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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There has been a bit of action on the IPO front over the past few months. Sixteen stocks have been added to the main board of the ASX, as set out below with their actual listing date.
I thought it might be a worthwhile task to run the ruler over them and see if any are potential investment candidates among the newcomers.
Let’s start our exercise at the more speculative end of the investment spectrum. I don’t gamble with money, so let’s eliminate those that are involved in exploration activities given their high risk/high reward dynamics. There are 12 exploration businesses among this group. I will leave these to others who are more suitably qualified in working out whether any opportunities exist here and whether they will find something before their cash runs out.
Of those remaining, well-known NZ website Trade Me and RXP Services are involved broadly in the IT space, Alliance Aviation is involved in mining services and finally Chorus, another NZ company, specialises in Telecommunications. These are the four businesses we will focus on. A brief review of these follows.
Alliance Airlines (AQZ)
I will start with a sector I know well – airlines. A capital intensive industry with lots of competition rarely makes for wonderful business economics (Qantas, Virgin) and despite Alliance operating in a niche market of fly-in, fly-out operations for the mining sector, my view remains the same: I will never invest a dollar into this sector.
Alliance has grown quickly since its formation in late 2002. From nothing, to a fleet of 20 Fokker 100 and Fokker 70LR jets as well as five Fokker 50 turboprops with established, long-term, profitable blue-chip relationships with BHP Billiton, Santos, Incitec Pivot, and Newcrest. That’s an outstanding achievement by management. A distinguishing feature is that approximately 75% of Alliance’s 2010-11 revenue was subject to medium to long-term contracts – recurring revenues.
No matter. Any airline cannot escape competition or its high level of ongoing capital requirements. And for a niche space, four other competitors (Cobham, Network aviation, Qantaslink, Skywest) appear to be a handful in terms of the prices they can charge, competition for future contracts (especially when 44% of 2010-11 revenue was from one client, BHP), ongoing operating margins and future market share gains.
A total 47.6% of Alliance’s forecast for 2011-12 EBITDA will be consumed on refurbishments, maintenance, rotables, new aircraft and property, plant and equipment. This leaves just over 50% to pay taxes, interest and for working capital requirements. And once all is paid for, only a little will be left over for future dividends, buybacks, etc. It is not surprising, therefore, that the prospectus does not forecast a dividend to be paid in 2012.
Despite a pro-forma forecast of $18.1 million NPAT, or 20.1¢ earnings per share, and the shares trading below what the business may be worth, if you ever see me buying an airline, please put me in a straitjacket.
RXP Services (RXP)
Unfortunately, this business has a very, very short history and no real track record. It was formed in October 2010, just 15 months ago, with the purpose of establishing an information & communications technology (ICT) business with a focus on medium/large enterprises and the government.
The founders have done this, but with one drawback. Rather than building a business organically, the purpose of the float was mainly to raise funds to acquire two unlisted businesses in Vanguard and Indigo Pacific. The rollup of these has seen RXP service capabilities expand overnight from nothing into a broad range of management, business and ICT consulting, delivery and support services.
With a number of already listed ICT businesses already competing for market share – SMX, CSG, OKN, many of which have had a chequered operating history as listed entities – the space appears to be a little crowded. I can’t see how RXP will differentiate a commodity product offering.
And turning to its financials, despite the consolidated accounts in the prospectus showing how the businesses may have looked had Vanguard and Indigo been owned in the past, they weren’t; what we see is what would have been a profitable little businesses. But as we have little to go on as to how they will actually function together going forward under new stewardship, we will watch this one from the sidelines for now.
Chorus (CNU)
Chorus is a spin-out from Telecom New Zealand. It is New Zealand’s largest telecommunications utility company, a technical way to describe a business that builds, maintains and repairs existing phone and broadband lines.
Following the demerger, Chorus is a business whose sole focus is on bringing fibre within reach to as many New Zealanders as possible – kind of like our own NBN Co., but not run by the government, even if it has been chosen by the Crown to build NZ’s ultra-fast broadband (UFB) network to 830,000 urban premises, as well as extend fibre further into rural New Zealand through the Rural Broadband Initiative (RBI) by the end of 2019.
Having so far deployed some 2500 kilometres of fibre optic cable, upgraded hundreds of local telephone exchanges with new broadband equipment and installed or upgraded about 3600 roadside cabinets, a target of 20,000 kilometres of fibre optic cable to deliver ultra-fast broadband will probably be met. Management’s recent experience in rolling-out ADSL2+ broadband is coming in very handy and helping to build New Zealand’s fibre future.
There are some obvious tailwinds here, with the long-term nature of this contract and ratings agency Moody’s has assigned Chorus a Baa2, stable issuer and senior unsecured rating. A rating similar to Bulgaria and Kraft foods.
Look under the hood, however, and you can see that about $NZ1.7 billion of net interest bearing debt was outstanding as at December 2011, all current. On just $NZ422 million of equity, it appears that Telecom New Zealand may have also let go of some unwanted baggage in the de-merger.
While 2011 cash flows appear to be well managed and interest payments well covered, I can’t help but be reminded of another infrastructure asset in Asiano when it was demerged from Toll holdings in 2007. It too was saddled with a large debt burden and at the end of its first trading day; Asciano had a market capitalisation of $7 billion. Today it is $4.5 billion.
Trade Me (TME)
Last but not least is the well-known NZ website Trade Me. Similar to eBay international, Trade Me is now dual-listed on both the New Zealand and Australian Stock Exchange.
While this is another spin-off, Fairfax Media Limited (ASX:FFX, SQR B3) has retained a shareholding of 66% – generally a good sign.
On one reading this might be the pick of the recent floats. The business has an moderately geared balance sheet, produces a significant amount of free cash with low levels of ongoing capital expenditure now that the website is mature and has a history of earnings growth which any shareholder, and that includes Fairfax, would be truly happy with. On top of this, with Fairfax retaining a material level of ownership in the business, they are still highly incentivised to continue promoting the website via its vast media network.
On another reading Fairfax paid $750mill for Trade Me (TME) and have just sold 34% of it for $363.5 mill or a total ‘value’ of $1.07Bln. This will help them justify the carrying value on their own balance sheet. Further, since 2007 TradeMe has made net profits totalling $276mill, the bulk of which has been taken out as dividends. So FFX have made an IRR of about 17% per annum. Given FFX have set up the company with market cap of about $1 billion, equity of $631 mill ($721 mill goodwill and therefore negative NTA) and debt of $164 mill, the expected return on equity is just over 10 per cent means FFX have got a return that you might not.
Posted by Roger Montgomery, Value.able and Skaffold author and Fund Manager, 6 February 2012.
Click on the above IMAGE to see a larger and clearer version of the screenshot from Skaffold.
The ability to turn off and tune out the noise of the market is a key to success. I don’t know whether the market will keep rallying amid improving US economic data in the short term while ignoring long term structural European banking and credit issues that is now ‘old news’. I do believe that the market reacts to new ideas while always keeping an eye on old ideas. European deterioration was new for a while and now its not. The ‘new news’ today is that the US economy is improving. Europe is, as I say, old news. But old news gets recycled when the new news the short termists are focusing on becomes old news itself. if you are keeping up, you are doing well. One expects that eventually the appetite for stocks could weaken when news of a resurgent US becomes old and unresolved structural issues return to become news again.
Putting that aside, here is a list of six companies that popped up in Skaffold (click here to join) today when I looked for A1, A2, A3 and B1 companies trading at a better than 15% discount to estimated intrinsic value. I then selected for no debt (net cash), forecast EPS growth and expected positive growth in estimated intrinsic value. You will note that I have left out the names of the companies that make the grade. There’s a good reason which I will discuss in a moment…
As an aside if you would like to see how the stocks in your portfolio compare to the Skaffold universe you can CLICK HERE and enter your five stocks directly into Skaffold. Once you have done that I imagine you won’t want to invest without it.
…To start a discussion about what is good value in the market right now, have a go at suggesting what the six stocks in the above list are. If you can get all six right in one go, I will ask the team to send a signed copy of my book Value.able to the first correct answer.
If you simply want to discuss a value opportunity you have uncovered go ahead by clicking the Leave a Comment button below.
Posted by Roger Montgomery, Value.able and Skaffold author and Fund Manager, 6 February 2012.
US jobs data was stronger than expected and resulted in global equity markets following the US reaction higher. But is all as it seems?
The increase in jobs was 243,000 but 490,000 were said to be temporary jobs. The employment number is now the same as a decade ago but a decade ago there were 30 million fewer people living in the US!
Charles Biderman notes that “Either there is something massively changed in the income tax collection world, or there is something very, very suspicious about today’s BLS hugely positive number,” adding, “Actual jobs, not seasonally adjusted, are down 2.9 million over the past two months. It is only after seasonal adjustments – made at the sole discretion of the Bureau of Labor Statistics economists – that 2.9 million fewer jobs gets translated into 446,000 new seasonally adjusted jobs.” A 3.3 million “adjustment” solely at the discretion of the BLS? And this from the agency that just admitted it was underestimating the so very critical labor participation rate over the past year? Perhaps with a hint of conspiracy theorist (all hints of which we run from as fast as possible) Biderman wonders whether the BLS is being pressured by the Obama administration during an election year to paint an overly optimistic picture. Hmmmmm…
For those of you who have seen the amazing Abbott and Costello skit ‘Who’s on first’, here’s another take on it:
COSTELLO: I want to talk about the unemployment rate in America.
ABBOTT: Good Subject. Terrible Times. It’s 8.3%.
COSTELLO: That many people are out of work?
ABBOTT: No, that’s 16%.
COSTELLO: You just said 8.3%.
ABBOTT: 8.3% Unemployed.
COSTELLO: Right 8.3% out of work.
ABBOTT: No, that’s 16%.
COSTELLO: Okay, so it’s 16% unemployed.
ABBOTT: No, that’s 8.3%…
COSTELLO: WAIT A MINUTE. Is it 8.3% or 16%?
ABBOTT: 8.3% are unemployed. 16% are out of work.
COSTELLO: IF you are out of work you are unemployed.
ABBOTT: No, you can’t count the “Out of Work” as the unemployed. You have to look for work to be unemployed.
COSTELLO: BUT THEY ARE OUT OF WORK!!!
ABBOTT: No, you miss my point.
COSTELLO: What point?
ABBOTT: Someone who doesn’t look for work, can’t be counted with those who look for work. It wouldn’t be fair.
COSTELLO: To who?
ABBOTT: The unemployed.
COSTELLO: But they are ALL out of work.
ABBOTT: No, the unemployed are actively looking for work… Those who are out of work stopped looking.
They gave up and if you give up, you are no longer in the ranks of the unemployed.
COSTELLO: So if you’re off the unemployment rolls, that would count as less unemployment?
ABBOTT: Unemployment would go down. Absolutely!
COSTELLO: The unemployment just goes down because you don’t look for work?
ABBOTT: Absolutely it goes down. That’s how you get to 8.3%. Otherwise it would be 16%. You don’t want to read about 16% unemployment do ya?
COSTELLO: That would be frightening.
ABBOTT: Absolutely.
COSTELLO: Wait, I got a question for you. That means there are two ways to bring down the unemployment number?
ABBOTT: Two ways is correct.
COSTELLO: Unemployment can go down if someone gets a job?
ABBOTT: Correct.
COSTELLO: And unemployment can also go down if you stop looking for a job?
ABBOTT: Bingo.
COSTELLO: So there are two ways to bring unemployment down, and the easier of the two is to just stop looking for work.
ABBOTT: Now you’re thinking like an economist.
COSTELLO: I don’t even know what the I just said!
While we are not waiting around for the swallows to sing – then spring will be over – we are buying stocks in a slow and measured way. We haven’t added any new stocks to our portfolio so we are adding to existing holdings.
In Australia, the situation may not be much better. Last year here at the blog we discussed the impending job losses at banks, manufacturers and retailers and all of that appears to be rolling along as predicted. But as my friend Bob Gottliebsen noted today; “At the weekend, Roy Morgan Research reported a big jump in unemployment during January. Almost certainly that will be reflected in the official figures when they are released later this month. Morgan uses a different method to calculate unemployment to the statisticians and Morgan’s December unemployment was 8.6 per cent, compared with the statisticians’ 5.2 per cent. But now Morgan estimates that January unemployment has skyrocketed from 8.6 to 10.3 per cent – the highest level since Morgan began calculating unemployment.”
“There is no doubt there are seasonal issues as those leaving tertiary education try to join the labour force. They are usually not employed until February or later months. A rise of the proportion shown by Morgan reflects much greater forces than seasonal influences and in 2012 it will be much harder for students to gain employment than in 2011.”
What does it all mean for value investors – remember, we are not economists and macro economics is not part of the value.able bottom-up approach to investing? The implications are that we should be seeking deeper discounts to intrinsic value estimates and those estimates could decline further.
Given Skaffold (click here to Join) is currently suggesting the ASX200 is not cheap, we tend to be cautious even though my learned peers are betting with the world’s central banks that their printing of money and associated reduction in interest rates will force the world out of being defensively cash weighted and into equities and commodities.
We reckon gold makes sense in these times of destabilised fiat money. As you know we own a number of gold stocks (some of which have returned nearly 100%) and I bought more gold (physical) before Christmas.
Here is the latest chart of the ASX200 plotted against Skaffold’s estimates of intrinsic value. You can see that the market is trading a little higher than the estimated intrinsic value for the index. That doesn’t mean it can’t go a lot higher, just that if you are a genuine bargain hunter, you may need to be patient. In light of the unemployment situation noted above and the painfully strong Australian dollar, that makes sense.
In addition to the powerful benefit of such a chart as the ASX 200 Skaffold line, which by the way, is automatically keeping you up-to-date daily for changes in analysts estimates of earnings and dividends for each of the 200 indices’ constituents, Skaffold members will enjoy an unprecedented level of interactivity in upcoming updates. By the way, I trust you are enjoying the enhanced search functionality the team delivered last week.
My team noted a few wanna-be competitors trying to plagiarise little aspects of Skaffold recently and I explained that they and you should “be flattered” and I told the team; “if you can see the competition, you aren’t at the front of the race”. Concentrate on staying in front by looking ahead and not at those trying to catch up. They respect Skaffold members too much to insult them by delivering second-hand ideas or technology. Skaffold keeps you in front with world beating ideas – remember the team that works on Skaffold works for Nike, Porsche, EA Games and Google. What possible hope do the competitors have? We’ve retained one of the world’s decorated design and development teams so Skaffold is.
Posted by Roger Montgomery, Value.able and Skaffold author and Fund Manager, 6 February 2012.
Reporting season has begun in ernest and a few companies we have been watching (and some of which we own in the Montgomery Private Fund) have reported. Today it was Credit Corp’s turn (ASX: CCP, SQR* A2). You can find the presentation here (be sure to read and agree to the ASX and our disclaimer).
Skaffold members are likely to have already seen CCP on the Aerial Viewer with an A2 rating and a discount to Skaffold’s estimate of Intrinsic Value. In the Montgomery Private Fund, we have owned the stock for some time now and I have mentioned it as a stock to investigate on many TV and Radio programs. Today’s 10 per cent gain is certainly a welcome boost to the gains already registered.
The highlights from the announcement of the half year results for us were 1) that earnings were at the top end of guidance, 2) a 12% increase in revenue translated to a 23% increase in NPAT, 3) a welcome reduction in debt to its lowest level since listing and 4) strong free cash flow after an increase in dividends and finally a conditional settlement of a “distracting” class action. This final point is particularly important for many investors who will now feel vindicated that it was not the investor who erred. The impact of the settlement on earnings will be immaterial thanks to insurances. At current rates of cash flow generation, debt could be extinguished completely by the end of the financial year.
Grant Duggan – a regular blog poster here – was kind enough to make the following comments below: “If i recall on YMYC a caller asked for one xmas stock to put under the tree for 2012, and much to your dislike [Roger] to only be able to pick one it was CCP, and i know two months don’t make a market but to me this is another indicator of value able investing starting to prove its worth. Thanks to Roger and all blog posts once again.”
I know I am harping on about it but if you have not joined as a member of Skaffold, how are you planning to find the best opportunities during reporting season? Join Skaffold who have done all the hard valuation and quality assessments for every single listed company so you don’t have to.
Posted by Roger Montgomery, Value.able and Skaffold author and Fund Manager, 2 February 2012.
Unless you live under a waterfall in the rainforests of South America, you will have heard that Facebook has lodged its S-1 (Prospectus) for a probably May 2012 IPO. Skaffold members can look forward to Facebook being available to view in Skaffold when the team loads up all the international stocks.
To become a Skaffold member today and discover how we have been investing click here
Back to our regular programming…
Hyped by the media around the world as the biggest internet IPO in history and asked whether we would ‘invest’ in Facebook, we note the following:
The company already has 500 shareholders and would have been required by the SEC to lodge financials in April.
Facebook Stock Code: FB
Maximum aggregate offering price: $5Bn
as yet, there is not sufficient valuation information listed in the S-1 filing with the SEC nor how many shares are being offered.
According to the S-1 cover:
845 million monthly active users (MAU)
483 million daily active users (DAU)
Users generated on average 2.7 billion Likes and Comments per day in Q4 2011.
100 billion friendships
250 million photos uploaded per day
Our observation: Not a mention of any dollars yet! “likes”, “friends” and ‘uploaded photos’ are today what ‘page impressions’ and ‘visitors’ where in the tech boom of 1999/2000.
FB generated $3.7 billion in Revenue in 2011, up from $2 billion in 2010. 12 percent of Facebook’s revenue in 2011 was linked to its relationship with online gaming giant Zynga.
FB generated $1 billion in net income in 2011, up from $606 billion in 2010, a 40% growth rate, compared to the 165% growth rate from 2009’s $229m.
EBIT margin peaked at 52.3% in 2010 ($1m in EBIT on $2 billion in revenue), has since declined to 47.3% or $1.756Bn on $3.711Bn in Revenue, still incredible.
$3.9 billion in cash and marketable securities
Western world user growth is slowing but thats the law of large numbers. Facebook says: “We believe that our rates of user and revenue growth will decline over time. For example, our annual revenue grew 154% from 2009 to 2010 and 88% from 2010 to 2011. Historically, our user growth has been a primary driver of growth in our revenue. Our user growth and revenue growth rates will inevitably slow as we achieve higher market penetration rates, as our revenue increases to higher levels, and as we experience increased competition.”
The company still reported +60% earnings growth rates in 2011. The key is whether users stay and whether they can be ‘monetized’ further. MAU additions peaked in 2010 when FB added 248m to a total of 608m; in 2011 it added 237MM to 845m.
On the subject of dividends FB says: “We do not intend to pay dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the market price of our Class A common stock increases. In addition, our credit facility contains restrictions on our ability to pay dividends.”
Here’s access to the S-1: http://www.sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm
The map of the world connected by facebook users is intriguing. What are those pirates on the west coats of Africa doing on Facebook?
I have previously written about the forthcoming floats of internet and social media sites here: http://rogermontgomery.com/which-ipos-are-you-watching/
‘Paradigm changers’ (remember Yahoo?) have come and gone so it is essential you don’t get caught up in the hype and instead stick to the valuation approach that is the bedrock of our approach. If you don’t know it, buy a copy of Value.able today for just $49.95. Or to save yourself reading the last ten annual reports for every listed company, try Skaffold.
There were eight large and highly media-promoted IPOs in the last year or two (GRPN, ZNGA, LNKD, P, YOKU, DANG, AWAY, and FFN). One analyst reported that if you could get stock in the IPO (forget it if you weren’t a major client of the lead broker or a ‘friend’ of the company) there was an average gain of 50%. If you bought each IPO in the market on Day 1 you now have an average loss of 54% with incredibly only 1 of the 8 names (ZNGA) still holding on to gains (+11%) thanks to a rally of 15% in the last week.
We would like to go through the numbers for Facebook today and try to come up with a valuation for you. You can do it yourself if you have a copy of Value.able.
There’s about $5.2 billion in equity, including $1bln of retained earnings. There’s 4.1bln Class A shares and the same number of class B’s. The preferred’s will be converted and only Class A’s sold. We cannot calculate equity per share because the S-1 does not disclose how many shares will be issued. ROE is about 26 per cent. No dividends will be paid. The company states in its S-1 that it will continue to grow by acquisition as well as organically. But the company will takeover Earth if it continues to retain profits and generates 26% returns on the incremental equity. Assuming earnings grow at 40% and faster than the rate of return on equity, then you can expect ROE to rise. Using these favourable metrics we reckon Facebook is worth $26-$28bln in 2012 rising to $57-$63bln in 2014. If the IPO ‘values’ the company at $100bln as many media outlets suggest, watch out.
This paragraph from the S-1 is important:
“If you purchase shares of our Class A common stock in our initial public offering, you will experience substantial and immediate dilution.
If you purchase shares of our Class A common stock in our initial public offering, you will experience substantial and immediate dilution in the pro forma net tangible book value per share of $ per share as of December 31, 2011, based on an assumed initial public offering price of our Class A common stock of $ per share, the midpoint of the price range on the cover page of this prospectus, because the price that you pay will be substantially greater than the pro forma net tangible book value per share of the Class A common stock that you acquire. This dilution is due in large part to the fact that our earlier investors paid substantially less than the initial public offering price when they purchased their shares of our capital stock. You will experience additional dilution upon exercise of options to purchase common stock under our equity incentive plans, upon vesting of RSUs, if we issue restricted stock to our employees under our equity incentive plans, or if we otherwise issue additional shares of our common stock. For more information, see “Dilution”.
Note the blanks, which makes FB impossible to value on a per share basis, yet.
We’ll have to wait until the final days of the capital raising before we can come up with a firm valuation on a per share basis but for now, the circa $27bln valuation stands.
Posted by Roger Montgomery, Value.able and Skaffold author and Fund Manager, 2 February 2012.
Do David Jones (DJS), Myer (MYR), ARB Corporation (ARP), Oroton (ORL), Billabong (BBG), JB Hi-Fi (JBH), Harvery Norman (HVN) or Campbell Brothers (CPB) make Roger’s coveted A1 grade? Watch this edition of Sky Business’ Switzer program broadcast 1 February 2012 to find out and also learn Roger’s views on the pricing of the upcoming Facebook IPO. Watch here.
Roger Montgomery discusses why the global investing outlook for 2012 will be impacted by a variety of negative influences in this Money Magazine article published February 2012. Read here.
Robert Gottliebsen penned an interesting piece in the Business Spectator today. Using data provided by James Stuart of Ferrier Hodgson that revealed Internet penetration – as a portion of sales for large US retailers – as high as 18% and comparing that to average penetration of online sales from retailers in Australia of 1%, Robert concluded that time is ticking for owners of commercial property.
I agree with Bob’s conclusions. Oroton’s online store is now its biggest store in terms of sales and sagging bricks and mortar retail growth will force many retailers to also move online and embrace the structural change or go the way of the dinosaurs.
Tight margins, expensive staff and exorbitant rents spell trouble for any business that cannot maintain prices in the face of an online and overseas onslaught.
The impact on rents of commercial buildings such as shops will ultimately be negative And on this point I agree with Bob. But we can add one more step to the scenario. Either a new generation of offerings replaces the old school tenants who are departing and rents are maintained or declining rents lead to lower real estate prices which encourages buyers who are both retail operators and store owners rather than tenants.
Incidentally, at Montgomery Investment Management we cannot find a single listed property trust that meets our criteria. If you can find value in the listed property sector do let us know, but we cannot.
I feel for those who bought shops in strips like to Toorak Road, Chapel Street and Oxford Street on capitalisation rates of less than 3% or 4%.
I also feel for fruit and vegetable growers in Australia who are about to find out what grocery suppliers and milk producers have recently experienced. Many farmers have told me of the mere cents per kilo received by them from major supermarkets who in turn sold the same produce at multiples of 10 and 11 times while explaining to farmers that they needed to charge such high multiples to cover the cost of business. The announcement on Today Tonight last night by Coles staffer Greg Davis of 50% cuts in the prices of fruit and vegetables, suggests the real cost of doing business is much lower than what the supermarkets have been telling farmers.
And if they’ve been dishonest with farmers then perhaps it’s a little disingenuous for Greg Davis to say on national television “We’re investing in prices as well, but our growers are working with us to plan our crops, to ensure that we’ve got certain year-round volumes. We buy in such huge volumes, it brings down the cost of the produce, so customers benefit and growers benefit, because we can move stock really quickly”. Do we reallyt need ore food to be produced? It seems Coles would like us to forget just how many thousands of tonnes of fruit and veg is thrown out by each of the supermarkets each year. According to the National Waste Report 2010, food waste constituted 4.5 million tonnes or 35% of municipal waste. When Coles talks about moving more products at lower prices are obviously not referring to us eating it!
Bruno writes in the comments below:
“Hi Roger,
Just a comment on what farmers are getting for their produce. Being a farmer I can tell you that the very most we have received for citrus is 40c per kg, but on average we get about 20c then we must pay 10c of that just to have them picked. My next door neighbor grew onions this year and also received 20c per kg. pumpkins are the same price. Rice is being sold by farmers for 18c per kg. wine grapes are being harvested right now for an average price of about 24c per kg (1kg is the amount of grapes needed for one bottle of wine) most if not all these crops cost about 10c per kg just to harvest! Of course farming is a cyclical business, and sooner or later what us farmers are paid will have to come up, otherwise there won’t be any farmers left. Where I live we are starting to see banks foreclose on farms, the irony is that no one is willing to buy a business that makes no money. So banks are forced to either lend more money, or spend their own cash to run the farms so the property value isn’t destroyed as fruit trees die. While we worry about the Europe crisis effect on the banks balance sheets we have a very big problem much closer to home which, if farmers don’t start to make a profit soon, will most defiantly effect the share values of the banks as bad debts get written off. if my wide went to work at woollies and at the end of the day she was given a bill from her boss for a days work, there’d be outrage. But when farmers are left in that exact situation, politicians and the like tell us “there’s healthy competition in the market place which benefit consumers” maybe in the short term but as more farmers abandon their farms which is happening, the price of all fruit and vege will definitely go up in the medium term as more and more farmers leave their land.”
Further, the wholesale buying of arable agricultural land by foreign interests, the decimation of profitable agricultural enterprises due to irrational competition of the major supermarkets and the replacement of their product by foreign alternatives will not ultimately produce the best outcome for Australia.Australians cannot buy freehold land in China and foreigners are banned from owning the ground floor apartment in any building in Singapore so one does wonder whether our generosity is well placed all in the name of pursuing lower prices for short sighted consumers.
Posted by Roger Montgomery, Value.ableauthor and Fund Manager, 31 January 2012.
Late last year the Federal Bank of San Francisco’s research department published their findings about a relationship between the ageing baby boomers and P/E ratios. I have long held the view that when Australia’s baby boomers (the majority of whom are asset rich and cash poor) reach the age that they need to fund their retirement spending and healthcare, they will need to sell their assets (typically real estate). Given the next generation have long complained of being unable to afford a house, it seems logical that prices for homes will need to fall. Only if prices fall can a generation of sellers meet the generation of buyers who say they cannot afford to pay current prices.
If that is indeed true for one asset classes then perhaps it makes sense for other asset classes. Wealthier baby boomers with DIY share portfolios will also need cash. They may not sell the family home (although downsizing is a very real trend), instead they may use their share portfolios as their ATM. This could put pressure on the multiples of earnings, sales and book values that trade in a free market.
The FRBSF seems to agree…Zheng Liu and Mark M. Spiegel discovered a strong relationship between the age distribution of the U.S. population and stock market performance.
“A key demographic trend is the aging of the baby boom generation. As they reach retirement age, they are likely to shift from buying stocks to selling their equity holdings to finance retirement. Statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades.
The baby boom generation born between 1946 and 1964 has had a large impact on the U.S. economy and will continue to do so as baby boomers gradually phase from work into retirement over the next two decades. To finance retirement, they are likely to sell off acquired assets, especially risky equities. A looming concern is that this massive sell-off might depress equity values.
Many baby boomers have already diversified their asset portfolios in preparation for retirement. Still, it is disconcerting that the retirement of the baby boom generation, which has long been expected to place downward pressure on U.S. equity values, is beginning in earnest just as the stock market is recovering from the recent financial crisis, potentially slowing down the pace of that recovery.
We examine the extent to which the aging of the U.S. population creates headwinds for the stock market. We review statistical evidence concerning the historical relationship between U.S. demographics and equity values, and examine the implications of these demographic trends for the future path of equity values.
Demographic trends and stock prices: Theory
Since an individual’s financial needs and attitudes toward risk change over the life cycle, the aging of the baby boomers and the broader shift of age distribution in the population should have implications for capital markets (Abel 2001, 2003; Brooks 2002). Indeed, some studies attribute the sustained asset market booms in the 1980s and 1990s to the fact that baby boomers were entering their middle ages, the prime period for accumulating financial assets (Bakshi and Chen 1994).
However, several factors may mitigate the effects of this demographic shift. First, demographic trends are predictable and rational agents should anticipate the impact of these changes on asset demand. Consequently, current asset prices should reflect the anticipated effects of demographic changes. In addition, retired individuals may continue to hold equities to leave to their heirs and as a source of wealth to finance consumption in case they live longer than expected (e.g., Poterba 2001).
Foreign demand for U.S. equities might also reduce the downward pressure on asset prices. However, the effect is probably limited for two reasons. First, other developed nations have populations that are aging even more rapidly than the U.S. population (Krueger and Ludwig, 2007). Second, there is substantial evidence of home bias in equity holdings. Individual investors typically hold disproportionate shares of domestic assets in their portfolios. For example, in 2009, the foreign equity holdings of U.S. investors were only 27.2% of the share of foreign equities in global market capitalization. While the low level of international equity diversification is still not well understood (Obstfeld and Rogoff 2001), it suggests that foreign demand for U.S. equities is unlikely to offset price declines resulting from a sell-off by U.S. nationals.
Demographic trends and stock prices: Some evidence
To examine the historical relationship between demographic trends and stock prices, we consider a statistical model in which the equity price/earnings (P/E) ratio depends on a measure of age distribution (for another example, see Geanakoplos et al. 2004). We construct the P/E ratio based on the year-end level of the Standard & Poor’s 500 Index adjusted for inflation and average inflation-adjusted earnings over the past 12 months. We measure age distribution using the ratio of the middle-age cohort, age 40–49, to the old-age cohort, age 60–69. We call this the M/O ratio.
We prefer our M/O ratio to the M/Y ratio of middle-age to young adults, age 20–29, studied by Geanakoplos et al. (2004). In our view, the saving and investment behavior of the old-age cohort is more relevant for asset prices than the behavior of young adults. Equity accumulation by young adults is low. To the extent they save, it is primarily for housing rather than for investment in the stock market. In contrast, individuals age 60–69 may shift their portfolios as their financial needs and attitudes toward risk change. Eligibility for Social Security pensions is also likely to play a first-order role in determining the life-cycle patterns of saving, especially for old-age individuals.
Figure 1 displays the P/E and M/O ratios from 1954 to 2010. The two series appear to be highly correlated. For example, between 1981 and 2000, as baby boomers reached their peak working and saving ages, the M/O ratio increased from about 0.18 to about 0.74. During the same period, the P/E ratio tripled from about 8 to 24. In the 2000s, as the baby boom generation started aging and the baby bust generation started to reach prime working and saving ages, the M/O and P/E ratios both declined substantially. Statistical analysis confirms this correlation. In our model, we obtain a statistically and economically significant estimate of the relationship between the P/E and M/O ratios. We estimate that the M/O ratio explains about 61% of the movements in the P/E ratio during the sample period. In other words, the M/O ratio predicts long-run trends in the P/E ratio well.
Figure 1.
This evidence suggests that U.S. equity values are closely related to the age distribution of the population.”
Posted by Roger Montgomery, Value.able author and Fund Manager, 31 January 2012.
There was a lot of surfing on the Montgomery annual holiday so I thought I’d publish these thoughts on Billabong International for you. Happy new year and all the best for 2012.
Billabong’s trading update in December attracted a great deal of attention – not only from shareholders who rushed the exits to sell their shares, but also from commentators who noted the result was a symptom of a cyclical and structural shift in the way retail goods, particularly fashion, is bought and sold in Australia.
That Billabong had downgraded its earnings guidance should not have come as a surprise: it is not the first time it has done this. In 2009-10, it announced a series of downgrades then failed to even meet the lowered figure in its full-year result. In 2010-11, it announced downgrades in October and December, then again in March 2011. Billabong is not a stranger to downgrades.
But downgrades aren’t the only reason I have never bought shares in this company. On a number of measures it has failed to live up to the high standards I set for a candidate to enter and remain in an A1 portfolio. On some of those measures it may be argued that Billabong has a “challenging road” ahead – a euphemism for the possibility of a serious structural change, which may include a capital raising, asset sales and/or write-downs.
Retailing in Australia has been doing it tough and I have written previously about the perfect storm facing conventional bricks and mortar retailers in this country.
Another retailer, JB Hi-Fi (ASX: JBH, SQR A3, $12.50), had been 5% of the Montgomery [Private] Fund portfolio until we sold out at $15.50. Our reasoning was simple: given present circumstances (the strong dollar and strong outbound tourism, and the consumer shift to online buying) and expectations for retailing (having spoken to many retailers recently), many retailers would have to revise their earlier outlook statements and this would produce lower future valuations.
Notwithstanding today’s speculation that the announced sale of Dick Smiths by Woolworths (ASX: WOW, Skaffold Quality Score B2, $24.45) will trigger a bid by the grocer for JB Hi-Fi, analysts’ forecasts are typically optimistic in the first half of the financial year (this year being no exception to that rule) and we should therefore be demanding much larger discounts and JB Hi-Fi’s shares were not offering that margin of safety.
I have also noted before that the deflation story – as explained by Gerry Harvey, who says selling plasma TVs for $399 last year means he has to sell three times the volume as last year to make the same money – would put pressure on profits because people already had enough plasma TVs.
Finally, we also believe ANZ’s reported profit growth last year, being dominated as it was by bad debt provisioning writebacks, meant that credit growth was non-existent. When you take away growth in credit card purchases that’s got to hurt discretionary retailers.
Billabong cannot be immune. And a long-winded, multipage analysis of the issues plaguing this company is not required because we’ve never suggested it as an investment.
Billabong reported that its first-half EBITDA in constant currency terms would be $4 million higher, but the company is a global retailer and its reported EBITDA is expected to be 20.8% to 26% lower. The company added that strong growth in constant currency terms in 2012 “is not expected”.
Tellingly, the company also noted that a full strategic review is required and a capital raising cannot be ruled out. The reason for this is simple: in light of deteriorating trading conditions the company has bitten off more than it can chew. This is best seen in the cash flow statement.
In 2010-11 Billabong reported profits of $119 million but cash flow from operations of just $24 million. Subtract dividends of $78 million (why pay dividends if you don’t have the cash?) and capex and investments of $266 million and you have a deficit that needs to be plugged with an equity raising or debt.
Turning to the balance sheet, you will find goodwill amounts to about $1.3 billion. That’s $1.3 billion of “oops-I-paid-too-much” and is more than half of the assets of the company. There’s also borrowings of $600 million and, despite the boost, the company is currently forecast to earn a return on equity of just 7%.
Given my bank is offering 90-day term deposits at 5.95%, I wonder how Billabong’s auditors can justify the carrying value of the goodwill on the balance sheet.
So there are two pretty good reasons you haven’t seen Billabong mentioned as a company to conduct more research on this year – or any year, for that matter.
Investing in 2012 could be largely about avoiding losses. To do that, you will need to watch out for companies whose structures are weak, whose performance is undesirable or whose price is too high. Obviously any stock that harbours all three conditions does not require my comment here.
Billabong’s debt has been rising, its return on equity falling, its balance sheet weakening and as an A4 on Skaffold’s quality scale, it was not investment-grade.
Skaffold’s Quality Score History for Billabong
If you are thinking about investing in retail in the coming year, be sure you know what to look for, even if mouth-watering prices are being offered.
Finally, for Skaffold member’s I hope you enjoy update 1.1 you will be receiving today, making Skaffold even more powerful and user friendly. If you are not a member of Skaffold, what are you waiting for? Skaffold is the best way we know of to deal with the market’s main risks;
Don’t miss an opportunity – every stock is covered and updated daily and automatically.
Reduce the risk of paying a high price for a stock – Skaffold’s intrinsic values ten years back and three years forward for every company.
Reduce the risk of buying the wrong company and suffering permanent capital loss – Skaffold’s Quality Scores, cash flow information and projected intrinisic values are updated in real time, keeping you abreast of vital changes to a company’s prospects as an investment candidate.
If you have been thinking about becoming a ‘Skaffolder’ there are few better times to get started than just before companies start releasing their important Half Year results. Skaffold’s intrinsic values are updated live and daily so as company’s prospects are upgraded (or downgraded!) during reporting season, you are likely to find a multitude of opportunities for investigation. Go to www.skaffold.com to get started just as reporting season takes off.
All the best for 2012.
Posted by Roger Montgomery, Value.able author and Fund Manager, 31 January 2012.
