ASX Deep Value Stocks – July 2017
Thursday, July 13th, 2017
StocksInValue’s In Value Today is our most popular search filter and subscribers are understandably curious about the stocks filtering as the most undervalued. But the results of this search need careful interpretation. In Value Today is not a mechanical trading rule where undervaluation of any size necessarily makes a stock a buy.
Instead, we encourage you to interpret undervaluation as a prompt for further research as conservative investors must, before investing:
- Be satisfied the stock’s risk profile is consistent with their risk tolerance
- Approve of the assets, management and strategy
- Decide if they agree with our valuation
- Decide if the discount to value is sufficient for the risks the valuation will not be realised.
To assist you in interpreting deep value situations we provide this regular (approximately monthly) report on low and medium-risk stocks where we do not already publish analyst research and valuation notes. High-risk stocks and REITs are not covered. Analyst Research and Analyst Comments are limited to universe stocks but this report briefly comments on some of the most undervalued non-universe stocks with emphasis on why the market is pricing them below value and what would have to happen for the price-value gaps to close.
‘Quality Traps’ label
Some of these stocks we would buy for the model portfolio or recommend to subscribers, and some we wouldn’t. The latter we will label ‘quality traps’ as their poor business quality is likely to leave them trading at discounts to value until earnings drivers beyond management’s control, like industry conditions, improve. These stocks are cheap for a reason. Buying them is likely to disappoint or require a long wait for industry conditions to recover.
In the table below the quality traps are designated with an asterisk after their ASX code and they are also tagged as Quality Traps in StocksInValue.
You will notice many of the same names from May appearing below with unchanged commentary. These stocks remain in deep value and our view has not materially changed.
- VRS (formerly known as OTOC) is a national infrastructure services and surveying business. In recent years, VRS has acquired several surveying businesses that provide urban design, town planning and surveying services to national property, infrastructure, construction and mining clients.
- VRS has fallen out of favour with the market after failing to meet expectations in the first half.
Lumpiness in profits is a common feature of industrial services businesses so the downgrade is no great shock.
- Prospective investors should rather focus on assessing the long term future of the business.
- VRS can create a premium national surveying business and by doing so, capitalise on the major east coast infrastructure development pipeline over the coming years. Whether it does so will hinge on management and execution, as is so often the case.
- The market values the enterprise at $33, while cash are expected to be $6m – 7m per annum, a figure likely to grow over the coming 3 to 4 years.
- Shriro is a kitchen appliances and consumer products marketing and distribution group operating in Australia and New Zealand. It operates exclusively as a wholesaler, and has no manufacturing or retail operations.
- Revenues are generated from product sales to retailers.
- SHM’s business model integrates design, development, branding, sourcing, marketing and distribution.
- Historically, it has acquired underperforming brands below tangible asset value (no goodwill) with a view to adding value via marketing/strategy.
- Kitchen Appliances includes wholly owned brands Omega and Robinhood, and third-party brand Blanco. Sales of kitchen appliances are directly correlated to housing activity (approvals, constructions, renovations).
- Consumer products includes wholly owned brands everdure (barbeques), altise (fans and heaters), and third party brands CASIO and Pioneer (car audio, speakers). A perceived risk is SHM’s handshake distribution agreement with Casio, but this for last 33 years. The economic relationship is strong.
- SHM generates solid baseline cash flow. Growth is moderate (~4%), however the stock offers a grossed-up dividend yield of 10.9%.
- Very strong balance sheet after $33m debt reduction over last two years.
- Upside from the new everdure barbeques division, which is currently being promoted by celebrity chef Heston Blumenthal.
- IVE Group is a vertically integrated marketing and printing business specialising in print production, catalogues, fundraising and retail display.
- IVE has carved a niche in the market through its broad offering, able to offer multiple services to single clients, increasing their own competitive advantage and attracting more revenue per client.
- Print media is a stagnant and fractured industry, growing at or below GDP in most cases. As a result, IVE has been largely ignored by the market despite very good fundamentals and an ability to effectively consolidate smaller players.
- In our view, though IVE should trade at a relative discount to the market, it is well below its intrinsic value. Though it is featured in this article for its capital appreciation potential, it should be noted that its yield is approaching 10% (fully franked) in FY18 at current prices.
- We view MBE as a quality trap.
- MBE historically generated most of its revenue via Direct Carrier Billing (DCB) based on subscriptions to its mobile phone games business ‘No Limits Games’, which is a portal of over 100 low quality games.
- Essentially the customer lifecycle is as follows: new user ‘subscribes’ to the portfol via a ‘low touch point’ subscription mechanism, their mobile bill arrives a few weeks later showing they’ve agreed to pay for a portal they don’t use (the Direct Carrier Billing part), then they promptly cease the subscription. This is reflected in MBE’s very short average customer lifetime. MBE tries to manage the ‘customer lifetime value’ by reducing the periodic payments so as fly under the radar and not annoy customers enough for them to go through the hassle of unsubscribing.
- Driven by the DCB segment, MBE’s revenues increased 5x between FY13 and FY16, however free cash flows were close to naught over the period due to increasing receivables and capitalised software costs.
- More recently, MBE’s other business segement, Performance Marketing, became the main driver and now exceeds the DCB business’s revenues and earnings. This segment is currently demonstrating growth.
- It is difficult to see where this business will be in the years to come. Clearly MBE has decent mobile marketing capability given they were able to generate $33m revenues last year by marketing a less-than-useful product like No Limits Games. Performance Marketing may in fact prove to be a sustainable business. We’ll wait and see.