During my research and screening processes I look for three different styles of potential share market investment opportunities:
- Great companies at a fair to discounted valuation.
- Solid cyclical companies at a large discounted valuation.
- Asset Plays – Companies trading at a large discount to their tangible assets.
This is my order of preference, with great companies at the top of my list, cyclical companies second and asset plays third. The reason for this is a great company should keep churning out large profits well into the future, a cyclical company as the name suggests will require you to keep an eye on the cycle and price more closely, and an Asset Play will be an investment you usually sell within 3-5 years once the market has realised it’s value or not.
All three styles all based on a value investing framework and my goal is the same for each: ‘To produce long term compounding annual returns over 15% (preferably 20%).’
A Quick Look
Whilst recently screening for companies I took a quick look at Capilano Honey (CZZ), Silver Chef (SIV) and Spotless Group (SPO).
Here are my notes on each:
Capilano Honey (CZZ)
What looked good about Capilano:
- Solid earnings growth – $0.311 (2013), $0.374 (2014), $0.905 (2015) and $1.102 (2016)
- Decent return on capital – 8% (2013), 11% (2014), 22% (2015) and 15% (2016)
- Increasing operating margins – 10% (2013), 9.2% (2014), 11.1% (2015), 12.1% (2016).
- A well known brand name in Australia.
- A Managing Director who has been with the company for 10 years and has a PhD in a field of study related to the bee industry.
- The company appear to have handled a recent slander campaign attack quite well, maintaining constant calm and consistent communication on their social media channels and sticking to the facts. I think they handled a difficult situation well.
- China – Australia’s high quality standards appear to be a winner for Australian food and vitamin producers. Their is a large potential market share here if the brand is managed well.
- The share price is down slightly of late.
Further thoughts about Capilano:
- I noticed that the Shares Outstanding went up by about 10% in 2016 and upon further research found out CZZ conducted a 1 for 10 Rights Issue which resulted in an extra 860,360 shares and $16.7 million in capital.
- Capital raising’s make me a little cautious. My feeling is a great company should spin off enough cash to more than cover their own requirements, plus further investment. The only time I do like to see a capital raising is when a great company is raising more funds to buy another great company and even then I am cautious.
- Capilano’s reasons for raising were:
- strengthen the balance sheet by reducing debt and provide flexibility for further acquisitions;
- help fund the acquisition of beekeeping enterprises;
- increase working capital to support business growth and new export sales;
- allow capital investment in selected production efficiency upgrades and new product capabilities;
- provide a dedicated marketing budget to support new product development and export growth.
- These reason’s make me a little cautious, especially raising capital to pay down debt.
- I would like to look deeper into the cashflow statement and also run the numbers on return on retained earnings to get an idea of how strong this business is.
- As well known as the Capilano brand is in Australia I would like to look further into their main ‘supermarket shelf’ competitor Beechworth to ensure Capilano can edge out a competitive advantage; and what that advantage is?
- Is honey just a commodity? Consumers will pay an extra 30 – 50% for a Mars bar as compared to a replica Mars bar. How much difference does a brand make with honey?
- The share price still seems a little high for me at the moment, so I would have to run the numbers more thoroughly to determine a price that provides an opportunity to meet my return goals and allows for a margin of safety in my buy price.
Silver Chef (SIV)
What looked good about Silver Chef:
- Solid earnings growth – from $0.109 in 2007 to $0.96 in 2016.
- Decent return on capital – consistently around 10 – 13%.
- Large operating margins – between 57 – 72%.
- On the surface the main numbers I first screen for (Earnings growth, ROE & ROC and operating margin) look impressive.
Further thoughts about Silver Chef:
- The initial numbers looked impressive, however the next set of numbers I look into (Debt / Equity, Interest cover and Shares Outstanding) turned me off.
- Debt / Equity – from 148% – 278%. Anything over 30-50%, depending on the business, makes me cautious.
- However, this business makes money by lending money, so it is going to have a higher Debt / Equity rate. So I next looked at the businesses potential to cover their interest payment obligations.
- Net Interest Cover is currently -5.47.
- I have not looked deeply into the SIV cashflow statement, but on the surface this number tells me SIV needs to either borrow more or raise capital to fund its interest payments. Even if this number has been effected by a one off item, it still means it is too close for me.
- Shares Outstanding – It does appear that their have either been capital raisings or SIV have been ] very generous with their executive incentives. Shares Outstanding have more than doubled from 15.8 million in 2007 to 35.2 million in 2016.
- These three numbers may not be telling me the full story and there may be justifiable reasons for them, but on the surface they look like a very slippery slope. I’ll pass on this one for now.
Spotless Group (SPO)
What looked good about Spotless Group:
- Caught my eye because the share price is down 50% since Nov 2015.
- Currently trading on a low PE Ratio of 8.92.
- Decent return on capital – consistently around 10 – 11%.
- Shares Outstanding have not been increased since 2013.
- New CEO keen to ‘upgrade’ Spotless’s service with investment in technology and efficiencies.
Further thoughts about Spotless Group:
- Business model appears to be very reliant on labour.
- Requires very skilled management to motivate and keep quality labour to do the jobs required of Spotless Group.
- Debt / Equity currenlty at 102% wouldn’t allow me to sleep well at night with this particular business.
- I’m not a big fan of turn around stories, as Warren Buffett once said, ‘Turnarounds seldom turn.’
- If the share price continues to fall I may take another look, but for now the risks don’t weigh up for me.
Out of these three companies I will only look further into CZZ, initially to make a rough valuation and then potentially a full research Checklist. The other two I will keep in mind, but I won’t do any further research at the moment.
Enjoy the ride!