Select Harvest Limited (ASX: SHV)

The weather gods had been kind to Select Harvest Limited (ASX: SHV).  California, the largest producer of almonds (approximately 80% of the world production), had been in a drought since 2011.  Almond production, a highly thirsty process, had plummeted in California.  Consequently, almond price had been on a tear and it had benefitted producers  in other parts of the world.  However, almond prices has started to drop as the drought in California has started to ease since late 2016 and is still continuing to improve.  At the Awkward Investor, we do not tend to invest in commodities in any form (e.g. companies) as we believe that predicting commodities’ prices is a mug’s game.  In the instance of SHV, we believe that SHV is a dud investment .  It can be frustrating to analyse and write on a stock which we know we will never take a position in but what the hell ….

SHV has two main business arms — an Almond and a Food division with the Almond division contributing about 80% to EBIT.  Therefore, the share price of SHV should be highly susceptible to any swings in almond price.  The key to determine a fair value for SHV is to try to determine a long term ‘equilibrium’ almond price.  As mentioned above, we are not commodities price guru and has no intention to be.  However, in our modest opinion, a long term price chart may be a useful way to ascertain an equilibrium price.

SHV almond price 1993 to 2017
Source: SHV HY17 presentation

The above chart shows an almond price chart from 1993 to 2017 and, ignoring the occasional spikes  it is fair to say that AUD almond price trades between a band of $4-$8 with median price at approximately $6.  Based on harvest volume of 14,200 MT for FY16, I estimated that the cost to produce each kg to be $5.94AUD (FY15: $5.48AUD).  That is, if corporate costs are ignored, the Almond division needs to sell each kg of almond at an average price north of $5.94AUD to generate a profit.  At a long term ‘equilibrium’ median almond price of $6 (I cannot stress enough that this is a guesstimate), the almond division will be close to worthless.  But fret not, the Food division is at least worth $2.7AUD a share based on a FY16 EBIT of $10M AUD. At SHV’s current share price of about $6AUD, I find it a little rich that the market is valuing the Almond business at about $3.3AUD per share.

A significant part of SHV’s growth story that management loves to harp on is its ability to do value accretive bolt on acquisitions.  In order to do this, management has repeatedly stressed on SHV’s ‘strong’ balance sheet which gives it sufficient headroom for acquisitions.  Just like a crazy man will never say that he is crazy,  SHV’s debt looks worse than it is.  Net debt went from 115M in FY15 to 69M in FY16 and 98.4M in HY17 and a non-astute reader would praise SHV for bringing its debt down significantly since FY15.  But is the praise deserved? A closer look at SHV’s accounts actually shows that SHV utilises sales and leaseback transactions to lessen its debt on the balance sheet.  What this means is that SHV will sell a land that it owns to a buyer and at the same time lease the land back from that buyer.  The upfront money that SHV gets from selling the land is used to pay off its other borrowers and SHV will have to pay monthly payments to the buyer of the land.  In a nutshell, SHV is simply just switching borrowers.  What SHV has managed to do is to use a common accounting trickery to move its obligation off balance sheet and to make its debt look smaller than it is.  Looking at Note 20 0f SHV’s FY16 annual report, SHV is liable for an additional $280M AUD of additional commitment which is not reflected in the balance sheet.  This brings its total commitment/borrowing to $380M AUD and assuming a NPAT of $40M AUD in perpetuity (this is extremely generous as SHV has only managed to surpass this amount once in its existence), it would still take SHV 9.5 years to pay off its obligations.  From FY17 onwards, total interest and lease payments will be around $20M AUD which is double the EBIT of its Food division.  A last point to note is that according to the FY16 annual report, SHV has a debt facility limit of $115M AUD and $5M USD of 11am facilities.  With net debt of 98.4M as at HY17, I fear of the prospect that SHV may have to tap shareholders for additional funds.

I would never ask anyone to short a stock.  However, anyone thinking of investing in SHV would do good to AVOID.  Obviously, if SHV were to bring production costs down or if almond prices find a new normal due to structural changes, its value may be well worth its current share price of $6 AUD.

General Motors (NYSE: GM) and Michael Kors (NYSE: KORS)

Bought a sizeable position for GM at $35.1 USD

Initiated a small position in KORS at $34.93 USD

A truly value investor should always sniff out value stocks regardless of the form.  Essentially, this means looking for underpriced stocks in different sectors, different countries, yield vs growth etc.  You get the drift — basically under every rock.  This would particularly ring true for any Australian investors.  Any trade in Australian equities would most probably be a crowded trade.  If you don’t believe me, just check out your default option in your superannuation and it will be heavily weighted to Australian shares.  The slush of cash flowing into superannuation which subsequent gets pumped into Australian equities results in immense bidding for a small pool of quality Australian companies.  Therefore, I see great benefits in investing in international shares.

For any potential converts, there are several ways to invest internationally.  One avenue is to use Australian brokers but the commission costs are unnecessarily high and will eat into your profits (especially if your investment amount is small).  Another way is to use an international broker such as Interactive Brokers which has more reasonable pricing.  The last avenue that I can think of is to invest international via contracts for difference (CFDs).  Full disclosure, I have investment interests in two CFD providers i.e. IG Markets and CMC Markets but I don’t imagine having enough sway via viewership numbers to make a difference.  The payoff profile when investing in a CFD of a certain company is largely similar to investing in its shares except for franking credits.  Also, CFD allows one to apply leverage but this can be a double-edged sword i.e. both gains and losses are amplified.

All of this babbling brings me to the main focus of this post.  General Motors (NYSE: GM) and Michael Kors (NYSE: KORS) had just received their latest earnings on the 7 February 2017 and both suffered significant drop in their share price.

GM is the largest automobile manufacturer in the USA.  Brands under its umbrella include Buick, Cadillac, Chevrolet & GMC brands in the USA and the Buick, Cadillac, Chevrolet, GMC, Holden, Opel & Vauxhall brands outside of the USA.  Analysing GM is simply a numbers game.  GM is extremely cheap with a share price of $35 USD and management guided earnings of $6-6.5 USD which gives it a P/E ratio of less than 6X.  GM pays out $0.38 USD of dividend per quarter which gives it a dividend yield of 4.5%.  It has also $10B USD worth of share buyback remaining and with a market capitalisation of $54B USD, that would equate to a buyback of approximately 20% of its shares.  Critics have been ranting on about ‘peak auto’ for some time and has so far been incorrect with 2016 numbers coming in at 17.6M cars sold (2015: 17.5M) .

us-car-sales
Source: CNN Money

With a dividend payout ratio of just 25%, GM would still be able to sustain its dividend if America’s new car sales crash and GM’s profits were to collapse by 50%.  Its latest earnings results prompted a 5% decrease in share price even when it topped estimates.  Sometimes, similar to God, Wall Street works in mysterious ways.  I can only assume that the decline in price is due to profit taking because of the YTD run up in share price.

KORS is a semi-premium brand best known for its women handbags.  It has seen its share price decline from a high of $98 USD to a current $38 USD which is near to its 52 week low. It is a serial buyer of its own shares with management (and I) believing that its share price is severely undervalued compared to its competitors.  Since the inception of the share buyback program in 2014, it has since bought back $2.5B USD worth of shares.  Compared to its market capitalisation of $5.5B USD, this is significant.

KORS Share Price
KORS Share Price (Source: Google Finance)

Like most retailers everywhere else, KORS is facing some headwinds and its share price has crashed by 11% since the latest earnings result.  It has seen less mall traffic and its wholesale channel is aggressively discounting its products.  To counter this, KORS is pulling its products from the wholesale channel and embarking on growth initiatives like selling smartwatches and increasing its presence into menswear.  According to the latest earnings call, management is currently looking at M&A opportunities and other capital initiatives.   Its main competitors are Coach (NYSE: COH) and Kate Spade (NYSE: KATE) and both companies has higher valuation than KORS despite lower earnings.  With the P/E ratios of COH and KATE at 21x and 19x respectively, KORS looks extremely undervalued at 9x.  It should be noted that, unlike COH with a dividend yield of 3.6%, KORS does not pay a dividend but instead focuses on share buybacks.  I reckon KORS would be trading at a higher multiple if it introduces a decent dividend in the future.

 

 

 

 

 

Seven West Media (ASX: SWM)

Added to IG Group with total position of 4500 and average price of 477.69GBX

Initiated position of 11000 shares in CMC Markets (LON: CMCX) with average price of 107.94 GBX

Initiated position of 30,000 shares in Seven West Media with average price of $0.793AUD

As noted in the previous post, I am periodically adding to my position in IGG. Despite the current price of 531GBX, I am still seeing great value in IGG.  In a similar vein, I see value in CMCX as well.  CMCX’s investment thesis is the same as IGG – great FCF, low P/E and high dividend yield.  I believe that the market has vastly over-reacted to the looming FCA regulation of the CFDs market and shares should trend higher in the next few months until the FCA update in March 2017.

Now to the main event – Seven West Media (SWM).  SWM is a media business based in Australia  with its main business being free to air (FTA) TV.  SWM has had  a turbulent year with its earnings downgrade for FY2017 due to spending for the Olympics and AFL broadcast and the sex scandal involving its CEO, Tim Worner.

Let’s not kid ourselves, FTA TV is definitely in a decline which is reflected in FTA networks’ share price.  SWM’s share price has declined from over $15 in 2007 to its current price of $0.84.  FTA TV also face other headwinds such as the potential watering down of the anti-siphoning laws in Australia.  For those of you living under a rock in Australia, anti-siphoning laws prevent subscription-based media e.g. Foxtel and Netflix to acquire monopolistic rights to certain sporting events and thereby granting FTA networks a first refusal to these events. However, the central question as always is whether the steep decline warranted?

SWM has a market capitalisation of 1.3B and a trailing P/E ratio of 7. SWM’s 2016 financial reports show a NPAT of 184M.  Just how much of this is sustainable with the onslaught of pay TV and potential weakening of the anti-siphoning list?  PwC has forecasted that FTA advertising to decline 1% until 2020 and the effect of any watering down of anti-siphoning list will be dependent on the final list.  In order to have a sufficient margin of safety, let’s assume that the SWM’s advertising profit shrinks by 50% and the death of all SWM’s other business e.g. newspaper and magazines.  Using a weighted average of segment profit in Note 1.1B against 2016 NPAT reported, it still leaves us with a NPAT of 84M and a P/E ratio of appropriately 15x.  Is 15x a demanding in light of lofty valuations today?  – I don’t think so.  Granted, this is an imprecise valuation of SWM but it shows that SWM is vastly undervalued with a little common sense thinking.

Another potential catalyst is the venture capital arm of SWM.  SWM invests in promising start-ups e.g. 15% of Airtasker which they see benefits in synergy.  Granted, that there will be numerous duds but investing in start-ups is sort of like playing roulette – the downside is limited but the payoff is exponential.

A sticking point for me is the amount of debt SWM carries on its books.  As at June 2016, it has 710M of net debt which is about 57% of equity and all of the debt is due on October 2018.  However, I don’t see any issues with SWM repaying or refinancing their debt under their current profit profile even under the dire scenario of 50% collapse in advertising business which I detailed above.

I will be looking to add to my position in SWM periodically below $0.9AUD.  I foresee SWM’s share price to trend higher slowly unless the CEO can’t keep it in its pants again.  In any case, it would be a great opportunity to add to my position if that happens.

 

IG Group

Initiated position for 1300 shares at 458.7 GBX on 6 December 2016

Adding to position  periodically below 550 GBX

 

Who can tell me an example of over-reaction? No-one? Let me try.  How about the 40% collapse of IG Group (LON: IGG)’s share price on 6 December 2016?  For those of you that are unfamiliar with IGG and the event surrounding 6 December 2016, let me attempt to shed some light.

 

IGG is a UK-based company and is also the leading provider of contract for difference (CFDs) globally.  On a high level, a CFD is a derivative whereby the value movement largely corresponds to the underlying asset. Therefore, for example, if you were to long a CFD on Apple shares,  the CFD payout profile would be largely identical to owning Apple shares.  So why not just buy the underlying share and not bother with CFD you ask?  The answer lies with leverage.  CFDs allows you to employ significant leverage to amplify your gains(losses) which may otherwise not be available in normal share trading. On the downside, you are exposed to counterparty risk (as the contract is with the CFD provider) and the possibility of margin calls.

With obvious reasons, the UK regulator (FCA) is looking to introduce policy measures to protect retail investors from such ‘dangerous’ products.  The main recommendations are better disclosures regarding risk profile and capping of leverage for novice and experienced retail clients.

Often, the best investments are those that are made on the market’s over-reaction.  After news of the FCA’s recommendations were released, IGG’s share price were hammered by a 40% drop in value.  Let me please point out, these are recommendations by FCA and still undergoing a consultative process.  My guess is that the final product will be watered down and right now, the market is pricing in a total disruption in IGG’s business model.  Don’t get me wrong, there may be risks with the CFD business.  IGG derives its revenue from commissions and spreads when a client executes trades and it also earns financing revenue on clients’ outstanding positions.  What IGG have to content with is residual risk from client’s position which is dealt with by its hedging strategies.  Therefore, IGG may suffer significant losses if those hedges are not implemented properly.  However, this is a known issue with financial institutions and the FCA’s announcement has done nothing to exacerbate it.

IGG’s business is highly cash generative and there is no reason to suspect otherwise going forward.  It has 68M GBP of cash left after all business expenses and dividend payments in FY2016  which increased its cash and financial investments to 330M against market capitalisation of 1.8B GBP.  Put it another way, close to 20% of IGG’s market capitalisation is backed by cold hard cash.  Its NPAT and cash position will only get better with future growth e.g. it is currently expanding to various countries and offering new products (e.g. shares trading and ETF).

As of FY2016, IGG’s NPAT is 164M GBP which gives it a historical PE of 11. UK contributes to around half of NPAT and if we were to consider a ultra conservative scenario of a total collapse of profit from UK as a result of FCA’s recommendation (i.e. zero profit from UK) , the PE would be 22 and a corresponding dividend yield of 3% at today’s price.  The questions a prospective investor should ask is that:

  1. Do you have concerns with IGG’s business model?
  2. Would there be a total collapse of UK earnings?
  3. If the answer to question 1 is yes, are you uncomfortable with a PE ratio of 22 and dividend yield of 3% for IGG?

I know my answer to all questions is no.  I will be looking to add to my position at a price below 550 GBX.