9 thoughts on “Update No. 319 – as at COB 31/01/19”
ed says:
LPE may (or may not) be a great opportunity, but I think you are too kind to management. Market clearly had little idea on the sensitivity to wholesale prices. The announcement was not proofread reading to the need for the subsequent correction. Overall a little shambolic. Commend you for educating them – they have quite a way to go.
Lee says:
Hi Tony,
I don’t know much about the history of the company but in your view is this management inexperience or incompetence or a combination of both?
I think it’s inexperience. The managers have demonstrated operational competence in spades, they’ve built a serious business from scratch with only a sliver of capital in a few years.
Where they have clearly fallen down to date is on communication. The downgrade is (in our view) not nearly as bad as it seems on the surface. The drop off in pricing caused around $2m in revenues to disappear by my estimates. The cash crunch they faced due to the delay of finalising the Black Rock facility caused them to push back conversions of embedded sites and defer conversions of large DMC sites (due to the prudential capital that must be set aside).
People are also overlooking the fact (and management hasn’t explained it) that a reversal in pricing in the financial year to date will likely flow on for the rest of the year. It’s a perfectly legitimate reason their forecast revenues will reduce, and as they have said, the higher margins they’re managing to extract mean that NPAT will not be impacted nearly as much as revenue – Tony
Simon says:
Hi Tony,
After reviewing the aer website it seems to me that pricing in qld over the past quarter would probably have dropped 5-10% on average. That seems a small amount to account for such a radical cull to revenue guidance. Also I find it hard to believe ‘the typo’… I’m sure it was pointed out that a 2-3% margin increase wouldn’t completely compensate for the reduced revenue. So not only are their forecasts poor, they are in my opinion not completely upfront either.
Having said that as their operational competence and track record is excellent and given the valuation I’m inclined to turn a blind eye and have started re buying the shares last week.
What do you make of the revenue impact from the aer rates vs on boarding delays or other factors? Look forward to them clarifying some of this information soon.
I agree, I think it’s a little over 10%, plus a little more for the network component, where I think the fall was over 40%. These two elements account for a roughly 15-20% undershoot of the expected cashflow. With management also putting the brakes on because they didn’t have the cash required to maintain their rates of conversion, I think the case can comfortably be made thet the cashflow number would have been closer to the $9m+ required to maitain their previous forecast revenue trajectory.
As I said in a previous comment, the wholesale & network price falls (and the slow down in Q2 conversions) must now be projected all through the second half too, making the previous revenues way off base. If they can resume and accelerate the previous trajectory with the BlackRock facility now in place, the return to the trend line could be much more swift than the market will project – Tony
Simon says:
Thanks Tony. Yep I certainly didn’t expect a 40+% network cost decrease. The release today was much better, good proof reading! (Just kidding).
Christian Toime says:
Thanks for the update. Finally got around to reading January report properly (been in Portugal, highly recommend it for a holiday, extremely good value). I actually picked up the Richest Man in Babylon last year at a school fete (so didn’t overpay !). A nice little book indeed. Money saving tip from me: 1) Ride to work 2) Make your own lunch !
Daniel says:
Hi Tony,
I’ve enjoyed reading your thoughts on matters related to your investments through EGP, namely removing depreciation from household budgets, etc. In that vein, I was wondering if you’d mind sharing your process on two issues which attract so little publication: when to sell and portfolio construction. Firstly, much is written about when to buy stocks, and much of your writing is about you thoughts about this; however, I’d like to hear about your criteria about when to sell. Secondly, as value investors we typically don’t use modern portfolio theory to determine the sizes of our portfolios. What do you use? I seem to recall somewhere you talking about looking at the downside price risk before taking a position which I understand – but I can’t seem to find it now. How do you construct your portfolio weightings? And how do you manage them?
Perhaps you could offer a worked example such as a universe that consisted solely of two possible assets – KPT and UOS?
Hello Daniel, I explain to our investors that we are looking for a hurdle IRR when we invest, call it X%. In a universe with two opportunities, the allocation would depend much on the expected returns.
Assume for example, the IRR for one (UOS) is X+3% and for the other (KPT) is X+7%. We could reasonably expect to allocate more to KPT than to UOS in this situation.
There is another factor however, which is the confidence ranges for these outcomes. Assume X=15%, then assume our range of expectations (say an 80% confidence interval) is 10% to 26%. Assume our confidence interval for KPT is (-12%) to 52%.
Despite the midpoint being 4% higher for KPT, the range is much higher. In 100 simulations of this outcome, we would be better off allocating a larger proportion of our portfolio to KPT. In the above situation, we would have a larger allocation to UOS than to KPT because the downside is much lower.
Obviously, this implies a level of mathematical precision that cannot be achieved in real life asset allocation, but we must have some basis on which to make our allocation decisions.
As to selling, it involves setting a minimum hurdle for the expected return from the capital below which you are not willing to remain invested in the business – Tony
LPE may (or may not) be a great opportunity, but I think you are too kind to management. Market clearly had little idea on the sensitivity to wholesale prices. The announcement was not proofread reading to the need for the subsequent correction. Overall a little shambolic. Commend you for educating them – they have quite a way to go.
Hi Tony,
I don’t know much about the history of the company but in your view is this management inexperience or incompetence or a combination of both?
I think it’s inexperience. The managers have demonstrated operational competence in spades, they’ve built a serious business from scratch with only a sliver of capital in a few years.
Where they have clearly fallen down to date is on communication. The downgrade is (in our view) not nearly as bad as it seems on the surface. The drop off in pricing caused around $2m in revenues to disappear by my estimates. The cash crunch they faced due to the delay of finalising the Black Rock facility caused them to push back conversions of embedded sites and defer conversions of large DMC sites (due to the prudential capital that must be set aside).
People are also overlooking the fact (and management hasn’t explained it) that a reversal in pricing in the financial year to date will likely flow on for the rest of the year. It’s a perfectly legitimate reason their forecast revenues will reduce, and as they have said, the higher margins they’re managing to extract mean that NPAT will not be impacted nearly as much as revenue – Tony
Hi Tony,
After reviewing the aer website it seems to me that pricing in qld over the past quarter would probably have dropped 5-10% on average. That seems a small amount to account for such a radical cull to revenue guidance. Also I find it hard to believe ‘the typo’… I’m sure it was pointed out that a 2-3% margin increase wouldn’t completely compensate for the reduced revenue. So not only are their forecasts poor, they are in my opinion not completely upfront either.
Having said that as their operational competence and track record is excellent and given the valuation I’m inclined to turn a blind eye and have started re buying the shares last week.
What do you make of the revenue impact from the aer rates vs on boarding delays or other factors? Look forward to them clarifying some of this information soon.
I agree, I think it’s a little over 10%, plus a little more for the network component, where I think the fall was over 40%. These two elements account for a roughly 15-20% undershoot of the expected cashflow. With management also putting the brakes on because they didn’t have the cash required to maintain their rates of conversion, I think the case can comfortably be made thet the cashflow number would have been closer to the $9m+ required to maitain their previous forecast revenue trajectory.
As I said in a previous comment, the wholesale & network price falls (and the slow down in Q2 conversions) must now be projected all through the second half too, making the previous revenues way off base. If they can resume and accelerate the previous trajectory with the BlackRock facility now in place, the return to the trend line could be much more swift than the market will project – Tony
Thanks Tony. Yep I certainly didn’t expect a 40+% network cost decrease. The release today was much better, good proof reading! (Just kidding).
Thanks for the update. Finally got around to reading January report properly (been in Portugal, highly recommend it for a holiday, extremely good value). I actually picked up the Richest Man in Babylon last year at a school fete (so didn’t overpay !). A nice little book indeed. Money saving tip from me: 1) Ride to work 2) Make your own lunch !
Hi Tony,
I’ve enjoyed reading your thoughts on matters related to your investments through EGP, namely removing depreciation from household budgets, etc. In that vein, I was wondering if you’d mind sharing your process on two issues which attract so little publication: when to sell and portfolio construction. Firstly, much is written about when to buy stocks, and much of your writing is about you thoughts about this; however, I’d like to hear about your criteria about when to sell. Secondly, as value investors we typically don’t use modern portfolio theory to determine the sizes of our portfolios. What do you use? I seem to recall somewhere you talking about looking at the downside price risk before taking a position which I understand – but I can’t seem to find it now. How do you construct your portfolio weightings? And how do you manage them?
Perhaps you could offer a worked example such as a universe that consisted solely of two possible assets – KPT and UOS?
Thanks for your consideration of the matter.
Daniel
Hello Daniel, I explain to our investors that we are looking for a hurdle IRR when we invest, call it X%. In a universe with two opportunities, the allocation would depend much on the expected returns.
Assume for example, the IRR for one (UOS) is X+3% and for the other (KPT) is X+7%. We could reasonably expect to allocate more to KPT than to UOS in this situation.
There is another factor however, which is the confidence ranges for these outcomes. Assume X=15%, then assume our range of expectations (say an 80% confidence interval) is 10% to 26%. Assume our confidence interval for KPT is (-12%) to 52%.
Despite the midpoint being 4% higher for KPT, the range is much higher. In 100 simulations of this outcome, we would be better off allocating a larger proportion of our portfolio to KPT. In the above situation, we would have a larger allocation to UOS than to KPT because the downside is much lower.
Obviously, this implies a level of mathematical precision that cannot be achieved in real life asset allocation, but we must have some basis on which to make our allocation decisions.
As to selling, it involves setting a minimum hurdle for the expected return from the capital below which you are not willing to remain invested in the business – Tony