AM I TOO PESSIMISTIC AND UNDER INVESTED?

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This year I have felt my blog has been a bit more down beat with my recent post warning of overheated asset classes, and generally I have probably written more about the selling I have done rather than any new buy ideas. Hopefully today’s blog post is a bit more upbeat as I go out and mention two new current holds and later clarify about why avoiding some markets at times in favour of cash is not necessarily being a permabear.

In my case, I can promise you a permabear would not quit their job two years ago like I did with nothing lined up!

I have also been negative about the many new LICs being launched. To provide some balance, if I was keen on boosting my exposure to LICs right now I think the international space provides a better hunting ground. I have found one recently to buy that I hadn’t previously owned so may get a chance later to write more on that. Obtaining some offshore market exposure (predominately outside of the US markets) run by decent managers at a reasonable discount to NTA seems like an ok strategy now, where value is difficult to come by.

This may shock some readers, as I now shall confess to investing in the retail sector. Recently I made a blog post warning about some potentially worrying consumer confidence data ahead for the Australian economy.

JYC is a new addition to the portfolio as I recently bought some shares up to $1.70. I consider it on the outside to probably be viewed as an “old economy” boring business, but beneath the surface may be cashing in on some new trends. JYC has a conservative balance sheet and can drive profit growth from the roll out of new stores, and the recent acquisition of Lloyds auctions online. The latter has probably been the main catalyst for me to buy after keeping an eye on the stock for a while since I noticed it was one of Mercantile Investment’s main holdings.

The latest half year result saw their Kitchen business (KWB) post 21% like for like revenue growth, and the bedding business (Bedshed) revenue up 48% (albeit with 2 new stores). The bedshed business is using the franchisee system for some stores now and experiencing a very high satisfaction rate from them. Both are the type of businesses that are less threat to the online theme. For the last half, JYC achieved EPS of 5.7 cents. This should be quite a bit higher for the current period, particularly as the recently acquired Lloyds online auctions business is experiencing rapid profit growth, and that the last half included some one-off costs associated with this acquisition.

Some may have concerns that the kitchen and bedding businesses are not where you want to be if residential constructions slow, yet they seem to be doing something a little bit better than just participating in the growth of the sector. Nick Scali (NCK) has shown in recent times that a boring industry to some can still be exciting to shareholders if you get things right. JYC mention the trend of “do it for me” these days is growing rather than DIY, more so with the millennials if you do some googling. That seems to be where management sees these businesses more aligned. They also point to a regular cycle when consumers typically update these items, which may counter to what extent they fit into the consumer “discretionary” retail camp.

It is the last mentioned of these three businesses (Lloyds Auctions) that could result in the most upside for the stock and the update surrounding this on March 13th was quite impressive. Likewise, the recent letter from management on April 6th. Lloyds auctions posted $1.8 million profit for the period (JYC own 51%). When it was acquired at the start of this fiscal year the expectations were EBITDA for $3 million, yet this will be exceeded. This online business grew by 46%. Lloyds auctions receive some publicity from their classic car auctions, and are gold cost based and known for other big ticket items which distinguishes it somewhat from other auction sites. At first glance this business may seem a little different from their two others, yet it may share some similarities. Lloyds auctions often deals with large items you may want to touch and feel first, not so dissimilar to the kitchen and bedding businesses and perhaps less exposed to threats of online competition. They also may hold more auctions away from their traditional base, not so dissimilar of how their other businesses look to expand nationally.

Businesses like this have the potential to continue rapid growth, and it can be self-fulfilling and very scalable. As more growth is achieved, this encourages more to use the online auctions site if more people are looking there. It doesn’t require much capital so a lot of the earnings growth can filter straight through to shareholders.

Property holdings are likely to be conservatively held on the balance sheet and could be revised higher in the future, which underpins quite a bit of book value in the stock.

They have been generous in returning large franked dividends to shareholders which is a good sign from management. Some are in the way of special dividends, another large one should come later this year. As so many are obsessed with large franked dividends this should put the stock more on the radar of some investors when they filter their searches for dividend stocks. Although the special dividends will cease soon, at a price of under $1.70 I still believe after this point it will be on quite an attractive yield from underlying profit growth. Handy for SMSF investors like myself.

I think the stock under $1.70 is priced very modest for potential high growth prospects for a few reasons. It has long been an old economy retail stock selling boring products. Yet the time to be invested in that style of retail business is when they clearly identify a need for new store roll outs as is the case here. They must be doing something right with the stores so credit again to management. The Lloyds auctions acquisition is relatively recent and the market may be slow to catching onto this. The stock is quite illiquid, but that suits an investor like myself not managing tens of millions, and could be a positive if it starts to perform even stronger as new investors struggle to obtain stock.

The growth in Lloyds Auctions is quite exciting now, I wonder how the valuation would be perceived if this was instead acquired by a shell company with the name changed to Lloyds online. Buried in a boring name like Joyce corporation selling boring products may offer an opportunity.

It may beg the questions will the stock get hit quite hard by a correction in house prices and the construction cycle, and why would I own it given I posted about this vulnerability of the Australian economy? I look at my overall portfolio when it comes to risks associated with a major theme such as this. Such a shock could make JYC a little vulnerable I agree, but in the last month at times when the AUD has been near the top of the range I have built up a much stronger tilt now to offshore investments and cash that I believe would stand to benefit. In the LIC space the offshore ones are at least a better hunting ground and have found one to accumulate. If house prices remain in an uptrend I see plenty of upside in JYC being a superbly managed retailer, but not so much upside in the AUD and retail sector overall as the high house prices may still act as a headwind for much of the economy.

 

AJA – Last year I did well out of the Japanese REIT GJT as a potential wind up play so have always had a glance at AJA from a distance. I was fortunate in some ways to acquire this over a month ago and then to see the AUD/JPY fall. Even though the share price has now climbed up to $6.70, in comparison to where I see the likely current NTA, it is probably still at a similar discount to where I purchased ($6.33). Therefore I thought it is still worth blogging about, we may be talking circa 14% discount at a time where there has been recent chatter about a takeover.

With AJA’s constant discount to NTA even whilst experiencing a few years recently of clear outperformance on many metrics, there will always be chatter about its future and how to realise the most value potentially from corporate activity.

A couple of months back it came to light in the press because Lone Star Funds had approached the board twice in recent months with offers for an all cash takeover, albeit highly conditional and with fees including terminating the management agreement. The board has declined to take matters further and it is business as usual, citing the fees and that book value is an unremarkable offer given the trust’s track record.

Regarding this I find it interesting that Lone Star went to the media after their second proposal was not taken to the shareholders. I wonder if this is to apply pressure on the board, and making sure the shareholder base is well informed that the board has kept the bids to themselves thus far. This may pave the way for a third approach, where there would be far more pressure on the board to take the offer more seriously. If they wanted to give up now, would Lone Star bother about running to the media?

Another interesting thing I find with the latest Lone Star proposal, is I haven’t heard key shareholders Ellerston Capital and Eley Griffiths complain about the board rejecting the proposal. Then I note the AFR article below.

http://www.afr.com/street-talk/astro-japan-owners-wait-for-an-explanation-20170305-gurayq

It says Astro may look to entertain the thought of a chunky capital return. In the board’s response (which had to be rushed out the next morning after the media article appeared), they don’t specifically speak about this but do say they are open to offers that deliver greater value. They have regularly sold parts of the portfolio above book value, and perhaps another method of appeasing shareholders about the large gap to NTA is by asset sales and a capital return. Maybe therefore Ellerston have been quiet. If that were the case it would be quite bullish, implying that key shareholders also see more value this way than via an all cash offer at NTA. Ellerston have accumulated more stock since.

Since then though they have gone the other way and acquired a property. This is not out of character as they have flagged a strategy of selling smaller, older and lower yielding properties but adding higher yielding major properties with better growth prospects. The latest purchase should boost distributable earnings by 5.5 cents, which is quite significant.

Quite a lot hinges on the question whether management are genuinely interested in the best outcome for shareholders, or are too biased with the connection to the management fees they are generating by keeping the current structure. What can we make of management’s form in the past? I don’t think they can be criticised of pursuing increasing number of fees and assets. They have acted quite appropriately in recent years with selective buyback offers and asset sales, and been cautious on acquiring new properties. Since Galileo (GJT) sold off their assets and redistributed funds back to shareholders (announced over a year ago), AJA haven’t been shy about commenting about the prospects of following suit. Indeed, they have specifically mentioned the prospects of a sale of some or all the portfolio, when speaking about the failed buyback in May, 2016. Then at the 2016 AGM they brought up specifically on their own accord about the prospects of a GJT type solution, saying that they will continue to exam this potential option. At the time of the AGM in mid-November, 2016 they pointed to the relatively disappointing performance of the new REIT from GJT in Sakura Sogo. This was partially why they were not pursuing this solution at the time, but keeping their minds open to it. If AJA were really all about keeping the structure unchanged in the future and after the management fee income, would they tend to push themselves into a corner by twice commenting about realising some or all the portfolio and distributing funds back to shareholders? I would have thought they would instead only guide the market about making the odd disciplined acquisition.

When management spoke about the disappointing Sakura Sogo REIT, the Sakura price initially bounced quite strongly into the early part of this year. It has since weakened somewhat, but still maybe a tad higher than when these comments were made. It may not take much more of a recovery here for management to start talking once again about this possibility. I would also point out that they were quite rushed in their response to Lone Star, because this was dictated virtually overnight from Lone Star running to the media. We may see soon further comments about management about the options ahead to assist the shares trading closer to NTA, thus addressing any potential criticism some unit holders may have about them declining two separate takeover approaches.

I understand many readers would never contemplate investing in Japan exposure and it is probably not one to take a huge position here. I won’t bother to make some bold macro prediction on Japan in this post as it would require another few pages writing about it and there are enough debates on the internet about whether Japan is a basket case with further deflation fears ahead, or the ultimate contrarian destination. I’ll just make the point that for quite a few years AJA has seen slow steady improvement in rents, occupancies, valuations, and I suppose the Olympics cannot hurt with some potential flow through to the retail and hotel sector.

 

HOW MUCH CASH TO HOLD?

A bit more about market timing and how much cash to hold in the portfolio – When I express occasionally in the past for example that I have sold a few holdings and boosted my “cash equivalents” exposure to over 30%, I want to provide some clarification. I am not endeavouring to time the market, for example sell the ASX200 at 5,900 and buy back in when it corrects down to 5,400. (I would be hopeless at this). It may just be temporarily sitting on the sidelines before taking the time to examine more depressed markets or sectors elsewhere.

The money that stays in cash earns close enough to zero these days, so why hold it? It does however contain some “optionality” within it. In times of market panic it becomes easier in my opinion to uncover opportunities that can beat the market on the way up. Also, the negative drain from holding cash does not have to mean underperforming in a bull market. Geoff Wilson’s funds are a good example of maintaining high cash balances and outperforming. It can of course reduce the volatility in returns, and I would argue you are mentally better placed to make the correct investing decisions when your portfolio is not swinging around as much. I would also add that as an individual investor, not having the large handicap that comes with significant size of AUMs gives you advantages. You can get set in micro-cap situations many instos can’t, and no one is criticising you about your poor 6-month performance number and suggesting you quit positions that are not currently popular or don’t have an exciting story. That should also make it easier to not lag the benchmarks despite sometimes holding above average cash levels at times.

I also refer to the term “cash equivalents”. I attended a Sandon Capital presentation in Melbourne yesterday (I recommend attending if you have the time by the way, it is usually a small audience) and I noticed Sandon often term it as “event driven / run-off” as a ball park figure of what may turn into cash soon. I see my “cash equivalents” bucket as also including stocks that have less beta to the overall market, and where you can point to a likely definitive date that they should turn into cash. They may stand a good chance of producing positive returns over periods of months, even if the market suffered a 15% correction. They could include for example wind ups or takeovers. Some on the blog that have fell into this category at various times include GJT, UPG, WCB & TTS. AIQ was a classic example some years ago but probably not now that the remaining underlying investments are quite illiquid.

I made the title of the blog “Investing for a Living” since I probably have more of a focus of limiting drawdowns in the portfolio more than others. That is another reason my cash equivalents may appear that I am quite under invested as far as many others may see it. Hence at times my writing style may seem quite cautious. It is different to how I would try and manage things if I was on the hedge fund gravy train with the classic 2 and 20 fee style arrangement. I would then try and shoot the lights out! No dramas if it doesn’t work out I still get some nice pocket money. I am just pointing out the goals of different investors. I endeavour to maintain some other small sources of income outside of the share market to live stress free and cover my living expenses, but I essentially make or lose most of my money based on my investment decisions. Hence the cautious sounding nature of some of my blog posts at times.

 

FUTURE BLOG POSTS

When I get the chance, I would still prefer to make a blog update in the future as an approximate recap of how the stocks I discuss as holds here have performed. I don’t have the time unfortunately to post on the same day every trade I make. Sometimes the stocks will have fallen after I buy and they become cheaper by the time I then write about them on the blog. I remember such happening with WCB, CYB, MAH & Nagacorp. I will just attempt to track the worst case, e.g. AJA as an entry price of the current $6.70 rather than my cheaper entry. The same case goes for KAR which I shall note now I have sold half my stake recently a bit above $1.60. I have marked it down as a half exit at the current level of $1.40 for the purpose of a later blog post where I hope to examine how the blog stocks have fared.

I hope to write more on KAR and various others (brief updates anyway) over the next week. There has been a bit of news flow regarding quite a few stocks I have mentioned as holds in the past.

 

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2 thoughts on “AM I TOO PESSIMISTIC AND UNDER INVESTED?”

  1. Steve, I would like to add RCG to your retail theme. For those who don’t know, RCH are shoe distributers and retailers with brands like Athletes Foot, Skechers, CAT, Dr Martens. Merrills, Sperry, Timberland +++. The share price has been hammered from $2 to less than 55 cents because of A) the general sentiment for retail, B) “The Amazon effect”,C) a large number of shares issued as part of a take-over by RCG coming out of escrow soon (which the vendor has indicated they will be holding for the forseable future) and D) Two small adjustments to profit forecast. A consequence being they are now selling at a P/E of 8x implying no growth.
    Why I like it is as follows;
    a) The quality and strength of their brands is second to none.
    b) Growth in earnings per share is still expected to be a 15%.
    c) The retail environment may slow growth a little but shoes wear out and change style and so the demand is always there.
    d) They have been experiencing the “Amazon effect” for 10 years and so it is already factored into the SP. If anything their market competitiveness is likely to improve when the tax-free threshold of $1,000 on imports is soon reduced to $50. Also most people like to/need to try on shoes before buying so leakage of sales to online is not significant in this category.
    e) The shareholders of the escrow stock have advised that they are not sellers at these price.
    I will probably buy RCG when I can see a technical support level for the shareprice

    Like

    1. Thanks for the contribution James. My suspicion is the Amazon effect may be extrapolated too far in some cases and lead to some unfashionable retail stocks being bargains. But I don’t get to research them all and have not been following RCG that closely. I would guess you are correct about the theory of lack of leakage to online sales. Most people I would have thought change styles regularly and need to try them on, rather than picking the same shoe over and over again and ordering online.

      I will probably confuse many my making the point I am also negative about the overall growth rate of consumer spending in Australia and level of consumer confidence going forward. Then here I am saying retail could be an area to look for bargains! I think my negative view may be more played out in declining bank share prices and a declining Australian dollar. I feel bank share prices have benefited from the love affair lately with passive investing and if this were to reverse it could compound any weakness.

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