What A1 companies does Roger Montgomery think are cheap right now?

34 Comments

1. 

   Peter Ralph
   August 17, 2011 at 3:40 pm:

   Hi Roger,

   I don’t know whether anyone in the past has raised IMD as a possible A1 company.

   It provides oil and gas fluids, instrumentation, equipment to the mining and oil industries and in addition has a drill rental fleet. I don’t see commodity prices falling off a cliff and despite the pull back in the oil price I don’t see exploration falling off anytime soon.

   In the latest year it increased sales by 51% and returned a NPAT of $29mil which was an ROE of 30.7%. Net debt to equity is only 6%. This company lost $21.5m in the prior year after taking an impairment charge of $34m……part of this was a write down of ininvestments which was written off through the P&L Account……in the current year those investments were revalued upwards by $6.5m via the creation of an investment revaluation reserve. I’ve always thought of this as an accounting anomaly where the impairment goes through the P&L but the revaluation goes through the balance sheet. I digress….with an asset backing of $0.63, minimal debt, an ROE of say 30%, a dividend payout ratio of 30% and a required rate of return of 12% I come up with an IV of $2.77 against a share price of $2.14. In the two years prior to the GFC this company had an ROE of 40% and if it could again achieve those returns it’s seriously undervalued. As it is there is $0.63 margin of safety based off the 2010/2011 Accounts and I have an end of year 12 IV of $3.62.

   I don’t own the stock…..I still get nervous when I come up with an IV of $3.62 and a price of $2.14……ditto MCE which I have an IV on of $14.23.

   What do you think of Imdex?

   Cheers,

   Peter

   • 

     Roger Montgomery
     August 17, 2011 at 10:58 pm:

     Hi peter,

     There is a some good discussion here on the blog about valuations of companies that have very high Rates of Return on Equity and low payout ratios. Such combinations are rarely if ever sustained without some other capital activity. In Value.able I talk about one of the weaknesses of the model being a straight line model. What that means is that whatever combination of ROE and Payout ratio you use, you are projecting it to be sustained for more than a decade into the future. Thats unrealistic and so it is important to lower your ROE or raise your payout ratio. The net result will be a lower valuation than the one you have for Matrix. I sincerely do hope that clarifies things for you Peter.

   • 

     Pat Fitzgerald
     August 21, 2011 at 6:37 pm:

     Hi Peter

     My posts here may help:
     http://rogermontgomery.com/is-jb-hi-fi-cheap-and-still-an-a1/#comment-17348

2. 

   Andyc
   August 16, 2011 at 9:16 pm:

   Hi Roger and fellow investors,

   I have a simple question to ask regarding Oroton Group (ORL).

   What is the source of their competitive advantage, if indeed there is one?
   I know they *currently* have a good brand, they also *currently* have a good strong rower pushing the boat forward. In my view, neither of these factors is a lasting structural advantage in and of themselves (i.e. a moat).

   Imagine Sally left, imagine Oroton as a brand loses it’s luster. Is my money safe? I’m really having a good think about this one, I’m not sold!

   Disclaimer: I own ORL shares

   Cheers,
   AndyC

   • 

     Roger Montgomery
     August 16, 2011 at 11:54 pm:

     Hey Andy,

     Have discussed here previously that dearth of companies in Australia with truly sustainable competitive advantages. The most value.able are those allowing the company to charge higher prices without a detrimental impact to unit sales volume – an ability to charge more even in the face of excess capacity.

     • 

       AndyC
       August 17, 2011 at 12:16 am:

       Maybe that points to the real question we might ask about Oroton’s investment potential. How long will the quality of this brand endure and what potential does it have to remain a powerful brand? I.e. the likes of Tiffany or Harley Davidson are able to charge consistently rising prices.

       It would appear that Oroton currently has this ability, but I feel vulnerable as an investor. The fact that fashion is inherently fickle makes me feel like I’m guessing that they will still be ‘cool’ in years to come. It feels like a loose assumption. The barriers to entry seem low.

       How can we measure the strength, depth of a brand?? Is this a mugs game?

     • 

       Roger Montgomery
       August 17, 2011 at 12:54 am:

       Evocative word association:

       The survey must be auditory not written. Say a series of words: eg; Friendly or Overpriced or Quality etc. Then ask a large sample of people to blurt out the first jewelry/handbag/department store they think of….you get an idea of brand strength from that.

     • 

       AndyC
       August 17, 2011 at 2:40 am:

       Thanks for that idea Roger.

       I also found this very illuminating paper …
       http://www.netzkobold.com/uploads/pdfs/the_one_number_you_need_to_grow_reichheld.pdf

       It boils things down to a very pivotal question that can cuts to the core of brand loyalty.

       “How likely is it that you would recommend [company X] to a friend or colleague?”

       Their reasoning is that when one recommends a company they don’t only expend energy in doing so, they are putting their reputation on the line. Interesting insight.

       Another word-of-mouth related concept worth checking is the concept of ‘flipping the funnel’ by Seth Godin a marketing genius
       http://sethgodin.typepad.com/seths_blog/files/flippingfunnelPRO.pdf

     • 

       Roger Montgomery
       August 17, 2011 at 3:37 am:

       SOunds like you are on the path to answering your question. That’s fantastic.

     • 

       Andrew
       August 17, 2011 at 9:28 am:

       I perform that very thing as part of my analysis. I have found it has helped a great deal and has resulted in a few surprising finds especially when measuring the strength of some of the online list companys, this led me to not being particularly big on Webjet despite them being a strong company financially.

       I would encourage others to try this exercise. It won’t tell you what the competitive advantage is but if the results are dominated by a particular company than you know that there is something there for further research.

     • 

       Dan S
       August 17, 2011 at 1:58 pm:

       Does ORL have this ability? I remember listening to Sally herself saying that she regrets that they didn’t go hard enough on discounting in the previous half to maintain unit sales.

     • 

       Roger Montgomery
       August 17, 2011 at 3:23 pm:

       She really said that?

     • 

       Dan S
       August 17, 2011 at 10:56 pm:

       When she presented 1HFY11 results, I’m pretty sure she said something like: their decision not to discount was a mistake.

       I met her, she was super nice.

       FGE result; ~40% ROE. Hopefully they can keep generating that on the cash they’re stockpiling.

       Acquisitions possible in 11/12…

       Was the $6m PPE sold one of the sites they closed?

   • 

     Andrew
     August 17, 2011 at 9:45 am:

     I hear your concerns and think it is great you are thinking of such things, this type of analysis makes up a huge part of my investment decisions. They are all risks you need to consider.

     I believe that a brand can only be successfully built if a sustainable competitive advantage exists beneath it (i think they are not one in the same). JB Hi-Fi’s brand can only exist if they remain the lowest prices which build into their processes resulting in their competitive advantage.

     I think oroton does have some but the nature of the fashion industry is as you say below “fickle” so these might not be as strong as others.

     Oroton, in my view, offer affordable luxury fashion products, they have a great little niche with little competitors currently in Australia at least. This means that they need to be able to make their products at a lower enough cost to sustain their price point. How do they go about this?

     In my view it goes back to how they manufacture the products, the more i research the more i find the supply chain set up backed by a good design team allow them to fulfill the brands promise (or what i and others think it is).

     • 

       AndyC
       August 18, 2011 at 1:46 am:

       Thanks for your feedback Andrew. It appears we have a similar way of looking at quality, or more specifically the durability of quality.

       Regarding Oroton’s potential competitive advantages, their presence in Australia at a reasonable prices doesn’t give me any confidence from a perspective of looking for a competitive moat. I would imagine it’s easy for a foreign competitor to enter our shores (Louis Vuitton springs to mind) but I concede that they would not lower their prices since doing so would erode their brand which enables them to charge high prices in the first place. As for Oroton’s design team, like fund managers, they walk out the door each evening (or in this case it might be the early afternoon).

       In the end Oroton is a business with an attractive brand, that is doing a lot of things right at the moment. But I can’t honestly assess if they will still be kicking goals in 3 years time.

3. 

   Ryan Joyce
   August 15, 2011 at 2:06 pm:

   Hi,

   Just had a look at the TSM interim reports and as a holder i am a bit concerned by the results. This is mainly due to the dilutitive effects of the capital raising significantly reducing EPS and ROE. If i were to calculate IV by doubling the half year profit i obtain an intrisic value of only about 40c.

   I have noted however that in the past TSM’s second half results seem to be a lot stronger than their first half results. Can anyone explain the reason behind this or offer an opinion on whether they expect the same to occur this year?

   For example if they were to increase NPAT by 5% for the full year ( as they did for this half) then the intrinsic value at Dec2011 would be around 70c, much higher than the 40c based on doubling their reported half year profit.

   Are TSM likely to offer some full year earnings guidance any time soon?

   Thanks

   • 

     ron shamgar
     August 15, 2011 at 5:49 pm:

     hi Ryan,

     im estimating eps will be either flat or under last years results for the full year. the high Aussie dollar and subdued consumer spending are some of the reasons. if you believe Jim rogers, that the Aussie dollar is going to $1.50 in the next few years, then even if TSM increases profits by 50% over time, in Aussie $ terms you are going no where.
     something to think about and is the reason i don’t own this one.

   • 

     Ash Little
     August 15, 2011 at 7:24 pm:

     Hi Ryan,

     I am not getting the capital raising as dilutive to earnings but the $a strength..

     Constant curreny returns were very good and I don’t think management expected such a rise when the funds were raised to invest in the UK.

4. 

   Peter Ralph
   August 13, 2011 at 6:24 pm:

   Hi Roger,

   I realise that MGX is a commodities producer but last week it reported a NPAT of $239.5m, an ROE of 25.8%. This is a consistent ROE over four of the past 5 years with only the only poor year being 2009 (7.1% ROE). In addition this company has $387m in cash, and debt of only $45m being lease liabilities. I recollect that you own shares in AGO, another iron producer, on the basis of its fundamentals, which in my view are not as “known” as MGX’s. EPS was 22.14 cents and a maiden dividend of 4 cents was declared.

   I used a discounted ROE of 20%, dividend payout ratio of 18% and a required after tax ROI to come up with an IV of $3.47 against a share price of $1.62…a discount of 53.5% and a very nice MOS. My only concern is the ever increasing horde of cash and what the company might use it for.

   I noticed last week that many bloggers bought MTU but when I did my sums I could only come up with an IV of $2.08. I’d appreciate it if anyone could show me their calculations as to why MTU was a buy?

   I agree that FLT and DTL are trading at discounts to their IVs but the discounts are not large enough to warrant buying. I have TGA and CCP trading at discounts of 18.5% and 29.4% respectively to their IVs and will be looking to add to my CCP holding this week.

   Cheers,

   Peter

   • 

     Roger Montgomery
     August 15, 2011 at 10:42 am:

     Hi Peter,

     Mine life is a known ‘issue’ for MGX. What they do with the cash will be important. I do believe we own every company mentioned in your post with the exception of AGO. Before you get too excited remember we also have nearly 70% in cash still.

     • 

       Peter Ralph
       August 15, 2011 at 11:53 am:

       Thanks Roger,

       The last resources and reserves report issued by MGX was at 30/6/10 which indicated resources (108.6mt) were increasing more than production depletion and that reserves (56.4mt) were marking time with production depletion. I guess when they issue their report for 30/6/11 it well tell the tale as to whether production depletion is exceeding the gross increase in resources and reserves. I will do some more research on ‘mine life’ but on the face of it I’m surprised that’s it an issue. That said, I appreciate your comments and will do so some more homework.

       Nic, I have $1.75 on CDA but it’s hard to apply an ROE…..I have 19.4% for 2009, 22.5% for 2010, 43.2% for H1 2011 and 24.4% for H2 2011 and 33.5% for full year 2011.. Also the second half result was roughly half that achieved in the first half and margin on sales came back from 16.8% to 9.2%….I haven’t done an indepth analysis and there may well be good reasons for this. Debt to equity was 100.2% at the end of 2008 and is now 35.4% and the reduction $36m) has been achieved without a capital raising which is impressive. I used an ROE of 30% in my calculations but was far from confident in doing so.

   • 

     sapporosteve
     August 15, 2011 at 12:32 pm:

     Hi Peter,

     A rough calculation for you –

     EPS – 28
     DPS – 12
     Po/R – 43%
     BV – 76
     ROE – 40%
     RR -14%

     .76X2.857X.43 ＝.94
     .76X6.617X.57 ＝2.86
     Value – $3.80

     .87X2.857X.63 ＝1.57
     .87X6.617X.37 ＝ 2.13
     Value – 3.70

     There are rough and I mean rough. I do not hold the company in my portfolio.

     regards
     Steve

     • 

       Peter Ralph
       August 15, 2011 at 5:31 pm:

       Thanks Steve,

       That helps a lot and I appreciate that the numbers you have used are as you said “rough.”

       The last guidance the directors of MTU provided was for a NPAT of in between $22m and $23.5m for FY11…..I’ve used $23m and SHF at the 30/6/10 of $77m to come up with an ROE of 30% ……I’ve also used a dividend payout ratio of 70%, RR 12% and an asset backing of $0.63 also as at 30/6/10.

       $0.63 X 2.5 X 0.70 = $1.10
       $0.63 X 5.203 x 0.30 = $0.98
       $2.08

       If I use the 31/12/10 Accounts I get a slightly higher asset backing (as it includes 6 months of the current year’s profits in it) and if I lower the RR to 10% I can get an IV of $2.83 but in my view the $2.08 above is a lot more accurate.

       I don’t own shares in MTU either but it’s a business I would like to own…..just not at current prices.

       Thanks again.

       Cheers,

       Peter

   • 

     ron shamgar
     August 15, 2011 at 1:00 pm:

     hi peter, whats your inputs for MTU? maybe i can help. i get around $3.80 and $4.70 for fy11 and fy12. they might even surprise on the upside with this year’s results. (29th Aug)

   • 

     Paul
     August 15, 2011 at 2:26 pm:

     Hi Peter,
     My MTU calc looked something like the following for 2011 intrinsic value:-

     EPS – 25.4
     DPS – 15.4
     BV – 73
     ROE – 34.8%
     RR – 12%
     DIV % – 60.63%
     DIV MULTIPLE – (2.900 which is 34.8 ROE divided by 12 being the RR)
     RETAIN % – 39.37%
     RETAIN MULTIPLE – (6.867 which is based on 35% ROE and 12% RR from ValueAble p184)
     MY IV – $3.26
     Share Price at the time I looked at it was $2.69 so a 17% MOS to the IV.

     I have at this stage the following IV’s for 2012 and 2013

     2012 – MY IV – $3.70
     2013 – MY IV – $4.60

     Cheers,
     PaulS.

   • 

     Camdyn B
     August 15, 2011 at 3:12 pm:

     I have watched the blog for a while and have evaluated a few companies, one being MTU. I myself can’t figure out how people think this company is cheap! Using the values and method in valueable I get 1.98. Scratching my head with this one. Are people using a much higher ROE than reported or very low RR?

     • 

       Peter Ralph
       August 15, 2011 at 5:36 pm:

       Sorry Ron, Paul and Camdyn,

       I didn’t see your posts until after I’d responded to Steve…..thanks for your help.

       Obviously my thoughts align with Camdyn’s but it helps to know how others arrive at their IVs.

       Regards,

       Peter

     • 

       ron shamgar
       August 15, 2011 at 7:53 pm:

       Peter, im using 26c eps and 16c div. im using ROE of 38%.

     • 

       Peter Ralph
       August 16, 2011 at 12:43 am:

       Thanks Ron,

       I think your ROE of 38% is a little optimistic and the dividend history of MTU is which suggest a 70% payout;
       EPS DIV.
       2008 7 5
       2009 8.9 5.5
       2010 14.6 10
       2011(h1) 9.4 7

       There are 123.761 mil shares on issue and guidance is for full year 2011 NPAT of $23m which is 18.6 cents a share and I’m guessing there’ll be a full year dividend of 13-14 cents.

       Cheers,

       Peter

     • 

       Ash Little
       August 16, 2011 at 7:42 pm:

       Hi Peter,

       It will be interesting to see what happens as current consenus is

       2011 EPS 25.4 DPS 15.4
       2012 EPS 30.7 DPS 19.8

       Using these I think Ron has it about right.

       Surely 2011 will be very close as this has been upgraded since last I looked.

       Just some thoughts

5. 

   Nic Arena
   August 13, 2011 at 3:31 pm:

   Posted this in an old blog (Thanks Ash for replying there. Hope everything is okay Ash as you said your thoughts were somewhere else … hopefully at another investment opportunity). Thought I would post it here again as it is more relevant.

   Just had a look at Codan’s annual report. I think it looks quite good. I have an IV of $1.71. Debt has been reduced and profit up (although underlying profits down slightly). Haven’t delved into it too much yet but it bottomed out at .995 cents the other day and if I had had their annual report before this and done a little bit more research could have definitely been a buying opportunity. Roger does it get your A1 rating for this report and do you have an IV? I would be interested to hear if any bloggers like the company. I know it has been discussed a little over the past year but maybe any updates people have to offer.

   • 

     ron shamgar
     August 15, 2011 at 12:57 pm:

     if you believe in the gold boom going forward, this company may sell more gold detectors in the future. it is cheap on my estimate of IV (i get around 1.60) but i don’t own it. hope that helps.

     • 

       ron shamgar
       August 15, 2011 at 5:53 pm:

       one more thing to add, if you see your neighbor walking around with a gold detector searching for gold in their backyard, then you know gold is a bubble! :-)

     • 

       Ash Little
       August 15, 2011 at 8:50 pm:

       LOL,

       That may be a few years off though..

       Fingers crossed(for me)