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What company valuation did you ask for this Easter?

What company valuation did you ask for this Easter?

Heading into Easter, I received an enormous pile of valuation requests and while many were little mining explorers burning through $500,000 of cash per month and with just $3 million in the bank, quite a few were solid companies that hadn’t been covered before.

And to confess, some of the requests were quite rightly keeping me accountable and making sure I post the company valuations I said I would, when I have appeared on Sky Business with either Nina May, Ricardo Goncalves and Peter Switzer.

What are they, I hear you ask? Forge Group (FGE), Grange Resources (GRR), Arrow Energy (AOE), Cabcharge (CAB), Coca Cola (CCL), Data 3 (DTL), Hutchison (HTA), Incitec Pivot (IPL), Metcash (MTS), Sedgeman (SDM) and UXC (UXC)

I am really impressed by the frequency with which I am now receiving emails containing insights I didn’t know about companies that I have covered.

As a fund manager it was not unusual for me to adopt Phil Fisher’s ‘scuttlebutt’ approach to investing. By way of background, Warren Buffett has previously described his approach to investing as 85 per cent Ben Graham and 15 per cent Phil Fisher. Fisher advocated scuttlebutt – talking to staff, to customers and to competitors.  I did the same and would often end my interview of a company’s CEO or CFO with I’d learned from reading Lynch; “if I handed you a gun with one silver bullet, which one of your competitors would you get rid of?” The answers were always revealing. Sometimes I would get; “there’s noone worth wasting a silver bullet on”, but most of the time, I would find out a lot more about the competitive landscape than I had bargained for. Occasionally, I would learn that there was another company I really should be researching.

Back to your insights, they are amazing. Now you know why I enjoy sharing my own insights and valuations with you as much as I enjoy the process of investing.

One thought for you; Many of you are sending your best work via email. I would really like to see everyone benefit from the knowledge and experiences you all have so hit reply and if you have some insights (as opposed to an opinion), just click on ‘REPLY’ at the bottom of this post and leave as much information as you would like.

So here are a few more valuations to ponder over Easter. I hope they add another dimension to your research. And before you go calling me about coal seam gas hopeful Arrow Energy, note that the valuation is a 2009 valuation based on actual results. The forecasts for Arrow for the next two years are for losses, and using my model, a company earning nothing is worth nothing. Of course Royal Dutch Shell and Petro China think its worth more and perhaps to them it is, but as a going concern its worth a lot less for some time to a passive investor.


I hope you are enjoying the Easter break and look forward to reading and replying to your insights.

Posted by Roger Montgomery, 1 April 2010

INVEST WITH MONTGOMERY

Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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56 Comments

  1. Hi Roger,

    Just wondering if you would change your intrinsic for metcash after their purchase of Franklins

    • Hi Mark,

      It is very likely the valuation would change. The purchase (subject to ACCC?) price of $215 million is 16% of the equity prior to the acquisition so the impact could be meaningful. Metcash generates circa 18% returns on equity. Whether the purchase increases or decreases the intrinsic value, will be dependent on the return on equity of Franklins. You can estimate what those changes are, or you can wait for the annual result after a company makes an acquisition.

  2. Hi All
    Anyone watching FGE should read report submitted to asx and should be received by shareholders in the next few days.
    Independant valuation says don’t accept, offer unreasonable, report
    is available for reading on asx.com.au

    • Great Stuff William,

      I am having a break up the coast for school holidays so thanks for being the eyes and ears! I am surprised and encouraged that a report comes back that in somes ways doesn’t restrospectively agree with the board’s decision. Note the independet directors recommended non acceptance but the directors with an interest have abstained? If those directors sell the strategic alliance with Clough is triggered. It is the view of just about everyone here that the value of FGE is higher. I continue to hold the view that operating a business and allocating capital are two different skill sets and few directors have both.

  3. Hi Roger,

    What is your oppinion on MMS now (after the recent acquistion of Interleasing (Australia) Ltd)?

    Regards,
    Bill

  4. Thankyou for these valuations Roger. I know we are only touching the very tip of the iceberg here in terms of business selection criteria, ie ROE and NetDebt/Equity etc. and you have said before that you use approx. 19 criteria, I think, to help identify ‘A1’ businesses. Is it asking too much for you to add brief comments to each valuation as to the relative strengths of the business, perhaps even a rating? The comments on your analysis of the Health sector stocks was useful.
    Also, could you provide valuation/thoughts on HVN, AMP, BBG, please? AMP would appear to have a good name in the market, but its Eq/share and EPS has been declining.

    • Hi Bruce,

      I will see what I can do in this regard. You’re asking a lot for free! I am away at the moment but will look into it on my return. Regarding a few more valuations – that will be no problem.

    • Hi Jared,

      OK. As I have already indicated its an A1. The issue is whether the long term contracts are a valuable competitive advantage.

  5. Ha Roger:
    You have mentioned “Richard S” lots, can you tell us more about “Richard S”, who and where or which about Richard S’ valution?

    WE can use it to fill the gap before your book.

      • Hey Nan – if it helps

        While I cannot read RM’s mind, I read and research a little bit, and I think I’ve found some interesting research from the elusive Richard S…

        I googled and found a couple of them, and was pretty sure it wasn’t the guy on about p/e ratios, so ended up downloading info from a certain business school (I had to pay, but it wasn’t much).

        It seems to fit in nicely with a value methodology such as RM’s, but don’t be expecting a one-off, one-size-fits-all magic formula as such; more so a way of thinking that lends itself to the creation of a formula – which I am unfortunately unable to nut out at this point!

        I appreciate RM’s pushing us to research on our own as it has certainly been (and continues to be) interesting, rewarding and will no doubt help put things into better perspective once Value*Able arrives. (Can’t wait)

        Good luck and happy researching!

    • My guess is that Richard S is Richard S Ruback, a professor of corporate finance at Harvard Business School and prolific author of papers on valuation techniques. As to which valuation technique Roger espouses, I guess we’ll have to wait for the book.

  6. Hi Roger,

    Now that Forge shareholders have voted in favour of the deal with Clough Group, I imagine your valuation for them will have reduced quite a bit. Can you let us know your thoughts?

    Regards
    Peter

    • Hi Peter,

      There’s a bit of work to do here. Its not automatic that my valuation will decline. Best not to make any assumptions until the numbers come in. Shareholders approved a placement but the board have recommended no action be taken with regard to the bidders statement. Thats standard procedure by the way. What will be really interesting to me is the so-called, independent expert’s valuation. The bid for 50% is at $2.10. Based on a continuation of past returns on equity, the valuation should rise materially from current its level which is already above the current price. I will speculate ( and I rarely do that) that the independent valuation will be low, suggesting shareholders would be silly not to take the Clough deal. Fortunately I rely on my own valuations.

  7. Hi Roger,

    Now that Forge’s deal with Clough has gone through, and ten odd million shares have been issued at $1.90, what does that do to your valuation numbers? From my perspective, the only positive to come from this is that Forge didn’t go down the path of the off market takeover and that it can live to be invested in another day – assuming the deal is a good thing.

    • Hi Robert,

      The issue of shares will have a negative impact on value if the shares are issued below equity per share. They can have a positive impact if they are issued at a price that is above the equity per share. The ultimate outcome however will also be dependent on the return on equity that results and that might not be known for six or twelve months unless the company provides updated guidance.

  8. greig whitelaw
    :

    Hi Roger

    Have only just stumbled across your you tube appearances and am very interested in your value investing approach. Just wondering how much your book will cost?

    • Hi Grieg,

      I think its coming in at $49.95, is almost 300 pages, is Hardback, weighs between 500 grams and a kilo and the price includes GST and Postage & Handling within Australia. Hope that helps.

      • Hi Roger
        As your book has been market priced at $49.95, what is intrinsic value do you give? well I am not going to give my valuation before my acqusition.

        Friday Joke.

  9. Hi Roger,

    Sorry, another question. Some companies are able to produce consistent profits year after year, but their cash flows can be wildly different every year. Some companies (like steel companies) spend loads of cash on capex every year and will continue to do so, just to keep up with their competitors. Do you look at cash flow or free cash flow ratios, or the cash flow statement when valuing companies?
    cheers
    mike

    • Hi Mike,

      The short answer is; absolutely. There’s a chapter devoted to the two ways I calculate cash flow in the book. One method uses the cash flow statement, the other use the balance sheet.

  10. Hi Roger,

    I understand that you use ROE as part of your valuation tool. How do value companies if they have debt, given ROE doesn’t consider debt levels? I noticed the companies above have various levels of debt, so how do you account for that? Do you also apply qualitative factors when you look at companies, e.g. quality of management, if directors hold lots of shares, competitive advantage etc?
    Thanks
    Mike

    • Hi Mike,

      Its all in the book. Buffett said some really insightful things about debt, namely; look for businesses earning good rates of return on equity with little or no debt.

  11. Hi Roger,

    Always good to read you thoughts. I am looking forward to the book release.

    I have some thoughts about FGE which I would like to bounce off of you. Its ROE is high and the amount of equity being retained is very high bringing about a valuation which is higher than the current price. If they keep retaining equity (and are able to utilise it to maintain the ROE) the valuation will rise at a fast rate. My concern is that the directors are content to recommend shareholders sell half of their shares at a price that is disastrously low! If they are happy to do this, do the directors realise what an enormous opportunity they have to maintain and build a wonderful business or will they do something stupid that causes the valuation to fall?

    Regards,
    Michael

    • Hi Michael,

      I also wonder if the board understands the concept. Companies that can retain large portions of earnings and re-employ those retained earnings at high rates of return are very valuable. Their intrinsic value rises quickly. The decision to issue shares below the current price (I would suggest it must have been arranged some time ago – were shareholders informed about this at the time?) and below the intrinsic value, goes to the heart of my column recently for Alan Kohler that the role of managing the operations of a business and the skills required are very different to the role and skills required in allocating capital.

  12. Hi Roger,
    I work for a company called Salmat and would like to know what you think
    of its intrinsic value and roe. Interestingly, this could be a good way to
    pick companies to work for :)

    We will shortly be offered a share plan and would like to get some input
    before I make a decision,

    Thanks Mike.

    • Hi Mike,

      I cannot give you any personal advice Mike, but I can say that what is most interesting is that the valuation today is the same as it was seven years ago. I like to invest in businesses whose intrinsic values are rising over the years. It seems the company quickly moved on from the recent issues with St George Bank’s statements and I would be interested in any insights you can appropriately share about the competitive landscape in Salmat’s suite of businesses.

  13. Hi Roger,

    I am looking at a PE of 2.28 on an iress based system for LEP (ALE Group)
    They are busy selling a number of pubs and paying down debt after a
    capital raising last year. Elements of their capital raising were done in
    range from $1.80, $2 and $2.25 and they paid out .24cents per share over
    the past year. Please can I have an opinion on their value based on a
    conservative investment. They are also currently buying back old debt notes
    and issuing replacements.

    Maybe at the other end of the scale, an energy stock Molopo has just
    wacked their pe with a capital raising to fund their production of
    significant oil recently found in Canada. They suggest they will be
    producing by the end of this year. Prior to this they were focused more on
    developing and producing alternative energy sources. One analyst has a
    forward valueation of up to $5?

    Kind regards,
    Ian

    • Hi Ian,

      I will eventually get around to every request, but cannot do them all immediately. I note ALE Groups’ intrinsic value is declining for the next two years.

  14. STAN TESCHKE
    :

    HI ROGER BEEN TRYING TO GET A VALUATION ON SOUL PATTERSON FOR SOME TIME. I KNOW THEY HAVE A POISON PILL WITH BRICKWORKS.

    I STILL THINK THEY ARE UNDERVALUED BUT HOW DO I FIND OUT HOW MUCH THEY ARE WORTH?

    tHANKS STAN

    • Hi Stan

      I know you have been waiting a long time and given we’ll be catching up in Melbourne soon, I better deliver. Quick back of the envelope calc suggests the intrinsic value is closer to $9.00 for the next two years than the current price.

  15. Richard (Russello)
    :

    Hi Roger

    It’s been a couple of weeks since my last visit, so it looks like I might have missed the boat on your Easter valuations. I’f you’ve still got the time (and inclination), I’d greatly appreciate your views/valuation on Monadelpheous (MND). I think (emphasis added) it’s a stock you would like, with massive and return on equity and little debt. A significant provider of construction services to the mining industry, MND has more recently endeavoured to widen its horizons by venturing into the somewhat related oil and gas space and even water infrastructure. For a number of years, MND have been growing the service/maintenance side of their business, so they are less exposed to the more lumpy construction related activities they have traditionally undertaken.

    MND always seems ‘expensive’ in terms of its P/E, but I know you don’t put much weight in P/E ratios.

    Curious to know what you think and what value you put on the stock.

    Regards

    Richard

    • Hi Richard,

      One of my A1 business with steeply rising valuations if it hits expectations. A little expensive right now but the forecast value in 2012 rises well above the current price. Remember seek personal professional advice before transacting.

  16. Hi Roger,

    I have always found the decision to sell shares in quality businesses difficult, especially when I know that the opportunity to buy back into those same businesses at a later date will be rare.

    It is only recently, through reading your blog and other contributions that I have developed more confidence to make rational decisions regarding selling. I particularly like your strategy of holding on to quality businesses when forecast intrinsic value (1-3 years hence) exceeds current market price.

    My only dilemma now is to forecast intrinsic value into the future.

    I still believe Roger, that with your research database and wealth of experience in value investing, there exists a beautiful window of opportunity for you to use your new book as a springboard into some form of consulting/advice newsletter.

    As I have suggested previously, it could cover A1 quality businesses (whilst also identifying potential “businesses to watch”), giving an indicator of present value as well as forecast value 1,2 and 3 years out. This way, a subscriber could make the decision to hold (or sell) an A1 business they already own, based not only on price relative to current value but price relative to future value. I truly hope you consider something along these lines.

    Thank you for your constant contribution to my investing education. I enjoy reading and listening to your input at any opportunity.

    • Hi Tim,

      Thanks for sharing your enthusiasm for value investing and for your idea for a newsletter. Everyone reading this blog, knows that I am a value investor but perhaps what you may not know is that it is a special brand of value investing that attempts to only fill the portfolio with the issues of quality companies. One of the criteria I look for in a quality company is an identifiable competitive advantage, a barrier to entry or imitation. Even in my own business, I try to operate those with characteristics that are difficult to replicate in some way and newsletters have few barriers to entry and imitation. I also have two close associates, even friends, that own and operate separate newsletters – Alan Kohler who runs the Eureka Report and Angus Geddes who operates Fat Prophets. Those relationships are a barrier to entry for me but stay tuned.

  17. Hi Roger. Great thanks for your info, appreciate your effort for all these education and analysis. Of the valuations above, FGE is trading well below its present intrinsic value and not hard to imagine the forecast value will be even higher. It was very lucky that I picked up FGE’s financial report last September and bought some shares immediately after reading it.
    Only a recent propose offer from CLO which I think the price is too low that worries me a bit (althought it looks like there will be a better offer from a 3rd party). Do you have any comments on that?

    Many thanks, hope you and your family a Happy Easter!

    • Hi Wing,

      Thanks for your email. I am a little miffed by Forge’s continuation with an agreement to approve the Clough deal on terms that don’t reflect current and future values. There are forcing shareholders to give away a lot. I get the impression there is some inexperience there. I wrote a piece for Alan Kohler about the difference skills that are required for operating a business compared to allocating capital. It is vital that directors know their limitations. And thank you for your Easter well-wishes.

  18. Hi Roger, On the sky business channel a few weeks back, you said you used analyst consensus forecasts to work out the future value of a business. I’m interested in hearing your comments on why you use consensus forecasts when I believe you have the same opinion as Warren Buffett that analyst predictions are usually ‘precisely wrong’.

    Cheers,
    Graham

    • Hi Graham,

      I use consensus for the numbers I publish but of course I get all the research from just about all the brokers and admittedly, some analysts know some companies better than others. As such, it might be for example that Pattersons knows one company better than the Deutsche analyst but the team at Deutsche covers another company with more insight than Macquarie. In those cases, I use the estimates that I think best reflect the company’s RANGE OF prospects and in my days managing funds I ask the CEO or CFO which analysts they think cover the company best. There is no replacing doing your own research and modelling though. Once I have a range of forecasts I put together a range of valuations and I try to buy below the range. A range of valuations gets around the ‘precisley wrong’ limitation that you raised. Good post Graham, thanks for sending it in.

  19. Paul Kloeden
    :

    Hi again,

    I would be interested in Roger’s, and others’, thoughts on FGE. It seems to be trading at a price well below value. At the same time it is the subject of a ‘strategic alliance’ whereby Clough may will be issued about 15% of the equity, for $1.90 a share, and offer to buy 50% of the rest for $2.10. The directors have agreed to sell 50% of their shares.

    The result could be that Clough owns more than 50% of the shares, or at least a controlling interest of over 30%, for a price not just below market price but well below valuation, even allowing for the dilution effect of the share issue .

    Such a deal makes me wonder about the Forge management. It also makes me wonder if it might be better to buy Clough rather than Forge, especially if the former is going to be a large owner of the latter at such a great price.

    On a more general note, should I even be looking at a company which is embroiled in such a change of ownership and should I consider a company which has, or will have, a single controlling shareholder?

    Time for some hot cross buns,
    Paul

    • Hi paul,

      I have written a piece for Alan Kohler that discusses Forge and I will post it here later in the week. The thought about buying Clough is a good one but remember if you buy Clough, it doesn’t only own Forge at a great price. So you have to update Clough’s numbers and see if you are able to buy the whole thing below intrinsic value. I do think there is merit in investigating Forge, remember you could own the other 50%. If my memory serves me correctly, the Board are accepting the bid for 50% of their holdings.

      • Today, further details about a competing proposal has come through. Briefly, it’s a full takeover at less than current market-price but above Clough’s offer with a required minimum of 90% acceptance. This could be the start of a takeover bidding war between Clough and the other as-yet-unnamed suitor but I have to say, it’s starting off a ridiculously low base. Kind of like rivals bidding for a Picasso from an initial bid of $1. Something in the writing of Forge’s announcements to date suggests to me ( speculation ) that Forge’s directors & managers are getting tired of running the business and just want to sell out before bad macroeconomics news hits them.

      • Hi John,

        I didn’t have the opportunity to respond to your post in time but as you are well aware the competing proposal was still at a price lower than the market price. A good example of the the reason to wait for full details rather than speculating. You may yet be on the mark with regards to your reading of the announcements but again speculation and investing are two very different things.

  20. Paul Kloeden
    :

    Hi Roger, I hope you are enjoying Easter with the family and not reading this until next week.

    I have been a keen reader, and watcher, of you for some time. I look forward to the book.

    I am interested in the variation, at some times large, between your valuation of a company and those of other services. I assumed you use the same formula – if not I guess I’ll need to wait for the book. But if so, then the differences can only arise because of different inputs.

    Thanks, Paul

    • Hi Paul,

      As a completely independent analyst, I use a completely new and original formula that nobody in the world has. I don’t subscribe to any third party services as I have no need to. The differences between my valuations and those of others, is due not only to different inputs but also a completely different formula. If you would like to start investigating useful valuation formula, you can print out Buffett’s 1981 letter shareholders and try and get some of the valuation research done by one ‘Richard S’. Buffett’s example suits companies that pay 100% of earnings as a dividend and Richard’s is useful for companies that pay no dividends. Using them both you can cover every company. Its the basis for a life long affair with value investing! You will have to wait for the book for everything to be revealed!

  21. Terence Harvey
    :

    Hey Roger. Recently finished the Warren buffet book the snowball and am really looking forward to reading value.able. Was going to pose you a question about investing but had too many Easter beers to get my point across. Hope you have a great 4 days. Will try again soon. :)

  22. I have done some calculations on Forge Group using the 1981 BRK method and only come up with a intrinsic value of $1.09, I must be missing a vital part of the equation. I know it only accounts for stocks paying out all there dividends, so how do i go about valuing retained earnings compounding at the ROE rate?

    Any feed back would be appreciated…

  23. Michael Sheehy
    :

    Roger,

    I was under the impression that you used a third party service to get your valuations.I cross referenced some of your valuations with others they are different. Are you able to divulge how your valuations differ from the others?

    Thanks,
    Michael

    • Hi Michael,

      I have no ongoing association or relationship to any businesses offering investment services or even any of the companies that I founded, listed on the stock exchange and sold. If anyone has given you the impression that I still have a relationship with them or that I use their services, that is plainly wrong. I am completely independent and as such have developed my own, entirely original and new formula for valuing companies and have no need for any third party services. The basis for my valuation approach is outlined in my forthcoming book. The first part of the formula is taken from Buffett’s 1981 letter and the second part from a valuation model first built by Richard S. On their own they are limited, but together they are very useful indeed.

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