Monthly Archives: March 2011

  • Will JB Hi-Fi continue to groove?

    Roger Montgomery
    March 3, 2011

    Since listing in October 2003, JB Hi-Fi has left analysts and shareholders spellbound by the impact of its extraordinary returns on equity. As you know, the Value.able magic began to fade for me late last year.

    Why? Well JB Hi-Fi’s business appears to be maturing. And there are only so many stores you can put on an island!

    No matter where you live in Australia, and no matter which shopping centre you walk into, you will never be too far from a JBH store – music blaring behind trademark billboard style placards screaming for your attention.

    Yes, there are more stores in the pipeline (currently 153 with a target of 210). At an opening rate of 15 stores a year, that implies another 4.5 years of growth. But will the new stores be as profitable as the existing ones?

    Retailers often have two, if not more, ‘Tiers’ of stores and JBH is no different. Of its target of 210 stores, 160 will be Tier-1 and 50 will be Tier-2. Tier-1 stores cost $2.5 million to set up, while Tier-2 are 20% cheaper. But Tier-2 stores generate only 70% of the revenue of a Tier-1 store.

    Of the 67 stores yet to open, 31 will be Tier-2. That’s half of JBH’s newest stores less profitable! Currently Tier-2 stores account for just 13 per cent of JBH’s business.

    JBH has $180 million sitting idle in the bank. With growth on the horizon, suppliers covering the cost of goods, high margins and low net debt, management’s decision earlier this year to review its capital management policy didn’t come as a surprise.

    As we enter the first month of Autumn, the Chairman will no doubt be preparing to reveal the results of this review.

    Whatever the company’s initiatives – buy back shares, return capital or increase the dividend payout ratio – the actions will have a material impact on my Value.able estimate of JBH’s value.

    With that in mind, I would like you consider which is more valuable… one dollar in a bank account earning 45% and that figure compounds at 45% year after year, or one dollar in a bank account earning 45% and that figure is paid out in dividends each year?

    If you’re a Value.able graduate, I’m certain you know the answer.

    The first bank account is more valuable, and that’s precisely why any changes in JB Hi-Fi’s capital management policies will have a material impact on its Value.able value.

    If JBH buys back shares (a disaster if management did that at a price higher than what the shares are worth) or lifts its dividend payout ratio, then my estimate of intrinsic value will decline.

    Business maturity is generally accompanied by a leveling off of intrinsic value (followed by a serious drag if a silly acquisition is made).

    Watch for how JBH reports its profit. Has return on equity stabilised, or will it continue to rise? Will your estimate of JBH’s Value.able intrinsic value continue to rise?

    Whist JBH remains one of my preferred retailers, I am less optimistic it will continue to generate the returns on equity shareholders have enjoyed over the past. What are your thoughts? Feel free to chat here about other retailers too.

    Posted by Roger Montgomery, author and fund manager, 3 March 2011.

    by Roger Montgomery Posted in Insightful Insights.

  • Look past the labels

    Roger Montgomery
    March 3, 2011

    If you are looking for a true blue chip portfolio, you may need to rethink conventional wisdom. According to Roger Montgomery, a true blue chip portfolio has nothing to do with size or longevity and everything to do with quality. Roger’s Value.able portfolio for Money is proof of this strategy – on average, the stocks in the portfolio have risen 27 per cent in just six months. Read Roger’s article.

    by Roger Montgomery Posted in Media Room, On the Internet.

  • Is CSL a master of share buy backs?

    Roger Montgomery
    March 1, 2011

    When a company buys back its shares, the announcement is often accompanied by reports suggesting either 1) the company has no other growth options towards which it can employ equity capital or, 2) the company has great confidence in its future and other shareholders should be following its lead rather than selling out to the company itself.

    Back in 1984, in his Chairman’s Letter to Shareholders (a source of information I have quoted frequently here and in Value.able), Warren Buffett observed:

    “When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.”

    Note to CFOs and CEOs: “shares selling far below intrinsic value in the marketplace.”

    It is just as important for the CEO of a public company to be buying shares only when they are below intrinsic value, as it is for Value.able Graduates building a portfolio.

    Buying shares above intrinsic value will destroy value as surely as buying high and selling low – something many Australian companies became all to expert at during the GFC as they issued shares in their millions at prices not only below intrinsic value, but below equity per share.

    One question to ask is if companies are engaging in buy backs today, why weren’t they when their shares were much, much lower? The answer of course may be that they may not have had the capital back then. A recovery from the lows of the GFC has not only occurred in the prices of shares trading in the market place, but also in the cash-generating performance of the underlying businesses themselves.

    Irrespective of the circumstances, a company now buying back shares that had previously issued them at the depths of the GFC is having a second crack at wealth destruction.

    I am pleased to report that not all companies are following the crowd. Some larger companies, including BHP, RIO and Woolworths, have announced buy backs at or slightly below my estimate of their Value.able intrinsic values.

    Webjet, Customers, Coventry Group and Charter Hall Retail REIT have all announced buy backs and Bendigo/Adelaide Bank is engaging in one to reverse the impact of shares issued through their DRP.

    As I wrote yesterday (Is there any value around?), value is becoming much harder to find. Companies are expensive, even my A1s. Whilst any Value.able valuation is merely an estimate, the absence of a large Margin of Safety, combined with the announcements of buy backs, does not inspire my confidence.

    In the US, share buy backs historically peak at market highs. Think back to the first half of 2007 and in 1999 and 2000 – two periods that investors may have wished they’d sold shares back to the companies – are also periods during which buy backs peaked.

    Share buy backs are a very public demonstration of management’s capital allocation ability, or lack thereof.

    Whilst Warren Buffett is regarded as the master of share buy backs, he has often sited another capital allocator as the real genius – the late Dr. Henry Singleton, the founder and CEO of Teledyne.

    When the inflation-devastated stock market of the 1970s had pushed shares to the point that some suggested ‘equities were dead’, Henry Singleton bought back so many shares that by the mid 1980s there were 90% less Teledyne shares on issue. Here’s a para from the web: “In 1976, the company attempted, for the sixth time since 1972, to buy back its stock in order to eliminate the possibility of a takeover attempt by someone eager for the cash reserves the company had accumulated. Altogether, Teledyne spent $450 million buying back its stock, leaving $12 million outstanding, compared to $37.4 million at the close of 1972. With many of the company’s divisions showing stronger results and fewer shares outstanding, Teledyne’s stock increased from a low of $9.50 per share to $45 per share, becoming the largest gainer on the New York Stock Exchange.”

    Who is Teledyne’s Australian equivalent?

    One iconic Aussie business (it achieves my second highest MQR – A2) immediately springs to mind. In 2009 this business issued shares at a high price to fund a $A3.5 billion acquisition. But things didn’t quite go to plan… the US Federal Trade Commission intervened and the shares slumped. What did management do? They used the cash raised from the share issue to buy them back. Amazing!

    Fast-forward twelve months and this business has nearly $1 billion in cash in the bank and no debt. If it keeps using its own cash and that being generated, and buying back shares at the present rate (and assuming the share price doesn’t change of course), it will have bought back all its shares in seven years. A Value.able business… what do you think?

    Yes, if not for management’s decision to buy back shares ABOVE intrinsic value.

    Unfortunately CSL’s share price may not be as high in seven years as it could have been, had management chosen to buy back its shares below intrinsic value.

    If you own shares in a company engaging in a buy back, ask yourself whether value is being added to the company? Value is generated when the shares being purchased are available at prices below your estimate of its Value.able intrinsic value.

    If management are overpaying, inappropriate capital allocation practices may be the only addition to the future prospects of the business.

    Posted by Roger Montgomery, author and fund manager, 1 March 2011.

    by Roger Montgomery Posted in Companies, Health Care, Investing Education.

  • My Equities Portfolio

    Roger Montgomery
    March 1, 2011

    Australian Investors’ Association member Brian McErlean recalls his investment journey and how thirty years on he now uses Roger Montgomery’s Value.able to calculate intrinsic value. Read Brian’s story.

    by Roger Montgomery Posted in In the Press, Media Room.