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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When China’s property bubble bursts, what will be the consequences for BHP and RIO? In the first part of his appearance on Your Money Your Call with Nina May Roger Montgomery also discusses Centennial Coal (CEY), Mortgage Choice (MOC), Virgin Blue (VBA), Santos (STO) and Woodside (WPL). Unfortunately none of these companies make Roger’s A1 grade. Watch the interview.
Roger Montgomery reveals his 2010, 2011 and 2012 valuations for Telstra, and it doesnt look good. In the second part of his interview with Peter Switzer Roger also tells viewers the value of Myer and Resmed. Watch the interview. Sign up free to Peter Switzer’s latest personal finance and financial planning news at switzer.com.au.
Roger Montgomery reveals the characteristics of top quality businesses – strong balance sheet, growing earnings, strong competitive advantage. Roger also talks about Toll Holdings and MMS. Watch the interview.
In 1999 TLS was the darling of the market. Analysts described it as a wonderful company, going to $20. One analyst even said it would be Australias first $100 stock. Not Roger Montgomery. He said the business was worth $2.70-$2.80. It was trading around $9. In this interview with Peter Switzer Roger reveals the valuation formula for a business that payout out all of its earnings out as a dividend, such as Telstra. Watch the interview. Sign up free to Peter Switzer’s latest personal finance and financial planning news at switzer.com.au.
Roger Montgomery reveals to viewers of Oriel Morrison’s Trading Matters program on CNBC Asia the businesses that are overpriced and represent a short selling opportunity, including IAG, AMP, WES, LLC, TOL, STO, AIO, RIO and LEI. In this appearance Roger also discusses the future prospects of The Reject Shop. Watch the interview.
Woolworths reported its first half 2010 results in recent weeks and the 17 per cent decline in the share price ahead of the result suggested investors may have been betting that the company was giving up ground to a revitalised Coles story. The price of Wesfarmers shares – being almost double their intrinsic value – certainly suggests enthusiasm for the latter company’s story.
Studying the results and the company however suggests any pessimism is unfounded and premature.
When I study JBH’s results there’s evidence of a classic profit loop. Cut prices to the customer, generate more sales, invest in systems and take advantage of greater buying power, invest savings in lower prices and do it again. Entrench the competitive advantage.
It would be obvious to expect Woolworths, with its history of management ties to Wal-Mart (who also engages the profit-loop) to be producing the same story, however WOW is flagging an arguably stronger position.
Where JBH’s gross profit margin keeps declining and net profit margin rising, Woolworths’ gross margin has increased every year since 2005. Revenues were 4.2% higher and gross profits rose by 6.5% in the latest half year result. Like JBH, WOW’s EBIT growth was stronger at 11%. As analysts we are mystified as to what is driving the increase in gross profit margins but standing back, you realise its a really good thing; if analysts cannot work it out then perhaps neither can the competitors and that’s good for maintaining a competitive advantage. Competitors cannot replicate something if they don’t know how its produced.
Woolworths competitive advantage – an important driver of sustainably high rates of return on equity (I expect them to average 27% for the next three years – subject to change of course at any time and without warning or notification afterwards) – is its scale and its total dominance, ownership of and class leadership in supply-chain management. The result is that a small increase in revenue even if due to inflation, results in a leveraged impact on profits.
From a cash flow perspective the other fascinating thing is the negative working capital. To those new to investing, working capital is typically an investment for a company; a business orders its products from a supplier, pays on 30 days terms and then spends the next few months selling the product it sells. If its takes a long time to sell the product and the customer takes time to pay, then there is an adverse impact on cash flow because the business is forking out cash today and not getting paid for some weeks or months.
In Woolworths case, as you might expect, the company is so strong and its buying power so dominant that it can dictate terms to its suppliers, making sure they deliver the right quantities at the right time. It can pay them when it likes and perhaps even pay them AFTER it sells the goods to consumers who buy with a debit, cash or credit card, which means Woolworths gets its money from its sales activity immediately. The difference of course can be invested.This virtuous cycle is highlighted by a negative number for working capital (WC = Inventory – Trade Payables + receivables – other creditors) which in Woolworth’s case, got even more negative! Don’t go rushing out and buying the shares because of this fact – its well known to the market and suppliers (who no doubt resent the company’s powerful market position). In the latest result, it was also attributable to timing differences in creditor payments.
The steep decline in the share price ahead of the company’s first half results suggests that many investors and analysts may have considered the company “ex-growth” and favoured Wesfarmers. Given the relative performances and valuations, this is likely to prove to be a mistake (more about that in a moment).
The company still has a lot of room to substantially increase sales and profits and the disbelief in this regard reminds me of the decade after decade in which analysts said Coca-Cola couldn’t grow anymore.
It would take a very almost illegally-informed and dedicated analyst to reach the conclusion that the company cannot continue to enlarge its coffers from further improvements to its overseas buying capability, its private label sales (both admittedly to the detriment of many smaller local owners of branded products) or its supply chain management. There’s also growth from acquisitions (speculative and don’t ever base a purchase on it), the Everyday Rewards loyalty card program and the hardware rollout (it will interesting to find out what they think their USP is).
While it will be interesting to find out what has been driving the competitor Wesfarmers sales numbers (basket size of more customers), the fact remains that it is premature to write off Woolworths. Many analysts will also be concerned about retailers cycling (comparing sales and profits to previous results) the fiscal stimulus, this is simply a short-term distraction and does not have anything to do with the long-term value of the company.
On that front, my calculated intrinsic value for Woolworths has risen every year for the last decade. When Buffett says he’s looking for companies with a “demonstrated track record of earnings power”, its because it translates to rising valuations. Woolworths was worth $2.39 in 2000. Intrinsic value rose to $14.84 in 2005 and $25.70 in 2009. Today’s value of $25.80 is expected to rise to $28.00 in 2011 and almost $30 in 2012.
The current price of $28.05 is therefore now equivalent to the valuation 15 months out and the February low prices are perhaps a better reflection of the current valuation that I have.
I have rarely been able to buy Woolworths at any significant discount to intrinsic value in the last decade and while I don’t know what the price will do next, I do know that irrespective of whether Woolworths offers lower prices in the supermarket or the share market, you would be ill advised to ignore them.
Please be reminded that my valuations for the future are based on analyst expectations, which can change at any time.
Posted by Roger Montgomery, 8 March 2010.
Bids to takeover Arrow Energy are very generous, says Roger Montgomery. He shares his view on Royal Dutch Shell and PetroChina’s $3 bn joint bid, with CNBC’s Oriel Morrison. Watch the interview.
Mark Twain (1835 – 1910) said; “I Am Not So Concerned With The Return On My Money As The Return Of My Money.” It may surprise you to know he was quite the investor and liked to make comment about his observations. His quips always revealed a deep understanding of the nonsense that goes on in the stock market. What fascinates me is that the mistakes Twain observed during his lifetime are being repeated today.
I am occasionally asked why I spend so much time offering my insights when many observe that there is neither an obligation nor financial need. The reason is quite simple, I enjoy the process and of course, the proceeds of investing this way. I find it reasonably undemanding and so I have a little time to share my findings. And there’s the ancillary benefit of seeing hundreds of light-bulb moments when people ‘get it’. I note Buffett’s obligations and financials are even less necessitous and yet he has devoted decades to educating investors and students. I really enjoy my work. It is fun and thank you for making it so.
Investing badly in stocks is both simple and easy. But while investing well is equally simple – it requires 1) an understanding of how the market works, 2) how to identify good companies and finally, 3) how to value them – investing well is not easy.
This is because investing successfully requires the right temperament. You see you can be really bright – smartest kid in the class – and still produce poor or inconsistent returns, invest in lousy businesses, be easily influenced by tips or gamble. I know a few who fit the “intelligent but dumb” category. Because you are bombarded, second-by-second, by hundreds of opinions and because stocks are rising and falling all around you, all the time, investing may be simple but its not easy.
Buffett once said; “If you are in the investment business and have an IQ of 150, sell 30 points to someone else”.
Everyone reading this blog is capable of being terrific investors. But it is important to know what you are doing and to do the right things.
To this end I have asked a couple of investors with whom I have corresponded for permission to discuss their correspondence because it provides a more complete understanding of the research that’s required before buying a share.
I regularly warn investors that what I can do well is value a company. What I cannot do well is predict its short-term share price direction. Long-term valuations (what I do) are not predictions of short term share prices (what I don’t do).
Generally the scorecard over the last 8 months is pretty good. The invested Valueline Portfolio, which I write about in Alan Kohler’s Eureka Report, is up 30% against the market’s 20% rise. I have avoided Telstra and Myer, bought JBH, REH, CSL and COH. Replaced WBC with CBA last year and enjoyed its outperformance. Bought MMS and sold it at close to the highs – right after a sell down by the founding shareholder – avoiding a sharp subsequent decline.
But this year, there have been a couple of reminders of the inability I admit to frequently, that of not being able to accurately predict short term prices. And it is understanding the implications of this that may simultaneously serve to warn and help.
Even though I bought JB Hi-Fi below $9.00 last year, its value earlier this year was significantly higher than its circa $20 price. And the price was falling. It appeared that a Margin of Safety was being presented. And then…the CEO resigned and the company raised its dividend payout ratio. The latter reduces the intrinsic value and the former could too, depending on the capability of Terry Smart.
The point is 1) You need a large margin of safety and 2) DO NOT bet the farm on any one investment – diversify.
You can see my correspondence about this with “Paul” at http://rogermontgomery.com/what-does-jb-hi-fis-result-and-resignation-mean/
The second example is perhaps more predictable. Last year, Peter Switzer asked me for five stocks that were high on the quality scale; not necessarily value, but quality. We didn’t then have time to reveal the list, so I was asked back, in the second half of October 09. By that time, the market had rallied strongly, as had some of the picks. The three main stocks were MMS, JBH and WOW.
But because I didn’t have five at that time, I was asked for a couple more. I offered two more and warned they were “speculative”. “Speculative” is a warning to tread very, very carefully – think of it as meaning a very hot cup of tea balanced on your head. You just don’t need to put yourself in that position! But I was aware that viewers do like to investigate the odd speculative issue. A company earns the ‘speculative’ moniker because its size or exposure (to commodities, for example) or capital intensity render its performance less predictable or reliable, earning it the ‘speculative’ moniker. Nevertheless, based on consensus analyst estimates they were companies whose values were rising and whose prices were at discounts to the intrinsic values at the time – a reasonable starting point for investigative analysis. ERA was one and SXE was the other. Both speculative and neither a company that I would buy personally because their low predictability means valuations can change rapidly and in either direction.
My suggestions on TV or radio should be seen as an additional opinion to the research you have already conducted and should motivate investors to begin the essential requirement to conduct their own research. Unfortunately, I have discovered to my great disappointment, that some people just buy whatever stocks are mentioned by the invited guests on TV. Putting aside the fact that I have said innumerable times that I cannot predict short-term movements of share prices, it seems some investors aren’t even doing the most basic research.
As I have warned here on the blog and my Facebook page on several occasions:
1) I am under no obligation to revisit any previous valuations.
2) I may not be on TV or radio for some weeks and in that time my view may have changed in light of new information. Again, I am not obligated to revisit the previous comments and often not asked. Only a daily show could facilitate that. An example may be, the suggestion to go and investigate ERA because of a very long term view that nuclear power is going be an important source of energy for a growing China followed by a more recent view (see the previous post) that short term risks from a Chinese property bubble could prove to be a significant short-term obstacle to Chinese growth.
3) I don’t know what your particular needs and circumstances are.
4) I assume you are diversified appropriately and never risk the farm in any single investment
5) The stocks that I mention should be viewed, in the context of other research and your adviser’s recommendations, as another opinion to weigh up – to go and research not rush out and trade…rarely is impatience rewarded.
There are further warnings that are relevant and described in the correspondence related to the post you will find at http://rogermontgomery.com/what-does-jb-hi-fis-result-and-resignation-mean/
One investor wrote to me noting he had bought ERA and it had dropped in price. This should not be surprising – in the short run prices can move up and down with no regard or relationship to the value of the business. But like JBH before it, ERA had of course made a surprise announcement that would affect not only the price but the intrinsic value. In this case, it was a downgrade and a rather bleak outlook statement relating to cash flows. Analysts – whose estimates are the basis for forecast valuations here – would be downgrading their forecasts and as a result the valuations would decline just as they did when JB Hi-Fi increased its payout ratio. Over the long-term the valuations in ERA’s case, continue to rise (these valuations are also based on earnings estimates – new ones but which it should be noted are themselves based on commodity prices that are impossibly hard to forecast), but all valuations are lower than they were previously.
Our correspondence reminded me to regularly serve you with NOTICE that there is serious work to be done by you in this business of investing. In a rising market you can pretty much close your eyes and buy anything but you should never conduct yourself this way. If you work appropriately during a bull market, you will be rewarded in weaker markets too. And while many may complain when I say on air “I can’t find anything of value at the moment”, I would rather you complain about the return ON your money than the return OF your money.
Posted by Roger Montgomery, 5 March 2010.
On 4 March 2010 Roger Montgomery’s YouTube channel, www.youtube.com/RogerJMontgomery, ranked as the #19 Most Viewed Guru Channel. Following is a message from Roger
“Yesterday I was looking for a video on my YouTube channel and noticed what looked like a ribbon I used to receive as a child at school carnivals. It turns out my channel has become more popular than I would have ever imagined. Yesterday I was ranked # 53 for Most Viewed category of Guru in Australia. And today… I am #19! I would not have achieved this success without your encouragement and support, and for that I would like to express my sincere thanks. Roger”
On 3 March I shared my thoughts about the future of Australian companies that supply directly or indirectly, the Chinese building industry, or have more than 70% of their revenues or profits reliant on China with subscribers of Alan Kohler’s Eureka Report. Following are my insights…
Glancing over yet another set of numbers as reporting season draws to a close, my mind started to wander as I wade through forecasts for one, two and three years hence. I began to consider what might happen that could take the shine off these elaborate constructions and which companies are in the firing line. Consider Rio Tinto, which, in an effort to make itself “takeover proof” back in 2007, loaded itself up with debt up to acquire the Canadian aluminium company Alcan. It paid top-of-the-market multiples just 12 months before the biggest credit crunch in living memory forced it to sell assets, raise capital and destroy huge amounts of shareholder value. Do you think they saw that coming?
Before I elaborate on events that could unfold, allow me to indulge in a bit of history and take you back to the mid-1990s when I was in Malaysia and the Kuala Lumpur skyline was filled with cranes because of a credit-fuelled speculative boom. It was the same throughout the region.
A year or so after my visit, the Asian tiger economies were in trouble and the Asian currency crisis was in full flight. These are the returns that are produced by unjustified, credit-fuelled “investing” unsupported by demand fundamentals.
In December 2007, as I travelled to Miami, I experienced a distinct feeling of déjà vu as I once again witnessed residential and commercial property construction fuelled by low interest rates and easy credit, unsupported by any real demand.
These are not isolated incidences. Japan, Dubai, Malaysia, the US. Credit fuelled speculative property booms always end badly.
So what does this have to do with your Australian share portfolio? Australia’s economic good fortune lies in its proximity – and exports of coal and iron ore – to China. Much of those commodities go into the production of steel, one of the major inputs in the building industry.
In China today there is, presently under construction and in addition to the buildings that already exist, 30 billion square feet of residential and commercial space. That is the equivalent of 23 square feet for every single man, woman and child in China. This construction activity has been a key driver of Chinese capital spending and resource consumption.
About two years ago if you looked at all the buildings, the roads the office towers and apartments under construction the only thought to pop into your head would be to consider how much energy would be required to light and heat all those spaces.
But that won’t be necessary if they all remain empty. In the commercial sector, the vacancy rate stands at 20% and construction industry continues to build a bank of space that is more than required for a very, very long time.
Because of this I am more than a little concerned about any Australian company that sells the bulk of its output to the Chinese, to be used in construction. That means steel and iron ore, aluminium, glass, bricks, fibre cement … you name it.
Last year China imported 42% more iron ore than the year before, while the rest of the world fell in a heap. It consumes 40% of the world’s coal and the growth has increased Australia’s reliance on China; China buys almost three-quarters of Australia’s iron ore exports – 280 million of their 630 million tonne demand.
The key concern for investors is to examine the valuations of companies that sell the bulk of their output to China. Any company that is trading at a substantial premium to its valuation on the hope that it will be sustained by Chinese demand, without a speed hump, may be more risk than you care for your portfolio to endure.
The biggest risks are any companies that are selling more than 70% of their output to China but anything over 20% on the revenue line could have major consequences.
BHP generates about 20%, or $11 billion, of its $56 billion revenue from China; and Rio 24%, or $11 billion, from its $46 billion revenue. BHP’s adjusted net profit before tax was $19.8 billion last year and Rio’s was $8.7 billion.
While BHP’s profitability would be substantially impacted by any speed bumps that emerge from China, the effect on Rio Tinto would be far worse.
According to my method of valuation, Rio Tinto is worth no more than its current share price and while the debt associated with the $43 billion purchase of Alcan is declining, the dilutive capital raisings (so far avoided by BHP) have been disastrous for its shareholders.
As a result, return on equity is expected to fall from 45% to 16% for the next three years. Most importantly the massive growth in earnings for the next three years is driven by the ever-optimistic analysts who are relying on China’s growth to extend in a smooth upward trajectory.
Go through your portfolio: do you own any companies that supply directly or indirectly, the Chinese building industry, have more than 70% of their revenues or profits reliant on China and are trading at steep premiums to intrinsic value?
Make no mistake: Australia’s future is written inside a fortune cookie – some companies’ more than others.
Subscribe to Alan’s Eureka Report at www.eurekareport.com.au.
Posted by Roger Montgomery, 4 March 2010
