Is there beauty in boring?
Making winches and bullbars for four-wheel drives sounds boring, but the latest figures from ARB offer exciting reading.
I am most excited about companies that are in boring industries. You might recall my column (here) enthusiastically discussing Embelton, a manufacturer and distributor of … wait for it … hardwood flooring. Since that article the stock has surged to new all-time highs. Great companies that are run by reliable and trustworthy managers can produce returns that are anything but boring.
Right now, retail and other sectors such as property have declined in prominence in the various indices. As a result, fund managers worried about their “tracking error” don’t need to own as much of these companies’ shares, which in turn means brokers don’t receive sufficient brokerage fees to warrant an analyst covering them. The net result is that analysts are made redundant, and coverage of the stocks declines along with the price multiples being asked for the shares. For a long-term value investor, this is bliss.
And with that we turn to the results of another of my candidates for most boring industry award: ARB Corporation. ARB manufactures and distributes 4WD aftermarket accessories. Think bull bars, snorkels, fridge-freezers and winches (among other items) manufactured in Thailand and Kilsyth and distributed around the world, now through 43 stores (16 company owned – think of the long-term store rollout potential!) from Africa and the Emirates to Mongolia.
Strong local demand has protected ARB from the impact of Thai floods on vehicle supply and a very strong previous corresponding period (thanks to a large order). And just as local demand in January (holidays) and February (job losses) will trim sales, a restoration of car manufacturing supply chains offshore will offset it.
In the most recent half, ARB increased sales 2.3% to $132.1 million, maintained its EBIT of $24.9 million, increased its net profit by 1.6% to $18.3 million and its earnings per share by 1.6% to 25.2¢. The interim dividend also rose by one cent to 11¢ a share.
Many investors might be concerned about the flat EBIT. Don’t be. This reflects increased staffing and in particular staff in the research & development department. It’s this department that is responsible for the company’s innovative product lineup that included the release of the Sahara bull bar range (2000), the Emu Dakar leaf springs (2005), the recovery strap range (2007) and the fridge freezer (2008). While the cost is expensed, investors should think of it as an investment in the future. EBIT was also flat thanks to store expansion and the NPAT increase merely reflected an increased interest income item. Like I said, don’t get too excited!
Some of our “informers” have, however, explained that price rises have been possible and if you have read my book Value.able (click here), you will discover just why I think this is the most valuable competitive advantage.
The resource boom in Queensland and WA is having a positive impact on smoothing the company’s revenues and earnings in addition to the obvious direct impact on aftermarket product sales. The company’s production facilities have been running full-tilt and this appears to have resulted in some buildup of inventory, which in turn has had an impact (not material) on cash flows and the value of materials and consumables used compared to sales.
Full capacity production facilities add to inventory that has become backlogged as a result of slow vehicle throughput, due to the Thai floods and Japanese earthquake. I expect the inventory will run down again as deliveries of post-flood vehicles overseas ramps up.
I am encouraged by the Thai facility being at full production so soon after commissioning, because it suggests that management were unduly conservative in their estimation of their global reputation. I expected more cash to be needed for an upgrade or expansion and that has been announced. With returns on equity the envy of their listed peers, I am delighted to see the company invest more.
At an ASX seminar I presented yesterday, one attendee asked about the impact of currency on the company. This was a very good question: It’s important to note that for ARB there are two impacts. The first is a strong Australian dollar is great for margins when inputs are purchased from overseas. The flipside is that marked-up revenues earned offshore are impacted negatively as the dollar strengthens and those revenues are repatriated.
Historically, the company has a record of paying special dividends and, with $32 million in the bank, it is understandable that many analysts would use this line to woo investors into the stock (as an owner of the stock; “go for it” I say!). But the large cash balance is partly the result of $7 million raised in 2010 (through an underwritten DRP if I recall correctly) and special dividends will also be dependent on the level of investment the company makes in plant:
Such an outcome is not beyond the realms of possibility but neither is a permanently higher dividend payout ratio. The latter of course reduces the intrinsic value of the company – better that MD Roger Brown keeps the money in ARB and reinvests it at near 30% returns on equity.
At the current price of about $8.63, ARB is trading just above its 2012 intrinsic value estimate (see above Skaffold chart). With only 43 stores globally and only 16 company owned, fully utilised production facilities however suggest the company has plenty of scope to grow while sustaining high rates of return on incremental capital for decades – notwithstanding management’s energy to do so. It seems boring but slow and steady seems to be winning the 4WD race.
Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 15 March 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.
Mick
:
I like the boring businesses because you can understand the business better and relate to it.You tend to have a problem valuing mining companies unless they are in the production and selling stage.Another area I look into is turnaround type of companies in the boring business area.Many of these companies however carry debt so you need to do your homework.Examples include AMA a boring automotive aftercare business which back in 2010 the directors were frantically buying shares.This company went from a massive loss in 2009 to profits in 2010 and 2011 and paying down debt.Another recent boring company QTG operates in the security business and has finally integrated the API locksmith business.It however has high debt and is looking to merge or be taken over.Other boring businesses include SYM and HST which are unfortunately have high debts but are useful to keep a watch on for any opportunities.
Slide
:
Hi All
I’m able to give fellow readers some further insight into ARP after meeting both the Brown brothers late last year.
It is quite likey that we will see Roger Brown step down from his board role in the next 12 months after serving a distinguished career establishing and guiding this fine company. It will be interesting to see if he maintains his shareholding if this does eventuate.
As we know ARP is an expertly managed company. Their strength lies in their ability to innovate and provide a constant stream of quality products. They have nurtured a substantial database of customers, and have a superb marketing team that produces an in-house magazine which is the envy of all competitors.
Despite looming management chages, a high achieving culture that has become entreched within this organisation is a strong basis for believing that ARP has many successful days ahead.
Roger Montgomery
:
thank you for your insights but I won’t be publishing your posts again if you fail to supply your name.
Andrew
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I thought i would add the following here as by using the boring tag we are in fact giving the company a type of personality. Just to remind people, i have had no formal education in finance etc so everything i do has been largely self taught and to help learn i have basically had to think about thins i do know and see how they link to investing and try to adapt them to it. So with that in mind, i will just say that the below might be a bit out there but i have found it useful.
One way that can help me understand a company better is to give it a personality. If the business is a living thing what would their personality traits be?
Are they boring, reckless, aggressive, stingy, two-faced, shy etc.
The brand is a form of personality for a business but this is the companies opinion on itself and what they want you to believe so even though in some cases it is accurate it is not necessarily to be trusted.
For example, ARB could be slightly boring and quiet, you don’t notice it much but they are hard working and always near the top of the class.
Apple could be said to be aggressive, innovative and creative, however they are also a bit stingy but are well liked and followed by a lot of people.
Qantas could be seen as an addict, they live beyond their means and constantly show up at your or your neighbour’s door with a bag asking for more money.
You can then use this personailty to think about whether that type of personality is what you are after in an investment and whether that personality will work in the industry they are in and why they have that type of personality.
it might not be an analysis procedure that would be backed by academics and professors etc but it is a good exercise to do that will help you open your mind a bit more to what the company is like so you can see why it has those traits, whether those traits are something that would work in the industry they are in and whether you want to own a company with those traits.
David King
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Andrew”s assignment of personality could just be the greatest analytical tool of 2012.
What about:
BHP A big bully pushing others around at school all the time, but because he’s also captain of the first grade football team and senior prefect, lots of people can’t help admiring him.
FMG. Twiggy’s the captain of the Third grade team, and he’s desperate to get everyone’s attention so he won’t be overlooked for promotion to second grade soon.
WOW. The Milo Minderbinder of retailing (see Jon Voigt’s character in Catch-22) Can and will sell you almost everything your heart desires, including the dream of wealth. Want to be rich? Here, try your luck in one of our dazzling pokies. Totally ruthless but possibly heading for a cropper as he tries to take over the entire market.
ANZ. Reincarnation of Orson Wells’ character in Citizen Kane. “Hell, give us time and we’ll own every decent bank in South-east Asia.”
What about some more from others of this family?
Rod
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Something has been puzzling me, perhaps because it’s more boring than boring. ARB is constantly being mentioned, no doubt with good reason, but I note that CMI is rated A1, is at 50% MOS and has healthy growth prospects. It’s also at least partly a direct competitor of ARB, as well as making cabling, etc. Is it simply the presence of ARB which makes CMI ‘ultra-boring’? What is wrong with this company?
Roger Montgomery
:
Hey Rod,
In the first instance I don’t need two 4WD after market suppliers in my portfolio of businesses, so prefer the superior of the two. Brian Fryth wrote up the shanenannigans between Troy Harry’s Trojan Equities LIC and CMI last week. Here’s the link: http://www.theaustralian.com.au/business/opinion/trojan-hoping-for-third-time-lucky-cmi-buyback-to-end-dividend-drought/story-e6frg9kx-1226294079390
Ash Little
:
Yes Rod,
Roger is right, getting in the better boat is more important than any other consideration.
Cheers
Tim S
:
I have been following this company for years as well but have done nothing but kick myself for not buying earlier as I watch the stock price continue head north over that period.
I was very lucky last year to pick up some on the August 9 panic day for $6.70 near the intraday low. Now wishing I had bought more I must keep reminding myself of the good fortune I received.
ARB is a great boring company and one I will hold until something drastic changes or reaches a saturation point (one I can’t see happening soon). And if we have more panic days ahead (which I’m sure will happen), I will be buying more if they fall below their intrinsic value.
*side note: and thanks to Skaffold, I also managed to pick up some FLT at $16.38! a significant discount to intrinsic value! Happy days.
Andrew
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I first heard abotu this company a few years ago on here. I didn’t know it existed. I have never owned a 4WD or Ute in my life and have no need to. Although once i was made aware of it through this blog a funny thing happened. I started seeing ARB badges everywhere. Every construction site i passed had some utes installed with the ARB canopies. I go to the local shopping centre and i look over next to me to see a 4WD with an ARB badge plastered all over it.
It is a great company and one truly great australian success story.
It makes me think that sometimes you can invest in unattractive industries if you find a back door. I put car manufacturing right up there with airlines as an unnattractive industry. However selling accessories to cars (ARB) and selling seats on planes (WEB,FLT) are a different story.
As for boring industries, boring is good. They usually have a stable competitive landscape and a clearly identifiable strategy, are unlikely to have many future major issues with technology and substitution risk. They also are likely to have consistent performance making forecasting a bit easier. One earning lots of cash and a good ROE is indeed a very attractive option.
Roger Montgomery
:
We like all three of those companies.
Pete Abela
:
Roger,
do you have any thoughts on the ACCC action against FLT?
I assume if there is any impact it will be one-off in nature. I am hoping it may lead to some short term buffeting of the share price and the opportunity to purchase at an attractive MOS.
Roger Montgomery
:
Yes and yes, Pete.