Update No. 19 – 07/08/11

Some investors in shares at the moment could be forgiven for feeling like Rodney Dangerfield when he said “My luck is so bad that if I bought a cemetery, people would stop dying”.

If your horizon is a couple of years out or more, I really believe you need not panic.  In fact for holders in EGP No. 1 Pty Ltd, it appears very likely that October will see a large holding, which represent a sizable portion of our (currently) small assets returned to us at a price 16.66% above current trading price.  Should the deal close, I will talk more about it then, but between now & then, you should pray for further declines, so I can deploy the incoming cash at advantageous prices.

Reporting Season:

NVT, Navitas is an education provider; they have reported profit up 20.5%, off revenues up by 15.6%.  These are the figures you’d have seen if you read the financial press coverage.  One area it always staggers me the financial press fail to focus on is the growth in earnings per share (EPS).  If a company I own doubles its profit, but at the same time doubles its shares on issue, the profit growth is essentially useless to the shareholder, yet the financial pages will trumpet “Company X doubles profits”.  Its EPS I care about, all else equal, if the EPS rises, the share-price rises.

I should say, EPS and the competitive strength of the business.  I will accept growth in profit, for example by acquisition, not reflected in EPS as long as I can see a compelling benefit to the business (that is to say, future EPS will benefit, so really it still comes down to EPS)

So, having had my little rant about EPS, I should point out, NVT grew their EPS by a quite impressive 15%, so the majority of profit growth was reflected in EPS.  NVT made a major acquisition, for which it paid predominantly in cash, taking it from a net cash position to a net debt position of $102.8m, which is about as heavy a debt-load for a company of their size as I’d tolerate.

I actually think the result is pretty impressive given an enormous variety of headwinds the company faced.  The most important, I think is the strong AU$.  This hurts NVT in two ways, with a good chunk of their earning coming off-shore, and also with the impact on international students, who when faced with a particularly strong currency are likely to choose alternative countries for their education.  There were also some issues around the issue of international student visas.

All in all, a pretty good result for Navitas, if a few factors turn in their favour, the 12% per year analysts are forecasting EPS to grow over the next 2 years could be conservative.  In any case, in my view, they are neither cheap nor expensive at present, my reviewed intrinsic value (IV) is virtually unchanged at $3.73, and doesn’t have me clamouringfor my wallet, given their SP is currently very near that.

The other result this week most likely to be of interest to regular readers is Rio Tinto (RIO).  RIO is a member of the EGP20, and I thought the result was very commendable.  RIO are in the fortunate position of being in the many of the best commodities, with extraordinary capacity in, for example iron ore when demand is very strong and supply is not expected to catch up for some time.  RIO’s result gives a good opportunity to draw attention to the use of EBITDA (Earnings Before Interest, Taxation, Depreciation & Amortisation) in reporting.  For some CEO’s, EBITDA is trumpeted loudly and often, but it is again, EPS that matters.  For an example here, if a company were to earn an extra $1b in a jurisdiction with a 40% corporate tax rate, it would not have as much value to shareholders as the same $1b earned in a jurisdiction with a 15% tax rate, in fact, the EBITDA earned in the latter jurisdiction would have about 41.66% more value to shareholders, so use the metric with care.

I don’t say this with particular reference to RIO, in my view; their reporting gives a good balance between the important metrics, cash-flow, EPS, EBITDA & net-earnings.  US$8.185 per share is what RIO has generated in the last full 12 months.  Using an AU$1.07 exchange rate, this equates to AU$7.65 in after-tax earnings.  RIO are trading at the close of the ASX this week at $72.00 (down 10% in a week, ouch… sometimes size doesn’t matter), which puts them on a P/E multiple of about 9.4x (trailing 12 months).  RIO trades generally at a discount to the market, over the last 7 years, the average P/E has been about 11.3x (this tells you they are 16% under their historic valuation, which would be $86.45).  There is understandable concern that many commodity prices are likely to decline over the medium term, in my view RIO’s growth in output should more than compensate, barring a particularly savage fall.  Come 2015, I would hazard they will be reporting EPS a good deal higher than AU$7.65, that being the case, I view them as pretty cheap.  My current estimate of IV is $103.75, which for one of 10 biggest companies (on the ASX) is a handsome discount (there are still far better alternative listed investments in my view, so none of our capital will be heading their way)

To me, the most fascinating thing in the RIO results package was a graph explaining the seemingly logarithmic growth in steel used in taller buildings, on a KG/M2 basis.  It showed that an 8 storeyor smaller building can be built using as little as 5kg/m2, whereas buildings over 100 storeyshigh require as much as 220kg/m2.  Estimates indicate that over the next 15 years, an additional 300 million Chinese will urbanise(move to cities), that’ll require a lot of very tall buildings and a mind-blowing amount of coal & iron ore.

Performance Table:
  April 1 2011 July 1 2011 Current Price Current Period Since Inception
EGP Fund No. 1 1.00000 1.08396 1.07596 (0.74%) 7.6%
S&PASX200TR 35632.05 34200.68 30472.60 (10.91%) (14.48%)
EGP20 1000.00 883.67 777.39 (12.03%) (22.26%)

EGP Fund No. 1 Pty Ltd. Down by 0.74%, leading the benchmark by 10.17% since July 1st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 7.60%, leading the benchmark by 22.08% all-time (April 1st2011).  It is probably a cold comfort to those who joined us on 1 July, that we’ve ‘only’ had our assets decline in value by 0.74%, but I maintain that if we can beat the market when it plunges and keep pace with it when it rises, our long-term results will be satisfactory.

EGP 20.  The EGP20 index is Down by 12.03%, lagging the benchmark by 1.12% since July 1st.  Since inception the EGP20 is Down by 22.26%, lagging the benchmark by 7.78% all-time (since April 1st2011).

S&PASX200TR  The benchmark index is Down by 10.91% since July 1st. The benchmark is Down 14.48% all-time (since April 1st2011).