Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger

There is no better way to set the stage for this book than by providing you with one of my all time favorite quotes:

History doesn’t repeat itself, but it does rhyme.

– Mark Twain

crashesOne book that gives detailed proof of this statement is the classic Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger. As explained by the subheading, the book is a collection and review of all financial crises that this world has experienced. Moreover, the book provides a very good overview of the stages and the common threads of these crises but also the lessons that can been drawn from them.

Although I’m not a top-down investor, staying away from macroeconomic analysis and forecasting, I still consider Manias, Panics, and Crashes one of the most important books to read as an investor. This is especially true if you have little or no real life experience of being an investor during a crises. As many times before, my thoughts about this subject has been influenced by one of my favourite investors, Howard Marks. Therefore, in connection to reading this book I urge you to read his memo ‘You Can’t Predict. You Can Prepare.‘ and especially note the following two paragraphs:

In my opinion, the key to dealing with the future lies in knowing where you are, even if you can’t know precisely where you’re going. Knowing where you are in a cycle and what that implies for the future is very different from predicting the timing, extent and shape of the next cyclical move. And so we’d better understand all we can about cycles and their behavior.

So forecasts are unlikely to help us foresee the movements of the economic cycle. Nevertheless, we must be aware that it exists and repeats. The greatest mistakes with regard to the economic cycle result from a willingness to believe that it will not recur. But it always does – and those gullible enough to believe it won’t tend to lose money.

– Howard Marks

Please comment if you have read the book and what you thought of it. Also, if you have found a worldly wisdom in the book that you think I should have included please comment on that as well. I’m very interested in what caught your eye while reading and why.

Worldly wisdom’s from the book

1.

“The thesis of this book is that the cycle of manias and panics results from the pro-cyclical changes in the supply of credit; the credit supply increases relatively rapidly in good times, and then when economic growth slackens, the rate of growth of credit has often declined sharply. A mania involves increases in the prices of real estate or stocks or a currency or a commodity in the present and near-future that are not consistent with the prices of the same real estate or stocks in the distant future. The forecasts that the price of oil would increase to $80 a barrel after the earlier increase from $2.50 a barrel at the beginning of the 1970s to $36 at the end of that decade was manic. During the economic expansions investors become increasingly optimistic and more eager to pursue profit opportunities that will pay off in the distant future while the lenders become less risk-averse. Rational exuberance morphs into irrational exuberance, economic euphoria develops and investment spending and consumption spending increase. There is a pervasive sense that it is ‘time to get on the train before it leaves the station’ and the exceptionally profitable opportunities disappear. Asset prices increase further. An increasingly large share of the purchases of these assets is undertaken in anticipation of short-term capital gains and an exceptionally large share of these purchases is financed with credit.”

(p. 12)

2.

“ Financial arrangements need a lender of last resort to prevent the escalation of the panics that are associated with crashes in asset prices. But the commitment that a lender is needed should be distinguished from the view that individual borrowers will be ‘bailed out’ if they become over-extended. For example, uncertainty about whether New York City would be helped, and by whom, may have proved just right in the long run, so long as help was finally provided, and so long as there was doubt right to the end as to whether it would be. This is a neat trick: always come to the rescue, in order to prevent needless deflation, but always leave it uncertain whether rescue will arrive in time or at all, so as to instill caution in other speculators, banks, cities, or countries. In Voltaire’s Candide, the head of a general was cut off ‘to encourage the others.’ A sleight of hand may be necessary to ‘encourage’ the others (without, of course, cutting off actual heads) to participate in the lender of last resort activities because the alternative is likely to have very expensive consequences for the economic system.”

(p. 23)

3.

“A follow-the-leader process develops as firms and households see that others are profiting from speculative purchases. ‘There is nothing as disturbing to one’s well-being and judgment as to see a friend get rich.’ Unless it is to see a nonfriend get rich. Similarly banks may increase their loans to various groups of borrowers because they are reluctant to lose market share to other lenders which are increasing their loans at a more rapid rate. More and more firms and households that previously had been aloof from these speculative ventures begin to participate in the scramble for high rates of return. Making money never seemed easier. Speculation for capital gains leads away from normal, rational behavior to what has been described as a ‘mania’ or a ‘bubble.’”

(p. 29)

4.

“Yet euphoric speculation with insiders and outsiders may also lead to manias and panics when the behavior of every participant seems rational in itself. Consider the fallacy of composition when the whole differs from the sum of its parts. The action of each individual is rational—or would be if many other individuals did not behave in the same way. If an investor is quick enough to get in and out ahead of the others, he may do well, as insiders generally do. Carswell quotes a rational participant on the South Sea Bubble:

“The additional rise above the true capital will only be imaginary; one added to one, by any stretch of vulgar arithmetic will never make three and a half, consequently all fictitious value must be a loss to some person or other first or last. The only way to prevent it to oneself must be to sell out betimes, and so let the Devil take the hindmost.”

‘Devil take the hindmost,’ ‘sauve qui pent,’ ‘die Letzen beissen die Runde,’ (‘dogs bite the laggards’), and the like are recipes for a panic. The analogy is someone yelling fire in a crowded theater. The chain letter is another analogy; because the chain cannot expand infinitely, only a few investors can sell before the prices start declining. It is rational for an individual to participate in the early stages of the chain and to believe that all others will think they are rational too.”

(p. 47-48)

5.

“Speculative manias gather speed through expansion of money and credit. Most expansions of money and credit do not lead to a mania; there are many more economic expansions than there are manias. But every mania has been associated with the expansion of credit.”

(p. 64)

Follow-up: 11 88 0 Solutions AG (telegate AG)

Q4 2016 – 0,48 € – ETR:TGT

After my thirteen months follow-up I have decided to sell my position in TGT. After brokerage fees and currency effects the return amounted to -51,7 %.

1kr50öre11 88 0 Solutions AG, formerly Telegate AG, is a Germany-based provider of directory assistance and call center services. The Company operates through two segments: Directory Assistance and Digital. The Directory Assistance segment provides services related to inquires made at by phone for information regarding to phone numbers, pre-dial numbers and addresses. The Digital segment receives revenue from advertisements on the Company’s platforms and Websites. The Company also offers online marketing services related to Google AdWords, Google My Business, social media Websites and company profiles on platforms, as well as tools and market analyses, and software for data, address and network management. – Google Finance.

1. The company is currently a net-net with an adequate margin of safety: 

  • P/NCAV < 1x
    • 0,75x ✓ 
      • MoS = 25 %
    • 1,7x (incl. operating leases).

Assessment of margin of safety:

Although the company is still a net-net and makes it through the rest of my checklist I regard the current margin of safety as inadequate. This is based on an assessment of the NCAV-brun rate that is negative for both YoY = -41 % and QoQ = -20 %. In other words, there is a high probability that the NCAV will continue to erode in a quick pace and that the 25 % margin of safety is gone by next follow-up. Also, taking operating leases into consideration the company is no longer to be regarded as a net-net as it is selling at a premium, 1,7x. This is relevant since TGT uses IFRS and the changes to be effective as of 1 January 2019 with IFRS 16 (operating leases are to be capitalized). Based on these notations and that I haven’t found any other value creation catalyst I have decided to sell my position in TGT.

2. The risk of permanent loss is low:

2.1 The risk of bankruptcy is low (criterion a) or b) must be met):

a)

  • Debt/Equity < 25 %
    • 0 % 

b)

  • Z-score ≥ 3
    • 0,2 X

2.2 The company’s business model has historically been profitable (criterion a) or b) must be met):

a)

  • Positive retained earnings:
    • -28M € X

b)

  • Positive aggregate operating income for the last ten years:
    •   118M € 

3. The company does not have a shareholder unfriendly capital allocation:

  • Shareholder yield TTM ≥ -2 %
    • Dividend yield TTM = 0 %
    • Net buyback yield TTM = 0 %
      • =  0 % 

MoS

Disclosure: The author doesn’t own any shares of ETR:TGT when this analysis is published.

The transformation from a hipster-contrarian to a stoic-contrarian.

A while ago I wrote a post here on the blog called Alla är vi värdeinvesterare, men vad är din edge? (that’s Swedish for: We are all value investors, but what is your edge?). My main point of argument was that everyone can be considered a value investor since we all expect a positive return on our investment, i.e. we would never buy something for more than we thought it was worth. What sets investors apart is their definition of value and in what ponds they fish for these values, i.e. where do they find their edge? In today’s post I thought I would continue to put my thoughts about investing philosophy into words but from a slightly different angle. What I thought I would write about today is the concept and importance of applying a ‘contrarian mindset’ in your investing philosophy but also how to apply it in an intelligent and financially sound manner.

The importance of being intentionally different

Wikipedia defines a contrarian as:

A contrarian is a person that takes up a contrary position, especially a position that is opposed to that of the majority, regardless of how unpopular it may be.

While I don’t think this is the complete definition you would want to apply to your contrarian investing mindset, more on that later, it is a good starting point for this blog post. This has to do with the fact that if you have chosen not to index you are, whether you like it or not, a contrarian. This notion splits the active investing population into two camps, the intentional contrarian camp and the unintentional contrarian camp. What sets the camps apart is whether the market consensus is an important factor in their investing philosophy.

Why is this important? No one has given a better explanation than Howard Marks on this point so why not use his explanation:

The price of a security at a given time reflects the consensus value. The big gains arise when the consensus turns out to have underestimated reality, or to have mis-estimated reality. To be able to take advantage of such situations, you must be able to think in a way that’s away from the consensus. You must think different and you must think better. It’s clear that if you think the same as everybody else, you’ll act the same as everybody else, and have the same results as everybody else. – Howard Marks

Note that Howard is not saying ‘different and right’, he is saying different and better‘. 

Superior performance does not come from being right, but from being more right than the consensus. You can be right about something and perform just average if everyone is right too. Or you can be wrong and outperform if everyone else is more wrong. – Howard Marks

The lesson from Howard is that we should try to invest in companies and situations where the consensus has developed disproportional payoffs between downside vs upside, i.e asymmetric bets. From this we also learn and understand that a good company does not in itself equal a good investment and that a bad company is not in itself equal a bad investment. Before we move on I would like to share a tweet that sums it up perfect:

screenshot

Being different (a hipster-contrarian) is not enough

The word and concept of ‘contrarian‘ is nowadays almost as diluted as the notion of being a ‘value investor‘. I’m part responsible for this dilution myself since I have up until recently used the contrarian title to describe my investing style here on the blog and on twitter. The reason why I removed the title is not because I think less of the concept but rather that I have changed my opinion of how to apply it to my investing philosophy. I have to admit that my modus operandi when investing early on in deep value and special situations was that; the market must be wrong in these cases. I now consider this mindset not only stupid but I also relate it to the same mindset that a hipsters applies to his or her everyday life, i.e taking a standpoint that is different from the mainstream for the sake of it being different. Questions regarding why, efficiency and effectiveness is not in focus for a hipster and he or she will most likely leave her knitting (shortsightedness) as soon as it becomes mainstream.

A hipster-contrarian mindset therefore might cause you to end up with a portfolio that although different from the consensus/mainstream is still from an alpha seeking point of view completely wrong. In other words, being different is not enough. We also have to think better as Howard Marks puts it if we are to beat Mr Market. So how do we become a better contrarian then? The short answer is to develop a stoic-contrarian mindset.

How to become a stoic-contrarian

The first step of becoming a better contrarian and developing a stoic-contrarian mindset is to always question yourself; why I’m I right and everyone else wrong, might it not be the other way around? In order to successfully answer this questions the hipster-contrarian mindset has to evolve from applying a first-level thinking framework into a second-level thinking framework. A first-level thinking framework focuses on efficiency (doing things right) before establishing that what we are doing is effective (doing the right things). In his book The most important thing Howard Marks develops the concept of ‘second-level thinking‘. I think most of you have read the book so I’m not going to bore you with the original description (you can find that on Google) but instead show a short clip from one of my favorite comedy series where second-level thinking is brilliantly demonstrated and how we should apply it in order to developing a stoic-contrarian mindset:

The point I would like to make with the clip is that in order to be a stoic-contrarian we have to develop a second-level thinking framework like Phil Dunphy. That is, taking a step back and focusing on that we are doing the right things before we focus on doing things right. This is absolutely necessary in order to answer the why question earlier mentioned and establish that we are not fooling ourselves, i.e. thinking that we are taking a contrarian standpoint but we are actually not.

The first principle is that you must not fool yourself, and you are the easiest person to fool – Richard Feynman

The second step of becoming a better contrarian and developing a stoic-contrarian mindset has to do with improving your self-control and patience. Again, no one has a better explanation of why this is important than Howard Marks:

The more you try to be a superior investor, the more idiosyncratic positions you have to take. Invariably they will be unsuccessful for a while, and you will look worse, and the greater will be the pressures to succumb. – Howard Marks

You have heard it before and I’m going to say it again. There are no free lunches in investing. What you have to pay up for when trying to be a superior investor with idiosyncratic positions is a big portion of emotional and social distress. Buying things that everyone hates or never heard of is not easy, trust me. However, the good side of the equation is that the attractiveness of a stocks is dependent on the how much optimism is in the price. When people are optimistic prices are high in relation to value and when they are pessimistic they are low in relation to value. This is why taking a standpoint that according to the crowd makes you look wrong/stupid in the start will in the end be the only way to be right/smart.

In order to succeed in your self-control of emotional and social distress you have to have an investing philosophy that you believe in, a process that develops a courage in your conviction but maybe even more important; a big portion of patience. Patience does not only relate to investment cases that you have in your portfolio but also being comfortable with the bat steady on shoulder and seeing pitch after pitch go by. One of the hardest things to do is to sit still and even more difficult is to sitt still when other people are making big money. That is, taking yet another contrarian standpoint by not joining the crowd.

Practical hacks for developing a stoic-contrarian mindset

I realize that this approach to investing is not easy, at least I don’t find it easy. But as a very wise man once have said:

Investing is not supposed to be easy, and anybody who finds it easy is stupid. – Charlie Munger

However, there are daily life hacks that in my opinion helps tremendously in improving on the two steps of developing a stoic-contrarian mindset that I have talked about in this post:

  1. Look at share prices and your portfolio as infrequently as possible.
  2. Have a fixed number of investment decisions that you are allowed to do per month/year.
  3. Mediate on a daily basis.
  4. Read and seek worldly wisdom from all fields of science.

I hope you have liked this post and that it was to some form of use. If not I would still like to wish you all a happy Easter!

P & F Industries, Inc. – Q4 2016

Q4 2016 – 6,95 $– NASDAQ:PFIN

1kr50öreP&F Industries, Inc. conducts business through its subsidiaries. The Company operates through two segments: tools and other products (Tools), and hardware and accessories (Hardware). It conducts Tools business through a subsidiary, Continental Tool Group, Inc. (Continental), which in turn operates through its subsidiaries, Florida Pneumatic Manufacturing Corporation (Florida Pneumatic) and Hy-Tech Machine, Inc. (Hy-Tech). Florida Pneumatic imports and sells pneumatic hand tools, most of which are of its own design, primarily to the retail, industrial and automotive markets. It conducts the Hardware business through its subsidiary, Countrywide Hardware, Inc. (Countrywide). Countrywide conducts its business operations through its subsidiary, Nationwide Industries, Inc. (Nationwide). Nationwide develops, imports and manufactures fencing hardware, patio products, and door and window accessories, such as rollers, hinges, window operators, sash locks, custom zinc castings and door closers. – Google Finance.

1. The company is currently a net-net with an adequate margin of safety: 

  • P/NCAV < 1x
    • 0,89x ✓ 
      • MoS = 11 %
    • 0,91x (incl. operating leases).

Assessment of margin of safety:

P & F Industries is an American nano-cap company that was incorporated in 1963 and that up until recently had two business segments, tools and hardware. In 2016 it was announced that the company’s Hardware subsidiary Nationwide Industries had been sold for 22,2M $ as well as its real estate property for 3,8M $. The proceeds from the sale was used to pay down almost all of the company’s debt, initiate a quarterly dividend policy of 0,05 $ per share and to pay a one-time special dividend of 0,50 $ per share. Finally, this Thursday it was announced that the company had acquired Jiffy Air Tool, Inc. for 7M $ (another 1M $ is entitled to the seller if certain profitability thresholds are met). Note that I initiated my position before this acquisition was announced and that the figures I present below are not adjusted for this transaction.

Besides the fact that P & F Industries makes it through my checklist there are four other factors that in my opinion makes the company at the current share price a good addition to a diversified portfolio of net-nets:

1. I would argue that even though the absolute level of NCAV margin of safety is only 11 % it is good enough considering that the burn rate is positive for both QoQ and YoY, i.e. the NCAV margin of safety has been growing.

2. Regarding historical profitability. In the picture below I have tried to demonstrate the company’s historical profitability as if Tool was P & F Industries sole business segment. Note that the ‘Adjustment Hardware general corporate expenses‘ is only correct for the 2015 numbers since I haven’t managed to find earlier years figures. However, I have used the same figure for earlier years to get some sense of the historical profitability. As can be observed in the picture the company has on a Tool business level alone been profitable for most years during the las ten year period. Based on the consistency and the fact that the company today is selling below liquidation value this must be a true oxymoron. Or is it?
operating income pfinIf we put the current enterprise value in relation to the average operating income for the last five and ten years that gives us multiples of 15x (5y) and 22x (10y). In other words, the company is not on a Tool’s operating income level what I usually consider cheap. Also, in P & F Industries Q4 conference call it was announced that they have chosen not to renew their Sears agreement which will result in a loss of 1M $ EBITDA going forward. However, in this context it should be noted that the recent announced acquisition of Jiffy Air Tool will probably help the situation a bit. To what degree I don’t know but I note the following positive sentence from the acquisition announcement: “We anticipate that this acquisition will be immediately accretive to earnings.

3. Regarding ownership structure. Insiders definitely have skin in the game when it comes to P & F Industries as they together own 39,7 % of the company. The CEO, Richard. A Horowitz, alone owns 36,1 %. Also, in relation to his total compensation (1,5M $) it seems that the CEO eats his own cooking as his stake in the company is currently worth ~6,x that amount (9,5M $). However, a total compensation of 1,5M $ annually for a CEO of a 25M $ company can also be questioned. One large shareholder (12,9 %) that has addressed the problem with compensation and that also keeps pushing for more shareholder friendly actions such as buyback programs is the activist Lawndale Capital Management (Andrew Shapiro)For those of you that have read my earlier analyses will know that I like having an activist investor involved in the company’s that I invest in.

4. Regarding hidden real estate value. In their latest 13D Lawndale also make an interesting note: “Lawndale believes the public market value of PFIN is undervalued by not adequately reflecting the value of P&F’s business segments and other assets, including certain long-held real estate.” On this note I conclude that the company owns’ a 72,000 square foot plant facility located in Jupiter, Florida and a 51,000 square foot plant facility located in Cranberry Township, Pennsylvania that together is valued at 5M $ on the company’s balance sheet. Also, the company has 1,6M $ worth of land on its books. This is interesting since their 56,250 square foot plant facility located in Tampa was just sold for 3,8M $. Therefore, I finally would argue that the P/TB multiple for P & F Industries of 0,67x shows a better picture of the current margin of safety in the company then what can be observed from a strict net-net point of view.

2. The risk of permanent loss is low:

2.1 The risk of bankruptcy is low (criterion a) or b) must be met):

a)

  • Debt/Equity < 25 %
    • 0,2 % 

b)

  • Z-score ≥ 3
    • 4,9 

2.2 The company’s business model has historically been profitable (criterion a) or b) must be met):

a)

  • Positive retained earnings:
    • 36M $ 

b)

  • Positive aggregate operating income for the last ten years:
    •   9,9M $ 

3. The company does not have a shareholder unfriendly capital allocation:

  • Shareholder yield TTM ≥ -2 %
    • Dividend yield TTM = 9 %
    • Net buyback yield TTM = 1 %
      • =  10 % 

MoS

Disclosure: The author is long NASDAQ:PFIN when this analysis is published. Also note that NASDAQ:PFIN is a nano-cap stock (25M $ in market capitalization). The trading is illiquid.

Clarius Group Limited – H1 2017

H1 2017 – 0,095 A$– ASX:CND

1kr50öreClarius Group Limited is engaged in the provision of permanent, contract and temporary employment services. The Company operates in two segments: Recruitment Services, which is engaged in the provision of recruitment services (permanent and contract placements), and Information Technology Services, which is engaged in the outsourcing and technical support services. It works with a cross section of employers in Asia Pacific, placing job seekers in contract, temporary and permanent roles at all levels. It helps government and private sector organizations source permanent, temporary and contract workers, placing all levels of seniority in various specialty areas, such as accounting, administration, customer service, engineering, information management, information technology (IT), and sales and marketing. It works with organizations throughout Australia, providing talent for short-term engagements and augmenting user’s in-house programs to execute IT projects. – Google Finance.

1. The company is currently a net-net with an adequate margin of safety: 

  • P/NCAV < 1x
    • 0,49x 
      • MoS = 51 %

Assessment of margin of safety:

Clarius Group is a small Australian net-net that is focused on employment and recruitment services in Australia and China. If you are interested in a good overview of the company and its business operations I recommend looking at the 2016 AGM presentation as I won’t go into any details here. Although I like the typical Graham net-nets, Coventry Group for example, I’m also a big fan of what famous net-net investor Jeroen Bos calls “cyclical service shares” in his book Deep Value Investing. If you want a explanation why these are interesting types of net-nets to look at here is an interview with him on the topic. Besides the fact that I like ‘service net-nets’ and that Clarius Group makes it through my checklist there are three other points that in my opinion makes the company at the current share price a good addition to a diversified portfolio of net-nets:

1. Regarding NCAV margin of safety in relation to NCAV-burn rate. I would argue that there is a good enough spread between Clarius Group NCAV margin of safety of 51 % and the NCAV burn rate for QoQ (-6 %) and YoY (-16%). As a general rule of thumb I like to see that NCAV-margin of safety / NCAV-brun rate > 3x. Clarius Group have the following NCAV MoS/Burn-rate multiples, QoQ = 8,5x and YoY = 3,2x.

2. Regarding historical profitability. Clarius Group have posted negative figures on an operating income level for the three most recent years. However, looking further back in time the company posted positive figures during the period 2013-2007. If we take the average operating income over the last ten years in relation to the current enterprise value that gives us a multiple of 1,4x. In other words, if Clarius Group can get back to some form of historical average operating income profitability level the company is at the current share price a real steal. Also, note that Clarius Group net income (and retained earnings) has been hit hard in recent years as a result of recurring impairments of goodwill. In other words, taking a free cash flow perspective we get a similar picture of Clarius Group profitability as we got with the operating income measurement. The average free cash flow over the last ten years in relation to the current enterprise value gives us a multiple of 2,9x.

3. Regarding ownership structure. One similarity with my most recent addition to the net-net portfolio, Coventry Group, other then the fact that both are Australian companies can be found via their shareholder lists. Both companies are in fact owned by the Australian activist fund Sandon Capital. While it may first seem that Clarius Group is a much smaller position for Sandon (1,5 %) that is not a fair presentation of their entire ownership in the company. According to a statement of ownership Sandon Capital have in fact control of 11,33 % of Clarius Group via different companies. In addition, Sandon Capital is not the only interesting shareholder on the Clarius Group shareholder list. Just recently another value focused fund, Collins St Value Fund, increased their position from 7,25 % to 8,56 %. Also, the largest shareholder of Clarius Group with an 25,3 % ownership through the company Ego PTY Limited is a private investor know as Victor John Plummer. Although he has not made an fantastic investment so far on his position I recommend reading this article from 2012 about him and the big position he has acquired in Clarius Group. Finally, although management doesn’t have any real skin in the game (< 1 % ownership) two directors have recently bought reasonable amounts of shares (Gabrielle Trainor and Garry Sladden) in the company. To summarize and conclude, the current ownership structure of Clarius Group will probably protect minority shareholders interest better than in most companies. On this point it should be noted that the company has recently appointed a new CEO and CFO and there has also been some changes on the board of directors. If this is an effect of activist shareholder pressure I can only speculate.

2. The risk of permanent loss is low:

2.1 The risk of bankruptcy is low (criterion a) or b) must be met):

a)

  • Debt/Equity < 25 %
    • 0,6 % 

b)

  • Z-score ≥ 3
    • 2,8 X

2.2 The company’s business model has historically been profitable (criterion a) or b) must be met):

a)

  • Positive retained earnings:
    • -63,5M A$ X

b)

  • Positive aggregate operating income for the last ten years:
    •   49,9M A$ 

3. The company does not have a shareholder unfriendly capital allocation:

  • Shareholder yield TTM ≥ -2 %
    • Dividend yield TTM = 0 %
    • Net buyback yield TTM = 0 %
      • =  0 % 

MoS

Disclosure: The author is long ASX:CND when this analysis is published. Also note that ASX:CND is a nano-cap stock (6,5M $ in market capitalization). The trading is illiquid.

Coventry Group Ltd – H1 2017

H1 2017 – 0,66 A$– ASX:CYG

1kr50öreCoventry Group Ltd is engaged in trade distribution, including distribution and marketing of industrial fasteners, stainless steel fasteners and hardware, construction fasteners, specialized fastener products and systems, and associated industrial tools and consumables, and importation, distribution and marketing of hardware, components and finished products to the commercial cabinet making, joinery and shop fitting industries; gasket manufacturing, and fluids business, which includes installation of fire suppression systems, and rock hammer service and repairs. The Company’s segments include Trade Distribution, which includes the importation, distribution and marketing of industrial fasteners and associated products, and cabinet making hardware; Fluids, which includes the design, manufacture, distribution, installation and maintenance of lubrication and hydraulic fluid systems and hoses, and Gaskets, which includes manufacturing and distribution of automotive and industrial gaskets. – Google Finance.

1. The company is currently a net-net with an adequate margin of safety: 

  • P/NCAV < 1x
    • 0,48x 
      • MoS = 52 %

Assessment of margin of safety:

Coventry Group is one of those classic Graham net-nets that you come across once in a while, its simple and boring. Distributing fasteners and other small parts to the construction and mining industry in Australia is no rocket science business model to say the least. The company consists of three segments, Trade (61 % revenue), Fluids (30 % revenue) and Gaskets (9 % revenue) where the two smaller segments are profitable. The third and largest segment Trade is struggling and the reason why the company’s overall profitability is currently negative. Besides the fact Coventry Group makes it through my checklist there are four other points that in my opinion makes the company at the current share price a good addition to a diversified portfolio of net-nets:

1. Regarding margin of safety in relation to NCAV burn rate. Coventry Group is today selling at a large margin of safety to NCAV, 52%. The relationship between the margin of safety and the NCAV burn rate for QoQ (-12 %) and YoY (-18%) is good enough for me to conclude that there is enough gas in the tank to keep the ship going for a while at current speed.

2. Regarding historical profitability. Except for the three most recent years Coventry Group has historically posted good figures on an operating income level. The average operating income over the last ten years in relation to the current enterprise value gives us a multiple of 6x. While this is not extremely appetizing it should be noted that the company is currently focusing on cutting cost and restructuring the Trade operating segment. In combination with hopefully some form of mean reversion for the mining industry I think there is a good chance that Coventry Group again will be a profitable company on a consolidated basis. On this note it should also be taken into consideration that Coventry Group has a couple of solid and profitable businesses that could be sold at reasonable multiples if the company was broken up. In other words, from a sum-of-part perspective I would also argue that there is good margin of safety in Coventry Group.

3. Regarding capital allocation. Coventry Group has over the last ten years continuously paid a good dividend to shareholders and for most of the years simultaneously bought back shares.

4. Regarding ownership structure. Although insiders don’t have any real skin in the game (owner of 1 %) there are two activist shareholders, Sandon Capital (owner of 6,1 %) and Dorsett Investment (owner of 3,6 %), that have been successfull over the last couple of years putting pressure on the management team and encouraging the return of excess cash (link 1, link 2). Because they are still owners of Coventry Group I would argue that they will continue to push for shareholder friendly outcomes.

2. The risk of permanent loss is low:

2.1 The risk of bankruptcy is low (criterion a) or b) must be met):

a)

  • Debt/Equity < 25 %
    • 13,5 % 

b)

  • Z-score ≥ 3
    • 1,9 X

2.2 The company’s business model has historically been profitable (criterion a) or b) must be met):

a)

  • Positive retained earnings:
    • -33,9M A$ X

b)

  • Positive aggregate operating income for the last ten years:
    •   48,4M A$ 

3. The company does not have a shareholder unfriendly capital allocation:

  • Shareholder yield TTM ≥ -2 %
    • Dividend yield TTM = 3,8 %
    • Net buyback yield TTM = 0 %
      • =  3,8 % 

MoS

Disclosure: The author is long ASX:CYG when this analysis is published. Also note that ASX:CYG is a micro-cap stock (20M $ in market capitalization). The trading is illiquid.

Follow-up 2.0 Kingboard Copper Foil Holdings Limited

Today the announcement from the supreme court of Bermuda was made public. If you want some background to this legal process and Kingboard as a company see my earlier published checklist analysis post and follow-up & special situation analysis.

The Board wishes to update the Shareholders that the Court of Appeal of Bermuda had allowed the appeal and found in favour of the majority shareholders that have filed the appeal (the “Appellants”). A written judgment in respect of the appeal had been issued on 24 March 2017 (the “Appeal Judgment”). The judge deciding the appeal found, among other determinations, that the entry into the license agreement by the Company’s wholly-owned subsidiary, Hong Kong Copper Foil Limited, and Harvest Resource Management Limited (the “License Agreement”) was not oppressive conduct and did not unfairly prejudice the minority shareholders of the Company. It was also decided that the costs of the appeal and the court proceedings below are awarded to the Appellants.

This outcome of the legal process is not what I had expected, I must admit I’m really surprised. But when you are wrong the only thing to do is to admit that you were wrong and then review the current situation and any new facts that have been presented. So what do I do now?

The tender offer 0,40 SGD per share is still active and the intention to take the company private hasn’t changed. This morning the shares traded between 0,40 – 0,41 SGD. So the interesting question that I had to answer was: is there any upside left or should I sell today?

There might be some upside left due to the fact that the independent financial adviser has not yet commented on the 0,40 SGD buyout offer. However, because of the outcome of the court case in favor of the majority shareholder I believe there is now a much smaller chance of that review resulting in an increased buyout offer than I had predicted before. Reason being that it could earlier be argumented that the valuation of the tender offer as a premium to historical share price was a really bad staring point of valuation since Kingboards shares had traded at depressed levels because of the ongoing legal process and unfairly prejudice of minority shareholders. While I still think that historical share prices are not a relevant staring point for any valuation the premium can now arguably be seen as more “fair” than before as a court case didn’t find that minority shareholders had been mistreated (i.e less reson for the financial advisors to come up with a different valuation).

Another factor that might result in potential upside relates to the problem for majority shareholders to acquire enough shares to take the company private. So there might be an increased share offer price in order to succeed with this intention. There might even be a legal shareholder fight regarding the current buyout price being to much of a low ball offer. But again, because of the outcome of the legal process I have a hard time making an argument for this as a likely and successful outcome for minority shareholders. We also have the time factor to take into account as this can easily result in a another drawn out legal process.

To summarize and conclude, the court case announcement was both surprising and unfortunately really negative in relation to my predictions made in the special situation analysis. My main argument then was that all shareholders would likely to be bought out at the same price as the minority shareholders (‘the Pope entities’) as a result of the Bermuda court case. As a result of todays announcement we now know that my assumption and analysis was wrong and that it is now less chance of an increased buyout price. Therefore I decided to sell my entire position in Kingboard this morning at 0,405 SGD. I could of course have waited and tender my shares at 0,40 SGD at not transaction cost, but at a price of 0,405 SGD the transaction cost are already “included”. Also, selling today equals better CAGR on the investment but probably the most important factor of all; it saves me all the potential headaches that could arise with a Singapore-tender-offer in combination with a low cost focused stockbroker.

After brokerage fees and currency effects the return in Kingboard for my initial net-net position amounted to +45,7 %.

After brokerage fees and currency effects the return in Kingboard for my later initiated special situation position amounted to – 5,5 %.

Disclosure: The author doesn’t own any shares of SGX:K14 when this analysis is published.