Thursday, 20 November 2008

Doublling Down with REF

"When stocks go down and you can get more of them for your money, people don't like them anymore." Warren Buffet.

What Buffet was getting at in this quote is that whilst people are willing to pay for a stock at say $2 they are unwilling to buy them when they fall to $1, even though you can get more of them for the same amount.

That's not to say that you should double down on any stock because the price halves. However, if the fundamentals remain in tact and you are paying a price significantly below intrinsic value, then why wouldn't you buy more? That is at least my rationale for purchasing another 10,000 REF shares today for $0.98.

I first purchased REF shares back in February at $2.22, at that time I was a little overly optimistic about earnings growth. Not because I thought the business would do better but I didn't anticipate the strong AUD which affected REF's GBP profits, from which they derive the bulk of their earnings. That exchange rate has improved in 1H09 to an average of0.454 as opposed to an average of 0.468 in 2H08. However it is still above the average for FY08.

Consensus earnings estimates are forecasting a decline of about -7.1% for FY09 and a cut in the dividend from $0.24 to $0.21. No, that is not a misprint, the stock is currently $0.96 and is forecast to deliver a FY09 dividend of $0.21 cps, for a dividend yield of almost 22%.

Using the consensus number, I value the stock at around $1.80 - $1.90. Remember this company has a return on equity in excess of 200%, has no debt and generates a trememdous amount of free cashflow which they pay out as dividends.

Of course, the effect of the current economic malaise is as yet unknown, however even if the company were to slash their dividend by a third from last year's level, at current prices you would still be receiving a 16% dividend yield. If earnings and divdends were halved, a scenario I think is very unlikely, you would still be getting a 12% yield. That's much better than I can currently get in the bank and thus an offer I can't refuse.


KS said...

I like REF too, what of their expansion plans though? Will dividend be cut back so they can use more free cash flow to fund France/Spain? Or do you think they will use some of the $10m debt line?

The Fundamental Analyst said...

Hi KS,

Traditionally REF has been able to expand with very little upfront cost, one of the great scalability advantages of this business. My sense is that if extra cash were required that they would tap the available credit line. I am also interested t o find out if they hedged their AUD/GBP exposure a few weeks back when the rate became very favorable.

Anyway, looks like I got in a day early, looks like even more of a bargain today.

KS said...

Those are my thoughts as well. I doubt they would require much of the credit to expand given the history.

I bought in this morning at about 89 cent. So cheap when you put it up against the dividend and high ROE. No brainer of an investment really.

Thanks and all the best!

Deano said...

What are the chances of Optus of TLS copying their product and undercutting them?

The Fundamental Analyst said...

Nice pick-up KS, at least it looks that way for now.

Deano, if Optus or Telstra wanted to copy them, you would have thought that they'd have done it by now. It's a very profitable little business but at the end of the day it's insignificant in terms of earnings for the likes of Telstra. REF pays them a fee for line rental anyway they get something out of it.

However, if in 5 years time they have successfully penetrated Spain, France Germany, New Zealand and a couple of other countries and are generating NPAT in the region of $100m someone might start to pay attention.

KS said...

You would think that if REF experience that kind of growth, Telstra will take over them by the time they reach NPAT of $50 - 60 million.

KS said...

Hi mate, I spoke to Reverse's MD today, Shane Donavon, seemed like a very knowledge guy. I can't find your email anywhere, so let me know if you want me to forward you some notes on our conversation. All the best.

Scott said...

Hey KS that would be great. I sent an email to Shane as well, haven't hear back yet. You can send me an email at: