Archive for the ‘Analysis – Stocks’ Category

The new defensives- drugs & health care

Thursday, October 1st, 2009

Conventionally, if investors want to be at the most ‘defensive’ (i.e. not take any risk) for their investments, there are no better places than US Treasury bonds. The US is the keeper of the world reserve currency and their Treasury bonds are backed by the full faith and creditworthiness of the US government. By definition, the US government can never default on its debt because it has the full powers of taxation on its people and as a last resort, crank up the monetary printing press of the world’s only reserve currency. In other words, the US Treasury bonds are the safest ‘cash’ an investor can ever get.

But the problem is, under the colossal weight of debt that the US government is going to face (see How is the US going to repay its national debt?) and the commitment of Ben Bernanke towards the idea of debasing the currency (see Bernankeism and hyper-inflation), the safest of ‘cash’ is no longer safe in real terms. The US government cannot technically default on its debt because it can always print money and repay them in continually depreciated dollars. The Chinese government are acutely aware of this (see Nations will rise against nations) and are earnestly diversifying their safest ‘cash’ into other forms of store of wealth. With interest rates effectively at zero (which is below the rate of price inflation) and likely to stay there for a considerable period of time (see Marc Faber vs Steve Keen in inflation/deflation debate- Part 2: Marc Faber?s view), even risk-adverse savers are forced to speculate if they want to preserve the purchasing power of their savings.

So, we have this ironic situation that the most risk-free investments (US Treasury bonds) are actually very risky (currency depreciation through debasement). For US-based investors, Marc Faber reckoned that they are better off risking their wealth in defensive stocks than risking it in ‘cash.’

The question is which sector is defensive?

One sector that Marc Faber has in mind:

Telstra entering the media business

Monday, April 9th, 2007

In our previous article, Is the Telstra T3 offering worth a buy?, we said that,

Will Telstra remain just a telecommunication company in the future? This is a very interesting question. If the answer is ?yes?, we would not be keen in investing in Telstra because there are much more lucrative opportunities elsewhere. We suspect the answer will be ?no? because if we were Sol Trujillo, we would have taken the strategic path to transform Telstra to one that is more than a telecommunication company. We believe this strategy is the key to Telstra?s future.

In this article, See like an entrepreneur… how will Telstra be like in 2010?, we quoted Sol Trujillo,

By 2010, Telstra wouldn?t any longer be called just a telecom business. It?s going to be a media-comms business, which means our revenue profile [will] change.

Today we saw this article in the news media: Telstra’s net bid for $1bn in ads.

See like an entrepreneur… how will Telstra be like in 2010?

Wednesday, February 14th, 2007

Today, we heard an interview on Sol Trujillo, the Managing Director of Telstra, on the Eureka Report podcast. In the interview, Sol was asked what will be the main drivers of revenue for Telstra in 2010.

Sol replied, ?By 2010, Telstra wouldn?t any longer be called just a telecom business. It?s going to be a media-comms business, which means our revenue profile [will] change.? He then went on to explain that revenue streams from Telstra’s traditional telephone services (PSTN) will decline, while other revenue streams will gain in prominence. Growth areas include wireless Internet broadband (NextG), mobile phone services, media content (Foxtel) and online and print directory services (Sensis). Furthermore, Telstra is expanding overseas, buying an online real estate business in China, which Sol affirmed that it was ?growing at triple digits? as the Chinese real-estate market is rising exponentially.

This is what we expect to hear. Back in November last year, we said in Is the Telstra T3 offering worth a buy?:

Will Telstra remain just a telecommunication company in the future? This is a very interesting question. If the answer is ?yes?, we would not be keen in investing in Telstra because there are much more lucrative opportunities elsewhere. We suspect the answer will be ?no? because if we were Sol Trujillo, we would have taken the strategic path to transform Telstra to one that is more than a telecommunication company. We believe this strategy is the key to Telstra?s future.

One of the pre-requisite skills of an atypically excellent investor is the possession of entrepreneurial foresight. Entrepreneurs see the future creatively and understand the big picture. If you can see the future through the eyes of an entrepreneur, it will lead you to today?s small businesses that may be on the way to become big businesses of the future. If you invest in such small businesses today, your returns can multiply in terms of hundreds and thousands of percent. Of course, such investments are not without risks. What separates the best investors and the mediocre ones are how they deal with risks. For the excellent investors, they mitigate risks with knowledge, understanding and skill. For the average investors, they mitigate risks with wholesale diversification.

Stock analysts, by definition, are usually not entrepreneurs. The dichotomy between their analysis and entrepreneurs? foresight is illustrated by Sol?s comment in this article, Hurdles, but Trujillo’s Telstra a winner:

Trujillo opened up on the sort of long-term group returns he is aiming at when I pointed out that most of the analysts say that Telstra will generate big future cash flows but not substantial profit rises. “Yeah, well, the analysts here in Australia that have written about Telstra have been absolutely wrong almost across the board,” he says. “Look back at what they said in November 2005 and what has happened since then. So that’s why some people are analysts and why some people are managers and leaders.

We guess many stock analysts will be insulted by Sol?s comments. By insults aside, let us see why analysts are often ?wrong.?

We believe the reason is in the difference between the thinking of analysts and entrepreneurs. Analysts, by definition of their job description, look at businesses through the eyes of the status quo. Yes, they may engage in the forecast of future earnings of a business, but their forecasts are usually made by extrapolating from the status quo or some other derivations from it. Entrepreneurs, on the other hand, look at businesses from the eyes of what can possibly be in the future. As such, what others see as ?impossible? is an opportunity for entrepreneurs to force the camel through the eye of the needle.

Thus, we would not go as far as to say that analysts are ?wrong? as Sol had done. The job of analysts is to base their analysis on what is already solid and ?proven,? which is usually what the eye can see as the current state of affairs. But the job of entrepreneurs is to take risks and turn the current order of things upside down and sweep the status quo aside. With luck, determination and skill, entrepreneurs may succeed. Or they may fail.

As investors, we rather go along with the entrepreneurs and try to understand the risks they take instead of shying away from them by diversifying and diluting our investments.

What to avoid at the peak of the business cycle?

Sunday, February 11th, 2007

In our last article, Where are we in the business cycle?, we mentioned that we are now probably at the peak of the business cycle. Given that this is the case, how should that affect our investment decisions?

In Peter Lynch?s book, Beating the Street, he wrote:

When the economy is in the doldrums, the professional money manager begins to think about investing in the cyclicals. The rise and fall of the aluminiums, steels, paper producers, auto manufacturers, chemicals, and airlines from boom to recession and back again is a well-known pattern, as reliable as the seasons.

Therefore, cyclical stocks are the ones in which their earnings follow along with the peaks and troughs of the business cycle.

One of the common mistakes that novice investors often make is to extrapolate the past earnings of cyclical stocks into the indefinite future during the turning points of the business cycle. Since the stock market always anticipates the future earnings of companies, cyclical companies will look ?cheap? (i.e. low P/E ratio) during the peak of the boom. This is because the market will have by then factored in the fall in earnings. The key is to identify which types of businesses are cyclical in nature and avoid them during the peaks? turning point. As Peter Lynch said:

When the P/E ratios of cyclical companies are very low, it?s usually a sign that they are at the end of a prosperous interlude. Unwary investors are holding on to their cyclicals because business is still good and the companies continue to show high earnings, but this will soon change. Smart investors are already selling their shares to avoid the rush.

In Australia, the economy has been expanding for the past 16 years already. This current expansion is twice as long as the previous two expansions. Thus, it is very easy for investors to believe that business cycles no longer apply and become complacent as a result. When we see that the stock market is continuously making record highs, as if the boom time will still continue indefinitely, it is time to become wary.

Telstra?s share price vulnerable in the short-term

Saturday, December 16th, 2006

For those who bought Telstra T3, they made a giddy gain of 34% in one month. This gain in one month, through the extrapolation of 34% to the next eleven months, is equivalent to 6003.49% of return (compounded monthly) per annum! Of course, in reality, you will not get this kind of return for almost all of the stock market investments available in the universe. Perhaps you may find such a super stock, but we guess your chances of doing so are pretty much zero. On the other hand, if you are a very capable (or lucky) businessperson, you may achieve such a return through your own private business. But anyway, let us now all stop dreaming and get back to earth.

Today, for a change, we will delve into some technical analysis. Some analysts may scoff at technical analysis and place it in the same league as astrology. But for us, we prefer to be agnostic about it. The reason being, since there are so many traders in the market employing the use of technical analysis, it will become a self-fulfilling prophecy.

Looking at the chart for Telstra?s share price we saw that it rosed from a low point of $3.59 in 21st November to yesterday?s high point of $4.12. We guess those who sold Telstra shares at that low point must be kicking themselves now. Right now, Telstra?s share price is in a strong uptrend and has increased in volatility. However, our technical indicators are telling us that its momentum has already approached the overbought level. Therefore, it will be vulnerable to any less than favourable news in the short-term. At this point in time, short-term traders are most probably positioning their fingers at the sell trigger and will pull it at the first hint of a pullback in Telstra?s share price. Since the price of Telstra T3 instalment receipts tracks the price of Telstra shares, it will also follow suit in that event. Please note that we are not predicting the short-term fall of Telstra?s share price. For all you know, the upward momentum may continue. But in that event, it will even be more vulnerable to any short-term pullback.

However, for the long-term, our views on Telstra remained unchanged (see Is the Telstra T3 offering worth a buy?).

The herd is buying Telstra

Saturday, December 9th, 2006

Today, this article, Telstra rise surprises even its biggest boosters, caught our eye. Ever since Telstra?s T3 receipts were listed in the stock exchange, it had risen from its offer price of $2 to last Friday?s close of $2.51. That?s a growth of 25.5% in just three weeks! From what we learnt in that article, sentiments seemed to be turning in favour towards Telstra again (or maybe towards telecommunication companies globally in general). Major brokers like Macquarie, Citigroup and ABN Amro have been upgrading their recommendations for Telstra.

We find this rather amusing.

Not long ago, while Telstra?s T3 receipts were being offered to the public, the crowd were scoffing at Telstra. The mood against that company was one of anger, disgust and ridicule. As we said before in Is the Telstra T3 offering worth a buy?, our advice is: get even, not mad with Telstra. Joining in the mob mentality is not going to do ourselves any favour when it comes to making investment decisions that require rational thinking. Before we decide whether to invest in any business, we should be making a meticulous evaluation on its merits and the maximum price that we are willing to pay for it. After we invest in the business, we should stick with it, unless new facts, evidences or developments have emerged to undermine the intrinsic worth of the business.

But as we can see, the market is often tossed and turned by every whim of emotions. It is very amusing to see those major brokers suddenly changing their minds about Telstra at about the same time. There are now talk that the Telstra share price was undervalued, implying that the government had sold it too cheaply. We guess the insiders who bought Telstra shares probably saw that fact too (see Insiders buying Telstra). As a result, the crowd are now rushing back to buy Telstra shares.

But dear readers, how much of Telstra?s intrinsic worth had changed since the T3 sale? Not one iota! Since the basis for Telstra?s long-term future had not changed within that space of time, why did those major brokers suddenly change their mind? Had they fallen asleep behind the wheel and suddenly wake up to find the beauty of Telstra?

We prefer not to disclose our cynical theories here.

Insiders buying Telstra

Saturday, November 25th, 2006

In Peter Lynch?s book, One Up on Wall Street, he said:

There?s no better tip-off to the probable success of a stock than that people in the company are putting their own money into it … When insiders are buying like crazy, you can be certain that, at a minimum, the company will not go bankrupt in the next six months. When insiders are buying, I?d bet there aren?t three companies in history that have gone bankrupt near term.

Generally, insiders? buying is a good sign, though it is not absolutely infallible. When you look at the legal disclosure on directors? share acquisitions, you can see that there are many types of purchase, from share purchase plan, dividend reinvestment plan, exercise of company options, on-market purchase and so on. Not all types of purchase are significant. The important distinction you have to make is that whether the director is using his or her own money to buy the share. If they use their own money, the next thing to look at is whether they are buying significant amounts of it?so much so that they will feel the pain if their company does not do well. Even better, if a significant number of the directors are doing the same, it is an even stronger tip-off. Finally, do not get carried away with one or two isolated incidents of such activity?stay calm and note the trend before jumping into conclusions too quickly.

Today, we saw this article in the press?Sol Trujillo (and Belinda Hutchison as well) put his own money to buy T3. Upon checking the other directors? transaction, we found a couple of interesting information. On 22nd August this year, one of the non-executive directors, Peter Wilcox, bought 20000 Telstra shares at $3.45 on the market when it was near its low point. Another interesting fact to note is that his current holdings of Telstra shares comprise 88% of his annual remuneration. Another non-executive director, John Zeglis, bought 16500 shares on the 3rd November at $3.99. His current holdings comprise 51% of his annual remuneration.

These signs are encouraging. At the very least, they are not negative. But as with all information, it is not wise to base your investment decision solely on insiders? buying information. In Telstra?s case, they are certainly interesting. We will be watching the trend of insiders? buying for this company.

Is the Telstra T3 offering worth a buy?

Monday, November 6th, 2006

Current situation

Currently, the prevailing market mood against Telstra, the largest telecommunication company in Australia, is one of anger. The mum-and-dad investors are angry because many of them bought into T2 (the Australian government?s second lot share sale of its holdings in Telstra) several years ago at $7.40 and now the share price is worth around half of that. To make matters worse, Sol Trujillo, the current CEO who took over the reins last year, engaged in a public wrangle with the government over regulatory issues and deliberately ?talked down? the share price even further. Since the government intended to sell its third lot of Telstra shares to the public, it was highly displeased to see that happen. There is no doubt that PM John Howard hates Mr. Trujillo?s guts. So, when you combine a volatile cocktail of engineered falling share price, quarrel with the government and massive job cuts, you get a fire of rage.

Thus, Sol Trujillo became the bogeyman.

As contrarian investors, we watched the unfolding drama with amusement. We are more inclined to see Sol Trujillo more as a hero and less of a villain. Compared to the previous CEO, Mr. Trujillo is a visionary who dare to overturn the tables and challenge the status quo. On the other hand, as expected, there was some digging of dirt by the media on Mr. Trujillo. But what do you expect the media to say on a bogeyman?

We sympathize with the mum-and-dad investors (that include the father of one of ours) who paid the exorbitant price for T2. But our advice is this: get even, not mad with Telstra. Part of the reason why Telstra had lost so much value since the sale of T2 was due to the fact the government owned half of Telstra?without such part ownership, the government would not have a conflict of interest issue (that is because it is unfeasible to play the dual role of shareholder and consumer advocate), which encouraged nothing more than the unsustainable status quo.

Our impressions

Now that the government is offering T3 for sale, should we subscribe to the offer?

First, we start with a confession. We used to loathe Telstra. As consumers, we felt that they were arrogant, the quality of their products shoddy and their customer service a joke. We remembered watching with glee as consumers launched a class action suit against Telstra for providing shoddy Internet broadband service.

However, since Sol Trujillo took over, our perception of Telstra had changed for the better. We believe they are putting substantial effort to shed their bad image and change for the better. Not long ago, we were paid twice to take part in two surveys conducted on behalf of Telstra in a consumer study on telecommunications. In the surveys, we were asked questions that gave us the opportunity to air out our unfavourable impressions on Telstra and their products?we were brutally frank in our comments. Lately, we also noticed the marketing blitz by Telstra. We admit that we liked what we saw. If we base on the assumption that the products work as advertised, we can say that as consumers, Telstra is finally giving us what we want. That is a good sign for us, as investors?if consumers (including ourselves) absolutely love a business?s products, it is likely that we will love the business?s shares too.

Critical issues

But wait, hang on! Before we get carried away, let us first examine these critical issues with regards to investing in T3.

Firstly, Telstra is undergoing a significant overhaul and transformation of its business, which carries considerable risks. Since they are in the process of investing heavily for their future, their net profit for the next few years may decline temporarily. Along with regulatory uncertainties, their earnings beyond next financial year can never be forecasted with any accuracy. Therefore, any amount of quantitative analysis will be woefully inadequate in analysing the merits of this investment. For the case of Telstra, qualitative analysis plays a more significant part in our evaluation of T3. The flip side of qualitative analysis is that since it is more of an art than science, it is far more prone to our subjective bias. In view of all these uncertainties, we can expect fluctuations and volatility in Telstra?s share price in the next few years ahead.

Secondly, contrary to what the press, government and financial market analysts are trying to convince us, basing our investment decision purely on the 14% dividend return in the next financial year is foolish. First (this is the minor point), you have to understand that in actual fact, the dividend return is less than 14 per cent?the magic number ?14? is based on the price you paid for the first instalment of T3. Including the second instalment (which is yet to be determined at this stage), which is payable in May 2008, the total return will be lower than the magic number of ?14.? That is true even if you save the money meant to pay for the second instalment in a high-yield deposit in the interim between the payment of the first and second instalment. Anyway, this is not the most important point. The main reason why basing our decision purely on the magic number is foolish is because if the underlying business turn out to be doing very badly (implying the share price and T3 price will probably fall significantly), the 14% dividend in the first year will not be enough to compensate you for the overall loss in the investment. Thus, we have to stress this point: your decision to invest in T3 will have to be rooted in your conviction of the future earnings of the business. Forget about the magic number.

Thirdly, the current Telstra dividend amount is actually higher than its net profit. Thus, they have to pay you for the dividend. That may sound forbidding, but at this point in time, with their yearly cash in-flow in the order of billions, the company is not suffering from terminal financial cancer. But at the same time, please be aware that this trend is not sustainable unless Telstra invest to increase their future profits.

Will Telstra decline irreversibly?

In Telstra?s T3 prospectus, it said,

Telstra?s traditional high margin PSTN revenues have been, and will continue to be, negatively affected by both intense competitive pressure and customers migrating to alternative platforms, such as wireless, high bandwidth Internet, IP telephony, and web and managed services.

In view of this, many are predicting that Telstra?s business is heading towards extinction and that it is suffering from permanent and irreversible decline into oblivion. We disagree with this doom and gloom prediction. The logic behind such prediction is based on extrapolation of the past status quo (the situation before Sol Trujillo took over) into the indefinite future and assumption that Telstra will stand in the sidelines idly and do absolutely nothing to save their business from technological obsolescence. With Sol Trujillo taking over, such extrapolation and assumption lead to fallacious conclusions.

The question we would like to ask those doom and gloom predictors are: if Telstra?s competitors in the ?alternative platforms? will eventually destroy Telstra?s last bastion of profits, what is stopping Telstra from embracing those ?alternative platforms? and counter-threatening their competitors? business? At this point in time, Telstra still possess considerable (although declining) competitive advantages that are exceedingly difficult for their competitors to overcome. With their existing competitive advantages, we believe their competitors have more to fear from them encroaching into their competitors? businesses than they have to fear from their competitors nibbling away their existing business. Take for example the case of Unwired, a provider of wireless Internet broadband service provider. Telstra is already in the business of providing wireless broadband and along with other new products (e.g. NextG), value-added cross-selling of existing products (e.g. Foxtel movies), sales reach and marketing prowess, which company do you think have more to fear?

To appreciate the considerable market power that Telstra still possess, we have to understand the strengths of their competitive advantage.

The first and most important competitive advantage that Telstra have is their cash position?the amount of cash that Telstra earn annually exceeds all their domestic competitors put together. For the doom and gloom predictors? worst-case scenario to happen, the national usage of ?alternative platforms? has to cross over from the marginal market to the mainstream mass-market. For this cross over to ensue, Australia?s Internet telecommunication infrastructure, which is in an abysmal state, has to be upgraded and overhauled significantly. Not one of Telstra?s domestic competitors has the financial firepower to invest billions of dollars to undertake this mammoth task. Furthermore, they are too fragmented and divided to take a united stand against Telstra and unilaterally take on such costly projects. So far, Telstra is the only one (other than the government) who has the financial firepower to do so. As such, this gives them significant weight when dealing with the ACCC. Australia desperately needs an upgrade and overhaul of its Internet telecommunication infrastructure in order for its economy to remain internationally competitive in the 21st century. Australia is falling behind many Asian economic tigers in this area and further delay will imperil its economic development. We believe that the Australian government needs Telstra to undertake such an economically vital project and we have no doubt that Telstra will take full advantage of the government?s weakness as leverage in their battle against the ACCC. Thus, we foresee further political tussle between Telstra and the government in the days ahead.

Assuming that Telstra will eventually be the ones developing Australia?s Internet telecommunication infrastructure (after extracting significant concessions from the ACCC), they will have control over two crucial variables?the timing of the launch and the first access to the mass-market. Whoever controls the timing has the first movers? advantage?the power to strike first at the most opportune time. Whoever has the first access will grab the first and bigger slice of the pie before the rest, which is a major competitive advantage. In view of that, Telstra can succeed by embracing and monopolising the ?alternative platforms? by using their existing competitive advantage. The crucial qualifier for this outcome is that Telstra will win the fight against the government and ACCC. As a note of interest, the ACCC recently declared that they will keep a hands-off approach on Telstra?s new NextG mobile and wireless Internet network. At this point in time, it is still too early to say whether this is the beginning of a trend. But if it is for Telstra?s non-legacy infrastructure assets, then it is indeed very good news for Telstra.

Is vertical integration Telstra?s strategy?

Will Telstra remain just a telecommunication company in the future? This is a very interesting question. If the answer is ?yes?, we would not be keen in investing in Telstra because there are much more lucrative opportunities elsewhere. We suspect the answer will be ?no? because if we were Sol Trujillo, we would have taken the strategic path to transform Telstra to one that is more than a telecommunication company. We believe this strategy is the key to Telstra?s future.

To understand the nature of this strategy, we have to understand the concept of ?vertical integration.? It is the integration of disparate set of individual technologies, platforms, products and services into a complete package that serves a need. A very good example of vertical integration is Apple’s iPod. An iPod is more than a MP3 player?it is part of an ecosystem of software (iTunes), service (Music Store), hardware (iPod), and content providers (media, record and TV show companies) to deliver to the consumers a complete entertainment experience.

Another reason why the ?alternative platforms? had not gained traction in the mass-market is because to have a working solution on it, consumers had to understand a wide array of different systems, hardware, software and technologies and do the vertical integration themselves. This is not always feasible for the average mum-and-dad. For a business to deliver to the mass-market a vertically integrated package, it needs to have ownership or control of the various parts of the system, including the platform (the Internet telecommunication infrastructure) that the system sits on. To be in such a position, a business would require deep pockets to embark on costly investments. So far, Telstra is the only business that fit this requirement.

Vertical integration can also lead to market power. A business that can serve the mass-market with a vertically integrated solution will have its customers locked into its system. This is because each component within the system is so interdependent to each other that without any one of them, the whole system will not work. For any competitor to succeed, it has to first build an entire infrastructure of an alternative system and then convince consumers to switch. As Telstra embarks on a path towards vertical integration, we can see it gradually building another future monopoly right under the nose of the ACCC. We hazard a guess that usually by the time the ACCC decides to do something about it, it would be too late.

Vertical integration is probably the reason why Telstra is acquiring businesses outside its traditional realm of telecommunication. Hence, we believe that ten years from now, Telstra will be radically different from today?it may not even be called a telecommunication company.

Would we subscribe to T3?

The deadline for the T3 offer is a few days away. We believe it is a good investment, though it certainly carries risks and there can be better value elsewhere in the market. Any investment in Telstra requires a long-term horizon of at least five years. In the meantime, we expect more fights and tussles between Telstra and the government and ACCC, which may drive down the share price via negative sentiments. Investors in T3 have to be mentally and emotionally prepared for such happenings.

We believe that if Sol Trujillo and his team can pull off such a radical transformation, Telstra?s share will be worth very much more in the future. But if they fail, the results can be unpredictable. At this point in time, the management looks to be doing the right thing. So, the decision to invest in T3 is a vote of confidence in Sol Trujillo and his team, which is very subjective in nature.

We leave the decision up to you.