Australia and Innovation

In Australia, there is concern about the lack of innovation. Instead, we are obsessed with houses, mining and sport. The media is partly to blame: we have been subjected to an election campaign for the last three years and all of the mind-numbingly boring and community degrading stuff that comes with it. This includes a bizarre obsession with demonising boat people who are looking for a better life.

However, yesterday I attended a presentation by Wholesale Investor from mostly small companies (listed and un-listed). The companies were a mixture of biotech, tech, medical, property and financial service. It was really inspiring to see some of the ideas and innovation efforts in this country.  Here are some examples:

• Spondo/RivusTV: interface between movies and social media and video-streaming (i.e. movies). Watch a video directly from a movie facebook page, either PPV or advertisements. 

• Skin Patrol: mobile skin cancer clinic utilising tele-dermatology technology. Provides services to companies and regional communities. 

• Carnegie Wave Energy (CWE): submerged wave technology producing both energy and fresh water. Now going into production off the WA coast for the Navy. 

Plenty of other examples. 

It would be great to see more community awareness and encouragement of what our entrepreneurs are up to. It would be even better to see some of these companies really hit the big time and inspire a generation. 

Kristian

Disclosure: no positions in any of the above names

Galileo Japan Trust (GJT) v Astro Japan Property Group (AJA)

This week I attended a presentation by the managers of GJT as part of a major recapitalisation of its balance sheet (both equity and debt). The market cap of GJT pre the announcement was $6m and post the issue of 102m shares at $1.50 each, the market cap will be $172m at the current price of $1.56. 

It's recapitalisation 'Extreme Makeover' edition. 

The raw numbers have me interested, and to keep things simple for this post I have compiled the table below simplistically comparing headline figures for GJT pro-forma (post recap) and the other pure-play Australian listed Japanese property player; AJA:

Please note this assumes the recapitalisation is successful. 

There is lots of information missing such as the location and quality of properties, cash-flows, quality of management and so forth.  

With a 15c DPU on offer for GJT shareholders, its not surprising to see the share price shoot up from 75c pre the announcement to $1.56. What's more, the DPU will likely be tax deferred for up to 5 years thanks to the combination of debt and depreciation. 

More to follow. 

Kristian 

Disclosure: no position  in GJT or AJA

FSA Group Ltd (FSA)

Written by Nigel Littlewood...

A couple of months ago I wrote an introductory piece on a small cap that I have a material investment in called FSA Group.

Since then, FSA has released its 2013 annual results and subsequently, the re-rating that has been going on for some time, has continued with the stock reaching $1.09 recently up from 75c when I mentioned it a few months back.

Lets consider the result:

At $1.09 the stock is capitalised at $137m (with excess cash of around $10m). For the year ending June 2013 FSA reported as follows:

Rev      $64m                                                  up 9%

PBT     $17.8m                                               up 19%

NPAT  $10.8m                                               up 26%

EPS     8.51c                                                   up 36%

Net cash inflow from op       $14m              up 49%

Dividends (full year)                        5c                    up 127%

The result was a little better than I had anticipated and the dividend was a full 1c higher than I expected for the full year too.

The post result commentary has highlighted the company’s intention to try and grow both loan books (mortgages and factoring) in the next couple of years and maintain existing profitability in the services division.  This strategy should provide further earnings growth and based upon the recently announced new banking terms with Westpac, this growth will be self funding and wont require further capital.

While the stock is now trading above $1, a healthy move since I first mentioned it at 75c, it’s far from expensive. On the basis that we see a 10% improvement in earnings to around $12m this year, the stock is trading around 10.5x (if we back out the current $10m cash to provide an adjusted cap of $127m at $1.09) and its cashflow multiple is even lower (circa 8.5x based on c/f of $15m) providing an operating cash flow yield of about 12%. I expect the dividend to get bumped again and 6c ($7.5m) is a reasonable expectation providing a fully franked yield of 5.5% at $1.09. The company maintains a high level of franking credits and could pay out a special dividend too but I’m not banking on that.

SUMMARY

All in all, a respectable result and FSA is seeing real institutional shareholder interest for the first time, which is helping to re-rate the stock. I can see further upside.

Editors Note: Please be aware that Nigel Littlewood is not authorised to provide financial advice. The views expressed are his only. Please also note that Kristian Dibble also owns FSA. 

Wilson Asset Management (WAM)

This is a follow up article to the initial post Wilson Asset Management (ASX: WAM, WAMO). 

In the initial article, I outlined that Listed Investment Companies (LIC) have long used options as a tool to periodically raise capital and detailed my strategy for obtaining plenty of exposure to the underlying stock with a small initial capital outlay. In the case of WAM, I noted a disconnect between the NTA and share price and strong dividend yield: at the exercise price of $1.60 the historic grossed-up dividend was 10.25%. 

The options have now expired. So how did it all work out? The post was written at the beginning of May when WAMO were 10c (I paid 8.4c) and the price moved up to 14c. The market then proceeded to get the wobbles and the price actually sank to a low of 1.8c before recovering to finish at 5.4c at expiry. Remember, options are a form of derivative and as noted in my disclosure in the initial article I noted I owned WAMO strictly as a leveraged way to buy shares in WAM. With hindsight my timing certainly could have been better. That will probably always be the case! 

Nevertheless the trade has worked out very well, albeit with plenty of luck thrown in. WAM now trade at $1.90. So all up a position initially comprising ~1% of my portfolio has led the way to an overall portfolio gain of ~2% allowing for some selling of WAM along the way. I keep underlining 'initial' because I still ended up paying $1.60 for the shares so therefore the capital was required to back up the trade. That is the beauty of keeping plenty of cash and cash equivalents handy. Obviously luck has been on my side: the market could have gone south. I took the view WAM was at least somewhat buffered from too much downside given the strong dividend and defensive positioning of its portfolio (lots of cash) and failing everything else, would have just let the options expire worthless.  

I give this idea about 6/10. The upside exposure versus dollar risk was acceptable. It won't win trade-of-the-year by a long shot, but a useful exercise regardless. I remember thinking toward the end of April that equity investors were generally getting too excited, so I genuinely think there was room for improvement in my timing on this trade (I bought WAMO near the peak of the excitement), or at least not buying the full position straightaway.  

Kristian 

Disclosure: own WAM

 

Hastings High Yield Fund (HHY)

HHY is in run-down mode. Please click here, here and here for previous posts. 

The following slides are taken from the annual results presentation:

As at 30 June, the portfolio was 'worth' $50.9m or 49.3c NTA. $13.6m is in cash. $31.1m is in Cory Environmental and Maher Terminals - both of which have another more years until maturity. The balance is made up of minor investments - including Hyne which is becoming more minor thanks to write-downs in its value. 

This compares to the current market capitalisation of $38.7m or 37.5c.

The good news is a chunk of cash is sitting on the balance sheet and should be paid out. Including the proceeds from I-Med, this amount should be around 15c per share. Another cash payment should be soon coming. 

The bad news is the timing has slipped - 2016 now looks to be the most likely finish date for this exercise and the quality of the remaining assets is difficult to get excited about.  

Hmmm. If everything does according to plan, the IRR continues to beat my investment hurdle rate. But as we know, everything may not go according to plan. In practical terms, getting comfortable with the underlying investments requires time that I can better allocate elsewhere especially considering my very minor position in the first place. 

I have sold my small stake in HHY ~ at cost. 

Kristian 

Disclosure: no position in HHY

MacarthurCook Property Securities Fund (MPS)

As you may be aware, the vote  to replace MacarthurCook as investment manager was not successful. I have provided some thoughts in response to a readers question here.

Kristian

Disclosure: own MPS

RHG Ltd (RHG)

This is a follow up to my previous post on RHG. There has since been further takeover activity with the latest offer from Resimac of 49.5c being endorsed by the RHG board. RHG is currently 49c. However this post is not to speculate on the takeover activity, but to update my valuation model now the full year financials have been released.

Please note the disclaimer at the right hand side of the page. The assumptions and figures used in this post should not be taken as financial advice.  

As noted in the initial post, RHG is a mortgage book in run-down mode. In determining value, the key considerations are a) interest earned, b) interest paid, c) how fast the book is being run-down and d) overheads. I can't stress enough these are purely my estimations and could be wrong. I went back through half and full year reports in order to determine the historical figures and have updated these figures for the full year results to 30 June. The spreadsheet below shows the updated results: 

I keep a bunch of these types of spreadsheets on stocks I follow. They may not make a lot of sense: the aim for these sheets is to condense information for my own purposes, so apologies if they aren't easily read. 

The estimated % interest earned and % interest paid have come down over the last six months, consistent with decreasing interest rates in Australia. Estimated Net Interest Margin is 1.9%, which looks about right. Other expenses have stayed fairly flat from 2012 to 2013: impairment costs have increased, offsetting a general reduction in other expenses. Over time I expect overall costs to reduce as the book reduces, although impairments as a % of mortgage assets may actually increase thanks to the 'puddle getting muddier toward the bottom'. Note: impairment expenses were responsible for the jump in costs in 2010. For my projections, I am going to keep things simple: use last years interest received and paid and the long term average rate of reduction in assets, liabilities and other costs. These assumptions are probably over simplifying; however I am not trying to achieve precision, but just get a rough idea of the valuation.  

Note I have lumped cash into total assets, along with other assets and I have also lumped liabilities together. This is a bit naughty as it will slightly distort the interest received and paid, but doesn't effect the numbers too much.  

I conceptualise RHG as two components. First is the current cash balance (35c ex the recent 3c fully franked dividend and not allowing for further profits since 30 June). Second is the future profits derived from the mortgage book. Future profits will increase the cash pile further. Excluding tax and risk, it doesn't particularly matter for valuation purposes whether dividends are paid. For simplicity, I have just left future profits on the balance sheet.

Okay, based on the historical run-dow rate, the book will pretty much be exhausted by 2018. I estimate a further $44m in total NPAT will be generated. Plug in a 10% discount rate gives an upfront equivalent of 12c. Add this to the 35c and we get 47c. That's actually a bit less than the current price. 

Something doesn't seem right. 

It bothers me that 'other expenses' aren't reducing at the same rate as the book. But even plugging in a similar rate of reduction to the mortgage book only increases DCF by around 3c. Heck, even completely chopping off other expenses only increases my overall valuation to 58c. Even playing around with the run-down rate of the book doesn't bump up the DCF too much, nor does changing the discount rate. This tells me either I have made a mistake, future variables will be substantially different from historical figures or Resimac/Pepper/Cadence see a brighter future for the business than a pure-run off. 

Overall my post-tax valuation has reduced slightly from 49c (52c from my previous post less 3c dividend) to 47c. 

I previously sold some shares at 52c (pre the 3c dividend) and continue to hold a number of shares. Although there are some firm takeovers are on the table, outside of franking credits, I'm not convinced of material upside from here. 

Kristian 

Disclosure: own RHG