Colorpak HY15 results: Disappointing (CKL)

When I originally wrote about Colorpak, I saw it as a better investment than Amcor for several reasons.  Now, looking at charts for both companies, Amcor as of today would have been a better investment.  The share price fell 22% on Friday, the lowest it’s been since July 2012.  So let’s review the numbers against HY14 and examine whether I should buy more, sell, or do nothing:

 

  • Revenue $84.1M, up 2%
  • Underlying EBITDA $6.5M, down 11.9%
  • EBITDA margin 7.7%, down from 8.9%

 

Now to the commentary, and it’s not too bad.  Profits are slightly up against PCP, though lower than expected due to slower uptake of benefits from the Victorian rationalisation.  Inefficiencies have also been identified at their facility in Braeside which should lead to margin improvement.  A positive free cash flow of nearly $3M was reported, much of which was used to reduce debt.  Dividends were reduced.

 

The business should benefit from a weaker Australian dollar over the medium term, and Colorpak appear to be having success selling their new paper cups to Supermarket brands.  I recently went to Coles and was impressed at the packaging of the Coles brand ice cream, which I’m assuming is Colorpak (Connoisseur brand is, their logo is on the bottom of the container).  Management’s comment about Supermarket pricing power was also interesting and is a positive sign.  Finally, there is a cost reduction opportunity for the NZ lease which expires in 2016.

 

My conclusion? This business is currently priced at $43M, about 13 times earnings.  There should be additional cost improvements over the next 2 years.  As I currently hold, I won’t be adding, although it’s a reasonable buy for a main street business.  If the share price drops below 40c without a change to the company’s fundamentals, I would increase my position.

Joel Greenblatt on value investing

One of the best quotes I’ve read on value investing, which is applicable across an infinite number of domains, is the below from Joel Greenblatt:

 
“Prices fluctuate more than values—so therein lies opportunity. Why do the prices fluctuate so widely when values can’t possibly? I will tell you the answer I have come up with: The answer is I don’t know and I don’t care. We could waste a lot of time about psychology but it always happens and it continues to happen. I just want to take advantage of it. We could sit there and figure it all out, but I like to keep it simple.  It happens; it continues to happen; the opportunities are there.”

 

The article is interesting throughout and serves as a good 10-minute introduction to value investing.

 

Greenblatt’s point is that while there might be use in finding out why prices move (for example, to identify whether it is likely to stop happening), knowing why they move is not important.  As an investor it’s more important to identify those stocks which are mispriced, and try to make as few mistakes as possible.  (after all, if it ever stops happening, you won’t find any more value stocks to buy)

 

Nassim Taleb also popularised a concept known as the Green Lumber Fallacy, which is similar.  A successful lumber trader spent his whole career thinking green lumber was wood painted green, and not actually fresh cut timber.  Knowing the difference was clearly not a requisite for success.

 

Greenblatt also wrote “The little book that still beats the market” which I have not read.

The Greek election could be a major inflection point for Europe’s future

Because I’ve been predicting GFC 2.0 for the past 2 years, I have limited myself from investing in public markets for this period, except for a couple of stocks like BGL and CKL, as well as a position in several gold shares as a defensive play which sit outside the value methodologies (so I haven’t written about them here).  Almost since the last GFC, central banks around the world have tried to lift global economies into a sustained recovery by continuous stimulation of the economy, while at the same time participating in a currency devaluation warfare in which the USD, Euro and Yen all take turns vying to see who can print the most money, devaluing their currency and stimulating exports.

Seeing as these 3 regions account for about 52% of GDP according to IMF’s 2013 numbers, most of the rest of the world is along for the ride.  Unfortunately, all 3 regions have a terminal addiction to cheap debt (their only option is to balance budgets triggering a depression, or default/hyperinflate their currency).  I’m excluding China from this group (12.5%) because the Yuan is not a reserve currency.

Over the past couple of months we’ve seen some dramatic changes in commodity prices and economic policy:

 

  • Iron Ore is now under $70 a tonne, meaning every producer in the world (except 3) is now operating at a loss
  • Oil is now under $50 a barrel, driving oil-rich OPEC welfare states to drill even more in an effort to balance their budgets
  • Copper, usually a leading indicator of economic health, has fallen to around $2.50 a lb
  • The Swiss National Bank suddenly removed their 1.20 Euro currency floor after intervening for 3 years to keep their price low.  Within an hour the Swiss Franc revalued itself 30% higher, not before obliterating every leveraged Forex trader who was short CHF
  • Denmark and Switzerland have both implemented negative central bank interest rates
  • Venezuela and Argentina have both implemented price and capital controls, resulting in rioting and major shortages of basic household essentials

 

The only thing more staggering than current government intervention, is the amount of debt these government owes to bondholders, as well as their own reserve banks, who are buying up their own government debt with newly created money.  The Eurozone looks to be the first to fall, and I suspect the catalyst will the election of Syriza in this weekend’s Greek election.  Negotiations with the ECB will fail, or Greece will fail to keep their side of any deal which does get negotiated, resulting in more standoffs or an exit of Greece from the Euro.

 

The problem with balancing a budget when you have a gigantic debt millstone around your neck, is that you cannot escape.  If you raise taxes, the wealthy will leave or be bled dry, curtailing private investment and further growth.  If you cut spending, the GDP will fall, triggering a depression, which will incite riots and the election of political nutjobs.  If you default, your problems are gone, but you carry the reputation of a deadbeat nation who will not pay their debts.  Or you can keep printing money, which will eventually hyperinflate your currency like in Germany in the 1920s, which is technically the same as default, because the money you repay your bondholders is worth less.

 

Greece is a $250B economy, and they actually ran a primary surplus in 2014 (They balanced the budget excluding debt repayments).  Italy’s economy is $2 Trillion, and Spain is $1.3 Trillion.  If Greece’s problems are creating this much anguish in the Eurozone, what’s going to happen when Italy (2.8% deficit) and Spain (6.8% deficit) queue up for handouts?  Combined, their economies are the same size as Germany ($3.6 Trillion).  I see no way that Greece can run a budget surplus in 2014, even if all government debts are cancelled.  Tax collections fell dramatically in the lead-up to the election, and Tsipras has made some very costly election commitments.  Moving back to the Drachma will be purely driven by how accommodating the ECB are to maintaining the status quo, but if the bailouts continue, Italy and Spain’s demands will eventually overwhelm the ECB’s ability to keep things going.  A harsh economic readjustment for southern Europe is inevitable long-term.

 

Even though the USA has problems, the almighty dollar is still going to be a safe haven.  John T Reed, an American, has written an excellent article on why the USA will fare reasonably well in the next economic downturn:

In 87% of the transactions, the USD is on one side. In only 13% are neither side either buying or selling USD. In other words, no one who needs a substantial amount of USD or USD bonds can switch to another currency. There is no such currency and none is on the horizon.

The article is interesting throughout and I highly recommend it.

I expect major problems in the Eurozone which will trigger major disruptions to markets, commodities, and currencies. The likely outcome is a stock market collapse and increased demand for precious metals.  Japan’s future is not a matter of if, but when.  Most of my money is in cash right now as I am anticipating Australian equities will get cheaper.

From value trap to cigar butt – Reverse Corp (REF)

I first discovered Reverse Corp a couple of years ago, after the company collapsed from it’s $6 price down to a few cents.  As less people used payphones and prepaid Telstra mobiles, the business deteriorated badly to the point where it made a small loss in 2012.  In FY13, the business was able to post a small profit, and started offering the service to prepaid Vodafone customers, who make up a higher proportion of Vodafone’s users than the other 2 carriers. They also divested the European business.  Management confirmed that the reverse charges business would continue to decline, and investment in new revenue streams would be required.  Not a great sign but at least they were honest about it!

In FY13 REF also started a new venture, Ozcontacts.com.au, an online ordering service for ordering contact lenses, in which they own a 65% share.

Turning to FY14 and the results are much more positive.  Back-office cost reductions and increased revenue from the Vodafone contributions have grown revenue from 4.9M to 6.6M and increased EBITDA margins from 33% to 52%, increasing EBITDA to 114% year on year.

The Tritel payphone business, a consistent money loser, was divested for a negligible amount.

Ozcontacts’ revenue nearly doubled, from 1.2M to 2.2M, and EBITDA margin improved from -17% to -14%.  EBITDA losses however have halved from H1 to H2 in FY14, and the business became breakeven in H1 for FY15.  I don’t know much about contact lenses but OzContacts don’t appear to offer a subscription-based ordering model, similar to Dollar Shave and offered by competitor OPSM.  This would further lock in customers and justify a bigger marketing budget.

It is reasonable to assume that the 1800 Reverse revenue will resume its decline, however the higher revenue base and EBITDA should continue to generate cash which can be invested back into new businesses such as OzContacts.  With a market cap of $13M, no debt, and $6M in the bank, REF appear to be a well-priced Cigar Butt with some upside.

The Chairman Peter Richie seems to think so having recently acquired another 400,000 shares to go with the 4 million he currently owns.

I entered a small position today and will continue to monitor earnings carefully.

Bulletproof Networks (BPF)

While BPF does not cater to the value metrics I espouse, I managed to get in at 25c in the last few days of 2014, buying an initial block of shares.  While it’s by no means a value stock (with plenty of “tech bubble” hype around it – the “C” word [cloud] features heavily in their literature), I’ve identified companies with similar business models before, and done quite well.  The 2 key companies being BigAir (BGL) and Amcom (AMM).

 

I could write a PhD thesis on the stock selection strategy of scalable annuity revenue businesses, targeting companies that have just broken even and continue to grow, while maintaining a fixed or semi-fixed cost base.  Your revenue is reliable – every month you pump out the same invoices to your clients.  You know how much infrastructure and how many people you need.  You know how much revenue will come in the door.  And every month, you add new clients, and generate more invoices.  Because your cost base is somewhat fixed (the infrastructure is a sunk cost), your incremental cost of adding new clients is very low.  Congratulations, you now have a (hard-earned) license to print money.

 

So let’s take a look at BPF’s numbers:

FY14 revenue: $18.3M

EBITDA: $2.9M

Underlying NPAT: $450k

Percentage Annuity Revenue: 85%

As an IT industry insider, I can confirm that cloud is here to stay, and will become a bigger and bigger part of many organisations’ IT spend.  Funnily enough, my prediction is that while companies will buy more IT, it will cost them less, as cloud and managed services lets them buy on demand rather than purchase infrastructure and hire a bunch of people to run it.

Don’t believe me?  10 years ago, every server in an organisation’s IT department was a separate physical box.  Then VMware came along, allowing you to mash a bunch of physical servers into a single cluster, and run each server on the cluster as a virtual machine, using only the capacity needed.  Most organisations nowadays are 80-90% virtualised, and the next logical step is to put at least 50% of your applications and data into cloud-based infrastructure.

 

Microequities have just published a report on BPF, which I encourage you to read.  It requires a membership which is free.  Microequities have rated BPF a Strong Buy with a price target of 33c.

 

Finally, BGL recently acquired Pantha corp, a DevOps and consulting company focused on cloud migrations.  Not only will this be earnings accretive, it will create some great cross-selling opportunities, and provide an additional differentiator for organisations wanting to migrate their infrastructure to the cloud.

 

I’m optimistic about BPF’s future, and I’m anticipating strong profit growth in the years to come.