During the year the Kanday group continued to focus on capital management initiatives to strengthen the group’s financial position, after the extensive capital purchases incurred in the 2007 calendar year. This occurred against a backdrop of plummeting market prices on financial markets worldwide.
Kanday Group has not been unaffected by these reverberations, with it becoming apparent property purchases were made last year at the peak of the market. Furthermore Kanday’s equity holding in Flight Centre Ltd has all but been dusted. I will have more to say on this in the report.
This year’s performance needs to be considered comparatively to gain perspective of whether we made progress this year and this will be a feature of all future reports. Relatively speaking, as long as Kanday group can outperform an index which is representative of the wealth of Australia then the Group’s wealth will have increased. This perspective is valuable during recessionary periods.
The overarching focus of the Group can be summarised by the term positive cashflow, the guiding light during periods of volatile market valuations. I have Robert Kiyosaki to thank for this.
ANNUAL PERCENTAGE CHANGE
| Year | Kanday | All Ords | +/- | |||
| 2003 | n/a | 11.10 | n/a | |||
| 2004 | 62.20 | 22.60 | 39.60 | |||
| 2005 | 23.70 | 16.20 | 7.50 | |||
| 2006 | 60.20 | 20.00 | 40.20 | |||
| 2007 | 26.30 | 13.60 | 12.70 | |||
| 2008 | -16.40 | -43.00 | 26.60 |
The shining light in the Group’s performance continued to be Crystal Brook Dental without which this year’s financial results would look terrible. Whilst the recession rages Crystal Brook continues to grow and the outlook is particularly bright. Upon reflection your Chairman needs to direct some more funds to Crystal Brook.
Even though no money is spared in capital maintenance, some new equipment would have been a better use of funds this year rather than ‘pissing in the wind’ which is what is appears I have done so far this year, underestimating the severity of the global slowdown.
The focus of this report will not be the global situation, as dire as it is, because this would be wasted space. Warren Buffett says he never makes purchases based on macro forecasts, as no one really knows what will happen next. Instead, my focus will be on the operating results of our businesses, something we do have some control over.
The Group focussed the first half of this year on converting non-deductible debt to deductible debt. The credit crisis hit the world in late January 2008. Fortunately I had been able to effect the sale of 48 Bland St Como by this time. I received full value on this sale. It quickly became apparent that I would not be able to sell 70 Todd Ave Como for a reasonable price, as credit markets around the world froze. If I had simply pressed sell in mid-late 2007, rather than renovating first, the property would have sold.
But that is Murphy’s Law in business. Without dwelling, I switched focus to maximising rental yield from the property to offset my enlarged debt position. In hindsight, I committed a classic mistake of over-capitalising by not ensuring the sale of my properties first prior to committing to purchase East Perth and particularly South Melbourne.
So with East Perth carrying $600K odd in non-deductible debt the focus became converting this to deductible debt. Fortunately I could do this expediently through Crystal Brook Dental. Revenue from Crystal Brook was diverted into paying down the East Perth mortgage and a loan was drawn down progressively to pay for the dental business operations. I discovered this tax play from dental accounting advice on the net,rather than from my accountant. This stresses how important self financial education is to achieve in business. Your helpers will only help if you know how to help yourself.
The second half of the year focus was to direct equity to investment properties, namely South Melbourne and Churchlands, in order to get all properties cashflow neutral. The end result of this process was to leave all the ‘unspoken’ for debt being serviced by my manpower at Crystal Brook Dental, not a great outcome, but one which was easy to visualise and begin to amortise.
The other activity during the second half of the year was to begin purchasing large amounts of securities in Flight Centre Ltd. Like all equity securities around the world , the share price of FLT was absolutely hammered, especially after a profit downgrade was announced in early November and again in December.
I want to make an important point here about accounting or conventional measures of net worth versus real business performance.
Especially as it applies to listed investments, net worth is calculated based upon the prevailing market price. If I made my investment decisions based upon this, I would be in a lot of trouble. Remembering Ben Grahams’ Mr Market allegory, the mood this year has been absolutely despondent with reflecting share prices.
Residential property prices are also under great pressure. I am more interested in the underlying business performance in deciding whether the assets I hold are of high quality and worth keeping. Indeed in these fearful times I have been looking to add to my positions in what I consider wonderful businesses trading at cheap prices.
A very important point to re-emphasise here is debt and cashflow. These are the two most important things which can bring an investment strategy unstuck. Have excellent relations with the issuer of the debt, control the amount of debt and be clear on who is paying for it and how certain those payments will be to avoid trouble.
As Warren Buffett says, a series of numbers no matter how impressive multiplied by zero still equals zero.
We show below Kanday’s proportional holdings in those non-controlled businesses for which only distributed earnings (dividends) are included in our own earnings.
| Security |
| FLT |
| TIMPB |
| BBG |
| TLS |
| ANZ |
| WDC |
| CXP |
| AMP |
Apparently I decided to throw the share purchase program (agreed 24/01/2006) out the window. If nothing is cheap then buy NOTHING. This thinking is the only way. Despite all the fancy ways to value things, I over time am simplifying the process. What is my yield today? Compare this with risk free rate. Is it a capital intensive game?
Who is in control? Me Hopefully. What is the downside?
The inability to sell Todd Ave forced a change in focus to the task at hand, and then plummeting equity valuations got the better of me during the second half of the year.
My allocations for this calendar year thus far are in the table below.
Allocations for PC Super fund especially were based on opinions of others. In the future I will rely more on my own judgement.
My commitment to FLT is yet to bear fruit but I am comfortable with holding a lot of this company.
| Date | Security | Purchase price | |||
| 17-Jan | BBG | 12.13 | |||
| 13-Mar | CAM | s | 0.802 | ||
| 13-Mar | FLT | 21.224 | |||
| 20-Mar | CAM | s | 0.8 | ||
| 20-Mar | FLT | 20.6 | |||
| 25-Mar | CAM | s | 0.8 | ||
| 25-Mar | SLM | s | 3.158 | ||
| 27-Mar | ANZ | s | 23.75 | ||
| 27-Mar | BBG | s | 13.02 | ||
| 27-Mar | CXP | s | 5.899 | ||
| 27-Mar | HVN | s | 3.8 | ||
| 5-May | FLT | 20.876 | |||
| 6-May | FLT | 19.47 | |||
| 26-May | WDC | s | 17.98 | ||
| 26-May | FLT | 17.958 | |||
| 3-Jun | FLT | 17.806 | |||
| 5-Jun | FLT | 17.724 | |||
| 10-Jun | FLT | 16.776 | |||
| 13-Jun | FLT | 15.927 |
|||
| 16-Jul | FLT | 15.6 | |||
| 10-Oct | FLT | 16.253 | |||
| 10-Oct | FLT | 16.611 | |||
| 15-Oct | FLT | 16.335 | |||
| 22-Oct | FLT | 15.586 | |||
| 22-Oct | FLT | 16.28 | |||
| 22-Oct | FLT | 16.31 | |||
| 23-Oct | FLT | 14.644 | |||
| 24-Oct | FLT | 13.649 | |||
| 27-Oct | FLT | 12.522 |
|||
| 30-Oct | FLT | 12.4 | |||
| 4-Nov | FLT | 12.004 | |||
| 11-Nov | FLT | 11.295 |
|||
| 11-Nov | FLT | 10.929 | |||
| 12-Nov | FLT | 10.8 | |||
| 17-Nov | FLT | 9.791 | |||
| 19-Nov | FLT | 8.22 |
Looking at these purchases, I was initially buying FLT at a dividend yield of 4% with tax imputation on top of this. Historically this has been not bad for a company growing 15% per annum. At current prices the yield is more than 10% or 14% grossed up after tax imputation based on 2008 earnings. Obviously the market feels the future is very gloomy. I measured my purchases in smaller tranches and as such have been able to average out my FLT purchases at about $13-$14 per share.
This would represent a grossed up yield of 9% on 2008 earnings. I feel this is the kind of margin of safety I need to look for more in the future. Any upside from here will be spectacular and the downside risk should be minimal. Of course these figures are talked about AFTER coming to the conclusion that FLT is a quality company first.
Crystal Brook Dental
Crystal Brook Dental needs to be given the recognition it deserves. In the past Chairman letters I have been a little derisory towards this amazing cash cow. I don’t want to work so hard, poor me blah blah. Well, lesson learnt, that sometimes hard work is the best medicine, especially during a recession when everyone is losing customers.
We added John Marsell to the team in January and he fit in immediately. This allowed your Chairman to start taking a day off each week to be with family. Con Hajigabriel continued to increase his output. Our staff turnover has been basically zero, with a maternity leave the only reason for staff change. And what credit crunch/ global meltdown? Crystal Brook will break one million in revenue for the first time this year. Albeit, this also comes from fee level increases.
But this underpins why this business is so great. It is essentially recession proof and patients are not price sensitive. Crystal Brook will continue to be the backbone of Kanday for the forseeable future. Bring on the hard work! The capital expenditures foreshadowed in the 2007 report have not yet occurred. Your Chairman needs to spend these funds in the near future to ensure smooth function. Deferrment has principally occurred because the existing equipment is still going well.
Another great development is the prospective addition of a full time on-site laboratory technician to Crystal Brook in February 2009. This will improve quality of service to patients and likely economies of scale can be brokered with the technician.
Commercial Property Division
Kanday continued to hold 34 Marri Cres Lesmurdie, the home of Crystal Brook Dental. With the addition of a full time laboratory technician in 2009 , the tenant income from the property will increase. And also the value of the property. Whilst other dental practitioners are subjected to inflation and market linked increases in their rents, by owning our property we are advantageously protected.
Indeed inflation slowly marks up the ‘price’ of the property. A long term goal will be to further develop the property and add a medical centre, which would markedly increase the property ‘value’.
I have taken preliminary steps towards this, especially with the realisation that a medical practice can have a non-doctor owner. It will be easier to hire an employee GP than leasing the space, and potentially more profitable. We will need to submit plans to the Shire. Hopefully development can commence in 2009.The synergy between GP and dentist would be tremendous.
Last year I mentioned a move towards fund management and possibly the need for commercial space. This is still a long term aspiration but is not a consideration at present.I am reluctant to take on new debt of any magnitude which would risk the solvency of the Group. Until gearing levels are stabilised we will not consider any new property acquisitions.
Residential Property Division
Kanday group acquired 906 / 2-14 Albert Rd South Melbourne in January 2008. This purchase was sourced via a buyer’s agent. This experience has taught me more about the power of incentive. Pursuing her commission the buyer’s agent was forthright and demanding that I do a deal. I got to Melbourne late having aborted travel plans in favour of Sydney 12 months earlier.
As a result everything looked expensive relative to rental yields. But the agent got her deal after I slightly lowered my buying criteria under pressure, after initially rebuking her. Part of the buyer’s agent agreement is that you pay a non-refundable upfront deposit. This works wonders for them in incentivising you to find a deal. It is a classic case of taking on a much larger commitment in order to ‘get value’ from the token initial outlay,even if the big outlay is not great value.Wow, I learnt from this one.
Rents have risen a further 15% since the purchase so the deal looks respectable now, however I expect limited upside for some time as the rent is now $615pw for a one bedroom apartment! The other properties in our portfolio have performed magnificently amidst the global financial crisis. Rents have risen between 10% and 20% with little or no vacancy.
Media reports say there is still a large undersupply of housing in Australia compared with the overhang in US,UK so property valuations should be steady. The external market prices should be of little concern to us anyway as we focus on the income from the properties, as we do not intend disposing any of the properties. Increasing rents will translate into increased valuations over time.
Interest rates
Interest rates have become an important consideration for the Group as we are carrying a large amount of debt due to the non-sale of 70 Todd Ave Como.
In the midst of the financial crisis the RBA has begun cutting interest rates aggressively in the later part of the year. Ironically, last year I talked about having modest debt and looking to capitalise from fixed interest deposit accounts. An unprecedented 3% reduction in official rates has occurred in the space of 3 months. Each 1% reduction represents about an increase in monthly cashflow of $X on the Group’s X million dollars of debt.
Nearly all of the Group’s debt is variable interest, but my plan by the time of this presentation, is to have converted all property related debt to long term fixed interest, to ensure certainty of future repayments. With governments globally pumping fiat money into the system there is a real risk of future inflationary pressures which may rapidly force up interest rates, which are currently being cut to the bone to stimulate the global economy. In the past I have not paid much time to this area of business but due to our present balance sheet I have started to learn quickly of the possible risks to the Group if I do not control the risks associated with sudden interest rate movements.
Flight Centre Ltd
To the end of June 2008 , FLT announced record profits , up about 40%. Importantly profit margins on revenue from TTV and underlying earnings both increased. Despite commissions being tightened (mostly in air travel) FLT has found other revenue sources (such as land) to offset this. FLT announced the purchase of Liberty Travel in the US for A$153 million in February 2008.
The purchase was funded using equity raised at an attractive price ($23.50 a share). I felt this was a quality move. However the credit crisis has struck deeper in the second half.
I travelled to Brisbane in November to attend the FLT AGM. I had another opportunity to have a brief meeting with Skroo Turner and had a chat with Anthony Grigson (FcM travel GM). He impressed me. The Chairman said they do not subscribe to recession mentalities and will increase hiring and advertising (an investment rather than an expense). I liked this. Skroo is hard to read. I asked him if he was staying on (on 9 months long service leave). He said he is still a young man (59 yrs old) and will stay while the board wants him.
He also brought to my attention the struggle they are having with Liberty. FLT paid 6 * EBITDA for Liberty. Since the downgrade the FLT share price has been hammered, and now you can buy the whole business for 4* 2008 EBITDA. They may still have paid too much for Liberty. I have been buying FLT heavily in the second half of the year. However, this is against a global backdrop of practically ALL public companies being savagely written down. This has tempered my enthusiasm as it seems many other quality companies are all available at historically low prices. I have resolved to try and focus on my business strategy and only purchase more FLT when I have the cash to do so, NOT to purchase with more debt.
Skroo’s holding in FLT has been slashed by $400 million so he has many good reasons to ensure the company does well in the future.
Primary Production
Timbercorp distributed funds from grower projects this year, recouping some of the invested funds. With the credit crisis the TIM public company has almost gone out of business, so hopefully final distributions will be received before this likely eventuality.Fortunately APT projects are now looked after by ITC,a subsidiary of Futuris Corp which is unlikely to go under. Distributions from APT projects should commence in 2009 and will be a nice little bonus on an investment we considered a complete writeoff at one point.
Ferngrove vineyards almost broke even this year, so at least the blood has stopped flowing. I call Ferngrove my little lifestyle investment! We don’t expect to add further funds to this area and continue to wind down our exposures.
Fixed Interest
Last year I talked about having idle cash to invest in fixed interest accounts and to not be over-leveraged. Owing to the failure to sell 70 Todd Ave we are more leveraged than expected. We are using the NAB portfolio facility to transfer all revenues into loan accounts, effectively achieving home loan rates of return on idle cash.
Miscellaneous
Group Separation of accounts has been a success with easier evaluation of group cashflows and investment purpose.
PC Super fund capital guarantee. Yes, as it reads , this is your Chairman’s intention. All funds invested with Kanday will be capital guaranteed on point of withdrawal. If funds are not immediately available, then any capital shortfall will be repayed as soon as possible. My only guarantee is my word.
Jess entering workforce.
My lovely wife Jess is finishing her uni degree in Business Administration and is looking to enter the workforce, with a particular interest in fashion. Good luck Jess. Your Chairman feels the challenges of this year (especially for others), may sow the seeds for significant wealth in the future. But we must remind ourselves to be patient and to work within our own balance sheet and margin of safety.
I will continue to update with 2 monthly reports and I look forward to speaking with any interested parties.
Marcel Candeias
Chairman
Kanday Pty Ltd