Monday, April 25, 2011

Moving to Wordpress

Dear friends,

Due to the better features I have moved my blog to wordpress. You can find it at asxvalue.com. All of the articles here have been replicated on the new site.

Because I've posted links to most of my articles on various stock market forums I'll keep this page around.

Wednesday, April 20, 2011

Regional Express (REX)

My biggest blunder of the year has definitely been Regional Express (REX).

The initial attraction for investing was the relatively high net profit margin of REX compared to other airlines like QAN and VBA. Running with a load factor (how full their planes are) in the 60% range and still being reasonably profitable made Regional Express worthy of further investigation.

Despite these and other promising elements, such as low earnings multiple, manageable debt, and access to low cost pilots through their in-house training school, REX has been overwhelmed by fuel costs and the downturn in regional Australian tourism to post lower profit guidance for FY11.

My doubts finally confirmed, I offloaded my stock for a 19% loss. What stings the most is that if I was more disciplined I wouldn't have gotten involved with such a dog in the first place.

Lessons learned:

1. Avoid the airline industry altogether. Mad Hedge Fund Trader does a nice job of outlining the key reasons why investing in airlines is a recipe for disaster, even though he recommends some stocks as a hedge against lower oil prices.

2. Uncertainty about future earnings
When I bought shares in REX in late 2010, the most recent shareholder presentation stated that management could not provide profit guidance - which should have been a huge red flag. I should have doubted investing in a business the management couldn't share a short-term expectation on.

3. Vulnerabilities
Even though REX was exposed to some decent upside if passenger numbers grew, and had a reasonable margin of safety thanks to their low debt and good profit margins, I didn't account for areas where the business was vulnerable to factors outside management's control. Fuel prices and the potential for instability in the middle east sending oil prices into orbit meant that REX was never a safe bet because of its downside exposure.

My approach to Value Investing is to find business which are robust to any major downside exposure and selling for a discount to fair value. REX might be cheap, but getting into a business with such huge downside exposure ran contrary to everything I supposedly stand for.

SNL profit upgrade

Easter has come early with Supply Network who are now forecasting a year-end EBIT upgrade of 15%, from the 3.1M-3.3M range up to the 3.5m-3.8m range.

Another important factor of note is that this EBIT improvement is a result of revenue growth rather than improved profitability. If the company transformation successfully reduces overheads this should improve profitability and EBIT further for FY12.

Saturday, April 9, 2011

HGL Limited (HNG)

Market cap: $70m
P/E: 4.86
P/Book: 0.94
Dividend Yield: 8.6%


Something like a mini-Berkshire (without the insurance "float" to source new capital), HGL is a conglomerate of diversified import businesses serving niche markets such as model cars, school hats, and special format printing. HGL make no effort to integrate their acquisitions, choosing to let senior management operate autonomously and incentivise them to build long-term performance.

HGL are value investors themselves, making acquisitions where they can purchase entire companies at the right price. HGL continue to look for quality businesses to acquire, and even list their criteria on their website.

Until very recently, HGL has held a stock portfolio in addition to its businesses. It was probably the correct move for management to liquidate this portfolio and concentrate on their importer business model: to improve core business profitability and find new acquisitions. While some of these businesses are 100% owned by HGL, a number have their ownership shared between HGL and management.

Dividends are regular and can be reinvested although no discount is offered. At a current gross of 8.6% HNG are very healthy payers, reflecting a payout of roughly 80% of earnings. The one weakness to HGL's relative cheapness is the inconsistency of earnings - HGL did not sail smoothly through the GFC, with earnings falling from 19.2 cps in 2007 to 10cps in 2009, before rebounding to 13.3cps in 2010. HGL's moat exists due to the niche nature of the products they offer. These niche areas are difficult tor larger players to service, and results in higher gross margins than you would expect for a typical importer/retailer (in excess of 40%).

Because the majority of purchases made by HGL are made in US Dollars, the current strength of the Aussie should benefit the business in the next reporting period. Long-term I expect the US Dollar to continue weakening, thanks to their terrible economic policy - resulting in continued benefit to HGL's businesses.

The current price of $1.28 puts HNG's P/E ratio at less than 5 - outstanding value for a company with negligible debt serving specialised markets, raising the barrier to entry for competitors. I've had HNG on my watchlist for some time, and I'm ready to take a long-term position over the coming weeks. The business is significantly undervalued, and I wouldn't give serious thought to selling until the share price rose to pre-GFC levels - roughly double the current price. Buying before the dividend is paid in June would also reduce capital gains if they were ever realised.

Wednesday, March 23, 2011

Cash Converters' strategic alliance with EZCORP (CCV)

Yesterday it was announced that EZCORP would be increasing their stake in CCV from 33% to 53%. This would be initiated through a 91c per share offering, pending approval from 50% of the shareholders and the Supreme Court of WA.

In addition to this controlling interest, Cash Converters and EZCORP will enter into a strategic alliance to develop more financial products, building on Cash Converters' experience as a consumer lender.

CCV and EZCORP will form a couple of JVs:

One equally owned to focus on consumer loans opportunities outside Australia, UK, and the Americas.

One owned 80% by EZCORP and 20% by CCV which will focus on consumer loans opportunities in the Americas.

Loans products will be marketed under the Cash Converters brand.

Cash Converters have been deliberately focusing on their loans business for future growth (observe the rapid takeup in the UK, where the loans business is still in the startup phase), and this new strategic alliance will focus these efforts in new markets.

As outlined in my previous article on CCV, I was awaiting an announcement from EZCORP to take over the entire company. I do not intend to sell my stake at this stage, as this strategic alliance opens huge potential in these new markets.

Thursday, March 3, 2011

BSA Limited (BSA)

Market Cap: $60m
P/E: 6.4
P/B: 0.88
Dividend Yield: 7.1%


On the surface, BSA ticks all the boxes for value investors. Selling for 6.4x earnings and 0.88x book value, BSA is sitting on $17m of cash, has less than 50% debt to equity ratio, and hasn't missed a dividend since they commenced paying in 2006. (management aims for a payout ratio of 50%).

Turning to the underlying business, I am going to frame my analysis of the business the same way management do, into 2 separate streams: Contracting Solutions and Building Services.

Contracting Solutions
BSA's legacy business is centred around the telecommunications and subscription television market. As long-term contractors to Foxtel, Silcar and Optus, BSA have a strong practice in maintenance installation and troubleshooting of telecommunications infrastructure, as well as installation and setup of pay TV services. BSA also own the Mr Antenna and Mr Alarms brands. While revenue has declined since FY09, in HY11 Contracting Solutions won the national ADSL provisioning and service assurance contract for Optus (having previously only held the East Coast contract).

Building Services
In 2007 BSA branched out from their core contracting business by acquiring the Triple M group of companies, who are focused on the HVAC and Fire Alarm markets. Further acquisitions have expanded the practice, with Building services generating $176M in revenue in FY10. Building services continued to perform well in HY11, generating $120M revenue, and the order book has grown in the 6 month period ending December 2010 from 180m to 260m. I anticipate more acquisitions of smaller HVAC and Fire Panel operators over the coming years, and the currently challenging market conditions are going to create opportunities for BSA to acquire smaller competitors at great prices, with plenty of cash on hand.

Aggregate performance for HY10 saw outstanding growth with revenue up 39% and NPAT up 72%. While much of the growth I expect to see in BSA will be through the Building Services arm, Contracting Solutions are exposed to a large potential upside in the medium term through subcontracting on the NBN project. BSA already participated in stage one, winning work in Tasmania and NSW. If the NBN goes ahead in the future, BSA will be in the right position to potentially win a large chunk of the subcontracting work.

My holding horizon for BSA is forever (barring a major change to the underlying business), and I intend to continue adding to my position given the low share price. The 5% discount for dividend reinvestment gives me another reason to buy, hold and reinvest.

Wednesday, March 2, 2011

BigAir Group Limited (BGL)

Market Cap: 20m
P/E: 10.9
P/B: 2.34
Dividend Yield: 0%


A niche Wimax operator, BigAir operates a national network in 7 of Australia's biggest cities. The company is geared towards delivering services to the wholesale market, leveraging the sales forces of other organisations who use BigAir services to complement their offerings. The key advantages of Wimax technology are:

1. Fast turn-on (hours vs weeks for a terrestrial connection)
2. High speeds for wireless (up to 1Gbps symmetrical)
3. Low install costs (Running fibre in built up areas costs well over $100 per metre)

Since turning cashflow positive in 2009, BigAir have been making smart acquisitions like Clever Comms (Their main competitor) and ISP operators who deliver managed internet services to the student accommodation market, such as Accessplus. While BigAir have a number of other competitors in the Wimax market, none of these operators have a national network.

For a company only selling at 11x earnings, with strong profit margins with no debt, BigAir is positioned to continue their significant growth. FY10 saw revenue growth of 17%, and NPAT growth of 50%. BGL is becoming more and more profitable, while revenue continues to grow rapidly, funding investment into more Wimax points, fuelling future growth in the business. Gross margins are in the region of 80%, now that they've binned the offnet business in favour of services delivered via their own infrastructure.

The fact that BGL currently doesn't pay a dividend isn't a major concern for me, right now the best place to invest their healthy profits appears to be back into the business. As the reinvested profits approach diminishing returns it will make sense to begin returning cash to shareholders.

BGL have just put up their mid FY11 numbers, and revenue growth has not slowed at all - maintaining their CAGR of 51%. Net operating cashflow doubled. This huge cashflow allows BigAir's growth to be fully self-funded, while making acquisitions with a mix of stock and cash. An important qualifier is while the half year numbers account for the costs of the CVA and AccessPlus acquisitions, they do not include any of the earnings. It is reasonable to expect good earnings accretion for year's end, which will result in significant profit growth for end FY12 once core network synergies have been realised.

One of BigAir's major assets is their CEO, Jason Ashton. Jason owns 10% of BigAir and successfully co-founded an ISP in 1993 which was sold 6 years later for $20M.

BigAir is a company I can see myself holding forever, provided the telecoms industry's evolution doesn't damage their market position. They're growing like mad, and it will eventually make sense to pay a dividend. In the meantime, BGL are a growth opportunity with significant potential and no major competition.

Saturday, February 26, 2011

Amcom mid year results (AMM)

This week Amcom announced their half year results to the market. Key points:

Revenue up from 29m to 41m 43%
NPAT up from 7.6m to 9.9m 30%
Final dividend increased from 0.4c to 0.6c up 50%

Much of these results are flowing on from the EOFY10 results Amcom posted in which earnings increased by 42%. It is also worth noting that while the business is growing, EPS was flat at 1.4c. Importantly, this is our first look at the results of the IP Systems acquisition and the performance of the NT Government contract.

Firstly on the IP Systems acquisition, this new subsidiary is already showing benefits from integration, with revenue from this business unit increasing 30% by cross-selling existing data clients. For now at least, my skepticism appears to be misplaced, as the rapid uptake of IP Systems services should be an important source of growth when Amcom's data business begins to mature.

The NT Government data network has already been rolled out, and since signing the original contract, Amcom have written 500k worth of new orders. Nextgen's competitive backhaul to Darwin should be complete by September this year, helping Amcom reduce their wholesale network costs to Telstra. As discussed in my previous post, Amcom has bucketloads of opportunity in Darwin due to the lack of competition in this market.

It's obviously still early days for the partnership with Bluefire, but there is significant potential for Amcom to write Cloud business with existing customers, due to the variety of cloud offerings and the SaaS nature of the Bluefire solution.

One negative is the performance of the Amnet consumer DSL business, which is being squeezed with both revenue and EBITDA decreasing. It would make sense for Amcom to offload this business to iiNET and focus on their Enterprise/Government clients instead.

The half year report came with an upgraded earnings guidance estimating Amcom's year-end NPAT at 21.6m, however there are opportunities for further upside this FY in growth of the NT business, increased services through IP Systems, and the uptake of cloud services with Bluefire. The dividend increase demonstrates confidence in future earnings. With a PE ratio of 10.5 and plenty of room for continued growth, I currently have no plans to exit my position in AMM.

Friday, February 18, 2011

Supply Network (SNL)

Market Cap: 17M
P/E: 9.2
P/B: 1.31
Dividend Yield: 6%


With a market cap of only $17M and thin trading volumes, a sensible investor would shy away from a company like Supply Network, which supplies truck and bus parts. Fortunately these disadvantages are minor enough not to be insurmountable, and Supply Network's niche operations generate a decent cashflow.

SNL's dividend history goes back to 2001 and at 7.9 x earnings is selling for an attractive price. Dividends are high and can be re-invested at a 5% discount.

What you do get when you buy SNL, is a steady business selling for not much more than book value, which continues to produce steady earnings. The 4 company directors are all subscribed to the Dividend Reinvestment Plan, collectively owning 17.6% of the company.

Supply Network are currently in year 2 of a 3 year growth strategy, aimed to grow organically by increasing network capacity and customer service. FY10 saw modest profit and revenue growth around 7%, which is net of a recent investment in new staff, branch expansion, and IT systems. The unaudited half year FY11 report showed a 40% increase to NPAT pcp which will be largely offset by an increase to 2nd half costs associated with new systems and the opening of the Mackay branch. Regardless, full year EBITDA has been revised upward from 3M to 3.1-3.3M.

Long-term, I see Supply Network as a business which will grow roughly in line with the economy, with potential for a bigger profit jump short-term by improving current business processes. While it lacks the prospect for spectacular earnings growth, this steady business has survived the GFC with no material impact and focusing on their core market means a more certain future.

Given the limited prospects for high growth, I plan to sell my holdings in SNL should it ever reach 15x earnings. If not, I anticipate continuing to hold this business for years to come.

Amcom (AMM)

Market Cap: $229m
P/E: 10.9
P/B: 1.55
Dividend Yield: 4.5%


This gunslinger of the wild west has had an interesting history. Founded in Perth in 1988 as a cabling contractor, Amcom gained a carrier license in 1998. In 1999, it was acquired by a gold exploration company called International Minerals, who divested their gold project and changed their name to Fibretel.

Today Amcom's network connects over 1200 commercial buildings in Perth, Adelaide, and Darwin. While the core business is focused on providing fibre-based data services to Enterprise, Government and Wholesale clients, Amcom also operates a 20,000 connection DSL network which contributed $2.6M to EBITDA in FY10. Amcom also owns 23% of $400m consumer ISP iinet (IIN) which provides roughly a million services across Australia and has achieved an average annual shareholder return of 16.7% for the past decade. A serial acquirer of its competitors, iinet is positioned to lead the consumer DSL market through its size and leading customer experience, although their main competitive threat, TPG, is a very aggressive player. IIN contributed $7.8m to AMM's earnings in FY10.

Amcom's biggest win of FY10 was a 5 year, 20M contract with the Northern Territory Government to provide data services. The Northern Territory is one of the least competitive areas of Australia in terms of telecommunications, particular in "on-net" infrastructure which doesn't rely on Telstra's copper network. I expect to see a significant increase in Amcom's business in the NT, both organically to NT Government and to the NT business market. There should also be potential to wholesale to other carriers operating national data networks but lacking significant access infrastructure in NT.

In FY10 Amcom also acquired boutique VOIP operator IP Systems, to complement their data network reach with IP voice connectivity and a national network footprint. I am waiting to see how well this pans out, as enterprise IP voice is a technically complex service more suited to the domain of traditional voice carriers. While there is potential to cross-sell to each other's clients, in the long term (past 2020) I think most enterprises will be operating entirely on mobiles, apart from the contact centre. In the future this market will be controlled by specialist contact centre practices who can provide a slew of value added services. The acquisition could provide potential benefit if Amcom can use IP Systems' POPs on the eastern seaboard to begin bidding for national data networks and delivering new services to their existing clients.

Today Amcom announced their partnership with Bluefire to provide cloud computing services over their fibre infrastructure. This is much more exciting than the IP Systems acquisition as despite all the hype, I see a big future for cloud computing. While many providers use the internet to deliver services (all you need is a few racks in a data centre, some servers, and a virtualisation environment like Vmware), carriers with access infrastructure can deliver services over private network, giving better service quality for real-time enterprise applications.

Over the course of the last financial year, AMM's share price doubled from 16c to 32c, thanks to IIN's share price appreciation and a significant increase to both earnings and dividend. Since then shares have been trading in the 30c-35c range which equates to 10-13 x earnings. This Financial Year Amcom expect to increase NPAT by at least another 20%, but I wouldn't be surprised to see this jump even higher.

The beauty of the telecommunications business is the fixed cost base and small marginal cost of adding new services. Once you have enough customers to pay for this fixed cost base, new services usually just fatten your margins (unless significant capital works are required through investment in new infrastructure build). If you are a carrier, your future is a lot more certain when you're in the access infrastructure game, because the barriers to entry are a lot higher than if you rely on other carriers access networks (or if you are a straight reseller). Although telecommunications is a deflationary business (think about how much you paid for a mobile phone call 5 years ago), this is offset by increased demand for data. Amcom's network is in a much less competitive area, reducing this deflationary pressure which is much higher for data on the East cost of Australia, and much higher for fixed voice.

This means once you have enough services to pay the bills, your network becomes a cash cow, generating free cash (AMM generated 21M in FY10) which you can either return to the shareholders, expand your network footprint to target new markets, or use to make acquisitions to broaden your service offerings.

Back to margins, these are something AMM has in spades, one of this company's biggest advantages. Amcom's NPAT margin in FY10 was 16.7%, based on revenues of $63.1m and NPAT of $10.6m. I wouldn't be surprised to see this decline slightly in the next reporting period due to the IP Systems integration, but provided the inclusion is successful, I anticipate AMM's profit margins will continue to grow.

The threat of the NBN is not significant in Amcom's case, due to their targeting of the business market and their typical network speeds in the 100Mbit - 10Gbit range.

I have been holding AMM since 2009 and intend to continue to do so for the foreseeable future. With a 4.6% dividend yield, lack of serious competition, and significant opportunities for earnings growth outlined above, I don't plan to sell my holdings unless the company's price began to approach 20 x earnings. Based on their current PE multiple of 11, AMM's share price would have to double.

AMM is a potential takeover target of TPG Telecom (TPM), which has acquired Soul and Pipe Networks. Amcom's fibre network would complement the strong east coast presence of Pipe's fibre network. The takeover could be partially funded by divesting Amcom's $95m holding in iinet.

Sunday, January 9, 2011

Cash Converters (CCV)

Market Cap: 298M
P/E: 11.1
P/B: 1.83
Dividend Yield: 4.5%


The first thing you notice when you look at CCV's financials is the cumulative shareholder return over the past decade: 37.7%. This means a $10,000 investment in the pawnbroker and personal loans company in 2001 would have grown to $245,097 today.

But that's history.

Looking at the contemporary state of CCV, we see a business which is selling for 11.1 times earnings and 183% of book value. With their market cap of $298m, CCV is sitting on a healthy $50m cash; this is being used to fund acquisitions, mainly of their franchisees. Debt/Equity ratio is 8.7%. Evidence of future growth is found in management's FY11 profit guidance of 27M, which would grow the company's bottom line an additional 21% year on year. Management has a long-term strategy to improve the image of the Cash Converters brand to be more legitimate, opening the business to new customers.

It is important to note that the cash sitting on the balance sheet is due to a share placement made by American equivalent EZCORP, which operates 897 pawnbroker and short-terms loans outlets in the USA and Mexico. EZCORP currently owns about 33% of CCV. This investment is a vote of confidence by a larger player which will help Cash Converters enter its next phase of growth by buying out franchisees. Long-term, the company will be getting more and more of its EBIT from financial services, while the franchising component will shrink as more stores move over to corporate ownership.

Cash Converters began buying back franchisee-owned stores in early 2008, at an average acquisition price of 3.9x EBIT (roughly equal to the company-level EBIT). They also acquired the Scotland master dealer license for £420,000. In addition to the annual license income of £131,000, this dealer license gives Cash Converters scope to expand the Scottish business above the current 10 stores (estimated saturation point of 60 stores).

Although the main Cash Converters store network is in Australia and the UK, they have boots on the ground in countries as diverse as Spain, South Africa, Malaysia, Thailand and the USA. I do wonder about how well they will do in these countries with less than 10 stores, when it may be more prudent to focus on their Eurozone operations first, using the UK footprint as a base to expand into mainland Europe. Due to their small numbers these ventures won't screw Cash Converters if they go bad, and is a good way to test the brand in new markets, expanding their footprint in countries where they are most successful. These non-European locations should be good for longer-term growth when the European market approaches saturation.

While they are still adding new stores in Australia (at the modest rate of 8 stores per year vs 32 per year in the UK), most of the business's growth will come from overseas. Store numbers in these core markets are by no means saturated, and management's disciplined rate of expansion is to be commended:

Australia: 139 stores with with potential for 200
UK: 150 stores with potential for 600

At 78.5c CCV is not as good value as it was 3 months ago, but the underlying business is just as solid. Negligible debt, profitable, plenty of cash and room for growth positions Cash Converters really well to continue their success. With current ownership at 33%, a takeover of CCV would be a natural development for EZCORP. EZCORP's share price has doubled in the past year, taking their P/E to 15 - while CCV are selling for 11.1 x earnings. If a cash or share deal were put on the table, I plan to sell immediately, provided I could get an equivalent price for my shares on the open market. Otherwise I intend to hold my shares long-term, unless an exuberant market pushes the earnings multiple too high, or the business changes structurally in a way which makes continued share holding undesirable.

Thursday, January 6, 2011

Colorpak (CKL)

Mkt Cap: 52M
P/B: .85
P/E: 8
Div Yield: 5.1%


My first buy of the year occurred after offloading the last of my blue chips.

Colorpak designs and prints packaging, a decidedly dull and steady business.

Recently CKL acquired Carter Holt Harvey's packaging business, for a mere $5m, funded from existing cash and debt facilities. The business is expected to add 125m rev and 4m EBITDA to CKL's existing business, and increase EPS in the first full year of ownership (ie end June 2012).

This will bring on more clients for CKL, realise operational synergies, expand their offering to market to include the fast food industry, and expand their current market footprint to include NZ.

This acquisition looks to be an inflection point for the company, a view held by CKL's executives. CHH's acquisition will nearly triple CKL's revenues and give them a market leading position to capture more of the market through additional acquisitions (CKL have made a number of acquisitions since 1998).

One such acquisition was made in 2010 of the Remedies printing business, which was in administration. This is expected to add another 1-2M of revenue and contribute to EPS over the next 12 months. This will also expand CKL's offerings outside the folding packaging business.

In terms of folding cartons, CKL's main business, CKL control roughly 11% of the market, with CHH and Amcor controlling about 25% each. The purchase will give CKL an equal market position against Amcor (who purchased part of CHH's folding carton business as well) and dominate VISY (who control about 10%).*

Turning to Amcor, over 150 times the size of CKL, you see a vastly different balance sheet. Selling for twice book and 15.3 times earnings, AMC operates on a net profit margin of 4-5% compared to CKL's of nearly 8.

Barring a major increase in price or major structural issue with the business, I plan to hold this into late 2012 when the CHH acquisition has been fully integrated. If the dividend yield continues to be high I plan hold past this date with the anticipation of further benefits through additional acquisitions and capture of additional growth and profitability through CKL's increased size.

* It has been necessary to revise this article due to new information about CKL's market share