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 have just completed a phone interview with Ross Greenwood on his Money News program at radio station 2GB. He was interviewing me and Patrick Elliott, the Chairman of JB Hi-Fi following todays result. As you have all probably noticed, the half year result was excellent but JBH has traditionally exceed the market’s expectations for earnings and sales growth. Today’s interim FY10 profit was up 29% on sales growth of 19%, and while it was at the upper end of expectations – it didn’t exceed those expectations. Believe it or not, the result will be downward revisions to analysts future estimates.
The share price decline today – it was down 6.5% at one stage – to be down 5.1% at $19.07 per share, was partly the result of the ‘voting’ machine saying; “the growth is not going to be as high as we envisaged” but probably to a greater extent, it was due to the fact that Richard Uechtritz announced his retirement in “July/August”.
Having grown revenues in ten years from $145 million to $2.8 billion, the resignation of Richard is a blow to the company. But as my restaurant owner friend says; “revenue is vanity, profit is sanity” and the new CEO will be no slouch. Terry Smart joined JBH when Richard did, as part of the private equity funded management buy in. They’ve all made millions and plenty of Terry’s money remains invested.
The changeover reminds me of the retirement of one of Australia’s retailing legends, Barry Saunders, from the Reject Shop. He handed the reins over to Jerry Masters and Jerry continued to grow and expand The Reject Shop. Jerry was an outsider and arguably not the first choice. Terry is a JB Hi-Fi insider and remember my comments that the business boat you get into is far more important than who is rowing it. I think you will find that with 210 identified stores and 140 likely to be rolled out by the end of 2010, there is still plenty of room for growth. More over, Richard’s resignation is similar to The Reject Shop in one important way; neither Barry nor Richard departed to compete. Richard, like Barry will remain a consultant and Richard on the board.
But unfortunately, it is not growth that determines intrinsic value. Its the return on equity, the payout ratio and the equity itself that determines whether the value continues to rise. The big news on this front is that the dividend payout ratio continues to rise. Now at 60%, the increased dividend is a classic response by the board to a business that is generating cash faster than it can use it. But thats a shame because the company is generating 45% returns on its equity. I would much prefer they kept the money – prepay some leases and get a discount (get the contingent liabilities down) – than hand it to me as a dividend. The best I can do with it is perhaps 8% in a 5 year term deposit. Not bad, but not 45%.
The result of not employing as much retained earnings at 45% is that the intrinsic value declines. Its still going up but not as much. The conservative intrinsic value before this result was about $20.30. Now it is $19.30. The intrinsic value next year falls from $24.14 to $22.50 and the year after from $29-ish to $26-ish. So where previously we were looking at a rise to the $30 area for intrinsic value by 2012, it now seems the value will be at best $26.50.
The sole reason for the change to intrinsic value is the increase in the payout ratio. More dividends means less profits being retained in the business, earning more than 45%. Now don’t get me wrong, this is still an amazing business – one of the best and intrinsic value is still forecast to rise by a compounded 16.3% per annum over the next 2 years or so. To get really excited however, you now want a bigger discount to the current intrinsic value.
Posted by Roger Montgomery, 8 February 2010
From the beginning of September last year, I warned investors about the pricing of the Myer float. If you read The Australian newspaper, watched or listened to the ABC or read the Sydney Morning Herald or Alan Kohler’s Eureka Report you couldn’t have missed the warning. On the 28th of September, using the valuation formula I have been explaining for some time and which I detail in the forthcoming book, I wrote:
“The current owners, including TPG and the Myer family, plan on raising $1.9b to $2.8b to exit the business. (Yes, the Myer family indicate on Page 33 that they may sell 100% of their shares).
$315 million will be used to pay down debt and $100 million odd are frictional costs associated with the float. The rest will go to Private Equity and the Myer Family.
Upon listing, the business will trade with a market capitalisation of somewhere between $2,282m and $2,768m.
What, however, is the business worth?
With all the relevant data to value the business now available and using the pro-forma accounts supplied in the prospectus, I value the company at between $2.67 and $2.78, substantially below the $3.90 to $4.90 being requested. It appears to me that the float favours existing shareholders rather than new investors.
Investing safely in the share market requires a wonderful business and a rational price. Myer is arguably now a much better business than it was, but the price being requested is even hotter than the cover.
By Roger Montgomery, 28 September 2009”
Then James Dunn wrote an article for The Australian entitled Is the Myer Float a Dog? (you can read the article and many others at http://rogermontgomery.com/media-room/in-the-press/ or by clicking MEDIA ROOM at the top right of this page and then selecting “IN THE PRESS”) In James’ article I was feeling a bit more generous toward Myer and gave it a valuation of $2.90.
Both institutional and private investors however willingly paid $4.10 to the vendors of Myer for their stake in the business and while this was at the lower end of the price range, the reality is that it was way above any sensible valuation of the company. Indeed in one article I was quoted as saying that I thought the valuation would be $3.90 in five years time. At the current price today of $3.14, shareholders have lost a total of $1.8 billion. This was an easy loss to avoid but analysts who cover the stock don’t use a valuation model based on Equity, Return on Equity and the payout ratio. Instead they looked at the $41.0 float price and compared the resultant P/E to that of DJ’s and concluded the lower P/E of Myer meant it was cheap. But what if DJ’s higher P/E was too high to begin with? What if it was the result of short term fashion or enthusiasm for something that didn’t eventuate. What if the promoters of the Myer float were buying DJ’s shares (or borrowing stocks to take it away from short sellers) to make the P/E of DJ’s higher? Then the P/E of both would decline.
Professional analysts get paid more than us and yet, their expertise in the case of Myer has currently cost their clients $1.8 billion in aggregate. Now, they will point to the turn down of the broader market, a change in sentiment towards retailers – things they cannot control, but Myer’s 23% decline since it listed on November 2, exceeds the All Ordinaries Index decline of 1/3rd of 1% and the 20 cent decline (less than 1%) of other (preferred by me) retailers such as JB Hi-Fi.
Investors thinking about buying Myer now, because 1) the shares have fallen so far or 2) have underperformed by so much, need to keep in mind that such reasons are purely based on price and therefore will result in financial pain and suffering. You must think about value not price. My earlier posts and analysis reveals that Myer’s valuation should rise to $3.90 in 5 years time. This change is equivalent to a 4.4% compounded annual return which is not high enough – given the risk, compared to the 8% now on offer by some banks for 5 year term deposits. In other words, Myer is still not cheap enough.
Posted by Roger Montgomery, 6 February 2010
Ps. And don’t forget, if you have any questions or you have an experience at Myer you can share click the Leave a Comment button below.
Asciano is a company I covered in detail this week in Alan Kohler’s Eureka Report. Its popped up because it seems to be winning rail haulage market share from Queensland Rail. One analyst sent me a research note today saying; “Asciano’s on a roll” Tee, hee, hee indeed.
AIO announced a coal haulage deal today with Macarthur Coal (MCC ) in Queensland for ~7mt starting in November. The company now has 100% (10.7 mt) of Macarthur Coal, a 14.0mt contract with Rio/Xstrata, 5.8mt with Anglo and 1.1mt with Isaac Plains. There are more contracts up for grabs as the coal business in Queensland continues to expand. Analysts assuming Asciano wins a decent percentage of these, are upgrading their earnings estimates for Asciano.
The company, however, offers several hurdles for the value investor. The first is the balance sheet, the second is the uncertain competitive landscape and the third the valuation.
Recently Asciano announced it has no debt due for two-and-a-years. But this will fly as any parent of young children knows, and then the debt WILL be due.
Reports of the company’s debt-free status are incorrect. A capital raising and debt refinancing has still left the company with loans of $2.9 billion and $300 million in cash. That’s like you taking out a $2.9 million mortgage to buy a $3.2 million house. Total forecast liabilities of $3.9 billion should be compared to equity of $4.2 billion, which in turn includes intangibles/goodwill of $3.9 billion.
While NPAT is expected to grow from the $71.8 million reported in 2009 to $205 million in 2010, $263 million in 2011 and $320–400 million in 2012 (subject to upgrades following today’s announcement).
The second hurdle I referred to above is the competitive landscape.
The Port of Melbourne Corporation would like a third operator to join Asciano and DP World’s P&O (also considering listing of its own later this year) on Melbourne’s wharves. In Queensland there are the proposed changes to the ownership of Queensland Rail (QR). Under new, non-government ownership QR will have the incentive to “do a Telstra” on its competitors, especially Asciano, by charging more for the use of its network so it can offer lower prices to its own rail freight customers.
Happily for those hoping for a better Asciano share price, the coal industry, with about $40 billion revenue last year and strong growth projected, has some clout and big coal companies will not be happy if their deliveries are affected in any way.
Instability around Asciano’s competitive landscape means it is imprudent to be optimistic when valuing the company. And thats the third hurdle.
Asciano will report its half-year results on February 24; most analysts, including me, expect it will show the company’s first ever December-half profit. But returns for the next three years will still average only about 7% for the next three years.
Adopting an after tax 9% discount rate – the lowest I have ever given for any company – I get a valuation of 73¢. The valuation rises for the next few years but goes nowhere the current price of $1.70 or broker target prices of about $2.
Posted by Roger Montgomery
February 4, 2010
Roger Montgomery gives some expert advice on selecting safe shares for the long haul with Warren Buffett’s help.
Does Asciano’s sharp price drop and bright outlook make it good value? Well no, if you consider the headwinds the company faces. Read online.
Half of all shareholders in Australia own at least one major bank in their share portfolios. Are you one of those investors? Read article.
Since early December Paul, Squigly, Steven and Darren have requested I value Westfield. WDC is also a popular stock with viewers of Nina May’s Your Money Your Call on the Sky Business Channel (you can watch highlights at my YouTube channel, just type ‘Westfield’ into the search feature), and rightly so. It’s a company run by three of the most capable men in the world and one whose shares I have owned in the past.
Today its price, according to a number of analysts and strategists, does not appear to have responded to expectations for an improvement in economic conditions in the US. The biggest gap between inventories and orders since the mid 70’s, the decline in housing inventory, the strong turnaround in cyclical indicators and the steep yield curve all suggest an acceleration in US economic growth – by the way if this doesn’t sound like me, you are right. I am just repeating what I have been reading.
I don’t subscribe to the view that it’s the job of the investor to allow macro economic forecasts to influence micro-based investment decisions.
If however the economists are right, and the US economic recovery does gain traction, then all that remains is a recovery in consumer confidence to see Westfield benefit. Of course if the US economic strength is sustained, then one suspects the US dollar will also recover, making Westfield’s profits more valuable in Australian dollar terms.
Those things aside, lets have a quick look at the valuation and take a dispassionate view about the price irrespective of whether others believe the price has or hasn’t responded to US growth expectations. Continue…
David Koch presents the ABC of a corporate collapse for CPA Australia. This series of videos will take you step-by-step through the actions and inactions of ABC Learning that lead to its spectacular collapse. Watch the trailer.
Whilst most investors make their buy and sell decision based on macro views, Roger looks at the characteristics of individual businesses ROE, debt level, competitive advantage. Based on his analysis, Roger tells viewers of Oriel Morrison’s Trading Matters program the outlook for JB Hi-Fi, CSL and Woolworths. He also discusses the riskier proposition of MMS, warning investors to be very cautious of the company’s unknown future based on the Henry Tax Review. Watch the interview.
