Good afternoon,

ASX200 up over 6000 again today and the market’s put on 120 points in the last week.  Small and mid caps leading the way, Resources lagging (but up strongly today).

I thought this week we’d take a look at where you can find some value or potentially mis-priced shares in the market right now and my thinking behind them.  I’m going to use Magellan (MFG) as the worked example and then I’ll rattle off a couple of others you can have a think about yourself (or if you’re a client, you can discuss with me/ask me for the details).

MFG is trading at $26 a share and has a consensus price target of $28.85 with a range from $27-29.70 across the 7 brokers who cover it.  The earnings range for the forward period is $1.29 to $1.37 with a consensus average of $1.32.

Looking at estimated changes however, the low estimates are generally moving up and the high ones are moving down, so I can see MFG beating consensus estimates based on analyst activity alone.  As a result, you can see the consensus estimate moving up in the recent 3 months.

This tracks with history with MFG beating or matching consensus at 7 out of 9 halves since June 2014.

Reading the analyst reports the main swing factor in estimates is the performance fee estimate, which makes sense as it’s a hard number to forecast given we don’t know how the funds will perform in the forward period.

The stock has traded on up to 24x earnings in recent history and is currently only trading on 16x FY19 earnings or 19x FY18 earnings.  This is a large margin of safety if you think MFG can keep growing their assets under management and generate decent returns for their investors.

So if performance fees are the question, let’s look for the answer.  Factset have MFG growing the average assets under management from $56b to $64b over the by EOFY June 2019.  With sales growing from $300m to $466m.  Traditionally MFG make 6-15% of fees in performance fees.  Their fee structure is probably coming down as they hit scale, so let’s say they are targeting 10%.  Assuming they make 95% of their sales from fees, they should pick up 40-50m in performance fees in an average-sorta year.  Both Morgan Stanley and Macquarie have them earning sub-$30m in performance fees in FY19.

They are concerned about adverse markets affecting MFG’s performance fee.  And it’s true, if that turns out to be the case, they might be.  But if you chose to invest at these prices, you are picking up a quality fund manager at a discounted valuation and getting the upside from performance fee potential for free.

Fund managers in Australia trade on PE ratios of 15-17x earnings for the next 12 months.  MFG is at the top of that class as a result of its superior management, growth and track record.  Janus Henderson (JHG) is at the bottom, 13x earnings and for the record, I just don’t think it’s that bad.

What else is worth investigating:
Well Integral Diagnostics’ (IDX) board just rejected a takeover at a $312m valuation from Capitol Health.  Management must be pretty confident in their ability to deliver for shareholders!  Brokers reckon it’s worth $2.30 and I’ve got their earnings growing 10-15% pa for the next couple of years.  It’s on a PE of 16x 1 year forward and there’s plenty of M&A activity in the sector.  I wouldn’t be surprised if they got another superior bid at some point.   Chairman just bought more stock on Friday as well.

Other names for you to look at:  Aristocrat (ALL), Reece (REH), SG Fleet (SGF) 

Moving quickly to the postive and negative moves from last week.  Nearmap (NEA) continues to gather momentum and investor support, the view now is they will clearly deliver on their much-awaited US roll out.   Otherwise, expensive growth got more expensive last week.  Pretty much a rag bag of stocks trading on PE >25 would have done best last week.
In the red were a few dogs and Nick Scali (NCK) which went ex-dividend.
Have a good week,

 * The information contained in this email is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser.