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.
find out about investing with montgomery
Fresh from signing up as CEO of Leighton Holdings in August 2011, Hamish Tyrwhitt seems to have streamlining on his mind. After selling HWE Mining to BHP Billiton for $705m, Leighton have just approved the sale of Thiess Waste Management to Remondis AG for $218m. Proceeds will be used to cut debt which hit$2.14 billion at their 31 December 2011 balance date.
With several earnings downgrades, the Leighton share price performance has been diabolical, down from $61 in late 2007 to the current $16.40 (-74%).
Monday’s announcement of total ANZ job ads falling by 8.9% year on year in June 2012 indicates the slowdown in many Western world economies is gaining momentum Down Under.
The ANZ Australian job ad market series (combined newspaper and online) fell by 1.2% in June 2012 on May 2012. In turn, May’s figure was down 2.6% from April.
The 8.9% year on year decline was driven by 8.5% and 17.5% year on year declines in online and newspaper job advertisements, respectively.
Early Friday morning Australian time saw coordinated easing from three of the World’s largest central banks. Firstly, the Bank of England raised their asset purchase target from GBP325 billion to GBP375 billion. Then the People’s Bank of China cut the one-year lending rate by 0.31 per cent to 6.0 per cent and the one-year deposit rate by 0.25 per cent to 3.0 per cent. China’s June Quarter GDP data is due out this Friday 13 July. Finally, the European Central Bank cut its main rate by 0.25 per cent to a record low 0.75 per cent.
ECB President Mario Draghi told reporters risk to the outlook remain “on the downside”. The European Union is China’s largest export market. At some stage this slowdown will weigh on China’s exports, which account for 40% of its GDP.
Sani Group, China’s biggest maker of construction machines has announced a cut to its workforce.
Given lay-offs did not occur in the down cycles of 2005 and 2008, this is a clear sign some pain is being experienced in China’s industrial heartland.
Sany’s 60,000 staff produces concrete machinery, excavators, cranes, pile drivers and road machinery. Its revenue exceeds RMB80 billion or US$12.5 billion.
With the tripling in demand for machinery in China since 2001, it appears Sany has recently been selling machines on generous credit terms. As a result the machinery maker saw its net receivables double over 2011.
The slowdown in Chinese construction activity is not a good omen for the iron-ore price, currently US$135/tonne. China’s demand accounts for 63% of iron-ore’s global seaborne trade.
Roger provides details of the sad decline of Hastie Group (HST) in this Money Magazine article for July 2012. Read here.
With 580 jobs to go, Perpetual is attempting to cut its way back to exceptional performance – however Roger Montgomery discusses why its glory days will be hard to recapture in this interview broadcast on ABC’s The Business on 25 June 2012. Watch here.
We all know that retailing is doing it tough and there’s hardly bright lights on the horizon. (Of course it is always darkest just before the dawn but our experience is telling us that most analysts are scraping the bottom of the barrel for opportunities when scrounging around trying to pick up scraps of returns from post announcement arbitrage opportunities. Conversely, the frequency of observations in this space suggests those with plenty of spare cash reckon we are close to the bottom).
One business that also happens to be a retailer (as measured by current business unit revenues) and one we have previously owned is Thorn Group but its outperformance of the retail sector is unlikely to be sustained unless its investment in new products pays off.
(NB. Later in the week I will seek permission to give you some School Holiday reading – Michael’s 20-page Magnum Opus on TGA)
The picture at left should really be of the Tortoise from Aesop’s fable The Tortoise and The Hare. You will see why shortly…
It goes without saying that Australian retailers are doing it tough. But just how tough? Compare the share price performance of some household names in retail to the performance of the All Ordinaries index over the past 12 and 24 months.
The high Australian dollar, record outbound tourism, high petrol prices, rising utility costs, indebtedness, a slowing economy, cautious consumers and a structural shift rendering bricks-and-mortar retailers less competitive have seen earnings downgrades come in thick and fast amongst retailers. As well as being tough on the businesses and their managers, retailing has also been a tough place to be an investor.
But one company appears to be bucking the trend, in business terms; that company is Thorn Group (TGA). While the past 12 months have proven just as difficult for the company’s share price as they have for its contemporaries (perhaps not pure peers), it’s the 24-month performance of this business that sets it apart. And if a business does well, the shares usually follow.
Many retailers have seen their share prices decline 40-50%, yet Thorn has delivered an impressive two-year return to shareholders.
Better still, the business continues to do well. In its latest annual report, released last week, Thorn Group reported NPAT up 26.4% (EPS was up 14% post capital raising). A retailer whose bottom line is actually growing is rare in the current environment; compare Thorn with forecasts for JB Hi-Fi (JBH), Harvey Norman (HVN), Myer (MYR) and David Jones (DJS) in 2012.
Tomorrow’s returns to shareholders however will be dependent on how the business performs in the future. So the question, of course, is whether this outperformance is sustainable? I always look for businesses with ‘bright prospects’.
A quick look under the hood reveals Thorn’s Revenue (first column each year) and EBIT (second column each year) breakdown. The key to the group’s prospects – even after the recent acquisition of NCML, which contributed 20% of EBIT growth – is the rental segment, which represents 92.5% of EBIT. It’s also identified by management as the company’s ‘core’ operations.
Clearly, given its contribution to the bottom line, it is the rental segment (not Cash First, Equipment Finance or NCML) that will help identify whether or not the business’ prospects are good. We appreciate that the other segments will/may grow but the company’s slow and steady organic approach to growth will ensure it is the prospects for the Rental/Retail business that determine investor returns in the foreseeable future). In this segment, we find Radio Rentals and Rentlo.
‘Consumer rental operations’ would be an apt description for this segment, which is responsible for the retailing of browngoods, whitegoods, PCs, furniture products and other goods such as gym equipment. The revenue breakdown by product and change in product mix is estimated as follows.
The ‘change’ column raises an eyebrow for me. Over the last two to three years, the rental segment of Thorn has experienced very strong customer growth, driven in the main by its $1 ‘Rent-Try-Buy’ promotion. High single-digit growth rates have been produced across the board.
Recently, however, this rate has fallen to the low single-digit rate of 3.1%, and as can be seen in four out of five product groups, growth is negative, flat or marginal. The hero in the product mix, however, is clearly furniture but in my observation, heroes eventually come unstuck.
I reckon the growth in furniture highlights the fact that consumers tend to ‘rent’ higher ticket items. Deflation in electronics means that the decision to buy over renting is a far less taxing one. The result is more people buying the laptop and LED TV versus renting. Indeed, much has changed in retailing because that which was once aspirational is now disposable. I like that phrase and have now trademarked it!
Couple the low rates of growth with customer churn and an increase in impairment charges on the rental book and we have a stronger case building for a period of muted to possibly negative growth. This is only offset if the company’s aim to extend furniture to outdoor product ranges and extend to new brands (eg Apple) works sufficiently.
According to a recent company presentation, 44% of customers are retained when their old rental agreement matures. That is to say, these customers purchase another product under another contract. This implies that about 56% of all customers will drop off once their first purchase is fully paid. Whether the 44% that remain are upsold and the rate that they are replaced, determines the rate of growth.
In strong growth years, churn is easily offset by more customers entering the business than leaving. And given the strong growth in customers over the past few years, this has been the case.
But when growth rates fall – a sign of a tighter marketplace, changing consumer trends and a potential maturing business (remembering that Thorn grew strongly during the GFC) – churn becomes harder and harder to fight, and the status quo tougher and tougher, as well as more expensive, to maintain.
With an average 27-month contract term, and given strong growth from 2009 onwards, from here the business will likely experience a larger proportion of their 100,000 customer rental agreements coming to term and maturing. Prior comparative period (PCP) comparisons could look less attractive.
Unless that retention rate can be materially lifted, new customers coming in must continue to exceed customers exiting. With the trend into 2013 on the up, the outcome here is likely to be a much tougher battle and flat to slightly negative growth in the core business, which generates in excess of 90% of EBIT.
The key question, therefore, becomes: how long will it take for the investment in new products – Cash First, Equipment Finance and Kiosks – to begin paying off? This will be the next leg in business performance and if that occurs, the share price will, of course, eventually follow.
Thorn is a well-managed business and has a strong balance sheet, cash flow and management, with a track record of delivering new revenue streams through differentiated business models that, with the exception of the NCML acquisition pimple, has been organic. But until those new models begin to gain traction, on my analysis it looks as though the business has a tougher couple of years ahead of it.
Before I head off on holidays I will provide a link to Michael’s Magnum Opus (POST SCRIPT: SEE MICHAEL’S 20-PAGE SPECIAL IN THE COMMENTS BELOW) on TGA where he agrees generally with this conclusion stating:
“I think that Thorn’s growth will slow for 2013, do better in 2014, then experience an up-tick as initiatives like Cashfirst, Thorn Equipment Finance and individual expansion initiatives in Radio Rentals/Rentlo and NCML move from making losses, or small profits, to being acceptably profitable. EPS will grow, but nothing like the EPS CAGR of the last five years.”
And while outperformance over the rest of the retail sector has likely to come to end, the company is one I plan to keep a close eye on.
First Published May 2012. Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 24 June 2012.
To pre-register for the soon-to-be-released Montgomery retail fund visit www.montinvest.com and click the APPLY TO INVEST button. A Pre-Registration Form will appear and after completing it, be sure to select the button “Retail Investor < $500,000″. You will then receive an automated email from my office and be registered to receive the PDS/FSG and Information Booklet as soon as it’s received all of its approvals. If you decide to proceed and/or your advisor does, we look forward to working for you. If you are a planner or advisor or responsible for dealer group approved lists or you are an executive at a research house or ratings agency and would like to discuss next steps feel free to call the Mr David Buckland at the office on (02) 9692 5700. Investments can only be made through the PDS and a Financial Services Guide (‘FSG’) will also be available.
