in Southeast Asia initially and eventually throughout Asia. The deal combines the RHCs three hospitals in Indonesia with Simes portfolio of healthcare assets in Malaysia, which include three hospitals and a nursing and health sciences college. The joint venture aims to assemble a portfolio of hospitals throughout Asia to benet from Asias rising middle class and ageing population. Simes nancial strength and business networks through South-East Asia should be a potent complement to Ramsays hospital management expertise. However, we note that RHC will continue to generate the majority of earnings roughly 75% - from its Australian business, the next biggest regional contribution coming from UK operations at near 18%. The Asian initiative is unlikely to become meaningful for several years at least. Sonic Healthcare (SHL) market cap $5.5bn (up 4% for month) Technological innovation has cut the cost of a general pathology test, translating into bigger prot margins. SHL leverages this know-how in overseas markets to deliver the next stage of growth. The US, Germany and UK offer scope to deliver efciency through acquisitions, and international scale will further enhance buying power. The federation business model aims to empower its operators to focus on revenues while SHL consolidates back ofce processing. The Companys Australian operations posted 5% organic revenue growth, in line with estimates of industry growth. There was a 1.1% fall in pathology fees from 1 January 2013 as the government seeks to offset growth above the 5% cap. In Germany, where SHL is one of the two largest players, it reported solid 5% organic revenue growth, and 8% growth including revenue from acquisitions. The Companys two non-pathology divisions Sonic Imaging (radiology), and IPN (medical centres) both delivered solid performances
and together generated around 20% of group revenues. The radiology division grew revenue 6%, while IPN grew revenue 15%. Both enjoyed strong margin expansion. SHL disappointingly lowered full-year guidance and now expects EBITDA to be at the lower end of guidance released in August 2012 for 5 10% growth. Key reasons for the lower guidance are larger than expected unfavourable industry funding changes in Germany, unexpected anatomical pathology fee cuts in the US ($6m pa), and lower than expected growth in the US (revenue fell 2%) including the impact of Superstorm Sandy. Cochlear (COH) market cap $3.9bn (down 4% for month) COHs implantable device is the gold standard for enabling profoundly hearing impaired patients to hear. The Company is an innovative leader in not overly competitive and growing markets. Growth stems from further penetration of existing markets and entry into undeveloped markets such as South America, Eastern Europe and China. Acquisition of Entic extends the presence to the larger partially-impaired market. COH invests 12% of sales in research and development to remain at the technology forefront. This is a strong cash generator with impressive operating margins around 30% and modest capital expenditure requirements. First half scal 2013 revenue at $392m was 1% higher than pcp. Excluding the negative $130m impact of the product recall on pcp prot, EBIT fell marginally to $108m while NPAT fell 3% to $78m. The stronger AUD had a negative impact of $21m on the bottom line. The EBIT margin was little changed at 28.5%, a good achievement given the stronger AUD. Earnings per share weakened 3% to $1.36. The Board raised the dividend 4% from $1.20 to $1.25 per share. Franking is 40%, down from 60% in the pcp. The result was below market expectations. Unit sales of cochlear implants (80% of revenue) rose 27% but resulted in only a 6% increase in dollar sales to $330m. In constant-currency sales rose 10%. The lesser revenue growth reects both low-priced government tender sales into China and distortion due to the product recall. A more telling statistic is that units grew 11% on a sequential half basis suggesting the Company is holding market share. Primary Health Care (PRY) market cap $2.5bn (at for month) PRY and Sonic Healthcares Independent Practitioner Network (IPN) are leaders in Medical Centre management while its pathology division is part of an oligopoly with Sonic Healthcare and Healthscope. These strong industry positions and the non-discretionary nature of medical services imply usually reliable and modestly growing earnings, underpinned by the ageing population. Managing director Edmund Bateman is PRYs principal founder and is responsible for delivering phenomenal returns through the development of 24-hour medical centres. The acquisition of Symbion Healthcare in 2008 transformed the asset pool. The merged group is the largest domestic pathology provider. Earnings are: Medical Centres 47%, Pathology 36%, Radiology 12% and Health Technology 5%. While the Pathology division has caused headaches, the Medical Centre division, which contributes around 45% of group EBITDA, continues to perform well, posting around 6% EBITDA growth in scal 2011, scal 2012 and rst half scal 2013. PRY is adding doctors to ll existing capacity in centres and does not plan material incremental investment in the division. The smaller Imaging division around 20% of group EBITDA is also displaying healthy growth, beneting in particular from the new fee-for-service model which ties radiologists pay more closely to revenue generation. Investment in equipment and information technology is also paying off. Imagings EBITDA jumped 30% to $35m in 1H13. The Company benetted from a material fall in borrowing costs from $56m to $40m. Ansell (ANN) market cap $2.1bn (up 2% for month) ANN is a global leader in protective health and safety protection solutions. Operations spread across four business segments covering industrial and medical gloves, and condoms. Products are predominantly made of natural and synthetic latex, exposing ANN to price uctuations in rubber and latex concentrates. Low levels of debt offer prospects for further capital initiatives or acquisitions. No franking credits means free cashow is distributed predominantly through share buybacks. First half scal 2013 NPAT fell well short of market expectations. This was a function of softening demand in Europe and to a lesser extent in emerging markets. Organic sales were at despite management expectations for mid single-digit growth. Total sales rose 6% to US$648m, but EBIT fell 8% to US$69m. NPAT and EPS fell 14% to US$57m and US$0.42 respectively. Gross margin weakened slightly to 41.3%, but materially higher marketing costs caused the EBIT margin to fall from 12.2% to 10.5%. Indicating its condence in a better outlook for the second half, the Board increased the interim dividend 1 cent to 16.0cps, unfranked. Fisher & Paykel Healthcare (FPH) market cap $1.1bn (up 1% for month) FPH is the worlds leading provider of Respiratory Humidication (RH) products and commands a high market share. It also produces CPAP and masks for treatment of Obstructive Sleep Apnea (OSA). The Company has unveiled a slew of new products and interfaces in respiratory and sleep apnea which should boost revenue and earnings over the long term. North America is a key growth area for FPH and a critical market for Obstructive Sleep Apnea (OSA). Earnings are sensitive to the NZ$/US$ exchange rate.
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FPH raised its earnings guidance from NZ$69-72m to NZ$75m, mainly due to strong trading in the second half so far. Sales growth was particularly impressive for the rms respiratory and acute care (RAC) business which is likely to achieve constant-currency revenue growth of 18%. In the rst half RAC grew by 11%. Obstructive Sleep Apnea (OSA) is also likely to see a lift in constant-currency growth from 3% in the rst half to 10% in the second half but the second half growth is below our forecast of 13%. FPH also expects an improvement in operating margins as a result of new products, operating efciency gains and cost savings from the Mexican manufacturing plant. Sigma Pharmaceuticals (SIP) market cap $0.9bn (up 12% for month) SIP is one of Australias three pharmaceutical wholesalers. Earlier in its history it impressed on a number of fronts and successfully grew both organically and by acquisition. In late 2005, it merged with Arrow Pharmaceuticals, a rapidly growing generics player, which proved an expensive exercise after protability in the generics sector plummeted. In late 2010, SIP sold its manufacturing and generics business to Aspen Pharmacare, allowing it to reduce debt. SIPs scal 2013 underlying result of $52m was broadly in line with expectations. New management has stabilised the business in the face of Pharmaceutical Benet Scheme (PBS) price reforms and we expect the severity of such reforms to moderate. Operational efciencies and expanding retail brand membership will support modest earnings growth. With $83m net cash on the balance sheet, capital position is healthy. The continued share buy-back is positive for investors and combined with a healthy full franked dividend of around 6.7%, provides some share price support.
Key Small Cap Updates

Strong Monthly Performers
Vita Life Sciences (VSC) market cap $79m (up 82% for month) VSC provided outlook commentary that revenue compound annual growth of 13% over the last three years is expected to continue in 2013 and potentially increase as the New Business Units start to make larger contributions. Over the same period EBIT compound annual growth has shown an increase of 54% reecting the gains made in cost control and operating leverage. Barring unforeseen circumstances, Directors are targeting a 40% to 50% increase in EBIT in 2013. The strong cash position, positive cash ows from operating activities and being debt free leaves the Company in a strong position to expand its business and take advantage of future growth opportunities as they arise. Capitol Health (CAJ) market cap $75m (up 30% for month) CAJ announced the acquisition of MDI Group, a specialist Diagnostic Imaging (DI) company with 11 clinics primarily located in the south-eastern regions of the Melbourne metropolitan area. The acquisition is expected to deliver signicant nancial and strategic benets to Capitol and position it as the largest community-based DI provider in Victoria with 48 clinics. The combined Capitol and MDI consolidated group is expected to generate annualised revenues of over $80m and increase EPS by 25% in 2014 (compared to 2013). It is expected to deliver higher margins per dollar of revenue earned due to higher rates charged by MDI clinics which operate under a gap charging model. Clover Corporation (CLV) market cap $102m (up 22% for month) CLV reported a 12.5% increase in 1H13 sales to $20.2m from $17.9m in 1H12. Sales of encapsulated ingredients for infant formula and related applications continue to grow, particularly in Asia and Oceania. The Company continues to invest in the future with additional funding provided for the development of new products including the provision of the preterm infant formula for the current Phase 3 clinical study. This trial is on time for the delivery of preliminary results by the end of 2014. In addition the evaluation by customers of several new products is likely to lead to small initial sales in 2H13. The CLV expects the strong demand for its products to continue for 2H13. Mayne Pharma (MYX) market cap $270m (up 22% for month) MYXs 1H13 result was at the top end of earnings guidance provided in October 2012. Metrics 1.5 month contribution exceeded guidance with strong growth in generic products through its own distribution channel and solid growth in contract manufacturing. This helped to offset a 29% decline in revenue from Mayne Pharmas existing business, on the back of lower Doryx sales in the US. The Company indicated that it remains on track to deliver FY13 results in-line with previous guidance and it expects 2H13 to benet from a return to Doryx revenue growth over 1H13. Greencross (GXL) market cap $169m (up 19% for month) GXL reported an underlying 1H13 NPAT of $3.5m (up 35%), and EBITDA was $7.8m (up 32%), on revenue of $51.2m (up 30%). Eight new veterinary practices were acquired, bringing the total to 89 at the end of the half. Acquisitions continue to be the main driver of growth and the Company will continue to target one to two new acquisitions per month. CEO Glen Richards indicated that it was operating in a resilient industry with a large client base of non-discretionary spending pet owners and continued to see increasing annualised visits and spend per patient.
Weak Monthly Performers

Tissue Therapies (TIS) market cap $34m (down 42% for month) In March 2013, TIS was informed by the Notied Body, British Standards Institute (BSI) that a European Commission (EC) Medical Devices Group meeting voted that VitroGro ECM should be regulated as a Medicine and not a Device. In October 2012, the Company was previously notied by BSI that the nal classication of VitroGro ECM was as a Device. Until the email from BSI on 13 March 2013, the advice to TIS from BSI was that it was waiting only for a formal start date for the European Medicines Agency (EMA) Committee review of manufacturing quality data as the last step needed for the granting of CE Mark and the start of sales. Pharmaxis (PXS) market cap $102m (down 41% for month) Pharmaxis received a complete response letter from the FDA conrming Bronchitol cannot yet be approved for marketing for the treatment of cystic brosis in the US. The FDA has concluded its review of the Bronchitol New Drug Application (NDA) and recommended Pharmaxis conduct an additional clinical trial to obtain an approval for Bronchitol. Pharmaxis CEO Gary Phillips commented We are clearly disappointed that Bronchitol cannot yet be made available to patients in the US. The FDA has provided guidance on the necessary measures to gain approval and Pharmaxis will now have a follow up meeting with the FDA. This will be a Type A meeting which I expect will take place next quarter and will examine the parameters of an additional clinical trial including how best to incorporate both adult and paediatric patients.
Overview of Contacted Small Caps

Figure 9: Business model, catalysts and risks
Company Business Description Key Focus IP Portfolio and Key Relationships Drivers Risks
Pharmaceuticals & Biotechnology Antisense Therapeutics Drug development company focused on developing antisense drugs. The Company has sufcient funding well into 2014 (including the ATL1103 Phase II clinical trial) and its technology platform was validated in January 2013 by Isis receiving FDA approval for the worlds rst antisense drug administered systemically (injected). Mayne Pharma Specialty pharmaceutical company that develops and manufactures proprietary and generic products. In November 2012 it acquired Metrics, a USbased provider of contract development services to the pharma industry which also develops and manufactures niche generic products. Health Care Equipment & Services Capitol Health Through organic growth and acqusitions, CAJ has become Victorias largest community-based diagnostic imaging provider with 48 clinics. CAJ operates clinics and associated practices across Melbourne and regional Victoria and offers a full range of procedures ranging from basix X-rays through to Nuclear Imaging. The Company was focused on providing diagnostic imaging services in Victoria predominantly under a Bulk Billing model. In March 2013, it acquired MDI Group, a specialist diagnostic imaging company with 11 clinics throughout the Melbourne metropolitan area that employs both a Bulk Billing and a fee-paying (gap) charging model. Defensive revenue base with consistently strong protability. Margin upside potential from increasing fee-paying services above rebate levels. Highly-scalable & low cost model. Supportive regulatory environment including expansion of MRI incentives. General health care operating risks: complex government health regulations; intense competition; loss of key personnel; potential liability; integrating acquisitions into existing business; additional capital requirements. ATL1103 targets diseases associated with excessive Growth Hormone and Insulin Growth Factor-I action such as Acromegaly. ATL1102 is an antisense inhibitor of VLA-4 protein, a clinically validated target in MS and potentially asthma and stem cell mobilisation. ATL1101 is an inhibitor of Insulin Growth Factor-IR, an emerging target in oncology. The combined group has a signicant product portfolio and pipeline, global reach through distribution partners in Australia, US, Europe and Asia and manufacturing facilities located in South Australia and North Carolina (US). Pipeline of 17 products under development post Metrics acquisition. Exclusive world-wide rights to three compounds in- licensed from Isis Pharmaceuticals Inc, the world leader in antisense drug development and commercialisation. ANP also has a strategic alliance with Tianjin International Joint Academy of Biotechnology and Medicine (TJAB) for its ATL1102 studies. The Company has a 30-year track record of innovation with its intellectual property portfolio built around the optimisation and delivery of oral dosage form drugs. ATL1103: re-rating following outcome of Phase II trial. ATL1102: re-rating on move into longer term Phase II studies. ATL1101: progress of potential partnering / development plans. Clinical progress or transactions involving antisense drugs external to ANP . General pharmaceutical operating risks: long lead times and uncertainty of result outcomes; complex government health regulations; intense competition; loss of key personnel; potential product liability; additional capital requirements.
Meeting FY13 guidance following acquisition of Metrics. SUBACAP approval in Europe. Relaunch of Kapanol in Australia. FDA approval of Doryx.
General pharmaceutical operating risks: long lead times and uncertainty of result outcomes; complex government health regulations; intense competition; loss of key personnel; potential product liability; additional capital requirements.
Source: Patersons
Continued page 22
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Recent Announcements
Antisense Therapeutics (ANP) 22 March 2013 Dr Peter Trainer, Professor of Endocrinology, The Christie NHS Foundation Trust, UK, and Chief Investigator for the Companys ATL1103 Phase II study, will present on the ATL1103 project and the previously announced Phase I trial results at a scientic meeting entitled 9th Consensus Conference on Medical Treatment of Acromegaly. This is the rst occasion that the ATL1103 Phase I trial results have been presented at a scientic meeting. Antisense Therapeutics (ANP) 19 March 2013 ANP had nalised preparations for a chronic toxicology study to be conducted to support a potential future Phase IIb study of ATL1102 in multiple sclerosis patients. The Company will execute an agreement with Pharmaron to conduct the chronic toxicology study. ANP estimates that the costs for completing the study will be less than $0.3m and is expected to be completed by the end of 2013. ANP will own all the data and associated intellectual property rights generated from this study and no benets will accrue to TJAB unless and until all of the conditions precedent to the joint venture proposal are fullled. In parallel, TJAB will undertake a stem cell mobilisation study at their cost.
Disclosure: Patersons Securities Ltd acted as Lead Manager to the Share Placement and Share Purchase Plan that raised $5.0m at 1.8 cents per share for Antisense Therapeutics Ltd in March 2012. It was paid a fee for this service. Patersons Securities Ltd is retained as a Corporate Adviser.
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22
Energy
OIL & GAS

Alexis Clark - Oil and Gas Analyst
OIL PRICES REBOUND DURING MARCH

Oil prices rebounded during March to settle at $97/bbl from $90/bbl (WTI) on the back of stronger condence in the economy with the S&P 500 nishing at a record level. Investors brushed off ongoing concerns over Europes economy stemming from the crisis in Cyprus. Brent oil for April settlement remained at for the month at $110/bbl on the London-based ICE Futures Europe exchange and the premium to the West Texas Intermediate contract decreased to $13/bbl. US natural gas prices increased slightly during the month to close at US$4.07/mmbtu. During March we attended the Excellence in Oil & Gas conference in Sydney. The conference focuses on a number of small/mid cap oil & gas companies aswell as current key industry themes. The key focus of a number of the presentations was the unconventional revolution, the progress in Australia and the large size of the resource potential. Whilst the resource potential is signicant in Australia the challenges are signicant and will take some time to develop for example the Barnett shale in the US took over 25yrs to develop from discovery in 1980, with the rst horizontal wells drilled in the early 1980s and it did not became a prolic producer until 2007. Australia has only 4 drill rigs that can drill horizontal shale gas wells and only 3-4 frac crews and limited infrastructure. Environmental challenges exist and approval processes are slow and onerous and the geology still needs to be proven. In summary, Australias unconventional resource has strong potential but investors will need to be patient as the exploration phase will take some time. We prefer energy stocks focused on liquids and higher priced gas markets as the preferred exposures. Well funded companies with strong management teams, operating in proven hydrocarbon basins and a proven track record in developing emerging oil and gas companies represent lower risk/higher reward propositions. Our preferred picks in the small to mid cap space are Sino Energy & Gas (SEH) and Central Petroleum (CTP).
HIGHLIGHTED STOCKS
SECTOR WEIGHTING COMPANY Sino Gas and Energy Holdings Ltd (SEH) Index/Under Weight RECOMMENDATION BUY COMMENT Our buy rating for SEH is predicated on SEHs 5.6tcf 2C gross resources (recently upgraded), high retained interests and projects located in the Ordos basin (Chinas 2nd largest gas basin) close to nearby infrastructure with strong gas demand from large population centres. SEH completed a $100m farm out with MIE Holding Corporation in June 2012 a key step in the development and commercialisation of SEHs Chinese projects and removes funding risk. Key Catalysts 2013: 25 well drilling programme completed by Q3 2013, Chinese reserve reports and pilot gas projects in 2H 2013, and Chinese gas price reform. Price Target: A$0.45ps. JKA is an emerging Oil & Gas company in Africa backed by management who have a proven track record in developing emerging plays in Africa. JKA is in the early stages of developing a portfolio with near term production and attractive exploration targets in relatively unexplored territory via recent farm in acquisitions in Somaliland and Tanzania. The recent farm out of 50% of the Somaliland acreage to growing UK E&P Genel Energy (A$4bn market cap) is a positive endorsement of JKA management. Price Target: A$0.42ps. Key Catalysts: Q1 2013: Hammamet West 1 well. Mid 2013: Aje well drilling and H2 2013 Tanzania exploration and farm out. CTP holds 40m acres in 4 basins at high retained interest in central Australia, targeting conventional and unconventional oil & gas. CTP has now completed 2 farm-out transaction with Santos and T otal for $300m over 25m acres in the Amadeus/Pedirka/Southern Georgina basins at an attractive price of $11/acre and $26/acre. These deals re-inforce the deal making abilities of new CEO Richard Cottee. Recent reserves report on Surprise eld was below expectations however majority of the value lies in STO/T otal exploration acreage. Price target of $0.34ps. Key Catalysts H1 2013: Petro frontier exploration, H2 2013: STO/T otal JV exploration results. TAP has a portfolio of oil and gas assets focused in Australia/Asia/Africa. It has a strong nancial position and near term upside is expected through production growth from the development offshore Thailand and exposure to high risk/high reward wells in offshore Ghana & Australia. We value existing cash and third party gas contracts at $0.59ps with limited value attributed to the development and exploration portfolio. BUY with a Price Target of $1.10ps.
23
Jacka Resources Ltd ( JKA)
Speculative BUY
Central Petroleum Ltd (CTP)
Speculative BUY
Tap Oil Ltd (TAP)
BUY
Sino Gas and Energy Holdings Ltd

Valuation Linxing PSC - 2P & 2C Sanjiaobei PSC - 2P & 2C Prospective Resource Upside Cash Corporate Debt Unpaid capital Total @ 10% Discount Rate Price Target (85%) Price Target Sensitivity Gas Price Sensitivity (A$/sh) Exchange Rate Sensitivity (A$/sh) A$m 442 211 93 19 (45) (50) 3 673
$0.155
A$/sh 0.35 0.17 0.07 0.01 (0.04) (0.04) 0.00 0.53 0.45 0% +10% 0.53 0.53 0.60 0.49 Commodity Assumptions US$/A$ RMB:US$ Crude Oil - WTI (USD/bbl) Sales Gas Price - USD Production Summary Linxing PSC Sanjiaobei PSC Total (bcf) Linxing PSC Sanjiaobei PSC Total (mmscf/d) Prot & Loss (A$m) Sales Revenue Other Income Operating Costs Exploration Exp. Rolayties Corporate/Admin EBITDA Depn & Amort EBIT Interest Operating Prot Abnormals Pre-Tax Tax expense Minorites Other NPAT Normalised NPAT Cash Flow (A$m) Adjusted Net Prot + Interest/Tax/Expl Exp - Interest/Tax/Expl Inc + Depn/Amort +/- Other Operating Cashow - Capex (+asset sales) - Working Capital Increase Free Cashow - Dividends (ords & pref) + Equity raised + Debt drawdown (repaid) + Other Net Change in Cash Exchange rate effects Cash at End Period Net Cash/(Debt) Balance Sheet (A$m) Cash Total Assets Total Debt Total Liabilities Shareholders Funds Ratios Net Debt/Equity (%) Interest Cover (x) Return on Equity (%)
Year End December 31

2010A 2011A 0.93 6.60 79.74 6.86 1.03 6.45 93.08 7.10 2012F 1.03 6.08 94.46 7.75 2012F 0.00 0.00 0.00 0.00 0.00 0.00 2012F 0.0 0.2 0.0 0.0 0.0 4.5 (4.3) 0.0 (4.3) 0.0 (4.3) (0.4) 0.0 0.0 0.0 (4.7) (4.7) 2012F (4.7) 0.0 (0.2) 0.0 (1.8) (6.3) 0.0 0.0 (6.3) 0.0 2.4 0.0 7.1 3.1 (0.0) 7.4 7.4 2012F 7.4 52.0 0.0 13.6 38.4 na na na 2013F 1.01 6.00 97.62 8.06 2013F 0.14 0.33 0.46 0.38 0.89 1.27 2013F 3.7 0.6 0.5 0.0 0.0 4.8 (1.0) 0.2 (1.1) 0.0 (1.1) 0.0 0.1 0.0 0.0 (1.2) (1.2) 2013F (1.4) 0.1 0.1 0.2 0.0 (1.2) (0.5) 0.0 (0.7) 0.0 10.0 0.0 0.0 9.3 0.0 16.7 14.0 2013F 14.0 57.9 0.0 13.6 44.3 na na na
2010A 2011A 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
-10% 0.46 0.57
Valuation Summary of Operating Assets
2010A 2011A 0.0 2.0 0.0 0.0 0.0 1.6 0.4 0.0 0.4 0.9 (0.5) (3.9) 0.0 0.0 0.0 (4.4) (0.5) 0.0 (0.5) 0.0 0.0 0.0 3.1 (3.7) 0.1 (3.7) 0.3 (4.0) (0.1) 0.0 0.0 0.0 (4.0) (4.0)
Sanjiaobei PSC - 2P & 2C Linxing PSC 2P & 2C Prospective Resource Upside Cash
Production Summary
1.00 0.80 0.60 0.40 0.20 0.00 2010A 2011A 2012F 2013F Linxing PSC Sanjiaobei PSC Sales Gas Price - USD 10.00 8.00 6.00 4.00 2.00 0.00
Production (bcf)
2010A 2011A (0.5) (4.0) 0.9 0.3 5.4 8.4 0.0 0.1 (1.7) 1.1 (6.6) (10.9) 0.0 0.0 0.0 0.0 (6.6) (10.9) 0.0 0.0 23.6 7.0 (13.6) 0.0 (0.1) (0.0) 3.3 (4.0) (0.8) 0.0 8.3 4.3 8.3 4.3 2010A 2011A 8.3 37.4 0.0 6.3 31.1 na na na 4.3 44.4 0.0 8.9 35.5 na na na
Reserves & Resources Reserves - as at Mar 2013 Net Reserves 1P 2P 3P 2C Contingent Resource P50 Prospective Resource Directors Name Gavin Harper Robert Bearden Bernie Ridgeway Peter Mills Colin Heseltine Substantial Shareholders Imdex Ltd SHL Pty Ltd Position Executive Chairman Managing Director & CEO Non-Executive Director Non-Executive Director Non-Executive Director Shares (m) 251.9 77.2 % 20.3 6.2 Oil/Cond (mmbbl) 0 0 0 0.0 0.0 Gas Total (bcf) (mboe) 32 5.3 94 15.7 199 33.2 653 885 108.8 147.5
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Tap Oil Limited

Valuation John Brookes GSA Manora Field - Development Exploration and Appraisal Net Cash - estimate Corporate Other Total @ 10% Discount Rate Price Target (80%) Price Target Sensitivity Oil Price Sensitivity (A$/sh) Exchange Rate Sensitivity (A$/sh) Valuation Summary A$m 44 119 133 76 (38) 0 334
$0.54
A$/sh 0.18 0.49 0.55 0.32 (0.16) 0.00 1.38 1.10 0% +10% 1.38 1.38 1.47 1.37 Commodity Assumptions US$/A$ Crude Oil - WTI (USD/bbl) Gas Price - contracted ($/GJ) Production Summary Harriet JV Area (mmboe) Woollybutt (mmboe) Manora (mmboe) Total (mmboe) Harriet JV Area (kboepd) Woollybutt (kboepd) Manora (kboepd) Total (kboepd) Prot & Loss (A$m)
Year End December 31

2011A 2012A 1.03 93.08 1.80 1.03 94.46 1.82 2013F 1.03 97.62 1.86 2013F 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2013F 30.0 2.5 12.0 15.0 0.0 11.3 (5.8) 0.0 (5.8) 0.6 (6.5) 0.0 0.9 0.0 0.0 (7.4) (7.4) 2013F 2014F 0.99 99.58 1.90 2014F 0.00 0.00 1.09 1.09 0.00 0.00 2.98 2.98 2014F 137.8 1.6 30.7 6.0 5.0 11.6 86.1 14.6 71.5 1.9 69.5 0.0 22.9 0.0 0.0 46.6 46.6 2014F 46.6 30.9 36.9 14.6 0.0 55.2 40.4 0.0 14.8 0.0 0.0 (8.8) 0.0 6.0 0.0 64.9 33.5 2014F 64.7 304.9 31.3 122.0 182.9 na na 25.5
2011A 2012A 0.75 0.16 0.00 0.91 2.06 0.43 0.00 2.49 0.25 0.06 0.00 0.31 0.69 0.16 0.00 0.85
-10% 1.30 1.39
2011A 2012A 39.4 14.9 19.9 3.4 0.0 14.8 16.1 9.8 6.3 0.0 6.3 (25.1) 1.5 0.0 0.0 (20.2) 4.9 41.5 4.7 21.5 8.7 0.0 15.5 0.6 0.0 0.6 0.5 0.1 0.0 3.4 0.0 0.0 (3.3) (3.5)
Exploration & Appraisal
Net Cash estimate
Corporate
Manora Field
John Brookes GSA
Production Summary
1.50 1.20
(mmboe)
Sales Revenue Other Income Operating Costs Exploration Exp. Rolayties Corporate/Admin EBITDA Depn & Amort EBIT Interest Operating Prot Abnormals Post-Tax Tax expense Minorites Other NPAT Normalised NPAT Cash Flow (A$m) Adjusted Net Prot + Interest/Tax/Expl Exp - Interest/Tax/Expl Inc + Depn/Amort +/- Other Operating Cashow - Capex (+asset sales) - Working Capital Increase Free Cashow - Dividends (ords & pref) + Equity raised + Debt drawdown (repaid) + Other Net Change in Cash Exchange rate effects Cash at End Period Net Cash/(Debt) Balance Sheet (A$m) Cash Total Assets Total Debt Total Liabilities Shareholders Funds Ratios Net Debt/Equity (%) Interest Cover (x) Return on Equity (%)
0.90 0.60 0.30 0.00
2011A 2012A 4.9 4.9 61.3 9.8 68.0 26.3 42.2 0.0 (15.8) 0.0 0.0 0.0 0.0 (15.8) (0.9) 82.5 82.5
2011A
2012A
2013F Woollybutt
2014F Manora
Harriet JV Area
Reserves & Resources (net TAP) Reserves - as at Dec 2011 2P Reserves Manora Total Group 2C Contingent Resource John Brookes GSA Resource (est.) Directors Name Douglas Bailey Troy Hayden Michael Sandy Douglas Schwebel Position Chairman / Non Exec.Director MD and CEO Non Executive Director Non Executive Director Shares (m) % 37.7 15.6 13.8 5.7 13.4 5.5 Oil/Cond (mmbbl) 6.1 6.1 0.0 0.0 Gas Total (pj)(mmboe) 0.0 0.0 0.0 26.3 6.1 6.1 42.2 3.9
(3.5) (7.4) 12.6 16.6 24.3 31.6 0.0 0.0 30.9 0.0 15.7 (22.4) 1.5 35.2 0.0 0.0 14.2 (57.6) 0.0 0.0 0.0 0.0 0.0 20.0 0.0 0.0 14.2 (37.6) (0.3) 0.0 96.5 58.8 96.5 38.7 2013F 58.7 267.1 20.0 110.7 156.4 na na na
2011A 2012A 81.8 301.1 0.0 90.2 211.0 na na na 96.4 254.5 0.0 55.1 199.4 na na na
Substantial Shareholders M&G Investment Management DFA Group Northern Gulf Petroleum Holdings Ltd
25
Mining and Metals

Tim McCormack - Resources Analyst
GOLD - THE HURT CONTINUES

Gold prices have dipped to lows last seen in mid-2012. A softening in price has signalled mass exodus from the sector with the All Ordinaries Gold Index (XGD) down 25% since the beginning of the year. While gold prices are down a reasonably modest ~7% this year the market seems to be pricing in further losses to the precious metal. While many macro-economic issues are at play, we believe good value still exists in the gold sector and the graph below highlights the disconnect between the gold price and equities over the past three months (Figure 1). Figure 1: Gold Price Performance vs ASX All Ord Gold Index
Gold has been held as a US dollar proxy and substitute to currency while interest rates globally have been low. If the global economy continues to improve the reasons for holding gold diminish. While early days yet, the spectre that global interest rates will one day start to lift could increase the opportunity cost of carrying physical gold which does not pay an interest rate or yield. If US rates were seen by the market as potentially lifting, and this would of course be rst undertaken by the FOMC reducing asset purchases, the US dollar would also hold potential to lift, which in turn could see gold reduce in value as a currency substitute. While this may be true, an improving $US may offer some respite for domestic gold producers. Our technical analysis of the gold price suggests that US$1550/oz is an important resistance level which is currently being tested with the next support level at $1480/oz. We recently reduced our forecast gold prices this month to better reect consensus estimates. Prices trend towards $1600/oz from current levels to CY16 then revert to our long term gold price of $1450/oz. An important consideration is our AUD/USD assumptions which are also included in the table below. Figure 2: Patersons Gold and Currency Forecasts 2011A Currency Gold Gold A$:US$ US$/oz A$/oz 1.032 1566 1518 2012A 1.034 1662 1607 2013E 1.027 1582 1540 2014E 0.980 1580 1612 2015E 0.950 1570 1653 2016E 0.920 1600 1739 LT Average 0.900 1450 1611
26
Mounting pressue has been enough to see the likes of Navigator Resources and Kentor Gold call in the administrators while the rest of the sector has wiped off 25% since January 1. We believe deep value still exists in the sector with high margin, domestic gold producers presenting the safest investment in these uncertain times. Our preferred picks in the space are Doray Minerals, Northern Star and Millennium Minerals which all present compelling investment cases.
HIGHLIGHTED STOCKS
SECTOR WEIGHTING COMPANY Doray Minerals Ltd (DRM) Index Weight RECOMMENDATION BUY COMMENT A recent site visit reiterated out positive view on the Company and rst gold production remains on track for August 2013. A maiden resource for the high grade Judy-South Lode last month gives us good condence in extending the mine life to ~5 year mine life which is impressive for a high grade narrow vein gold mine. Open pit mining is nearing completion which will dovetail into establishing an underground network at the end of the month and we expect production stoping to be the mainstay of ore supply by late November. DRM will produce ~75kozpa for cash costs around $600/oz. BUY price target $1.03/sh. Millennium Minerals (MOY): All is going well operationally for MOY with March performance being well above budget and compensating for a cyclone-disrupted February. With previously announced production for January of 6,726oz of ne gold, we believe our forecast of March Q output of 19,700oz should be matched or exceeded. The good operational performance is starting to deliver solid cash generation with approximately $3m of cash being generated for the March Q after the $1m debt repayment. We are condent the Company will hit guidance of ~80koz in CY13 for cash cost in the order of $850/oz. BUY price target $0.055/sh. Northern Star (NST): NST is primed for a record breaking year with the Paulsens mill expansion complete and mining rates outperforming expectations. We remain condent the Company will achieve at the high end of CY13 guidance to produce ~115koz at a total operating cost of ~$870/oz. The increased scale and improved operating efciencies will translate to ~$55m free cashow this CY allowing NST to meaningfully explore growth options and maintain its commitment to paying dividends. BUY price target $1.13/sh.
Millennium Minerals Ltd (MOY)
BUY
Northern Star Resources Ltd (NST)
BUY
27
Doray Minerals Limited

Valuation Andy Well Exploration Unpaid capital Corporate Forwards Investments Cash Debt NAV (@ 5% discount rate) Andy Well - NAV Sensitivity NPV(nom) @ 5% disc. NPV(nom) @ 0% disc. Valuation Summary A$m 110.9 25.0 0.8 (13.0) 0.0 0.0 38.1 (15.0) 146.8
$0.57
A$/sh 0.77 0.17 0.01 (0.09) 0.00 0.00 0.27 (0.10) 1.03 Commodity Assumptions A$:US$ Gold (US$/oz) Silver (US$/oz) Gold (A$/oz) Target Price Sensitivity FX (A$:US$) Gold Price Operating Costs Production Summary Production (koz) Andy Well Total 2012A 1.03 1671 33.05 1622 -10% 1.20 0.84 1.11 2012A 0.0 0.0 na na na 2012A 0.0 1.6 0.0 0.3 5.2 (3.9) 0.2 (4.2) 0.0 0.0 (4.2) 0.0 0.0 (4.2) (4.2) 2012A
Year End June 30

2013F 1.04 1635 29.55 1577 0% 1.07 1.07 1.07 2013F 0.0 0.0 na na na 2013F 0.0 0.9 0.0 0.0 4.5 (3.6) 0.0 (3.6) 0.3 0.0 (3.9) 0.0 0.0 (3.9) (3.9) 2013F 2014F 1.00 1574 27.50 1574 2015F 0.97 1575 28.00 1632
+10% Change 0.86 1.19 0.98 2014F 85.3 85.3 491 841 1,576 2014F 134.4 1.2 41.8 0.0 4.1 89.7 29.8 59.8 3.4 0.0 56.4 13.9 0.0 42.5 42.5 2014F (19%) 11% (8%) 2015F 73.1 73.1 640 990 1,632 2015F 119.3 1.7 46.8 0.0 4.2 70.0 25.6 44.4 0.6 0.0 43.8 13.2 0.0 30.7 30.7 2015F
1.03 1.17
Exploration 14%
Cost Summary Cash Costs (A$/oz) Total Costs (A$/oz) Price Received (A$/oz) Prot & Loss (A$m)
Andy Well 64% Cash 22%
Gold Production Summary

100 80
(koz)
1800 1600 1400

(US$/oz)
60 40 20 0 2014F Total 2015F 2016F 2017F Cash Costs (A$/oz)
1200 1000 800 600 400 200 Gold (US$/oz)
Sales Revenue Other Income Operating Costs Exploration Exp. Corporate/Admin EBITDA Depn & Amort EBIT Interest Abnormals (pre-tax) Operating Prot Tax expense Abnormals (post-tax) NPAT Normalised NPAT Cash Flow (A$m) Adjusted Net Prot + Interest/Tax/Expl Exp - Interest/Tax/Expl Inc + Depn/Amort +/- Other Operating Cashow - Capex (+asset sales) - Working Capital Increase Free Cashow - Dividends (ords & pref) + Equity raised + Debt drawdown (repaid) Net Change in Cash Cash at End Period Net Cash/(Debt) Balance Sheet (A$m) Cash Total Assets Total Debt Total Liabilities Shareholders Funds Ratios Net Debt/Equity (%) Interest Cover (x) Return on Equity (%)
Reserve and Resource Reserve Andy Well Resource Wilber Lode/Shear Webbs Patch Judy Lode Total Directors Name Peter Alexander Allan Kelly Heath Hellewell Leigh Junk Jay Stephenson Substantial Shareholders Directors/ Management Domestic Institutions Ramelius Resources Renaissance Top 20 shareholders Position Non-Executive Chairman Managing Director Technical Director Non-Executive Director Non-Executive Director % 11.1 34 5.3 5 52.6 Kt Au g/t Au koz 733 11 250 831 44 393 875 13 5 8 11 339 7 106 452
(4.2) (3.9) 0.0 0.3 4.5 5.8 0.2 0.0 0.0 0.0 (8.4) (9.4) 9.2 78.8 (1.8) (0.4) (15.8) (87.8) 0.0 0.0 1.0 41.0 0.0 50.0 (14.7) 3.2 5.2 8.4 5.2 (41.6) 2012A 5.2 28.6 0.0 2.0 26.6 na na na 2013F 8.4 116.1 50.0 52.4 63.7 65.3 na na
42.5 30.7 17.3 13.7 21.4 17.9 29.8 25.6 0.0 0.0 68.3 52.1 15.3 32.3 0.0 0.0 53.0 19.8 0.0 0.0 0.0 0.0 (20.0) (30.0) 33.0 (10.2) 41.4 31.2 11.4 31.2 2014F 41.4 138.6 30.0 32.4 106.2 na 17.6 40.0 2015F 31.2 139.1 0.0 2.2 136.9 na 76.2 22.4
28
Millennium Minerals Limited

Valuation Nullagine Gold Project Hedging Corporate Exploration Unpaid Capital Cash Equity Investment Debt NAV (@5% discount) Price Target (1x NAV) A$m 303 3 (26) 13 0 3 0 (54) 242
$0.018
A$/sh 0.07 0.00 (0.01) 0.00 0.00 0.00 0.00 (0.01) 0.055 0.055 Commodity Assumptions Gold Gold Price (US$/oz) Gold Price (A$/oz) Production Summary Production (koz) Nullagine Gold Project Total Production Cost Summary 2012A 1.03 1662 1607 2012A 12 12 2012A na na na
Year December 31
2013F 1.03 1608 1565 2013F 81 81 2013F 873 1086 1629 2013F 132.2 0.2 70.9 5.1 5.1 51.4 17.3 34.1 2.9 31.2 0.0 0.0 31.2 31.2 2013F 31.2 8.0 13.0 17.3 0.0 43.4 8.1 0.0 0.0 35.3 0.0 0.0 (26.7) 8.6 11.4 (16.0) 2013F 11.4 167.3 27.5 55.3 112.1 14.3 11.7 27.8 2014F 0.98 1610 1643 2014F 79 79 2014F 836 1049 1635 2014F 128.7 1.2 65.8 2.1 5.2 56.8 16.8 40.0 1.4 38.7 0.0 0.0 38.7 38.7 2014F 38.7 3.4 5.5 16.8 0.0 53.4 5.2 0.0 0.0 48.2 0.0 0.0 (16.0) 32.2 43.6 32.2 2014F 43.6 189.7 11.5 38.9 150.8 na 29.5 25.7 2015F 0.95 1620 1705 2015F 76 76 2015F 836 1049 1642 2015F 124.5 2.8 63.3 3.2 5.3 55.5 16.1 39.4 0.2 39.1 11.7 0.0 27.4 27.4 2015F 27.4 15.1 3.4 16.1 0.0 55.3 5.3 0.0 0.0 50.0 0.0 0.0 (11.5) 38.6 82.2 82.2 2015F 82.2 217.0 0.0 38.9 178.2 na 185.8 15.4
Exploration 4%
Weighted Ave C1 Costs (A$/oz) Weighted Ave Total Costs (A$/oz) Realised price (A$/oz) Prot & Loss (A$m)
2012A 0.0 0.6 1.9 0.0 7.5 (8.9) 4.4 (13.2) 4.2 (17.5) (0.7) 0.0 (16.8) (16.8) 2012A (16.8) 3.6 5.1 4.4 0.0 (13.9) 72.2 (1.6) 0.0 (84.5) 0.0 23.2 54.2 (7.9) 2.8 (51.3) 2012A 2.8 155.9 54.2 75.0 80.9 63.4 (3.1) na
Nullagine Gold Project 96%

100 80 60 40 20 0 2012A 2013F 2014F 2015F Total Production 1800 1600 1400 1000 800 600 400 200 0 Weighted Ave C1 Costs (A$/oz) Realised price (A$/oz)
(A$/oz)
1200
Sales Revenue Other Income Operating Costs Exploration Exp. Corporate/Admin EBITDA Depn & Amort EBIT Interest Operating Prot Tax expense Abnormal Losses / Minorities NPAT Normalised NPAT Cash Flow (A$m) Adjusted Net Prot + Interest/Tax/Expl Exp - Interest/Tax/Expl Inc + Depn/Amort +/- Other Operating Cashow - Capex (+asset sales) - Working Capital Increase - Other Investing Free Cashow - Dividends (ords & pref) + Equity raised + Debt drawdown (repaid) Net Change in Cash Cash at End Period Net Cash/(Debt) Balance Sheet (A$m) Cash Total Assets Total Debt Total Liabilities Shareholders Funds Ratios Net Debt/Equity (%) Interest Cover (x) Return on Equity (%)
Reserves & Resources Resources Nullagine Gold Project Total Reserves Nullagine Gold Project Total Directors Name Peter Rowe Brian Rear Richard Procter Ross Gillon Simon Durack Substantial Shareholders LinQ Resources Fund Merrill Lynch Nominees CitiCorp Nomineees Pershing Australia Position Chairman CEO Non Executive Director Non Executive Director Non Executive Director % 17.5 12.6 8.7 6.3 Mt Au g/t Au koz 34.7 1.2 1329 34.7 1.2 1329 Mt Au g/t Au koz 16.4 1.4 741 16.4 1.4 741
(koz)
29
Northern Star Resources Limited

Valuation Paulsens Gold Mine Exploration Unpaid capital Corporate Forwards Investments Cash (est) Debt NAV (@ 5% discount rate) Price Target (1x NAV) Paulsens NAV Sensitivity NPV(nom) @ 8% disc. (spot) NPV(nom) @ 0% disc. Valuation Summary of Operating Assets A$m 341.6 70.0 3.4 (11.6) 0.0 4.1 66.3 0.0 473.8
$0.895
A$/sh 0.81 0.17 0.01 (0.03) 0.00 0.01 0.16 0.00 1.13 1.13 Commodity Assumptions A$:US$ Gold (US$/oz) Silver (US$/oz) Gold (A$/oz) Target Price Sensitivity FX (A$:US$) Gold Price Gold Grade Operating Costs Production Summary Production (koz) Paulsens Gold Mine Total Cost Summary Cash Costs (A$/oz) Total Costs (A$/oz) Price Received (A$/oz) Prot & Loss (A$m) 2012A 1.03 1669 33.05 1620 -10% 1.28 1.00 0.98 1.19 2012A 67.2 67.2 713 964 1,621 2012A 99.5 2.6 45.5 2.1 5.5 49.1 17.4 31.7 0.2 0.0 31.4 9.5 0.0 22.0 22.0 2012A 22.0 11.6 25.6 17.4 0.0 25.4 20.3 (12.9) 18.0 0.0 48.0 (1.2) 58.3 75.0 75.0 2012A 75.0 134.0 9.4 39.5 94.5 na 128.3 23.2
Year End June 30

2013F 1.04 1634 29.55 1576 0% 1.13 1.13 1.13 1.13 2013F 94.9 94.9 623 873 1,637 2013F 155.6 3.0 59.1 2.9 4.4 92.2 23.7 68.5 0.5 0.0 68.0 20.4 0.0 47.6 47.6 2013F 47.6 23.8 43.3 23.7 0.0 51.8 22.0 0.1 29.7 14.5 0.0 (4.7) 9.2 84.2 79.5 2013F 84.2 171.1 4.7 33.2 137.9 na 136.4 34.5 2014F 1.00 1574 27.50 1574 2015F 0.97 1575 28.00 1632
+10% Change 1.01 1.26 1.29 1.07 2014F 118.0 118.0 582 832 1,575 2014F 185.7 4.8 68.7 2.0 4.5 115.4 29.5 85.9 0.1 0.0 85.7 25.7 0.0 60.0 60.0 2014F 60.0 27.8 41.2 29.5 0.0 76.2 12.3 0.0 63.9 17.0 0.0 (4.7) 42.2 126.4 126.4 2014F 126.4 209.4 0.0 28.5 180.9 na 627.1 33.2 (11%) 12% 14% (5%) 2015F 118.0 118.0 610 860 1,632 2015F 192.6 7.2 72.0 5.9 4.6 117.3 29.5 87.8 0.0 0.0 87.8 26.4 0.0 61.5 61.5 2015F 61.5 32.3 36.8 29.5 0.0 86.5 12.5 0.0 73.9 17.0 0.0 0.0 57.0 183.4 183.4 2015F 183.4 253.8 0.0 28.3 225.5 na na 27.3
1.05 1.24
Paulsens Gold Mine 83% Exploration 17%

120 100 80
(koz)
2500 2000 1500 1000 500 0 2012A Total 2013F 2014F 2015F 2016F Price Received (A$/oz) Cash Costs (A$/oz)
(US$/oz)
60 40 20 0
Sales Revenue Other Income Operating Costs Exploration Exp. Corporate/Admin EBITDA Depn & Amort EBIT Interest Abnormals (pre-tax) Operating Prot Tax expense Abnormals (post-tax) NPAT Normalised NPAT Cash Flow (A$m) Adjusted Net Prot + Interest/Tax/Expl Exp - Interest/Tax/Expl Inc + Depn/Amort +/- Other Operating Cashow - Capex (+asset sales) - Working Capital Increase Free Cashow - Dividends (ords & pref) + Equity raised + Debt drawdown (repaid) Net Change in Cash Cash at End Period Net Cash/(LT Debt) Balance Sheet (A$m) Cash Total Assets Total Debt Total Liabilities Shareholders Funds Ratios Net Debt/Equity (%) Interest Cover (x) Return on Equity (%)
Resources Paulsens Gold Mine Ashburton Gold Project Total Directors Name Chris Rowe Bill Beament Michael Fotios John Fitzgerald Peter OConnor Substantial Shareholders Van Eck Associates Corp Investmet Ltd Paradice Investment management BlackRock Group Position Non-Executive Chairman Managing Director Non-Executive Director Non-Executive Director Non-Executive Director Shares (m) 22.7 21.9 21.8 21.3 % 5.2 5.0 5.0 5.0 Mt Au g/t Au koz 2.4 5.0 0.4 21.3 2.4 1.7 23.7 2.7 2.1
30
Specialty Metals
RARE EARTHS
Andrew Harrington - Coal & Specialty Metals Analyst
WEAK HANDS CREATE OPPORTUNITY IN A RARE PRODUCER

In the rst week of April, our favourite Rare earth company suffered a large share price fall for no apparent reason. It fell up to 12% but later recovered to an 8% fall. There was no direct link to LYC. In searching for reasons, it instead looks to be more a reaction to the share price weakness of its peer in the US, Molycorp (MCP) and the weak guidance from major Chinese REO producer Baotou. MCP has earlier reported a big loss for the quarter, including a write-down from its recent NeoMaterials acquisition and looks to be behind schedule on its plant in California. It is also under investigation from the US SEC. It share price has touched multi-year lows. Secondly, Baotou, the biggest producer in China, has provided weak guidance of a 20% decline in future revenues. The REO price is down very slightly in recent days to $36/kg, but it is a long way from year-ago prices of over $100/kg, and with the LYC production ramp up hitting the market also likely to cap prices, it is predictable that Baotou will get lower revenues. There was no news on the Malaysian election, to which many seem to attach a greater importance than they should. Soon after, however, the Prime Minister of Malaysia dissolved parliament and called and the poll date has to be before 2 June. From our perspective the political rhetoric surrounding Lynas has become much milder. One of the key takeaways from our recent site visit was that previous statements from the opposition parties that the LAMP will be stopped have been re-worded to will be stopped if it is unsafe. The latter wording applies to all industrial processes in the country and puts LYC and the LAMP in the same basket any other company. The only direct links to LYC that we can surmise are that 50c was perhaps a substantial stop-loss point for the share price that was triggered this morning and forced the share price down further than it otherwise would have and that the short position on LYC is now nearing the record levels of last year at almost 200m shares. At current market volumes, it would take 27 days of trading to close the short position. We expect that there will be a share price appreciation following the reporting of sales revenues by LYC, which creates the potential for a big short squeeze once this takes place. We recently visited the Lynas Advanced Materials Plant (LAMP) in Malaysia. Below are the highlights of the visit and prior discussions with management. No Protestors, Locally Staffed: There were no protestors anywhere near the front gates to the LAMP . The parking lot was full. 95% of staff are Malaysian with very few expats. These few are from Australia, France, and China (4x process experts). Lynas Advanced Materials Plant (LAMP) Phase1 complete: Phase1 is complete and producing. It is ramping up to design capacity of 11ktpa of REO products. First deliveries to clients have taken place. Revenues are expected this quarter. The plant is currently running at approximately 50% of Phase 1 nameplate capacity (11ktpa). Recoveries are better than design at +90%. The company will be testing the process at lower than the 700C design because it looks like the concentrate can be cracked successfully at lower temperatures. All 5 product streams have been produced. Phase2 near complete: There are 1500 staff on site, but this will decline to 350 when construction ends, which is starting to happen already. As at 31-December, Phase2 was ofcially 90% complete but we expect that practical completion is imminent. To our eyes, Phase 2 looks very well advanced, with paint nishing on concrete areas taking place. Probably a month to go. The Company will be ramping-up Phase2 during the course of 2013. We expect that by the end of 2013, the LAMP will be operating at the full design capacity of 22ktpa rate. There is no more capex after this. Production from Phase1 is 90% contracted: Prices will be on a China plus basis which will be roughly in line with the published China FOB prices, ie roughly 50% more than the Chinese domestic price. LYC readily admits though, that it is a new supplier and it will be a price taker for its products. Even though it does not sell only individual Oxides, market pricing is based on the oxide equivalent of the nished product from the LAMP . We calculate using the published individual REO pricing and multiply by the individual REO proportions in the LYC resource to achieve the average pricing for the basket per kilo. Our long run price assumption is $40/kg.
Continued page 32
31
Page 31 continued
Residue processing: There is no condition requiring LYC to export waste. The ToL licence condition requires that a permanent disposal facility (PDF) be identied this year for storing all of the solid wastes. The Company has already made the rst of 5 $10m payments for the expected cost of the PDF. Alongside this, LYC has made a voluntary undertaking to reprocess the waste and sell the material as roadbase/construction material. The original plan was for long term storage at site which would have lasted many years but, because of the sensitivity from local community, LYC has made its undertaking to reprocess and export. The material is Iron Phospho Gypsum (IPG), which contains 6 Becquerels per gram (Bq/g) of radioactive material from 1600ppm Thorium. International rules require 10Bq/g before a material needs to be classied as radioactive. LYC has built a trial Synthetic Aggregate Plant for the residue product to convert it to Road Base material known as RB10. LYC aims to combine IPG with Steel Slag to produce a road base which makes it stable in different temperatures/humidity. It is expected the development of this product and market development will take about 12 months but the Temporary Operating License is not dependent on the successful marketability of RB10. As stated above this is a commitment from LYC, but it is not an economic decision because it is likely to be only break-even. It does however, add transparency and sustainability for those seeking a totally green supply chain, especially for those producing green products from Rare Earths. All new licences in Malaysia are temporary. If the plant operates safely and within its licence conditions for the rst 2 years then the licence just becomes a regular operating licence. Court Challenges have all failed: The series of legal challenges brought by the SLSM protest group have all been rejected so far. There is one remaining before the courts against the Ministry of Science, which was due to be heard in February but has now been postponed. We believe the strength and number of legal precedents will stand up well for LYC. REE market developments: Molycorp (MCP) is close to commissioning the rst 20ktpa plant. It has recently written off ~$200m from the NeoMaterials acquisition. The single biggest plant in the world is 16ktpa at Boatou. Rare Earth Prices have at-lined at around $36.00/kg over the past couple of months. This is well below the levels of over $100 from last year but will still provide very healthy margins for LYC, which we expect to have operating costs of about $24/kg in the ramp-up stage and gradually declining to around $12/kg in steady state. Why LYC chose to set up in Malaysia: The key reasons are 1) lower cost of construction and labour, 2) the government actively lobbied to have the plant located there and granted LYC a 12-year tax holiday as an incentive, and 3) the location has many existing chemical and petrochemical plants that can supply cheap energy, water, and consumables for the rare earth process. ICI, BP , and BASF al operate petrochemical plants in the Gebeng Industrial Park immediately surrounding the LAMP . Additionally, LYC buys 10-11 tonnes of consumable materials from domestic suppliers for every tonne of concentrate from Mt Weld. Plenty of Cash: At last report cash on hand is $226m, of which $37m is restricted for the completion of Phase2. There is $90m of spending planned for the March quarter, of which the main items are $27m for Phase2 construction, $40m for the ramp-up of Phase1, and $7m for interest payments. Mt Weld: Still the largest and richest Rare Earth deposit anywhere. The concentration plant has been idled since May 2012 as it has built up more than enough ore and stockpiled concentrate. It has 15.2kt of concentrate at 35% REO, which is about 6 months of supply for the Phase1 plant in Malaysia. It has been shipping material since November 2012. The Phase2 expansion of the Mt Weld mine and concentrator plant is about 70% complete and is expected to be nished by April-13 in order to match the expansion of the LAMP to full capacity. At full capacity the LAMP will only require the mining of about 250ktpa and the production of 65-70ktpa of concentrate. So it is a very small scale mining operation. LYC plans to mine in short campaigns of approximately 750kt, which will then be concentrated over a three-year period for shipping to Malaysia. Paying only for the construction cost and getting the earnings for free: At the current market cap, of $990m at a share price of $0.49, investors are paying for the build cost of the plants at Mt Weld and Kuantan and almost getting for free one of the worlds largest and richest rare earth deposits. Further, there is little value being factored in for the future earnings that are imminent. LYC is trading at 5x and 2x PE on FY14 and FY15 earnings. It is trading at 2x EV/EBITDA on FY15. The recent decline adds further to the value proposition. Accordingly, we retain a Buy recommendation with a price target or $2.08/share.
HIGHLIGHTED STOCKS
SECTOR WEIGHTING COMPANY Lynas Corporation Ltd (LYC) Index Weight RECOMMENDATION BUY COMMENT Lynas is producing rare earths from its plant in Malaysia and is nearing completion of Phase 2 at the plant. By the end of 2013 it will be producing at nameplate capacity of 22ktpa and generating about $100m in revenue per quarter.
32
Lynas Corporation Limited

Valuation Mt Weld Crown Polymetallic Kangankunde- Malawi NTU Shares Exploration Forwards Corporate Unpaid Capital Cash Debt NAV @ 10% Discount Rate Price Target (1.0 x NAV) Sensitivities Rare Earth Prices Neodymium Price A$ : US$ A$m 4571 25 60 2 50 0 (270) 0 226 (399) 4,265 -10% 1.78 1.97 2.39
$0.49
A$/sh 2.23 0.01 0.03 0.00 0.02 0.00 (0.13) 0.00 0.11 (0.20) 2.08 2.08 0% +10% 2.08 2.08 2.08 2.39 2.20 1.83 Commodity Assumptions 2012A
Year End June 30

2013F 2014F 2015F
A$:US$ 1.03 1.04 1.00 0.97 Mt Weld REO suite (US$/t) 118648 43110 40705 41525 Mt Weld REO suite (US$/kg) 118.65 43.11 40.70 41.53 Lanthanum (US$/kg) 62.77 17.56 26.11 26.64 Cerium (US$/kg) 60.17 15.15 13.06 13.32 Neodymium (US$/kg) 220.63 88.25 81.24 82.87 Praseodymium (US$/kg) 210.07 90.63 81.24 82.87 Samarium (US$/kg) 95.37 34.56 13.78 14.06 Dyprosium (US$/kg) 1686.62 660.84 333.65 340.37 Europium (US$/kg) 3683.99 1740.76 1508.67 1539.07 Terbium (US$/kg) 2867.04 1600.95 1740.77 1775.85 Production Summary Lanthanum Cerium Neodymium Praseodymium Samarium Dyprosium Europium Terbium Total REO Production (t) Cash Cost (US$/kg) Prot & Loss (A$m) Sales Revenue Other Income Operating Costs Exploration Exp. Corporate/Admin EBITDA Depn & Amort EBIT Interest Operating Prot Tax expense Minorities NPAT Signicant Item gains(losses) Normalised NPAT Cash Flow (A$m) Adjusted Net Prot + Interest/Tax/Expl Exp - Interest/Tax/Expl Inc + Depn/Amort +/- Other Operating Cashow - Capex (+asset sales) - Working Capital Increase Free Cashow - Dividends (ords & pref) + Equity raised + Debt drawdown (repaid) Net Change in Cash Cash at End Period Net Cash/(Debt) Balance Sheet (A$m) Cash Total Assets Total Debt Total Liabilities Shareholders Funds Ratios Net Debt/Equity (%) Interest Cover (x) Return on Equity (%) Gearing (%) 2012A 0 0 0 0 0 0 0 0 0 2013F 2014F 2015F
186 2,704 5,242 340 4,956 9,608 135 1,961 3,803 39 564 1,094 17 241 467 1 13 25 3 47 91 0 7 14 728 10,602 20,555 86.25 14.61 11.85 2013F 28.1 3.9 55.1 0.0 40.1 (63.1) 5.7 (68.9) 20.3 (89.1) (12.9) 0.0 (76.2) 0.0 (76.2) 2013F 2014F 434.3 3.4 137.5 0.0 40.7 259.5 10.6 248.9 19.6 229.3 0.0 0.0 229.3 0.0 229.3 2014F 229.3 19.6 19.7 10.6 0.0 239.8 36.6 0.0 203.2 0.0 0.0 0.0 203.2 323.9 (75.1) 2014F 2015F 886.2 10.1 229.7 0.0 41.5 625.1 20.6 604.6 19.0 585.6 0.0 0.0 585.6 0.0 585.6 2015F 585.6 19.0 19.0 20.6 0.0 606.1 35.3 0.0 570.8 0.0 0.0 (50.0) 520.8 844.7 495.7 2015F
Mt Weld 97%
2012A 0.0 2.8 38.1 0.0 31.6 (66.8) 5.0 (71.8) 10.1 (82.0) (10.1) 0.0 (71.8) (15.9) (87.8) 2012A
REO Production Summary

25 20
(kt)
120 100
(US$/kg)
15 10 5 0
80 60 40 20 2012A 2013F 2014F 2015F 2016F 2017F 2018F 0
Total REO Production (t) Mt Weld REO suite (US$/kg) Cash Cost (US$/kg)
Reserves & Resources Reserves Mt Weld Mt Grade (%) REO (kt) 9.7 11.7 1,138
Resources Mt Grade (%) REO (kt) Mt Weld - CLD 14.9 9.8 1,465 Mt Weld - Duncan 9.0 4.8 432 Kangankunde- Malawi 2.5 4.2 107 Crown Tantalum & Niobium Deposit 37.7 1.2 437 Total 64.2 3.8 2,442 Directors Name Nick Curtis Liam Forde Eric Noyrez David Davidson, Kathleen Conlon Jacob Klein, Ziggy Switkowski Substantial Shareholders Morgan Stanley Union Investment GM Van Eck Associates Nick Curtis Vanguard Group Position Non-Executive Chairman Deputy Chairman Executive Director, CEO Non Executive Directors Non Executive Directors Shares (m) 87.6 31.7 17.9 16.0 10.4 % 4.5 1.6 0.9 0.8 0.5
(87.8) (76.2) 0.0 7.4 (2.4) 7.4 5.0 5.7 0.5 25.2 (79.8) (45.3) 350.9 205.0 (10.3) 0.0 (420.4) (250.4) 0.0 0.0 1.2 169.7 190.7 (4.0) (228.5) (84.7) 205.4 120.7 (197.6) (278.4) 2012A 2013F
205.4 120.7 323.9 844.7 1023.7 1081.7 1345.8 1921.4 403.1 399.1 399.1 349.1 460.2 451.9 486.7 476.8 563.5 629.8 859.1 1444.6 35.1 na na (54.7) 44.2 na na 26.0 8.7 12.7 26.7 30.7 na 31.9 40.5 0.0
33
NOTES
34
NOTES
35
T H E AU S T R A L I A N S TO C K B RO K E R
1300 582 256 patersons@psl.com.au

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Monthly Strategic Outlook April 2013

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Monthly Strategic Outlook April 2013

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T H E AU S T R A L I A N S TO C K B RO K E R

Patersons Securities Limited Monthly Strategic Outlook - April 2013

MONTHLY STRATEGIC OUTLOOK

Macro Investment Strategy

WHIPSAW MARKET - NEUTRAL VIEW

Slow global growth, adds US economic emphasis

Towards a volatile whipsaw market

MONTHLY STRATEGIC OUTLOOK

Pulling the wool over your eyes?

MONTHLY STRATEGIC OUTLOOK

Again the world looks to the US

12-Month view Neutral

Primary risks The sustainability of US growth

SECTOR Consumer Discretionary Consumer Staples Energy

WEIGHTING Index weight Index weight Index/Under weight Index/Over weight

Index weight Index weight

Information Technology Materials

Index weight Index weight

MONTHLY STRATEGIC OUTLOOK

Professionally tailored portfolio management.

In most cases, fees are tax deductible.

Residential and Non-Residential on the Rise, but Renovations Still Lagging

Source: ABS, Patersons Research

MONTHLY STRATEGIC OUTLOOK

Source: ABS, Patersons Research

USING A MULTIFACTOR MODEL TO IDENTIFY INVESTMENT OPPORTUNITIES

MONTHLY STRATEGIC OUTLOOK

Most Attractive Stocks

MONTHLY STRATEGIC OUTLOOK

Least Attractive Industrials

Least Attractive Resources

MONTHLY STRATEGIC OUTLOOK

COMPETITION IN THE AUSTRALIAN HOME MORTGAGE SPACE IS HOTTING UP

Owner Occupied Home Loans - Big 4

Source: APRA, Patersons Research

MONTHLY STRATEGIC OUTLOOK

Source: APRA, Patersons Research

Upcoming Bank Trading Updates Source: Various bank announcements/websites

MONTHLY STRATEGIC OUTLOOK

HEALTH CARE SECTOR REVIEW - MARCH 2013

Key Health Care Equipment & Services News

Recent Small Cap Contact

Health Care Equipment & Services

Source: Thompson Reuters consensus estimates, IRESS

* FY13 net debt forecasts used for EV

MONTHLY STRATEGIC OUTLOOK

Figure 2: Summary of contacted small caps

Figure 4: 5-year index performance

Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12

Figure 5: Monthly Pharmaceuticals & Biotechnology movers

Figure 6: Yearly Pharmaceuticals & Biotechnology movers

MONTHLY STRATEGIC OUTLOOK

Sep-12 Dec-12 Mar-13

Figure 7: Monthly Health Care Equipment & Services movers

Figure 8: Yearly Health Care Equipment & Services movers

20% 15% 10% 5% 0% -5% -10%

Pharmaceuticals & Biotechnology Sector News

Health Care Equipment & Services Sector News

MONTHLY STRATEGIC OUTLOOK

Key Small Cap Updates

Weak Monthly Performers

Overview of Contacted Small Caps

International Securities Services

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