The ASX200 added 40 points last week, marking 3 weeks of positive weeks in a row. This morning the market is up another 18 points despite weak trading on Friday in the US, driven primarily by Apple (down 4.1%), with analyst reports suggesting that smartphone sales could be slowing.
It’s reporting season over in the US and 16% of the S&P 500 companies have reported earnings so far. The bulk of the companies (42%) put out numbers this week and I suspect this is what will dominate markets in the short term. If results in hand are anything to go by, we should expect solid ‘beats’ above consensus estimates. I’d be on the lookout for quantum though, these beats could be materially larger than normal with strong economic conditions with pretty moderate wage/raw material inflation…margins could get a kick.
Too much bear sh*t in the woods
I’m not sure why there are so many bears around at the moment. It’s like because the market isn’t going up in a straight line and we’ve had a 200 point pull back from new highs, everyone has lost their nerve. This makes me extra-confident that we are in the midst of an ‘opportunity’ rather than a ‘threat’.
Why am I so confident? Well for one, my #1 macroeconomic lead indicator, the PMI’s, are looking just fine (and before you start arguing about it’s relevance, bring me one other macro factor that’s better at statistically forecasting forward 1 year index returns).
Particularly here in Australia, we are just starting to see some of the benefits of the recent recovery in commodity prices, with significant free cash flow (in absolute terms) still to be generated over the next few years (before, mark my words, resource companies costs start going up, they over employ people again, the fat starts to accumulate…) Notice how Australia & Brazil, the two big iron ore countries’ current PMI value is equal to the previous 12 months? i.e. trading at highs, whilst others are slowing. Like interest rates, rates of change matter, but absolute values matter too. And it can be easy to forget (and I think the market has forgot) that whilst economic growth is slowing, being too conservative during a slow down and neglecting the fact that PMI’s are still largely above 55 (!!!) means moderate expansion, not recession. If you’re a business, no reason you shouldn’t be KILLING in this kind of environment (rising employment, low cost of funds, global opportunities, wages still haven’t really gone up…. it’s a margin fiesta!)
A case study in ‘technology’, moats, broker research and common sense.
iSelect listed back in 2013 at a valuation of $479.3m or $1.85 per share after an oversubscribed institutional offer on the back of a $24.1m EBITDA result in FY12, a profit which had grown 61% compounding over the previous 2 years.
The stock traded up and down during 2014 and 2015, highs of $1.99, lows of 63.5c before rallying during 2017, up to $2.26. From that point, it’s pretty much been a disaster.
Today the business announced earnings before interest and tax (EBIT) were expected to be in the range of $8-12m, down from the previously guided $26-29m. The share price is down 67.6% since 1 January 2018 and is trading at 45c, down 80% from it’s high.
The stock is covered by Bell Potter (Price Target $1.70), Baillieu’s (PT $2.20), Evans & Partners (PT $1.85), Credit Suisse (PT $1.95).
Lesson 1: Common Sense
iSelect had 9.8m people visit their website to search for the comparison products they offer in FY17. From those 9.8m people, they generated $18.89 per customer in revenue. From that $18.89 they make $2.30 in EBIT.
The business had no margins. Why would you want to buy a business that given the slightest nudge, is going to tip over?
Lesson 2: Moats
ISU is just a distributor, they clip the ticket from all the product they market on their website. They are essentially a referral service. They pay to have certain kinds of shoppers look at their website and if those customers buy stuff, they get a rebate. They hope that the cost of acquiring those shoppers is less than the rebates they receive and they pray that those customers don’t use their website as a research tool and then shop direct. Nobody is ‘loyal’ to iSelect, nobody wears iSelect tshirts or trusts iSelect any more than CompareTheMarket.com.au, eBay, Facebook, Amazon et al. They don’t even have a ‘talent advantage’… see below on technology.
Lesson 3: Technology (the only certainty is change)
iSelect figured out what thousands of teenagers a few years back figured out. That is, if you can drive traffic to other people’s websites better than they can, you can get paid. This was called ‘affiliate marketing’, (you can read about why it’s dead here)Essentially, by using search-engine optimization (SEO), content-marketing and a bunch of other internet-based hustles, you can get people to click on stuff and get paid for each one.
Problem is, because anyone with a brain can do it, the dollar per click got driven down to near zero. And because we are getting smarter at avoiding ads and clickbait, the demand driven by this kind of advertising also dried up. It’s not that hard to see why these kind of profits would be arbitraged out of the market in the worlds most efficient market (the internet). Anyway in ISU’s latest announcement they said:
“Both the Health and Energy & Telco verticals have been negatively impacted by…lower than expected leads due to changes in the marketing mix, particularly reduced search engine marketing (SEM)”
“Energy & Telco was impacted by higher digital customer acquisition costs and lower leads”
Regarding Health division “33% increase in marketing spend did not deliver the forecast yield increase”
“the mix between traditional media and digital spend must be carefully
balanced to ensure both objectives are met. As such, the mix of marketing spend is being adjusted in the near-term to allow for the continued support of iSelect’s long-term growth strategy, while better supporting short-term lead generation.”
The company clearly had a formula for marketing that was working, built a business up to c.$500m valuation on the back of it and as it declined, so did their business. As Google Ad-words became more expensive, Google’s algorithm became smarter (old SEO tricks don’t work as well/at all anymore) and attention shifted from TV, iSelect’s marketing strategy failed. And they just don’t have the margins to withstand it. Now, unfortunately, it’s too late.
Lesson 4: Broker Research
Honestly, if you are still making investment decisions based on broker price targets, you deserve to lose your money. Most broker research isn’t worth the paper they still print it on! Research analysts are like an educated journalist. They collect information and present an opinion on it. If you can’t critically read it, evaluate it for its merit, compare it against your own opinion or thesis, and that of other valid opinions, aggregate that opinion, estimate the probability etc.etc. etc. you might as well use that report for kindling or as paper airplanes to throw at your colleague/spouse/neighbour who’s dog keeps crapping on your lawn. Recycle responsibly.
There’s lots of good analysts, lots of valid opinions. It’s about knowing who’s good, what’s valid and most importantly, when they are wrong….
The Data Exchange Network (DXN)
I promise you won’t get a weekly run down on DXN, but CEO Peter Christie did get interviewed in the Sydney Morning Herald over the weekend. If you didn’t catch it, here’s the link:
Movers & Shakers
A few small mining companies leading the charge this week with linen retailer Adairs (ADH) after an earnings upgrade as like-for-like sales growth accelerated to 18%. Online also is killing for Adairs, +99% sales growth, now accounting for 13% of group sales. I like ADH, it passed all my screens (I think it was even mentioned in this note a few weeks back, can’t be sure). I’ve just neglected buying it because I’m worried about discretionary spend/cost of living/mortgage pressure. Maybe, its like GWA Group (GWA) and benefiting from “The Block” phenomena and people tending to renovate rather than upgrade their housing. Food for thought.
Blue Sky CEO Rob Shand has fallen on his sword after the recent share price performance/short selling fiasco. Probably appropriate given it’s been handled pretty poorly in my humble opinion. From all reports, Mr Shand is a gun operator, great investor and I’m sure he’ll move onto a bunch of other opportunities that will come his way.
Village Roadshow (VRL) also had an earnings downgrade after sub-par performances from their theme parks during the Commonwealth Games whilst Cinema’s also started softer. I reckon Cinema’s likely to continue to battle, I’m surprised they’ve done as well as they have. Too much content, too much competition, too comfortable on the couch in my PJ’s!
And with that little visual, have a good week,
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