Update No. 48 – 24/02/12

Our advantage over the benchmark disappeared this week when it took off for a run, but our stocks stayed static.  Our final four stocks report this week, so I’m hoping for a significant move, but time will tell…

I promised last week to go into some more detail about the first disposal we have ever made in EGP Fund No. 1 Pty Ltd.  The stock we have (partially) disposed of was Maxitrans Industries (MXI).  When the fund kicked off, I put 7.1% of our assets into MXI, this was the first big mistake I made with EGP Fund No. 1 Pty Ltd.  My analysis had thrown up 14 companies I liked and at the time, MXI ranked 2^nd with my intrinsic valuation indicating a potential/theoretical per annum gain over the ensuing 10 years of 21.41% (see workings below). Based on this it should have been my 2^nd largest holding, perhaps as much as 20%.

My partner at the time was very nervous about this stock; it was his least favourite of the 8 we decided initially to hold, we set it as our 6^th largest holding.  Now that he has moved on and I am solely responsible for the asset allocation, I will hopefully not make this mistake again in a hurry.  MXI shares grew to over 12.5% of our portfolio, and I have only disposed of about 1/8 of our holding, so I guess I am implicitly letting you in on what about 10% of your funds are invested in, though there’s no guarantees I won’t do more selling (though only if prices rise further, or something else becomes compellingly cheaper).

So you get a clearer idea about how I think when buying, I will share my notes with you, I subscribe to the policy that if you can’t fit your investment basis on less than half a page, then the investment is too tricky, believe me when I say I knew a lot more about the business than is apparent in the following 200 words:

MXI. Maxitrans Industries – At $0.235, Market Cap = $42.5m.  MXI own a lot of Semi-Trailer truck body names you’ve heard of, Hamelex White tippers, PEKI refrigerated units, Freighter & Maxi-Cube trailers.  Their performance has been poor over the last couple of years as transport companies deferred CAPEX in an effort to preserve cash through the GFC.  I believe these deferred orders will lead to increased demand over the next few years.  Australia is a massive country with a poor rail network, trucks are the viable alternative.  I have tried hard to make a bear case for MXI with no success, the expansion through New Zealand and the new facilities in China are the key risks.  They are consolidating, selling & leasing back their properties to reduce debt (debt should be less than $12m by end 2011 & D/E will be less than 15%.  I conservatively forecast 65c EPS over the coming 10 years (they earned 45.1c over the last 10).  I expect they will continue to pay about 2/3 of earnings as dividends (43.5c over 10 years), my terminal EPS of 10cps in 2021 and an assumed P/E of 12 means terminal value is $1.635/$0.235^^-10 = 21.41% annualised.

You need to think about the purpose of the above, a basic picture of where the business was headed based on my analysis, nothing more.  I knew much more about the business than that, but that briefly put on paper why I wanted to own it.  There are shortcuts in the valuation (such as lumping all dividends into the terminal year and ignoring Franking Credits), but the idea is a broadbrush one.  I was particularly impressed by the growth in their parts and service business (this has massively exceeded my fairly high expectations), and viewed this area with outstanding potential, this and the lowered manufacturing cost-base were where I pinned most hopes for future EPS growth.  Further to that, the management are frank, which I like, when things are hard they say they’re hard (and importantly make no excuses), they are if anything overly conservative (with write-downs etc in tough times), and even when the statutory profits were down, cash-flow still hosed in.  Believe it or not, they are also extraordinarily innovative too, virtually every year some innovation which significantly improves the productivity of their offerings is developed.

Based on the half year results, which you should take time to familiarise yourself with, I was probably too early in selling.  Debt was half my expectation and net debt was much lower than I’d expected by end 2011, this company really does spew cash for a company of its tiny market capitalisation. The company declared an interim (Fully Franked) dividend of 2c and it’s hard to imagine the final dividend won’t be about 3c, if that’s the case, the grossed up yield at our 23.5c purchase price (see below) will be about 30%.  The trailing 12-months NPAT exceeds $9.5m, meaning P/E is still unusually low, less than 10x.  It is pretty hard not to imagine MXI trading somewhere closer to 60c over the next 12 months (though you never can tell what the market might do…).  To display my conservatism, you will from above see I forecast ONLY 65c EPS over the next 10 years in the above investment case, you will have also noticed FY2012 first half EPS were 3.27c, which if only maintained for the next 9.5 years would more than cover the 65c (65.4c) I targeted, I am very conservative in my calculations of IV and future earnings.

We purchased MXI at 23.5 cents per share on average, over the next few months, they traded down as low as 18c, so I could have done much better (but we don’t have a crystal ball!).  We sold our first parcel at 47.5 cents, if you look at the trading on 8 February, you will see 73 shares crossed at 47.5c (the 12-month high – at the time), from that price, I chased the market down until I had unloaded the 1/8 of our holding I wished to free up at those prices.  Does this mean I no longer think MXI a good investment?  Simple answer is NO, or 10% of our assets would not still be resting there.  The fact is though, even though my intrinsic value has risen (though not nearly as quickly as SP), the implied 21.4% growth I figured on last year by 2021 has shrunk considerably, MXI was second best of my top 14, has now slid down the list, far enough that it has started to make economic sense to replace it with greater potential stocks.  Assuming my 2021 valuation of $1.635 has not changed (it has), potential growth is now 15.41%, so fully 6% per annum of potential growth has disappeared (assuming static IV).  Whereas I had viewed MXI as selling for well less than half its intrinsic value, it is now within striking distance of IV with another good run.  My basic premise in switching some of our MXI into other holdings is simply a relative value one, if I am right, the stock I am replacing MXI with will have grown in price at a greater clip over the next few years than MXI will have.

There were 14 stocks on the inaugural ‘Investment Cases’, I will revisit another one in the next couple of weeks which we chose not to invest in.  I will discuss the merits of that decision – Tony Hansen 24/02/12.

EGP Fund No. 1 Pty Ltd. Up by 3.87%, lagging the benchmark by 2.98% since January 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Down by 0.01%, leading the benchmark by 7.39% all-time (April 1^st 2011).