Clime Investment Management Ltd (CIW, CAM, CAMPA)

Clime has the following share structures:

• Funds Management operating business: Clime Investment Management Ltd (CIW)
• Listed Investment Company (LIC): Clime Capital Ltd (CAM)
• Preference shares on CAM: Clime Capital Ltd Preference Shares (CAMPA)

CIW is an Australian funds manager and financial analysis software provider. I am not going to look at CIW today, and instead focus on CAM and CAMPA. CAMPA fits into the Listed Income Securities bucket and has an interesting structure and is not just an ordinary share.

CAMPA aren't anywhere near as attractive as AFIG notes, but interesting nonetheless. CAMPA were issued in 2007 at an issue price of $2.40. The shares pay a fixed interest rate, initially of 7.5% p.a. fully franked, therefore 10.7% p.a. grossed up. The actual dollar interest payment has since been upwardly reset following further rights issues of new CAM shares (I will explain this in a moment) so the current dividend is 19c per share. Based on the current price of $2.14 per share the yield equates to 8.9% p.a. or 12.7% p.a. including franking credits. 

That's the first bit. CAMPA will convert into ordinary CAM shares 10 years from the issue date - which means 2017. Again, as new CAM shares have been issued and diluted value, the conversion rate from CAMPA to CAM has increased. Initially, the conversion rate was 1 for 1, however it has increased to 1.30967 shares for every 1 CAMPA share. 

Th reason for the increase in dividends and conversion rate is that by selling more CAM shares, it dilutes NTA and therefore the negatively impacts CAMPA holders. The adjustments to dividends and conversion rate compensate CAMPA holders for this.

The overall return from CAMPA will depend to a very large extent on the underlying performance of the CAM price between now and 2017.

Let's put some numbers around that.

CAM is currently $1.04. So the current conversion value of each CAMPA share is $1.36 ($1.04 * 1.30967). That's an awfully long way down from the current CAMPA price of $2.14. Listed below are some scenarios based on assumed growth rates in the CAM price between now and 2017 and how that will translate into an overall Internal Rate of Return (IRR) for CAMPA. The IRR takes into account both the current yield and capital gains/losses.  

What stands out to me is the performance of CAMPA is dependant on a better performance from CAM. And that doesn't take into account dividends from CAM, where the CAMPA IRR does. I can't for the life of me understand why CAMPA is trading at these levels. Either I have missed something (always possible) or investors have been seduced by the high current yield, not knowing the equity risk lurking below.

The current pre-tax NTA of CAM is $1.17. You could make an argument that CAM price is undervalued, however if that's your view, you are still better off with CAM than CAMPA.

Kristian

Disclosure: do not own CIW, CAM, CAMPA

Australian Foundation Investment Company Ltd Convertible Notes (AFI, AFIG)

As a follow up to the Listed Income Securities article, I have been reviewing some previous posts and have updated my numbers on AFIG. I can't explain why I didn't buy AFIG earlier when the stock was issued at $100: I knew about the trade, the downside was extremely low, plenty of upside, simple. Maybe it was just too simple! 

Live and learn. But it is better to learn and live. 

Moving on. AFIG are now up a bit to $117.50. AFIG pay a coupon rate of $6.25 so the current yield is 5.3% p.a. Okay, the notes are trading well above the face value of $100. A number of things could happen. First, the notes could mature in 28/2/17 for the face value of $100. Under this scenario, the yield-to-maturity (YTM) is 1.5% p.a. As noted in the first post, this type of return isn't a great outcome, but there are stocks out there far more downside potential than +1.5% p.a. 

The other possibility is the conversion of the notes into ordinary shares. AFIG shareholders have the right to do this every semi-annual interest payment date of Feb and August. Each AFIG share can convert into AFI shares at a fixed rate of $5.09 per AFI share. $100/$5.09 = 19.6 shares. Therefore, as the AFI share increases in value, the value of the in-built option in the AFIG shares increases. 

The potential return therefore depends on the timing of the conversion and the AFI share price. I have updated my scenarios based on assuming conversion takes place at maturity in 2017 and AFI share prices of $5.72 (the current share price), $6, $8 and $10. Please note I have no idea what the share price will actually be: the purpose of the analysis is to understand the types of returns possible depending on the AFI share price. 

Here are the potential pre-tax returns based on the assumed AFI share prices:

If the AFI shares reach those levels earlier, the IRR gets better.

I don't own AFIG, but they are on my list to buy when I stop procrastinating about it.  

Kristian

Disclosure: do not own AFIG or AFI

ASX Listed Income Securities

The last few years have been good to income focussed securities. When it comes to the stock market, 'income' is a very loose word. For simplicity, I tend to think there are two types of income stocks, a) stocks that are ordinary shares that have a relatively high dividend but expose the investor to ups and downs in the stock market and b) stocks that are specifically structured for income and provide little or no room for capital growth. 

A strategy that selects ordinary shares is the Dogs-of-the-Dow strategy. In my previous role, we ran the Australian version of this strategy since the GFC and the returns have been truly eye-popping. I have been waiting for mean reversion, which would mean that resource stocks would need to  outperform financials, however it hasn't happened and clearly the markets hunt for yield has continued. 

The main focus for this post however is stocks structured for income. I keep on top of most of these stocks and they can be found in the tables at the back of the Australian Financial Review (AFR) under Interest Rate Securities. There are various classes of securities including hybrids and convertibles. 

Warning: it is extremely important to note that an income security does not necessarily mean safe or similar to a term deposit. Two cases illustrate the point perfectly: 

a. PaperlinX SPS Trust (PXUPA). Issue Price: $100. Current Price: $6.90

b. Elders hybrids (ELDPA). Issue Price: $100. Current Price: $27.00

Some of today's stocks trading at $100 or thereabouts will possibly be donkey's in the future. Seth Klarman wrote an excellent piece for Forbes in 1992 called Don't Be a Yield Pig. 

Moving on. 

When considering this area of the market, two sets of analysis needs to be undertaken. First, understand the structure of the stock and second the underlying fundamentals of the issuing company. Not necessarily in that order. 

The structure of each issue has its own terms and conditions. Some pay a fixed rate, others a floating rate. Some are cumulative, some are not. Some have a fixed maturity date, some are perpetual. Most (but not all) have a 'face value' of $100. Personally, I keep a spreadsheet of these stocks and periodically update the prices, new issues and update base interest rates. This makes the job manageable. I calculate a current yield and yield-to-maturity. Current yield is the current interest divided by the current price. Yield-to-maturity takes into account the current yield and any capital gain or loss. 

I am of the belief that some investors are not considering yield-to-maturity when paying above face value for some of the securities. Many of the stocks don't have maturity dates, so yield-to-maturity is meaningless (unless you assume they may be bought back). 

I have covered some of these securities in previous posts: AFIG, HLNG, HLNGA, MYBG and MXUPA. 

There are many more. 

My list is not complete, however of the 55 I track, the average current yield is 6.8% p.a.. Two years ago, that figure was (from memory) closer to 9% p.a.. My argument back then was the long term combined income and growth return from the share market was anywhere from 9-11% p.a. depending on the time period and market, so making the majority of that from a collection of income stocks without having to worry about growth seemed sensible. 

I find less bargains these days, however it is an interesting area that is constantly growing and I am sure it will produce some more good buys in the future. 

Kristian

Disclosure: own MXUPA 

Disclosure: 

Merricks Capital Special Opportunity Fund Ltd (MEF)

I have been sitting on this post for a while, pondering the situation and hoping for some more liquidity in the stock before I personally bought. Neither have occurred. Regardless, the situation is incredibly interesting and informative. In this article I have used a share price of 45c, even though the last trade was 47c. The stock is bouncing around these levels. 

Enjoy.    

Background

MEF was previously called the Fat Prophets Australia Fund (FAT). After shareholder agitation over mediocre performance, Merricks Capital were appointed managers 1 August 2010. The portfolio moved away from a boring general portfolio of shares (holding the usual-index-suspects) to a concentrated, specialist stock-pickers portfolio.

At the time, Net Tangible Assets (NTA) were $1.13 pre-tax and $1.09 post-tax.

I had to re-read what comes next multiple times to make sure I had it right. The subsequent destruction of MEF shareholder wealth has been astonishing and even more disturbing given the otherwise decent returns Merricks other funds have produced. Post the manager change, the first major holdings included $6.3m (3m shares) in Straits Resources Ltd (SRQ) and $6m (52m shares) in ING Real Estate Entertainment Fund (since changed name - see later). Total MEF assets at the time were $31m. Note: that's an investment of 20% of available capital into one small resources stock. And to think the original FAT shareholders went in on an ASX200 style investment and had no choice or redemption opportunity other than to sell on-market at less than NTA. As at June 30 2011 SRQ accounted for 50% of the portfolio value. Even more in subsequent months. 

The subsequent performance of SRQ:

Not pretty. 

Fast forward to now. Merricks was replaced by Aurora Funds Management in March. Aurora appointed a sub-manager who has embarked on a new strategy focussing on financial services; i.e. yet another change in strategy. The sub-manager, Andrew Barnes has taken a 19.9% stake in MEF. 

Wilson Asset Management (see the previous post here) are also shareholders in MEF. 

It was at this point I was getting interested because MEF was trading at a big discount to NTA and the potential value-realisation catalyst was Wilson agitating for change. 

I've been disappointed so far. The share price has higher than what I would like (getting to 47c on very very light volume) and the new manager has allocated a very large part of MEF's assets to an unlisted purchase. All of a sudden, the investments have gone from tangible (other listed stocks) to intangible (an unlisted business). Nothing necessarily wrong with that, but just adds a layer of complexity. But complexity can equal opportunity. 

The new investment is a 49.6% stake in van Eyk Research for $13.3m. From my previous days in the industry, they seemed to have a good enough reputation. From the MEF news release: 

The NTA at 31 March was 55c including tax deferred assets and 53c excluding tax deferred assets. This is pre the van Eyk purchase. Anyway, using using the 53c NTA gives a total asset base of $15.1m. What I don't understand is that MEF still has sizeable investments in SRQ and Lantern Hotel Group (LTN). I guess the actual cash transaction is still to take place. 

As an aside, I've been doing some work on LTN which in itself quite interesting, especially now a receivables from the Panthers has now been collected. LTN share price could suffer in the short-term from stock overhang. It's on my to-do list to research. 

Regardless, the new manager is undertaking a new strategy and the existing investments will sooner or later get sold leaving ~$3m more to invest. 

Okay, so taking a share price of 45c, MEF has a market capitalisation of $12.8m. Investors can effectively buy van Eyk slightly cheaper than what the fund has paid and have exposure to a further ~$3m or 10.5c per share.

No dividends are currently being paid and we have no idea if and when dividends will be paid in the future. We are clearly in a market that has the hots for income, therefore non income paying stocks have tended to lag. This is where a contrarian might see opportunity, especially for stocks that could start paying dividends again. 

A meeting will be held 20 May and one of the resolutions is to change the name to Australasian Wealth Investments. 

Liquidity in this is stock border-line non existent. If something goes wrong, the downside could be large if there are no buyers to be found. 

Interesting. Still mulling this over. 

Kristian 

Disclosure: no position in MEF, SRQ or LTN

Wilson Asset Management Ltd (ASX: WAM, WAMO)

WAM is a long-standing, popular and successful Listed Investment Company (LIC). A common strategy used by LIC's to raise more funds is to offer 'free' options: the usual format is one free option for each new share bought. The option gives the shareholder the right to buy another share at a certain price by a certain date. 

In its latest round of capital raising, WAM issued options with a strike price of $1.60 and the expiry is 31/7/13. These options are listed under the code WAMO. 

Here is the current prices of WAM, WAMO and other relevants facts: 

• WAM share price: $1.71
• WAMO share price: $0.10
• WAMO exercise price: $1.60
• WAM NTA (31/3/13, post tax): $1.82
• Estimated WAM NTA assuming 100% exercise of options: $1.79*
• Next Dividend Ex Date: September 2013

*Estimation only. There is likely to have been more growth in the portfolio since 31/3/13 however a 6c dividend was also paid. 

WAM has an excellent track record of paying a growing level of fully franked dividends. The rolling 12 month dividend is 11.5c or 16.4c including franking credits. Based on the current share price, the historic  dividend yield is 9.6% p.a. To provide some points of reference, that yield is a) three times the RBA Cash Rate (3% p.a.), b) the current grossed-up yield on the ASX equivalent of the Dogs-of-the-Dow is 6.8% p.a. and c) the current yield on a selection of hybrids I follow is 7.2% p.a. 

The yield based on the exercise price of $1.60 is 10.25% p.a.

The graph below is a recent history of the share price v post-tax NTA: 

There has been a disconnect with the share price and NTA in the short-term. This is not common for WAM but has been a big problem for other LIC's. 

Obviously a few things can happen from here: 

• The NTA sinks - depending on how far the NTA sinks, the share price may stay roughly where it is or also sink
• The share price rises to close the gap to NTA
• The disconnect continues  

To lose money on the options, they must expire worthless: ie the share price must drop to $1.60 over the next few months. This could happen. Either the NTA gets smacked or the disconnect in the share price just continues and for some reason drops to $1.60. The former scenario is more likely. As noted, the historic dividend yield on $1.60 is 10.25% p.a. 

The upside is the market remains stable and the share price may wander back up to the NTA and if investors are lucky, the NTA keeps moving up giving a double-win. 

Kristian 

Disclosure: long WAMO, strictly as a leveraged way to buy shares in WAM. 

LVMH Moët Hennessy Louis Vuitton (LVMH) - an interesting fact

Just a short post on some information I find very interesting. Many people know the LVMH company. Essentially it is an aggregator of luxury brands and is headed by billionaire Bernard Arnault. Mr Arnault recently made news with his proposed change of residency to Belgium to avoid France's extremely high tax rates for the rich. The snapshot below shows you the portfolio of their brands: 

Australian readers may also find it interesting that LVMH has bought a stake in RM Williams.

What I find extremely interesting is that as a group, the spend on marketing is about the same as what is spent to make the actual products (cost of goods sold). See the latest financials below: 

This trend holds true over previous years. 

So that means for example when you spend $2,000 on a LV handbag, you are paying roughly the same amount for marketing as the actual product itself. I guess it makes sense: luxury is just as much about the image it creates for us as the actual product. All that advertising and high end stores generates a perception in our minds. I'd be a hypocrite to say I'm immune to the charms of luxury brands: I own a German car, Italian suits and a Swiss watch. Truth be told I don't need these things, but sure like how they make me feel. 

Kristian 

Disclosure: no position in LVMH. Long in some of their products!