Does Burson offer great value?
As readers of our blog will know, the funds of Montgomery Investment Management have held shares in Burson Group Limited (ASX: BAP) since its initial public offering (IPO) in early 2014. Since that time Burson has delivered stellar returns (circa 50 per cent in a year) and it’s interesting to contrast our reasons for entering the position with our thoughts now.
Burson is a simple business that sells car parts and accessories to mechanics, generally for regular servicing work.
Burson is clearly a great business to be in, with very predictable revenues, a good cash flow and an overall sound financial track record. Additionally, in our opinion CEO Darryl Abotomey, CFO Greg Fox and their team have shown to be very capable managers.
Given that we still hold a large position in the firm, we have clearly had to revise our valuation. Notably with the share price hovering around $3.04, this appears to us to be trading at approximately fair value.
It’s important to note that when assessing Burson’s historical profitability you’ll need to adjust for the payments the firm was making to its private equity owner pre-IPO. Our assessment of the firm’s stock at the time was worth at least $2.20-$2.40
Of course, there are cases for further upside which we can debate. One is the competitive dynamic between Burson and their longtime rival Repco. Both firms are known for their good service and mechanics are able to more or less buy whatever they require at either shop. However, this leads to commoditization of their offering and – you guessed it – competition. Naturally, as competition rises prices for goods and services fall and this presents a risk to our investment.
In analyzing Burson, we are acutely aware that the intrinsic value of the firm is closely tied to the gross margins, or prices, they can charge. Indeed, for the shares to be worth what they are now it’s clear that gross margins will need to be increased over time and we are confident that they will. However, this will be a function of a rational level of competition existing between Burson and Repco. Should competition become too irrational gross margins will struggle.
Likewise, further upside can be realised should gross margins rise at a faster rate than currently expected. This point is important because marginal increases in gross margins can lead to rather large increases in intrinsic value for retail stocks.
Of course, we cannot foretell the future, and we’ve yet to find a crystal ball that works, but monitoring competitive dynamics is a relatively simple task that will yield the answer to this issue over time.
The Montgomery Fund and The Montgomery Private Fund hold positions in Burson Group Limited.
This article is for general advice and educational purposes only. Before you commit to any investment decision we strongly recommend you seek the counsel of a licenced investment adviser.
Scott Shuttleworth is an analyst at Montgomery Investment Management. To invest with Montgomery, find out more.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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Rod Schofield
:
Roger,
A question to clarify the valuation produced by Skaffold in the context of the original post. I’ve only recently finished reading Value.able and I’m taking my first albeit tentative steps towards practicing the techniques taught and plan to trial the software.
Does the valuation provided by Skaffold represent the price that a value investor should consider investing at, or is it the estimate of the intrinsic value of the stock?
Thanks in advance for your response and in arrears for the uncommon common sense in your book.
Rod
Roger Montgomery
:
Intrinsic values are an estimate of the value or worth of the underlying business based on the prospects, which in Skaffold’s case are based on consensus analysts estimates. Value investors believe that because they are etiolates they are prone to errors of optimism (as are the analysts forecasts that go into them in this case). As such you should seek a margin of safety and the bigger the margin of safety the better. One margin of safety is the discount to the estimate of value. ANother margin of safety is to do your own financial modelling of the business and its prospects rather than relying on analysts – which you should remember work for firms who are incentivised to see investors trade. if you read Value.able you should gain an appreciation for the many margins of safety required.
James Henderson
:
COuld you explain what value is there in Skaffold at all if it says that Bursons is worth about half its current share price? I have observed this same phenomenon on many of the shares that the Montgomery funds own (I have gleaned which they are by various disclosure comments in articles and substantial shareholder forms).I understand completely that that your fund will buy and sell shares anonymously for your fundholders according to your teams judgments and rightly so. Does Skaffold play a part in the the decision process?
Roger Montgomery
:
Hi James,
Thanks for your blog post.
There is great value in a tool that tells you a company’s share price might be frighteningly expensive. It is not the case that the Montgomery valuation is “right” and all other valuations are “wrong”. Reason is; no valuation is accurate. By definition, they are only estimates. Witness the recent fall in the price of Sirtex; While the shares were trading at $39, the Skaffold valuation was less than $18 (not unlike your Burson example). The share price fell below this level on the announcement of the results of the Sirflox trial).
I have been through many market cycle highs where a patient and conservative value-investing approach yields a conclusion that there is simply nothing to buy. RIght now, The Australian market is offering few clear deep-value opportunities. Do we then conclude that the value-investing approach is useless? No. I understand that the market will swing from extreme bouts of optimism to extreme bouts of pessimism. This however can and does take years.
Montgomery funds use the A1 to C5 quality and performance scoring process (seen also in Skaffold) as part of its investment process. Montgomery however uses a variety of valuation techniques and internal business modelling to arrive at its final valuations. It would be wrong to conclude that ours are right and every other valuation is wrong. We too will make every kind of mistake.
With respect to Montgomery (the fund manager) discussing Skaffold (the research platform), the two businesses are completely separate. They reside in different suburbs and each have their own staff, leadership teams and CEOs.
Hope that helps.
Dean Bourke
:
James, Roger,
I am in a similar position as James, where I am trying to gain a better understanding in calculating value.
Having read Roger’s book Value.Able I compiled a similar formula as explained in the book (eq/No.Shares * ROE * IRR, essentially – check out his book, it’s explained well). I then moved onto using Skaffold, which is a phenomenal tool for understanding the value of a company (plus many other great features).
However, like Jason, I have noticed that my valuations or Skaffold’s valuations sometimes come in considerably different to blog posts from Roger and his team regarding ‘fair’ value. CSL is one that comes to mind recently, where both Skaffold and my valuations placed the company at approx. mid 40s however, a blog at a similar time from Mont had them at approx. mid 80s.
Given my (growing, but still limited) understanding of valuing companies, I had a suspicion that other qualitative factors were used to further calculate the value of a company (such as competitive advantage). However, these would be very hard for Roger and his team to explain in a blog.
Further on that initial suspicion, and which may have been touched on in this article, was the relationship between margins and competitive advantages.
I don’t expect Roger or his team to divulge the specific formula(s) they use, however, I would love to know more about what factors impact Roger’s valuations.
Cheers
Dean.
Roger Montgomery
:
Keep in mind, two people with the same data will inevitably arrive at different estimates of value. And also keep in mind (as the recent Sirtex example demonstrated) our higher valuations might not be helpful in all scenarios. When the Sirtex price was high and Skaffold’s valuation low, many investors were probably frustrated thatMontgomery valuation was higher and had captured the share price gains. Following the recent trial outcome however the share price fell 55% and close to Skaffold’s valuation. So which valuation is superior?