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What do you think of the QAN, JBH and ITX results Roger?

What do you think of the QAN, JBH and ITX results Roger?

Here we are in the midst of reporting season and there are some reasonably predictable results. Qantas reported a profit today that was less than a quarter of its profit more than ten years ago. The airline reported a $112 million profit but that was boosted by $1 billion of revenue from its Frequent Flyer program and a $300 reduction in employment costs. For those of you interested in the real numbers, the company actually lost $302 million (see my chapter in Value.able on cash flow) and this can be explained by the very wide gap between the depreciation item in the profit and loss statement and the real expenditure on property plant & equipment. Depreciation looks backwards, but new planes cost more.

Separately, JB Hi-Fi’s result was excellent but my concern is that its $94 million of cash flow (of which $67 million was allocated to dividends and $20 million allocated to paying down debt) is superfluous to its needs. Take a look at the biggest asset on the balance sheet – Inventory of $334 million. Then take a look at the creditors item in the current liabilities section. Almost the same amount!

Think about it this way; the suppliers are funding the inventory so the company doesn’t even need cash to pay have the stuff it sells and that are on its shelves. Actually it really does, the gap is about what is left over once we subtract the debt repayment and dividends from the cash flow. It is small though. Once the debt is gone and the cash keeps growing it may do something that could harm intrinsic value.

Now don’t get me wrong; JB Hi-Fi is an amazing business that retained its A1 status in this result and the risk associated with its plans to roll out more stores is very low. I also think intrinsic value will continue to rise at a satisfactory rate. The concern for me with all this cash (and there is no evidence of it yet) is that the company increases the dividend payout ratio again. This would mean a reduction in the rate of growth of intrinsic value. It could stop being the “compounding machine” it has been to date. Return on equity also appears to be flattening, which could mean within the next few years, the valuation may plateau (but at a higher level than the current price).

On an unrelated issue, I note that back on 4 May 2010, I put together a list of the companies that I though represented the last of value in a blog post entitled Do these three companies represent the last of good value? ITX was one of the companies listed and I note the company has announced “itX confirms that it is in discussions with an interested party regarding a preliminary non-binding indication of interest to acquire 100% of the ordinary shares in itX.”

I’m pleased to strike another one up for the quality rating and valuation approach advocated here at my Insights blog!

Posted by Roger Montgomery, 12 August 2010


Roger 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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  1. Hi Roger,

    I’d love to know what you thought of the CSL FY2010 result announced today (the 18th of August), as well as the new $900m share buy-back.

  2. Roger/Jarrad

    Have just emailed the itX company secretary outlining why the current price being paid is a steal, and suggesting the transaction should be at $100m or more (sorry Roger, couldnt bring myself to suggest a dollar more).

    Not your valuation technique roger, but basically said that by the time the transaction goes through, itx should have 15m of cash in its coffers. subtract this from the 77.5m offer and that leaves an enterprise value of 62.5m. if we make the conservative assumption that a sustainable fcf is 7m, this gives a fcf enterprise yield of 11.3%. this is far too low for a business of itx’s quality (no capital required for growth and considerable moat through its supplier relationships/contracts). I have suggested 8% is more appropriate and a transaction price of $102.5m (=7m/0.08 +15m).

    Will let you know if i hear back from him.

    Hears hoping the independent expert can see the light (doubt it)


    Justin S

    • Hi Justin,

      I am pleased that you are reaching the same conclusions. Remember being a good manager doesn’t not mean you are qualified to know anything about company valuation. Don’t expect to hear back from the Secretary. AT the very least, to get their attention, you would need to write a letter separately to each board member. It is very frustrating when another good company gets taken off our hands.

  3. The directors of ITX are doing the shareholders a disservice. The company would appear to have a much higher intrinsic value than the accepted offer.

    Let us hope a competing offer comes along

    • Hi Ashley,

      As frustrating as it is, unless you have 5% and can call and EGM (or can gather together shareholders with 5% with a request to the board for the share register), there is not a lot you can do.

  4. Roger,

    I noticed on your last couple of TV appearances you mentioned that you had moved from 90% cash and made some recent share purchases. Would you care to share some of these on your insights blog? I’m wondering if this means there has been some more value emerging recently in some good businesses apart from those few mentioned in blogs over the couple of months?


    • Hi Steve,

      Yes, I have made some purchases in recent days. As I have also said on TV I would be happy to re-enter when the full years results are out for some companies. These results have confirmed some companies as A1 and seen a few enter that rarified status for the first time. I will be posting a blog in the next few days with some updated A1’s and valuations and you can then go and do your own research. I will also note if I have an interest in any of them.

      • Roger,

        NCK and DWS make the grade?

        NVT result is one thing, but the outlook is potentially another given the sensitivity over education visa policy and the electoral outcome? Plus it seems to trade consistently at around 180%- 200% of best case outcome IV.


  5. Roger i have been asking for 6 months now,
    whats your opinion on Flexigroup (FXL).
    It stacks up quite nicely in my opinion,
    + there are non-financial criteria such as heavy insider ownership, insiders participating in the recent capital raising (and we are not talking about insiders giving lip service with a contribution of a few thousand dollars, some serious money was allocated by insiders).

  6. I am now using Rogers insights to gain international exposure (but hopefully it will be a case of diversification, rather than deworsification).

    The high AU$ presents a margin of safety (on a long term basis) to start acquiring international equities, especially in the US.

    Also check out a number of ‘quality’ US companies.
    Go through their reports in the manner Roger describes, i think the evidence will surprise many.

  7. Hi Roger, having a great time reading your book. I am considering a few companies to start my portfolio. I like JBH & ORL, but was wondering the impact on the takeover bid for ITX. It seems to be trading at a discount to its intrinsic value.

    Thanks Roger

      • Hi Roger

        First, I have to thank you and your wonderful blog for sparking my interest in ITX. I went away and assessed the quality and value of the business. Armed with this information I bought a small piece of the business.

        I too think that the company is trading at a very big discount to my estimate of the value of the company, even though the share price has rallied so much.

        Management have negotiated a deal to extract $1.55 of cash (see recent announcement by ITX on ASX website) and the potential benefit of some additional franking credits for shareholders. Does this mean that the Board of Directors are selling the business too cheap (when compared to the intrinsic value) and are far better off rejecting the offer unless significantly higher bids are received by Avnet or another party?

        Thank you for all your opinions on the blog.
        Looking forward to the next post!


      • Hi Jarrad,

        In my opinion, the price being paid for itX is a steal. Its worth possibly a dollar more than that! If anyone can get me infront of the board, I would be delighted to explain to them why.

      • Too late. Better to convince some of your buddies in private equity to take a run at it as there is clearly more than a dollar on the table for the taking. What it needs is some competitive tension brought to the transaction. The ITX Board has failed in this regard, just as it did in its disclosure obligations and confidentiality in the run up to the announcement that an offer was being discussed. The business is great but has been let down by its Board.

  8. Roger,

    More value slashing news from Telstra (TLS) today. No suprises there. As much as you can take credit from your winning picks you should take double credit for calling out the dogs.

    On JBH. I was looking at a list of businesses my retired parents could buy (they rely on dividends much to my disdain). JBH is ticking the boxes for me at the moment as a good fit for them.



  9. It seems to me that the JBH story is a very pertinent one for the small Australian market. There is a limit to growth, much smaller than in the US for example. Once companies mature, as I think you are rightly suggesting JBH will in the next few years, they take on more of the nature of a bond (assuming they remain A1s and use their excess cash wisely) where the value lies more in a consistent dividend return with capital growth being limited to inflation or close. This doesn’t mean that they might not still make a valuable contribution to a portfolio.

    The interesting question for me, however, is when to get on board such a company. On one hand Buffett likes to see that a company has been operating for ten years, with figures over that time to see that it is what you call an A1 company. But if we wait for that long, in Australia in particular, we potentially miss the phase where intrinsic value rises fastest. From memory JBH hasn’t been listed for ten years.

    I would be interested to hear how much history people (Roger and others) look for. As for me – I would be reluctant to buy a business that didn’t have a track record of at least 3, and in many cases 5 years, even if that does mean missing some of the upside. Part of my margin of safety.

    • I agree with you Paul. An intelligent investor should look for long term (>10 years) double digit growth as a requirement of a stable business to invest your hard earned e.g WOW. However Oroton is a A1 business and I would BUY this business before JBH or even WOW because of its ROE and intrinsic value combined. In this case its a bit like hands in poker a full house is a good hand (WOW) but a straight flush (ORL) beats it everytime.

  10. Hi Roger, great to see your thoughts. I’ve actually owned the itx group since april at $1.07, at the time I didn’t have your valuation technique but I thought they were worth around $1.40 so I stocked up on them. I’ll be very dissapointed to see them go. I would’ve liked to hold on to them for quite a bit longer. They have a great ROE! At the moment I have scaled the companies on the asx high and low trying to find another good quality bargain but so far, besides CSL and JBH (which I already own and are not in my margin of safety any longer) the best value reasonably reliable company i can find is IDT. have you heard of it? what are your thoughts?Thanks.

  11. Great to read about your thoughts Roger. Also thanks for the insight on JB Hi Fi. Your book as opened me up to new oppourtunities. Money well spent I say!

  12. I valued itX and bought it at $1.28 then half an hour later almost fell of my seat! Had no idea about the takeover! I asked a couple of mates in IT what they thought of itX then priced in a high required rate of return. I have had it on my watchlist since you mentioned it Rodger. I went through the last two annual reports once more (6th time since may) and then decided to go for it despite it rising from around $1 to $1.28 recently. If I had taken another 15 minutes it would have risen another 12%! I told my Dad who is a bit of a sceptic that I bought a peice of a business I liked using value investing from Rodgers book and backing my convictions, then clearly someone with a lot more money maybe did the same,lol. If the takeover goes through or not I dont mind and thats the beauty of it. Thanks for sharing the tools Rodger

  13. I agree with you on JB hi Fi. As it operates in Australia and NZ It can really only open up a limited number of stores. So as it grows and makes increasing profits it cannot go on increasing stores at an ever growing rate. So what does it do with the money it makes? Well it has to either pay down debt, pay it back to shareholders or find some other avenue for expansion such as opening up stores in some overseas market. I think JB Hi Fi said that they planed to open 10 – 15 new stores per year for the next 5 or so years. Assuming that the first stores that they opened are in the best locations with highests population you would think that future stores should increase profits but not by as much as the stores they already have.

    So If JB Hi Fi are planning to open the same number of stores each year over 5 years percentage growth must slow down and increase in intrinsic value must slow down.

    Still looks like a good company but we can’t expect the great rates of growth of the last 5 years to be repeated in the next 5 years.

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