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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Value.able investors can be forgiven for giving up. You wait so long for value to be presented and then when it appears it just hangs around, remaining ‘good value’ for what seems an age. Value can sometimes nag and nag and by the time action becomes urgent, the newest and least patient value investors are no longer listening. I can see it in the statistics of my friend’s financial services businesses and no doubt it’ also being felt by tip sheets purveyors and CFD merchants. For all the talk of value investing, few really have the patience to succeed.
Value.able-style investors can be forgiven for giving up. You wait so long for value to appear and then when it does, its just hangs around. STocks that were expensive, become cheap and then, simply, boringly, stay cheap. Value can sometime nag and nag and by the time action becomes urgent, the newest and least patient investors are no longer listening. I have no doubt this is impacting the revenues of the tip sheet purveyors and the CFD merchants, indeed any business in financial services whose revenue is dependent on investors maintaining the faith.
That is the situation I was recently delighted to observe as the Cochlear share price plunged another 14% to $51.30, or about 40% since its April 2011 high of $85.
Recently I ascribed to Cochlear’s shares, a valuation of $59. Since 2004 the price has been persistently above my intrinsic value estimate, which means the combination of circumstances that have pushed the share price below value most recently are worth exploring.
Cochlear has the largest market share for cochlear hearing implants worldwide and, after announcing a voluntary recall of its flagship Nucleus CI500 implant range recently (the Nucleus accounts for more than 70% of sales), investors voted with their feet and the stock fell more than 20%.
The recall was voluntary and relates only to those devices that have not been implanted. The devices have a fail rate of about 1% and the fault – due to moisture on 1 of 4 diodes from loss of seal – is not believed to be harmful in any way, the device simply shuts down.
With about 25,000 of the units in use globally, that implies around 250 recipients of the implant will be affected and although that is significant, the proactive and patient-focused response of the company should ensure the reputational damage is contained.
As Cochlear’s technicians work to isolate the problem with the Nucleus 5 range, the company will dust off the Nucleus Freedom range, which it has marketed successfully for many years against products such rivals as Advanced Bionics and Med-El.
Med-El is gaining market share in the US generally but patients waiting for implant surgery have switched to the Cochlear Freedom product and apparently with no delays.
At the same time as Cochlear’s recall, Advanced Bionics received FDA approval to sell its product (which was itself recalled in November last year) into the US market. This turn of events is not unusual for the industry … but it is unusual for Cochlear and that’s why the news came as such a blow. Cochlear is one of the highest-quality companies trading on the ASX today. The company that almost never puts a foot wrong appears to have tripped itself up and investors became spooked.
And in that reaction a potential opportunity may be presented.
The financial impacts of these events won’t be fully known until later in the year but is expected currently to be $130 – $150 mln, translating to an after tax impact of about $20 mln.
Over the past decade, Cochlear has increased profits every year with the exception of 2004. Net profit was just $40 million in 2002 and most recently the company reported profits of $180 million for 2011.
Operating cash flow over the same period has risen from less than a $1 million (an exception for 2002) to more than $201 million, allowing debt to decline to just $63 million from nearly $200 million in 2009. Net gearing is now minus 1.86%.
Those impressive economics have resulted in an intrinsic value that has risen by nearly 18% each year since 2004. If your job as a long-term investor is to find companies with bright prospects for intrinsic value appreciation – believing that in the long run prices follow values – then it quite possible that Cochlear is being served up on a plate.
The recently reported net profit figure of $180.1 million for 2011 was up 16% and in line with consensus analyst estimates, although this occurred despite sales of $809.6 million exceeding analysts’ estimates. It seems the analysts did not expect the EBIT and NPAT margins that were reported. These were flat, which given a very strong Australian dollar, suggests impressive efficiency gains in the operations.
If only that blasted “Australian peso” would go down and stay down!
Back on August 19, 2009, I wrote in the Eureka Report: “Fully franked dividends have risen every year for the past decade, growing by almost 500% (or 22% pa) since 2000. These are not numbers to be sneezed at; the company has produced an impressive and stable return on equity since 2004 of about 47% with very modest debt. Clearly this is a company worth some significant premium to its equity.”
Nothing changed really for 2011. A final dividend of $1.20 per share was 70% franked and up 14%.
Importantly, it seems Cochlear’s market is growing. Unit sales volumes were up 17% for the year and, given in the first half they were up 20%, it suggests the second half were up 14%. Double digit growth was reported in sales volumes for all major regions and Asia was the most impressive, rising more than 30% to the point where it makes up 16% of total revenues.
This really is impressive stuff. Just two years ago the company reported unit sales growth of only 2%, to 18,553 units, and many analysts were blaming slow China sales. Nobody expected the company to ever repeat its 2007 and 2008 volume growth of 24% and 14% respectively, and certainly not off a higher base. Growth has always been viewed as being limited by the high cost of the devices and the reliance on insurance and healthcare schemes to subsidise the costs and those of surgery to implant to them.
According to the World Health Organization however, almost 280 million people suffer from moderate to profound hearing loss and an ageing population means this figure will rise. Cochlear is one of a handful of companies that actively contributes to improving the quality of life of its clients.
When great companies stumble, the impact can be exaggerated by the reaction of shareholders who never believed it could happen. Then comes a wave of selling amid doubts that the company will ever regain its mantle.
But strong market share and strong cash flow, high returns on equity and low debt, are rarely offered at bargain prices so I picked up some Cochlear stock for the Montgomery [Private] Fund. It is expected that I will to add to this position over the coming weeks and months (provided value remains) when the full financial impact of the recall is known.
I must confess I didn’t bet the farm on this particular investment because the financial impact of the recall remains uncertain; when that changes it will impact my intrinsic value estimate.
Whatever the impact, it will be temporary, even though it won’t necessarily preclude lower prices from this point. During the GFC, Cochlear shares fell from $78 to $44. No company is immune to lower share prices and I don’t know when or in what order they will transpire.
What I do know is that in 2021 we aren’t likely to be thinking about this recall, just as nobody now talks about the Wembley Stadium delays that dogged Multiplex back in 2006. Mercifully, investors’ memories tend to be short.
Recalls, competition, marketing gaffes and wayward salary packages are all part of the cut and thrust of business and if lower prices ensue for Cochlear shares, it will be important to determine whether the recall will inflict permanent scars. My guess is that it will not. I wonder whether you are listening for value?
Posted by Roger Montgomery, Value.able author and Fund Manager, 19 October 2011.
It is AGM season right now and the new executive pay rules are in everyone’s thoughts. Roger Montgomery shares his insights with Ross Greenwood on 2GB Money News. Listen to the podcast.
Telstra’s deal with NBN Co could give the company a lift, however as Roger Montgomery writes, “the longer-term outlook is less certain”. Read Roger’s article at www.eurkeareport.com.au.
With high salaries, higher rents, a strong Aussie dollar and ‘level-playing-field’ policies, are Australian manufacturers being unwillingly and inexorably dragged to doormat status?
We are in a race to the bottom and run the risk of ultimately being chewed up and spat out when our commodities are no longer required with such urgency.
Driven by a belief that economists are right and the way to measure happiness is by the consumption of “stuff”, government policy in Australia is set to keep the masses happy by making that “stuff” as cheap as possible.
Our way of life, and the quality of that life for our kids, is at risk if we continue to be apathetic. Driving around Sydney’s Eastern Suburbs and Lower North Shore, its apparent there isn’t a communal approach to the solution. Instead there is an individual race to accumulate more “stuff” to protect oneself. “Forget about the neighbours”. “Look after number one”. “If I have plenty in the bank, the kids and grandkids will be set up. What do I care if the rest of Australia goes to pot?”
It’s like watching seagulls fighting over a Twistie.
When competing against a country with an ethos that puts ‘the people’ first, what hope does a country whose constituents are clambering over each other for the next short-term dollar have?
Manufacturing in Australia needs help. I am not suggesting protection or a hand out. I am suggesting a leg-up.
Singapore rolls out the red carpet for new businesses with tax-free holidays for the first few hundred thousand in profits. What does the Australian government do for new businesses in Australia? A TAFE course? R&D tax breaks are a start, but helping big business roll out classrooms at $5000 per square metre helped who exactly?
Unemployment in Australia’s wealthiest suburbs is creeping up because we don’t need so many bankers and Merger & Acquisition experts when there aren’t any businesses left to merge and acquire.
Can our current way of life survive without manufacturing? It seems we may just find out. What will we do without manufacturing?
The commodity boom will end one day and we are selling large tracts of arable land to foreign investors. Without manufacturing, will we be running around serving each other lattes? Is that it?
Australia is still the home of ingenuity. Just look at programs like the ABC’s New Inventors. The best and brightest should be receiving generous awards and access to incubator programs that ensure the international success and that the commercial benefits flow back to Australia.
One American recently lamented “10 years ago we had Steve Jobs, Bob Hope and Johnny Cash. Now we have no jobs, no hope and no cash”. If we don’t want to end up in the same place, Australia needs to do more to help incubate, nurture, commercialise and protect our best ideas.
And what are we doing bringing the brightest foreign students into Australia, giving them some of the world’s best education and sharing our IP and then, when they graduate, telling them they cannot work here and sending them home to compete with us?
“Go Australia”? Or “Go, Get Out of Australia”?
We also have some amazing established manufacturing businesses – paint, water heaters, bull bars, truck tippers, caravans, mattresses, wine, beer, pharmaceuticals, chemicals, anoraks, toilets.
The list of those producing attractive products and results is nothing short of A1.
A company that…
1) Has built a brand and or reputation for quality, value or innovation;
2) Is vertically integrated – owning the distribution channel;
3) Is manufacturing a highly specialised or customised product and not competing solely on price;
…has a chance to succeed in manufacturing in Australia. And while it’s a shame our government has gradually allowed manufacturing to ‘die’, there are pockets within which Value.able Gradutes can find extraordinary businesses, especially when the market’s manic phase turns to depression.
Many of the manufacturers listed in the following table have a long history of operating through a variety of economic conditions. They are ranked from A1 down to C5 – you can immediately see the broad spread of quality. I find looking at the ‘tails’ to be particularly insightful.
While declining in volume, manufacturing in Australia is not dead. Indeed some businesses are positively ‘raking it in’.
Manufacturing is tough and because inflation is always running against a business with a high proportion of fixed assets, smart managerial decisions are constantly required.
Ironically, with so many winds against manufacturers, those that have little or no debt, high rates of return on equity, bright prospects for future growth in intrinsic value and are trading at substantial discounts to current intrinsic value, may just prove to be Value.ablely positioned to leverage a broader economic recovery, locally and globally.
Who’s your top pick for Australia’s best manufacturer? I also want to hear your stories about manufacturing here. Are you a business owner that makes something we should be proud of? How is government policy or a monopoly customer affecting you? What changes need to be made to give Australia a fighting chance?
The universe of great businesses to invest in will inevitably decline unless something is done.
I look forward to your stories. They will be read by the who’s who in banking, management and government, so jot down your thoughts and share your Value.able experiences.
Posted by Roger Montgomery and his A1 team (courtesy of Vocus Communications), fund managers and creators of the next-generation A1 stock market service, 13 October 2011.
Whilst the latest iPhone won’t ignite JB HI-Fi’s share price, the stock is back in Roger Montgomery’s buy zone. Read Roger’s article at www.eurekareport.com.au.
The Carbon Tax is one everyone’s lips at the moment. Roger Montgomery shares his thoughts on the government’s new tax with Ross Greenwood on 2GB money News. Listen to the podcast
Vocus Communications is in the business of selling bandwidth. The company resells it on the cable that runs under the Pacific between Sydney and the US. Last night they laid some of their own under another sea; Sydney Harbour. The company – in which I have previously disclosed I own a small number of shares – sent me these photos of the process. As we have met with management as part of our analysis, we were delighted they remembered our interest in everything they are up to. I thought these photos were fascinating and given its something most of us wouldn’t ever get a glimpse of, I thought you’d be interested too.
There’s no investment merit in the photos so don’t go rushing off to buy shares (certainly not without conducting your own research and after seeking and taking personal, professional advice).
Think of this post as a Value.able photo essay of what some people are up to while you were sleeping.
Meeting point and briefing at the North end of the Tunnel
A closed Sydney Harbour Tunnel
A very empty Sydney Harbour Tunnel
Hauling starts about 900mtrs from the South Exit. It’s a single piece of fibre from end to end
3kms of conduit installed the previous few nights
First meter of fibre coming off the drum
Energy Australia, the RTA and the other carrier’s fibre exiting the tunnel on the South Side
Fibre coming out of the Tunnel on the North side
Posted by Roger Montgomery and his A1 team (courtesy of Vocus Communications), fund managers and creators of the next-generation A1 stock market service, 6 October 2011.
Montgomery Investment Management founder Roger Montgomery reassures stock market investors that its quite easy to value a business. Using Roger’s simple Value.able formula, investors can value any business, listed or unlisted. “If you simply take the return on equity, divide it by the required return, so the return that you think is reasonable, and multiply it by the book value, you’ve got a valuation that’s going to be pretty sensible” Roger said. Read the transcript or watch the interview at www.abc.net.au.
This journey began with the simple question Will David beat Goliath?
Value.able Graduate Scott T resolved to take up a fight with conventional investing, by tracking the performance of a typical and published ‘institutional-style’ portfolio against a portfolio of companies that receive my highest Montgomery Quality Ratings.
By 30 June 2011 the A1 portfolio was up 1.8 per cent compared to the XJO, which was down 2.9 per cent. As for the conventional ‘institutional’ portfolio, the bankers were down 6.2 per cent.
Over to Scott T for his third quarter update…
“For new readers to Roger Montgomery’s Insights Blog, welcome. Here at Roger’s blog we are conducting a 12-month exercise measuring the performance of a basket of 10 stocks recommended by Goldman Sachs, against a basket of 10 A1 or A2 businesses that were selling for as big a discount to Intrinsic Value as we could find.
“Nine months have now passed since our twin brothers each invested their $100 000 inheritance, and it has been a very turbulent time in the market.
“Our Queensland regional accountant has had his head down at the office for the entire quarter. The end of the financial year had come and gone and hundreds of clients where sending in their tax documentation, calling with questions and chasing their refunds. Time flew by in the office, and he hardly had time to try to attract new clients, let alone watch the daily gyrations of the global equities markets. By the end of September when he was finally able to take a breath and look at the performance of his portfolio.
“He was surprised at how poorly his portfolio of A1 and A2 companies, acquired at prices less than they were worth, had faired. But he quickly realised the overall market had done even worse. Loosing 12 per cent, or $12 000, YTD was bad. But it could have been worse, much worse.
“His twin brother was in a world of pain. The federal department he worked for felt like it was under attack. The mood in the department was that the media seemed hell bent on criticising everything the government did. No initiative was well received and every announcement was instantly compared to last months failure. To top it all off, every night he would check his portfolio, to see how much more of his inheritance had vanished. The red negative number on his spreadsheet just seemed to steadily increase. With little information to go on, and a feeling of helplessness washing over him, he thought seriously about visiting his financial advisors, desperately seeking reassurance, and perhaps changing the mix of the stocks held. He resounded, “Buying what they advised would be good for 2012”.
“As per the first half of the year, dividends will be picked up in the fourth quarter, when shares have finished going ex-dividend and the dividends have actually been received.
“In summary for the nine months to 30 September 2011:
The XJO is DOWN 15.5 per cent
The Goldman Sachs Portfoliois DOWN 19.7 per cent
The A1 and A2 Portfolio is DOWN 12.0 per cent
The A1 and A2 Portfolio has achieved an OUTPERFORMANCE of 3.5 per cent over the XJO and 7.7 per cent over the Goldman Sachs portfolio.
“Here are the portfolios in detail, including cash dividends received in the first half (click the image to enlarge)
“We will visit the brothers again at the end of December for a final wrap up of their first year, and discuss their strategies for 2012
“All the Best
Scott T”
Thank you Scott.
How is your A1 portfolio performing?
Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 stock market service, 6 October 2011.
Nominations for Finsia’s Pinnacle Awards, including most outstanding industry contribution, most outstanding young professional and most outstanding future leader, were announced recently. Roger Montgomery has been nominated for most outstanding future leadership. The winners will be announced at Finsia’s 125th Anniversary Gala Dinner on October 25. Read the article.
