I mentioned a couple of weeks ago that I would give an update on the valuations of the underlying assets of EGP once reporting season had passed. This week’s offering contains lots of numerical data, and may be more detailed than most might like, but I think it serves my fellow shareholders well to know how the outperformance has been generated, so that when I produce similar ‘valuation metric’ figures in the future, an educated assessment as to whether continued outperformance is likely to occur can be made.
Apart from two of our fifteen holdings that report out of sequence with the Australian financial year, I have updated the results using the second half of FY12 and the first half of FY13 as the ‘annual results’ (basically calendar 2012). Based on the updates, our holdings are valued as follows:
- Free Cash-Flow Yield of underlying assets: 14.6%
- Dividend Yield of underlying assets: 5.0%
- Price/Earning ratio of underlying assets: 8.1X
- Net Tangible Assets per $1 of Market Capitalisation: $0.93
- Return on Equity: 14.9%
- EV/EBITDA: 4.9X
- Weighted Average Market Capitalisation: $320.1m
- Net Interest Bearing Debt: -$15.4m
These figures are ‘weighted averages’, our largest holding makes up nearly 30% of our asset-base and our smallest less than 1.4%.
On all valuation metrics, we are better ‘value’ than the broader market. For ‘Free Cash-Flow’ I can find no formal assessment of the market average, though this piece makes the assertion that only ‘five industries can boast having a positive average free cash flow yield’, given that there are 14 sectors, if we extrapolate 5/14, it could indicate only about 35 or 40% have any free cash flow. My instinct tells me that the market average would be about 5% on FCF yield (I am happy to be guided to any research on the Australian market), which means we are almost 3 times higher (at 14.6%), or extremely cash rich in our holdings cash yielding power. It is prudent of me to note that our largest holding, which I have previously referred to as ‘stingy’ on the FCF metric generated a lot of cash this year (it is in a ‘lumpy’ industry) and on a more ‘normal’ result, our FCF yield might have looked more like 11 or 12%, which is still well better than market averages. Our ‘weakest’ performer on this metric yields 4.6% and our ‘strongest’ yields 29.9%. These figures could be misleading the ‘weakling’ is a turnaround stock in a cyclical upswing with a de-leveraging balance sheet, where ‘free-cash’ will (in my expectation/projection) increase substantially in coming years. The ‘strongest’ stock on the FCF metric is in the opposite situation, as a ‘mining services’ stock, as the cyclic downswing gathers pace over the next couple of years, the 29.9% yield is generated by the fact this company is spending only 30.3% of its (very large) depreciation charge on new CAPEX. So it is preparing for the downswing by substantially reducing its operating leverage. I point these differences out to demonstrate (like all valuation metrics) caution must be used.
Our dividend yield is 5%, despite 5 of our 15 holdings not paying dividends, our two highest pay 12.9% and 8.5%. According to Thompson Reuters FTSE world indices (taken from Australian Financial Review on Thursday 28 February 2013), the dividend yield of the Australian market is 4.23%. It is on this metric our portfolio is ‘closest’ to the market, our holdings yield ‘only’ 18.2% more (5/4.23) in dividends based on the trailing 12 months results.
On price to earnings (P/E) ratios, our holdings are meaningfully cheaper than the market. Our weighted average P/E ratio is 8.1X, depending on where you source your data from, the ASX200 is about 14.5X, this may fall slightly when earnings season updates are adjusted, though with BHP & RIO, which make up a big portion of the market both posting big first-half declines, perhaps not. An 8.1X P/E indicates an earnings yield of over 12%, which is pretty close to what I described as our ‘normalised’ FCF yield of 12%, this means we don’t own ‘capital intensive’ businesses and most of the profits are in the form of genuine ‘cash-flow’, which is something too many investors overlook. Our holding with the lowest P/E is 4.9X and the highest is 18.8X, P/E is a very good starting point when examining for value, but there are many low P/E companies that are not ‘cheap’ any many higher P/E companies that are not ‘expensive’. I should mention, based on a combination of my forecasts (mostly) and consensus forecasts (rarely), I expect 15 – 23% earnings growth in calendar 2013, so whereas our holdings are currently earning 12.3 cents per $1 of market capitalisation, the mid-point of my forecast calendar 2013 earnings is about 14.7c (assuming static prices). This does not mean we can expect 19% growth in EGP’s share-price between now and this point next year. However, if my earnings forecasts are correct, and current P/E ratios remain steady, that would be the result. It is virtually certain to be either much lower or possibly even higher, depending on the prevailing market sentiment and the particular sentiment toward our holdings.
I included the NTA per $1 of market capitalisation ratio to indicate the substantial ‘tangible’ asset backing of our portfolio. Again, it is hard to make an assessment of the ‘market’ figure on this metric, but I reckon based on some research I’ve conducted that within the Australian ‘industrial’ (that is excluding miners) market, the average is about 53c per $1 of market capitalisation. EGP’s weighted average holdings are covered by 91c in NTA. We have a few ‘asset-plays’ within the portfolio, where (in my view) substantial undervaluation of NTA exists, for example land held on books at nearly 20 year old valuations or recent sales of comparable assets within the same firm at meaningful premiums to current book value. Our ‘best’ stock on this ratio owns $2.27 of tangible assets for every $1 of market capitalisation. However, one of our firms has negative 90c of NTA per $1 of market capitalisation, so again it is an imperfect metric in some circumstances.
ROE for the EGP portfolio is 14.9%. Once again, I couldn’t find satisfactory data on the Australian market average but according to a January study by NYU, across 6177 US firms, ROE averaged 12.9%, I would hazard the Australian market average would be just below that currently, perhaps 11 or 12%. Our highest ROE stock has 44.6% ROE, our lowest 2.6%. ROE is actually my least favourite valuation technique, because the important things, which are mostly overlooked when examining ROE are firstly, the price YOU will be paying for the equity. Secondly, what matters most of all is how well the equity will be able to be employed in future. Current ROE levels help little when considering those two factors.
Our final valuation metric is EV/EBITDA, where the EGP weighted average is 4.9X. Based on Merrill Lynch Institutional Factor Surveys for ‘deals’ conducted from 1989 to 2006, Australian Market average EV/EBITDA was 8.5X, assume because this is for ‘deals’ that a premium was paid, I would say 7X to 7.5X would be a suitable normal average (if a little conservative). Given we tend to the smaller end of the market, where multiples are smaller, even if we used 6.5X as a target for ‘fair’ valuation, current prices would need to rise by about 30+% to match this conservative level. The lowest EV/EBITDA multiple in our portfolio is 3.2X and the highest is 9.7X, again this valuation methodology is a useful contributor, but many other factors need also be considered.
Finally, I included our weighted average market capitalisation and debt levels. Our market capitalisation averages $320.1m, our $320m company on average holds $18m in net-cash on balance sheet. This means on (weighted) average, not only do our stocks have ZERO debt, they hold a substantial cash balance, averaging over 5% of market capitalisation. Six of our fifteen holdings have net debt on balance sheet, but the other 9 are either neutral or cash-heavy. Our average market capitalisation back in September 2011 was $220m; the increase reflects a combination of an increase in the underlying value of our investments and a slight increase in larger and more liquid holdings as our investor base widens to mitigate the risk created should a sudden outflow of funds occur.
In closing (this post turned into a long one…) our holdings are no longer as heinously mispriced as they have been in the past (the September 2011 post linked above mentioned a weighted average P/E of 4.4X). However, there is still demonstrable undervaluation based on the valuation metrics listed above, as such, I expect we can continue to outperform, though it is possible the level of overall outperformance could shrink.
In Update No. 78 I said ‘I believe our holdings as a group are every bit as undervalued as they have been at any point in our existence relative to the market.’ Their value has risen 22.9% since then (in 161 days) this equates to an annualised 59.6% change in valuation, clearly the underlying businesses have not improved at that rate. I still believe our holdings are undervalued, but not by nearly so much as they were 161 days ago. I point this fact out to keep fellow holders realistic – Tony Hansen 01/03/13
P.S. The annual Berkshire Hathaway shareholder letter for 2012 will be available here from about 9am AEST tomorrow Saturday 02/03/2013, and if history is any guide will be extremely useful for investment-minded folk .
|
|
Apr 1st 2011 |
Jan 1st 2013 |
Current Price |
Current Period |
Since Inception |
|
EGP Fund No. 1 |
1.00000 |
1.21730 |
1.41637 |
16.35% |
41.64% |
|
35632.05 |
37134.53 |
40932.09 |
10.23% |
14.87% |
EGP Fund No. 1 Pty Ltd. Up by 16.35%, leading the benchmark by 6.12% since January 1st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 41.64%, leading the benchmark by 26.77% all-time (April 1st 2011).
