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Tim Boreham
Expert
+ About Tim Boreham

Welcome to the New Criterion, authored by Tim Boreham.

Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.

Tim Boreham has now joined Independent Investment Research and is proud to present The New Criterion, which will honour the style and purpose of the old column. These were based on covering largely ignored small- to mid-cap stocks in an accessible and entertaining manner for both retail and professional investors.

The New Criterion will strive to continue the tradition in a weekly online format.

The column will not offer stock recommendations because we think readers can make up their own mind on the facts and opinions presented.

Our coverage will include both the industrial and mining sectors, including listed investment companies and IPOs. The stocks covered will not necessarily be of investment grade with sound financials. But they will have credible management and – at the very least – an interesting story to tell.

We hope readers will find The New Criterion both entertaining and informative.

More disruptions in the recruitment sector

Thursday, August 16, 2018

Until Seek came along, recruiting was pretty much about bunging an ad in Saturday’s classifieds and sifting candidates based on their ability to write a semi-coherent application.

Or in the case of Melbourne, it was more about the old school tie they wore -- and perhaps nothing much has changed.

Of course the bulging papers are long gone, but the disruption continues.

These days, job seekers are more likely to belong to ‘talent communities’ and post on jobs boards, with their applications sifted by impersonal algorithms.

Even the great disruptor Seek (SEK, $20.65) is feeling the effects of the fast shifting landscape, but the company still grew revenue by 25% and ebitda by 15% in the 2017-18 year.

For the rest of the sector, it’s been hard labour for the upstarts and the stalwarts alike. No matter how clever, new business models have struggled to gain traction in a sector that remains fragmented and heavily competed.

Further threats are likely to arise from jobs automation and the intentions of Google, which has launched a portal in the US called Google for Jobs.

1. Ambition (AMB, 12.5c)

In the traditional white-collar sphere, accounting and legal recruiter Ambition struggles to shake off the effects of the global financial crisis. But the firm is modestly profitable and is eyeing an opportunity in specialist recruitment for start-ups, especially in Asia.

2. Ashley Services (ASH, 24c)

This one typifies the angst around the sector. Having listed four years ago, the Sydney-based recruiter and trainer has been around for almost 50 years but became embroiled in the training sector drama that led to the overhaul of the abysmally rorted Vet Fee Help scheme.

Ashley posted a $67m reported loss in 2015-16, including an ebitda loss of $6.7m. In May the company lost a contract worth 17 percent of its annual revenues, but expects this revenue to be more than offset with work from new and existing clients of its blue collar and skilled recruiting divisions.

Ashley’s half-year accounts showed stirrings of life: a $2.2m on revenue of $169m, a turnaround on the previous $5.1m loss. What’s more, its shares have almost quadrupled since plumbing their 7c low of a year ago.

 3. Rubicor Group (RUB, 2.3c)

Here’s another interesting recruiter to watch because it’s a substantive player in the local market with $180mj of annual revenues, but with a measly $8m market capitalisation. The mark-down is well deserved, given the company’s near-death experience with debt that saw it bat on only at the grace of its bankers.

The company is only just profitable: ebitda of $200,000 in the December half. But its balance sheet is in better shape.

Rubicor boasts an impressive rota of local clients, including Google, Facebook, Westpac, Bluescope, Amcor, the ABC and Telstra.

Not that the latter two are doing much hiring these days.

4. Livehire (LVH, 44c)

Meanwhile, it’s a case of divergent fortunes for Livehire, which listed in June 2016 at 20c. Backed by recruitment doyen Geoff Morgan, LiveHire curates a talent pool for every job in a client organisation.

A key difference is that candidates own their data and can join the talent pools of as many companies as they want.

5. ApplyDirect (AD1, 4c)

This also listed in June 2016 at 20c and is more about bypassing the jobs boards and recruitment firms, so that candidates access jobs from employer websites on one carefully-catalogued page. Across the broader listed cluster of recruitment stocks, performance has been highly variable. Rather like your average employee, come to think of it.

6. HiTech (HIT, $1.10)

Some niche plays, such as HiTech, have hit the bullseye with the IT recruiter’s shares almost doubling over the last 12 months and gaining more than ten-fold over the last three years.

7. Schrole (SCL, 1.3c)

However academic recruiter Schrole has lost 25% of its value since back-door listing in October last year. With June quarter receipts of $438,000 and cash outflows of $169,000, Schrole may have to do a little bit more to avoid after-school detention.

While it’s clear that at least some of the recruiters will continue to struggle with executing their strategy, at least the macro conditions are favourable, with local unemployment at six-year lows.

More corporate action is likely after two of the biggest ASX-listed recruiters – Chandler Macleod and Skilled Group – were taken over last year.  The former was acquired by Recruit Holdings of Japan for $290m, while Programmed was subsumed by Persol (also Japanese) for $778m.

8. RBR Group (RBR) 0.6c

The obscure Perth-based resources recruiter is little known here, but is part of the scenery in Mozambique where Prince Andrew opened its new training centre in 2016. Resources-wise, the southern African country is the place to be, with $US50 billion of LNG work slated across two major onshore projects.

In their development stage the projects will need 50,000 workers – and by law 19 out of every 20 have to be Mozambican. This puts RBR in an enviable position.  A junior explorer that ran out of puff, RBR bought an administrative services company in Mozambique that was the springboard for its training and recruiting operation.

Having amassed a local database of 110,000 workers, RBR expects to be the first recruiter to obtain the requisite British Engineering and Construction Industry Training Board (ECITB) certification. The company currently is one a few to hold a labour broking licence in the country.

“Every worker needs an ECITB qualification and no-one in the country is registered to provide it,” says RBR executive chairman Ian Macpherson. “I’m sure there will be more (providers) but it’s just that we will be the first.”

Led by ExxonMobil and Anadarko, the two LNG consortia ventures are at final investment decision phase.  The Anadarko venture entails an initial 12 million tonnes per annum plant, building to 50 mtpa in phase two.

The ExxonMobil project is pitched at 15mtpa and involves building two of the biggest liquefaction plants outside of Qatar, the world’s biggest LNG producer.

Both plants are due to start construction in 2023 or 2024.

RBR currently has a contract with Anadarko lead contractor McDermott’s, but also hopes to sign directly with at least one of the two giants.

 Currently, RBR draws about $500,000 of revenue annually from non-LNG contracts, such as training stevedores in the country’s northern port which received its first commercial cargo in two decades. The company also provides training at South32’s aluminium smelter at Mozal in the country’s south.

RBR’s value proposition is pretty simple: if it wins a mandate to sign up 5000 workers – 10 percent of the required number – that amounts to earnings of $10-15m per year on a profit margin of $15 per worker per day. Given RBR currently bears a sub $6m market cap, investors don’t need the Duke of York’s seal of approval to see how enriched they could be if the Mozambicans plans bear fruit.

The rub is that the company had $340,000 of cash at the end of the June quarter and needs to raise more.

Tim Boreham authors The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

 

 

Is cannabis a good investment?

Thursday, August 09, 2018

The charts of most of the dope stocks show a sharp retraction from their ‘highs’ attained between November last year and January this year, although most of them are still well up on their levels of a year ago.

Yes, medical dope is now legal here – as it is in most other key jurisdictions – but access is strictly controlled. While there’s a broad acceptance that cannabis is useful for indications such as epilepsy and cancer pain, there’s a dearth of formal clinical evidence and innately conservative doctors need to be convinced.

Rather than going through the bureaucratic hoops, many patients will continue to ‘self-medicate’ illegally with less than desirable therapeutic outcomes.

Reflecting the difficulty of the medical caper, the trailblazing MMJ (MMJ, 26c) is now focused on the recreational Canadian cannabis market via its minority-owned Harvest One.

1-Page (1PG, 16c) has also smelt the skanky breeze of change. The cashed up shell of a failed recruitment house, 1-Page is to abandon the ASX in favour of a European domicile after buying a dope company there.

One dope stock that’s found favour is the natural supplements outfit BOD Australia (BDA, 51c), which is pursuing a two pronged strategy of developing over the counter products as well as a dissolvable wafer to deliver medical cannabis products.

BOD executive chairman George Livery says that despite the awareness of the benefits of cannabis components – hemp oil is a source of desirable omega 3 and omega 6 acids – wellness groups such as Swisse and Blackmores have refused to inhale.

Livery should know: until recently he was Swisse’s strategy and corporate director.

“I guess it’s the stigma attached to the word cannabis,” he says. “They just don’t have their eyes on what’s happening in the space.”

BOD already had a range of skincare products on market, but only found market favour after announcing its cannabis foray with Swiss group Linnea and Singapore’s iX Biopharma.

Describing its products and research as “evidence based”, BOD has commenced an early stage trial of a sublingual wafer to deliver cannabis derivatives to the blood stream more efficiently.

Natural medicines

BOD chief (and 10 percent shareholder) Jo Patterson says BOD has a “clear point of difference” to the crowded medical dope stock sector.

“We started business with a vision of bringing natural medicines to the market. A pharma drug is a singular molecule solution while natural medicines are complex molecules working in harmony.”

BOD has exclusive rights to the wafer, developed by iX Biopharma, which could be applied to any number of cannabis therapeutics.

The local Therapeutics Goods Administration in July gave permission for an early stage clinical trial, to test how much of the active substances get into the blood stream relative to the standard injected delivery.

“Our hypothesis is water will slow efficient absorption of the drug into the blood stream,” Patterson says. “Intravenous delivery is the gold standard but what else can we deliver more efficiently into the blood stream. We want to avoid the organs breaking it down.”

Meanwhile, BOD continues to chalk up modest revenues from its current range that includes the pregnancy supplement MamaCare, Bright Brains (anti-dozing), SediStress (irritable bowel syndrome) and the Uber Secrets (an alternative to Botox, not a certain ride share operator’s surge pricing formula).

The deals with API and Symbion cover two-thirds of the country’s chemists, or about 3,500 outlets.

In conjunction with Manuka Pharma, BOD also hopes to market a hemp honey replete with the antibacterial agent methylglyoxal.

Meanwhile BOD shares have also been helped along by the $800m – but now messy – takeover offer for skincare rival BWX (BWX, $5.42). BWX owns the Sukin and Trilogy brands, while BOD sells a range called Pommade Divine and has the local rights to Dr Roebucks.

“The move showed the market value of these businesses and we got a little bit of a rub-off effect,” Patterson says.

Despite this, BOD remains valued at a mere $23m.

MGC Pharmaceuticals (MXC) 5.6c

Our second oldest listed ‘pot stock’, MGC is also in the cosmetics game with posh British department store Harvey Nichols, now stocking 18 of its cannabis-based skin care products that sell for $50 to $100 a pop.

MGC chairman Brent Mitchell said the company saw the success The Body Shop was having with its hemp-based products.

Beyond that, though MGC’s cosmetics business – in joint venture with an Israeli company called Dr M Burstein – is likely to remain a sideline as MGC pursues its broader “seed-to-sale” strategy in Europe.

Unlike its ASX-listed peers, MGC focused on Europe from the outset, creating manufacturing facilities in Slovenia and the Czech Republic where the regulators were most amenable.

“We wanted to set up a cultivation operation in Europe but with a pharmaceutical-grade processing facility to sell to European pharma companies as well as make our own medicine,’’ Mitchell says.

“That’s been our vision since we relocated from Israel to Slovenia and Czech Republic three years ago.”

Now, the company plans to build a four times bigger facility in Malta, where the hot weather reduces the cost of propagation and allows for three crops a year instead of two.

“It will be one of the most operationally advanced facilities for certification purpose in Europe,” Mitchell promises.

But where does all the cannabinoid-rich greenery go?

MGC expects to supply the certified raw product in Europe, especially to Germany which currently bans cultivation within its own borders but otherwise has a booming medical cannabis sector.

But first and foremost, MGC plans to launch a line of approved pharmaceuticals for ailments such as post-chemotherapy nausea, adult and child epilepsy and anorexia.

It’s already developed Cannepil, a treatment for sufferers of drug resistant epilepsy.

MGC has approval to supply Cannepil in Australia, where it has lined up a base of 100 registered users.

Mitchell describes the local market as small but lucrative.

 “If we can capture less than half a per cent of the available market for drug-resistant epilepsy, that equates to $1m of revenue a year,” he says. “If we can grow that to 3-5% then it’s a serious business.”

Of the 18 MGC products gracing the Harvey Nix shelves, 15 of them are non-clinical stuff like day creams and face washes, while three are for the symptoms of conditions such as acne, eczema and psoriasis.

Achieving scale in the cosmetics game requires deep pockets and deep distribution. Rather than taking pot luck, MGC is amenable to a partnership with a more substantive industry operator.

Tim Boreham edits The New Criterion

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

The New Criterion: Finding value in the Aussie gold sector

Friday, August 03, 2018

Despite the multitude of worries in the world, the gold price in $US terms continues to be under pressure, trading about 2.7 % below its level of a year ago and about 10  % off its January peak.

So much for bullion being a safe harbour investment.

The higher greenback is the obvious ‘culprit’, interlinked with higher US interest rates that mean richer investor returns are available elsewhere.

US inflation – gold’s traditional friend -- remains benign although Trump tariff barriers might change that.

But for Australian gold producers the good times continue to roll, with the $A-denominated price up about 4 % over the 12 months.

On average, local miners can extract the stuff for $1000 an ounce, which leaves a fat margin relative to the current circa $1650 an ounce spot price.

There’s a catch, though: the big producers like Newcrest Mining (NCM, $21.60)Northern Star Mining (NST, $7.20) and Evolution Mining (EVN, $2.79) look fully or overvalued, having outperformed their global peers for some time.

 RBC Capital Markets notes investors are flocking to the majors because of their strong balance sheet and margins and consistent operating performance (which hasn’t always been the case).

They simply look expensive, although not so much relative to their global peers.

Meanwhile, most of the smaller gold plays on the ASX are trading at a discount. “It’s time for investors ... to look down the curve for value in the Australian gold space,” the firm says.

What better a place to start than in the West, where operating risks are low and the geology is generally well known?

Investment options include mid-tier extant producers such as Saracen Gold (SAR, $1.87), Ramelius Resources (RMS, 56c) and Silver Lake Resources (SLR, 55c).

For more patient investors, gold plays in the development or advanced exploration phase are an alternative gambit.

Take Dacian Gold (DCN, $2.94), which has been ramping up its underground Mt Morgan mine, in WA’s Leonora region. From the December quarter it plans to produce commercially from what would be Australia’s biggest new gold mine in six years, at a rate of 180,000-210,000 ounces a year.

Like all decent deposits Mt Morgan has been subject to pass- the-parcel ownership. Dacian bought the project from the administrators of Range River Gold, which in turn had acquired it from Barrick Gold in 2009.

As it ramps up output to commercial levels, Dacian has raised a chunky $40m via an institutional placement to bolster its reserves base, with a drilling push at its Westralia and Cameron Well sub deposits.

It’s also shelling out $12m to extinguish an obligation to pay royalties pertaining to output from its Jupiter deposit, also part of the Mt Morgan project.

The raising struck at a $2.70 a share, a 10 % discount, was heavily oversubscribed.

 All things being equal – and they're usually not – RBC expects Dacian to generate underlying earnings of $47m in 2018-19, rising to $107m in 2019-20.

 These numbers represent earnings per share of 21c and 48c respectively, putting Dacian on a miserly earnings multiple of 12 times and then six times.

Investors are waiting for a July resource update. The current mine is predicated on an eight year life but if the drilling push delivers results this could be elongated.

Alternatively, Gold Road Resources (GOR, 67c) offers an exposure to a new mine slated for production by June next year, at its Gruyere deposit.

With a total resource of 5.88 million ounces – 3.56 m.o. in the more assured reserve category – Gruyere is of Australia’s biggest undeveloped gold deposits.

It’s a case of quick work for Gold Road, which discovered the Gruyere, on the Yilgarn Belt near Laverton, only in 2013. In late 2016 the company sold half of the project to South Africa’s Gold Fields for $350m of cash, which underpinned the $585m cost of the plant.

Construction work is well underway at Gruyere, which is slated as a 270,000 oz a year producer with a 13 year mine life. But it’s hoped that current drilling on neighbouring targets – some within the JV and some fully owned by Gold Road – will eventually provide further mill input or even justify a separate project.

With a $650m market cap, Gold Road is now far from a penny dreadful. But with expected all-in costs of $950/oz and with the path to production fully funded, Gold Road promises to be a veritable golden goose if the $A bullion price holds firm.

Macquarie Equities forecasts calendar 2019 revenue of $69m and net earnings of $8m, ramping up to serious revenue of $255m and a $69m net profit in 2020.

Sticking with the WA gold theme, minnow NTM Gold (NTM, 4c) faces an unusual dilemma as it contemplates contemplates a drilling campaign at its mainstay Redcliffe gold project.

Rather than craving institutional backers, the well-backed NTM wants more retail punters to round out the register and inject some liquidity into the stock.

The stock is 7 % owned by Ausdrill, which earned the stake by providing drilling services.

NTM shares have gained favour since mind June, when the company almost doubled its resource base to 538,000 oz (roughly evenly split between the indicated and inferred categories).

The company aspires to double again one million ounces – enough to support a 100,000 oz a year operation – but to achieve this it has to find new deposit on the sprawling tenement.

Not wanting to die wondering, NTM is testing 30 targets along a 40 km strike zone, much of which is yet to see a drill bit. The campaign covers previous drill hits, extensions to existing deposits and “new conceptual targets”.

Should NTM get into production, mining is likely to be based on a “toll treatment” operation by which the ore is trucked to one of four nearby processing plants.

NTM chief Andrew Muir says the market is valuing NTM’s resource base at a fraction of which it values the company’s local peers. 

Criterion has heard such a lament many times before, but given NTM’s slender $12m market cap he might have a valid point.

 NTM is not only proximate to Mt Morgan, but on the same geology of other famous-name projects including Gwalia (owned by St Barbara), Thunderbox (Saracen), Darlot (Red 5) and Kin Mining’s Leonora, which is in development.

“We are a pretty simple digestible story,” Muir says.

Despite bullion’s current lack of popularity, bullion tends to react well to ballooning government deficits and debts, which is what’s been happening in the US.

On the supply side the best and biggest gold resources are also rapidly declining, leaving the next bunch of up and comers to fill the gap.

Tim Boreham edits The New Criterion

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

 

 

 

The New Criterion: Growth stocks

Friday, July 27, 2018

Growth stocks have outperformed value stocks in recent times, but the 31 year old value investor Templeton Growth Fund is a patient investor. Elsewhere in the listed investment company sector, a new fund is taking a different approach to ensure it doesn’t trade at a discount to asset backing

Templeton Global Growth Fund (TGG) $1.42

Funds oriented to growth stocks such Hamish Douglass’s Magellan have been the rock stars in recent times, which makes value funds such as Templeton the crooner on stage at the RSL club belting out hits from the 1960s.

The disparity is reflected in the Nasdaq – which is laden with tech stocks – gaining 22 % for the year to date, compared with the S&P500 index (of top global companies) climbing 14 %.

The listed exponent of the global Templeton ethos of finding opportunities among unloved established companies, Templeton Growth hasn’t wavered from this approach since debuting in May 1987 (just in time for October’s Black Monday).

“We’re about value as well as patience,” says chief investment officer Peter Wilmshurst.

Since inception the fund has returned 7.5 % per annum after fees, compared with the global MSCI index’s 6.7 % return (the index includes emerging countries so is the fund’s preferred measure).

Value funds do better when interest rates are high, because investors are less more likely to plonk their money in cash rather than push stock valuations to silly levels.

Given the “artificially low” US rates are definitively heading north – the 10 year bond rate broke through 3 % in May – value stocks should be gaining favour.

But last year, the asset class underperformed growth funds by 10 % (the Templeton fund itself fought to a draw, gaining 14.4 %, compared with the MSCI’s 14.8 % increase).

As with all investment trends, the worm will turn and low-multiple stalwarts again will be favoured over extravagantly valued growth stocks. The simmering trade war ignited by Donald Trump could well be the catalyst if it stymies economic growth.

But Templeton hasn’t waited for the macro conditions to shift, having taken a punt on two under loved sectors.

The first one is oil.

As the price for the primordial sludge tumbled in 2015 before bottoming in early 2016, Templeton was bulking up its exposure.

Not on Wildcat Strikes Inc, mind you, but traditional plays such as Shell and BP. With crude breaching the $US70 a barrel, these stodgy stalwarts have roared back into favour.

The fund has also been keen on oil services plays – which are almost as numerous as the oil producers themselves -- but they too have rallied hard and are only fairly valued.

The fund’s second big punt is on European banks.

Most financial services stocks struggle with low interest rates, but that’s especially the case with Europe where the banks receive negative interest if they park a deposit with the European Central Bank.

On the customer side, it’s hard to price a deposit below zero so the banks have experienced a margin crunch.

Wilmshurst reckons that European Central Bank president Mario Draghi will be keen to engineer a rates rise before his term ends in 2019.

“You would expect him to go out as a central banker who saved Europe and put it back on the path to prosperity with normalised interest rates.”

The fund weighed into the European banks in 2012-2013, picking up Credit Agricole at 0.3 times book value (now the French bank is trading at a slight book premium).

Wilmshurst also likes the Asian focused UK banks HSBC and Standard Chartered and Barclays. He also dubs Chinese telcos as “among the cheapest in the world.”

Meanwhile, Templeton does have a few tech growth stocks (such as Alphabet) in its portfolio, but it’s largely a case of no FAANGS to these investments.

Currently the Templeton lic is trading 7.6 % below the value of net tangible assets (the value of the underlying portfolio) of $1.58/sh.

Wealth Defender Equities (WDE) 86c

Still on listed investment companies, the Perennial Funds Management offshoot was touted as offering investors airbag-type protection against market downturns. But like those faulty Takata airbags, the concept is subject to a recall.

The idea underpinning Wealth Defender was that the fund would deploy derivates such as caps and collars and futures to protect the portfolio against market-wide declines up to 20 %.

But protection comes at cost – one to two %age points of performance --and the fund has sadly underperformed since listing in May 2015.

Since inception, Wealth Defender’s NTA has grown only one % compared with the broader market’s 5 % growth (the fund largely invests in the ‘usual suspect’ top 50 companies).

Wealth Defender’s other woe is that its shares have traded at a persistent discount to NTA (the gap is currently around 10 %).

To rectify this, from August 1 management has the option of using protection on a “dynamic, discretionary” basis, when it deems it appropriate “in view of the market outlook.”

Management has also taken a bath on its management fees, widely perceived as too high. Notably, a 15 % fee was payable even if returns were negative, but above the index return.

Now, the fee still accrues but is only payable when there’s positive NTA growth.

Like the rhythm method, there’s an inherent risk with such “optional protection”: the manager needs to be able to foresee a sharp market downturn, which often come with no warning.

Wealth Defender shareholders will feel like right Wallies if the fund decides to ride bare just at the wrong time.

Meanwhile, Paul Moore’s PM Capital has a different approach to narrowing the NTA discount that blights so many lics.

The global investor is doing the rounds to raise up to $490m for a new listed vehicle called Ptrackers, which emulates the performance of PM’s existing PM Capital Global Opportunities  (PGF, $1.30).

The difference is that in June 2025 holders have the option of redeeming their shares at the prevailing NTA value, or converting to PGF shares. Any discount should vanish closer to D-Day as arbitrageurs do their work.

Of course, the Ptrackers ‘no discount warranty’ doesn’t guarantee the fund’s NTA will actually grow over the seven-year period.

Tim Boreham edits The New Criterion

tim@independentresearch.com.au

Disclaimer: Ptrackers and Templeton Global Growth Fund are covered by Independent Investment Research. Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

 

 

The new criterion: Paying staff on time

Friday, June 29, 2018

Paygroup (PYG) 90c

The number one imperative of managing staff is not to provide the troops with chocolate biscuits in the tea room or a subsidised gym, but to pay them accurately and on time.

“If you stuff up someone’s pay you will be forever in the bad books,” says Paygroup chief executive and co-founder Mark Samlal. “You just can’t afford to do that.”

With that in mind, the recently-listed Paygroup is tackling the Asian market, where its multinational clients have to cope with an array of different rules and cultures.

On behalf of 410 clients, the Singapore based Paygroup operates two divisions: business process outsourcing (payroll services) and human capital management software (other HR stuff such as expense and leave management).

Samlal says Paygroup, which operates in 18 countries, faces “all levels of sophistication”. The clients are generally based in Singapore or Hong Kong or, increasingly, Kuala Lumpur.

But they have a habit of expanding into the smaller and less developed economies and they expect Paygroup to follow them. For instance, one client has taken over a plant in Myanmar which not too long ago was a closed dictatorship (and if you’re a Rohingya, it’s still got its issues).

The company handles 80% of the work itself, but in countries such as Pakistan, Bangladesh and Sri Lanka. “We pay people in over 25 cities in India so we have a strong capability there,” Samlal says.

Paygroup shares have bounded from the blocks since the company listed on May 25, having raised $8.5 million at 50c apiece.

The buoyant performance was helped along by the lack of pre-IPO investors, which meant there wasn’t a conga line of punters selling out on the first day.

The float was also priced to sell, as measured by guidance of sharply higher earnings for the year to March 2018.

The listing was a case of third time lucky for Paygroup, which tried to debut last year based on an acquired operation called PeopleHR based in Colombo, Sri Lanka.

“It didn’t perform so we pulled the prospectus in early September and decided to list our own company,” Samlal says.

The float was then further delayed after ASIC expressed concern about unaudited half year accounts.

Paygroup’s board seems well-credentialed: its chairman Ian Basser was the former head of the ASX-listed recruiter Chandler Macleod, which was taken over.

Director David Fagan was the former chief of law firm of Clayton Utz and is on the Medibank Private board.

Paygroup generated a $477,000 net profit on revenue of $5.94 million in 2016-17, but expects a $2.61 million profit on revenue of $7.3 million for 2017-18.

Paygroup’s revenues tend to be reliable and clients are on an average three-year contract. Unless the aforementioned “stuff ups” occur, they won’t change provider.

At the time of listing Paygroup traded on an earnings multiple of a mere eight times; now it’s more like 12 times.

While Paygroup doesn’t have a directed ASX-listed peer it shares characteristics with Elmo Software (ELO, $5.54), which provides technology for HR and payroll functions but doesn’t execute these processes holus bolus.

There’s also some overlap with salary packagers McMillan Shakespeare (MMS, $16.31) and Smartgroup (SIQ, $11.68).

“I don’t want to sound like a smarty pants but there’s no-one on the ASX quite like us,” Samlal says.

Serko (SKO) $2.78

Still on staff management: the process of booking corporate travel has been manual and ponderous, usually involving visiting multiple service provider sites.

The more parties involved, the higher the likelihood of a snafu.

“Travel is of one the most personal things,” says Serko co-founder Darrin Grafton. “You don’t want to turn up at an airport without a ticket or arrive without a hotel booked.”

But it’s the New Zealand based Serko’s artificial intelligence, rather than the personal touch, that strives to prevent double bookings, non-appearing hire cars or corporate travel rule breaches that result in humble functionaries living it up in business class.

Called Zeno, Serko’s robotic tool predicts the booking behaviour of staff and recommends flights, hotels and other services accordingly.

It even compares dates on online calendars to ensure that the marketing manager doesn’t arrive for a sales conference that was held two days earlier (probably didn’t miss much).

Meanwhile Serko’s eponymous platform processes 20,000 bookings per day and is used by 70% of Australian corporate travel companies as well as companies such as Wesfarmers, Santos, Fortescue Metals and Telstra.

Mind you, the latter will have less of a need to move around middle managers after last week’s announced cull.

Don’t be alarmed if you’ve never heard of Serko because much of the business is white-labelled: for instance it’s the platform behind Flight Centre’s corporate booking business.

Grafton says “we don’t care what brand is visible as long as we are making money’’ – and we can’t argue with that.

Serko has been listed on the NZ Stock Exchange since 2014. The stock was the bourse’s best performer in 2017, surging from 29c to $2.19 and making multimillionaires out of Grafton and co-founder Bob Shaw.

The company listed on the ASX last Monday. But unlike the accounting software giant Xero, which is now exclusively ASX listed, Serko will maintain an NZ listing.

Given Serko gleans about 95% of its revenue from across the ditch, it’s perhaps surprising the company has taken so long to list here.

“A lot of Australian institutions have visited us, but many have mandates that prevent them from buying the stock unless we have an ASX compliance listing,” Grafton says.

“But we wanted to be in a pretty good financial position before flicking that switch.”

The switch-flicking moment came after Serko recorded a $NZ2 million ($1.86 million) net profit for the half-year to March 31 2018 compared with a $NZ3.3 million loss previously,  on revenue of $NZ18.3 million (up 28%).

The company expects to remain profitable, even as it spends a decent sum on US and British expansion.

The dilemma for shareholders is whether Serko’s $200 million market cap just about does it.

Tim Boreham edits The New Criterion

tim.boreham@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.
ENDS

 

The New Criterion: Finding light in the financial sector

Friday, June 15, 2018

 

With the mortgage broking sector already under the regulatory blowtorch, Mortgage Choice has added to the pain with revelations of unhappy franchisees. But is there value emerging in the marked down shares, as well as those of listed counterpart Australian Financial Group?

Mortgage Choice (MOC) $1.50 

With Mortgage Choice joining the casualty list of high-profile franchised operations, investors are pondering just how low the mortgage broker’s shares can go following reports of a looming franchisee revolt.

The experience of franchise ‘floperoo’ Retail Food Group, which has lost more than 80% of its value since early December, is hardly encouraging.

But there’s comfort of sorts for Mortgage Choice holders: according to Macquarie Equities, the value of the company’s cash and up-front and trail commissions already earned is worth $1.09 a share.

In other words, at these levels the market would be valuing Mortgage Choice’s franchise network and ongoing business at a big fat zero.

Even before last week’s revelations of a revolt among a large rump of Mortgage Choice franchisees, the mortgage broking sector faced stiffening headwinds with the prospect of tighter regulation and the onset of a housing downturn.

Even before that, investors had marked down Mortgage Choice shares after the banking royal commission created unfavourable headlines in March.

And let’s not forget that Mortgage Choice John Flavell departed suddenly in early April and without explanation, leaving CFO-turned-CEO Susan Mitchell to face what the French would politely call a sandwich de merde.

The immediate outlook for Mortgage Choice is not pretty, even though management scurried to change the commission structure to give discontented franchises a greater share of the spoils.

But if half the franchise base proceeds with a mooted legal action, the repercussions will soon bite the bottom line.

The broader question is whether the whole sector faces an existential threat because of dubious practices such as loan churning and lax customer vetting.

At the royal commission, the lightning rod for fury centered on the conduct of another major participant, Aussie Home Loans.

Rather than saving people from the banks these days, Aussie is fully owned by the Commonwealth Bank of Australia, in relation to dealing with a fraudulent broker.

Among the lowlights aired, an internal CBA report also admitted deficient oversight of broker loans in relation to misconduct and miss-selling.

Such revelations have prompted the mortgage brokers’ ultimate customers – the banks – to make ominous noises about curtailing the brokers’ commissions or pushing for a fee-for-service model.

The overwhelmingly majority of brokers don’t charge the borrower, but reap an up-front and trail commission from the bank (these average 0.65% and 0.15% of the value of the loan respectively).

The truth is the bank-broker relationship is symbiotic: regional banks without a bank network rely heavily on them and any bank failing to nurture this third-party network has quickly found their mortgage market share decreasing.

Mortgage brokers account for 55% of all home loan originations and that figure has been creeping up over time.

In the past, the banks have tried plenty of times to curtail these payments. The Bank of Queensland even stopped using brokers for a period in the noughties.

The broker commission model means that brokers indeed have every incentive to recommend loans from the lender offering the best cut and up selling the value of these loans.

But a bank loans officer subject to aggressive performance targets can equally be guilty of writing bad business.

It’s likely the royal commission – as well as an ongoing Productivity Commission inquiry – will result in tighter regulation. One prospect is capped commissions similar to the life insurance industry.

But given the entrenched role of brokers in the $1.7 trillion mortgage market your columnist can’t see them being driven into the Red Sea. But they’ll get a bit wet.

The industry cites a separate ASIC review of broker remuneration, which concluded the broker model wasn’t broken but needed some tweaks. Whether these tweaks turn out to be an adjustment of the carburetor settings or a full engine rebore remains to be seen.

Arguably there are too many brokers – about 7000 active ones – and a housing downturn will hurt volumes. But rising rates will prompt existing borrowers to refinance and brokers love churn.

Based on expectations of flat full-year cash earnings of around $23m, Mortgage Choice trades on a current-year multiple of under eight times and a fully-franked yield of more than 10 percent.

However any investor who has been around for more than two seconds will know that such low multiples and high yields are usually illusionary. 

Australian Finance Group (AFG) $1.31

At the time of writing, AFG shares looked to be suffering contagion from Mortgage Choice’s woes, although AFG CEO David Bailey offers other reasons for the sell-off.

“There’s a lot of uncertainty around the sector because of the royal commission and discussions about (broker) remuneration,” he says.

“Certainly Mortgage Choice is the big brand name while we’re more like a wholesaler.”

But while both stocks are mortgage brokers their business models differ markedly and Bailey has been on the investor hustings to drive the point home.

While Mortgage Choice is a franchisor – franchisees pay a buy-in amount for a designated patch – AFG is more of a support act for independent brokers.

Under AFG’s agglomerator model, brokers sign up for support services such as technology and (If they choose) the right to use AFG’s credit license.

AFG charges a monthly fee for the services ($70 for the technology support, for example) and takes a modest cut of the broker commissions (about 7 percent of the upfront component).

AFG also has the primary relationship with the lenders via its lending panel. But in effect the brokers remain independent, operate under their own name and chase their own leads.

“In reality we give the brokers the tools to start a business,” says CEO David Bailey. “That can be anything from mums and dads in Parramatta to larger organisations like iSelect or Oxygen Group (part of the McGrath real estate group).”

AFG is also more diversified than Mortgage Choice, having entered home and small business lending in its own right.

AFG has also expanded its wares further by paying $10.9m for one-third of Thinktank, a mortgage-backed lender specialising in commercial loans.

The idea is that Thinktank sells the loans through its 2900 strong broker network.

With 2900 brokers on its books, AFG represents about half the broking industry. But AFG’s broking activities accounted for 60% of half-year earnings and this component should decline over time as the company builds its own-branded products.

AFG trades on a measly multiple nine times earnings and yields about 9 per cent. Notwithstanding a lending apocalypse, its business looks more robust than Mortgage Choice’s.

Tim Boreham authors The New Criterion

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

The New Criterion: Tech and manufacturing

Friday, June 08, 2018

 

Carbon components specialist Quickstep is flying high with an ongoing parts contract for the Joint Strike Fighter program, but investors remain wary because the company is yet to turn a profit. Also in the tech space, Sensera has gone to market with a better tool to track mining equipment – and cows.

Quickstep Holdings (QHL) 7.5c

Quickstep’s recently-appointed CEO gives a succinct explanation for why shares in the Bankstown Airport based carbon composites maker are trading at close to record lows.

“We have been listed for 12 years and have never made a profit,” Mark Burgess says. “We have made a lot of promises and fuelled expectations, but not met them.”

Yep – that about sums it up. But in the words of Bob Dylan, the times are a changin’ and when Quickstep management talks about earnings these days it’s not just blowing in the wind.

Quickstep’s revenues derive from two key sources: long-term contracts to supply parts for the Joint Strike Fighter (JSF) and the Hercules C-130J, an updated version of the old warhorse of the skies.

The US JSF program is the biggest military project in history and worth so much that we have run out of noughts.

The sleek jets have been derided as inferior to those of our putative enemies - we won’t be so crass as to name names, me old China – but we’ll never really know until there’s a combat situation.

Hopefully, we’ll never know.

Given Australia is a purchaser of JSFs – 72 at last count – Australian suppliers are entitled to a share of the spoils.

Hence local hero Quickstep wrangled contracts to supply 700 carbon parts on behalf of JSF lead contractor Northrop Grumman.

Quickstep has been producing the JSF parts – including doors, panels, skins and vertical tail parts – under a 14-year contract. The difference now is that the company is doing it in profitably, the result of a back-to-basics program called OneQuickstep.

The program was initiated by Burgess, a former Honeywell Aerospace and BAE Systems heavy who took over the role from David Marino in May last year.

Marino had an automotive background and it’s no coincidence that Quickstep’s ambition to supply the cut-throat car industry with lightweight parts has been wound back.

The OneQuickstep effort focused on the core Bankstown facility and head office, with measures including key executives from nine to five and halving the non-executive directors to three.

R&D spending was halved, including the closure of a German facility.

The proof of the pudding is that Quickstep’s March quarter revenues improved by 15 percent to $14.6m, with positive cash flow of $2.74m.

The company has reported quarterly surpluses before, but like Criterion’s footy team it has struggled to cobble two ‘wins’ in a row.

Quickstep also repaid a $2m director loan, but is still $13m in hock to the government export credit agency EFIC. Burgess expects further debt reduction, but adds that EFIC is an attractive alternative to a capital raising.

But management is confident of sustained earnings for the full year that will be maintained din 2018-19.

While often associated to lumbering white elephants, the JSFs are now rolling off the production lines at a decent clip.

The company expects peak JSF output of 160-170 units is expected in the early 2020s, but production scheduling means Quickstep experiences demand about 18 months beforehand.

In theory, the JSF order book is worth up to $1 billion for Quickstep up to 2030, the envisaged sunset date for the program.

Quickstep has some other irons in its high-tech furnace with some smaller jobs with Boeing and a tie up with Italy’s ATR Group.

Another specialist sideline is specialist parts for medical devices such as x-ray machines.

But it’s efficient delivery of the JSF and Hercules contracts that will determine whether this one, er, flies.

Sensera (SE1) 19.5c

What do ruminating cows and mining trucks have in common?

The answer is that both cattle and mining equipment move around and it’s nice to know their whereabouts.

Sorry, that’s not exactly a zinger for the upcoming Edinburgh comedy festival gig, but a straight-laced reflection on the core nature of the tech minnow’s activities.

A specialist in “location awareness”, the sensor house provides collision avoidance systems for mines. In the case of cattle its tool can detect heat, lameness or the onset of infections in beef and dairy cattle.

In effect, Sensera plays in the ‘internet of things’ sector, with a presence in both the hardware and software side.

One aspect is micro electrical management systems (MEMS), the wondrous sensors that transform physical events into electrical signals (for example, rain on a windscreen can activate a wiper)

Sensera had the MEMS bit down pat already, but entered the location awareness business in August last year by acquiring a German outfit, Nanotron, for €6.4m ($10.3m) in shares and scrip.

Given the venture-capital backed Nanotron spent €38m on honing its technology, the deal looked like a sharp one for Sensera.

The Nanotron systems currently are used in 60 mines in South Africa, as well as a handful of pits in Mexico, Chile, Canada, China, India Poland and Turkey. Given there are more than 60,000 mines globally, that’s tip of the iceberg stuff.

Under Sensera’s ownership, Nanotron then struck a deal to supply its chips to the animal eartag maker Strongbow.

The Nanotron trackers are used on” hundreds” of farms, but with a global population of 1.25 billion cattle there’s a total annual addressable market of $3.8 bn.

 Sensera is not exactly devoid of competition, especially with movement sensors. But in the case of mining, many GPs-based tools are unsuitable because of the number of obstacles and the ever-changing layout of a mine.

Whatever the case Sensera is generating revenue: a record $US2.2m ($2.9m) in the March quarter, up 38 percent with a cash burn of $1.75m.

Management is “solidly on track” to achieve revenue of $US6.25-7.25m for the 2017-18 year and is bold enough to forecast a 60 per cent increase in turnover in 2018-19.

The company also expects to be “operationally breakeven” by the end of 2018-19.

Sensera is headed by US semiconductor industry veteran Ralph Schmitt, who ran a number of listed Silicon Valley companies. Most recently he led the cognitive computing software program at Toshiba America Electronic Components. 

Schmitt contends that tech investors have paid dearly for the “learning curve” of inexperienced management, resulting in follies such as focusing on the small local market rather than the global stage.

In Sensera’s case, punters are yet to be convinced and the shares have halved in value over the last year. The company listed in December 2016 after raising $10m at 20c per share.

A key reason for the subdued showing is that the company expects to have to raise $5-10m of additional capital (possibly including equipment leasebacks or debt).

Otherwise, Schmitt says, there’s no fundamental reason for the sell-off.

Here’s hoping Sensera avoids the pitfalls as it broadens its scope to medical applications and miniaturised gas (methane) sensors that can be incorporated into a miner’s (or a cow’s) tag.

Tim Boreham edits The New Criterion

tim.boreham@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.


 

 

The New Criterion: Wonderful world of broking firms

Friday, June 01, 2018

 

In the old days, the listing of a broking firm was a sure sign the market had peaked. Meanwhile, a niche broker is relying on the wisdom of the masses to seek the best investments.

Evans Dixon (ED1) $2.50 and other listed brokers

Aside from the hoary old one about bellhops imparting share tips, the sure-fire sign of an impending bear market is when stockbrokers seek a public listing to share the dubious love.

Well it used to be, anyway. Wizened readers will remember that three brokers listed in quick succession in 2007, only to come a cropper after the market tumbled in November of that year.

So we note with trepidation the recent listing of Evans Dixon, the amalgam of Melbourne blue blood broker Evans & Partners and the self-managed super fund specialists Dixon Advisory.

It’s a case of so far so good, with the shares roughly on par with their $2.50 a share debut price having poked as high as $2.70.

And much has changed since the noughties, when brokers relied on trading commissions and fees from equity capital market activities.

Old school brokers versed in wheeling and dealing might choke on their third post-luncheon port, but now brokers call themselves wealth managers and operate high falutin’ investment platforms (generating annuity fees that don’t depend on the vagaries of the all-ordinaries index).

Evans Dixon also has considerable sums invested in the US Masters Residential Property Fund and solar farm owner New Energy Solar. 

Meanwhile the class of 2007 – Bell Financial Group (BFG, 82c), Wilson HTM and Austock – have morphed beyond recognition.

The latter solid its broking arm to Intersuisse in 2012 and is now an investment bonds specialist Generation Development (GDG, $1.22)

The Brizzie-based Wilson HTM was subject to a management buyout of its securities arm in 2015. But its funds management arm Pinnacle (an amalgam of boutique) lives on as Pinnacle Investment Management (PNI, $5.44).

Previously Bell Potter, Bell Financial Group is enjoying its best conditions in a decade.

The firm has funds under advice of $47 billion, 10% of which enjoys recurring revenues. “These numbers clearly demonstrate we are not simply a traditional broker relying on day-to-day revenue from secondary market execution,” managing director Alastair Provan.

The Perth-based Euroz (EZL, $1.20), which listed earlier, rides the ups and downs of the WA resources sector (which currently is more up and down).

Once again, the firm has earnings diversity through $1.43bn of funds under management and two listed investment companies (Westoz Investment Company and OzGrowth).

As with so many other professional service plays including real estate (McGrath) and accounting (Harts and Stockfords), broking was not amenable to the listed model.

One reason is that the brokers were more like independent deal-chasers working under the one shingle. Many were also unable to be herded into a corporate structure because they were eccentrics and/or permanently out to lunch.

Self Wealth (SWF) 13.5c

Who needs the help of brokers when you’ve got the collective investment wisdom of the masses, a la Wikipedia?

That’s the unusual premise of Self Wealth, which is best known as a discount online broker but is also developing a line in peer-to-peer stock selection.

Self Wealth has analysed the performance of 35,000 investor portfolios to create the SW200 index, which incorporates the stock selections from the best 20 portfolios.

It’s a case of so far so good, with the SW200 outperforming the ASX200 by 76% in the six months to January.

Founder and CEO Andrew Ward honed the concept after a 20 year stint in the financial services industry, including the fledgling First State (now the Commonwealth Bank owned Colonial First State).

Even back then, Ward didn’t like what was going on from a “moral and values” perspective and sought to create an online broker with a traditional service model.

That one didn’t quite come off, but it formed the basis for the current self-directed platform. “It dawned on me I could use the best investors to create a portfolio,” he says.

Self Wealth’s business model entails either traders availing of its $9.50 per trade flat fee, or punters signing up for a $20 a month “premium service”. The latter allows subscribers to track top-performing or like-minded members and receive alerts whenever they trade.

 But what if all the investors are wrong?  “There is no greater herd mentality than in financial markets so you do have to remove that noise,” Ward says.

To do this, Self Wealth overlays two tools over the model portfolios. One is a safety rating based on the level of diversification, the other is a test of returns over the longer term

In the third quarter, Self Wealth recorded revenue of $318,000, up 90% on the quarter with active users gaining 50% to 3382.

However only 10% of these are paying subscribers to the premium service and management’s priority is to boost this take-up.

Self Wealth also recorded a loss of $1.2m and at the end of the quarter held $5.1m of cash, having raised $7.33m on listing in November last year.

To date, most of Self Wealth’s revenue derives from interest on $30m of client deposits, but Ward says that contrary to perception the $9.50 trades are profitable.

Seeing you asked, exchange traded funds account for seven of the top ten investments held by the best ten investors.

The others are CSL, BHP Billiton and Rio Tinto.

Macquarie Group also features, while not surprisingly the Big Four banks have slipped in popularity.

Sadly, Self Wealth investors are yet to benefit from the wisdom of the masses, with the shares well below their November 2017 listing price of 20c apiece. As usual, profit taking, pre-IPO investors who got in at a much lower price appear to be to blame.

“As we’re a microcap, investors are waiting to see our track record. About 20 to 30 funds say they like the story, but they won’t get in yet.”

Self Wealth’s next step is its own ETF for self-manages super funds, based on the portfolios of the 200 top performing SMSFs distilled from 30,000 portfolios.

In the company’s favour it’s backed by BGL, Australia’s biggest SMSF administrator and this provides a channel to attract business.

The catalyst for a re-rating is decent set of full-year numbers, due to be released in August. Until this happens, Self Wealth is consigned to the ‘concept stock’ category.

Tim Boreham edits The New Criterion

Tim.boreham@independentresearch.com.au 

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

 

The New Criterion: Insurance and Data operators

Friday, May 25, 2018

 

Freedom Insurance (FIG) 43c

While the banks are beating a hasty retreat from life insurance, the low-key Freedom stands to benefit through its recent purchase of the Bank of Queensland’s St Andrews business for a headline $65 million.

In one of those exquisite corporate games of pass-the -parcel, BOQ acquired St Andrews from the Commonwealth Bank of Australia for $60m in 2010. The CBA had inherited the business when it took over the distressed BankWest in 2008.

Life is tough in the life game, especially in the income protection sector, but Freedom chief Keith Cohen is confident there’s a place for a niche player offering simple and understandable products.

Until now, 88% of Freedom’s has derived from death, rather than life, cover: funeral insurance. Post acquisition, funeral cover is diluted to 66% of Freedom’s premium income, with St Andrews delivering a substantive position in mortgage and credit insurance.

These products are cover taken by lenders to protect their position with riskier clients.

Cohen says: “St Andrews is a B2B business and Freedom is a B2C business and so they fit together complimentarily.”

The cash and debt funded acquisition is chunky one for the $107m market cap Freedom, but it appears to be low risk. That’s because St Andrews will still sell to a captive audience of BOQ customers under a three year distribution tie up (extendable by two years).

Freedom also won’t be exposed to the risks (and rewards) of the in-force policies, these are assumed by a reinsurer that will fund $35m of the purchase cost.

As a pure-play listed life insurer, Freedom is a rare beast. Ranked in terms of new business written the company rates as third biggest direct insurer, which means it sells through its own sales force rather than agents.

The two biggest direct insurers are the Japanese owned TAL (formerly the listed Tower) and Comminsure (which CBA last year sold to the Hong Kong based AIA Group for $3.8bn).

Cohen expects Freedom can become second biggest in the medium term – or even the gold medallist. Not that he’s obsessed with league ladders.

“But what you need is scale and this brings more scale and opportunities to add good value products.”

Cohen notes that most of the issues have related to group cover (to companies or superannuation funds) that Freedom doesn’t offer.

But Freedom’s first half sales – down 11% to $28.3m –were affected by what Cohen dubs “lead quality issues” (that is, the calls did not lead to sales).

But these problems appear to have been overcome.

“We’re a well oiled machine. We had a bit of an issue but we are back on track,” Cohen says.

Freedom’s closest listed relative is Clearview (CVW, $1.21), although Clearview also offers wealth management and distributes its life insurance via advisers.

Freedom listed in December 2016, having raised $15m at 35c apiece.

The company is well backed, with Thorney Investments, the Packer-linked Ellerston Capital, Bennelong Funds Management and (more recently) Forager Funds all gracing the register.

Freedom is a punt for those convinced a niche operator can make a decent fist of what the banks have ballsed up.

Data Exchange Network (DXN) 29c

The data centre entrant has a clear and bold aspiration to rival the size of its listed counterpart NextDC (NXT, $7.66) which bears an eye-watering $2.5 billion market capitalisation.

Actually, scrap that: its real ambition is to take on the $US32bn, Nasdaq listed Equinix, the world’s biggest data centre operator with more than 700 outlets.

While Data Exchange shares have surged more than 50 percent since listing on April 11, the Perth-based entity is still worth a modest $26m.

But CEO Peter Christie notes NextDC – which recently raised $280m in an aggressive expansionary push -- was valued at $20m when it listed in 2010 with a single leased building in Brisbane.

“The difference is we have an operating business with $5m of revenue.”

There’s no doubting data centres are a sexy sector – insomuch as rows and rows of whirring servers can be.

Locally the data storage sector turns over $5bn-plus a year, with growth is all but reassured because of the rise of cloud computing, ecommerce and data hogging ‘internet of things’ applications.

Despite common perception data centres are not high-tech themselves, but temperature controlled and secure repositories for computers rented and controlled by third parties.

In a sense, they’re high falutin’ self-storage facilities.

A crucial requirement is access to reliable power, because the servers collectively sap more electricity that a decent sized aluminium smelter.

Data Exchange’s approach is different to that of NextDC or Equinix, as it has no plans to acquire its own property.

By leasing rather than buying, the company can build smaller ‘modular’ facilities that can adapt to customer needs more quickly.

Still, Data Exchange’s core facilities will be its substantive outlets be in Sydney and Melbourne, with the company signing 20-year leases on two warehouses in Sydney’s Homebush and Port Melbourne.

These will be converted to collocated data centres at a cost of about $4.5m each (most of the company’s $16m IPO raising is earmarked for this purpose).

Christie says the company initially has targeted 200 ‘racks’ per facility, rising to 1000.

For the uninitiated, a rack is a cupboard of a standard size of 2.3 metres by one metre, housing about 40 servers.

Each rack attracts rent of about $2000 a month, which implies Data Exchange should chalk up $50m of annual revenue when the two sites are at full capacity.

Despite the cost of power – by far the biggest outgoing – Christie expects ebitda margins of 65%.

(In comparison, NextDC cites an 85% margin, although this excludes head office costs).

To date, Data Exchange has generated $4-5m of revenue a year from its ‘manufacturing’ business that builds data centres for third parties.

This business is already profitable and Christie expects the colocation business to break even after about eleven months.

In the longer term, Data Exchange is casting further afield, with its Singapore-based chairman Richard Carden scouring for partnerships in Asia.

Christie reckons countries such as Malaysia and Vietnam are ripe for the modular data centre approach because property trusts have overinvested in huge centres that are too big to fill.

Tim Boreham edits The New Criterion

tim.boreham@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

The New Criterion: The dental sector

Monday, May 21, 2018

This week The New Criterion drills down into the listed dental sector, which has just expanded by one-third with the listing of a new practice consolidator

Smiles Inclusive (SIL) $1.04

The unwritten law of the dental industry is that practice consolidators must incorporate “smiles” into their name, a catchy and upbeat reference to a visitation most clients associate with pain – hip pocket and otherwise.

But let’s face it, even medical professionals need to market their wares in the best possible light, especially when most of the population would rather hose out a putrid wheelie bin than front up for their annual check-up.

So smiles it is for Smiles Inclusive, which joined Pacific Smiles (PSQ, $1.70) and 1300 Smiles (ONT, $6.37) in the ASX ranks after raising $35m at $1 a pop.

Despite their homogenous monikers, we detect some differences in strategy and style between the trios.

1300 Smiles founder Daryl Holmes prides himself as a practising dentist who dons the drill one day a week.

“While that’s not everything, it certainly counts for something,” he says.

In contrast, Smiles Inclusive's Michael Timoney is an unashamed marketer, focused on getting bums on seats.

 “I position us as a sales and marketing company that does dentistry,” he says.

Trading as Totally Smiles, Smiles Inclusive has contracted to acquire 52 practices nationally and aims to have 100 under its banner within a year.

That’s all well and good, but with other consolidators in the market as well – and not just the listed ones – there’s a danger of overpaying.

In 1300 Smiles’ half-year report, Dr Holmes referred to other operators paying over-the-odds prices.

“When others are acquiring practices for silly amounts, we simply step back and let someone else do the buying.”

Timoney concurs the market has hardened in favour of the vendors. Smiles Inclusive is paying an average of five times earnings before interest and tax, which compares with 3-4 times when the company started amassing its portfolio.

Fancy cosmetic dental practices are changing hands on a multiple of seven times. For the time being, Smiles Inclusive is avoiding these “rock star” practices and focusing on drill-and-fill general dentistry.

 “With my CEO hat on I’m not prepared to pay any more, but five times earnings is a fair and reasonable price,” Timoney says.

Broadly speaking, the three companies tread the same path of acquiring practices from baby-boomer dentist getting a bit old in the, er… tooth.

But Smiles Inclusive’s business model differs from its peers, in that practice owners who sell to the company can continue to hold some equity through a joint venture vehicle.

These vendors continue to operate the practice, paying Smiles a service fee for the digs and support services. Through the JV vehicle they can share in some of the profits and eventual capital gains.

Smiles Inclusive has also resolved to stick to mainstream locations in metropolitan city locations.

Unlike Pacific Smiles it’s avoiding large shopping malls because he is not convinced customers want to combine a trip to the dentist with a grocery run to Woolies.

Unlike the others, Pacific Smiles has joined arms with the health insurers, with eight of its 75 clinics operating under the nib Dental Care banner.

The corporate dental model only makes sense if it can be more efficient than stand-alone locations, while retaining dentists at the same time.

Timoney’s productivity priority is to improve seat utilisation: of the 154 dental chairs being acquired, 61 are never used.

Sceptics of corporate dentistry argue the benefits are overblown because a dentist can only ever attend to one mouth at a time.

But Timoney argues every active seat improves economies of scale through shared reception and cheaper procurement.

According to research house IBIS, the dental market is worth $10 billion and revenues have been growing at 3 percent per annum.

As a non Medicare item, dentistry is mainly funded privately (or through private insurers) and is sensitive to economic conditions.

Despite the relentless march of the consolidators, dentistry remains a cottage industry: of the 7000 dental surgeries in Australia, the biggest owner (the health fund Bupa) accounts for only 6.5 per cent.

The real potential lies in persuading the 65 percent of adult Australians who don’t regularly visit a dentist.  Given the cost and discomfort involved, this cohort will wait until black and rotting teeth force them to drop by.

1300 Smiles paved the way with a $1 a day dental scheme to address the affordability issue. Smiles Inclusive is trying to persuade corporate employers to offer dental incentives to their staff, in the same way they might fund a $300 gym membership.

Despite growing investor acceptance of the dental roll-up model, the Smiles Inclusive listing was struck on an earnings multiple of ten times – half that of its two listed peers. That’s because the practice acquisitions are yet to be completed and the company does not have a performance track record.

Personally, Timoney has form in the industry, building up the Dental Partners chain before selling it to the New Zealand-listed Abano Healthcare Group.

(Abano changed Dental Partners operating name to Maven Partners, which shows that a smiley title may not be mandatory after all)

Smiles Inclusive’s $64m market valuation compares with the $153m ascribed to 1300 Smiles and Pacific Smiles’ $256m worth.

The Townsville based 1300 Smiles reported half-year net earnings of $3.9m, on patient revenue of $28m.

Pacific Smiles reported a $4.9m half-year profit, on patient fees of $80.7m

Smiles Inclusive forecasts a full-year profit of $5.8m.

While wary of ratcheting practice valuations, 1300 Smiles and Pacific Smiles haven’t been idle with the cheque book, either.

1300 Smiles recently acquired orthopaedic practices in Chatswood and Bathurst, as well as five conventional clinics (including one ironically located in the sugar centre of Ingham).

Pacific Smiles bought Everything Dentures and Sculpt Lab in November last year. Overall the group rolled out 12 new clinics in 2016-17 and expects to expand by another ten in the current financial year.

1300 Smiles and Pacific Smiles haven’t had everything go their way: for instance, the removal of the federal government’s $1bn and widely rorted Chronic Diseases Dental Scheme, which left a revenue hole even the best composite resin filling couldn’t plug.

But 1300 Smiles shares have gained 700 percent and Pacific Smiles stock have increased 30 percent, since listing in March 2005 and November 2014 respectively. 

Tim Boreham edits The New Criterion

Tim.boreham@independentresearch.com.au 

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

ENDS

 

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