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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On Sky Business last week with Nina May, a caller asked for my thoughts on Industrea. I offered to put together an opinion and of course, the only way I know how to do that is to first run it through the model to learn whether or not it is 1) A Wonderful Business with 2) Bright prospects and available at 3) A bargain price.
On the first point, a wonderful business, Industrea lost money until 2006 when it earned just under $2 million. Its not history however that determines your returns. It will be the future performance of the company. More on that in a moment. Last year the profits grew to $15 million but in order to generate that increase the company has raised equity and borrowed additional funds, to the tune of $309.5 million. Dividing the additional profit of $13 million by the additional equity of about $110 million is a return on incremental equity of about 11%. Not great but not bad either. (see note about profit adjustment below which makes this return higher)
According to some analysts and a recent company announcement (for FY10), the profit is expected to rise materially in the next three years to $48 million next year and $60 million in 2012 corresponding to a return on equity of about 25%. Of course the 2009 profit probably wasn’t $15 if you back out unrealised movements in interest rate hedges, amortisation and impairment of Customer Contracts and the like. If 25% returns are the case then the business looks ok except for the fact that debt exceeds equity. Of course if the profit figures come through as expected, then the debts could be paid down considerably, unless the directors choose to pay much higher dividends.
Based on the analysts forecasts for the next three years (of course subject to change in a moment’s notice and without any update here) the value of Industrea is 48 cents rising to 70 cents in 2012. So the prospects for value increases looks ok and the shares are currently at a discount to today’s intrinsic value.
Do I think its a great business? I think there are better quality businesses around unless you can satisfy yourself that this company has genuine sustainable competitive advantages. If you can, and believe the debt will start to decline, then the shares don’t look expensive. Of course this is not a forecast of the share price. Valuing a company is not the same as predicting the direction of the shares. Seek professional advice with someone familiar with your needs and circumstances before acting.
Posted by Roger Montgomery, 18 February 2010.
Qantas reported its half year profit today and the oft’ heard investor refrain “but Roger, its pays me a good dividend” was dealt a heavy blow with the company announcing no dividend would be paid for the half year.
As you all know by now, an airline profit is an accounting construct. If the depreciation charge was replaced by “a provision for replacement cost of aircraft” (my own accounting invention), the charge would be a lot higher and no profits would exist. Indeed, even though I have been saying this since the 90’s, it was evidenced again in Qantas’s half yearly report with $142 million of “additional depreciation”
So how are dividends ever paid?
A quick look at the debt and equity over the year reveals it is the charitable nature of banks and shareholders that keeps the planes in the air. As I write this, the total market value of the company is less than all the money that has been injected into it and left in it over the last decade and a half.
Can you believe a private equity group wanted to pay $11.1 billion for Qantas, or $5.45 per share? Can you believe that the stock market price went as high as $6.06, valuing the business momentarily at $12.3 billion? And they say the stock market and that its participants are rational!
The world’s airlines have accumulated aggregate losses of almost $54 billion over the last decade and in 2010 will lose another collective $5.8 billion[1]
Now don’t get me wrong. I am not saying Qantas isn’t a great Australian icon. Nor am I saying that the team isn’t doing a world-class job. Indeed, Qantas is regarded as the most profitable airline in the world. But you can see yourself that it would be very painful financially to own Qantas outright. From a purely capitalist perspective, I would rather own something else. A term deposit perhaps.
Here is a link to todays ABC Radio Interview about Qantas on The World Today: ABC RADIO qantas interview
[1] International Air Transport Association (IATA) Report 2009
Posted by Roger Montgomery, 18 February 2010.
Qantas had bad news to spare – in the air and on the ground – after a plane with troublesome landing gear was forced to turn back as the company announced a massive fall in profit.
Qantas says its airfares will rise, as the world economy recovers and demand for air travel picks up.
As much as I enjoy receiving dividends, I struggle to accept them. Here’s why.
Its a question I have fielded innumerable times since selling my funds management businesses and leaving them as well as the investment company I listed on the ASX. I am not in a position to answer it – having had 8 months of R&R since leaving, but I will let you know when I am. It occurred to me however that most investors already have an established portfolio. Those who are approaching or have entered retirement may have a large number of stocks too – although sometimes more a ‘museum’ than a portfolio.
When I am asked on air, often without notice -by Paul Turton on the ABC or Ross Greenwood at 2GB or the Peter, Richard or Nina on Sky Business – what I think about a company, I will detail the price, the intrinsic value, the ROE, the debt and whether I believe that the intrinsic value will be rising by a decent clip in coming years. These are the things that I believe are the most important determinants of an investor’s return.
How then do investors with established portfolios respond? What does one do, if for example, I believe a company is trading above its intrinsic value or is of an inferior quality to something else? My concern is that an investor holding the stock may sell. It may come to pass that this was the right decision, but there are many things to consider first. And there is also the possibility that selling would be the wrong decision.
(Most importantly, don’t act without first speaking to an advisor who is familiar with your circumstances and needs. You must not rely on my musings – they could change in a moment and anyway, they relate only to me. My thoughts here are “insights” into the way I think about stocks and they don’t have you in mind.)
By way of example, suppose you purchased the shares of a particular company many years ago at a significantly lower price than today’s price, rendering the yield now irreplaceable. What I mean, is that you bought the Reject Shop back in 2004 at $2.40. The yield today is more than 25% on your purchase price. And, what if the value is expected to rise to the current price in the next two (or three years)? In this scenario, while it might seem a long time to wait for the value to catch up, it may be that the yield (based on the purchase price) is sufficient to warrant the wait. Your personal circumstances are always relevant and on air, or here, I cannot know what your circumstances are.
Of course, what I can do here is take a hypothetical portfolio and detail the quality, the value and the prospects of each company – all of them companies I have received from you multiple requests to value – based on my own approach. It is the same as the detail I provide on my own Valueline portfolio in the Eureka Report for Alan Kohler, which I have now been publishing for eight months. From here, the hypothetical investor could approach his or her financial adviser and have a chat about their circumstances, armed with additional and relevant information about some of the topics covered in that meeting. If the adviser suggests the sale of stocks with losses for example, the investor so armed, can propose a response that involves selling the stocks (after receiving the advisor’s approval) displaying the highest premium to intrinsic value or with the least attractive prospects for intrinsic value. Alternatively of course the advisor may recommend a completely different approach for you to take.
So here is a theoretical portfolio:
| Company name | Price | Intrinsic Value | Forecast Intrinsic Value
(above current price/above current value) *If you believe analyst’s forecasts for sale,production and profits |
2yr forecast ROE range
>20% preferred |
Net Debt/Equity
<50% preferred |
| AMP | $6.25 | $4.98 | no/yes (2012) | 34%/36% | N/A |
| ANZ | $20.81 | $17.73/$23.68## | yes/yes (2012) | 12%/16.4% | N/A |
| BHP | $41.50 | $36.44 | yes/yes (2012) | 27%/32% | 14.4% |
| Connect East | $0.44 | $0.00 | no/no (2012) | -2.2%/-5.9% | N/A |
| Fortesque | $4.76 | $2.09 | yes/yes (2012) | 33%/46% | 210% |
| Leightons | $37.92 | $32.18 | yes/yes (2012) | 24.6%/25.2% | 34.3% |
| NAB | $24.88 | $22.12 | yes/yes (2012) | 11%/15.4% | N/A |
| OZ Minerals | $1.01 | $0.06 | no/yes (2011) | 2.9%/9.4% | 33.8% |
| RIO | $69.88 | $42.01 | yes/yes (2012) | 17.8%/20.4% | 182% |
| Skilled Engineering | $1.72 | $0.66 | no/yes (2012) | 7.4%/11.8% | 114.4% |
| Santos | $13.31 | $3.59 | no/yes (2012) | 4.3%/5.2% | 19.3% |
| Suncorp | $9.01 | $5.18 | no/yes (2012) | 7.5%/8.5% | N/A |
| Transurban | $5.23 | $0.25 | no/yes (2012) | 1.5%/3.6% | 113% |
| Telstra | $3.27 | $3.12 | yes/yes (2012) | 31.6%/32.4% | 130.7% |
| Uranium Ex. (UXA) | $0.05 | $0.00 | no/no (2012) | n/a | net cash |
| Wesfarmers | $28.45 | $11.24 | no/yes (2012) | 6.3%/9.4% | 14.7% |
| Woodside | $43.03 | $26.42 | yes/yes (2012) | 12%/20.7% | 40.5% |
| CBA | $52.84 | $46.86 | yes/yes (2012) | 18.3%/21.2% | N/A |
| Myer | $3.32 | $2.76 | no/yes (2012) | 20.6%/23.5% | 173.8% |
| Bluescope | $2.60 | $0.53 | yes/yes (2012) | 2.9%/10.6% | 13.3% |
| Alesco | $4.32 | $1.88 | no/yes (2012) | 5.6%/8.6% | 29.8% |
##Read the following comments about the valuations:
We’d all prefer intrinsic values that were cast in stone. Unfortunately, they’re not. The valuation depends on the input so to be safer, I always run my model using two data sets. Importantly, I only run ONE valuation formula. One valuation is based on estimates for next year’s result and the other is based on a continuation of the historical performance of the company. It gives me a ‘max’ and a ‘min’ – a kind of ‘range’ of valuations and that which Buffett has always advocated. The ‘historicals-continuing’ valuation version is useful where previous results have been volatile. The other reason for having this version is that I simply cannot get access to some companies or there are no analysts covering it – they can’t get access either or don’t want to, and so that’s when I have to use some progression or variation of past performance continuing. It’s the only way to get a valuation estimate for some companies. The idea is not to be perfect but to protect capital and do better than the market. For example ANZ’s valuation based on a continuation of historical performance is $17.73, but based on forecasts is $23.68. My preferred method of investing would be to buy at a discount to the most conservative valuation but if I can’t get that and valuations are rising strongly in future years I might invest a smaller proportion of my portfolio in first class business at a substantial discount to the upper valuation.
I would be interested in hearing what you prefer to see. Would you prefer to see 1) the most conservative valuation only, 2) the valuation based on next year’s earnings forecast 3) based on the continuation of the historical performance of the company, or 4) both? Feel free to vote. What I like to use myself may not be what you want to see.
Now, a couple of warnings. Firstly, these valuations can change at any time and I may or may not update them here on the blog. A company, for example, could announce a downgrade and the valuation would drop – potentially precipitously and I will probably busy doing something with my own portfolio(s) so do not under any circumstances rely on or expect these valuations being kept up to date here at all. Second, my forthcoming book contains the information you need to calculate intrinsic value the way I do, so rather than ask me how I arrived at a valuation above, please wait for the book. Third, don’t act on this information (which can and is likely to change without warning and without notifying you) – seek a professional advisor’s recommendation, preferably someone who knows you, your financial circumstances and needs. Finally, valuing a company is not the same as predicting the direction of its shares. Just because a company’s shares are lower than my valuation, does not mean the shares will go up. Conversely, a price that is well above my valuation doesn’t mean the share price is going to fall.
Having said all that, I hope you found the theory and exercise stimulating and thought provoking.
Posted by Roger Montgomery, 12 February 2010.
(A REMINDER: SOME WEBSITES AND COMPANIES MAY BE LEADING YOU AND OTHERS TO BELIEVE THAT THEY HAVE SOME ASSOCIATION OR RELATIONSHIP WITH “ROGER MONTGOMERY” AND THAT BY PURCHASING OR SUBSCRIBING TO THEIR PRODUCT OR SERVICE, YOU WILL HAVE ACCESS TO MY THOUGHTS AND INSIGHTS. IF THIS HAS HAPPENED TO YOU, LET ME KNOW. YOU CAN LEAVE A MESSAGE HERE)
RIO released an upbeat result, but is it a superior business to BHP? In Part I of Rogers appearance on Nina Mays Your Money Your Call on 11 February 2010 Roger Montgomery also discusses the value of Metcash, but views Woolworths as a superior business, and provides investors considering in speculative mining companies, such as Kangaroo Resources (KRL), a few things to consider before taking the plunge how much are they going to produce, when are they going to produce it, and how much is it going to cost? Check the quarterly cash statement – how much cash they are burning! Can they last longer than 6 months without a capital raising? And to read Rogers thoughts on Industrea, visit the blog – http://rogermontgomery.com/what-do-i-think-of-industrea/. Watch the interview.
Cochlear is one of the great success stories of Australian business and its value is rising over the next few years, but is it cheap? Can Wesfarmers ever recover following the overpriced Coles acquisition? And ANZ and NAB – Back in August 2009 Roger Montgomery said buy CBA, Australia’s superior bank, but now its expensive. ANZ is cheap and NAB is expensive, but they are inferior businesses to CBA. Visit Rogers blog, rogermontgomery.com, for his latest comments on NAB and ANZ. Watch the interview.
McMillan Shakespeare shares dropped in January because the founding shareholder sold shares, just before the Henry Tax Review was released. MMS is still a good business, but there are questions about the company’s future, and too many uncertainties for Roger Montgomery to keep the stock in his portfolio. In his appearance on Nina Mays Your Money Your Call Roger also shares his thoughts on Bradken and Asciano, and reminds viewers that whilst he doesn’t like airlines because of their capital intensity, Regional Express has a unique market advantage. Sadly the same can’t be said for Fosters. Watch the interview.
United Group may be well liked by fund managers, but not by Roger. In this appearance on Your Money Your Call Roger Montgomery also comments on the value of AMP, Tatts Group and one of his favourites, Telstra (ASX:TLS). Roger admits viewers may get sick of him saying so, but Telstra is a business going nowhere, despite its high dividend yield. Watch the interview.
