Quarterly Report December, Q2 FY18

Quarterly Report December, Q2 FY18

The December quarter’s gone and the 10foot portfolio is finally starting to move in the right direction, albeit still lagging the market quite badly. I am now around 64% invested and have 36% of the portfolio in cash.

Here’s my performance for the quarter just gone vs my primary index, the XNT. I am up 3% since inception in March 2017, including returns on cash and dividends, vs a gain of 6.4% from my primary index (which also includes dividends reinvested).

And performance versus secondary indices, the XJO and XSO. See that XSO soar:

I am contemplating increasing the value of the portfolio, simply because transaction costs are killing me and I can’t smooth out bumpy prices by averaging into a position. I don’t mind volatility per se, except that it does affect my mental processes somewhat when I can’t average into a position.  I will increase the portfolio by between 2x and 4x,  currently undecided.

With the portfolio starting to ‘mature’ a little, in a year or two it may become important to start reporting returns on a time weighted basis which is something I’ll look at.

Asset Allocation:

The % allocations will change with the size of the portfolio (below). Overall I’m pretty happy with it so far, although if I had a choice I’d like to increase Oliver’s and Just Group’s weightings as these are somewhat higher conviction positions for me – albeit not enough to double down to 10%, which would be the next step up, given the size of the portfolio.

Volatility and increasing the portfolio size: 

I started with $10,000 in capital, so the effective 3% brokerage ($14.95) on a $500 position (the minimum size purchase) is killing me. So is the minimum 5% position size, as some holdings realistically should not be 5% positions. This limits my ability to average into an investment, and also prevents me from strengthening/trimming a position as the thesis plays out. Thus, rather than taking a 0.5%-1% starter position in many stocks (as I’d prefer) I’m risking 5% of capital on a starter thesis. That would be OK if I were hitting genuine compounders, but I’m not. I will have a formal update on the portfolio size increase when it occurs.

I am also looking into changing broker, but it seems as though there are none that have all the features I want. Interactive Brokers is current shaping up as the best and cheapest. Some others like CMC aren’t really cheap enough to justify switching. Optionsxpress (now Schwab AU) has prohibitively high application requirements. With Schwab and IB, the fees also appear to be in USD. Do readers have a broker they recommend?  I need a solution that’s cheap and can trade a range of international markets as well as the ASX.

Anyway, here’s what I think of my stocks so far:

Eureka Group Ltd (ASX: EGH) – down 4%

Eureka Group changed Chairman following some shareholder activism. It also received approval for its Terranora redevelopments. I think Eureka is cheaper than it appears, given the value to be unlocked by the sale of Terranora and divestment of one (hopefully soon to be all) of the aged care homes. However, the investment is not going to plan. Costs appear to be climbing, even after accounting for additional investment in Terranora (which was included in operating costs). For example this year, EBITDA is forecast to be between $9.5m-$11.5m, including $2m-$3m of Terranora apartment sales.

Excluding Terranora, therefore EBITDA would be $6.5m-$9.5m plus whatever the cost of investing in Terranora was (say $2m?). This compares to $9.4m in FY17, despite acquiring several new properties. I had expected if anything there would be slight margin expansion. Recycling of capital is expected to generate up to an additional $4m in annualised EBITDA once used for acquisitions. This won’t be for a couple of years, but using the FY18 guidance it suggests Eureka could earn between $10.5m and $13.5m in EBITDA, pricing the company on an EV/EBITDA of 9.5x-12x – not exactly cheap. I continue to hold.

Probiotec Limited (ASX: PBP) – up 53%

Probiotec shares ran hard this quarter, rising some 50% after the acquisition of South Pack. This is a dilemma as the company has moved up the risk scale somewhat, given a poor historical record of acquisition as well as debt + working capital requirements. The company unfortunately did not really benefit from multiple arbitrage, as it issued Probiotec shares priced at ~6x EBITDA to buy a business priced around 5x EBITDA. Offsetting this are management reports of strong sales, forward demand for contract manufacturing, and potential further benefits to come from increased capacity utilisation at the factories.

Uncertainty has increased. However at $0.80, Probiotec was still somewhat below my estimate of fair value (estimate has become less certain due to the acquisition), growing its earnings, and I continue to hold. I wrote about the latest developments at PBP in more depth here.

I didn’t include this info in the linked post, but I purchased a second lot of Probiotec shares, buying 600 for an average of $0.885 including brokerage. My total holding of Probiotec is 1800 shares at a total cost of $1055.90, for an average price of $0.586 including brokerage.

I also forgot to disclose my voting preferences in that post, but FD I will be voting in favour of the options grant to management at the upcoming EGM.

Crowd Mobile (ASX: CM8) – down 9.6%

I have lost some conviction in Crowd Mobile after the recent CEO share sale and decision to stop reporting quarterly. A strong update at the AGM was somewhat encouraging. The digital influencer space is a legitimate opportunity, but it remains to be seen whether this company can benefit. I also made a procedural error in not selling at $0.23-$0.24, despite having ample opportunity. These prices were below my IV estimate, but the additional prospective returns (from reaching IV) were probably not attractive on a time-weighted basis. Now back below my buy price, Crowd is not expensive and I continue to hold.

NGE Capital Ltd (ASX: NGE) – down 6%

NGE Capital is basically flat in line with NTA, as strong gains in its largest position, Mineral Deposits (ASX:MDL) were offset elsewhere. Godfrey’s (ASX:GFY), an NGE holding, kept falling after a disappointing # of company store to franchise conversions. Godfrey’s looks astonishingly cheap IF you assume that the company will be around for more than a few years, and can convert more stores to franchises in time. Eureka Group shares, which NGE also holds, were flat as you saw above.

I remain confident in NGE’s holdings and previously researched Godfrey’s as a possibility for the 10foot portfolio, but declined to invest. I am comfortable with a small indirect allocation to Godfrey’s via NGE, however (my minimum 5% position size made GFY unsuitable for 10foot).

NGE’s NTA is around 61 cents and its discount to NTA of ~27% remains constant. Over time I think NGE will deliver, and I continue to hold.

Mayne Pharma Group Ltd (ASX: MYX) – up 2%

Mixed performance. Shares were basically flat and US generic sales fell 12%, further than I expected, partly due to one-off returns of branded drugs. Restructuring costs are also likely to impact the bottom line and I don’t see shares recovering this year. However, there were some positive green shoots at the recent AGM, and overall I still believe the business is undervalued. I continue to hold.

Just Group plc (LON: JUST) – up 10%

Revenue growth at Just Group this year has been flat so far, as the company focuses on profitability rather than growing market share. This should still continue to create value by growing the investment book, but it does mean growth could be slower than otherwise. Just is effectively an insurer, so the focus on profitability should generally reduce the risk, and this is one of my higher conviction positions. I think it is quite well managed and it takes significant discipline to resist attempting to grow market share in a market (Defined Benefit de-risking) that appears set for a huge boom.

On a related note, I’m looking for UK superannuation wealth managers (and/or doing rain dances to encourage Just Group to buy a boutique fund manager) to add to the portfolio so if you know stuff about this, get in touch. I think UK Fin Services is a genuine structural opportunity and would enjoy the opportunity to have a discussion with somebody who has looked at the space.

Oliver’s Real Foods (ASX: OLI) – down 21%

There were some savage share price falls at Oliver’s during the quarter (largely recovered now) and I have learned another painful lesson about patience. When I first purchased OLI, my order sat at $0.18 for weeks until I lost patience, and moved it up to $0.22, missing the opportunity to buy shares as low as $0.16. I also could not average down because of the small size of the portfolio, as Oliver’s is currently not worthy of a 10% position. With the portfolio increasing in size, I will be prepared to buy more if there are any falls in the future.

On the business front, there was a pleasing $1.4m positive improvement in OCF at the latest quarterly, going from negative to break-even sooner than expected. Front of house execution + customer satisfaction remains a key risk and is more important (but harder to evaluate) than the financials alone. The next few quarters will be vital, and I continue to hold Oliver’s.

Undisclosed position (ASX:XYZ) – up 10%

A certain event I was waiting for occurred, resulting in a 23% decline on my initial purchase. This is a positive, and within the parameters of my strategy, as you will see in time. In response to the falls I bought a bunch more shares. I am now currently up around 10% overall on this position.

This company is currently ~19% of the 10foot portfolio, although I am looking to increase the size of the portfolio, so I expect it will be around a 7%-10% position following that. I have an eye to buying more shares over the next ~two months if significant holders sell down as I hope. Low liquidity could push shares to stupidly cheap prices if I’m lucky and, while I am ready to disclose this position,  I won’t be doing so until after I see if that sell down is going to occur (over the next 1-2 months, perhaps).

I had expected to witness total capitulation from shareholders already, which has frustratingly not played out in the share price. I shopped this idea around to a few small fund managers after I bought my initial stake, so I have wondered if they have been buying. None of them were particularly interested in the idea initially – not a good sign – and the volumes + their monthly/quarterly updates don’t seem to suggest any big buyers, but I am at a loss to explain the activity. Maybe the thesis is obvious, shareholders are keen and the market is already efficient, which would have annoying implications for the value of this company.

Anyway, I am in the rare position of actively cheering my stock lower (because I have a strong thesis), and I find that I like it.

Google Finance

Finally, Google Finance is shutting down its Portfolio function in what will prove extremely inconvenient for the 10foot investor. This is probably the last quarter where I’ll be able to give performance charts like the above. In the future I will have to record the values of the index and the portfolio at each quarter and build my own.

Until next time.

I own shares in Eureka Group, Probiotec, Crowd Mobile, NGE Capital, Mayne Pharma, Just Group, Oliver’s and an undisclosed company. This is a disclosure and not a recommendation.