Intelligent Investor Australian Small Companies Fund - August 2019 update

The fund lost 2.10% for the month of August. The benchmark lost 3.85%.

By ·
11 Sep 2019 · 7 min read

Reporting season was encouraging with strong results from our larger investments Audinate, RPMGlobal, Seek and Lovisa. We ended the month lower as trade war concerns impacted valuations across the board and our smaller investment in Donaco incurred a legal setback. We added one new investment - Napier Ports on the New Zealand exchange - and have a long list of new opportunities to investigate.

To the nitty gritty. Mining software provider RPMGlobal (up 17% for the month) reported an encouraging result that showed its transition to recurring subscriptions is working. Software sales rose 46% over the prior year with 46% take-up of its subscription offering. Upselling potential also improved as 15 new mining companies bought RPMGlobal's software for the first time, on top of 25 last year.

We think RPMGlobal is dramatically undervalued. The market is currently ascribing $100m of value to RPMGlobal's software business, after deducting $20m for its non-software businesses (four times pre-tax profit) and $28m of net cash. For $100m, investors get a software business that's invested $70m in R&D since 2012 (predominantly expensed), generates $50m of revenue ($29m recurring) with rising free cash flow.

RPMGlobal remains relatively unknown as its only covered by one broker ($1.11 price target), but with the heavy lifting of the subscription transition behind them, we suspect it will start appearing on more investors' radars.

Audinate (down 5% for the month), owner of the Dante audio visual (AV) networking solution, churned out another strong result that reinforced our investment case.

It closed the year with 2134 AV devices adopting its technology, up 30% on the prior year and now six times the nearest competitor. And with 170 manufacturers developing their first range of Dante enabled products, Audinate's ecosystem has lots of growth ahead. 

End user adoption was also strong, with 42% growth in its core chips, cards and module unit sales, which we expect to continue as global AV users transition to digital solutions. Software contributed only 16% to Audinate's revenue, but we expect that to rise sharply in the coming years as new products like Dante Domain Manager gain traction.

Seek's (down 3% for the month) full year result issued an important rule: pay close attention when a company issues a six-year target, as it takes oodles of confidence in a business, and management's position within it, to do so.

Seek hopes to compound its revenue at 20% a year to 2025, and we think they have the right assets and people to achieve it. Recent market share gains in China, with Zhaopin rocketing to the number one position in the world's largest job market, shows that their delayed gratification strategy is working.

Lovisa's (up 14% for the month) fast fashion jewellery has resonated with international customers and its store rollout is gathering pace. 64 new stores were opened during the year and we expect that run rate to be maintained for several years.

The start-up costs of new stores muddies reported profit, so we're overlooking Lovisa's forward price earnings ratio of 30 times. It takes a highly cash generative business to self-fund a rapid store rollout and pay a healthy dividend whilst maintaining a squeaky-clean balance sheet. 

South East Asian casino operator Donaco (down 40% for the month) was our lone disappointment. The business is beginning to show signs of improvement under new management with $5m of EBITDA recorded in the month of July (Donaco's market cap is $58m for context). 

But their long-standing court battle took a negative turn when a Cambodian Court decided to terminate Donaco's lease. If the decision is ultimately upheld, Donaco will lose its largest earnings stream but be owed approximately $49m for the property and equipment on site, although collectability is highly uncertain. Donaco retains its Vietnamese casino which is unaffected by the Cambodian dispute and generates $14m of operating earnings (before corporate costs). 

We suspect its early days in the legal proceedings as Donaco appealed the Cambodian decision and its $340m Singaporean case against the landlord is still pending.

We're not huge fans of buying initial public offerings (IPO), as the sellers typically have an informational edge over the buyers, but we make a few exceptions. One is when Governments sell assets as they're incentivised to price the float cheaply to appease voters and they often leave room for operational improvements. That's partly why we participated in the IPO of Napier Ports on the New Zealand exchange (up 19% for the month), which owns New Zealand's 4th largest port (and happens to be my hometown).

It's predominantly an export port connecting New Zealand's pip fruit and timber heartland to Asian markets, but cruise ships are increasingly visiting the region's art deco and wine hotspots. Earnings have steadily grown at 8% p.a. through higher throughput and pricing power, and the new wharf under construction allows that to continue. We're happy buying reliable infrastructure assets at decent prices, especially in a low interest rate world.

See here for more information including how to invest in the Intelligent Investor Australian Small Companies Fund.

 

Disclaimer
Intelligent Investor provides general financial advice as an authorised representative under the AFSL held by InvestSMART Publishing Pty Limited (Licensee). InvestSMART Funds Management Limited (RE) is the responsible entity of various managed investment schemes and funds and is a related party of the Licensee. The RE may own, buy or sell the shares suggested in this article simultaneous with, or following the release of this article. Any such transaction could affect the price of the share.

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