Is LMC investment quality?
This blog is for viewers of Nina May’s Your Money Your Call program on Sky Business Channel last week who requested a valuation for Lemarne Corporation Limited (LMC).
LMC’s history is a lumpy one. It is no JB Hi-Fi or The Reject Shop in terms of its economic performance. This makes the process of valuing the company more subjective.
ROE over the last 10 years has averaged 14%, varying between -1.2% to 25.8%. Since a capital return that reduced equity, and the sale of C10 Communications, ROE has been higher.
Cash flow is good (exceeds reported profits) and the balance sheet is debt free. Debt free, an attractive ROE and good cash flow are desirable characteristics, particularly when they appear in concert. Management have also shown they are owner-oriented, buying back shares last year at depressed prices equivalent to 10 per cent of today’s market cap, and plan to also provide a capital return through an unfranked dividend of 50c.
But this a small company, and I have done no work identifying whether any competitive advantages (the ability to regularly raise prices without a loss of sales volume) exist. They often don’t in small businesses. If they do, they tend not to be small for long. The focus is now on one business – Lemtronics. On first impressions, it is not the most memorable of brands.
My estimate of value is $4.00 – $4.50, but there are plenty of other companies whose businesses I know better.
By Roger Montgomery, 1 October 2009
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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James Sturtz
:
Thank you Liz and Roger,
I’m also a part owner of Lemarne. Liz’s thoughts are pretty close to my own. I might add my thoughts on the “big dividend” and whether it is a rational use of capital.
With little franking credits left by virtue of having no Australian businesses left, a capital return by special unfranked dividend exposes the owners to tax on the dividend at their marginal rate.
This will be between 15 and 45% in most cases.
Taking somebody on AWEarnings, they pay 31.5% tax on an unfranked dividend. For every $100 the company distributes they get $68.50 To get to break even, I would have to make $31.50 after tax and include a time value of money to that.
Sitting in a company bank account the after tax and inflation return is close to zero, but zero is still in “don’t lose” territory.
The good thing about Lemarne is they do recognise and acknowlege mistakes – like their foray into healthcare, and are open to suggestions from their shareholders, if you ask them in a businesslike way. I’ll be asking them to hang onto their cash by letter, sometimes they listen.
For prudent investors it appears the GFC wasn’t brutal enough. Well managed companies with cash apppear to be finding vendor expectations are still high. So the likes of Lemarne and Washington H. Soul Pattinson will probably have to hang on to cash.
Knowing that our one remaining business is in Malaysia. The risks are more cultural and attitudinal for our personell than sovereign. The business has commodity characteristics but by broadening the customer base and maintaining a quality reputation may amerliorate this to an extent.
Like all investing, it’s a wall of worry and the choices for deploying capital are never easy.
Look forward to seeing you at Storey Hall -RMIT if you’re still going, 1st Wednesday in August 2010. I’ve just bough Valu.able off the website. Look forward to reading it.
Roger Montgomery
:
Hi James,
Thank you for that. I look forward to seeing you there. Be sure to come up and say hello afterwards.
Michael Winter
:
Hey Roger
RE your thoughts of a investment workshop I would be very keen. Did one or your opening bell workshop at the traders expo in bris several years ago and learnt a lot and would be very keen to learn more. Would prefer brisbane but if you were only doing the one for the year I would try to get whereever you were doing it so you can put my name to the list. Thanks
Liz
:
As a value investor/trader, I’ve followed Lemarne since 2004 and bought it on at least 4 separate occasions, all of which have provided positive returns. I hope you won’t mind if I take the opportunity to add my own view on valuing them.
There are so many different ways to measure “value” and the choice of method depends on the type of company, stage of business and economic environment. While I agree that looking for businesses that are less commoditised and able to generate high ROE is a good long-term “buy and hold” strategy, there is still a place for buying “value” in more commoditised sectors. In the immediate environment, the pressure on margins for commoditised businesses will weigh on them, but we must perhaps by now be reaching a point where those with weaker balance sheets will either disappear or be available at fire-sale prices to stronger companies. With reduced competition and capacity, margins will then gradually return to levels that meet or exceed cost of capital, while revenue rises. So it could be a good time to buy into more cyclical businesses.
In the current depressed/recovering economic environment with low access to credit, a strong balance sheet is a huge plus. In Lemarne’s case, even post the 50cps dividend, the company cash+receivables-total liabilities leaves a value of $2.81. i.e., even if Lemtronics was declared worthless tomorrow, along with inventory and all equipment, there is still $2.81 of value left over in LMC. There are not many companies with that kind of underlying backing.
As for the value of Lemtronics itself, I don’t think the historic results of Lemarne are a great indication. It has been more of an investment business in the past, with multiple businesses and the value dependent more on their investment skill in buying, improving and selling those businesses. For now, they appear to have restricted themselves to Lemtronics in the current year, so the valuation is more dependent on this business. The growth in Lemtronics is not readily apparent, but its contribution to Lemarne has increased significantly over the last 4-5 years. However, it would still be wise to consider it a moderately “commoditised” asian electronics business. I’ve used various assumptions and valuation methodologies and would suggest a valuation for this business of about $24m. (For comparison, Grant Thornton came up with $28-$35m in their valuation earlier this year).
Add back $24m to the underlying value calculated earlier and I’d put the value of Lemarne at $5.60. However, anyone investing for the dividend should be cautious. While I’d expect Lemarne to keep paying dividends, I think that given the low level of franking credits remaining available, they are unlikely to repeat last years dividend level in at least the next two years. I would also expect Lemarne to trade between 5-20% below my valuation due to low liquidity.
Finally, while the high cash component of Lemarne is an advantage, it is quite likely that directors will choose to invest a portion of it – possibly in acquiring a fire-sale business in the same space as Lemtronics. This could lead to a year or two of lower valuation by the market until any acquired business has been fully integrated and begins to show a return on investment.
rogermontgomeryinsights
:
Good thoughts. Your ideas about mean reversion are solid however you might find that things take longer to revert to the mean than my long term ROE method will take to generate returns. Your proposal to value a company based on net current assets has a long history of success around the world going back to Ben Graham and I can think of a large number of very prominent US fundies that still apply it today. Of course after calculating the ‘net nets’ figure you are still having to ‘arrive at’ a valuation for the business. I am doing just that without the step in between. More importantly I am using the economics of the whole business as it stands today to arrive at that estimate. Finally be very very careful about commercially incentivised ‘valuations’
Liz
:
Thanks for the comments Roger. I agree with most of them – especially the bit about commercially incentivised “valuations” which are usually a great source of amusement!
Last year was the first time in my 13 years of investing that I had been able to come close to finding a “Ben Graham” stock – i.e. cash+receivables+inventory-total liabilities>market cap. Another one that came close was MAQ which I was able to purchase at 85cps and has turned out quite well.
I think there is a “right time” for book value analysis and it is really only suitable when trying to buy in to a bear market and perhaps for a little while after the market has bottomed, so I wouldn’t use it for much of the time.
If I was using just one ratio to screen stocks by, my favourite would be a one year forward estimate of EV/EBIT/Growth (an EEG?). I figure it should be an improvement on PEG in a market where debt is more problematic. Of course, that still relies on an accurate estimate of upcoming results!
Matt
:
My preference is Melbourne. As for price, I think it would depend on the number of people attending. I’m unsure of the costs involved your end to facilitate this.
Daniel Jones
:
Hey Roger, you already know that I’m pretty enthusiastic about most of the advice that comes from your mouth so, I’d certainly be interested in attending a investment workshop pending two factors – location and price.
rogermontgomeryinsights
:
I would be interested to know what locations and price you prefer?
Matt
:
I’d be interested in a value investing workshop Roger. Of course, as with investing, it would come down to price!
I have just finished The Making of an American Capitalist by Lowenstein. An enjoyable read.
Thank you for the other recommendations in your post.
rogermontgomeryinsights
:
Great to hear Mark. Let’s wait and see how many other people are interested and we can go from there.
Mark
:
“I have always wondered if I ran a workshop just once a year, whether there would be a small group of people, who are really serious about investing, that would attend…”
Hi Roger,
Just tell me when and where and I’ll be there.
I’m really looking forward to your book.
I have been buying some of your recommendations in the Eureka Report..waiting for the correction to buy the others.
Regards,
Mark
Spiggy
:
Hi Roger. I have seen you on sky business channel and have become a keen student of value investing. Do you have any recommendations for reading matrerial and how does one come to aquire the knowledge that you have on the subject?
P.s Do you teach anywhere?
rogermontgomeryinsights
:
Hi Spiggy
There are some books but nothing teaches you better than experience. The first funds management business I founded and have since sold and resigned from was the result of, and also provided a lot of, experience. I am writing a book at the moment that will comprehensively cover the way I approach equities.
Here are some of the books that will keep you going. The book I am working on will be ready in February.
The Essays of Warren Buffett. Cunningham
The Making of an American Capitalist. Lowenstein
Damn Right. Lowe
The Warren Buffett Way. Hagstrom – not the best good book but a small handful of really useful ‘bits’
The Warren Buffett Portfolio. Hagstrom – better
With regards to teaching, it is something I am interested in but time precludes frequent opportunities. I have always wondered if I ran a workshop just once a year, whether there would be a small group of people, who are really serious about investing, that would attend…
Online Stock Trading
:
what a great site and informative posts, I will add a backlink and bookmark your site. Keep up the good work! :)
rogermontgomeryinsights
:
Thank you
Les Woods
:
Dear Roger,
Thanks for awnsering my question on lMC. I didn’t know you had the awnser on your BLog. I just looked you up from todays SMH and behold there was the anwser. I wish I had known this earlier as I went an bought them for there div. I’ll keep them for a while in the hope they climb back up.
Thanks again. I watch Your Money Your Call regularly.
Cheers Les W.