StocksInValue’s In Value Today is their most popular search filter and subscribers are understandably curious about the stocks filtering as the most undervalued. But the results of this search need careful interpretation. In Value Today is not a mechanical trading rule where undervaluation of any size necessarily makes a stock a buy.
Instead, we encourage you to interpret undervaluation as a prompt for further research as conservative investors must, before investing:
- Be satisfied the stock’s risk profile is consistent with their risk tolerance
- Approve of the assets, management and strategy
- Decide if they agree with our valuation
- Decide if the discount to value is sufficient for the risks the valuation will not be realised.
To assist you in interpreting deep value situations we provide this regular (approximately monthly) report on low and medium-risk stocks where we do not already publish analyst research and valuation notes. High-risk stocks and REITs are not covered. Analyst Research and Analyst Comments are limited to universe stocks but this report briefly comments on some of the most undervalued non-universe stocks with emphasis on why the market is pricing them below value and what would have to happen for the price-value gaps to close.
‘Quality Traps’ label
Some of these stocks we might “buy” for the model portfolio or suggest to subscribers, and some we might not. The latter we will label ‘quality traps’ as their poor business quality is likely to leave them trading at discounts to value until earnings drivers beyond management’s control, like industry conditions, improve. These stocks are cheap for a reason. Buying them is likely to disappoint or require a long wait for industry conditions to recover.
In the table below the quality traps, currently screening in StocksInValue, are designated with an asterisk after their ASX code and they are also tagged as Quality Traps.
- One of Australia’s largest vacuum cleaner developers and marketers with an 80 year history and a strong brand.
- Floated in December 2014 with expectations of accelerating growth due product innovation, new stores and franchise conversion. Analysts were forecasting double digit growth vs ~4-5% industry growth, however the stock was heavily downgraded this financial year due to negative like-for-like sales growth, which was -5.2% for 1H16 and -9.7% for FY16.
- FY16 earnings of $9.2m in-line with guidance, and down from FY15 earnings of $12.9m.
- The attributed the poor performance to a failure to adapt to what they said was an abrupt market shift toward stick vacuums, which experienced 12 month sales growth of 60%. Dyson dominates this segment with over two thirds of sales.
- Godfreys is the traditional bagged barrel and robots leader, whilst Dyson is dominant in the faster-growing and more innovative bagless and stick vacuum segments. After the expiry of Dysons patent on bagless vacuums in 2013 GFY’s focus has been on these products.
- These issues came to a head in January when GFY’s board appointed retail veteran Kathy Cocovski as CEO, replacing Tom Krulis, who was made responsible for international operations and product development. However on 6 July Cocovski resigned with non-executive director John Hardy installed as interim Managing Director.
- Over the course of the year management has adjusted the product portfolio to address industry trends. The corresponding inventory build contributed to weak FY16 operating cashflow of $6.7m.
- Net debt has increased to $21.5m, up from $17.6m. This is around one times consensus FY17 EBITDA of $17m.
- GFY’s recent poor sales performance could simply be mix issues, but we aren’t inclined to give the company the benefit of the doubt. GFY needs to turnaround to rerate, and this is uncertain. The company indictaed it would add at least 5 stores to its 222 store network in FY17, however it needs to fix its offering.
|Donaco International Ltd (DNA)*
- South East Asian casino resorts operator with a 2-year listed history.
- Operates Star Vegas Resort & Club, the largest casino in the Cambodian city of Poipet, on the border with Thaliand, and Aristo in Northern Vietnam and located near the border of Yunnan Province of China.
- Star drives three quarters of operating earnings and Aristo the remainder.
- Similar to Macau but on a smaller scale the Casinos mainly service customers from Thailand and China, where gambling is prohibited.
- Demand appears to be strong with gaming revenues tracking ahead of expectations. Headline FY16 earnings of $79m largely reflected a $55m gain on bargain purchase and $11m of acquisition costs related to the Star Vegas acquisition. Adjusting for these items underlying earnings was $35m.
- Cash flow from operations was strong at $48m
- Strong growth is expected with consensus earnings increasing to $58m in FY17 and $80m in FY18.
- Strong balance sheet allows further acquisitions
- Unstable regulatory environments in South East Asia and DNA’s short listed history.
- Shares are cheap reflecting these risks and perhaps scepticism of reported figures for a company with operations outside Australia.
|WPP Aunz Ltd (WPP)*
- Largest marketing services group in Australia and New Zealand housing 80 subsidiary businesses, which collectively employ over 5,500 staff.
- Formerly STW Group, the company was formed in March this year via the merger of STW Group and the Australian and New Zealand businesses of WPP Inc
- The merger accelerates the company’s strategy to cover 100% of clients’ customer experience budgets via a diverse range of specialist businesses. Management is targeting $15m of merger cost synergies per annum over a 3 year period.
- Enterprise value (adjusted for -142m net working capital) of $1.2bn
- Recently guided to EBIT of $140m and underlying NPAT of $86m, representing high single digit growth.
- Marketing is a tough game. Across the industry staff and client churn is high (natural rate of 20%+ per annum), and most work is performed on a project basis. Revenue and cost visibility is low.
- Aligning subsidiary managers with the group’s financial goals is challenging given a general lack of financial experience and focus on creative work.
- Stretched balance sheet with $373m debt in the context of highly cyclical marketing expenditure. Marketing is typically one of the first business expenses to be reduced in a downturn, and debt could potentially compound the downside.
- Global provider of international payment services for consumer and business clients. The majority of its operations are conducted through its online platform that is user friendly, quick to use and transparent on fees.
- Capital light business model with excellent cash conversion (~100%) and focused on growth of international money flows by both consumers and businesses.
- Recurring and scalable revenues. repeat clients and with low operational costs makes the businesses highly scalable.
- Organically growing and self-funding due strong free cash flow and net cash positions (current net cash of $140m)
- Competitve advantages: unique technology platform deisgned over 15 years, which is “white-labelled” by major money transfer players Travelex and MoneyGram.
- Undemanding share price: market cap of $370m; forecast FY16 EBITDA of $34m; excess net cash of $40m ($100m of the $140m on the balance sheet is client money held in trust) means the enterprise is trading at of 9x EBITDA, having listed at 13x.
- Lower foreign exhange volatility driving lower transaction volumes,
- Competitive erosion transaction margins over time as volumes increase (although margins have been asteady around 0.57% in recent years), better technology drawing customers from OFX
- Regultory risks. OFX is classified as a Money Services Bureau (MSB) which is essentially a non-bank provider of currency services. It is therefore possible for countries to change regulations/licensing.
- Banking partnerships. OFX relies on partner banks to provide network of local bank accounts and act as counterparties to manage its foreign exchange and interest rate risks – there have been cases where banks are reducing the number of MSB’s they use e.g. Barclays cutting number down to 15 of which OFX is one. OFX tries to reduce this risk by partnering with more than one bank in each territory.
|TFS Corp (TFC)
- Vertically integrated Indian sandalwood products business with plantations in northern Australia plus processing and oil distribution facilities in Albany, WA. Sandalwood oil and wood products are sold to the fragrance, cosmetics and wood crafts industries.
- TFS is the world’s leading grower with 5.4 million sandalwood trees under management and 30% market share, which the company expects will increase to 80% by 2030.
- Time provides a barrier to entry as it takes c15 years to grow a mature tree
- Initial plantations were established in 1999 and TFS had its third harvest this year. The company forecasts production will be maintained at the current rate of 300t per annum, however it expects the production rate will increase 40-fold to 12,000t between 2020 and 2030 as plantations mature.
- TFS not well covered or understood and has generated poor cash earnings in recent years. Most of its statutory earnings have been generated from the revaluation of its sandalwood trees.
- Currently trading at a 28% discount to book value. Still in its early stages, it should become a high-margin, high-barrier business.
- As an agricultural products business with a long harvest cycle TFS is exposed to weather risks, unpredictable commodity prices and input costs.