Further one-legged update on the reporting season

Well folks, we are at the tail end of reporting season. I don't know about you, but I will be glad to give my one leg a much needed rest after this bout of ass-kicking.

23 August 2013

LYL results out. NPAT for FY 2014 will be reduced by 50%. Price is getting interesting, but my call is that there could be slightly more pain for LYL given their position in the food-chain.

CAB analysis. Postulate that market is overweighing the impact of ACCC recommendation to reduce 10% to 5% for payment systems.  The absolute downside is that $45m being wiped from the top travels right to the bottom, reducing FCF from $60m to $15m. Multiple compression follows as ROE of 20% becomes 5%, turning a good business into a capital intensive substandard business. A compression of multiple to 8 means the current market cap of $500m falls to $120m, which is a 75% drop. It is probably obvious that the outcome lies somewhere in between the absolute downside and the current situation, therefore it will be helpful to map out multiple scenarios in preparation for a price opportunity.

26 August 2013

SCD results.  Operating cashflow of $2m, resulting in $7.2m in cash, but there is $1.2m in tax liability and $1.6m tied up with banks as security for bank guarantees.  Factory revalued downwards from $4.4m to $3.2m. Equity increased from $10.2m to $12.6m.  Service revenue increased from $4.5 to $5.2m.  Orders on hand $6.9m. One customer made up 30% of revenue. I have covered this company in a previous post.

MTU results.  Underlying margins appear to be declining.  ROA declining. Debt increased.

VTG results.

MLD results.

HSN results out.

27 August 2013

SRV results out. Operating cashflow of $27m (after paying tax of $10m). Occupancy increasing. Cash on hand $99m. Weakening AUD may boost earnings in FY14. 23 out of 38 immature floors will mature in FY14.  Opening another 8 large floors which will boost total office space by 10%.  All USA floors are cash flow neutral and all expected to mature in FY14. Occupancy rate is 88% as at June 2013 (USA recovery).  Using $27m of FCF, with 10% RRR, assuming zero growth for 10 years and adding unencumbered cash of $90m, yields $345m value.  Using dividend discount model, on grossed up dividend figures, current market cap requires dividend to rise by 5% every year, and terminal value of 10x grossed up dividend.  Current price means that an investor gets growth for free. I have held this for over 5 years now (first post here), and this long holding period has been helped immensely by a very competent management.  

FLT results out. NPAT up 20%.  Amazingly, current price implies growth of 5% per annum in FCF for the next 10 years. I missed picking this up during the GFC for under $4, which means a 10-bagger has gone down the gurgler.

VEI results out.  All metrics declined. Revenue down, gross margins down, cashflow down, but surprisingly, wage expenses and doctor payments were also down.  FCF of $18m, debt of $45m. DCF of $168m, less debt of $45m, yields $123m. 148m shares on issue.

Examples of edge- information, analysis, behavioural, structural. From Robert Robotti.

28 August 2013

TWD results out.  Good yield. Exposure to housing in SE Queensland. Worth a deeper look.

AMA results out. Revenue up, but EBIT down. EBIT margin increased by 2%.  Company is debt free, with cash at $10m in August 2013.  Cashflow very strong at $10m. 332m shares. Net of cash, AMA priced for no growth. Good to see a capable and honest CEO delivering on his promises.

IFM- founder CEO is leaving and has sold all his shares.

WTF results out.  Revenue down, profits down, and cashflow down. But somehow market is valuing shares for 10% growth pa for 10 years. Madness.

MLB results out. Heavy in cash, new management team coming in, but premium core business under pressure.  Core business valued at 5x cashflow after backing out cash chunk.

TTI results out. Debt still of concern.

29 August 2013

VOC prelim results out. Revenue increased to $66m. Profit down. Cashflow $18m, tax $3m. Free cashflow $15m.  Fibre and DC showed tremendous growth.  Cash balance of $14m will fully fund next year’s $13.3m capex. Locked in recurring cashflow will pay off IRU obligations of US$10m next year. USD hedge runs out in Dec 14, so some exposure to declining AUD. FCF $15m, current market cap implies 5% growth pa for 10 years. Adding debt to get EV of $220m, with FCF $15m, implies less than 10% growth pa.  In the presentation, VOC stated that FY14 capex is in response to customer demand, and this was repeated.

CTE Prelim report out. NPAT $1.25m. Operating cashflow $1.9m. FCF $1.6m. Cash on hand $5.7m. No dividend declared.  Wage costs up $300k and one-off capex spend.  $2m tax losses remaining.  Record number of blood cord clients. FCF estimated at $1.7m. Fair value at $23m, assuming no growth. But note:   “The Board is confident that subject to any unforeseen circumstances, the benefits of its common infrastructure and operations systems to support the business units will allow it to increase revenue, improve margins and overall financial performance of the Company during the next financial year.”

IPP HY report out.  Revenue period to period hardly moved.  Not a good sign, as M’sia went backwards due to elections, but increase in prepaid services plus record month in July, so momentum will continue. HK shows very good growth and is close to breakeven, locking in 4 out of 5 major developers.  INA growth slowing but still strong, whereas Singapore is lagging (still number 2). REA trading at 14X revenue. IPP is trading at 12x revenue.  We await next quarterly cashflow statement.

30 August 2013

DDR results out. Cashflow negative.

SST results out. Loans paid to other entities??

UOS HY results out. I have held this for over 3 years, and posted about it here. Within the HY report, I found an amazing and pristine balance sheet:

Cash	$429m
Receivables	$159m
Inventories	$294m
Land held for property development	$20m
Property plant and equipment	$28.2
Investment properties	$566.8m
Total of Asset Items above	$1497m
Financial liabilities	$319m

Rent and parking fees for half year is $20m.  Shares on issue is 1.1b, market cap is AUD$580m.  Book value increased 15% over 6 months.

That's it folks.  Time to sit back and think through ideas. By the way, the reading list has been updated, for those interested.

Disclosure:  My family and I own shares in AMA, CTE, SRV, SCD, TWD, IPP, VOC and UOS.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Business going for a song (and a one-legged dance)

Imagine that you are the owner of a manufacturing business.

You manufacture leading edge scanning equipment which scans and analyses materials in realtime.  Your customers are operators of cement factories, coal mines, coal fired electricity stations and iron ore producers, and you are proud of your product because it saves costs for your customers. Moreover, it is good for the environment as your machines reduce wastage, reduces electricity usage and increases plant efficiency.

Your business has a history going back to 1981, with a founder hailing from the esteemed CSIRO.  You employ a group of dedicated engineers who has created ingenious products which have been successfully installed in over 1000 locations around the world. Your patents and intellectual property portfolio is valued at over $1m. Your business has weathered the turbulent economic climate for over 3 decades, and most recently has emerged from the GFC unscathed.  Your bank is flushed with cash of over $5.2m, and you  own your own factory valued at $4.43m, with a $2m mortgage on it. Other than that, you owe the banks nothing.

Your business has had its up and downs, but nevertheless the business has generated profits for the last 7 years, even through the trough of the GFC. You have build up net value from under $5m all the way to over $10m in 6 years, despite generously returning over $1.7m in capital to all shareholders last year. Business is good, with a backlog of orders. on the books. You will probably make about $1.5m to $2m this coming year.

One day, some hotshot investment banker walks into your factory. He takes a look around, and says that he will offer to buy your business, your factory, your IP, your management team, on a walk-in walk out basis for $8m. He figured that you have $5.2m in the bank, $4.4m worth of real estate property and a mortgage debt of $2m, which comes to roughly $7.6m, and he says you can keep the change.

Would you agree to sell? Chances are you would tell the banker to go to hell. The offer is insulting. Even if you make only $1.5 m per year after tax, you would probably be asking for $7m at least for the business on top of the cash and property values. A realistic offer to start talking would have to be in the vicinity of $15m.

For some curious reasons, even with exactly the same situation, things work slightly differently in the sharemarket.

On 11 March 2013, Mr Market is kindly offering me a slice of Scantech Limited (SCD) for 45 cents. With 17.6m shares on issue, plus about 1.7m worth of options exercisable at prices of 70 cents and above, the undiluted market capitalisation of SCD at 45 cents is $7.9m.

This is the 90 seconds pitch to buy SCD:

“As at Dec 2012, SCD has $5.2m of cash in the bank. It owns a factory valued at $4.4m, and this factory has a mortgage securing $2m. Cash and property less debt totals $7.6m. At 45 cents, SCD has a current market cap of $8m. At this price, the business is valued by the market at just $400k. The business has been profitable for the last 8 years, and generated cash of $50k and NPAT of $260k last half year. The company manufactures and supplies equipment which analyses compositions of materials in realtime on conveyor belts. The equipment is used by companies in bulk commodities such as cement, coal and minerals. The order book is increasing and stood at $9m as at Dec 2012, and importantly service revenues are starting to catch up with equipment sales. Management owns a substantial amount, and navigated the GFC without making at losses or raising any capital. In fact, they did so well that they returned $1.7m to shareholders as a capital return in 2012. Management has given guidance for a similar result in 2013 as 2012, which is about $1.7m of NPAT.”

This is the 90 second pitch against buying SCD:

“The company owns the factory and therefore does not pay rent. Let’s assume the company sold the land and leased it back at market rates. As industrial property is valued at yield, taking a conservative 8% yield on $4.4m yields a yearly rental expense of $352,000. We credit the finance costs of $130,000 per annum (since the $2m mortgage is no longer required) to yield a net expense of $222,000 impacting the bottom line. This virtually wipes out half of the half yearly profit to $150,000, and puts the company into cashflow negative for the half.  In this scenario, the company will have $7.5m of cash, and a business barely breaking even.  We should assume mining capex is decreasing going forward, and thus 2012 and 2013 will probably be peak revenue for SCD. $8m is probably a correct fair value, being $7.5m of cash with a nominal amount of $500k for the business which has historically erratic margins, net profits and cashflow.”

The critical investment issue with SCD is just simply, is the business worth more than $400,000 and if so, how much is the business worth? The problem with the negative case is that the first half is traditionally the weak half. SCD sold 11 machines, but is contracted to deliver 17 machines the next half. So we can be reasonably confident that figures for the full year will be respectable, probably above $1m in NPAT.  If we average out NPAT over the last 7 years, we get average NPAT per year of $850k per annum. A conservative 6x multiple for this equates to $5m. These are conservative, and we can easily mount an argument for the business to be valued at $8m. If this is so, addition of cash and property yields intrinsic values of $15m to $16m, double the current market cap, thus achieving a 50% margin of safety.

The downside to SCD is adequately covered by real cash and hard assets. The cashflow of SCD is also covered by an increasing stream of service fees. Service fees have increased steadily from $1.9m in 2006 to $4.5m in 2012, and the only year it has dropped is 2011 by a mere 10%. As the installed base of equipment gets larger, service fees will form an important buffer to earnings going forward. Another investor has pointed out that any decline in mining capex will not have a major impact on operating mines which will concentrate on production efficiencies, thus increasing opportunities for SCD.

Enjoy and prosper.

Disclosure: The author owns shares in SCD.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.