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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Among nano caps. Embelton Limited stands out even though its too small to attract broker research. Read Roger’s article at www.eurekareport.com.au.
Amid all the talk of GFC II and the Eurozone unravelling, Warren Buffett’s Berkshire Hathaway Inc. (BRK/A) has been increasing its stake in US bank, Wells Fargo & Co (WFC – 420 Montgomery Street San Francisco).
Buffett (or was it Todd Combs?) topped up Berkshire’s holdings in the world’s 24th biggest bank by 9.7 million shares in the three months to June 2011 (we don’t have more recent information because Berkshire requested and was granted permission to withhold stock specific information). Between 1 March and 30 June – the three months during which the stake was increased – Wells Fargo traded as high as $33 and as low as $27.
WFC currently trades at $25.65 and its book value is $26.10 per share. Paying a small discount to book value for a bank that earns a return of 11.86 per cent on that book value doesn’t seem like a fantastic bargain and paying a premium to book value is perhaps less so. But the fact remains one of the best investors of our generation, reckons it is ok to be selectively buying US banks. Is Buffett going to make off with a bank fortune the way Butch Cassidy did or will he be caught red handed this time? Should you be doing the same as Buffett with Australian Banks?
Wells Fargo is the biggest U.S. home lender (think Commonwealth Bank) and Berkshire is its biggest shareholder. Given Berkshire’s interest in Wells Fargo and Bank of America should be taking a look at our own Banks?
I know there are conflicting and well-articulated opinions here at the blog about the banks, so feel free to add your own thoughts.
Here are mine.
Broadly, the local banking system is in a relatively strong position compared to peers globally. The funding, capital and liquidity position of the major banks has been strengthened and those who fear a housing collapse in Australia should be mindful that such an event would impact consumer confidence and credit growth more than the immediate profits of the banks, who have insured their exposure.
From a funding perspective, bank deposit growth has outstripped lending growth and while further increases in wholesale funding costs could reasonably be expected, the banks are ahead of schedule in raising term wholesale funding that is said to provide 6 months grace. Of course if deposits continue to grow faster than loans, the gap that is funded from overseas wholesale markets diminishes.
As I have previously noted, high levels of leverage at the consumer, company and country level simply take time to pay off. You just don’t go off spending aggressively again until you feel your debt is under control. As a result, it is reasonable to expect bank balance sheet expansion will be muted over the next year or two at least. Some of you may think even longer or permanently…
Globally, the banking picture is at the very least, interesting to watch. The five biggest US banks excluding bank of America posted 8 per cent profit growth, while in the UK the five majors posted H1’11 profits that were half of those reported the year before. Predictably this has resulted in announcements of an intended five billion Sterling cost cutting drive by 2014. In Europe, the largest ten banks saw profits fall less than 8 per cent. Curiously some observers suggest that the present problems befalling sovereigns will have less of an impact on banks than the GFC because sovereign debt is less complex than credit default swaps on collateralized debt obligations and stress testing has been completed and widely reported. With little exposure to European debt and strong growth domestically, Asian banks (with the exception of Japan) are the one bright spot.
Globally, banks are targeting cost to income ratios of less than 40 per cent despite the higher costs associated with reengineering systems and procedures to meet a heightened regulatory environment.
Locally, our major banks have posted more than acceptable profits considering global financial conditions and local consumer and business sentiment, which has remained muted
Growth has been achieved at least partly by the reduction in the provision for bad and doubtful debts. Additionally, the reduction in the aggregate loan impairment charge was 37%; from $8.4 billion to $5.3 billion.
While significant reductions in loan impairment charges can be seen as a positive, future growth in profits – in the absence of a recovery in consumer and business confidence – will have to come from cost cutting.
Collectively, cost cutting is being reflected in some results – cost to income ratios improved for the CBA and NAB and less so for the ANZ and Westpac. Further improvements should be expected and I have been reliably informed to expect significant retrenchments – in the thousands – in the financial services sector, even though full time employees increased at the ANZ and CBA last year. The changes in cost to income ratios should also be seen in the light of the dramatic reductions achieved since the early nineties when cost to income ratios were; ANZ 74%, WBC 68%, CBA 67% and NAB 57%.
Net interest margins – the net margin earned or the difference between interest paid on deposits and interest earned on loans – were broadly unchanged and while the CBA recorded an improvement, this has not been widely reported elsewhere as being materially due to an accounting reclassification of net swap costs. Competition for retail deposits and higher-cost, post-GFC funding as well as regulatory changes forcing an increase in liquid assets put pressure on margins. A broad maintenance of margins is therefore laudable.
The banking industry’s preferred measure of profit is Cash Profit (after tax), which removes the impact of discontinued operations, adjustments for acquisitions, Treasury shares and fair value adjustments.
On this measure, all the banks posted healthy increases.
The ANZ increased profits from $5.1 to $5.6, the CBA $6.1 to $6.8, NAB $4.6 to $5.5 and Westpac from $5.9 to $6.3.
Non-interest income, which includes trading, fees & commissions and Wealth management & insurance (which includes life insurance, superannuation and investment management products), declined in aggregate. Fees & commissions across the major banks were largely steady at just under $12 billion due to a drop in lending offset by an increase in corporate M&A. Wealth management profits fell for all the banks bar Westpac (BT). Profits here are largely a function of equity market performance given the big brand’s focus on index hugging and fund inflows/outflows. Funds under management and administration grew only for the CBA.
The outlook for Australian banks will remain mired by the general ‘funk’ Australian consumers and business are in. Our one-cylinder economy is not going to spur rapid balance sheet expansion (read credit growth) for the banks in the near term. With property prices and volumes in some areas also depressed the number of mortgages and the size of a loan on any individual property is necessarily lower. Banks love mortgages the most because their perceived lower risk means the banks have to provision less for each one they write. You are welcome to discuss your views about the direction of property in Australia in the comments below and I would welcome your thoughts. I think that we shouldn’t expect any immediate recovery in property activity to spur bank balance sheet expansion.
With the details broadly out of the way what are the current estimated valuations and prospects for intrinsic value growth for each of the banks? Keep in mind the intrinsic value expectations for the next three years are based on earnings growth and equity figures as stated in the table included with this column.
Skaffold’s (www.Skaffold.com) current estimated intrinsic values for the banks are: WBC $22.12, ANZ $24.49, CBA $51.54 and NAB $27.69. Of course these will change over the next weeks and months as estimates are updated and the banks make announcements about prospects, acquisitions or capital raisings etc. and I may not update those details here at the Insights Blog.
The bank displaying the greatest estimated margin of safety currently is ANZ, which at the current price, is displaying an estimated safety margin of 16%. Of the others NAB appears to be next, with an estimated margin of safety of 11%, WBC 5% and CBA 3%.
Despite being second on this list, the NAB has produced the lowest returns on equity and assets but also the lowest cost to income ratio, second highest Net interest margin and the highest forecast earnings per share growth for the next three years.
In aggregate the opportunity to buy at either very large discounts or smaller discounts but with solid growth potential does not appear to be available. An investor requiring meaningful margins of safety, would demand lower prices before being seriously interested. I will leave that decision to you after taking personal professional advice of course – from Buffett or your advisor. Growth doesn’t have to be sensational to make attractive returns but in such cases, one should require a large margin of safety to be more certain of a reasonable return.
What are you thoughts about the banks? Have I missed an angle that you would like to add? For example do you think the economic growth prospects are bright for the US compared to Australia? What are your estimates for earnings growth and what are your expectations for the residential, agricultural or commercial property market? I would be delighted to facilitate a discussion on these subjects.
Posted by Roger Montgomery, Value.able author and Fund Manager, 16 November 2011.
I have not discovered a method for predicting the short term direction of share prices. Once we purchase an A1 company’s shares at a discount to intrinsic value, we cannot know what the share price will do in the short term. We do know that provided the prospects for intrinsic value growth remain bright, the weighing machine that is the market will eventually cause share price and intrinsic value to converge.
Thats why it is so valuable to have an current and future intrinsic value estimate for every company updated daily. Having a long term demonstrated track record of intrinsic value growth can also provide us with insights into management’s capital allocation decisions. Knowing what the cash flow profile of a company looks like and whether the company has profitably employed capital entrusted to it by shareholders can further ensure you aren’t overstaying the party.
Soon you too will able to simply and confidently navigate the noisy distraction of the stock market to be shown those securities that deserve your time and avoid those that have a higher probability of permanently impairing your returns. Skaffold is launching now (so keep an eye on your inbox today!)
Last week I spoke on CNBC with my old friend and peer Matthew Kidman.
You can watch the interview here: http://video.cnbc.com/gallery/?video=3000054986
Our view about the market is influenced by how many companies we can find that are both high quality and cheap. I remember back in April this year, we had just started investing on behalf of investors in our fund but we could only find a small group of suitable companies. That was enough to suggest that the other 2050 listed companies were either expensive and or of unsuitable quality. A similar thing appears to be happening now. The lower credit growth and declining iron ore prices have impacted the growth rates of future intrinsic values for banks and resource companies and these dominate our stock market index.
If you are following the Value.able-style approach to value investing, you would only be interested in high quality companies with bright prospects at substantial discounts to IV. If that fact changes as a result of the constant process of re-evaluating the prospects for the businesses in which we are interested, then one must act accordingly.
I cannot tell you whether the market is going to rise or fall in the weeks and months ahead but it does seem that value is a precious and rare commodity. With that in mind, what are the companies that may be most at risk?
We will update this post with a table shortly but here is the short list (keep in mind the issues that have caused the companies to be in this predicament may be temporary): Tap Oil, Neptune Marine, AACo, Somnomed, Elders, Centro and Gunns. I will update soon with a more comprehensive list of expensive C4s and C5s soon.
The current list is not exhaustive, what I have done is taken C4 and C5 companies and sorted them by those that most recently reported cash flows that were unable to cover interest. There are many more but these are the names that piqued my interest and I thought they might pique yours.
Posted by Roger Montgomery, Value.able author and Fund Manager, 09 November 2011.
Good luck trying to buy shares in this boring but reliable business. It is rarely traded and the family owns two-thirds of the shares. Read Roger’s article at www.eurekareport.com.au.
Gerry’s share price and intrinsic value are about what they were in 2003 and the outlook is not encouraging. Read Roger’s article at www.eurekreport.com.au.
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.
The float of Collins Foods earlier in the year at a price of $2.50 did not interest your author. The lack of interest however was not shared by others and the company listed on the ASX with a ‘Top 20 Shareholders’ list that included many if not most of the major nominee companies (Nominee companies have long been established as the mechanism by which asset managers and custodians can process transactions on behalf of their clients).
I wrote a column for Alan Kohler in which I explained why investors might want to reconsider any enthusiasm and you can find the full column here http://rogermontgomery.com/invest-in-kfc-or-just-eat-it/
Much of the commentary around the time of the float referred to the “defensive” nature of fast food restaurants but as we have always suggested here, the only truly defensive stock market investment is an extraordinary business at a large discount to a conservative estimate of its intrinsic value.
One of the issues I had with the float was articulated thus:
“To begin with it is important to note that Pacific Equity Partners (PEP) – the private equity firm behind REDgroup, the parent company of Angus & Robertson and Borders now under administration – will be exiting its stake completely.
“Perhaps more interestingly, the existing management team is cashing in, too. Managing director Kevin Perkins will reduce his holding from over 20 per cent to about 8% and the rest of management will reduce their holding, too.
“When Pacific Equity Partners paid $US210 million in September 2005 (the $US6.92 a share was a 42% premium to the then traded price of $US4.92) for Worldwide Retail Concepts, the US publicly listed company that is now Collins Foods, management then co-invested with a 48% stake. According to all reports, management will now retain just 10%. In other words, management is selling 80% of its holdings into this float.”
Shares fall 50%
The prospectus (which didn’t include the above photo of a genetically modified chook) noted Collins Foods strengths included: “Attractive market dynamics”, “Leading market position” and “strong financial track record”. But just two months after the float, Collins Foods has warned that it will miss prospectus forecasts. The shares are down 50% at the time of writing after the company stated that it would miss forecasted by almost a third (up to 27% to be precise). Collins Food said that the downgrade is due to “fragile consumer confidence and a highly competitive restaurant industry”.
Indeed. My contacts tell me that, according to analysis of credit card usage, the only place doing really well in Australia’s retail sector is…wait for it…restaurants. Meanwhile at yesterday Dominos Pizza AGM, that company confirmed that on a like-for-like basis, sales had grown by double digits.
You cannot help but wonder, what was motivating management to sell so much of their stake into the float?
If you had your hands on the prospectus for Collins Foods and followed the steps in Chapter 11 of Value.able to value the float of Collins Foods, you might have used a forecast profit of $16 million, equity of $161 million, 93 millions shares on issue (giving an equity per share of $1.73), earnings per share of 17.3 cents and dividends per share of 11.8 cents (giving a payout ratio of 68%).
Return on equity of 10% is low and this is with the benefit of leverage (total borrowings $105 million). Immediately you know that if you are using an Investor Required Return of more than the ROE of 10%, the intrinsic value will necessarily be less than the equity per share of $1.73.
Shares fall to Intrinsic Value Estimate
Using Tables 11.1 and 11.2 and an Investor Required Return of 13% Table 11.1 produces an income valuation of $1.33 and Table 11.2 produces a growth valuation of $1.08. Multiplying $1.33 by the payout ratio of 68% results in 90 cents and Multiplying $1.08 by one minus the payout ratio of 68% results in 34 cents. Adding 34 cents and 90 cents gives a valuation of $1.24. (You can see just how bullish you or I would have to be to produce, at the time of the float, a valuation of $2.50!)
You might like to download the prospectus yourself from the ASX website here and try using Value.able’s Table 11.1 and 11.2 to arrive at the same valuation. If you don’t have a copy of Value.able, you can order your copy here
I’d love to know how you go. If you have valued any ‘Turkey’s’ yourself, go right ahead and upload your thoughts about the company and your valuation, along with a comparison to its current price.
Posted by Roger Montgomery, Value.able author and Fund Manager, 03 November 2011.
There’s something in the air…. And you may be able to assist.
Skaffold® is set to go live and I am incredibly proud of what Team Skaffold have achieved.
Before Skaffold, the stock market was noisy and confusing. Very soon, all that will change. Skaffold will reinvent and reignite the way you invest.
The data that automatically updates Skaffold each day is from arguably the world’s most reputable source (that’s right, not all data is the same!). With customers that spend hundreds of millions of dollars a year for our provider’s data, we have been delighted with their fascination and interest in Skaffold.
As you may already know, Skaffold’s designers and developers have been recognised by design awards and industry accolades and already work for Nintendo, EA Games – the world’s biggest games company, Google, HTC, and Porsche. Like us, they are immensely proud of Skaffold and are putting together their own video for the launch to showcase Skaffold to international IT media and judges. Their Managing Director is even flying to Sydney for the launch!
Here at home, we are building a team with amazing international credentials and their task is simple: make sure Skaffold stays at the cutting edge of stock market applications.
Here is how you could help: We’re still searching for someone super smart, who can mentor, teach and lead a team, who knows, understands and loves the stock market, can be RG 146 compliant and is truly passionate about talking one-on-one with and helping private and professional investors. If that’s you, or you know someone that fits the bill, we want to hear from you!
A1 or C5, Skaffold’s Quality Scores are powered by more than 40 years of published academic research into the predictors of company failure and and investment returns. And the secret herbs and spices in Skaffold’s valuations – and the ways they change – have won me over time and time again.
I must confess to having a bit of fun recently… I uploaded some international data, and looked at IBM, Apple, Google and Microsoft and… nothing surprising. Skaffold just worked. No whacky valuations either like the $800 for Apple or $400 for IBM or $60 for Microsoft that I have seen elsewhere. In time, I imagine we’ll be able to switch on Turkish stocks, if that’s what you want!
The team and I have been genuinely encouraged by your excitement. What’s also been really amazing is the anticipation, not only from private investors like you and me, but from brokers, other fundies, planners and advisers who have expressed a real need to independently ’stress test’ their own research or the stocks on their approved lists.
One friend recently said we had developed a Ferrari that Volvo drivers will love to drive. I reckon that’s about the sum of it. And congrats, by the way, to Ian – one of very first investors who jumped the gun, sent in his cheque and guaranteed himself Member #2 status for life.
Get ready to enjoy looking at the Australian stock market like you have never seen it before. Put 1 November 2011 in your diary to Join Skaffold and be part of our mission to make every investor a professional.
Skaffold is the world’s most reputable company data married to half a century of leading investment thinking and the world’s most exciting and easy-to-use interface for investors. We can’t wait to hear what you think of Skaffold after you have made it part of your investment routine.
Posted by the Skaffold Team, 28 October 2011.
Skaffold® is a registered trademark of Skaffold Pty Limited
According to Value.able investor Roger Montgomery, Woolworths is approaching its intrinsic value. However, as he explains, the company faces so many challenges that new CEO Grant O’Brien is going to have offer a compelling new growth strategy very soon. Read Roger’s article at www.eureakreport.com.au.
Back in July I wrote the following column about the impending float of Collins Foods/KFC at between $2.50 and $2.92 per share and suggested I would not be participating in the float on behalf of investors in the Montgomery [Private] Fund. For Value.able investors, the column, along with the fact the shares now trade at a substantial reduction, offers some insights into the thinking around a new float…
“As a parent I’ve never been much of a fan of fast food but I do know that many of the strong brands in this sector command enormous market share.
But I’m not here today to give you a lesson in nutrition; what I want to talk about is the opportunity to invest in the future success of KFC in Australia through the $238 million initial public offering of Collins Food Group.
The KFC brand is owned by US-based and listed Yum! Brands. Owning a strong brand is one of the best competitive advantages money cannot buy.
The value of this competitive advantage is reflected in the returns on equity, gross margins and pre-tax profit margins Yum! Brands generates of 66.2%, 33.6% and 14.3% respectively for the most recent 12-month period.
Amongst 47 listed restaurants in the United States, Yum is number two by return on equity and 17th among 790 listed services companies by the same measure. There are indeed very high returns to be made from leveraging a great brand like KFC and selling franchises.
Being the franchisee, on the other hand, is rarely as lucrative and the forthcoming listing of Australia’s largest KFC franchisee – Collins Foods Limited (CKF) – will demonstrate this to investors.
Collins has 119 KFC stores (117 of them in Queensland), along with 26 Sizzler restaurants in Western Australia, NSW and Queensland, and it’s the franchisor of maybe 60 Sizzlers in Asia.
The price point of these restaurants will inevitably have fund managers – who are participating in this week’s bookbuild – referring to Collins as a “defensive” investment. But as I have previously indicated, the only defensive investment is a brilliant one; mediocre companies need not apply.
To begin with it is important to note that Pacific Equity Partners (PEP) – the private equity firm behind REDgroup, the parent company of Angus & Robertson and Borders now under administration – will be exiting its stake completely.
Perhaps more interestingly, the existing management team is cashing in, too. Managing director Kevin Perkins will reduce his holding from over 20 per cent to about 8% and the rest of management will reduce their holding, too.
When Pacific Equity Partners paid $US210 million in September 2005 (the $US6.92 a share was a 42% premium to the then traded price of $US4.92) for Worldwide Retail Concepts, the US publicly listed company that is now Collins Foods, management then co-invested with a 48% stake. According to all reports, management will now retain just 10%. In other words, management is selling 80% of its holdings into this float.
If PEP bought the company in 2005 alongside management who owned 48%, and you buy in 2011 with management owning just 10%, do you think the deal has a whiff of fried chicken to it?
During the privatisation, PEP and the management were arguably similarly incentivised but when you buy Collins Food Group’s from PEP in the IPO, you will not have the same committed management.
And when PEP bought Worldwide Retail Concepts in 2005, the company operated, joint ventured or franchised 302 Sizzler restaurants (with 28 in Australia), 112 KFC sites (111 in Queensland) and it also owned 22 sites of the US “quick casual” or family value restaurant chain Pat & Oscars.
Worldwide Restaurant Concepts reported revenues of $US347.2 million in the year to April 30, 2004 ($A444 million at the then exchange rate of US78¢) and 70% was generated in Australia. All this for $US210 million ($A269 million).
According to reports, you are being asked to pay $A230–278 million ($US244–295 million) for 119 KFC outlets, 26 Sizzlers and around 55 franchised Sizzlers in Asia. I am not sure if the IPO company will offer a stake in the other 220 Sizzlers but I can tell you the Pat & Oscars chain was sold to management in 2009 after another buyer in 2007 failed to secure funding.
Oh, what doesn’t Google know!
Same-store sales growth has been positive while in the care of PEP and Collins Foods, and is forecast to hit $430 million in 2012, according to one report, but it is the growth in earnings since the purchase in 2005 that has been spectacular.
For the year to April 30, 2004, Worldwide Restaurant Concepts earned just $4 million. In 2011 that number might be closer to $25 million for Collins Foods and it is probably for all this hard work that management want to cash in their 38%.
Despite this wonderful growth in profits, the best (read most optimistic) estimate of intrinsic value I can give you is $2.55. This represents the low end of the expected range of possible prices at which you might be entitled to any shares.
But before you jump in like a headless chicken, remember two things: management are taking their cream; and the franchisor always makes more money than the franchisee. Just look at Yum! Brands’ return on equity and compare it to Collins Food Group’s when we see it.
Finally, it’s always interesting to follow the cash account, which can give an alternative picture of the company’s position before and after its float. For those who have access to the prospectus have a look at the pro forma cash balance prior to the float.
Let’s presume it is close to $50 million. That cash balance will first increase by the proceeds of the float – say $250 million – but any debt repayment will see the account decline again.
Then you need to look carefully. If there is a further drawdown (because all the proceeds were used to reduce debt) it will see the account restored but then payments to vendors and reimbursing costs associated with the float will result in a starting cash balance that may be a lot less than it was before any float was contemplated.
If this is indeed the scenario – and it would not be one without precedent – the drawdown would have effectively funded the payment to vendors and costs. If there is no further drawdown or refinancing, there could be no payment to the vendors including management.
The prospectus will be out shortly. The last float we looked at was MACA at $1 and we suggested participation for those lucky enough to have been offered shares.
MACA shares now trade at $2.35, after being as high as $2.96, trouncing the return of the other floats we reviewed, Myer and QR National. Will Collins Food Group be an addition to the portfolio? There’s a greater chance that my kids will be regulars at a KFC restaurant!”
Posted by Roger Montgomery, Value.able author and Fund Manager, 25 October 2011.
