Wednesday, December 11, 2013

Future Science: Current Reading

If you have read Charlie Munger's Psychology of Misjudgment, some articles in this book will resonate very strongly. I am only halfway through my first reading of this book, and I will provide further updates when necessary.

At this point in time, I am pondering issues of behavioural traits that are ingrained in us.  There is simply no way to change these behavioural biases which sometimes lead us to bad decisions and irrationality, especially in the field of investing. The only effective way to deal with this is to recognise them and then to devise ways to make such behavioural biases work in our favor.  For example, I believe there are long term benefits if one could find a way to switch viewing screens to monochrome when checking stocks portfolio.  Better yet, don't check the portfolio more than once per fortnight, although I doubt that 90% of investors can actually do this.

Wednesday, November 13, 2013

Current Rereading

A very entertaining and instructive book.

The author presented evidence suggesting that humans intuitively think about number series in a logarithmic manner rather than in a linear manner, and that the human brain is more adept in dealing with ratios and relative sizes, and is much slower in grasping absolute numbers, especially with large numbers.  These have interesting ramifications for long term investing, especially when market participants attempt to discount a series of cashflow way out in the future.

I will update with further insights as I slowly wend my way across Alex's Numberland.

Wednesday, October 30, 2013

Les Jeux Sont Faits

On 31 October 2013, I closed the books on a small partnership venture started 3 years ago. Due to a series of fortunate events and good timing, audited performance figures for the venture have exceeded all initial expectations.

First year: 25.6%
Second year: 22.6%
Third year: 55.3%
Total return for 3 years: 103.5%
CAGR for 3 years: 34.5%

The major caveat I must emphasize is that funds under management are relatively small, plus this three years coincided with a general market uptrend which took the All Ordinaries Index from a starting figure of 4750 on 31 October 2010 to 5420 on 31 October 2013. Despite a one-legged handicap, everyone knows that a rising tide lifts all swimmers.

The partnership venture is now being liquidated, and a new venture will commence on 1 November 2013. To be frank, I really do not feel that it is an ideal time for fresh money in the current environment. Certainly not reassuring if one reexamines the Buffett Thermometer mentioned in my previous posts.

Cest la vie...and as I have twitted earlier today, Les Jeux Sont Faits.

My parting thought today to my readers:

"1, 2, 4, 8, 16, 32, 64, 128, 256, 512, 1024"


Monday, September 16, 2013

Market "Thermometer" courtesy of Warren Buffett

Just completed some preliminary work based on Buffett's famous 1999 speech at Sun Valley.

Buffett's speech can be found in this link.

Our work can be found here

Enjoy and prosper.

Thursday, August 29, 2013

Further one-legged update on the reporting season

Well folks, we are at the tail end of reporting season. I don't know about you, but I will be glad to give my one leg a much needed rest after this bout of ass-kicking.

23 August 2013

LYL results out. NPAT for FY 2014 will be reduced by 50%. Price is getting interesting, but my call is that there could be slightly more pain for LYL given their position in the food-chain.

CAB analysis. Postulate that market is overweighing the impact of ACCC recommendation to reduce 10% to 5% for payment systems.  The absolute downside is that $45m being wiped from the top travels right to the bottom, reducing FCF from $60m to $15m. Multiple compression follows as ROE of 20% becomes 5%, turning a good business into a capital intensive substandard business. A compression of multiple to 8 means the current market cap of $500m falls to $120m, which is a 75% drop. It is probably obvious that the outcome lies somewhere in between the absolute downside and the current situation, therefore it will be helpful to map out multiple scenarios in preparation for a price opportunity.

26 August 2013

SCD results.  Operating cashflow of $2m, resulting in $7.2m in cash, but there is $1.2m in tax liability and $1.6m tied up with banks as security for bank guarantees.  Factory revalued downwards from $4.4m to $3.2m. Equity increased from $10.2m to $12.6m.  Service revenue increased from $4.5 to $5.2m.  Orders on hand $6.9m. One customer made up 30% of revenue. I have covered this company in a previous post.

MTU results.  Underlying margins appear to be declining.  ROA declining. Debt increased.

VTG results.

MLD results.

HSN results out.

27 August 2013

SRV results out. Operating cashflow of $27m (after paying tax of $10m). Occupancy increasing. Cash on hand $99m. Weakening AUD may boost earnings in FY14. 23 out of 38 immature floors will mature in FY14.  Opening another 8 large floors which will boost total office space by 10%.  All USA floors are cash flow neutral and all expected to mature in FY14. Occupancy rate is 88% as at June 2013 (USA recovery).  Using $27m of FCF, with 10% RRR, assuming zero growth for 10 years and adding unencumbered cash of $90m, yields $345m value.  Using dividend discount model, on grossed up dividend figures, current market cap requires dividend to rise by 5% every year, and terminal value of 10x grossed up dividend.  Current price means that an investor gets growth for free. I have held this for over 5 years now (first post here), and this long holding period has been helped immensely by a very competent management.  

FLT results out. NPAT up 20%.  Amazingly, current price implies growth of 5% per annum in FCF for the next 10 years. I missed picking this up during the GFC for under $4, which means a 10-bagger has gone down the gurgler.

VEI results out.  All metrics declined. Revenue down, gross margins down, cashflow down, but surprisingly, wage expenses and doctor payments were also down.  FCF of $18m, debt of $45m. DCF of $168m, less debt of $45m, yields $123m. 148m shares on issue.

Examples of edge- information, analysis, behavioural, structural. From Robert Robotti.

28 August 2013

TWD results out.  Good yield. Exposure to housing in SE Queensland. Worth a deeper look.

AMA results out. Revenue up, but EBIT down. EBIT margin increased by 2%.  Company is debt free, with cash at $10m in August 2013.  Cashflow very strong at $10m. 332m shares. Net of cash, AMA priced for no growth. Good to see a capable and honest CEO delivering on his promises.

IFM- founder CEO is leaving and has sold all his shares.

WTF results out.  Revenue down, profits down, and cashflow down. But somehow market is valuing shares for 10% growth pa for 10 years. Madness.

MLB results out. Heavy in cash, new management team coming in, but premium core business under pressure.  Core business valued at 5x cashflow after backing out cash chunk.

TTI results out. Debt still of concern.

29 August 2013

VOC prelim results out. Revenue increased to $66m. Profit down. Cashflow $18m, tax $3m. Free cashflow $15m.  Fibre and DC showed tremendous growth.  Cash balance of $14m will fully fund next year’s $13.3m capex. Locked in recurring cashflow will pay off IRU obligations of US$10m next year. USD hedge runs out in Dec 14, so some exposure to declining AUD. FCF $15m, current market cap implies 5% growth pa for 10 years. Adding debt to get EV of $220m, with FCF $15m, implies less than 10% growth pa.  In the presentation, VOC stated that FY14 capex is in response to customer demand, and this was repeated.

CTE Prelim report out. NPAT $1.25m. Operating cashflow $1.9m. FCF $1.6m. Cash on hand $5.7m. No dividend declared.  Wage costs up $300k and one-off capex spend.  $2m tax losses remaining.  Record number of blood cord clients. FCF estimated at $1.7m. Fair value at $23m, assuming no growth. But note:   “The Board is confident that subject to any unforeseen circumstances, the benefits of its common infrastructure and operations systems to support the business units will allow it to increase revenue, improve margins and overall financial performance of the Company during the next financial year.

IPP HY report out.  Revenue period to period hardly moved.  Not a good sign, as M’sia went backwards due to elections, but increase in prepaid services plus record month in July, so momentum will continue. HK shows very good growth and is close to breakeven, locking in 4 out of 5 major developers.  INA growth slowing but still strong, whereas Singapore is lagging (still number 2). REA trading at 14X revenue. IPP is trading at 12x revenue.  We await next quarterly cashflow statement.

30 August 2013

DDR results out. Cashflow negative.

SST results out. Loans paid to other entities??

UOS HY results out. I have held this for over 3 years, and posted about it here. Within the HY report, I found an amazing and pristine balance sheet:

Land held for property development
Property plant and equipment
Investment properties
Total of Asset Items above
Financial liabilities

Rent and parking fees for half year is $20m.  Shares on issue is 1.1b, market cap is AUD$580m.  Book value increased 15% over 6 months.

That's it folks.  Time to sit back and think through ideas. By the way, the reading list has been updated, for those interested.

Disclosure:  My family and I own shares in AMA, CTE, SRV, SCD, TWD, IPP, VOC and UOS.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Thursday, August 22, 2013

One Legged Update on Reporting Season

1 August 2013

Reporting season kick-off.

GUD- under pressure, failing to invest in tiring brands, dividend is too high, debt is mounting. Dropped from superstar status after 10 years of stirling results.

UBI- burning through $6.7m in cash last 6 months, with $18m in the bank and some minor liabilities.

TCL- new CEO with lower pay, and 198% rise in profits due to toll rises. Flagged increasing dividends.

2 August 2013

AMA paid off all debt with $10.8m, and negotiated a new $6m facility. Given that balance on Dec 12 is close to $13m, looks like it is a good deal (assuming they made no repayments in the 2nd half). AMA’s cash position should be about $8m to $10m.

HSN upgraded profit due to currency movements.

6 August 2013

UOS update- HY PBT is $110m.  The good keeps giving. See here.

7 August 2013

Rumours of tie-in between MND and SSM in the AFR.  Not denied by SSM after ASX please explain.

8 August 2013

ASW- flat results, not much growth, as expected- spinning back cash, good ROE at 20%. 

9 August 2013

Thorney Holdings increased stake in SSM.

12 August 2013

COF FY results out today. As expected, International Developments propped up the whole group. ID EBITDA running at $18m per year.  The whole group’s FCF is about $11m after deducting $10m in restructuring payments. Trading at 5 times EV.

WTF- heavily shorted- 10% shorted as of 8 August 2013.

NWH- CFO resigned without resign. Aftermarket announcement, not looking good.

AMM- results out, pretty impressive.  Good indication for VOC results.

REA- another blistering result.  Pity about the price

14 August 2013

CRZ- good results, $90m cashflow. Priced at $2.4b implies growth rate of 15% per annum for 10 years.

CSL- results as expected. R & D over US$450m pa now, and cashflow still strong at $1.3b.

CBA- results reaffirmed position as the highest quality bank.

UGL and WOR providing better outlook in mining services space.

15 August 2013

IRI results flat.  Cannot understand the price.

SRX results out. Operating cashflow of $24m but capitalised $12m in R & D. Market cap of over $720m implies 20% pa compounded growth for 10 years.  Very optimistic price.

16 August 2013

ONT results out. Slightly better than expected.  Fair valuation at $4 compared to $6.50 SP.  Management is top class, reports are easy to read, and commentary is clear and relevant with very little corporate geekspeak.  Very rare management quality. 

19 August 2013

Question of the day: why do you rationally believe that you have an edge to beat the market?

20 August 2013

EAX results out. Top line showing good growth. But decision to capitalise $1.2m of commissions is questionable.  Expensing these payments would have resulted in NPAT being down yoy.

21 August 2013

SGH- another acquisition. WIP is now $300m, ROE slightly up to 16%.  Disaster waiting to happen.

SEK- FY results with significant gains.  FCF now $160m and current pricing implies growth of 10% per year for next ten years.  Reasonable pricing amongst all these network effect plays.

BYL- record FY results. Flagged no growth for 2014. Mentioned large infrastructure spend for WA. Bodes well for NWH.

FAN- continues to deteriorate. ROE is 13% and no longer a superstar.

COF- director picked up 500k shares. Serious money.

22 August 2013

NWH results out.  Evidence of margin compression, and affected by mining downturn. Management has countered by cutting headcount by 50% (showing in the cashflow) and diversifying into other sectors such as oil and gas where they just completed their first project.  Outlook is good, with 60% of $1.2b of work already secured, and over $3b of works in tender. Debt has gone up slightly, and cashflow has crunched in the second half, even though overall cashflow is still healthy.  At this stage, NWH is unlikely to suffer solvency problems, and is holding up well in difficult conditions.  However, it is priced as if it will be going out of business soon.  Current multiples of below 5 allows 50% drop in cashflow and NPAT.

CDA results out.  Downgrade to short term earnings outlook.

PEA results out.  Lots of contract terminations and variations.  This puts question mark over reliability of cashflows, which is required to balance out mediocre return on capex spend.

IMF results out.  $35m of receivables subject to appeal.  Not exactly conservative accounting.

CMI results out.  Debt free. Declared dividend. $10m operating cashflow, $8m FCF.  TJM continues to lose money, but revenue is up.  NPAT of $10m.  Trading at PE 5 and 5x Operating Cashflow.

23 August 2013

FFI results out.  The food operation has improved PBT to $3m, but food business also incurred $1.5m in capex.  Cashflow healthy, dividend declared.

Tuesday, July 16, 2013

Reading List

Dear readers,

If you are getting restless and bored, here is a reading list for your kind consideration.

I will be grateful for any recommendations to add to the list.

Yours truly,
One Legged

Monday, June 10, 2013

Book Review- Swiss Made

Reading this now.  Fascinating.  Review to come.

Update: I have always been fascinated by the relatively large proportion of multinationals and brand names originating from Switzerland. This book provides a cursory glance and examines some salient historical, geographical, cultural, and political factors.  My main take on the causes of Swiss success is the ability of its citizens and businesses to adapt to constant change over an extended period of time, due to a willingness to absorb and integrate foreign talent, a decentralised political structure, and the lack of a domestic market forcing its entrepreneurs to deal with brutal competition right from the outset. The ability to absorb and integrate foreign talent has occupied a greater part of my thinking when considering the future of countries such as the USA and China. Even Lee Kuan Yew has stated that he believes the ability to integrate foreign talent to be vital to the future success of the USA, and this same factor may prove to be a problem for China moving forward.  I am nowhere near a stage where I can form strong opinions, but this book is certainly a step in the right direction.

Tuesday, June 4, 2013

Confession Box 5 June 2013

On 4 June 2013, I sold my FGE holdings for $4.48.

This came in the aftermath of FGE's announcement of an acquisition. Despite massive cash holdings and a weakening AUD, management decided to fund the acquisition through a mixture of debt and equity.

My rationale for purchase of FGE was first set out here, and also in a subsequent post here.  Events subsequent to my purchase have eroded my margin of safety in this investment.  Nevertheless, I wish to make it clear that the purchase was an error on my part as it was based on inadequate due diligence.  If I had done some better due diligence, the events subsequent could have been mostly foreseen.

The half yearly results in February 2013 clearly disclosed severe margin crimp, given that revenues increased 120% yet NPAT only increased by 60%, with NPAT margins in single digits. This arose as a direct result of increasing reliance on low margin work from the power division.  Subsequent contract awards in this space only heightened the risks involved.  My attitude to this was blase to say the least.

Then Clough decided to sell all its shares in FGE, which further weakened the investment thesis. However, since the probability of a takeover at higher prices was a free option in my investment thesis, I brushed off this event without further investigation.

The unusual nature of the Taggart acquisition prompted me to do a much belated due diligence on the management team, particularly David Simpson, the MD.  One of my Google searches turned up several articles on the appointment of David Simpson on a very lucrative pay package, which was acknowledged by the FGE board (then) as being on the high side.  The sad thing is that all of these articles predate my purchase, and I did not read a single one at any time prior or at the time of purchase.

In a nutshell, Simpson was paid $750k to sign on, with a yearly salary of $1,000,000, together with short term incentives of 2 tranches of $500,000 payable on achievement of an increase of 10% EPS from one period to another.  This is such a ridiculously low hurdle for such a huge payoff, it amounts to a joke.

Briefly, David Simpson's bio:

Diploma of Law, Masters of Law and Management.  Progression through lawyering as corporate counsel in three previous companies. Started career as a paralegal in ABB in early 1990s, then corporate counsel in Leighton, and then moved to UGL as corporate counsel, then as manager of one of UGL's divisions, before taking on the post of MD in FGE.

In other words, you have a corporate lawyer with very little technical/engineering background leading an engineering company, with a $1 million dollar short term bonus dangling in front of him.  All he needs to do is increase diluted EPS by 10%. Upon his appointment, the old guard at FGE left and promptly sold all their shares in the mid $5s.

Once I saw this, everything fell into place:

1. The Taggart acquisition was structured with an upfront cash payment, funded by debt. Subsequent milestones payments are paid via 70/30 mixture of cash and shares. The upfront cash payment goes straight to the balance sheet, and does not affect earnings, but the target acquisition earnings are accretive immediately. Subsequent dilutive milestone payments in shares do not affect the MD's short term bonus.

2. Continual contract awards in the low margin power divisions.  Margins are being sacrificed for the sake of volumes, which is very dangerous in any business other than mature businesses with incumbent management with demonstrated experience in a low margin high volume environment. 

Given this trend, I see a distinct possibility of continual erosion of my margin of safety in this investment, with gearing up of the balance sheet and increasingly high capital requirements to maintain low margin businesses in the power area and underground coal mining, coupled with integration risks of Taggart, together with some massive headwinds hitting the mining services sector. Plus a huge risk with a corporate boardroom MD granted questionable incentives.  

Taken to extreme, increasing debt and low margins are recipes for very sudden implosion, which brings us back to Rule Number 1.

This investment yielded 19% returns over a 6 month period, which was again just down to pure dumb luck.  My penance was an immediate indepth management review of all portfolio holdings.

Sunday, May 26, 2013

Pain Killers

I wish there are more blogs with articles such as this.

Disclosure: I own shares in MVP.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Thursday, May 23, 2013

One Legged Discipline

This link explains the importance of adhering to discipline in your investing process, rather than focussing on desired outcomes.

Reminded me of a humorous line from a science fiction book I cannot now remember:

"As I walk through the valley of the shadow of death, I shall feel no fear, because I am the baddest motherfucker in the whole valley."

Monday, May 20, 2013

Getting Dumber Every Day

What happens when the one-legged investor meets Dumb and Dumber?


This presentation is very useful as it provides a template for my analysis. If I can get my thoughts in some decent semblance of order, I will attempt a post of past investment experiences based on the framework set out by Zeke Ashton in his excellent presentation found in the link above.

I leave you, dear readers, with the following proposition: "stock selection is a misnomer, the investing process in the main largely involves stock elimination."

Thursday, May 16, 2013

UOS- keeps getting better

Mr Market is quite generous with this one.

Consider this:

1. Property developer with minimal debt;
2. Growing at 20% plus per year for the past decade;
3. Flushed with cash;
4. Rental earning properties in prime areas;
5. Huge runway;
6. Asian market exposure;
7. Buying back shares in chunks;
8. Priced at nearly half NTA;
9. MOS increasing with every decrease in AUD;
10. Steady stream of dividends;
11. Management with demonstrated capability and integrity;
12. 191% rise in NPAT in first quarter alone for major subsidiary.

In effect, a value play with free growth upside. 

Disclosure: I own shares in UOS.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Wednesday, April 3, 2013

About nothing in particular

A quick note to my small band of loyal readers.

There are often periods of long silence on this blog.

The long periods in between frenetic activity could be understood if you read the start of this post.

I am not inclined to blog about nothing. There are other talented people better able to monetise a philosophy of nothing. See here. I am not quite so gifted.

On average, I get a good investable idea every three months. This could be quite unsatisfactory to people looking for ideas every week, if not every day. Nevertheless, in the context of a portfolio with about 12 to 20 positions, with average holding periods of 3 to 5 years, a good idea every 3 months is plenty enough.

Heck, this may even be too much for Warren Buffett's 20 punch card holes. At my current rate, I only have 5 years before I am stopped out.

But we do what we can, with what we are given, as best as we could.

Sunday, March 17, 2013

Book Review: Free Capital by Guy Thomas

A great review of this book could be found here on Amazon. I agree with the substance of this review, which I have found to be accurate insofar as it describes the book and what to expect.

Nevertheless, this is not a book for inexperienced or new investors.

This book will also disappoint readers trying to find an instant magic formula to making money in the markets.  The writer is clear in his objective of merely presenting the outcome of his interviews with 12 private investors who have been successful in the stock market. What lessons can be drawn from these interviews will clearly be a matter for each individual reader, although the writer also sets out his own thoughts at the end of the book.

To me, the interviews illustrated clearly how each of the investors applied their own strengths and expertise in their investment process, and how their background shaped a large part of their own thought processes. For me,  this is the most important message. To be successful as an investor, you have to find your own way. The general roadmap has been laid out long ago by Graham and Buffett.  There are no secrets except the secrets within each investor.

Disclosure: I received the Kindle version of this book from the publisher on a complimentary basis.

Wednesday, March 13, 2013

Everybody Loves Buffett

Everybody loves Warren Buffett.

We probably have a small contingent of young investors today who all wants to be Buffett when they grow up.  I hear of investors advocating Buffettism and also Mungerism, looking for the great company with a great moat and hoping to sit on it for decades making great compounding returns. And then plonking a huge chunk of the portfolio into a few names. Diversification is out, concentration is in, that sort of thing.

It is good to aim high, but we have to learn to crawl before we learn how to walk. Personally, I think it is much more realistic to start off with a low hurdle. The genesis of value investing started with Ben Graham and cigar butt stocks. From this genesis, there is actually a continuum towards the Munger/Buffett great business at fair value method. And the continuum is not necessarily linear, but presents various pathways.

Buffett, in his legendary article on the super-investors of Graham & Doddsville, referred to an investor who made 21% per annum (16% per annum net of fees) for a total of 46 years. 21% per annum compounding for 46 years is stupendous performance. If you do not believe me, just plug in quick numbers into a spreadsheet or an online calculator and see what $1000 is worth after 46 years of compounding at 21% per annum.

This performance was achieved with huge diversification of portfolio in many stocks, and the basic premise was just to buy cheap and sell at fair value, and protecting the portfolio with wide diversification. That was it. Remember simplicity, consistency and valuation?

The Super Investor in question was, of course, Walter Schloss (RIP).

So without further ado, I present:

Sixty Five Years on Wall Street- remarks by Walter Schloss

16 Factors to Make Money in the Stock Market

Forbes Article- Experience

Monday, March 11, 2013

CMI update

I purchased CMI base on the premises set out in this blog post.

On 19 February 2013, CMI's share price jumped as ASIC sold the overhang parcel for $2.65. The resulting market capitalisation of CMI reached $100m.  being what I estimated to be conservative fair value.

Consequently, I began to prepare to sell. The share price has reached a conservative fair value and more importantly, I was unwilling to stay the long haul with the current management. As I have explained previously, management competency and integrity at these relatively small companies can have a major effect on shareholder value.

On 20 February 2013, we found out that Acorn Capital has emerged with slightly less than 10% holding in CMI. I have great respect for the managers at Acorn Capital, and accordingly, I was prepared to wait until the half yearly result is published and hence deferred my sale decision.

On 27 February 2013, CMI published its half yearly results.  My overall impression was as if management has fallen asleep on the wheels. No doubt Mr Colin Ryan had other more pressing matters to attend to, notably his prosecution by authorities in New Zealand on charges of misleading conduct. Just to backtrack a little, CMI's announcements on 18 and 20 February 2013 did nothing to allay my deep mistrust of this board. If anything, my fears were actually accentuated by the contents of these announcements.

Looking at the results, accounts receivables and inventories continued to increase. CMI has enough inventories for 10 months worth of sales. This is an inefficient use of capital. The tax bill was higher due to an overprovision of $581k in the previous period which ate into cashflow. Only half of debt repaid. Electrical is still making good margins, but margins are decreasing. TJM still making losses of $600k despite a revenue increase, and taking up over $29m of assets. This division should be sold.  

What took the cake was that recently appointed director Stephen Lonie mysteriously resigned without any reason.  

On 27 and 28th Feb 2013, all CMI shares in the incubation fund was sold at $2.65. The gain is 59.6% in slightly under 3 months. Quite a fortuitous windfall considering the circumstances.

As a matter of disclosure, I still own a small holding of CMI in my family account. Unless circumstances change, this holding will also be sold if the share price approaches $2.65 again.

Obviously, this will continue to be on my watchlist. No doubt there are some lessons to be learned here, primarily as to whether assessment of management should be a strict filter, or whether this factor can be balanced off against a deeply undervalued share price.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Sunday, March 10, 2013

Business going for a song (and a one-legged dance)

Imagine that you are the owner of a manufacturing business.

You manufacture leading edge scanning equipment which scans and analyses materials in realtime.  Your customers are operators of cement factories, coal mines, coal fired electricity stations and iron ore producers, and you are proud of your product because it saves costs for your customers. Moreover, it is good for the environment as your machines reduce wastage, reduces electricity usage and increases plant efficiency.

Your business has a history going back to 1981, with a founder hailing from the esteemed CSIRO.  You employ a group of dedicated engineers who has created ingenious products which have been successfully installed in over 1000 locations around the world. Your patents and intellectual property portfolio is valued at over $1m. Your business has weathered the turbulent economic climate for over 3 decades, and most recently has emerged from the GFC unscathed.  Your bank is flushed with cash of over $5.2m, and you  own your own factory valued at $4.43m, with a $2m mortgage on it. Other than that, you owe the banks nothing.

Your business has had its up and downs, but nevertheless the business has generated profits for the last 7 years, even through the trough of the GFC. You have build up net value from under $5m all the way to over $10m in 6 years, despite generously returning over $1.7m in capital to all shareholders last year. Business is good, with a backlog of orders. on the books. You will probably make about $1.5m to $2m this coming year.

One day, some hotshot investment banker walks into your factory. He takes a look around, and says that he will offer to buy your business, your factory, your IP, your management team, on a walk-in walk out basis for $8m. He figured that you have $5.2m in the bank, $4.4m worth of real estate property and a mortgage debt of $2m, which comes to roughly $7.6m, and he says you can keep the change.

Would you agree to sell? Chances are you would tell the banker to go to hell. The offer is insulting. Even if you make only $1.5 m per year after tax, you would probably be asking for $7m at least for the business on top of the cash and property values. A realistic offer to start talking would have to be in the vicinity of $15m.

For some curious reasons, even with exactly the same situation, things work slightly differently in the sharemarket.

On 11 March 2013, Mr Market is kindly offering me a slice of Scantech Limited (SCD) for 45 cents. With 17.6m shares on issue, plus about 1.7m worth of options exercisable at prices of 70 cents and above, the undiluted market capitalisation of SCD at 45 cents is $7.9m.

This is the 90 seconds pitch to buy SCD:

“As at Dec 2012, SCD has $5.2m of cash in the bank. It owns a factory valued at $4.4m, and this factory has a mortgage securing $2m. Cash and property less debt totals $7.6m. At 45 cents, SCD has a current market cap of $8m. At this price, the business is valued by the market at just $400k. The business has been profitable for the last 8 years, and generated cash of $50k and NPAT of $260k last half year. The company manufactures and supplies equipment which analyses compositions of materials in realtime on conveyor belts. The equipment is used by companies in bulk commodities such as cement, coal and minerals. The order book is increasing and stood at $9m as at Dec 2012, and importantly service revenues are starting to catch up with equipment sales. Management owns a substantial amount, and navigated the GFC without making at losses or raising any capital. In fact, they did so well that they returned $1.7m to shareholders as a capital return in 2012. Management has given guidance for a similar result in 2013 as 2012, which is about $1.7m of NPAT.”

This is the 90 second pitch against buying SCD:

“The company owns the factory and therefore does not pay rent. Let’s assume the company sold the land and leased it back at market rates. As industrial property is valued at yield, taking a conservative 8% yield on $4.4m yields a yearly rental expense of $352,000. We credit the finance costs of $130,000 per annum (since the $2m mortgage is no longer required) to yield a net expense of $222,000 impacting the bottom line. This virtually wipes out half of the half yearly profit to $150,000, and puts the company into cashflow negative for the half.  In this scenario, the company will have $7.5m of cash, and a business barely breaking even.  We should assume mining capex is decreasing going forward, and thus 2012 and 2013 will probably be peak revenue for SCD. $8m is probably a correct fair value, being $7.5m of cash with a nominal amount of $500k for the business which has historically erratic margins, net profits and cashflow.”

The critical investment issue with SCD is just simply, is the business worth more than $400,000 and if so, how much is the business worth? The problem with the negative case is that the first half is traditionally the weak half. SCD sold 11 machines, but is contracted to deliver 17 machines the next half. So we can be reasonably confident that figures for the full year will be respectable, probably above $1m in NPAT.  If we average out NPAT over the last 7 years, we get average NPAT per year of $850k per annum. A conservative 6x multiple for this equates to $5m. These are conservative, and we can easily mount an argument for the business to be valued at $8m. If this is so, addition of cash and property yields intrinsic values of $15m to $16m, double the current market cap, thus achieving a 50% margin of safety.

The downside to SCD is adequately covered by real cash and hard assets. The cashflow of SCD is also covered by an increasing stream of service fees. Service fees have increased steadily from $1.9m in 2006 to $4.5m in 2012, and the only year it has dropped is 2011 by a mere 10%. As the installed base of equipment gets larger, service fees will form an important buffer to earnings going forward. Another investor has pointed out that any decline in mining capex will not have a major impact on operating mines which will concentrate on production efficiencies, thus increasing opportunities for SCD.

Enjoy and prosper.

Disclosure: The author owns shares in SCD.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Tuesday, March 5, 2013

Simplicity, Consistency and Valuation

Knowledge is timeless.

This piece of lucid and erudite wisdom from 1981 by Dean Williams.

I read it when people say "this time it is different" or when I reach for spreadsheets.

Enjoy and prosper.

Sunday, February 24, 2013

You think you are smart, punk?

I admit it.  I am a lazy blogger.  I am a poor writer. Many others do a much better job than me.

So herewith an article reflecting my own sentiments.  I could not have said it better than this.

Wednesday, February 20, 2013

The One Legged Investor

The title of this post was prompted by a good friend and fellow value investor. He recently emailed me to tell me that he was as busy as a one-legged man in an arse-kicking contest.  Well, it is reporting season on the ASX after all.

The one-legged man construct was a very clever use of vivid imagery by Charlie Munger to hammer home his message concerning the advantages of multi-disciplinary learning.  I use this imagery on myself with a slight twist- there is always something that I do not know, and hence, I am the one-legged investor in the ASX bottom picking contest. 

Readers will note that I have even changed the blog name to reflect this.

And herewith, without further ado, are my snippets from recent half year results:

CSL continues to forge ahead. R & D is now a whopping US$190m per half year. 

CBA is benefitting from Ian Narev’s focussed approach, centred on improving core competencies and customer service via use of technology.  A recent interview with the Business Spectator illuminates further Narev’s risk management approach.  My preferred bank by a country mile, but not at current prices.

CPU results were lacklustre. A big chunk of earnings contributed by margin income, which is unsustainable in the long term.

REA FY revenue estimated at $300m, and market cap is now over $3.3b yielding a market cap/sales ratio of 11.  IPP 2012 revenue is $15m and market cap is $180m yielding a market cap/sales ratio of 12.  Both still growing strongly

CCV reported good growth in personal finance.  Heads up TGA.

COF- three directors picking up shares.

BSA- continuing with dismal results.

FFI revenue and profits slightly down, affected by difficult trading conditions and rising costs. Full effect of property deals will not flow until 2014.  ACCC inquiry into supermarkets behaviour may improve FFI’s margins in the future.

FGE HY results- as expected. Revenue of $504m, EBITDA $62m, NPBT of $50m, NPAT $34m.  Cash on hand of $187m, order book $1.04b, and work won over last 6 months total $600m, with management providing a strong outlook for growth. Contrast this with sombre outlook from MND, which has spooked the market.  Capex $11m.  If iron ore prices continue to stabilise, projects by RIO, FMG and Roy Hill will go ahead, and FGE is the front running incumbent for these huge projects.

CLO- cash holding increased to $177m. Record order book.

SRV results held up despite difficult conditions (77% occupancy).  Operations churned out cashflow of $18m this half.  US is now cashflow neutral, with 2 floors turning mature, and 19 floors still immature. Earnings figure boosted by $3m due to artificial change in accounting treatment with the lowering of depreciation rate for leases from 15% to 10%. But the focus is clearly on cashflow.  With a market cap of $330m, and backing out cash of $100m, SRV has an EV of $230m underpinned by over $30m in operating cashflow.

FMG- Operating Cashflow barely enough to cover Interest during last half when IO price collapsed despite average realised price of US$116 per metric tonne.  There is no room for hiccups here due to the high leverage. On the bright side, FMG announced commencement of last phase of Solomon, which will benefit FGE.

IFM continues to improve under the guidance of its founder CEO. Revenue up 4% but NPAT surged 30%. A reminder that I missed this opportunity at prices under 20 cents.  SP is now over 40 cents. 

CDA has hit the ball completely out of the ballpark.  Metal detection division’s revenue of $91m for the last six months is nearly equal to one year of sales last FY.  Mining technology is also increasing strongly, albeit from a lower base. I am a bit worried about the Daniel’s acquisition. Management has upgrade guidance from $40m to $50m NPAT for this FY. I reckon this will be exceeded. Metal detection market is mind blowingly huge, even management has no idea how to quantify it.

Readers with a statistical bent will note the preponderance of shares starting with the letter C.

Sunday, February 10, 2013

COF: update

Happy Chinese New Year to all!

COF published its half yearly results on 11 February 2013.  Revenues from Geosciences and International Development increased from previous half, and revenue from Project Management decreased. Margins for Geosciences decreased, margins from International Development increased, and Project Management incurred a loss. Overall, this is quite a commendable result given the difficult conditions in the last half year within the mining and mining services sector. 

I am expecting a much better result this half given the improvements in conditions. In any event, COF's financials are clearly improving since my last posting here:

Cashflow looks very good. After adjusting the operating cashflow to account for movements in trade receivables, trade payables, increase in debt and increase in cash holding, the half year operating cashflow comes to about $17m.  Net debt has decreased to $61m.

Market cap has increased from $82m since last posting to about $100m on 11 February 2013. A conservative estimate of full year cashflow at $25m yields an enterprise value/cashflow ratio of 6.4. My view that a fair value ratio of 10 remains, and hence COF appears to remain good value despite a 25% increase in price.

Disclosure: The author owns shares in COF.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Tuesday, January 8, 2013

Xmas and New Year break

Investing does not provide much of a "break".  I am making the best of the situation, and taking a rest, so my time spent on investing is much reduced during this period.

Given the events in the US at the end of the year, the markets and the portfolios under my management have been given a fillip. Though pleasing, this means that buying opportunities are being reduced with the daily rise in prices.

I have a suspicious feeling that finding bargains may not be as easy in 2013. Nevertheless, there is no reason not to be fully prepared.

To my readers, best wishes for the coming year, and may your portfolio be headed steadily towards the top right hand corner!