Portfolio Performance

The aim of this post is to present the performance of the fund and discuss why some of the stocks in the portfolio have added or detracted from fund performance. I hope not to bore you with the details so I try and limit the discussion and analysis to a relatively minimal level given the purposes here. It is very important to understand that the quoted fund returns do not account for cash that is invested elsewhere - in term deposits for example. This overestimates the returns. If the cash return was factored in, the returns quoted below would be lower. I hope you enjoy it.

The preceding five months ending 22-7-16 have been interesting to say the least from a portfolio perspective. Stock specific news, market volatility and portfolio movements have led to a somewhat distinct result. Pleasingly, the portfolio added +19.46% in the five month period net of all fees and transaction costs but before taxes, representing an annualised return of +53.24%. If this theoretical annualised return were to eventuate, it would take the portfolio’s annualised return since inception (a 3 year period) to +25.97% per annum or a total return of +99.89%, net of all transaction costs and fees but before taxes.The actual return since inception to date (i.e. ~2.4 years) is +20.12% per annum, net of all transaction costs and fees but before taxes.

As usual, we will discuss the positions and actions which detracted value from the portfolio first. The biggest detractor from performance was selling out of Mineral Resources (ASX:MIN) too early. Despite it adding significantly to the performance, the detraction is derived from the fact that since selling out the price has risen substantially and so this represents an indirect cost. Unfortunately, the position got exited before the major rush of investor optimism toward the current fad, Lithium. While I believe the business is still undervalued, I made the mistake by giving into pressure and not controlling my temperament, costing the fund approximately 8% of gains (to the 22-7-16) on top of the aforementioned 19.46%. It’s important to reflect on mistakes in order to progress. The proceeds have been invested in a business which I believe offers significant risk-adjusted returns over the next three years. Despite this, it was a choice with which there is a high degree of discontent.

The other major detractor was Sirtex Medical (ASX:SRX). Earlier in the year, Sirtex made an announcement stating that it expects its dose sales growth to not remain at the near 5 year historical growth rate of ~19.7% but rather slow to 15-17% on the back of weakness in Europe and Asia despite strength in the US, which represents ~70% of its dose sales. EU and Asia experienced weakness as reimbursement funding was delayed. Subsequent to this market release, Sirtex confirmed actual dose sales growth of 16.4% for FY16.

I am still a believer in the long-term proposition of Sirtex, however, investing is expectations based and understanding why a stock trades at certain levels plays a role. Sirtex is a great business but it’s essentially a play on market opportunity, backed by outstanding management who continue to deliver. Sirtex has penetrated less than 5% of the salvage market which is continuing to grow. The business, however, does come with its fair share of risks. For example, a key risk I believe shorter-term, is the upcoming trial results which may see SIR-Spheres being used as a first-line treatment (or lack of) and thus lead to a quantum leap in market opportunity. Another risk is the fact that it’s a business with (currently) one product so obsolesce combined with a lack of product diversification is a real threat but one which I believe is not an issue just yet given the aforementioned market opportunity.

On the other hand, all other positions in the portfolio contributed to the positive performance. Key contributors were Enero Group (ASX:EGG), Mynetfone (ASX:MNF) and RCG Corp (ASX:RCG). EGG’s FY16 result will be of paramount importance to how it performs in the ensuing months and possibly, much longer term. The key for this one will be margin expansion driven by a reduction in the operating cost ratio and staff costs and strength from all regions. In my opinion, EGG remains priced for the direst of outcomes on a long-term view. I strongly believe the risk-reward for this stock is very favourable. The latter two stocks we’ll leave for another time.

Thank you for reading and the best of luck.

Yours faithfully,

Chadd Knights

Please note that this post may contain general financial advice that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking advice from a financial advisor if necessary. Moreover, the firm I work for and I personally have financial interests in at least some of the companies discussed.

Portfolio Performance Update - 22/02/2015 to 22/02/2016

The 22^nd of February marked 2 years since I made my first investment which was in Aveo Group (AOG) which unfortunately, I sold out of too soon. Since then, I’ve added and detracted from various positions. From 22-2-15 to 22-2-16, my portfolio increased by 10.6% post fees (12.3% pre-fees). This takes my annualised return since inception to 14.2% p.a. post fees (16.1% p.a. pre-fees).

My portfolio would be in a much worse off position if I didn’t make the large purchase Enero Group (EGG) that I made a few weeks ago which is up 22% (572% annualised). The portfolio was also aided by a late stage rally in Mineral Resources (MIN) which posted a strong result on the back of robust crushing volumes despite the slump in the iron ore price.

Unfortunately, the market had a tumultuous CY15 and this has continued into CY16. We are at a time where global growth and inflation forecasts are below trend in most regions, commodity prices have collapsed, global trade has slowed and margins are peaking. On top of all of this, corporate and government debts are at heightened levels and riskier assets have been bolstered by credit pumping Central Bank’s around the globe.  

Interestingly, returns in the ASX have been flat but volatility has surged. This begs the question: are we getting paid to move to riskier assets such as shares? Maybe, but maybe not. It appears we are operating in an environment where value investing isn’t working and momentum investing is. Investors who prioritise the mitigation of downside risk over upside return aren’t being rewarded in the current market environment.

If we look at stock specifics of the market, some performed tremendously most notably: Ballamy’s, Blackmores and A2 Milk – the Chinese story was a hit with investors. However, some performed terribly - essentially anything tied to commodity prices took a hit except in some rare occasions. Bellamy’s stock value grew from about $1.65 at the beginning of 2015 to about $13.61 by the end of 2015 – a rise of about 725%. At (almost) the same time between FY14-15, Ballamy’s book value per share changed from $0.22 to $0.51, representing a respectable 132% increase but when compared to its share price appreciation, something just doesn’t add up. The recent Stock price performance of these “hot stocks” have increased risk and diminished prospective returns. Contrastingly, returns on book have risen in companies such as BHP and at the same time, their risk has reduced and their prospective returns have strengthened.

This is by no means a distraction from the fact that I didn’t reach my performance target of 15%, but just some commentary around the current market environment. There will come a point in time when valuations will again be prioritised.

Enero Group – ASX:EGG . A Summary Of The 1HFY16 Results.

Enero Group – ASX:EGG

1HFY16 Results – A Summary

A flattening revenue line, record breaking profitability, strengthening margins and 40% of its market value backed by cash does not set the stage for basement level market prices.  

Enero Group (EGG) reported strong 1HFY16 results which saw net revenue rise 3% to $57.6m (helped by a FX tailwind of ~$4.3m) and operating EBITDA by 57% to $7.2m compared to the pcp. Driving this strong operating EBITDA performance was robust margin expansion from 8.2% to 12.6% over the same time period last year as a result of a resilient revenue base and cost management. Operating costs as a percentage of revenue continue to decline as a result of stricter cost controls.

Marketing budgets are generally one of the first budgets to get culled when times get tough. Despite this, EGG delivered a strong result from all three key operating hubs. Australasia saw revenue decline 21.8% to $22.9m and operating EBITDA fell by 25.0% to $3.3m. However, EGG was able to arrest a material decline in margin erosion which fell by a mere 0.6% to 14.4% on the back of cost control measures. I do not expect revenue declines in Australia to continue into 2HFY16.

Robust performance in the UK & Europe region was helped by a recovering economy and the resurgence of marketing spending by companies and led to some significant client wins such as Ebay. Revenue in the region was up 13.1% to $27m and operating EBITDA increased 63.9% to $6.7m. All of which helped boost the operating EBITDA margin from 16.7% to a respectable 24.8%. I expect strength in this facet of the company to continue its momentum and deliver a good 2HFY16 result. 

The turnaround in the USA is gaining traction but it’s still sub-scale. Revenue grew by 6.0% to $7.7m and operating EBITDA rose 59.8% to $0.7m. Given the size of the US market, it represents a large opportunity going forward. Given the large cash balance and need to grow scale, M&A activity may seem appropriate.

On almost any measure, this stock appears undervalued. Barring upside (downside) from revenue growth (decline), continued focus on cost management, the expansion of margins,  and momentum in key agencies will see continued profit growth. With almost half of its market value backed by cash (which continues to grow), and trading on about 3x EV/EBITDA  (FY16e) and a FCF yield of ~17% FY16e, such a risk-reward is extremely favourable.

Background Information

Enero Group (EGG) is an integrated marketing and communications firm with a portfolio of 10 companies. EGG operates from three primary locations – Sydney, London and New York with Australia being the largest by revenue and exposure. EGG’s key services fall into three main categories including advertising and production, public relations and research.

Please note that this post may contain general financial advice that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking advice from a financial advisor if necessary. Moreover, the firm I work for and I personally have financial interests in the company discussed.