What do I think of Industrea?
On Sky Business last week with Nina May, a caller asked for my thoughts on Industrea. I offered to put together an opinion and of course, the only way I know how to do that is to first run it through the model to learn whether or not it is 1) A Wonderful Business with 2) Bright prospects and available at 3) A bargain price.
On the first point, a wonderful business, Industrea lost money until 2006 when it earned just under $2 million. Its not history however that determines your returns. It will be the future performance of the company. More on that in a moment. Last year the profits grew to $15 million but in order to generate that increase the company has raised equity and borrowed additional funds, to the tune of $309.5 million. Dividing the additional profit of $13 million by the additional equity of about $110 million is a return on incremental equity of about 11%. Not great but not bad either. (see note about profit adjustment below which makes this return higher)
According to some analysts and a recent company announcement (for FY10), the profit is expected to rise materially in the next three years to $48 million next year and $60 million in 2012 corresponding to a return on equity of about 25%. Of course the 2009 profit probably wasn’t $15 if you back out unrealised movements in interest rate hedges, amortisation and impairment of Customer Contracts and the like. If 25% returns are the case then the business looks ok except for the fact that debt exceeds equity. Of course if the profit figures come through as expected, then the debts could be paid down considerably, unless the directors choose to pay much higher dividends.
Based on the analysts forecasts for the next three years (of course subject to change in a moment’s notice and without any update here) the value of Industrea is 48 cents rising to 70 cents in 2012. So the prospects for value increases looks ok and the shares are currently at a discount to today’s intrinsic value.
Do I think its a great business? I think there are better quality businesses around unless you can satisfy yourself that this company has genuine sustainable competitive advantages. If you can, and believe the debt will start to decline, then the shares don’t look expensive. Of course this is not a forecast of the share price. Valuing a company is not the same as predicting the direction of the shares. Seek professional advice with someone familiar with your needs and circumstances before acting.
Posted by Roger Montgomery, 18 February 2010.
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.
John Prouzos
:
Hi Roger,
I did not get a chance to talk to you on the business Sky channel last week.
I just bought some HST at $1.78 and wanted to know what valuation you had on them. Also I am trying to buy some MLB at $1.78. Do you have a valuation on these?
I thought I heard you say on the air that you have a band of followers or an investment group that you advise or recommend stocks to buy or sell. Please advise if I misunderstood.
admin
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Hi John,
You misunderstood. As NetJ.com said in their 1999 prospectus: I am “conducting no business activity of any description”. I will put those stocks on the list and hopefully will get around to valuing them soon but there are no guarantees of course. I will try my best.
Eve de Klerk
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Hi Roger
I do like seeing you on the Sky Business Channel. With the deal between Harvey Norman and ikea; Would you value Harvey Norman as a buy?
My 2c worth with Origin. I believe their retail outlet would make the share worth $8+. I had very good advice for solar panels and hot water. It was very professionally done for me. They are a ‘green’ company. When others look at my hot water system which is gas boosted they are truly amazed with the technology used.
I would be interested in your comments.
Tyler
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Harvey norman will go broke once Gerry is gone. there business structure with such high rebates has been demolished by JBHifi’s no rebates system. Harvey normal only continues due to gerry’s business excellence
admin
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Thanks Tyler,
Partly retailer, partly property trust.
admin
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Hi Eve,
I have posted a table of some recently valued companies including Origin. Here is the link to take you directly to the post – Stocks Mentioned on Sky Business There are two parts to a great investment, 1) a great company (and the characteristics you mention anecdotally point to that) and 2) a great price. If you buy a great business at too high a price it can turn into a lousy investment. I hope that helps Eve. Of course its all spelled out in the most useable detail for you in my book.
dany
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hi roger, love your show on sky business, i have bought some share on FML, great small gold producer, with no debt, and intend to increase the volume, could you please help me out with the technical analyse of this company ,
many thanks,
admin
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Hi Dany,
Thanks for the question. I have put together a list of all the companies for which I have received requests to value and I am very slowly going through them. I post those for which I have received the most requests first. Thanks for your patience Dany. I’ll get to it soon.
Peter
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Hi Roger,
I have just heard a broker reccommend Industrea as a strong buy and I just wanted to post my thoughts on some broker reccomendations
Its interesting to note the emphasis that analysts put on future earnings to base their valuations, and tend to ignore the historical earnings. ” I dont drive using the rear view mirror ” is a phrase I have heard them use.
I vaguely remember reading somewhere by Benjamin Grahame that, conversely, he does place emphasis on Historical earnings, particularly in the last 3 yrs.
I know you dont like using PE ratios, but for the purpose of this excercise if we were to use PE ratios as a proxy, for a rough valuation of Idustrea, we would get results which are at the opposite end of the spectrum when we compare historical earnings vs Future forecasts.
The historical earnings based on a 3yr average for industrea is 2.9c per share. This equates to a PE of 13.4 times. This is above its peers and suggests that the current price is expensive.
If we took the forward looking PE’s and averaged the 3 yrs looking into the future, the EPS is 6.3c per share. Then if we multyiply that by its peer average of 11.27x we come up with a forward valuation of 0.71c – Which suggests the price is currently at a discount.
So if industrea meets expectations and performs inline with the analaysts expectations then the stock is undervalued and at a bargain price.
But hang on a minute. The highest that industrea has earned is 4c per share and in 2008 and 2009 they did not meet expectations and suprised to the downside. Industrea has never demonstrated that they can deliver or achieve these new forecasts.
So I wonder, how can analysts be so confident that industrea will turn around now, start meeting expectations and exceed the last 3 years earnings by over 100% ( on average )
My point is, that I believe that historical data is important and more emphasis should be placed on a company been able to prove themselves first.
I prefer to invest with a company that has demonstrated that they can deliver on the expecation. And Whilst I can undertand that we need to take into account growth going forward, I prefer to assume moderate steady growth in line with growth targets that are achievable.
What are your thoughts ?
admin
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Hi Peter,
Thanks for the time you have put into your post. As I mention in my post, I too use both to produce a range of valuations – i.e. forecasts and a sort of mean of the history continuing. In finance it is relatively easy to forecast continuation but very hard to forecast change and its the change that is the key. This is where the return on incremental equity is so important. By that I mean the return on the additional capital being put in or left in. It can say a lot about which way the return on equity might head.
Regarding Historical data versus forecast, my response is; yes, a demonstrated track record of earnings power is essential.
Jason
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Cheers Rog.
Damian
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Roger,
You mentioned that the debt to equity of Industrea is over 100%.
Does the level of debt get included as a factor in working out your valuations, or is it just a figure that you use to filter out the less favourable stocks?
In other words, would the valuation be the same if the stock had zero debt?
Vishal
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Hi Roger,
This raises the question of is it better investing in a lower quality business which is a discount to intrinsic value or a better quality business that is at (or above) its intrinsic value?
P.S Great Blog!!
admin
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Hi Vishal,
You left out an option; its best to invest in the best quality businesses only when they are trading at a discount to its intrinsic value. I have had to learn this lesson time and time again – I am obviously a slow learner
Danny
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hey Roger,
I am an avid subscriber to eureeka and read and watch all articles and shows you are on and cant wait for your book. I wrote you a while back on thoughts on (MND) as i know that u have mentioned before that you have liked it. I have since purchased on weakness and am already up over 17%. I have been reading comments on your blog have noticed one comment from Damien and he suggested three stocks to look at. (NVT) (ARP) (RKN)
I have done some research on these companies and all have good increasing ROE with increasing earnings per share. Little or no debt. They have have good runs up in the share price over last few months. My picks would be RKN then NVT and ARP as the weakest of the three. I beleive that they may be still fairly good value would like your thoughts.
thanks Dan
admin
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Hi Danny,
You are right, all companies that tick some of the main boxes. Now that there have been a few requests for them, I will post something up in the next week or two.