Although Kogan showed another outstanding result this year, growing revenue 40% and EBITDA 90%, the market does not support the current valuation and has punished the share price soundly.  The day the results were announced, I sold my entire holding for a 230% gain on my average buy.  A great result, but it’s hard to escape the fact that I could have sold at closer to 400% returns.  The reason I’m taking a break is that things like this get way too far inside your head, which stops you from making rational decisions.

Knowing when to sell is hard, so for the time being I’ve decided to take all my cash off the table and get my mindset back in order.  I am also in the process of selling down ST1, as I believe we are around fair value and the company isn’t growing as rapidly as I would have expected.

This means I will be down to 4 stocks and holding 50% cash, primed for future opportunities.  I look forward to giving my brain a break so I can make better decisions when I emerge from the self-imposed blackout period.

I’ll be back in September with a better mindset, and hopefully, wiser.

My 4th quarter showed a return of -5.52% vs a benchmark return of +8.27%.  This was primarily due to a large decline in Kogan after the directors sold 6m shares at $7, having earlier invited offers around the $10 mark.  Nonetheless, I am pleased with my overall results for the year, showing a total return of 67.3% against the benchmark of 12%.

Stripping Kogan from the results I am still up 27.1% for the year which I’m pleased with.  The recent decline of Kogan has highlighted a gap in my own thinking (as well as some greed) in not trimming back my position as the share price rose.

In hindsight, would I still allocate 45% of my portfolio to Kogan at $9.80?  No I wouldn’t!  So why did I continue to hold?  I can partly claim a desire to err on the side of doing nothing, but I was greedy, and justified my lack of action under the guise of letting winners ride and the difficulty to calculate their full potential, and ignored increased market activity from eBay and Amazon.  Right now I’m waiting for full year results and expecting them to be excellent.

Recent events have caused me to notice that the quality of my thinking has degraded, and I don’t trust myself to make rational decisions.

The time has come to take a break.

In some ways, deciding to buy is easier than deciding to sell, and as I start considering turning over my portfolio I need to make lots more decisions.  When a stock is undervalued by a decent margin of safety, the only decision is how much of your portfolio to allocate to it. But when selling there are many considerations.  Is it at or above fair value? Should I sell all or part of it? What are my tax considerations? Do I hold cash for now or do I have better ideas to move my money into right away?

One thing that’s clouded my thinking is checking my portfolio several times a day.  I’m lucky if any stock posts news in a single week, let alone by the hour. It’s become a distracting habit that is a net negative on my ability to make decisions on a time horizon which tends to be 1 year plus.

So, I plan to go the full month of August without looking at public markets – no checking my portfolio, no HotCopper, no Financial Review.  The companies are unlikely to undergo dramatic change in 31 days.  I will use July to adjust my portfolio based on FY18 results, with a view to increasing my cash reserves.

August will be spent reflecting on what has been an excellent year, and building up my background knowledge with plenty of reading (and re-reading of books that got me where I am today) and watching old Berkshire Hathaway AGMs. I will be going on holiday at that time, and look forward to getting back into public markets refreshed and with the right mindset.

I should be in no rush to deploy excess cash and will be comfortable holding around 50% cash for 3-6 months as I search for better investment opportunities.  The recent difficulties have forced me to grow as an investor and for that I am grateful.

Although I haven’t written about Reece before, the acquisition of MORSCO, announced today, prompted me to write about this amazing company, of which I have been a shareholder for the past 12 months.

Most Australians have heard of Reece Group, but most of us won’t appreciate how significant they are as a company: $5B market cap, with FY17 revenues of $2.4B and 600 stores across ANZ.  Reece are a significant company.

The Wilson Family have controlled Reece for over 50 years, and own nearly 80% of the shares.  It is Wilson owned and Wilson run, with Peter Wilson having run the business for the past decade and grown the business significantly over that period.

Today they announced a capital raise to help fund the acquisition of MORSCO, a plumbing and HVAC distributor based in Fort Worth, TX, and spread across the Southern United States, a rapidly growing region of the USA.

Reece would actually be the perfect acquisition for Berkshire Hathaway to deploy some of their excess cash – they are sizeable enough to be worth pursuing, and have extremely competent management with an ownership mindset of the business and a wide, wide moat. Maybe the expansion into America will put Reece on Warren Buffett’s radar?

While the acquisition cost of 14.4x EBITDA seems very high, I will freely admit that I know nothing about distributing toilets and air conditioners, but if it’s good enough for the Wilson family to make this acquisition, that’s all I need to know.

It goes without saying that I will be taking up the rights offer, and am excited to witness this great leap forward for a home-grown Australian icon.

Fortescue recently released quarterly numbers as well as another updated presentation today from the Macquarie conference.  FMG’s share price has been getting a beatdown lately, I think largely due to the lower Q3 production, increase in C1, and low revenue realisation.

But the company continues to spew out masses of cash – $1.4B USD in HY18, and NPAT of $681M USD.  That’s around 8x earnings for a business that will continue to generate money for the next century and is currently suffering difficult operating conditions.

There is currently a significant gap between the Platts 62 price and FMG – thanks to China’s desire to limit pollution during their winter by focusing on higher cost ores.  I would expect to see a reversion to the mean, either by a change in policy, more ore being processed in India, or new technology improving the useability of lower-grade ores.

Just in case that doesn’t happen, the new Eliwana development will improve FMG’s blended content to 60% Fe.  As I wrote in my original post, while FMG is not a perfect business, they are very cheap, and will be profitable throughout the commodity cycle.  I continue to hold my shares, average buy around $4.95.  There is room to buy more although I’ll probably build up more cash reserves waiting for better opportunities.  In the meantime I plan to sit back and continue to collect the dividends, as I watch how the landscape develops.

Q3 was another excellent result, returning +14.59% against the benchmark return of -4.04%.   YTD return for the financial year so far is +77.05%.  My only trade for the quarter was purchasing Webjet.

Kogan again contributed a significant proportion of the return, but the standout in percentage growth was Spirit Telecom, rising 70%.

I am constantly re-evaluating my portfolio to see whether a sell decision is warranted, but haven’t had justification to do so yet, and have lacked a good enough opportunity to warrant freeing up additional cash.

Current portfolio breakdown:

KGN: 41.7%

REH: 12.8%

AVJ: 12.6%

DDR: 3.1%

ST1: 8.9%

WEB: 1.6%

FMG: 6.9%

Cash: 12.4%

Kogan released their HY numbers a couple of weeks back, and did not disappoint.  Revenue, expected to grow at 35%, instead grew at 45.7%. Gross margins improved to 19.4%.  And the dividend was increased to 6.9c per share.  Based on the IPO price of $1.80 just a year ago, this annualises to a dividend yield of 7.7%!

Kogan blew the doors off on all metrics, and importantly there is significant upside yet to be realised from their new lines of business such as NBN and Life Insurance.  So far, the Amazon threat is yet to dent their business (not saying that it won’t, just that it hasn’t so far).

With this level of upside difficult to quantify, it’s hard to predict when the stock is overvalued.  With current growth rates, Kogan will easily surpass $1B revenue in FY21, and at 20% GP should be earning well over $1 per share.  So even current share price levels of over $9 a share don’t seem too far-fetched.  I continue to hold my full position, even thought it now exceeds 43% of my portfolio.

Once again, KGN made a majority of the contribution to my returns this quarter, with the stock price increasing 75% this quarter.  The portfolio return was +27.11% for the quarter, against the benchmark Vanguard ASX300 index of +6.98%.  Removing Kogan the fund still outperformed with a +8.17% return.

I got rid of DTL (After the company downgraded earnings) and JIN (as the company lacks a strong moat and is now approaching non-bargain status at around 20x earnings).  The only other change was continued accumulation of FMG, which continues to be priced very cheaply.

While KGN’s current earnings multiple may seem to be ridiculous at 87x (Even factoring revenue growth of 35%+), the additional upside from new lines of business is difficult to quantify.  Every time they sign up a new 3rd party agreement (for example, private healthcare), Kogan has a brand new business unit which they can cross-sell into their 8 million customer database with very low cost of sale due to the online nature of the business and high level of automation.

The current portfolio breakdown is as follows:

KGN: 38.9%

REH: 13.6%

AVJ: 15.4%

FMG: 9.0%

DDR: 3.7%

ST1: 6.2%

Cash: 13.2%

Company Overview

Fortescue is a well-known Australian success story.  A former stockbroker buys some mining leases in the Pilbara, is blocked from accessing BHP and RIO’s rail infrastructure, so he builds his own debt-funded railway.  Nowadays, Fortescue is almost debt-free, generates masses of cash every year, and has the lowest C1 production costs in the industry (ore grades notwithstanding).

Why I bought

What excites me the most about FMG is the low price – at $4.84 it is 6x FY17 earnings, for what is a very solid business.  Commodity businesses have disadvantages being price-takers, but that just means you need to be laser-focused on minimising or maximising 1 or 2 key variables – in this case production volumes and production cost.

FMG’s business is very easy to model, and based on a revenue realisation, will be cash flow positive even if we see a 12 month or longer period of sub $40/T prices.  While demand may ebb and flow depending on China and the developing world, there is a huge overhang of expensive production that can’t keep producing at a loss forever.  FMG’s position as the lowest C1 in the world gives it a strong moat, off the back of a huge infrastructure and supply chain that is already in place.

While they aren’t going to double production overnight, at 6 times earnings I’m happy for them to keep punching out $3-4B every year of free cash flow, particularly when then debt is fully repaid and FMG rolls on as a money-printing machine.

Risks

Safety

Safety is top of the list for mining companies, and FMG’s TFIFR has improved dramatically over the past few years.  There is no reason to assume they are any more exposed than other mining majors to safety risks

Long-term drop in IOP

I see this as the biggest risk, more to medium-term cashflow than the viability of the business.  There is likely to be impact when Vale ramps up to 90mT of new production from their 66% Fe S11D mine next year.  Due to the long lag between new mine development, you get periods of very high prices and periods of very low prices.  Due to FMG’s position as a low cost producer, they will be able to weather any storm.

Production interruption

An obvious risk that would seriously impair earnings.

Poor deployment of excess Capital

I am concerned about FMG’s desire to explore new mine opportunities in Gold and Copper tenements in NSW, SA and Ecuador.  Admittedly I am not an expert on the mining industry, but I would have thought that it makes more sense to either buy back shares or return excess capital back to shareholders than it does to focus on non-core exploration.

Ore Grades

FMG’s ore is 58% vs the Australian Benchmark of 62% and Vale’s S11D of 66%.  This means FMG sells their ore at a discount to the benchmark rate which results in a revenue realisation of 75-80%.  The risk is mills in future want higher grade ores or negotiate for greater discounts (this could also go the other way if new mill technology allows producers to get better results with low-grade ores).

Summary

While FMG has a few minor flaws and is in a competitive industry, their cheapness justifies making this a part of my portfolio.

Thanks largely to Kogan, my first full quarter running my SMSF was an absolute cracker.  The portfolio finished up 21.6%* against the benchmark (The Vanguard ASX300 index) of 0.77%.  Without Kogan, performance still would have been a respectable 4.52%.

I don’t have any big plans to add anything new, but will add to my portfolio if stocks I already hold become cheaper, or if something well-priced appears on my radar.

Here is my current portfolio breakdown:

KGN 28.6%

JIN 3.7%

AVJ 18.9%

REH 15.5%

DTL 1.8%

DDR 4.1%

FMG 4.1%

ST1 6.6%

Cash 16.7%

I’m aware that almost 2/3 of my total portfolio is concentrated on 3 stocks.  Here is Warren Buffett’s take on diversification.

His business partner Charlie Munger says that the surest way to succeed is to avoid doing dumb things, rather than attempt brilliance.

Some of my dumbest moves this quarter:

Buying FMG because it was so cheap on a P/E basis, without modelling forward P/E based on current IOP (Would not have affected my decision which is why I still hold).

Buying DMP the day before it dropped 20% on earnings release, then tripling the size of my position, before coming to my senses and exiting at a small loss 2 days later, because I realised I should never have bought them in the first place, because they are overpriced based on earnings growth and are borrowing $300m to buy back shares at these prices.

Overloading my JIN position blithely ignorant of the fact that they lacked any significant moat.  I still hold, but it’s now a smaller percentage of my portfolio.

I have high hopes that the mistakes I make over the next 3 months will be better than the previous 3.
*Originally reported as 17.7% in error.  17.7% is the percentage of current portfolio value at quarter end which was profit.  The percentage return on start of quarter portfolio value was 21.6%

One of the key things we need to do if we are to make good quality decisions, is to be aware of our own internal biases and not let them cloud our judgement.  This last 2 months, I’ve really gotten into Charlie Munger’s wisdom (a starting point here).  For the uninitiated, Charlie Munger is Warren Buffett’s friend and business partner.  I’ve collected a number of his quotes, some examples below:

The worst thing to anchor to is your previous conclusion. Do the best you can to destroy your current ideas.

You don’t need to be the smartest or the most diligent to succeed. You need to be a learning machine, and go to bed smarter than you were the night before.

Not many people integrate multiple disciplines. If you do that you’re in a territory with not a lot of competition.

If you want to disagree with somebody, you should be able to state their case better than they can. Otherwise you should keep quiet.

It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folk saying, “It’s the strong swimmers who drown.”

Any single one of the above quotes is enough to make you measurably more successful, and they all refer to certain biases and assumptions we all make as human beings.

I was reminded of that this week when Jumbo Interactive started dropping in share price, presumably off the back of the market becoming more aware of competitive lottery apps.  Jumbo are by no means the lowest cost player, they charge a large premium over The Lott (in the case of Ozlotto, $1.45 per game vs $1.30) and Lottoland charges $1.45 also but offers a $1m bonus on any winning jackpot.

The problem being, while Jumbo is a cash machine, they don’t have a significant moat (They do have an existing customer base and are part-owned by Tatts Group).  Looking at the current market price, I started my decision process in context of my buy price, which should not have been relevant to my decision.  What I should be asking myself is this: Is the company now a buy based on new information? (or in my case, information I always had at hand, but was too blinkered to pay attention to).

I concluded that while I wanted to continue holding JIN, I had too many shares (~10% of my total portfolio), so sold down about 60% of my holding at what was basically breakeven.  It feels good to have gone through a more logical thought process and to have had the self-awareness to make a better decision than I would have normally.  I am learning!