March 1, 2011
When a company buys back its shares, the announcement is often accompanied by reports suggesting either 1) the company has no other growth options towards which it can employ equity capital or, 2) the company has great confidence in its future and other shareholders should be following its lead rather than selling out to the company itself.
Back in 1984, in his Chairman’s Letter to Shareholders (a source of information I have quoted frequently here and in Value.able), Warren Buffett observed:
“When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.”
Note to CFOs and CEOs: “shares selling far below intrinsic value in the marketplace.”
It is just as important for the CEO of a public company to be buying shares only when they are below intrinsic value, as it is for Value.able Graduates building a portfolio.
Buying shares above intrinsic value will destroy value as surely as buying high and selling low – something many Australian companies became all to expert at during the GFC as they issued shares in their millions at prices not only below intrinsic value, but below equity per share.
One question to ask is if companies are engaging in buy backs today, why weren’t they when their shares were much, much lower? The answer of course may be that they may not have had the capital back then. A recovery from the lows of the GFC has not only occurred in the prices of shares trading in the market place, but also in the cash-generating performance of the underlying businesses themselves.
Irrespective of the circumstances, a company now buying back shares that had previously issued them at the depths of the GFC is having a second crack at wealth destruction.
I am pleased to report that not all companies are following the crowd. Some larger companies, including BHP, RIO and Woolworths, have announced buy backs at or slightly below my estimate of their Value.able intrinsic values.
Webjet, Customers, Coventry Group and Charter Hall Retail REIT have all announced buy backs and Bendigo/Adelaide Bank is engaging in one to reverse the impact of shares issued through their DRP.
As I wrote yesterday (Is there any value around?), value is becoming much harder to find. Companies are expensive, even my A1s. Whilst any Value.able valuation is merely an estimate, the absence of a large Margin of Safety, combined with the announcements of buy backs, does not inspire my confidence.
In the US, share buy backs historically peak at market highs. Think back to the first half of 2007 and in 1999 and 2000 – two periods that investors may have wished they’d sold shares back to the companies – are also periods during which buy backs peaked.
Share buy backs are a very public demonstration of management’s capital allocation ability, or lack thereof.
Whilst Warren Buffett is regarded as the master of share buy backs, he has often sited another capital allocator as the real genius – the late Dr. Henry Singleton, the founder and CEO of Teledyne.
When the inflation-devastated stock market of the 1970s had pushed shares to the point that some suggested ‘equities were dead’, Henry Singleton bought back so many shares that by the mid 1980s there were 90% less Teledyne shares on issue. Here’s a para from the web: “In 1976, the company attempted, for the sixth time since 1972, to buy back its stock in order to eliminate the possibility of a takeover attempt by someone eager for the cash reserves the company had accumulated. Altogether, Teledyne spent $450 million buying back its stock, leaving $12 million outstanding, compared to $37.4 million at the close of 1972. With many of the company’s divisions showing stronger results and fewer shares outstanding, Teledyne’s stock increased from a low of $9.50 per share to $45 per share, becoming the largest gainer on the New York Stock Exchange.”
Who is Teledyne’s Australian equivalent?
One iconic Aussie business (it achieves my second highest MQR – A2) immediately springs to mind. In 2009 this business issued shares at a high price to fund a $A3.5 billion acquisition. But things didn’t quite go to plan… the US Federal Trade Commission intervened and the shares slumped. What did management do? They used the cash raised from the share issue to buy them back. Amazing!
Fast-forward twelve months and this business has nearly $1 billion in cash in the bank and no debt. If it keeps using its own cash and that being generated, and buying back shares at the present rate (and assuming the share price doesn’t change of course), it will have bought back all its shares in seven years. A Value.able business… what do you think?
Yes, if not for management’s decision to buy back shares ABOVE intrinsic value.
Unfortunately CSL’s share price may not be as high in seven years as it could have been, had management chosen to buy back its shares below intrinsic value.
If you own shares in a company engaging in a buy back, ask yourself whether value is being added to the company? Value is generated when the shares being purchased are available at prices below your estimate of its Value.able intrinsic value.
If management are overpaying, inappropriate capital allocation practices may be the only addition to the future prospects of the business.
by Roger Montgomery Posted in Companies, Health Care, Investing Education
April 1, 2010
Heading into Easter, I received an enormous pile of valuation requests and while many were little mining explorers burning through $500,000 of cash per month and with just $3 million in the bank, quite a few were solid companies that hadn’t been covered before.
And to confess, some of the requests were quite rightly keeping me accountable and making sure I post the company valuations I said I would, when I have appeared on Sky Business with either Nina May, Ricardo Goncalves and Peter Switzer.
What are they, I hear you ask? Forge Group (FGE), Grange Resources (GRR), Arrow Energy (AOE), Cabcharge (CAB), Coca Cola (CCL), Data 3 (DTL), Hutchison (HTA), Incitec Pivot (IPL), Metcash (MTS), Sedgeman (SDM) and UXC (UXC)
I am really impressed by the frequency with which I am now receiving emails containing insights I didn’t know about companies that I have covered.
As a fund manager it was not unusual for me to adopt Phil Fisher’s ‘scuttlebutt’ approach to investing. By way of background, Warren Buffett has previously described his approach to investing as 85 per cent Ben Graham and 15 per cent Phil Fisher. Fisher advocated scuttlebutt – talking to staff, to customers and to competitors. I did the same and would often end my interview of a company’s CEO or CFO with I’d learned from reading Lynch; “if I handed you a gun with one silver bullet, which one of your competitors would you get rid of?” The answers were always revealing. Sometimes I would get; “there’s noone worth wasting a silver bullet on”, but most of the time, I would find out a lot more about the competitive landscape than I had bargained for. Occasionally, I would learn that there was another company I really should be researching.
Back to your insights, they are amazing. Now you know why I enjoy sharing my own insights and valuations with you as much as I enjoy the process of investing.
One thought for you; Many of you are sending your best work via email. I would really like to see everyone benefit from the knowledge and experiences you all have so hit reply and if you have some insights (as opposed to an opinion), just click on ‘REPLY’ at the bottom of this post and leave as much information as you would like.
So here are a few more valuations to ponder over Easter. I hope they add another dimension to your research. And before you go calling me about coal seam gas hopeful Arrow Energy, note that the valuation is a 2009 valuation based on actual results. The forecasts for Arrow for the next two years are for losses, and using my model, a company earning nothing is worth nothing. Of course Royal Dutch Shell and Petro China think its worth more and perhaps to them it is, but as a going concern its worth a lot less for some time to a passive investor.
I hope you are enjoying the Easter break and look forward to reading and replying to your insights.
Posted by Roger Montgomery, 1 April 2010
by Roger Montgomery Posted in Companies, Consumer discretionary, Health Care, Insightful Insights
March 25, 2010
I am guessing from the many emails I received this week about healthcare stocks that the quantity may have something to do with the sector being in the headlines (remember it is an election year)?
Government numbers show that spending on healthcare is expected to nearly double as a proportion of GDP over the next 40 years. With fewer babies being born and people living longer, it is inevitable that the population is ageing. In the next thirty years, the proportion of the population aged over 65 will double to 22% and in the next forty years, the number of Australian’s aged 85 and over is expected to increase from 1.8% of the population to 5.1%.
Government estimates show that this will exact a heavy toll on the cost of providing health and the following chart reveals where those costs for the government and opportunities for healthcare companies lie.
Using government estimates for GDP growth, the above charts suggests the government will spend $38 billion on medicare and $68 billion on the PBS in 2040. Figures such as these have provided the large community of buy-and-hold investors with a sound investment theme to pursue. But in some cases this theme has led to some extremely irrational pricing, as we will discover.
There are more than 20 healthcare stocks listed on the ASX that essentially fall into two categories.
1. The provision of care and related services. This can mean pathology companies such as Sonic Healthcare, private hospitals such as Ramsay Healthcare, and providers of specialist ancillary services, such as software provider iSoft.
2. Research and development. This can mean companies that produce generic pharmaceuticals, such as Sigma, or research into and development of cancer drugs, such as Sirtex.
Like another exploratory industry, the mining sector, the size of these companies can vary from the very small, such as Capitol Health with a market cap of just $15 million, to global blood products and plasma giant CSL, which has a market cap of about $20 billion.
The ideal combination of characteristics for a healthcare company that an investor would seek out is no different to those that should be sought more generally; a very high quality balance sheet, stable performance, a high Return on Equity, little or no debt and a discount to intrinsic value.
So what do I think are the superior businesses? Following is a table of my findings.
Using a combination of 15 financial hurdles, I note that the best quality companies, but not necessarily the cheapest in the sector, are CSL, Cochlear, Sirtex, Biota and Blackmores.
Do you see that Search box to the right, just under my photo? You will need to scroll up. Type CSL, Cochlear or Blackmores into the box and click GO to read my past insights. And if your appetite remains unsatisfied, visit my YouTube channel, youtube.com/rogerjmontgomery, and search there too (there are many videos in which I talk about CSL and Cochlear).
I should point out that each of the remaining three – Sirtex, Biota and Blackmores – are generating high Returns on Equity and has manageable or no debt.
The lowest ranked by quality are Primary Healthcare, Sigma, Australian Pharmaceuticals and Vision Group. I won’t be buying these at any price and their Returns on Equity are less than those available from a risk-free term deposit.
Alchemia, which manufactures a generic treatment for deep vein thrombosis and pulmonary embolism, Phosphagenics, with its patented transdermal insulin delivery system, and Capitol Health are also low in terms of quality and also highly speculative because they are yet to report profits. Analysts, however, are forecasting profits for all three in 2011 and 2012 and Alchemia is forecast to earn more than 30% Returns on Equity after a loss in 2010.
In between this group are companies whose quality is neither compelling nor frightening; these are businesses that if I was forced to by I might only if very large discounts to intrinsic value were presented and in some cases, only if I was happy to speculate – which generally I am not. Sonic, Ramsay (search RHC for more analysis), iSoft, Pro Medicus, Healthscope, Halcygen Pharmaceuticals, ChemGenex, Acrux and SDI fall into this band.
I have ranked all of the healthcare companies by their safety margin: a measure of their discount or premium to the current year’s intrinsic value. This reveals that some companies are trading at discounts to intrinsic value. As an investor you need to be satisfied that the companies you choose also meet your quality criteria, which should mimic your tolerance for risk.
Take a close look at Biota, for example. Its price of $2.38 is significantly lower than the estimated intrinsic value, however you will also see that the return on equity is forecast to fall from 50% to 11%. There will be a commensurate decline in intrinsic value in coming years and the apparent discount will no longer exist, meaning that unless return on equity improves considerably in a few years it will cease to be a good investment.
If my portfolio approach were to include some exposure to healthcare then my first choices would be CSL and Cochlear. These are both well managed, large-cap businesses with stable returns on equity and zero or low levels of gearing.
My next preferred exposure would be pathology and radiology operator Sonic, alternative medicine distributor Blackmores, and liver cancer treatment marketer Sirtex
Finally, if I was comfortable speculating on stocks then the companies I would seek to conduct further research on would be the two pharmaceutical minnows, Halcygen and cancer drug developer Chemgenex. Both companies are forecast to generate attractive rates of return on equity in 2011 and 2012 and have little or no debt. Halcygen is also currently trading at a discount to its estimated intrinsic value.
REMEMBER… Before making any investment decisions, my comments should only be seen as an additional opinion to the essential requirement to conduct your own research and see a qualified financial professional.
Everyone is capable of being terrific investors, you just need to remember that there is serious work to be done by YOU in the business of investing.
Posted by Roger Montgomery, 25 March 2010
by Roger Montgomery Posted in Companies, Health Care
March 19, 2010
The requests for valuations and insights have been coming in thick and fast, and I have to confess to being a little surprised. The vast majority of requests have been for great quality businesses, some of them even the ‘A1’ companies that I alluded to on the Sky Business Channel a few weeks ago (the highlights will be on my YouTube channel in the next week or so).
If you have sent me an email requesting my insights and valuation for a particular business, thank you. You have uncovered some really interesting stories.
Lloyd, who was kind enough to drive me to the airport following my ASX Investor Hour presentation in Perth last November, suggested one such company to me, Forge Group Limited (FGE). At the time, FGE was trading at a bit more than a dollar.
If my memory serves me correctly, Lloyd bought the stock around 30 cents. I looked at it, ran it through my models and liked it a lot. For a tiny little company it was a true A1 – very high quality on all counts. It had also doubled its profits a few times.
Today it trades at $2.82 and has received a bid for 50% from Clough Limited. They have a hide! This company is potentially worth a great deal more, but don’t take my word for it – remember that you should see my view as just one more opinion, should always conduct your own valuations and research, and if necessary, seek independent advice from someone familiar with your financial circumstances and needs.
If you asked me to value a particular business, and there have been a few requests, I would have explained that I will do my best to post a valuation up as soon as possible but those companies that received the most requests would be posted first.
So here are my insights, and valuations, for the most popular businesses, as requested by you over recent weeks and even months.
Electrical contractor, Southern Cross Electrical Engineering Ltd (SXE)
Prior to its capital raising and downgrade, SXE was expected to generate Returns on Equity in excess of 37% in 2010 and 30% in 2012. Recent events however are likely to see these numbers fall to 22% and 27% respectively. The value today is 96 cents and lower than the current price, however the value next year, if it can earn the new forecast numbers, will be higher than the current price. You need to satisfy yourself that the revised expectations are indeed achievable.
Pawn shop chain (and commercial microfinance operator), Cash Converters International (CCV)
There has been a lot of interest in Cash Converters. I have seen these stores and while I cannot see them becoming a retailing powerhouse like a JB Hi-Fi or even The Reject Shop, that may not be the company’s intention. More than 2/3rds of reported profits are generated from secured and unsecured small personal loans that are distributed by a network of 509 second hand goods stores. CCV has the metrics of an attractive business indeed its an “A” class stock, but scale is the issue. Just how big can they ever be? If we remember that we want a) Big Equity and b) Big Returns on Equity, then I can see the big returns on equity but Big Equity may be someway off.
The value of CCV today however is 74 cents – about ten cents higher than the current price, and based on current estimates is worth 93 cents in a couple of years. Those valuations compare favourably to the current price and very favourably to the 32 cents the shares traded at in March 2009. Always keep in mind that you want to buy these sorts of stories at very big discounts to intrinsic value.
Figure 1. CCV’s historical and forecast earnings and dividends per share
On the surface here’s a company that has the quality characteristics I like and is at a discount to intrinsic value. The only question mark is about how big they can get. If you intend to trade shares of CCV seek independent financial advice from a qualified professional who is familiar with your needs and circumstances and do not rely on the general nature of comments posted here.
Investors must also be aware of the impact of the intention of the Consumer Credit Code Amendment Bill 2007 and the subsequent Fee, Credit and Transition Bills as they relate to the nationalisation of regulation of operators such as Cash Converters and its perceived competitors, such as City Finance.
(Postscript: ‘Reg’s’ comment below and my response are worth reading and considering and investors should pay attention to the growth of the company’s loan book and the relationship with its new largest shareholder and try to get answers to the questions I pose about continued growth and the ongoing relationship of loan book growth to retail stores)
Online job lister, Seek Limited (SEK)
Seek is a great business. Like all of the world’s most successful internet stories, it’s a plain old list. And it has developed that competitive advantage some companies achieve when scale and popularity leads to ‘essentialness’. People search for jobs at seek.com.au because there are lots of jobs, and there are lots of jobs because lots of people look for jobs there. I haven’t worked out if reaching this point is a function of strategy or dumb luck, but by definition someone has to make it to this point and he who gets there generates a lot of money and a high Return on Equity that is protected from imitation.
Seek is no exception, and its Return on Equity is expected to exceed 30% over the next two and half years. But while ROE is good and its earnings and intrinsic value growth is heading in a smooth north easterly direction, the fact remains that its popularity, as reflected in the current price of $7.90, is well in excess of the value, which is closer to $5.00 and rising to $6.30 in a couple of years. Sorry guys! Of course it was available to buy below $5.00 as recently as August last year, but that is of little use to you now. Patience is required.
Cranes for hire company, Boom Logistics Limited (BOL)
Boom Logistics is a business I remember reviewing when it floated. I was there at the IPO briefing and even then I didn’t like it. And didn’t I look foolish not taking any stock – it shot up from its listing price of 99 cents to almost $4.00 in less than 28 months.
I can sometimes get very frustrated knowing what a business is really worth and since 2005, the value of this business has been declining, along with its Returns on Equity. In 2004 ROE was 30% and today it is expected to approach 4.5%. Because you can do better in a bank account with no risk, you should think very carefully about investing in BOL. It is trading at 33 cents, but its value is less than 10 cents.
Hospital operator, Ramsay Health Care Limited (RHC)
Ramsay Healthcare is a business whose ‘theme’ I like. The population of Australia is ageing – the number of people over 75 will double in the next decade and a half, and while that will bring much sadness, the reality is that hospitals are there to provide the care that an ageing population needs. Despite a great story, hospitals aren’t that easy to run well.
You see, unlike most other businesses, hospitals can’t simply place a price on a service based on its cost and add a mark-up. Instead, they have to deal with insurance pay scales, meaning hospitals will make more money taking care of some patients and not others, and this is often not within their control.
Generally, hospitals make more money when more things happen to patients, such as pathology tests, diagnostic and therapeutic procedures, and operations. Operations are usually reimbursed at a higher rate than a medical patient, and while length of stay counts, its usually the hospital that has more surgical patients is the one that makes more money.
Conversely, a patient who lingers in a hospital is costing them money as their ongoing care may not be justified and they are blocking that bed from receiving another, better paying patient. Ever had a baby in hospital and felt like you were being booted out before your were ready? Anyone?
This is just the tip of the iceberg, but explains why running a hospital is so much more challenging than selling DVD’s to teenagers.
Having said that, Ramsay is doing a good job, as Figure 1 testifies.
Figure 2. RHC’s historical and forecast earnings and dividends per share
Of course, there is a bit of hockey-stick optimism in the forecasts, and you can thank my peers in the analyst community for that. More importantly however, the hospital is generating Returns on Equity of about 14% over the next three years, up from circa 10% in the last few years.
The value of the business is rising, along with the returns. In 2000 Ramsay’s intrinsic value was just 58 cents. In 2012 its forecast intrinsic value is $8.13. – that’s an increase of 25 percent per year! Exceptional, but the price has never allowed investors to buy at a discount to intrinsic value.
In April 2000 RHC shares traded as low as 74 cents, but never below the 2001 valuation of 91 cents. Since then you have had to buy the shares above intrinsic value in order to participate in the growth in intrinsic value. But whereas in 2000 you only needed to wait a year for intrinsic value to catch up, you would be waiting much longer today. With the shares currently priced at $13.50, even a 2 -year wait won’t see the value catch up. It looks a little pricey now.
Keep in mind that I cannot predict share prices. I can tell you what things are really worth and tell you that over time price and value catch up with each other one way or another, but that is all I can tell you. I guess I can also vouch, having managed a couple of hundred million dollars, that if you buy good businesses below intrinsic value, things tend to work out ok.
Mining laboratory operator and cleaning solution seller, Campbell Brothers Limited (CPB)
Second last on the list is Campbell Brothers. Its been generating a decent Return on Equity for a decade, and its intrinsic value has been rising every year in that time. But like Ramsay, CPB’s intrinsic value will still not have reached the current price, even in 2012. I reckon it is worth $20 in 2011, and today its trading at $29.
Finally, one that needs no introduction, ASX Limited (ASX)
I have written about the ASX in my forthcoming book, Value.able. The ASX is worth less than $21 today and intrinsic value should rise to $26 in 2012. But Returns on Equity are not a patch on other companies, averaging 13.5% over the next few years. And despite the monopoly characteristics the company evidently has, it has not been able to charge what it wants for fear of emigration to rivals applying to set up. As a result, there is some correlation to the direction of the stock market, and predicting it is like predicting the price of a commodity – difficult.
Is your hand still up?
I have deliberately left out any discussion about debt, so be sure the companies you are investing in have little or none. There is much more on this in Value.able, including a chapter devoted to when to sell.
I hope you are getting a great deal of use from these valuations and I look forward to your comments and input.
Posted by Roger Montgomery, 19 March 2009
by Roger Montgomery Posted in Companies, Health Care, Insightful Insights
December 3, 2009
A long-term value investing friend, Pauline, recently asked me: Do you value CSL at all?
The short answer is yes – I wrote an article on November 4 for Alan [Kohler] about CSL.
Click here to read my thoughts.
Posted by Roger Montgomery, 3 December 2009
by rogermontgomeryinsights Posted in Companies, Health Care