Update No. 129 – 08/09/13

The fund finished at its sixth consecutive record weekly high this week. But the beard survives to grow for another week at least…

I had a very good response to the last mention of a stock we hold, a huge amount of correspondence with people asking questions and giving interesting feedback.

With a view to that and given it is trading within shouting distance of fair value, I thought I might give a little background to another of our holdings. The holding is Dicker Data (ticker-DDR), a stock we’ve held for nearly 18 months and which has been responsible for a meaningful proportion of our returns over the period of ownership. This post is not an in-depth look at valuation, but rather my take on how to think about the business. Interestingly, the stock breached one of my self-imposed criteria. I prefer a stock which has at least a 7-year listed history (the rigour of analytic and business challenges over such a period giving me greater confidence in the accounts and in the business generally), Dicker did not have that when I invested your money in it, but sometimes the business metrics are so good, they can’t be ignored, our average buy price was near enough to 40c, so with the stock mostly trading at around 90c currently and given we’ve received about 10c in dividends since owning it, I am pretty pleased to have made the exception in this case. Dicker is the type of opportunity that will only exist in this early part of EGP’s history, because given the small size, limited free-float (founders still own about 95%) and thinly traded nature, if we were 10x our current size, we would have struggled to get a sufficiently large position to make a reasonable impact on our results, as it is we are the 9th largest holder of the stock.

I suspect a lot of investors would be looking at the negative operating cashflows from Dicker over the last two years and wondering about the veracity of their profitability.

Over the last two years, the negative cash from operations can be primarily attributed to massive warehouse expansion requiring expenditure on P & E which will substantially drop-off from the over $3.7m in FY13 to something more like $1m per annum in future years.

The warehouse needed to be filled also, so other major hit to cashflow was in the working capital. The newly acquired borrowings have been used (I understand) to get early payment discounts on inventory, which has helped to achieve higher margins.

I suspect a lot of people in the investment community have missed the substantial improvement in the second half of FY13 attributable in part to the extra warehouse space and in part to the access to the whole HP range. H2 revenue was up about 1.5%, $237.73m against $234.16m, but with the focus on higher margin goods and the use of the credit lines to obtain vendor discounts, H2 NPBT was up nearly 21.5% from 7.036m to 8.547m.

In order to properly see what is happening in the business, I think you are best served by taking NPBT margin (NPBT/Revenue) map it by halves:

H1FY11 – 1.10% (after stripping P&E impairment)

H2FY11 – 3.18%

H1FY12 – 2.36%

H2FY12 – 3.00%

H1FY13 – 2.20%

H2FY13 – 3.60%

There is a very clear upward trend with first half margin being leaner than second half, annually, it looks a little cleaner:

FY11 – 2.61% (after stripping impairment/listing costs)

FY12 – 2.69% &

FY13 – 2.94%

So clearly, through a combination of scale and product mix, Dicker has been able to grow NPBT margins, despite the challenging consumer/business/retail environs of late.

I believe there is a better than average possibility of between 4 & 8% revenue growth in FY14, with the doubled warehouse capacity operating for the full period along with the broader range and some confidence returning post-election.

However, for conservatism, I will assume first half (2014) revenues of around $222m and second half revenues of $238m. If we assume the H2FY13 NPBT margin of 3.6% moderates through FY2014 to a level more like 3%, then the NPBT for FY2014 would be something in the order of $13.8m or a 4.1% increase on FY13, I consider this a fair ‘base’ expectation.

In a scenario where 8% growth in revenues occurred the majority of the margin gain from the second half of FY13 was ‘sticky’, perhaps leading to a FY14 NPBT margin of 3.2%, then the result of that (not wildly optimistic in my view) scenario NPBT of about $15.6m could be derived off revenues of about $487.7m. Any business trading at a multiple of about 12.3x where a 17.7% rise in NPBT is a realistic prospect is pretty cheap.

Furthermore, David Dicker is a very bright operator, who still owns 50% of the business, and his ex-wife is on the board holding most of the remainder, so the likelihood of any really foolish decisions should be mitigated by self-interest. Most of our holdings have a meaningful insider ownership for just this reason.

I would prefer a sharper focus on working capital & a reduction in debt levels given the choice. But this is a CEO with a very clear view of where his business is going, look at this interview (3 years ago) and tell me you’re not impressed with how he forced his need for HP’s full range to come to fruition (they announced the deal for full access only in June this year):

“The other low point is the fact he can’t get his hands on the IPG (Imaging and Printing Group) part of the HP business – it’s the only missing piece of the puzzle, Dicker said.

“To be honest, I get the feeling we might finally be in a position where it’s possible to get it. I think it’s insane we don’t have it when you look at our performance on PSG and server,” he said. “The fact we don’t have it just doesn’t make any logical sense. I don’t really see how anyone could argue against us having it.”

His understanding of the value-drivers in his industry is outstanding:

“To be honest, it’s still the same basic methods – product knowledge is the key, doing what you say you are going to do is the key. I’ve never been a big fan of this whole value added thing. I mean it’s a mirage really. Look, we’re a volume distributor, that’s what we do. Someone has got to do it, and we do it better than anyone else, in my opinion.”

It is not a moat business in my view. I believe given $115m (the current DDR market cap) I could probably build a business that would compete with Dicker. The protection is the nature of the business, volume-distribution, ‘box-shifting’ is ‘unsexy’, and the likelihood of someone trying to force their way into the industry is quite remote. You would watch for such an eventuality through margin and volume decline and by monitoring the industry closely.

I may be wrong, but I would hazard the cashflows for FY14 will properly resemble a business achieving the profitability levels that Dicker is, with a tight focus on making the working capital, cash-flows exceeding the profit are also possible.

At 90c per share, you are being paid a grossed up 9.92% (based on maintenance of the 6.25cps FF dividend) to hold a company which appears to be a pretty good prospect of double digit EPS growth.

Furthermore, both Harvey Norman and JB HiFi reported the declines in the prices of electronic goods over the last few years have stopped and some have started rising. In the same way as a retailer clips margins on sales turnover, the prospect of higher prices will probably lead to higher revenues upon which to clip the margin for Dicker all else constant. A weaker AU$ will also increase the retail price of imported electronics, so you’re starting to get several factors potentially all operating in your favour.

The ASX200 is currently forecast to grow earnings by about 12% in FY2014, and trades on a TTM P/E of a little over 15x. The grossed up dividend yield of the ASX200 is about 5.46% (about 4.2% franked at about 70%). Obviously in comparing Dicker with the ASX200, the comparison is favourable.

Comparing favourably to the market doesn’t mean it’s a good buy, but the undemanding metrics, combined with a CEO with a very clear vision for his business, and a historically strong growth mean I am happy wait to see what further improvements the Dicker Data business can generate at current pricing levels.

My view on valuation based mostly on a DCF modelling is that the mid-point of my range of valuations is about $1.13. Meaning it is around 20% undervalued (in my estimation). I seek to buy when I see a business trading at least 50% below my estimate of fair value, meaning I would probably not be a buyer until nearer to 60c. At that price, I would get the pencil out and try to figure whether/when I should start buying again.

When I tell people that I’m trying to buy stocks at half of their true economic value, they mostly disbelieve it is possible. When I started buying Dicker in the high 30c range, I was pretty confident the business at that point was worth at least 80 or 90c per share. With hindsight, I think I was about on the mark (I am often not, which is why I go for such a wide margin-of-safety). The intrinsic business value has in my view increased by around 30% over the intervening year and a half, but the quoted price has more than doubled, while big chunks of dividends were being returned. It is possible to buy at half price, you just need to be ready when opportunity presents – Tony Hansen 08/09/13


Apr 1st 2011

Jul 1st 2013

Current Price

Current Period

Since Inception

EGP Fund No. 1












EGP Fund No. 1 Pty Ltd. Up by 11.78%, leading the benchmark by 3.34% since July 1st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 52.66%, leading the benchmark by 33.48% all-time (April 1st 2011).

*1 after 31May 2013 dividend of 2.333 cents per share plus 1 cent per share Franking Credit

*2 calculated based on dividends reinvested