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.
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Roger Montgomery discusses why excessive focus on High Yield stocks is likely to yield disappointing returns in this Australian article published on 23 June 2012. Read here.
Roger Montgomery and Ross Greenwood discuss the recent Fairfax Media (FXJ) restructuring announcement and its implications in this edition of Ross’ program on Radio 2GB broadcast 20 June 2012. Listen here.
Click on image to enlarge
Recently Mercer released their 1 year fund manager tables to the end of May 2012 (see above table). We decided to compare our returns to the sixty -odd covered in the survey. The red line marks the return and relative ranking of the Montgomery [Private] Fund to those of other managers. If The Montgomery [private] Fund had been covered in the survey, it would rank No#2 all things being equal. The median manager return -9.3%.
As many of you know Montgomery Investment Management recently hired Mr David Buckland as CEO and Mr Tim Kelley as Head of Research. I have linked the Press Releases of their appointments with their names and you can simply click on their names above to see their backgrounds and credentials.
David has wasted no time preparing a new Product Disclosure Statement for The Montgomery Fund. The Montgomery Fund will be a Retail Fund that will continue in the value investing tradition already employed here with great success for the very small group of investors we work for in the wholesale The Montgomery [Private] Fund.
With the hiring of Mr David Buckland and Mr Tim Kelley we now have the capacity to offer the benefits of our unique value investing style to all investors for the first time. Of course investments will only be able to be made through the form that accompanies the Product Disclosure Statement, which will also disclose other material information such as fees and charges and personnel.
Prospective investors should seek and take personal professonal advice before making any investment decision.
At our meeting today, we discussed an anticipated August launch date as well as providing access to investment insights exclusively to The Montgomery Fund investors.
If you have been interested in investing but felt the $1 million minimum for The Montgomery [Private] Fund is not appropriate for your circumstances, then the retail The Montgomery Fund could be worth discussing with your adviser or accountant. We currently anticipate offering a minimum investment application of $25,000.
Once again please be sure to read the PDS in its entirety and seek and take personal professional advice.
I will soon be sending you correspondence to pre-register your interest.
If however you feel you might miss that correspondence, your email has recently changed or you will be away, you can pre-register at www.montinvest.com and click the APPLY TO INVEST button. The above 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 as soon as it’s received all of its approvals. If you decide to proceed and/or your advisor approves, 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.
Please Note: Investments can only be able to be made through the form that accompanies the Product Disclosure Statement, which will also disclose other material information such as fees and charges and personnel.
Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 18 June 2012.
Fairfax Media’s restructure announcement has been welcomed by the market, but what prospects does their revised business model have for future profitability? Roger Montgomery provides his Value.able insights to ABC1’s Ticky Fullerton in this edition of ‘The Business’ broadcast on 18 June 2012. Watch here.
Roger Montgomery discusses why he foresees Gina Rinehart’s substantial shareholding will deliver her board representation in Fairfax Media (FXJ) in this interview with Ticky Fullerton from the 15 June 2012 edition of ABC1’s ‘The Business’. Watch here.
Amid news of Qantas’ latest conniptions and Spain’s arrival on the set of the great euro drama (Italy and France to enter stage right shortly), one Aussie company is quietly going about its business.
That business is ARB Corporation (ARP), and its compelling fundamentals are the reason we have held the company’s shares in the Montgomery Private Fund since inception.
Those fundamentals have also helped to produce acceptable results for Montgomery investors (See Figure 1) amid an otherwise manic, depressive market.
Guided by its founder, Roger Brown, ARB designs, manufactures and distributes accessories for 4WD and light commercial vehicles – something it has focused on solely and successfully for almost as long as I have been alive.
And while producing and selling accessories for 4WDs doesn’t sound like an overly exciting business, consider the fundamentals over the past 10 years.
Since 2002, ARB has managed to grow its after tax earnings from $8.36 million to $37.8 million – a compound growth rate of 18.25% per annum. This is a fantastic achievement and largely organic because it has required just $133.5 million of retained profits and equity – the latter from the issuance of options.
In 2002, $8.36 million profit was generated on $31.2 million of shareholders’ equity, generating a return to owners of 26.8%. Fast forward to 2011 and returns are equally impressive. $37.8 million is being generated on $129.3 million or 29.2%. Many businesses have also grown their profits over the same period of time, but it is far more often that growth has been ‘acquired’ and declining return on equity suggests those acquisitions have been expensive.
Fig. 1 Results are net of all fees.
As the business has grown and developed its economies of scale, returns have actually improved. This is a rare achievement in practice and a development which creates significant value for shareholders.
If you were a part owner of the business in 2002, your shares would have grown steadily in value (not share price) from $1.91 to $8.09. If you believe Benjamin Graham’s observation that in the long run, the market is a “weighing machine’, then you must agree that prices follow valuations over the long run. Provided you can see which businesses are able to increase their per share intrinsic value, there is no longer any need to try and predict share prices! Simply buy high-quality businesses – with rising intrinsic values – at discounts to that intrinsic value.
Figure 2 reveals the change in the ARB’s valuation mapped against its share price over the last decade.
Fig. 2 Skaffold Line ARB and its Intrinsic value 2002-2014*
*Source: www.Skaffold.com 2012-2014 valuations are estimates
(If you have been thinking about becoming a Skaffold member, having a chart like Fig 2 above for every listed Australian company and a chart that is updated automatically and daily coming up to a Greek election, a Spain bailout and a very crucial reporting season is more than just a little helpful. I find it essential. So if you are thinking about a membership to Skaffold, go to www.skaffold.com and take advantage of the 13-months-for-the-price-of-12 “It’s Time” celebration promotion (and be sure to chat to your accountant about any pre-June 30 tax benefits)).
This represents a total value increase over the period of 353.93%. Including $1.76 in fully franked dividends, the business has generated a total return over the past 10 years of 446.1%. Suddenly selling bull bars gets a whole lot more exciting doesn’t it?
Fig. 3
ARB Corporation’s rising valuation and share price clearly reflect the high-quality nature of the business and superior investment fundamentals. You can understand why it’s something we have been attracted to for some time.
Last week we asked whether Thorn Group’s (TGA) recent outperformance was sustainable. The reason to ask is because it’s not the results of the past that will deliver returns to new shareholders, but whether the future matches that which is currently estimated.
To some extent, this question was answered for ARB by its management at the start of May – “The Board expects sales for the full year to be up by about 4% and for profit after tax to be in line with the previous year.”
While it is a slightly disappointing development – the market was expecting more – we think that any growth sans acquisitions in the current economic climate is not something to sneeze at. The business has faced challenging conditions this year following the Japanese earthquake, tsunami and Thailand floods, which together dramatically impacted the supply of new 4WDs. The key risk ahead is what proportion of their sales is impacted by declining iron ore prices feeding into a lower level of capex by mining companies.
Conversely, there is pent-up demand from a lack of vehicles being available for sale in the first half. May car sales data continued to show a strong rebound and indeed a record 38,000 new 4WDs sold out of a total 96,000 in total new cars in Australia. A record and, of course, ARB’s most important business segment.
Add to this the associated pent-up demand of accessories to fit out these new vehicles and what ARB is faced with is a current order book heading into the last three months of the financial year where demand is outstripping supply. An enviable position to be in.
Coupled with a highly capable management team who have not only controlled the businesses operating expenses at a time where sales and revenues were severely impacted, but have also used their conservatively managed and high quality balance sheet to continue expanding their production and distribution capacity to support future growth plans, we think the business has not hit its straps. And remember there are less than 50 stores worldwide.
Until our view changes, which is currently unlikely, this remains to us a business that is already succeeding in expanding overseas, a business that we will happily hold and a business for whom any share price weakness (provided intrinsic value’s remain unchanged) is a signal to accumulate more.
Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 14 June 2012.
Roger Montgomery certainly thinks so – and he explains why Value Investors need to do their homework to experience exceptional returns in this Australian article published on 9 June 2012. Read here.
It is with some excitement that I announce that Mr Tim Kelley will soon be sitting alongside David Buckland, Russell Muldoon and myself at the offices of Montgomery Investment Management.
Tim’s background as a director at Gresham Advisory included M&A advice to the likes of BHP in their bid for RIO as well as their merger with Billiton. You can read our Media Release Here: 20120605_Montgomery_Media_Release.
Tim will be joining at a time of great consternation worldwide and I am sympathetic to the nervousness pervading our markets and more importantly, investors’ portfolios.
We expect volatility to continue for some time as Greece moves another step towards deja vu on June 17.
One of the real issues for the United Nations of Despair of course is that their currency does not reflect their individual predicaments.
Germany is arguably less interested in a collapse of the Euro because it is more competitive than it would be if it returned to the DMark. On the other hand Greece’s exchange rate is overvalued.
But for Australia, Greece is a sideshow that ironically has a huge and real impact. This is because Europe is a giant consumer of Chinese and American products and services. In turn, America is a giant consumer of Chinese products. The butterfly effect ensures China – the driver of the one cylinder of our economy that has been working – slows down.
The Chinese slowdown comes just as the supply of Iron Ore ramps up and Australian economic growth, which was being held up by the resource boom, will be hard hit by a slowdown in resource investment and expansion if iron ore prices resume their slide.
At Montgomery Investment management we have been navigating this latest turn of events with both confidence and a little trepidation. Value investors tend to be early to leave the party and the rally between January and April – a rally in many undeserving companies – left us with a little of an egg-on-the-face feeling.
But sticking to our processes (which involves moving to cash in the absence of companies that meet our criteria for value and quality) will inevitably lead to periods of underperformance. Nevertheless we took advantage of the strong, and arguably unjustified, prices on offer in April to take profits on anything with exposure to the materials sector.
Those of you who have been watching our appearances on TV over the last six months will be familiar with our staunch distaste for mining particularly coal and iron ore. The result of this action to take profits amid what we believe to be declining commodity prices and related-company valuations, has been continued outperformance (see chart, which is net of management fees and charges – an investment in the Montgomery [Private] Fund can only be made by wholesale or sophisticated investor through an application attached to The Information Memorandum).
And so, with market prices declining significantly, we are excited about the value Tim will quickly add for investors in The Montgomery [Private] Fund, right when bargains abound and as markets correct.
If you would like to discuss an investment in The Montgomery [Private] Fund for wholesale investors upon its next opening, please send an email by clicking here and selecting the Apply To Invest tab at the top right hand side.
Finally if you have some time and would like to watch Tom Elliott, Nabila Ahmed (AFR companies Editor) and myself chat with Alan Kohler about Hastie, Iron Ore and Europe click on the screenshot:
Could things get worse? What’s the impact of low interest rates? Who forecastIron Ore prices of $187 tonne?
Should Greece Default?
And a more recent chat on ABC news
Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 5 June 2012.
…Oh and let us know if you like us:
As you already know, despite the enthusiasm for mining service companies back in April, we sold our holdings substantially and in some cases completely. We have not shared our peers’ – some of whom include themselves in the ‘value investing’ camp – enthusiasm for BHP. Our reasoning for this is our thesis regarding iron ore prices, which is unchanged from late last year.
Back then it was simply the classic investment response to higher prices. Iron Ore prices between 1985 and and 2004 have traded between $11 and $15 and in real terms since the 1920’s prices have traded between $30 and $45. In 2004 the price of iron ore started rallying and hit $187 in 2007.
Putting aside the fact that iron ore experts now ‘guess’ $140 is the new medium term price and $100 the long term price, the rally in price from 2004 to now has produced a huge investment boom and turned millionaires into billionaires as they revalue their reserves (or other bulls value them for them).
It follows that the investment boom will now produce additional supply. The impact of this additional supply cannot be anything but falling prices.
Well, that was our thesis. And then China began slowing down. We wrote about that too
If you have been a regular to the Insights Blog, you will be familiar with some of our recent thoughts on iron ore here:
April 3) http://rogermontgomery.com/mining-services-a-crowded-trade/
April 18) http://rogermontgomery.com/building-heaps-piles-at-bhp/
APril 11) http://rogermontgomery.com/will-china-demand-iron-or/
And you can watch this video I published here on December 8 last year:
Since July last year BHP is down 30% and RIO down 36%. Since April and early May they are down 15% and 20% respectively. Many investors are now thinking they are cheap. But there is the possibility of a classic Value Trap.
Forecast valuations may yet decline further, even if share prices bounce. Here’s our thoughts…
PORTFOLIO POINT: BHP and Rio’s review of capex programs represents a stark turnaround from comments made just two months ago, and it’s a worrying sign for the rest of the sector.
BHP is trading at three-year lows, Fortescue is down 17% from recent highs and Rio is visiting lows last seen in 2008. If you own shares in any of these companies, only Telstra would have saved your portfolio from a shellacking.
The big caps, however, are not the only stocks that have suffered. Over recent years, it is likely that you would have observed my interest in mining services. That interest was a product of the presence of value for money.
This is a sector I know well and have covered numerous times. I have discussed and brought listed businesses – including Decmil Group (DCG), Forge Group (FGE) and Matrix Composites & Engineering (MCE) – and IPOs – GR Engineering (GNG) and Maca (MLD) – to your attention.
This was mostly at a time when there was little market interest, despite their apparent growth profiles, quality aggregated balance sheets and (now with the exception of MCE) management.
Today, however, that story is very different and I find myself erring on the side of caution when it comes to ‘picks and shovels’.
Each week, a stronger case is building that a key growth engine for capex spending by our miners is slowing – that is, commodity prices are falling.
Take one commodity I have discussed recently: iron ore.
In 2010-11, world iron ore production grew 8.1% (or 227mt) to 2.80bt. Assuming similar growth levels in 2011-12, iron ore production will grow to 3.04bt, an increase of about 237mt. (In a classic supply response, BHP production is forecast to grow by 20%, Rio by 30% and FMG by 25%.)
And assuming China consumes 60% of global production again (highly optimistic), its demand would increase by 136.2mt. However, moderating growth means current estimates for China’s iron ore requirements are half this level. With few other countries growing or competing heavily with China, who will pick up that supply overhang in a low-growth environment?
By 2015, two entire Pilbara regions (700mt) in supply terms are estimated to come onto the market. It’s a far stretch to expect China to absorb 420mt (60%) of that.
The impact, I expect, is pressure on iron ore prices.
Many other commodities are looking like they are set to suffer a similar fate. Record prices over a decade have created an investment boom that is climaxing at a time when global demand is losing interest. And you need two to tango. When soaring supply meets softening demand, lower prices follow.
So what are the implications? Put simply, for those who dig stuff out of the ground and export it, margins and cash flow will be squeezed (a situation I have been monitoring closely and alerting readers to for at least six months). It’s why I haven’t bought BHP.
In previous periods, a revenue squeeze has been a precursor to capex plan deferrals or delays lasting years. Barely economical projects are shelved as miners focus instead on financing core (capital-intensive) operations, rather than aggressive growth targets.
Indeed, the 1990s was a very different period for miners, and those who serviced the mining sector barely made it onto investment radars. Companies struggled to cover their cost of capital and total annual capex was less than $20 billion for the entire mining industry.
Today, many miners are generating returns on equity in excess of 30% (‘super profits’?) and capex runs in excess of $60 billion per annum. Are such numbers maintainable forever? No. And if it can’t go on forever, it must stop.
Just a few days ago, BHP Billiton and Rio Tinto announced that they are re-evaluating their capital expenditure programs. These comments are in stark contrast to their latest financial reports and presentations made just two months ago.
In those reports, confidence was effervescent and the deployment of $40 billion in a global cash capex spree was on the cards. Today, as China’s growth rate slows and some investors lobby for a greater focus on cost control and returning funds to shareholders, tens of billions of dollars of an extensive development project pipeline is under review.
When the two leading businesses that account for about 35% of total industry investment start to make noise, it’s time to sit up and pay attention.
We are bound to see many other miners follow suit and the chorus is growing louder by the day. Citigroup conducted a survey in April and found that 50% of all miners were considering lowering their investment budgets.
That compares to less than 20% in January.
Figure 1. A picture tells a thousand words
At the start of the financial year, capital expenditure was forecast to rise 34%, with an increase of 18% in 2013.
The forecast today is for a rise of only 13% this year and a fall in 2013. This represents a material deterioration in market conditions in a very short period of time. All of this weighs on the ‘bright prospects’ that once surrounded those companies which service the miners.
This brings us back to Decmil, Forge and investing. I bought both of these businesses in the Montgomery [Private] Fund near its inception.
Forge is a business that has a significant exposure to second-tier miners, especially those expanding their iron ore operations. Decmil, on the other hand, has around 43% of its business exposed to resources and the balance to oil & gas.
While plenty of work is still forecast to be in the pipeline for mining services companies, there are also plenty of companies trying to win it.
If we are at the peak of the current capex cycle, this is as good as it gets in terms of margins for mining services businesses and also workloads.
With that in mind, and coupled with prices increasing to levels I deem attractive for what are businesses with high operating leverage, I have decided to read the writing on the wall and position our investments in a more conservative manner. I sold our Forge holding some weeks ago and also scaled back our holding of Decmil.
It is possible I am early to leave the party – the band is still playing. But the mining industry is bracing for a pullback in investment spending, as the biggest companies reassess their capital expenditure plans amid escalating costs and an uncertain growth outlook. I anticipate that analysts will revise their earnings forecasts lower for 2013 and beyond.
The valuations I look at in Skaffold will also fall, I expect, as those earnings revisions are fed through. Of course, I could also be completely wrong but I reckon the big mining companies’ historical predilections for over-paying for acquisitions (another reason I have been loath to invest) may just revisit them.
The combination of a contracting market and high operating leverage means I simply prefer the safety of cash. Better to be confident of a good return than hopeful of a great one.
This article was first published on May 16, 2012
Roger Montgomery discusses why the forecast profit downgrade foreshadows some creative accounting treatments at financial year end for Qantas in this ABC News interview broadcast 5 June 2012. Watch/Read here.
