Companies

At the outset, let me say I am not going forecast anything.  I don’t know whether the market will rise or fall next.  Andy Xie however, in his column entitled; A world flying blind wrote:  “Playing with expectations works temporarily. The risk-on trade is in a mini bubble, as today’s, buyers want to be ahead of the slower ones. The buying trend is sustainable only if the global economy strengthens, which is unlikely. The stocks aren’t cheap. Desirable consumer stocks are selling for 20 times earnings. Banks are cheap for a reason. Internet stocks suggest another bubble in the making. The Fed is trying to inflate an expensive asset. The rally, hence, is quite fragile. As soon as a shock like Greece defaulting or bad economic news unfolds, the market will quickly head south.”

In the great de-leveraging we are witnessing, cutting interest rates (monetary policy) doesn’t spur economic activity because businesses and individuals are simply trying to get out from under a mountain of debt first.  The next option is to simply hand over money (quantitative easing) and then if that doesn’t work expand budget deficits through government spending (fiscal policy).  A positive by-product of the money printing is that lower long-term bond rates guarantee a negative real yield – How can bonds be seen as ‘safe’ if they are 100% guaranteed to result in less purchasing power? – and investors are forced to buy other assets like stocks and pile into the “risk on” trade referred to above.  Sadly, just as the money being printed isn’t finding its way into the economy – its being hoarded by the zombie banks who should have been allowed to collapse and/or write off their bad loans – the rally in the stock market isn’t helping the masses and indeed may itself be fading.

Chart 1 suggests to some investors that the latest attempt to encourage participation in the stock market hasn’t worked.

Chart 1 reveals that not only have retail investors continued to pull out cash from US equity mutual funds (about $66 billion since October), but the market peak of the week of February 29 coincided with the biggest weekly outflow for 2012 – $3 billion.

Chart 2.  Ratio of accumulators to dissavers plotted against P/E ratios

Back to more recent observations and the 20% stock market rally over the last four months has been described as a completely artificial “ramp” by some and has been driven entirely by the global liquidity injections of the US, UK, European and Japanese central banks.  The conclusions for some investors is that the smart money – those that have bought in anticipation of retail ‘follow-through’ will soon scramble for the exits.  What do you think?

Skaffold’s ASX200 Value Indicator is a live and automatically-updated valuation estimate of the ASX200.  It updates and changes every day.  The future valuation estimates are based on the the constantly updated forecasts for earnings and dividends of the biggest 200 companies.  You can’t beat it as a guide to the overall market level and whether you should be enthusiastic or not about looking more deeply for value.

Chart 3.  ASX200 Value Indicator

Source: Skaffold.com

Based on current forecasts for 2012 you can see that the market looks about fair value.  It isn’t overly expensive but neither is it, in aggregate, cheap.  Based on 2013 forecasts however the market appears to be reasonable value.  So the question is whether those 2013 forecasts are reasonable.  Typically, forecasts are optimistic.  We have previously written here of the persistence of optimism in forecasts by analysts.  If that is again the case for 2013, then you wouldn’t be getting overly enthusaistic about our market unless there was a pull back.  And according to those referenced above, a pull back is on the cards.  What do you think?

I believe there are individual companies that have produced amazing results this reporting season and in an upcoming post we will list the very best.  I also think that there is still some value among these companies.  The challenge for those new to long term value investing is to be able to stick to your guns, accumulate positions in extraordinary companies at deep discounts to rational estimates of intrinsic value and stand apart from the daily gyrations of fear and rumour about default, money printing and recession.

Looking forward to your comments.

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 8 March 2012.

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Roger Montgomery discusses why ‘watching the Directors’ is a “Value.able” strategy when assessing future business performance in his March 2012 Money Magazine article.  Read here.

by Roger Montgomery Posted in Companies, Intrinsic Value, Investing Education, On the Internet.

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Do BHP Billiton (BHP), Fortescue Metals (FMG), Seek (SEK), Bluescope Steel (BSL), GR Engineering (GNG), CSL (CSL), Peak Resources (PEK), Harvey Norman, (HNN), Buru Energy (BRU), The Reject Shop (TRS), ASG Group (ASZ), Tatts Group (TTS) and  Webject (WEB) make Roger’s coveted A1 grade?  Watch this edition of  Sky Business’ Your Money Your Call broadcast 29 February 2012 to find out.  Watch here.

by Roger Montgomery Posted in Companies, Energy / Resources, Investing Education, TV Appearances, Value.able.

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We have been delighted with the reports coming out from the smaller industrial companies and note again the growing divergence in the performance of the XJO versus the XNJ (ASX 200 versus All Industrials). We attribute this to a declining enthusiasm for the ‘resource story’ and the fact that many of the industrial companies we like (and own, including MTU) are producing such fantastic results despite evidence of a terrible domestic economic backdrop.

Headline revenue was down 14% as a result of the reduction of unprofitable EDirect business activity.  Thats good.  Underlying revenue (excluding the zero margin Edirect business) rose 8% and the dividend was up 29%. Business cash flow was $17.5mln compared to reported profit of $16.7mln.   The impact on valuations should be positive again but ultimately will be determined by the returns generated on the $21.8mln paid for the two acquisitions made in the current half.

Since 2003 (the year before MTU listed) the company has increased profits by more than 91% per annum and is forecast to grow profits again to $36 mln in 2012.  To generate the increase in profits (of $27mln to 2011) $60 million has been raised and $30 million borrowed.  The return on incremental equity is about 50% suggesting the acquisitions made thus far have reflected an astute allocation of capital.  We’ll be keeping an eye on the debt but reckon a recovery in the local economy (as interest rates are lowered and hopefully passed on by the banks) will give MTU another boost.

According to one of our brokers who has a buy recommendation on the stock, the following stocks are at risk of reducing their dividends:  Examining for factors…”forecast earnings revisions, payout ratios, stock price stability and free operating cashflows, the companies that are most at risk of further dividend cuts are SWM, GWA, TTS, HVN, QBE and MYR. Those that have reduced dividends but continue to pose a risk include BBG, CSR, DJS, GFF, HIL, MQG, OST, PPT, PBG, PTM, TAH, and TEN.”

Not a recommendation of course. Seek and take personal professional advice before engaging in ANY securities transactions.

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 27 February 2012.

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We all know retail businesses are swimming against the tide. We have written about that subject here at the blog on many occasions and below is a brief list of more recent posts:

We are not investors in momentum or sentiment however this blog allows me to share our thoughts with you and we are noticing a shift in investor sentiment now. The stock market indices with exposure to resources are underperforming the indices without. The industrial indices are rising at a faster rate and falling at a slower rate than their resource-rich bretheren.  Today is a classic example, This tells us that a shift is afoot. If you have been reading this blog regularly, you will know that we are also not enthusiastic about Iron Ore prices and believe prices of $100 per tonne or less are possible in coming years.  On air, I have explained that is our reason for not purchasing BHP despite optimistic earnings forecasts by analysts.

I think the lower-iron-ore price story is catching on and quietly but surely investors are reducing their relative weighting to resource heavyweights.

With that in mind, it could be that most down-in-the-dumps retail sector that now holds a few gems. Next week we’ll explore the results of the reporting season but for today I thought we should revisit The Reject SHop following its half year results.

Here’s the list of recent posts covering retail stocks and the retail sector.

http://rogermontgomery.com/invest-in-kfc-or-just-eat-it/
http://rogermontgomery.com/is-it-just-harvey-norman-or-bricks-mortar-retailing-generally/
http://rogermontgomery.com/are-bargains-available-at-woolworths/
http://rogermontgomery.com/now-waving-drowning/
http://rogermontgomery.com/not-so-high-at-jb-hi-fi/
http://rogermontgomery.com/dumped-by-the-wave-of-fashion/

Way back in September 2009, I published my reason for selling The Reject Shop:

“I can’t stop thinking that the value of the business just cannot rise at a fast enough clip to justify the current price. I really don’t like trading things that I have bought but I don’t think the value of the business can continue to rise indefinitely. With a share price of $13.45 (intraday today) and a valuation of $11.27, the shares are 24% above their intrinsic value. This combination of factors tells me we are safer in cash.”

Like many value investors, I was a little premature and the price first rallied to more than $17.00.  Since then the price has steadily declined to $11.80 after hitting a low of $9.12.

More recently – in December – I wrote:

“The Reject Shop still enjoys its high brand awareness but, as is typical in many store roll out stories, as the offer matures the later sites are less profitable than the early sites.

This doesn’t fully explain the fact that during a period in the economy where one would expect a bargain offering to shine, it hasn’t. Eighty percent of Australians still know the brand but I believe consumer experience and mismanagement has done it some damage.

According to one report, 20% of the population believe the company offers rubbish – cheap Chinese junk that quickly breaks after use and fills our tips. It’s the very reputation China itself is trying, but frequently failing, to shake off.

The other reason for damage to the brand is confusion brought on by mismanagement. Several years ago the average unit price was about $9 and basket size was $11, but over the years one cannot help but have noticed many higher-priced items creeping into the stores.”

Value investors are often early to buy and early to sell but over the long run, being certain of a good return is safer than being hopeful of an exceptional one and so, when it comes to buying decisions a demonstrated record is often essential.

In TRS’s FY12 earnings guidance, the company noted “Significant expenditure on increasing brand awareness”.  This is a real shame because at the time the company float The Reject Shop enjoyed 90% brand recognition and thats why its store roll out was working so well – shoppers knew the company, the store and the offer even though they had never been into a store in their area.

The company has provided earnings guidance for the full year 2012 of $20.5 to $22 million and while some smart analysts will note this is a 53 week year – we don’t care about such arbitrary lines in the sand.  Our approach to investing is involves treating any purchase and ownership as if we owned the whole company.  In that light and over the long term it doesn’t matter whether there are 52 weeks in a year or 52.5 or 53.

Thirteen analysts cover the stock and this week, eight have upgraded (only one downgraded) their forecasts for 2012 (remember the downgrade could be an error on the part of teh analyst rather than the company disappointing) .  I still believe the business will mature but there could be some value in the turnaround and a stabilisation of strong cash flows, and returns on equity over the next few years around 35%.  This is the rate of return on equity the company generated on $21 million of equity in 2005 (its intrinsic value then was around $4.00).  Today the company is expected to return to 35% returns on equity but on 3 times the equity.  You should be able to estimate the intrinsic value from those metrics.

There have been terrific results amongst our fund holdings such as Credit Corp, Seek, Breville Group, ARB, Decmil and Maca.  Have you been encouraged by any of the results?  Start a discussion by clicking on the Comments button below.

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 24 February 2012.

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Click on the image at left to see a close up of the stocks we like.

I reckon 2012 will be the year to get set and fill your portfolio with high quality businesses, demonstrating bright prospects for intrinsic value growth and a margin of safety. That will be the topic of my talk today as I kick off the ASX’s 2012 Investor Hour series. Here are the details:

Topic: Buying opportunity

When: Tuesday 21 February
Where: Wesley Conference Centre, 220 Pitt Street, Sydney (venue location)
Time: 12 noon – 1pm. Please arrive by 12.00 noon for start
Details:

The time to get interested in share investing and make good returns is precisely when everyone else isn’t. But know that the key to slowly and successfully building wealth in the sharemarket is to avoid losing money permanently.

At this event Roger will set out his principles for stock selection.

Roger Montgomery is a highly-regarded value investor, analyst and author and a regular contributor and commentator across the media. Roger is an analyst at Montgomery Investment Management Pty Ltd.

Presenter(s): Roger Montgomery, www.Skaffold.com, www.Montinvest.com

Posted by Roger Montgomery, Value.able and Skaffoldauthor and Fund Manager, 21 February 2012.

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On one side of the investing coin is the idea that you lay out money today to get more back later. The flipside is that buy purchasing today you forego consumption today for the ability to consume more later.

They aren’t quite the same thing of course, because the latter idea introduces inflation and suggests the purpose of investing is to at least maintain purchasing power (generate returns in line with inflation) or increase purchasing power (generate real returns in excess of inflation).  In a useful reminder Buffett observes:

“Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.””

Therefore an investment that is price stable but loses purchasing power is very risky (think US T-Bonds) while an asset that is volatile in price but almost certain to increase purchasing power over time is less risky than the conventional measures of risk would dictate.

This is how Buffett begins an excerpt of his forthcoming letter to Berkshire Hathaway shareholders HERE. One scenario his introduction does not contemplate of course is deflation. Japanese real estate and equity prices are fractions of their previous levels and a bond offering even a miniscule return would produce an increase in purchasing power. Like many readers, you might reach the conclusion that the absence of this scenario in his letter along with the knowledge of aggressive equity purchases in recent months, indicates he does not believe deflation is a possibility.

The other subject of his letter is Gold. Melted down all the gold in the world would amount to one 68 cubed foot of uselessness. Somewhat ironically he reflects on its purchasing power today – all the agricultural land in the United States, sixteen companies as valuable as Exxon and a trillion dollars in walking-around money.

But he points out that the companies will have thrown off dividends and the land would have produced food. And so the article leads to the defence of buying businesses as a superior strategy (to owning gold ‘that just sits there’) – as we believe at Montgomery Investment Management, and you might as Value.able graduates (after seeking and taking personal professional advice).

I believe Buffett’s take on the investing landscape is ultimately correct (bubbles are always followed by a bust and nothing goes up forever);

“What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth — for a while.”

But I trust you can see the irony in claiming gold is useless and yet it can buy 16 Exxons and so on. As the chart shows, it has underperformed stocks over the long term and without boasting about it Buffett uses the S&P500 index to demonstrate the superiority of stocks. In a thinly veiled warning to gold bugs he likens the current enthusiasm for gold to the internet bubble and US housing speculation pre-2007.

In his enthusiasm for stocks being best able to retain purchasing power or increase it, I can’t but help remembering that Buffett was a more circumspect proponent of stocks in the seventies – a period of very high inflation. While in 1974, when Forbes asked Buffett how he felt about the stock market at the time, Buffett replied, “Like an oversexed guy in a whorehouse”, his 1979 letter to investors serves as a useful reminder of the limits of any asset to retain purchasing power during bouts of high inflation.

“Just as the original 3% savings bond, a 5% passbook savings account or an 8% U.S. Treasury Note have, in turn, been transformed by inflation into financial instruments that chew up, rather than enhance, purchasing power over their investment lives, a business earning 20% on capital can produce a negative

real return for its owners under inflationary conditions not much more severe than presently prevail.

If we should continue to achieve a 20% compounded gain – not an easy or certain result by any means – and this gain is translated into a corresponding increase in the market value of Berkshire Hathaway stock as it has been over the last fifteen years, your after-tax purchasing power gain is likely to be very close to zero at a 14% inflation rate. Most of the remaining six percentage points will go for income tax any time you wish to convert your twenty percentage points of nominal annual gain into cash.

That combination – the inflation rate plus the percentage of capital that must be paid by the owner to transfer into his own pocket the annual earnings achieved by the business (i.e., ordinary income tax on dividends and capital gains tax on retained earnings) – can be thought of as an “investor’s misery index”. When this index exceeds the rate of return earned on equity by the business, the investor’s purchasing power (real capital) shrinks even though he consumes nothing at all. We have no corporate solution to this problem; high inflation rates will not help us earn higher rates of return on equity.”

Another warning to stick to high ROE businesses…

Finally remember that if you are buying stocks, unlike commodities, there exists management risk, execution risk, result risk, competitor risk, economic risk, currency risk etc. Anything can go wrong in a business and frequently does. And while Chalrie Munger has pointed out that “Almost all good businesses engage in ‘pain today, gain tomorrow’ activities”, you must know what you are doing.

I think stocks are indeed the best opportunity to retain and increase purchasing power but only the good quality ones.  Knowing what you are doing and sticking to high rates of return on equity, little or no debt and A1 or A2 businesses increases your chances of doing even better than the both the stock market index of which they are constituents and inflation.

Posted by Roger Montgomery, Value.able and Skaffoldauthor and Fund Manager, 14 February 2012.

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It’s been a lackluster start to this year’s company confession session. Only a few companies have so far bucked the stable / downward trend in revenues and profits.

At the top of this list, reporting what I would consider to be quality results are CCP (SQR A2) – so far the clear standout and a business we own in the Montgomery Private Fund. This is followed by WEB (SQR A2) a business whose Total Transaction Value (TTV) is growing at rates 4x the industry average but is a little expensive in terms of its future prospects for now.

And that’s about it at the quality end of the investment spectrum (with the exception of Breville, Forge and Decmil’s updates). Remember that we rate every single listed company from A1 (the best) to C5 (the worst) so we follow them all. If you want to find opportunities such as CCP before everyone else, take a look at Skaffold.com

There have been a number of other businesses which have reported so far and on face value, while LGD (SQR B2) experienced strong revenue and profit growth; a large proportion of its growth was driven by several recent acquisitions. Organic growth is less than 50% of that being reported currently; something to watch in future reporting seasons.

Now to our friends long Telstra:

(SQR B3) the half year was a little sobering for those who have bought the stock for its dividend yield. Whilst reported Free Cash Flow was $1,795b and dividends paid amounted to $1,738b, one would assume the yield was fully covered. Not so. The free Cash number reported did not include $559m in interest repayments on almost $15b debt. $500m additional debt was borrowed to fund dividends and CAPEX – debt to equity thus increased and is currently 104%. While dividends are being paid, and will probably continue being paid, its just worth noting how they are being funded…

Over at the Big Australian – BHP:

Staying at the big end of town and global diversified mineral and petroleum producer BHP (SQR B1) reported a HY NPAT $9.9b NPAT down on last year’s. The lower results was despite very attractive Iron Ore, Bulks and Petroleum margins – prices which declined in the latter part of 2012 and which may impact profits further in the 2nd half.  The acquisition of Petrohawk for $13b (which pushed gearing to 34%) contributed to earnings but couldnt arrest the decline. Industry-wide cost pressures with consumable, labour and contractor costs added $400m to cost inflation! On a more positive note, the project pipeline of $27b and $5b in actual committed projects. In the half total CAPEX (investment) projects + exploration spend was $9b – this continues to support EPC / EPCM engineers, drillers, mud suppliers (Decmil, Forge, Maca, Fleetwood et. al.) which are all operating at full capacity and expanding like there is no tomorrow. However for BHP investors, because the company continuously has to invest in greenfield projects to offset natural production decline, this results in a capital intensive investment program – something investors in BHP 20 years ago might be acutely aware of. Although they have long-life, world class assets and significant cash flows that are able to meet the demands currently, over the past three months profits have been downgraded from circa $25b to circa $19b. Indicative of an economic slowdown and slowing demand for resources. So something to be watchful of is the fact that declining profits = declining cashflows = declining future investment. Albeit the investment future and plans looks like its all boom time right now.

Posted by Russell Muldoon per Montgomery Investment Management, Value.able and Skaffoldauthor and Fund Manager, 9 February 2012.

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The ability to pick stocks that never go down, is NOT one of our skills.  Plenty of you can attest to that.  Value investing using the method we advocate in Value.able and using Skaffold.com cannot prevent losses, it is about minimising the cases of permanent impariment.

Asked by BRW’s Tony Featherstone which small caps we liked we nominated a few. Here’s the list and if you cannot read it properly or would like to also read about the TOP 10 Start Ups of 2011, grab this week’s copy of the BRW.

Remember to seek and take personal professional advice before engaging in any security transactions.

Posted by Roger Montgomery, Value.able and Skaffold author and Fund Manager, 9 February 2012.

by Roger Montgomery Posted in Companies, Energy / Resources, Insightful Insights, Skaffold.

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Reporting season has begun in ernest and a few companies we have been watching (and some of which we own in the Montgomery Private Fund) have reported. Today it was Credit Corp’s turn (ASX: CCP, SQR* A2). You can find the presentation here (be sure to read and agree to the ASX and our disclaimer).

Skaffold members are likely to have already seen CCP on the Aerial Viewer with an A2 rating and a discount to Skaffold’s estimate of Intrinsic Value.  In the Montgomery Private Fund, we have owned the stock for some time now and I have mentioned it as a stock to investigate on many TV and Radio programs.  Today’s 10 per cent gain is certainly a welcome boost to the gains already registered.

The highlights from the announcement of the half year results for us were 1) that earnings were at the top end of guidance, 2) a 12% increase in revenue translated to a 23% increase in NPAT, 3) a welcome reduction in debt to its lowest level since listing and 4) strong free cash flow after an increase in dividends and finally a conditional settlement of a “distracting” class action.  This final point is particularly important for many investors who will now feel vindicated that it was not the investor who erred.  The impact of the settlement on earnings will be immaterial thanks to insurances.  At current rates of cash flow generation, debt could be extinguished completely by the end of the financial year.

Grant Duggan – a regular blog poster here – was kind enough to make the following comments below:  “If i recall on YMYC a caller asked for one xmas stock to put under the tree for 2012, and much to your dislike [Roger] to only be able to pick one it was CCP, and i know two months don’t make a market but to me this is another indicator of value able investing starting to prove its worth. Thanks to Roger and all blog posts once again.”

I know I am harping on about it but if you have not joined as a member of Skaffold, how are you planning to find the best opportunities during reporting season?  Join Skaffold who have done all the hard valuation and quality assessments for every single listed company so you don’t have to.

Posted by Roger Montgomery, Value.able and Skaffold author and Fund Manager, 2 February 2012.

by Roger Montgomery Posted in Companies, Investing Education, Skaffold, Value.able.

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