Are you sitting down?
I have just returned to the office after appearing on CNBC with my old friend Matthew Kidman. We were in agreement on virtually all points (which perhaps surprisingly made the program very interesting). If the market does indeed provide a once-in-a-lifetime opportunity, in the next 12 months, to buy excellent value industrial companies, then you may want to be aware of the companies that are either really poor quality or extremely overpriced now.
Stay tuned over the next few days, as I will be publishing our list of companies whose shares are in the hot seat. Some of them may shock you.
If you would like to pre-empt the report, with some of your own suggestions, go right ahead and list them by clicking on the Comments link below.
Posted by Roger Montgomery, Value.able author and Fund Manager, 03 November 2011.
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.
Michael Horn
:
I wrote earlier that I would make comment on TGA when I had seen the Interim Report, and as it was published today, here goes. I hold TGA, and I would consider selling some of the holdings if I found a stock that was manifestly a superior investment.
What would one pay for a stock with the following metrics and business model, assuming you had none, or only a few, and you had $50K looking for a home? As a sanity check, if you had a hundred thousand or more of shares in that stock (TGA), at what price would you sell some or all of them of them? There is no single number, or pair of numbers (buy price and sell price), because margins of safety, required rates of return, funding circumstances and alternative investing options vary from investor to investor. The answer may lie somewhere between $1.50 and $2.30, I think.
TGA published its Interim Report for the half-year ended 30/03/2011 today (22/11/2011), and in general it was a good result. I’ll first supply background so that from its historical performance you get the idea that this is a successful business that keeps on improving. Bear a few thing in mind – namely, TGA:
● makes it living by entering contracts that deliver revenue streams (about 100 thousand such streams are now extant), and hence it is insulated from short-term changes in consumer sentiment;
● earns its revenue in Australia, which reduces its risk; and
● has low debt, about 8% debt to equity.
TGA floated as RRA on 13/12/2006, but if you look at its website you can find figures that pre-date the IPO. Also, if you take the Interim Report, you can reasonably extrapolate the figures for YE 30/03/2012. Some of the figures below could be debated, but the thrust of the story would not be altered as a result. Some of the 2012 figures are guesstimates, but changing them with justification should not alter the big picture. Further, I have attempted to normalise the EPS figures to accommodate: the additional IPO shares; small year-on-year increases in shares; the recent 16,000 share rights issue; the $1 million in non-recurring NCML acquisition cost in YE 30/3/2011; and the $630K amortisation of the customer relationship intangible relating to the NCML acquisition in the current financial year.
EBIT
– – 2004 – – – – 2005 – – – – 2006 – – – – – 2007 – – – – 2008 – – – – 2009 – – – – 2010 – – – – – 2011 – – – – 2012
$5,196K – – $6,837K – – $9,484K – $12,387K – $16,262K – $18,093K – $24,612K – $32,700K – $41,500K
Average contract term in months and rental due
– – 2004 – – – – 2005 – – – – 2006 – – – – – 2007 – – – – 2008 – – – – 2009 – – – – 2010 – – – – – 2011 – – – – 2012
– 13.9mth – – 17.5mth — 17.9mth – – – 19.1mth – – 21.0mth – – 22.0mth – – 23.0mth — 23.0mth – – 27.0mth
– – – – – – – – $5,564K – – $5,970K – – $6,670K – – $7,302K – – $8,103K – – $9,128K – $10,360K- $11,500K
The above is an important set of metrics, because they will inform one of thigs going downhill long before the usual metrics do so.
Return on capital
– – 2004 – – – – 2005 – – – – 2006 – – – – – 2007 – – – – 2008 – – – – 2009 – – – – 2010 – – – – – 2011 – – – – 2012
– – – – – – – – – – – – – – – – – – – – – – – – – 14.51% – – 17.77% – – 17.19% – – – 20.35% – – – 19.02% – – – – ???
Normalised Diluted EPS
– – 2004 – – – – 2005 – – – – 2006 – – – – – 2007 – – – – 2008 – – – – 2009 – – – – 2010 – – – – – 2011 – – – – 2012
– – – – – – – – – – – – – – – – – – – – – – – – – – – 5.05c – – – – 8.42c – – – 9.52c – – – 15.00c – – – 17.62c – – – – 19.44c
I worked out the EPS for 2011 by normalising it by adding back $1 million of NCML acquisition costs that will not be repeated. For 2012 I doubled the half-year net income of $14,307K, then took off 70% of the ATO profit before tax of $800K, because it will not be repeated, and I added back 70% of the $630K that was for the amortisation of the customer relationship intangible relating to the NCML acquisition, which will not be repeated, and I divided the result by the weighted average number of ordinary shares of 146,606,000.
The debt to equity ratio is now about 8%. I did not attempt to work out the ROE, but you can assume it will be marginally better than the return on capital, because TGA carries little debt.
Roger Montgomery
:
Simply, clearly and convincingly put. Simply well done. Disclosure, we own it too. Seek and take personal professional advice.
Michael Horn
:
This post addresses two shortcomings in my earlier post – namely:
* I forgot to adjust the normalised basis of the EPS to recognise that the NCML acquisition occasioned a period of higher interest payment (about $600K), which because of the capital raising, will not be repeated, and hence it uplifts the forward projections; and
* I did not supply the ROE metrics, because I was too tired to expend the time finding the numbers that night.
On editing what I wrote below, I realised that the words seemed to have developed legs, and run off on their own. However, it is easier to let the wording stand than invest time paring them back to only cover the above two shortcomings.
FOREWORD PROJECTIONS BASED ON NORMALISED METRICS
My forward projections are higher than what brokers and others suggest, but I prefer my own numbers because I do not know the underlying arithmetic of the alternatives. Apart from normalising EPS by adjusting for one-offs (including the interest spike), I assumed an EPS growth of 11%, which is not over the top relative to five years’ history (see later in this post). On the matter of history, I normalised the EPS for YE 30/3/2007 by using the “adjusted” figure of 5.05 cents suggested by Thorn Group to accommodate the shares issued in the IPO of December 2006 (Skaffold does not do this, which may create the impression that TGA went backward for YE 30/3/2008). The correct EPS trajectory is important, because a steady trend allows one to project the future with a higher level of comfort, which should also adjust the risk-adjusted required rate of return that one assigns to TGA (I am happy with 10%).
Normally, I would question numbers that are higher than consensus, but the Interim Report for H1 ended 30/9/11 reports a considerable increase in the average months outstanding on contracts to 27 months (it was, I think, 23 months a year ago), and this will translate into increased revenue, other things being equal. Also, the Outlook Statement forecasts a “substantial” increase in revenue for YE 30/3/2012, and in my experience TGA is modest with its outlook statements, so I expect a surprise to the upside. As an aside, Skaffold reports that the last report is for H1 of 2010, whereas it is for H1 of 2011. Of course my thinking will not be 100% correct, but that is what I think will happen, and if I am wrong, it will not be a train smash – future results will simply be good, rather than very good.
ROE METRICS
As for the ROE, two days ago I decided to compare TGA to WOW, and lest it be interesting, rather than simply copying the ROE row for TGA, I have dumped all the rows for both stocks. The collection of metrics suggests to me that TGA is the better investment if one is not wedded to the idea of only investing in large and liquid stocks. One may query why I compared such dissimilar companies. The answer is that there is no company that I can think of that offers me a superior comparison for TGA, and both firms have revenue streams that are stable in both good and bad times, and their customer demographics have something like an 80% overlap. TGA has its YE on 30 March, so the comparable periods do not exactly match, which is why I have a 2-line header below.
WOW – – – – – – – – – – Jun 2007 – – Jun 2008 – – Jun 2009 – – Jun 2010 – – Jun 2011
TGA — – – – – – – – – – Mar 2007 – – Mar 2008 – – Mar 2009 – Mar 2010 – – Mar 2011
W – Book Value – – – – – $4.37 – – – – – $4.95 – – – – $5.57 – – – – $6.15 – – – – $6.24
T – Book Value – – — – – $0.42 – – – – – $0.48 – – – – $0.53 – – – – $0.62 – – – – $0.72
W – EPS – – – – – – – – – – 107.8c – – – – 133.5c – – – 149.7c – – – – 163.2c – – – 171.5c
T – EPS – – – – – – – – – – – 5.1c * – – – – – 8.3c – – – – – 9.4c – – – – – 14.9c – – – – 16.7c
W – Dividend – – – – – – – 74.0c – – – – – 92.0c – – – 104.0c – – – – – 115.0c – – 122.0c
T – Dividend – – – – – – – – 1.0c – – – – – – 4.2c – – – – – 4.7c – – – – – – 6.2c – – – – 8.4c
W – Debt/Equity – – – – – 55.7% – – – – 44.5% – – – – 45% – – – – – 45.3% – – – 61.8%
T – Debt/Equity – – – – – 14.7% – – – – – 8.0% – – – – 8.7% – – – – – – 7.3% – – – 37.9%** (now 8%)
W – Return on capital – – 19% – – – – – 22% – – – – – 20% – – – – – – 21% – – – – – 21%
T – Return on capital% – 13% – – – — -18% – – – – – 17% – – – – – – 24% – – – – – 17%** (NCLP)
W – Return on Equity – 24.5% – – – – 27.2% – – – – – 27% – – – – 26.7% – – – – 27.5%
T – Return on Equity – 12.0 % – – – – 17.5% – – – – 17.8% – – – – 23.8% – – – – 23.2%
* TGA floated in December 2006, so in its own reporting TGA has an “adjusted” EPS to 5.05c.
** TGA acquired NCLP a few weeks before YE 30/09/10 using borrowed funds, and these were substantially repaid via a $30 million capital raising six months later, so these figures (37.9% debt/equity and the 17% return on capital are aberrations that do not apply today).
POSTSCRIPT
Within weeks TGA will have five years of history as an ASX listed company, and in recent months it slipped into the ASX 300 list. This makes it less likely to be excluded by filters applied by brokers and the likes of Team Invest, so I think a new investor demographic will emerge in coming years – more middle-sized investors like SMSFs with tens of thousands invested. Currently there seem to be a few large institutional shareholders and some individuals who in recent months have substantially been inactive while hordes of dabblers have been trading minuscule parcels for reasons that probably lack substance because it would make no sense investing time in a transaction of $1K or less.
Be wary of the stock market opinions of others (mine especially) – they may not know as much as they pretend to know, or even know what they don’t know, or they may have self-serving agendas – do your own research, make your own assumptions and do your own arithmetic. Also, if I opine that a share should do well, I am probably thinking within a three-year time frame, and using a required rate of return of 10%, whereas you the reader may be thinking weeks, and want 15% return for TGA, or you may have stumbled on a gem that is so good that investing in TGA does not warrant thought.
Darren
:
G’day Roger,
In the light of Buffett’s big bet on IBM, what local companies are in the same space? I would need to do more research but I was thinking both DTL and SMX operate in a similar area to big blue.
Cheers.
Michael Horn
:
There is nobody other than IBM in the mainframe space, and its licensing of the z/OS operating systems software is a licence to print money, with only a few pesky independent software houses like CA (Computer Associates) and Compuware nibbling at the edges, plus a few much smaller niche players like Syncsort.
If you step down into the so-called midrange market, there is Oracle, who now own Sun Microsystems and many other vendors who Oracle have acquired, and this includes Storage Tech, who Sun had acquired a few years earlier. The operating systems in this space tend to be UNIX based, which is not a profitable area to be in, because it uses open systems IP. Oracle made its initial pile of money in the Relational Database, where it owned the IP outright. HP is in this space, but it might be struggling.
Below that one gets into the desktop space, although the same technology can be used as “servers”, and hence overlap with the midrange. Microsoft is the dominant player, and Windows is the dominant operating system. Flavours of Unix can run on desktops (and servers of that architecture, but there is no money to be had there.
Below that one gets into all sorts of devices and operating systems and network environments. Apple is the one USA player that springs to mind. I do not know much about the likes of Google, but I understand it is doing very well.
Roger Gibson
:
Roger, has the Skaffold team tried using the software to investigate the theory that the rate of change of intrinsic value is in proportion to its deviation from the price? I see being able to establish this as central to balancing a portfolio in proportion to margin of safety. I look forward to being able to have a play.
Michael Horn
:
At current prices I like TGA and SGH – both seem to have good metrics, but more importantly, are not much exposed to the vicissitudes of the Australian and world economies, and neither are they exposed to a few customers like some mining services firms, which reduces the threat of sudden downward spikes of revenue. Both also have revenue buffers – rental revenue in the case of TGA and work in progress in the case of SGH, which makes it easier to predict future revenue.
I hold both stock – enough TGA in two holdings to put me in the top-20 shareholders if they were combined (I should sell some to lessen that exposure, but not at the current SP). I would buy more SGH, but I do not have the loose funds to do so. I hope TGA goes up so I can sell some (10%), and SGH stays down so I can buy some more when I sell some TGA.
I had 5040 PTM from when they floated at $5, but sold yesterday at $3.96, because the FUM (Funds Under Management) seem to be retreating, and the cash realised can be diverted to pay for TGA shares that I bought with borrowed money – that is, reduce that debt. I should have sold PTM a week or so after the float, but did not through inertia, rather than any belief that the SP was equal to or below IV.
Roger Montgomery
:
That brings back memories. I do remember selling PTM on the first day. At the time the valuation was $5.00 and it listed at over $8.00. Three days later we discovered that joining us in the selling on the first day was a founder.
Greg Mc
:
Like you say Roger, value investors both buy and sell a bit early. Day 2 after listing was where the big money was…
Ricardo C
:
Just wondering if you could take a look at Ausdrill (ASX:ASL) and what your thoughts regarding IV as well any further fundamental thoughts.
Regards
Monkey Salad
:
I have recently bought into TGA
It is basically priced for no growth and from their recent releases the core rental business appears to be going well.
A large % of their revenue is recurring, which will partly insulate it against any large external shocks.
Good buying at $1.60
Michael Horn
:
I have TGA shares (too many relative to my total wealth), and I can assure you that having so many TGA shares focuses my mind on its business. Being a value investor, I do not worry too much about the weird movements of TGA’s SP.
The management tend to announce very little, but in the four years since I have been investing in TGA, I have never known them to talk up the stock, and hence one can attach much to the sentiments that they express, and for now that is that the main cash generating business, Radio Rentals and Rentlo, is doing well, as are the minor lines, except perhaps NCML. TGA has shown good growth since listing, including through the miss-named GFC. TGA is growing EPS very nicely thank you, but I do not want to proffer metrics in this post, because the Interim Report is due circa 22 November, so I would rather wait before I revisit the financial mathematics. I could write a weighty tome about TGA, but I’ll constrain myself for now.
In respect to the NCML acquisition, I was neutral towards it per se, and a bit negative when TGA requested shareholders to pay for the acquisition via a rights issue – I like my investments to internally fund growth, and secondly, TGA could have easily carried the debt, and whittled it down over time. That the MD did not participate in the rights issue was also a negative. What turned a minor negative into a middle-sized negative was the loss of a seat on the ATO’s panel of debt-collection service providers, which was worth about $3.5 million a year, and one presumes about $1.3 million profit (about 1 cent off the EPS in loose terms). I have experience in Commonwealth procurement, so failure to remain on the debt-collection services panel surprises me. Anyhow, NCML is a small part of the whole, so all we should do is remove a few sparkles from the shining star that is TGA.
In about two weeks time after I have seen the Interim Report, I will post my views on TGA (with supporting metrics). I do not expect the report is going to surprise me in any way, but as the event is so soon, there is no point in not waiting.
Michael Horn
:
Today I stumbled on an analysis of TGA. The report is a mixture of fundamental analysis, Retail Sector comparison and technical analysis. I did not read the report minutely, because being neither a buyer nor a seller currently, I am uninterested in technical analysis, and comparisons to the Retail Sector are spurious because TGA is a unique beast, being more a finance company than a retailer.
The report suggests that TGA had one decline in earnings in the last five years. From memory, TGA (then RRA) floated in the YE 30/3/2007, and the incomplete figures for that financial year are best ignored. I do not think TGA has ever gone backward, so it passes that Benjamin Graham criterion with distinction. As an aside, in respect to sales, the sales figures per share that one sees via Westpac broking (probably the same for Comsec) show a decline for YE 30/3/2010, but figures in the Annual General Report, which aptly uses the term “Revenue”, rather than “Sales” reports growth. Whether one divides revenue by Share Number, Weighted Average Share Number or Diluted Weighted Average Share Number, all show an increase in YE 30/3/2010 over YE 30/3/2009.
It will be much more interesting to take the half-year figures to be published next week, and extrapolate for YE 30/3/2012, and then to look at the metrics starting with YE 30/3/2008 with a view to extrapolating further into the future. The loss of the profit from the ATO business should be offset by the one-off NCML acquisition cost of $1 million that will not be repeated in the current year, so extending trend lines for EPS should give a reasonable result if one using actual rather than normalised figures.
As at COB today (Thursday, 9/11/11), TGA’s SP has increased to $1.71 from Friday’s close of $1.60, so from a margin of safety perspective, some of the shine has come off for those contemplating getting in. For the long term investor, this may be neither here nor there.
Jeff
:
Just watched the interview on CNBC and I am now confused and have a couple of questions.
1)You said you are no longer buying. Does this mean you are selling as well?
2)Doesn’t this “not buying” fly in the face of what you have been teaching us? I can remember you saying numerous times that you “don’t worry about the macro”, “just focus on exceptional business’s at discounts”, “this too will pass” “Valuable investors often buy and sell a bit early”,”don’t be frightened to buy when you see value” and so on.
Need some help here please.
jeff
Roger Montgomery
:
Hey Jeff,
http://video.cnbc.com/gallery/?video=3000054986
Our valuations are lower and that is influencing our view. When the facts change, you have to respond. We only buy high quality with bright prospects at substantial discounts to IV. If that fact changes, then we must act accordingly. As I said in the interview, we have found that our valuations are lower as a result of the constant process of re-evaluating the prospects for the businesses in which we are interested. As I also said in the interview; This is based on what companies are telling us. Credit growth, building approvals etc are all going to influence what company management think the prospects for their business are. I also recall saying that compressed Iron Margins will impact valuations. ANZ’s profit growth was driven by reductions in bad debt provisions. If previously our valuation was $10 and the shares are $9.00, then there may have been an interest in buying. If the new valuation is $9.00 then the margin of safety is not there. And where the valuation has fallen and we have previously purchased, the absence of a margin of safety or the absence of a good clip in the growth rate in intrinsic value in future years as a result of our constant process of re-evaluating the prospects for the businesses, means yes, we would sell. Trust that helps and don’t forget, we could be wrong in the short term!
Kent Bermingham
:
Jeff,
“we could be wrong in the short term!”
This is a very pertinent statement from Roger, there may be some fund managers posturing performances as we lead up to Xmas but watch out for the next phase of the European Crisis, which will make Greece pale in significance.
Be careful, very, very careful as valuations may be extremely different in 3 months time!
Michael
:
Given the amount of people who are saying to watch out for the European crisis, this makes me more confident that there is very little to worry about (from a stockmarket perspective). I have bought very little this year, but the time is right now to buy, and not be over cautious about the debt, interest rates, the possible double dip, the exchange rate, inflation, deflation, consumer sentiment and the unemployment rate. If you would prefer to wait until you are no longer concerned about these things, thats fine, as long as you are also prepared to pay higher prices.
Matthew R
:
I don’t have an opinion on where the market is going, but I’m not sure we have seen the full effects of bankrupt european governments quite yet. When it becomes a topic of conversation on the bus, at the water fountain (in a school, not an investment bank), it goes on Kerry-Anne, ie when everyone knows the market is crashing and everyone is commenting on it……. That is the bottom.
On a related note however, has anyone noticed the increased frequency of TV and radio advertisements for property investment? Phrases like “secure your financial future today”, “all you need to get started is $1000” and “anyone can do it” abound…. When I start seeing advertising like that it makes me wonder.
Steve Moriarty
:
Roger,
Setting aside the qualitative judgements regarding future valuations, will it be possible to use Skaffold to aggregate future valuations of a large number of companies? So for examples, would it be possible to look at the 2013 valuations of the top 100 companies, aggregate them and if these 2013 valuations are declining for large portion, one could determine that the market may be heading downwards?
regards
Steve
Roger Montgomery
:
There’s an even simpler way to achieve that! We have been using it for some time. It’s one of the Aerial Viewer screens.
Peter
:
Roger,
You keep saying ANZ’s profit growth was driven by reductions in impairments, as if that was a bad thing, but if you look at NAB & WBC, you will see they also had reductions in this area. That is just the nature of the lending world at this time and I fail to see why it’s a negative, and especially why you single out ANZ.
Peter
Roger Montgomery
:
Exactly Peter! The fact that profit growth was dominated by that accounting entry means that the other sources of profit increases – credit growth – was very slow. Combined with the fact that since 2008 deposit growth has exceeded loan growth by $49 billion, the slow credit growth has implications for retailers and the other cylinders of the economy (building) that haven’t been firing. Thanks for sharing your insights Peter. Its quite acceptable that you don’t see this as a negative, every buyer of ANZ shares agrees with you. Keep in mind we may be a shareholder in ANZ.
Tim S
:
Hi Roger,
Seems like everyone has taken the weekend off.
Just had a look at whats included in the ASX Industrials list; I think the following are good but would like to get your view as well-
CPB – Expensive
SEK – About to be glutted with cash which is good but what are they going to do with it? and I think its expensive
MND – Great company but again expensive
MIN – Has been a winner.
DCG
CCP
FGE and GNG – great mining services companies that are looking quite favourable as far as the IV is concerned (FGE more so). As you mentioned on YMYC, mining services are running on the back of the mining boom; how long will it last is the question on all our lips and the only caveat for those types of companies going from hero to zero.
Roger, can Skaffold be used for some international securities? If not can you give us views via the blog? I know we are focusing more on ASX companies here on the blog but I really enjoyed your post on Apple so it would be good to get your thoughts.
Yes thank your friend Nick for sharing his experience of Italy. I was there a year ago and people were very pessimistic then. I also was only speaking to a friend a couple of weeks ago saying that the focus will most probably shift to Italy… Makes me wonder how it all will play out. With all this uncertainty it definitely gives us the opportunity to demand a greater MOS to IV hopefully more so over the next 12 months.
Look forward to seeing your list.
Peter
:
Roger,
Two questions about Skaffold.
When is it going to be available ?
Why did you feel the need to source this from overseas ?
Peter
Roger Montgomery
:
This week I am told, Peter. Regarding your second question; why not?
LukeS
:
Smarties are to M&Ms as Woolies is to Coles
Michael Horn
:
Smarties and M&Ms may both be made by FFI, who according to the last annual report, or the one before, have a new machine that spits these multi-coloured sugar pellets out on contract.
PeterB
:
Smarties does not have any artificial colouring, M&M does. How about Woolies?
PeterB
Andrew
:
Without seeing the episode so i do not know the rationale behind the prediction (but look eager to reading about), i thought i would supply some companys which i think are overpriced and could be attractive if they have a decent fall.
Firstly most of my companys are still at a premium so it makes up most of my watchlist.
The list companys- REA, WTF, WEB, SEK, CRZ
All are too expensive for me to different degree’s but still quite attractive competitively and have good cash generating abilities and very little in the way of capital expenditure needed to generate those profits. My ranking of these companies has changed but will happily at the right price pick up any of them.
One that doesn’t get discussed too often and probably a few people will disagree with, David Jones. Currently too expensive but i think has great potential into falling into the unloved category. I think they at the right price would make a good investment and i can see value into their offering and their strategy. The new brands they have brought into their fold (most exclusively) will be very popular, online retailing is a threat but DJ’s are still relevent and at a decent price i would happily snap up a few handbags worth of shares.
I would like to see Oroton get a bit cheaper, i have them at a premium to 2012 but a small discount to 2012 (my forecasts are very conservative as i am factoring in the fact that they can’t have a 70-80% ROE forever)
Flight Centre i think will be primed for a fall, now that the $AU is starting to come down from its high’s i can see demand for international flights start to dwindle. This will lead i think to some people being dissapointed with results and selling off. Also, once again i think it is overpriced and if the market drops significantly than so should this company.
Others that come to mind are Computershare, Woolworths, CBA, Blackmores and Reckon
On the flip side, i would like to see JBH go down further however with interest rates starting to be cut easing some cost of living pressures and christmas starting to come up i would not be surprised to see them starting to use their oily rag they run on to produce some decent results.
Warning, this post appears to contain a fair chunk of my own speculation, but i do think they are all quality companys
Jason Drewe
:
Thanks Ash. Must admit to a bit of personal interest in these shares, particularly a large holding (and was building) in QBE until I read Roger’s book. I sense Roger may throw QBE, Brambles, Hills and other companies out of love at us very soon. By the way I contribute very little due to time restraints but do browse this blog a lot and you clearly are a very good value investor – Regards Jason
Robert
:
Hi Roger,
I have been reading ” A bull in China” by Jim Rogers with interest. The sections on energy, tourism, agriculture/consumer foods are very interesting.
Accordingly, I am interested in identifying superior western & asian based businesses that will benefit from the long term growth of China & Asia. Could you suggest a stock information source (such as morningstar here) that will allow me to search & filter business with desirable ROE & gearing levels so that I can then undertake more in-depth research.
Kind regards,
Robert
Nic Arena
:
In no particular order (All these businesses would be close to A1s just expensive – in my view):
*Campbell Brothers
*Macquarie Telecom
*Technology One
*Iress Market Tech (sorry I know alot of people like this one)
*Seek
*CSL (not hugely expensive but about 20% over) (again I know alot of people love this company – question id growth in IV over the next few years???)
Some great companies that I would consider purchasing if the share price is hammered over the next year but currently above their IV.
Roger Montgomery
:
I am a solutely delighted to hear you talking of expected rate of change in future intrinsic values.
Jason Drewe
:
Hi
Having looked through the industrial companies in the AXS list, I would like to nominate REC, ZGL, CPB, CCP and QBE for consideration – Kind Regards Jason
Roger Montgomery
:
Thanks Jason. Anyone else?
Ash Little
:
Just my view but in order if listing
will have a look, no , no, yes, no
But this is just my thoughts so don’t be offended
Raymond
:
Just a question Ash, is that a no for CCP? If so, could you briefly share your reasoning on that please – Regards, Raymond
Andrew
:
I think he was saying yes to CCP
Ash Little
:
Yep Andrew,
CCP is a yes, and that was before the profit upgrade today
Raymond
:
Thanks Ash, appreciate your input and commentary – Raymond
Nic Arena
:
Would have a look at ZGL and CCP. Both need to be a little cheaper but close. Just need some more bad news and they could get there.
Roger Gibson
:
Who is REC? For the rest I agree with Ash.
James
:
There’s a lot of uncertainty at the moment – the Europe crisis, the US not recovering, what will happen with interest rates, and why was value.able tv shutdown.
Roger Montgomery
:
Value.able TV will return next week. We were working on the programming…
Matty
:
Eye spy with my value eye two stocks beginning with S:
2011 IV 2012IV Price MOS
SEK $3.26 $4.74 $5.90 -81%/-24%
SRX $3.32 $4.10 $4.60 -39%/-12%
SEK high debt >60% but interesting growth opportunities
SRX Looks like a promising product, but unsure of the profit forecasts.
Simon
:
James Hardie Industries JHX and Fortescue Metals Group Limited FMG are two companies that top my list of companies to avoid. Debt coupled with falling comodity prices and enemic growth in the U.S construction requires a significant MOS that at todays prices wouldn’t be met in these two companies even if they fell by 40% overnight!
Harley
:
If Scaffold does not bloom next week can we check some “old fashioned value calculations” with your team.?
Roger Montgomery
:
Sure Harley.
Gabe
:
I have to agree with Michael 4-11- comments and I am shocked that anyone could make the statement of once in lifetime opp. in next yr.
There is no doubt about poor quality buys – But Extremely overpriced
ones, Roger I am keen to see that list – nothing comes to my mind.
The Banks and Miners still offer the best foundation looking forward with reasonable risk – by the way did anyone sell and make 12% GP
in the last 10 days – It is still a short term high risk play – but you have to have a core holding for the longer term – Aust. businesses are in deep trouble this will become evident after the 1st qtr. 2012.
and a severe downturn to follow. Bye for now.
Michael
:
Hi Roger,
When two experts agree on the future direction of the stockmarket, there is an 82% chance that they are both wrong based on my observations.
I see that the next 12 months will be the final phase of the bull market that started in March 2009. So 2012 will be a year of underperformance for those who are concerned about Europes debts and the possible double dip in the US. These are known factors. When crashes happen, it is when there is too much optimism. We are not at that point now.
The once in a lifetime opportunity is a few years away yet – mid to late in the decade – when people have abandoned the stockmarket, they think it always goes down, and when the debt issues have been worked through but people are no longer taking notice.
Eric
:
I have been closely watching the price of BHP, RIO, CBA and WBC and have used the volatility to purchase few more of each over the last few months.
Roger Montgomery
:
Hi Eric,
How have you considered and incorporated the declining Iron Ore price into your decision?
Eric
:
I am aware that the Iron Ore price will drop but, unless I am doing something basically wrong, my calcs on the IV of BHP at about $89 and RIO at about $151 for 2011 based upon performance over last ten years and latest forecasts.
My personal belief is that the Iron Ore price will not decline substantially over the next year or so due to demand and growth of India and China.
Hope my theory is correct!!
Roger Montgomery
:
Hi Eric,
Your valuation will be based on a profit figure, which in turn is dependent on revenue. If half of BHPs profits come from Iron Ore and prices have recently dropped by a third then the impact on your estimate of value could be meaningful. What iron ore price does your valuation assume? That’s one of the helpful questions to ask when deciding if it is conservative or not.
Liz
:
If you look at:http://www.standardandpoors.com/indices/sp-asx-200/en/us/?indexId=spausta200audff–p-au—-##
The performance of the industrial index over 5 years has been -10.2% with consumer discretionary -13.25% being the worst performer. Consumer staples and energy have performed best; but nothing to cheer about so in many cases the divvies (eg Banks, WOW, WES) have been good but capital base has been eroded. TLS has been one of the better ones; you could have picked them up for 2.67 this time last year!
Eric I hope I’m wrong but there are plenty of reports indicating that commodity prices will decline including Fe (there’s a lot more coming on stream in the next few years). Steel mills are going broke or losing money in the markets they sell into – including China. They will survive but I wouldn’t be buying either right now. Capital costs are continuing to increase as well. I think it’s a traders market – volatility, not to mention plenty of chaos globally. I have a problem with ‘intrinsic value’ in the context of global events – not the concept – but the belief that we may have to ‘devalue’ value (if that makes sense) globally. I’m not buying anything because unraveling the debt mess must mean ‘less’ before ‘more’. I’m watching stock like DMP and ARP but whilst market momentum is quite negative I wonder if ‘value’ buying right now might offer better value next year?
Dave W
:
Hi Roger
Doesn’t Iron Ore have an IV (or equivalent)? Taking the long term view that you advocate for shares, shouldn’t you look at the long term IV for Iron Ore when considering its impacts on the long term share prices of BHP, RIO and the like?
The growth in population and urbanisation in China and India will ensure consistently high demand for Iron Ore at least to the middle of the century. The increases in Urban population for China and India will be (UN medium variant):
China – 2010 – 630m
China – 2050 – 948m
India – 2010 – 367m
India – 2050 – 917m
These are huge increases (especially in India) and ongoing construction will be needed to accommodate these populations.
Of course short term fluctuations in Iron Ore price might produce even better buying opportunities for BHP and RIO (something that I am hoping for!). Obviously there is a risk that short term growth issues (including in China) could lead to depressed commodity prices (in the short term), and these companies could experience short term price declines, which could be substantial considering the volatility of many resource stock prices.
Would you recommend that turning off the market also applies to commodity markets, which, like equity markets, are also driven by speculation and reflect price, not value?
Luke
:
Hi Dave,
That is the deamnd side, but perhaps you also need to look at supply side.
Regards
Luke
Eric
:
Hi Roger
Thanks for the information and I will take it on board. I am new at share investing and gratefully accept the feedback.
I note that recently the Iron Ore prices, have fallen from U$180/t to U$120/t which is 30%. BHP made $20b profit and if I assume that 50% is from Iron Ore and that the previous profit was based upon U$180/t then with the 30% drop they would have made U$17b. Assuming that all other factors stay the same then IV drops to about $67.60 / share. Current share price still looks good value to me.
Do you agree with my reasoning?
Roger Montgomery
:
Hi Eric,
What cost of production did you use and what margin did you arrive at?
Eric
:
Hi Roger
Have not delved into that much detail and I do appreciate that production costs increase all the time. Having said that so does the cost to produce diesel and petrol and they keep putting the price of fuel up all the time to retain margins. People still buy petrol and diesel and do a lot of mileage.
As explained above my interest in investing has just started a few years back and limited time available for research because of my day job. Would love to have more time to do all of the necessary and correct research.
I did however find enough time to read your book from cover to cover and am a lot wiser now than when I started in 2007.
Liz
:
Hi Eric, FE prices are down – about 30 – 35% since September and the market in China is soft right now. Annual pricing has gone to quarterly and now monthly in many cases so the situation is fluid and volatile. I have read forecasts of +50% more supply by 2015. Even with Indian and Chinese demand, that’s a lot more Fe on the market, and, the Chinese and Indians have also invested elsewhere. One thing Rio, BHP and Vale have going for them is that even if prices drop their brownfield sites are lower cost than anyone else! Hope this helps a bit.
Liz
:
I should have added a) if the ‘cost’ of pdn for any project is anywhere near the $100 mark, its too high.b) If the steel makers are losing money/going broke – and many are – then something has to give.
Rod
:
Last time I saw their reports, FMG was producing at about AUD49/tonne, but I have no figure for BHP.
Matty
:
I found a recent BHP iron ore presentation on their website that shows their cost of production under $40, somewhere around the $38 mark.
Total profit for BHP was around $23.6 billion. Iron ore as a segment contributes around $13.3 billion EBIT, say $10 billion contribution after tax profit. (Bear with me I am not an expert here on how to treat this but just feeling my way into the potential risks).
Average price for Fe2O3 was around $167 for 2011 producing 134 m. Tonnes. Who knows what the average price will be for 2012, but let us assume $80/t (Around GFC lows) to be really pessimistic. If we assume they increase production by 8% then we get EBIT around 6 billion. Assuming nothing else changes that is a profit of 23.6-4=$19.6 bill.
Checking against a simpler method of $80 million profit impact per US$1 change on the after tax profit given in the Annual report is not as conservative. (80×80 = 6.4 billion impact=> NPAT=17.2 billion)
This really seems the wrong forum to be speculating on commodity price action, but it is a risk factor worth thinking about when it comes to portfolio construction and how much exposure you have to iron ore. This is only one product for BHP but if the economy tanks then petroleum is going with it, which is another big sector for BHP. International oil companies are not on a P/E of 6 for nothing. Investors are expecting oil prices to drop significantly as well by the looks of it. High oil price is another big reason why the economy is struggling in my opinion.
So to end on an IV note I have BHP at $38.21 based on %14RR and taking the ROE to %30 to factor in falling Iron ore price. (Assumption of A$ staying where it is makes this also conservative when you think what will happen to it if we see Fe2O3 at $80, but again this is just speculation). This is around the price on ASX. You will only get safety margin if you buy on LSE where it is trading around 20% cheaper (perhaps because the same currency hedge is not there when commodity prices fall?)
All the best Value investors. Hang in there.
Matty
:
I apologise, please BARE with me, I used the more conservative 17.2 billion profit estimate to get the future ROE estimate.
Matty
:
Of course 6 billion EBIT is around 4.6 billion NPAT so 23.6 -10+4.6=18.2 billion NPAT. Closer to the 17.2 billion, but still not as conservative. So next time I will keep it simple and believe the Annual report figure.
Ok, I will go back in my hole now.
McCoy Pauley
:
In my opinion, it’s very difficult to calculate an intrinsic value for BHP because it’s such a conglomerate. Although the revenue and profit it might derive from its iron ore sales might diminish over time, BHP has invested a significant amount of capital into oil and gas, and a serious calculation of an intrinsic value will need to take into account that, in particular, gas prices are at their lowest level for a long time. If those gas prices increase in the next two or three years, what effect will that have on BHP’s profit?
Ash Little
:
And the Zero growth in the top line from most of our banks
Eric
:
Hi Ash
I have just had a look at the financial past performance and forecast for ANZ, CBA and WBC on CommSec site and they have all made significant profits over the last 4 years through the GFC with shareholder equity increasing each year. Do admit that ROE is in mid teens for each but growth forecasts, except for CBA, seem to be predicted at about 6%.
They all seem to be performing well in my opinion. Might be missing something though??
Roger Montgomery
:
ANZ’s profit growth of $600 million needs to be looked at in light of the $500 reduction (an accounting entry) in provisioning for bad debts. ANZ should generate growth from Asia just be aware it will take time and be more expensive. Credit growth in Australia was just 0.5% last quarter. Construction approvals for the Sep quarter were down 13.9%. If you look back to 2008, ANZ’s deposits grew by $49 billion more than their loan book…Can Bank’s grow profits at twice the economic growth rate? Maybe, maybe not, thats why I keep saying BIG margins of safety required.
Simon
:
It also raises the question: How much of ANZ growth from Asia will be factored in today share price for 2012 profits? Will they meet expectations of analysts for their expansion plans. After listening to Mike Smith I feel that his 2-3 year forcast is surprising conservative in relation to ANZ forward looking ROE as a bank (if they meet all there targets in rolling out branchs and increasing the size of their loan book) either he is having a bet each way or is downplaying the positive benefits of his current strategy compared to NAB, WBC and CBA.
Roger Montgomery
:
And there’s the possibility of an Asian acquisition from a forced European seller…
Ash Little
:
Yes and that would involve a capital raising and at what price if is the capital raising if things are so bad that Europe need to sell…………..Don’t get me wrong……I think Mike Smith is very good but these are unchartered waters…….Good luck
Ash Little
:
My View is to forget the Banks…..we have not had a recession for 20 year……..we are over due for one…….If you think they are cheap now (and they are not) then wait till we have a recression and they fall to their book value (The hard part will be determining book value)…..Most at risk is WBC..they lent heaps when kevie did his cash splash……..All of these loan will now be underwater………..Banks = Avoid in my view
James
:
2009 was a recession, just not under the technical definition. And with the mining boom, this time is different from previous cycles. Deep recessions are less likely in Australia while China is doing well.
Either way I am a value investor and not adopting a short term view.
Lindy Lu
:
WBC is levered to the downside (vs peers) as it has the captive reinsurance sub that wrote the mortgage insurance on a segment of the loans originated.
IIRC whin I looked at this 1 year back the more risky loans had PMI provided from Genworth and the less risky high -LTV were underwritten with risk retained inhouse.
You can pull WBC PMI subs filings from ASIC.
Golden days of Australian banking are behind them.
Kisses, LL
Roger Montgomery
:
No QBE at all then?
Matthew Smith
:
QBE have very conservative underwriters but QBE would need to trade much closer to its $10.4bn book value for me to get excited…1.5 times book would be fine if the historical Average ROE was around 25% or if I was buying a controlling stake and could effect changes to how the float was invested.
But the avg ROE is closer to 15% since ’97 and therefore buying for book value makes more sense to me…same with a bank depending on its ROE
All I want is my 15% return from day one and have it compound from there!!
Have fun
Tim S
:
I didn’t think it fell under the Industrials but would love to know what your view is if your including it in the list.
Ash Little
:
No 4 words strung together in the English languages has lead to more Mania’s Bubbles and Crisis than “This time is different”…..
:-)
BTW Banks got to their book value and below in 2009.
I wish people well with their Banks but remember me when they are half the current price and have a dividend yield of zero
Ash Little
:
Hi Eric,
analyst forecasts are wrong, very wrtong
How can we get a 6% growth when credit growth is less than inflation.
Australian already have alot of debt so at best we will see top line growth being equal to GDP. If we delever though growth will be negative.
Banks may have been good investments over the past 20 years but not the next 20 in my view……..I am avoiding them until Australia has a recession………That will be the time to buy them
Matthew Smith
:
Ash
Check out Wells Fargo if you want to buy a bank which is trading for less than it book value at present…I would suggest thinking about the balance sheet first & what % of equity bad debts could possible destroy…loan books are not all created equally…think Washington Mutual and Freddie & Fannie vs Wells Fargo
Aussie banks with their full recourse lending & the big 4’s necessary existence in Australia’s financial system is my margin of safety.
CBA trading at 2 times book is crazy but at 1 times a potentially very sound safe investment
Peter
:
“CBA trading at 2 times book is crazy”….. yet many on here are happy to pay 6x for COH, 4x for CSL, 4x for ARP, 3x for MCE…and so the list goes on.
CBA at 2x sounds fine to me, (despite what Ash thinks is going to happen to our banks.)
Peter
Ash Little
:
Hi Peter,
This is very funny,
I just had a call from a friend and fellow blogger…
He had been looking back at past blogs and said that I was consistent…….In February I said to pay book value for the banks.
Trust me……….the banks will be at book value in the future………..I just don’t know when.
:-)
Ash Little
:
Hey Matthew,
I am laughing about wells fargo, The reported book value is never never land stuff.
I have said before the had part is working out what the book value is. In Wells fargo’s case it is much less than what is reported.
The Market may be a voting machine in the short term but If you look back at history it has been very accurate at calculating the book value of banks during tough time.
These are just off the top of my head as I have not had a look for 6 weeks or so but bank of america has a book value per share of $23 us……at the time it was trading @ $5 us.
What will happen is that the toxic waste on the banks balance sheet will be written down to $5 per share……..These are massive unrealised losses and by my maths don’t take into account potential losses from the club med problems
My view is(and it is very unpopular here) don’t get excited about banks……People think they are a no risk way to make money…….nothing could be further from the truth…….All Banks…..And yes that includes our big 4 banks are risky.
Anything that makes a 1% return on assets is very very scary in my view.
best of luck
Roger Montgomery
:
Hi Everyone,
Please understand we are talking about stocks and everyone’s opinion about a stock is valid. Etiquette here at the blog is easy to follow; stick to stocks, don’t point fingers and don’t call names. We’re just talking about stocks. The market can accommodate all your views and we really all benefit from your insights.
Matthew Smith
:
Ash,
I appreciate you view about the 1% ROA of banks.
However remember as an equity investor you are interested in the return on the equity portion of the capital structure.
You agree with me about needing to look at the book value and work out if it is going to get wiped out by bad loans or not. I like some confirmation bias every now and then.
I agree with you most people only look at the earnings power of a bank and do the $1bn of earnings / 10% = $10bn of equity value (Buffett)
And that they should also then look at the balance sheet and say well there is $100bn of loans x the discount on the latest prime CMO was 7% = $7bn of loan losses (Graham)
Leaving you with only $3bn of equity.
So if anyone wanted to buy Wells Fargo – I would suggest having a good look at the book value as Peter Pan drops me off more and more dollars each night from never never land.
PS Westpac is my favorite bank due to the bad debt & impaired loans ratios
Matthew Smith
:
Peter,
If CBA is trading at twice its book value and earning 15% on that book value.
If you bought the entire bank for twice the book value what would your return from day 1 be??
It would only be 7.5% and would compound from that point onwards.
Just something for you and others to chew on…
Rici Rici
:
I have been using the recent volatility to buy ‘good quality companies’ at significant discount to intrinsic values.. These include Cabcharge and Treasury Group.
But i have also been buying significantly in ‘average companies’ but at massive discounts to intrinsic value (especially on a look through the cycle approach). These include: Myer, APN, SWM, FXJ, SXL. I have been especially attracted to media companies given the difference between earnings and cash flow per share (whereby cashflow per share is significantly higher than earnings per share).
My nanocap purchase was AMA before the recent share price spike.(now the proud owner of 0.5% of this company, lol)
R. Jay
:
Regarding Rici Rici’s comment about buying “average companies”. Regardless of how cheap they appear, Charlie Munger’s often-quoted aphorism echoes in my head. “When you mix raisons with turds, you’ve still got turds.” I will be following Roger’s advice and sticking to the discipline of buying really good companies when they’re going cheap. There are plenty of such opportunities out there without having to stick your arm deeper into the barrel.
By the way, Roger. Without setting us up for disappointment again … an approximate new launch date ?
Roger Montgomery
:
Hi R.Jay,
The Skaffold Team have told me early next week. I am keen as ever to see Skaffold launched. We are really encouraged by the feedback we are receiving from investors who have noted that would-be competitors are throwing all sorts of incentives at them such as longer free trials and cheaper prices but they’re joining the revolution at Skaffold.
On a separate note, my friend Nick P. is in Italy at the moment – the soon-to-be new heart of the Euromess… he reported back:
“Regarding Europe, that is, italy in particular, I previously thought that the Aussie
media was making things worse than what they are.
Having been here a week, I can tell you that the whole country is engaged
and terrified that they will go broke.
There is 24 hour discussions on TV about the subject and everyone I meet
is so envious of Australia!! I’m tired of explaining that
Australia’s doors are shut to unrestricted immigration.
I have never in all my years, including when we had 19% interest rates in
Oz, witnessed such doom and gloom.
The arguments are the same, does the government spend more money out of
this mess or do we sack every man, woman & child holding government &
service jobs.The argument is passionate and fierce, as you could imagine..”
Ash Little
:
Hi Roger,
Can you thank Nick P for sharing this please
Jim
:
Hi Roger and bloggers
Having just returned from a month in various parts of Italy, I can only reinforce R.Jay’s comments about the doom and gloom. Their gloomy outlook is reinforced because no one has any faith in the government bodies and basically feel they will be at the mercy of whatever Germany wants
Cheers
Jim
Michael
:
Does the doom and gloom make you think the stockmarket will go up or down?