Result was less than expectation, page-16

Hi @Captgogo,

I'm not sure if you saw the NCK result today; it was quite exceptional, representing the culmination of a perfect set of circumstances when strategic execution, operational performance and business conditions all meet in a most favourable way.

When you ask to compare DLX versus NCK: Usually I would find comparison of one business with another to be quite easy to make, but in the case of these two businesses, it is a lot harder to differentiate one from the other, because I see them as quite similar quality business overall, with one having certain slightly superior attributes to the other, and vice versa.

For example:

NCK has a great product brand presence; DLX's is excellent

DLX's balance sheet is in fine shape (NIBD-EBITDA of 1.5x; NCK's is exceptional (net cash), although NCK does have significantly higher off-balance sheet liabilities in the form of lease obligations.

Both have similar Gross Profit Margins (~60%), but DLX's CoDB ratio is higher, meaning that DLX's operating margins are lower than NCK's (EBIT margins of 12% and 18%, respectively, although DLX's Paint and Coatings margins are on a par with NCK's group margins)

Neither business is particularly capital intensive, but NCK - essentially being a distribution business - is definitively NOT capital intensive (in fact, it operates on negative working capital). Hence both businesses generate especially attractive ROE's: DLX at 35%, NCK at 45%

NCKs çurrent rate of organic earnings growth is a lot faster than DLX's, but I believe DLX's earnings are less variable over time.

Both have very good organic growth time horizons in front of them (in excess of 5 years for NCK and even longer for DLX), but NCK's growth is more a function of internally drivers, whereas DLX's is more an outworking of what happens in the external environment.

Etc. etc. (there are many other unique traits to these two businesses, but in the interest of brevity, I'll leave the comparison there at the somewhat superficial level.)

If you held a gun to my head and said, "Choose the better quality business", then I'd choose NCK (even though I've only become a NCK shareholder this year).

(As an aside, I had followed NCK in the past, but my lazy assessment of the business was always influenced in a somewhat jaundiced fashion by experiences of some other retailers who were undertaking aggressive store roll-outs, which were all going along just fine, until suddenly one day, they were no longer fine... and then the results were ugly.

But then I encountered some opinons on HotCopper that compelled me to look at things in a different way. And after that I realised my default thinking had been wrong, so I re-visited the investment thesis and thereafter started to buy shares in the company.

And that lived example, I think, is a strong endorsement of the power of HotCopper. When it is utilised by its members in the right way.)


But back to your view on DLX, where you say "I only see downside over the next 2-3 yrs due to limited growth in earnings and being somewhat well above intrinsic value", I have to say I don't quite agree with you on the lack of earnings growth.

Because when I look at its history, DLX has grown as follows since listing (FY2016 figures vs FY2010 figures, followed by the 6-year compound annual growth rate in parentheses):

Revenue: $1.70b vs $960mn (CAGR = 10% pa)
EBIT: $200m vs $123m (CAGR = 8.4% pa)
NPAT: $126m vs $71.5m (CAGR = 9.9% pa)
EPS: 32.0cps vs 19.7cps (CAGR = 8.6% pa)
DPS: 23.5cps vs 15.0cps (CAGR = 9.4%pa)

(And if we look just that the core paints and coatings business, which it really the core of DLX, its growth in EBIT has been closer to 11%pa over that time frame, meaning that the rump of the business (that which faces the non-residential construction, consumer sector) has actually been a drag on underlying growth.))

So I'm not sure how you say DLX lacks growth... to me it is growing just fine (sure, maybe not at 20%pa or 25%pa, but at 10% pa over time, which I find to be appealing, especially if I consider at the low-risk nature of that growth).

I am quite sure that, in 5 years' time, I will reflect on the 5 years that just passed and I'll find that the company will have maintained its growth rate (in fact, if anything, I think that the company's competitive position in the market has improved in recent years).

[Of course, you might be thinking about the earnings trajectory from a cyclical standpoint, i.e., maybe along the lines of a pending downturn in the housing cycle, or a domestic recession, which is a separate discussion in which I won't be able to add any value because I don't try to make macroeconomic forecasts and therefore I don't invest with them in mind.]


So while I don't quite share your view on static earnings, I do concede that the stock does not appear to be fundamentally cheap (19x P/E and 11.5x EV/EBITDA, which is where my model has FH17's valuation metrics, is not overly mouth-watering).

However, I have long learnt to not sell the shares of good-quality businesses. In my experience, good companies have the ability to go from strength to strength over time and I have found that the market tends to under-estimate this.

So, while the stock does not look egregiously cheap to me on 12-month prospective point multiples, I will continue to hold it. Because I believe the rise in its intrinsic value in coming years will come to match, and then exceed, the current market value of the company.

Besides, like you, I have owned DLX since its listing, meaning I am sitting on a meaningful capital gain. So for me to sell the stock, and to incur the capital gains tax liability, it means that the hurdle rate of return requirement, from whatever stock(s) I buy with the after-tax proceeds after my DLX sales, would have to be so much higher to compensate for my tax bill.

And the trouble is, it seems to be getting harder to find much in a way of good investments at attractive valuations.

That said, in my experience there are always some little gems that are overlooked by the market at any given point in time; we just have to look a bit harder for them, but they always exist (which is why I never hold excessive amounts of cash in an attempt to "time the market".... I think that's a cop-out that people use when they don't want to put in the effort)

Over the course of this year I have managed to find some value in somewhat small, and illiquid stocks, such as ANG, CYB, LYL, MND, and NCK, and at the moment I am in the process of buying shares in two little companies that are so illiquid that I am jealously guarding their identities until I am set, as churlish as that might sound.


And to complete this rather long-winded answer to your question, which I interpret as being what other stocks would I be looking at as an alternative to DLX had I been inclined to selling DLX and re-investing the proceeds elsewhere, well a few stocks I intend to research in greater depth with a view to constructing a financial model - as soon as I can get motivated enough to do so - are (in no particular order of urgency):

AMA
CVW
CZZ
ISD
RWC

And I would also like to spend some time at some stage contemplating my navel about FLT because, while it looks fundamentally cheap, I have bouts of schizophrenia about whether it is an excellent business or merely a so-so, deeply cylical creature.
(And my experience is that schizophrenic feelings are not conducive to successful investing outcomes).

Not sure if that answers your query.


Note: None of the stocks listed above as prospective research candidates are suggested by me as investment opportunities; so please don't interpret it that way. All I am saying is that if I was to allocate research my time, that's where I would start. Researching, that is. Not buying. There is a big difference between the two.