What are your Twelve Stocks of Christmas?

159 Comments

1. 

   Glynn Sessions
   December 15, 2010 at 5:06 pm:

   oops I will not mention the ROE

2. 

   Rad
   December 15, 2010 at 4:56 pm:

   Hi & Merry Christmas to everyone and indeed happy birthday Roger.

   It was good to see you present yesterday at the ASX Hour.

   One of the things you discussed early on in your presentation was being invested in the good companies as opposed to the bad ones.

   Well, one of my observations has also been that some industries perform better that others and also have improving prospects for the future.

   For example, if you didn’t include the last few years, the mining & oil index has underperformed the industrial index historically.

   So in that vein I’d like to nominate the healthcare industry as a standout. You see, no one plans to get sick or injured it’s just a statistical occurance. And with the aging population, adding to that the growth of the middle class in developing countries such as India and China who can now afford better healthcare and you have an almost perfect scenario for well managed scalable healthcare business. My stock pick CSL.

   Also, as a father of 3 teenage children who listen to thei Ipods at maximum volume I can see the where the future growth for companies like COH will come from. But also as my parents age I’m noticing the fact that I have to repeat myself and speak louder more often, something that’s perhaps waiting for me in the next 10 or 20 years. So, I clearly see the cause and effect.

   Also, at some point companies like IVC will come into their own and although it’s a bit early, they are positioning themselves to take full advantage of the aging population.

   The companies I have put up are all overpriced but they have;

   1. Proven succesful track record
   2. Good management
   3. Growing business
   4. Defensive industry
   5. Profitable
   6. Excellent future prospects

   As the Oracle of Omaha somewhere points out, an important rule is preservation of capital and also be invested in the good businesses. All 3 I would want to own outright.

   By the way, I do own all 3 diractly or inderectly.

   It would be good to hear your viewpoint on this Roger.

   Be well…Rad

   • 

     Roger Montgomery
     December 15, 2010 at 7:06 pm:

     Thanks Rad. Great thoughts and I agree with you on the hearing issue. Stats are already coming through that the average age of people requirement hearing assistance is falling.

3. 

   Glynn Sessions
   December 15, 2010 at 4:54 pm:

   Riversdale Mining Limited….A look at the fundementals says it all
   and coal will be a much needed commodity in the short & long term.

4. 

   Manny
   December 15, 2010 at 4:36 pm:

   Hi Roger – My stock for the new year is CCV (Cash Convertors). I have just got your Value.able a few weeks ago and crunching some numbers on a spreadsheet (I tell you, this is addictive.. I am thinking of doing valuations whenever I have spare time :-) ) , CCv came out to have an IV of 76cents based on 06/2010 FY. With IV going upto 1.02 by end of 2011 FY. I noticed another blogger (Jason ) has also selected this stock. Hope you are right Jason (for both of us). Are these your IV’s as well.

   Since I am new to this, I have a quick question. Since we need to use the previous years equity to calculate ROE (as per the book) i.e. ROE = NPAT / Previous Yr Equity . This in some situations results in very high and most likely incorrect IV. This mainly happens when shareholders have been tapped for more funds but it might only be a one off. For e.g. when working out IV for MIN (Mineral Resources ltd) using data from comsec, I got an IV of 53 ( ROE was 67%). Obviously this is not correct. This happened because comsec data showed that the shareholder equity went from 144m (in 2009) to 460m (in 2010). In such situation how would we calculate a close to accurate ROE. Is it worth for calculation purposes only, in such a scenario, to increase the 2009 equity to a higher amount (but by how much and how?).

   Regards
   Manny

   • 

     Roger Montgomery
     December 15, 2010 at 7:10 pm:

     Hi manny,

     Delighted you are enjoying the process. Regarding your question, there has been some discussion about that and some creative thought. In essence some value.able graduates are suggesting some divergence with my idea in the book about using an average or time-weighted average equity figure. Instead they propose a technique that results in using the higher of the two equity figures. I am not averse to this idea but thought still needs to be put into what the likely pattern of ROE will be in the future. High and stable or high and growing is best and thats why understanding whether a sustainable competitive advantage exists is key.

5. 

   Terry Trickey
   December 15, 2010 at 4:27 pm:

   I would like to add

   CELLESTIS (ASX:CST)

   Startup biotech companies can have huge promise. Unfortunately, in the end very few live up to their promise. Investors need to be very choosy about which biotech investments they risk their capital on. ASX listed Cellestis is one of a very few such companies, unlike many biotech?s, it has developed past the research and development stage, selling its product (TB blood test) here and overseas. Cellestis has gone from a start up to a profitable business, a fact that only a handful of Australian biotech companies achieve..

   ✔ A potential market of ~ $800m – $1bn
   ✔ Cash flow positive, Profitable
   ✔ Paying Dividends increased dividends by 100% this financial year
   ✔ FDA approved (twice), Centre for Disease Control USA. (CDC) guidelines accepted June 2010. All regulatory approvals are in place, clinical data required to support sales has been generated.
   ✔ Recurring and largely compulsory market
   ✔ Strong and lengthy IP protection until 2023
   ✔ Extensive product pipeline CMV, Leishmania, Lyme disease etc. new product development represents the future growth of the company
   ✔ Honest and competent management with integrity

   COMPANY OVERVIEW
   Cellestis owns the patented QuantiFERON (QTF) methodology for medical diagnosis (originally developed by the CST Directors whilst employed at CSIRO back in the 1990?s). The technology is an Intereferon Gamma Release Assay (IGRA) which has the potential to revolutionise the diagnosis and treatment of a wide range of conditions that are otherwise difficult or impossible to effectively diagnose. Potentially, QTF could be used to diagnose Tuberculosis, Cytomegalovirus, Lyme Disease and many forms of cancer. The company has elected to concentrate initially on the huge potential of a diagnostic for TB.

   The company was floated on the ASX in 2001 and has spent the subsequent time in refining the diagnostic and developing a consensus acceptance in the medical community. With over 400 independent peer reviewed studies, the QuantiFERON technology is now well recognized throughout the medical community. The methodology now has full FDA approval in the USA and the CDC has released positive guidelines for its use. For the Investor, CST now presents an exposure to the exciting biotech field with an unusually low risk profile. Ten years of solid building has the company making profits, currently paying a modest dividend and intends to give dividends in line with the company?s profits.

   TUBERCULOSIS
   Around the world, every year, around ten million people are diagnosed with active TB and two million die from this curable disease. One of the main reasons for this appalling and unnecessary loss of life is the lack of an effective diagnostic for TB infection. After 100 years of this state of affair, only one company, Cellestis, has developed a clinically practical, whole blood serological diagnostic for TB ? QuantiFERON-TB Gold is superior in accuracy and specificity to the current test and delivers better value for money. Tuberculosis itself exists in two states. Many people are unknowingly infected with TB but show no symptoms (latent TB or LTBI). It is only when their immune system is unable to contain the latent infection that this TB becomes active and communicable. Many conditions can cause this conversion, including other diseases, HIV, immunosuppressive therapies (eg arthritis treatment) or ageing. Once latent TB becomes active it is highly communicable.
   TB is endemic in much of the world and is an issue of extreme concern in every country. The combination of HIV and TB is particularly deadly and it has been estimated that one-third of the deaths of HIV patients can be attributed to TB.
   In more recent times drug resistant forms of TB (MDRTB, XDRTB) are becoming more common.
   The treatment of these forms of TB are very expensive and are not always successful.
   All experts agree that the only way to ultimately control TB is to diagnose and treat the pool of latent TB.
   The only existing test for latent TB is a more cumbersome skin test that has been in use for well over 100 years. The skin test is notoriously inaccurate, not specific enough to differentiate between those vaccinated against TB and those with latent infection. As a result it gives a large number of false positives. It has often been referred to as “the most hated diagnostic” amongst medical practitioners.

   MARKETS
   Cellestis have defined their initial markets for QuantiFERON-TB Gold as the developed world, currently more than 50million skin tests are carried out each year.

   USA. In the USA, QTF-TB Gold has received full FDA approval and more importantly has had full guidelines for its use, published by the CDC. These guidelines permit the use of QTF-TB Gold in all circumstances. Furthermore, in many situations it is recommended as the preferred test (over the skin test). These latest guidelines were released in June 2010 and will accelerate market take-up. It is estimated that the total market potential in the USA is 15 million tests per year.
   Cellestis markets in the USA through a wholly owned subsidiary. Currently the Quantiferon-TB test sells for US$22.00 with a granted health rebate.

   JAPAN. Japan has an enormous problem with TB due both to their social structures and the fact that their population is almost 100% BCG vaccinated (rendering the skin test ineffective). The use of QTF-Gold TB has been approved by the MHLW (similar to FDA) and has been incorporated into the Japan TB control guidelines. QTF-TB Gold is marketed in Japan by the largest TB control organization in Japan, Nippon BCG. The market for TB testing in Japan is estimated at around 12 million tests per year.

   EUROPE. QTF-TB Gold has full CE-Mark approval in Europe. Many European countries have now adopted QTF-TB Gold into their TB control programs. The estimated market in Europe is 10 million tests per year. QTF-TB Gold is marketed in Europe through a wholly owned subsidiary based in Germany and qualified distributors.
   Currently the QFT-TB test has around 3% of the developed world market.

   RISKS
   Every investment has potential risks. Cellestis has minimized most risks with a conservative management style and an aggressive approach to ensuring medical acceptance. This approach has resulted in a lengthy process but investment grade outcomes.

   NON-ACCEPTANCE. The medical profession is inherently conservative and is often hesitant to change established procedures. With our health in their hands this is an understandable attribute. Cellestis have taken on the task of moving this market through the accepted approach of independent, peer reviewed trials. This approach has rewarded with even the most conservative of the medical community now publically stating their belief in the improvements that QTF-TB Gold brings to TB control. The risk of non-acceptance is now minimal ? the only question yet to be answered is the rate of adoption.

   COMPETITION. The main competition is the incumbent skin test. This is a well known test and therefore has a certain market inertia. On the other hand, its deficiencies are well known, returns many false positives.
   Another IGRA (T-Spot) has been developed but it is at a significant disadvantage to QTF-TB Gold because it cannot be used on whole blood, is far more complex to perform and much more expensive.

   FINANCIAL RISK. The company has no debt, $20 million in cash, is cash flow positive and is making a profit,
   The risk of failure through financial event is extremely minimal.

   INTELLECTUAL PROPERTY (IP). Through a combination of patents and licensing the QTF-TB Gold product is well protected until at least 2020. Patents over the In-Tube technology used in the diagnostic further provides protection for other products through to at least 2023. It will be difficult for a generic test to just copy. Another company would have to go through the same process as Cellestis has undertaken (around 6 years), expensive process, cannot get me too approval, not many companies are going to do this when there is an incumbent.

   PERSONNEL. The company is driven by the current Directors. Their ongoing involvement would be seen as of great import to the future of the company. There is no indication to date that their commitment to the company will change.
   The biotech sector cops flak from attracting spruikers the Directors, Dr Radford and Dr Rothel are the exact opposite, bordering on reticent, they refuse to talk up sales figures or flood the market with boastful but immaterial announcements.
   Among the board members is Chairman, Ron Pitcher who is also on the board of Reece and Macmillan Shakespeare also well lead companies.

   FINANCIALS.
   Cellestis announced a maiden profit in 2007 and commenced paying a dividend in 2008. F/Y sales 06/09 increased 83% to $34.4 million, net profit after tax grew 391% to $8.2 million this is due to the high 62.4% Gross Profit Margin and low overheads. ROE 37%.

   EQUITY.
   The company has 96m shares on issue, no options, 30% of shares are held by the
   Directors and almost 40% are held by the top 20 shareholders.

   • 

     Roger Montgomery
     December 15, 2010 at 7:11 pm:

     Wonderful contribution Terry. I hope that you are going to take a holiday after that mammoth effort. Thank you sincerely for taking the time to write your thoughts down so comprehensively.

6. 

   Chris
   December 15, 2010 at 1:52 pm:

   Hi Roger,

   My pick is Specialty Fashion Group Limited (SFH), who operate the Millers, Crossroads, Katies, Autograph, City Chic, and Queenspark branded stores.

   Competitive advantages: SFH has is strong brand awareness (I’m sure most readers on this blog have heard of most of these retail outlets) as well as diversity.

   Like many other listed retailers (think DJS, MYR, JBH, HVN) the share price of SFH has been knocked around lately – probably just a function of it being in the consumer discretionary sector.

   The company has managed to reduce the levels of debt over the years, however their revenues and profits have been rather…lumpy. Consequently, the ROE shows a very lumpy profile, although many years SFH has generated ROE far greater than 30%.

   Using Roger’s formula for valuing businesses I get an IV for 2011 that is substantially higher than the current trading price. I do not however own shares in the business.

   Merry XMAS to all and thanks everyone for their contributions,

   Chris.

7. 

   David C.
   December 15, 2010 at 1:48 pm:

   Roger please send a complementary copy of your book to Christopher Joyce & Clyde Cameron

   Christopher Joyce writes …”NAB’s Cameron Clyne also got it when he told the Senate Inquiry yesterday, “What we are is a solid, dividend-paying stock. Not everything has to be a high ROE if you are able to pay a strong dividend.””

   • 

     Roger Montgomery
     December 15, 2010 at 7:15 pm:

     You would be very surprised by who is reading value.able! Thanks David C.

8. 

   Dan S
   December 15, 2010 at 1:33 pm:

   Hi

   My choice of stock is EZL Euroz.

   Euroz (EZL) is a Western Australian stockbroking house with private and institutional client desks supported by a research arm in addition to a corporate finance and funds management businesses.

   EZL has produced excellent, albeit bumpy (due to the nature of financial services) returns on capital through the cycle while maintaining a net cash balance.

   These returns are driven by its compeitive advantages of having strong client relationships assisted by its high quality research product and positioning in the booming WA market place.

   Currently EZL is undervalued, with a margin of safety in the order of 40%, which is possibly a factor of the low liquidity, lack of institutional ownership and research coverage of the company.

   Competitive Advantages:

   An efficient integrated investment banking model can generate outstanding returns on capital in prosperous economic periods. The business of generating brokerage, earning fees on capital raisings and funds management generally has low overheads and little capital outlay, as the key assets of the business are fee generating client relationships. The model is synergistic when strong retail and institutional broking desks and generators of value adding research ideas combine with quality corporate deal flow and substantial funds under management.

   Euroz has managed to combine the above package of products into a strong WA based franchise leveraged into the mining boom.

   In particular Euroz produces a quality research product which introduces thoughtful ideas into the market. This is a contrast to other mid tier sized brokers who often produce reports of little depth to generate capital raising work.

   Euroz’ close client ties are evident in its history of repeat business with both corporate clients requiring access to capital and institutional and retail clients. This is likely to generate repeat raising fees (ie: revenue) going forward. Capital raising fees are a factor of capital raised for the corporate client and margin on the capital raised. The margin on capital raised (price) is generally fixed on equity raisings in the order of 3.5 – 5%, with anecdotal evidence suggesting that some WA houses charge as much as 6%. Thus the major driver of increased revenues, and correspondingly, profits, as the cost base is largely fixed, is through generating a greater number and larger size of raising. This is quite quite likely going into CY2011 as market sentiment and commodity prices improve and more mining projects become feasible and require funding.

   Euroz’ client relationships are supported by its position as a WA “born and bred” house that is as Western Australian as Emu Export. Perth advisors on both sides of the Chinese wall benefit from the sense of parochialism that exists in a town which is often neglected by larger, East Australia centric advisors, who are unlikely to have bodies on the ground.

   Risks:

   In light of the potential returns on capital listed above in light of the WA mining boom, competitors have been expanding to Perth recently. Macquarie, UBS, Merrill Lynch are expanding their presence in Perth. Market share is not easy to win, given the key assets of the business are relationships with clients which generate future fees. These relationships will always take time and large expense accounts to develop.

   Key men risk is present in the potential for star bankers, broker, analysts and fund managers to be poached. The ability to retain staff principally lies in their remuneration, and is mitigated through the high level of employee ownership.

   The upside of the above risks is the potential for a well funded global house to gain leverage to WA through buying relationships rather than developing them through an acquisition.

   Valuation:

   In the last three years, EZL’s mean average return on equity has been 31%, which includes GFC years FY09 and FY10. This is fairly conservative given a five year mean average ROE is 41%.

   Using book value per share of $0.83, I conservatively estimate there is a margin of safety of around 40% at current prices.

   Note this is derived using a 100% payout ratio, as dividend policy is assumed to be fairly arbitrary.

   Dan S

   • 

     Roger Montgomery
     December 15, 2010 at 7:16 pm:

     Thanks for that Dan and great to meet you yesterday. Don’t forget to send that material through!

9. 

   Jack L
   December 15, 2010 at 1:11 pm:

   This is my first post ever in this blog. Hope it will add some values.

   My favourite company is Forge (FGE). I think many of you are aware of this company so I don’t spend too much time to outline what this company does.

   Here is my research findings:

   =================
   Competitive Advantages

   1. The integration of Cimeco and Abesque provides an effective full service model for mining companies. This so-called ‘The Forge Hub’ model allows the group to pool resources and position as a one service provider, particularly between Cimeco and Abesque; and between Cimeco and Webb. (ie. Abesque provides early stage services such as engineering, design and procurement; Cimeco provides the fabrication and construction services. Both can provide ongoing services.) Webb can also access Cimeco’s fabrication facility in Ghana. Cimeco’s fabrication is currently only limited to SW of WA, Ghana and Perth.

   2. Cimeco has an established market position in WA and provides multi-disciplinary project management and mechanical construction services to the resource and mining companies. It is positioned as a leading commercial builder, steel and tank fabricator, manufacturer and onsite civil and mechanical contractor. $7.9m has been spent on upgrading equipments in 08/09FY. Cimeco has successfully merged and integrated into the business in 2005 and 2007, so should have no ongoing integration issue.

   3. Abseque is structured that critical resources are sourced and controlled internally allowing effective allocation and prioritisation to meet project schedules.

   4. Webb has established position in West Africa (over 15 years) by providing construction services to the material sector. It has access to Cimeco’s fabrication facility in Ghana to duplicate a one service provider model.

   5. Overall, this integration model allows the company to operate on a lower cost structure and greater costing advantage. While this ‘Hub’ model is not fully matured, it is heading to the right direction.

   6. It is believed that to a certain degree these competitive advantages do help the group win more contracts, but a large portion of the revenue growth is explained by the industry trading environment. On average, FGE is awarded a contract in every 3 tenders submitted.

   =================
   Growth Story

   1. The group’s current order book for 2011 increased 50% to $371m. If I assumed Hillgrove project ($50m) continues to be delayed and no other orders to be completed in 2011, we still expect at least 30% increase in 2011.

   2. Given the current robust level of capex by mining companies, next 3 years revenue should not be a concern. Further than that would depend on whether the group can develop its competitive advantage.

   3. Organic growth expected to continue on its current robust industry.

   4. A newly created E&I division under Cimeco is expected to make major contribution in 2011FY.

   5. Strategic alliance with Clough may contribute to FGE’s bottom line through: (1) allowing FGE to tap into Clough’s resources and systems; (2) allowing FGE to expose to oil and gas industry (ie. widen revenue base); (3) allowing FGE to have stronger capital base ($20m more) to support larger contracts. FGE has traditionally exposed to base metals and gold sectors, as Cimeco has commenced tendering larger more sophisticated construction packages with Clough as a partner in the oil and gas industry, any contract awarded will have significant implication to the group’s future earnings. The alliance with Clough is to allow FGE to cope with increasing operation size in terms of resources, expertise and management.

   6. Further acquisition opportunities in the future. The company currently has net cash position of $45.6m (cash less borrowings) and healthy OCF. In addition, the land and building assets (Abesque) are now listed for sale (book value $6.9m), this will further add to the company’s net cash position. With such strong cash reserve, the company has indicated its intention to look for acquisition opportunities in engineering and construction businesses in Australia. The company has also proven its ability to integrate businesses to the group. Its ‘Forge Hub’ model can also be enhanced further via business acquisition.

   7. The company’s current exposure is only limited to WA and West Africa. The positive is that the company enjoyed established position in those mining rich areas. However, if the company grows to a certain size it may need to seek to expand into other geographical areas. This is not a concern for now for me.

   =================
   Profitability

   1. The group currently generates majority of its business through construction activities (88%) rather through engineering activities (12%). Majority of the revenue is contributed by Cimeco via its construction activities.

   2. The group currently generates most of its revenue from Australia (mostly in WA), accounting 82%. West Africa operation only contributes 18% to the group’s revenue.

   3. The group has $51.9m (cash and cash equivalents), $6.9m (non-current asset listed for sale), and $15.5m (undrawn credit). Total available fund is $74.3m. This means the group has the capacity to take up to $495m worth of order. (The group so far has $371m order book for 2011)

   4. While the group is growing in size, with enhanced financial position the group is targeting to continue to increase its project size. The average size of contract is currently between $25m and $50m (2007-2010). After that, the group expects the average size may increase to $50m-$100m. If it turns out to be successful, it would further improve its margin.

   5. Required investment for capital equipment and depreciation is not a concern. It accounts for a small portion of the group’s revenue.

   6. My calculated ROE for the group is 53.2% (2007), 30.1% (2008), 46.4% (2009), 51.6% (2010), and 45.8% (2011E). My ROEs are adjusted figures.

   7. Net profit margin improved from 3.6% (2007) to 11.8% (2010)

   =================
   Financials

   1. It seems that these engineering services companies tend to carry significant amount of account receivables and account payables. It is good to see that the company also carry significant amount of cash (from $3.5m in 2007 to $51.9m in 2010) and healthy OCF. This will add more liquidity to the working capital.

   2. The company has low level of debt. Net debt to equity ratio is 18%. That is one of the lowest among the peers.

   3. A good cash position also enables the company to engage in acquisition if needed.

   4. Off balance sheet commitment total $9.6m (ie. $5.8m hire purchase commitment and $3.8m operating lease commitment)

   5. Usable credit line total $15.5m plus working capital $53m (2009: $17m)

   6. Minimal doubtful debt expensed (2010: $84,000). $13m receivables past due but not impaired, this accounts for approx. 5% of the revenue.

   7. Materials, plant, subcontractor costs account for 50% of the revenue; employee benefits expense 32%. There has been significant increase of employee benefit expense from $17.3m (2009) to $79.2m (2010), the number of employees increased from over 400 to 650. There is no explanation for this increase in the annual report but I assumed that it might partially be to do with office relocation or departure of some senior management persons.

   =================
   Valuation

   1. With booming industry trading conditions and promising order book, revenue growth over the next 3 years should not be a concern to me. Therefore using a higher ROE is justified. However, longer term investor (5-10 years+) should use a lower ROE to indicate the sustainable return. I would use 45% for the former and 25% for the later.

   2. I am willing to use high ROE is because (1) the company has shown a consistent ROE around this level; (2) there is no reasons to believe current robust mining sector will slow down significant in a foreseeable future; (3) Clough factor is also not factored in.

   3. To factor in the foreseeable future (ie using 45% ROE), I would be using 13.7% for RR. My valuation for FGE is between $15.07 and $15.50.

   4. To calculate the long term IV (5-10 year out), I would be using 15.1% RR and 25% ROE (assumed long term sustainable rate). My valuation for FGE would become $3.91-$4.23

   =================
   Risks or Factors for Investors to note

   1. The current competitive advantage is not fully matured and sustainable. It will take time for the company to prove its model and increase its size in order the gain greater advantage. Given the fact that average project time is around 18 months, the long term revenue growth will eventually rely on the company’s competitive advantage to win contracts.

   2. Market conditions may change, but I do not see anything to substantiate this speculation at the moment.

   3. Availability of qualified labour and increasing labour costs.

   4. Assessment of a suitable ‘pipeline’ of projects with correct costing. FGE currently takes on risk as a lump sum hard money contractor (an aggressive mode), therefore cost control and estimation skills are very important. But so far FGE has not made a loss making job in 3 years.

   5. There is high level of shareholding concentration. 66 holders own 74.6% of total shares, most of them are non-institutional holdings (ie. passive investors). (1) Unless there is private placement, FGE is not likely to be bought by fund managers given its size and lack of liquidity; (2) this may partially explain why FGE share price is not fully priced in when the shares are not actively traded by professionals.

   6. Maybe I haven’t done enough due diligence, but it seems that the company has offered no explanation for the following management changes:

   (A) Stepping down of Andrew Ellison from executive role to a non executive role in Sep 2009. Andrew is believed to be instrumental to the group given his experience and being the MD of Cimeco which is the driving engine of the group. But it seems that the Board is having difficulty to find someone to fill in his shoe, because in 2010 report, Andrew becomes an executive director again. (no explanation) But one thing for sure, the group is planning to upscale the management skill from individual level to a corporate level.

   (B) The departure (2009) of the CFO (Michael Kenyon). He is only 41 and has recently appointed as CFO and Company Secretary in March 2009. I suspect it may to do with performance issue?!. The position is yet to be filled.

   Disclaimer: I currently do not hold this share, but I am planning to buy some. Not sure when, still looking. This is my own opinion only, not advice.

   • 

     Roger Montgomery
     December 15, 2010 at 7:18 pm:

     Hi Jack,

     That is an extremely comprehensive first post. I hope you haven’t set the bar too high for yourself. Well done and I concur with many of your points. There are so many great companies being mentioned, the decision for me will have to be on the basis of a combination of biggest discount to intrinsic value and fastest expected growth in intrinsic value.

10. 

    Craig
    December 15, 2010 at 11:27 am:

    Hi Roger,

    Whilst COH may not be a stock for this Christmas, it may well be a business for any occasion.

    This article from earlier in the year was of interest to me:

    http://www.theaustralian.com.au/business/cochlear-wont-hear-of-mergers-or-acquisitions/story-e6frg8zx-1225926428900

    There are a few statements in the article, which if turn out to be true, are music to the ears. Here are a couple I liked…

    “Mr Roberts, though, is not one for diversions, saying it will be “decades” before the company exhausts its opportunities around the world for organic growth.”

    “Mergers and acquisitions is not everything it’s cracked up to be by investment bankers: growth by M&A is actually fraught with danger and often driven by ego.”

    Merry Christmas Roger.

    Regards,
    Craig.

11. 

    Craig
    December 15, 2010 at 10:47 am:

    All,

    FSA Group (FSA) is my contribution.

    ROE (comsec) the last 5 years – 21, 35, 12, 29, 17 %.

    First guidance this FY has been a 32% increase in 1st Qtr profit.

    Barriers to Entry – an increase in the capital requirements for debt administrators will make it harder for smaller players to get into the Debt Management sector (this is from their 2010 Ann Rpt, but it won’t prevent larger players.)

    Similarly, the proliferation of Non-Conforming home loan lenders prior to the GFC has been reversed, with increased capital requirements, the credit squeeze, and failures reducing competition.

    Current Conditions suit – Their revenue is derived from 2 segments mainly, Personal Financial Services (Debt mainly), and Non Conforming Home Loans. Increased Interest Rates increase demand for the Debt Services, but would also impact on the ability to repay of some Home Loan clients. FSA are better able to manage this – than competitors – using the Debt Servicing facilities they have in place. The two segments compliment each other. Their Annual Report from 2010 states their average weighted LVR to be 67%, quite low by industry standards. The current robust employment outlook in Australia further strengthens their business by mitigating against Home Loan defaults, and allowing people to enter into debt servicing with the knowledge that a more secure income stream is available.

    The current Equity of around 42M consists of approx 12M contributed capital and 30M retained earnings.

    The Valuation comes out at above $1.20 using a RR of 10% and ROE of 20%.

    Current Price circa 32-37 cents.

    I won’t mention the low PE. Not on this site.

    Merry Christmas indeed!

    • 

      Craig
      December 15, 2010 at 11:02 am:

      Pardon me, as my copy of Value-able appears to be in another state, and the relevant spreadsheet on another computer, but my ROE was more like 30%, with a payout ratio of 0%.

      cheers

    • 

      Chris
      December 15, 2010 at 3:08 pm:

      Craig, you may also note that FSA’s net asset value is 32c per share (and rising to forecast 40c in FY11) and that forecast NROE will be 25%, with 0% dividend (awesome!).
      Therefore, you can currently buy a business at 1 x equity per share that returns 25% a year.
      That’s Graham post-Depression valuation territory….

      Disclosure: Have a position in SMSF and personally.

12. 

    Justin
    December 15, 2010 at 7:52 am:

    I would endorse Andrew’s comments about Oroton (ORL) and name it as my christmas stock. Roger has said that its competitive advantage lies in Sally McDonald. Having attended the AGM, seen Ms McDonald with Roger on Switzer and closely read the company reports, I can only agree. I would add three things: first, it showed great nouse for the Lanes to step back from management and bring in a new CEO (particularly such a good one); secondly, this advantage is being carefully entrenched through the addition of well-chosen individuals, for example, Mark Newman as head of the Ralph Lauren business and Eddy Chieng as a director. Both of these people have extensive retail experience in Asia, unquestionably an attractive growth prospect for a luxury goods retailer. Thirdly, one of four key management platforms of the company is retail innovation. This includes on-line stores in Australia and, more recently, developing a position on China’s most popular social network site (see http://www.asx.com.au/asx/statistics/announcements.do?by=asxCode&asxCode=orl&timeframe=Y&year=2010). The recent noise about online retailing has been foreseen and taken advantage of instead of being a surprise.

    Finally, thanks to all the graduates on the site (and, of course, Roger) it has been a great year of education for me. Have a happy and safe christmas, hope to join you again next year.

13. 

    Matthew D
    December 15, 2010 at 6:57 am:

    This page was great to read. Thanks guys! :D

14. 

    AndyC
    December 14, 2010 at 11:39 pm:

    Hi All,

    My pick is international, drum roll please… The Coca Cola Company.

    When I eat at McDonalds drinking my coke I often say to my wife, “do you realise we’re sitting in the second best business in the world, and I’m drinking the best business in the world”.

    I know I’m such a romantic with lines like these :\

    I like the fact that Coke is ubiquitous, and has pricing power a key factor if, or should I say ‘when’, inflation becomes an issue. Also, it’s a unique and quality product preferred by *b*illions. I think emerging markets will keep growing as fast-food stores (KFC, Maccas etc) roll out across China, Brazil and other emerging nations.

    I might just go get a coke zero out of the fridge. And remember, Coke is it!

    Cheers,
    Andrew

    • 

      Roger Montgomery
      December 15, 2010 at 11:30 am:

      Well done AndyC. I like that you are eating your own cooking both ways!

15. 

    Simon
    December 14, 2010 at 9:52 pm:

    I’m not sure that GXL fits the Xmas stocking status but it is in an industry that I know something about.
    The veterinary industry is fragmented and cottage industry. GXL is an acquirer and consolidator of veterinary practicies and has been listed for about 3 years. They have overcome initial difficulties of industry acceptance plus the issue of aging sellers remaining in the business for the escrow period. Their growth will come from acquisition but also then training their systems into practices, standardised pricing and business intelligence. GXL now offers a number of franchise type options for vets who want to partner in the business in various ways thereby providing career paths for their vets. , as well as the traditional fire brigae type pratice. They will only acquire “small animal” practice as wellness and preventative health strategies can be introduced and developped. As pets become more and more important to families, this type of practice will grow and succeed. GXL has first mover advantage as the number of target businesses in Australia as a small percentage of total businesses.
    I haven’t got the skills yet to produce valuations or ROE but thought it might be of interest.

    • 

      Roger Montgomery
      December 14, 2010 at 10:19 pm:

      Thank you for the contribution and thoughts Simon. Can you elaborate a little on why you believe pets will become more important to families (than perhaps they already are)? Are you referring to the companionship trend coinciding with aging baby boomers?

      • 

        ron shamgar
        December 15, 2010 at 12:13 am:

        i do also operate within the pet industry marketing rspca pet insurance. i work with 2000 vets nationally and also with greencross vets (gxl). unfortunately vet practices may be profitable for their owners and very crucial for pet owners, but financially GXL does not seem enticing for an investment with ROE around 10% and lots of debt.
        trust the vet with your dog but not with your wallet :-)

      • 

        Brian
        December 15, 2010 at 12:57 pm:

        Please be v careful purchasing veterinary chains. They have worked in the US but have a poor history of survival in Aus. Although feminisation is occurring in the profession, vets tend to be independent workers.

        Have a look at the low ROE for GXL
        Look at the chart for GXL since inception.Compare the chart to ARB, FWD, ORL,MCE.
        This company has lost a considerable amount of capital – not a good track record sadly.

16. 

    Greg Nunn
    December 14, 2010 at 9:03 pm:

    Christmas Greetings, Roger. I’m getting close to the end of your book but was impressed enough to get each of my 3 kids a copy before Xmas (so we can discuss it when they’re all home). I don’t have access to Sky and my question is- will we be able to access your appearances re The Stocks of Christmas somewhere on the net?

    Thanks to you and all your contributing graduates for the generous sharing of information.

    • 

      Roger Montgomery
      December 14, 2010 at 10:07 pm:

      Hi Greg,

      Thank you for your support and a Happy Christmas to you too. I republish all of the Sky appearances on the youtube channel. Here’s the link http://www.youtube.com/user/RogerJMontgomery

17. 

    Simon Anthony
    December 14, 2010 at 8:33 pm:

    Having read the following article:
    http://www.chinadaily.com.cn/bizchina/2010-06/12/content_9971693.htm

    I wondered if Roger you would consider having having a “annual” lunch put up for auction? Instead of say just one Value.able investor winning the pot, we could have say a table of ten (ten highest bids) booked at Rodger’s favorite restaurant in Sydney, with the proceeds to go to a charity of your choice. What does everyone think?

    • 

      Roger Montgomery
      December 14, 2010 at 10:12 pm:

      I would be delighted to participate and already have a cause in mind. I will have to hold back some of the best ideas to be revealed only at the lunch.

18. 

    Scott T
    December 14, 2010 at 5:05 pm:

    Hi Everyone,

    Belated birthday wishes Roger! Sorry I am leaving this to the last minute, and is a bit half baked but I am travelling and not able to access my Spreadsheets and research, however:

    My 12 stocks of Christmas nomination is Industrea IDL.

    They have had a number of issues weighing on their share price over the past few years, and they are currently addressing all of them.

    Debt is being repaid

    The Convertible bonds have been redeemed, thus removing the overhang.

    A 3:1 share consolidation has been completed, thus helping the share price look “like a real company” – this has no fiscal impact buy apparently has a significant sentiment impact.

    On top of that there is all this:

    Margins are improving.

    Mine safety is flavour of the month.

    $50ml capital raising completed

    A $35ml order from BHP has been booked this quarter

    They have specific patented technology in the mining equipment/ underground collision avoidance space.

    They are now much more focused on NPAT growth, ROE growth and debt reduction.

    This is all off the top of my head, for more details read the ASX announcements, there is plenty happening.

    Disclosure: I hold IDL shares. Seek and obtain advice relevant to your personal circumstances.

    Merry Christmas everyone, here’s to a great 2011.

19. 

    zoran
    December 14, 2010 at 3:11 pm:

    MY CHOICE IS TRS

    I recently lost 25% on this stock so please can you guys(above) start buying it so I can get my money back( I will sell as soon as I recover my loss)

    If this is not one share for “MY CHRISTMAS” i dont know what is.

    Cheers
    Zoran

20. 

    Adam
    December 14, 2010 at 1:52 pm:

    Hi Roger,

    Great work throughout the year, youre book was well worth the read i’ve recommended it too many of our client’s. (I’m a financial planner.)

    Could you please post an updated list with valuations soon for your current undervalued A1s you’ve been mentioning for a while, i.e. FGE, MCE, ORL, JBH. It would be great if you include actual intrinsic values rather than current dicount %, and also the next few years forcast valuations. I think these blog updates are invaluable, and the ones everyone looks forward to the most!

    Adam

    • 

      Roger Montgomery
      December 14, 2010 at 9:54 pm:

      Thanks Adam,

      Yes I appreciate they’re valuable!

21. 

    Guy
    December 14, 2010 at 10:26 am:

    My pick is CIL I think centrebet is is building strong roots in the online gambling world and have a good strong plan to take more market share. I currently value them at around $2.30. share price $1.43. Love to hear what you have to say Roger.

    Cheers

    • 

      Nic Arena
      December 15, 2010 at 4:39 pm:

      I Have CIL valued at 1.85-1.93 (EQPS .70, payout approx 80, ROE 25%). Not enough of a discount.

22. 

    Clint
    December 14, 2010 at 9:37 am:

    Hi Roger,

    First time commenting… Reading through the comments, I see a lot of businesses with a competitive advantage, but I still ask myself, is this advantage durable?

    As an owner of a couple of websites myself, I can’t go past online businesses. Wotif Holdings Limited (WTF), Seek (SEK), Carsales.com limited (CRZ) & REA Group (REA). All these companies have little or no debt, with high ROE.

    In evaluating all these, which one has a durable competitive advantage?

    In my opinion, SEK and REA have a durable competitive advantage, I say this because what’s the first thing that comes into your mind when you are looking to buy sell or rent a house, Realestate.com.au and what’s the first thing that comes into your mind when your looking for a new job or you have a need to advertise a position in your organisation? Seek.com.au

    Shame there both over priced at the moment…

    Merry Christmas,

    Clint

    • 

      Roger Montgomery
      December 14, 2010 at 9:49 pm:

      Thanks Clint for the thoughts, insights and for writing. One of the risks of course is embedded in the latent power of the customers. In the case of carsales.com.au two customers make up a large proportion of the revenue – they can take their competitive advantage with them.

23. 

    Brian
    December 14, 2010 at 7:13 am:

    Hi Roger, Thanks for giving the amateurs an opportunity to put their
    favourite companies up. Whilst I realise others may favour the growth
    potential in CSL ORL MCE and so on, my favourite is FWD. It is from the
    perspective of safety of capital, 10 year performance, good ROE, no debt,
    right industry and sustainable advantage. I attended the AGM in Perth
    recently and have not changed my view.
    Here are some facts using Comsec.
    Average annual return over 10 years 32% with 67% in the last 12 mths.
    Zero debt – in fact they managed an acquistion this year using cash and
    script without a discounted capital raising.
    Over 10 years the ROE has steadily risen from 10 to 24.
    There is a steady growth in earnings and dividends over 10 years.
    Add to this
    Proven management not dependant one one person. This was demonstrated
    through the GFC and the rising Aussie dollar.
    On the down side, the payout ratio is very high at 95% and it is overpriced
    at present. I have a value of $9.50. In the last 12 months FWD have
    fluctuated between $7.36 and $13.18.
    Risks:
    1.The danger of transportable homes being imported in containers from
    Europe and China using the strong Aus currency, may well be negated by the
    quality of the product offered here and the capacity to solve problems
    quickly eg assembly of kitchen canteens etc.
    2. Exposure to the commodity boom.
    Just remember they are also in the caravan, mobile home market and so have
    diversity in earnings from the baby boomers with wealth.

    It has been a great performer where I have felt my money is safe, the
    management is exceptional and the future is still bright but if you pay the
    current price around $12.50 you are paying too much as a value investor.
    Perhaps it will have a low under $9.50 in 2011.
    Patience.

24. 

    Annette Middleton
    December 13, 2010 at 9:14 pm:

    I must add my vote of support to Ken’s sentiment on ARB Corporation being a cornerstone investment in the 12 stocks of Christmas. This is truly a remarkably successful company which has not failed to deliver year-in-year out with regard to financial performance, importantly over a number of years.

    Management has navigated this business expertly through a number of major impediments – including record high oil (fuel) prices affecting 4WD vehicle sales, skilled labour shortages in Australia, soaring steel prices (Input cost) and widely fluctuating exchange rates. Management’s vision to set-up the Thai manufacturing plant has proved very astute, and is the launching pad to grow sales in Asia. In this respect, the company may well be on the verge of exponential growth.

    The clearest evidence to us all when espousing the success of this company is threefold:
    1. Profits march upward year after year, and you can be virtually assured that they will continue to march upward.
    2. They do not like to, and do not need to raise capital by issuing shares.
    3. They are one of the few companies to pay very significant special dividends, this is real money being returned to shareholders with franking credits too!

    When directors continually underpromise and overdeliver, you know you have a unique and wonderful company such as ARB.

    ARB’s has strong and enduring competitive advantages:
    1. Consumers know ARB to produce high quality products (reputation).
    2. The company has deep relationship’s with 4WD manufacturer’s whereby they supply products designed specifically for vehicle models.
    3. ARB have invested in research and development over many years, A number of their products have taken a considerable period of time and effort to develop, a process that is not easily dupilcated by competitors.

    You really can’t ask for much more than this for Christmas, but you get more – because they just keep giving!

    • 

      Ken D
      December 15, 2010 at 11:49 am:

      Nick’s comments on Phillip Fisher’s “Common Stocks and Uncommon Profits” prompted me to dust off my copy. I really enjoyed this book the first time round and must read it again. Chapter 2 “What to Buy” talks about the attributes that a company should have to provide the highest likelihood of a several hundred percent gain in a few years (or more over a longer period). Fisher lists 15 points, most of which should be met. I’ve quickly run this checklist over ARB Corporation. Just a tick or cross as no time for elaboration. Many of the points have been discussed in various posts here on this company.

      1) Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? Yes

      2) Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited? Yes

      3) How effective are company’s research and development efforts in relation to its size? Yes, strong emphasis on R&D.

      4) Does the company have an above average sales organisation? Yes, strong emphasis on sales.

      5) Does the company have a worthwhile profit margin? Yes

      6) What is the company doing to maintain or improve its profit margins? The proof is in the pudding to a certain extent but a number of initiatives have been discussed in posts here.

      7) Does the company have outstanding labor and personnel relations? Some scuttlebutt needed but I suspect yes

      8) Does the company have outstanding executive relations? Ditto above

      9) Does the company have depth to its management? Mmm good question..must look into that. I suspect yes.

      10) How good are the company’s cost analysis and accounting controls? I would guess pretty tight.

      11) Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition? Yes, discussed in previous posts

      12) Does the company have a short-range or long-range outlook in regards to profits? Definitely a lot of foresight in their thinking.

      13) In the foreseeable future will growth of the company require sufficient equity financing so that the large number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth? No. Annette makes this point above.

      14) Does the management talk freely to investors about its affairs when things are going well but ‘clam up’ when troubles and disappointments occur? Not the case.

      15) Does the company have a management of unquestionable integrity? Yes, with a good stake in the company.

      • 

        Roger Montgomery
        December 15, 2010 at 7:20 pm:

        Great addition Ken D. I am struggling to choose. The great thing about investing is you can build a fundamentally impressive portfolio out of the companies that have been listed here.

25. 

    Craig Marsh
    December 13, 2010 at 8:52 pm:

    Hi Roger first of all I hope you had refreshing break and very happy 40th.

    My choice for the Christmas stocking is Sirtex Medical (SRX) which makes SIR-Spheres microspheres used in the treatment of inoperable liver cancer.

    From their website:

    The primary objective of Sirtex is to research, develop and commercialise effective treatments for liver cancer using novel small particle technology. Liver cancer is a disease of the cell. It develops when cells in a part of the body begin to grow out of control. Cancer cells can form a mass of tissue commonly referred to as a tumour.
    Sirtex has developed an innovative means of treating liver cancer. In cases where it is not possible to surgically remove the liver tumours, this product can be used to deliver targeted, internal irradiation therapy directly to the tumour. This new therapy is called Selective Internal Radiation Therapy also known as SIRT.

    This technology was developed in the 1980’s in Perth, Western Australia. Many patients have been treated commercially and within a clinical trial setting all over the world (Australia, USA, Europe, Singapore, Hong Kong, New Zealand and India). Sirtex technology has TGA listing in Australia, PMA approval by the Food and Drug Administration (FDA) in the USA and BSI consent for Europe (CE Mark).

    My thoughts:

    Along with regulatory approval, insurers or healthcare authorities pay for the procedure in Australia, US, Germany and a few other countries. Currently the product is administered in late stage liver cancer but through trials underway the company is hoping to provide doctors with evidence that it should be used at an earlier stage. The trials are comparing the use of SIR-spheres in conjunction with chemotherapy as opposed to the use of chemotherapy alone for the treatment of liver cancer.

    These trials are being conducted in various countries around the world and so therefore are affecting short-term profitability, with EPS expected to be down 20% next year. This has had an effect on the intrinsic value(IV) calculation for next year making the company look over-valued currently but when you consider the potential profits that will come from the success of these trials, the future IV is tantalising.

    At the moment SRX sells less than 5000 doses a year for a NPAT of just over $16m. When you consider that worldwide each year 600,000 cases of this hideous disease are diagnosed their prospective market is enormous.

    Now I prefer to invest in companies selling at large discounts to their IV and that IV increasing into the future, the proverbial virtuous circle. SRX has one part of this equation missing, the current margin of safety but I believe that by the time we see the profits roll in from the investment in these trials the price will be a lot higher than the current.

    In FY10 EPS were 28.8 cents and EPS have grown at an average rate of 55 per cent over the past five years. Europe remains the fastest growing region, with dose sales up 31% to 1,288 and revenue of $21.5m. In the US, dose sales were up 8% to 2,490 delivering revenue of $40m. Sales in the Asia Pacific region grew 5% to 393 and revenue of $2.8m.

    SIR-Spheres microspheres dose sales were a record for the first quarter, being up 16% to 1,181 with revenue of $17.8m, an increase of 8% but operating profit is down 15% to $4.6m due to the strong $A.
    I calculate FY11 IV at @$4.20 but with analyst forecast of FY12 EPS of 42c, I calculate a ROE of 39% and IV of $12.50, rising further into the future. The company has net assets of $41m which is also the amount of cash on the balance sheet and no debt.

    Other positive considerations are the new clinical study to assess the safety and tolerability of its targeted internal radiation therapy to treat primary kidney cancer.
    The fact that Hunter Hall has a 30% investment in the company and Platypus AM has recently moved to 10%, a big vote of confidence.
    A new manufacturing facility is being built in Singapore and is expected to open early 2011.

    Negatives are that if the trials don’t prove SIR-spheres in conjunction with chemo are more effective than chemo alone, future growth will vaporize and downside is probably $4.00. I view this as unlikely because a trial published in Sept 09 showed that SIR-spheres and chemo combined was effective. Directors own very few shares and founder Robin Gray is selling and quite a shareholder agitator.

    Competitors are Canada’s MDS Nordion and the UK ‘s Biocompatibles.

    I hope you find their potential as enticing as I do and to finish off I see an investment in this company as not only monetary but also of a social benefit by assisting with a possible reduction in suffering of affected individuals. It’s also a chance to get behind a great little Aussie company taking innovation to the world.

    Merry Christmas Roger and all the value.able graduates.

    • 

      Roger Montgomery
      December 13, 2010 at 11:17 pm:

      And a Happy Christmas to you too Craig.

      • 

        Ashley Little
        December 14, 2010 at 7:02 pm:

        Thanks Craig,

        I have looked at this one a number on time.

        Great to get you views on it

        It looks like the valuable grads gathering wont be happening in 2010 so we will have to share a beer at the 2011 event should Roger think it suitable that we all get together.

        Merry Xmas and all the best to you and your family.

      • 

        Roger Montgomery
        December 14, 2010 at 10:20 pm:

        Hi Ashely and all,

        We will put something on for 2011. Too much to do this year. Looking forward to some very exciting opportunities in 2011.

26. 

    Joab Soh
    December 13, 2010 at 8:44 pm:

    Merry Christmas everybody!

    My stock for Christmas is still MCE. Although most of the value.able graduate are familiar with MCE, I still continue to believe that next year will be another good year.

    Let’s start with the basic:
    1) Is it a good quality business? Below are some stats for FY10:
    -Gearing = 0% (cash on hand exceed debt)
    -Revenue up 89% in FY10.
    -EPS of 31.0 cents per share (from 6.3 cents in FY09)
    -Order book $188m (from $136m FY09). Recent announcement states order book is approximately $170m by end of Oct.

    When reading FY10 annual report, what draws my attention is that ‘Order Book’ is listed as one of the performance measure by management. This demonstrates that management is always focusing on securing future revenue/growth.

    2) In terms of ‘sustainable’ competitive advantage, my view is that the one key ingredient is ‘constant innovation/ evolution’. What does Apple Inc & Roger Montgomery have in common? Apple Inc launches iPad (a new product in between laptop and smartphones) and changes its existing products every 18 months. Roger now has a class of value.able graduate (which I am proud to be part of).

    In the same way, MCE is constantly improving its product and relaunching existing products. In FY10, $2m was spent in R&D which management believes it will place the business as a market leader with significant competitive barriers.

    3) Lastly, considering our investment strategy is to buy
    (a) good quality business
    (b) with rising intrinsic value
    (c) trading currently at a discount

    MCE was attractive 6 months ago, and is still attractive now.

    • 

      Joab Soh
      December 13, 2010 at 9:09 pm:

      quote ‘Too much of a good thing is wonderful’

      • 

        Roger Montgomery
        December 13, 2010 at 11:16 pm:

        Thank Joab and Mae!

    • 

      Ray H
      December 15, 2010 at 1:58 am:

      Can we add a big thank you to Roger for this interactive format? I love it.
      Thank you Roger for making my purchases (yes plural) of Value.Able more valueable.

27. 

    Julian Hunter
    December 13, 2010 at 8:32 pm:

    As one of your silent readers I thought I’d come and finally make a contribution. My number one stock for christmas may be a bit out of left field as it is not one listed on the ASX and thus you may not have a MQR for it but I’ll go ahead and post anyway.

    The stock which is my favourite is Ebix (NASDAQ: EBIX). The company is basically a software company operating in the insurance industry. It is involved in cloud computing and its primary business is the operation and deployment of insurance exchanges. It’s goal is essentially to eliminate paper from the process of insurance (Similiar to what E*trade did with shares I guess).

    I believe it has some extroadinary competitive advantages. Namely it’s CEO has turned the company around from a business which was losing millions of dollars to a company rated by Forbes as one of the fastest growing companies on the planet. Ebix’s average ROE over the last few years has been in the 30% range. Relatively little debt. The management owns a good chunk of the outstanding shares and the company has been purchasing its own shares back recently. It’s margins are phenomenal as they usually are in software where there are few competitors (Microsoft? Google?) up in the 38%-40% net profit range though this might not be sustainable long term.

    The management seems very candid and the CEO has stated that he will not issue a dividend in the near future as he “can get better returns for shareholders by reinvesting their money back into Ebix”. That type of philosphy from a CEO is one I definately admire. As a self confessed Warren Buffett fan, the CEO of Ebix, Robin Raina, seems to recognise the economics of this business are similiar to the newspaper industry that Buffett recognised several decades ago. While there may be multiple exchanges eventually one will come to dominate it’s particular market and he is positioning Ebix to become that dominant player. Check the market share of Ebix in Australia and you will see what I mean.

    Ebix has strong recurring revenues with a customer retention rate close to 98% so it’s earnings are relatively predictable. As aformentioned it has, and is growing, some monopoly like characteristics in some countries (such as Australia with it’s Sunrise exchange). After it recorded record earnings this year its share price is down from a high of $28.21 to it’s current price of $22.46.

    Now I am not naive enough to think this stock comes without risks. It operates in the technology arena which, with the fast pace of progress, always poses a threat. It also has a “growth via aqcuisition” strategy which, depending on management, can be either a positive or a negative. It has a very high short interest ratio which could indicate something wrong with the underlying business (although with the CEO owning 4+ million shares I see this as unlikely, unless he starts selling heavily in which case I may do the same!). The other threat I see is similiar to ORL where the CEO may decide to jump ship.

    Anyway just thought I’d throw in something a bit different. Merry christmas to all the value.able graduates!

    • 

      Roger Montgomery
      December 13, 2010 at 11:34 pm:

      Thnaks for the heads up Julian and for making your first contribution. There is indeed an exciting array of businesses when one turns their mind globally.

28. 

    Bernie Robinson
    December 13, 2010 at 7:55 pm:

    G’day Roger
    I was your second book purchaser and love it !!!!
    My stock is Thorn Group (TGA).
    My intrinsic valuation seems to come in a bit higher than others at $2.17 – Book val .63 ROE 23.8 (I used 22.5) P/out 42%. What do you think?
    Since their low on 4/5/10 at 96cents, they have steadily grown to a high of $1.89 on 6/12/10 – a level of high resistance but I’m confident. I originally bought in at 67.5cents on 29/05/10 and have bought a few since (especially armed with the intrinsic value confidence). They have a great business model with Radio Rentals, with a high level of cusomers on direct payments from Centrelink which means they have a very low level of bad debt. Their current 4.1% fully franked div is also very nice. Many people rent in bad times, this plus their rent-then-buy-at $1 plan I see a great future. Hope you and everyone else see the same and help them along!

    • 

      Roger Montgomery
      December 13, 2010 at 11:24 pm:

      Hi Bernie,

      It will be in the final column for the year. Thanks for your sentiments about my book.

29. 

    Nic Arena
    December 13, 2010 at 6:20 pm:

    Hi Can anyone tell me how to “translate” the asx announcements of JB HiFi recently. Are they purchasing or selling shares?

30. 

    Tiago
    December 13, 2010 at 3:31 pm:

    Hey Roger! How are you? Good holidays? Mate, get some $$$$of the market and print my book!! Still haven’t got it !!
    Have a nice Christmas!!
    Take care

    • 

      Roger Montgomery
      December 13, 2010 at 6:05 pm:

      Thanks Tiago,

      Send an email with your purchase confirmation information and I will have it looked into.

31. 

    James
    December 13, 2010 at 2:29 pm:

    Roger, I’m sure you’ll be familar with Headline Group, and I would be interested in your current opinion.

    Headline is an obscure retailer to most, and rarely hits the headlines, but had more exposure recently after buying the 13-store Babies Galore operation for $8.8m. One thing that interested me was the involvement of the private Myer Family Company, which is investing $5m in equity stake. I’m even more excited about the potential of Headline’s licence to build the successful British Mothercare brand in Australia, which is a quite prized brand in the UK. Mothercare also agreed to invest $12.2m in convertible notes, exercisable at 28c, terms the independent expert called “not fair, but reasonable”. The Babies Galore purchase puts Headline on course to roll out 48 Mothercare-formated stores by 2020, while lifting revenue from $40m now to $175m by 2014.

    The rollout means Headline will dominate the specialist baby care sector, the only main rival being Baby Bunting. But when general retailers are taken into account, Headline will still account for only a fraction of what is a $4.1 billion market. Headline lost $3.3m last year. An $800,000 shortfall this year is forecast and a $6.4m profit in 2011-12, rising to $13m by 2013-14. Having 4 children of my own and witnessing my wife doing a first class job at draining our household finances on every piece of baby paraphernalia imaginable, I rate Headline a long-term buy. If it’s good enough for Myer, it’s good enough for me.

    • 

      Nick Mason
      December 13, 2010 at 8:45 pm:

      Great suggestion James, I am fully invested at the moment although am considering what I could possibly sell to purchase a small stake in this company. It appears a wonderful prospect.

    • 

      ron shamgar
      December 13, 2010 at 9:21 pm:

      my family friends were the founders of baby galore who sold the chain pre-crisis to private equity. private equity then thought they knew how to better manage it (including the guy who founded super cheap auto), when they failed big time, they sold it off to another private equity who ruined the business further and finally decided to pull out any cash that was left in the business, not pay suppliers and declare bankruptcy right after selling it for half of what they spent to the headline group.
      Now, a lot of these suppliers are not happy and a lot of these stores have been badly managed. watch out…
      also if my memory serves me right, the myer family were investors in some of the allco funds….and we all know what happened to those.

      merry Christmas!

32. 

    Darrell
    December 13, 2010 at 1:34 pm:

    Roger, could you give me your latest ratings for QBE. Suncorp and
    AMP. I have shares in all three and I’ve had advice to consolidate all the
    funds into just one company. I’m part way through Value.able but have not
    yet got the skills to do the ratings myself.

    Thank you

    • 

      Roger Montgomery
      December 13, 2010 at 6:12 pm:

      OK Darrell,

      Will get to it. Have a few deliverables ahead in the queue.

33. 

    Andrew Schiller
    December 13, 2010 at 11:17 am:

    Hi Roger,
    yet another of your appreciative students says first-time hello, also Season’s Greetings!
    On a darker note, I am wondering what’s happening with JBH and TRS – hopefully it’s just transient retail weakness?
    Is there some attitudinal change going on with JB? Today for the first time I noticed one of the funds unloading a percentage of their holdings in it.
    My Xmas stock is MMl, Medusa (gold) mining in the Phillipines.
    It has no debt, a high ROE the last two years since it started producing, the cheapest production cost of any gold miner and I’ve been happily (in my own small way!) swing trading it on its stellar 2010 rise.
    Happy days,
    AS.

    • 

      Roger Montgomery
      December 13, 2010 at 6:18 pm:

      Hi Andrew,

      Welcome to the blog and thanks for writing. There’s lots of discussion here about those two stocks. Have a read of the comments under the last couple of posts.

34. 

    Pat T
    December 13, 2010 at 9:52 am:

    Hi Roger,

    One of my Twelve Stocks for Christmas would be ThinkSmart (TSM). TSM has a 51% compound annual growth rate over the last 4 years, a strong competitive advantage in Australia, and is rapidly growing its overseas business – particularly in the UK. As economic circumstances dictate, or people decide it’s better to lease/rent computers with full support services and upgrade after 2 years, rather than buy equipment that rapidly becomes obsolete, this company will continue to grow strongly.

    Using an RR of 12%, I calculate TSM has an intrinsic value of $0.99, which currently represents a 31% margin of safety. TSM has little or no debt after a recent capital raising, a strong institutional list of shareholders, and its current ROE of 25% is forecast to rise. Much will depend on the Christmas trade which has been very encouraging in the UK, but TSM deserves some smart thinking as one of the Twelve Stocks for Christmas.

    Pat T

    • 

      Roger Montgomery
      December 13, 2010 at 6:20 pm:

      Thanks for the ideas Pat.

35. 

    Pat T
    December 13, 2010 at 9:28 am:

    Roger,

    One of my Twelve Stocks for Christmas would be ThinkSmart (TSM). Currently rated an A3 stock, TSM has a 51% compound annual growth rate for the last 4 years, a strong competitive advantage in Australia, and is rapidly expanding overseas – particularly in the UK. As more people decide it’s better to rent/lease computers with full support services and upgrade every 2 years, rather than buy equipment that quickly becomes obsolete, this company will continue to grow strongly.

    Using an RR of 12%, I calculate TSM’s intrinsic value at $0.99, which currently represents a 31% margin of safety. After a recent capital raising there is little or no debt and a very strong list of institutional shareholders.One analyst forecasts TSM will exceed its current ROE of 25%. Much will depend on the Christmas trade, which is already very encouraging in the UK. TSM deserves some smart thinking as one of the Twelve Stocks for Christmas.

    Pat T

    • 

      Roger Montgomery
      December 13, 2010 at 9:58 am:

      Thanks Pat T. I will have a good look at it.

    • 

      Ashley Little
      December 13, 2010 at 10:52 am:

      Hi Pat,

      I too like TSM.

      We will have to keep a keen eye on the Yearly accounts to see if the money from the capital raising has been used well.

      That is, incremental ROE etc

    • 

      Ken G
      December 14, 2010 at 1:35 pm:

      Hi Pat
      I like TSM as well but not so certain of your valuation of .99 mine is closer to .65. What is yours Ashley. If you havn’t floated away in the floods. We should be selling tinnies with 20hp motors or bigger.

      • 

        Nic Arena
        December 15, 2010 at 4:25 pm:

        I have an IV of .66 to .74 (EQPS .18, payout around 60%, ROE of 25%).

        Thanks to everyone for their contributions.

36. 

    Ken D
    December 13, 2010 at 2:52 am:

    Hi all,

    I will have to nominate ARB Corporation (ASX:ARP). Why ARB? I outlined what I see as the merits of the company in my post under Roger’s “Are you drowning in a sea of complexity?” I ask that this previous post be considered along with the following additional comments.

    What I didn’t emphasise in that previous post was ARB’s current international presence and future growth potential. ARB Corporation’s products have a truly global presence, with the company exporting to over 100 countries (hover cursor over the dark grey areas of map on http://arb.com.au/stores/worldwide.php) with 1300 authorised distributors in North America alone (see arbusa.com). Whilst ARB has benefited from growth in 4wd and utility sales in Australia over the last few years, the company’s future growth prospects aren’t limited to the Australian market. Judging by the company’s global distribution footprint, there are still untapped markets in Asia, the Subcontinent, Middle East and northern Africa (hover cursor over light grey areas of the map on http://arb.com.au/stores/worldwide.php – note the company is actively seeking distributors in many of these regions).

    Rather than suggesting one purchase a share of ARB Corporation for Christmas, instead might I suggest putting ‘a little patience’ in the Christmas stocking (the greatest gift for an investor) and wait for an opportunity to arise through 2011 to purchase with a slightly higher margin of safety (if Roger’s calculations reflect my own below).

    Roger has promised to update his numbers on ARB but, as a Value.able graduate, I should be prepared to have a go myself. I calculate an IV of just under $8.00 (margin of safety of 11% based on current shareprice). This calculation is based on: 1) a required rate of return of 12%; 2) forecast EPS of 49.1 cents/share for 2010/11; 3) an implied ROE of 32% on shareholders equity ($111.4 million as at June 2010); and 4) a dividend payout ratio of 45% (could be a little higher or lower). Using the same approach, for 2011/12, I calculate an IV of $8.70 given a forecast EPS of 55.3 cents/share and implied ROE of 30.6% on forecast equity of $131 million as at June 30 2011.

    Although only one analyst has contributed to the above forecasts, over the last 13 years analyst’s forecasts have regularly surprised on the upside by an average of +4.3% (range -0.4% to +12.8% with -0.4% being the only negative surprise in June 1999). I see this history of positive earnings surprise as being a reflection of good management i.e. management being: 1) on top of the business; and 2) slightly conservative in making forward looking statements. So one can put some store in these forecasts, not to say that they may not change before June 30 e.g. based on new company guidance.

    Implicit in the above calculations is a 17.5% increase in shareholders equity in 2010/11 and 16.8% in 2011/12. The calculated projected increase in IV is more modest. This is because: 1) based on forecast EPS, projected ROE will decline slightly all things being equal; and 2) I have assumed a small increase in payout ratio. If the share price was to rise to meet my calculated IV over the next 12 to 18 months, I calculate a return of 12-13% per annum (including dividends) based on the current share price.

    Remember, one should not be greedy at Christmas time! Furthermore I would consider a share in ARB Corp to be the kind of gift that should keep on giving.

    One should not be greedy at Christmas time but one should be safe, and keep one’s family safe. Hence I think it only reasonable that one demands a solid margin of safety, particularly at this time of year. So one might wait patiently for a dip in price, or even more interestingly, external forces leading to a hint of a wobble in that solid track record (see my previous post mentioned above) which, in turn, may lead to market ‘short-termism’ i.e. the market ignoring factors such as the company’s capable management, sustainable competitive edge, solid past track record and, more importantly, long-term future prospects.

    I must state that I don’t have industry experience. However, I can disclose that my 4WD does sport an ARB bullbar! Folk at my work engage in extensive 4wd surveys in all sorts of terrain. New vehicles are always heavily accessorised from the ARB catalogue.

    Merry Christmas to Roger and all

    Ken D

37. 

    Brad S
    December 12, 2010 at 8:40 pm:

    Roger,
    Happy birthday, Merry Christmas and thank you for sharing your knowledge over the last year. I feel privileged to be in your class of 2010. I have learnt many things since seeing you on Switzer for the first time in early Feb 2010, and am grateful in finally learning a valid approach to investing in companies. I still have a lot to learn however really value the foundations you have instilled with your education.

    My stock is Seymour White Limited, (SWL) an infrastructure development company with 23 years of history in construction. They specialise in building bridges and roads in SE QLD /Northern NSW. They floated in May 2010 at $1.10 per share, and has since had a 70% increase in share price to be currently trading at $1.87. My 2010 intrinsic value is $3.10, the current price being at a 43% discount to intrinsic value. (2010 equity/share : 36 cents, ROE 50%, payout ratio 50%, RR 12% with multiplier of 13.05 from page 184).

    They have a competitive advantage of being able to deliver complex engineering projects on time and cost, with a proven track record over the last 20 years. They have strong relationship with government authorities and understand their requirements and hence keep winning contracts.
    They have an organic growth strategy, no debt, a strong order book going forward over 2011/2012 and have won a new contract on Friday 10/12/2010. They originally seemed to be thinly traded however recently there is enough liquidity for retail investors.
    I think future prospects are positive in terms of winning future contracts. Roads, bridges and developments are going to continue.

    Thanks again,
    Brad S

38. 

    Rainsford
    December 12, 2010 at 6:41 pm:

    Hi Roger
    My Xmas stocking filler is Bradken BKN. While it is trading at over $8, a substantial premium to my IV calculation of around $6, I just think this company is poised for growth and has come through the GFC in good shape, It is a specialist foundry business and makes consumables for the resource sector. It also makes rail wagons in China and has recently bought a business that makes consumables for the oil sands business in North America. Smart thinking in my view. In 2007 and 2008 it had a ROE of over 30% which has subsequently dropped to 15% but I think it’s on the way up again! I think it has a good moat, good management and is well positioned to take advantage of the continuing Australian resource strength, tied in with some globalisation.
    Merry Xmas
    Rainsford

    • 

      Roger Montgomery
      December 13, 2010 at 9:59 am:

      Thanks Rainsford for the contribution and throughout the year!

39. 

    Geoff Cruickshank
    December 12, 2010 at 5:28 pm:

    After their Dec 1 update, it looks to me as though MCE is proceeding well. First quarter earnings about half of last full year, plenty of orders, strong quotation requests, new facility soon to be operating. Let’s be cautious and say 31 million earnings for the year, 15% dividend payout (?), then the shares seem to have an IV north of $10. I like the stage this company is at- early in a growth phase, compared with some of the more established high ROE companies.

40. 

    Nicholas
    December 12, 2010 at 10:03 am:

    Apologies Roger. I should have added to my comment for the benefit of other posters that the ASX code for Hunter Hall is HHL.

41. 

    Nicholas
    December 12, 2010 at 10:01 am:

    Here is my contribution from the industry within which I work (please note that I have no association with this company): Hunter Hall.

    Introduction
    Hunter Hall is a funds management business. They were established in 1993 and are Australia’s largest ethical investment manager. They operate 5 investment trusts – Value Growth Trust (“VGT”), Global Ethical Trust, Australian Value Trust, Global Deep Green Trust and International Ethical Fund. They also operate 1 LIC – Global Value LTD (HHV). Hunter Hall’s income is generated from the management fees and performance fees collected on their assets under management. Their funds under management (FUM) as at 30 June 2010 was $1,817m (down from a pre-GFC level of $2,351m at 2008).

    Competitive advantage
    Hunter Hall’s competitive advantage is as a result of:

    1. Their position as the market leader in ethical investing. For those advisers specializing in ethical investment and retail investors with a similar bent, Hunter Hall is the first port of call. Thus they have a strong position in a niche segment of the funds management business. Despite speculation that ethical investing was going to become a growing part of the investment community it has arguably failed to gain traction. The GFC could have played a role in this – people may have stopped worrying about saving trees and started worrying about saving their jobs/super balances! Ethical investing could again pick up momentum though as investor confidence grows. Ethical investing is also reasonably popular amongst younger investors.

    2. Strong management. Peter Hall has built Hunter Hall into an excellent investment manager. He appears to be an extremely talented investor and an inspiring leader. What mistakes he may have made along the way – such as perhaps giving some of his portfolio managers too much leeway in the past – appear to have been corrected. Peter is around 50 years of age so is probably not about to retire which bodes well for the medium term future of the business. Importantly Peter Hall continues to hold a large portion of the stock (around 44% issued capital). Other senior portfolio managers – Jack Lowenstein, James McDonald and David Buckland – also feature in the top 10 shareholders.

    3. HHV – this LIC that Hunter Hall floated in 2004 has a long-term management agreement that entitles Hunter Hall to the management fees from this entity. Those fees help underwrite the cost structure of the Hunter Hall group. Thus incremental revenue growth from other assets e.g. increasing fund flow into the VGT fund or its new Asian fund (see notes below) should predominantly flow to the bottom line.

    4. Long and proven track record. In funds management a long track record of success helps. Hunter Hall has that. Its VGT fund has been one of the top performing investments in Australia since 1994.

    Weaknesses
    To the best of my knowledge Hunter Hall has little or no market share with institutional investors. My guess is that the reason is the volatility (or probably more accurately the ‘perceived volatility’) of Hunter Hall’s funds may be a concern for the institutions and their researchers and secondly their high management fees may be an obstacle to gaining institutional support.

    Other weaknesses are their reliance on stable equity markets (something that has been missing in the last few years) and perhaps some key man risk around Peter Hall although I’d argue that he has done a better job of mitigating that than perhaps Platinum or IML have done.

    Threats
    Distributors of retail products (otherwise known as platform providers) are seeking to use their scale advantages to crunch product manufacturers (e.g. investment managers such as Hunter Hall) on their fees. Hunter Hall is likely to resist this – in much the same way Platinum Asset Management seems to have – on the basis that their excellent long term returns justify the fees.

    Opportunities
    Hunter Hall has never aggressively marketed its products through adviser channels. To date it hasn’t had to – it has relied on its stellar long term performance to attract investors. However to grow its business it needs to invest more money in getting its message across. To assist in this they’ve appointed a business development manager (another name for a sales representative) to the southern states to drum up business. Assuming that person is competent then it should help to focus greater adviser attention on Hunter Hall’s products.

    Another area of opportunity for Hunter Hall is the new investment trust it plans to open in 2011. The trust will focus purely on Asia and it could be a good revenue generator for Hunter Hall. Hunter Hall has an excellent track record in uncovering winning stocks in Asia and given the region’s strong growth attributes and investor enthusiasm for Asia it could become a popular fund.

    Financials
    The financial position of Hunter Hall makes good reading.

    At 30 June 2010 Hunter Hall had cash on their balance sheet of $20.88m (before dividend and tax payments). They have debt of $3m which is effectively just an internal margin loan linked to their International Ethical Fund (IEF). Thus total net cash and investments were around $30m at June this year.

    The ROE figures over the last 5 years have been: 2006 = 63.3%, 2007 = 56.8%, 2008 = 62.9%, 2009 = 64.6% and 2010 = 30.3%.

    Their payout ratio is effectively 100%.

    Since 2001 funds under management have increased from $200m to roughly $1,817m at 30 June 2010. The revenue in the business is below its pre-GFC (FUM reached around $2,300m) but is recovering. The GFC caused a fall in Hunter Hall’s funds under management due to both lower asset values and outflows.

    So in summary the business has zero net debt, net cash and investments of $30m and a historically high ROE.

    Valuation
    I’ve got a good financial background but I must admit that I really struggled with the valuation of this stock (more so than I have with other stocks). But here are my thoughts: I used data directly from the financial reports (as opposed to Comsec), I applied a ROE of 42.5%, a 100% payout ratio and a RR of 12%. I came up with an IV of $6.40.

    • 

      Roger Montgomery
      December 13, 2010 at 10:01 am:

      Great post Nicholas. Thanks for the thoughts. Funds management can be extraordinary and simple businesses.

    • 

      Brad 17
      December 13, 2010 at 12:08 pm:

      Great analysis Nicholas – I like HHL too.

      But I cannot get close to your valuation of $6.40 – with equ/shr of $1.05 and your other inputs above I struggle to get IV above $4. You have done the hard work and reviewed the fin reports – how does your equ/shr compare to my $1.05?

      Thanks Brad 17

    • 

      Ashley Little
      December 14, 2010 at 10:15 pm:

      Hi Nic

      Nice,

      Thanks for that

42. 

    Ray H
    December 11, 2010 at 10:45 pm:

    Hi Roger,

    My company selection is Cellestis (CST).

    Overview
    Cellestis is a medical diagnostics company, focussed on cell mediated immune response diagnostics. Presently their main commercial product is Quantiferon TB Gold in-tube, a blood test for latent tuberculosis (not to be confused with active TB, which is diagnosed in a completely different way). For the medically or technically minded, the test is a type of interferon gamma release assay (IGRA). The Quantiferon test is approved for use in all major markets, including the USA, Europe, Japan, the Middle East and Australia. The use of this test was recently recommended by the US Centres for Disease Control. Cellestis also have a product for diagnosing cytomegalovirus, principally for use in solid organ transplant patients. They are currently researching and developing diagnostics for Lyme disease, a couple of cancers, an autoimmune disease, and allergy and immune function testing.

    Competitive Advantage
    The main competitor for latent TB testing is the TST skin test, a test that has been used for over a hundred years. The TST suffers from a number of limitations. It requires an injection, which must then be ‘read’ for a reaction 2 to 3 days later, meaning the patient must return for a second visit. The reading of the test is very subjective and prone to error. It is also quite common to achieve a ‘false positive’ reading in patients who have received a prior BCG vaccination for tuberculosis.
    Numerous medical studies have shown that Quantiferon does not suffer from these shortcomings. As it is a laboratory analysed blood test, the patient is only required to make one visit to draw a small amount of blood. The laboratory testing process is automated, meaning large volumes can be tested relatively cheaply. Although the Quantiferon product is more expensive than the TST injection, it actually saves money by requiring less labour in the process, and also reduces expensive treatment of those who are not actually infected.
    Oxford Immunotec in the UK also manufacture an IGRA blood test for latent TB, however their process involves counting spots in the processed sample to determine a result. This is labour intensive and expensive and is thus useful in a research setting, but not considered a commercial threat to Cellestis.
    Cellestis has strong IP protection over its products, and continuing R&D to improve the process. Generic competition is expected after 2017. In the meantime, the company is focussed on branding to establish an enduring competitive advantage. Just as consumers think Panadol rather than paracetamol, the company aims for medical professionals testing for latent TB to think Quantiferon rather than IGRA test.

    Growth
    The medical profession is notoriously conservative, and the TST has been around a long time, meaning it is entrenched as the standard test. Around 45 million TST tests are performed each year. For the financial year ending June 2010, Cellestis sold 1.9 million Quantiferon tests. A large body of scientific research has been collected showing the benefits of the Quantiferon test over the TST, and the tide is now starting to turn. The potential for growth is clearly large, and Cellestis dedicate a substantial budget to sales and marketing in all major markets. Importantly, customers are ‘sticky’ – once they convert to Quantiferon testing they are unlikely to go back. The company has enjoyed sales growth every year since 2004, and current forecasts are for 30 to 40% sales revenue growth this year and again next year. Profit growth is expected to equal or exceed revenue growth.
    New diagnostic products also provide future growth opportunities.

    Financials
    The company generates a very favourable gross margin of around 65%. ROE for the last financial year was 29.4% and expected to increase in future years. The company has no debt (it has $22.5 million in the bank). It is cash flow positive with no goodwill on the balance sheet. It generated revenue of just over $40 million dollars last financial year from the 1.9 million Quantiferon tests sold, and an NPAT of $8.2 million. The dividend payout ratio of around 60% is anticipated to continue for the foreseeable future.
    The only issue I have with the balance sheet is the growing cash balance that is only earning bank interest. It could be put to better use with more R&D or a share buy-back. There is a currency exposure with translation of foreign profits back to Australian dollars, however there is a natural currency hedge as manufacture and marketing costs are generally made in the currency where revenues are earned.
    I have calculated a conservative IV (12% RoR) for this financial year of $2.49 and for 2012 of $3.90.

    Disclosure: I hold CST and add whenever a margin of safety exists.

    • 

      Roger Montgomery
      December 13, 2010 at 10:01 am:

      Thanks Ray H,

      You aren’t the first to mention it and I there are some here on the blog with medical industry insights that agree with you.

      • 

        Ian
        December 15, 2010 at 12:50 am:

        with the major cautionary note that the World Health Organisation (WHO) recently endorsed a rapid diagnostic for TB based on commpletely different technology….www.who.int/mediacentre/news/releases/2010/tb_test_20101208/en/index.html

      • 

        Ray H
        December 15, 2010 at 1:44 am:

        Thanks Roger – it is nice to get in a stock that ticks all the Value.Able boxes (in my opinion, of course) before it gets mainstream coverage. Perhaps the reason that I love this company so much is that I would love to own it. I don’t care what the share price does – to me this is a fantastic business and I love it when the share price goes down. I also buy nice wine at a discount to my own value :) What better comparison?

43. 

    ken fraser
    December 11, 2010 at 7:45 pm:

    Forge will be the stock on Summer Money. It is 100% under value and hopefully it will continue to grow like it has the last 3 years. All the best, Ken.

44. 

    john frilingos
    December 11, 2010 at 7:37 pm:

    Against the backdrop of a strongly performing gold price over the past three years – which has seen the price rise to an all time high in nominal terms of just over US$ 1,400 per ounce – gold shares have continued to perform well. Most forecasters predict that the gold price will remain firm but volatile over the next few years, principally from its role as a store of wealth and increasingly preferred alternative to paper currencies and especially the weakened US dollar.
    A small cap gold mining company that could benefit from these favourable conditions is Focus Minerals Limited (Focus).
    Operates gold mines in the famous historical gold district of Coolgardie in WA where the company has built up the largest ground holding and embarked on a program of renewal and expansion that most analyst’s forecast will lift annual output towards 130,000 ounces over the course of 2011.
    Improving its operations with modernised infrastructure comprising the company’s’ various mines and recently refurbished large treatment plant at Coolgardie and potentially important new mine nearby called The Mount.
    Other benefits include;
    Improving financial returns by lowering unit costs and boosting gold output.
    Increasing its gold resource base of over 2M ounces.
    Broadening its exploration activities to include regional projects such as its exciting Treasure Island gold prospect on Lake Cowan.
    Focus has been a modestly profitable gold producer from operations that have relied on external ore processing in the past. Forecasts are that the company will significantly improve its profitability and operating cash flows from FY11 onwards from higher ore grades and ore processing at its own treatment plant.
    And the best feature of their operation there is no debt.

    • 

      Roger Montgomery
      December 13, 2010 at 10:02 am:

      Thanks for that insight John. And thank you for your posts this year.

    • 

      Steve I
      December 15, 2010 at 11:25 am:

      Good pick. Whilst it has high production costs per ounce, there are a lot of positives and has the potential to significantly increase production. If the company doesn’t make any major mistakes, it certainly looks as though there would be a massive increase in the intrinsic value over the next couple of years. By my calculations there is a big margin of safety.

45. 

    Jason Ruth
    December 11, 2010 at 4:36 pm:

    Hi Roger,

    My stock for 2011 is cash converters CCV.
    The main reasons this is my favourite stock are listed below.

    Profit upgrades – dividend upgrade? The company has become a serial “profit upgrader” over the last 12-18 months. Profit has been increasing and as the payout ratio is around 50% with cash on the balance sheet there is plenty of room for a dividend increase if things continue to go well.

    Return on Equity – was effected by a share placement to Ezcorp (to fund growth in lending & store buy-backs) and the negative is that ROE was falling (still 13%). ROE will turn this year to be around 20% if profit forecasts (and my calculations) are correct.

    Marketing – The current extensive marketing campaign has “cashies” targetting a new clientelle. They are almost becoming a trendy place to shop. The stores are being upgraded and the public is being made aware of the finance offer.

    Roll out of lending services – this is still in its infancy and is a very profitable part of the business. The majority of stores are in England and the rollout has only recently commenced there with good early results. Recently they have made the lending service available fully online.

    Store buy-backs – the balance sheet (from the placement by excorp) enables the company to buy back stores – which seem to be done at a reasonable price. Cashies seem to announce a number of store buy backs every few months.

    New store openings – Cashies now has 600 stores – they have limited presence in Sydney and recently purchased the rights to expand in Scotland. The company also has said that they see Spain as a growth area for them.

    I believe that CCV is poised for some good numbers – it does not seem to be widely covered by brokers, but has moved into the top 300 stocks. 2011 will be a good year for CCV shareholders of which i am one.

    • 

      Roger Montgomery
      December 13, 2010 at 10:05 am:

      Thanbks Jason. CCV has been a few times here and it has some promise through lending given the limited scale of the retail model. Foreign interest (Ezcorp) and busy stores are a positive too. You make some excellent points and observations.

    • 

      Jovan
      December 14, 2010 at 4:46 pm:

      This is my pick as well.

      Too many people (thanks to Roger) are focused exclusively on ROE. They are looking at high ROE stocks, and dismissing everything else.

      Sure, a high ROE is great, but you want to buy BEFORE the ROE starts rising.

      Share prices follow the ROE trend, so ideally you want to buy before it starts rising, CCV is a great example.

46. 

    Simon Anthony
    December 11, 2010 at 12:17 pm:

    QBE Insurance Group (QBE) Company Profile
    Company: QBE Insurance Group (QBE)

    Stock code: ASX:QBE

    Industry: Insurance
    QBE is Australia’s largest international insurance and reinsurance group, operating in 45 countries with about 13,000 staff. The company primarily underwrites general insurance risks, providing all lines of insurance cover for personal and commercial risks. QBE was listed in 1973 following the merger or Queensland Insurance, Bankers’ and Traders’ Insurance Company, and The Equitable Probate and General Insurance Co.

    CEO: Francis O’Halloran

    Main competitors: IAG, Wesfarmers, AMP

    MQR: A3

    Margin of Safety: -22%

    Expected Change in Intrinsic Value: 26.8%

    Dividend Yield: 7.5%

    Company website: http://www.qbe.com.au

    When buying a business to own it’s always best to own a category killer of its industry. In the core business of insurance underwriting, QBE continues to be the industry’s brightest light; delivering superior performance even when compared alongside Warren Buffett’s legendary Berkshire Hathaway, over the past couple of years! Basically for each dollar of premium QBE has received over the past five years, it’s paid out less than 90 cents in claims and expenses! What does it do with the remaining 10%? Why it gets to invest those premiums and keep the returns. It’s those investment returns that allow QBE to have such a strong cash flow and healthy balance sheet, from which 62 cent dividends are able to be paid out.

    Currently half of QBE’s US$22.3bn investment portfolio is held in fixed interest securities. The value of those securities moves in the opposite direction to interest rates, which had a positive effect on QBE’s results in the last few months of the half-year but those gains were offset by the sharp pull-back in global sharemarkets between April and June 2010 (the company has a share portfolio of around US$1.5bn).

    QBE still faces several challenges, though, including the headwind created by the strong Aussie dollar. Most of QBE’s revenue is received in US dollars, Euros or pounds, and it reports lower revenues when the Aussie dollar rises against these currencies.

    At home there is strong competition from IAG and AMP for business. I would like to see AMP disappear from the market as the merger with AXA has the potential to make AMP a stronger competitor in South East Asian markets. Which would make it more difficult for QBE to dominant the region without increased spending larger amounts in marketing and advertising campaigns.

    Conditions are also quite competitive in many of the company’s key markets and the past few years have been particularly good ones for the company as investment returns are significantly constricted as the majority of QBE’s $23.4bn investment portfolio sits in short term deposits and floating rate notes predominantly in Europe and the US.

    Lumped on top of that, a number of catastrophes have bitten the bottom line this year, from savage storms in Perth floods in Queensland/NSW and Melbourne to a major earthquake in Chile. However such occurrences remind clients why they need insurance and the flow on events result in greater amounts of new business being written up.

    QBE’s past financial performance has been remarkable. QBE’s seven year average return on equity exceeds 22% It’s posted a return on equity of more than 18% for the past seven years straight. And if it can manage anything like 18% over the next five years strong rises in the company’s intrinsic value will also occur.

    QBE’s balance sheet permits the company’s extension. QBE’s ‘borrowings to shareholders’ funds’ ratio is lower than it’s been in more than a decade, placing QBE in a strong position to make acquisitions without having to ask shareholders for any capital. In this light, QBE is becoming a stronger business as the years pass, although its underlying progress is currently being masked by unflattering currency movements.

    With Australia accounting for only 2% of the world’s non-life insurance market, QBE recognised long ago that its future lay offshore. But, unlike so many Australian companies which have embarked upon international expansion strategies, QBE has successfully located and integrated more than 120 acquisitions over the past 25 years. Such results hardly come down to chance.
    QBE is a company that is well managed and very conservative with risk. Whether it’s M&A activity in a mature market like Australia, or opening up a new geographic or product area through an acquisition in North America, QBE conducts rigorous analysis before moving in any particular direction.

    QBE Chief executive Frank O’Halloran, who joined the company in 1976 as Group Financial Controller, knows this company inside out. He’s made it a success by pursuing a strategy at which most companies fail: acquisition-led growth. This makes more sense at this time of the cycle; ‘When new business pricing is less than renewal pricing,’ he began, ‘I can absolutely assure you – and I’m happy to go through slide after slide – organic growth, when you’ve got new business pricing lower than renewal pricing, [that] is a recipe for absolute disaster.’ He went on to say that organic growth made sense when new business rates surpassed renewal rates, which is not the case now.

    Such thinking reveals an intimate understanding of the cyclical nature of the industry and how QBE plans to play it to its advantage. Few managers possess such clarity, especially those parachuting in from foreign lands on three-year contracts.
    O’Halloran went on to explain that in order to grow organically,

    QBE would have to loosen its legendary underwriting discipline; ‘I can go through some numbers but I can tell you, if we went out and grew organically by 5% next year in certain parts of the world, I wouldn’t be sitting here telling you that we’ve got an 89% combined ratio.’ Translation: O’Halloran isn’t about to grow the top line at the expense of the bottom line; profitless prosperity is not on the agenda. He then reminded his audience of the conditions under which QBE strung together five years of explosive growth.
    ‘In 2002, 3, 4 and 5, when we really pushed the button on organic growth, new business pricing was higher than renewal pricing.’ To which the questioner, satisfied but seemingly slightly peeved, retorted: ‘When do you expect the current trend to change, then?’
    The response was as clear as it was calm. ‘It’ll happen,’ O’Halloran said reassuringly, ‘but the key is to be patient and wait for it to happen. And in the meantime go out and make some acquisitions and get our organic (sic) growth that way.’

    With more than 120 acquisitions over the past 25 years, including several recentely in North America QBE’s highly acquisitive strategy makes sense. In the years when renewal pricing is greater than new policy pricing, O’Halloran goes shopping for existing insurance books which his expert underwriting team then improves. They do this by combing through individual policies or lines of business and removing (or repricing) the duds.

    When the cycle turns and conditions are favourable to writing new business, QBE then has an expanded base from which to do so. As long as management stays close to the business and gets the timing right, something at which O’Halloran has proven remarkably adept, it’s a virtuous circle.

    Yet, while QBE is clearly a growth-oriented company, its captain O’Halloran will not tolerate his ship sailing through profitless seas of prosperity. ‘No-one,’ he emphasised in the last shareholder briefing, ‘no-one in QBE gets any pressure on their top line.’

    For an insurance company, growing the top line is easy enough. But it’s much more difficult to do so profitably, if the pricing of its product is more than the market can afford, QBE will lose market share to its competitors. But over the long term, this is the only rational way to approach the insurance business; QBE’s breathtaking returns are testament to that as QBE has recorded the second highest return on equity of the world’s top 50 property & casualty insurance groups (it was bested by Danish group TrygVesta).

    In US dollar terms, QBE’s numbers were much more impressive. And that is likely to be the case for 2011 as well as the higher currency rate masks underlying progress. An analyst serving short-term focused institutional clients could be forgiven for being lukewarm on QBE due to the currency’s powerful retarding effect. Decent profit growth is perhaps 12 months away. But this business is improving, and therein rests the opportunity.
    Investors who backed QBE over the past 20 years are currently nursing a capital gain of more than 10 times their original investment, plus an unbroken string of dividends to boot. While it’s not prudent to bank on those numbers being repeated over the next couple of decades, with the share price falling 47% from its 2007 high of $35.49 the odds now favor an attractive return.

    With a 7.5% dividend yield (20% franked) to line the inside of your wallets, investors can afford to buy and hold allowing the rising tide of an falling Aussie dollar, increasing intrinsic value (> 25% p.a), increasing acquisitions for organic growth- any changes to market sentiment for this industry would see QBE’s many virtues reflected in a share price back above $30.
    The only question is are you willing to purchase QBE without a magin of safety? For many of you the answer would be no and you would wait for the share price to fall below $16 (which may happen in the New Year!) In that case the prospect of owning such a wonderful business becomes a forgone conclusion.

    • 

      Roger Montgomery
      December 13, 2010 at 10:19 am:

      Thanks Simon. One of the few successful growth-by-acquisition examples in Australia. With monotonous regularity, the cycle presents falling premiums followed by weakened competition, then industry consolidation then higher premiums.

    • 

      Paul R
      December 13, 2010 at 2:41 pm:

      QBE is my pick.

      I would add that about 8% of the investments are in equities with the rest in short-term fixed interest with an average duration of 6 months. The average duration of the policy liabilities is 2.8 years. That is asset-liability mismatching in favour of QBE. Think about it, QBE’s policyholder liabilities are due on average 2.8 years later and it’s largely conservatively invested assets have a duration of 0.5 years. Interest rates are highly likely to increase as a result of the GFC and a 1% increase in interest rates increases QBE’s EPS by 15%. Unfortunately banks are mismatched the other way with assets (loans to customers) having a duration longer than their liabilities (i.e. borrowings from depositors, term-funding etc.). During an ongoing global financial crisis, there is no way I would invest in banks but am very comfortable in the asset-liability profile of QBE.

      As Simon has explained, QBE has outstanding underwriting results (i.e. insurance profitability results) and whilst the results may not in the short-term be providing high ROE due to low global interest rates, some poor exchange rate and equity losses during 2010H1, QBE will provide a reasonable rate of return with a high degree of safety of capital. 2010 is a blip in their performance, 2011 is a new year for premium renewals and investment experience that will consign 2010 to history.

      Frank O’Hallaron’s boringly repeated message heard in QBE webcasts that repeat QBE only makes acquisitions when they meet management’s 15% ROE benchmark is from an investor’s viewpoint, actually quite exciting. Acquisitions are likely to be more successful since the onset of the GFC as insurance asset prices are depressed globally so it is quite encouraging that QBE is making acquisitions as they will be of great benefit in the long-term and as a shareholder, it is reasonable to expect that they are being picked up at a reasonable price given the current environment.

      If you are doing IV calculations on current analysts’ forecasts, this is a clear mistake as you are not considering the long-term as a patient value investor should. Value investors should work out the impact of higher interest rates on QBE’s increasing investment float, NOT attempt to predict when the rise will occur and how this flows through to IV.

      • 

        Roger Montgomery
        December 13, 2010 at 6:07 pm:

        Hi Paul,

        My forecast valuations back up your comments but I would dearly like to see US bond rates rise – partly because I also have investments that benefit from falling bond prices.

47. 

    Ashley Little
    December 10, 2010 at 8:14 pm:

    Merry Christmas Roger and follow bloggers,

    For 2011 I think we have two likely outcomes for the world so long as the chindia story does not hit a major speed bump these are my thoughts

    1) Senerario 1

    The American and European economies will remain sluggish and these countries will do more 21 centaury version of printing money (Quantitative easing)-.

    Quantitative easing is not really having the desired effect of boost demand as consumers in those nations are still in the process of a very painful deleveraging. The additional money instead is finding its way to emerging markets and commodities. Pushing Asian currencies and world commodities higher.

    2) Senerario 2

    The American and European economies return to trend or just below trend growth. To me this is a less of a chance of occurring in the next 12 months and will only occur if the very cautious banking sector starts lending. That said, with the amount of money sloshing around in these economies any sign of the velocity of money speeding up will lead to inflationary presures picking up further pushing up commodity prices higher.

    These means if supply and demand of commodities remain constant (which they never do) then its heads I win tails you loss for commodities in 2011.

    The world miners have not been reticent in reacting to current world commodity prices with many new mines coming on stream in the next few years. As a result, extreme care, as always is needed with commodities.

    So let’s leave our discussion to the big 2 in world commodities (Gold and Oil).

    Now imagine for a moment if we had no gold in the world. How would this effect the world. The answer is not too much at all. Gold has little or no use to us. Warren Buffets thoughts on gold are “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head. “

    Now imagine if the world had no oil……now that’s a totally different scenario. The world is totally dependent on oil and with cheap easy to get at oil running out we have to start drilling in harder to get at oil including offshore.

    This is will continue beyond 2011

    Based on my arguments above my 2011 stock of the year is Matrix composite & Engineering (MCE) To my fellow bloggers MCE needs no introduction but to the those new to the blog MCE is an engineering company providing engineered product solutions for the offshore, subsea, mineral processing, military and manufacturing industries. MCE designs and manufactures products through its oil and gas, mineral and industrial and advanced materials divisions. (yes thanks for the add………………….copied straight from data feeds)

    The fact is that a very large part of MCE’s income comes from the manufacture of riser buoyancy devices for offshore oil rigs……A product that can only increase in demand over time .

    The company is taking on some huge companies throughout the world but with prudent research and some luck has developed a competitive advantage in what they do …..With the new and bigger manufacturing facility coming on line in the next few months and the demand for their product rising heaps past 2011 this company has bright prospects.

    The valuable graduates are looking for 3 things…….1).High quality businesses, 2) Big discounts to intrinsic value, and 3) bright prospects…… Currently I can think of only 3 stocks that fulfil these prospects…..FGE, JBH and MCE…,.I am selecting MCE because it believe it has brighter prospects that the other two……

    No advice BTW seek and obtain your own advice……

    Have a lovely Xmas guys hope it all find you happy and healthy

    • 

      Roger Montgomery
      December 13, 2010 at 9:36 am:

      Thanks for those insights Ashley. On behalf of all the silent readers on this blog, I really appreciate all the time and knowledge you have shared. Happy Christmas to you too.

      • 

        Ashley Little
        December 13, 2010 at 6:21 pm:

        Thanks Roger for your kind thoughts but no thaks are necessary really.

        This is tapdancing to work stuff…..I love it

      • 

        Craig Marsh
        December 13, 2010 at 9:01 pm:

        I concur with Roger, thanks Ashley for your insights, knowledge and humour this year. Your the second reason I visit here mate. Merry Christmas

      • 

        Ashley Little
        December 14, 2010 at 6:02 am:

        Thank you Craig,

        If I was a lady I would be blushing right now

      • 

        Craig Marsh
        December 14, 2010 at 10:50 am:

        LOL, you’d also get more out of that ORL investment bloke.

        My wife has I reckon she’s underwritten next years divvies

      • 

        Ashley Little
        December 14, 2010 at 10:20 pm:

        LOL Craig,

        Too Fuuny Mate

        I hope you don’t have to sell any MCE to fund the ORL divy

      • 

        John M
        December 14, 2010 at 7:02 pm:

        I am a little late in responding but I agree with Ashley. I think MCE ticks all the boxes. MCE has a high ROE, neglible debt, a competitive advantage – high barriers to entry and intellectual property which limits competition to a very few competitors. I believe it has great prospects, as long as one believes that oil will continue to be a scarce commodity and in great demand over the next ten years, considering the new demand due to the growth of emerging nations on top of existing demand.

        I also like MIN, it is trading around about my IV, but it is forecast to have a greater growth in IV than MCE over the next couple of years. I was hoping for a pull back but unfortunately it’s price has taken off. I wait in hope.

        Something that I have been wrestling with lately is; does one go with a great company that is trading a significant discount to IV with some growth, or is it better to invest in another great company at IV but has significant growth in the next couple of years. What does everybody think?

        My opinions only, not a recommendation, get personal professional advice before investing in any stock.

        Merry Christmas to everybody and hope the New Year is very prosperous, compliments of Rogers investment college knowledge.

        Thank you once again Roger for all your knowledge, thoughts and time during the year.

      • 

        Roger Montgomery
        December 14, 2010 at 10:16 pm:

        Hi John M

        Thanks for your Christmas wishes. I am excited to have been able to share a few insights and suggestions. The market has been kind and provided plenty of ideas. Its not like that every year though. Regarding your dilemma; its one faced when looking at Westpac and CBA.

    • 

      John Watson
      December 13, 2010 at 12:56 pm:

      Yes, MCE does indeed have bright prospects, though Forge also has bright prospects and substantially more upside to my 2013 IV. I recalculated my valuation of Forge following the company’s NPAT guidance upgrade issued on Nov 9th indicating that NPAT for the Dec 2010 half is forecast to be $25m-$27M, which is a 42% increase on pcp. If it is reasonable to extrapolate this guidance out for the June 2011 half, then FGE’s projected ROE rises to 58%, which sees a substantial boost to IV and given that prior to the profit guidance upgrade I had FGE’s 2013 IV more than 300% above the current share-price, I’ll leave other Value.able graduates to recalculate FGE’s forecast IVs. For MCE I currently have a 2013 IV of $10.66 giving 97% upside from current prices – and one other to throw in is Decmil (DCG) which using my 2013 IV 0f $5.20 has a similar magnitude upside potential to MCE.

      I own FGE, DCG and MCE and I encourage all bloggers to do their own research and compare the these three stocks.

      • 

        Roger Montgomery
        December 13, 2010 at 6:15 pm:

        Thanks John,

        The valuations you are producing are based on those high rates of ROE and current payout ratios continuing for a very long time. Do you think that’s reasonable?

      • 

        John Watson
        December 13, 2010 at 7:45 pm:

        Hi Roger,

        My valuation of MCE relies on CommSec’s forecast EPS and DPS, which for 2013 are EPS 67.7cents and DPS 19.9 cents i.e. a forecast payout ratio of 29.3%.The ROE that I have used for MCE is 30%. In the absence of further information I believe this to be reasonable.

        Even leaving FGE’s ROE at 30% I get a 2013 valuation 3 times the current share-price (you will see from my post tjat I do not disclose a valuation using a 58% ROE that I agree is unsustainable) and I recall one investment guru recently interviewed on Switzer saying something to the effect of “I am embarrased to say that my valuation of Forge is three times the current share price….”.

        Cheers,
        John

      • 

        Roger Montgomery
        December 13, 2010 at 11:23 pm:

        Valuations need to reflect the very likely possibility that as a company matures at the same time investors start taking notice, the pressure to increase dividends results in the payout ratio increasing just as the ROE stablises or declines. Embarrassing indeed!

48. 

    Mark H
    December 10, 2010 at 2:32 pm:

    Hi Roger,

    My top pick for Xmas is Acrux (ACR). 2010 was a breakthrough year for the company in delivering it’s first maiden profit of $46m, with more revenue to come via milestone payments from Eli Liily ($195m following the launch of Axiron, it’s leading product) plus royalties from Axiron.

    In the same way that Cochlear has a grip on the market for bionic ear implants, Acrux has the potential to compete strongly in the drug therapy market given the approval to sell Axiron in the US. The US market worth $1.2bn and is growing at 20% p.a. The company believes royalties from Axiron sales will eventually form a substantial part of the overall value of Axiron. It now has 2 products for sale in the US, with plans for another 2 in the US and Europe.

    Financials and Outlook
    Given the milestone payments the company now has:
    – Postive cashflow of $145m,
    – Positive company cashflow
    – Very high ROE (83%)
    – No debt.
    – A strong relationship with Eli Lilly who will be marketing the products in the states

    Previous Years Performance
    Given the lack of payments before 2010, the company needs to demonstrate a solid financial record over the next few years to establish itself as a leader.

    Valuation
    Importantly, I have it trading at a decent discount to my 2010 and 2011 IV’s. A 0.28 2010 EPS moves to 0.425 in 2011.

    Given the financials, I’d be surprised if Acrux wasn’t an A1 or A2 business for 2010.

    Competition
    It takes a long time to test and approve a product (due to multiple product trials and approval of FDA required) in this industry. It could be replicated if future returns are lucrative but it can’t be done quickly.

    So ACR is my pick. I think it will do well over the next few years, it has good prospects for growth, a differentiating product and is about to hit new markets..

    I own this stock and bought in Sept ’10.

    An Aside on Competitive Advantage…
    In terms of competitive advantage, it’s not surprising that only a few companies were able to ride out the GFC (i.e. not have a signigficant deterioration in share price between ’07 and ’09) but some did, and become stock market stars. Some examples of companies who achieved this are: CSL Limited, JB Hifi, Little World Beverages, M2 Telecom, Navitas and Oroton.

    Whether it’s reputation, having a unique product or a solid strategy to maintain customer footfall, all these businesses have to be special, esp if there is a big MOS.

    Thanks for posting again!
    MarkH

    • 

      Roger Montgomery
      December 13, 2010 at 9:25 am:

      No THANK YOU MarkH!

49. 

    Nick Mason
    December 10, 2010 at 2:05 pm:

    Hello Roger,

    A Very Happy Birthday to you for last week and a Merry Christmas to you all.

    I had no intention of writing again so soon on your blog although couldn’t resist the challenge. An excellent topic and one I hope you’ll repeat in future years should you continue with your site.

    Perhaps your readers who recognise my name can already guess which company I am going to nominate?? I am sure you already have.

    Resource Equipment Ltd (ASX code RQL)

    A short summary of the company: RQL specialises in the design, construction, maintenance and rental of pumping, mine dewatering and mobile power generation equipment. The company also provides specialized hydromining services and oil and gas pipeline pre-commissioning services. It predominantly services the mining and oil & gas sectors and to a lesser degree, the civil construction market.

    Quantitatives:

    Return On Equity of 20%

    Operating Margins 39.8%

    Net Profit Margins 26.8% (Readers should be aware that for the last FY RQL did not pay tax, it is my understanding that RQL still has 20 million in tax credits left. These will eventually run out and when they do this metric will be affected.)

    Debt/NTA 28% (debt is through Hire Purchase contracts only and is typically paid of over 1 year.)

    Recurring revenues (RQL aims to secure long term site presences and their services are typically ongoing. 75-80% of revenues are recurring.)

    Qualitatives:

    High Barriers to entry ( specialist personnel, capital, product knowledge, track record and experience, technical understanding, design capabilities (RQL is not a typical rental company, they design and construct very specialised equipment.))

    Competitive advantage? RQL notes that they are a “Specialist solutions driven business with a process that (can) include design-construct-test-install-comission-maintain. This all inclusiveness is their competitive advantage. I know of no other company which offers this kind of service.

    Very well diversified: RQL is well diversified across industries (the oil and gas sector (7 projects worldwide)), hydromining, dewatering solutions to mines across Australia, reverse osmosis (recycling impure water) and now they also provide power generating facilities to remote mine sites. RQL is diversified across industries, across commodities and geographically (within Australia and also internationally.)

    A highly competent MD, James Cullen, with a great track record (former MD of PCH Holdings, a minnow company eventually taken over for $250 million)

    Opportunities for growth?

    RQL estimates that more than 70% of mines in Australia have water issues and 90% of these mines deal with these issues in-house. RQL claims they can handle these problems more effectively and more cheaply than the companies can do themselves and have so far only penetrated a fraction of this market.

    RQL claims their has been strong interest shown and a record number of inquiries and expressions of interest shown in their new divisions in hydroming and the oil and gas industry.

    RQL’s operating subsidiary Resource Equipment Rentals formerly operated only in WA. The company now operates Australia wide and is securing for themselves large amounts of work in Queensland and entering the markets in NSW and the NT.

    How is the company dealing with growth?

    Employee numbers up from 59 to 108.

    Relocation to new, larger and improved premises.

    This has affected margins (which was foreshadowed by the company) by around 2%.

    The company also estimates that capital expenditure this year will be between 16-17 million dollars. This is higher than anticipated due to a higher than expected demand for their services.

    July-August-September-October of this year saw consecutive records set for monthly revenues.

    The second half of this FY will see RQL market their products and services internationally.

    My Valuation?

    I currently value the company at just under 70c so at today’s price investors have a nearly 30% margin of safety (according of course to my valuation.)

    Which of their competitors would I like to see out of business?

    RQL notes in their AGM presentation that there are ‘few companies in this space (domestic or international) and none of size.’

    Personally I do not know of any competitors.

    Thank you to all the contributors to this forum, I have enjoyed reading your posts over the last months. To the best of my ability I have tried to be entirely factual with regard to ratios and figures although readers, please always do your own research and double check everything I have written.

    • 

      Roger Montgomery
      December 13, 2010 at 9:32 am:

      Great work Nick,

      Thanks and its adds a great deal to your comments back in late November.

      • 

        Mark
        December 15, 2010 at 4:03 pm:

        I was just reading the your views on RQL and wandered out of my office and low and behold straight across the road from me a new sign has been erected for this very company.

        The estate they are on has just been extensively overhauled and there is a heap of activity going in and out of the place.

        I have also noticed lots of company cars with their logo on. I will do some detective work on what looks like a good prospect.

        BTW I work for a mid range Engineering Services Company similar in a way to Forge but without the positives even thou our share price has spiked from a low of 40c to around 1.40c.

      • 

        Roger Montgomery
        December 15, 2010 at 7:12 pm:

        Thanks for the insights. Keep us informed Mark!

    • 

      Paul R
      December 13, 2010 at 1:46 pm:

      I would adjust your valuations to use a 14% ROE (20% x (1 – 30%)) for tax and also use about 200 million shares in your calculations noting that there is a significant amount of options to be exercised with strike price at $0.20 and $0.24, and when they are exercised your investment will be diluted. It sounds like a good story, but management could be in the business of rewarding themselves rather than shareholders as evidenced by the large number of options on issue. I will wait until February 2012 to see their half-year results and to consider profitability after all options are exercised. Post-tax ROE needs to improve otherwise there are much better businesses to invest in.

      It pays to heed Benjamin Graham’s advice not to invest in companies when they don’t have a ten year track record (OK let’s say five for Australia). Roger should write an article explaining why he has the confidence not to heed Graham’s advice (e.g. MCE) as it would make for interesting reading. For the mere investing mortals amongst us, investing in companies with a short listed history still verges on speculation as management has yet to prove themselves, at least from a shareholder’s view on profitability and such businesses have not proved to have a durable competitive advantage.

      • 

        Roger Montgomery
        December 13, 2010 at 6:11 pm:

        Hi Paul,

        MCE was founded in 1982. As I am buying businesses not stocks, its the history of the company rather than the history of its stock that must be considered.

      • 

        Nick Mason
        December 13, 2010 at 7:59 pm:

        Thank you Paul, although when coming up with my valuation of just under 70c I was assuming a fully diluted company.

        You are right that this type of investment would not meet many of Benjamin Graham’s criteria, it is much more a Philip A. Fisher type investment, that is (stated briefly,) a wonderful growth stock selling at excellent value (albeit without a long history of financial results.) I stated my reasons for it being a (possibly) wonderful growth stock in my previous post although time will tell.

        If you haven’t already done so I would strongly recommend reading Fisher’s book “Common Stocks and Uncommon Profits” an excellent read, where Fisher strongly advocates the ‘scuttlebut method’ (talking to people within the industry in which the company operates, competitors, clients or customers of the company… although NOT the management of the company as they will often paint too rosy a picture.) This is a very pragmatic hands on approach which I think perfectly compliments the more academic financial analysis which you have obviously learned well after reading Roger’s book and also Benjamin Grahams. Incidentally, Warren Buffet acknowledges himself as an investor as a combination of the two (Fisher and Graham, not Fisher and Roger!)

        Have management within RQL yet to prove themselves? Not in my opinion. Anthony Ryder and Keith Lucas did a brilliant job with Resource Equipment Rentals from its beginning until incorporated into and publicly listed as Resource Equipment Ltd in July 2009 (formerly RER Group until the recent name change.) Both men have excellent reputations within the industry (and I found this out from talking to clients who have benefited from their services in the past.)

        The current MD, James Cullen, firstly distinguished himself at Price Waterhouse where he worked on their behalf all over the World (and obviously learned business fundamentals well.) James Cullen then went on to work as MD at PCH Group where again he distinguished himself.

        I agree with you though that,

        “For the mere investing mortals amongst us, investing in companies with a short listed history still verges on speculation”

        and that is why everyone must do both their academic (quantitative financial analysis) and practical (‘scuttlebut method’) homework very very thoroughly if considering this type of investment.

        Best Wishes and a Happy Christmas to all.

      • 

        Paul Kloeden
        December 14, 2010 at 8:55 am:

        While Buffett did say he considered himself as a combination of Graham and Fisher, my recollection is that it was 85% Graham and 15% Fisher. I think the proportions tell us a lot.

      • 

        Nick Mason
        December 15, 2010 at 10:58 am:

        Correct Paul, Warren Buffet did give those percentages as the breakdown.

        What is most fortunate for Berkshire Hathaway shareholders is that his partner, Charlie Munger is much more from the Philip Fisher school of investing so shareholders get a great combination and balance of both insights and strategies.

        Although Warren Buffet is far more conspicuous and famous than his partner Charlie Munger I would rate Munger as the superior investor.

      • 

        Roger Montgomery
        December 15, 2010 at 11:23 am:

        Munger most definitely added intellectual firepower but Buffett is no slouch. Buffett however had the temperament to be able to take and hold outsized bets. Temperament is very important. Being able to pull the trigger, to add to a position whose share price is declining and to hold in the face of all the ups and downs is something you cannot be taught.

      • 

        Paul R
        December 15, 2010 at 3:21 pm:

        Hi Nick

        Fisher’s book is on my bookshelf, I’ll read it after I finish Joseph Calandro’s Applied Value Investing. I’m also getting Charlie Munger’s “Poor Charlie’s Almanack” for Xmas. How exciting. Who said Xmas is just for the kids? Merry Xmas to all.

        As I have a required investment return of 15% for businesses that have less than $200m in NPAT, and the tax-adjusted ROE for RQL is about 14% but looks to be rising due to higher incremental ROE, I will wait for this to improve and also the full effect of the dilutionary issues to flow through to reported results. Currently targeting businesses with both ROE and incremental ROE>20%. RQL is on my watch list but Forge Group, Austin Engineering and maybe Lycopodium appear to be better engineering business alternatives at the moment. Oh, and did I hear Roger say MCE. It does have a ROE of 30%. ;)

        Cheers Paul

50. 

    Lloyd
    December 10, 2010 at 11:38 am:

    Roger,

    I understand that Twelve Stocks of Christmas will be about a stock for 2011, not the longer term.

    You will be judged on its performance in the next twelve months, which is a pretty short window. Therefore, my selection is driven by nothing more than the most out of favour, heavily discounted to IV A1 business around, that of JBH and the likelihood that Mr. Market will change his tune on this stock early in the New Year.

    The sentiment against this company is largely based on spurious views of the threat (short and long term) posed by international online sales, which have seen the stock price plumb fourteen month lows today. On my reckoning at it is now priced on the basis of a 15% decline in sales and 12% decline in profit (2011 over 2010). Yet the last guidance statement given at the October AGM, advised of sales running 12% ahead of last year. Clearly the Mr. Market is predicting a monumental collapse of sales in coming months if the company is to come in 15% down on 2010 sales. This sets the company up for a re-rating in the New Year once the reality of positive sales growth in the first six months of 2011 occurs to Mr. Market. That is to say the weighing machine will cut in come late February 2011 and price will move up toward IV.

    Now as to the internet threat. Mr Gerry Harvey of Harvey Norman (HVN) fame has promoted this somewhat lame excuse for the under-performance of his business, which is more of a real estate trust than a retailer, with the ball and chain of international operations around its leg. Let us not mention Ireland and some unfortunate expansion effort into some of the FSU states! Now Morgan Stanley has jumped on the bandwagon with the statement that “We estimate that if by full-year 2015 Australian online retail penetration reaches the current US level, then internet retailing could take 22 per cent of the incremental growth in Australian retail sales.” Result, sell HVN and JBH. Poor old Gerry, hoist with his own petard! Unfortunately, JBH is caught in the collateral damage, but reality will win through in the New Year.

    Now thinking about international internet or online sales. Do you think that the statement that online sales will take 22% of incremental growth by 2015 means that JBH will suffer a year over year sales collapse of 15%? Do you even think that the Australian Dollar will remain near, or above parity, for the next five years to underpin the supposed threat to incremental sales growth? The maths does not stack up, nor does history bear out the underlying assumptions. And this is before we even consider probable Government reaction to the loss of tax of tax revenue inherent in this forecast.

    Hence my pick for one of the Twelve Stocks of Christmas: JB HiFI (JBH). The out of favour sentiment currently in the market will quickly turn as the reality of positive business performance is recognized by Mr. Market in early and mid 2011.

    Fill your boots while the opportunity is here!

    Regards
    Lloyd

    Disclosure: I own JBH stock and just topped up my holding on the announcement of Morgan Stanley’s view of online sales impact.

    • 

      Callan
      December 10, 2010 at 3:12 pm:

      Hi Lloyd,

      great to finally hear of somone with the same view! I am extremley bullish on the future for JBH and am actually hoping for the retail sector to cop more of a bashing from the media.

      Im not sure about you but i dont think i would buy a LCD TV or something where i would compare product online. Simply because you cant compare and see the live product working. Games, music etc to a certain extent agree that internet sales could hamper but JBH have done a fantastic job in enticing consumers thus far.

      All the retailers are struggling however every JBH store i have been in have people qued up. When i think electronics i think JBH not harvey norman!

      There is also plenty of people wandering the streets carrying the trademark yellow JBH bag. Great opportunity to take up whilst this sentiment is about, my thoughts are it wont last more than 6 months.

      Regards,

      Callan

      • 

        Andrew
        December 13, 2010 at 11:28 am:

        Completley seperate to the 12 stocks of christmas in which i have found the posts extremley enjoyable and have learnt more about some companies on my “getting to know you” list.

        I do think that online retailing will take an extremley large percentage of the CD, DVD, games etc market if not all of it in future years (don’t ask me how long though). This has already been seen with CD singles obsolete as they are cheaper and easier to get from iTunes and Amazon. I think this is already starting as well.

        Nearly everyone interested in this market has a MP3 player and new model cars are starting to have them rolled out as a standard feature as well once the older model cars start getting scrapped then there will be little need for CD Players and there for CD’s.

        This will make CD’s as close to obsolete as possible. Its easier to download a song straight away then to buy a CD, import it onto a computer program so you can load it to a MP3 player. Most gaming consoles can be connected to the internet and as technology advances this will become easier and probably wireless. This means that you can just download the game from online. DVD’s will go much the same way i think.

        I see in the future a hard drive replacing book shelves as awell as CD and DVD storage facility.

        CD, Games and DVD’s are products that you know what you are getting in advance and there for the main concern will be where to get the product at the best price this could well mean that the internet is the answer. I think the same will go for things like ipods, ipads, and some other electronic goods.

        I don’t believe as i have mentioned in another post that all store based retailers will become obsolete but the electronics market will come under pressure.

      • 

        Roger Montgomery
        December 13, 2010 at 6:17 pm:

        You are right Andrew, Fragmentation is one form of Fast change that needs to be understood.

      • 

        Aaryn
        December 13, 2010 at 10:25 pm:

        Hey guys,

        According to a money manager I spoke with the other day, another looming concern for JBH is the ACCC cracking down on their issuance of “extended warranties”. Further, JBH may also have trouble with reporting their advertising rebates (from Samsung/Sony etc) included in the top line. I haven’t investigated this yet – just word on the street FYI.

      • 

        Roger Montgomery
        December 13, 2010 at 11:13 pm:

        Thanks Aaryn,

        “ACCC cracking down” does sound a little alarmist on the part of the money manager.

        A computer is sold with a free 12-month warranty given by the manufacturer. The seller advises the consumer that they need to purchase a three year extended warranty, otherwise they will have no right to a remedy after the 12-month warranty period expires. In this case, the seller is likely to have breached the ACL by advising the consumer that they need to pay for rights provided for under the consumer guarantees.

        The ACCC notes; “Statutory rights have no set time limit – depending on the price and quality of goods, consumers may be entitled to a remedy after any manufacturers’ or extended warranty has expired. In addition to the legal obligations that the Act says are a part of any contract between a consumer and a seller, some businesses offer extra promises about their goods and services, even though the law does not require them to. These promises, often called voluntary or extended warranties, provide extra customer protection if problems arise after a sale. Voluntary and extended warranties may also entitle consumers to a refund, replacement or repair in the event of a problem. This kind of promise, if it is offered, is in addition to consumers’ statutory rights – statutory rights cannot be overruled.”

        adding; “Sellers sometimes give consumers the option of buying an extra warranty that provides protection for a specified period, often for some time after a manufacturers’ warranty runs out. These kinds of agreements are called ‘extended warranties’. While some extended warranties may ‘extend’ a manufacturers’ warranty, many are actually a separate service or insurance contract with different ‘fine print’. An extended warranty may offer repair and maintenance for three years after the manufacturer’s one-year voluntary warranty expires, for example. Some extended warranties promise extras such as priority customer treatment, or technical support. Before buying an extended warranty, consumers should decide whether the services and protection being offered are worth the money, and in particular whether the extended warranty provides protection beyond their statutory rights.”

        You are referring to the example where the ACCC suggests “businesses should take particular care when describing and selling extended warranties to ensure that consumers are not misled into thinking that they are required to pay for rights that are already provided by the consumer guarantees”. If JBH are found to have breached the requirement not to mislead in the “describing”, the two questions are, what is the revenue from this and the revenue impact of any modification and what is the remedy for the ACCC? That probably covers the financials. The next question is what is the reputation impact, if any.

    • 

      John D H Bell
      December 11, 2010 at 1:58 am:

      One stock: CSL. about 2000 a stockbroker Campbell Gorrie gave a talk in Perth that gelled with me. It was titled “Small Disposables” and was one of the reasons I bought into CSL. I remember working in the Pilbara in 1982 and treating snakebite with CSL antivenom. Brilliant lifesaver. We needed big doses and discovered that the ampoules when they neared expiry after 4 – 6 months were given to the Vet. Occasionally we needed to retrieve those ampoules. And I remember the wholesale Hospital price in those days was around $350.00 per amoule. Nowadays it’s flu vaccines that are never used tho paid for. Brilliant company. Monopoly almost …… competitors are a bit lame.

      I’m a longterm holder also of the 4 big banks, BHP, RIO, WOW, If I had to decide on one stock only, I’d be happy to have any of them as alternatives.

      Do you know the difference between choose and decide ?
      Decide comes from Latin Descissire – cut yourself off from any other eventuality !
      So I decide on CSL. They have done some great capital raisings with share offers in the past. Could they do a buy back ? Yes.

      Really enjoyed meeting & hearing you in Perth. If you want a chauffeur, a bed, a factotum in Perth I’m your man !

      • 

        Roger Montgomery
        December 13, 2010 at 9:14 am:

        Thanks for the offer John. Happy Christmas.

      • 

        Roger Montgomery
        December 13, 2010 at 9:38 am:

        Hi John,

        I used to work with Campbell. It was nice to hear his name again. I think CSL is an excellent choice.

    • 

      Michael Spargo
      December 11, 2010 at 8:00 am:

      Hi Lloyd,

      Your insights are always well considered – I always enjoy reading them. The idea that “all retail businesses are toast and that the internet will take over” is something that may result in some high-quality businesses being available at silly prices. I don’t think there will be a big impact in the medium term. Hopefully people in the market become more pessimistic about these businesses, and we can find some bargains in the near future!

    • 

      Paul
      December 11, 2010 at 9:33 am:

      Hi Lloyd,

      good analysis, one more point, are Australians really brave enough to buy large LCD panels or furniture from offshore retailers? I don’t think so !. Therefore I struggle to accept Gerry’s argument that the $AUS strength is sending HVNs sales offshore.

      HVN is losing the battle for sales in Australia because it chose to stick with the 90’s retail model and in turn has failed to connect with the needs of the modern shopper. Nobody wants to waste their weekends walking through HVNs worn out warehouses that cannot price compete within its market.

      As a consequence, HVNs neglect to embrace the modern retail habits has led to the emergence and growth of the JBs of today. Furthermore, there are many other Australian online or shopfront retailers out there that are challenging the goods and services HVN dominated for decades.

      As you have rightly pointed out, I am confident that in the months ahead JBHs results will expose the HVN story.

      Regards,
      Paul

    • 

      Ashley Little
      December 14, 2010 at 10:25 pm:

      Hi Lloyd

      Merrry Xmas and thanks for your blog

51. 

    Kent Bermingham
    December 9, 2010 at 8:02 pm:

    Company Code Market Capitalisation ROE Retained Dividends Per Share Retained Dividends Per Share Price KB Valuation Margin of Safety
    $ Millions % % $ $ $ %
    BHP $144,144,000,000 29.75% 61.97% $2.76 44.89 $83.85 86.79%

    No Debt, Good Management, No Competition, Good Outlook for Growth, Strong ROE

    Regards and Good Luck

    Kent

    PS what RR do you use for CBA?

    • 

      Ken Milhinch
      December 10, 2010 at 12:50 pm:

      Kent,

      Debt was US$15.8Billion at year end, my valuation is around $30 (2010) and it has competitors all over the place.

      Regards, Ken

    • 

      Roger Gibson
      December 15, 2010 at 10:39 am:

      I’m with you Kent. I first bought shares in BHP in 2002 for $9.54 and worried that I might be paying too much. I’ve traded them a few times since, selling when I’ve thought overpriced and buying on the lows. Overall I show a 29% annual compound interest rate of return over the period. I’m sorry that I bothered with anything else. A world leader trading below IV with a long and excellent record.

      Low valuations are reach by some by asking for a higher rate of return from the worlds largest diversified miner than they would for a $50M or $100M startup – because of “higher risk”. Ludicrous.

52. 

    Darrell
    December 9, 2010 at 7:48 pm:

    I have recently bought Value-Able and am eagerly devouring it. I note that you appear to give Platinum Asset Management a tick (page 50). I have been advised recently to sell my holding by a stockbroker (I bought them in 2008 at $4.52, also on advice from a different broker). I would appreciate your comment about their Value-Able rating and their future prospects.

    Many thanks

    Darrell

    • 

      Roger Montgomery
      December 10, 2010 at 11:37 am:

      Hi Darell,

      I will take a look for you on my return.

    • 

      Ashley Little
      December 14, 2010 at 8:34 pm:

      Hi Darrell,

      I can’t give you advice but PTM is a very very good business (A1 MQR rating) with a very nice competitive advantage (AKA Kerr Neilson)

      If I owned the stock (which I don’t) and a broker recommended that I sell it to buy a commodity business then I would never speak to that broker again.

      However, if the broker was suggesting selling this business because to was at or above IV and they wanted you to buy a really really good business with big discounts to IV and bright prospects then that is a totally different.

      I think it is much more important to consider what the broker wants you to buy when you sell PTM

      My view for what it’s worth PTM is a very good business with rising IV. The broker better have a better one to replace it…..I have PTM going to high $6 range by 2013 .(Plus you get a good divy)….I hope I am wrong but it would not surprise me in the least if the broker wanted you to buy a mining company that has never made a profit.

      Hope this helps

53. 

    Bruno Altin
    December 9, 2010 at 7:21 pm:

    Hi Roger, Woolies would have to be my stocking filler this year. Woolies have the largest market share in the supermarket industry. I’m a farmer, I know how much we sell our fruit for, Its a hell of a lot less than they do. I know people who complain of oranges for sale in Sydney at $8 or $9 per Kg. I’d be happy if we got 40 cents. It takes us 7 years to get a decent crop of oranges. Woolies has made farming become like the airline industry. high capital, requiring lots of additional capital and generally low rates of return. The high Aussie dollar doesn’t effect them. The supermarkets buy products, store them for a short amount of time and mark them up. They buy from price takers and they in turn are price makers. they can increase their prices every year (and often do) and generally people don’t complain, and even if they do, there is often no where else for them to go. I would love Woolies to go broke even though I own their shares. Woolies have little debt, and an enviable track record. They don’t have to deal with cyclical comodity prices, they don’t require large amounts of capital, they have a great ROE and it doesn’t matter what happens in the global economy, everyone has to eat.
    It is often said in regional towns. “you would be better off selling the farm and putting all your money into woolies shares” unfortunately, money wise. they are right. There is no other company on the ASX that is so dominant over every industry they enter. be it groceries, fuel, or poker machines. No other company on the ASX is as agressive as Woolies in fighting off competitors, and still increasing their prices. they consistantly manage to increase their NPAT by more than their Revenue. That is a sign of a true A1 company. Current price is around $26, not all that cheap, but not expensive either. Its better to buy a wonderful company for a fair price, than a fair company for a wonderful price

    • 

      Roger Montgomery
      December 10, 2010 at 11:34 am:

      Great Contribution Bruno, Thank you!

54. 

    Bob Fairless
    December 9, 2010 at 2:51 pm:

    Hi Roger, I am into the last chapter of the book so yet to start implementing your Value.Able approach. But in reading your blog re a contribution to the xmas stocks, there is one stock that I have been looking at for some time.The only issue is that it has negative cashflow as it is growing quckly. it is called iCash Payment Systems ASX CODE ICP and is rapidly establishing itself in the Australian and South Korean ATM sector.They have designed and sold over 11000 ATMS in Korea.Has an established growth path. Profit growth forecast at 80% in 2011.Revenue comes from ATM placements (sale and lease) and transaction fees here in Australia and in South Korea. Shares are trading at about 40 cents but on my limited knowledge and your intrinsic value approach I think it is closer to 70cents but I have not done much work on it yet.

    They have plenty of productive capacity at their South Korean factory.They have also establised an office in China I believe. Ebit margin has slipped in the last year or so due to inventory building.Cash flow has been weak in the ramp up stage as it builds inventory ahead of sales.Balance sheet seems Ok with net debt of 5million.and gearing of 12%.That is all the info I have at this time. I hope it makes it onto your list as it is in a growth industry ,seems to have competitive advantage and keeps costs down by manufacturing off shore. Sales revenue in 09 was 19.1m,2010 41.7m, (forecast) 2011 76.1M,9Forecast)
    Regards
    Bob

    • 

      Ken Milhinch
      December 10, 2010 at 11:55 am:

      Bob,
      For what it is worth, my IV for ICP is $0.03. ROE was only 9.3% last year. It has significant negative cash flow too. For my money, it is a good one to avoid, but of course you should make your own mind up about it based upon your own research.

      Regards,
      Ken

55. 

    Michael
    December 9, 2010 at 10:16 am:

    Roger, What’s your opinion on the The Reject Shop’s 15% profit downgrade and subsequent sell off in the stock.

    Cheers,
    Mike.

    • 

      Roger Montgomery
      December 10, 2010 at 11:21 am:

      HI Michael,

      Back in Septmebr last year, I wrote a column for Alan Kohler’s Eureka Report explaining my reasons for selling The Reject Shop as it hovered around $14. It is an extraordinary business but there were a few signs for me to write:

      “My sale of The Reject Shop from the ValueLine portfolio a few weeks ago – a company whose shares I first acquired in 2004 at $2.40 – is a closer-to-home example of this third reason for selling. I sold The Reject Shop not because I believe that the company’s opportunities are drying up; indeed earnings are heading in the right direction, as are dividends. There is only modest debt and the company has many more stores to roll out.

      The reason for selling at near $14 was primarily that the shares were trading at a near 25% premium to their valuation of $11.27. Today The Reject Shop trades at $12.69.”

      I believe the company may have not explained fully the reason for the downgrade and I will discuss this in a post on my return.

      • 

        David
        December 10, 2010 at 2:05 pm:

        Hi Roger, l’ve been a silent observer of your blog and TV apperances since I bought your first book in July. Since then lots have happened in the market – we had some sell-off and a good rally and now it seems the good runs are coming to an end soon from a technical perspective.

        What I have reflected from the last 6 months since having read your book is that in an ideal world the analysis learned from your book is the way to go for ‘investing’, however the more and more I learned from technical analysis while the market price action unfolds around us, I think ‘timing’ is everything when it comes to investing in the share market. All the good analysis from value investing is well and good but can be wasteful if not in line with timing in the market. Examples like JBH, CSL, QBE just to name a few. It’s curious to learn that you sold TRS Sept last year, to miss out a run up to the high of $19 not long ago (which is almost 30% from your $14 sale price and you sold at $14 because it was 25% over the intrinsic value at the time).

        You stressed on many occasions that you would never buy stocks that is not deeply discounted to its intrinsic value and you would sell stocks that are overpriced to its intrinsic value, even if it’s an A1 company. (is 25% a threshold for both ways?) However it appears to me that chances to buy quality companies at deeply discounted price will either a) never appear b) or price will take too long to catch up with intrinsic value in the event of a deep discount.

        Sorry I know my view is more from a ‘trading’ mindset than an ‘investiing’ one but with many this type of ‘shocking’ financial results, retail investors are almost always the last to know and are at the mercy of the ‘good’ accounting cycles of listed companies. How much can we trust the financial figures published in annaul reports and base our valuation in a TIMELY fashion on these days? Hence the doubtful view I will have on ‘value investing’

      • 

        Roger Montgomery
        December 13, 2010 at 10:23 am:

        Thanks for your thoughts. We had a great discussion about charting and technical analysis here on the blog some time ago. There was some consensus that many chartists have had ‘shocking’ financial results too.

      • 

        David
        December 13, 2010 at 5:26 pm:

        Like many fundental analysts who just know how to read P/Es, there are many chartists who only know MACDs, so results are still achieved by individual skills not the methods themselves. But I think at least the chart is very transparent and timely, unlike so many financial reports that give these type of massive surprises.

        Anyway It’s a personal choice at the end of the day whether one wants to be more active in the market or just wait for that once-in-a-lifetime opportunity to buy like the GFC. Good thing is another such chance is just around the corner…. I guess it’s time to get some A1 companies onto my watchlist for the shopping spree soon.

      • 

        Matt C
        December 14, 2010 at 1:11 pm:

        Hey David,
        I’m interested whether the charts would have predicted the massive drop-off in TRS share price prior to the announcement. If you use the traditional 200-day MAP vs 50-day MAP you might still be holding the stock. This is obviously a blunt instrument, but interested in your thoughts about whether many people would have sold this stock from a technial perspective and what indicators they may have used.

      • 

        David Sinclair
        December 14, 2010 at 8:42 am:

        Hi David,

        Anyone who sold The Reject Shop for about $14 would have missed out on the recent run up to $18.50, as you point out, but they would also have missed out on the even more recent fall to around $13, a lot of which happened in a single day! If you have the time to monitor prices closely enough to catch that kind of fall before it goes too far then you may have come out ahead on TRS over the last twelve months, but anyone who held TRS and still holds it is worse off than those who sold at $14. Anyone who sold TRS would also have had the cash available to invest in another business such as Forge or MCE, which have both risen in price by more than TRS did to its peak and are both still priced at well below intrinsic value. That puts a different perspective on Roger’s decision to sell!

        David S. (another of the many Davids)

      • 

        Paul R
        December 10, 2010 at 7:56 pm:

        I dialed into the investor conference call yesterday to hear what management had to say about the shocking break in upward trending profits for TRS. Management reported 4.2% increase in revenue for the 4 months ended 31 Oct 10 on prior corresponding period (pcp). Nov and Dec earn the most sales (approx. 20%) with Dec being the best month for the year, Nov second best month. The IT system feeds management a report every 15 minutes on sales and the impact of the Cup day interest rate rise on the following day’s sales was immediate and dramatic. Nov sales were down 3% on pcp. Dec has continued this trend. Analysts asked lots of questions regarding what was being stocked, Hampers etc. for XMas which management view as having a use by date of 25 Dec to questions about the success of Halloween merchandising. It seemed analysts were trying to get a grip on TRS’s merchandising to see if they have made mistakes in this area but at this stage, the interest rates applying to heavily mortgaged households appears to be causing a lot of problems. General foot traffic through shopping centres is down which affects all retailers. I also imagine the rollout of more Aldi stores has reduced TRS’s sales in house cleaning products, toilet paper etc. Average basket of sales per shopper is about $13 and avg sales is slightly down on pcp. On the flip side, all retailers are experiencing price deflation, it is surprising that TRS will take a hit to incremental profit given 20 stores will be rolled out this year. All stores opened this FY are reportedly doing well except one due to the poor general foot traffic in a newly opened shopping centre that affects all retailers in that centre.

        I suspect Australia’s one trillion plus in private debt is really starting to bite, especially in Victoria where TRS has a large number of stores. Buying a house at 8+ times the average wage at median prices is causing a real structural problem in the Australian economy that will affect consumer expenditure as interest rates rise. The average variable interest rate for the last 35 years was 10% and as a result of the GFC, I think it is very reasonable for the average over the next 35 years to be no less with the last 20 years more of a structural short-term departure due to nifty inventions such as mortgage-backed securitisation to recycle money for lending at cheap rates. Rolling over global debt will be a problem for years to come and will coincide with rising interest rates.

        TRS will continue to roll out new stores to move from 200 to their long-term target of 413. Whilst in the short-term, they are experiencing a blip, I expect they will benefit from their recent IT systems investments and the second distribution centre recently opened in QLD as they scale up. As credit related pressures continue into the future, TRS is likely to benefit in the long-term as a discount retailer but this certainly isn’t evident right now.

      • 

        Roger Montgomery
        December 13, 2010 at 9:35 am:

        Thanks for providing those insights and thoughts Paul.

56. 

    Andrew
    December 9, 2010 at 8:36 am:

    On the 1st day of Christmas my true love gave to me a business with high ROE. Hoepfully this isn’t too long but you did say you wanted detail.

    My stock for Christmas is Oroton (ORL).

    Introduction:
    Oroton are a luxury manufacturer and retailer of fashion accessories such as handbags, purses and underwear. They are also the sole licensee of the well known Polo Ralph Lauren brand in Australia.

    Competitive advantage:
    ORL’s competitive advantage in my opinion is that it offers high quality fashion products that can be classified as luxury however they are able to charge affordable prices. Add to this a CEO who has turned the company around since she came into her position by offloading poor performing businesses and focusing on its strengths.

    They appear to have a great design team behind their products which stay current and relevant in what can be a tough industry with continually changing trends. This is a huge strength and cannot be understated.

    They also, in my opinion, operate in a very good environment with few competitors. The closest thing would be Mimco but this does not have the broad appeal, design strength or following that Oroton have. The big luxury brands are competitors but Oroton has found itself a nice little niche of being the affordable brand where as the big European companies like Chanel, Gucci, Prada and LVMH are the giants but similar products would cost you upwards of $1.5k instead of $200-$500 at Oroton.

    Next time you are out on a rainy day, have a look at how many young and fashionable professional women are using Oroton branded umbrella’s and you will see this company has phenomenal brand awareness and strength or if you prefer to stay dry take a visit to some of their factory outlet stores and you will be pleasantly surprised to see a line up of people waiting to get in the store. If a company has customers preparing to line up in the hope of buying a product then it gets a big tick from me.

    The Polo Ralph Lauren license is another great asset and is a internationally well known brand with a large following as well and the fact that only Oroton can clip some income from sales of these products is a good addition to back up the sales generated by Oroton.

    They have also helped their products become more available through an online store which is by accounts one of their busiest stores for sales showing that this company is also aware of the changing market around them and are willing to move with the changing technology and landscape of retailing.

    The products are reasonably available to most customers with boutique stores of the Oroton brand available in most major shopping centres and also in David Jones stores.

    Polo Ralph Lauren are found in most high end shopping centres and so it should be, to set up these stores in other less fashionable or high end shopping precincts would damage the brand in my opinion as it is a luxury label.

    The management for this company needs a huge pat on the back as they have been doing a great job.

    Financials:
    Oroton has been extremely profitable since 2007. The business has regularly been operating with high and rising Return on Equity levels from over 42% in 2007 to over 80% in 2010. Operating cash flow is consistently higher than the reported NPAT showing that ORL is a cash generating machine.

    They also generate enough net operating cash to adequately fund their investing activities.

    Although the company’s debt levels have increased in the recent years with gearing levels hitting 32.53% in 2010, it is still at an acceptable limit in my opinion and the management team have shown in their history a focus on minimising debt whenever the chance arrived and the high cash generating ability of this company means that it should adequately be able to meet its debt requirements.

    ORL, as expected for a luxury retailer, operates at high profit margins which have been steadily rising from 2007 to currently 2010 where ORL had a gross profit margin of 21.44% and net margin of 15.69%.

    Since divesting the poor performing labels and focusing on its strength in their 2 luxury brands they have restored the business to a profitable cash generator with a grand brand behind it.

    Also, as the products are manufactured in Asia, a high Australian dollar will not have as big of an affect as it does on some similar retailers.

    Dividend levels have been high with a payout ratio of around the 70-80% range of their earnings. I expect this to be the same although with the upcoming expansion they may wish to keep a bit more in their tank to help fund that without increasing its debt. If that happens and their profitability stays as good as it is or increased I would not mind at all and would expect this to actually increase the value of the business.

    Outlook:
    Oroton plan on opening more retail stores in the following year which should help add extra sales to their bank account and have reported that their current and 1st overseas venture has been performing well. They also plan to open around 4 extra stores in Asia to complement their existing one.

    Asia is a large customer base for fashion accessories and if ORL get it right, could become a huge sales area. They will find more competition in this area but one thing ORL does have going for them is a identifiable brand that stands out in the marketplace and if the Asian population likes it then this will help ORL carve out a great share of the market. This will also help offset the problem of the company reaching saturation point in Australia which it might do within the next 3-4 years.

    I expect interest in this company’s products to remain strong. Their Asian stores will hold the key to the future path for this company.

    Other potential avenues that I can see that would be successful for Oroton is to launch a clothing range. They already have a great design blueprint in their accessories that would immediately be able to design a clothing line around for women and the brand following that would mean that there is an existing product base of customers.

    Risks:
    There are two main risks that I see in this company at the moment.
    1- The company is closely reaching saturation point in Australia. This would have the result of either decreasing the profitability of the business, encourage the business to make a bad acquisition which would also decrease profitability or engage in another high risk expansion strategy. However, my concerns with this are balanced against the realisation that management have done an extremely good job so far at due diligence and making decisions in the best interests of the long term profitability of the business.

    2- Unsuccessful overseas expansion. It can be tough for an Australian fashion business to make it overseas. We do not have the reputation of being a fashion capital and are seen as mostly followers of overseas trends. Very few Australian’s have made it overseas but also the quality of the current designers leave a lot to be desired with the talented ones finding it hard to get help with a start up. The American and European labels have huge brand appeal and a set following which will mean that Oroton will need to battle some heavy hitters in the industry to gain share in a market where very little is known about them. So far however there have been some promising signs and hopefully these continue. I believe Asia is a good starting point as they are a fashion forward area with a large number of consumers of the exact type of products Oroton produces and sells.
    Valuation:
    Following the Value.Able approach, valuing Oroton as an investment is hard due to its extremely high levels of ROE. This means that either a value.able graduate uses the 60% figure or fiddles around with other inputs to try and compensate for the extra 20% of ROE that is missed by using the 60% figure.

    With a 60% ROE and 10% RR I have a value of $6.41 for 2010 and forecast valuations of $7.99 for 2011 and $8.56 for 2012. But as mentioned using a 60% ROE for a company that has a 80% ROE means that a potentially higher IV could be justified however I have used a 10% RR to compensate for this and would instead had I been able to appropriately work it out with an 80% figure would have been more comfortable with a 11% or possibly 12% RR as fashion is a tough game that rapidly changes and has very few barriers to entry.

    Conclusion:
    This is a phenomenally profitable business and I thoroughly recommend it as a stock for Christmas. I expect it to continue performing extremely well.

    • 

      Andrew
      December 9, 2010 at 9:07 am:

      Forgot to ad to the financial or outlook section:
      I have for the next couple of years ROE staying at a similar amount to current levels however it is unlikely that Oroton can sustain these levels for a long time.

      Add to the valuation section:
      One advantage of the valuation being done at 60% and not 80% is that it compensates for a future decline in ROE and also will re-inforce a larger margin of safety due to the difference between 60 and 80% on the valuation allowing a factored in margin of safety to go along with the regular margin of safety to go with the normal margin of safety required beneath the value to purchase the company.

    • 

      Roger Montgomery
      December 10, 2010 at 11:11 am:

      Thats a great benchmark setter Andrew. Thank you and well done.

57. 

    David King
    December 9, 2010 at 8:31 am:

    Hi Roger. I wonder what you think of the “new” Seven group. (Code SVW) Clearly it’s very Kerry Stokes dependent, but what a success he’s been, despite all his past dithering about on lawsuits and side issues. I don’t know how to value the company, and no-one whose comments I’ve read seems to either. His Caterpillar farnchise for WA and parts of China looks like a winner, but who knows? And somewhere I read it is cancellable on 90 days notice from Caterpillar. I have no shares, though our super fund has some of his hybrids (SVWPA) which are paying us about 15% on cost. Would appreciate any comment from you.

    Best wishes

    David (and Anna) King

    • 

      Roger Montgomery
      December 10, 2010 at 11:11 am:

      Hi David K,

      I will make a note to have a look when I return.