The “Australian Berkshire Hathaway” – Is there an opportunity to buy in due to recent underperformance?

Welcome to Finance and Fury, The Say What Wednesday Edition

I’ve been looking at Soul Patt (ASX: SOL) recently as I’ve heard some commentators refer to them as the “Australian Berkshire Hathaway” but noticed they have underperformed the ASX200 index over the last 12 months. As they have overperformed over any other longer-term period, would you see this as an opportunity to buy in? And what do you think about this particular stock? Looking forward to hearing your thoughts. Thanks, Gab

Disclaimer – not advice – general discussion in nature – seek personal advice

1. Washington H. Soul Pattinson and Company Limited – call it SOL for short – is an Australian investment company – SOL invests in a portfolio of assets across a range of industries – main business activities include ownership of shares; coal mining; gold and copper mining and refining; property investment; and consulting.
2. While the broader market gained around 25% in the last year – SOL lost 16% (even including dividends)
   1. Keep in mind that even the best stocks will sometimes underperform the market over a twelve month period
   2. Long term shareholders have made money, with a gain of 14% per year over half a decade
   3. So, is the recent sell-off an opportunity to buy in? worth checking the fundamental data for signs of a long term growth trend
   4. I find it very interesting to look at share price over the long term as a proxy for business performance
      1. Not always the same thing – to truly gain insight, we need to consider other information, too. Consider for instance, the ever-present spectre of investment risks of the underlying companies or the changes in forecasted earnings
3. One thing – not too correlated to historical crashes – losses minimal in 2008/09 and other corrections
   1. But has just gone through a loss in price
4. Also note – is a High conviction investment operator – Similar to Monday’s episode –

Current Investments

– SOL invests in a range number of companies across a variety of industries. In addition to a large diversified listed and unlisted portfolio, their larger investments are:

1. TPG Telecom (ASX: TPM) is a force in the Australian telecommunications industry – 25.3% shareholding
2. New Hope Group (ASX: NHC) is an Australian owned and operated diversified energy company which has been proudly based in South East Queensland for more than 60 years – 61% shareholding
3. Brickworks Limited (ASX: BKW) – main business is the manufacture and distribution of clay and concrete products, property development and realisation, and investments – 43.9% shareholding
4. Australian Pharmaceutical Industries (ASX: API) is one of Australia’s leading health and beauty companies. API has a number of brands and banners in the retail health and beauty industry, including Priceline, Soul Pattinson and Pharmacist Advice. – 19.3% SHAREHOLDING
5. BKI Investment Company Limited (BKI) is a Listed Investment Company on the Australian Securities Exchange. – 8.6% holding
6. Round Oak is a mining and exploration company focused primarily on copper, zinc and gold – 100% shareholding
7. Milton Corporation Limited (ASX:MLT) is an Australian Listed Investment Company which aims to invest in a diversified portfolio of assets to generate growing dividends and increased value of assets – 3.8% shareholding
8. Apex Healthcare Berhad (APEX.MK) is a leading healthcare group with operations in Singapore, Malaysia, Vietnam and Myanmar. Apex is publicly listed on the Main Board of Bursa Malaysia – 30.3% holding
9. TPI Enterprises Limited (ASX:TPE) is one of nine companies licensed worldwide to manufacture narcotic raw material for the international pharmaceutical industry – 20% shareholding
10. Ampcontrol Pty Limited is a leading international supplier of electrical and electronic products with a strong presence in providing products and services to the mining sector – 43.3%
11. Pitt Capital Partners is an independent corporate advisory firm with a track record of completing successful corporate transactions. Since inception, they have advised some of Australia’s most successful companies on over $10 billion worth of transactions – 100%
12. Clover Corporation Limited (ASX: CLV) is an Australian research-based company dedicated to providing quality lipid based products which enhance the health and well-being of the community – 22.6% shareholding
13. Has got 75% of holdings in 3 companies though – New Hope Corp, TPG and Brickworks
    1. Large holding in New Hope Corp – which is a thermal coal mining – the loss of value from their shares seems to have come mainly from a drop in price from over $4 a year ago, to about $1.80 now.
14. Comparison to Berkshire Hathaway – owns majority (100% or above 90%) of 71 companies
15. Not the same as Berkshire Hathaway – would say closer to a high conviction LIC

Is it a good share?

Growing DPS and EPS

1. In his essay The Superinvestors of Graham-and-Doddsville (back to high conviction and value managers) Warren Buffett described how share prices do not always rationally reflect the value of a business. By comparing earnings per share (EPS) and share price changes over time, we can get a feel for how investor attitudes to a company have morphed over time.
2. Over half a decade, SOL managed to grow its earnings per share at 13% a year. This EPS growth is higher than the 10% average annual increase in the share price. So it seems the market isn’t so enthusiastic about the stock these days –
   1. Shares can act as trends – but like fashion, can be in and out –
3. It’s probably worth noting we’ve seen significant insider buying in the last quarter, which we consider a positive.
   1. Share price drops – so those on the inside of the company buy up more
   2. But the earnings and revenue growth trends are even more important factors to consider
4. What About Dividends? As well as measuring the share price return, investors should also consider the total shareholder return (TSR). The TSR incorporates the value of any spin-offs or discounted capital raisings, along with any dividends, based on the assumption that the dividends are reinvested.
   1. So for companies that pay a generous dividend, the TSR is often a lot higher than the share price return. As it happens, Washington H. Soul Pattinson’s TSR for the last 5 years was 89%, which exceeds the share price return mentioned earlier. This is largely a result of its dividend payments! – has had stable dividend payments – growing
5. Payout ratios – Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Washington H. Soul Pattinson paid out 56% of its profit as dividends. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business – which could be good or bad.
   1. In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Washington H. Soul Pattinson paid out 80% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances. It’s encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don’t drop precipitously.

Net tangible assets per share – $13.76

Return on Equity –

1. ROE has a ROE of 8.0%, based on the last twelve months. Another way to think of that is that for every A$1 worth of equity in the company, it was able to earn A$0.08.
   1. Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
      1. 8.0% = AU$359m ÷ AU$4.5b (Based on the trailing twelve months to July 2019.)
   2. It’s easy to understand the ‘net profit’ part of that equation, but ‘shareholders’ equity’ requires further explanation. It is all earnings retained by the company, plus any capital paid in by shareholders. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.
   3. What this means – ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the yearly profit. That means that the higher the ROE, the more profitable the company is. So, all else equal, investors should like a high ROE. That means ROE can be used to compare two businesses.
   4. Is it good? Compare it to the industry average – but far from perfect here due to the nature of their business – Oil and Gas is 15%
   5. But – has low debt – debt to equity ratio of just 0.088, which is very low. I’m not impressed with its ROE, but the debt levels are not too high, indicating the business has decent prospects. Careful use of debt to boost returns is often very good for shareholders. However, it could reduce the company’s ability to take advantage of future opportunities.
2. Has had good long term performance – Stock pickers are generally looking for stocks that will outperform the broader market. And in our experience, buying the right stocks can give your wealth a significant boost.
   1. SOL shareholders have enjoyed a 63% share price rise over the last half decade, well in excess of the market return of around 23% (not including dividends).

Summary – Not advice – may be beneficial to hold long term – as short term may continue a decline if their major holdings go down

Major risks – coal business continues to decline, TPG gets beat out by TLS or Optus, or property takes a hit – which would impact brickworks

Thanks for the question Gab

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