Thursday, December 14th, 2017
October and November saw a number of Clime Smaller Companies Fund (CSCF) holdings provide AGM updates, giving us the opportunity to assess how they’re tracking against expectations.
It has been quite a strong period broadly, with the S&P Small Ords returning above 10% over the last three months. This is well above the long-term annual trend. Whilst it’s nothing to complain about, further rapid gains across the index are unlikely, so it’s a time to think about capital preservation and positioning away from the froth.
Following our value-based approach, we seek to own well managed, profitable businesses with strong cash flows, low debt and genuine growth and hold them when they trade below intrinsic value.
We’re happy to report the AGM season was generally positive across our holdings with no nasty surprises. Below we discuss recent updates from APN Property Group (APD), 1300-Smiles (ONT), Hansen Technologies (HSN), and Jumbo Interactive (JIN).
APN Property Group (APD) – MCap: $143m
APD is (in our view) a very well-run, specialist real estate manager, having solidly outperformed broader and market indices. Whilst the sector has enjoyed significant tailwinds from falling interest rates, we’re positive about APD’s outlook for FY18.
As highlighted in its recent AGM, APD impressively doubled Funds Under Management (FUM) from FY13 to FY17 to $2.6bn driven significantly via investments by Convenience Retail REIT (CRR) prior to its July IPO. Funds are spread across (mainly commercial) real estate securities funds – Industria REIT (ASX:IDR), Convenience Retail REIT (ASX:CRR), and direct property syndicates.
As at 30 June 2017, APD also had $110m of net tangible assets (NTA) on its balance sheet, mostly comprising co-investments in funds it manages, as well as directly held property (which serves to seed new property funds). NTA should increase strongly this year, driven in part by mark-to-market gains on APD’s 21.4% interest in IDR, the market value of which has risen from $60.9m at 30 June to $69.7m amid corporate interest by Growthpoint (ASX:GOZ).
Income is recurring in nature, coming from both management fees on FUM plus rent-derived income from its co-investment stakes. However, APD’s bottom line has also been strongly supplemented recently by mark-to-market gains on balance sheet investments, reflecting cap-rate compression in the lower interest rate environment.
Management reiterated operating earnings guidance of 2.35 cps to 2.65 cps, however, this does not include potential transaction or performance fee revenue for the remainder of FY18. Dividend guidance was 2 cps, representing a fully franked yield of 4.3%. Following a solid run in recent weeks, shares are trading $0.45. We believe fair value is around $0.50.
1300 Smiles (ONT) – MCap: $144m
Consistent with a body of evidence suggesting founder-led businesses are more likely to outperform over the long-term, ONT has an excellent track record of steadily growing cash flow, earnings and dividends. On a per share basis, earnings, dividends and operating cash flow have all approximately tripled over the past decade, which was mostly driven by reinvested cash flow.
ONT provides facilities and management services to self-employed dentists, allowing them to focus on the dentistry side of their business. Listed in 2005 with 6 QLD-based surgeries, ONT currently manages 30 multi-dentist facilities across QLD, NSW and SA. The company ultimately aspires to establish a national network.
We’re particularly impressed with the fact that founder and MD, Dr Daryl Holmes, who has a 62% shareholding, has structured his remuneration in such a way that he gets almost all of his annual income via dividends. You don’t get much more aligned than that.
Skin in the game is a powerful determinant of outcomes. For ONT, it means management is strongly incentivised to add value by pursuing low priced acquisitions and keep a disciplined approach to managing costs and staff performance to produce organic growth. It has also resulted in ONT keeping a conservative net cash balance sheet for several years.
Including an acquisition announced the day prior to the 23 Nov AGM, ONT has acquired a total of 7 dental practices this calendar year, equating to a 25% increase in network size. Management didn’t specify FY18 guidance, however, suggested improving network performance and reiterated discipline in ongoing acquisitive growth. Shares are trading at a slight discount to our (unchanged) $7.07 FY18 valuation, and we see strong value growth over the next three years.
Hansen Technologies (HSN) – MCap: $729m
Utilities billing software provider HSN is led by Andrew Hansen, who took over from his father, Ken, as CEO in 1993. On becoming CEO Andrew Hansen initiated what has developed into a highly disciplined acquisitive growth strategy, which took the business from relative obscurity to a globally recognised player in the industry.
Andrew Hansen’s major shareholding equates to 19.4% of the register and, similar to ONT, we think skin in the game has had much to do with the company’s success. In particular, HSN consistently acquires targets at modest multiples, which has required considerable patience. The company also has a strong track record of extracting efficiencies from the acquired businesses to bring them up to the Group target EBITDA margin of 25% to 30%.
HSN’s AGM update was one of the month’s highlights and represented a continuation of the company’s form.
The recently acquired Enoro business, which was purchased for $96m in July, is performing in-line with expectations and should drive significant top line growth in FY18. HSN also expects to bring Enoro’s EBITDA margin from 16% to within the Group’s target range. Overall, margins are expected to improve towards the midpoint of the 25% to 30% range (vs sub 26% in FY17).
Another positive was the strong cash flow generation implied by $6.7m net debt reduction after paying out $5.2m in dividends. HSN’s net debt as of 31 September was $25.1m, which leaves significant balance sheet capacity for future growth. Although management said it was too early to provide definitive full-year guidance, they are expecting a strong first half. On review of this update, we remain positive about HSN’s outlook and continue to see shares as undervalued below $3.60.
Jumbo Interactive (JIN) – MCap: $177m
2017 was a significant year for JIN, and its October AGM update was mostly a summary of the key events. These include:
- Exiting loss making international operations (leading to improved financials)
- Consolidating state-based contracts with Tatt’s and extending them to 2022 (removing the perceived risk of contract termination).
- Strong growth of the recently launched charities lotteries division.
Also this month, the Northern Territory government prohibited NT-licensed betting operators from taking wagers on Australian-based lotteries, meaning NT-licensed Lottoland no longer poses a material threat to JIN and Tatts.
JIN’s share price has doubled on the back of these events, however, we see further upside. The reason is that JIN has strong compounding potential and still trades on a modest multiple of around 13 times FY18 earnings on an ex-cash basis (i.e. excluding our estimate of $30m net cash by 30 June 2018). Only JIN and Tatts sell tickets for Australian lottery online, and the barrier to success for any potential entrant is building a database of scale (very difficult given existing players have databases of 2 million+ accounts). With the proportion of online ticket sales now at 15% and with plenty of room to grow (note in the UK the figure is 21%, and 48% in Finland), JIN should be able to generate strong returns from reinvested cash flows.
We were also pleased to see a recent report in published in the AFR highlighting Tatt’s digital lotteries sales growth of 29.6% in 1Q18. The article also noted that while Tatts recorded the same number of $15+ jackpots as the corresponding period (8), the average size of $32.5m was substantially higher than the $25m average last year. This certainly bodes well for JIN for the half, as jackpot activity is a key driver of near-term sales. Our view is unchanged with an FY18 valuation of around $3.50.
Clime owns shares in APD, ONT, HSN and JIN