My Investment Journey

[skc]

What do I do with companies like LYL, where I expect them to have a bad year in 2014. I bought them because they were cheap enough, I did not try to time the low point. If they go on to have a bad 2014, just as I expect, and the share price drops even further, do I sell? My underlying assumptions have not changed, everything is going as I expect, what to do?

I am curious of what your previous FA experience tells you. How often did you get out and the price has gone back up? Was it a worthwhile percentage play in your case?

I think a lot of the auto sell comes from background of timing the market. Sell, wait till it goes up, buy again. I have nothing against that approach, but I have long ways to go before I am competent in anything like that. So what are the benefits of it for me, who makes no attempt to time the market?

I think with LYL you are confusing "timing the market" (which a FA may rightly choose not to do) with "timing the industry" (which a FA absolutely should do especially for companies in a cyclical industry).

 

[KnowThePast]

2 month update:

 

[Sir Osisofliver]

Thanks Sir O.

I agree it is only with hindsight that we will know which ones continue falling and which ones will bounce back.

But what are the odds? I will ramble on...

Out of 10, or 100, good, financially sound companies - how many continue going down and how many recover? My analysis/experience/reading tells me that selling after a big drop in these kind of companies is not the best strategy.

Furthermore, "good" companies experiencing large drops are very often (but far from always) the very best investment opportunities. Again, I feel experienced human judgement is required rather than an automatic decision.

Another argument is about risk - is the company that dropped in price more volatile and therefore more risky, or is it less risky because it is cheaper?

I agree that selling on substantial decline will further mitigate risk - but I think it will end up being the wrong decision more often than not. For the type of companies I invest in, anyway.

I'm not wanting to sound critical here, just trying to demonstrate the differences in how people (and therefore the market) think, using myself in the role as a commentator/analyser on the stocks you've selected as "good" companies. So far you've indicated that you have purchased CAB, SDL and LYL. Ok let's take a look at one of them and I'll choose CAB because it was the first you purchased and you mention it below. (I haven't looked at CAB for a while - so this should be interesting). This is the normal process I go through, (and for this example will be somewhat superficial - I just want to tell you what I'm thinking)... NOTE - I DO NOT HOLD CAB. THIS IS NOT ADVICE...DON"T MAKE ME GET THE DISCLAIMERS OUT. I MEAN IT. DYOR.

CAB - Mcap 523M 120 Million shares on issue Average of broker consensus - Sell recommendation price target $4.49 current price $4.43 (Ok so with that MCAP the stock is well outside the top end of the market. As such in terms of how I would categorize the stock it does not meet my criteria for a "Blue Chip" portfolio. (It does meet a couple of the requirements, but it fails for me to class it as blue chip {and therefore be prepared to hold the stock on a longer-term - across market cycles - basis}). It would therefore fit into one of the other categories I use to determine the appropriate time to invest in the this type of stock. Income, Growth, Cyclical or Defensive. These are dominant categories - frequently stocks possess attributes across categories. Looking at the stock it would appear to have income characteristics (nominally due to the high payout ratio), but have significant growth/cyclical characteristics. It's greatest optimal entry for a capital growth objective (as opposed to an income objective) would therefore tend to occur in a late cycle of the broader market cycle. Prior to late cycle it would be suitable as a trading position. Are you intending to hold this for yield or growth?

Earnings 0.48
Market 0.98
Sector 0.68

Actual NPAT fall in 2012 Forecast NPAT fall in 2013 2014 Ouch! errr that's not attractive, that's catching a falling sword. There would need to be a significant announcement on the 22nd of August when it releases it's Prelim Report. Taking a look at those numbers immediately turns me off the stock and makes me wonder if there is a short position to be had at the end of August depending upon the prelim report.... we'll see.

Top five shareholders hold 48.94% of issued capital Hey that's not half bad...hope none of them pull the pin. In fact I think I might see if any of them have been adjusting their holdings (Looking for either an overhang or predatory behaviour)... Hmm So UBS Australia has been been selling down but UBS London have been buying up as has Aberdeen (based in Singapore) in the last few months....in fact hold about 14% of issued capital... I see them doing this for yield in comparison to yields in their home countries - confirmation of the income characteristics I spoke above.

Hmmm ok so a purchase now would seem to be a contrary to popular opinion but overall Institutions seem keen under an income basis to acquire. On one hand you have an obvious headwind in the short term time-frame you are working against. On the other hand the Insto's tend to be sticky holders and 14% holding isn't insignificant). But I do want to ask.....how does the above match up with...

But generally, I will only buy companies that have at least some of these:
1. I feel have every chance of being around and doing very well 20 years from now.
2. Company founder or long serving management on board, and owning a large stake in the company.
3. Consistently profitable over many years.
4. Acceptable or higher ROC.

Things I generally won't invest in:
1. Things I don't understand, whether it is the business, the industry, or the annual reports.
2. Companies that are generally not profitable.
3. High debt.

My bolds.

It would seem that the market, superficially at least, does not agree with your assessment. But, this is the art of stock selection, finding good companies that are sold well below their intrinsic value, and then allowing the market time to recognize the intrinsic value. I would have said that (without doing any TA) that you were early in your purchase if your objective is capital growth, as an upwards trend of sentiment does not yet exist, but that early signs are there for the possibility, but it may be six to 12 months away. I would start looking at the announcements from here on looking for fundamental stability and news flow. It is at this point I would normally go do TA to see if the tech and fund align or if I just got it wrong - but you aren't interested in that. (One quick look tells me that the stock has been neutrally trending since 2009 and in a negative trend since May 2012.....a period of time where the market went from 4088 to +5000... It's trending against the market). Given that you have said that you are benchmarking against the index....How do you feel about that? (given that expectation is fundamental to financial risk).

Let's go back to CAB. I bought it 2009 for my super at $6.20. It has recently fallen down to under $4, for reasons we all know. Now, I agree with "the market" that the company is worth less now than a year ago. It has deteriorated. Should I sell? But despite deterioration in value, I still think there's plenty there now that the price has fallen.

If I sold at $4 or under because it's gone down, when do I allow myself to buy back in? Do I time the market?

I am curious of what your previous FA experience tells you. How often did you get out and the price has gone back up? Was it a worthwhile percentage play in your case?

Given the number of transactions I have done over the years this has happened many times. Do I regret any of them...no, would I do it exactly the same again...yes.

I think a lot of the auto sell comes from background of timing the market. Sell, wait till it goes up, buy again. I have nothing against that approach, but I have long ways to go before I am competent in anything like that. So what are the benefits of it for me, who makes no attempt to time the market?

I would suggest you then need to look at what your goals and objectives are and think deeply about whether you want to benchmark against the index. Perhaps something more akin to a stated target regardless of market performance would suit you better.

I will have to disagree with you on one bit - simple to understand. I looked back on my notes for it and I have just one sentence against it - "I don't understand this business well enough". But that's for me, it's not the kind of company I usually invest in, so other may find it easy to understand.

But that places me in a good position for your experiment because I've done no research on them and can therefore try to guess why you sold:
- got too expensive based on FA analysis
- too many people talking it up, etc.
- fundamentals changed.

Am I close? Or was there a large dip in the price?

I hope the above gave you a bit of window into process. Knowing the process now, you could imagine that I looked at BNB like this....

1) Is not a blue chip (doesn't meet my requirements)
2) My goal is therefore shorter-term capital gain rather than longer term income/gain
3) The stock is cyclical in nature (like MQG).
4) The market is late cycle.
5) I've had an almost 500% increase on my purchase price.
6) They've spent a lot of the money they've raised on expensive assets late in the cycle.
7) The cash-flow statement looks a bit squiffy.
8) They triggered a technical sell signal (which was ultimately a little early)

All the above = sell, ignore those that said it was going to reach $50.00, go find the next one.


KTP - if you were to do the same, using those simple characteristics above, what part of the cycle are we in, what sort of stock is it, what category does it fit in....what would you come up with for SDI and LYL?

Cheers

Sir O

 

[KnowThePast]

New purchase - NWH. 2100 @ 0.98.

There is one reason for this purchase - cheap.

Cheap based on its PE of 3.6.
Cheap based on its Price/NTA of 0.9.
Cheap based on its PE of last 5 years average - 5.3
Cheap(ish) based on its earnings from 5 years ago - 7.5.
Cheap based on assumption their average long term earnings will 1/3 of last years - PE of 8.4.
Cheap based on a current dividend yield of 18.4%.
Cheap based on 1/3 of dividend yield of 6%.

It has a funny cash/debt situation. $210m cash on hand and $240m debt. About $200m of unused debt facilities.
A glorious, popular and exciting business of earth moving. So what are the negatives about this Cinderella in the rough:
- It is a relative of the mining sector.
- Original founders are no longer part of the business, but the MD has been there a long time and owns a substantial number of shares.
- high capital requirements + fixed costs.

Now, as much as I would love for them to continue making as much money as they do now, I do not think that is a realistic expectation. Not out of the question, mind you, just very unlikely. Instead, I am making an assumption that they will shrink to a third of their size. If this investment makes sense to me after a 2/3 drop, I think there is sufficient margin of safety for me to take on this risk. So, what am I expecting to happen along the way? 3 most likely scenarios:
1. Management will wait out the downturn in expectation of quick turnaround. Capital expenditure will remain about the same, losses likely in the next year or two.
2. Fixed expenses are reduced by asset sales, write-offs, redundancies, etc.
3. Fixed expenses are reduced by not maintaining the unutilised equipment. P/L will still be negative, but cash flow should show a healthy surplus.

Most likely a combination of 2 & 3. Because of high depreciation/cap exp., operating cash flow is significantly higher than reported profit. $467m versus $257m over the last 6 years. Depreciation last year was $41m.
So given my expectation of a 2/3 drop for this company, what is likely to happen, should this drop occur over 3 years:

Start: $210m cash, $240m debt. Net 30m debt + $200m unused debt facilities.
Redundancies, etc. Current staff of over 4,000. Assuming 2,500 are made redundant at a cost of $20k each, that is $50m.
Say another $20m for any expenses, leases, etc.
Gives us debt of $100m.

Now we can add extra equipment sold, or depreciation charge unused. $28m*3 = $84m. Their PPP is $360m on the balance sheet, so I think $84m for 2/3 of it is conservative.
Total = $16m debt, $200m unused facilities, ~30m/year earnings, PE of 8.4.

Above is what I think the most realistic bad case scenario is. More likely, in 5 years time the company will be somewhere between this and today.

There's 1.3bn worth of work in hand, so next year might not be a complete disaster. But depending on how much of that work is newly won, or a carryover from last year's $1.9bn order book, things may start to get messy in the second half of next year.

As long as this company can remain alive without massive share dilutions, I think it will work out well.

 

[Klogg]

There's 1.3bn worth of work in hand, so next year might not be a complete disaster. But depending on how much of that work is newly won, or a carryover from last year's $1.9bn order book, things may start to get messy in the second half of next year.

As long as this company can remain alive without massive share dilutions, I think it will work out well.

OK, I must ask - while they have 1.3bn order book:
- What are the margins like?
- What's the future macro picture look like? (check out mining capex forecasts - you won't like what you see... and yes, they're only forecasts)
- As a result of the above, are the asset valuations on the balance sheet accurate? (i.e. will there be write-downs?)

This is not to say they can't continue on, but you're essentially investing in a company where you're expecting very minimal profits in the next few years and therefore minimal/no cash returned to shareholders.

I personally stay away from miners and mining services because I don't understand the area well enough and they're essentially price takers... but if you're jumping in, you'd want to know the answers to the above questions.

 

[KnowThePast]

OK, I must ask - while they have 1.3bn order book:

Hi Klogg,

Thank you for the questions to keep me honest.

- What are the margins like?

Last year, but prior years are similar:
EBIT/Revenue = 11.3%
NPA/Revenue = 7.1%
ROC = 20%

I expect these to take a hit, how much depends on whether they downsize or not.

- What's the future macro picture look like? (check out mining capex forecasts - you won't like what you see... and yes, they're only forecasts)

The consensus seems to be that the outlook for the next couple of years is terrible. I don't disagree. But what about long term? Is it not safe to say that humans will consume more and more resources as population grows and so do consumer demands? It is no secret that this is a cyclical industry.

Buy low, sell high. The big problem with buying low is that there's always a perfectly good reason why things are low.

I had a look at the forecasts. Yes, they are bad. But I went much further than any of them and assumed that things will decline 67%. Based on that, the investment still made sense to me. That's my margin of safety.

- As a result of the above, are the asset valuations on the balance sheet accurate? (i.e. will there be write-downs?)

Yes, quite possibly there will be write-downs.

The way I look at it is that they could take all their unused equipment to the scrap yard, spend some money on redundancies and continue being profitable with a much lower cost base to match that of demand. Write-downs of this kind will result in a reported loss, but positive cash flow.

This is not to say they can't continue on, but you're essentially investing in a company where you're expecting very minimal profits in the next few years and therefore minimal/no cash returned to shareholders.

Yep, that is part of the price that I pay for future earnings.

I worked out what the business is worth, say 5 years from now, when write-downs are finished and business is profitable off a lower cost base. The correct thing to do, I guess, would be to discount it to present value.

But it's also quite likely, that if the company doesn't lose too much money, and does generate some cash from asset sales, it will continue paying some dividends. Sale price of assets does not need to equal the value on the balance sheet - it's the cashflow that's important here.

I personally stay away from miners and mining services because I don't understand the area well enough and they're essentially price takers... but if you're jumping in, you'd want to know the answers to the above questions.

That is an excellent point.

NWH is not a company that enjoy any competitive advantage as far as I can tell.

Therefore, strong argument can be made that they are worth a replacement value of their assets, as long as the business they are in, remains viable long term, which I think it clearly is.

I have not done an accurate valuation of the company's replacement value, because a quick look at the balance sheet told me that they are trading far below it.

Another interesting value-based premise - a company that achieves a poor return on capital is:
1. in an industry that is not viable long term
2. has poor management.
3. operates in a temporary industry environment of either under-demand, or over-supply.

My money is on number 3. I think that due to various factors there is less mining related work available in the near future. Long term, however, it is a viable industry that will continue growing. I don't know when it will turn, but I am sure that it will and I am betting money that NWH will be there once it happens.

 

[KnowThePast]

Sir O,

I have to say our thinking is both very different and very alike - we seem to arrive at similar conclusions for complete different reasons.

I'm not wanting to sound critical here, just trying to demonstrate the differences in how people (and therefore the market) think, using myself in the role as a commentator/analyser on the stocks you've selected as "good" companies. So far you've indicated that you have purchased CAB, SDL and LYL. Ok let's take a look at one of them and I'll choose CAB because it was the first you purchased and you mention it below. (I haven't looked at CAB for a while - so this should be interesting). This is the normal process I go through, (and for this example will be somewhat superficial - I just want to tell you what I'm thinking)... NOTE - I DO NOT HOLD CAB. THIS IS NOT ADVICE...DON"T MAKE ME GET THE DISCLAIMERS OUT. I MEAN IT. DYOR.

OK

CAB - Mcap 523M 120 Million shares on issue Average of broker consensus - Sell recommendation price target $4.49 current price $4.43 (Ok so with that MCAP the stock is well outside the top end of the market. As such in terms of how I would categorize the stock it does not meet my criteria for a "Blue Chip" portfolio. (It does meet a couple of the requirements, but it fails for me to class it as blue chip {and therefore be prepared to hold the stock on a longer-term - across market cycles - basis}). It would therefore fit into one of the other categories I use to determine the appropriate time to invest in the this type of stock. Income, Growth, Cyclical or Defensive. These are dominant categories - frequently stocks possess attributes across categories. Looking at the stock it would appear to have income characteristics (nominally due to the high payout ratio), but have significant growth/cyclical characteristics. It's greatest optimal entry for a capital growth objective (as opposed to an income objective) would therefore tend to occur in a late cycle of the broader market cycle. Prior to late cycle it would be suitable as a trading position. Are you intending to hold this for yield or growth?

To be honest, I never understood the distinction between yield and growth. I am there for profit. Yes, arguments can be made mentioning things such as earnings and dividends stability, asset backing, yada, yada. But I generally completely disregard this in my valuations. Whether management distributes cash or re-invests it in the business is an interesting topic and is one of the things I look at when assessing management, but I don't build it into the price.

Earnings 0.48
Market 0.98
Sector 0.68

Actual NPAT fall in 2012 Forecast NPAT fall in 2013 2014 Ouch! errr that's not attractive, that's catching a falling sword. There would need to be a significant announcement on the 22nd of August when it releases it's Prelim Report. Taking a look at those numbers immediately turns me off the stock and makes me wonder if there is a short position to be had at the end of August depending upon the prelim report.... we'll see.

It is at this point I would normally go do TA to see if the tech and fund align or if I just got it wrong - but you aren't interested in that. (One quick look tells me that the stock has been neutrally trending since 2009 and in a negative trend since May 2012.....a period of time where the market went from 4088 to +5000... It's trending against the market). Given that you have said that you are benchmarking against the index....How do you feel about that? (given that expectation is fundamental to financial risk).

You are looking at EPS/profit figures and price movements. I am going to go ahead and mention the elephant in the room. The inquiry, which resulted in lots of uncertainty surrounding the stock, culminating in a recommendation that will eat away a substantial amount of CAB's revenues and profits. It gives a clear explanation why the price was going down and earnings are forecast to decline.

What comes first - price action or news? In short term future, depends.

But when looking back, it is usually major news + earnings that move share price long term.

While I won't dispute that prolonged price decrease may signal worse things to come, one must also look if there's an underlying reason for that. Most importantly, does that reason still apply?

In CAB's case, the underlying reason is resolved. End result was deterioration in company's value, but also an end to uncertainty. That's my reasoning for forthcoming "reversal of the downtrend".

Top five shareholders hold 48.94% of issued capital Hey that's not half bad...hope none of them pull the pin. In fact I think I might see if any of them have been adjusting their holdings (Looking for either an overhang or predatory behaviour)... Hmm So UBS Australia has been been selling down but UBS London have been buying up as has Aberdeen (based in Singapore) in the last few months....in fact hold about 14% of issued capital... I see them doing this for yield in comparison to yields in their home countries - confirmation of the income characteristics I spoke above.

Closely related to this is the biggest known risk for me in this investment - given that this is such a widely followed stock, what are the chances of me valuing the company more accurately. My honest opinion - close to zero. But when everything else about a stock matches your criteria, is this a valid enough reason not to buy? Still pondering over this one.

Hmmm ok so a purchase now would seem to be a contrary to popular opinion but overall Institutions seem keen under an income basis to acquire. On one hand you have an obvious headwind in the short term time-frame you are working against. On the other hand the Insto's tend to be sticky holders and 14% holding isn't insignificant). But I do want to ask.....how does the above match up with...

But generally, I will only buy companies that have at least some of these:
1. I feel have every chance of being around and doing very well 20 years from now.
2. Company founder or long serving management on board, and owning a large stake in the company.
3. Consistently profitable over many years.
4. Acceptable or higher ROC.

My bolds.

CAB has always been profitable. It will not be as profitable in the future due to new regulations, but it's always been profitable. I usually look for profit growth, but not always.

It would seem that the market, superficially at least, does not agree with your assessment. But, this is the art of stock selection, finding good companies that are sold well below their intrinsic value, and then allowing the market time to recognize the intrinsic value. I would have said that (without doing any TA) that you were early in your purchase if your objective is capital growth, as an upwards trend of sentiment does not yet exist, but that early signs are there for the possibility, but it may be six to 12 months away. I would start looking at the announcements from here on looking for fundamental stability and news flow.

Yes, quite possibly I am early. But that's the difference in our approaches. I buy when there's enough "value", I don't try to time it.

Saying that - I find that most often when a company announces bad news, there's more bad news to come. While good companies usually recover and grow from this bad news, it is rare for it to happen quickly.

So, I don't necessarily disagree that one should get out quickly when bad news start coming, and I don't disagree that one should probably wait until bad news stop coming. The period in between is usually 1-2 years, I find.

But CAB is different, I feel, because the bad news did not originate within the company and will not take any/much effort to implement. They will simply charge less per transaction, while everything else will remain as is.

So I simply take CAB's value prior to inquiry, subtract the expected effect and carry on.

I am curious of what your previous FA experience tells you. How often did you get out and the price has gone back up? Was it a worthwhile percentage play in your case?

Given the number of transactions I have done over the years this has happened many times. Do I regret any of them...no, would I do it exactly the same again...yes.

Interesting, thanks for that.

As I wrote above, I agree in principle that one should get out on bad news, and try and buy again when things start to pick up. It's the automatic stop loss and my ability to time the market which worry me. Without the ability to get back in properly, at the right time, however, stop loss will stop more long term gains than losses in my type of portfolio.

I would suggest you then need to look at what your goals and objectives are and think deeply about whether you want to benchmark against the index. Perhaps something more akin to a stated target regardless of market performance would suit you better.

Maybe for my overall wealth...

For share investments, though, I want to learn and get better. Measure against an index is the only way that I know of to properly track your progress.

I hope the above gave you a bit of window into process. Knowing the process now, you could imagine that I looked at BNB like this....

1) Is not a blue chip (doesn't meet my requirements)
2) My goal is therefore shorter-term capital gain rather than longer term income/gain
3) The stock is cyclical in nature (like MQG).
4) The market is late cycle.
5) I've had an almost 500% increase on my purchase price.
6) They've spent a lot of the money they've raised on expensive assets late in the cycle.
7) The cash-flow statement looks a bit squiffy.
8) They triggered a technical sell signal (which was ultimately a little early)

All the above = sell, ignore those that said it was going to reach $50.00, go find the next one.


KTP - if you were to do the same, using those simple characteristics above, what part of the cycle are we in, what sort of stock is it, what category does it fit in....what would you come up with for SDI and LYL?

We have very different ways of looking at things, but I can see a lot in your ways that would be useful for me.

LYL:
1. Not a blue chip.
2. Stock is cyclical.
3. It is well down from the top of the cycle. The T/A in me says they will fall further. F/A says the price is good enough, better than cash account adjusted for risk.
4. They preserved cash and are prepared the downturn.

Buy/Sell depends on time frame here.

SDI:
1. Not a blue chip.
2. Not cyclical.
3. Poor earnings growth, going down in fact. Until forecast for this year.
4. Price has been going up and up from 0.10 in July 12, to 0.65 today.

I am guessing you would sell based on how much price appreciation it had and its P/E multiple. I am also guessing that you would have never bought it in the first place? Disclaimer: I bought at 0.15 in my super.

I suspect you won't approve of my latest purchase either - NWH


You mention that you only hold blue chip stocks through all cycles. I generally don't look at these and have a different criteria for stocks I would want to hold on to:
- small/micro cap companies that keep on growing and become an ASX100/200 member.

Getting lucky with just 1 or 2 of such stocks can erase a huge number of errors from one's portfolio. And this is the biggest reason why someone's portfolio may significantly outperform the market over many years. It takes a lot of luck, I don't think this is something you can forecast with significant accuracy. But one can increase his chances by digging around somewhere in the vicinity. Makes a good case for more diversification in that area as well.


Sir O, your posts always make me think and question my approach. It is especially enlightening for me when discussed in the context of stocks I know, a big thank you for your efforts.

 

[Ves]

NWH is not a company that enjoy any competitive advantage as far as I can tell.

Another interesting value-based premise - a company that achieves a poor return on capital is:
1. in an industry that is not viable long term
2. has poor management.
3. operates in a temporary industry environment of either under-demand, or over-supply.

My money is on number 3. I think that due to various factors there is less mining related work available in the near future. Long term, however, it is a viable industry that will continue growing. I don't know when it will turn, but I am sure that it will and I am betting money that NWH will be there once it happens.

I think this is the most important part of your analysis and your starting point for valuation.

Arguably, for a company that does not enjoy a competitive advantage, but participates in a stable or growing industry, the valuation should be equal to the reproduction value of its assets. The cavaet to this is, of course, if the entity will continue to be a going concern - you need to answer that question (and it appears that you have above).

The future earnings are irrelevant because the long-term profitability of this business (ie. its return of capital) will not exceed its cost of capital if it does not have a competitive advantage. This means that new entrants and other competitors could enter the same industry and compete on a level-footing if they are willing to stump up the costs of purchasing assets of a similar nature. In other words; how much would a competitor need to spend to derive the same profit that NWH makes?

If you do not understand why this theory almost always works in practice then you need to read more about competitive advantage.

 

[KnowThePast]

I think this is the most important part of your analysis and your starting point for valuation.

Arguably, for a company that does not enjoy a competitive advantage, but participates in a stable or growing industry, the valuation should be equal to the reproduction value of its assets. The cavaet to this is, of course, if the entity will continue to be a going concern - you need to answer that question (and it appears that you have above).

The future earnings are irrelevant because the long-term profitability of this business (ie. its return of capital) will not exceed its cost of capital if it does not have a competitive advantage. This means that new entrants and other competitors could enter the same industry and compete on a level-footing if they are willing to stump up the costs of purchasing assets of a similar nature. In other words; how much would a competitor need to spend to derive the same profit that NWH makes?

If you do not understand why this theory almost always works in practice then you need to read more about competitive advantage.

Hi Ves,

It seems we read the same books

 

[Ves]

Hi Ves,

It seems we read the same books

It's mentioned in a lot of the value-investing literature, but my favourite sources for this are Bruce Greenwald and Aswath Damodaran.

Greenwald's "Competition Demystified" is definitely worth a read if you want to explore competitive advantage further.

 

[KnowThePast]

It's mentioned in a lot of the value-investing literature, but my favourite sources for this are Bruce Greenwald and Aswath Damodaran.

Greenwald's "Competition Demystified" is definitely worth a read if you want to explore competitive advantage further.

You wording made me think Greenwald, so I was partly right.

 

[KnowThePast]

Another out of schedule purchase - CKL, 2355 @ 0.845. 45 more shares pending, but doesn’t look like they will get filled.

Every time I bought a share, this came a close second in my comparison. Looking back, buying LYL and NWH ahead of this was the wrong decision. I was buying into slightly more attractive opportunities that depend on change within an industry in order to make a profit, and that usually takes time. CKL, on the other hand, was undervalued right now.

With hindsight, I now know that I would have bought CKL at 0.70 if I pulled the trigger earlier. Not much would have happened in terms of price with LYL and NWH should I have bought a little later.

I wrote this back in July, before deciding on LYL instead.

Essentials:
- A family run packaging business, directors own lots of shares.
- modest debt.
- always profitable.
- acceptable ROC. I would prefer it higher, they are getting good margins for their industry, I don't think there's much left to squeeze out price wise. Saying that, I do expect their margins to improve, see more on that below.

My first thought about the packaging business was that it is quite likely to move offshore. While that pressure is certainly there, there is always a place for a local company with good customer service and products.
They've recently made a big acquisition (late 2011). Usually, I do not like them, but I can't fault their judgement on this one. It's one of the few times I've seen where the company had to recognise an immediate profit on acquisition, as the purchase price paid was less than assets acquired.

$5m was paid for the acquisition (Carter Holt Harvey).
$8.8m was booked as profit, due to increase in net assets.
$10.9m was then spent on restructuring the business to fit it in.
Making the total price about $7.1m, or one year's worth of earnings.

What do they get in return? CHH was generating about $125m in revenues, but making almost no money from them, as it was concentrating on "expansion", worry about profits later strategy. That hasn't quite work out for them, so CKL will now have a job of getting rid of any contracts that are not making money, leaving the profitable ones.

They are essentially going to be doing it by raising the prices for those customers when the contract is up for renegotiation and they are expecting lots of those low-margin clients not to re-sign.

Assuming only 20% of the acquired revenues are worth keeping, they've paid a great price for them. And there’s more, CHH’s low prices have no doubt been undercutting CKL. Just getting rid of a competitor with $100m+ business was worth the price paid.

Here's an interesting part. If one was to look at financials of CKL without understanding of the underlying factors, one could easily conclude that:
- revenues are going down.
- margins are shrinking.
- Last year was a loss of $3.2m, a first. Due to one off restructuring charges related to acquisition.
- business is clearly going downhill.

But if one is to take away the unprofitable contracts from acquisition, it is the exact reverse for the underlying business - revenues are growing, margins improving, as are earnings, as evidenced by first half of 2013.

Their NPAT/Revenue prior to acquisition was ~7.2%. Once the dust settles, assuming they keep 40% of acquired revenues as profitable ones, I would then expect total revenues of $130m and npat of $9.36m, or 0.115/share, or a PE of 6.8.

That's for a business that is excellently managed, has modest debt, long history of earnings and growth.

The focus in the last year was paying down debt, prior to that they had to pay for the acquisition and integration, prior to that they invested a lot of money in new, state of the art equipment. I think it is very likely that they will increase their payout ratio in the near future.

So what are the risks?
1. Offshore pressures and competition. This is very real and they will certainly be losing customers to offshore competitors, even with the recent fall in AUD. My wife recently had to get packaging organised for her business, and her experience left me convinced that there is always room for a local player, whom you can talk to face to face. CKL normally go for much bigger customers than my wife's business, but it's true on that level as well. The hassles of dealing with problems are much bigger when they are offshore. And great product/service is always going to find a buyer willing to pay a premium.

2. Debt. It is modest but higher than I like. Large chunk of it is due to the acquisition, which I thought was a good opportunity to seize, and they are concentrating on paying it off now. A lot of their customers are on multi-year contracts, giving some stability to revenues. Still, it is something to watch.

At the current price, if they can achieve/maintain/grow earnings of 11c/share, it's more than enough margin of safety for me to invest in.

************************
I almost bought CLK again on the 1st of August, but again, it came second to NWH. I was also slightly spooked by their announcement about plant relocation and $2.5m expense to go with it. There were 5 days to go until their annual results announcement, I couldn't work out why they couldn't just announce it then. So, I held back just in case.

Annual report was good. Full year profit was a little under what I was expecting. A slight surprise was that they are confident of record profit not just in 2014, but also in 2015.

Falling AUD should help CKL, but I am going to assume that offshore competition will further intensify. What could their earnings look like over the next 10 years, assuming management downsizes appropriately and doesn't try to maintain an empire.

I use earnings, rather than traditional adjusted cash flow for 2 reasons:
1. Historically, it's about the same for CKL.
2. For a company that downsizes, cap expenses should fall below depreciation charge, eg. cashflow should be better than reported profit. I won't make estimates by how much, this will simply be my buffer.

2014 = 0.09. Growth in underlying profit, but offset by plant relocation expenses.
2015 = 0.12. Growth in underlying profit + savings from relocation.
2016 = 0.12.
2017=0.11. I assume this industry will move offshore more and more, somewhat offset by CKL gaining greater Australian market share.
2018 = 0.10
2019 = 0.09
2020 = 0.08
2021 = 0.07
2022 = 0.06. I will expect the company to be sustainable at roughly half of its current size, as there is always a place for a local, customer friendly option.
2023 = 0.06

Gives me a total of $0.90, less than $0.70 in present value, depending on inputs.
In addition to that, there's a company left over generating 0.06/year.

This is not the worst case scenario, but I think it is substantially worse than the "most realistic scenario".

*************************

So far I've talked mainly about negatives and how cheap CKL is. Are there any positives? A few, I think:

1. I think management is doing an outstanding job, and has their skin in the game. Reading their annual reports over the last 10 years, they always do what they say, they clearly understand the business and are in it for the long haul.
2. They keep increasing their market share, up to number 2 in Australia, behind Amcor. There's ~25 competitors in Australia. Before packaging is offshored completely out of Australia, I would expect there to be some consolidation into the strongest(s) player. So, I think they have room to grow in Australia for some time even while the total market is shrinking.

This is a company operating in the toughest of industries, yet they management to consistently grow their revenues, profits and assets without issuing more shares or taking on excessive debt.

 

[Sir Osisofliver]

Hey TKP,

You broke the rules again? Assume the position. (not serious, just something I say to myself when I'm tempted to break my own trading rules).

To be honest, I never understood the distinction between yield and growth. I am there for profit. Yes, arguments can be made mentioning things such as earnings and dividends stability, asset backing, yada, yada. But I generally completely disregard this in my valuations. Whether management distributes cash or re-invests it in the business is an interesting topic and is one of the things I look at when assessing management, but I don't build it into the price.

OK two things...

- So do you measure your holdings on TSR? (Total Shareholder Return - yield and growth together) - in which case your benchmark is not the All Ords Index, but the All Accumulation Index...mind you I'm still thinking that this is not the way for you to benchmark, but this is your show.

- I asked the question, because it tends to solidify (in my mind at least) the underlying reason for continuing to hold a stock. If my driving motivation is yield...then I know I will be holding the stock for a reasonable period of time. If my objective if growth...I'm holding it until I've made enough money and my decision to sell is more transparent. I was talking to someone last month who put a not inconsiderable portion of an inheritance into Gold. With gold there is no div, when I pointed this out, they clearly realized that their objective had to be growth and focused their decision.

Yes, quite possibly I am early. But that's the difference in our approaches. I buy when there's enough "value", I don't try to time it.

So lets turn that around....why do think I do try and time it? Obviously sometimes I'm going to get it wrong, I'm going to stuff it royally, and kick myself when my analysis was right and there's an event that makes the price jump before I've entered. Why do you think I persist in attempting to time it?

For share investments, though, I want to learn and get better. Measure against an index is the only way that I know of to properly track your progress.

I'm going to talk to you about the three main portfolio's I run personally.
1) Run's across market cycles and is comprised of big end of town, blue chip investments. (My definition - part of my stock selection). There's a bit of filling around the edges during the market cycle as far as doing things like Covered Calls, and Underwriting but the main focus of this portfolio is Income and growth is a secondary characteristic of it. This portfolio uses Leverage, (which is how I enhance my ROE because I'm using other people's money to make money) and the concentration on income means that the interest burden on the leverage is offset (and produces an additional income). I can effectively hold this portfolio indefinitely. My goal is to beat the long term performance of the market by a 2% yoy margin. (because most of the profit occurs in this portfolio at inception) so I can coast over the remaining part of the share market cycle.

2) Is a shorter-term portfolio whose focus is growth. I don't care what the index is doing - my goal is to make 40% per year. Funds generated here, go into number 1. An index and it's performance is just a number. It's just a target that you set to beat. This portfolio is not leveraged.

3) Is an outlier system that I only turn on only in the later part of the share market cycle. There's an example in the Newbie Thread when I spoke about JBH, or BNB earlier, but I'm also looking for smaller cap stuff that's going to explode...Last time it was coal seam gas stocks. I'm looking for multibaggers. My goal is 3x equity invested (300% return) over the later part of the share market cycle - (I will only know this in hindsight). I have other measures on a shorter-term timescale.

An index is just a number you can measure against, you could just as easily say... I wish to earn better than bank deposit rates... and track your performance against that. If your goal is to learn and get better, setting an unrealistic target will discourage you.

LYL:
1. Not a blue chip.
2. Stock is cyclical.
3. It is well down from the top of the cycle. The T/A in me says they will fall further. F/A says the price is good enough, better than cash account adjusted for risk.
4. They preserved cash and are prepared the downturn.

1) So under my systems it would not fit into number 1 or 2 (for reasons I won'y detail). I would only be looking at it from a multi-bagger, system 3 perspective.
2) Being cyclical it does have the dominant characteristics that I'm looking for in system 3...it's cyclical and SHOULD grow during the later part of the share market cycle.
3) No you misunderstood. Where are we now? What part of the cycle are we currently in? This is an environmental big picture look. I hold Blue chips with yield focus because regardless of the time in the cycle, that yield sustains the value over the entire cycle. I buy Outliers, late cycle, because in the balance, there is a higher probability of success of this system only during that part of the cycle.
4) Is great, but will only be transferred to an equity increase, in the kind of way I'm looking for, at a certain part of the cycle.

Can you see how critical point three is to the investment decision and type of share I purchase?

From my perspective, a lot of what you've purchased fit's into number 3....and of all the systems, number three has the greatest volatility associated with it. When something has high volatility, your options are...hold on through it and back yourself that you are right, or attempt to time and use stops, positional sizing, money management etc, to skew the probability in your favor.

You are doing the first one...I do the second one. Here's the sixty thousand dollar question......why do I do the second one?

Cheers

Sir O

 

[KnowThePast]

Hey TKP,

You broke the rules again? Assume the position. (not serious, just something I say to myself when I'm tempted to break my own trading rules).

Yes, sir!

My list of available opportunities at a great margin of safety to my valuation is almost exhausted, I will now invest in opportunities as they come up, so the pace will probably slow down from now on.

OK two things...

- So do you measure your holdings on TSR? (Total Shareholder Return - yield and growth together) - in which case your benchmark is not the All Ords Index, but the All Accumulation Index...mind you I'm still thinking that this is not the way for you to benchmark, but this is your show.

Excellent point, will correct from my next update onwards.

I use index as the benchmark, because I want to measure how good I am at investing in the sharemarket. It's not so much about measuring wealth/progress for me, as it is about measuring skill. Or luck.

- I asked the question, because it tends to solidify (in my mind at least) the underlying reason for continuing to hold a stock. If my driving motivation is yield...then I know I will be holding the stock for a reasonable period of time. If my objective if growth...I'm holding it until I've made enough money and my decision to sell is more transparent. I was talking to someone last month who put a not inconsiderable portion of an inheritance into Gold. With gold there is no div, when I pointed this out, they clearly realized that their objective had to be growth and focused their decision.

Makes sense. CAB is probably more of a dividend play for me. However, I also expect it to be re-appraised to a higher multiple in the future. Reasoning for that is that it will remain a near monopoly, just with small profit margins.

So lets turn that around....why do think I do try and time it? Obviously sometimes I'm going to get it wrong, I'm going to stuff it royally, and kick myself when my analysis was right and there's an event that makes the price jump before I've entered. Why do you think I persist in attempting to time it?

Because you are able to do it successfully often enough to be worthwhile, I would imagine.

I've never had much luck doing it myself, however.

What is your focus when it comes to timing it? Is it the general cycle/outlook for the economy/sector or more company specific? Do you try to form your opinion or do you look at measurable indicators such as average PEs, interest rates, etc?

I'm going to talk to you about the three main portfolio's I run personally.
An index is just a number you can measure against, you could just as easily say... I wish to earn better than bank deposit rates... and track your performance against that. If your goal is to learn and get better, setting an unrealistic target will discourage you.

1) So under my systems it would not fit into number 1 or 2 (for reasons I won'y detail). I would only be looking at it from a multi-bagger, system 3 perspective.
2) Being cyclical it does have the dominant characteristics that I'm looking for in system 3...it's cyclical and SHOULD grow during the later part of the share market cycle.
3) No you misunderstood. Where are we now? What part of the cycle are we currently in? This is an environmental big picture look. I hold Blue chips with yield focus because regardless of the time in the cycle, that yield sustains the value over the entire cycle. I buy Outliers, late cycle, because in the balance, there is a higher probability of success of this system only during that part of the cycle.
4) Is great, but will only be transferred to an equity increase, in the kind of way I'm looking for, at a certain part of the cycle.

Can you see how critical point three is to the investment decision and type of share I purchase?

Yes, I think I understand exactly where you are coming from.

I think we are doing the same thing, in a different way. You look at cycles, trends and catalysts. I look at value relative to price. If we are both right in our analysis, we should make the same decisions most of the time, even though we arrive at them from completely different angles.

I buy mining service stocks now because they trade at low PEs, high NTA/share, etc. This approach means it is unlikely I will ever buy them at the top of the market. It is no guarantee I will buy at the bottom either, but in some ways, that's what I am aiming for, juts from a value perspective.

In terms of where we are in the cycle, as I said, I don't belive in my ability to time it, but here's my take: We are no longer on top, both from price and demand/supply point of view. For many years supply has been catching up to demand, we may now be somewhere closer to parity at the moment. Which means drop in prices for resources, even if volumes remain the same or just grow moderately. At the moment, noone yet knows juts how much prices will drop and how much flow on effect it will have. So current prices are market's estimates of how bad things will get in the next year or two. This is usually closer to the low point, long term things are generally not as bad as people predict them to be.

Still, commodity prices will flow, it will have a flow on effect, and even though all this may already be built in the price, there's no telling how much lower things can go on those news. So, depending on just how badly companies will report in the next year, we could be either close to the bottom, or just the first leg into it.

On a sharemarket as a whole, I think we will see a recovery that leads to new XAO highs in the next 2-5 years. In the meantime, I expect a bumpy ride.

From my perspective, a lot of what you've purchased fit's into number 3....and of all the systems, number three has the greatest volatility associated with it. When something has high volatility, your options are...hold on through it and back yourself that you are right, or attempt to time and use stops, positional sizing, money management etc, to skew the probability in your favor.

You are doing the first one...I do the second one. Here's the sixty thousand dollar question......why do I do the second one?

Cheers

Sir O

I think you do that to reduce risk as measured by volatility, and to take human emotion out of equation.

I also think you misunderstand my approach - it is not buy and hold forever. I will sell things on a regular basis and I have clear price targets + trigger points when I will do so. I also do use position sizing and timed entries.

But I don't necessarily agree that volatility = risk, and I don't always agree that small = risky.

But assuming that is so, one must not forget that there is much more upside as well. You can be lucky 1 time out of 10, and do extremely well. My current portfolio is a an example of that at the moment: I outperform the index because 1 company out of 5 decided to move up 50%. This completely made up for the relative underperformance of the other 4.

It comes down to risk tolerance. I am happy to spread my entire capital over quality small companies. Every one I invest in, I look for a high margin of safety, and won't invest in until the price falls to a level I find acceptable. At the same time I know, that if I am to significantly outperform the market, it will most likely be because of a couple of standout performers.

Sounds easy in theory, but in practice it is much, much harder. Looking at most of these small caps that went on to become big, most of the had great fluctuations in price and earnings over the years. If one can time this, great. If not, it is better to hold on. Unless something fundamentally changes.

Going back to stop losses - they make sense, provided you can then time the entry back correctly. I can't do that, not at this point anyway. If I am just going to implement stop losses anyway, that will completely invalidate two key points of my strategy:
- investing in small caps, expecting some of these to move ASX200 in distant future.
- calculation of value and belief that market price is not always reflective of that.

Take NWH. Let's pretend, I think it is worth $2+. I may also think it may be worth $0.50 in case of bankruptcy. I bought at $0.98. Say the price drops to $0.50, with no visible changes in the company itself. I might not average down in this specific case, because there's no certainty to future revenues, but to sell now? Do I admit that I was wrong at this point despite no fundamental changes? Is the company now more risky, despite trading at firesale values?

If a company announces an unexpected earnings downgrade or other bad news, I am not opposed to selling. I will sell in most cases like that myself. But if nothing changed except for the price, not so convinced.

 

[Ves]

CKL has been coming up in my scans for quite some time now. I have also done some fairly in-depth thinking / research on it over the past few weeks in particular.

I am still undecided on it; I agree with much of what you have said. In summary, it's a closely held by astute management, operates in a boring (semi-defensive industry), has fairly well diversified revenue streams across a few industry segments and has achieved adequate long-term returns that support the case of there being some kind of competitive advantage (especially in the pharma packaging business which helps them generate the highest margins out of all of their business segements).

The margin declines (some would say quite dramatic) over the last few years have been due to acquistions (and integration costs) outside of their traditional core pharma business. The expanded business will not be able to generate EBIT margins at tradition levels of around 16% and it will be closer to 8 or 9% at the very most going forward I would have thought.

As you said Amcor and Visy are their biggest competitors. The CHH acquisition enabled them to compete on an even footing against both in the folding cartons space. And they got it dirt cheap.

Also handy to look at vertical integration - Amcor has been winding down or closing their mills; whilst Colorpak seems to be going for the centralisation of their cost base (they also have contracts with NZ mills that may give them a cost advantage in the short and medium term).

I am still not sure about the long-term prospects of this business (see sustainable competitive advantage), but it is definitely at an appealing stage of the capex / rationalisation curve (most of the major spending has been down) and the debt and margin cycles have probably seen the worst.

Price is attractive, but the question of long-term competitive advantage is the key for me, not quite clear enough on that in my own thinking. It means that I may miss opportunities, but my strategy is buy right, hold tight so I am punished if I get the company wrong in the first place.

 

[KnowThePast]

CKL has been coming up in my scans for quite some time now. I have also done some fairly in-depth thinking / research on it over the past few weeks in particular.

I am still undecided on it; I agree with much of what you have said. In summary, it's a closely held by astute management, operates in a boring (semi-defensive industry), has fairly well diversified revenue streams across a few industry segments and has achieved adequate long-term returns that support the case of there being some kind of competitive advantage (especially in the pharma packaging business which helps them generate the highest margins out of all of their business segements).

The margin declines (some would say quite dramatic) over the last few years have been due to acquistions (and integration costs) outside of their traditional core pharma business. The expanded business will not be able to generate EBIT margins at tradition levels of around 16% and it will be closer to 8 or 9% at the very most going forward I would have thought.

As you said Amcor and Visy are their biggest competitors. The CHH acquisition enabled them to compete on an even footing against both in the folding cartons space. And they got it dirt cheap.

Also handy to look at vertical integration - Amcor has been winding down or closing their mills; whilst Colorpak seems to be going for the centralisation of their cost base (they also have contracts with NZ mills that may give them a cost advantage in the short and medium term).

I am still not sure about the long-term prospects of this business (see sustainable competitive advantage), but it is definitely at an appealing stage of the capex / rationalisation curve (most of the major spending has been down) and the debt and margin cycles have probably seen the worst.

Price is attractive, but the question of long-term competitive advantage is the key for me, not quite clear enough on that in my own thinking. It means that I may miss opportunities, but my strategy is buy right, hold tight so I am punished if I get the company wrong in the first place.

Hi Ves,

That's a great summary, thanks for posting it up.

How did you arrive at your future EBIT margin of 8-9%? Is it your general feeling of industries future, competitor numbers, or the CKL's trend over the past few years?

It's very difficult thing to get a grasp on at the moment. As a result of the acquisition, they obviously inherited some unprofitable contracts that they still had to fulfill and that reduced their margins the last 2 years. I believe they've now fulfilled all those contracts and either renegotiated them to a better rate, or let the customers go.

Prior to that, they spent a couple of years buying lots of new eqiupment, heavy capital spending.

This coming year should be more or less return to the baseline, apart from $2.5m plant relocation cost.

Management stated that after 2014 capital expenditure should be in line with depreciation for a "few years", which tells me there are no forthcoming needs to replace outdated equipment or anything like that.

My thinking was along the lines of:
-Their 2013 EBIT margin was 7.8%, on EBIT of $13.8m.
-$2.5m plant relocation is expected to pay itself off within 12 months, so we can add $4.5m (EBIT/NPAT).
-All bad acquisition contracts coming off the books after this year, let's say that will reduce Revenues by $10m, with no effect on EBIT.
- Further efficiency improvements are expected in 2015, I'll assume another $2m to EBIT.

Assuming no new revenue streams, gives me revenues of $167m and EBIT of $20.3m. Margin = 12.1%.


Their long term prospects were my biggest question mark as well and that's why I spent the last 2 months bypassing them in favour of another stock every time. In the end, I decided that at the current price, they don't need great long term prospects, they just need to remain competitive for a few more years. Should they grow as well, it will be a very welcome upside.

Sounds like our strategies are a little different too - I look for companies that I can hold, but have nothing against finding opportunities to exploit temporary mispricings and getting out afterwards. CKL is somewhere between those two - like yourself, I do not have a firm view of where they may be long term.

 

[Ves]

How did you arrive at your future EBIT margin of 8-9%? Is it your general feeling of industries future, competitor numbers, or the CKL's trend over the past few years?

I've just looked at what I thought was possible if they aimed for organic growth, price competition and the business cycle over the long term. They appear to me to have focussed on lower margin growth over the past few years because they already hold a high market share in their phrama packaging operations. I expect this to continue.

I'm not given the impression that they will shed too much more revenue, most of the fat appears to be gone.

EBIT post-rationalisation I think will be around $16m (give or take a bit in terms of the plant rationalistion in Victoria, but I'm not sure it adds $4.5m per year). I usually discount any management estimates of rationalised or synergised cost savings!

Base line revenue is around $174m - I'd actually expect it to grow slightly after they have renegotiated and retained existing contracts and tried to win business against lessor competitors post Amcor's mill closures... hence EBIT margins falling somewhere between 8-9%.

All of that being said... short and medium term is pretty meaningless to me if they don't have a moat that allows them to retain their profitability going forward.

 

[craft]

Hi Ves,

That's a great summary, thanks for posting it up.

How did you arrive at your future EBIT margin of 8-9%? Is it your general feeling of industries future, competitor numbers, or the CKL's trend over the past few years?

It's very difficult thing to get a grasp on at the moment. As a result of the acquisition, they obviously inherited some unprofitable contracts that they still had to fulfill and that reduced their margins the last 2 years. I believe they've now fulfilled all those contracts and either renegotiated them to a better rate, or let the customers go.

Prior to that, they spent a couple of years buying lots of new eqiupment, heavy capital spending.

This coming year should be more or less return to the baseline, apart from $2.5m plant relocation cost.

Management stated that after 2014 capital expenditure should be in line with depreciation for a "few years", which tells me there are no forthcoming needs to replace outdated equipment or anything like that.

My thinking was along the lines of:
-Their 2013 EBIT margin was 7.8%, on EBIT of $13.8m.
-$2.5m plant relocation is expected to pay itself off within 12 months, so we can add $4.5m (EBIT/NPAT).
-All bad acquisition contracts coming off the books after this year, let's say that will reduce Revenues by $10m, with no effect on EBIT.
- Further efficiency improvements are expected in 2015, I'll assume another $2m to EBIT.

Assuming no new revenue streams, gives me revenues of $167m and EBIT of $20.3m. Margin = 12.1%.


Their long term prospects were my biggest question mark as well and that's why I spent the last 2 months bypassing them in favour of another stock every time. In the end, I decided that at the current price, they don't need great long term prospects, they just need to remain competitive for a few more years. Should they grow as well, it will be a very welcome upside.

Sounds like our strategies are a little different too - I look for companies that I can hold, but have nothing against finding opportunities to exploit temporary mispricings and getting out afterwards. CKL is somewhere between those two - like yourself, I do not have a firm view of where they may be long term.

KTP – you’re more optimistic than me – I’m around 8% Ebit Margin next year and 9% by 2016 on flat to slightly increasing revenue. Accounting treatment of the uneconomical contracts has been a boost to the current numbers – no such tail wind next year. How much of the benefits from the plant relocation will stick to CKL’s ribs in a competitive industry?

Amcor closing their paperboard mill is the significant story here to me. The big questions: Does CKL now have a competitive advantage in raw material sourcing because of the relationship with CHH? What happens to imported prices for competitors with the dollar decline? Will Amcor look for higher margins now that the packaging business can’t be cross subsidised with the board manufacture.

Tough competitive, capital intensive industry – Appears some potential that industry conditions may move in favour of participants (short to mid term play) – but all in all for this lazy long term investor, I’m with Ves – it doesn’t warrant a spot on my team.

If the industry conditions are in fact easing – I hope you complete a timely trade and make some nice bucks. It’s refreshing that you have sparked a bit more in-depth research then ASF normally sees.

 

[KnowThePast]

I've just looked at what I thought was possible if they aimed for organic growth, price competition and the business cycle over the long term. They appear to me to have focussed on lower margin growth over the past few years because they already hold a high market share in their phrama packaging operations. I expect this to continue.

I'm not given the impression that they will shed too much more revenue, most of the fat appears to be gone.

EBIT post-rationalisation I think will be around $16m (give or take a bit in terms of the plant rationalistion in Victoria, but I'm not sure it adds $4.5m per year). I usually discount any management estimates of rationalised or synergised cost savings!

Base line revenue is around $174m - I'd actually expect it to grow slightly after they have renegotiated and retained existing contracts and tried to win business against lessor competitors post Amcor's mill closulres... hence EBIT margins falling somewhere between 8-9%.

All of that being said... short and medium term is pretty meaningless to me if they don't have a moat that allows them to retain their profitability going forward.

Thanks Ves,

I do agree it is quite possible that their margins, revenues and profits will take a hit long term. It's very useful to hear someones else's thinking on it as well.

I've priced it based on some severe long term reductions and the price was still under my margin of safety.

An interesting question, I think, is whether great management can be considered a competitive advantage. True, it is not enduring, but to counter that, great management leaving does not usually get punished by the market as much as it should, IMHO.

 

[KnowThePast]

KTP – you’re more optimistic than me – I’m around 8% Ebit Margin next year and 9% by 2016 on flat to slightly increasing revenue. Accounting treatment of the uneconomical contracts has been a boost to the current numbers – no such tail wind next year. How much of the benefits from the plant relocation will stick to CKL’s ribs in a competitive industry?

Hi craft,

Not being optimistic, I do agree with you that margins are going to shrink. The calculations I've posted are the best case scenario, then I discount from that.

An an excellent point on uneconomical contracts, yes, they were recorded as liabilities that were than worked off.

Amcor closing their paperboard mill is the significant story here to me. The big questions: Does CKL now have a competitive advantage in raw material sourcing because of the relationship with CHH? What happens to imported prices for competitors with the dollar decline? Will Amcor look for higher margins now that the packaging business can’t be cross subsidised with the board manufacture.

Tough competitive, capital intensive industry – Appears some potential that industry conditions may move in favour of participants (short to mid term play) – but all in all for this lazy long term investor, I’m with Ves – it doesn’t warrant a spot on my team.

If the industry conditions are in fact easing – I hope you complete a timely trade and make some nice bucks. It’s refreshing that you have sparked a bit more in-depth research then ASF normally sees.

Thanks craft, I am really enjoying this and was also surprised at the level of detail many forum members have gone into here compared to other threads. Hopefully, this keeps up. I'll be doing my part.

Somewhat on topic, should some of the posts in this thread be copied over to stock specific threads? I don't mind copying them over, but I am too lazy to clean them up to separate company specific writings from my portfolio specific writings.