Why is successful investor Sir Ron tightening his grip on Murchison Metals?

Sir Ron Brierley’s vehicle Mercantile Investment Company (ASX:MVT)  has just made its first activist investment play under Sir Ron. Though Mercantile is small in size with assets of around A$21 million as of June 2012, Sir Ron’s investment savvy is legendary in stature.

Sir Ron stood down as the Chairman of Guinness Peat Group (ASX: GPG)) in late 2010,under pressure from a group of fund managers and investors who had very “short term” aspirations for Guinness Peat Group(forgive the sarcasm but your author was not impressed by this show of misguided investor activism!) . Sir Ron is making sure the same situation does not repeat itself at Mercantile Investment Company, where he has taken a controlling 54% shareholding in Mercantile through his private company Siblow.

Sir Ron’s latest play, Murchison Metals Ltd (ASX:MMX), is a Brierley classic – a company with a sizeable cash chest, no clear corporate direction,  a depressed share price and a group of overpaid Directors*. This is exactly the sort of company that Sir Ron has targeted consistently throughout his successful career at Brierley Investments and Guinness Peat Group.

Sir Ron’s Company Mercantile filed notice Tuesday afternoon with Australian Stock Exchange that it had raised its shareholding in Murchison Metals to 76.4 million shares, raising its shareholding from 11.7% to 17% of the outstanding float.

Sir Ron lodged a requisition yesterday for a General Meeting of Murchison Metals to be held for the purpose of removing the Managing Directors Greg Martin & Chairman Ken Scott-MacKenzie and replacing them with two new Directors put forward by Sir Ron. Sir Ron has indicated that this was “a direct response to the discovery of the excessive level of expenses being incurred by MMX” and his new Directors” first priority will be to stem the cash outflow”.

Murchison Metals Ltd was a co-developer of the A$6 billion Oakajee port & rail infrastructure project in Western Australia but was unable to come up with the financing. As a result,it sold its stake to its joint venture partner Mitsubishi in February 2012 for A$325 million which left the company with A$223million in net funds. A large portion of these net funds amounting to A$207 million have been returned to shareholders this year.

But Murchison’s remaining cash is being eaten up through operating costs that Murchison estimated in its October quarterly report will run at hefty $500,000 a month for the October to December 2012 quarter. These are excessive for a company with no active business operations. Further, additional advisory and operating costs will be incurred if shareholders of Murchison vote to wind up the business in early 2013.

Hence the reason Sir Ron wants to step in and stop these excessive cash outflows by ousting the current board & potentially stopping the winding up process.

So what is in this move for Sir Ron? A cash arbitrage & a sizeable tax asset!

As of 30 September 2012, Murchison had A$26.9 million in cash. Subtracting out recent legal settlements with Premar Capital & O’Sullivan Partners for A$3.39 million, that falls to A$23.51 million. Subtracting Murchison’s expected operating cash outflows for the December 2012 quarter of A$1.5 million, will leave A$22 million as of 31^st December or 4.87 cents per share , this is  22% higher than the current share price. The current Directors of Murchison have proposed winding up the business and returning just A$15.8-18.09 million or 3.5-4 cents per share via a final capital distribution in February 2013 after closure and operating costs. Sir Ron is trying to move quickly, oust the incumbent Directors and capture this cash arbitrage.

As of 30 June 2012, Murchison Metals was sitting on deferred tax asset of $19.5 million which is not shown in Murchison’s balance sheet but is available to be offset against future taxable income subject to statutory tests being met. This tax asset will be lost if Murchison is wound up and could be a potential big bonus for Sir Ron!

* By way of a side note, according to Murchison’s Annual Report for 2012, key Executives and Directors at Murchison pocketed just under A$13 million in remuneration benefits for the 2012 financial year – not bad for a company that has no active business operations and which reported just A$7.2m in revenue. In 2012, Mr Martin, Murchison’s Managing Director, received $5,000 a day plus leave entitlements & worked just a 3 day week!

Disclosure: No positions held in MMX,MVT. Hold long position in GPG through an investment account I manage.

Disclaimer: The opinions expressed by the author in this article are not intended as investment advice and should not be relied upon as investment advice by the reader.

Tarn Crowe

Director, Crowe Finance Pty Ltd (private investment company)

Update on my submission for monthly Gurufocus competition - ING Group (ING-NYSE)

ING Group ADR (ING-NYSE)

ING Group ADR price 14 Sep 2012 US$8.98 (buy price recommended US$5.96 on 22 May 2012)

I last wrote about ING Group in May in an article “Finding Value in a European Banking Storm” . Please find the link here  http://www.gurufocus.com/news/177589/finding-value-in-a-european-banking-storm

Since this article ING Group has made good progress on its divestures and the second quarter earnings were solid albeit lower than last financial year.

The net underlying 2^nd quarter earnings for ING Group  (excluding ING Asia classed as a discontinued operation) came in at €1.05 billion and both ING Bank & ING Insurance performed well. The results  were good given the difficult economic conditions in Europe and Asia, the tepid growth in the US and slowdown in Asia including China.

There was a marginal increase in lending for ING Bank but the focus of management was clearly on strengthening ING’s capital position and loan exposures.

Capital & funding position

ING Bank’s Core Tier 1 ratio improved to 11.1% at the end of June 2012. Based on the Company analyst presentation on 11 Sep 2012, the sale for ING Canada and shares in Capital One will further strengthen ING’s capital position to 11.9%. This is well above the 9% level required by Basel III.

More than 60% of ING Bank’s funding comes from retail and corporate deposits. The customer deposits position of ING Bank experienced a marginal reduction of €4 billion or less than 1% to €473 billion with €4 billion in higher retail deposits offsetting €8 billion in lower corporate deposits.

Loan exposures

ING has continued to reduce its funding mismatch in Spain by reducing its Spanish assets by 6.2 billion both in the lending book and reducing debt securities held.

The Spanish funding mismatch between assets and liabilities has been reduced to a little over €12 billion from €27 billion at the end of 2010.

Non-performing loans (NPLs)  for ING Bank increased to 2.3% overall from 2.1% at the end of the first quarter due to pressure from Real Estate Financing and higher NPLs amongst SME corporates in the Netherlands. NPLs for Dutch mortgages remained at 1.2% due to the low unemployment levels in Holland. The housing market remains weak in Holland and along with difficult economic conditions in the Eurozone and Netherlands , ING Bank’s NPL ratio will remain under pressure.

Political risks – the Dutch bank tax

The Dutch labor party which is leading the pre-election polling in Holland, is seeking to raise the  bank levy from the proposed €600 million to €1 billion, ING’s share would be €300 million or approximately 7% of underlying net earnings. Further they are seeking to impose a financial transactions tax http://www.businessweek.com/news/2012-09-10/feuding-dutch-politicians-agree-on-toughening-rules-for-banks.

There is further risk that mortgage interest deduction will be curtailed on home loan repayments in the Netherlands which could also damage the housing market, economy and ING Group’s loan exposures there.

The political risks above represent are negative for ING Group and do reduce my fair value for ING Group.

Divestures

ING is close to divesting some or all of its Asian insurance businesses all of which have received expressions  of interest. Due to regulatory considerations and the demand of potential buyers, ING is expected to divest the operations on a piece by piece basis.

I am confident ING Group will achieve good prices for its Asian businesses. ING Bank’s recent sale of its Canadian operations for US$3.1 billion (versus a book value of approximately US$1.7 billion) supports the view that ING’s management is committed to achieving solid sale prices for its assets and not just selling at any price.

In relation to the ING’s US Insurance operations, they have independently made debt issues this year strengthening their stand-alone status in preparation for an IPO. The European insurance operations are also being readied for an IPO.

In summary

ING Group’s ADR shares have increased since May 2012 due to

·         a firmer commitment being shown by the ECB to protect to EU by undertaking sovereign bond purchases to lower interest rates for at risk countries such as Spain and  Italy. This has boosted the value of financial firms and banks in Europe including ING Group in particular;

·         an increase in the value for Euro versus the US Dollar raising the value of ING Group’s ADR shares;

·         progress made  by ING Group on the strengthening of its capital position with the sale of ING Canada, its stake in Capital One and the imminent sale of its Asian operations.

·         Continued solid performance in ING Group’s underlying businesses.

·         Investor recognition that ING Group’s shares were undervalued.

Disclaimer: This article represents the journalistic opinions of the author and is not intended to be provided as investment advice or relied upon as investment advice.

I own shares in ING Group for my company, personally and on behalf of investment accounts I manage.

Delhaize Group - a supermarket chain with an attractive yield & single digit PE multiple

The business

Delhaize Group (NYSE:DEG) is a food supermarket chain with stores throughout the United States, Belgium, Luxemberg and Southeastern Europe and Asia.

Delhaize Group was founded in in 1867 by two brothers Jules and Edouard Delhaize and their brother-in-law Jules Vieujant. Initially a wholesale distributor, they expanded their stores throughout Brussels and Belgium and opened their first supermarket in 1957 in Brussels.

Spanning 3,408 stores as of the end of December 2011 , 80% of Delhaize stores are company operated and 20% are operated as affiliated or franchise stores.

In total, 90% of Delhaize revenues are generated from the operation of retail food supermarkets in the US, Belgium/Luxemberg & Southeastern Europe & Asian businesses.

The United States market is a significant part of Delhaize Group’s business generating over 65% of their revenues in 2011. They operate under the banners of Food Lion, Hannaford, Sweetbay Supermarket, Bottom Dollar Food, Reid’s and Harveys.

In Belgium & Luxemberg, they have a strong franchise with a 25.8% market share and which generates US$6.1 billion ( EUR 4.8 billion) in revenues or 23% of Delhaize Group’s total revenues.

The third part of the business,  Southeastern Europe & Asian business has grown considerably throughout the last 3 years with the acquisition of Delta Maxi and now represents 12% of Delhaize revenues.

Competitive advantages

Delhaize Group stores face substantial competition from retailers across their different brand name stores including retailers such as Wal-Mart, Kroger, Bi-Lo, Super Valu and Royal Ahold . As a result, there is substantial pressure on profit margins across their various stores particularly in the United States. This has manifested itself in disappointing results recently that have pressured the share price.

Delhaize Group owns well established brand name stores including Food Lion, Delhaize Belgium and Alfa Beta and the majority of the customer purchases in these stores were made with loyalty cards which shows good customer retention.

In the US, many of their stores are located in established urban locations that would be difficult for a competitor to replicate and are spread across south eastern, mid-Atlantic and northeastern part of the United States.

Profitable for the last 10 years

The last 10 years of financials shows that the Delhaize Group has been steadily profitable every year. Their lowest EPS was US$3.41 in 2003 & highest EPS was US$7.11 in 2010. Their average EPS over the last 5 years is US$5.95.

They have paid an average dividend of US$1.92 (EUR$1.51) over the last 5 years (based on a US/EUR exchange rate of 1.27 which we have used throughout this article). The dividend has approximately average one-third of their after tax net profit.

Their share count dilution has been minimal with 99.34 million shares outstanding at year end 2007 versus 100.71 million shares outstanding at year end 2011.

Cash from operations have averaged US$1.386 billion(EUR$1.092 billion) over the last 5 years. They have used approximately 53% of their operating cash flows to pay for capital expenditures (excluding business acquisitions)  over the last 3 years.

Debt level

At the end of 2011 Delhaize Group had consolidated debt level of EUR 3.2 billion with EUR 700 million of unused commitments. The company historically has a track record of reducing leverage over time.

Moodys & S&P have marked their long term debt investment grade with stable outlook. Their maturities are in my view manageable in the context of their cash flow generation. Their average interest rate on long-term debt was 5% at December 2011 and this has fallen over the last 12 months.

Outlook

They are targeting free cash flow of US$635 million ( EUR 500 million) in 2012 and capex of US$889 - US$952 million (EUR 700-750 million) .

They are expecting a fall in underlying operating profit by 15-20% for the full year at identical exchange rates as they are determined to be more price competitive across their stores to generate greater revenue. Assuming an operating profit pre-tax of EUR 670 million in 2012 down from EUR 812 million in 2011, I estimate their net profit to be US$454 million (EUR $358 million) or $4.51 per share assuming a financing cost of EUR 180 million similar to 2011 and a 27.5% tax rate estimate.

The slowdown in world growth combined with price inflation will continue to pressure margins of the Delhaize Group. Offsetting this are some positive developments within Delhaize’s business.  In 2011 they bought a supermarket chain Delta Maxi that has enabled them to expand their footprint in southeastern Europe, they have seen growth in their Bottom Dollar chain in the US and they are focused on cutting costs throughout their business that has delivered close to US$500 million over the last few years.

Valuation

The shares were recently trading at US$35.64 on 25th June 2012, which puts the current year’s PE at 7.9 and the company is paying a healthy dividend yield of 5.95%. At this single digit PE multiple, a lot of bad news is already priced into Delhaize group’s shares.

Disclaimer: The author owns the ADR shares of Delhaize Group (DEG). This article represents the opinion  of the author and is not intended as financial advice for the reader and should not be relied upon as financial advice.

Finding value in a European Banking Storm - ING Group

The recent events in Europe have punished the ADR shares of the Netherlands based ING Group (NYSE: ING) which traded for US$5.94 a share as of 21^st May 2012, down 52% from their 52 week high of US$12.68.

There is no doubt that the European Banking system will need to strengthen its capital position and the issue of whether the Euro will survive is an open question. However, what we do know is that in times of distress often the best investment opportunities present themselves.

ING Bank NV is systemically important bank to a strong sovereign

When looking to invest in banks in Europe, I would approach it from this point of view. If the European Union was to dissolve, which bank and in what post Euro currency and country would I want to own? The Netherlands has AAA rating and ING Bank is systemically important to the Dutch economy. In a post Euro world, the Netherlands would remain one of the strongest sovereigns in Europe along with Germany, Finland and Switzerland to name a few.

Recently Moodys has indicated that it may reduce the ratings of the Netherlands and the ratings of ING, however, even with a ratings downgrade, I expect the the Netherlands & ING Bank to retain strong credit issuer ratings.

Strengthened capital position

 ING Bank NV is one of just a few banks in Europe that has not participated in the LTRO operation offered by the ECB, including the second round in February 2012. Further, ING Bank has been methodically boosting its capital position and recently sold ING Direct USA for US$9 billion (€6.3 billion) to Capital One. This has helped raised its Core Tier 1 Capital position to 10.9%, well above the 9% level required under Basel III.

ING Group has repaid €$7 billion of the €10 billion of aid provided by the Dutch Government and with the eventual sale of ING Insurance Asia, which has received several offers as of the 18^th May 2012 , they will be able to repay the remaining €3 billion.

ING shares fell recently as the EU re-opened the issue of whether ING received favourable treatment on its bailout. I think the ramifications of this investigation are manageable.

The catalysts for ING Group

·         Sale of ING Insurance Asia for around US$7billion will boost the capital position of ING Group , allows ING to repay the remaining Dutch aid and also raise its dividend paying capacity.

·         ING Group carries a cheap valuation as it trades at adjusted PE ratio (excluding interest on Dutch aid) of 3.5 based on its 2011 earnings and a price to book of 0.34. Further it is trading close to its 52 week low.

·         ING management have said they will reinstate dividend payments once the Dutch Government  is repaid & Basel III requirements are met.

·         Slow economic improvement in the European and global economy will boost ING’s business and the market price of ING’s shares.

·         The IPO of ING’s US insurance business, which is their preferred divestment option as required under their EU bailout, at an attractive valuation will further boost ING Group’s financial position.

The risks

·         A severe further deterioration in the Netherlands economy , the European and global economy due to ongoing austerity measures and low economic growth. The Dutch unemployment rate has risen to 4.9% which could lead to higher NPLs on its loan book in the Netherlands as well as other European markets.

·         A severe disruption in the wholesale bank funding market. ING has already raised €9.2 billion or over 50% of its wholesale funding needs for 2012 and has not needed to tap the LTRO financing. The Dutch Government would ultimately support ING Bank in a severe funding squeeze.

·         There is political uncertainty over the whether tax deductions for interest payments on Dutch mortgages will gradually be reduced which could raise the real cost of mortgage debt , however, mitigating this factor are the high level of Dutch private savings, benefits for unemployed workers, Government guarantees on mortgage debt and low unemployment rate.

·         ING Group’s loan exposures in Spain, Italy & Greece are potentially a problem, however, they appear manageable and ING has been reducing its exposure over the last few quarters.

·         ING Group is unable to divest its insurance businesses at attractive valuations. So far, ING Group has been achieving good prices for its divestments.

Conclusion

I would recommend ING Group as a buy based on its cheap valuation, solid capital position and the strength of its franchise. ING Group will be a survivor in Europe among its financial peers.

Note: I own shares of ING Group. The author’s  views expressed in this article are for journalistic purposes only and should be construed as investment advice or relied upon as investment advice.

Looking for those elusive 40 cent dollars!

The famed Canadian investor,Peter Cundill, articulated his value investment approach when he coined the expression "Buying a dollar for 40 cents". I particularly like this phrase because it really encapsulates the notion that you are putting in a big margin of safety into every security purchase.

Even if your investment turns out to be worth 60 cents rather than the dollar you had hoped for, you are still making a profit and achieving a satisfying result.

What is a 40 cent dollar?

For this blog I am limiting my analysis to publicly listed investments which meet strict quantitative & qualitative criteria. These criteria are not always rigid because financial statements that companies produce are dynamic.

However, there are general themes that would encompass the type of investments we are looking for :-

1. we are avoiding investments in options, futures and any other derviatives. I would only recommend using options (eg puts) to hedge an existing position but not to speculate on.

2. we will consider investing in public companies internationally that meet the following criteria :

• trade for large discount to book value
• trade at 5 x free cash flow or less,
• offer 5% or higher dividend yield
• have little or no debt OR a conservative funding profile in terms of short & long term debt.
• have competent management who are shareholder friendly and have a good track record
• have understandable and sustainable business with a minimum operating history of 10 years or more.
• operate in a Country that has a history of protecting the rights of shareholders and private property rights generally.

Going forward

Thank you for visiting my blog. I look forward to sharing my views and ideas with you and hopefully unearth some hidden investment gems that qualify as true 40 cent dollars!