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Robert Miller
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Robert Miller is a Portfolio Manager at NAOS.

5 CEOs who tick all the boxes

Wednesday, October 04, 2017

By Robert Miller
The quality of management is a major factor in assessing any investment opportunity. We adopt the rule that no matter how good a company may appear on paper, if we are not comfortable with the CEO, we will not invest.
In our previous piece we highlighted five key points to consider when assessing the value and quality of a CEO

  1. Consistency in their message portrayed to the market on the company’s strategy
  2. A long term tenure in their current and previous positions
  3. Alignment with shareholders or ‘skin in the game’
  4. Being commercially minded plus knowing the detail, the concept of ‘lab coat vs commercial coat’
  5. And finally what makes them tick? What’s the non-financial motivation?


To follow up, we’ve outlined five company CEO’s that we feel are best of breed in what they do and how they manage the hard-earned dollars entrusted to them by their shareholders.
Capital Cities/ABC Inc. (owned by Disney) – Tom Murphy (CEO)

The legendary Tom Murphy is the ultimate case of a CEO with all the attributes to make him best of breed. For those unfamiliar with Capital Cities, it was a US media conglomerate built up by Murphy over a 30-year career which included buying the American Broadcasting Company (ABC) for $3.5 billion, and eventually in 1995, purchased by Disney for $19 billion. Over this time Capital Cities grew both earnings per share and return on equity by close to 20% p.a. and the value of a share went from under $10 to $12,000.
Murphy’s strategy; all capital allocation decisions must not only be cost focused but they must also improve the core business rather than expand into new areas. Furthermore, he shared a similar decentralised management methodology to Berkshire Hathaway (of which he was a board member). Murphy knew the cost items for his businesses intimately and ran his stations at significantly higher margins than industry peers. He also handled the M&A processes for Capital Cities, his ‘lab coat vs commercial coat’  balance was excellent and it’s refreshing to see a CEO making investment and management decisions in unison.
Whilst waiting for the next Tom Murphy might prove an uphill battle, there are numerous ASX listed businesses which we feel have CEOs with attributes to qualify these leaders as standout.
Smartgroup Corporation Limited (ASX: SIQ) – Deven Billimoria (Managing Director and CEO)
Deven’s tenure is extensive, having been involved with Smartgroup since 2000 when he joined as CEO. During these 17 years a ‘return on capital’ focused strategy has remained consistent through both organic and acquisitive growth; and revenue and earnings have seen compound annual growth rates of circa 30% and 40% respectively.
Since listing on the ASX in July 2014, the market capitalisation has grown from $162 million to over $900 million, and during this time fully franked dividends have grown by close to 150%.
If you’ve had the opportunity to hear Deven present, you would know he is extremely customer focused. Success rates on tenders, net promoter scores and industry awards SIQ has been able to consistently achieve over the past decade demonstrate the company’s customer focus. A read of their annual report further highlights their in-depth focus on non-financial attributes.
Deven is a top five shareholder, furthermore the market can take comfort from the quantum of director buying that has occurred over the past 12 months. The chairman and numerous other directors have been purchasing shares on market, a great sign of an aligned board with confidence in the company.  
MNF Group (ASX:MNF)* – Rene Sugo (Director and Group CEO)
What started out as a small wholesale tech company writing its own software in 2002 and then listing in 2006, is now Australia’s largest interconnected voice network with a strong global presence and a market cap of approximately $350 million.
Rene was the co-founder in 2002, and lead technician behind the original build out. Since mid-2008 with a market cap of $8 million, MNF has been able to compound earnings per share growth at 70% p.a., all the while paying out dividends to shareholders. Rene has significant alignment with shareholders, owning circa 20% of the company (as does his co-founder), both of whom have consistently acquired more shares since the 2006 IPO.
Apart from his tenure, shareholding, and heightened responsibility for the company as its founder, what we see as a key attribute contributing to the quality of Rene’s leadership is his ability to wear both the ‘lab coat & commercial coat ’. He has a handle not only on all the technical specifications of company operations but business development and the commercial/financial aspects as well. In our opinion, a small cap CEO’s job is to know their business inside out and Rene is a prime example of this given he is the founder who also built the technology.
Macquarie Atlas Roads Group (ASX: MQA) – Peter Trent (CEO)
Peter Trent has been at the helm of MQA since it spun out of Macquarie Bank and listed in early 2010. Prior to this he had over a decade’s experience managing toll road investments for Macquarie Bank. Macquarie Bank remain the second largest shareholder in MQA.
Operationally this might sounds like a bizarre business to quantify a good CEO, as in some respects a business like MQA could be seen to almost ‘run itself’. On the other hand, the key for MQA has always been capital allocation and Peter Trent has done a fantastic job at this as demonstrated by total shareholder returns (TSR) of above 25% per annum. It is worth noting that MQA has paid out more in distributions than the market cap of the company at time of IPO, and returns on capital have been continually improving.
As a bond proxy style investment, the job of the MQA management team is principally return on capital focused, Peter has proven to be successful across creating operational efficiencies, capital allocation for tollway upgrades, debt management and refinancing, asset sales, capital recycling and asset purchases. Going forward, we believe further rationalisation of capital spend and debt should be a driver for continued TSR growth.
Pro Medicus (ASX: PME) – Dr Sam Hupert (CEO and Managing Director)
Dr Hupert was a co-founder of PME in the 1980’s and is the equal largest shareholder with 30% equity. During the global financial crisis Pro Medicus bought the Visage Imaging software business from Mercury for approximately $6 million. Three years later PME had sold off the non-core assets for about 3 times the total value of the original Visage purchase price. Dr Hupert was quoted at the time saying “the opportunity came along and we decided to take it”. The assets which remain in PME are now worth $500 million (the company has consistently paid dividends along the way) and the software is being rolled out across many of the leading hospital institutions throughout the western world. The core R&D team who built the software came across to PME and remain in the business today.  
For every dollar of capital allocation the company makes, 30 cents belongs to Dr Hupert, with this strong alignment to shareholders, impressive long term track record and product knowledge from both a commercial and technical standpoint, we feel PME is one of the best managed small cap businesses on the ASX.

This is a sponsored article by NAOS Asset Management.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances. 

* NAOS Asset Management are substantial holders of MNF Group (ASX: MNF)

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Cash flow statements: 3 things to look out for

Tuesday, August 01, 2017

By Robert Miller

It is fast approaching the time of the year when annual company reports will be coming in thick and fast. With so much information on hand, one is quickly drawn to the financial reports which include the income, balance sheet and cash flow statements. This reporting season, we encourage you to read the statements back to front, that is, cash flow first, then balance sheet, and finally, the income statement.

Investors can often overlook all things cash flow, so in this article, we will step through three key sections of the cash flow statement which can highlight positive signals and warning signs.

1. Operating Cash Flow

The focus here is ‘cash conversion’. We think of cash conversion as the following:

Cash Flow Conversion = EBITDA / (Receipts from Customers – Payments to Suppliers)

This ratio helps to outline the working capital requirements of a business. The ratio result can vary widely. For example, it could be negative if a company is paying invoices before collecting invoices. Or, it could be positive if the opposite is true. In other words, a positive working capital balance, or if the company happens to receive payments in advance.

Cash flow conversion profiles will vary across different industries. For example, a building contractor is likely to have more ‘lumpy’ cash flows than an IT services company. However, the key items to look for are the payment cycles from both debtors and creditors. If a company is receiving payments in from debtors on a 60-day cycle and making payments out to creditors on a 90-day cycle, this creates a positive working capital position.

Given the degree of variability in cash flow conversion, it is essential to look for consistency and identify any occurrences of lumpiness to gauge business health. We try to look for companies producing a consistently positive cash conversion ratio result between 75-110%. A ratio in this range supports a well-managed, strong cash generative business which is not placing pressure on growth by running a negative working capital position. High cash conversion also provides comfort around a company’s ability to pay dividends. We tend to avoid negative working capital businesses, as any growth may quickly lead to funding gaps.

2. Investing Cash Flow

A company’s spend on property, plant & equipment or capital expenditure (‘capex’) has the potential to be a large item, which can vary drastically from year to year due to significant one offs. It is important to understand the reason management is spending on one offs, such as purchasing a new piece of land, upgrading an old plant, etc.

We like businesses that are coming to the end of a big ‘capex spend cycle’, meaning a company’s capital spend is expected to significantly drop (but not stop) over the next 1-2 years. Assuming the investment has been for growth or efficiency purposes, a drop in spending should hopefully equate to improved business leverage and higher profit margins.

It is worth noting that capex is a vital component for business growth. If a company spends nothing on capex, then this can be a sign of management ‘short termism’ and can negatively affect long-term growth. Lack of any current capex spend may increase the likelihood of a large one-off spend to play catch up. If this eventuates, negative pressure could be placed on the company.

An ideal scenario is a consistent level of ‘maintenance capex’, meaning a stable level of spend towards existing business improvements. You can be comfortable with a management team which has a level of capex that is roughly the same as their depreciation profile, this will result in little or no net impact on earnings. 

Capitalised development spend is a concept all investors should be aware of. These are essentially expenses which are not included within the profit and loss statement but rather appear in the cash flow statement. Management teams will try to justify this course of action by classifying the spend as a long-term asset for the business, as opposed to an asset being expensed within the period which the spend occurred. This may be appropriate, however, it can be fraught with danger, so it is something to look out for. Capitalising costs can distort the earnings profile of a business, as expenses are excluded from the profit & loss statement, leading to a higher profit figure, which may lead to the market placing an inflated multiple on a company.

In some cases, accounting standards require a certain level of capitalisation. However, we always prefer to see businesses (including software companies) which fully expense all their capital spend as they end up with a ‘truer’ earnings figure. This helps limit downside risk to the current earnings multiple.

3. Financing Cash Flow

The financing section is all about debt and equity funding within the business. This needs to be healthy to sustain and complement the operating and investing cash flows. There is no hiding in the financing cash flows.

There are a couple of important questions to ask;

  • If the company has issued equity, have they done this regularly over the years?
  • Has a company taken on further borrowings to fund their poor working capital position or investing activities? If so, is the amount borrowed growing every year?

If the answer is yes to any of these questions, investors should be cautious. Debt is OK, but we like to see consistent repayment of this debt over the years and nobody likes continual issue of equity which may cause dilution of existing holdings. This can signal poor management decision making regarding deployment of capital.

We also like to look at the dividend payment amounts flowing out of the financing cash flows and check to see if these are consistently growing. If they are volatile over the years, try to understand why. Was it a special dividend, or is there inherent volatility in the company cash flows? Be cautious of the latter. We like a company that is in a position to both repay debt and pay dividends, as this combination should translate into much higher dividends as the debt repayment continues to fall.

Understanding the cash flow statement is a crucial tool for gaining comfort around the downside risk of a business. The NAOS Investment Team like to see high cash generation companies, consistency, minimal capitalisation of costs, and we avoid companies if funding holes are continually being ‘plugged’ with debt or equity. Strong cash flows allow a company to maintain a healthy balance between dividends and reinvestment back into the business, which are key to sustainable shareholders returns.

This is a sponsored article by NAOS Investment Management.

This article is general information, it is not intended as financial advice and does not consider the circumstances or investment needs of any individual.

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5 things to look for in a CEO

Wednesday, July 19, 2017

By Robert Miller

One of the most fundamental factors that is consistent across the majority of company success stories in the NAOS investment universe is, arguably, a high-quality leader. Simply put, no matter how good a company may appear on paper, if we are not comfortable with the CEO, we will not invest. On the flip side, we may be able to look past a business with certain issues if we have a lot of confidence in the leader.

Here are five key points to consider when assessing the value and quality of the person at the top. 

1. Consistency 

The message portrayed to the market on the company’s strategy needs to remain consistent over the short, medium and long term. Investors will build their investment thesis around this message. If the CEO’s message changes either positively or negatively, it is time to review your investment. If it changes frequently, it is time to reconsider your investment altogether. We like to look back to our previous notes to see if they have done what they said they would do – there is great benefit for all investors who practise this.

2. Tenure

A management bio will give you the information you require to go back and learn from the past. Anyone who has had multiple, short tenures in different businesses would raise a red flag. Ideally, we like to see a CEO who has demonstrated building long-term shareholder value in a similar sector/industry throughout their career. Channel checking is always recommended, whether it be to fact check an industry, sector, company or manager.

3. Shares and incentives

It is no secret that investors like to see a capable management team with skin in the game –  this is a very powerful factor when selecting an investment. Furthermore, it can be a warning sign if the leader of a small/micro-cap stock doesn’t hold a substantial position. Alignment extends to the incentive structures in place for the leadership team and we recommend having a good understanding of all key contributors.

Be cautious if share price is the only focus, as this may cause a CEO to concentrate on short-term decisions that create ‘hot air’ in a stock and could be detrimental to the business in the longer term. We prefer to see earnings per share growth included as a reward metric, as this reflects a focus on improving business quality over the long term. If this is delivered upon, it should reflect positively on the share price.

4. Commerciality vs lab coat

By their very nature, small businesses are hands on and those in charge can benefit from being ‘Jack of all trades’ type leaders. A high-quality CEO will have the ability to candidly and confidently talk about all parts of their business in a way that investors understand. We get a lot of comfort from a leader who is able to answer questions about the smallest of issues, or show an understanding of their customer base by explaining a key client in detail - this is the ‘lab coat’ part of a management skillset. 

At the same time, they must be commercial. Here, we would look for managers who have a good handle on their competitors, corporate activity and their own share register. This might sound like a lot to ask, but quality CEO’s do this naturally in equal balance.

5. What makes them tick?

Trying to understand the motivation of a CEO can be very subjective. In simple terms, we like to see something more than just the financial aspect which drives someone to run a business every day. Generally, a small company is started because a CEO wants to take a chance and provide something different from the industry status quo. It is a case by case assessment of the individual and the company they are leading, however passion, confidence and commitment are crucial to create long-term shareholder value.

This is a sponsored article by NAOS Asset Management.

This article is general information, it is not intended as financial advice and does not consider the circumstances or investment needs of any individual.

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