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Why I'm no longer interested in Codan (ASX: CDA)

Claude Walker — Wed, 18 Dec 2013 07:42:04 +0000

Subscribers will know that when Codan announced their original profit downgrade, I took the opportunity to buy shares from panic sellers. At the time, I described the position as a "research position" and subsequently, I did my research. One disturbing piece of information that I found was that the Chinese may have had access to Codan's secure radio codes.

I then updated subscribers to let them know that I sold my Codan shares for a small profit. In that update, I said, that if panic returns, I might be interested once again. Well, panic did return, but this time, I wasn't interested.

I wasn't interested because originally, I thought Codan was a top notch company that had faced a temporary setback. I also implicitly valued the Radio Communications business as if it were growing. Despite a recent acquisition, it is not. The company reported falling revenue for its communications business in 2013. Revenue from that segment has fallen every single year since 2010. So that's one major problem with the original Codan thesis.

Secondly, follow up research I did on Codan identified the catalysts for the Minelab business. I said: "the dates to watch are 28 July and 24 September 2013. These are the election dates of Mali and Guinea respectively."

Well as it turns out, the July elections in Mali were a complete joke, and French solidiers are still in the country trying to keep the peace. The president has just "won" another election - with very low voter turnout. The BBC reports that "despite some success, Islamist groups have stepped up their operations." So it is extremely suprising that anyone thought that gold detector sales to Mali would pick up.

Meanwhile, the situation in Guinea is not much better. The internet would have informed investors that their elections were a farce, as I predicted. The incumbents won the allegedly rigged elections, the results of which are still disputed. To quote AFP:

Dozens of police patrolled the streets of the Guinean capital Conakry on Tuesday after two days of pre-election violence that left a policeman dead and more than 70 people wounded.

The officers were deployed on the main thoroughfares running through opposition areas of the city with four days to go until long-delayed nationwide polls as youths looked on, sitting under trees lining the roads.

"We are quietly observing the situation. If the police provoke us or ask us to leave the side of the road, all hell will break loose again," one youth told AFP.

Opposition protesters shot dead a trainee policeman and wounded two other officers, according to the government, as violence broke out Monday in Conakry.

How stupid that Tony Abbott and the other hysterics describe the carbon tax as adding to sovereign risk. Codan shareholders are now experiencing the bitter taste of sovereign risk gone wrong. The inhabitants of those violent lands are experiencing something much worse, though, so keep it in perspective.

All this information has indicated for some time that there would be no imminent recovery of metal detector sales to Africa. So it was all the more important that the Radio Communications business pick up the slack. Alas, it seems that radio comms business is shrinking.

Sure there is a point at which I would buy Codan shares, but the share price would have to be a lot lower than $1. I don't want to be in the position where I am waiting for Mali or Guinea to reach peace. No doubt someone bought shares at 65c and is currently offloading them at $1; I know at least a one reader who would have been tempted. But I didn't want to play that game (again), as I'm trying to be an investor not an opportunist. Even at current prices, there are better places for your capital, in my opinion.

I won't consider buying shares in the company until it starts to seriously develop new markets (such as Latin America, Central America, and Asia). I'd also like to see inventory reduced by about 75%.

The Author has no financial interest in Codan. Nothing on this website is advice, ever. This post is for entertainment (and for my own reference!)

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Why I sold my Codan shares (ASX: CDA)

Claude Walker — Mon, 02 Sep 2013 02:23:17 +0000

About a month ago I wrote this article in which I estimated that I would have to buy shares in Codan at $1.81 in order for the investment to meet my required return on investment, assuming that results largely reflected my predictions in this update to subscribers. I also examined some of the risks facing the company.

Subsequently, shares traded well above $2.10. At a premium of over to 15% to my estimate of a good buying price, I sold part of my holding.

When the results came out, they confirmed that sales in Africa would be lower in FY2014, and that the company expected results in the range I had predicted. Shares continued to trade above my personal buying price (as often the case with the companies I cover).

As a result, I have sold my remaining shares at slightly below current prices ($1.98, as I write). The market seems broadly rational, and it would also have been a reasonable decision to hold my shares. Should panic return, I would consider buying again.

I think the trade was a good one, because at $1.60 there wasn't a very big chance of permanent capital loss. The fact that the share price recovered so quickly is down to luck. Either way, the market panic that led shares to be sold down to $1.50 is an instructive experience in herd mentality, and demonstrates what can happen when an over-hyped company (as Codan was) runs into trouble.

Given that management has a proven track record, it is a difficult call. I expect, over the long term, Codan will generate satisfactory returns to shareholders. It would probably make sense to hold the shares. However, my understanding of the company is simply not as sophisticated as it should be, so until I have a better understanding of the mining services and radio communications businesses, I will sit on the sidelines.

The Author has no financial interest in Codan. Nothing on this website is advice, ever. This post is for entertainment (and for my own reference!)

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Is Codan (ASX:CDA) still worth holding? An update, and discussion of risks.

Claude Walker — Wed, 24 Jul 2013 02:54:59 +0000

The purpose of this article is to follow up on comments I made available to Newsletter subscribers about a month ago.

On the 17th of June, in the hidden report on Codan, I wrote:

I would love to be able to provide more in depth research to you right now, but alas, time does not permit it. I expect the share price to remain volatile for a while. At $1.50, the PE under the hypothetical worst case scenario would be just of 13, which is not outrageously high, but not a bargain either. Shares are currently trading at $1.65. A lot of hot money will be selling over the next few days, and you never know how low it might get, but even at current prices, I think Codan is undervalued, and I bought a few shares this morning. However, I am going to consider the position carefully over the coming week, and I consider my purchase a “research position” – the perfect incentive to take a closer look at the company.

The low on that day was $1.60. In the subsequent weeks, Codan shares went as low as $1.47. On the 18th and 19th of June, no fewer than five of the eight directors bought shares at prices ranging from $1.56 to $1.60. The shares are currently trading at $1.85. For someone who bought shares at $1.60, that’s over 15% return in a month.

As a recent buyer myself, I am now considering whether I would like to be a long term shareholder and I’d like to share some of the concerns I have about Codan.

Their radio business in unlikely to earn much: their recent acquisition should earn about $1.2 million to NPAT at a minimum. Their mining services devision is even losing money, albeit a relatively small amount. Codan announced that its full year profit would be $45 million.

Minelab is the good business. It sells metal detectors in many countries in the world, and reportedly has the best product. It faces a risk from cheap imitators and we must conservatively assume that Chinese companies already have their proprietary IP.

Fortunately for Codan, the brand and quality control is very important, especially as faulty metal detectors result in people dying where they are used to find land mines. Similarly, trust in the equipment is important when looking for gold or coins.

The previous guidance – for a repeat of the first half in the second half – would have resulted in a profit of about $53 million. In April, the company responded to this price query by saying that it did not know of any information that could have caused the sudden drop in share price. I find it hard to believe that sales into the African markets were not slowing at that time. However, because Codan supplies distributors in those countries, it may not yet have dawned on them that unrest was making it impossible to sell their metal detectors.

If we assume that they were on track to deliver $53 million in April, at that stage they had already made about $39.5 million. In that scenario, since April the company has made just $5.5 million. That would imply a NPAT of $22 million a year, broadly in line with FY2012 and FY2011 ($23.1 million and $21.8 million respectively).In the profit downgrade, the company said:

“The African markets that are currently being impacted by civil unrest are due to hold government elections early in FY14. With the return to more stable trading conditions, coupled with the work to develop more new gold detecting markets for our products, the Board remains confident that the company is well-placed for a successful FY14.”

This inspired me to speculate as to what markets are being impacted. I believe that the main impacted markets are Mali and Guinea. That is because both of those countries descended into instability as a result of the Malian coup (they both have armed Islamist fighters, and are neighbours). Both of these countries are also major gold producers, so I wouldn't be surprised if Codan was selling metal detectors into these markets. Evidently, there is gold to be found.

If that is the case then the dates to watch are 28 July and 24 September 2013. These are the election dates of Mali and Guinea respectively (fits the bill, right?). All indications are that the Malian elections will be a complete farce. Based on what the Australian Government says, I wouldn't want to live in Guinea, either. I think that the unrest will continue for a while. Maybe even years.

Finally, no-one seems to be talking about it, but I’m a bit worried about the fact that Codan secure networks were reportedly hacked by the Chinese. Four corners covered the breach, probably resulting from a Codan executive using free Wi-Fi in China.

How much would I buy Codan for

I therefore think we should assume that underlying NPAT is $22 million (in line with the last two years). If we average the cashflow for those two years, we get $33 million. In the first half of this year, cashflow was $22 million. I’ve simulated a discounted cashflow model, to get an idea about what kind of returns Codan would be likely to generate for holders. In this model, I assume cashflow for 2013 to be $37 million, then I assume it will contract to just below $30 million as a result of the inability to sell into certain African markets in 2014. I then assume there will be no growth, but that Codan will fetch 10x cashflow in 2017. The Author owns shares in Codan. None of the above is advice.

Edit: Please note I subsequently sold my shares for an average price of just under $2, as described to subscribers in this article.

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