The Las Vegas Edition

Join the team as they discuss ideas from the recent Value Investing Congress held in Las Vegas.

Join the team as they discuss ideas from the recent Value Investing Congress held in Las Vegas.

Please download the podcast here,

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For the next couple of weeks we'll be transcribing the Doddsville podcast. Please let us know in the comments if this is useful so we can decide whether to continue doing so. We're publishing the transcription as is. There will be errors, but we hope it's valuable nonetheless.

The Las Vegas Addition. Welcome to the Doddsville Podcast for Thursday the 1st May 2014. Join the team as they discuss ideas from the recent Value Investing Congress held in Las Vegas.

GS:Welcome to Doddsville I am your host Gaurav Sodhi, joining me today is researcher Nathan Bell, welcome Nathan.

NB:Thanks Gaurav.

GS:With us also is Analyst, oh or former Analyst, I will just call you Jason Prowd. With us also is Jason Prowd, welcome Jason.

JP:Morning Gaurav, morning Nathan.

GS:Welcome back from your break guys, what did we get up to Nathan anything good?

NB:Yeah, I actually put a big dent in the couch I didn't move for about four days straight, whether it was on the computer doing some reading or just trying to wipe off everything off Foxtail that I have been recording for months.

GS:Oh, in case someone found it right?

NB:Well Jaden was just very annoyed that his dad had all these boring shows on there, so I got rid of them. I did the family thing but there is a hole in the couch now.

GS:Did you read anything good?

NB:I did and I have drawn a complete mental blank, I cannot remember a thing I read although I did read some broker reports of QBE interesting for those who like that kind of stuff.

GS:Boring reads and boring television. Jason what did you get up to?

JP:Yeah, it sounds like I had a similarly relaxing time, I did a bit of running, a bit of reading, a bit of cooking it was pretty good. I just stayed in town.

GS:You were I Sydney were you?

JP:Yeah, it was nice.

GS:I thought you would have gone off to Canberra, back to the old home town?

JP:No my parents were away any, but no. What did you get up to Sodhi I imagine you spent a lot of time at home playing Play Station or did you get out of Sydney?

GS:Now normally that would be my usual fair for a long weekend but this time I did something completely different. My wife is a huge AFL fan and she dragged me over to Melbourne to watch my first ever AFL game.

NB:And what a game.

GS:And what a game, yeah.

NB:And a crappy result.

JP:Sort of Hawthorn winded.

GS:There are two teams, actually I learnt so much about the game I didn't understand how it worked, how the scoring worked or anything but it was fantastic.

JP:There was a red leather ball …

GS:You have got to chase around or something.

NB:We should point out the game that you did go and see was Easter Monday Geelong verses Hawthorn top of the table clash, 80,000 people beautiful day.

GS:Yeah, it was really good and it was amazing stadium it's so much better than the SCG, I can see why Melbournians get behind that game so much. But while I was in Melbourne I also saw the opening of H&M and Uniqlo in Bourke Street is it Nathan?

NB:Yeah.

GS:In the Bourke Street shopping centre and it was the first day opening and H&M which I am sure everyone knows is a mid-market, very boring clothing retailer there were queues 800, 900 metres long just to get into the store. And I think that tells you something about Australian retailers there is clearly a market that they are not meeting and it was really really telling. The same thing was going on with Uniqlo, Uniqlo has actually set up mini shops all around the city because you couldn't actually get into their major shop it was that packed. So you know the big department store should be very concerned about the upcoming competition because they are providing something that they haven't been able to, it was very interesting almost as interesting as the football. But I suppose we should get onto to some stuck ideas, you guys actually went to Las Vegas a few weeks ago, right?

NB:We did so we attended the Value Investing Congress it was their Spring event, they run it twice a year normally in Autumn they have it in New York it just happened to be a Wynn Encore on the strip in Vegas.

GS:Yeah, it just happened to be the one you attended, I see?

NB:Yeah, which was nice and we got a free upgrade to the top floor, 63rd floor so it was a pretty good view from up there.

GS:And what is the idea behind the Value Investing Congress, I have heard a lot of presentations from this event I have never actually been there myself?

JP:Lots of investing ideas and particularly lots of long investing ideas, so they get a whole bunch of hedge fund managers, fund managers, just people in the industry together and they all come and pitch a couple of interesting stock ideas. So we heard 26 presentations over about 3 days and probably about 50 to 70 different stock ideas within that.

GS:And is it just to share information, why do fund managers get up there and give away their ideas?

JP:Yeah, it's a good question isn't it, I often think with these conferences are you getting the second hand ideas that applied last year. Look I think part of it is building credibility for new funds management businesses, its quite a competitive market running a fund and I think people want to get out there and talk in front of their peers and develop some credibility so they can raise more money and build a business. And I also think that with the Value Investing fraternity there is a genuine desire to share ideas and help other people out where they can and that's what I find really interesting about visiting the U.S we don't necessarily have that in Australia but in the U.S there are lots of value investors out there and they like getting together and talking about stocks, because I am sure most of the time they are sitting by themselves with one or two other people in a small office managing money and don't get to have these kind of large gatherings where they get to debate ideas where people often have very different views to their own.

NB:I think also over in the U.S because their stock market is so broad and you can actually have very original ideas across a wide section of people, whereas in Australia you are fighting over much smaller buckets of stock so it's hard to have original ideas unless you are particularly at the bottom end of the market.

GS:The worst thing about Australia actually is that there is not only a dearth of ideas but there is plentiful money, so you have got all this money and talent looking at a tiny tiny segment of the market it's very hard. Alright, well lets talk about some ideas, Nathan you brought a couple of ideas along with you why don't you start with, oh I know which one I really want to hear about this Latin American McDonald's adventure?

NB:Yeah, so the company is called Arcos Dorados.

GS:I just wanted to hear you say the company's name.

JP:So is that U.S listed?

NB:I believe it is, yeah and to actually spell that it's A-R-C-O-S and then the second word D-O-R-A-D-O-S, I can't actually remember how I got that name but I just noticed a Latin American McDonald's as well that is in Brazil, its in Argentina, its in Chilli and a whole bunch of other places, emerging markets generally. And it's actually the largest McDonald's franchisee in the world but that is by store numbers and also I think by sales. There is a couple of key things to know, so its run by a guy called Woods Staton and McDonald's actually pursued this guy for, I think was it 3 years Jason or 4 years?

JP:Yeah.

NB:And they really wanted this guy to be the one that really launched and managed the McDonald's franchise in Latin America. So McDonald's the parent company waited years and years before they finally got this Woods Staton guy to run the show. Woods Staton I don't know a lot about his background but he comes from a successful family I think from memory and they obviously have a lot of money and other business interests and they thought this is the guy they wanted, although he sounds like he lives in the Hampton's he is actually a local and they say he is a man of the people so that is part of the reason they wanted this guy to run the show. So what has happened with the share prices, the share price is down I think more than half, there is a few things to note I think there was trouble in Argentina, I think that was a big part of it wasn't it Jason? So you are going to get that in these sorts of countries and you know currency problems was another big part of it and you get a very inflationary situation in Argentina I think at the moment. And also there was also riots and I think that was mainly in Argentina.

JP:Yeah, and in Mexico as well I think.

NB:Yeah in these couple of places, so you have got all these geographic issues that come with a company like this. On the flip side the good thing is it's in a sense an underpenetrated market, you can argue about how many McDonald's stores a Latin American population can handle and should it be the same as America or Australia or wherever else. But none of this, there is still plenty of room to open new stores. This isn't a franchisee roll out situation like McDonald's parent company, what you see in the last 10 years in particular and particularly at McDonald's is a lot of these companies owned a lot of company owned stores and the magic in these businesses has really been turning these company owned stores into franchisee stores. And there was actually an interesting article to come out recently for some research that showed franchisees actually produce 20 per cent better profits than what the company owned stores do. That's not to say you shouldn't have company owned stores because you still want to be I think showing your franchisees at least to some point that you are in the game as well and you want to be able to test new ideas before you … you know you don't just want to go to franchises and say, here do this and its untested and they wear any bad karma from it. So this is one of those franchisee roll outs which is where a lot of the value has been created by activists in the U.S, Jack in the Box is another one and Burger King with Bill Ackman involved. But there is still a lot of room for store roll outs and the share prices as I said they are more than half.

GS:What kind of valuation approach did … who was the fund manager actually who pitched this?

NB:[ph: Rubaclava] I think was the funds management.

GS:What kind of evaluation technique did he talk about?

JP:Yeah, so the guy that presented the idea had this really interesting way of thinking about or how many McDonald's stores could there be rolled out in America, how many McDonald's stores could there be rolled out in South America, now it would be incorrect to just say, well there is x number of stores per person in the U.S so therefore there can be x number of stores per person in South America, obviously there is a very very different wealth demographics and so what he did was look at store count per dollars of GDP. And what he did by doing that was essentially adjust for the wealth of the country and say well if fast food reaches the same level of penetration in America, in South America then x number of more stores can open and he came up with a number that was almost double the current number of stores. So there is plenty of roll out to go and this was a business that was getting valued like a mature business where there wasn't a lot of growth and we know from any kind of retail business you can make a lot of money if there is a good roll out runway. And I thought that was a nice way of solving the problem of just saying, okay well how many people are in Brazil, how many McDonald's stores can there be because that wouldn't be the right way to think about it.

NB:And the other thing is there is a very big culture difference into the way the brand is perceived in some of those markets. So we see it as a cheap treat I guess you know fast food doesn't cost much and you know we get it and run off, whereas there was some of the … I cant remember whether it was Brazil or just a bit more broadly in Latin America but they are seen as a bit of a premium place to go and so like a little bit of a place to show off and I think the McCafe was quite different over there as well.

GS:There is no doubt in developing countries McDonald's is an aspirational brand as a lot of Western brands actually. Yeah, especially the ones we think of as quite low end or cheap event tacky dare I say but it's not the case overseas. That is quite interesting stuff.

JP:Yeah, I remember reading about how you know in Australia Pizza Hut closed all their sit down Pizza Hut restaurants years ago, I think there is one for tourists still in George Street here in the city. But in China for example sit down Pizza Hut restaurants are a destination place to go if you want to pay a premium to go and eat pizza, so yeah they perceive it very differently.

NB:Do you remember the free gingerbread men they used to give you when I was a young kid and it had icing and hundreds and thousands on one side, you thought oh its going to be great even though you know its all these gingerbread men laying underneath and it never tasted any good.

JP:Nothing beats the works, come on.

GS:Alright Jason so you have got a few ideas as well, you mentioned property play, Kennedy Wilson Europe?

JP:Yes I did, so this is a new fund started by a property fund manager called Kennedy Wilson so it was launched in 2009 and then they IPO'd it in February last year or maybe this year I am not exactly sure. But essentially Kennedy Wilson are really smart property managers I actually heard the CEO speak in Canada a few years back and he is a value investor he thinks about things the right way, he is not one of these typical kind of property speculators he is looking for down and out property that he can buy that's decent value on the current earnings and then perhaps its more vacant than it should be, perhaps they can do a smart reno and increase the rent so that kind of thing. So I knew this guy was smart already, I didn't realise they had launched a European fund and what's interesting about that is European property is pretty cheap at the moment, now this fund trade is around its net asset backing but there is probably a bit of [0:13:02] value in the property themselves, their vacancy rates across the portfolio of around 20 per cent, rents are lower than they have been so there is a chance there for you to increase the earnings yield out of it and you are starting with an earnings yield of 9 per cent. I thought that looked interesting.

GS:Did he mention how they accounted for the property value was it historic or market based?

JP:No but it would be mark to market.

GS:Right, okay.

NB:I think a lot of it, I maybe wrong here Jason but I though a lot of it was it a cash box like he was putting the money together, they didn't necessarily invested everything in a sense it was a chance for public investors like us to get in at the ground floor with a guy who had an amazing record, I would love to actually spend some more time seeing what this guy has done. He started out very small with one tiny office and 20 years later he has got a global property business, I find in Australia we do have some, you know the [0:13:52] is a very well followed class of assets but its very institutional, we don't have those big owner managers generally running these businesses. Yeah, you look at these things and say, okay its trading in AV or whatever but you are not really buying today's portfolio, what you are trying to do is associate yourself with a wonderful business owner and an operator and for the next 10 or 15 years where you would expect particularly in Ireland where I think the original base is for this company, where property has just been absolutely smashed, you know this is a guy that is hopefully going to create a lot of value over the next 10 or 15 years and if you want a chance to partner with those sort of people which is very hard to do in Australia I thought this was a really interesting idea.

JP:So this guy Bill McMorrow who runs the business has delivered compound annual returns of 50 per cent per year.

GS:For how long?

JP:Since 1988.

GS:Wow that is probably the highest I have ever heard, that is extraordinary.

JP:Now my understanding is not all of that is from direct property ownership there is a bit of equity juicing up that if that makes sense, so collecting fees off funds that spun off so its not just from owning a really asset heavy property business, but that's a phenomenal return.

GS:That's remarkable, and how do you get access to this is it a listed … is it the equivalent of an A rate overseas or how is it structured?

JP:Correct.

GS:So it isn't in an A rate, well not A rate but, what is it a Euro rate.

JP:Yeah, it's listed on the London Stock Exchange.

GS:Do you have a code there?

JP:Yeah, I do so it's KWE.

GS:KWE, interesting idea, right okay. Let's move onto to your next pick Nathan it's a little retailer?

NB:It is a little retailer, its only 227 billion dollar market cap, it's a company called Bon-Ton stores, it's just a very small regional department store business it's normally a thing you go and look at and probably throw up on and say I don't want to own this piece of garbage.

GS:Yeah, I am surprised actually.

NB:And not to say I have done my work here or anything this is just straight coming off the presentation, a guy called Daniel Miller of Gabelli Fund, Gabelli have a very good name in value investing industry, Daniel Miller I should just say was quite funny, he is very short you could barely see him over the lectern and I am not sure how old he is my guess he is mid 30's or early 30's but he looks like he is 18 years old and he couldn't actually talk properly during the presentation because he had just been to Spring Break passing himself off as a college boy.

JP:Yeah, look I was shocked when he started talking he said, I have been doing this for 12 years and I am sort of double taking looking at the lectern, I was expecting him to say, oh when I graduate uni I am going to be doing …

NB:And he is a director of Gabelli funds so he is doing really well for himself.

JP:Here is a stat for you Nathan I just pulled up Bon-Ton on Capital IQ so you are right 250 mill market cap over 3 billion dollars of sales so I think that tells you what kind of idea this is straight off the bat, it's a retailer that is making no money at the moment and made a loss last year.

NB:And the main reason that it made a loss was, and you have probably heard of it the Big Freeze in the U.S and so Bon-Ton stores actually had to close down a lot of its department stores through that period.

GS:Are we talking about the Big Freeze in terms of budgets or Big Freeze in terms of weather?

NB:Weather.

GS:Weather, right okay.

NB:Yeah, because there was a big cold and they literally had to close their stores for a while because you couldn't get into them, there was snow and water damage and all the rest of it and people just couldn't get to the stores. So people freaked out about this and the share price down by more than half, and they are about half at the moment it has come back a little bit recently. So he is a business that, you know I wouldn't say it's a good business anyway but its down 50 per cent simply because, well by the sounds of it without having done my own homework or fact checking, but its just got very poor comps, very poor comparable sales at the moment because you know the stores were literally closed. But that was just a temporary thing and sales should come back in the months ahead. And the second thing was the CEO who had done a really good job I think over the last 3 years or something like that has decided he is not going to re-sign so its sort of a double whammy if you like, a guy that they … the market had trusted who had done a good job with this business and then plus you have got these really poor sales numbers because of the temporary closures. So that was the main thrust of the thesis is just if these two things should be temporary problems and if they get solved then you know potentially there is 50 to 100 per cent.

JP:I mean you think about those numbers, right if they own a 3 per cent margin their profit margin on 3 billion dollars of sales that's 100 million dollars of profit and it's a 250 mill mark … so if they generate some profit it will look cheap, right the question is whether they can generate any profits or not.

NB:Yeah, just for future interest Gabelli is someone certainly worth following you can often see stocks from them on I think Guru Focus and those sort of places and if you pick up their quarterly's and things they are definitely worth reading because they are probably of somewhat more interesting than a lot of the big large cap funds because they do look at the smaller things that … its more interesting fund stories but obviously riskier as well.

GS:That is small, for the U.S where anything under 5 billion dollars is considered micro-cap, and looking at something at 200 million dollars is really out there.

JP:Hyper micro-cap investing.

GS:It's amazing in Australia when, I think it was the reject shop they had a flooding issue in one of their stores, not one of their stores, one of their distribution centres was damaged, they couldn't get stock out of Queensland for a while and that impacted dozens of their stores. I mean there was an impact on the share price but it didn't fall by 50 per cent you know people sort of looked at this and thought, well this is probably a one off event. I mean the Australian market is picked over an awful lot and we were saying before how a lot of money chases a few ideas, the upside of that is that there is often a lot of efficiency in those markets its hard to spot this sort of opportunity in Australia that you have just outlined with Bon-Ton. I find it amazing to think that in Australia a weather event would cause a retailer to fall by 50 per cent.

JP:It has to be [0:19:45], right so a similar kind of thing happened with [0:19:49] a few years ago and its market cap was 25 million dollars or something because it wasn't making any earnings currently and then subsequently it has worked out all right.

NB:I don't know if I am right in saying this but I think reject shop was probably still profitable even through that period, whereas Jason has just pointed out this thing is making a loss and you can imagine people seeing department store losses and you know people wouldn't be bothered, yeah people wouldn't even bother doing the work on this sort of stock I wouldn't have thought.

GS:And I understand it's a general kind of Pants Co situation where they just retail other brands, but they don't actually manufacture …

JP:It is straight rated retailer from what I understand.

GS:No terrific idea I will definitely have a look at that one. And Jason you have got one more for us as well?

JP:Yeah, so I heard an interesting presentation from Zeke Ashton from Centaur Capital Partners about BMW, he sort of started off by talking about Tesla, now a few people have spoken about Tesla it's a very interesting business, we spoke about it on the podcast.

GS:We did.

JP:A month or so back and I think they are doing really smart stuff, now that doesn't mean it's a really smart investment and so what he did and I thought this was really smart was line up all the comparables of the up and coming Tesla, the stock everyone is in love with its gone up fourfold in the last year, its got a market cap now of around 30 bill compared to BMW an established automotive player that has got a market cap of 80 billion dollars and compare the two.

NB:I should just point out for listeners that in the original article I posted or published called Leaving Las Vegas there wasn't a link to this particular presentation but one recently got published so I have gone and put the link in so you can actually go to that article and download it.

JP:So here is some numbers to put the two in context and as Nathan just said, I won't go into all of them because you can see the presentation yourself. But Tesla expects to have revenue of around 3 billion dollars this year, BMW 76, earnings 100 million dollars for Tesla compared to over 5 billion Euro for BMW, gross margins are around the same, BMW produces 10 billion dollars of operating cash flow, Tesla 250 million dollars. So you can see that they are worlds apart as far as the actual numbers they are producing. So Tesla expects to sell maybe 35,000 cars next year, BMW sold 2 million cars last year, like these are very very different businesses and if you are buying Tesla today you are essentially make a bet that they are going to sell what 300,000, 400,000, 500,000 cars in a short period of time.

GS:We should keep in mind however that the sales model for Tesla is a little bit different to BMW, BMW has sold their cars outright, Tesla has contract arrangements so the revenue numbers they probably reflect contractual arrangements as well. So you probably want to capitalise some of the contracts in any valuation.

JP:Yeah, sure but the flip side of that is that Tesla also wear some of the operating expenses, right if you buy at Tesla you get free electricity for life.

GS:Yeah, that's true.

JP:And Tesla has to come up with a way to fund that, I mean at the moment they are thinking about building battery factories and they are thinking about getting energy supplier, I wonder how much of a liability everyone actually driving their Tesla around creates. But you kind of get this sense that they are very different businesses and the whole argument was around, well everyone at the moment is assuming that BMW is going to fall in a heap because Chinese demand is going to fall off, so China is now the largest market for BMW.

GS:Wow.

JP:Its up nearly 20 per cent of the revenues, I am not sure about sales volumes. The argument that Zeeg made was that, look that may or may not happen but what we are forgetting is over the last 10 years BMW has spent 110 billion dollars on R&D, this compares to total R&D spend of less than 1 billion dollars by Tesla and so BMW are now in 2014 about to release good fully electric city car called the i3 and then there is the i8 coming later which is more of a sports car kind of arrangement. Now this could be a serious threat to Tesla and it means that someone like BMW could pick up a decent chunk of the electric car market, I mean Tesla are still saying that their cheap “less than 50 grand” electric car is probably a couple of year away. BMW are selling their electric car in Europe for I think about 30,000 dollars and I think it's in Australia for around 50 grand that is much cheaper than the current Tesla. So you can see how someone like BMW could catch up a lot they probably haven't been wasting their 100 billion dollars even if you assumed that half of it has been wasted, half of it is still 50 times more than the amount Tesla has spent. They have probably got a few ideas up their sleeves as well and to cap all that off the business is cheap if you buy the ordinary shares, there is also preferred shares available which removed the voting rights and they are available at about 25 per cent discount. Now in BMW's case it's owned I think 30 odd per cent by the state in which the province where they are made. So voting rights probably don't count for a whole lot with this stock and they don't count for a whole lot if you are a small retail investor anyway. So you can buy this business on 6 times Ford earnings and this is a business that potentially has lots of interesting new products that are coming out plus a pre-existing decent car business.

NB:Yeah, there is a really interesting quality aspect of that analysis too and Zeeg just talked about you don't really hear much from BMW but if you are the sort of person like me that probably looks at management more for their actions than what they say, BMW just seems like a fantastic business you know you look at what they have produced, where they are heading. Like this is a business like Jason said it has spent over 100 billion dollars on R&D, you don't really hear about it but you see the products coming out now and they are actually beating the company that everybody thinks of when they think of electric cars they think of Tesla and here is BMW with the superior products. You know its just funny because you hear so much about the U.S auto makers and its often you know we get Fortune and Bloomberg magazines in here and every second issue has got an article in there about one of the big auto's and you just don't hear anything about BMW and they just keep on knocking on .. and it turns out that if you look at a presentation its clearly the better, I would say in a risk adjusted basis anyway is clearly the better investment.

JP:And they have got amazing strengths, right like BMW has a huge distribution network, if they release a product that people genuinely want they can get it to market quickly. I actually imagine the issue with selling these electric vehicles partly will be marketing convincing people that they are worth buying and partly will be producing enough of them if they can crack the idea of a car that you never have to buy petrol for again, so get your operating costs down from 5,000 dollars a year to a 100 people will pay a premium for that, right that will work out very quickly that its worth paying 5,000 dollars, 10,000 dollars more upfront for a car that you never have to buy petrol for again.

GS:I agree with the thesis of BMW press, I thought it was a cracking idea when you first brought it up but I would just point out some caution with regard to comparing R&D spending. I find that quite a dangerous idea sometimes especially in these tech heavy sectors because the amount of money you spend doesn't always tell you much about the return on that money. And especially in this sort of area where I imagine BMW spending a lot of money on things that Tesla isn't spending money on, so they are not directly comparable.

JP:Sure, but even if BMW's R&D spending is only 1 per cent as effective as Tesla's they have spent the same amount of money so the sheer numbers outweigh it would be marginal.

GS:Yeah, again though the other point is that once someone has spent money on R&D the competitor doesn't have to match that dollar for dollar it will cost the competitor a loss less to match that R&D spending, it's the guy who forges ahead is always the guy who has put out the most cash and so from that regard the competitor, the smaller competitor is at an advantage in these sort of tech heavy industry because they can take existing technology that has already been, had all this sunk capital invested into it.

NB:The big advantage that BMW has got it just makes money and so if they want to spend the money they can and Tesla is going to have to you know it's pulling all the strings just trying to keep this business going because it has to spend that much money and not much is coming in. And I think from memory Jason Zeeg actually pointed to some accounting shenanigans at Tesla so the numbers weren't actually real anyway so that caution on the accounts is very warranted.

JP:Yeah, so he pointed out that Tesla had a gross margin higher than BMW which if you think about that for more than 30 seconds, well wait a second how does a company that's in the scale business manufacturing cars, one company makes 2 million and another company makes 35,000.

GS:I am waiting for the subsidies here, the roll of subsidy surely.

JP:Yeah, and that was part of it, but if you deduct out the subsidies and the image you … rebates they get the margins were significantly lower which makes sense, right much lower volumes start up business.

GS:And I imagine those same benefits are available to BMW as it produces its electric cars as well?

JP:Yes.

GS:Well that is a really good idea interesting argument and you can go back and listen to our discussion on Tesla in a previous Doddsville Podcast if you wish. Now guys this is your first, actually was this your first investing conference or have you been to these before, I have not been to one before?

NB:This was my second value investing congress I went three years ago in 2011 when everyone thought Europe was about to … so it was a very different vibe this time.

GS:Yeah, I bet, Jason?

JP:Yeah, first of the congresses I have been to.

GS:Okay, and so what else do you learn here besides investing ideas, are there any different approaches or any different insights that you pick up, Nathan?

NB:There is, there is just such a broad range like we say we are value investors but the way people go about it is just so different, you know in one hand you have got guys talking about a platform speciality which is a company that was a Shell company it got set up to do something specific, you know this is a multi billion dollar business and they are talking about it being a huge huge business. And then you have got Daniel Miller getting up talking about Bon-Ton stores and even on the Wednesday the first day we did a bit of a workshop type thing and there was guys up there talking about stocks that only trade on the pink sheet so they are actually unlisted because they haven't put their accounts in for a year or two and they are just you know 15 or 20 million dollars businesses. And I just love that variety because you just get such different personalities involved and it just shows you, you know often it's the younger guys sort of looking at the small stuff obviously because they are just starting out and that's where they find they can make the big returns and then you see the old wise heads that have been around for a while imagining large sums of money just looking for much bigger businesses. But I just think it's interesting to see the same philosophy of buying something cheap and just seeing how differently it is applied.

GS:Yeah, okay now you mentioned off air that you learned about something about Russo's five rules, let's talk about that a little bit?

NB:Yeah, so I briefly touched on this in the article I wrote but I just thought this was a great lesson in analysis for anyone experienced or even those new to investing. But we always talk about intelligent investors not relying solely on the numbers, you really need to understand what is behind the numbers and understanding a business is a lot different to just looking at return on equity and you know using some … there is all these sort of valuation techniques, dividend discount models or whatever that you can just sort plug the numbers into and think you are going to get the right result and it doesn't work like that. And I thought Tom Russo, he often gets criticised at these congresses because he tends to get there and talk about very high quality businesses that trade on high PER's for example and everyone says, this is a value investing congress I cant believe he has got up and talked about Heineken or whatever it is he is supposed to be cheap you know cheap, funky ideas. But he is the guy who has been in the market for a long time, he has been very successful and he talked about just five, he picked out five metrics that Wall street love, which he said just don't make any sense and I will just through them. So the first one was research and development as a percentage of sales and you see this all the time, you know even we write about this stuff as ResMed, you know ResMed spending x per cent on R&D but he pointed out that, I think it was Heinz and said the best development they have had in that business in the last 10 or 20 years was turning the bottle upside down. Now they didn't need to spend 15 per cent of sales to come up with that idea and then produce a whole other series of sales and growth for the business. And again he just made the point that looking at these static numbers is meaningless. And the other one was working capital as a percentage of sales and he said this was particularly important for international business that are expanding and he says, the last thing you want if you are rolling out, lets say an alcohol manufacturing distribution business, the last thing you want to get caught out is the lack of stock, if you are trying to penetrate new markets you always need to make sure you have got plenty inventory there so nobody ever runs out. So that is an example where you can have higher working capital as a percentage of sales because you need to make sure that everything in that supply chain is ready and raring to go. So again following the next one which was this cash flow conversion cycle everyone is looking for tighter cash flow conversion, in other words more cash coming out of the business and less cash tied up in debtors, creditors and stock, now that's great you know we always want more cash coming out of the business because it means there is more cash just being on buy backs and dividends. But there are times when its just worth having that inventory build up or you know depending on who your suppliers are maybe you need to fatten them up a little bit sometimes and give them better terms just to make sure your product is getting to where it needs to go in the markets. And you should never underestimate how difficult it is expanding overseas it takes times, it takes money and that is what Russo really looks for is those businesses can expand for years and years and years around the world and as he says, prepare to suffer and what he means by that is he is prepared to wear short term earnings pain for a long term sustainable business. So the other two were, he said, I haven't heard this one before, but what is apparently looks for is the percentage of business from new products within the last 3 years.

JP:I think we can blame 3M for that so I think where that comes from is 3M famously had that as their business goal.

NB:They still do.

JP:That more than a third of sales come from new products and so people have applied that to any kind of Apple, tech type business and they are saying look if you are not creating new products you are not innovating, so we can blame 3M.

NB:And Russo made the point, I cant remember which company it was, but said that you know often its actually extremely expensive and a waste of money by investing in new products when if you have got a great set of businesses or brands already you are better off sometimes just re-investing in those brands and try and grow the moat around those brands. And the last one he said, Wall Street is just [0:34:38] investing in family controlled entities and Russo is an investor in Europe which is where you tend to find more of these types of businesses, and he said these are some of the most wonderful businesses in the world, they run smart, conservatively, they have durable businesses, operating for the long term and he said, just Wall Street is missing a trick basically.

JP:He said most of his top ten holdings which makes up 70 per cent of his portfolio are family controlled. He sees it as a real strength.

GS:Okay, so there was more details about that in one of our articles in your Leaving Las Vegas?

NB:Yeah, I did write a little bit about it but I think that conversation is probably better than what was written in the article.

GS:Okay. Jason I know you used to be our casino analyst did you find any time having a look at the Vegas strip from a purely economic point of view?

JP:Did I ever, we invested a whole 5 dollars in gambling in Vegas and I brought home two 1 dollar chips. Its funny I caught up with one of my mates when I got back and he said, I should have just given you money I would have got you to bet on behalf, he was sort of outraged that I hadn't spent lots of money at the casino when I went to Vegas. I am not a big gambler but I found the exercise of looking at how a casino operates fascinating. So here is just one small way they try and get a lot of money out of you, so you check into the hotel just to the left of where you check in there was a café, when you check in they give you a map of the hotel and they say, are you hungry and you say, yeah its about lunchtime yeah. And they draw on the map and circle a restaurant on the other side of the hotel, you know why would they do that, well they pointed you straight through the casino floor and they must do it quite deliberately because there was actually a replica of the same café one was three metres away and on was twenty five through the casino. But I just think stuff like that they have thought through all of this, even when for example casinos quite frequently close gambling tables when there aren't enough people in the casino. Now they don't put up a sign that says this is closed because there aren't enough people here, they put up a sign that says we are renovating this area for your convenience, now its just complete nonsense right they have just got tables there, its just closed because there aren't enough people in the casino but they have thought through every part of extracting money out of you and its quite a fascinating thing because people flock these casino's, they go there because of all of this and its quite an interesting game I think.

GS:The interesting thing about casinos I think is that everyone thinks they are a license to print profit, and often they are a license to generate revenue but the entire Las Vegas strip because of the intense competition makes less money than the two Singapore casinos themselves. So the entire strip Las Vegas which is the most famous casino strip in the world less profit than two relatively new casinos in one of the most conservative Asian countries in the world. I find that amazing and its also very telling about the impact competition has on casino profits. There has actually been casino closures in the U.S quite regularly this year and last year because of intense competition and now some of that is impacting the game operators themselves, the international game technologies and aristocrats of the world. So it's a very interesting sector and I am glad you had a closer look at it.

JP:Yeah, look we went to one of the casinos that I think now cost the most to build, so the Cosmopolitan costs 4 billion dollars to build it and it opened in 2010, it now has a valuation of between 1.5 and 2.

GS:Wow.

JP:So that is just an example of how you can overcapitalise and you can spend too much money and if there is too much competition you don't get a good return.

GS:You can sort of see it in the way people talk about Crown and the valuation that is subscribed to Crown, I think the management of Crown are now looking at their success and thinking wow we have just hit the jackpot all we have to do is roll out more casinos all around the world and we are guaranteed to make money.

NB:I think the main thing that they are trying to do is open up monopolies essentially like they are going to places where there aren't a lot of casinos already although that said now [0:38:40] is interested in buying that particular casino in Vegas but at least its at a discounted price. But that is very different to the operators on the strip there has been I think 13 years since I have been there and the strip wasn't unrecognisable but it had been developed far more than what I remember, particularly in the middle of the strip a load full of new hotels that had been built and that place is more competitive than ever.

GS:But I think that's what happens, right even in Sydney we used to have one casino in Sydney and now were about to have two, I mean once you have a successful casino its very tempting to issue more licenses because they are very valuable. I can easily see a situation where a monopoly casino becomes a mini strip of sorts I don't think it's unlikely at all.

NB:Well it's tough in Melbourne if you are looking at Crown for example like where are you going to build another big one. Well the colour of the building couldn't be any worse than the colour of the water.

GS:Well you were away for a couple of weeks and its good to have you back, excellent insights. Anything else we would like to add gentleman?

JP:The general mood so this was a long investing conference you hear their pitch cheap stock ideas and a bunch of people got up and said, here is my short book and that was very different to what Nathan was saying a couple of years ago when the people were finding lots of value and it was highlighting that U.S stocks have come back a long way and people are finding it more difficult to find cheap things, still [0:40:04] things is the four we talked about but I think that general vibe of the conference is also an important take away.

GS:So there a sort of consensus that the U.S markets are expensive?

NB:Yeah, I think that was widely recognised and it was interesting to hear that [0:40:21] said there is just a lot of short sales out there that had been closing their doors lately, they have just been absolutely creamed over the past few years and all the guys said, look the shorts are killing us, I think Tilson said he had done 32 per cent last year on the longs and lost 16 per cent on his shorts and net 16 in a year that he probably should have 30 plus. You know and he is sticking with it because he has never seen such a better, you know he has said this publically a lot, he said the last time he saw this number of great shorts was 2007 and he just cannot take them off despite how painful they have been.

GS:I thought he was going to mention some beach or something. Its good to have you back, we wont do any long or short this time, time is quickly running out but we will back in a fortnight with the regular Doddsville format. Until then Jason, Nathan thank you very much for joining me and for everyone else thank you for listening.

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