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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I was on the Sky Business Channel’s Your Money Your Call a couple of weeks ago. The next day Phil let me know how disappointed he was on my Facebook page – his email wasn’t featured on the show and he couldn’t get through on the phone. I should let you know that until I am hosting a program (don’t get any ideas!), I don’t have a say in which calls are taken and what emails are featured. I did however promise to share my observations on Ausenco with the disclaimer that they are didactic.
Up until 2008 Ausenco (AAX) was a darling of the market – indeed it had reason to be. It had a track record of being an A1 business and in 2007 was generating a profit $41.5m on only $56m of equity – a stellar 95% return. A 2007 estimate of AAX’s intrinsic value would be something like $15.07.
But with the share price now trading around $2.33 and my current valuation at $1.54, something has changed. Why has Ausenco fallen on such tough times?
In 2007-8 Ausenco went on somewhat of a buying binge. To diversify away from the operations of mining and minerals processing, PSI, Vector and Sandwell were added to Ausenco’s business. Looking at the share price today, compared to two years ago it appears Ausenco paid a very high price for this strategy.
At the end of 2007 a significant portion of Ausenco’s $56m of equity was cash. The business had only $7m of debt. Up until that time shareholders had grown the business by simply investing $11.5m of their own equity and retaining a cumulative $45.7m in profits. A nice position and in my opinion, very attractive. Ausenco was a small, highly profitable, organically-grown and well-run business.
By the end of 2008 growth was turbocharged. The combination of substantial acquisitions however saw an additional $106.6m of equity raised and debt jumped to $66. In other words, shareholders equity ballooned by 325%, to $182m, compared to the previous year.
With this aggressive growth came a host of challenges. Running a focused small business is a much easier task than steering a larger ship that has diversified into a ‘pit to port’ engineering business.
And by 2009 the numbers agreed. A profit of $20.3m was reported, but $260m was needed to produce it. So the profit was lower than 2007, but significantly more money had been contributed.
Ausenco was far more valuable as a small business than it is as a larger one, as anyone holding the shares through this period can attest.
As an investor, you should ask questions when a small, highly focused and highly profitable business becomes enamoured with the idea that bigger is better. Some may argue that the GFC is partly to blame. My response is to take a look at another business in the same sector, Monadelphous – one of my A1s and a business that has never attempted to grow beyond what Buffett refers to as its circle of competence.
Unlike Monadelphous, Ausenco has slipped from an A1 to an A4. Yes its still high quality (A), but with a performance rating of 4 (5 being the lowest), its predictability is not something to be excited about.
Posted by Roger Montgomery, 18 June 2010
You may not have heard of Return on Incremental Equity but it determines which bank is the best value. Read Roger’s article at www.eurekareport.com.au.
Most investors tend to focus on capital gains (or, more recently, losses), ignoring the income-producing potential of shares. But, Roger Montgomery warns, picking stocks for an income-producing strategy, can be costly. Read article.
Roger Montgomery introduces his new column on constructing a winning share portfolio for Money magazine. Read article.
In March this year I shared my insights about QBE with readers of Alan’s Eureka Report. Since that time QBE’s share price has fallen from over $22.00 to $19.00 – a decline of around 15%. That may explain why I have received a few requests asking for an updated estimate for QBE’s value?
If you take your cues from price action, you would probably conclude something might be wrong with the company.
Open up a newspaper, flick on the TV, or do both on your new iPad and you will be overwhelmed with the events in the US, the debacle that is the Euro zone, and BP’s oil spill – one of man’s greatest catastrophes.
With 40% of gross written premiums being derived in the US and a further 40% from London and Europe, it is likely QBE is exposed, somewhere.
Even at home the company appears to be right in the firing line of the Lennox Head twister, Victoria’s bushfires and recent floods.
It’s not all bad news though – the declining Australian Dollar ensures QBE’s overseas earnings are now worth more.
So is there something wrong at QBE? Or is the market just reacting to bad news? Buffett says you pay a high price for a cheery consensus, so maybe bad news is just what’s needed to make QBE attractively priced…
You have to remember that QBE is in the business of forecasting and betting against bad news – it exists to manage risk and spread it around when there is too much for it to shoulder alone. And given its successful decade-long track record of doing so, I can strongly argue that it performs this activity significantly better than many, if not most, of the other insurers listed on the ASX.
Things that you and I perceive as negatives are usually positives for insurance companies. Think of the last time you had to make an insurance claim. Did your premium rise the next time you chased around for a better price?
In March this year a sensible price to pay for QBE was $19.83. Now a sensible price is $19.92. So even with all the negative news and natural disasters, the only thing that appears to have changed is the market price.
The truth is that the business operations that make up QBE’s brand have been moving much slower than its share price would suggest, and the rising valuation suggests things are believed to be improving.
While the price was well above the estimated valuation three months ago, I couldn’t have predicted the share price would fall below it.
I did say that “With a gun to my head and forced to make a decision, I would bet with Frank O’Halloran at QBE every time”. That remains the case today.
I do get excited when the market, in its wisdom, decides that it temporarily dislikes great businesses. The result is a fall in the share price. Who doesn’t like to buy more of a good thing for less? The price however may not have declined far enough to provide the sort of Margin of Safety Ben Graham said should be required in Chapter 20 of his Intelligent Investor – arguably one of the two most important teachings in investment history.
There are a bunch of insurance businesses listed on the ASX. Some are pure insurers and some have insurance divisions within the business. I am interested to hear what you think of any of them. Have you had to deal with them and have you had a good or not so good experience? Do you work in the industry? Can you shed some light on who you think is the best and why? Share your thoughts by clicking Leave a Comment below. AND REMEMBER – YOU MUST OBTAIN PERSONAL PROFESSIONAL ADVICE BEFORE CONDUCTING ANY TRANSACTION OF ANY KIND IN ANY SECURITY IN THE MARKET.
Posted by Roger Montgomery, 11 June 2010.
Sometimes selling bad businesses can be just as profitable as buying good ones. Take iSoft. Read Roger’s article at www.eurekareport.com.au.
Leading Equities Analyst, Portfolio Manager and self-made entrepreneur, Roger Montgomery recently visited Sydney University to bring to life the complex subject of stock market investing. Read article.
“Roger, would you buy Nick Scali (NCK) over the likes of TRS, ORL and JBH?” This last week, its been a frequently asked question.
Let me start by saying that I consider Nick Scali to be a high quality business. While the business listed in May 2004, I have run my ruler over the business financials since the year 2001. In every single year its been an A-Class company and an A1 in most. This is impressive. Few businesses have such an excellent track record, which speaks highly of management.
Indeed, given my tough quality and performance criteria, NCK would be in the top 5% of all companies listed on the ASX.
But are high quality financials and a good track record of performance enough to justify buying a business?
Let’s consider the businesses of NCK and The Reject Shop – another high quality retailer.
NCK is engaged in sourcing and retailing of household furniture and related accessories. The Company’s product portfolio includes chairs, lounges, outdoor, dining, entertainment – what are called ‘big-ticket’ items as well as and furniture care products. It has 28 showrooms located in New South Wales, Victoria, Queensland and South Australia under the Nick Scali brand, and additional showrooms in Adelaide under the Scali Living and Scali Leather brand.
TRS on the other hand is engaged in discount variety retailing. Its footprint of around 187 ‘convenience’ stores is focused on low price points, offering a wide variety of merchandise. Stores are spread throughout Australia.
TRS has an exceptional history of quality and performance, and in that respect is not dissimilar to NCK.
While NCK and TRS both have top tier fundamentals, there is one major difference; their business models. And this is the important difference that puts TRS far ahead of NCK in my mind from an investor’s perspective.
Consider the economic cycle and the impact it could have on each business; NCK is a retailer of ‘big ticket’ items and TRS is a retailer of ‘low price point items’. Cast your mind back just a few years to when the stock market was crashing, and depression talk filled the media. Do you think spending on big-ticket items like a sofa or a $2 tube of parallel imported toothpaste selling at a cheaper price than a major supermarket, would have been reined in first? This is where TRS offers arguably a more stable and slow-changing revenue stream. TRS of course has its own issues and risks, just as any business has, but the stability of earnings is perhaps superior to that offered by NCK.
TRS has positioned itself as providing ‘low price points’ on everyday goods. Things you always need – daily essentials. I’m guessing you wouldn’t stop brushing your teeth, even during a credit crunch, but you may defer the purchase of that new sofa or outdoor furniture. TRS gets you in by offering really low prices on the daily essentials and then tempts you to fill your basket with other cheap items that have a higher margin for the retailer.
The problem for investors deciding between TRS and NCK is therefore not the quality of each business – they are both very high quality and have excellent management teams – it lies in the cyclical nature of NCK’s earnings.
After determining the quality and risks for a business, the next step is determining its intrinsic values. If you don’t complete this step, you are not investing, you are speculating.
Now to me, investing in a business like TRS is a fairly straight-forward decision. An investment decision in NCK on the other hand requires much more thought about consumer sentiment toward big-ticket discretionary purchases and how susceptible leveraged households are to increases in interest rates. Buffett once said find the one-foot hurdles that you can step over.
I’m not saying I would never buy shares in NCK. There is always a time and a price at which even a cyclical business is cheap, provided its of the highest quality of course. I just prefer to stick to the one-foot hurdles rather than trying to jump over seven footers.
I’m off to brush my teeth. Don’t forget to leave your thoughts.
Posted by Roger Montgomery, 5 June 2010.
When it comes to investment strategies, plenty of people swear by P/E ratios but is it the best approach to take? Not according to Roger Montgomery, independent investment expert. Read article.
Peter Switzer interviewed Sally MacDonald, CEO of Oroton Group last month on the Sky Business Channel. He invited Roger Montgomery to join them. Watch the interview.
