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.