2009 has been a year of both expansion and consolidation for the Kanday group. Last year I reported the heavy unrealised losses experienced with equity investments. My main criteria for not investing further in Flight Centre was that nearly every stock on the share market was punished severely. I reasoned I did not see any rationality in this and hence could not warrant further investment Well , the take-away from this is that as long as one’s time frame is of sufficient duration, then the focus must still remain on Value.
As it has turned out equity markets have rebounded rapidly and a buying opportunity was missed.This is not to say 2010 won’t see gains retrace again. The key is to focus on the Value on offer and not be blinded by fear and greed. Work within my balance sheet and I will be fine.
Actually after the large rebound in equity markets, I have been a seller of stocks, almost selling out of all my positions. This is not due to fear or market timing, I just feel that after re-assessing valuations of equities, that at current prices there is unattractive value on offer. Our superfund and Pcandeias Super now sit with large amounts of cash.
I have also elected to cease managing the funds of Pcandeias super as I feel her investment profile is one of extreme aversion to risk which may impact on my investment decision making. Mum is best left in cash, and she will be fine for her future.
Instead of investing in equity markets, this year we have focussed on re-investing in Crystal Brook Dental, my primary source of cashflows. This move was flagged in last year’s letter and makes a lot of sense. The Australian government is offering a 50% depreciation bonus allowance on all new plant purchased in 2009 and upgrading CBD facilities was overdue. A lot of this is maintenance capex but the facelift is good for staff morale and fewer machinery breakdowns (I hope).
The other big project in 2009 has been the planning of facilities upgrade at 34 Marri Cres, home of CBD. This project is now budgeted at approximately $650,000 and if new tenants can be attracted, especially GPs, will greatly increase the profile of the location. This is a risk I am prepared to take, and at the least the facility will be upgraded to 2010 standards.
Further, I have purchased an OPG radiography machine which will increase revenues/profits at CBD by about $25K per annum. Return on capital should be about 40% We decided to fix half of our interest rate exposure ( approx $800K) during the year as interest rates were near all time lows.The timing has been quite prescient as rates in Australia have rebounded sharply. Our fixed period is only for another 18 months, so I need to position the group to be ok if rates go significantly higher.
The Marri Cres project will increase debt levels and so careful negotiation with NAB or another lender is required. Hopefully a lessee can be found to offset mortgage cash outflows. Group cashflows are strong, but in worst case we could look at selling our Melbourne investment property to reduce debt.
I should add we purchased a lovely family car. This was also timed because of the business tax allowance.
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 | |||
| 2009 | 31.70 | 31.30 | 0.40 |
How true it is that the more things change they often stay the same.
So many macro-economic factors have buffetted the perceived performance of business in 2009, yet the true value of business has little changed. The core determinants of value have remained intact.
The recession of the last two years has exposed the vulnerability of the cashflows of a lot of business and the brittle nature of many over-leveraged balance sheets. Margin of safety has once more emerged as the three most important words in business and investing. Combined with rationality, patience and moderation of the emotions of fear and greed, these are the hallmarks of success.
Along with hard work and some luck. I will elaborate on market asset valuations later.
The last couple of years has highlighted to me the underlying mechanisms of the capital system, and re-inforced my strategy for prospering from knowing the rules of the game. Some call this a conspiracy but really in my opinion it is the best efforts of the architects of our society to enhance the general well-being of the community. The key word in my investing/business philosophy is cashflow. This word is the root underpinning all of my actions. Through the knowledge gained from the readings of Robert Kiyosaki, I combine this with structure to minimise tax, enhance returns through leverage of good cash-flowing debt, maintain as much control as possible over my business and investments
i.e I want the cheque banked in my account first then I decide who gets paid and expose myself to as much asset as possible whose valuation marches up with inflation. A rough summary of this structure is as follows:
Build business, the core source of cashflow.
Try to build cashflow streams which don’t involve my physical labour Invest the cashflow with debt in income producing real estate.
Keep real estate cashflow neutral.
If real estate appreciates through inflation or increased income, then re-appraise and use increased equity tax free to re-invest in more real estate or income producing business. i.e keep building the asset base which keeps increasing the cashflow stream.
Combine this with margin of safety rational market timing and a patient time horizon and buffer of cashflows to ensure Murphy’s Law is kept at bay (i.e if a scenario can be imagined, it can and likely will happen sometime).
Increasing knowledge of business helps me to focus on quality assets. Quality assets is all we should buy. Quality i your friend over time.
Crystal Brook dental
CBD had another wonderful year with general contentment amongst staff and the effects of the incentive programs really showing through. Funnily these programs have more penalised the Owner than motivated staff. I feel the same amount of work would have been done regardless, as the dentists do not appear very motivated by the program. An equipment addition (OPG machine) will further add to revenues next year without any incremental operating costs except debt servicing, which should be well covered. I guess the sweat equity is still king and of course very reliable, but it does creat a taxation headache which we try and diminish through other asset classes such as residential real estate.
Next year we are faced with the prospect of searching for a new dentist. We will be patient.The second half of the year has seen refurbishment of all rooms and equipment at a cost of about $300K.Capex will be significantly lower in future years.
Dental services have proved to be recession proof and can be indexed to inflation, a comforting prospect in uncertain times. Adept Dental Lab leased the laboratory space and a good working relationship has established, lowering unit costs and providing
Jessica Candeias
Kanday director Jessica Candeias had a transformational year in 2009. She achieved her driver’s licence and saw fruition after two years of directed planning and study. She was given employment as a make-up artist and cosmetic retailer by global giant L’Oreal, specifically focussing on the Lancome brand. Jessica’s contribution will be meaningful to the Kanday group going forward and her role is likely to increase, with L’Oreal management already impressed by her.
Commercial Property Division
Five years of interrupted planning finally saw progress on the re-development of Kanday’s only current commercial property at 34 Marri Cres Lesmurdie. Word of mouth industry contacts have seen the use of town planner, architect, civil and structural engineers, FESA and all building trades to arrive at a plan which will rejuvenate the facility and make it industry compliant. Works are expected to commence in early 2010 and will run for about five months. The extra debt taken on to complete the project is planned to be offset by leasing the 150sqm or so of extra space created. If a synergistic business such as a medical practice can be secured, I expect this will have exponential benefits to the existing dental business.
This project will be the core focus of the Group in the first half of 2010.
Residential Property Division
Our residential property division has continued to perform well in 2009. Property prices in Australia have so far held up very well in the face of the GFC. Rental occupancy has been excellent with the exception of our Melbourne investment.
While this apartment is rented easily, tenancies are usually only for shorter terms. As a result, with turnover there is increased vacancy and the manager keeps gouging letting fees. We will continue to hold Melbourne as exit fees are also onerous and likely to offest any gain from selling, unless we are compelled to do so by rapidly increasing interest rates or such.
The Group will look to add to our portfolio in 2010, if high yielding well-located properties can be found.
Bankers/balance sheets/perceptions of value/it’s worth what you say it is Effects on roe
The volatility in financial markets has emphasised an issue about balance sheets and valuations of assets.
In the accounting world liabilities are fixed. What you owe is what you owe.
But the asset column is a complete other matter. So often in liquidation, the value of a company’s assets on a balance sheet vanish in a puff of smoke. This is not necessarily because the company was intentionally overstating value. Going concern assets have value whilst these same assets are often worthless in liquidation. Debt is often the killer and cashflow the problem. Some things which are given little value on a balance sheet, often have tremendous hidden value. These ‘intangible’ items are often goodwill, trade-marks, customer, staff and supplier relationships. Accounting conventions typically only show goodwill as the excess purchase price in a take-over over the value of discernible property, plant and equipment.
Why is this important? Well, firstly one should not take at face value the balance sheet of a given company. The valuation of assets can have a marked effect on the reported return on equity. In previous reports I have mentioned the virtue of companies with high roe and low debt.
Obviously one needs to question all asset valuations in arriving at an adjusted nett asset position, prior to calculating roe. Also on capital markets, company equity is often valued differently to stated balance sheet nett equity. This is a function of the perceived future earning power of that equity. An extreme example I can use to demonstrate is FLT in 2008-2009. FLT states nett equity at approximately $600M. Of this , greater than 50% is listed as intangible assets, representing goodwill of the group’s operating network. The valuation of this equity fluctuated between $3B and $400M over the course of 2008-2009. Ben Graham’s words are ringing in my ears.
The market is there to serve you. As long as you are confident that the company will not default, manic depressive market valuations represent a buying opportunity. Manic optimism is a sell signal. This is all related to valuation and the anticipated cashflows which will accrue from the company’s assets over its lifetime. Look at the average earnings and you will have a signpost as to when assets are being under or overvalued.So both the accounting balance sheet and the market perception of balance sheet value need to be critically assessed.
Kanday group has a large amount of residential property. Because this is capital intensive it will put pressure on group roe. The roe of operating business such as CBD needs to be stripped out to better appreciate the relative strength of the group’s financial position. We particularly use residential property to ameliorate the taxation effects from the highly profitable CBD, and as an asset storage vehicle.
At the company level, asset valuations are particularly important in relationships with bankers. Residential property valuations in particular are highly subjective, yet can influence greatly the finance available. Mortgage rates are lowest when backed by residential property security, so our challenge is to secure the maximum asset valuations to maximise finance available. Shopping around is worthwhile as banks want the business.
So don’t be distressed to see a sliding roe for the Kanday group. We hold a lot of property.
We try to be conservative in valuing assets on our balance sheet to give a margin of safety view of our position, but at the same time it is in our best interests to convince the banks that our assets are as valuable as possible.
Commodities / Gold
A lot of media coverage has been devoted to the decline of the US dollar. Warren Buffett always has counselled against trying to predict macro-economic trends. Governments globally are printing money to try and inflate the world out of recession. Many are arguing that gold and other commodities should be bought as a hedge against inflation and the impending decline of the world’s fiat currencies.
My biggest issue with commodities per-se is that they do not derive any income stream, so whilst important, their value is difficult to quantify. Gold as an investment must eventually be redeemed for cash if it is to have intrinsic value, so this creates a timing issue.
Unless there is a collapse in global fiat currency especially US dollar, gold has a speculative quality to it in my estimation. I certainly feel it unlikely the world will return to a currency pegged against gold reserves, so the Kanday group will continue to only stockpile gold in the form of jewellery, and look for quality cash-flowing assets instead.
New business and cashflows/when will I take the plunge?
Your Chairman investigated some other private businesses for sale during the year. We are unlikely to make any firm commitments in the near future, as so much capital is being consumed in the upgrade of CBD, our core operations.
Business investigations in themselves are instructive though, and it is my intentions in future to try and add to CBD cashflows utilising business acumen I have accrued. We will look for complementary businesses which have strong stable cashflows and which can be run under management. I was not put on this planet to merely fix teeth.
Flight Centre Ltd
The share price of FLT has been a study of the vagaries of Mr Market in the past 12 months. In this time frame FLT shares oscillated between $32 , dropped a full 90% to $3.50 and then recovered half to $18.50.
During this time the underlying moat or long term competitive advantage of FLT was little changed.
However the short term fragility to recession of the travel industry was highlighted.My confidence in FLT management particularly Graham Turner was re-inforced by the conservative balance sheet which meant the company did not require any capital raising during the downturn ( they cancelled the dividend instead!).
If anything I think Skroo was too nervous, selling the company’s equity positions at market bottom to mitigate perceived downside risk. However the core business philosophies are good, as Skroo expands operations to take market share from floundering competition. FLT will be more dominant when the recession fades.
The share price gyrations re-inforced lessons to me. Firstly this is a key reminder why never to buy shares on a margin account. Second it is a reminder to me that I should be demanding in my requirement for clear value before I purchase.
I purchased FLT up to $20 which long term I think would do fine. I purchased FLT on the way down but got spooked when all equities were crashing. The lesson is clear. If the value is compelling, then trust your judgement and keep buying. It is the only way we will differentiate ourselves from other investors, for good or bad, in the long run.
Even on conservative estimates, FLT at $4 is about $200,000 per travel agency shop, with management and all the network advantages thrown in for free, with an operating profit historically of $70-90,000 per shop. That’s a 40% return on cash investment unlevered. You could not set-up a start-up retail shop alone for less than $300,000.
This is the kind of dumbed down logic I need to bring to future investment decisions. This simplicity will make decisions easier through all the macro clutter, and will make Kanday group rich. Just got to be patient now and apply it instead of sucking on my thumb in fear or overstretching with greed.
Value return on equity with simplicity. Be greedy when others are fearful. Be fearful when others are greedy.
Miscellaneous
In December we entered into a contract to purchase a 2 bedroom apartment in East Perth. I have included this acquisition in this year’s report even though the contract will only settle in January 2010.
On reflection we are paying a fair price for a well located asset that should attract a desirable rental income over time.
This purchase though has put some pressure on our financing ( I keep myslef under pressure that’s for sure), but we will cope just fine. What the purchase has prompted me to do is to seek re-valuation of some of our investment properties by a licensed valuer, who is recognised by the major lenders, as the NAB has not been forthcoming in agreeing to revaluations.
Whilst a small expense, hopefully this exercise will prove fruitful in expanding our credit limit. If successful, this will be a strategy we will look to employ in the future when we feel the market valuations of our properties have increased. This will be a source of tax free equity with which to expand the portfolio.
I will continue to provide quarterly updates of the groups position and look forward to enquiries from interested parties.
Dr Marcel Candeias
Chairman Kanday Group