Thursday, April 24th, 2014
In April 2012 a growth portfolio was constructed (for the Eureka Report) with the aim of achieving a compounding return of 10% per annum over the medium to longer term. Those most familiar with Clime will be aware that this is our broad benchmark for our investing process and philosophy.
The progression of this portfolio (and also an Income Portfolio) can be tracked in the model portfolio section of our site.
Last week, the growth portfolio was wound up and we have undertaken review of it’s final holdings and performance over the period.
It is pleasing to report that the growth portfolio constructed two years ago, and adjusted at various times over the period, has returned about 26%. The original portfolio commenced with $120,000 invested equally over 10 securities. Today, its value sits just above $150,000. Notably, the portfolio will close with more than $62,000 in cash and with only eight remaining stock positions (as you are aware, we continue to find it difficult to identify value in this market).
We will briefly outline my views on each of the remaining stocks and home in on what we think is the best value stock in the portfolio – namely McMillan Shakespeare Limited.
>> click to discover our 8 remaining growth stock holdings.
Portfolio comments (with six month target values)
BHP Billiton Limited (ASX:BHP) has held its position in the portfolio over the two years and we believe it is trading in value for long-term investors. Today, more than ever before, the short-term outlook for our economy is very much determined by the price of iron ore and the value of the Australian dollar. We maintain our view, which has been tested recently, that the Australian dollar will continue to devalue over the next few years.
Simply stated, Australia cannot withstand the oppression of an inflated currency and BHP is a major beneficiary of a weaker Australian dollar and higher iron ore export volumes. Investors should reflect that if BHP does not do well in the next few years then it is hard to see how Australia will do well. (Our September 2014 valuation is $40).
Australia and New Zealand Banking Group (ASX:ANZ) is the best value of the major banks with a pre-tax running yield of more than 7% and a small discount to value. Generally we maintain our view that our major banks are fairly fully priced, but there is no denying that each is benefitting from the strong growth tailwinds of mortgage lending. The housing market is certainly pumped up in Sydney, after a similar rise in Melbourne. There is much discussion regarding housing prices and the concentration of risk developing in this area for the banks. Time will tell as to whether these risks are overstated, but our view is that affordability measures often quoted for housing loans are widely misleading. Just the other night John’s elderly mother told him that in the post-war years borrowers of housing loans were required to repay their loans over just five years! Today’s 20-year loans with low deposits simply allow borrowers to borrow too much and overpay for a house. It is said to be affordable, but with the extension of more debt. Anyway, that’s good for banks and good for ANZ (with a forward value of $34.41).
Westpac Banking Corporation (ASX:WBC) has many of the same comments as those stated for ANZ. However, its market price is approaching our 2015 valuation and so it has certainly run pretty hard. It becomes a very weak hold at prices above $35 ex the next dividend, and we think a repurchase at prices approaching $32 is appropriate. That range may seem tight but we expect Westpac underlying value to grow slowly in coming years.
Woolworths Limited (ASX:WOW) does maintain its position in any sensibly constructed long-term portfolio. Our six month target valuation is $36.78, with the value expected to rise by 5% per annum over the foreseeable future. Woolworths, like Wesfarmers, is a genuine beneficiary of Australia’s solid population growth and we expect immigration to continue to grow as we battle an ageing demographic. However, acquirers of the stock should patiently wait for a price below $34.
The Reject Shop Limited (ASX:TRS) is very good value towards $9. We suggest that “shorting” hedge funds could get active and we note that TRS short interest has now lifted to over 7% of the register and the stock price has risen. Our two-year target price is above $12 and we retain an accumulate on the stock at prices below $10.
Brickworks Limited (ASX:BKW) has generated a healthy return for the portfolio over the last two years with a spirited corporate play and discernable uplift in house building activity. The shareholders meeting called by Perpetual Fund Management is set down again for May. The actual holding of this meeting remains subject to a tax ruling concerning the transactions proposed by Perpetual.
In the meantime the Millner family has disclosed that it has bought more Brickworks shares ahead of the meeting. We must say that we are confused as to why ASIC insists that Soul Pattinson (ASX:SOL) cannot buy Brickworks shares (and we think that SOL should be allowed to) whilst the directors of Soul Pattinson can.
SMS Management & Technology Limited (ASX:SMX) has fallen in price since it entered the portfolio about six months ago. However, the forward valuation looks compelling and certainly a normal economic recovery cycle would see the fortunes of SMX improve dramatically. Also, we do regard SMX as a strategic asset for a major offshore company looking to enter the Australian/Asian IT services market. Our forward valuation is above $5 and we expect to see this price over the next two years with fairly healthy dividends being paid.
McMillan Shakespeare Limited (ASX:MMS) is clearly the best value stock in the portfolio when comparing market price to current intrinsic value. Of course, the risk to the salary packaging company is regarded by the market as high as the May 2014 budget is drawn up. We guess the doomsayers can point to the statements of the Treasurer, who seems to suggest that budget pain is going to be shared by everyone.
We may well be shot down on May 13 but we cannot see why the Government would target the salary packaging benefits of “non for profit” employees or public health workers. These benefits may well be “means tested” as every other tax benefit should be – including superannuation, but the lifting of the cost structures for the public health system simply does not make sense. Salary packaging keeps the costs of healthcare in check and this is an area of federal and state budgets that will balloon in future years. If salary packaging benefits are cut then wages will rise in compensation. Further, private doctors will have less incentive to operate in the public domain.
So investors have an opportunity to acquire MMS shares at an attractive discount to today’s intrinsic value. Further, the company’s retained earnings are being directed into growth opportunities in the United Kingdom so as to diversify the risk of the business.
The following table (Figure 2) shows the impressive history of MMS. The recent dip in 12 month rolling profit was caused by the previous government indiscretion and that explains the current market concerns.