Dear stakeholder, welcome to the 6th annual letter for Kanday Group. 2011 has been a very successful year for the group, through a combination of hard work, luck and bad luck, against the backdrop of a global economy in political and economic turmoil.
Hard work appears to be our destiny for the moment.
We were lucky because our cashflow was allocated to debt reduction from the 34 Marri Cres development, which shielded us to some degree from the (temporary?) losses incurred on equity markets.
We were unlucky because after making a good call and shifting our equity focus to the US market, our equity selections have performed poorly in the short term. My analysis revealed several stocks representing good value. We only have limited funds at present, so I had to rationalise. Omitted stocks included HANS, DECK, COH, all which have appreciated considerably since. Our luck will turn.
Net worth increased by 19.6% versus a loss of 13.9% for the XAO Index. Our main sources of gain were again from Crystal Brook Dental and a remarkable performance from Ella Bache Nedlands.
ANNUAL PERCENTAGE CHANGE
| Calendar 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 | |||
| 2010 | 24.84 | 1.4 | 23.44 | |||
| 2011 | 19.6 | -13.9 | 33.50 | |||
| Cumulative Return | 2003-2011 | 569% | 27% | |||
| Compound Annual Return | 2003-2011 | 26.82% | 3.01% |
Key Themes of 2011
Our main focus this year has been on the 34 Marri Cres Lesmurdie development.
After 18 months of stop/start activity and cost variations the project is nearing completion. See more below.
We shifted our focus from Australian stocks to US publicly listed stocks. Using Valueline and Buffett/Valu.able foundations we identified several attractive equities domiciled in the US and of higher quality than domestic equities.
Furthermore, the AUS dollar has traded at all time highs against the US dollar. I felt it prudent to gain a currency hedge against the commodity/risk rated AUD and shifted approximately 10% of our exposure into USD.
Also, I timed this transfer to shift the funds through our Superfund which receives a $50K tax offset annually. These moves act to diversify our risk exposures and maximise tax effectiveness.
The balance of our cashflow was committed to Debt reduction to again minimise Group risk profile.
Matching assets to debts to cashflows led to residential property sales of 2 Albert Rd Melbourne and 24 Pearson Street Churchlands.
These sales appear to have been well timed as full prices were achieved and the Aus residential real estate market has slumped up to 10% in the past 2 years as over-leveraged reality has sunken in globally and deleveraging has continued.
Time and Structuring and Patience
Time plus constant cashflow is the secret to patience and good decision making
Structure – you can only act with confidence when you are debt free , lifestyle handled and the cash is flowing in every month This is the only position to be in when opportunity presents and you need to act As Charlie Munger says, ‘a couple of good decisions can make a lifetime of difference in the end result’ Being patient to wait until an opportunity arrives, and in the mean time having the discipline to burrow away and work hard, and then having the gumption to make a sizable bet when the odds are in your favour, using the proceeds of all those years of hard work.
I have spent the past 15 years to arrive at this position where now I can focus on building passive income Life is about to get easier.
If you invest with leverage/debt, then you are putting yourself against the clock and as Warren says, ‘the stock market is where money is transferred from the impatient to the patient’. Debt based investing requires an element of timing and hence luck as no-one truly knows what is coming next. Concept of Permanent Capital – only investing with business cashflows is truly patient and has ultimate holding power. How patient is your capital?
What access to equity and debt capital do you have and on what terms?
We show below Kanday’s proportional holdings at reporting time in those non-controlled businesses for which only distributed earnings (dividends) are included in our own earnings. All figures are in AUD using exchange 1AUD = 1USD
| Name/Code/Index | Name/Code/Index | |
| JB Hi Fi(JBH) ASX | Goldman Sachs(GS) NYSE |
|
| Computershare(CPU) ASX | Apple(AAPL) NDQ |
|
| ARB(ARP) ASX | 3m(MMM) NYSE |
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| Woolworths(WOW) ASX | Microsoft(MSFT) NDQ |
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| Aeropostale(ARO) NYSE | Best Buy(BBY) NYSE |
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| Guess(GES) NYSE | Gilead Science(GILD) NYSE |
|
| Google(GOOG) NDQ | Colgate(CL) NYSE |
Accounting tid-bits
As we are essentially a holding company, and will continue to purchase portions of other businesses, whose accounts we cannot bring to full bearing on our financial statements, expect to see our return on equity decline over time, even though the companies we are invested in exhibit high rates of return on equity. Furthermore, often we will have to purchase these quality companies at a premium to book value, which again will have a dampening effect on our group’s stated return on equity. Thus, the best general measure of our progress over time will become similar to Buffett’s Berkshire, where tracking book value is a reasonable proxy to change in value.
34 Marri Crescent Lesmurdie Development
The cost for this project has ended up at $700K afer budgeting for $500K. The reasons were general variations in the original works, including renovating bathrooms, miscellaneous items such as mirrored sliding doors, electrical works to bring existing wiring up to code, wooden reception counter finish, relocating alarm sensors and re-wiring the phone system. Variations add up. Additionally, we had to negotiate with the Shire of Kalamunda to extend the carpark onto land being used for sewer irrigation. To comply we had to install a sewerage treatment ATU unit which added @ $20K cost. Carpark works were in the vicinity of $60K.
As the project proceeded I recognised the need to render fully all internal spaces at a further $30K cost. This included extending electrical services for future uptake when the now vacant old reception is leased. Also I recognised the now or never opportunity to digitise the dental practice. With new ceilings being installed the timing was ideal to run cabling to network all the surgeries. The cost was about $60K but has ushered the practice into the digital age. The project despite running well over time and budget has been a success.
In the new year we will focus on finding a suitable co-tenant for the space created to increase rental income and further upgrade the profile of the property. The development should see the property remain relevant for the next 40 years.
Crystal Brook dental
I have espoused the virtues of this business many times before and 2011 was no exception. Through your Chairman’s hard work, revenues increased by more than 20% and provided the main source of cashflow for our other activities.
Against a backdrop of health fund intervention/contracts and a volatile economy, the dental business remained consistent and predictable. As usual your Chairman did most of the work, but hopefully we can add a GP tenant and pathologist to the facility next year which should boost patient flow and associate work output.
Ella Bache Nedlands
2011 will undoubtedly be remembered as the year a star was born. Praise cannot be high enough for the turnaround which our CEO Jessica Candeias has engineered at Ella Bache Nedlands.
In the space of 12 months she has re-energised the shop brand and image and added a talented group of associates full of talent and enthusiasm. Her management talents have led to revenues rising by 60% year on year since take-over, whilst operating costs have been closely kept in check. Jessica has turned her eye to further expansion opportunities to leverage her undoubted skills.
Momentun
Momentum – as espoused by Donald Trump, is critical to business success. Positive momentum works as a recurring feedback loop leading the business and brand to greater heights.
Momentum of your business and your brand requires constant vigilance and maintenance.
Put simply, you are either growing or you are dying. Standing still is not an option. Surviving success is often quoted as harder than success itself. The most common way to lose momentum is the complacency that success can bring. Mostly importantly, lost momentum, like inertia, is hardest to recover.
Focus on Quality at a Fair Price and Buy in Bulk
Focus on quality first – then if you overpay, you will just have to be more patient and over the long term you will be ok.
Understand, if you overpay, you will have to tie your capital up for longer to get your return Even worse,if you overpay and your capital is not ably patient, then you will have to trade and sell at a loss – a sure fire way to the poorhouse As Warren Buffett says, don’t own anything that you aren’t prepared to hold for at least 10 years. This is a reference to both quality of the investment and the patience of your capital.
Buy stocks like when you are in the supermarket – once you have the quality sorted, when there is a sale , buy in bulk Sharemarkets have gone nowhere for a decade because 10 years ago they were SOOO expensive e.gs MSFT , FLT , HVN all have performed well over the past decade, but share prices have fallen as they were so overvalued. Furthermore, a decade is a long time in business and competitive advantages which once existed have been eroded away, and now those valuations look even more tenuous.
When it pays to ba a pessimist / Nett profit margins
When valuing a business for potential purchase, it pays to be a pessimist. Repeat again the need for a considerable Margin of Safety. Margin of safety includes the relative predictability of future earnings, and future earnings potential. Often this is industry specific.
Net profit margins are another industry specific element. Each industry has operating ratios which are typical for that industry.
When a company starts demonstrating the ability to grow profit margins, this may be indicative of the presence of a competitive advantage. Conversely, the company may just be enjoying tailwinds from favourable macro-economic conditions present at the time.
Similarly a company whose margins are being compressed, may be due to poor management, or simply macro-economic headwinds, or indeed structural changes in the industry in which it operates. With the advent of the internet, several traditional industries have been thrown into chaos as new nimbler competitors harness the powers of technology to undercut the ‘establishment’.
This year has seen prominent examples. E.g where the strong AUD has helped travel companies with an international focus e.g FLT and hurt local operators e.g WTF
In analysis it is important to identify the cause of margin change and then ‘normalise’ to arrive at an appropriate valuation. Focus on not losing money first by projecting conservatively , before thinking of making money.
Return on Equity
RoE – best to adopt an RoE which the company has demonstrably maintained for several years – if you apply an RoE which is high, get ready to be burned when the company performance comes crashing back down to the long term fundamentals of its industry.
Similarly don’t overly extrapolate low RoE over a short time period – this is likely to be where the buying opportunities are, when the company’s performance bounces back to its long term industry fundamentals. This ties in with normalising profit margins over the industry cycle. In other words, don’t use this years income statement / profit and loss to project the future – use the conservative average of the last 10 years And if the last ten years are too volatile – don’t invest, and if the last 10 years are not available – don’t invest Importantly, spend the time to analyse the business from all angles before committing your money.
Business Valuation and the Stockmarket
“No one in my opinion has any idea where the market is going. We had that super long weekend the Dow climbs over 100 points and our market bucked the trend and tanked. All in one business day.
If that doesn’t make you want to turn the market off, nothing will.” Don’t try and be too smart – churn is your worst enemy , eating into profits flipping from business to business with similar long term prospects. Often patience is the key to good returns – pick your entry point, focus on long term quality and then be Patient.
Remain most focussed on how the capital is being allocated – is it increasing return on equity? i.e are management decisions producing a reasonable rate of return on capital , are management acting to widen the competitive advantage/moat of the company? The value is here now, we just need to get the cash and start allocating wisely.
The Crying Game
Huge Personal residence, Mercedes and BMW motor vehicles, overseas holidays, Rings and Jewellery and all the toys/trappings are neon signs for the poor capital allocator.
However, the wave of life encompasses – lifestyle, wife, children, family home, cars plus inflation-monetary debasement, taxes. Embracing this dream makes wealth accumulation out of reach for most. The crying game is the 95% of people who are trampled by the wave of life and their own indulgences.
Only when one is Debt free on the above, can cash be allowed to stream in and the focus on asset accumulation to occur. This is the lament of an older man, a quotation I have copied: “Finally, the kids have left home. Magically there is now money left at the end of the week. I can see a finish line up ahead so saving hard so I hit that line running. From now to dust I will spend less on housing, cars, education, shampoo, food, finance, shoes, haircuts.. in fact if I didn’t have a wife I would barely spend anything”
This is the story of life which is what keeps everyone much poorer. This individual has run out of time. I have a different perspective on how to live. There is only one way to make money at first – FAST. Otherwise life takes over and you will never catch up Business comes first always. Period. Enjoyment second.
Ask, Why am i spending this money, do i have to spend it? Will it make me happier? Will it make me richer? Live this way and you will have all the toys and beautiful family home, except you will acquire them with pre-tax income and won’t be hitting the ground running when you are 60years old! Only once you are in front of the ‘wave of life’, do you switch the investment strategy to ‘don’t lose money’ and look for can’t-miss investments which are almost certain to be worth more in the future.
It is worth quoting Robert Kiyosaki. He says it is more fun to live life like Rambo than Pee-Wee. That is, have a go and don’t regret never ever going for glory.
Bacon and Eggs
Once you’ve decided to live life in the right manner, the next choice is to contemplate how commited and desperate you are going to be. This will likely determine your ultimate wealth.
This is the parable of the bacon and eggs breakfast. The difference between being involved or committed. For this breakfast/life, the chicken is obviously involved but the pig is committed.
It pays to identify pigs and bet on them rather than chickens.
Future capital allocation plans
Despite our best endeavours, the Group enters 2012 still shouldering almost $500K in debt related to this past years’ activities. It is my intention to eliminate this debt as expediently as possible. As aformentioned, the market is offering opportunities due to continued ( and appropriate?) pessimism.
I look forward to throwing more fuel on the fire/the market in the second half of the year, when our gearing is absolutely conservative, assuming favourable opportunities still present.
We will continue to look for more direct businesses which can be handled in a management capacity. This past year we have been fairly true to our intentions and our results have borne this out.
Be Prepared is the motto we will carry into the new year.
Yours faithfully
Marcel Candeias
Chairman of the Board