Do hard assets offer real value?

Is buying a stock below net tangible assets a road to riches? Perhaps, but hard assets can be softer than you might expect.

There are two schools of thought about whether assets matter to investors. One, they do. Or two, they don’t.

Steve Johnson, chief investment officer of Forager Funds, is in the assets matter camp, saying that, “good things tend to happen to companies with lots of assets. They get taken over. They start using the assets efficiently. Or the assets get sold to someone who can earn a return on them.”

Investors like Steve hope to nab a bargain by seeking out stocks trading below net tangible assets (NTA) per share. The theory is that this figure reflects hard assets – the type a company could sell if it needed to.

The calculation is simple enough. Head to a company’s balance sheet, deduct intangible assets (such as goodwill) and total liabilities from total assets, then divide the result by the number of shares on issue.

Take the figures from the balance sheet of Carsales.com as an example. With a share price of $10.65 and NTA of $0.30 per share, you’ll be waiting some time to buy this stock below NTA.

But the company’s lack of assets was one of the reasons why it until recently sat on our buy list. Carsales.com is a great business precisely because it’s not a capital-intensive. So if assets aren’t all that great, is Steve misguided?

Not necessarily. Assets matter in some industries but not others. Like Carsales, you’ll rarely find a retailer like The Reject Shop or a fund manager like Perpetual trading at a discount to NTA.

Assets matter most in industries where they produce income directly. If you can buy a property trust or a listed investment company at a decent discount to its adjusted NTA, then you should do well.

But the ‘adjusted’ qualifier is important. Financial ratios like NTA need to be calculated with an understanding of the underlying business so you can make any necessary adjustments. Before buying listed investment companies, for example, work out the discount to ‘fee-adjusted NTA’. With property companies, the situation is complicated by debt.

So here’s the point: don’t take NTA at face value. You’ll usually need to make adjustments to determine if hard assets represent real value. And the adjustments will depend on the business under consideration.

Nevertheless, there are some warning signs that NTA is about to evaporate. Take a look at the table, showing the decline in the NTA of BlueScope Steel after 2008.

Some people might have been tempted to buy BlueScope shares in late 2010 at around $2.00 each, taking comfort from the NTA of $2.59. Unfortunately, that figure was completely fictional.

In 2011 BlueScope management declared the company’s assets were worth $926m less than the year before. Almost 70% of that represented a writedown of plant, machinery and equipment. The remainder was goodwill.

Making matters worse was that the writedowns hit shareholders’ equity as cash flow was weakening and debt surging. By the end of 2011 BlueScope had launched a $600m capital raising at $0.40 a share. The result? NTA fell to $0.99 a share in 2012.

What can we learn from the BlueScope fiasco?

One, plant and equipment isn’t necessarily worth its value on the balance sheet, particularly during an industry downturn when buyers are scarce. Inventory is another hard asset that can be difficult to shift in tough times.

Two, debt increases risk. BlueScope copped a dilutionary capital raising because its debt levels were inappropriate. A capital raising at a price below NTA – invariably at the worst possible time – dilutes NTA even more.

Three, intangibles matter. Acquisitive, capital-intensive and cyclical businesses like BlueScope tend to have the ‘wrong’ type of assets. They pay too much for acquisitions during the boom times, generating goodwill that needs to be written down during the bust, making capital raisings more likely.

NTA can point you towards value, but don't be lulled into thinking that it necessarily is the value. Accounting assets, particularly those with specialised uses, can disappear at the stroke of an accountant’s pen.

BlueScope Steel
Year ended 30 June200820092010201120122013*
Assets ($'000) 8,466 8,865 8,998 7,793 6,734 7,331
Intangible assets ($'000) 999 1,089 1,041 679 454 496
Liabilities ($'000) 4,524 3,201 3,242 3,397 2,955 2,871
Net tangible assets ($'000) 2,943 4,574 4,715 3,717 3,325 3,964
No. of shares (m) 760 1,823 1,823 1,842 3,349 558
NTA per share (c) 3.87 2.51 2.59 2.02 0.99 7.10
* Note: BlueScope had a 6-for-1 share consolidation in 2013

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