Investment Matters

Price to book investments

This week Investment Matters considers a valuation methodology that is part of our investment thesis. 

Price to book

Your equity (i.e. Australian shares) portfolio contains some investments where the asset value of the company is considerably more than is reflected in the share price.  In other words, the 'price-to-book' is favourable.  [Typically, we see value in the context of metrics such as P/E, EV/EBITDA and discounted cash flow (DCF) and / or dividend discount modelling (DDM).]

There are three investments in your portfolio that fit this criteria – Moreton Resources, Aveo and MMA Offshore.  Aveo is also modelled using traditional means and is viewed favourably in both contexts.  Moreton and MMA Offshore currently have low or no operational earnings, and thus do not warrant investment if only considered by methods such as EV/EBITDA or DCF /DDM.

Source: IRESS, First Samuel, company reports and announcements

It should be noted that the book value of all of these assets is based on the valuation of hard assets – no intangible assets are on the balance sheets.  (A good thing, as intangible assets – created when an acquisition is priced higher than the hard asset value of the acquired entity – are often misleading.  Especially when too much was paid for the acquisition!)

The opportunity

For these investments, the opportunity lies in the assets that as shareholders / securityholders you partially own.  It should be noted that your Investment Team has confidence that the asset value in these three investments is real.  But it is not recognised in the share / security prices.  And that is where the second part of the investment opportunity comes in - the realisation of the asset value, one way or another.

For Aveo, the planned way is via a formal strategic review, which commenced in late August.  The outcome of this review is unknown – we believe possible outcomes include asset sales or a whole-entity transaction.

We don’t know specifically how the asset value will be realised for Moreton and MMA Offshore.  For the former, the company has advised if has had ‘several approaches pertaining to its asset portfolio’ (ASX announcement 13-Sep-18), and advisors have been appointed to assist.  Thus we would not be surprised to see asset sale/s as the means by which the gap between price and book value is closed. 

For MMA Offshore, it may be as simple as earnings growth coming through in coming years.  As it does, the share price should close the gap towards book value.

By contrast

An interesting contrast to the three investments above is the big-4 banks:

Source: IRESS, First Samuel

As can be seen, they are trading at a meaningful premium to their book value (and yet it is better than it was in the recent past, when share prices were considerably higher earlier in the year, see the chart in What Matters above).  This implies that they are really awesome at generating profit off the asset base they own.  And given the 15-year credit boom, they have been.  In the past.  But will it continue…

We expect that this premium will reduce as they simplify back to core banking operations (e.g. selling / demerging their insurance and wealth operations) and credit conditions are reigned in.  Additionally, there downside risk to the book values of the banks, if conditions deteriorate and, for instance, bad debts increase.  Given this, we have not changed our assessment that the time has not yet arisen to invest in the banks.

Conclusion

A discounted price to book can give rise to an investment opportunity in the right environment.  The investment reward comes with the closure of that discount – which can be via various means. 

By contrast, the big-4 banks remain, in the eyes of your Investment Team, an unattractive investment.  This is on a price to book basis (and other assessments as well).

-          Fleur Graves