Tough love for Soul Patts

Never fall in love. Coming from anyone other than a stock analyst, that is terrible advice. From one investor to another, however, these are words to live by.

Only two months ago, Washington H Soul Pattinson - the closest thing the ASX has to Berkshire Hathaway - was overpriced. Trading at over $28, we couldn't make sense of, or justify, an enormous premium to underlying valuation.

So we stuck with our Sell, which we first slapped on the company last September. It pained us to do so, given our admiration for the company and its outstanding long-term record.

Simple but effective

Over 40 years, Soul Patts has generated a return of 17.3% a year. We aren't aware of a fund manager in the country who can top that. 

Better still, those returns have been made with a simple, dull strategy of buying cheap businesses and holding them for a long time. Soul Patts' management has never tried to bolster returns with risk or complexity.

Yes, selling was hard - but it had to be done. Soul Patts' investment portfolio, dominated by stakes in New Hope Corporation, TPG Telecom and Brickworks, was valued at just over $21 a share. After taking into account tax and corporate costs, this fell to about $17 a share. 

Yet the stock traded at $28 a share at the time of our last Sell recommendation, a premium of over 60%. Perhaps some premium is warranted to account for the track record but the share price, in our view, didn't reflect reality. Investors had fallen in love.

Out of love

Fickle as ever, though, it didn't take long for their ardour to cool. The stock has fallen over 20% as a series of negative developments have hurt the underlying investments.

Chief among these was the decision by the ACCC to block TPG's merger with Vodafone. The logic of the deal is compelling and, as we explained in TPG: how good can it get?, TPG could be worth up to $10 a share should it happen. That is now in question.

TPG shares have sensibly fallen while the case is being appeal. The merger seems to offer compelling logic but that means little in matters of government.

New Hope's share price has also fallen and the cause is equally as shady. Chinese authorities have delayed passage of Australian coal through ports and benchmark coal prices have fallen. This appears to be a short-term obstacle although there are no doubt demand pressures on coal in the longer term. In An opportunity in New Hope, we outlined why we're more optimistic than most. 

Brickworks completed a trifecta of bad news, with the market marking down shares in response to an American acquisition and a weak domestic construction market. 

Flirt, don't fret

These are all sensible reasons to fret. Yet against a track record four decades long they can appear petty. 

Despite the difficulties with its largest investments, Soul Patts is more than the sum of its holdings. Here is a testament to long-term thinking and proof that, over time, value still matters. 

With the lower share price, we're reverting from Sell to Hold and are hopeful of eventually welcoming Soul Patts back on to our Buy list. Just don't call it love. HOLD