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Pro Medicus (ASX:PME) 1H FY2020 First Half Results Analysis

2020-02-12T23:32:58+00:00

Over the years, Ethical Equities has written plenty about Pro Medicus (ASX:PME). We received more feedback on that one stock than any other.

Importantly, Ethical Equities is now archived as a website, and exists as a column within A Rich Life, a new periodical covering arts, culture, philosophy and ethical investing.

Happily, if you're interested, you can therefore read coverage of the Pro Medicus (ASX:PME) 1st Half FY 2020 Results on that new website.

- Claude

List of Ethical Investment Funds

2019-11-08T02:03:42+00:00

A List Of Ethical Investment Funds In Australia

One of the pleasing developments I've noticed over the last few years is the continually expanding selection of ethical funds available to Australian investors. But unfortunately, some funds could be considered to have much stronger ethical policies than others. For example, AMP Limited (ASX:AMP) has a fund called "The AMP Capital Ethical Leaders Fund".

When the Ethical Advisor's Co-op reviewed the fund, they found that it invested significant amounts of money in fossil fuel companies and -- to rub salt in the wound -- they apparently used their shares to vote against a variety of environmentally conscious resolutions put forward by activists. The reason I think this is problematic is that I believe some investors in the fund might assume that "ethical leaders" would not include fossil fuel companies. But hey, millennials don't make the rules, do they?

In any event, I've enjoyed discovering the Ethical Advisor's Co-op "leaf ratings", and so thought I'd incorporate them into this short list of some of the ethical managed funds available in Australia.

BetaShares Global Sustainability Leaders ETF and the BetaShares Australian Sustainability Leaders ETF

These publicly traded ASX ETF basically apply a fairly stringent negative scan, including avoiding companies that are major financiers of fossil fuel projects.

The Ethical Advisors Co-op gives it 4.5 leaves out of 5.

Australian Ethical Emerging Companies Fund

Australian Ethical launched this fund a few years ago, tracking its benchmark for much of that time, before opening up a solid lead more recently, with a gain of 19.9% in the twelve months to August 2019.

The Ethical Advisors Co-op gives it 4.5 leaves out of 5.

Nanuk New World Fund

This is a global fund in operation since 2015 has handily outperformed its benchmark, generating over 14% per annum for investors.

The Ethical Advisors Co-op gives it 4 leaves out of 5, the best result of any global managed fund, from what I could tell.

Samuel Terry Asset Management

The Top performing Samuel Terry Absolute Return fund recently showed themselves to be very ethical investors! They said:

"During the year, we formalised a previously informal policy of not investing in businesses primarily engaged in the following activities: Thermal coal (i.e. coal for electricity production – coal for steel is not excluded), Tobacco, Gambling, and Lending to poor people at very high interest rates.

We recognise that this policy will not please everyone. Some say that it is not our job as fund managers to make moral judgements with your money. Others say that we should exclude other sectors such as oil production. However, this is the basis upon which we have been investing for some time, so we believe it is time to articulate our policy."

It is not yet rated by the Ethical Advisor's Co-op.

MX Capital

Run by star stock picker Weimin Xie. Avoids companies that are damaging to human society, violation of animal rights, human rights violations, un-remediated destruction of the environment. I invest in this fund.

It is not yet rated by the Ethical Advisor's Co-op.

Personally, I look forward to seeing the Co-op develop their fund rating system further, you can check their list here.

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

If, somehow, you are not already using Sharesight, please consider signing up for a free trial on this link, and we will get a small contribution if you do decide to use the service (which in turn should save you money with your accountant, or time if you do your own tax.)

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That Time I Got Lucky, Anatomy Of My Pro Medicus (ASX:PME) Investment

2019-10-08T22:00:57+00:00

An Ethical Equities Supporter has requested I do more case studies of investments I've made in the past, which I think is good for learning, so here is the first one.

The Process

I came across Pro Medicus because I have two beliefs about the long term future.

Software is eating the world
Healthcare is the best defensive industry

So I was looking for companies that were working in software and healthcare.

I also look for:

Insider buying
High Insider ownership
Profit and dividends.

Pro Medicus in 2013

Made $5 million in profit, market cap of <$50 million.

However, on an underlying basis, only made about $1 million in profit.

The big profit was because it sold its part of its Amira business (which it bought in 2009), for a multi-million dollar profit.

It sold the software, but it kept the team of software developers that built the software -- they were now working on software for the visualisation of large radiology files: Visage 7.

https://www.youtube.com/watch?v=idCQOUHv7Q4

Pro Medicus in 2014

In October 2013, PME made its first sale of Visage 7, worth $4 million.

Then, in April 2014 it announced a 6 year deal worth $20 million. This was the inflection point.

In July I bought shares. In August it reported profit of $1.5 million (ie, an improvement on the year before, backing out Amira proceeds). It had a market cap of about $90 m, plus over $20 million in the bank.

If you adjust for the cash, it was trading on EV to Earnings of about 46 times -- so it was definitely not cheap on the past metrics. It announced another deal in November, worth $8m. CEO said gross margins on these deals would be around 80%.

Importantly, both founders were involved in the business, and insiders were buying shares in the business, despite already controlling over 60% of the shares.

The CEO was willing to take time to explain the business to a little-young-nobody like me. My research indicated that both founders sourced some of their energy for life and work activities, from pride and passion. This is important because if majority owners are motivated only by money then they will not share the spoils of success fairly with minority shareholders.

Looking to the numbers; forward gross margins of around $25m had been won in the space of 1 year of launching Visage 7, while the company's entire enterprise value was around $100m.

It was clear if the company kept winning Visage contracts then it was extremely cheap. While I did of course perform a discounted cash flow valuation, the undervaluation this was extremely obvious, given the material gross profit uplift caused by each new contract, and the fact that the company was profitable already. The only it needed to do to be very undervalued, was to keep winning Visage contracts. The key question was whether it would. Given that it was well publicised the entire healthcare industry was moving towards deconstructed picture archiving and communication systems, there was a technological tailwind driving adoption. Thus, further wins seemed likely.

The Journey Since Then

As the company continued to win contracts and grow revenue, the market begun pricing in further wins. Whereas in late 2013 the price arguably reflected announced wins, rather than future wins, by 2019 the price arguably reflects many future wins, including both Visage and the Vendor Neutral Archive product. In this way, the market has become more optimistic and is now willing to pay a higher multiple of (much increased) earnings. You can see in the chart how I've traded the stock over the years. I still hold despite seeing it as too richly valued -- see here for my lament on why.

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Disclosure: The author owns shares in Pro Medicus.

This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

It's Time To Die, Livehire (ASX:LVH)

2019-09-23T02:55:49+00:00

Time To Die, Livehire (ASX:LVH)

Livehire (ASX:LVH) is a “talent management technology company” with a market capitalisation of $84 million at the current share price of $0.285. The company has around $35 million in cash which we believe should be returned to shareholders since we believe the business is destined to fail and the business itself is worth nothing, at best.

The Livehire Business Model

We believe Livehire’s core value proposition is to sell companies contact with potential employees. It calls these potential employees ‘talent communities’, but the actual product is simply information about, and access to, those people who make up the ‘talent communities’. Livehire charges its customer about 50 cents per ‘potential employee’ per month, for the right to access information about them, and reach out to them. You can see an example of how this might manifest, from the Livehire Facebook page, below.

Now, the real question here is how Livehire built up its database of potential employees. Indeed, Whirlpool user “Invictus” asked that very question quite some time ago (in 2015).

Perhaps the best answer came from whirlpool user “Antonluigi”, who claims to work for Livehire and happens to share a name with the founder and CEO.

However, while this answer is a lot of fun to read, it doesn’t actually answer the question of how Livehire was able to make the ‘private connection’ to a potential employee, in the first place. In the image below, Daniela from Livehire once explained that a profile is only created once an employee accepts an invitation to join a talent community. But the question remains; how did Livehire get the details of that person which were required to invite them to the talent community in the first place?

Judging from the prospectus, it seems that Livehire makes contact with potential employees ‘on behalf of’ any (client) company to which they had previously applied for a job.

Now, we’re not sure about this, but it seems that once clients have accepted entry into one ‘talent community’, simply by clicking on a link, then their ‘profile’ becomes available for all Livehire’s customers to invite to their own talent community. Now, what sort of information might that profile contain? Let’s look, again, to the prospectus:

We can scarcely believe it's the case, but it seems to us that Livehire has managed to sell access to former applicants back to the very employers they already applied to, for 50 cents per month, all while creating the potential for brand damage for those blue-chip customers (if the posts above are anything to go by).

Questions for Livehire Chairman Mr Michael Rennie

Are all applicants whose information is shared with Livehire by your customers clearly informed that if they agreed to create a Livehire profile, then they would receive personal messages asking them to expose their CVs to other customers of Livehire?

Did they opt-in to receive that contact from Livehire?

Do you check they have opted in or do you simply assume your customers have had them opt in?

Even if your customers such as Tree Of Life and Little Real Estate do pay you $6 per year to access potential employees, how do the economics of this business ever stack up? Why is it worthwhile for customers to pay $6 a year simply to invite 'workers' to apply for jobs?

It’s hard to believe high value employees would willingly be part of this system. What percentage of jobs placed through your talent communities go to employees with a salary over $100,000?

How does this business ever scale? In FY 2018 the company lost over $10 million to achieve revenue growth of around $1 million in FY 2019, during which the company lost over $14 million. With privacy laws only getting tighter, how can you hope to continue to convince employers to provide you with applicants' details?

Under the privacy act, an entity must not collect sensitive information about an individual unless the individual consents to the collection of the information and if the entity is an agency—the information is reasonably necessary for, or directly related to, one or more of the entity’s functions or activities. Does Livehire hold sensitive information within CVs and if so, does it have evidence of express permission to hold that information? Or do you believe that simply assuming that your clients have gained that permission would suffice in this regard?

Livehire often talks about growth in ‘talent community connections’ but how much is your list of potential employees growing, by which we mean the list of email addresses (and or mobile phone numbers) that you can message to invite to join a ‘talent community’?

Finally, would it not be better simply to wind up the company and return what remains of its cash back to shareholders?

Disclosure: the author is neither short Liverhire, nor does he own shares in Livehire .

For occasional exclusive content, join the FREE Ethical Equities Newsletter.

This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

How To Calculate Free Cash Flow And 2 Rules To Avoid The Hype Trap

2019-09-09T00:04:20+00:00

I recently shared "2 Rules To Avoid The Hype Trap" with Ethical Equities Supporters. Following those rules requires that investors can establish revenue growth, free cash flow and profit from the primary documents. It is always important to take these numbers from the accounts themselves, because companies will often highlight misleading adjusted numbers in their presentations, not the statutory numbers.

How To Calculate True Free Cashflow

Free cash flow = operating cash flow minus investing cashflow. You can get this information from the cashflow statement in a company's annual report. Let's look at Livehire (ASX:LVH) as an example. Below is their cashflow statement from page 31 in their annual report.

Livehire's free cash flow for FY 2019 is -$9,877,307 -$1,259,530 = $-11,136,837 (the blue boxes). Since that is a negative number, we can surmise that the company has free cash outflow (or negative free cash flow) of about $11.1 million. That means that the company used up $11.1 million in its operations over FY 2019.

Now that is the "pure" or "true" free cash flow number. However, we may wish to make adjustments that would reflect free cash flow without certain benefits or costs that we might consider to be one-off or unsustainable. I've highlighted some such values with the pink arrows. You could also adjust for big changes in the receivables and payables (check the balance sheet for that) or share based payments to employees (check the profit and loss statement for that). Knowing when to make this adjustments can be important for valuation, and can be complex and subjective, but it doesn't matter much for the purpose of this exercise.

How To Calculate Operating Revenue Growth And Ascertain Statutory Continuing Profit

The next step is too look at how much it grew revenue in the same year that it spent $11.1 million. For that, we'll look at the income statement, below, from page 28 of the annual report.

Calculate the operating revenue growth by subtracting last year's revenue from this year's revenue (top blue boxes). In this case, that is: $2,622,814 - $1,650,517 = $972,297. We can then use that revenue growth of $972,297 to calculate a percentage growth rate by dividing the growth amount by last year's revenue, like this: $972,297 divided by $1,650,517 = 0.589086328707914 = 59%. Of course, a revenue growth rate of 59% is neither good nor bad on its own, since it depends on all the context (such as whether it was off a low base, and how much the company spent to get that result).

Finally, it's also important to identify the true profit from the profit and loss statement statement (the bottom blue box). We can see Livehire has a loss of over $13 million.

2 Rules To Avoid The Hype Trap

On the ASX, there are plenty of companies that exist for years, and continuously raise capital. Their businesses are never really going to take off, but they usually have some glossy presentations, a great story about some amazing technology, cannabis-related business model, or mining tenement. Many (but not all) of these stocks (which can eventually fall 90% or more) can be avoided if you follow the two rules below. If you've had less than three years investing experience, or still consider yourself a beginner, then I recommend applying these rules to the vast majority of your portfolio.

Rule 1: Generally only ever buy stocks with positive free cash flow, profit, and growing revenue.

Rule 2: If you break rule one, only do it if the company had at least $10 million in revenue in the trailing financial year.

If I had applied these rules to my investing I would have avoided only a few of my winners, so I don't believe the price of restricting oneself in this way is very high.

Disclosure: the author does not own shares in Livehire (ASX:LVH).

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Dicker Data (ASX:DDR) HY 2019 Half Year Results Analysis

2019-08-29T22:14:38+00:00

Dicker Data (ASX:DDR) HY 2019 Results Analysis

On Friday last week, IT distributor Dicker Data (ASX:DDR) reported its results for the first half of 2019, demonstrating that it remains a great source of funding for its co-founder’s private race track and superfast racing cars.

Plenty of credit must go to the operational team along with the employees more generally, who have shown in this half what they can achieve if the facility is running at close to capacity. Revenue was up about 19% of the prior corresponding period while earnings per share gained close to 50%, thanks to record-breaking margins.

I agree with my friend Tony Hansen that this is partly a demonstration how cramped they are in the current facility and suggests that expenditure on new staff isn't being made as they don't have the room. Therefore, it seems unlikely this NPAT margin will be maintained as the company gears up for another growth leap with its new facility. In any event, you can see how the profit spiked in the most recent half, in the graph below:

Operationally, it was good to see a good rebound in NZ revenue, which was a key target for COO Vladimir Mitnovetski to improve on after the company suffered a set-back there in losing one distribution agreement, a couple of years ago. In my observation this is a team that usually achieves its stated goals.

Free cash flow came in at $13.8 million, which is obviously below profit, due in large part to a massive build-up of receivables. Cynics among us might quite fairly object to this and in my view the worst decision the business has made in the last few years is to offer “by-the-month payment solutions that can be specifically tailored to suit our partners and their customers’ varying needs” which “will be underpinned by DDR’s own balance sheet”. Ironically, I actually do trust CFO Mary Stojcevski to run this program sensibly, but I nonetheless think it increases risk for the company and probably creates a negative narrative that is suboptimal.

Having said that, I would expect nothing less from the board of Dicker Data who seem to do exactly whatever they want and don’t worry too much about what analysts think. Usually, this would be entirely unacceptable but when you take no salary and pay out 100% of earnings as a dividend then you have proven alignment with shareholders so in my view you earn that right. The main ramification of all this is that if Mary or Vlad quits I think I will sell most or all of my shares in a hurry.

Speaking of dividends, the company maintained the 5 cents quarterly dividend, putting the company on a trailing yield of 3.2% at yesterday’s close of $6.66 (someone has a sense of humour with that pricing). I’m forecasting the dividend to increase, with a final dividend to increase for the fourth quarter, potentially by a meaningful amount.

At current prices, I think that Dicker Data is roughly fairly valued. I could see myself selling some shares at around $7, but I’m not in a massive hurry. I’m not sure if I would be a seller at current prices. It has re-rated by well over 100% since I called it my preferred dividend stock for November 2018. I was buying around that time, with my last purchase in January 2019, and I might be more motivated to sell once a tick past the one year holding period.

Potential Upside

This analysis has characterised the extremely strong improvement in margins as unsustainable. I think that is the case, but also note that the company said, it is “moving even more so to becoming a solution aggregator business focusing on strong value added services for our vendors and partners”. This approach should lead to higher margins, so it is possible that the company will actually be able to keep margins above historical levels. This hypothesis is consistent with the multiple on-market purchases of shares by COO Vlad and CFO Mary, over the last year. If it comes true, I will be pleased.

Potential Downside

Dicker Data is gearing up to move to a bigger facility. This is the correct move as it will allow the business to continue growing over time. However, this kind of transition always comes with risks and is likely to depress profit growth, if not profit itself, during the transition period. As you can see in the chart above, Dicker Data has previously depressed its profit when undergoing a transition period in 2014. Keep in mind that the company has net debt of over $100 million, and historically pays out 100% of earnings as a dividend, which necessitates borrowing. In a period of declining profits (but increasing revenue) the company might face some funding difficulties, although I think that reasonably unlikely. The announced sale of the Kurnell property for $36 million will help in this regard.

Conclusion

I continue to like Dicker Data as a business although I am not likely to be a buyer at current prices.

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Disclosure: Claude Walker owns shares as disclosed and will not trade any for at least 2 days after publication of this article.

This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Vista Group (ASX:VGL) HY 2019 Results: Valuation Downgrade

2019-08-29T06:00:52+00:00

Vista Group HY 2019 Results and Valuation Downgrade

This morning Vista Group (ASX:VGL) reported its results for the first half of 2019 and they were very disappointing, sending the shares down by about 30% to $3.60 (AUD), at the time of writing. Please note, all currency below is NZD unless stated otherwise.

As a reminder Vista software provides modules for stocking food and drink, mobile ticket scanning, web bookings, loyalty programs, and assessing the performance of specific movie titles. It has a huge global market share, as you can see in the map below.

While revenue did grow by over 10% on the prior corresponding period, to $67 million, that was down slightly on the second half of 2018 (recall that Vista reports on the calendar year). The core vista cinema software did reasonably well, but Movio saw its EBITDA contribution fall back, as did the earlier-stage investments. You can see what I mean in the graph below.

Looking to the bottom line, there was absolute carnage, with a $5 million increase in administrative costs leading to reduced profit (excluding currency impacts), which came in at $4.1 million for the half, down on $5.7 million last year. Probably the most concerning aspect of this result for me is that I would have preferred if management showed more cost discipline. On the call, the CEO called out the “Biennial customer conference” as one reason administrative costs went up, and also seemed to imply that revenue was less than hoped, commenting that, “one of the elements of a business such as this is that the timing of revenue doesn’t always fall exactly as we would like”.

Free cashflow unfortunately went negative, with an outflow of around $3.4 million, due to weak operating cashflow, the derecognition of one partly owned subsidiary’s cash balance, and increased software development expenditure.

One of the issues with Vista Group is that it is on an old software model and not a recurring software as a service model. The company says it has $41 million of recurring revenue during the half. That would imply annualised recurring revenue of around $80 million. Compared to other growing software companies, then, Vista would not seem particularly over-priced after todays share price fall, which puts it on around 8 times hypothetical annualised recurring revenue.

The bigger news from today’s release was that the company will go to 100% SaaS “as fast as we can”. This process will incur substantial short term pain for substantial long term gain. I hate to say it, but it is probably the right move, and the company should probably have done it a long time ago. It is a testament to its business model that it has been able to tie up so much of the market without a proper core SaaS model. The reason for this is a proper SaaS offering will enable it to roll out upgrades to clients much more regularly and cheaply. This in turn will maximise the benefit they gain from the cinema management software.

Conclusion

I have previously outlined why I was holding my Vista shares, and valued them at “about $5 Australian”. Unfortunately, it seems like I was wrong on that valuation, at least in the short term, and I apologise to anyone who relied on it. If I had sold at that price, I’d be 28% better off on the holding. I feel very bad for getting this one wrong.

Having said that, I still think that the company will emerge from this ordeal quite a bit strong. Compared to other entrenched enterprise software stocks, I think it is quite attractively priced. Even so, I am now lowering my valuation to about $3.10 Australian, which means it is not attractively priced at the current price of $3.65.

Over the next week, I plan to sell some of my Vista Group shares, since it is still a reasonably big holding for me, even after getting smashed today. I’m not sure how many I will sell, and I don’t know what the price on offer will be. I think one day shares will be worth a fair bit more than the current price, if they can execute on the business transformation to fully SaaS. However, I believe the time to buy will be once there is evidence they can execute well.

I currently intend to hold at least some shares for the whole journey, or until it becomes clear they will fail on execution. If it looks like they are succeeding, I will try to buy back my shares.

I am very disappointed in this investment, and I think it will be one of my bigger losses this year. However, that’s what happens sometimes on the stock market sometimes. I am nonetheless, very sorry to my readers and listeners.

Disclosure: Claude Walker owns shares in Vista Group and is planning to reduce his holding soon.

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Nanosonics (ASX:NAN) FY 2019 Results Analysis: Shortsellers Ruthlessly Owned

2019-08-27T22:41:56+00:00

Nanosonics (ASX:ASX) FY 2019 Full Year Results Analysis

We joined the Nanosonics (ASX:NAN) journey at Ethical Equities when we published this report predicting a short squeeze last year, when the price was around $2.60. Yesterday, the company, which sells the Trophon device and associated consumables, has delivered a record full year result for FY 2019. That saw its share price spike 32% to close at $6.50. You can hear me outline the (old) short squeeze thesis at around 18min 30s in this podcast.

For the full FY 2019 year increased 39% to $84.3 million, with installed base of the Trophon grew across all regions. As you can see below, the company is continuing to grow revenue strongly, albeit not smoothly, due to changes in selling model and the release of the Trophon 2. It just so happens the second half was an improvement on the first half, in terms of revenue, but not in terms of profit, as you can see below.

Note: This post was supported and assisted by Strawman founder, Andrew Page. I recommend Strawman as the best ASX stock forum available.

As you can see below, the number of Trophon units installed in North America continued its long term climb to reach 18570, with the growth rate steady at about 1500 per half.

Nanosonics has 75% market penetration in Australia and NZ, and is finding much growth there anymore, but on the conference call the CEO said that he sees no reason that the company cannot reach a similar market share in the USA. At current (absolute) growth rates, that implies around 10 years of growth in the US (albeit with a declining rate in percentage terms). So, a long runway remains.

Looking to Japan, the CEO reminded listeners that they do not have guidelines for adoption there (which are required to compel purchasing of high level infection control devices like Trophon.) However, he said, "things should start kicking in very positively from 2021”, which implies he thinks that "the fundamentals for adoption", as he calls them, are falling into place.

On top of that, the company has taken over the distribution of its consumable products in the US from July 2019. That means that instead of selling its consumables through GE for some of its customers, it will sell consumables directly to customers and get a better margin. The impact of this margin uplift is expected to be fully felt in the second half of FY 2020.

Importantly, however, operating expenses grew by around 15% in 2019 due largely to a 27% lift in headcount and an increasing R&D spend. The company said costs would increase significantly in the current year, forecasting $67 million in operating expenses (a 36% increase) for FY2020 as the business readied itself for its “strategic growth agenda”. That includes new products, sales & marketing and business development. We now expect the second product to be announced in the 2020 financial year, and note that this is expected to weigh heavily on profit in the short term.

While the company did achieve record profit before tax and revenue in FY 2019, we note the (significant) exchange rate benefit in these results. Without that, revenue growth would have been 29% instead of 39%. This benefit is unlikely to be repeated and may in fact reverse in future periods, so it would be unwise to build a model based on sustained growth at those levels.

On the call the CEO said that the impact of upgrades to Trophon 2 was “quite minimal during the year… probably sub-100” in the US. That means the capital sales in the US were new installed growth and what they sold to GE into their inventory. This bodes well for the company's prediction that growth in capital sales remains at constant absolute levels. Over 30% of the current installed base is due for renewal in the next two years, and that replacement cycle, even if not well conformed to, should help.

Buy, Hold, or Sell?

Nanosonics is a profitable business with over $72 million in cash on hand. However, after the share price pop yesterday it has a market capitalisation of $1.95 billion, giving it an enterprise value of $1.88 billion. Against that, it produced free cash flow of $2.6 million in FY 2019, putting it on an astronomical EV / FCF ratio of 722. The company is now trading on 22 times revenue, which is pretty phenomenal given it is a medical device maker, rather than the sexiest software stock you've seen.

For contrast, Resmed (ASX:RMD) the sleep apnoeia device maker, trades on around 8 times sales and Cochlear (ASX:COH), the hearing implant company on around 8.5 times sales. For Nanosonics, even if we bullishly assumed 30% revenue growth for five next five years, and some margin improvement, returns from here would arguably be lacklustre.

As I have previously disclosed, I had already begun selling my Nanosonics shares, at lower levels. For the last year or more, I have been holding on to Nanosonics stock because I believed, correctly as it turns out, that the people who had short sold 13% of the company when the share price was under $3 would receive a severe lesson and be forced to cover at higher levels. With short interest now sitting at about 3%, that thesis has largely played out.

As such, I intend to take more profits from Nanosonics after publishing this report. Because I believe Nanosonics is a great quality company, I will almost certainly be retaining a small holding, so that I remain engaged with the business and capable of understanding it properly. I would very much like to participate in another short squeeze of such epic proportions in the future. I'll take an 100%+ gain in about a year whenever I can.

However, I strongly believe that the company is very generously priced at current levels. While the business could continue to perform very well over the long term, and the stock could become even more richly valued, to quote Andrew Page, "should growth not materialise as expected, the downside could be severe." He too, has taken some profits.

Nanosonics is a high quality business that is making the world a better place by reducing the transmission of the HPV virus, among others. That in turn reduces the number of people who get cervical cancer. That is very considerable pain and suffering alleviated. At current share prices, I will be doing some selling for sure, but am unlikely to sell out completely. I will likely sell in only small increments, as I am enjoying the sport of watching to see how ridiculous the price can get, and basking in the glow of what has to be one of the most satisfying short squeezes I have ever seen.

Thanks again to Andrew Page for helping with this article. We recommend you continue the conversation over at the Strawman forum for Nanosonics.

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Disclosure: Claude Walker owns shares as disclosed and will not buy any for at least 2 days after publication (but does intend to sell a few as disclosed).

This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Pro Medicus (ASX:PME) FY 2019 Results Analysis: Record Profit Yet Again

2019-08-22T22:05:06+00:00

Pro Medicus (ASX:PME) Posts Record Results In FY 2019

Yesterday radiology imaging company Pro Medicus (ASX:PME) reported revenue of $50.1 million for the full year, along with profit of $19.1 million, an increase of over 91% on last year. When I reported on the half year results, I noted that it would be hard for the company to grow half on half, since last half was such a strong half. I also expressed my hesitancy about the share price. It turns out I was too conservative, as the stock has gained well over 100% in the intervening period, to close above $30.50 on the day of the results.

The business seems to be doing very well indeed. As you can see below, the company grew profits strongly, half-on-half, in the end. Some of that growth coming from existing customers using the image viewer more. Many clients have signed transaction-based contracts, which mean Pro Medicus benefits if they view more images. However, the company also benefited from on-boarding new clients and receiving the first full year contribution from others.

The Australian business, which is primarily a radiology information system (RIS), showed good growth, largely because it now serves two of the biggest radiology companies, in iMed and Healius Ltd (ASX:HLS), along with other customers. The company had to invest for many years to win this dominant position, but it now enjoys natural growth as its clients themselves are growing.

It was the US business that stole the show, with the viewer product (Visage 7) accounting for the vast majority of the revenue. You can see below how revenue from the US is tracking.

Turning to free cash flow, the company did very well indeed, converting 90% of profit to free cash flow, which came in at about $17.1 million. That lead to net cash of just over $32 million. That puts the company on an enterprise value to free cash flow (EV/FCF) ratio of around 175; an eye-wateringly expensive price! The good news, at least, is that as the company continues to grow, free cash flow should remain strong (or even get stronger) relative to net profit, as accounting changes mean that some payments received up-front will be recognised over the period of the contract on a flat line basis. There will of course be some volatility in cash flows related to capital sales.

While there is no doubt that the stock is not cheap, any more, it also seems clear that the company is of very high quality. For example, it still has minimal salespeople but has only ever lost 4 tenders for its Visage 7 product. This year, it did increase staff numbers, but its investments were in R&D and implementation. This expenditure helps delight customers, if not win them. Over time radiologists who have used Visage become advocates for it when they move to an institution that does not have Visage. Therefore, in my view, the best kind of marketing is continual investment in the product. This focus is evidenced by the fact the company has around 40 software engineers out of a total staff of about 75 globally.

Following on from our sociological examination of the Pro Medicus share price, it seems clear the company is getting a lot more attention now, with several questions from analysts indicating that they were relatively new to the stock. In my view, this process of discovery is a large part of why the share price is so high at the moment.

Longer term, it was pleasing to learn more about the twofold potential for artificial intelligence algorithms on the Visage viewer platform. As the company develops AI applications, it can roll out those improvements with the next update. Some technology will be made available to all users.

However, the company is also encouraging other organisations and people to develop their own diagnostic algorithms for radiology, and make those technologies available for radiologists for a price through the Visage 7 platform. Pro Medicus would take a cut. If the company ever achieves this, it will have profoundly improved the business because it would have positioned itself to profit from the capital (monetary and intellectual) of third parties. This path would result in better outcomes for patients (based on past documented experience of the impact of Visage), and also potential savings for radiologist employers. In the US, radiologists are paid a lot, so anything that improves their workflow is very beneficial. For me, a key milestone in the next few years will be when the company first manages to sell a third party product (an algorithm, essentially) over the Visage 7 platform.

On the call, one analyst elicited some interesting insight into the radiology market over in the USA. According to the CEO, requests for tender amongst radiology groups is in “deep freeze” because there has been so much consolidation in that market. When a radiology group is looking to either buy another, or sell itself to another, it is not an attractive time to change move to a deconstructed PACS system with Visage. Once consolidation dies down in this sector, Pro Medicus should see a pick up in the pipeline selling to these kinds of clients. Longer term, consolidation is a tailwind for Pro Medicus, as the company specialises in large radiology and hospital groups. The reason for this is that their product is expensive, and the product is designed to optimise ROI for large groups; and these are the contracts Pro Medicus tenders for.

Valuation

Notably, one of the difficulties for modelling how Pro Medicus might justify its current $3 billion market cap is that at present the company is focussed on the larger, more attractive end of the radiology market. However, they already are making quite a splash in this end of the market, and it’s not clear how much further they can grow before it simply gets harder to continue to increase market share. From memory, they already have 5 of the top 20 hospital groups. I think they can go to 10, or even 15; but would that be enough to justify the current price?

That is not guaranteed.

One bright spot, however, is that the company’s vendor neutral archiving is continuing to appeal. The CEO said that one day he thinks it could be worth 30%-40% of the imaging business, which would be a significant contribution. At present, it seems there is some potential for them to cross sell the VNA product to customers who already use their viewer, and going forward, it seems more likely they will manage to sell some combined offerings. We’ll need to see growth in the VNA business if the company is to fulfil its potential.

I stand by my recent comment that the aggressive buying of Pro Medicus shares at around $33 by passive index funds is frothy-mouthed accumulation. However, I also think those people who have been short selling the company, many of them since much lower prices, are cruising for a continued bruising. Time is their enemy, because even though the valuation is frothy as it comes, the company continues to improve in quality over time.

I have upgraded my valuation on the back of these results. I think the company is now worth at least $1.5 billion (or a share price of around $15) which has me at a much more conservative valuation than most. Having said that, the main argument for it being worth buying at $3 billion is to understand the company through a gorilla game framework.

If Pro Medicus to become the gorilla in its niche it will need to achieve the following:

Maintain its technology advantage through continual improvements to its Visage and VNA technology (Within its control).
Sell other people’s algorithms over its platform to assist with diagnosis in both radiology and other medical sciences (Partly within its control).
Continue to be able to find clientele who are willing to spend money to make money. Pro Medicus provides strong ROI to its clients, but some (for example, public health organisations) cannot make that ROI because internal process mandate they go for the cheapest option, even when it will leave them worse off in the long term. (Not really within its control).

If Pro Medicus does end up dominating algorithmic radiological diagnosis, in the long term, then I suggest that in fact it will be considered to have been cheap at current prices. While I do not necessarily think the risk versus reward is brilliant at current prices, I maintain Pro Medicus as my largest single shareholding, due to this long term potential. Of course, I do not expect a smooth run, and I will take profits as and when I deem appropriate.

Finally, it’s worth noting that the founders have previously said they would sell 3 million shares each but have only sold 1 million each so far, so we may see a further sell-down after these results. It is very positive that the founders remain committed to the business and I believe that the retention of the team at Pro Medicus (at multiple levels, not just top management) is the most important thing for me to track. It’s truly rare to see a group of people doing such good work and the longer that is sustained, the better for everyone.

Disclosure: Claude Walker owns shares in Pro Medicus at the time of publication, and will not sell for at least two days.

Post Script: Claude's subsequent coverage of Promedicus can be found on A Rich Life

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Is Ooh! Media (ASX:OML) Good Value After Its Share Price Crash?

2019-08-16T02:11:42+00:00

Back in December 2018, I explained on this podcast with Matt Joass and Andrew Page that I was short a stock called oOh!media (ASX:OML) as a hedge, since it is a poor business that is highly leveraged to the Australian economy.

Today the share price has fallen 25% on a big downgrade to its guidance. Let's take a look at the numbers to see if the short thesis has now played out.

The company has disclosed that it had underlying EBITDA in the first half of $56 million. It claims that over current year it will magically release $16 million in synergies that it has been unable to release in already. Annualising the first half underlying EBITDA, and adding the magical synergies, we get an underlying magical EBITDA for 2019 of a bit under $130 million. This is in line with their guidance of $125 million to $135 million.

Offsetting this, the company has forecast capital expenditure of $55 million - $70 million. Last year operating cashflow was about $70 million against underlying EBITDA of $110 million, so if we are generous we could model operating cashflow of perhaps $100 million in FY 2019. Adjusting for the forecast capex, we thus have an (extremely generous) free cash flow forecast of about $55 million.

At a share price of $3 OML has a market capitalisation of $717 million. It last disclosed net debt of $372 million, so the enterprise value is almost $1.1 billion. Against a reasonable free cash flow forecast of $55 million.

That means the FCF / EV is almost 20.

Even those who were pushing the stock above $4 (presumably) admit it is cyclical, and this guidance at least implies it is on the wrong side of that cycle. I've no doubt in the world that today's buyers are "looking through" the cycle and seeing some magical future where a company with zero moat is able to maintain high margins. Of course, the truth is that there is no shortage of outdoor space for advertising and any exceptional profits accruing to exceptional locations will eventually accrue to the property owners.

Whether or not the Ooh Media share price beats the market from here, I do not see any rational argument that it can provide good risk adjusted returns. The utility of the stock is as a hedge against an economic downturn. It is true that the company is a real business that will probably still be around in many years, but the chances of exceptionally good returns are nowhere near high enough to compensate for the very real risk that investors suffer exceptionally bad returns, based on factors the company cannot control.

In my view he stock is still overvalued, once adjusted for the risk of economic slow down in Australia. As I said at 34 min in the aforementioned podcast: "Ohh Media is a bad stock and I would not own it for anything, Disclosure: I am short".

Disclosure: Claude Walker is short Ooh Media, increased his short position earlier this morning, and will not close his short position (but may increase it) for at least 2 days after the publication of this article.

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Cleaning Up The Portfolio

2019-08-06T00:06:35+00:00

Generally speaking, I try to let my winners run, even if I do take some profits.

Today, with momentum changing, escalating trade wars and Hong Kong in chaos, I'm going to ditch some of my lower conviction positions that I have been umm-ing and ahh-ing about.

We've published on three of those on Ethical Equities, so I thought I should mention here.

I'm going to sell out of Elixinol (ASX:EXL). A couple of quarters ago I said "As a result of this analysis, I can only conclude that in the best case scenario my confidence in the company is now lower than it was, and two days after this post, I intend to sell a significant chunk of my Elixinol shares."

The subsequent results weren't great either, so I'm all out today.

When we last covered Clinuvel (ASX:CUV) I said, "I have not sold any shares in Clinuvel, and while I may adjust my position size in due course, I have no current intention to sell out of the stock. I differ from Matt because I think there could be enough growth to justify the risk of losing exclusivity for afamelanotide. Clinuvel has a head start in terms of marketing and manufacturing expertise. I do, however, agree that there is a real risk of over-valuation if the market underestimates this risk."

I subsequently reduced my position size and now I'm selling out completely on valuation concerns and because this AFR article made it seem like a strange company.

Finally, I will also sell out of Xref (ASX:XF1). When we last covered the stock, I said "While I could imagine myself taking some profits if I find superior uses for my capital, I do believe that this thesis needs longer to play out, and I have held on so far. At the very least, I'm inclined to give the business until the end of the financial year, when we will find out about the all-important fourth quarter sales. " Unfortunately, its most recent results disappointed slightly, so now I'll probably sit on the sidelines.

This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Will Someone Buy Pro Medicus (ASX:PME) At Any Price?

2019-08-01T04:00:25+00:00

Will Someone Buy Pro Medicus (ASX:PME) At Any Price?

I'm on record as saying I think Pro Medicus is my favourite stock on the ASX. But the stellar share price run from around $1 five years ago to $33 today is truly stupendous. When we covered its results less than a year ago, we did not predict it would gain more than 200% in just one year.

We need multiple mental models to understand markets. At this point, I believe it's largely a waste of time to try to use a valuation model to understand the current pricing of Pro Medicus shares. The business is super high quality. It has far more room to grow than most people realise, given its stated aim to move beyond radiology, and into vendor neutral archiving (which it is already doing, profitably). But there can be no doubt that only through a series of long-sighted and optimistic estimates can one calculate significant upside at the current share price.

Obviously, I do not think Pro Medicus shares are a buy at any price. But someone thinks they are a buy at above $33 in July 2019. Let's take a look at why.

A sociological model combined with a supply/demand model.

Pro Medicus has a remarkably tight share register. Over half the shares are held by the founders who cannot currently sell due to their trading rules. Small-cap funds like LHC Capital and Lakehouse Capital have been in the stock for years, but are run by savvy operators who prioritise quality and know how to drip-feed shares and hold for the long term. Both those funds have disclosed selling (some of) their stock, but these aren't the kind to let go of high quality businesses on the cheap.

Furthermore, for a $3 billion company, Pro Medicus has a surprisingly large retail shareholder base. This is partly due to it being a darling of The Motley Fool, Ethical Equities, Three Wise Monkeys and more recently, momentum traders, and partly due to the fact that it had, for many years, a clear, understandable, exciting business plan with strong share price momentum. Retail investors often don't value shares themselves, so overvaluation will not cause them to sell.

While supply is scarce for the aforementioned reasons, the institutional complex has recently arrived on the scene, bringing huge demand for shares. First, we have seen a veritable explosion in broker coverage, from less than three analysts covering it a few years ago, to more than ten today. This has stimulated a lot of buying demand. Second, the company's rising share price has seen it added to first the S&P All Australian 200, and then the S&P ASX 200.

This means that many index funds are mandated to buy shares of Pro Medicus and many more index hugging funds are strongly inclined to buy them. I said to (paid) newsletter subscribers on Friday, "The main reason I am selling [Pro Medicus] slowly is because I think index funds and index huggers are forced buyers and I'm hoping for one last spike before reality hits."

As I write, the share price is up over 7%, largely off the back of the announcement yesterday evening that the company would enter the ASX 200 on August 7.

So, is this the final spike before reality hits?

I think that there are a huge amount of momentum traders in the stock, who are basically taxing the 'dumb money' index funds that are now forced buyers. While I don't know where the short term share price will top, what I do predict is when the hype comes out of this stock, it will come out very quickly. What we are seeing is a transfer of wealth from your best mate's superannuation fund to long term active investors (and momentum traders). The blind faith in "passive investing" will only create more of these kind of opportunities in the future.

Me? Pro Medicus is still my largest shareholding, but I've been selling a lot lately. I first bought the stock at 86 cents and accumulated more at below $1.20, around five years ago. Subsequently, I joined Motley Fool Hidden Gems where I recommended the stock -- and members got in at below $1.60. Finally, I publicly called it my favourite stock at around $3.50, and continued to regularly feature it as a Best Buy Now at Hidden Gems until I left the role last year (It had a share price of below $9.) I'm making hay while the sun shines. I've never sold so many shares as I have in the last few weeks. But when the dust settles, I'll still be holding on to some, because this company is such high quality that I want to hold at least some for the rest of my life (if I can).

While for many years Pro Medicus has been a classic example of growth at a reasonable price, over the last year the share price has veritably exploded in a frothy-mouthed frenzy of fomo accumulation and example of stock market euphoria.

But I'll be holding at least some Pro Medicus shares for what (I imagine) is the virtually inevitable retrace. I'm bracing for it.

Disclosure: Claude Walker hold shares in Pro Medicus. He sold shares earlier today, and intends to continue selling shares -- but not all his shares.

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If you don't yet use Sharesight, please consider signing up for a trial on this link, and we will get a small contribution if you do decide to use the service longer term, (which in turn should save you money with your accountant, or time if you do your own tax.) Better yet, you can get 2 months free added to an annual subscription.

This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Is The Forager Australian Shares Fund (ASX:FOR) Undervalued?

2019-06-28T02:38:03+00:00

I often get asked by investors for suggestions about investing in Exchange Traded Funds (ETFs) and Listed Investment Companies (LIC).

While ETFs are a great modern tool for gaining instant portfolio diversification, far too many investors misunderstand what a listed investment company is. A listed investment company is where you invest with a manager, but you can't even be assured that you will be able to sell your investment at its true net asset value. As such, you should generally only ever buy an LIC at a discount to net asset value.

The Forager Australian Shares Fund (ASX:FOR) provides a useful cautionary tale in this regard. One year ago shares traded at $1.90, which was a premium to the net asset value (NAV). Anyone buying on that day was basically either betting that the premium would be maintained (greater fool theory) or that the investment returns would be so good that it would justify the premium. The fact that there was a "deep value" fund trading at a premium to NAV was a sharp irony, apparently lost on many.

To their credit Forager has publicly reflected on this performance by looking at their Net Asset Value taken from yesterday which has the effect of including the larger dividend paid previously. To wit:

However, that calculus changes today, and I believe a truer picture of investor returns (and therefore sentiment) can be deduced by looking at the actual price paid, and then the potential price received.

If you take the performance from June 28, instead of June 27, the Forager Australian Shares Fund has declared a dividend of 1.35 cents for the period, and the share price has declined from $1.90 to $1.17. That's a decline of about 35% in a market that is up over 10%. If that doesn't have investors re-thinking their strategy, then what will? While it's true that the actual investment performance in the fund has been better, that is of scant comfort to the investors, highlighting the harsh realities of investing in a LIC. Investors who are rethinking the strategy must now find a buyer, and after that underperformance, buyers are harder to find. This highlights the pro-cyclical insanity of paying a premium for a deep value fund. But will the same investors who paid that premium now sell at a discount?

Is ASX:FOR Undervalued?

Forager NAV is currently $1.28, but the share price is $1.17, an 8.5% discount to Net Asset Value. Despite the crushing nature of an LIC (for investors), it is surely a structure any fund manager would lust after, so I can't blame them for taking the opportunity when it was there. Management seem honest and competent, although I find it confusing that they ignored my warning that Freedom Insurance was a sell, and continued to hold.

Since I could scarcely be more stylistically divergent from Forager, I follow their disclosures, because if I ever agree with them on anything, then that is interesting to me. Dicker Data (ASX:DDR) is an example of a stock I have held that they have also held (although it's a big position for me, and it's not in their top 5 holdings, and I don't know if they still hold it.)

In any event, I think their current cohort of major holdings still hold some high risk/ low reward investments such as Thorn Group (ASX:TGA), which has $300m in debt against a $45m market cap, and Experience Co (ASX:EXP), which is relying on tourist growth in North Queensland. However, there are also some higher quality businesses such as Carsales (ASX:CAR), which seems to to have a better risk-reward profile, despite being a pro-cyclical business.

Most importantly, it is true that growth stocks have been hoovering up capital which has generally fled lower-growth "value" stocks. Should that tide change, we could see an improvement in performance by Forager. If they are able to outperform in the coming year, that might have the flow on effect of narrowing the discount to net asset value. As such, if the market were flat, and Forager generated a 5% return, then the discount might narrow to 5%. That would mean a gain of perhaps 8% in a flat market. I think with the current discount the downslide from a widening of the discount is, at least, limited.

Therefore, I tend towards the view that units in Forager (ASX:FOR) are currently mildly undervalued.

Ultimately, I wouldn't invest in Forager because it invests in companies like Thorn Group, which has a history of breaking consumer laws, thus harming customers. However, I do think it is ironic that growth investors could use some profits from hot growth stocks to buy discounted units in a "deep value" fund from the same "deep value" investors who preferred premium-priced units in a "deep value" fund over growth stocks, one year ago.

Disclosure: The author, Claude Walker, owns shares in Dicker Data and will not sell them for at least 2 days following the publishing of this article.

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Can Xref (ASX:XF1) Accelerate Revenue Growth?

2019-06-11T08:12:19+00:00

Can Xref (ASX:XF1) Accelerate Revenue Growth?

Since Xref Ltd (ASX:XF1) released its quarterly results, we’ve seen an initially muted reaction, followed by a rising, then falling, share price. To me, that suggests that the market didn’t really know how to respond the results, which were “good enough” without being impressive.

As you can see below, receipts from customers were slightly up on the preceding quarter but lower than the first quarter, which benefited from strong fourth quarter sales. The company excitedly pointed out that, “Historically, sales for the fourth quarter are similar to total sales for the preceding first half of the year”. While this kind of cyclicality surprises me, it is reasonable to wait for that peak first quarter cashflow to get a picture of annual growth.

While at first glance I find the 36% quarter on quarter growth to be a bit low, I am hopeful that the growth rate will actually increase as the company gains traction overseas. The nascent international business saw revenue grow to $298,000, a 165% increase year-on-year off a low base. Channel revenue, where the product is on-sold to the customer by a channel partner, was up 200% to $359,000 proving that partners are willing to generate significant revenue for the company.

The only reason I’m interested in the stock because it claims it can self-fund itself into an international business, that should itself be leveraged to the growth of its own customers. Obviously this sort of business will have its ups and downs, but it could really fly at the top of a cycle. Should Xref be able to take a chunk of this market, even (and most likely) by sharing significant revenue with channel partners then it will be a capital light way to profit from a diverse array of businesses.

With almost $9.6 million, and trailing twelve months negative free cash outflow of $4.7 million, the company has a least a year to show what it can do before it will have either proven it does not need further capital, or be well-advised to sure up its balance sheet. On that subject, the CEO says that the company is “well positioned to reach cash flow break-even”. He further ventured that “we have never been in a better position entering the last quarter than we are this year”.

This sort of guidance stakes enough that his reputation will take a blow if the company needs to raise capital before proving (ironically) that it does not need to; but sufficiently vague to allow wriggle room on timing. I still think there’s a decent chance they could come through, but plenty depends on fourth quarter sales.

At today's close of 55 cents the share price is up about 15% since we published this hidden report touting the prospects of the company. When we sent that report to newsletter subscribers, I considered the stock price compelling. However, with the increase in price and the slightly disappointing growth rate, I see the share price as less compelling today. While I could imagine myself taking some profits if I find superior uses for my capital, I do believe that this thesis needs longer to play out, and I have held on so far. At the very least, I'm inclined to give the business until the end of the financial year, when we will find out about the all-important fourth quarter sales. What I like most about this opportunity is the potentially significant international opportunity -- because if the company can expand profitably on a global scale, then it will be worth many multiples of what it is today.

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

My Portfolio Performance Update

2019-05-16T00:41:34+00:00

Claude Walker's Portfolio Performance Update

I've recently been thinking a bit about whether my skills are most useful as a research analyst and investor, or if they are most useful as an analyst and writer. Although they are obviously related, it's possible that some analysts could be better off focusing purely on investing, while others are most valuable as communicators.

While I think I get the most gratification out of communicating about ethical investing to my readers, I don't want to be limited to that sort of role. Ultimately, I get the most satisfaction out of successfully investing; but it remains to be seen whether professional investing is the optimal setting for me to succeed as an investor.

Without further ado, a review of my returns to date. (Note that I'm a Sharesight beta tester so the graphs are not as granular as they are for most people - the beta version calculates faster but the proper version looks better). The returns calculation methodology is annualised and money weighted. Find the details here.

Ethical Equities Portfolio: 1 Year Return to May 15 2019

Ethical Equities Portfolio: 2 Year Return to May 15 2019

Ethical Equities Portfolio: 5 Year Return to May 15 2019

Top 5 Winners Over 2 Years

The most profitable 5 stocks over the last 2 years on an absolute basis have been: PME, KME, NEA, AD8 and ANO.

Worst 5 Losers Over 2 Years

The biggest losses over the last 2 years were suffered as a result of investing in: RBL, IAB, HCT, MUA, and XPL (formally MGP).

A Lesson For Me

Looking at the last 2 years of winners and losers, it's pretty clear to me that I did a lot more work on the winners before accumulating a full sized position. So taking my time was not costly. While I did study Mitula closely, I simply got it wrong. But except for Mitula I built full sized positions in the other losers far too quickly, before I had really followed the stocks closely for long. These losses would have been lesser if I had built my position over the course of 6 months, rather than a few weeks. This observation reinforces my resolve to only build full positions over time as I do more research and if I have followed a company closely for at least 6 months, but preferably more.

Remember: Our Best Research Is Hidden

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Three Wise Monkeys Podcast: Season Finale, Vista Group (ASX:VGL) and Reminiscences On A Glorious ASX Bull Market

2019-05-01T09:56:11+00:00

The three jolly primates are back for a bonanza season finale episode of the Three Wise Monkeys Podcast.

I bring up cinema software stock Vista Group (ASX:VGL), while Andrew gives a background on the cinema industry, and Matt a refresher on software.

Then the fun really kicks off as the three of them take a tour through the hits -- and misses -- of the season.

Were we right about Kogan (ASX:KGN)? Envirosuite (ASX:EVS)? Nanosonics (ASX:NAN)?

With plenty of satirical flair and ten or more stocks mentioned, this is one of my favourite episodes yet.

Some listener comments:

"Best show yet" - John

"Thanks for what has been an informative & enjoyable podcast series." - Joshua

"Awesome podcast guys. Thanks for sharing." - Stewart

"[Quoting me] 'You don't have to pat every fluffy dog' – I vehemently disagree, Claude. Worst take ever." - Dave

Listen to episode 22 on Soundcloud here.

Or, if you prefer, subscribe to the feed on iTunes by clicking here.

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Disclosure: The Author, Claude Walker, owns shares in VGL, NAN, and EVS. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Elixinol (ASX:EXL) Quarterly Cashflow Q1 2019: A Weak Result

2019-04-24T02:06:38+00:00

Elixinol Global Ltd (ASX:EXL) Quarterly Cashflow Q1 2019

Cannabis oil company Elixinol (ASX:EXL) yesterday released its quarterly cashflow report, showing that cash receipts were not impressive, given that it operates in a growing market. As you can see below, the receipts from customers decreased significantly, but expenses did not -- leading to a very poor operating result.

The company said that this reduction was “driven by Elixinol’s strategic decision to reduce focus on low margin private label business in the US to enable increased capacity for expected future growth of higher margin branded products and provide the ability to capture further market share.” This is extremely concerning.

However, it is also confusing because the company also said “Private label sales were significantly lower largely due to the Company restructuring supply arrangements with a private label customer whereby the Company will no longer perform private label services but instead will supply only bulk CBD products.”

It is not obvious to me why moving from private label services to bulk CBD products is a higher margin activity. In any event a couple of sentences seems like an alarmingly flippant explanation for what is, on the face of it, an extreme quarter-on-quarter drop. If this was indeed a carefully thought out strategy, then it should have been justified at length and in very precise detail.

In the worst case scenario, the strategic decision only made sense because private label customers were increasingly low margin. That is, they were putting continual pressure on Elixinol to reduce prices, or else they would go elsewhere. If that’s the case, Elixinol made the right decision, but are unable to compete on price, which shows they either lack scale or low-cost operational systems.

In the best case scenario, Elixinol has decided to use its capacity to fulfill its own branded business, which was being constrained by the private label services. While this scenario could be true based on the announcement, I don’t think it is explicitly stated, so it may not be an accurate understanding. In this case, we should see a stonking improvement in both receipts and operating cashflow next quarter, and the thesis would remain viable.

However, even in the best case scenario, in my opinion, the company has shot itself in the foot.

It is better business to ensure you are a trusted and reliable business partner, who will not suddenly stop supplying a customer private label services because it no longer suits you to do so. Rather, in my view the company should manage its own capacity so that it can maintain its business relationships, while also growing their high margin direct sales. Ultimately, that will allow it to be a more powerful player in the cannabis oil market than it could be if it focuses only on its own brands.

There might well be a time limit private label clients, but if we are at the beginning of a rapidly expanding market, I’m not so sure that it makes sense to do that now. And in any event, if that is what the company has chosen to do, then the decision should be explained and justified clearly to shareholders.

As a result of this analysis, I can only conclude that in the best case scenario my confidence in the company is now lower than it was, and two days after this post, I intend to sell a significant chunk of my Elixinol shares.

I do note, however, that Fabregasto, who wrote our initiation report on Elixinol, is currently more optimistic about this quarterly than I am.

Claude Walker owns shares in Elixinol and will not sell for at least 2 days after the publication of this article.

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This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Audinate (ASX:AD8) Q3 2019 Quarterly Cashflow Report

2019-04-21T04:02:13+00:00

Just prior to Easter, audio networking protocol (Dante) owner Audinate (ASX:AD8) released its quarterly cashflow report. Receipts from customers were down on the prior quarters, at about $6.2 million, but up 40% on the prior corresponding period. As you can see in the chart below, the third quarter was the weakest quarter last year, so it seems likely that the result was impacted by some seasonality.

The company produced $1.6 million of positive operating cashflow but only about $300,000 if you exclude the government rebate. This lead to negative free cash flow of just under $1.5 million (in its weakest quarter). While I would prefer to see free cash flow breakeven, this level of outflow is acceptable given that the company still has $12 million cash in the bank.

The number of Dante enabled products available for sale increased by 11% over the quarter, to 1,946. This increase of 197 is a really strong result, given that the prior 4 quarters have averaged about 115 new products per quarter. This was explained by a big leap in the number of Original Equipment Manufacturers (OEMs) shipping a Dante enabled product, up by 13, to 241. Again, this was a strong result compared to prior recent quarters -- the last half saw an increase of only 7 OEMs shipping Dante enabled products, while the half before that saw a gain of just three.

This growth in customer numbers could be seen as a strengthening of Audinate’s network effect, whereby widespread acceptance of its Dante protocol support further acceptance. In selling the shares down, upon release of the quarterly, the market has perhaps overlooked this fact.

Having said that, I believe that the market price for Audinate is now far more reflective of its potentially strong market position, despite the fact the company has yet to exercise its (theoretical) pricing power to drive profitability. So while I would not say the opportunity has passed, I cannot deny that as the share price has risen strongly in recent months, the balance of risk and reward has become less favourable.

Nonetheless, I remain a happy holder of Audinate shares.

Finally, Audinate has now produced four quarters of positive operating cashflow and will therefore no longer be required to submit quarterly cashflow reports.

Claude Walker owns shares in Audinate and will not sell for at least 2 days after the publication of this article.

For ethical investment ideas I back with my own money, join the Ethical Equities Newsletter.

This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

3 Reasons To Avoid The InvestSMART Ethical Share Fund (ASX:INES)

2019-04-01T10:12:34+00:00

3 Reasons To Avoid The InvestSMART Ethical Share Fund (ASX: INES)

I often get asked about various diversified ethical investments, both index funds and managed funds. Generally, when I think about ethical funds, I consider both the track record of the investors both in terms of performance, and in terms of ethical investing itself.

The InvestSMART Ethical Share Fund (Managed Fund) (ASX: INES) rates so poorly on both measures. Here’s why.

1) InvestSmart Has A Concerning Performance Track Record

Based on early marketing, Investsmart will market the fund based on the long-term performance of the Intelligent Investor newsletter. Looking past the headline, the performance of the newsletter business is still good with their best portfolio outperforming at around 6% p.a. outperformance over 10 years, 2% p.a. outperformance over 5 years, and -4% underperformance in the last year. Performance has declined in recent years.

I don't believe that an analysis of all the Intelligent Investor buy recommendations, ever, is reflective of the constraints of a fund that “will comprise 10 to 35 shares at any one time but will also have some exposure to cash”. For a start the buy recommendations have no cash drag, no tax and no brokerage, that I’m aware of.

I think a more relevant measure of performance is the more recent performance "Intelligent Investor Equity Growth Portfolio”, which is run by the same portfolio manager who will manage the new InvestSMART Ethical Share Fund. As you can see below, it is trailing the market over every time period reported on the website, except for "since inception", which I do not believe is a good guide. The current portfolio manager joined InvestSmart in 2018.

2) InvestSmart Has Track Record Of Opposition To Ethical Investing

It seems that the people launching this fund have a minimal long term track record of Ethical Investing (at best).

For starters, you have this 2017 Intelligent Investor opinion piece, which actively argues you should not practice ethical investing:

Now that article could provide a rich vein of material for me to critique, but even Intelligent Investor (now InvestSmart) seems to have backed away from Graham Witcomb’s claims, since they now say ethical investing “pays off”. From what I can tell, their position seems to have changed at about the same time as their decision to launch an ethical fund was announced. How coincidental!

More importantly, the proposed ethical fund portfolio manager shared the organisational skepticism for ethical investing, having admitted, “When I was originally asked about the merits of launching an ethical fund, I was sceptical. The last time I’d heard such enthusiasm for ethical funds was right before the GFC.”

Put simply, my googling doesn't produce a scrap of historical evidence that Intelligent Investor (which they are saying will inspire the approach) has ever said a nice word about ethical investing (until they decided to launch a fund). But there is plenty of evidence of their disdain for it.

For example, the long serving editor of Intelligent Investor, was published in multiple platforms, years ago, decrying that “it’s one thing to find an undervalued stock but quite another to find one that is cheap and socially responsible.” And that’s before we touch on the Intelligent Investor’s confusion about whether Cochlear is an ethical investment.

As if to compound this impression, the fund’s brochure has almost zero information about what is -- and is not -- permitted in terms of what is “ethical”. Its almost as if it's all in the name. You can see what I mean below:

I can't find any clear ethical investing philosophy expressed by the organisation, at all, besides (arguably) deep in marketing documentation for this fund.

Here's my heartfelt ethical investing philosphy, if you're interested.

3) Ethical investors have attractive alternatives to the InvestSmart Ethical Shares Fund

The passive ethical investor is spoilt for choice in 2019. Contrary to the assertion that ethical investing had a lull between now and “right before the GFC”, it has actually been growing strongly.

Thanks to Future Super, Australians can now buy a very low cost ethical ETFs sparked (in part) by the founder of GetUp. I know several Future Super employees and mark my words they are very passionate about making a positive impact. (Disclosure: I went to uni with some of them, and I admired them then).

I don’t invest with Future Super, but they’ve done a service to all by supporting these low cost ETFs.

If you want to invest ethically on the ASX, you have the BetaShares Australian Sustainability Leaders ETF (ASX:FAIR) which invests in ethical ASX stocks. It also avoids institutions that lend plenty of money to fossil fuel companies.

Notably, the Investsmart fund will charge almost 1% in fees per annum whereas ASX:FAIR charges 0.5%.

And the ASX:FAIR brochure is rather comprehensive, displaying its ethical standpoint prominently, in stark contrast to the InvestSmart Ethical Shares Fund. You can see what I mean below:

Meanwhile, my preferred stock-standard ethical ETF is BetaShares Global Sustainability Leaders ETF (ASX:ETHI), which invests in companies throughout the world. Its fees are a smidgen higher than ASX:FAIR, at 0.6%. I’ll throw to Intelligent Investor again, to explain why the extra 0.1% might be worth it:

When it comes to active investing, my preferred ethical managed fund is one of my own major investments: MX Capital. It doesn’t have 1% of the marketing heft of the InvestSmart fund, but the portfolio manager Weimin Xie has a track record of outperformance in his prior roles, and his fund is off to a good start, too, despite his hedging.

I think it’s easier for him to perform better when it’s smaller, so am pleased to be in early. In personal conversations, Weimin exudes the sense that he has a burning desire to have a high-performing fund, and he articulates his ethical philosophy very clearly and prominently on his website. You can see for yourself if you visit his http://www.mxcapital.com.au/ and scroll down.

Lastly, my superannuation is invested with the superannuation fund Australian Ethical Investments. Aside from my cash holding, my super is split between the Growth fund, the International fund. Both have outperformed the Intelligent Investor Equity Growth Portfolio over three years. However, I have a longstanding plan to start my own SMSF, and I will do that sometime soonish, I think (hence the cash holding).

In Conclusion

Allocating capital is like voting: you get to decide what to support, or you can cast a donkey vote. There’s no doubt that this new fund is targeted at people who mean well, but it disturbs me because there are much better options, on the balance of probabilities, for those very well-meaning people.

I find it troubling that ethical investors will end up supporting an organisation with a history of using their platform to vocally discourage people from making ethical decisions with their capital, over the course of many years. Because ethical investors: at Ethical Equities, we are your friends!

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Disclosure: The Author, Claude Walker, has a beneficial interest in units of the MX Capital Fund and the Australian Ethical Super Funds. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Three Wise Monkeys Podcast: Pro Medicus (ASX:PME), Wisetech Global (ASX:WTC) and How We Use Leverage

2019-03-27T22:04:06+00:00

In Episode 18 of the Three Wise Monkeys Podcast Claude outlines why he's holding on to Pro Medicus Limited (ASX:PME) even at high prices.

Meanwhile, Matt talks Wisetech Global (ASX:WTC) and gives a rundown on the capital raising.

And the primates discuss leverage, recessions and how they think about position sizing.

Listen to episode 18 on Soundcloud here.

Or, if you prefer, subscribe to the feed on iTunes by clicking here.

Please feel free to sign up to the forums and let us know what you think!

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Disclosure: The Author, Claude Walker, owns shares in PME, at the time of publication. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.