Comments on AFR latest article, page-2

@travelightor

Perhaps I'm lazy, or even negligent, but the minutiae of a business is not my strong point. For me, a business is a black box. The black box has three key parameters: cash input, cash output, and size (all on a per share basis). The size needs to be considered in the context of whether or not the business is growing in value (getting bloated with PPE or intangibles, may not equate to becoming more valuable).

Below, in rough order, is what I consider important in a black box that I may have a stake in, and what I devote my time and energy on.

In terms of financial performance, a long track record of:

1. Attractive returns on capital.
2. Earnings that are well matched by actual cash generation after adjusting for maintenance capex.
3. Cash consumption due to capex or working-capital, that is not increasing unduly with respect to revenues.
4. Debt levels that can be easily serviced by earnings.
5. Debt levels that do not significantly weaken the balance sheet (unless the balance sheet is not truly representative of the value of the business, in which case a good degree of discretion may have to be applied).
6. A strong balance sheet as measured by current asset ratio, quick ratio, assets-to-liabilities (etc). This, once again, may have to be treated with a good degree of discretion, if the balance sheet does not well reflect the value of the business (for example, intangibles may have to be discarded, or may have to, in effect, be added).

In terms of other attributes of the black box:

1. A leadership with a long association and understanding of the business.
2. A leadership with a sense of ownership of the business (emotional and financial).
3. A leadership that is incentivized to add value rather than to "grow".
4. A leadership with an independent mindset.
5. A leadership that is frugal and has an aversion to bureaucracy and low value add activities.
6. A leadership with a general respect for equity capital.
7. A leadership with an eye to the long term.
8. A leadership with a workman-like, non nonsense attitude.
9. A leadership with respect for all owners of the business.
10. A leadership that is frank, open and transparent in communications with all owners.
11. A business with a strong market position.
12. An industry which is not subject to frequent and unpredictable change.
13. A business that is simple to understand.

This is how I would rate HVN against each of the 6 financial attributes:

1. Good (this is despite the overseas expansion, which has mostly been less than stellar, and the growing property portfolio).
2. Good (despite comments in that AFR article, my numbers indicate such, once adjusted for property revaluations and changes in working capital).
3. Good.
4. Good.
5. Excellent.
6. Very good.

And this is how I would rate HVN against each of the 13 other attributes:

1. Excellent.
2. Excellent.
3. Very good (the fact that the substantial overseas forays have not done substantial damage to the balance sheet, is testament to the caution HVN has displayed when allocating capital).
4. Excellent (whether you agree with the leadership, or not, is another issue).
5. Excellent (frugality and an aversion to red-tape is in Gerry's genes).
6. Good.
7. Fair (much as Gerry has a no-nonsense attitude to getting things done and dislikes red-tape, I mark him down here due to his all too frequent "blowing his own trumpet).
8. Poor.
9. Poor.
10. Good.
11. Fair (this is retail, after all).
12. Poor.

So, on balance I would have to rate HVN a better than fair and probably good business. I wouldn't be rushing to buy at current prices, especially given all the uncertainty surrounding the future of "big box" retailers. But if the price drops below $3, I think you could do worse. A lot worse.

So what do I make of all the bad press and the fact everyone loves to knock HVN? Well, it just makes it that little bit harder for me to dislike the business.