3 treasures hidden in the trash

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As the old saying goes; “one man’s trash is another man’s treasure”. And nowhere is this truer than the sometimes-scary world of deep value and contrarian investing. Some of the stocks mentioned here have fallen 80% or more from relatively recent highs, and have fallen off the radar of index funds, stockbrokers, and other investors. So where is the deep value to be found today? Our three contributors provide ideas from across the market: big and small cap, financials, gold miners, and even a collection of stocks from a long-forgotten corner of resources. Responses come from Alex Shevelev, Forager Funds; Michael Goldberg, Collins St Value Fund; and Tim Hillier, Allan Gray.

Everything that could go wrong did

Alex Shevelev, Forager Funds

This one is really contrarian. No one wants to hear about it. Many investors think the business is dead. The stock is Thorn Group (TGA), provider of washing machines and TVs to consumers and equipment financier for small and medium businesses.

Thorn has been off the radar of many investors for a long time. And rightly so.

The stock was trading at close to $3 a share at the start of 2015. Then came the earnings downgrades. Then the failed acquisitions and debt issues. Then the ASIC investigation and a class action. It is now trading at about $0.60.

Leasing out household goods to cash-strapped consumers was a profitable business for years: the 10 years to 2017 saw return on capital average more than 20%. Those days of high returns on capital are over. But with brand recognition, a strong market position and loyal customers Thorn’s Radio Rentals does have a place in the world. A return on equity of 10% seems reasonable over time.

Then there was a rare bright spot over the past few years. Thorn also owns a quickly growing (earnings up 50% last year) equipment finance business. Think cars, kitchens and machinery for small businesses. It’s a decent asset and not at all reflected in Thorn’s current market capitalisation. It would make a lot of sense to sell it and focus on the traditional business where returns on capital should be higher.

All told Thorn has net tangible assets (mostly cash still to be received from customers) of close to $200m. This is double the current market capitalisation. It’s not going to be an easy path and, if it goes wrong, the flaws will seem like they should have been obvious. But there is plenty of upside if things go well.

A whole sector that’s being ignored

Michael Goldberg, Collins St Value Fund

Despite the attractiveness of our other positions, it is our basket of uranium companies that we are most excited about. We’ve written about that position on Livewire before, but despite first investing in the sector a year ago the thematic is simply too attractive to bypass - the risk/reward balance is the most asymmetrical case that I’ve seen in as long as I can remember.

Demand for uranium is rapidly increasing while supply is decreasing.

Miners are shutting down mines and opting to meet their contractual agreements by purchasing material from the spot market.

The average cost of production is circa $50 per pound compared to the current spot price of $27 per pound.

Prices have begun to improve in the last two months, but as yet no one is talking about the industry. We anticipate that as utilities sign new long-term contracts, the spot price of uranium will increase materially and with them, the underlying uranium miners.

We’ve created a basket of uranium companies for our Fund, with the four largest positions being in Paladin (PDN), Peninsula (PEN), Boss (BOE), and Deep Yellow (DYL).

Be patient, let the thesis play out

Tim Hillier, Allan Gray

Newcrest is underappreciated by the market. It is a gold miner that produces about 2.3 million ounces of gold a year, equivalent to about 6,000 of the gold bars you might see in a Swiss vault (or, more likely, a movie about a Swiss vault). Thanks to its very large reserves, we expect it to continue doing so for a couple of decades.

Newcrest’s operations are at the lower end of the cost curve. At today’s gold price of US$1,200/oz, Newcrest should make more than US$700m of free cash flow before interest and tax from its 6,000 gold bars.

Newcrest trades on a multiple of about 17 times those pre-tax earnings. This is not attractive compared to a market that trades on about 12x pre-tax earnings, but we hold the view that today’s earnings are probably not representative of the company’s earning potential.

Some of the larger gold miners are generating negative free cash flows at today’s gold price.

Profits for those that have positive free cash flows represent dismal returns on invested capital, and are certainly not sufficient to justify the investment required to extend the life of many mines, build new capacity or explore for new deposits. As a result, companies have not been able to offset reserve depletion, and reserve lives have been falling over the last decade. Our view is that gold prices would have to be somewhat higher to justify future investment.

On this basis, we think both the gold price and Newcrest’s profits should be somewhat higher than they are today, and that Newcrest trades on an attractive multiple of those potential earnings. We contrast this to the market, where many companies may well be earning profits that may be less sustainable.

This dynamic makes Newcrest appear very attractive on a relative basis. Its low cost and long life assets mean we can be patient and wait for the thesis to play out.

More on deep value and contrarian investing

How do the contrarians and deep-value specialists of the world find their ideas in a market like today’s? Find out in part one of this Collection.

What are the hardest aspects of being a contrarian investor? And how can investors handle them? Find out in part two of this Collection.


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