Globe International – Value trap? (GLB)

 

Are GLB investors in for a nice ride or a wipeout?

Market Cap: $19m

P/E: 8.6

P/Book: 0.37

Dividend Yield: 10.9%

 

Well-known surf and skatewear brand Globe also happen to be listed on the ASX, and fulfill many of the common metrics value investors look for.  Selling for a mere 1/3 of book value with no debt and a whopping $12.5m cash on hand, such a company should at least qualify as a Benjamin Graham “Cigar Butt”.

 

Delving more deeply into Globe’s business raises several red flags, summarised below:

Decline in revenues and book value:

GLB’s revenue per share has been declining for the past decade, and at $2.21 per share in FY10 is more than half what it was in FY01.  Similarly, book value has fallen from $2.74 to $1.23.  And while the company has returned to profitability in FY10, revenue continues to decline.  In the 6 month period from June 2010 to January 2011, NTA backing dropped from 74c to 67c.

Huge losses as a result of GFC:

The company has faced some major problems in the past few years, and only just returned to profitability; indeed the most recent 5c dividend in September was the first time Globe returned money to shareholders since 2005.  EPS for FY09 was a loss 21c, and FY08 was a huge 59c.  To management’s credit, Globe have effected a dramatic turnaround, ripping $15m of annual cost overheads from the business.

Reliance on American market:

More than half of Globe’s revenue comes from North American market, which contributes 65% of the company’s EBITDA.  One would expect this contribution to fall in FY11 due to the strength of the Australian dollar.  At a macro level I have no faith in the US economy and expect neither the US Dollar nor US economic conditions to improve long-term.

Weak HY11 performance:

While net profit increased slightly for HY11 compared to HY10, this was solely based on a change in inventories. Revenue and EBITDA fell, trading conditions in Australia worsened, and input costs increased.  No interim dividend will be paid for FY11, as HY11 operating cashflow was 1/3 that of HY10, and once accounted for the dividends became a net cash outflow of more than $1 million.

 

While Globe have reasonably strong brand equity and plenty of cash on hand, both of these things are nullified by the fact that the company’s value is rapidly decreasing and entirely dependent on a niche segment of the retail market.  Management have demonstrated that they can tighten their belts during tough times, but until GLB can demonstrate consistent long-term profitability and grow the company’s book value, they are too vulnerable for me to justify investing in.

BigAir increased earnings guidance for FY11 (BGL)

Today after the market close, BGL announced a significant increase to EBITDA guidance for FY2011 up 30%, from $4m to $5.2m.  Much of this uplift results from the contribution of the CVA and AccessPlus acquisitions.

Because BGL’s revenues are largely from subscription services, the current annual EBITDA run rate is $7.5m, which should grow well above that figure for FY12 when factoring in new orders activated from now until June 2012.

The acquisitions integration are proceeding on track with an additional $1.6m of annual cost reductions realised over the next 12-18 months.  This will further improve BigAir’s stellar profitability, with gross margins currently sitting at 80%.

 

 

iiNet vs TPG Telecom (IIN, TPM)

This is what a DSLAM looks like
This is what a DSLAM looks like

In the hotly contested consumer broadband market, the 2 key players are iiNet and TPG Telecom. Despite TPG’s Pipe Networks business, both are pretty pure consumer internet plays which should make comparison fairly straightforward.  Apart from the 2 integrated giants Telstra and Optus, TPG and iiNet are the biggest broadband operators in Australia, and unlike Telstra and Optus, their core business is consumer fixed broadband.

Turning to the consumer broadband industry as a whole, while the market is beginning to reach saturation, there are segments, currently off-limits to TPG and iiNet, which will be contestable via NBN.  This doesn’t just include remote towns, there are significant subscriber opportunities for the 2 million households on Telstra HFC (which under the current structure will be removed in a deal with NBN) and Pair Gain systems (which other players can’t service).  As long as the NBN allows iiNet and TPG to use existing elements of their own network (to give them an advantage over straight resellers) and the opportunity to earn a decent margin on NBN-delivered services, iiNet and TPG are still exposed to plenty of organic growth opportunities.

The outback isn't the only part of Australia that will benefit from NBN
The outback isn't the only part of Australia that will benefit from NBN

To go beyond organic growth, iiNet and TPG both augment their core offerings with home phone, mobile, and internet TV services to increase ARPU (Average Revenue Per User), offering bundled services to encourage takeup.  The home phone in particular will become a big contributor for both parties, as these on-net services generate high margins and ARPU.  As the market continues to heat up, smaller players who don’t have the scale to deliver these offerings at the right price are likely to get consumed by larger ones chasing growth.  iiNet has a particularly good track record with integrating their acquisitions.

Turning to some basic statistics:

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Both are currently selling for under 15x earnings, with IIN being slightly cheaper.  Looking at the growth of these businesses for the past 5 years, TPG has made an impressively swift transition to profitability, turning 6% revenue growth into a doubling of earnings. Operating cashflow was $172M in FY10 and should exceed $200M in FY11.  PIPE’s fibre infrastructure will give TPG a better platform to target the enterprise and mid-market business segment compared to iiNet, whose offerings are squarely centred on the SME business segment.

iiNet has also maintained its momentum, growing EBITDA by 20% and earnings by 36% for FY10.  Operating cashflow was 62.1M.  The big difference is how margins are tracking for HY11 – iiNet’s EBITDA margin has held steady while TPG’s has grown to 41%.  I expect to see even greater profitability improvements for TPM as they migrate the offnet Soul home phone business to on-net TPG, and grow home phone subscribers organically with their bundled offers.  iiNet’s should increase albeit by a lower rate.

iiNet have made a number of bolt-on acquisitions over the past couple of years, including Westnet, Netspace and AAPT’s consumer division.  The most recent acquisition of AAPT demonstrates the strength of iiNet’s management, who have successfully reduced the number of TIO complaints by aligning products and call centre resources with iiNet’s internal best practice.  iiNet’s innovation is also impressive, building their next generation of the BoB home phone in-house to better control quality, and being first to market with fetchtv.

I don’t own either of these stocks (apart from indirectly through my shares in Amcom, who own 23% of iiNet).  I think both are reasonably well priced and both should show NPAT growth above the market, however right now they aren’t attractive enough to provide sufficient “margin of safety”, particularly when you factor in industry uncertainty due to NBN.  If we have a repeat of 2009 (triggered, perhaps, by a US Treasury default) and the All Ordinaries drops to 3000, I’m going to be buying these.  Broadband is a basic utility, whether or not you’re in a global depression.

Regional Express (REX)

You want to know how to become a millionaire? Be a billionaire, and buy an airline.
You want to know how to become a millionaire? Be a billionaire, and buy an airline.

My biggest blunder of the year has definitely been Regional Express (REX).

The initial attraction for investing was the relatively high net profit margin of REX compared to other airlines like QAN and VBA. Running with a load factor (how full their planes are) in the 60% range and still being reasonably profitable made Regional Express worthy of further investigation.

Despite these and other promising elements, such as low earnings multiple, manageable debt, and access to low cost pilots through their in-house training school, REX has been overwhelmed by fuel costs and the downturn in regional Australian tourism to post lower profit guidance for FY11.

My doubts finally confirmed, I offloaded my stock for a 19% loss. What stings the most is that if I was more disciplined I wouldn’t have gotten involved with such a dog in the first place.

Lessons learned:

1. Avoid the airline industry altogether

Mad Hedge Fund Trader does a nice job of outlining the key reasons why investing in airlines is a recipe for disaster, even though he recommends some stocks as a hedge against lower oil prices.

2. Uncertainty about future earnings

When I bought shares in REX in late 2010, the most recent shareholder presentation stated that management could not provide profit guidance – which should have been a huge red flag. I should have doubted investing in a business the management couldn’t share a short-term expectation on.

3. Vulnerabilities

Even though REX was exposed to some decent upside if passenger numbers grew, and had a reasonable margin of safety thanks to their low debt and good profit margins, I didn’t account for areas where the business was vulnerable to factors outside management’s control. Fuel prices and the potential for instability in the middle east sending oil prices into orbit meant that REX was never a safe bet because of its downside exposure.

My approach to Value Investing is to find business which are robust to any major downside exposure and selling for a discount to fair value. REX might be cheap, but getting into a business with such huge downside exposure ran contrary to everything I supposedly stand for.

Supply Network profit upgrade (SNL)

Easter has come early with Supply Network who are now forecasting a year-end EBIT upgrade of 15%, from the 3.1M-3.3M range up to the 3.5m-3.8m range.

Another important factor of note is that this EBIT improvement is a result of revenue growth rather than improved profitability. If the company transformation successfully reduces overheads this should improve profitability and EBIT further for FY12.

HGL Limited (HNG)

Market cap: $70m
P/E: 4.86
P/Book: 0.94
Dividend Yield: 8.6%

Something like a mini-Berkshire (without the insurance “float” to source new capital), HGL is a conglomerate of diversified import businesses serving niche markets such as model cars, school hats, and special format printing. HGL make no effort to integrate their acquisitions, choosing to let senior management operate autonomously and incentivise them to build long-term performance.

HGL are value investors themselves, making acquisitions where they can purchase entire companies at the right price. HGL continue to look for quality businesses to acquire, and even list their criteria on their website.

Until very recently, HGL has held a stock portfolio in addition to its businesses. It was probably the correct move for management to liquidate this portfolio and concentrate on their importer business model: to improve core business profitability and find new acquisitions. While some of these businesses are 100% owned by HGL, a number have their ownership shared between HGL and management.

Dividends are regular and can be reinvested although no discount is offered. At a current gross of 8.6% HNG are very healthy payers, reflecting a payout of roughly 80% of earnings. The one weakness to HGL’s relative cheapness is the inconsistency of earnings – HGL did not sail smoothly through the GFC, with earnings falling from 19.2 cps in 2007 to 10cps in 2009, before rebounding to 13.3cps in 2010. HGL’s moat exists due to the niche nature of the products they offer. These niche areas are difficult tor larger players to service, and results in higher gross margins than you would expect for a typical importer/retailer (in excess of 40%).

Because the majority of purchases made by HGL are made in US Dollars, the current strength of the Aussie should benefit the business in the next reporting period. Long-term I expect the US Dollar to continue weakening, thanks to their terrible economic policy – resulting in continued benefit to HGL’s businesses.

The current price of $1.28 puts HNG’s P/E ratio at less than 5 – outstanding value for a company with negligible debt serving specialised markets, raising the barrier to entry for competitors. I’ve had HNG on my watchlist for some time, and I’m ready to take a long-term position over the coming weeks. The business is significantly undervalued, and I wouldn’t give serious thought to selling until the share price rose to pre-GFC levels – roughly double the current price. Buying before the dividend is paid in June would also reduce capital gains if they were ever realised.