Consumer discretionary

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.

by Roger Montgomery Posted in Consumer discretionary.

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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…

by Roger Montgomery Posted in Companies, Consumer discretionary, Property.

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I had a call yesterday from one of my brokers (who also happens to have become a friend). He informed me that the restrictions have come off all the broker’s so that they are now able to write research about Myer. As you would expect so soon after its widely supported float (A float that lost money for the thousands of investors who sold out in the first weeks), the research has been predictably bullish. It is not however the views of the analysts that is interesting. What is interesting is the reference in several of the reports to a relative P/E. The argument goes that because Harvey Norman and David Jones have a higher P/E than Myer, that the gap should narrow and Myer’s P/E should rise, pulling the price up with it. See any weaknesses in the logic?

Its like saying that there’s a Ferrari and there’s a VW Combi and the VW combi will get faster because the Ferrari is too fast compared to it.  Clearly such conclusions are flawed.

The performance of management, the economics of businesses and their prospects all affect their values and the sentiment towards them, which in turn, affects prices in the short term.

Buffett has frequently said that academics where correct in observing the market was frequently efficient.  In other words, a lot of the time, the price is right and perhaps in the case of Myer it should be on a lower P/E than David Jones.  This post should be read in conjunction with my previous posts on Myer that discuss its intrinsic value.

Roger Montgomery, 10 December 2009.

by rogermontgomeryinsights Posted in Companies, Consumer discretionary, Insightful Insights.

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That is the question I have been asked by some investors. Putting aside the many individuals who have written to me to say they have recently had a less than encouraging shopping experience at Myer, meeting with disinterested casually employed staff, it seems there are those who are taking the current price as a signal that a $2.90 valuation is too conservative.

If ‘price’ is what you pay and ‘value’ is what you get, then your job as an investor is simply to pay a lower price than the value you receive. It is essential therefore that your valuation is completely independent of price.

When I bought JB Hi-Fi at $8.50, the valuation was much higher. When I bought Fleetwood at $3.50, the valuation was much higher. Had I taken my cue from the price of Fleetwood and JB Hi Fi, I would have been fearful that the price was correctly reflecting the possibility that the GFC would roll into something much more damaging.

The Myer valuation of $2.90 is based on the facts presented in the prospectus. The only subjective part of the valuation is the selection of the after tax Required Return. If I adopt a 12% required return I get a $2.85 valuation. At 11.5% the valuation is $2.99, at 11% is $3.19 and at 10% is $3.65. You can take your pick.

In any event, even an optimistic Required Return produces a valuation well below the current price and remember, you want to buy shares at big discounts to valuations. I adopt a policy of simply saying I want to buy the very best businesses when they are trading at substantial discounts to even the most conservative valuation. Compromising this standard in the attempt to generate more activity or valuations that are closer to the current price has the effect not of making you more money, but of making you more active!

By Roger Montgomery, 5 November 2009

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In short, the answer is no. Three years ago Myer was purchased from the Coles Myer Group by a private equity team called TPG/Newbridge. The Myer Family was also involved and together the consortium acquired Myer for $1.4 billion. The group used $400 million of their own money and borrowed the rest.

Before the first anniversary, a very long-term lease on Melbourne’s Bourke Street store was sold for about $600 million, and a clearance sale reduced inventory and netted $160 million. All this additional cash allowed the new owners to reduce debt, pay a dividend of almost $200 million and produced a capital return of $360 million. In other words, before the first year was out the owners had received all of their $400 million outlay back, and arranged a free ride on a business with $3 billion of revenue.

But as a participant in the upcoming float of Myer you are not being invited to pay $1.4 billion, which was 8.5 times the Earnings Before Interest and Tax (EBIT). You are being asked to stump up to $2.9 billion, or more than 11 times forecast EBIT. You are also being asked to replace the vendors as owners and while they know a lot about extracting maximum performance out of department stores, you don’t.

In estimating an intrinsic value for Myer, I have ignored the fact that the balance sheet includes $350 million of acquired goodwill as well as $128 million of capitalised software expenses. I will also ignore the addition of sales made by concession operators “to provide a more appropriate reference when assessing profitability measures relative to sales”, the removal of the incentive payments to retain key staff (not regarded as ongoing costs to the business), costs associated with the gifting of shares to employees and most interestingly, the reversal of a write-off (meaning it has been left in) of $21 million in capitalised interest costs; all regarded as non-recurring.

While ignoring these in my estimate of intrinsic value seems irresponsible, it merely means that whatever number is produced by the calculation, it is going to be higher than it really should be. That’s fine; I just have to ensure a larger margin of safety.

Taking a Net Profit After Tax figure for 2010 of $160 million and assuming a 75 per cent fully-franked dividend payout, I arrive at a return on equity of about 28 per cent on the stated equity of $738 million – equity that could have been higher after the float if $94 million in cash wasn’t also being taken out of retained profits. Using a 13 percent required return I get a valuation of $2.90.

Alternatively, I am buying $738 million of equity that is generating 28%. If I pay the $2.9 billion that is being asked for that equity, or 3.9 times, I have to divide the return on equity by 3.9 times, which produces a simple return on ‘my’ equity of 7.2 per cent. For ‘my’ money it’s just not high enough for the risk of being in the department store business.

And looking into the future, things don’t become dramatically more attractive either. Based on the numbers in the prospectus I estimate the value only rises by 6 per cent per year over the next five years and delivers a value in 2015 of $3.90 – the price being asked today.

In valuing Myer I am not predicting its price. Remember what Benjamin Graham said; In the short run the market is a voting machine.  Shares that are popular can go up a lot even if the value is much lower. In 1999 and 2000 Telstra’s value was less than $3.00 and yet the shares traded around $9.00 for a long time. But Ben Graham also said in the long run the market is a weighing machine. In the long run, Myer’s share price will reflect its value.

So no, I have not changed my view of Myer’s float.  I am going to pass on My piece of Myer.

By Roger Montgomery, 26 October 2009

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I’m not talking about the front cover.

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

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Like me, your Myer One card entitles you to pre register for a prospectus for the forthcoming float of Myer. Should you take the next step and buy the shares?

The answer to that question depends on three things. First, does the business have bright prospects? Second, what is the business worth? Third, at what price is it being offered?

Clearly, Bernie Brookes is the talk of the town, and his work in turning Myer around is fast becoming legend.  But is the talk about Bernie’s ability to improve returns on sales from 2 cents in the dollar to 7 cents, or is the talk because a private equity firm bought a business with $400 million of equity and $1 billion of debt then, in the first year, paid themselves back their equity – essentially getting the business for free and then a few years later still, floated the business for what many analysts believe will be $2.5 billion?

Myer may be a better business than it was and it may be that earnings next year will be higher again, but this is not a JB Hi-Fi, able to roll out another 100 highly profitable stores with short payback periods. This is a department store.

It is, I confess, now a highly profitable business and highly profitable businesses are the sorts of businesses to own. But what should you pay for it?

To value a company, we need to know a few things. How much is reasonable to expect the company to earn on its equity going forward? What will be the equity going forward? And what will be the policy for the distribution and retention of earnings? In other words, what portion of its earnings will the company pay in dividends?

The company earned $109 million on beginning equity of about $300 million. That is a return on equity of 36.3%. If we assume the company and its management earn another 30% next year, pay half out as a dividend, and if we assume that we require a twelve percent return, the business is worth about $2.4 billion.

But there’s a catch, the company will not earn 30% on its equity, particularly if its equity keeps growing as half the profits are retained. In reality, if the company kept retaining profits, the equity would rise and the return on equity would fall. As the business matures, it will have to pay an increasing proportion of its earnings as a dividend.

Now that probably means that the business’ value will not grow significantly after about three to five years.

Investors who are considering buying shares in the float need to consider what the true value of the business is and what it will do in the future. And also keep an eye on how much goodwill is added to the balance sheet and how much tangible equity is taken out prior to the float.

By Roger Montgomery, 17 September 2009

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It seems the profits to be made by TPG on the re-listing of Myer will be outsized beyond what has been reported thus far. When a TPG-led consortium purchased Myer and the Bourke Street store, they paid $1.4 billion. Of that total, just shy of $450 million was equity – the contribution by the new owners and $1 billion was debt. Here’s the interesting part… in the first year of ownership, the owners held what you might recall was a massive clearance sale. They also sold the Bourke street store. The sale of the store netted around $600 million and the clearance sale, about $160 million. With the excess cash generated by these activities, the owners received a dividend of almost $200 million and a capital return of $360 million and hey presto, the owners bought Myer and got all their money back in the first year effectively buying Myer for nothing! Whatever the company lists for, subtract a billion to pay down the debt (assuming Myer is listed debt free) and the rest goes straight to the vendors – an infinite return on equity. What will be even more intriguing is whether the company is IPO’d with any debt. The more debt left on the balance sheet, the more of the float proceeds go to the vendors and remember they bought Myer for free.

By Roger Montgomery, 9 September 2009

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