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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Following the release of their full year results, Roger spoke with senior management at JB Hi-Fi and discussed their cashflow and working capital.
JB Hi-Fi scores an A3 (down from A1) thanks to a debt-funded buy back of shares. It is nonetheless a company with great cash flow. Value.able Graduates paying close attention to Cashflow in JBH’s latest result may have been concerned by the large jump in inventory, which had a detrimental impact on Cashflow from Operations since last year.
So, what did Roger discover?
In 2010 JBH stores were cycling low inventory numbers. Arguably this resulted in a sell-out of stock, which was due to under-provisioning,
Stepping back and looking over time at a pre-store level, Roger says “If you have a look at the inventory on a per store basis, $2.2m – $2.6m per year, it’s fairly consistent. I’m not concerned.”
Roger suggests the future is interesting for JB Hi-Fi. If store growth continues at the current rate (13-16 stores per year) for the next three to four years, then by the time they reach 214 stores, there will be a lot of free cash. Extra cash from the maturity of existing stores, combined with a reduction in debt, will see a very cash rich JBH.
What will management do with the extra cash?
In Roger’s view, management have three options: increase dividends, buy back more shares or make a [silly] acquisition.
Roger’s estimate of JBH’s Value.able intrinsic value in 2012 is around $17, rising to $20 by 2013.
Will intrinsic value continue to rise after that?
“That will be largely dependent on what management does with that cashflow when it’s freed up” Says Roger, noting; “I think the future for JB Hi-Fi will prove to be a didactic experience for value investors.”
Value.able Graduates: What are your insights on Australia’s embattled retailers?
Value.able TV #4 was recorded at Montgomery HQ on 15 August 2011.
Posted by Roger Montgomery’s A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 15 August 2011.
iiNet’s full-year results have been released. I have taken particular interest because communications and data is one sector of the marketplace I believe is relatively less affected, in terms of share-of-wallet, by the ructions in the US Europe.
The results released today (15 August 2011) were marginally below the expectations of several analysts we correspond daily with. Underlying EBITDA was up just shy of 30 per cent to $104.8 million (some analysts were expecting $106 million and a little more).
With DSL (Digital Subscriber Line) – the technology that significantly increases the digital capacity of ordinary telephone lines, and excluding HFC (Hybrid Fiber-Coax network – CABLE) – iiNet is now the number two competitor and the leading “challenger “in the Australian residential telecommunications market. As an investor, I am always interested in the number 1 or 2 player in town. However the gap between number 1 (Telstra) and iiNet (#2) is enormous. iiNet have 641,000 paid DSL subscribers (up 19 per cent). Telstra has 2.4 million.
The company reported its underlying Net Profit After Tax was $39.0m, up 12.4 per cent on FY10, while reported NAPT fell 3.7 per cent to $33.4m (FY10 $34.7m). On a quick glance, I reckon underlying profit was $37 million (you have to add back $3.9 million in deal costs, redundancy costs of $1.2 million and legal costs of $1.4 million but tax effect it). Stripping out the impact of the acquisition, I also estimate cash flow was close to $40 million.
The reason for the less than stellar growth in reported net profit was because iiNet’s tax bill was much higher than last year. The increase in tax wiped out all of the increase in the net profit before tax.
Whilst many analysts will look at the growth in operating profit (EBITDA), I’d look at the net profit before tax. If I add the legal costs in 2010 back to that year’s profit-before-tax and then add the one-offs for 2011, I get a jump in net profit before tax from $43.85 to $53.4 million and a reduction in margins from 9.25 per cent to 7.6 per cent. Hopefully the company’s expected ‘synergies’ (an extra $10 million from porting AAPT customers across to the iiNet billing system?) raise this to 8.5 per cent.
Net debt increased to $96.4m from $56.3m as a result of the AAPT Consumer division. This has had an impact on our Quality Score (the A1-C5 system), which was B2 previously. Gearing will be 40 per cent. And the the balance sheet? It now contains $302 million of goodwill compared to $242 million of equity.
Revenue and operating cash flow was up significantly with the full year’s benefit of the Netspace acquisition and a nine month benefit of the AAPT consumer division. What really would be interesting however is an estimate of what like-for-like revenue and operating cash flow is. Sure iiNet has no ‘stores’, but acquisitions and synergy extraction doesn’t have the same whiff of sustainability as a business that can grow organically. I would like to see how the old business (excluding the acquisitions) is travelling. Value.able Graduates – would you?
And when I hear company say that it is “Ideally positioned for the future“, I want answers as to whether they were previously ideally positioned for ‘now’.
The 19 per cent growth in DSL subscribers includes AAPT’s consumer division, so it doesn’t give us much insight into the organic growth of the company. With ARPU (Average Revenue Per User) largely unchanged, yet network and carrier costs up 56 per cent – above the 47 per cent increase in revenue – some insights into organic growth would be helpful. I suspect subscriber growth will reflect slow organic growth in FY12, and any margin/profit improvement will come from ‘synergies’. While these may be significant ($9 – $12 million from migrating AAPT customers onto iinet billing system), they are not a long-term delivery platform for profit growth.
It is clear that management’s confidence is high. They have significantly increased the dividend from $12.1 million last year to $16.7 million this year and have announced separately a share buy-back of up to 7.6 million shares, or about 5 per cent of the issued capital (about $17 million at current prices), despite the fact that debt has risen substantially by a net $52 million. Perhaps when you have $766 million coming through the door you can afford to be a bit fancy-free with your capital allocation? Thoughts anyone?
I hear whispers in the background… Roger, how do you know all this? Yes, I do listen to company presentations and we do read investor briefings. But nothing compares to the clarity that comes from using our A1 service. It is, quite literally, extaordinary. And we can’t wait to share it with you. Value.able Graduates – expect to receive your invitation very soon. Now, back to the program…
If organic growth is slow and acquisitions begin to thin out, one would expect debt repayment followed by an increase in the payout ratio. Or perhaps the other way around, if share price support is contemplated?
The prices paid for acquisitions does not immediately cause concern for me, because the returns on equity being reported aren’t poor. But they aren’t A1 either.
Investors have tipped in $223 million and left in $15 million. On those amounts, iiNet’s Return on Equity is about 16 per cent.That’s not bad, but are there better opportunities out there. Before you suggest Telstra, keep in mind it is 140 per cent geared and profits are boosted by the failure of the company to recognise software development expenses in the year they are incurred.
The old fashioned Value.able investor in me doesn’t like looking at a balance sheet that reveals the debt-funded acquisition of goodwill. I have witnessed far too many examples of this turning out poorly. Sure, some of you may say that MMS did the same thing? But while debt rose significantly there, the corresponding asset was PP&E, not goodwill. You may instead point out that interest cover is still high at 9 times (20 times last year). That, I accept.
Finally, the NBN. What does it mean for iiNet?
First, some background. An ‘Off-net’ customer is provided a DSL service through another network – usually Telstra wholesale. An ‘On-net’ customer is one that is provided a DSL service through the iiNetwork (iiNet’s own broadband network). The NBN is expected to reduce the average monthly cost of broadband + Voice bundling to $33, which compares favourably to the current off-net cost of $57. This is a potentially major saving, but the reason I am not as excited about this as the company is because as the transition is made, there will be some leakage. It will occur over an unexciting period of time and any number of offsetting factors could adversely impact revenues, costs and profits during that time.
I am more excited about other companies at the moment. A growth by acquisition strategy may offer wonderful potential in the short-term, but it can also be used to mask slow organic growth. The buy-back can be a sign that cashflow will be strong, but it can also be used to merely ‘display’ confidence and support the share price. At Montgomery HQ, we reckon the shares are very close to their Value.able intrinsic value, but iiNet’s fall in quality, from A3 to B2, suggests shifting your attention to other opportunities.
You should be practising your own Value.able valuations. So what do you get for iiNet for 2011, 2012 and 2013?
Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 15 August 2011.
The Dow Jones dropped 500 points. The ASX immediately followed. Is this rational investing or just another correction? In this appearance on Switzer TV with Peter Switzer, Roger Montgomery reveals eight extraordinary A1 companies whose shares are trading at prices below his estimate of their Value.able intrinsic value. Roger reveals Flight Centre (ASX:FLT), Data#3 (ASX:DTL), Oroton (ASX:ORL) and Cash Converters (ASX:CCV). What other extraordinary businesses make Roger Montgomery’s A1 grade? Watch the interview.
Last night, First Edition Value.able Graduate Scotty G shared his stock market story at our blog. Scotty’s story is far too value.able to not receive its own, very special post! Over to you Scotty…
A Tale of Two Crashes
by Scotty G
2008/2009
An ‘investor’, whom we’ll call Scotty G for anonymity purposes, has woken for work at 05:00 to see that the Dow is off 700 points. He nervously heads in to work to check what it means for his portfolio of ‘blue chips’. He’s down badly and it’s only made worse by the fact that he is in a margin loan, which he kept at a ‘conservative’ 50 per cent level of gearing.
His ‘great’ stock picks are not holding up well in this environment and his ‘genius’ ‘value plays’ like buying Babcock and Brown at $7 because ‘its fallen from $28 and surely at a quarter of the price it represents value’ no longer looks like genius at all. He had imagined himself some sort of Buffet-ian hero, stepping into a falling market and making the tough buy call that would surely pay off. No actual analysis is done to back up these calls.
Finally he is 1 per cent off a margin call. He is tense at work, snapping at friends and chewing a red pen so hard it stains his lips and chin. He capitulates, calls his broker and sells out, including his ‘value pick’ Babcock and Brown at 70c. He feels relieved to be out, but is bruised and jaded by his experience. He vows to return to the stock market some day and do better, but doesn’t know how.
2010
Our ‘hero’ comes across a beacon of light in a sea of information. It is the Value.able column in Alan Kohler’s Eureka Report, penned by a knight known as Roger M (name changed to protect the innocent). He follows the link to the Insights blog and is astounded that the information he has been searching for is all here. He eagerly orders the Tome of Wisdom (known as Value.able to some). Upon receiving it, he reads it in one sitting. Wheels click in his head and light shines in the dark. Could it be so simple? Knowing what something is worth and then refusing to pay above it? In fact, demanding a discount? He set off onto his journey for the Grail.
2011
Our hero is now equipped with a spreadsheet devised from the Value.able rule book. He can value companies quickly and decisively. Many don’t make it onto the spreadsheet, as he can now spot a ‘Babcock and Brown’ coming from a mile away. Stock ‘tips’ from colleagues can now be waved away. When they ask why, he tells them. If they say he’s crazy, he smiles and feels at peace. He knows he is still not perfect, but he’s a darn sight better than he was three years back.
The markets turn down. The spreadsheet is rechecked. MCE and FGE are added as they shift below his 20 per cent discount rate. JBH is added soon after. The markets shift lower. But reassured by the facts this time, and not the hype, he buys more of the above.
Markets shift lower still. Figures are checked and rechecked as more great businesses come within range. The panic of a fall is now replaced by a calmness and certainty that an anchor of value provides.
The market finally slides steeply over several days.
Finally! Some of his best targets are in range.
VOC falls, then MTU (a company he has waited ages to acquire), and finally DCG. Sadly, ARP refuses to come within range, but he his patient and does not chase it.
He retires to his castle (lounge/bar), content with the work he has done and happy to await the next chance to hunt and switches on the sport, deftly ignoring the news and business channels hosting ‘experts’ eager to proffer their take on why things were the way they were. He feels at peace and sleeps soundly that night.
“Ok, stripping out all the ‘poetic’ and imaginative stuff, this is pretty much how it went in real life. I suffered a loss due to poor decisions with no research. I found Value.able, I converted (or got innoculated as some of the greats say) and took advantage of the recent situation. And I do sleep soundly at night.
“Thank you Roger for your willingness to share and to all on the blog for the same spirit of camaraderie. I look forward to many years of sleeping soundly at night.
To Value.able and to Value!”
Thanks Scotty.
If you are yet to join the Graduate Class, click here to order your copy of Value.able immediately. Once you have; 1. read Value.able and 2. Like Scotty, changed some part of the way you think about the stock market, my team and I will be delighted to officially welcome you as a Graduate of the Class of 2011 (and invite you to become a founding member of our very-soon-to-be-released next-generation A1 service).
Posted by Roger Montgomery and his A1 team (on behalf of Scotty G), fund managers and creators of the next-generation A1 service for stock market investors, 10 August 2011.
There’s an odd whiff about the upcoming float of Australia’s top-selling cheese brand. No matter what the company says, investors will have their shares diluted by Bega’s acquisition of Tatura Milk Industries. Read Roger’s article at www.eurekareport.com.au.
The changing retail environment that JB Hi-Fi must negotiate has taken a back seat in the minds of investors, many of whom are almost singularly focused on events unfolding in the US and Europe. Value.able Graduates, I am proud to report, remain focused on the business.
Australia’s retail environment is in a state of flux. The only thing that is permanent is that the retail environment is always in a state of flux!
Success however for retailers who don’t own their own brands is always based on the same recipe – low costs, the right products and the right prices irrespective of what the market is doing.
JBH doesn’t shift its brand positioning. It is known as the “value” player in the electronics retail market. Its sells exactly the same big brands as its rivals, such as Harvey Norman and the Good Guys, but has won mind share as the low-price alternative. Its low-end branding and cheap shop fittings is particularly helpful when consumers start zipping up their wallets.
JBH sold $2.9 billion dollars worth of gadgets, music and games in 2011, up 8.35 per cent from $2.73 billion the year before. The company’s headline profit was down 7.6 per cent to $109 million (at the lower end of its guidance range) and compares to $118.7 million the previous year. Excluding the Clive Anthony’s write-down, the result was $134.4 million, which is up 13.3 per cent. EBIT grew by almost 12%. Like for like hardware sales were up about 4%, which compared to the industry-wide number being down about 4% suggests the company is continuing its habit of winning market share. The final dividend of 29 cents per share ensures the payout ratio remains at 60 per cent. Aggregate sales grew 8.3 per cent while same store sales were down 1.2 per cent (Australia was down -0.5 per cent and New Zealand up 2.4 per cent). Second half like-for-like sales were up 0.1 per cent for JBH, but down 14.8 per cent for Clive Anthony’s.
Costs remain under control with the CODB (Cost of doing business) at 14.5 per cent – unchanged for the year (but up from 13.2 per cent in the recent past), and the EBIT margin rising to 6.6 per cent. Gross margin rose to 22 per cent – but I have to confess I prefer to see gross margin falling as it further entrenches competitive advantage.
Sales and marketing expenses rose by 8.2% – in line with group sales but occupancy expenses rose by 13%. This could suggests the tail end of store openings – second tier and the company is not getting as attractive terms.
A $73.4 million increase in inventory – largely due to new stores (but requires more investigation because the company says $49.1 million was invested in new store inventory but last year the jump was just $10 million) – resulted in cash flow from operations of $109.9 million compared to $152.1 million last year. Capex of $45.1 million relating to the opening of 18 new stores also needs to be considered in any cash flow analysis. The buyback of 10 million shares pushed borrowings up from $70 million to $232 million, which will have an impact on free cash flow for the next few years, but contributed to the fact that $260 million was returned to shareholders this year.
My business cash flow is a positive $71.2 million and then $88 million was paid in dividends.
Eighteen stores were opened and four Clive Anthony stores were converted. The expectation is that there are another 62 stores to open, at a rate of 13-15 stores per year. If we assume 2-3 per cent sales growth and another 4-5 years before reaching the targeted number of stores, sales in 2016 could be $4.5 billion. And if current NPAT margins are maintained, JB Hi-Fi could be reporting profits of $204 million, which is equivalent to a compounded growth rate of 11% per annum and earnings per share of $2.08 per share in four years. And that expectation assumes no improvement in retail conditions (nor any deterioration either).
The big story however is that Terry Smart will need to start looking beyond this organic growth to other strategies if JB Hi-Fi is to avoid developing the profile of another mature Australian retail business like Harvey Norman.
On that front, JB Hi-Fi will release a streaming music service by the end of the year – a challenger for iTunes. They already have 800,000 unique weekly visits to their website so before you dismiss its chances, remember this: consumers will be unlimited in terms of the devices that music can be “streamed” to. The service will be a ‘playlist’ service much like GrooveShark, which is discussed regularly amongst the team here at Montgomery HQ. There will be 6-8 million tracks from 100,000 artists at launch and one expects, if it catches on, a small investment could lead to deals with concert promoters and outdoor entertainment events – wherever teens congregate to listen to music. JB Hi-Fi needs to establish new and emerging business models to try and counter the shift away from physical music unit sales.
Having said that, the current sales environment is probably not representative of the future. Share market investors generally use the rear view mirror when assessing the future. I have previously discussed the “economics of enough”, which David Bussau from Opportunity International introduced me to many years ago. As it applies to consumers generally, they will get sick of trying to keep up with the latest technology, be happy with their TVs and replace everything less often – opting instead to ‘experience’ travel, food, adventure and other cultures. That of course doesn’t mean JB can’t grow its share-of-wallet. In the face of declining retail sales volume growth over the last five to ten years and deflation, JB is proving it is already the market leader.
The announcement was overshadowed by the July stats. Being ‘actuals’ the company was in a position to report them. Same store sales were negative 3.3 per cent, but aggregate sales were up 6.4 per cent. The like-for-like decline was partly attributed to the company ‘cycling’ the release of the iPhone 4.
As I have said before I don’t think the current retail malaise will continue forever and JB will emerge stronger and with more market share when we come out the other side of this consumption ‘funk’.
JB Hi-Fi’s quality score dropped from A1 to A3 and interestingly, this was only partly due to the increase in debt. (We really need to know whether it was just timing issues and new stores that contributed to the jump in inventory).
Furthermore, our estimated valuation for 2012 is now $17.30, rising to $20.30 in 2013.
Your Job:
Then come back here to our Insights blog and share your findings.
Very soon, finding extraordinary companies offering large safety margins will become simple and may I even suggest, enjoyable. The next-generation A1 service my team and I have created will inspire your investing and re-energise your portfolio. (Value.able Graduates – your invitation to pre-register is imminent).
If you are yet to join the Graduate Class, click here to order your copy of Value.able immediately. Once you have; 1. read Value.able and 2. changed some part of the way you think about the stock market, my team and I will be delighted to officially welcome you as a Graduate of the Class of 2011 (and invite you to become a founding member of our next-generation A1 service).
Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 9 August 2011.
The Australian share market and dollar have staged spectacular turnarounds, with All ordinaries index rising phoenix-like from falls of more than 5 per cent to finish with a 1 per cent gain. Fund Manager, Roger Montgomery reveals his thoughts following the market turnaround. Read the article.
In light of the market downturn, Roger Montgomery is finding bargains in extraordinary companies that are trading at discounts to their intrinsic values. In this interview with Ross Greenwood, Roger shares his thoughts on Macquarie Bank (MQG) and Zicom (ASX:ZGL). Roger also reveals which A1 and A2 MQR (Montgomery quality rating) companies are trading at discounts to their intrinsic values. Listen to the podcast.
It’s a common question. Stockbroker recommendations often travel from ‘Buy’ to ‘Hold’ then back to ‘Buy’, and then all of a sudden ‘Ceasing Coverage’ appears. Rarely is a ‘Sell’ mentioned, let alone maintained for any length of time.
So the question remains… should you sell after the stock market has fallen 511 points? Or when the share price of an extraordinary A1 business falls by as much as 26 per cent?
“Of course not, Roger!”, I hear Value.able Graduates shouting from the rooftops across the country.
In Chapter 13 of Value.able I describe my five rules for when to sell. In this video, I will elaborate on Rule # 1: No junk policy.
I will assume 1. You are a Value.able Graduate, 2. You have changed some part of the way you think about the stock market. I will also assume you can confidently pick an A1 company from a basket of so-called ‘blue chips’.
Your mission: Go through your portfolio. Turn the stock market off and look at the businesses you own. Are you blessed with A1s? Or is your portfolio full of ‘blue chips’ that fail to make the A1 grade?
If you are yet to join the Graduate Class, click here to order your copy of Value.able immediately. Once you have 1. read Value.able and 2. changed some part of the way you think about the stock market, my team and I will be delighted to officially welcome you as a Graduate of the Class of 2011 (and invite you to become a founding member of our soon-to-be-released next-generation A1 service).
Value.able TV #3 was recorded at Montgomery HQ on 5 August 2011.
Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 9 August 2011.
The US stockmarket had its biggest one day selloff since the GFC last night.
Back on 1 December 2008 the Dow Jones plunged 679.95 points. Last night the US market dropped 511 points – that’s a 4.31% decline. All 2011 gains were wiped out.
The Dow Jones Index is now down 10 per cent since May. The US is officially in recession territory.
Humans instinctively have an aversion to a debt crisis, but not a solution. And how do investors (not Value.able Graduates) react in such an environment? With fear. And it is that fear that drove our market down 4 per cent today.
But has anything significantly changed that would result in the intrinsic value of Decmil falling 12 per cent since yesterday? I will let you judge and respond accordingly.
Value.able Graduates, stick to our mantra: put together a portfolio of extraordinary A1 businesses that you believe will be much more valuable in five, ten or twenty years time.
If you are yet to join the Graduate Class, click here to order your copy of Value.able immediately. Once you have 1. read Value.able and 2. changed some part of the way you think about the stock market, my team and I will be delighted to officially welcome you as a Graduate of the Class of 2011 (and invite you to become a founding member of our soon-to-be-released next-generation A1 service).
Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 5 August 2011.
