Update No. 263 – 15/04/16

This week’s movement could well be described as the rally EGP forgot.

The market was up sharply this week, over 4%, we rarely keep pace with such violent upward movements, this week was no exception, and in fact a number of our larger holdings have been quite weak over the last couple of weeks. We were up more than 1%, but as always our best work is done in the down weeks.

Fortunately, we have a couple of holdings really shooting the lights out lately. One is Service Stream (SSM), which I last mentioned in our December Letter (.pdf). At the time it was trading at 46.5c per share. Today it trades at 73cps. A 57% rise in the price of a share (we’ve enjoyed a dividend along the way too) that operates in a relatively staid industry in the first 3.5 months of the year should be a reminder to us all that the market might be a lot of things, but ‘efficient’ is not one of them.

Since December 31^st, SSM has announced only one modest contract win and a set of results which I doubt were meaningfully different to the expectations of anyone that followed the stock closely.

It serves as a subtle reminder of three things for me in my job as your asset allocator. The first one is that sentiment matters very much. Make no mistake; it is sentiment driving the price at present. If the half-year result is annualised, SSM will earn $17.6m of NPAT in FY16 (I actually think they will do a little better than that). At 75c, the business is capitalised at about $286m, if the cash held on balance sheet at last report date is removed, enterprise value is roughly $250m, so it trades at an EV/E of a shade over 14x at 75c. The multiple is still relatively undemanding, but if I’m honest, it is currently trading a shade above the midpoint of what I think is fair value for a business with relatively lean margins. Despite this, the industry has tailwinds and I suspect the intrinsic valuation is rising and will probably rise for a while yet. At least some SSM would be sold if a really good idea came along and I needed cash, but at this point, we will continue to hold.

The second lesson I had an unwanted reminder of is to buy aggressively when the story is playing out as you expect. On no less than 3 occasions, I have placed bids for SSM since acquiring our initial stake in November 2014. Usually the bid was at a modest discount to the last traded price, hoping to ‘buy the dip’. But when sentiment turns for a business, there are sometimes no decent dips… My every bid has acted as a repellent for the SSM share price. Given my history, if I were to bid 72.5c for some more stock on Monday morning, I could probably have the stock at 80c by the end of next week… Our IRR since purchasing SSM has been over 180% annually, the failure to add to it along the way has been the type of very costly mistake you often forget to consider when measuring your portfolio returns. Rather than kicking oneself too hard, it is also important to remember undervaluation is much easier to identify in hindsight.

The third is the value of relatively concentrated positions when you get the analysis right. We put almost exactly 2% of your funds into SSM in November 2014, making it only our 14^th largest holding at the time and despite a couple of failed attempts since, have never acquired another share. Despite very substantial investment inflows into EGP and the generally strong performance of the other holdings over the period we’ve owned SSM, it has grown into our 6^th largest holding and is now 3.84% of our stock portfolio. It has been an important contributor to our performance over the 500-some days we have owned the business. A holding that more than quadruples in a relatively short period is always helpful for returns, but this situation remains one where if I am to pat myself on the back for a job well done, I need to simultaneously kick myself in the butt for a missed opportunity. The position should definitely have been enlarged at some point – Tony Hansen 15/04/2016

EGP Fund No. 1 Pty Ltd. Up by 8.02%, leading the benchmark by 8.30% since July 1^st 2015. Since inception, EGP Fund No. 1 Pty Ltd is Up by 100.57%, leading the benchmark by 64.55% all-time (April 1^st 2011).

^{*1 after a 31 May 2013 dividend of 2.333 cents per share (cps) plus 1.000 cps Franking Credit, a 31 May 2014 Dividend of 7.000 cps plus 3.000 cps Franking Credit and a 31 May 2015 Dividend of 8.6667 cps plus 3.7143 cps Franking Credit}

^{*2 calculated based on dividends reinvested}