Insightful Insights

  • Surprising on the Upside

    Tim Kelley
    November 27, 2012

    We’re delighted to see CSL announce this morning that it expects NPAT in FY13 to be 20% higher (in constant currency terms) than in FY12. Previous guidance was for 12% growth.

    CSL is exactly the sort of business we like at Montgomery. Its impressive balance sheet and financial performance have earned it a Montgomery quality rating of A1 or A2 for each of the last 6 years. In addition, the strong financial position of the business has allowed it to buy back shares. As a result, earnings per share will grow faster in FY13 than the estimated 20% rate of profit growth.

    High quality businesses tend to be rewarding investments for long-term investors. While the broader market sits currently at about the same level it held in 2005, CSL shares are some 250% higher. The Montgomery [Private] Fund is happy to own shares in this excellent business.

    by Tim Kelley Posted in Insightful Insights, Technology & Telecommunications.

  • Unearthing informed Mining Services research

    Russell Muldoon
    November 26, 2012

    Although it has taken a while for our alert earlier this year to flow through, project delays, cancellations and profit downgrades are mounting as the mining services sector confronts its post-capex-boom. To name a few: Macmahon is shedding staff and cutting pay rates, Emeco’s hiring rates have collapsed with an industry wide surplus of idle heavy machinery, Diploma Group is no longer proceeding to build a 244 man camp near Tom Price for Rio Tinto, ALS is reporting no growth, Ausdrill severed its earnings guidance and Orica wrote down the value of its equipment finance division, Minova, by $367m.

    continue…

    by Russell Muldoon Posted in Energy / Resources, Insightful Insights.

  • Lamenting the Australian Index

    Tim Kelley
    November 24, 2012

    One of the strategies available to people who lack the time or inclination for active portfolio management is to “buy the index”. This is normally done via an index fund, which invests in companies according to their index weights. These funds have a certain intuitive appeal, as they typically charge low fees and are easy to understand.

    However, if you step back and think about it, we think some serious issues arise. In essence, an index fund invests in a company, simply because it is there. This may be a satisfactory rationale for climbing a mountain, but we think it falls short as an investment strategy, particularly in the Australian context.

    The chart below shows the industry composition of the ASX200 index. Ignore the % numbers – they are the daily price changes from yesterday – and look at the size of the slices. What stands out is that financials and basic resources together account for more than 60% of the total. If you buy the Australian index, your returns will be dominated by the big 4 banks and a handful of large resources companies. This doesn’t look like a sensible portfolio construction to us, and the rationale “because they’re there” doesn’t provide much comfort.

    ASX200 Index Composition

    For comparison, the second chart, below, shows the composition of the US S&P500 index. A few things to note:

    – Firstly, the US index has a much more even distribution, with 7 different industry groups representing a material part of the whole.

    – Secondly, it’s interesting to note that technology is the largest single component of the US index, but is nothing more than a rounding error in the Australian index. In an age where commerce is being transformed by technology, is it good enough for Australian investors to have a <1% allocation to this sector ?

    S&P500 Index Composition

    by Tim Kelley Posted in Insightful Insights, Technology & Telecommunications.

  • The Clever Country?

    Tim Kelley
    November 23, 2012

    We have been preparing some statistics today as part of an external review being done on The Montgomery Fund. One thing the reviewers want to know is how our portfolio differs to the index in terms of its exposure to different industry sectors.

    The answer is that it differs markedly. We are far more interested in owning great businesses than in minimising our index “tracking error”. One striking example is the information technology sector, where The Montgomery Fund has identified some interesting opportunities and has allocated almost 15% of its capital. By comparison, information technology makes up less than 1% the ASX300 index.

    The real issue of course is what this second number says about the composition of the Australian economy. Our competitive advantage in digging things out of the ground has now been lost to high costs. As a nation, what other tricks do we have up our sleeve?

    by Tim Kelley Posted in Insightful Insights, Technology & Telecommunications.

  • Building Brand Australia

    Roger Montgomery
    November 22, 2012

    Australia’s wish for a new government may be granted at the next election but its dream for a more competitive, more productive and more efficient country may remain just that – a dream.

    I despair for Australia.  A Laissez-faire approach to the economy and to regulation held by the opposition – making people responsible for themselves and allowing companies and people to make their own choices – may work to help large companies (the Libs have previously had to deal with accusations of favouring big business) but left to their own devices, a ‘light touch’ produces legislated abuses of market power.  More on this another time.

    But my despair comes from a philosophical position held by some in Canberra that may be too reliant on the idea of playing to our self-labelled “strengths”.

    On the one hand, we are told by our politicians that we have to endure a structural deficit in our balance of payments current account – the value of our imports are always higher than the value of our exports.  This makes the speaker sound like they know what they are talking about.  Say ‘deficit’ and everyone agrees, throw in the word ‘structural’ and you can really sound like you know what you are talking about.  We are also told that our strengths are resources and agriculture.  If the next government is going to focus on our strengths, then that means focusing on low return on equity businesses that have no enduring competitive advantage because they are price takers rather than price makers.

    The bloody reason the value of our imports is higher is because other countries are taking our raw materials (which nobody values very highly) and turning them into products we all want and do value highly.

    Only when Australia starts to add value to raw materials and builds brands for which people are willing to pay a premium, can we be a price setter.  The best businesses are those that can charge a higher price for a product than the competition, even though the competition may produce essentially the same thing.  Think Tiffany diamonds.  Diamonds are the same all around the world, but Tiffany’s can charge more and people are willing to pay up.  They have a brand, they have a story, they have a reputation, there is desire.

    This is a real and enduring ‘strength’.

    Andrew Robb MP told me last week at a breakfast function that if, for example, as a country, we are good at ‘sport’, we should play to our strengths and focus on getting better at sport.  But without the incentives in place to encourage those who aren’t great at sport we will end up with an economy populated with a few jocks and little else.  Those that are good at science, IT, or have other skills are not given the incentives to even try if the focus is only on ‘sport’.  In Singapore for example there are attractive incentives to get people started in new endeavours.

    This paragraph from Singapore’s Tax Portal tells the story of how they are encouraging new businesses to set up, to innovate and to create jobs.

    “The tax exemption scheme for new start-up companies was introduced in Year of Assessment (YA) 2005 to support entrepreneurship and to help our local enterprises grow.

    Under this scheme, a newly incorporated company that satisfies the qualifying conditions can claim for full tax exemption on the first $100,000 of normal chargeable income* (excluding Singapore franked dividends) for each of its first three consecutive YAs.

    Starting from YA 2008, a further 50% exemption is given on the next $200,000 of the normal chargeable income* (excluding Singapore franked dividends) for each of the first three consecutive YAs.”

    So a new business gets a tax holiday on the first $100,000 of profit for the first three years and the next $200,000 is taxed concessionally. That’s up to $900,000 of seriously low tax rates over three years and you pay zero tax on the first.

    I enjoyed breaky with Mr Robb but I do think it is inadequate for a hopeful opposition to simply believe that encouraging resource investment and agriculture (our ‘strengths’) will do anything to change the long term narrative of our country.

    Why?  Because digging up stuff out of the ground is not highly valued by the rest of the world and so they won’t pay much for it.  Our ‘structural’ deficit will remain.

    If instead, we think about tax reform that produces incentives for value adding industries to start up and prosper, the value of our exports will rise and the structural deficit might just be a thing of the past.

    I fear that the opposition currently have resigned our country to perpetual balance of payments deficits, which therefore make us dependent on foreign investment.  We are told that we as a nation are dependent on foreign investment because the capital account must offset the deficit in the current account.  The deficit on the current account can be fixed but we need courageous leaders willing to make long term changes rather than those focused on political marketing and self preservation.

    If we don’t have to be dependent on foreign investment then we don’t have to sell off our farms and our mines and our infrastructure either.  Our government could also balance its own budget because it could preserve the cash flows from these assets.  But we need to start by getting real tax reform that incentives our smartest kids to stay in the country and develop value added products and services so the value of our exports is more than what someone will give us for our dirt.

    The discussions about efficiency and productivity will then be in the right context rather than some abstract concepts cobbled together to make people think we have solutions.

    by Roger Montgomery Posted in Insightful Insights.

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  • Montgomery Funds’ Performance to 15 November 2012

    Roger Montgomery
    November 21, 2012

    Recently you may have received a copy of the first bi-monthly Investment report for The Montgomery Fund along with a copy of Tim Kelley’s White Paper “What’s Under the Bonnet?”.  We are of course enormously proud of the very early results The Montgomery Fund has achieved and we won’t be resting here.  For those who missed out however and are interested in the latest performance numbers, please find them below.

    To invest $25,000 or more in The Montgomery Fund, you will need to click here and request a copy of the Product Disclosure Statement, which includes the Application Form.  Don’t invest in any security that is not appropriate for you of course and to determine that you must seek and take personal professional advice.

    continue…

    by Roger Montgomery Posted in Insightful Insights, Investing Education.

  • The Real cost of capital

    Roger Montgomery
    November 21, 2012

    Kyle Bass is a recently minted billionaire investor. But he didn’t gain prominence for the billions he made presciently trading credit default swaps and collateralised debt obligations in the US sub prime markets, nor for the billions more he made by levering his subprime profits and trading credit default swaps on Greece. He because famous for being the hedge fund manager Michael Lewis left out of his book because Lewis thought Bass was a bit of a nutter.

    The results, however, speak for themselves and now Kyle Bass is a fixture on the business circuit, on CNN and Bloomberg and feted as a speaker at conferences globally.

    continue…

    by Roger Montgomery Posted in Insightful Insights.

  • What is the U.S. Fiscal Cliff?

    David Buckland
    November 19, 2012

    The terms of the Budget Control Act of 2011 are scheduled to become effective at midnight on 31 December 2012. This will result in a 2% tax increase for workers, the end of certain tax breaks for businesses, the beginning of taxes related to health care law and deep automatic spending cuts. This would reduce the budget deficit by an estimated $560 billion or 3.7% of the $15 trillion US economy, however the Congressional Budget Office (CBO) estimates Budget Control Act would cut GDP by 4% and increase unemployment by at least 1% in 2013. The fiscal cliff is concerning investors and there is a strong possibility Congress won’t act until the eleventh hour.

    The indecision is likely having an effect on the US economy as households and businesses “sit on their hands”. Walmart, for example, reported like for like US sales growth of only 1.5% for the three months to 31 October 2012. Their forecast for the three months to 31 January 2013 is for same store sales growth of between 1 percent and 3 percent.

    by David Buckland Posted in Insightful Insights.

  • Is Telstra in love with Ten?

    Roger Montgomery
    November 16, 2012

    With the Ten share price up 5% today we reckon some participants must be trading on rumours. In this case, rumours are swirling around the market that Telstra is about to buy Ten. We don’t of course trade in rumours and we won’t be starting now. We are keen however to watch Telstra’s content strategy roll out – in anticipation of the NBN being completed. As we have previously mentioned, by 2017 Telstra will likely dominate the digital delivery of content. The delivery platform will have been levelled and so the competitive focus for Telstra needs to be content. They’ll knock on your door with a big black box and bundled deal offering IPTV, Foxtel, FoxSports and (Ten?) all on the one platform for one great price….

    So could Ten be part of that strategy? As is always the case with rumours, time will tell.

    by Roger Montgomery Posted in Companies, Insightful Insights, Market Valuation.

  • Hybrid Securities – Equity Downside for Fixed Interest Returns

    Tim Kelley
    November 16, 2012

    We often hold a material amount of cash in our funds management operation and, with deposit rates at painfully low levels, we have been considering ways we might work the cash a bit harder. Like many investors, we have focused attention on hybrid securities as one possibility.

    Having studied this possibility for a short time we are now focusing elsewhere. Analysis of the terms of some of the recent offerings reveals highly complex instruments with concealed downside risks and an interest rate that falls well short of compensating investors for the hidden downside. A cynical observer might think that some of these products are designed to exploit retail investors who are unable to fully assess the downside risks they are taking on.

    by Tim Kelley Posted in Insightful Insights, Investing Education.