Pushing the edge of credulity

Pushing the edge of credulity

One of my biggest investing edges, I think, is the fact that I come from a working class background. It has also been a drawback more than once, but you have to make your weaknesses work for you to succeed in investing.

Fear not, this is not a ‘plebeian kid makes good‘ cliche where I learn the value of a dollar and that hard work brings honest rewards and how my ancestors used to walk 40 miles to school in the pouring rain after waking up for school at 11pm the night before to feed the 17 dogs (“you could have as many dogs as you want back in them days”) and ride their pushbike instead of kids nowadays who “sit on their bloody phone all day”.

I’m quite different to the rest of my family but one thing I did take away was a thoroughly working class mindset. Which is to say that I think, and at times talk, like a 50 year old tradesperson.

What’s that got to do with the price of tea in China?

One of the ways I like to use this edge is to think about an investment in a practical sense. By which I mean, I imagine that if I explained a company’s business model to a bricklayer or plumber and they said ‘that’s fucked,’ that is a sure sign of a weak point that I need to zero in on. Maybe it’s an unethical or useless business, maybe it’s odd…or just maybe, they called it right and I should avoid it. I have three scenarios to illustrate:

Scenario 1: A Thorn analogue

You may have had a little taste of this thought process in previous posts about Thorn Group Ltd (ASX: TGA) when I thought out loud about the possible customers of this company. For the record I believe that customer demand is fairly reliable; low-income earners buying essentials for the most part. But it’s not inconceivable for a company like Thorn to look something like this instead:

Lending money at very high rates to the dodgiest and poorest borrowers in society so they can buy Xboxes and sound systems. 

I beg your pardon?  Or should that be: “You’ve got fucking rocks in your head, mate.”

Scenario 2: Estia

I came across an absolute cracker a while ago in the aged care sector, where companies like Estia Health Ltd (ASX: EHE) were obviously using Refundable Accommodation Deposits (RADs) and aggressive levels of debt to fund their operations, expansions, and sometimes even dividends.

Residents sell their house, give the proceeds (the RAD) to a retirement home, and move into the home. Rent and food etc is deducted from the RAD and the RAD itself is basically treated as an interest-free loan from resident to aged care company. This means that the RAD is basically due ‘on call’ whenever the resident leaves.

Retirement home operators were using retiree (client) funds as their own money to fund an acquisition rampage and pay dividends to shareholders.

Actually, this is legal and it makes a lot of sense; it was the government’s way of injecting additional investment funds into the sector and encouraging new care facility construction to support anticipated growth in demand in the future. But it didn’t pass the test, the way that companies were spending it and stretching their balance sheet, and I didn’t invest.

Anonymous and evil short-seller findthemoat research published a number of truly outstanding pieces on Estia and (I assume) made a lot of money shorting its shares. You can discover more through the above hyperlink.

Scenario 3: Aveo Group?

I came across a third one that didn’t pass the smell test this week. Actually, it came across me – and everyone else in Australia. I’m talking about Aveo Group (ASX: AOG), of course. It’s also in the retirement business.

This company has $1.5 billion in loans from residents on its books, that appear to be similar to the RAD in structure, i.e., they are due on call (although in truth I only had time for a brief look and I am not sure). This company has also been actively trying to lift resident churn in order to benefit from high exit fees and thus improve its cash flow.

Aveo Group, a retirement village operator with an average resident age of over 80 years, is actively aiming to get 10%-12% of its residents to leave every year in order to improve its cash flows by harvesting very high exit fees from them. 

It also looks as though the company would be plunged into a dire situation if too many residents left and it couldn’t attract new ones, because it wouldn’t be able to repay their deposits.

Say what?

Rocks, heads, the whole 9 yards. Maybe you’ll hear more from me about that one in the coming days.

I own shares in Thorn Group and have no financial interest whatsoever in the other companies mentioned. This is a disclosure and not a recommendation.

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