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What A1 companies are the best value right now?

Companies, Investing Education | Comments (39)

What A1 companies are the best value right now?

Peter Switzer invited me to join him on the Sky Business Channel last Thursday evening. We discussed the market and my way of thinking about businesses. Then he asked me to reveal which A1 companies are the best value right now. Here is the interview.

If you received my email update yesterday about Value.able‘s delivery date, this is the video I referred to as ‘Montgomery’s best value stocks‘.



Switzer TV with Peter Switzer was broadcast on 15 July 2010 on the Sky Business Channel. Visit www.rogermontgomery.com to secure your first edition hard back of my step-by-step guide to valuing the best companies and buying them for less than they are worth.


The video is provided by Switzer.com an online portal for retail investors and small business owners. Switzer also provides Financial Planning and Business Coaching services.


Posted by Roger Montgomery, 17 June 2010
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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39 Comments

  1. AndyC
    :

    Hi Roger (and others interested in the contractors),

    I’m surprised that no-one is talking about Southern Cross Electrical. I’ve been obsessively staring at KPIs for years now, SXE seems to always jump out at me.
    ROE > 30% for last 2 years
    Profit margins > 20% last 2 years
    Debt is zero
    Stable earnings and increasing last 2 years
    Chairman owns a huge chunk of the shares (maybe too much?)

    Their price recently has come down.

    Does anyone have any ‘goss’ as to the quality of this electrical engineering contractor?

    Cheers,
    Andrew

  2. Pete
    :

    Hi Roger

    I am enjoying everyone’s comments on the blog…I thinks its great service you are providing.

    I’m am normally not a bad stock picker…I just thought I would run a company by everyone Bass Metal (ASX:BSM) normally not my investment style – “bottom picking” but the company has some good fundamentals…do yourself or anyone else care to make any comments?

    Happy Investing!

    Pete

      • Eamon
        :

        Hey Pete,

        I wouldnt know how to value resource stocks as they seem to follow a style i call herding.
        What you have to do is determine or predict what will be the next big thing on the resources front, ie; 2006- Uranium, 2007- iron ores,2008- phosphate, 2009- lithium. 2010- gold.
        Alot of speculators will tell you stuff like this would be a great company it has awesome fundamentals, great assets thats worth billions if they could mine it first and hugh potential to become the next BHP, and so you get con into buying nothing more than hope that it goes higher the next trading day.

        But what I notice invariably is that alot of this hype on a particular sector in the resources industry seems to drive price. The company itself seems little irrelevent when people become overwhelm with all the noise around them. So what eventually concludes from all this activities is that the stock that are hot goes to absurd levels before investors finally realise; either through the commodity price plummetting or the cash burn exceeds the cash in the bank, and then you get a tap on the shoulders by the managers for more equity for life support or the adminstrators get sent in to liquidate the assets, or your spose slaps you on the face and tells you to wake up as you are really fantasing something to good to be true. That eventually leads to the stock prices returning to earth and you eventually realisation that you have lost a lot of your family money speculating.

        So inclusion, unless you can pick the next big thing, dont speculate on resources you will only get burnt invariably, EAMON! Cying you guys at the Melb. expo tommorrow!

      • Roger Montgomery
        :

        Hi Eamon,

        really good thoughts. The result – according to comments that Lloyd made a little while back – is that prices for Aussie resource stocks are much higher on a relative basis when compared to their overseas counterparts.

        and to everyone else, be sure to come over to the ‘speakers corner’ after my brief talk and say hi personally.

  3. Chris Prunty
    :

    Roger,

    Good to see Decmil (DCG) and Forge (FGE) getting a mention. As you know, very few market participants have a detailed understanding of these companies. For your readers benefit it is probably worth mentioning a few of the similarities and differences between the two.

    Essentially, they are both design and construction companies with exposure to mining and oil and gas projects in WA. Decmil does large contracts typically worth $50-$100m and has ‘tier one’ customers such as Woodside, Chevron, BHP and RIO. Forge does smaller jobs with an average contract value of $20-$30m and tends to have more ‘tier two’ clients (i.e. a whole bunch of gold miners you’ve never heard of!).

    Decmil has built somewhat of a specialty in construction of villages and camps and recently won a $82m tender for the construction of Fortescue’s 800 bed village at Christmas Creek. Decmil tends to do EBITDA margins around 10% whereas Forge’s margins are in excess of 15%. Forge earn higher margins as they do more fixed price work, have a lower quality customer base, earn very high margins in Africa and have more of their own equipment (cranes and the like) on which they earn high (rental-like) returns. Decmil does a mix of fixed price and cost plus work while Forge has mostly done fixed price work so far. Fixed price work is higher risk as any cost overruns are worn by the contractor. Cost plus work is lower risk because, as the name suggests, work is done at cost plus a fixed margin.

    Clearly, Decmil is the more ‘evolved’ of the two businesses with larger contracts, better customers and more cost plus work. The price they pay for this, however, is lower margins. Both businesses are sensitive to the macro outlook and commodity prices as they have little to no recurring revenue.

    Earnings:
    Decmil is guiding to $400m revenue at 9% EBITDA margins for FY11 EBITDA of $36m. Forge will do in excess of $300m revenue in FY11 and are insistent that their relatively high (~15%) margins are sustainable. Let’s say FGE does $325m revenue. At this margin then they will do close to $50m EBITDA. Forge may pay a dividend at their result in August but both companies will likely retain the vast majority of their earnings. They will do this because of the bonding* requirements as they win larger jobs. The banks, who provide guarantees for the bonds, often ask for them to be cash backed. This means contractors tend to hold a lot of cash on their balance sheets. Both FGE and DCG have very good balance sheets with approximately $60m and $40m of cash respectively. This compares to their $230m and $190m market capitalisations.

    What it all means:
    DCG and FGE are great stocks if you are a believer in the long-term China / mining story. There is the chance one of these could become the next Monadelphous (MND). MND is a large contractor with >$1bn order book which still earns ROE >60%. The key driver of these stocks tends to be the size of their order books and announcements of new contract wins. To this end there is plenty of work at the moment with Gorgon, Pluto 1 & 2 and various Iron Ore expansions for BHP, RIO and FMG.

    Happy investing.

    Chris

    *Understanding bonding:
    Bonding is like a surety contract where a third party (i.e. a bank) guarantees that the contractor will perform their duties in accordance with the agreed contract. For example, when a first party (say, Woodside) calls upon a second party (Decmil) to perform duties in contract form, a bond is issued by a third party, guaranteeing Decmil will fulfil an obligation (to build an accommodation village) for Woodside. In the event that the obligations are not met, the Woodside will recover its losses via the bond.

    • Roger Montgomery
      :

      Hi Chris,

      Really value your contribution (and not just because we share a common juliet in these companies). Thank you. I was secretly hoping the mention might tease you out of the ivory tower! I am sure I speak on behalf of everyone reading this blog that your contribution is highly valued. Thank you again.

  4. Steve
    :

    Hi Roger,

    I really enjoy watching Switzer – he gets some great guests on the show and always asks interesting and pertinent questions. Your appearances on the program are very insightful and I certainly hope you will continue to be a regular guest.

    I find it quite interesting that there are a number of mining services companies which you classify both as good stocks and (potential) good or fair value at the moment – Forge, Monadelphous and Decmil. Do you think this is just a coincidence or is the market ignoring these specific types of businesses at the moment?

    In particular, I would be interested to hear your personal intrinsic value calculation for Decmil Group. I know you have mentioned the stock a bit recently but I haven’t heard what you think is fair value now and over the next few years (if it continues to perform well obviously)

    • Roger Montgomery
      :

      Hi Steve,

      Keep in mind you have to be a believer in the ongoing strength in the commodity cycle and be content that China’s property bubble doesn’t implode causing more widespread havoc. Those caveats aside and based on current estimates (see Chris’s comments earlier) my estimate of value is $2.00 and $2.37 for 2011 and 2012. This is not a recommendation. You must seek and take personal and professional advice before doing anything.

  5. Tarlock
    :

    Hello Roger,

    You mentioned 2 engineering services companies . One if Forge Group. What is the other? Is it decnol?

    Thanks
    Tarlock

  6. Ben
    :

    Hi Roger, I was watching one of your videos about calculating cashflow, and you mentioned some phone apps where you could follow a companys announcements. I tried hard to look for these and got nowhere. Could you name some so I could get them as it would be a very handy app to have. Thanks.

    P.s Love your work and can’t wait to devour the book.

    • Roger Montgomery
      :

      Hi Ben,

      Will come back to you. I am surprised you couldn’t find the one I am sure has been launched. Gee, I hope I wasn’t announcing something that hasn’t been launched.

    • Roger Montgomery
      :

      I have just been reading its annual reports today. Darryl Holmes seems grounded and Buffett would love him – he pays himself $90k. The questions I am trying to understand the answers for are how much can it grow and how long will it take?

      • Eamon
        :

        I dont know about you but he doesnt like issuing new capital its been stale at 20M, in addition no options released as incentive to managements, high returns on equity sinces it listed, 91% of the stock is held by the top 20 shareholders Darryl himself owns 70% roughly and they are expanding organiclly with retains earnings. The only problem I’ve is that its doesn’t trade often and it isnt cheap. Personally if i had an oppotunity to speak to Darryl Holmes I would suggest that he delist the stock from the asx and run the business as an unlisted entity given the fact that happy existing shareholders will be content to hold onto those stock forever. So therefore why fork out administration fees to the asx when it selves little use.
        Inclusion I do believe it looks expensive but like Charlie Munger says its better to buy wonderful businesses at fair prices, and to buy a meaningful amount. Eamon!

      • Eamon
        :

        Yes, Roger the mystry stock is 1300SMILE, usually when a company doesn’t come out annoucing any downgrades few months before the results ie; virgin blue we should have great confidences in managments ability to delieve on it’s goals, fingers cross all goes to plan! Eamon

      • Eamon
        :

        In response to your answer i think it has good growth potential looking forward, as it’s fairly a simple business to understand. Nothing complicated with Dentistry, what i like about its modus operandi is it focuses on doing the admin work so that dentist’s that chooses to join the team can focus on what they are professionally good at which is to provide outstanding dentistry pratice applicable.

        My estimation for the stock last year was $2.10 this year its around the $3 dollar range base on full year results around 22-25cents I like to be conservative. Im not sure if this is what your valuation formula spits out, but I hope its close cos then perhaps then my own valuation formula may have some merits. Eamon!

      • Roger Montgomery
        :

        Hi Eamon,

        Before I supply a valuation estimate can I respectfully make the observation that if we have one company for which our valuations agree, it may not mean that they will agree over all companies. As they say, one robin does not a Spring make. The current valuation is $3.27 to $3.68 but I would rather wait for the 2010 results and some guidance about the future. Perhaps we have a dentist reading the blog that can offer some insights?

  8. Eamon
    :

    Hi Roger,

    How come you dont value micro-cap stocks? The potential would be highly lucrative if you could pick them before fund managers discover these few gems from the rest. Eamon

    • Roger Montgomery
      :

      Hi Eamon, I value every stock. With microcaps there is a little extra work involved to be confident with forecasts of course but you are absolutely right – it is an entirely valid approach to investing to go looking for companies the brokers and fellow fund managers haven’t picked up yet.

  10. Brad
    :

    Hi Roger,

    You mentioned Decmil (DCG) on Switzer last week. Would you be kind enough to let us know what is your valuation?

    Cheers

    Brad

    • Roger Montgomery
      :

      Hi Brad. Its should now be up. Have a look at one of my earlier comments. Remember it is not a recommendation, there are many caveats and warnings. Seek and take personal professional advice.

  11. Luke
    :

    Hi Roger,

    I am looking forward to hearing your C5 company list. I have heard you talking before about VBA and QAN. It’s hilarious when you talk about how bad these businesses are. I have a friend who enjoys looking at stocks that perform horribly (not to short sell, just to laugh). I will have to tell him to watch your C5 list.

    Cheers

  12. Lloyd
    :

    Roger,

    A question which has troubled me for months: Do you know if any TV presenters have a fortifying tipple before the cameras roll?

    Regards
    Lloyd

      • Lloyd
        :

        Roger,

        Diplomatically sidestepped!

        I’ll take that as a yes response to my original question.

        Have you ever considered a career in politics, or diplomacy?

        Regards
        Lloyd

      • Lloyd
        :

        Roger,

        A pity, your political and diplomatic talents appear to be well honed, far better than most who walk the political stage. And that is before mentioning financial and economic capability.

        Regards
        Lloyd

      • Eamon
        :

        It is very interesting to note that we have the wrong people running our economy, governments are good at making new rules and regulations. But when it comes to running our budget through treasury it should be left to people that treats it in a business manner that invariably ensure its in surpluses. Not what we currently have at the moment, selling out assets to get us out of deficits isnt the way to go. As it reminscent to a teenager on a binge credit card spree and then selling their most valuable assets ie; Telstra to met those deficits and return the budget to surplus to once again spend and this time round they invariably have run out of assets to sell so what they do, slug the resources industry with a big fat tax to make them look better at running the economy, but clearly not! Eamon.

      • Roger Montgomery
        :

        Whether Telstra is a valuable asset is an interesting question. You are right, government could hang on to TLS and create legislation that ensures competitive advantages but then of course, the government changes and so does the legislation. It is one of the reason that you have to watch out for government featherbedding and businesses reliant on current legislative support.

  13. Kim Jordan
    :

    I think you need to have a few more jibes at Peter next time you’re on – he delights in mocking you a bit – all in the name of good entertainment of course, but I think you could ‘return the serve’ a bit more *_*

    Looking forward to the next ‘encounter’!

    • Roger Montgomery
      :

      Thanks Kim,

      I am certain he’s only trying to ensure a direct answer for your benefit. I can tell you from backstage that he really is trying to put himself in the shoes of the viewer and make sure you are finding out what all his guests really think. I am not much of a fence sitter with respect to many issues but as an experienced TV host he is probably able to sense quicker than me, if one of my answers looks like its going to be an each-way bet. Thank you for your support and encouragement though.

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