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Have you been getting your daily dose?

Companies, Insightful Insights, Investing Education, Value.able | Comments (155)

Have you been getting your daily dose?

If only it worked that well all the time!

Last Thursday evening (4 November) on Peter’s Switzer TV I listed, amongst other companies, Credit Corp and Forge Group as two I would have in the hypothetical Self Managed Super Fund Peter challenged me to set up that day.

Why did I nominate CCP and FGE? Both receive my A1 or A2 MQR and both have been trading at a discount to their intrinsic value.

If you are a regular reader of my blog you would have read my insights for some months on these companies. And if you saw today’s announcements, you can imagine why I am a little happier than usual.

Credit Corp’s previous 2011 NPAT guidance was $16-$18 million. Today the company announced FY11 would likely produce an NPAT result of $18-$20 million.

Forge Group’s announcement states “The Board wishes to advise that the company forecasts net profit before tax for the half year ending 31st December 2010 to be in the range of $25-$27 million. This represents an improvement on the previous corresponding period (pcp $19.04m) of up to 42%.”

As I fly to Perth for a presentation and company visit, I am encouraged that several of the companies Value.able graduates mentioned in our lists are also hitting new 52-week highs. In a rising market that lifts all boats, it is perhaps unsurprising, but nevertheless it should be an encouragement to Value.able graduates and value investors that companies like FLT, DCG, MIN, FWD, FGE, CCP, NCK, DTL, MCE, MTU and TGA have all hit year highs – some of them yesterday. More importantly those prices are perhaps justified by their intrinsic values.

Of course I am not here to predict where those prices will go next, because I simply don’t know. Short-term prices are largely a function of popularity and the market could begin a QE2-inspired correction, an Indian infrastructure-inspired bubble or a China liquidity-inspired bubble tomorrow. I have no way of telling and instead, I focus on intrinsic values and only pay cursory attention to share prices.

So, as I always say, seek and take personal professional advice before taking any action and remember that 1) I don’t know where the share price is going 2) I am under no obligation to keep you up-to-date with my thoughts about these or any company, my Montgomery Quality Ratings or my valuations and I might change my views, values and MQRs at any time so don’t rely on them and 3) I may buy or sell shares in any company mentioned here at any time without informing you.

And so I remind you one more time. Please seek and take personal professional advice and always conduct your own research.

Posted by Roger Montgomery, 9 November 2011.

INVEST WITH MONTGOMERY

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.

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155 Comments

  1. Ben
    :

    I’ve noticed most posts are specific to certain company valuations rather than valuation theory, so apologies if this is out of place or a bit maths-y. Anyway…

    I am curious to hear from the community their thoughts on the way intrinsic value changes over time. What I mean is, if investors have an expected return of 10%, then shouldn’t the investor value their shares such that they see their valuation rise by 10% each year, provided the firm’s prospects continue as expected (ie. consistent ROE)? However, when we value shares we see that those with high ROE and low payouts have intrinsic values that increase more rapidly each year, despite those very valuations being determined using the investor’s required return.

    So we determine valuations using the expectation of an annualised rate equivalent to our required return, and buy below these valuations to achieve a greater return. Yet, running the formula the next year sees our valuation increase (for high ROE companies) at a rate greater than our required return. I’m pretty sure it’s due to the fact that most valuations use ROE to determine a multiple of book value the investor should be willing to pay (hence Roger’s brilliant tables), but the book value of great companies increase at a rate beyond the investor’s typical 10% requirement, hence intrinsic valuations rise rapidly due to rapidly rising book value. Should the investor, in theory, then be willing to pay a premium ABOVE intrinsic value for such great companies, as the underlying value is still increasing beyond the required rate? Any thoughts?

    Note: I understand that buying great businesses well below intrinsic value is the key to producing above average returns, and one should always err on the side of caution, but I am just curious from a purely mathematical/theoretical point of view. I figure there’s no better community in which I can think these ideas out-loud than this! cheers.

    • Roger Montgomery
      :

      Hi Ben,

      I recently wrote a post about things getting a little technical so let’s not lapse again. Very quickly then, the model is proposing one solution to the fact that in theory if ROE > RR and the company retains all profit, the valuation is infinite. Imagine for a minute someone offered you an ATM machine that allowed you to take out any amount of cash (an infinite amount even) at any time. What would you pay for it? In theory, the ATM is worth an infinite amount. Clearly nobody is going to pay that so some valuation needs to be found. One solution is mine and because there’s no ‘to the power of infinity’ pure mathematicians should dismiss it. I don’t worry too much about that because I know that companies don’t produce infinite profits. Even if their ROE > RR, they are not worth an infinite amount. If a soldier from Ancient Rome invested 1 dracma 2000 years ago at 4%, he could not claim his return today because there’s simply not enough cash in the world to go around. If a thousand trillion dollars is $1,000,000,000,000,000 our roman soldier’s heirs would have $11,659,464,315,023,100,000,000,000,000,000,000. So a ‘profitable’ and conservative solution (for example a utility function) needs to be applied.

      • Ben
        :

        Thanks Roger,
        In light of the ancient Roman soldier, I think short of finding the key to immortality and waiting for compounding to do it’s thing, I’ll stick with our margin of safety approach!

  2. Jasmine
    :

    Hi Roger,

    I have noticed that the market had dipped if you will back in June/July this year 2010 and I was considering buying shares now, Dec 2010. However the prices have increased substantially since June/July. Would a person wait for the market to go down if you will or just buy in any event as not to miss out. Or would it be wiser to find a share that is value for money instead?

    Sorry, I’m very new to this.

    Many thanks
    Jasmine

    • Roger Montgomery
      :

      Hi Jasmine,

      I would normally say seek and take personal professional advice. But before you even do that I would like to suggest doing a lot more research and study first. You work at the right place to get some seriously good education about financial markets so see if you can take some reading home over the holidays and after reading that have a read of Value.able too.

  3. Thomas Lyddiard
    :

    Hi Roger,

    I have been looking into Silver Chef (SIV), which looks very pronmising. From what I understand, it has a barriers to entry, has a good ROE and has had a steady ROE for the past few years since it was listed in 2005. It has a good positive share trend and has also just raised its earnings forecast for the financial year.

    The only concern I could find was that it had a very high debt -to -equity ratio, which i understand can be a two edged sword. But it has a good cash flow history that has just kept on increasing exponentially.

    Can you have a look and give your opinion, as i tried to find some
    information in your blog history and couldn’t find anything?

    Kind Regards
    Tom

  4. Jeff
    :

    Thanks Roger, They were interesting comments about Maca. I feel they are similer to Sedgeman (SDM) however sedgeman have a very pleasing order book in place for the next few years. In regards to Linc Energy I am a big fan of the stock and the CEO Peter Bond. They have an enormous asset base and have interests in coal, gas, oil and clean coal technology. While they are yet to commence production, due to the sale of an asset earlier this year they now have $450 million in the bank with continuing royalities, no debt and have advised that no further dilution will be needed in the stock. They are also due to sell another asset Q1 2011. So in my opinion if the UCG industry gets the all clear and moves past the current political and enviromental drama it is experiencing in QLD then there is a big upside.

    I look forward to shortly learning how to calculate IV’S myself and will post a few after I have for comments.

    Kind Regards
    Jeff

  5. Jeff
    :

    Hi All
    I am new to the blog and invest for myself after only after extensive research. I am a holder of Linc Energy and Maca Limited (unfortunately I didn’t buy during the IPO) to name a few and was wondering if you felt they were trading at a discount to IV currently.

    Kind Regards

    Jeff

    • Roger Montgomery
      :

      Hi Jeff,

      Welcome to the blog. I cannot give you advice here so you must always seek and take personal professional advice. You will find a range of valuation estimates for these companies on the blog. You may like to try simply searching through the comments of the posts that were made a week or two before the MACA listing for some of the contributors’ estimates. I would be interested in hearing your thoughts on Linc – a coal explorer and technology pioneer (a combination of a commodity business and fast changing technology company) that hasn’t made any consistent money. In the last three years an additional 120 million shares have been issued and $250 million raised. Ten years ago retained losses were $10 million, today they are $54 million. Jeff, it gets a B3 from me but of course the shares price could hale or double from here, I have absolutely no ability to predict share price direction.

  6. Hannah
    :

    Hi guys,

    I’m new to investing and was wondering what some of you got for the intrinsic value of EQN?

    Thanks!

  7. Jules
    :

    I’m new to investing and having purchased the book, I don’t understand what to make of DCG.

    Doing the sums gives me an Intrinsic Value less than the current share price, I’m basing this on the 2010 financial report released on August 26, the full report in October has the same figures.

    Another thing that is curious is there are discrepancies in the 2010 and 2009 reports.
    eg. 2010 report has 2009 revenue at $254924k and 2009 report has 2009 revenue at $272880k?
    It seems a bit dodgy to me but there must be something I am missing.

    Please help!!
    Jules

    ps. I’ve gone through several of the “Ten Valueable Valuations” and got the correct results.

  8. Ken G
    :

    Hi Roger
    Would like to ask you and others if an ipo listed on the RBS Morgans web sight called Corporate Travel Management has much merit and if you use them on your travels.
    There are 2 other ipo’s as well
    One is called Nextdc its being estabilished by ex pipenetworks PWK Bevan Slattery, to build and operate carrier and systems integrator neutral data centres in Australia and New Zealand.PWK was taken over last year.it was very successful.
    The last is RedFlow RedFlow is a technology based, unlisted public company located in Brisbane. Their zinc bromine batteries are used in energy storage systems for in-grid applications This does not hold any appeal to me.
    Others may wish to give some feed back
    Do Know some ipo’s are rubbish but did subscribe to SWL @1.10
    AIR@.50 & SMR @.20 which i sold at .88 bugger.

  9. george
    :

    Hi Roger and bloggers,
    Does anybody have a view on Austin Engineering (ANG). I have held it for a number of years and it has been a great investment.
    Over the last week it has really been sold down, I have no idea why.
    It appears to be a good engineering company that has positioned itsself well here and in South America to take advantage of the mining boom. It is a company I want to continue to hold but am a bit spooked by the sell off. It has an ROE mid thirties a low payout ratio and it trading below its IV for 2011.

    Thanks

    George

    • Roger Montgomery
      :

      Hi George,

      Without talking about AUN specifically, a sharp sell off can sometimes precede an adverse development or announcement but generally it is important NOT to take your queues from price changes.

    • Ken Milhinch
      :

      George,

      Moving into a country like Colombia would be enough to spook me into selling. The announcement to this effect on 3/11/10 could have been the trigger.

      Regards, Ken

      • george
        :

        Hi Ken,
        Thanks for the reply. You may be right the decision to go into Colombia could be the reason. ANG are already sucessfully operation in other parts of South America so the don’t have a large part of the business exposed to Colombia. I trust they have done their homework properly. The share price initially went up on the news. Maybe some investors have become spooked. I will continue to hold until I see a decline in the performance of the business.

        Regards

        George

  10. Mark H
    :

    Afternoon Ken,

    My inputs for SWL are below and are for 2010.

    Looks like the main differences in our figures are due to NPAT and ROE. My ROE’s lower as I always err on the cautious side. I think you’re right to add the ASX listing cost to NPAT (I missed that, thanks). If I add that in (with ROE=45%) my estimate becomes $2.34.

    Did you calculate 2010 IV’s for Finbar and CCV?

    NPAT $11.8
    ROE 40%
    Shares 77.0
    TY Eq $28.4
    LY Eq $21.1
    EQPS $0.32
    POR 50%

    Cheers, Mark H

    • Ken Milhinch
      :

      Mark,

      I think you are still understating the NPAT for SWL

      CCV 2010 $0.45 2011 $0.63
      FRI 2010 $1.17 2011 $1.31
      I use 14% RR for real estate coys and generally regard them as an unacceptably risky investment.

      Regards, Ken

  11. Mark H
    :

    Hi Jeremy, Phil, Shaun and Room.

    I did some rough IV’s on your queries.

    For Finbar – I got $1.70. I used a 12% RR, yours may be lower given your IV. Even at my lower value it’s trading > 20% margin of safety.

    Finbar Group Limited (FRI) is a property investment and development company with a core focus on land acquisition, design, construction and sale of medium to high-density residential apartments. The company operates through direct ownership, ownership through fully owned subsidiaries or by jointly controlled entities.

    For Seymour White – I got $1.94, using 12% RR. Company has positive cashflow and good ROE, tho operating cash in ’10 is about half that of 2009 (due to higher supplier payments and higher tax). Current price is just under 20% Margin of safety based on my IV. The latest annual report lists some of the competative advantages (that you may or may not agree with).

    Seymour Whyte Limited (SWL) is an infrastructure development company with projects in NSW and Queensland . The companys activities focus on: construction of major roadworks; bridgework construction and associated concrete structures; major traffic management schemes; heavy industrial concrete works; and aquatic facilities and community infrastructure.

    For CCV – I got $0.67, using 12% RR. ROE’s a bit low for me at 19% given there’s higher out there. The company had negative company cashflow for last 2 years and a positive net end of year cash in ’10 mainly through the issuing of shares (that raised $68.8m).

    Cash Converters International (CCV) is a second-hand goods dealer and financial services provider. The core business of Cash Converters is that of the franchising of retail stores, which operate as retailers of second hand goods.

    Hope this helps.

    Regards,
    Mark H

    • Ken Milhinch
      :

      Mark,

      I am puzzled how you can get an IV of $1.94 for SWL using 12%. Is this for 2010 or 2011 ?
      Perhaps you could share your inputs ?
      I have $2.87 for 2010 and $2.99 for 2011.

      I used the following for 2010;
      NPAT $12.91 (I add back in the ASX listing costs as they are an abnormal)
      ROE 45.4%
      Shares 77.817
      Equity $28.436
      LY Equity $21.11
      EQPS $0.37
      Dividends $5.393

      For 2011 I allow for 10% increase in NPAT and 1 cent in dividends.

      Regards, Ken

      • Steve
        :

        Thank you everyone for sharing your information regarding SWL. It looks interesting to me. While the exposure to Government contracts carries risks – anecdotally it seems that Governments are often willing to pay a lot more for something than it is really worth. That has been my basic observation working in the public sector. They just don’t seem to push for a ‘good price’ nearly as much as private companies do. While this might not be great for taxpayers (a potential waste of their money?) I’m wondering if this translates into higher margins for this company? This is all just my speculation really.

        Roger can you shed any more personal thoughts on this company? What is your current valuation and forecast rise over next few years? Thanks

      • Roger Montgomery
        :

        Hi Steve,

        A3 and $2.10 rising to $2.70. The issue is not the quality (A3 and ROE to stay around 35% for the next couple of years – economic collapse notwithstanding) or the value. What is the important thing is to identify a competitive advantage that will stand the company in good stead because barriers to imitation seem low. Perhaps someone visiting the blog with civil engineering experience can offer some suggestions that I have been unable to pick up. It does of course look cheap and good quality. Seek and take personal professional advice.

      • Ken G
        :

        From the very little I know about Goverment Contracts. There is a barrier of entry, You need to be on their list of eligable contractors which has a minimum company size plus other restrictions.This is not a big barrier but helps.

  13. george
    :

    Hi Roger,
    I attended your talk last week in Perth and must say it was very informative.
    A company I have looked at that might be of interest to you and your bloggers is SWL (Seymour White). They are involved in the construction of infrastructure in Queensland. Using the techniques outlined in your book this companies shares look cheap. I doubt there is much of a competative advantage with this company but it looks to be priced well below its IV. It is also in final negociations with the Queensland government for a large infrastructure project.
    The ROE is around 40%. The company has only recently gone public so there is not a lot of historical financial data available.
    I would be interested to read some opinions on the company.

    Regards

    George

  14. william gill
    :

    Hi Roger / Richie
    Regarding ERA I worked on the construction of the Jabiru mine in the late 1970s,
    My view is, great country,excellent barra fishing, nice bush lifestyle.
    But if a stock is trading at a good discount to their IV is only one part of the story.
    Richie keep in mind that the mine life was extended a few years ago until 2012, the mill will continue crushing about 8 years longer.
    Some of the many barriers to entry are,environmental issues,traditional land owners, negotianions with Northern Territory Land council High maintainance expenses.
    A NPAT in 2010 half of the previous years.
    I like Ashley will spend the remainder of my life in good old QLD Only the fishing will get me back for brief periods.

  15. Shaun
    :

    Hi Roger,

    I watched you on Switzer a little while ago when Peter asked you to name some companies that you would put into a SMSF. One company you mentioned was Cash Converters (CCV) and I also notice you have this stock listed as an A2 business.

    I sold my old mortgage lending business in 2008 so when I saw that cash converters was getting heaviliy into micro lending and expanding rapidly through the UK and online I took some interest in the company. I also notice that the revenue from their franchisee owned stores has been quite flat with very little growth each year, but revenue and earnings from their company owned stores in rising nicely each year, thanks to their acquisition spree -CCV have been paying existing franchisee owners approx a multiple of 4.7 times earnings, for their stores, making them earnings accretive from year one. They are continuing to buy existing stores and expand their lending book each year which should produce a nice increase to earnings each year going forward.

    The only figure that has not increased is EPS due to the issue of new shares – this cash gave them the money for the expansion, but EPS will increase once a full financial year is taken into account.

    Lastly, Ezcorp, the nasdaq listed company that bought the additional shares inn CCV for the capital raising, now holds 32% of CCV. Ezcorp is a large pawn broker and micro lender in the USA – they now have two board seats with CCV – I find this interesting and a major positive.

    The one negative about the stock is that it is not very liquid, and not many brokers cover it.

    Roger, could you please tell me your intrinsic value of CCV for now and future years, I would be very interested to see your valuations?

    Thanks again Shaun

    • Roger Montgomery
      :

      Hi Shaun,

      The safety margin is about 18%. ROE has decline materially since 2003. In 2007 100 million shares were issued resulting in ROE falling to mid 20%s. Then in 2010 another 140 million shares were issued and ROE fell to circa 17%. Based on the forecasts I have ROE will slowly rise from circa 17% over the next three years. If that happens then IV could rise by about 16%. My only issue is deciding whether I ever think it can become a big business and whether it has sustainable competitive advantages.

      • Shaun
        :

        Thanks for your comments Roger, they are very valued. I dont think it will become a very big business as I think most of their strategy going forward will be to keep increasing the loan book in Australia and in the UK and buying existing stores, but I think their growing network of stores is a good advantage and hard for a new comer to catch up. City pacific is in the same game as I have looked at their model when I was lending, but there is room for both and I am guessing they are much smaller? I have been buying these shares over the last week and will continue buying for a while, I think they are a great investment. I also can not think of any other reason why Ezcorp would be increasing its holding and sitting on the board other than to make a bid for the company at some stage. Thanks again for your insight.

  16. Ian
    :

    Roger,

    I have read you book and can produce valuations which closely match yours. I love the fact that it provides me with a discplined process to value stocks, but I believe that the process is only as good as the assumptions and understanding that go into the valuation method.

    I am now re-reading the book and am currently focusing on goodwill and specifically whether or not a company has paid too much for an aquisition or whether a writedown is required.

    Using Worley Parsons as an example, I see their intangibles have grown rapidly since 2005 ($341M to $1 781M, and goodwill currently makes up 90% of total intagible assets and 43% of total assets. Rather than amortising the goodwill they use an impairment test and total impairment to date represents 0.1% of goodwill at cost.

    I would be interested in your comments as similar companys seem to be growing via acquisition (eg Ausenco), but organic growth seems to prefered by Lycapodium.

    • Roger Montgomery
      :

      Hi Ian,
      Quite simply, I prefer to avoid growth by acquisition. Impairments should transpire when ROE declines but, looking at Fairfax, you wonder what the auditors might be inhaling. Organic growth has advantages on a multitude of levels, not least of which is transparency.

    • Matty
      :

      Hi Ian,

      I am glad you brought up Worley Parsons. This is one where I can’t seem to get an IV close to the mark. I thought I was getting the idea of this business valuation idea. Can we compare numbers?

      TYE 1839
      LYE 1655
      Shares 245.4
      EqPS 7.49
      NPAT 291.1
      DIV 231.7
      ROE 16.7%
      ROES 17.5%
      RR 11%
      IV 13.02

      Even accounting for 2011 earnings of $1.39 and DPS 0.83 I come to about IV $16.63.

      Matt

      • Ken Milhinch
        :

        Matt,

        If I may offer this,

        Equity is 1830.1 not 1839 (You should ignore minority or non-controling interests)
        LY Equity is 1648.6
        Shares – Agree
        NPAT – Agree
        Divs 220.5 (Again, ignore non-controlling interests and get the number from the “Statement of Changes in Equity”)
        ROE – Agree
        RR% – I use 14% for a company like Worley Parsons, and therefore I get an IV of $9.76.

        Regards, Ken

  17. Chris
    :

    Hi Roger,

    Great results from great companies. Which makes me wonder, how often do A1 companies trade at discounts to their intrinsic values? We’ve obviously had a few in the past couple of years. Is this the norm, or is it not uncommon to go 12 months with none?

  18. jeremy
    :

    Roger,
    What are your thoughts regarding FRI (Finbar Group Ltd)? I have its IV at $2.29. Its linked to WA’s mining boom. Its trading at $1.29. Seems interesting. My other post is above this one but no-one seems to be elaborating on my IV calculations, sob sob.

    Thanks heaps mate
    Jeremy

  19. Phil
    :

    Hi Roger/ Bloggers,

    I used the ‘search’ function on the blog to see if a mention of Seymour Whyte (SWL) popped up anywhere but I got zilch. Have you looked at this infrastructure company? I’ve had a look at their last 4 ARs. ROE, NPAT, EQ look good. Net cash increases have been decreasing and I wonder if that is because of its PPE costs. Cash on hand though is fairly steady and revenues are increasing nicely. I’m not familiar with this sector of the market yet so I don’t know who their competitors are and whether they would have a sustainable advantage over them or not.

      • Lloyd Taylor
        :

        Phil,

        On SWL; a further to Roger’s comments:

        And it is trading well below IV.

        Competitive advantage is in its relationships and reputation with incumbent governments in the NE Australia …. not necessarily sustainable, but good to the next elections in NSW and QLD! That said it is much easier to deal with and much more competitive than the bloated LEI’s of this world, so it will always fly beneath the radar on small civil engineering contract tenders.

        Think carefully… not just on the competitive advantage issue, but also on liquidity of the stock.

        Regards
        Lloyd

        Disclosure: I own equity in SWL (small parcel consistent with daily liquidity).

      • Peter
        :

        Hi Phil,

        I bought into SWL a couple of months ago, and overall think they are a good story. Their biggest risk is probably their small customer base – primarily NSW and Qld governments. They are, however, working to expand this. Similar to MCE, they have been around as a company since the 1980s, and have a number of long-standing staff in their management group. The directors still have a large stake in the company. Given Australia’s love affair with the car and the continually increasing congestion on our roads, I feel that project opportunities will continue to arise and if they continue to execute successfully that augers well for their prospects. Much of the above is only my opinion, so take it for what it’s worth..

      • Joab Soh
        :

        Hi Phil,

        I am researching this at the moment too. Below are some of my thoughts:

        Seymour Whyte Limited (SWL) is an infrastructure development company with projects in NSW and Queensland . The company’s activities focus on: construction of major roadworks; bridgework construction; major traffic management schemes; etc. There’s a list of awards on their website.

        The company has a 23 year history that was IPO last year. Its principal customers are government authorities (e.g. Department of Transport, RTA, Councils, and Queensland Rail. It ‘claims’ it has competitive advantage by its ability to deliver complex projects, and has a good understanding of public authorities. To me, this has similar theme to DCG and FGE, differences is its customers are government bodies, not miners.

        In term of numbers, for FY10, I have ROE of 48% based on EPS 15.4 cts/share; Low debt $0.8m; debt/equity 4.6%. I am struggling to find any analyst consensus for future EPS. That said, they do have an order book that goes to FY12, but there are contracts that drop off this year but there are some announcement on recent projects in Oct 10. My IV is significantly higher than current prices.

        On the surface, it looks very attractive, but I have concern over my lack of information around its future, and its concentration risk to government projects.

        Opinions are much appreciated.

      • Ashley Little
        :

        Hi Joab,

        I too have been looking at SWL

        I have it at about IV but big rises in the future
        .
        Do you think they can maintain the current ROE and what about the payout ratio.

        Love your thoughts mate

        and thanks for your efforts

    • Ken Milhinch
      :

      Phil,

      Strong financial base and well credentialled in Qld & NSW government circles, which gives them a bit of an inside track for multi million dollar government contracts. I have them trading significantly below their IV, and I am happy to report that I own some and they are well into the green numbers with quite a bit more to go I think.

  20. Aidan
    :

    Hi Roger and others,

    Thankyou for your continued efforts through this blog and to the investment community in general. Your adopted and modified investment strategy fits me like a glove and I hope to continue down this path for hopefully quite sometime, being in my early 20’s.

    Onto business, I have derived an IV of $1.95 for MLD (Maca) for 2010 and $3.19 for 2011 based on their prospectus.

    I used a ROE of 40% and IRR of 11%. How do your figures compare?

    Maca looks like a decent business, but I’m always weary of any competitive advantage of construction related firms. I think a lot of the time their competitive moat girths are only as wide as their circle of friends. It can be hard to make new friends (e.g., to grow) when some of the bigger clients are already quite cosy with others and are happy with their project pricing. To me that seems to keep a mid-tier firm a mid-tier firm somewhat indefinitely, and hence is a ceiling to their growth appears and are likely to stagnant, be bought out (which could be a good or bad thing), or do something silly to try to grow more (which may or may not pay off). Either way, I’m happy to ride the boat while the going is good and I find I tend to stick to construction related stocks, as it is what I know.

    What are some others opinions?

    • Greg Mc
      :

      G’day Aidan,
      If only I had Value.able when I was in my early 20’s! Would have avoided a few mistakes (ok, many mistakes). I have a valuation of $2.10 for MLD with a ROE of 35% and RR 12%, POR 40%, EQPS of $0.40.

      I share some of your concerns about MACA and Roger wrote a good article about them in the Eureka Report. I think that they were sold too cheap ($1) and are still well below their IV, but this company is no Monadelphous. I did buy a small number last week but at the same time I am wary of assuming too much about future years until I can see evidence of their successful expansion – again for the reasons you outline.

      Speaking of MND, I bought 2200 of them on my father’s suggestion at about $2 in 2001 I think it was. They went up a little and I sold around $2.20. 10% return in a month or two, then they subsequently fell to about $1.35. What a genius I thought I was! 25 years old and I already had the sharemarket licked! I didn’t buy any back though and now look what’s happened. After the share split, those original 2200 shares would now be worth about $150,000, without including the dividends. The passage of time may prove me wrong but I can’t see MLD doing that.

  21. Richard Quadrio
    :

    Bank bashing is somewhat of a national pastime in a place like Australia. The last few weeks have seen this in somewhat plague proportions, as politicians of all persuasions are falling over each other in an attempt to land blows on the Australian banks. Somehow in the process a number of rather important facts have been lost.
    Firstly, we ought to be a little respectful of just how fortunate we are in Australia when it comes to banks. In many parts of the world the poor would dream of access to a safe place to put deposits and a ready and available place to borrow money at what is still, in any historical perspective, quite inexpensive rates. Add to this that our Government currently guarantees our deposits and we should realise how privileged we are. Secondly, unlike many parts of the western world, none of our banks have been in serious financial trouble and thus the Government has not had to waste taxpayers’ money in bailing them out. In the UK, in Ireland, in Iceland, in many other places in Europe and in many instances in the USA, banks have faced either insolvency or some form of nationalisation.
    Having been nice to our banks, I then wonder why politicians on all sides miss one very important issue in the current dilemma. Over the last 10 to 15 years banks in Australia have been able to grow and grow and grow, as the overall amount of money they have loaned has grown and grown and grown. This credit growth has only been achieved as our banks have increased their borrowings overseas, thus making them (and us) vulnerable to international interest rate markets. Over the last decade banks, who once required a deposit of 25% for a person to buy a home, have often loaned sometimes over 100% of the value of a home. ‘Low doc’ loans have meant that many people borrowed by simply declaring they could afford to pay it back. Credit card limits have steadily been increased and we have lapped it up. The banks even invented new terms like ‘equity mate’ as a smooth way of convincing us that we were not really borrowing – we were just ‘unlocking our equity’. Bank profits have grown as credit has grown.
    But guess what? With the GFC the credit growth party is starting to peter out. Banks addicted to growth now face the prospect of not being able to actually get us as a nation much more in debt. With $140 Billion in personal debt (including $ 45 Billion on credit cards) and over a Trillion Dollars owed on home loans, we are at last starting to lose our appetite for more debt. And so the banks, it seems, now have a new strategy – increase the cost of our current debt and that will ensure their profit growth is maintained.
    Of course no politician in her right mind is going to criticise the banks for lending too much, because we gladly received the credit to inflate our standard of living. Home loans at 7.8% are really still cheap if you consider where rates have been over the last 30 years. But when we owe over one trillion dollars, then every 1% increase in interest rates will cost the borrowers across this nation 10 billion dollars more in interest payments, every year.
    The Bible warns that the borrower is always the servant of the lender. We might not like banks but maybe we only have ourselves to blame.
    The rich rule over the poor, and the borrower is servant to the lender. Proverbs 22: 7

    • Roger Montgomery
      :

      Great perspective Richard,

      And our ten year bond rates are the same as Spain and Italy! Economic growth does indeed rely on the banks being allowed to continue to increase their lending to us. Thank you also for taking the time to contribute. I am delighted to hear from you. I look forward to your next post!

    • Ken Milhinch
      :

      And that’s another thing that the bible got wrong. Back when I had $2M in investment property mortgages Westpac provided me with a personal banker, fee free accounts and a monthly call to make sure I was happy with everything. Now I have zero debt and money in the bank, I am lucky if I can get the Westpac teller to acknowledge my presence.

      Regards, Ken

  22. fred
    :

    Hi jeremy,

    CBA, a little high…….about 15% or so

    WPL about double high…..about 50% or so

    QBE a little high…….about 15% or so

    You will have to get an opinion from the guns in this blog and of course before you do anything you will need professional advice.

    See ya jeremy and I am also new at this so yeah…….

  23. Greg W
    :

    Hi all

    I would be interested to hear everyones valuations of DCG and Industrea. I get

    DCG – 2011 $2.45, 2012 $2.90, 2013 $3.22
    IDL – 2011 $0.52, 2012 $0.59

  24. Greg W
    :

    Ken

    If agree with your conservative estimate of NPAT of approx $40M for the year, which would mean closing equity will be around $129. Based on average equity I get a ROE of closer to 36% and a payout ratio of 12%.

    Using a ROE of 35% and RR of 12% I get a value of $10.44 based on 2011 equity per share of $1.63 so I think there is a lot of upside yet.

    I saw mention above that 3.5m of shares are being issued this half. If this is correct then my numbers will obviously be lower.

    Also I am wondering if anyone can help me get future yr forecasts for FGE as comsec don’t provide any.

    • Ken Milhinch
      :

      Greg,

      I have included the extra 3.55M shares in my 2011 estimates, and because the equity has increased so much over 2010, I use the 2011 equity to calculate ROE, which gives me 31%. (I also use 12%RR)
      As for forecasts, I have used the latest market update to apply 35% increase in NPAT and allowed another 2 cents increase in the dividend. That’s really all you need. I don’t do 2012 forecasts because the further out you go the less reliable they are, and in fact I think they are little more than guesswork beyond 2011.

      Regards, Ken

  25. Gavin
    :

    Profitability for DEC 09 half was 34.7% (NPBT/Average Equity)
    Profitability for June 10 half was 27.6% (NPBT/Average Equity)
    I estimate profitability for DEC 10 half as 25.7% (NPBT/Average Equity). Assumptions are 27 Million NPBT from the announcement and an average equity for the half of 105 Million.

    I was trying to make a point about not just taking announcements at face value.

    I did not say that FGE doesn’t represent value against the market price. I’m happy to leave that in individual’s hands based on their assumptions about the future.

    Regards

  26. Lloyd Taylor
    :

    Roger,

    Like you I am a fan of share buybacks, when done at a value adding price, which for me is one lower than the IV of the business concerned.

    However, many businesses persist with buybacks at inflated share prices. This appears to be the case currently with CSL with the buyback proceeding gangbusters at a price well in excess of IV and at ever higher share price levels with each tranche.

    What is your opinion of the wisdom of share buybacks at prices well in excess of the IV of the business?

    Regards
    Lloyd

      • Lloyd Taylor
        :

        Roger,

        Thanks. You have confirmed what I always thought.

        However, with CSL’s buyback actions I began to think I must be missing something. It raises the question in my mind as to whether CSL’s leadership has lost its value creating way after more than a decade of uninterrupted growth? Coming on top of the bungled Telacris acquisition and the associated premature billion dollar capital raising, the answer to this question appears to be yes!

        The company is now facing more than exchange rate headwinds. Some of the business value and growth problems are of most definitely of management’s own making.

        Identifying the turning point for long running growth stories like CSL is difficult. But all growth stories do turn in the end and recent actions do no augur well for the business.

        Regards
        Lloyd

      • Roger Montgomery
        :

        Hi Lloyd,

        I can’t help but thinking you could be right and at the same time unduly harsh. When making a bid for a company, its often a requirement to show you have the financial firepower. You can do this with prove of debt facilities or you can raise capital. Of course you can make the bid with shares too but cash is often preferred by the board of the target. In that event, a capital raising in anticipation of a bid is not inappropriate – especially if the shares are relatively expensive. The failed bid for telacris is arguably the result of an unknowable response from the regulator. Of course it is also arguable that Talecris overstating the effectiveness of its Prolastin medicine and CSL suggesting its Zemaira drug worked better than has been shown in studies, may have got up the nose of the FDA. Regardless, the failure of the bid meant that the shares dropped, the company had lots of cash it didn’t need and a value-adding buy back was in order. I wouldn’t mind if it issued shares at high prices (above IV) and bought them back at low prices (below IV) every day of the week. This would result in an increasing intrinsic value.

      • Lloyd Taylor
        :

        Roger,

        “I wouldn’t mind if it issued shares at high prices (above IV) and bought them back at low prices (below IV) every day of the week. This would result in an increasing intrinsic value.”

        Exactly!

        But unfortunately that is not what is happening!

        CSL issued the stock well above IV at the time and although they are buying it back below issue price, it is now well above a collapsing business IV. Yet Mr Market thinks otherwise at this point of time.

        Go figure? The madness of the market (and business leadership) demonstrated, if anyone needed proof?

        Geez that is harsh… but not unduly so and it is factual.

        Honestly, I have been a long time supporter of CSL, but I think the growth story has now turned and the market is out of step with the turning point.

        Regards
        Lloyd

      • Craig M
        :

        Hi Roger and Lloyd

        CSL management also transfered the cash from the capital raising in 08 over to the US when $A was around 0.90 and after the Talecris acquisition was denied, repatriated the $Blns at around 0.80. This created an abnormal profit of about $180mn for shareholders, premature but fortuitous I say.
        I am not really sure what management have done to give you the impression they are creating growth problems or declining the business value. Yes this buyback is proceeding at levels above the current IV but when future profits are higher, the eps will be calculated on lessor issued shares. The future equity will be otherwise lower because of the buyback and with the higher profits the ROE will otherwise be higher also.
        From consensus data I have calculated 2012 equity to be around 3.8bln and with a profit of 1.08bln I get a ROE of 28%, shares on issue decline to 525mn, if the payout ratio is around 45% I get a value higher than the current price.
        Maybe the relentless rise of the $A will cause structural and possibly irreparable damage to the business but that’s really outside managements control.

      • Lloyd Taylor
        :

        Craig,

        You say that …”From consensus data I have calculated 2012 equity to be around 3.8bln and with a profit of 1.08bln I get a ROE of 28%, shares on issue decline to 525mn, if the payout ratio is around 45% I get a value higher than the current price.”

        The problem here is the consensus data. To recap what CSL have said recently on the subject:

        1) CSL 2010 results announcement : For the 2010/11 financial year we anticipate net profit after tax of between $980 and $1,030 million, at fiscal 09/10 exchange rates.

        2) Then this a few weeks later on 13 Oct 2010: Chairman Elizabeth Alexander told the annual shareholders’ meeting that if the dollar held at the 98.4 US cent level of October 8 for the balance of the fiscal year, net profit would be “in the
        order of between $880 million and $940 million”.

        See/smell the “dead elephant” in the room, of which the consensus data is in apparent denial?

        Now as to the management control issues question – the major blood serum market on which CSL is dependent is saturated and the regulatory response to the Telarcis acquisition proposal shows that CSL management is now in a strategic box canyon by virtue of its focus and past success. To add to this, it is buying back shares well above the IV of the business, which means that it is turning each buyback dollar (that is to say a current dollar of shareholder equity) into something considerably less (at least twenty five percent less by my estimate) as the market inevitably goes into weighing machine mode when the “dead elephant” in the room is recognized for what it is. It would be fa better to write a check to shareholders as a direct capital return, for the equity devoted to the buyback, than turn each dollar into 75 cents over the long run, as is now occurring.

        Regards
        Lloyd

  27. James
    :

    Hi Roger,

    Noting CIL’s 5 year strategic plan announced yesterday, I was wondering your opinion. Obviously a halving of profit will also halve ROE for the year and hence value, but the long term prospects appear better than they were before the announcement. Does this significantly affect your inclination to buy the stock at current levels given its short term problems, or enhance your confidence that it is a good long term buy?

  28. Brian
    :

    Hi Roger
    Attended in Perth last night and the presentation was clever witty and brilliant. Is there any chance that you could run a weekend workshop where we could bring a few annual reports, laptops and work through our favourite companies. It would allow value investors to meet, network, debate and ask all those questions.
    Eg Should we even consider COH given it is a single product company? Should we ever invest in a company with less than 5 years figures on the board? Some debt is good or is it? Is there a durable competitive advantage in .coms? Pick and shovel companies are tied to a temporary commodity boom – or this time is it different?
    Please run a weekend workshop – many of us will fly over!!

      • Scott T
        :

        Heaps.

        However this leads me to encouraging you to establish a bespoke fee for visit based advisory service. However that may be a topic for another day.

        All the best

        Scott T

      • Brian
        :

        I have attended weekend seminars that cost around from $300-$500 per person + accomodation, depending on the numbers attending and the quality of the venue. Some hotels will do deals where the conference venue hire is reduced if attendees stay at the hotel. Sponsors might come to the party. Melbourne/Adelaide are probably best to get west coasters along but I realise Sydney may be easier for you.
        Given it would be a meeting of “like minds” the networking would be great.
        A workday on Saturday, dinner on Saturday night and a round table debate or discussion on Sunday morning might be a good way to go. Buffet had annual meetings of like minds and they would have a topic like “why did the stocks of the previous decade not make it in the next decade?” to get people thinking.
        You could always survey your data base and ask them which month, format and city they would prefer. It will all be tax deductibe if set up properly. We have to spend the FGE profits on something.

  29. jeremy
    :

    Greetings all,
    I have done a few more IV calculations and am wondering if anyone gets roughly the same?

    CBA – $50.51
    WPL – $45.84
    QBE – $20.88

    Thanks heaps
    Jeremy

    • Jarrad Stuart
      :

      Hi Jeremy
      My value for CBA is roughly the same, and I will consider buying if the press continues to be negative on it.
      My QBE valuation is significantly lower than your valuation. Maybe you should receck your inputs.
      WPL is one that I do not follow closely.
      Jarrad.

    • Greg W
      :

      Hi Jeremy

      I calculate the following IV’s

      CBA – 2011 $47.42, 2012 $49.76, 2013 $52.15
      QBE – 2011 $17.84, 2012 $17.99

      If you graph QBE over the past 5 yrs you will see there ROE has be in decline, forecast NPAT going forward is lower now than it was in 2007 and intrinsic value has been in decline.

      QBE needs interest rates to increase in the US before its ROE, NPAT and intrinsic value will increase dramatically. Great company all the same.

      • jeremy
        :

        Thanks for your reply mate, im new at this so i any help is greatly appreciated, these are the numbers i used from comsec,
        QBE- c/eq $10222, c/sh 1020, eqps $10.02, npat-1970, r/div-1305, por-66%, pyeq-$11159, roe-17.65%, ror10% & using the tables & formula gives me $20.88.

        What am i doing wrong?

        Jeremy

      • Greg W
        :

        Hey Jeremy

        Happy to provide my thoughts mate.

        The numbers you are using are from 2009 accounts and I agree totally except for the dividend which I have as 1118. This amounts comes from the annual accounts and reflects the actual dividends paid during the year. Comsec use calender year for calculating dividends per share.

        As such my payout ratio is about 57%. My IV at 2009 is $21.82 so not to different from yours however future years the IV reduces dramatically to $16.72 (2010), $17.84 (2011) and $17.99 (2012).

        Remember 2009 has past and we need to look forward to see how the valuation of a company is expected to change. In QBE’s case it is going down so would only buy well south of $16.72.

        Hope this helps

    • Thomas
      :

      I’ve been using RR 10% and getting:

      CBA 2011: $52-56
      WPL 2010: $18-22
      QBE 2010: $16-18

      can you explain how you got $45 for wpl?

      • jeremy
        :

        This is what I used and judging by peoples comments im waaaaaaaaay off!
        WPL- c/e 9865, soi/748,npat1824 r/d822 pye 6705 and using 12%ror.

        Oh well, making mistakes is an essential part of learning, or thats what i tell myself!

        Thanks for replying

    • Ric
      :

      As much as I absolutely love IV investing…It makes such sense!!!! I reckon you have to also look at macro investment cycles. CBA will be crucified in the coming housing crash…

  30. SUE
    :

    GOT YOUR BOOK WORKING ON IT, NOT SURE IF I GOT THE INTRINSIC VALUE OF PRG RIGHT. I GOT $2.03
    THANKS RODGE

    • Ken Milhinch
      :

      Sue,
      By the look of that, you are using RR of 10%. I would suggest that is a bit low, and you should at least use 11%. I have an IV of $1.71, but I wouldn’t regard them as an investment grade company. Their ROE for 2010 was only 7%.

      My opinion for what it is worth.

  31. Pat Fitzgerald
    :

    Hi Roger

    Do you expect that CCP’s recovery rates would decline during periods of high unemployment ? If someone is unemployed and unlikely to find a job quickly they may want to repay but with the high cost of housing (rent or mortgage) and general living expenses they will be unable to make their repayments. Australia’s has a strong economy at the moment and CCP are going well.

    • Roger Montgomery
      :

      Thats a great question Pat. Time will tell as we have not seen such a circumstance. The jury is out on how much harder it becomes. Interestingly a not insignificant portion of the people who’s debts are overdue and being collected are not unemployed but simply tardy or thought they would ‘get away with it’. Many if not most have the capacity to repay these debts. In the meantime, may I remind everyone that none of the above blog post represents a recommendation. YOU MUST SEEK AND TAKE PERSONAL ADVICE. UNDERSTAND ALL THE RISKS BEFORE YOU INVEST and UNDERSTAND THERE IS A VERY REAL RISK OF LOSS.

    • Ken Milhinch
      :

      Pat,

      Unemployment is often a causal factor in someone appearing on the debtors ledgers in the first place, but that doesn’t mean the debt is non-recoverable. The skill in debt collecting ( I did it for while in my earlier life) lies in the assessment of the likelihood of recovery and pricing the ledger accordingly. Looking at CCP’s figures, they seem to be very good at it and their results are commendable from my perspective.

      My opinion for what it is worth.

  32. Gavin
    :

    Forge forecast increase in half year earnings of between 25-27 million. This represents an improvement on the previous corresponding period of up to 42%.

    How positive!!!

    I’m more interested in profitability than headline numbers. So here’s a rework of a the release into a format that I would have preferred to see.

    FGE forecast half year earnings of between 25-27 million dollars. We started this half with equity of $93.375 Million so this represents a maximum profitability of 29% Return on Equity (based on 27m). Profitability in the previous corresponding period was 35% based on average equity. This represents a decline in profitability of at least 17% although it is likely to be greater once we know closing equity which will be boosted by retained earnings and 3.5 million shares issued this half.

    The decline in profitability was caused by ……………….. and is being addressed by……………………

    • Roger Montgomery
      :

      Hi Gavin,

      The decline in profitability you are forecasting is more dramatic than mine and the gap between intrinsic value and price as well as the rate of increase in intrinsic value in future years has, so far for me, been too mouthwatering to pass up.

    • Ken Milhinch
      :

      Gavin,

      If we assume, for the sake of argument, that the NPAT for the second half is only 50% that of the first half, we see a NPAT of approx $40M for the year, against an equity of approx $129 (assuming a constant payout ratio of 10-11%). That’s an ROE of 31%, and that will do me every day of the week. I calculate their IV for 2011 (using 12% RR) at $7.70 so I think there is a lot of upside yet.

      Personally, I get less enthused by MCE than I do by FGE, and the way their respective share prices are moving at the moment is reinforcing that view.

      Disclosure: I own lots of FGE and none of MCE and I am very happy with that.

      Regards, Ken

      • Paul
        :

        It took me too long to feel comfortable about investing in this company as I didnt fully understand the workings of it. Now that I have investigated and have a thorough understanding they then go and release a profit upgrade pushing the price north. It is still below my estimated IV of $5.91 but am hoping patience will pay of for me, with a lower price than currently trading once all the recent excitement wears off.

      • Roger Montgomery
        :

        Hi Paul, Based on what you have said you have dismissed something you know – a discount to intrinsic value, and replaced it with something you don’t know – hoping the price will fall. Hmmmmm…
        No advice of course, seek and take personal professional advice.

      • Ashley Little
        :

        Hi Ken,

        I also like FGE but I have a lower IV than you.(Never thought i would say that lol)

        I am using a higher RR and I have not assumed a constant payout ratio. It may be extremely difficult to maintain a high return of equity with a 10% payout ratio.

        It is Inevitabe that the payout ratio will rise but I may be too early with my predictions with this.

        Keep up the good work

      • Roger Montgomery
        :

        Thanks for sending it through. Coke gets lots of imitators too but nothing tastes as good. I am flattered by the sudden explosion of intrinsic value experts. The more people thinking about it the better.

      • ron shamgar
        :

        Hi Ken,

        Why would you be less enthused about MCE? its a well managed business that is expanding capacity to meet demand and lets not forget there are only 4 companies like that around the world! Oil is getting harder to find, so more deep sea drilling and the last i hear india and china are building more petrol cars then electric ones!

        I think you will do very well with your forge shares, but you will regret not buying matrix at today’s prices when it will be trading at around $10 in 2 or 3 years from now…

        Good luck.

      • Ken Milhinch
        :

        Ron,

        That was not a criticism of MCE, it’s just that I find their business harder to understand, and I have a nagging feeling that the market is going to take a longer time to recognise their true value. Oil is not that hard to find by the way, and the world is a long way from being short of the stuff, certainly during what’s left of my lifetime.

        In the end, we should always invest in companies that we fully understand, and stay away from those that we don’t.

        Regards, Ken

      • Ken Milhinch
        :

        Ron,

        Since my initial reply to you, I have done some more self education on MCE. This is what I found.

        There are at least 6 other companies involved in riser buoyancy manufacture around the world – probably more, viz;

        Trelleborg – Sweden
        Cunard Technologies – Australia
        Flotation Technologies – USA
        Cuming Corporation – USA/Brazil/Germany
        Balmoral Offshore – UK
        Aker Solutions – Norway/Worldwide

        A couple of these are large companies with a great deal more financial clout than MCE.

        Further, I note that the initial announcement of the Henderson facility in Nov 09 said stage 1 would be completed in April 2010. Now in October 2010, we hear it will be completed in May/June 2011. Not very reassuring in respect of their project management skills.

        As Henderson progresses, MCE’s debt to equity ratio is going to rise considerably, (I estimate to somewhere near 65%), and that sends up a red flag in my scoring system. In the last 4 months they have moved from net debt of minus $5M to plus $8M, no doubt as a result of progress payments that need to be made on Henderson. Company cash flow and free cash flow are both already negative in the 2010 report so there go another couple of red flags for me.

        Should the oil price go down, deep sea drilling becomes less viable and that represents a serious business risk, as a fall in revenues could impact their ability to service the debt they are taking on.

        None of this may mean very much if their sales revenues and profits increase the way they are predicted to do, and the shareholders may do very well, but the more I look at MCE, the less thrilled I am by their story. I am happy to stay away from this one.

        My opinion for what it is worth.

        Regards, Ken

      • Ken Milhinch
        :

        Roger,

        Point taken, but isn’t that a bit like the EBITDA argument ? These costs have to be paid from somewhere, and after the construction is completed, the drain on the cash flow will become interest and loan repayments.

        They may well generate sufficient to service both with some to spare, but debt worries me, and the future rather depends upon a high utilisation rate in this new facility.

        Don’t get me wrong, I am not trying to forecast disaster for MCE, I am just not convinced that the future is as sewn up as some think.

        My opinion etc, etc.

        Regards, Ken

      • ron shamgar
        :

        hi ken,

        to answer your points:
        -their business is simple, riser bouyancy manufacture mainly.
        -unfortunately the market has recognized their potential value and bid up their shares five fold in a year!! (current PE is 20) the only reason its not going higher is the market is not sure about 2012 order book.
        -according to jim rogers, no new discoveries of oil have been made, therefore in the long term oil is only heading one way..
        -cashflow is quite strong considering the cap expenditure
        -cunard technologies is not really a competitor if u read what they do.
        -their competitors being much larger is a positive as they may wish to take matrix over in the future and get their hands on their state of the art new facility.
        -and i would like to add that there’s a very good chance the company is underplaying the future capacity at the new facility.

        i do own shares in this one and i hope more people share the same thoughts as you about this company so i can buy more :-)

        regards Ron.

      • Lloyd Taylor
        :

        To Ron’s comments I would add that MCE are not dealing with mass produced systems or products. The buoyancy systems are bespoke products, purpose designed and built for each specific application. Under these circumstances size does not confer a competitive advantage and economies of scale are negligible, if not non-existent.

        It is more about intellectual property, design and execution capability and these are things that MCE appears to have in spades. The record suggests that they are more than capable of meeting their competitors head on and coming out ahead.

        Also as I have stated elsewhere their product is a component in a complex system that often has a lead time from conception to implementation of 5-10 years. Short term oil price volatility has no impact on the strategic decisions that drive the investments into which MCE is supplying product. Reputation and reliability are paramount under this circumstance. The question simply becomes one of whether MCE meets the requirements of the major offshore project developers? I’ll leave that for you to decide!

        Regards
        Lloyd

      • Ken Milhinch
        :

        Ron,

        You say their business is simple, but do you know how long it takes to make a buoyancy device and do you know how many they can make in a day ? Do you know how many an oil rig uses and do you know how often they need to be replaced ? There are many aspects to this that aren’t exactly common knowledge.

        The fact that the shares have gone up 400% doesn’t mean they will go up in the future. You simply do not know.

        Jim Rogers says no new discoveries of oil have been made. That is going to come as a shock to the well operators. Oil is being discovered every week, and if the US ever start to get serious about the reserves in Alaska, their deep water drilling may be cut back severely. Oil prices are currently falling back to where they were a year ago.

        Cash flow is not “quite strong”, it is negative, and whilst I acknowledged Roger’s points about cash flow, the debt levels still concern me.

        I am not sure that a company’s size relative to its competitors is a reason to buy shares in the expectation of a takeover. I also think that a couple of these competitors may already have “state of the art” manufacturing, given their size and length of time in the industry.

        MCE may be unintentionally underplaying the capacity of their new facility – they have certainly shown that they can’t estimate an accurate completion date.

        Ron, you and Roger and many others here think that MCE is an excellent investment and you may well be right, but I don’t share your enthusiasm. That’s fine though, we are not all going to agree on everything even if we arrive at the same IV.

        Regards, Ken

      • ron shamgar
        :

        hi ken,

        just to clarify and reply to your points:

        -i meant their business profile is quite simple to understand. i did not refer to the actual manufacturing of their products. that part is very complex and involves years of research and experience. this experience and reputation is what is compelling about matrix not to mention their valuations. if you want to know more intricate details of their business just go to their website and read analysts reports.

        -Jim rogers said “no MAJOR new discoveries have been made”. on the other hand, brazil recently discovered huge amounts of oil off their shores deep in the ocean…. i guess they better call matrix to book their orders for fy12-fy15!! :-)

        -you should never buy a company based on takeover potential, but its an added bonus to own the best one in its industry if consolidation ever occurs or maybe private equity would like to load it up with debt.

        and finally i agree with roger, matrix has already ticked the box of an excellent investment!

        cheers Ron.

      • Ken Milhinch
        :

        Ron,

        I would like to call an end to our debate on MCE. I sincerely hope you make a lot of money out of it, (over and above what you have already made), but they won’t be getting any of my money.

        FGE, SWL, TRG, STU, ARP, CBA, AIR on the other hand, have all got my nose in their troughs, and most are feeding me very well.

        To each his own.

        Regards, Ken

      • Craig M
        :

        Ken

        Ron’s statement that the business is simple refers to the product they manufacture and the markets they service, the rest of the questions you ask in that first paragraph are quite irrelevant and I believe MCE would like to keep it “not exactly common knowledge”. Why? – see Lloyd’s didactical first two paragraphs.
        As to negative cash flow, the business produced 26.35mln last year, invested 41.3mln in new PPE (mostly Hendo) and the proceed from the issue of new shares totals nearly 27mln, is my math wrong?
        Hendo is purported to cost 60mln of which about 40mln has been payed for so far, now as you say they have gone from 5.5mln in net cash to 8 mln in net debt wouldn’t that leave about 7mln left to pay.
        I acknowledge note 15 and the 35.5mln progress claims and deposits liability. If we surmise that 13.5mln was payed and 22mln is left, this is funded from debt and debt climbs to 30mln. They don’t use any of there free cash flow to pay the debt down. That equates to a debt to equity ratio of only 50% high but not 65% as you suggest. I don’t think for one moment debt to equity will get anywhere near either figure.
        I do thankyou Ken for the post and for taking the devils advocate roll, it got me thinking and digging deep looking for answer and questioning my own work. Please keep it up and don’t be disparaged by our disagreement, as value investor we have to question and look from the otherside. For now I am happy to hold on to my excellent MCE investments.

    • Luke
      :

      Gavin,

      I suspect the decline in returns is due tighter margins on larger contracts which generally are more competitive. Also increasing retention moneys on construction contracts will play a role. I doubt they will be able to maintain 35%, but propsects of good profitibaility I still beleive are very good.

      Luke

    • Lloyd Taylor
      :

      Gavin,

      “We started this half with equity of $93.375 Million so this represents a maximum profitability of 29% Return on Equity (based on 27m).”

      I think you may be misleading yourself by focusing on too short a period and non-annualized returns. Timing of realization is critical in the engineering contracting business and the longer the period of analysis the better the averaging of timing effects and the closer the reality.

      Based on 2010 accounts FGE had an average ROE of 40.9% and with 19% dividend payout, an implied growth rate of 33%. Annualize the the ROE for the six months months you have calculated in the quote above and you see that FGE is tracking more than very nicely against the implied growth rate…an astounding outcome (but not necessarily one to be repeated in the second half)!

      So is the glass better than half full (as I would suggest), or more than half empty as you suggest? I think that it may be a bit more than a matter of the perspective of the observer in this case.

      Regards
      Lloyd

      • Gavin
        :

        To avoid any more friendly fire (as I am in fact on the same side)

        Let me clarify why I posted the re-write of the announcement.

        The notification on the figure – $25-$27 Million before Tax was useful information and it does underpin the investment case for the time being. (In light of the market valuation)

        The point I was making is that the only commentary on the figure was “ Up 42% on the PCP” which in my view was entirely useless information and potentially misleading from a profitability point of view.

        Some good insights here as to the reasons for reduced profitability, i.e. timing, scale, retentions etc but it would have been nice to have management’s perspective. Maybe I expect too much but I want to be treated as a part owner – not a mushroom. – “Kept in the dark and fed Bull….”

      • Lloyd Taylor
        :

        Gavin,

        Unfortunately the keep them in the dark and feed them bulldust philosophy is endemic management practice across the board when it comes to ASX disclosure requirements today. Spin is the order of the day and more often than not it is what is not said, or not disclosed, that is most important.

        This situation has arisen from the regulator’s (the ASX) loose interpretation of the disclosure requirement… i.e. the disclosure of business FACTS that are relevant and material to the consideration of share price.

        FACTS have been replaced by SPIN and the ASX in its conflicted role as market platform and regulator is only too happy to encourage any approach that lubricates the wheels of greater trade volume and thus greater trade commissions.

        The sooner we get full and complete separation of market regulatory responsibility from the ASX the better. Hopefully the threatened acquisition of the ASX by the Singaporeans will result in full, rather than the partial regulatory separation that we now have. ASIC is in effect half pregnant in its new, but partial, market regulatory role. To be frank, a genuine buggers muddle of roles between the ASX and ASIC prevails at present!

        Disclosure SPIN needs to be replaced with regulatory enforced disclosure of FACTS as is already required, but not enforced, under the continuous disclosure requirement.

        Regards
        Lloyd

        PS … no offense intended in my strong language to the wilting marshmallows and ASX apologists out there, but if you take offense so be it…the truth hurts !

  34. richie
    :

    Hi Roger, Tried to post this comment up before but something must have failed. Anyway If you receive this twice I apologise. What is your intrinsic valuation for ERA, a price taker that has had some production downgrades lately.

  35. Johnny
    :

    I was just wondering if you are able to
    comment on IOF and MQG? If so I look forward to hearing from you. Kind
    regards Johnny.

  36. john
    :

    Hi Roger,

    Once again value investing rises to the top. As for FGE, I have calculated the IV for 2011 to be $5.40, just wondering what everyone else works it out to be.
    Also, I think CBA is good value at this point despite the negative press.

    • Ashley Little
      :

      Hi John

      That is close to my FGE IV

      I you have a look on some other posts you may find that i am not that keen on the banks

    • Ken Milhinch
      :

      John/Ashley,

      Your IV’s for FGE seem awfully conservative to me. I take a conservative approach myself, and I have 2011 at $7.56. Would you like to share your inputs ?

      Regards, Ken

      • john
        :

        Hi Ken,

        What do think about the directors of FGE selling some of their share holdings for $4.40

        regards

        John

      • Ken Milhinch
        :

        John,

        This was done to facilitate the entry of a number of institutional investors onto the share register. I don’t see anything sinister in it.

        Regards, Ken

    • Andrew
      :

      I had CBA at $48.42 which of course it has recently fell below. However, remember the margin of safety, we don’t just want to buy companies below the IV we want to buy them for a big discount to their IV.

      As the 20 or so cents did not form a large enough Margin of Safety or discount to IV then i let that one just sail through to the kepper and and got ready to face up to the next ball.

  37. Ken Milhinch
    :

    Very pleased that I doubled up on my Forge holding recently. Today’s news is very reassuring. Further to my recent comment about TRS facing some competition from a Japanese competitor, my wife went to their store on Sunday (she claims it was research on my behalf) and reports that it was full of excellent products – everything is $2.80 – and many, many happy customers. After leaving about $50 behind, she continued with her research in other shops.

    Daiso has 2,570 stores in Japan, opening at a rate of 20 per month, and another 550 overseas (24 countries) so they are a force to be reckoned with. Clearly the cost of shipping and handling for one or two stores in Australia is prohibitive, and as they are a price point retailer, they can’t raise prices to cover. This then suggests that they will open quite a lot of stores to gain the economies of scale needed to operate profitably.

    Many of the products that they sell are made in Japan, so are of better quality than the Chinese made stuff you find in the Reject Shop. I think it is only a matter of time until TRS start feeling the pinch and I am not sure there is much they can do about it.

    Information for what it is worth.

    Regards, Ken

    • Greg W
      :

      Ken

      I agree there is a chance that competition will increase but I am happy to stick with TRS as they have performed without fail for many years and my intrinsic value of them is still increasing at a reasonable clip.

      2011 – $16.04
      2012 – $19.33
      2013 – $22.49

      • Ken Milhinch
        :

        Greg,

        That’s fine, I was merely making the point that they may have a few headwinds in their future, and the departure of Brian Beattie may see them less well equipped to handle them. I have a 2011 IV OF $12.48 but then I use 12%RR for retailers.

        Regards, Ken

  38. Steve
    :

    Does this change your valuation for Forge Group Roger or was it in line with your expectations? And can I ask for your valuation of CCP.

    Thanks!

  39. richie
    :

    Hi Roger. Just received your book. Many thanks. I was wondering about your thoughts on ERA, with the production downgrades and also being a price “taker”. Is this company an A1 still, and attractively valued?

    • Roger Montgomery
      :

      Hi Richie,

      Not attractively valued. A classic example of why commodity companies are 1) high risk and 2) not always the best way to take advantage of a view on commodities. Note that even though Uranium prices are rising, simply buying stocks that dig the stuff up doesn’t always work. Jim Rogers once told me over the phone that he prefers direct commodity exposure than through companies, despite the leverage on offer. For him, its another layer of analysis that he doesn’t have to perform.

      • Martin Anderson
        :

        Hi Roger,

        I think I have become addicted to your blog, at least my wife thinks so! Would you be kind enough to let us know what instruments you use to gain exposure to commodities? Is this something a retail investor can gain access to?

  40. Scott T
    :

    Great post Roger,

    We are not here for advice, we are here to discuss ideas and share our views on things. Opinions differ and that is a good thing, sometimes I am right, sometimes Ashley is wrong :-)

    All the best

    Scott T

    • Craig M
      :

      Ashley wrong when was that must have missed that one?
      A quote from Graham “You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right”
      I think there is a bit there for all of us

  41. David Harms
    :

    Roger, Another that you rated earlier this year as A1 that has been doing well and has hit a 52 week high is SMX. Looks like it is at about its IV but not sure how it maintains a competitive advantage. I checked to see if it was at an all time high but note that from Feb 99 to March 00 it rallied from $1 to $20. Not bad if one could have timed it right. Soon came crashing back to earth as the IT bubble burst.

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