Rejected?
We all know retail businesses are swimming against the tide. We have written about that subject here at the blog on many occasions and below is a brief list of more recent posts:
We are not investors in momentum or sentiment however this blog allows me to share our thoughts with you and we are noticing a shift in investor sentiment now. The stock market indices with exposure to resources are underperforming the indices without. The industrial indices are rising at a faster rate and falling at a slower rate than their resource-rich bretheren. Today is a classic example, This tells us that a shift is afoot. If you have been reading this blog regularly, you will know that we are also not enthusiastic about Iron Ore prices and believe prices of $100 per tonne or less are possible in coming years. On air, I have explained that is our reason for not purchasing BHP despite optimistic earnings forecasts by analysts.
I think the lower-iron-ore price story is catching on and quietly but surely investors are reducing their relative weighting to resource heavyweights.
With that in mind, it could be that most down-in-the-dumps retail sector that now holds a few gems. Next week we’ll explore the results of the reporting season but for today I thought we should revisit The Reject SHop following its half year results.
Here’s the list of recent posts covering retail stocks and the retail sector.
http://rogermontgomery.com/invest-in-kfc-or-just-eat-it/
http://rogermontgomery.com/is-it-just-harvey-norman-or-bricks-mortar-retailing-generally/
http://rogermontgomery.com/are-bargains-available-at-woolworths/
http://rogermontgomery.com/now-waving-drowning/
http://rogermontgomery.com/not-so-high-at-jb-hi-fi/
http://rogermontgomery.com/dumped-by-the-wave-of-fashion/
Way back in September 2009, I published my reason for selling The Reject Shop:
“I can’t stop thinking that the value of the business just cannot rise at a fast enough clip to justify the current price. I really don’t like trading things that I have bought but I don’t think the value of the business can continue to rise indefinitely. With a share price of $13.45 (intraday today) and a valuation of $11.27, the shares are 24% above their intrinsic value. This combination of factors tells me we are safer in cash.”
Like many value investors, I was a little premature and the price first rallied to more than $17.00. Since then the price has steadily declined to $11.80 after hitting a low of $9.12.
More recently – in December – I wrote:
“The Reject Shop still enjoys its high brand awareness but, as is typical in many store roll out stories, as the offer matures the later sites are less profitable than the early sites.
This doesn’t fully explain the fact that during a period in the economy where one would expect a bargain offering to shine, it hasn’t. Eighty percent of Australians still know the brand but I believe consumer experience and mismanagement has done it some damage.
According to one report, 20% of the population believe the company offers rubbish – cheap Chinese junk that quickly breaks after use and fills our tips. It’s the very reputation China itself is trying, but frequently failing, to shake off.
The other reason for damage to the brand is confusion brought on by mismanagement. Several years ago the average unit price was about $9 and basket size was $11, but over the years one cannot help but have noticed many higher-priced items creeping into the stores.”
Value investors are often early to buy and early to sell but over the long run, being certain of a good return is safer than being hopeful of an exceptional one and so, when it comes to buying decisions a demonstrated record is often essential.
In TRS’s FY12 earnings guidance, the company noted “Significant expenditure on increasing brand awareness”. This is a real shame because at the time the company float The Reject Shop enjoyed 90% brand recognition and thats why its store roll out was working so well – shoppers knew the company, the store and the offer even though they had never been into a store in their area.
The company has provided earnings guidance for the full year 2012 of $20.5 to $22 million and while some smart analysts will note this is a 53 week year – we don’t care about such arbitrary lines in the sand. Our approach to investing is involves treating any purchase and ownership as if we owned the whole company. In that light and over the long term it doesn’t matter whether there are 52 weeks in a year or 52.5 or 53.
Thirteen analysts cover the stock and this week, eight have upgraded (only one downgraded) their forecasts for 2012 (remember the downgrade could be an error on the part of teh analyst rather than the company disappointing) . I still believe the business will mature but there could be some value in the turnaround and a stabilisation of strong cash flows, and returns on equity over the next few years around 35%. This is the rate of return on equity the company generated on $21 million of equity in 2005 (its intrinsic value then was around $4.00). Today the company is expected to return to 35% returns on equity but on 3 times the equity. You should be able to estimate the intrinsic value from those metrics.
There have been terrific results amongst our fund holdings such as Credit Corp, Seek, Breville Group, ARB, Decmil and Maca. Have you been encouraged by any of the results? Start a discussion by clicking on the Comments button below.
Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 24 February 2012.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Pat Fitzgerald
:
For those that are interested in the larger US stocks, I think the following businesses had good results and I think their future growth prosects look good: Visa, Mastercard, Ebay, Coach, Starbucks, Intuitive Surgical, Priceline, Apple, IBM & Intel.
In my opinion during 2011 most of these businesses were at some point in time trading at a reasonable price and while I am not predicting a fall in the US stock markets in 2012, if it does occur some of these stocks may become available again at a reasonable price. Therefore doing some research into them and placing the ones that you like on a watchlist may be a good idea.
Matthew R
:
Warren Buffet’s letter is now available at the Berkshire Hathaway website
Craig B
:
On page 5 there’s an interesting observation on the effect the housing oversupply backlog is having on employment:
“At our current annual pace of 600,000 housing starts – considerably less than the number of new households being formed – buyers and renters are sopping up what’s left of the old oversupply. (This process will run its course at different rates around the country; the supply-demand situation varies widely by locale.) While this healing takes place, however, our housing-related companies sputter,employing only 43,315 people compared to 58,769 in 2006. This hugely important sector of the economy, which includes not only construction but everything that feeds off of it, remains in a depression of its own. I believe this is the major reason a recovery in employment has so severely lagged the steady and substantial comeback we have seen in almost all other sectors of our economy.
Wise monetary and fiscal policies play an important role in tempering recessions, but these tools don’t create households nor eliminate excess housing units. Fortunately, demographics and our market system will restore the needed balance – probably before long. When that day comes, we will again build one million or more residential units annually. I believe pundits will be surprised at how far unemployment drops once that happens.”
Simon
:
Just wait for JBH & BLD results (Feb. 28th) to “surprise” the market on the upside and boost their respective share prices based on a stronger U.S recovery in 2012.
Roger Montgomery
:
And not everyone agrees with him.
From Tyler D. “While mostly a regurgitation of old, very trite, and quite meandering thoughts, there are some tidbits of information in the latest just released 2011 Berkshire Letter to shareholders such as that Buffett has chosen a successor to the 81 year old increasingly more confused head (unclear who), that Buffett is on the prowl for large acquisitions, that he hopes IBM shares languish for the next five years (frankly we can’t wait until Buffett opens a stake in Apple so he can control the two stocks that between them account for about half of the moves in the DJIA and the NASDAPPLE – after all “economies of scale” is all about how Nominal Buffett exudes ‘success’), that he once again sees a housing bottom (he adds: “Last year, I told you that “a housing recovery will probably begin within a year or so.” I was dead wrong” – this admission is far more than we will ever hear from James Cramer who has been calling a housing bottom since 2009), and “Housing will come back – you can be sure of that” – sure, just not in your lifetime, and probably not in ours either, but most importantly, is the discovery not that BRK’s profit declined by 30% (to $3.08 billion from $4.38 billion) on a smaller gain on derivatives, but that since he actually will have to post collateral on new derivatives, “we will not be initiating any major derivatives positions.” The reason: “We shun contracts of any type that could require the instant posting of collateral. The possibility of some sudden and huge posting requirement – arising from an out-of-the-blue event such as a worldwide financial panic or massive terrorist attack – is inconsistent with our primary objectives of redundant liquidity and unquestioned financial strength.” So his warning that derivatives are WMDs years ago was only appropriate if there was money to be lost, such as is the case for 99.9999% of other investors? Ah, there goes the good old hypocritical, crony Warren we have all grown to known and love. And finally what would be a recent Buffett missive without the obligatory gold bashing section: after all, how will the Ponzi scheme inflate if people have realized it is a … well, Ponzi, championed by none other than the person everyone once thought was actually an investing genius. Fast forward to Buffett’s 2020 Letter (when Greek debt/GDP is precisely 120.5%) his main message will be: “I told you to run away from gold. I was dead wrong.””
Ash Little
:
Good one Tyler,
I like it
Nick Mason
:
I’ve met many gold fanatics who love nothing more than to tell me the World is ending and that soon the ‘Western’ World will be reduced to a rubble ruled by megalomaniacs over a brainless, zombified citizenry.
They may be right! Although its the glee with which they repeat all of this which really concerns me.
Buffet is right, gold has no real utility except as a perceived protector of wealth and that ‘protecting’ capacity is completely reliant on more and more people believing that it is a safe haven to protect their money. Still, I reckon it will be an okay investment over the medium term because as the middle classes of India and China…. increase their income they love to buy gold to show off to their friends by just how much its been increasing and also to diversify their investments. That is a large pool still to be exhausted although when it is, watch out.
Still, wouldn’t you rather be a part owner in a business which produces a service or product which adds something to society?
Roger Montgomery
:
Yes, so, speaking for myself of course, we do.
Ash Little
:
Hey Nick
Good post,
Just my view is that gold is not an an investment……
Anyone who is holding gold now as an investment is totally silly.
It’s an Insurance policy against the money printing that is likely to happening………Nothing more nothing less.
It’s not an asset class it’s just a hedge against the (in my view) certain money printing that will happen.
It’s a currency……….not an investment
Cheers
Dave T
:
If the ‘Western’ world does fall apart and zombies attack, wouldn’t the gold fanatics be better investing in a handful of businesses that produce: canned food, filtered water, breathable air, energy, guns and ammunition? Unless the gold bugs plan to eat, drink, breath and throw gold bars to survive.
Attached is a humorous article from a couple of years ago, when gold hit an all time high of $1271.90.
http://seekingalpha.com/article/225806-survivor-index-real-men-dont-buy-gold
Matthew R
:
Good one Dave
Not that I think it is an investment where big returns can be made, but if you are worried about an apocalypse rural land is similarly a store of value, the reasons being:
1) no more is being made
2) there is no significant depreciation (fences are minor)
3) a bomb can drop in the middle of it & the value is unchanged
And I’ve just thought of another – it can’t be stolen!!
Justin
:
I liked the results of IDEAS International Ltd (IDE). I took a small position in the stock in December 2011. It delivered a strong rise in earnings for FYE 2011 (IDE follows a calendar year). However, it is very illiquid, so it requires a lot of confidence to be had in its future prospects. It’s not a stock for every one but there’s a lot to like in it for the discerning value investor, I feel.
Andrew
:
This company has been on my radar (although still slightly outside my circle of competence) for a while. What i have seen and understood from it so far i have liked. You are right, it is very illiquid and also it appears not that well covered by analysts either. When i first looked at it based on the latest current results it was at a discount but i don’t know where it stands at the moment.
Justin
:
I had assessed its intrinsic value in December last year at around $1.50.
Lindsay Byrnes
:
Hi Roger
I was a tad disappointed with the BHP result and that of the mining sector in general which has experienced softer prices in the second half. Nevertheless I find it hard to be too negative about the future notwithstanding some commodity analysts are becoming decidedly bearish.
What I think is there is a possibility that any softer future steel making demand in India and China for construction (and hence iron ore demand) may be offset by robust growth in the consumption-related sectors such as machinery and transportation. This is a natural progression for these developing economies fuelled by demand from a burgeoning middle class and echoes China’s latest five year plan.
China is aiming at reducing its reliance on exports and investment to be more reliant on local consumption to sustain its economy.
If there is going to be any slowing in demand in commodities than a more likely outcome is a gradual decline but anyone predicting further massive falls is foolhardy.
The dynamism of developing economies and their ability to sustain demand for resources over the next several decades should not be underestimated. Are the massive investments by the big miners to increase future supply misplaced? I invested in BHP in the nineties when it was about $5 (prior to the share split of 2 for one) so that it has been a relatively sound performer but now BHP has a splendid resource base.
Best wishes
Ann
:
A lot of Retailers are moving staff off full time contracts to part time at lower rates. I believe LNG is the play at the moment
Michael Horn
:
Like airlines, LNG will be good for mankind, but, alas, on a global scale it may not reward those who invest in its production, because recent discoveries of natural gas resources and exploitation technologies have changed the supply-demand dynamic. If one searches the net looking for “natural gas prices” and “2012” you will find words like “Major natural gas producers recently cut back on production, as prices linger around a 10-year low. But analysts say they’re not doing enough to reduce the glut.” and “This year, because of drastic oversupply, the natural gas market has taken a gut-wrenching nosedive.” Add to the global glut problem the NIMB (not in my backyard) factor so common in Australia, and Aboriginal land rights, and one can guess that some natural gas and coal seam gas resources here will not be exploited quickly, easily and cheaply.
Warren Buffet’s of February 2011 report alludes to the low-gas-price problem – to quote: “A few years back, I spent about $2 billion buying several bond issues of Energy Future Holdings, an electric utility operation serving portions of Texas. That was a mistake – a big mistake. In large measure, the company’s prospects were tied to the price of natural gas, which tanked shortly after our purchase and remains depressed. Though we have annually received interest payments of about $102 million since our purchase, the company’s ability to pay will soon be exhausted unless gas prices rise substantially. We wrote down our investment by $1 billion in 2010 and by an additional $390 million last year.”
I deliberately used the word “global” in the opening paragraph, because there can be localised exceptions – for example, where there is a pipeline to a consumption point (e.g., an electrical generator), and particularly if the gas producer owns the pipeline. Warren Buffet’s investment company owns a profitable company that has at least two such pipelines, plus the electrical utilities to which the pipelines are linked – see his February 2012 report to shareholders.
As for long-term contracts to supply natural gas to China – precedent suggests that the Chinese will dishonour the contracts as soon as all their needs can be met via a cheaper source of supply. Currently, 50% of China’s natural gas imports come via pipeline from Turkmenistan. The top four suppliers of seaborne natural gas are Qatar, Australia, Indonesia and Malaysia, with Australia accounting for about 20% of the seaborne trade, or 10% of the total. Forward contracts with Japan are probably more reliable.
Peter
:
Ian,
Breville is a mainstay for KMart, Target, Big W et al. They are not regarded in the business as “high quality products”. The company does what it does well, and their fundamentals look fine, but don’t kid yourself that they make high end products.
Peter
Ian
:
I am not at all suggesting that Breville make high end products. However their proudcts are a level above the basic entry level home brand appliances. Homebrand appliance compete mostly only on price (more like a commodity) and margins are small. Breville have some appliances that are higher quality than the basic with more features. It allows them to be sold at a higher price and a higher margin.
I refer to high quality as being against comparable products within the price category as opposed to the very best that money can buy.
Some of Brevilles products such as juicers and coffee makers sit between very basic and high end. People who may not want to pay high end prices may choose breville appliances for a better than basic product at cheaper than high end price.
Warren Buffer
:
“but over the years one cannot help but have noticed many higher-priced items creeping into the stores.”
Totally agree with that statement!!!
Whenever I look at the Rejectshop catalogue I’m always thinking “ripoff” compared to say Kmart where you can get just about any similar item for much cheaper!
Roger Montgomery
:
HI Warren, your second post 30 mins after this one presumes I am available to approve them as they come in. I am not. Your post was found in my spam folder. Patience my friend.
Matthew R
:
I was impressed by Flight Centre – a uniquely good result when compared to similarly sized companies that have reported so far. They have had a lot in their favour recently (high AUD & people buying experiences rather than going shopping) but a good result all the same.
WTF, in the same space but a company relatively hindered by the high AUD also did well.
Dominos Pizza had a great result
There is a theme here – the “experience” providers
Oh, & Cochlear showed their stamina
Ian
:
At first look the breville result looked quite good. Exiting the low margin non electircal business in the US looks to have been a good move and there has been a good sales increase in the higher margin electrical products in the US which has given a good lift in profit and ROE. Also Breville have paid down their debt.
I am interested to see if this latest results changes Brevilles MQR from A2 to A1.
The Australian business is mature and not expected to give any growth but hopefully there is still growth to come in the overseas markets.
I like breville as thier R&D helps them to develop better quality and differntiated products. As long as they keep doing the R&D well and come out with good quality products that people want then things should go Ok for breville. In the low price segment there will be continuing pressure from homebrands.
I do own a holding in breville which I increased in late January as news of good electrical proudcts in the US came out.
Many of Breville’s products are well regarded as being high quality and having features people want. The company may not shoot the lights out but I can understand the business. while Breville can continue to grow in overseas markets they should do well if management keep the company on the track they have over the last few years and don’t make any crazy aquisition.
Roger Montgomery
:
Well done Ian. One of our portfolios biggest movers over the last couple of days.
Liz
:
I still think its a bear market rally so am not a buyer of anything right now but I liked CDD, DMP, SUL, and TOX results. I think there will be ongoing growth in environmental engineering (CDD) and waste management (TOX), and DMP if they get Europe right. Some of the service/engineering/drilling related companies have had good results on the back of the mining boom; for example IMD and ANG.
Michael Horn
:
I have held CDD since I launched my SMSF in 2006, and it has consistently performed well. CDD seems to have mastered the art of expanding abroad via acquisitions, and although I prefer stay-at-home companies that expand organically, CDD has not disappointed me. I have not worked out why CDD succeeds where others fail. I suppose the wonder is that the others fail, rather than that CDD chuggs along in an upward trajectory. From memory CDD has had something like seven years of continual EPS uplift. I hold 9527 shares, and I will subscribe to the 1-for-9 rights issue now in the offing at $4.90 (closing SP was $6.41 on 24/2/2012). Not many weeks ago CDD’s SP was about $4.90.
mike
:
Hi Michael,
CDD is fairly ordinary in my opinion and heading for large writedowns of its intangible assets.
Since listing its raised capital every year totalling $350m (including its latest $111m raising). Where has the money gone? By my calculations, CDD have spent $322m on acquistions, and intangible assets have risen from $2.3m to $355.7m as at June 2011.
The number of shares on issue has blown out from 32m to 123m currently. That’s not a shareholder friendly company in my opinion.
And another issue, Net tangible assets per share is $0.01.
You might also want to have a look at the company cash profit (as calculated in Valu.able). Since listing in 2004, CDD has produced a cash profit of -ve $214.8m.
EPS growth is not a safe measure of a company’s performance, and should be considered along with other factors.
Roger Montgomery
:
SInce 2004 CDD has reported NPAT of $197m and generated cash from operations of $250.2m. CDD has however invested $351 million and paid divs of $112m and so there is a funding gap of about $223.3m. This gap needs to be funded from dilutive capital raisings or additional borrowings. CDD has raised equity of $239m (surprise, surprise) and increased debt by $64 million. The excess cash raised has added to the company’s bank balance. (Note this is all taken word-for-word from the Cash flow evaluation page for CDD of Skaffold)
Michael Horn
:
As I wrote, I have not understood CDD’s apparent success, and as a rule I prefer stay-at-home companies that grow organically. These three things (not understanding, overseas exposure and acquisitions) occasion dissonance in my mind, so I’ll have a disciplined look at a stock that has been in my bottom drawer for years. When CDD was below $5 recently, I thought it was worth about $6, but this was a less-than-rigorous assessment. At the current SP, I am nervous, so I’ll run through the numbers, and perhaps skip out. The rights issue at $4.90 is traded as CDDR, so I do not have to take them up – I could sell them.
Like some investors, I concentrate on buying stock, and selling gets neglected, often to my detriment.
Liz
:
Thanks Michael. It’s a very very good point re intangibles and a lesson I’m grateful for. I did the calcs as well and then sent an email to my broker asking for their thoughts given their current valuation and recommendation. I may take a profit as a result!
Thank you.
Raze
:
Breaking News
GUD Holdings has sold its entire 19.3 per cent interest in electrical products group Breville for a profit of $66 million.
Read more: http://www.news.com.au/business/breaking-news/gud-sells-stake-in-breville-for-66m/story-e6frfkur-1226284377603#ixzz1nfb22t2K
Roger Montgomery
:
I can also share that fund managers who took the stock in the sell down were scaled back.
Roger Montgomery
:
You also need to watch closely because the seller does know the industry very well and the verdict from the ACCC was a long time ago now. In other words despite the decision he held the position for some time but perhaps now doesn’t see as much value there.