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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The other day, Andrew Robertson interviewed me for ABC’s Lateline Business Program about property trusts (you can find the transcript in the Media Room, On TV). I thought you might benefit from an expanded précis.
For a very long time, property trusts were described rather derisorily as the investments of widows and orphans – boring, uneventful and staid. Then with the advent of a name change to REITS (Real Estate Investment Trusts), cheap credit and a healthy dose of me-too-ism, property trust managers trotted down the path that took them to near extinction.
Managers of today’s REITS are falling over themselves to once again describe themselves as staid boring old property trusts. But don’t be fooled, while a decade of stable returns and the life savings of so many are gone, many of the managers responsible are not.
With some basic arithmetic, let me explain what has occurred. Company A has $10 of Equity per Share that is returning 7% to 11% year-in and year-out. Somewhere between 2005 and 2006, like a kid at a toy shop screaming “I want one too”, the managers of property trusts started expanding in a debt-fuelled binge to get bigger.
Arguably led by Westfield a year earlier in 2004, and as one might expect, the increased debt produced rising Returns on Equity. But it didn’t last.
The party’s last song may have been August 29, 2007. That’s when Westfield was leading again. It sold a half share of Doncaster Shoppingtown for $738 million to one of the world’s largest property managers, LaSalle, on a yield of 4.7% – a record low. Westfield also sold half of its Westfield Parramatta centre for $717 million at a time when Centro, for example, was still loading up on debt. It sold another $1.3 billion in property-linked notes, launched a UK wholesale fund into which it sold $1.3 billion of its inventory, and sold more than A$750 million of US assets. And while it was selling assets, it was raising $3 billion of capital through a rights issue ostensibly to acquire more assets.
Unfortunately for many investors, the managers of other property concerns thought they were smarter than the Lowys. Have a look at the debt to equity ratios in 2007 and compare them to the corresponding ratios in 2004. And the US was reported to be heading into recession.
While it would be some time before the revelers turned into pumpkins and mice, the band had packed up and gone home.
If you want to set your kids on the road to financial success, tell them this: “If you can’t afford to buy it with cash, you don’t deserve to have it.” Its harsh, but I grew up on that advice. There were a few lay-buys for Christmas, but there wasn’t a single card in my Mother’s glomesh purse.
The lesson however was lost on the property trust managers, and it wasn’t their money anyway!
Eventually everything did turn to pumpkins and mice, and what happened next saved the entities and protected many of the executive jobs but arguably did far fewer favours for the unit holders.
In 2008 Company A writes down its properties, triggering loan covenants and LVR limits. Debt to equity ratio explodes. Bank tells Company A to sort it out. Company A’s share price falls to meaningless price and far below even the written down NTA. Company A conducts a capital raising anyway and issues hundreds of millions of new shares at a discount to the price and in complete annihilation of the equity per share, as the following tables demonstrate.
The result of all this activity, quite apart from the corporate finance fees it generated, was a dilution of Equity per unit, Earnings per unit and Return on Equity.
GPT’s, ING’s and Goodman’s Returns on Equity are expected to average 5 per cent or less for the next two years – that’s less than a bank account. Stockland and Dexus are expected to average 7 or 8 per cent – a little better, but nothing to write home about.
And finally, you can’t dilute Equity per Share, Earnings per Share and Returns on Equity without a reduction in the intrinsic values of these entities, and that’s precisely what has happened.
Stockland’s intrinsic value has fallen from $4.00 in 2008 to $2.16 today. Westfield from $8.25 to $6.71, Dexus from $2.74 in 2007 to 15 cents today and GPT, from $4.10 in 2007 to 30 cents today. Those intrinsic values aren’t going anywhere in a hurry either, unless Returns on Equity can rise significantly, but with debt now substantially lower that appears less likely.
Posted by Roger Montgomery, 9 April 2010.
Before Roger Montgomery reveals his top five stock tips, which he ranks in terms of quality and performance from A1-C5, he talks about the characteristics of great businesses – his A1s: 1.Great quality high rates of ROE, little or no debt; 2.Intrinsic value is rising; 3. Share price is trading at discount to intrinsic value. Watch the interview. Sign up free to Peter Switzer’s latest personal finance and financial planning news at switzer.com.au.
On the opposite end of the spectrum of Roger Montgomery’s A1 stock picks are C5 businesses – low quality, high debt, low ROE and trading at prices significantly about their intrinsic value. Transurban and Primary Healthcare are two such companies Roger talks with Peter Switzer about. Another is Myer. Watch the interview. Sign up free to Peter Switzer’s latest personal finance and financial planning news at switzer.com.au.
Tatts Group’s purchase of NSW Lotteries could reduce its intrinsic value. A lottery ticket might be a better investment. Read Roger’s article at eurekareport.com.au.
Developer and funds manager Mirvac has unveiled a $500 million capital raising and revealed it is in exclusive takeover talks with Westpac’s fund management arm. Fund manager Roger Montgomery says he’s not surprised at Mirvac’s interest. Read article.
Developer and funds manager Mirvac has unveiled a $500 million capital raising and revealed it is in exclusive takeover talks with Westpac’s fund management arm. Fund manager Roger Montgomery says he’s not surprised at Mirvac’s interest. Read transcript. Read related blog post.
Twelve months ago TheBull.com.au asked four stock pickers to select a portfolio of 10 stocks to hold for one year. So how did they fare? Independent investment analyst Roger Montgomery blitzed the field with a whopping 51.90% gain, beating off his competitors by as much as 24% as well as the All Ordinaries index by a hefty 13% margin. Read article.
Heading into Easter, I received an enormous pile of valuation requests and while many were little mining explorers burning through $500,000 of cash per month and with just $3 million in the bank, quite a few were solid companies that hadn’t been covered before.
And to confess, some of the requests were quite rightly keeping me accountable and making sure I post the company valuations I said I would, when I have appeared on Sky Business with either Nina May, Ricardo Goncalves and Peter Switzer.
What are they, I hear you ask? Forge Group (FGE), Grange Resources (GRR), Arrow Energy (AOE), Cabcharge (CAB), Coca Cola (CCL), Data 3 (DTL), Hutchison (HTA), Incitec Pivot (IPL), Metcash (MTS), Sedgeman (SDM) and UXC (UXC)
I am really impressed by the frequency with which I am now receiving emails containing insights I didn’t know about companies that I have covered.
As a fund manager it was not unusual for me to adopt Phil Fisher’s ‘scuttlebutt’ approach to investing. By way of background, Warren Buffett has previously described his approach to investing as 85 per cent Ben Graham and 15 per cent Phil Fisher. Fisher advocated scuttlebutt – talking to staff, to customers and to competitors. I did the same and would often end my interview of a company’s CEO or CFO with I’d learned from reading Lynch; “if I handed you a gun with one silver bullet, which one of your competitors would you get rid of?” The answers were always revealing. Sometimes I would get; “there’s noone worth wasting a silver bullet on”, but most of the time, I would find out a lot more about the competitive landscape than I had bargained for. Occasionally, I would learn that there was another company I really should be researching.
Back to your insights, they are amazing. Now you know why I enjoy sharing my own insights and valuations with you as much as I enjoy the process of investing.
One thought for you; Many of you are sending your best work via email. I would really like to see everyone benefit from the knowledge and experiences you all have so hit reply and if you have some insights (as opposed to an opinion), just click on ‘REPLY’ at the bottom of this post and leave as much information as you would like.
So here are a few more valuations to ponder over Easter. I hope they add another dimension to your research. And before you go calling me about coal seam gas hopeful Arrow Energy, note that the valuation is a 2009 valuation based on actual results. The forecasts for Arrow for the next two years are for losses, and using my model, a company earning nothing is worth nothing. Of course Royal Dutch Shell and Petro China think its worth more and perhaps to them it is, but as a going concern its worth a lot less for some time to a passive investor.
I hope you are enjoying the Easter break and look forward to reading and replying to your insights.
Posted by Roger Montgomery, 1 April 2010
They might be able to run a business, but many managers are incompetent at allocating capital. Read article.
On 31 March 2010 Roger Montgomery’s YouTube channel,www.youtube.com/RogerJMontgomery, ranked as the #16 Most Viewed Guru Channel in Australia. Following is a message from Roger.
“Today my YouTube channel achieved a new record, # 16 Most Viewed (Today) – Gurus – Australia. Once again I would like to say thank you for your encouraging Facebook comments, emails and blog interactions. I enjoy sharing my knowledge almost as much as I enjoy the process of investing, and to be able to interact with so many of you online makes the process even more rewarding.”
