Can Ausenco be an A1 again?
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
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.
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.
Peter Wordsworth
:
Hi Roger,
Seems I have a bit to learn: your intrinsic value of Navitas (6 July) is $1.97, yet current consensus estimates range from $5.04 to $5.57.
Hypothetically (of course) at a current price of $4.20, on this basis, should an investor buy or sell.?
Hopefully this will become clear after reading your book!
PS next time settle for a yellow coin! (or talk to me about finding a better printer)
Roger Montgomery
:
Hi Peter,
All I do is convert the economic performance of the business to a valuation. It all started in the mid twentieth century and I have just refined it a little. Its in the book. What happens to the price, what everyone else is willing to pay is anyone’s guess. I remember when Myer floated at $4.10. The ABC 7.30 report asked me what I thought it was worth amid all of the positive outlook statements by the management, the vendors and the brokers. I responded with $2.90. You cannot imagine the flood of calls that followed – and not all complimentary! More recently the shares traded at $2.90.
Last year I wrote a piece for Alan Kohler about iSoft. I put it on my ‘Negative watch” list in my Valueline column and valued it at about 17 cents. It was trading at more than 60 cents at the time. Again, plenty of disagreement with my conclusion. I listened to what everyone had to say but it couldn’t change the performance of the company which is what I was using in my models. Recently it traded less than 17 cents. Perhaps there’s an opportunity in an Australian version of Kynikos!
The result should speak for themselves lest listing them appears boastful but I merely point out what Ben Graham told Warren Buffett: You are neither right or wrong because others agree with you. Find a method and stick to it. The job of valuing a company is not the same as predicting its price. I don’t know if Navitas will fall to my valuation or not. All I do is avoid buying anything that isn’t at a discount to my valuation. Navitas may very well double from here and I have no way to predict that. I jst look elsewhere.
I will keep your details on file when I need a printer again. I have to say, the guys responsible for my book are working really hard to make the graphics work and simultaneously get it to you on time.
Les Smith
:
Hi Roger
I have always concerned myself with the quality of management as a key factor when selecting stocks. By that I mean prudent business pratices, low debt, strong earnings growth and respect for the interests of (retail) shareholders.
With Auscenco, I believe it has failed to demonstrate these qualities, highlighted by prejudicial use of debt, margin calls, unsustainable remuneration packages, options, etc at times when the business remains unprofitable.
Not for me.
kind regards
Les
Roger Montgomery
:
Great stuff Les. Thanks for posting your thoughts. I look forward to reading more.
les field
:
HI ROGER, I HAD TO HAVE A LOOK AT THIS COMPANY SDL. I CANNOT SEE HOW THEY WERE A SUCCESSFUL COMPANY. THEY STARTED OUT SOME 10 YEARS A GO. WITH 140 MILLION SHARES THEY NOW HAVE 2.1 BILLION SHARES THEY HAVE NEVER MADE A PROFIT. THE SHARES ARE WORTH NEXT TO NOTHING. HAVE I MISSED SOMETHING??????
Roger Montgomery
:
Hi Les,
A sensitive one. I will have to take a closer look.
James
:
Hi Roger,
I was wondering if you had an opinion on any of the utility plays such as APA, DUET Group, Spark Infrastructure or Hastings Diversified?
They are all on spectacular yields and will soon be going ex-dividend – are these yields sustainable in your opinion, and are they worthy of investment?
Roger Montgomery
:
Hi James,
Sometimes great assets can be mired by bad structures. Its a good topic for a future blog post. I am really glad you raised it. It makes my job of thinking up a topic for another post that much easier. SIncerely appreciated.
Arvin Kumar
:
Hi Rodger,
What do you think of Transfield Services Ltd ( TSE). I had a look at it, This company is well divisified by its services and geography.
It’s debt level has come down and has recurring revenue. Recently It has won contracts all around the world with Big Name miners, and also won Government contracts. Share price has fallen around 20% percentage recently amid all good news.
Is this a time to buy this company.
Your thoughts on this will be greatly appreciated.
Regards,
Arvin
Roger Montgomery
:
Hi Arvin,
I will put it on the list that also includes Count Financial and write something up in the next week or two.