Paperlinx (PPX and PXUPA)

On better news (than the previous post), the PPX AGM was held in Melbourne last week which I attended. 

PPX is one of the more talked about and controversial stocks, however I think one has to agree that at least they are making the big decisions to try and fix the business. Europe is all but done and I as understand there may be some relatively minor lease obligation residual after Germany is finished. Maybe VW can rent it to store some of their cars that no one wants to buy.

Clearly the traditional paper business in ANZA has done okay but is in structural decline. PMP, another company facing structural decline has tackled the issue by savaging costs across the board. PPX's response has been to cut out the cancerous parts and diversify into other areas such as sign & display and commercial packaging.

Diversification could go really well, or really bad as in the case of Peter Lynch's diworsification. Unfortunately I don't have any particular insight as to how well management and the new CEO will execute this strategy. With $43m in net cash (less some allowance for a potential German lease liability), they have ammunition to go buy more sign & display type businesses which in the private market ought to be no more than 4-5 EBIT. It would be a great result to see management turn the business around and navigate past an extremely difficult period.    

Corporate costs last year were $11.5m and they wouldn't provide guidance as to what these costs will be this year. To be fair, they probably in part don't know exactly themselves. If another PXUPA holder throws a legal grenade at them, PPX is responsible for the PXUPA Responsible Entity's legal fees.

In addition, there were no numbers around the Q1 update. Noting that Australia got off to a 'difficult' start (Asia stable and NZ good), it was hard not to be a little bit alarmed about the short term earnings of the business. If the old business declines faster than what they can build the new business, then the result just isn't going to be pretty in the short run. 

Finally, there is the issue of PXUPA. Management did seem genuine in their expressed desire to resolve the PXUPA issue, yet at the same time made it clear the fiduciary responsibility of the board was to PPX shareholders. So my read is that PXUPA shareholders will not be offered the farm, if any deal is made.

After the AGM, I'm just not sure with how much confidence we can value the business. If we don't know what the corporate costs are and they aren't telling us how Q1 went, then just what valuation do we use? Book value isn't going to be overly useful if the assets are in an industry declining. Crassly, if we take the $43m net cash and assume no liabilities outside of ANZA and assume last years EBIT of $14.7m will be earned again this year and also assume corporate costs reduce to $5m to produce net EBIT of $9.7m and give this an EBIT multiple of 5 (which is generous considering you can buy PMP on 4*), you get a sum of part of the parts valuation of $101m. This is even more conservative than previous valuations I have arrived at. This of course is all a bit of a stab in the dark!

Given that both PPX and PXUPA have both rallied pretty hard, the combined value of those securities is now $63.8m (PPX $22.5m and PXUPA $41.3m). So regardless of how the pie gets split between PPX and PXUPA and if you adopt a more conservative valuation because we just don't know what the numbers are, then the upside is not necessarily that big from here.

I've taken a more conservative approach and sold my PXUPA into the recent price strength and been happy with that decision. Also happy to get back in if I can get comfortable there is plenty more upside to come - I just can't see it right at the moment. If I am proven to be too conservative, then so be it.    

Kristian 

Disclosure: own PMP

Devine Ltd (DVN)

In my last post on DVN, I noted "Well, I got this one completely and utterly wrong". It turns out I was even wrong about that. Some trades you (I) just get wrong from start to finish. DVN is mine. After deciding to hold on to most of my holding after the sale process fell over, DVN released a shocker profit downgrade last week noting their forecast profit of $10-$13m for the year 31 December will now be zero. 

And this is despite a strong property market. 

Clearly, this business is run poorly and clearly I should have seen this a bit sooner. The share price has been sold-off more to the current price of 55c, representing a good loss (my biggest in a long time) yet an absolute monster discount to NTA. NTA (30 June) was $1.55, so if that number roughly holds true, the discount is 65%. That's pretty incredible in an otherwise normal market. 

To add on top of that, plenty of people now think we have passed the top of the housing cycle, which if true means there are potential macro headwinds facing DVN. And as noted in previous posts, companies tend to upgrade and downgrade in cycles meaning there is potentially more bad news to come from DVN. 

Tough situation: it feels hard to sell a stock selling at such a big discount to hard assets yet the fundamentals of the business have gone backward and management have been incredibly shy in providing transparency to the market and there are better businesses out there. It's a situation I'm pondering. 

Kristian 

Disclosure: own DVN

Keybridge Capital Ltd Convertible Notes (KBCPA)

I discussed KBCPA recently in July. When writing this update I reviewed that initial post and I am quite embarrassed about the incredibly poor grammar - profuse apologies! 

I noted the convertible notes issued by KBC and the pretty decent return on offer (10% including franking credits on the issue price of $1) and also noted that although they were interesting, I was not buying because I was looking for more upside and would prefer to wait for a lower price. Interesting to see the price since come off to 96c and as a result KBC have announced a partial buy-back of the notes to help prop up the price. This is good for KBCPA holders and to be frank cheap buying by management. Unfortunately however it will probably mean they won't get to be a true bargain to get me buying. 

Kristian 

Disclosure: no position in the above names

Feedback Loop

Over the last three years I have kept a record of trade decisions - and importantly that also includes decisions to not buy or take any further action. I have been reviewing these decisions over the last few weeks looking for areas of improvement. 

This is quite confronting, and to be frank down right embarrassing on occasion. But this feedback has been highly informative and most definitely worth the effort. So much so, I have incorporated in to my weekly list of things to do a quick review of some previous decisions. It feels a bit like going over video replay a few times before going out and swinging at the ball. 

I have listed some of my observations below. There are plenty of other observations - enough to write a small book probably. None of these are necessarily new, but I thought you might find them interesting anyway.  

• Be careful of writing off a situation because it looks superficially expensive. Funnily enough, this has been one of the main reasons for not getting more big winners (i.e. multi baggers). If something is growing quickly and is now getting the full benefit of operational leverage, a high PE stock can rapidly become a low PE stock. Key point - do more digging before concluding a stock is 'expensive'. MFG is a perfect example. 
• Be careful of getting too excited because it looks cheap.  It's amazing to see just how many value traps are out there - far more than you think. Usually a stock is cheap for a good reason and sometimes it takes a while to uncover why. The irony is cheap stocks are often dangerous - at least in terms of getting caught in a long term value trap.
• Big winners almost always have 'winner' people somewhere in the mix. This might be at management level and/or shareholder level. Jim Collins makes a compelling argument for quality management in Good to Great and after reviewing my decisions it is hard to disagree. Usually the biggest asset or liability on the balance sheet is not shown - the quality of management. What I would also add is there are plenty of times where management may not be great but good shareholders can get in and shake things up. Whether good people are involved from the inside or outside, I can't really think of examples where a stock has moved up multiple times where an A-Grader isn't involved somewhere. 
• Finding an interesting situation, getting bored, forgetting about it and moving onto the next latest-and-greatest. Often, a company may not be ready for buying when you discover it. I decided not to buy AAPL around the lows at $64 in 2013 on not unreasonable grounds (was incredibly cheap but quarterly earnings weren't going the right way). I moved on and forgot about it looking for something more complicated. Carl Icahn bought a few months later and the stock doubled over the next two years - an unbelievable trade given the size, value, quality of AAPL and green light given by one of the smartest smart-money men around. If I kept an eye on the situation, buying when Icahn announced and started pushing for a buy-back was an easy trade. Key point - keep an eye on interesting situations, even if it means being across less stocks. 
• Price volatility. This one cuts both ways. It's easy to get scared by prices falling. It's also easy to get put off by a price that has increased recently. Stocks that are turning around or are reaching an inflection point and moving into profitability may have moved up 50-100% and still be an incredible opportunity as there still might be multiple lots of upside to be had. However the cheapskate in me finds it tough to buy a stock that has already moved a lot. Price volatility also really depends on the trade. A bombed asset play will inherently have an upper bound in terms of value and quite often will never reach fair value. So buying one of these after a price run is usually not brilliant - unless there is still a very long way to go to NTA. 

Kristian