Digging for bargains
Value investors around Australia are united in their view that there are few bargains remaining in the Australian stock market. This is evidenced by the M&A activity seen in the market for inferior-quality companies who have lost market share and suffered declining profits and/or margins.
Few bargains, however, doesn’t mean no bargains.
Below is our list of six quality companies held in both Montgomery funds that we believe still represent some value.
According to our valuation methodology, the three cheapest companies are: Ainsworth Gaming Technology (ASX: AGI), Veda Group (ASX: VED) and Amcom Telecommunications (ASX:AMM). The remaining companies, listed from largest margin-of-safety to smallest, are: CSL Limited (ASX: CSL), Woolworths (ASX: WOW) and SEEK (ASX: SEK). SEEK is The Montgomery [Private] Fund’s largest holding; a position it purchased at an average price of $7.58 (today’s price is $16.68), and values at $17.02 – based on internally-derived estimates of earnings.
Ainsworth is the eponymously named company founded in 1995 by Len Ainsworth. More than 50 years of experience in the gaming entertainment industry (having previously founded Aristocrat Leisure) Mr Ainsworth notes: “With a fully integrated operation including design, development, assembly testing, sales and field service, Ainsworth encompasses the entire product development cycle, from conception through to installation, service and support.”
With 197,892 poker machines in pubs and clubs across the country, or one machine for every 111 people, Australia has the fifth-highest total number of gaming machines in the world, and is ranked number 8 of international gambling hot spots.
Montgomery’s philanthropic policy has delivered hundreds of thousands of dollars to important charitable causes, and while we continue to wrestle internally with the moral arguments surrounding gaming as entertainment, and the distribution of profits from that investment, I am reminded of the highly addictive but ultimately un-harmful after-school obsession I had as a teen – pouring 20 cent pieces into games like Space Invaders, Pacman and Galaga. For many participants (I am told) the entertainment value and danger is the same.
For those willing to surmount the ethical issues, there are two paths to investing in this sector. One is to own listed gaming operators like Crown Entertainment (CWN), Sky City Entertainment Group (SKC), Tatts Group Limited (TTS), Reef Casino Trust (RCT) and Tabcorp Holdings (TAH). For one reason or another we have avoided these. Another is to own those who supply these operators with their machines.
Over the years, operators cannot escape the fact that the machines they buy simply wear out or become unfashionable. With about 200,000 machines constantly ageing, pub, club and casino owners need to annually replace about 40,000 machines with the latest and greatest. Because of this, Ainsworth’s share of this replacement market – its ‘ship-share’ – has risen from zero to 25 per cent. Further, a management team with decades of experience and a balance sheet with little or no debt back the company.
Those also looking for exposure to foreign earnings, or to benefit from a declining Australian dollar, might also be attracted to the fact that the company is expanding in the US and South America, and slowly growing the proportion of earnings generated offshore.
In North America, IGT is the dominant incumbent with the lion’s ship-share of about 50 per cent, followed by Bally at 15 per cent, WMS also at 15 per cent and others at 5-10 per cent, including Konami. However, surveys show that IGT is losing ground on the product development and acceptance side, while at the same time, Scientific Games and Bally have both changed CEOs quite recently.
With 850,000 machines in the US, where the replacement cycle is 60,000 a year, North America is an important addressable market for AGI. This is where the opportunity gets very exciting, as the replacement cycle picks up following years of under-investment after the GFC.
AGI’s profits are growing at high double-digit rates, and an update to full year result expectations should be released in a matter of days. Whether this proves to be an upgrade or a downgrade to consensus analyst expectations for this year is less relevant to us than the larger and longer-term opportunity presented by increasing penetration into the US and South American markets.
AGI’s share price has fallen from over $4.70 late last year to $3.90 today, and while we don’t pay much heed to PE ratios, a multiple of 15 times for a company growing earnings at greater than 20 per cent per annum thus far and paying up to 60 per cent of earnings as a dividend with no debt, represents a solid opportunity to provide long-term shareholders with a strong return.
You can download a Product Disclosure Statement (PDS) for The Montgomery Fund, which includes an Application Form, here.
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.
Min Jian (David) Tan
:
Hi Roger.. keen to hear your thoughts on AGI now that they’ve announced their profit forecast.
Roger Montgomery
:
We are meeting with the company over lunch next week and will obtain some insights into the longer term prospects helping to avoid being distracted by the short term.
Min Jian (David) Tan
:
Great, looking forward to reading your insights. Many thanks for the prompt response.
Bob
:
Just wondering if you guys are still holding AGI?
Philip Labore
:
An interesting post, thank you for sharing your thoughts of value in the local market right now.
Unfortunately, Ainsworth Gaming Technology is not investment grade for me as a retail investor. A history of selective institution placements (dilution) and limited track record of profitability are risks that cannot be overcome for me. There are fatter pitches I think.
Roger Montgomery
:
That’s what makes a market Phillip. Always delighted to hear where you, and everyone else visiting the blog here, think they are…and share our insights for each suggestion…
Michael Horn
:
In my post on BYL, the value of the RIO contract is about $67 million, obviously not $67. Also, it seems that Mrs Brierty may have done with her selling, because the SP had a healthy rise (about 3 cents) today, 14/07/2014. This means that on paper, my pigeon pair bet, BYL and NWH, has broken even, loosely speaking, and ignoring dividends received. I hold 460,000 BYL in my SMSF, and 200,000 personally – many bought in recent weeks. I tend to hold shares that I buy for years, so I’ll not be in a hurry to sell, BYL.
Roger Montgomery
:
3 cents = a healthy rise? Good luck in your attempts, many have failed before you. Remember the market is merely a transfer mechanism, transferring wealth from those who have no patience to those that do.
Michael Horn
:
Roger
Two or more years ago you wisely advised folk to avoid mining services companies. When the retreat of these stocks was patent, I wondered if bargains could be found in babies tossed out with the bathwater. It seems that BYL may transpire to be a good find. Let us see how it plays out.
I often invest in pairs, so In mid-2013 I invested in NWH and BYL as punts (that is, I took a risk knowing that I might be wrong). I am behind on NWH, ahead on BYL, and a behind in total. I’ll probably exit NWH and stick with BYL, and hope soon to be ahead for reasons explained below.
The longer I held BYL, and the more I delved into it, the more I liked it, so I regularly increased that holding. In fact I would be 33.3% ahead if I remained with my first buy of 50,000 BYL at 30¢. in August 2013. I think that the SP will jump a few cents above 40¢ when BYL’s Annual Report announcement is published circa 20/08/2014, and when Mrs Brierty stops selling at about 40¢. Consequently, I bought 155,000 BYL shares this week at 40¢, and now I am fully invested in BYL. I expect the Annual Report will report revenue at roughly $300M, NPAT of $9M, EPS of 8¢ and DPS of 3¢.
The outlook statement should state that FY2015 should be better than FY2014 (due to strong order book and recently demonstrated ability to secure contracts). With $250M of currently contracted work earmarked for FY2015, and BYL’s track record of picking up about 20 contracts a year (check its website), I would be astounded if it did not have a revenue of $350M in FY2015, and that figure is low, because I have thought that if I were calling the shots, I would attempt to lift margin and secure less low-margin work, and so avoid the dangers of too much growth. Sticking to a NPAT margin of 3%, FY2015 should pan out something like revenue of $350M, NPAT of $11M, EPS 9.5¢ and DPS 4¢,. but it could easily be better. There is no goodwill, so an impairment is unlikely in my opinion to impact NPAT and EPS. I am unaware of any toxic contracts that will come back and bite BYL, although the margin on the $66.7-a-year RIO contract may be slim (I don’t know), but this is anyhow accommodated by the low rule of thumb that I used, 3% of revenue, to guesstimate NPAT.
BYL is an income play for me, so its short-term SP is less important to me than its ability to sustain and grow the DPS. BYL has an Order Book of $570 million – more than ten times its equity, and about twice its annual turnover. This is I think one healthy baby tossed out with the bathwater, and when Mrs Brierty stops selling shares, the SP should adjust to the underlying metrics and future performance of BYL. I value BYL at 50¢, but that may be too low if my FY2015 prognosis is correct, or too conservative.
Punting on stocks is a valid approach to investing, provided one thinks the upside is more likely than the downside, and as long as one accepts that a punt can go either way, and one is not too upset if a punt turns out negative. The trick is to know the stocks well, and use that information to get more punts right than wrong. Peter Lynch suggested that getting six out of ten punts right sufficed to be successful, because the money made on wins, tends to be larger than the the losses. I think it was Peter Lynch who said that he knew a man who studied harness racing, which attracted less mental focus from experts than conventional horse racing did, and he was successful. Micro caps fall into a similar game – they fly under the radar, so time spent understanding them gives one an edge, because the good stock analysts cannot justify analysing them.
Roger Montgomery
:
The “trick” you speak of – getting more punts right than wrong – is the issue. Most don’t.
bruce richards
:
Noticed on Switzer TV recently you were mixing up the Leisure companies Aristocrat and Ainsworth. What are your views on Aristocrat (ALL) not (AGI) after its recent takeover announcement ?
Roger Montgomery
:
Hmmmmm, your the second person who said that. Ainsworth (AGI) should be the only company I was referring to. Must have been nerves associated with being on TV! With respect to ALL, and being very diplomatic, we don’t believe its prospects or its economics/financials are as bright as Ainsworth’s, which is why we own the latter.
Here’s a quick and high level snippet, from our internal research, about AGI:
“The quality stems in part from the company’s growth potential in North and South America and the founder, Len Ainsworth’s ownership of a meaningful $620 million, 49 per cent of the total shares outstanding. AGI’s revenue base is also geographically diverse with operations spanning Australia/NZ, the Americas, Asia and Europe, minimising country risk.
There are many reasons to like the economics displayed by AGI but its attractiveness isn’t limited to its financials. AGI has built a defensible position in the concentrated Australian market supported by regulatory barriers to entry, strong customer captivity and sustained R&D investment. AGI is seeking to replicate its success in selected International markets, in particular North and South America, which represent attractive growth opportunities. Indeed, in 1H14, South America accounted for one-third of AGI’s total earnings growth.
Historical financials are equally impressive and demonstrate a track record of earnings power: revenue growth north of 20%, sustained EBIT margins above 30%, strong cash flow, returns on capital above 30% and returns on incremental capital above 40 per cent. Moreover the balance sheet is in a net cash position.
The Australian market is concentrated with the top four players accounting for around ~90% market share. This concentration weakens the competitive intensity of the domestic market.
At first glance, AGI’s valuation appears expensive but by viewing the company’s R&D as a capital investment, rather than as an expense, the valuation changes materially.”
Steve Banks
:
Hi Roger,
Just some thoughts on ownership of gaming stocks. Some may be surprised to find that Woolworths are owners of poker machines through its associaton with ALH. I would assume most superannuation funds own WOW and as such most Australians own shares in gaming machines. Should you not own a quality company like WOW because of this, absolutely not!
If people have a moral issue with this can I suggest they buy some Ainsworth shares and distribute their future gains to a charity of their choice.
Finally I have read Valuable many times and have brought copies for friends.
Can I suggest to your followers that this is the best $50 you will ever spend.
I particularly enjoy the video insights and follow you on Sky Business every second Thursday. Please keep the great articles coming.
Thank you to you and your team for your efforts to date and the great work you have done with Skaffold.
Roger Montgomery
:
Wow Steve, really appreciate the encouraging words.
rastij
:
Personally I like to think that the time & money spent on Space Invaders/Pacman/Galaga was an investment in gaining knowledge about the future (internet).
Not sure it transpired that way, but I sure got good at the games. And the pinball machines at Uni.
And I can now put that knowledge to good use in solving the investing puzzle. Hopefully!
ryan fowles
:
Roger speaking of good deals, what’s your view on Russian Oil Companies such as Gazprom or Lukoil, Aside from governance, issues like Ukraine seem to be having a negative (positive if you’re buying) effect on value however to me the proximity of fields to both Europe and Asia and development of infrastructure point towards a bright future. Hypothetically speaking what margin of safety would you require to buy?
Roger Montgomery
:
Hard to put a precise number but lets just say a big one!