Australia Updates: DWS & Silver Chef
DISCLAIMER: THIS IS NOT INVESTMENT ADVICE. DO YOUR OWN RESEARCH !!!!!!
Almost exactly 1 year ago I started my exploration into the Australian stock market with DWS Ltd. and Silver Chef.
As some readers know, I didn’t buy DWS (I only put it on my watch list) and bought Silver Chef instead. Now, 1 year later it seems to be that I backed the “wrong horse”:
DWS is up +42,5%, SIV is down -19% (in AUD). So let’s look at DWS first.
DWS Ltd update
DWS released 6M numbers for 2016/2017 a couple of days ago. Overall things look good. EPS increased by +19%, and also margins, which were on a long downward trend, increased again.
For the time being it seems that they have integrated their acquisitions well. DWS currently trades at a 12,3 x earnings which doesn’t look expensive. However with currently around 1,68 AUD they are in the range of “fairly valued” if I believe what I have written last year:
The neutral case assumes stable margins, no growth but a multiple “adjustment” to a level of around 13x P/E which in my opinion would be reasonable. In that case we could double the H1 2016 result to an expected profit of 16 mn AUD times 13 = 208 mn AUD equity valuation, or 1,57 AUD per share.
One could now argue that we are maybe even in the positive case, as both profit and margins seem to have even increased:
In the positive case, I would assume the same margins but more growth and a P/E of 15. Assuming 5% growth p.a. for 3 years (and flat thereafter), I would then see a value of 2,10 AUD per share in that scenario.
But again, that “only” leaves a 20% upside based on my assumptions. Compared to Bouvet, the Norwegian IT consulting company I own, the upside would be higher based on their current multiples (like +50% or so). But maybe Bouvet is already over valued ?
So at current levels, I will not invest as the upside seems to depend on multiple expansion which in my opinion is risky. In the DWS case I was maybe just too slow.
Silver Chef is a different story. After a strong rally of the stock price in Summer 2016 (and without apparent reason), suddenly in November 2016 they released a “shock” press release outlining a cyber fraud case in their quickly growing GoGetta business.
Silver Chef indicated that this would impact the expected profit negatively, both for the first 6 months:
On the basis that the Company intends to provide for the entire Fraud Event at 31 December 2016, statutory earnings is expected to be in the range of $4.0 to $5.0 million after tax, with underlying earnings in the range of $6.3 to $7.3 million after tax.
Consequently, statutory earnings is expected to be in the range of $21.0 to $23.0 million after tax, with underlying earnings in the range of $23.0 to $25.0 million after tax.
This pushed the stock price down from around 11 AUD to 8,40 in mid December. Clearly shareholders didn’t believe in a pure one-off event as the loss in market cap totaled around 94 mn AUD.
Then a few days ago Silver Chef released 6 months numbers and shareholders again were not happy.and the stock dropped close to 7 AUD.
What happened ? 6 month net profit was 4,6 mn, right in the middle of the range provided. Full year guidance remained unchanged:
There is no change to the Company’s full year after tax earnings forecast range of $21 million to $23million, with underlying earnings in the range of $23 million to $25 million, provided in November 2016 post the fraud event..
So let’s look at the information they provided in more detail:
- on a statutory basis, earnings in the first 6M decreased by more than -50% because of two effects: the -2,3 mn losses from the cyber fraud and a one-off positive effect in the last year. Nevertheless, even on an adjusted basis the profit would have been lower than last year
- topline growth was pretty good, especially Canada and New Zealand do well, but are still relatively small but approaching ~20% of total hospitality assets
- they lowered the 6M dividend from 0,17 AUD to 0,129 AUD per share which many investors might not like
The investor presentation provides some more details:
- bad debts increased in hospitality (3% of assets), but losses decreased
- Bad debt at Gogetta increased to ~7%
- overall bad debt is 5,2%
I think some people got spooked by those numbers. What is interesting however is the footnote on page 16:
Group bad debt increased to 5.2% -target range of 4-5%
So Silver Chef is clearly not a lender to high quality credits but rather a “small commercial subprime” lender and bad debt is part of the business. Clearly Go Getta has to improve and one now needs to look if the measures they announced are effective.
One big advantage of Silver Chef is of course that thy can reprice their business quickly. With an average maturity of 22 months, margins should improve very quickly. This is different to a mortgage bank where mispricings on 30 year mortgages will remain on the books for a very long time.
Should they just stop GoGetta and concentrate purely on hospitality ?
Hospitality is clearly the better business. With their experience and their infrastructure they have a clear competitive advantage in Australia and in my opinion also a good chance to achieve this in New Zeeland and Canada. Margins and Returns on capital are higher in the core business.
From the comments and from discussions the major criticism of many investors is that with GoGetta Silver Chef is “diluting” its margins and returns and that this is clearly value destroying.
Without knowing if GoGetta ultimately succeeds I think the underlying argument is wrong. Why ?
If a company allocates capital, value for shareholders increases if the allocated capital earns more than cost of capital. From that perspective it is irrelevant if any new business is better or worse than the existing business. The only thing that counts if you earn your cost of capital plus a margin.
If I believe the above argument, Warren Buffett should not have invested in anything that generates lower returns than See’s Candy. But Buffett the master allocator clearly knows that the returns of your existing business only matters if you can allocate more capital into it. If this is not the case, than the only thing counts is your cost of capital or in Buffet’s case the opportunity cost when you allocate capital.
In Silver Chef’s case they clearly had exhausted to a certain extent their ability to invest much more into the Australian hospitality business and decided to start new businesses. Despite the current issues at GoGetta at the moment , there seems to be demand for their product and I think there is a decent chance to turn things around.
Also their other two growth options are looking promising despite being at an early stage.
In my opinion this shows that the company has a lot of entrepreneurial energy trying to grow those businesses organically. The easier and quicker way is clearly to do a lot of M&A. With M&A you can show success much more quickly but a lot of value creation is lost for paying out shareholders of the acquired companies.
Silver Chef summary:
Based on what I discussed above and despite the obvious issues, Silver Chef still looks like a great risk/return opportunity in my opinion due to the following reasons:
- the problems are known and in my opinion can be solved relatively quickly
- there are still significant potential growth opportunities for the company
- they seem to do the right things (reducing capital, focusing on the issues etc.)
So for the portfolio I decided (as I already mentioned in the comments of the original post) to double the stake from around 2% to almost 4%.
I could of course be wrong and I am far away from Australia, but I do think that the stock still offers the best risk/return potential of all my current holdings over the next 3-5 years.
DISCLAIMER: THIS IS NOT INVESTMENT ADVICE. DO YOUR OWN RESEARCH !!!!!!