Devine Ltd (DVN)

Well, I got this one completely and utterly wrong.

My reasons for buying DVN were a) big discount to NTA, b) improving/firming general property market, c) the first upgrade in years (the end of the profit downgrade cycle), c) the company putting itself up for sale (following major shareholder Leighton wanting to cash out) and d) plenty of good gossip that a firm bid would be made. 

I wrote this is in detail almost a year ago when the price was 93c. 

The company sales process has fallen over and the share price is now 75c. So that adds up to a decent loss and makes me a schmuck.

Two questions:

With hindsight, would I do the trade again? Probably. There were two decent catalysts being an earnings upgrade and the company putting itself up for sale. And plenty of value in the stock with a decent margin of safety - even taking the view the company would be sold for less than NTA.

Checkout the share price movements over the last year:

The price-action makes it pretty obvious the deal has been dead for some time and insiders have been well ahead of the market. What I would do differently is be attempting to reconcile why the share price kept sinking in the face of good news. These are tough situations to judge. As often as not, selling because of poor-price action can also be the wrong thing to do, however a stop-loss rule would have made the decision a lot easier.

The second question is what to do now. The fall-through of the sale process is the loss of a big catalyst, so to continue holding really requires some damn good reasoning.

DVN is cheap. NTA has actually pushed up a bit from $1.52 to $1.55 (31/12/14) so at 75c you get a whole bunch of property for half price. However: value alone is not a great reason to buy, and as noted in my last post (BOL) a value stock without a catalyst is a value trap. For example AV Jennings (AVJ) has been a long-term dog trading at a big discount to NTA for years. DVN's fundamentals have been improving, free cash flow has really pumped along over the last 12 months helping to get debt rapidly paid down and put a chunk of cash in the balance sheet, forecast profit looks pretty good (and is a good jump from current levels) so it's really quite eye opening to see the price where it is.

Anyway, I haven't made a decision as to what to do with DVN. The commitment I made to myself in starting this blog was not to sweep losses under the carpet - so I wanted to publicly discuss this trade. Please feel free to contact me if you have any views on DVN (or other stocks).    

Kristian 

Disclosure: own DVN 

Boom Logistics (BOL)

Value trap = value stock without a catalyst

BOL so far has been a perfect value trap, and if I didn't already appreciate what a value trap was, being a BOL investor has certainly has taught me that lesson. I apologise if anyone has followed me so far on this one and not made money. To recap on the original reason for buying (see some of the original posts here, here and here), the core idea was the huge gap between market cap and NTA. It is still monstrous: market cap $57m (12c/share) v Net Equity of  $227.5m*; a 75% discount. *Estimate based on the last management update of net debt $72.8m and gearing of 32%. Note that most of the intangibles have already been written down, so NTA is within ~1% of net equity. 

BOL has lots of exposure to mining which you don't need me to tell you is in a world of hurt. So BOL keeps the bad news flowing and has completely failed to initiate the stock buy-back and has instead kept on paying down debt, helped partly by the sale of surplus assets. 

This isn't news. The question is what to do: a company that will probably continue to experience an indefinite period of operational toughness thanks to mining, a slow Australian economy and unions sucking the life out of the business YET trades at a massive discount to NTA. 

We are missing a catalyst.

Management need to get their heads out of the sand and act. As noted in previous posts, if the NTA is anywhere near correct, then speeding up the asset sales process and simultaneously buying back it's own stock at a fraction of physical cost just has to be a smart move - it's called arbitrage! At the current prices, the arbitrage difference is 4 times, or sell something for a $1 and buy it back for 25c. Management have fobbed off the buy back until once the company has a more stable earnings outlook and current volatility in pricing pressures and activity levels have settled (page 5, half year report to 31 December). This business will always inherently be cyclical thanks being exposed to cyclical industries. But with an opportunity to buy-back the farm at 25% of the balance sheet value, who cares about stability or the earnings outlook - in fact if the earnings outlook is that bad then surely it makes even more sense to sell more assets at current prices? Surely there is plenty of risk to the downside to asset prices if the tough times continue? The argument to buy-back only gets stronger as debt levels continually reduce and management keep proving that either they can't run the business effectively or the macro headwinds are just too strong. Again, as noted in previous posts, as the market cap is so small, it won't take a massive buy back to move the price along.

Other than management, we can of course hope for a lucky break through a takeover/merger or a big uptick in the economy and crane hire business. That however we would be exactly that - a lucky break. Unfortunately I'm not the lucky type of guy. I don't know what other catalysts can get the price moving.

Shareholders have simply not been rewarded for their investment and therefore I believe it's now time for a change of management to shake things up. I hope the board agrees. 

Kristian

Disclosure: own BOL

Paperlinx (PPX and PXUPA)

I last wrote about PPX/PXUPA late 2013.

The company has since been sputtering along and as a result, the board has clearly had enough and has been busy over the last six months selling Spicers Canada, sacking CEO/MD Andrew Price and most recently deciding to close its European operations.

Paperlinx is a lot like Elders: a crappy business with a crappy capital structure. This hasn't stopped ELDPA in particular being a superb trade. I noted in August 2013 the anomaly of ELD outperforming ELDPA for several months (it made no sense to me why ELD should be worth anything while ELDPA was valued at only a little bit). Since then, ELDPA has moved up by 356% while ELD has moved up 204%.

Today we are not in a dissimilar situation with PPX and PXUPA. And with both stocks selling at pennies-in-the-dollar and the company now in drastic weight-loss mode, I think the situation is worth a closer look.

Note the performance since the shares begun trading again April 15: PPX is up 106% v PXUPA up 34%. Again, this doesn't make sense to me. PXUPA stand in front of PPX for dividends and a wind-up, however PXUPA is being valued at 9.5% of face value yet PPX doubles in value, while PXUPA 'only' goes up by 34%? Someone is wrong here. Here are the market caps of PPX and PXUPA:

PPX: 665m shares @ 3.6c = $23.9m
PXUPA: 2.85m shares @ $9.50 = $27m

The face value of PXUPA is $100 per share (or $285m) however the market cap is less than 10% of that. So with PPX at $23.9m, I guess the market is punting lottery ticket style that assuming the company survives and PXUPA holders agree to a big haircut or the company does REALLY well that PPX shares might actually be worth something.

The company has traditionally had three operations: Europe, Canada and Australasia. Canada has been sold. Europe has long been a cancer to the business, however this is now being finally cut-out with businesses either being sold-off or placed into administration. The company has noted on several occasions that ANZA is financially separate from Europe. On this basis and assuming no skeletons in the closet (a big call), the slimmed-down company ought to be okay. FY2014 underlying EBIT for ANZA was $15.3m and has actually been pretty good: underlying EBIT for the last few years are FY13 $12.6m, FY12 $14.9m and FY11 $11.1m. Corporate costs have been tracking around the same level as the profit of the ANZA business, however that of course should be slashed drastically especially as Europe winds-down.

On a simplistic basis, wiping out Europe from the balance sheet and adding the C$63m from the sale proceeds of Spicers Canada to the net assets for ANZA of $146.7m (A $225.2m and L $78.5m) adds up to $209.7m - which is still well short of the face value of PXUPA. Looking at it another way, assuming corporate costs get wiped out entirely, ~$15m EBIT can't service interest on the remaining debt and potential PXUPA interest obligations (4.65% + BBSW - ~$18m p.a.). So even on a slimmed down basis it's hard to see much equity value left for PPX at the moment. It is much easier to see a very big capital raising for PPX to help pay down debt and try and come up with a deal for PXUPA holders. Note we have seen multiple capital raisings at ELD which have only helped ELDPA. 

I recently read a good blog post from Canada demonstrating the link between a clean capital structure and share price performance. As a generalisation this makes some sense. Lots of share issues, options, use of preference shares all show either a company in lots of need for finance and/or management being a bit clever with finance and not just growing a business. Compare that to a company with a relatively low and stable number of shares on issue tightly held by management: supply and demand dictates that if the company is doing well, the small free-float will be highly sought after by the market. PPX/PXUPA doesn't fit this category! These difficult situations are just that - difficult.

However after following this situation for years, I finally mustered the confidence to buy a few PXUPA. This is probably more out of curiosity to see how this all finally pans out! 

Kristian 

Disclosure: own PXUPA

Berkshire Hathaway Analysis - Follow Up Post (Part 2)

Happy Easter holiday.

This post follows from my post last week. In this post I look at Buffett's performance a bit more closely and discuss some strategies. This discussion isn't meant to be exhaustive - it is just some observations I have made over the years.

The central point of discussion is Buffett's Alpha, an article which decomposed Berkshire's performance for the period 1976 - 2011. Berkshire, with Buffett at the helm, has been going much longer than that. And previous to Berkshire, Buffett was more of a traditional fund manager via a series of partnerships from 1957 to 1969. This period is probably a better time to analyse his performance as no debt was involved. I say probably because there are stories of him finding good quality growth stocks selling for a PE of 1; you don't see that everyday! 

Anyway, his estimated pre-fees performance* over this time was 29.5% p.a. v the S&P500 performance of 7.4%. You would agree that's a truly extraordinary performance. That was during a time when Buffett managed a much smaller amount of money, and could therefore easily trade in and out small-cap situations and make great returns without leverage. That edge slowly disappeared as his funds grew and therefore his strategy had to evolve to the model we now see in Berkshire. 

So, if you aren't interested in using debt, however you want to really make a lot of money, then you will need to find investments that will deliver outsized un-leveraged returns. That may come from sources such as a job (a job with upside from commission, revenue or profit split is actually pretty cool: as an employee you risk absolutely no money, get trained, don't need to be loyal for a long period of time and still get upside potential), own a business or in the case of shares, go for the small cap space (as the younger Buffett did) where higher returns can be made (and lost). Un-leveraged property can work, but leverage is usually required unless the timing is bang-on. 

Let's consider using leverage. Would you go and get a margin loan to buy a portfolio of shares? After having gone through the GFC and seeing how badly both big-cap company's share prices and margin lenders themselves can act, I'm personally a bit iffy about it. In good markets the strategy can be amazing, however it gives you pause when it all goes pear shaped and you talk to a story of a postie who lost his life savings as he had a big fat margin loan against property stocks, Babcock & Brown and other similar stocks that are like Nassim Taleb's turkey just before July 4th. At the least, to use leverage in stocks you should have some other form of safety net such as using stop-losses, sticking to big relatively safe blue-chips, hedging through puts or shorts, an appropriate cash buffer etc. 

Personally (as an Australian), I think the Buffett-leverage model works pretty well with residential property for ordinary investors. Property is one of the very few assets that will undoubtedly be around in 10 years time (which is one of Buffett's criteria for an ideal investment) and bought cheaply should meet the 'value' criteria and bought in a location bound for growth (capital and rental) should meet the 'quality' criteria. Leverage on property is usually not a problem at all - in fact, banks love lending money against residential property. The major point of contention is the lack of cash-flow. Does neutral or negative gearing really fit the Buffett-leverage model? In isolation, no. However in context of overall income, tax minimisation and getting exposure to a relatively large amount of capital then I think it does. 

This is all obviously horses-for-courses and there are other considerations such as personal circumstance, experience, liquidity requirements, income requirements and appetite for debt. Naturally people should do their own research and please don't take this post as financial advice - it's not! 

Kristian 

*Estimated post-fees performance of 23.8% p.a. after paying 20% of profits above 6% threshold. 

Berkshire Hathaway Analysis - Follow Up Post (Part 1)

Just over two years ago I wrote a post called Berkshire Hathaway Analysis. I don't think I could have come up with a more boring title if I tried.  

That post has been sticking-in-my-side for some time now, and finally I had some headspace to go back and re-consider it. I started the initial post by asking just why so many smart people in finance don't know or admit to what impact leverage has had on Berkshire.

Well, as discussed in that post, some researchers attempted to answer that very question in a superb paper called Buffett's Alpha. Tim Ferriss would be proud of the attempt to decompose just how a world-class performer has achieved his remarkable success. Until now I actually can't think of any other article that I have read that quantitatively decomposes his returns - every article focusses on his stock picks, witty comments, insightful and extremely written letters and him as a person.  

There has long been a general consensus that Buffett has an X factor about his ability to synthesise information, develop insight and translate that into outstanding stock picks. After reading the article a number of times, I concluded that he does have an X factor, however not specifically as a traditional stock picker (e.g. a fund manager) but as a strategist: he developed a simple yet very powerful system at an early stage and had the stomach to see it through.

The research paper covers the period 1976 - 2011 and notes the excess return (over the T-bill rate) of the S&P500 was 6.1% v Berkshire 19.0%. The S&P500 (like all stock market indexes) have the privilege of a 0% tax rate, yet Berkshire is a tax-paying entity and therefore the pre-tax return is likely higher, however the paper does not split out tax (this would be a very difficult exercise).

The paper decomposes Berkshire's performance into a few different quantitative components.

Firstly leverage. The S&P500 is un-leveraged whereas Berkshire uses leverage. The paper estimates leverage to have averaged around 1.6:1 or a gearing ratio of a bit less than 40% based simply on assets and liabilities on the balance sheet over time. That's pretty significant, and the researchers estimate the index return would jump from 6.1% to around 10% if it was leveraged on a similar ratio.

So that still leaves around 9% excess return to account for. The next component is a quantitative screen for stocks based on value and quality. i.e. they were looking to decompose the Buffett stock picking X factor into a repeatable formula based on value metrics (P/B,CF,E etc) and quality (ROE, margin etc). What they found is that controlling for these quantitative metrics almost entirely removed the 9% excess.

That's pretty interesting.

The real magic seems to be the combination of leverage with relatively safe instruments such as cheap, quality stocks. A high beta portfolio does not work particularly well with leverage. This magic itself has a few ingredients. One is time. It's outstanding that Buffett thought of this idea at a relatively young age and had the stomach to stick with it over good times and bad and just let compound interest work its wonder.

The next is conditioning his fellow shareholders to think along his lines and not revolt during periods when it appears not to be working (e.g. the dot com era) therefore creating true 'permanent capital' - the holy grail of funds management. Never does he need to worry about fast money coming nor scared money leaving. I'm absolutely willing to bet that plenty of other good fund managers could achieve similar returns if they used a bit of leverage and had truly permanent capital.

The other ingredient is cheap debt. It is widely known that he invests the float of his insurance businesses. Most insurance companies lose money on their float however Buffett and his managers have often managed to actually make money on the float meaning they have had a negative cost of capital.

In the follow-up to this post I will delve into Buffett's performance a little more deeply and discuss how us ordinary investors can implement these ideas and delve into Buffett's performance

Kristian

AIMS Property Securities Fund (APW)

Apologies for the lack of posts. Been a little busy with some projects. 

In my last post on APW (December 1, 2014 click here) the unit price was 11.5c and I took the view it was worth on holding on for further gains given the massive discount to NTA and lots of cash.

That view proved to be correct.

The price has marched forward to 14.5c. NTA has also marched forward to 18.52c, thanks to further buy-backs and movement in the underlying NTA.

Controversially has management changed its investment guidelines to allow it be 100% invested in one security or manager. I read this as meaning APW could be fully invested in other AIMS securities. Management has stated previously it intends (and has done) to invest in other AIMS securities. Some people despise this given the potential conflict of interest it creates. Judging by the strengthened share price, it seems that on-balance the market seems to be fairly comfortable with this. As previously stated I am little more indifferent to this: I can see both sides of the argument.

I have gradually sold down my position completely, although regrettably less than the current price. I took the view - possibly incorrectly - the price may never reach NTA. I tend to find with these types of situations you need to be really cheap and sell cheap. Please don't take that as gospel, and clearly I was premature in this case. My original investment case was buying at ~50% discount to NTA and the view the NTA should grow over time. The discount has closed (but not fully) and the NTA has grown, so the investment case has worked out. Personally I'd be happy to buy back-in at cheaper prices.

Kristian

Disclosure: no position in APW

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

Happy New Year, 

Please click here for last post on AFIG. 

Here's a quick recap on how AFIG works: 

• Pay a fixed coupon of $6.25
• Current price is $117.49
• Current yield therefore 5.3% p.a. 
• Face value $100
• Maturity 28/2/17 (mature for $100)
• Investors can convert into ordinary AFI shares before maturity at a rate of $100/$5.09 = 19.6 AFI shares 

At the time of my last review (May, 2013), the AFI share price was $5.72. It is now $6.08. So what this means is the conversion value of AFIG to AFI shares are currently worth 19.6 * $6.08 = $119.17; a small 1.4% premium to the current AFIG price. 

The biggest risk, I think, is the AFI share price sags and AFIG shareholders basically lose $17.49 in capital value over the next few years until maturity. AFI is a very conservative listed investment company and is a loose proxy for the overall share market. Of course the stock market could go down over the next few years, however what I like is the limited downside in these notes. 

The flip-side of course is full upside exposure to AFI. That makes AFIG an asymmetric bet and an interesting vehicle for people looking to bet the market is going up over the next few years but wanting to remove some downside exposure. 

I'm personally chasing more alpha in my portfolio, however I can still see the case for AFIG in cash/fixed interest portfolios. 

Kristian 

Disclosure: no position in AFI or AFIG