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The Experts

Tim Boreham
+ About Tim Boreham

Welcome to the New Criterion, authored by Tim Boreham.

Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.

Tim Boreham has now joined Independent Investment Research and is proud to present The New Criterion, which will honour the style and purpose of the old column. These were based on covering largely ignored small- to mid-cap stocks in an accessible and entertaining manner for both retail and professional investors.

The New Criterion will strive to continue the tradition in a weekly online format.

The column will not offer stock recommendations because we think readers can make up their own mind on the facts and opinions presented.

Our coverage will include both the industrial and mining sectors, including listed investment companies and IPOs. The stocks covered will not necessarily be of investment grade with sound financials. But they will have credible management and – at the very least – an interesting story to tell.

We hope readers will find The New Criterion both entertaining and informative.

The new criterion: Paying staff on time

Friday, June 29, 2018

Paygroup (PYG) 90c

The number one imperative of managing staff is not to provide the troops with chocolate biscuits in the tea room or a subsidised gym, but to pay them accurately and on time.

“If you stuff up someone’s pay you will be forever in the bad books,” says Paygroup chief executive and co-founder Mark Samlal. “You just can’t afford to do that.”

With that in mind, the recently-listed Paygroup is tackling the Asian market, where its multinational clients have to cope with an array of different rules and cultures.

On behalf of 410 clients, the Singapore based Paygroup operates two divisions: business process outsourcing (payroll services) and human capital management software (other HR stuff such as expense and leave management).

Samlal says Paygroup, which operates in 18 countries, faces “all levels of sophistication”. The clients are generally based in Singapore or Hong Kong or, increasingly, Kuala Lumpur.

But they have a habit of expanding into the smaller and less developed economies and they expect Paygroup to follow them. For instance, one client has taken over a plant in Myanmar which not too long ago was a closed dictatorship (and if you’re a Rohingya, it’s still got its issues).

The company handles 80% of the work itself, but in countries such as Pakistan, Bangladesh and Sri Lanka. “We pay people in over 25 cities in India so we have a strong capability there,” Samlal says.

Paygroup shares have bounded from the blocks since the company listed on May 25, having raised $8.5 million at 50c apiece.

The buoyant performance was helped along by the lack of pre-IPO investors, which meant there wasn’t a conga line of punters selling out on the first day.

The float was also priced to sell, as measured by guidance of sharply higher earnings for the year to March 2018.

The listing was a case of third time lucky for Paygroup, which tried to debut last year based on an acquired operation called PeopleHR based in Colombo, Sri Lanka.

“It didn’t perform so we pulled the prospectus in early September and decided to list our own company,” Samlal says.

The float was then further delayed after ASIC expressed concern about unaudited half year accounts.

Paygroup’s board seems well-credentialed: its chairman Ian Basser was the former head of the ASX-listed recruiter Chandler Macleod, which was taken over.

Director David Fagan was the former chief of law firm of Clayton Utz and is on the Medibank Private board.

Paygroup generated a $477,000 net profit on revenue of $5.94 million in 2016-17, but expects a $2.61 million profit on revenue of $7.3 million for 2017-18.

Paygroup’s revenues tend to be reliable and clients are on an average three-year contract. Unless the aforementioned “stuff ups” occur, they won’t change provider.

At the time of listing Paygroup traded on an earnings multiple of a mere eight times; now it’s more like 12 times.

While Paygroup doesn’t have a directed ASX-listed peer it shares characteristics with Elmo Software (ELO, $5.54), which provides technology for HR and payroll functions but doesn’t execute these processes holus bolus.

There’s also some overlap with salary packagers McMillan Shakespeare (MMS, $16.31) and Smartgroup (SIQ, $11.68).

“I don’t want to sound like a smarty pants but there’s no-one on the ASX quite like us,” Samlal says.

Serko (SKO) $2.78

Still on staff management: the process of booking corporate travel has been manual and ponderous, usually involving visiting multiple service provider sites.

The more parties involved, the higher the likelihood of a snafu.

“Travel is of one the most personal things,” says Serko co-founder Darrin Grafton. “You don’t want to turn up at an airport without a ticket or arrive without a hotel booked.”

But it’s the New Zealand based Serko’s artificial intelligence, rather than the personal touch, that strives to prevent double bookings, non-appearing hire cars or corporate travel rule breaches that result in humble functionaries living it up in business class.

Called Zeno, Serko’s robotic tool predicts the booking behaviour of staff and recommends flights, hotels and other services accordingly.

It even compares dates on online calendars to ensure that the marketing manager doesn’t arrive for a sales conference that was held two days earlier (probably didn’t miss much).

Meanwhile Serko’s eponymous platform processes 20,000 bookings per day and is used by 70% of Australian corporate travel companies as well as companies such as Wesfarmers, Santos, Fortescue Metals and Telstra.

Mind you, the latter will have less of a need to move around middle managers after last week’s announced cull.

Don’t be alarmed if you’ve never heard of Serko because much of the business is white-labelled: for instance it’s the platform behind Flight Centre’s corporate booking business.

Grafton says “we don’t care what brand is visible as long as we are making money’’ – and we can’t argue with that.

Serko has been listed on the NZ Stock Exchange since 2014. The stock was the bourse’s best performer in 2017, surging from 29c to $2.19 and making multimillionaires out of Grafton and co-founder Bob Shaw.

The company listed on the ASX last Monday. But unlike the accounting software giant Xero, which is now exclusively ASX listed, Serko will maintain an NZ listing.

Given Serko gleans about 95% of its revenue from across the ditch, it’s perhaps surprising the company has taken so long to list here.

“A lot of Australian institutions have visited us, but many have mandates that prevent them from buying the stock unless we have an ASX compliance listing,” Grafton says.

“But we wanted to be in a pretty good financial position before flicking that switch.”

The switch-flicking moment came after Serko recorded a $NZ2 million ($1.86 million) net profit for the half-year to March 31 2018 compared with a $NZ3.3 million loss previously,  on revenue of $NZ18.3 million (up 28%).

The company expects to remain profitable, even as it spends a decent sum on US and British expansion.

The dilemma for shareholders is whether Serko’s $200 million market cap just about does it.

Tim Boreham edits The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

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The New Criterion: Finding light in the financial sector

Friday, June 15, 2018


With the mortgage broking sector already under the regulatory blowtorch, Mortgage Choice has added to the pain with revelations of unhappy franchisees. But is there value emerging in the marked down shares, as well as those of listed counterpart Australian Financial Group?

Mortgage Choice (MOC) $1.50 

With Mortgage Choice joining the casualty list of high-profile franchised operations, investors are pondering just how low the mortgage broker’s shares can go following reports of a looming franchisee revolt.

The experience of franchise ‘floperoo’ Retail Food Group, which has lost more than 80% of its value since early December, is hardly encouraging.

But there’s comfort of sorts for Mortgage Choice holders: according to Macquarie Equities, the value of the company’s cash and up-front and trail commissions already earned is worth $1.09 a share.

In other words, at these levels the market would be valuing Mortgage Choice’s franchise network and ongoing business at a big fat zero.

Even before last week’s revelations of a revolt among a large rump of Mortgage Choice franchisees, the mortgage broking sector faced stiffening headwinds with the prospect of tighter regulation and the onset of a housing downturn.

Even before that, investors had marked down Mortgage Choice shares after the banking royal commission created unfavourable headlines in March.

And let’s not forget that Mortgage Choice John Flavell departed suddenly in early April and without explanation, leaving CFO-turned-CEO Susan Mitchell to face what the French would politely call a sandwich de merde.

The immediate outlook for Mortgage Choice is not pretty, even though management scurried to change the commission structure to give discontented franchises a greater share of the spoils.

But if half the franchise base proceeds with a mooted legal action, the repercussions will soon bite the bottom line.

The broader question is whether the whole sector faces an existential threat because of dubious practices such as loan churning and lax customer vetting.

At the royal commission, the lightning rod for fury centered on the conduct of another major participant, Aussie Home Loans.

Rather than saving people from the banks these days, Aussie is fully owned by the Commonwealth Bank of Australia, in relation to dealing with a fraudulent broker.

Among the lowlights aired, an internal CBA report also admitted deficient oversight of broker loans in relation to misconduct and miss-selling.

Such revelations have prompted the mortgage brokers’ ultimate customers – the banks – to make ominous noises about curtailing the brokers’ commissions or pushing for a fee-for-service model.

The overwhelmingly majority of brokers don’t charge the borrower, but reap an up-front and trail commission from the bank (these average 0.65% and 0.15% of the value of the loan respectively).

The truth is the bank-broker relationship is symbiotic: regional banks without a bank network rely heavily on them and any bank failing to nurture this third-party network has quickly found their mortgage market share decreasing.

Mortgage brokers account for 55% of all home loan originations and that figure has been creeping up over time.

In the past, the banks have tried plenty of times to curtail these payments. The Bank of Queensland even stopped using brokers for a period in the noughties.

The broker commission model means that brokers indeed have every incentive to recommend loans from the lender offering the best cut and up selling the value of these loans.

But a bank loans officer subject to aggressive performance targets can equally be guilty of writing bad business.

It’s likely the royal commission – as well as an ongoing Productivity Commission inquiry – will result in tighter regulation. One prospect is capped commissions similar to the life insurance industry.

But given the entrenched role of brokers in the $1.7 trillion mortgage market your columnist can’t see them being driven into the Red Sea. But they’ll get a bit wet.

The industry cites a separate ASIC review of broker remuneration, which concluded the broker model wasn’t broken but needed some tweaks. Whether these tweaks turn out to be an adjustment of the carburetor settings or a full engine rebore remains to be seen.

Arguably there are too many brokers – about 7000 active ones – and a housing downturn will hurt volumes. But rising rates will prompt existing borrowers to refinance and brokers love churn.

Based on expectations of flat full-year cash earnings of around $23m, Mortgage Choice trades on a current-year multiple of under eight times and a fully-franked yield of more than 10 percent.

However any investor who has been around for more than two seconds will know that such low multiples and high yields are usually illusionary. 

Australian Finance Group (AFG) $1.31

At the time of writing, AFG shares looked to be suffering contagion from Mortgage Choice’s woes, although AFG CEO David Bailey offers other reasons for the sell-off.

“There’s a lot of uncertainty around the sector because of the royal commission and discussions about (broker) remuneration,” he says.

“Certainly Mortgage Choice is the big brand name while we’re more like a wholesaler.”

But while both stocks are mortgage brokers their business models differ markedly and Bailey has been on the investor hustings to drive the point home.

While Mortgage Choice is a franchisor – franchisees pay a buy-in amount for a designated patch – AFG is more of a support act for independent brokers.

Under AFG’s agglomerator model, brokers sign up for support services such as technology and (If they choose) the right to use AFG’s credit license.

AFG charges a monthly fee for the services ($70 for the technology support, for example) and takes a modest cut of the broker commissions (about 7 percent of the upfront component).

AFG also has the primary relationship with the lenders via its lending panel. But in effect the brokers remain independent, operate under their own name and chase their own leads.

“In reality we give the brokers the tools to start a business,” says CEO David Bailey. “That can be anything from mums and dads in Parramatta to larger organisations like iSelect or Oxygen Group (part of the McGrath real estate group).”

AFG is also more diversified than Mortgage Choice, having entered home and small business lending in its own right.

AFG has also expanded its wares further by paying $10.9m for one-third of Thinktank, a mortgage-backed lender specialising in commercial loans.

The idea is that Thinktank sells the loans through its 2900 strong broker network.

With 2900 brokers on its books, AFG represents about half the broking industry. But AFG’s broking activities accounted for 60% of half-year earnings and this component should decline over time as the company builds its own-branded products.

AFG trades on a measly multiple nine times earnings and yields about 9 per cent. Notwithstanding a lending apocalypse, its business looks more robust than Mortgage Choice’s.

Tim Boreham authors The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

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The New Criterion: Tech and manufacturing

Friday, June 08, 2018


Carbon components specialist Quickstep is flying high with an ongoing parts contract for the Joint Strike Fighter program, but investors remain wary because the company is yet to turn a profit. Also in the tech space, Sensera has gone to market with a better tool to track mining equipment – and cows.

Quickstep Holdings (QHL) 7.5c

Quickstep’s recently-appointed CEO gives a succinct explanation for why shares in the Bankstown Airport based carbon composites maker are trading at close to record lows.

“We have been listed for 12 years and have never made a profit,” Mark Burgess says. “We have made a lot of promises and fuelled expectations, but not met them.”

Yep – that about sums it up. But in the words of Bob Dylan, the times are a changin’ and when Quickstep management talks about earnings these days it’s not just blowing in the wind.

Quickstep’s revenues derive from two key sources: long-term contracts to supply parts for the Joint Strike Fighter (JSF) and the Hercules C-130J, an updated version of the old warhorse of the skies.

The US JSF program is the biggest military project in history and worth so much that we have run out of noughts.

The sleek jets have been derided as inferior to those of our putative enemies - we won’t be so crass as to name names, me old China – but we’ll never really know until there’s a combat situation.

Hopefully, we’ll never know.

Given Australia is a purchaser of JSFs – 72 at last count – Australian suppliers are entitled to a share of the spoils.

Hence local hero Quickstep wrangled contracts to supply 700 carbon parts on behalf of JSF lead contractor Northrop Grumman.

Quickstep has been producing the JSF parts – including doors, panels, skins and vertical tail parts – under a 14-year contract. The difference now is that the company is doing it in profitably, the result of a back-to-basics program called OneQuickstep.

The program was initiated by Burgess, a former Honeywell Aerospace and BAE Systems heavy who took over the role from David Marino in May last year.

Marino had an automotive background and it’s no coincidence that Quickstep’s ambition to supply the cut-throat car industry with lightweight parts has been wound back.

The OneQuickstep effort focused on the core Bankstown facility and head office, with measures including key executives from nine to five and halving the non-executive directors to three.

R&D spending was halved, including the closure of a German facility.

The proof of the pudding is that Quickstep’s March quarter revenues improved by 15 percent to $14.6m, with positive cash flow of $2.74m.

The company has reported quarterly surpluses before, but like Criterion’s footy team it has struggled to cobble two ‘wins’ in a row.

Quickstep also repaid a $2m director loan, but is still $13m in hock to the government export credit agency EFIC. Burgess expects further debt reduction, but adds that EFIC is an attractive alternative to a capital raising.

But management is confident of sustained earnings for the full year that will be maintained din 2018-19.

While often associated to lumbering white elephants, the JSFs are now rolling off the production lines at a decent clip.

The company expects peak JSF output of 160-170 units is expected in the early 2020s, but production scheduling means Quickstep experiences demand about 18 months beforehand.

In theory, the JSF order book is worth up to $1 billion for Quickstep up to 2030, the envisaged sunset date for the program.

Quickstep has some other irons in its high-tech furnace with some smaller jobs with Boeing and a tie up with Italy’s ATR Group.

Another specialist sideline is specialist parts for medical devices such as x-ray machines.

But it’s efficient delivery of the JSF and Hercules contracts that will determine whether this one, er, flies.

Sensera (SE1) 19.5c

What do ruminating cows and mining trucks have in common?

The answer is that both cattle and mining equipment move around and it’s nice to know their whereabouts.

Sorry, that’s not exactly a zinger for the upcoming Edinburgh comedy festival gig, but a straight-laced reflection on the core nature of the tech minnow’s activities.

A specialist in “location awareness”, the sensor house provides collision avoidance systems for mines. In the case of cattle its tool can detect heat, lameness or the onset of infections in beef and dairy cattle.

In effect, Sensera plays in the ‘internet of things’ sector, with a presence in both the hardware and software side.

One aspect is micro electrical management systems (MEMS), the wondrous sensors that transform physical events into electrical signals (for example, rain on a windscreen can activate a wiper)

Sensera had the MEMS bit down pat already, but entered the location awareness business in August last year by acquiring a German outfit, Nanotron, for €6.4m ($10.3m) in shares and scrip.

Given the venture-capital backed Nanotron spent €38m on honing its technology, the deal looked like a sharp one for Sensera.

The Nanotron systems currently are used in 60 mines in South Africa, as well as a handful of pits in Mexico, Chile, Canada, China, India Poland and Turkey. Given there are more than 60,000 mines globally, that’s tip of the iceberg stuff.

Under Sensera’s ownership, Nanotron then struck a deal to supply its chips to the animal eartag maker Strongbow.

The Nanotron trackers are used on” hundreds” of farms, but with a global population of 1.25 billion cattle there’s a total annual addressable market of $3.8 bn.

 Sensera is not exactly devoid of competition, especially with movement sensors. But in the case of mining, many GPs-based tools are unsuitable because of the number of obstacles and the ever-changing layout of a mine.

Whatever the case Sensera is generating revenue: a record $US2.2m ($2.9m) in the March quarter, up 38 percent with a cash burn of $1.75m.

Management is “solidly on track” to achieve revenue of $US6.25-7.25m for the 2017-18 year and is bold enough to forecast a 60 per cent increase in turnover in 2018-19.

The company also expects to be “operationally breakeven” by the end of 2018-19.

Sensera is headed by US semiconductor industry veteran Ralph Schmitt, who ran a number of listed Silicon Valley companies. Most recently he led the cognitive computing software program at Toshiba America Electronic Components. 

Schmitt contends that tech investors have paid dearly for the “learning curve” of inexperienced management, resulting in follies such as focusing on the small local market rather than the global stage.

In Sensera’s case, punters are yet to be convinced and the shares have halved in value over the last year. The company listed in December 2016 after raising $10m at 20c per share.

A key reason for the subdued showing is that the company expects to have to raise $5-10m of additional capital (possibly including equipment leasebacks or debt).

Otherwise, Schmitt says, there’s no fundamental reason for the sell-off.

Here’s hoping Sensera avoids the pitfalls as it broadens its scope to medical applications and miniaturised gas (methane) sensors that can be incorporated into a miner’s (or a cow’s) tag.

Tim Boreham edits The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.


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The New Criterion: Wonderful world of broking firms

Friday, June 01, 2018


In the old days, the listing of a broking firm was a sure sign the market had peaked. Meanwhile, a niche broker is relying on the wisdom of the masses to seek the best investments.

Evans Dixon (ED1) $2.50 and other listed brokers

Aside from the hoary old one about bellhops imparting share tips, the sure-fire sign of an impending bear market is when stockbrokers seek a public listing to share the dubious love.

Well it used to be, anyway. Wizened readers will remember that three brokers listed in quick succession in 2007, only to come a cropper after the market tumbled in November of that year.

So we note with trepidation the recent listing of Evans Dixon, the amalgam of Melbourne blue blood broker Evans & Partners and the self-managed super fund specialists Dixon Advisory.

It’s a case of so far so good, with the shares roughly on par with their $2.50 a share debut price having poked as high as $2.70.

And much has changed since the noughties, when brokers relied on trading commissions and fees from equity capital market activities.

Old school brokers versed in wheeling and dealing might choke on their third post-luncheon port, but now brokers call themselves wealth managers and operate high falutin’ investment platforms (generating annuity fees that don’t depend on the vagaries of the all-ordinaries index).

Evans Dixon also has considerable sums invested in the US Masters Residential Property Fund and solar farm owner New Energy Solar. 

Meanwhile the class of 2007 – Bell Financial Group (BFG, 82c), Wilson HTM and Austock – have morphed beyond recognition.

The latter solid its broking arm to Intersuisse in 2012 and is now an investment bonds specialist Generation Development (GDG, $1.22)

The Brizzie-based Wilson HTM was subject to a management buyout of its securities arm in 2015. But its funds management arm Pinnacle (an amalgam of boutique) lives on as Pinnacle Investment Management (PNI, $5.44).

Previously Bell Potter, Bell Financial Group is enjoying its best conditions in a decade.

The firm has funds under advice of $47 billion, 10% of which enjoys recurring revenues. “These numbers clearly demonstrate we are not simply a traditional broker relying on day-to-day revenue from secondary market execution,” managing director Alastair Provan.

The Perth-based Euroz (EZL, $1.20), which listed earlier, rides the ups and downs of the WA resources sector (which currently is more up and down).

Once again, the firm has earnings diversity through $1.43bn of funds under management and two listed investment companies (Westoz Investment Company and OzGrowth).

As with so many other professional service plays including real estate (McGrath) and accounting (Harts and Stockfords), broking was not amenable to the listed model.

One reason is that the brokers were more like independent deal-chasers working under the one shingle. Many were also unable to be herded into a corporate structure because they were eccentrics and/or permanently out to lunch.

Self Wealth (SWF) 13.5c

Who needs the help of brokers when you’ve got the collective investment wisdom of the masses, a la Wikipedia?

That’s the unusual premise of Self Wealth, which is best known as a discount online broker but is also developing a line in peer-to-peer stock selection.

Self Wealth has analysed the performance of 35,000 investor portfolios to create the SW200 index, which incorporates the stock selections from the best 20 portfolios.

It’s a case of so far so good, with the SW200 outperforming the ASX200 by 76% in the six months to January.

Founder and CEO Andrew Ward honed the concept after a 20 year stint in the financial services industry, including the fledgling First State (now the Commonwealth Bank owned Colonial First State).

Even back then, Ward didn’t like what was going on from a “moral and values” perspective and sought to create an online broker with a traditional service model.

That one didn’t quite come off, but it formed the basis for the current self-directed platform. “It dawned on me I could use the best investors to create a portfolio,” he says.

Self Wealth’s business model entails either traders availing of its $9.50 per trade flat fee, or punters signing up for a $20 a month “premium service”. The latter allows subscribers to track top-performing or like-minded members and receive alerts whenever they trade.

 But what if all the investors are wrong?  “There is no greater herd mentality than in financial markets so you do have to remove that noise,” Ward says.

To do this, Self Wealth overlays two tools over the model portfolios. One is a safety rating based on the level of diversification, the other is a test of returns over the longer term

In the third quarter, Self Wealth recorded revenue of $318,000, up 90% on the quarter with active users gaining 50% to 3382.

However only 10% of these are paying subscribers to the premium service and management’s priority is to boost this take-up.

Self Wealth also recorded a loss of $1.2m and at the end of the quarter held $5.1m of cash, having raised $7.33m on listing in November last year.

To date, most of Self Wealth’s revenue derives from interest on $30m of client deposits, but Ward says that contrary to perception the $9.50 trades are profitable.

Seeing you asked, exchange traded funds account for seven of the top ten investments held by the best ten investors.

The others are CSL, BHP Billiton and Rio Tinto.

Macquarie Group also features, while not surprisingly the Big Four banks have slipped in popularity.

Sadly, Self Wealth investors are yet to benefit from the wisdom of the masses, with the shares well below their November 2017 listing price of 20c apiece. As usual, profit taking, pre-IPO investors who got in at a much lower price appear to be to blame.

“As we’re a microcap, investors are waiting to see our track record. About 20 to 30 funds say they like the story, but they won’t get in yet.”

Self Wealth’s next step is its own ETF for self-manages super funds, based on the portfolios of the 200 top performing SMSFs distilled from 30,000 portfolios.

In the company’s favour it’s backed by BGL, Australia’s biggest SMSF administrator and this provides a channel to attract business.

The catalyst for a re-rating is decent set of full-year numbers, due to be released in August. Until this happens, Self Wealth is consigned to the ‘concept stock’ category.

Tim Boreham edits The New Criterion 

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.


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The New Criterion: Insurance and Data operators

Friday, May 25, 2018


Freedom Insurance (FIG) 43c

While the banks are beating a hasty retreat from life insurance, the low-key Freedom stands to benefit through its recent purchase of the Bank of Queensland’s St Andrews business for a headline $65 million.

In one of those exquisite corporate games of pass-the -parcel, BOQ acquired St Andrews from the Commonwealth Bank of Australia for $60m in 2010. The CBA had inherited the business when it took over the distressed BankWest in 2008.

Life is tough in the life game, especially in the income protection sector, but Freedom chief Keith Cohen is confident there’s a place for a niche player offering simple and understandable products.

Until now, 88% of Freedom’s has derived from death, rather than life, cover: funeral insurance. Post acquisition, funeral cover is diluted to 66% of Freedom’s premium income, with St Andrews delivering a substantive position in mortgage and credit insurance.

These products are cover taken by lenders to protect their position with riskier clients.

Cohen says: “St Andrews is a B2B business and Freedom is a B2C business and so they fit together complimentarily.”

The cash and debt funded acquisition is chunky one for the $107m market cap Freedom, but it appears to be low risk. That’s because St Andrews will still sell to a captive audience of BOQ customers under a three year distribution tie up (extendable by two years).

Freedom also won’t be exposed to the risks (and rewards) of the in-force policies, these are assumed by a reinsurer that will fund $35m of the purchase cost.

As a pure-play listed life insurer, Freedom is a rare beast. Ranked in terms of new business written the company rates as third biggest direct insurer, which means it sells through its own sales force rather than agents.

The two biggest direct insurers are the Japanese owned TAL (formerly the listed Tower) and Comminsure (which CBA last year sold to the Hong Kong based AIA Group for $3.8bn).

Cohen expects Freedom can become second biggest in the medium term – or even the gold medallist. Not that he’s obsessed with league ladders.

“But what you need is scale and this brings more scale and opportunities to add good value products.”

Cohen notes that most of the issues have related to group cover (to companies or superannuation funds) that Freedom doesn’t offer.

But Freedom’s first half sales – down 11% to $28.3m –were affected by what Cohen dubs “lead quality issues” (that is, the calls did not lead to sales).

But these problems appear to have been overcome.

“We’re a well oiled machine. We had a bit of an issue but we are back on track,” Cohen says.

Freedom’s closest listed relative is Clearview (CVW, $1.21), although Clearview also offers wealth management and distributes its life insurance via advisers.

Freedom listed in December 2016, having raised $15m at 35c apiece.

The company is well backed, with Thorney Investments, the Packer-linked Ellerston Capital, Bennelong Funds Management and (more recently) Forager Funds all gracing the register.

Freedom is a punt for those convinced a niche operator can make a decent fist of what the banks have ballsed up.

Data Exchange Network (DXN) 29c

The data centre entrant has a clear and bold aspiration to rival the size of its listed counterpart NextDC (NXT, $7.66) which bears an eye-watering $2.5 billion market capitalisation.

Actually, scrap that: its real ambition is to take on the $US32bn, Nasdaq listed Equinix, the world’s biggest data centre operator with more than 700 outlets.

While Data Exchange shares have surged more than 50 percent since listing on April 11, the Perth-based entity is still worth a modest $26m.

But CEO Peter Christie notes NextDC – which recently raised $280m in an aggressive expansionary push -- was valued at $20m when it listed in 2010 with a single leased building in Brisbane.

“The difference is we have an operating business with $5m of revenue.”

There’s no doubting data centres are a sexy sector – insomuch as rows and rows of whirring servers can be.

Locally the data storage sector turns over $5bn-plus a year, with growth is all but reassured because of the rise of cloud computing, ecommerce and data hogging ‘internet of things’ applications.

Despite common perception data centres are not high-tech themselves, but temperature controlled and secure repositories for computers rented and controlled by third parties.

In a sense, they’re high falutin’ self-storage facilities.

A crucial requirement is access to reliable power, because the servers collectively sap more electricity that a decent sized aluminium smelter.

Data Exchange’s approach is different to that of NextDC or Equinix, as it has no plans to acquire its own property.

By leasing rather than buying, the company can build smaller ‘modular’ facilities that can adapt to customer needs more quickly.

Still, Data Exchange’s core facilities will be its substantive outlets be in Sydney and Melbourne, with the company signing 20-year leases on two warehouses in Sydney’s Homebush and Port Melbourne.

These will be converted to collocated data centres at a cost of about $4.5m each (most of the company’s $16m IPO raising is earmarked for this purpose).

Christie says the company initially has targeted 200 ‘racks’ per facility, rising to 1000.

For the uninitiated, a rack is a cupboard of a standard size of 2.3 metres by one metre, housing about 40 servers.

Each rack attracts rent of about $2000 a month, which implies Data Exchange should chalk up $50m of annual revenue when the two sites are at full capacity.

Despite the cost of power – by far the biggest outgoing – Christie expects ebitda margins of 65%.

(In comparison, NextDC cites an 85% margin, although this excludes head office costs).

To date, Data Exchange has generated $4-5m of revenue a year from its ‘manufacturing’ business that builds data centres for third parties.

This business is already profitable and Christie expects the colocation business to break even after about eleven months.

In the longer term, Data Exchange is casting further afield, with its Singapore-based chairman Richard Carden scouring for partnerships in Asia.

Christie reckons countries such as Malaysia and Vietnam are ripe for the modular data centre approach because property trusts have overinvested in huge centres that are too big to fill.

Tim Boreham edits The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

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The New Criterion: The dental sector

Monday, May 21, 2018

This week The New Criterion drills down into the listed dental sector, which has just expanded by one-third with the listing of a new practice consolidator

Smiles Inclusive (SIL) $1.04

The unwritten law of the dental industry is that practice consolidators must incorporate “smiles” into their name, a catchy and upbeat reference to a visitation most clients associate with pain – hip pocket and otherwise.

But let’s face it, even medical professionals need to market their wares in the best possible light, especially when most of the population would rather hose out a putrid wheelie bin than front up for their annual check-up.

So smiles it is for Smiles Inclusive, which joined Pacific Smiles (PSQ, $1.70) and 1300 Smiles (ONT, $6.37) in the ASX ranks after raising $35m at $1 a pop.

Despite their homogenous monikers, we detect some differences in strategy and style between the trios.

1300 Smiles founder Daryl Holmes prides himself as a practising dentist who dons the drill one day a week.

“While that’s not everything, it certainly counts for something,” he says.

In contrast, Smiles Inclusive's Michael Timoney is an unashamed marketer, focused on getting bums on seats.

 “I position us as a sales and marketing company that does dentistry,” he says.

Trading as Totally Smiles, Smiles Inclusive has contracted to acquire 52 practices nationally and aims to have 100 under its banner within a year.

That’s all well and good, but with other consolidators in the market as well – and not just the listed ones – there’s a danger of overpaying.

In 1300 Smiles’ half-year report, Dr Holmes referred to other operators paying over-the-odds prices.

“When others are acquiring practices for silly amounts, we simply step back and let someone else do the buying.”

Timoney concurs the market has hardened in favour of the vendors. Smiles Inclusive is paying an average of five times earnings before interest and tax, which compares with 3-4 times when the company started amassing its portfolio.

Fancy cosmetic dental practices are changing hands on a multiple of seven times. For the time being, Smiles Inclusive is avoiding these “rock star” practices and focusing on drill-and-fill general dentistry.

 “With my CEO hat on I’m not prepared to pay any more, but five times earnings is a fair and reasonable price,” Timoney says.

Broadly speaking, the three companies tread the same path of acquiring practices from baby-boomer dentist getting a bit old in the, er… tooth.

But Smiles Inclusive’s business model differs from its peers, in that practice owners who sell to the company can continue to hold some equity through a joint venture vehicle.

These vendors continue to operate the practice, paying Smiles a service fee for the digs and support services. Through the JV vehicle they can share in some of the profits and eventual capital gains.

Smiles Inclusive has also resolved to stick to mainstream locations in metropolitan city locations.

Unlike Pacific Smiles it’s avoiding large shopping malls because he is not convinced customers want to combine a trip to the dentist with a grocery run to Woolies.

Unlike the others, Pacific Smiles has joined arms with the health insurers, with eight of its 75 clinics operating under the nib Dental Care banner.

The corporate dental model only makes sense if it can be more efficient than stand-alone locations, while retaining dentists at the same time.

Timoney’s productivity priority is to improve seat utilisation: of the 154 dental chairs being acquired, 61 are never used.

Sceptics of corporate dentistry argue the benefits are overblown because a dentist can only ever attend to one mouth at a time.

But Timoney argues every active seat improves economies of scale through shared reception and cheaper procurement.

According to research house IBIS, the dental market is worth $10 billion and revenues have been growing at 3 percent per annum.

As a non Medicare item, dentistry is mainly funded privately (or through private insurers) and is sensitive to economic conditions.

Despite the relentless march of the consolidators, dentistry remains a cottage industry: of the 7000 dental surgeries in Australia, the biggest owner (the health fund Bupa) accounts for only 6.5 per cent.

The real potential lies in persuading the 65 percent of adult Australians who don’t regularly visit a dentist.  Given the cost and discomfort involved, this cohort will wait until black and rotting teeth force them to drop by.

1300 Smiles paved the way with a $1 a day dental scheme to address the affordability issue. Smiles Inclusive is trying to persuade corporate employers to offer dental incentives to their staff, in the same way they might fund a $300 gym membership.

Despite growing investor acceptance of the dental roll-up model, the Smiles Inclusive listing was struck on an earnings multiple of ten times – half that of its two listed peers. That’s because the practice acquisitions are yet to be completed and the company does not have a performance track record.

Personally, Timoney has form in the industry, building up the Dental Partners chain before selling it to the New Zealand-listed Abano Healthcare Group.

(Abano changed Dental Partners operating name to Maven Partners, which shows that a smiley title may not be mandatory after all)

Smiles Inclusive’s $64m market valuation compares with the $153m ascribed to 1300 Smiles and Pacific Smiles’ $256m worth.

The Townsville based 1300 Smiles reported half-year net earnings of $3.9m, on patient revenue of $28m.

Pacific Smiles reported a $4.9m half-year profit, on patient fees of $80.7m

Smiles Inclusive forecasts a full-year profit of $5.8m.

While wary of ratcheting practice valuations, 1300 Smiles and Pacific Smiles haven’t been idle with the cheque book, either.

1300 Smiles recently acquired orthopaedic practices in Chatswood and Bathurst, as well as five conventional clinics (including one ironically located in the sugar centre of Ingham).

Pacific Smiles bought Everything Dentures and Sculpt Lab in November last year. Overall the group rolled out 12 new clinics in 2016-17 and expects to expand by another ten in the current financial year.

1300 Smiles and Pacific Smiles haven’t had everything go their way: for instance, the removal of the federal government’s $1bn and widely rorted Chronic Diseases Dental Scheme, which left a revenue hole even the best composite resin filling couldn’t plug.

But 1300 Smiles shares have gained 700 percent and Pacific Smiles stock have increased 30 percent, since listing in March 2005 and November 2014 respectively. 

Tim Boreham edits The New Criterion 

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.


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The New Criterion: Uranium - recovery wave or down in the dumps?

Monday, May 14, 2018


With a number of false dawns since the 2011 Fukushima disaster that smashed demand, no-one should be holding their breath. But the industry true believers contend the market will drift into undersupply and catch buyers on the hop when their current long-term contracts expire.

Paladin Resources (PDN, 12c) last month joined other major global producers by flagging a likely mine closure: it’s taken the first steps to putting its Langer Heinrich mine in Namibia on care and maintenance, citing the lowest spot uranium prices in 15 years.

In November last year Kazakhstan’s Kazatomprom said it would cut output by 20 percent for three years. In early December Canada’s Cameco to suspend output at its McArthur River mine for ten months.

In all, the cuts are thought to remove 17 million pounds of primary uranium supply this year, or 12 per cent of supply. Kazakhstan is the world’s biggest uranium producer McArthur River alone supplies 10 per cent.

Langer Heinrich produced 3.4 million pounds in 2017, with the mill fed by previously stockpiled ore.

Amid a global oversupply, the spot uranium price hovers around $U23 ($30) a pound, not far off the late 2016 nadir of $US20/lb.

The price peaked at $US140/lb in 2007, when more than 500 resource explorers purported to be looking for the element (with the exception of a handful of them, they’re now looking for lithium or growing cannabis).

Predictable shares in ASX-listed uranium explorers and developers such as Vimy Resources (VMY, 12c), Bannerman Resources (BMN, 4.3c) and Toro Energy (TOE, 2.7c) are in the dog box.

But does every canine have its day?

Vimy’s Mike Young recently said the yellowcake market is on the crest of a wave of a price recovery and that “it’s better to be on your surfboard in the takeoff zone rather than sitting on the beach waxing it.”

On Young’s reckoning, uranium costs an average $US55 a pound to produce, so most miners would go bankrupt at the spot price.

While contract prices are less than transparent, they’re much higher than the spot price: in 2016 fellow ASX-listed developer Peninsula Energy (PEN, 26c) signed a ten-year supply contract, while Berkeley Energia (BKY, 86c) inked a five-year offtake deal at $US43.78/lb.

At the time the spot price was below $US20/lb.

 “The uranium market is unique compared to other commodities in that contracts are signed years in advance of first delivery,” Young says. 

Vimy has good reason to talk up the market, given it’s due to release definitive feasibility study on its flagship  Mulga Rock project (near Kalgoorlie) in the current quarter.

The country’s third biggest undeveloped uranium mine, Mulga Rock was approved by the Barnett government and re-approved by the Labor administration.

With a resource of 71.2 million tonnes containing 90.1 m.t. of uranium oxide, Vimy is envisaged as a 3.5 million pounds a year producer.

(Ironically, the economics of Mulga Rock are supported by side production of copper-zinc and nickel-cobalt, key ingredients of alternative battery technology).

Put in context, Vimy assumes global demand of 240m pounds by 2024, compared with the current 150m pounds.

On Vimy’s numbers, there are 447 reactors across 31 countries, with a further 56 under construction and 160 planned or permitted.

Of these, China accounts for 38 reactors, with 20 under construction and 40 planned.

Joining Vimy in the surf is Peninsula, which is seeking to expand its Lance project in Wyoming. The mine currently produces about 400 pounds a day (146,000 pounds a year), but is licensed for three million pounds a year.

Berkeley Energia this year it starts building its Salamanca mine in Spain, the only major uranium project under construction.

Bannerman, meanwhile, is developing its Etango project in Namibia as an open pit and heap leach operation, based on a nano-filtration technology that is expected to reduce costs.

But without definitive signs of a recovery, we suspect investors will remain happy to eat Chiko Rolls on the beach while the likes of Vimy wait in the breakers.

 Silex Systems (SLX) 27c

The uranium processing innovator is one of those once high flyers the market has long forgotten about. But a vaunted deal with a heavy-hitting consortium of US nuclear companies could put Silex back on investors’ radars.

Having shed its solar assets some time ago, Silex’s focus has been on commercialising its laser uranium enrichment technology.

This know-how, which makes the process far more efficient, has been licensed to the US-based Global Laser Enrichment (GLE) consortium.

In May 2016, the 76 percent GLE owners GE Hitachi said they wanted out of the venture, citing “changing business priorities and difficult market conditions.”

Silex intended to introduce new shareholders, but with no apparent interest it has been negotiating to buy the stake at a “heavily discounted valuation”.

Nuclear power producer Cameco would continue to hold the remaining 24 percent of GLE.

Rather than receiving royalties as initially planned, the purchase will give Silex a controlling stake in a facility intended to be built at Paducah, Kentucky.

The initial feedstock probably would be 300,000 tonnes of depleted uranium called the Paducah tails, owned by the US Department of Energy (DOE).

While subject to change, the plan is to process over 40 years into natural grade uranium at a nominal rate of 2000 tonnes a year.

That output, to be sold on the global market, is the equivalent to that of one of the biggest uranium mines.

There’s a few missing parts of the equation, notably the likely purchase price and the cost of building the plant. As a rough guide for the latter, Cameo acquired its stake for $US124m in 2008, implying a $US550m valuation for the entire venture at the time

Understandably, Silex also needs the approval of the DOE, the US nuclear watchdog.

 Silex had expected a deal to come to fruition in the March quarter, but deadlines have slipped. The company said its due diligence had identified “additional risk factors”, with some sort of result in the “near future”.

Can’t be too careful.

In its heyday Silex was worth more than $1 billion, compared with today’s market cap of $57m supported by $36m of cash.

A third generation processing technology, Silex’s process involves laser excitation to separate isotopes, rather than the old gaseous or centrifuge diffusion.

 It’s more efficient and enables smaller, modular plants to be built.

Tim Boreham edits The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.


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The New Criterion: EML and Cabcharge

Friday, April 27, 2018


Payments provider Emerchants is strongly expanding its global reach – but not reaping the share price benefits – while the 40 year old Cabcharge is seeking to restore its rightful place in the disrupted taxi industry.

Emerchants (EML) $1.21

The provider of both reloadable and non-reloadable payments cards exemplifies the life cycle of a tech start-up, with unabashed investor enthusiasm in the blue-sky stage giving way to caution even as the enterprise grows it revenues and turns profitable.

Having reverse listed in 2012, Emerchants came from nowhere with its approach of filling the gaps in the payments chain vacated (or never filled in the first place) by the banks.

Contrary to common perception the banks aren’t entirely monolithic, despite their dominance of traditional lending and transactions. They choose not to play in some payments activities that require a bespoke approach or are not big enough.

Examples of Ecommerce’s offerings are gift cards, loyalty schemes, supplier payment cards and online bookies so that punters can download winnings directly on to a stored value card (or, more likely, upload them when they stop winning).

Emerchants manages 1100 card programs in 19 countries – a mix of direct white-labelled consumer programs or business-to-business products.

About three-quarters of volumes derive from the US, where the old fashioned cheque book lives in, along with the imperial system and the right to bear arms.

In its recent half year report, Emerchants reported gross debit volumes (GDV) of $3.58 billion, up 86 per cent. The company’s actual revenues also grew by 18 per cent to $38.2m, with ebitda of $13.5m (up 35 percent) and a net profit of $2.03m (up 50 percent).

But since late November Ecommerce shares have tumbled almost 50 percent. The first catalyst for the sell down was CEO Tom Cregan selling four million shares, pocketing $8m.

Director (and former Bank of Queensland chief) David Liddy peeled off 800,000 shares – half his holding – for $1.59m.

In a statement pitched at “confused and upset” shareholders, Emerchants Chairman Peter Martin said the selling was for personal reasons and it did not reflect the company’s "excellent” long-term outlook.

Cregan still owns 16m shares – 6.6 percent of the company – and doesn’t plan to shed any more.

The stock then fell further after February’s half year results, which saw full-year GDV guidance trimmed from $7-8bn to $6.7-7bn.

Emerchants executed a flurry of deals with 2017, notably to provide pre-paid cards for customers of salary packager McMillan Shakespeare.

The company also signed up Mize Houser, a Kansas-based accounting firm that manages the accounts payable functions for restaurants.

Then it acquired Sweden’s Presend Prepaid Solutions, which supplies non-reloadable cards for shopping malls.

In a show of faith in Emerchants, the Swedes accepted only $1.6m of the $11.1m in up-front cash, with the rest in deferred scrip.

Over five years, Emerchants has managed compound annual revenue growth of 63 per cent (to $58m) and ebitda growth of 237 per cent.

At its peak the company was valued at $550m and its still bears a healthy $285m market cap.

If that sounds over the odds, consider that reverse lay-by play (and recent market darling) Afterpay is still valued at close to $1bn, despite recent concerns about fraud and irresponsible lending.

In the current financial year, Emerchants and Afterpay are expected to generate similar ebitda of $20-23m.

A key difference is that Emerchants is more globally diversified and does not bear any credit risk when the interest rate cycle turns.

On the contrary, Emerchants would love to see higher interest rates globally, it earns interest on balances held with banks on behalf of Emerchants customers.


 Cabcharge (CAB) $1.89

Unlike Emerchants, Cabcharge is a hardly a start-up, but a 44 year old payments operator (and listed embodiment of the taxi industry) trying to protect its patch against new entrants.

Cabcharge may not have declared victory against Darth Vader – a.k.a. Uber -  but CEO Andrew Skelton believes the worst is in the rear view mirror.

For the first time in years, Cabcharge is seeing top line growth in terms of both fare volumes and the company’s actual revenue derived from processing non-cash fares.

“We are a little ahead of where we might have thought,” Skelton says.

In effect, more people are using taxis and Cabcharge itself is winning market share from other in-cab payment operators such as GM Cabs and Ingogo.

In terms of top-line fare volumes, Cabcharge bucked a two-year decline trend and reported a one per cent increase in the December half, to $515m. The company also saw fare growth in every state and territory.

Cabcharge’s share of taxi fare mobile app downloads ahs also increased, from 6 per cent in the previous first half to 10 per cent.

Skelton claims younger passengers stung by Uber’s surge pricing are ‘discovering’ taxis, while ride-share drivers are turning to cabs as they realise the cost of maintaining their own vehicle.

There’s also some regulatory angles helping and hindering Cabcharge.

Firstly, most states have reduced the allowable payments surcharge from a lavish 10 percent to 5 percent.

In theory, this halved Cabcharge’s payments revenue overnight but it hit its newer rivals even harder.

Queensland implemented the cut in November and that’s still washing through. Cabcharge’s dramatic long term decline in payments revenue decline has, well, declined.

The second regulatory move presents both advantages and headwinds because of the dichotomous approaches of the NSW and Victorian governments.

In Victoria, taxi plates have been abolished and replaced with a $52.90 annual licence fee. At their peak, the plates were worth up to $500,000.

In NSW, the government has capped taxi numbers to protect the plate owners’ investment.

As a result, the number of cabs operating under Cabcharge’s network in Victoria grew by 445. But in NSW its taxi pool shrunk by 600 vehicles.

Skelton argues NSW’s stance is unsustainable because taxis simply won’t be able to meet demand growth. “It’s been a frustrating experience not to be able to grow in biggest market.”

A state election looms next year but it’s not clear whether Labor’s stance will be any different.

In theory, the top-line growth will trickle down into improved earnings for Cabcharge.

Cabcharge also expects an uplift from its investment in hailing apps and its handheld terminals called Spotto, which in part enable cabbies to be paid more quickly.

It’s also poised to launch a digital version of a Cabcharge voucher that can be sent directly to the user’s mobile phone wallet or other device such as an Apple Watch.

The handbrake to the Cabcharge recovery theme is the entry of two new ride share operators, Taxify (which started nationally last December) and Ola (in Sydney and Perth).

As well as providing better returns to drivers, the newcomers don’t employ Uber’s unpopular surge pricing (which on anecdotal evidence is wearing thin with passengers).

Despite the spirited fight back, Cabcharge shares are trading not much above their record low of $1.60 in late November.

On March 19 the stock was chucked out of the ASX300 index.

Despite (or because of) this, Pinnacle Investment Management became a substantial shareholder with a 13 percent stake.

Spheria Asset Management has also upped its stake from 10 percent to 11.4 percent.

Unlike the lavish valuations ascribed to Emerchants or Afterpay, the market is valuing Cabcharge assuming ever-diminishing margins.

But the $200m market cap Cabcharge is still profitable and pays a fully-franked dividend yielding around 5 per cent.

Tim Boreham edits The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.



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The New Criterion: The baby formula craze

Friday, April 20, 2018


Clover Corp has been a big winner from the China-led boom in infant formula, but by supplying a key ingredient rather than the end product. Meanwhile, other dairy suppliers have refused to follow the herd and are diversifying into goat’s milk.

Clover Corp (CLV) 1.05

The maker of a key baby formula ingredient has ridden the boom in the commodity, led by demand from a Chinese populace freed from the shackles of the abolished one child policy.

But Clover is now set for a leg-up from further afield: a European dictate that will mandate increased minimum levels of its encapsulated form of tuna oil containing docosahexaenoic acid (DHA).

That chemical moniker doesn’t sound like the sort of substance mums should be feeding their little ones.

In reality, it’s an omega-3 fatty acid that occurs in breast milk and is linked to improving kids’ brain development and preventing heart disease.

It’s also prevalent in fish oil and thus a crucial additive in baby infant formulas.

Happily for Clover holders, the company is a leading supplier of DHA in the form of encapsulated or powdered tuna oil additives for the food and pharmaceutical industries.

The process, licensed from the CSIRO until 2027, means the product doesn’t pong like a rotting fish and it has a longer, two-year shelf life.

“We are a little business very focused on doing one thing well,” CEO Peter Davey says.

“We are in a great industry that’s running to keep up with itself at the moment.”

Europe is the biggest single infant formula market and by January 2020, any baby formula sold there must contain double the current requirement (as measured by calorific content).

Despite Australia’s ‘clean and green’ hype The Netherlands is the biggest single exporter to China, followed by New Zealand, Ireland, France and Germany.

While formula sold outside of Europe won’t require the supersized DHA dose, Davey says Europe tends to drive global regulations and other countries are likely to follow the lead.

“There’s a perception if the Europeans can get together and make it work, then others will follow.”

Currently, the global DHA market is equally shared by encapsulated powder and processed tuna oil (the latter is injected into the milk, which is then spray dried).

Currently most European and US producers use the older oil injection method, while Asian producers use powders because their milk is imported in powdered form in the first place.

Davey expects DHA powder to fill at least half of the increased requirement, with Clover enjoying the benefit.

In the meantime, Clover supplies about half of the world’s global powdered DHA demand and it only has three competitors (Dutch groups DSM and FrieslandCampina and Germany’s BASF).

Clover also supplies most of the world’s infant formula makers with its niche product. Management has expanded the company’s client base from five to 50, so it doesn’t have to pick winners.

Having said that, one customer still accounts for 30 percent of revenue and four other customers speak for another 40 percent.

Ahead of the European changes, Clover’s fortunes have been buoyed by signs of a more stable Chinese regulatory climate after the recent importation crackdown that resulted in Bellamy’s Australia shares tumbling.

Over the last six months, the Chinese regulator CBEC has granted seven new canning licences in Australia, taking the number of licensed exporters to 15. One more permit has been issued in New Zealand, taking the total to 14.

The proliferation of suppliers means more intense competition for the manufacturers, which include Bega Cheese and A2 Milk.

But for raw materials supplier Clover, the opposite is true.

“The new licensed facilities and continued dairy investment in Australia and New Zealand provide Clover with opportunities to diversify its customer base and increase demand from China,” Select Equities says.

Clover recently reported a 208 percent surge in half year net profit to $3.2m, on revenue of $31m (60 per cent higher).

Clover derives 70 percent of its revenue from encapsulated tuna oil, with 62 percent of its sales from Australia/NZ and 28 percent from Asia.

Bear in mind though that the local component goes into mainly exported product.

Margins were helped by management renegotiating unfavourable terms with two customers, with more of this benefited expected to flow through in the current half.

Select Equities forecasts full-year earnings of $7m, rising to $8.7m in 2018-2019.

Clover, meanwhile is working on variant products such as a DHA-infused ‘gummy bear’ lolly for the US sports market (omega-3 is claimed to help cardio-vascular recovery, visual acuity and hand-to-eye co-ordination).

But infant formula will continue to drive the fortunes of Clover investors, which include the value-sniffing listed investment company Washington H Soul Pattinson.

The infant formula game is seen as politically incorrect in some circles, insofar as it replaces free and perfectly good breast milk (which naturally contains DHA).

But Clover itself is eco-friendly because the oil used is a waste by-product of tuna canning.

Bubs Australia (BUB) 80c and others

With the Chinese food regulator declining to tinker further with the rules over the last six months, there’s a heightened confidence on the part of the local infant formula producers.

While the Asian (mainly Chinese) demand remains resilient, the market is becoming increasingly crowded as dairy producers seek to avoid the depressed market for commoditised milk.

But infant formula itself is a commodity (despite the marketing gloss) and any board that relies on a simple ‘build it and ship it’ business model is a herd of goats.

Speaking of which, at least two players are eyeing the market for goat’s milk infant formula, which is a much smaller market than for cow’s milk formula but less heavily competed.

In November last year Bub’s Australia acquired Nulac Foods, the country’s biggest producer of goat’s milk products, for up to $38.4m plus a 19.9 percent Bubs stake.

The deal includes Caprilac brand and – crucially – a five year exclusive supply deal with 8500 goat farms here and in NZ.

These farms can supply 6.2m litres, but the cow cockies shouldn’t be worried given our conventional milk output is around nine billion litres a year.

Bub’s is in “advanced discussions” with the CNCA to get a goat’s infant formula certified.

Rather than bleating about dairy conditions, food manufacturer Wattle Health (WHA, $2.26) has won a Chinese ‘brand slot’ for its goat milk based product, via Blend and Pack Pty Ltd.

Wattle Health estimates the Chinese goat’s milk market at $1.9bn.

Goat’s milk is the preferred nutrient for the lactose-intolerant and has other claimed health benefits such as being lower in cholesterol and allergens.

At the time of writing, Wattle Health shares were suspended pending a potential capital raising and finalisation of a joint venture with the country’s biggest organic milk producer, the Organic Dairy Farmers of Australia co-op.

The J.V. plans to build a dedicated organic spray drying facility in Geelong.

Victorian land owner Australian Dairy Farms (AHF, 20c) recently said it would convert its farms to organic production and build a compliant plant (including a spray dryer) to produce infant formula.

Tim Boreham edits The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.


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The New Criterion: The gold miners

Friday, April 13, 2018

With stock markets entering a period of volaitility, there's plenty going on to keep investors of gold interested. Here are two gold mining companies you may be wanting to keep a particular eye on.

West Wits Mining (WWI) 2c

The gold minnow has taken a unique approach to the rush in the Pilbara to find the equivalent of South Africa’s Witwatersrand, a region that has produced 40 percent of the world’s gold.

True, West Wits has joined the throng pegging ground in the Pilbara, where watermelon seed nuggets lie waiting to be kicked with a Blundstone just below the surface.

But the company’s main pursuit of Witwatersrand mineralisation is in the actual Witwatersrand Basin, where it owns a producing open-cut project with a local partner.

As far as we can see, that makes West Wits the only ASX-listed stock with projects in the ‘real’ and ‘fake’ Witwatersrands.

Until recently, West Wits fortunes lay with a project in Irian Jaya (West Papua) called Derewo. While it’s still on the books, the venture stalled because of problems with the local partner, a common refrain for an Indonesian project.

West Wits’ Witwatersrand Basin Project (WBP) was mined by giant DRD Gold up until 2000, producing 41 million ounces at an average five grams a tonne gold over six conglomerate reefs.

But a sagging gold price and concerns about the post-apartheid political climate meant that DRD (as well as other majors) scurried elsewhere.

“They just opened the doors and ran, leaving 30,000 mine maps covered in owl poop,” says executive chairman Michael Quinert.

 To date the open-cut phase has been a simple operation based on a contract miner and a toll treatment arrangement.

But it’s been a handy source of cash, generating $300,000 a month compared with the targeted   $200,000-250,000 a month.

To supplement its current resource of 3.26 million tonnes West Wits has identified 17 open pit and underground targets, initially focusing on two.

West Wits also sits on two Pilbara projects, Tambina and Mt Cecelia which – you guessed it – “show similarity to the famous Witwatersrand gold deposits.”

Tambina has three granted mining licences and management is pondering a mining start up later in the year “once the geology team identifies suitable conglomerate-hosted targets”.

Meanwhile, investors can expect the small-scale South African stuff to fund the company for the next 12-15 months.

But the company is confident of finding more, citing an exploration target of 25,000-40,000 ounces. It harbours plans to be an eventual 100,000 ounce a year producer and we guess there’s nothing wrong with reaching for the stars.

While many miners have shunned South Africa because of its political and economic uncertainties, new Cyril Ramaphosa was sworn in without incident last month.

The Nelson Mandela associate is making the right noises to the business and mining community, although there a few nervous white farmers feeling less than comfortable and relaxed despite Peter Dutton’s pledge of support from across the seas.

While West Wits is generating useful cash, with production and cash flow in January and February in line with internal targets.

West Wits’ $10m market cap (including $2m of cash) looks cheap in comparison weith peers such as  Stonewall Mining (SHJ), which has a three million ounce resource project in South Africa and is valued at $30m despite not yet being in production.

The king of the Pilbara stocks, Artemis Resources (ARV) is valued at $122m ahead of its plans to drill a super-deep hole of 3300 metres in its Balmoral tenement package.

This program is expected to provide clarity on the geology of the much-hyped Pilbara Witwatersrand story. In the meantime, the stock is in trading halt at the behest of the ASX.

Artemis and Canadian partner Novo Resources sparked the new-age Pilbara rush by finding ‘watermelon seed’ nuggets at its Purdy’s Reward project south of Karratha.

Kingsrose Mining (KRM) 7.3c

Still on gold, a stirring tale of redemption has emerged from the wilds of Sumatra as a recapitalised Kingsrose fights back from its near-death experience.

Kingsrose started mining Way Linggo – majestically perched on a hill surrounded by jungles where elephants and tigers still roam -- as an underground venture in 2010.

The mine made a motza over a two-year life, but then management made the mistake of investing the proceeds in a second high-cost underground operation, Talang Santo.

To cut a long and sad story short, costs mounted to the point where extracting the gold cost as much as $US2500 an ounce, way more than the spot bullion price.

Debts also mounted and the board opted for voluntary administration in late 2016.

“A lot of people nearly did their dough on this one,” says CEO Paul Jago, an experienced miner bought in to fix the mess last year.

A recapitalisation has seen Kingsrose re-emerge as a debt-free entity, with Way Linggo purring as an open-pit venture based on previously unrecovered ore.

The fruit’s of management’s labour were apparent in the company’s half-year results: a $3.16m profit compared with a $13m deficit last time around.

Way Linggo produced 14,868 ounces in the period, at an all-in cost of $US712/oz compared with the prevailing spot gold price of above $US1300/oz.

Amid its troubles, the company suspended operations at the high-cost Talang Santo underground mine, but plans to revive the mine as an open-cut operation with mining expected to re-start later this year.

Presumably the added output would further reduce per-ounce costs because any Talang Santo output won’t entail further big expense: infrastructure such as the mine camp already exists, while the processing plant is running at only 70 percent capacity.

Beyond the two open cut projects, Kingsrose’s longer term fate lies with finding more of the lustrous stuff on the tenements, on the fecund Ring of Fire geology.

“When we closed Talang Santo we had to make 450 people redundant,” Jago says. “But we redeployed 100 of them and we now have an exploration department of 65 people.”

The company is also open to the idea of acquiring another Indonesian project. Because the country has a reputation of being tricky to work in, assets are cheaper because fewer competitors are chasing them.

 Kingsrose’s $56m market cap is supported by cash, receivables and bullion of $9.65m.

 In the meantime, the timeline on Kingsrose’s website refers to “smells racy free announcing”.

That sounds like a case of either hacking or lost in translation. But hopefully Kingsrose’s investors (including several offshore institutions) will get the whiff of more racy announcements.

Tim Boreham edits The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense. 

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