where to from here, page-16

All this talk about a mature, ASX50 company, and not a single discussion of the appropriate valuation methodology?

I believe that the appropriate way to value WES is on an EV/EBITDA basis.

The reason for this has to do with the balance sheet and working capital dynamics, where NIBD is on par with EBITDA and Working Cap is negligible, at a mere 3% of Sales.

This means that a significant component of EBITDA converts to FCF (around 75%, which is significant higher than the overall corporate average of around 45%).

This cash generating potency, plus a balance sheet is pristine condition means that the use of P/E multiples do not do justice to underlying intrinsic value of the organisation, nor – importantly – its rate of change.

So that’s why most institutional investors look at EV/EBITDA multiples and FCF yields.

So what sort of relevant valuation metrics is WES trading on?

According to consensus forecasts, the stock is valued at around 8.8x EV/EBITDA and a7% FCF yield (~$3bn of FCF on a market cap of $43bn).

For a high-quality business:

1. that is one of the ASX’s most definitive proxies for interest rate sensitive sectors of the economy, at time when interest rates are falling,
2. exposed to sectors of the economy that the reserve bank is actively stimulating to take up the slack from the cooling mining sector,
3. growing earnings at double-digits for the next 3 years,

I don’t think those valuation metrics are at all demanding even when seen in absolute terms.

And when viewed in RELATIVE terms compared to other asset classes, notably bonds and cash, then it is very cheap....7% FCF yield, 5.5% DY compared to <1% yield on five-year bonds and <2% on ten-year bonds, and falling yields on deposits.

Unfortunately, what I sense happening among investors - institutional and retail alike - is that most today have the GFC experience still raw in their memories and they are convinced that it will recur, and in an even bigger way because some of the severe economic imbalances are still intact.

But what they are overlooking is the fact monetary policymakers globally have been filling the liquidity dam for four years now, but the sluice gates are being opened only now.

And as the water (capital) from the dam has increased from a trickle in 2010, then to a gentle stream (2012); and hereafter it will increase into a strongly-flowing river fill to its banks (2013), and finally into a raging torrent (sometime down the track).

It might be for all the wrong reasons to wannabe purists like myself, but the sheer atom bomb of unbridled monetary easing that is forcing surplus liquidity to all nooks and crannies of the globe, will inevitably involve continued asset price inflation, a process that will continue until the earlier of:

• equities becoming valued at less of a discount to risk-free assets, or
• when the current uber-easy monetary conditions reverse.

And neither of those outcomes is close to coming to pass.

Shorting equities with this sort of once-a-century capital market backdrop is a strange thing to do, but shorting a company like WES in particular, one which has a direct exposure to the psyche of the consumer, at a time when policy makers are bending backwards to ensure the psyche of the consumer is nurtured and stimulated and cosseted, is downright risky, as some posters have rightly alluded.


Rameez:

I had a good self-deprecating chuckle at your post about my nay-saying of CDD as an investment.

I have to admit to having conveniently forgotten about by disinclination to invest in CDD, only for its share price to rise dramatically thereafter.

But that's nothing unusual.

There are hundreds of companies that I don't invest in, whose share prices subsequently rise.

Sometimes spectacularly.

So CDD is not the first, and it won't be the last. Lots of stuff goes up for all manner of reasons, without my being on board.

Conversely, I also buy stocks that go down.
Sometimes permanently.

But the trick, self-evidently, is to buy more that go up than go down, and to not get trapped in the mindset of Return Envy.

[Return Envy is that little-publicised, but highly prevalent, psychological phenomenon that has been shown to compel investors – especially retail investors – to take on disproportionate amount for risk relative to a given quantum of return on offer, due to the fear of missing out.]

Thanks again for the mirthful reminder.



MMennel:

"I reckon it is fully priced and future earnings growth is likely to disappoint mkt resulting in the SP sliding. We'll know by end of Feb."

The trouble, with respect, is that “by the end of Feb” is immaterial. The reason for that is that the market, as you know, is anticipatory by nature and as such is looking forward through the valley of a tough domestic economy, and into the upturn – perceived or real – on the other side.

Everyone knows the past 6 months have been tough in retail land.

What becomes far more important at this time of the reporting cycle is what investors believe the landscape will look like over the subsequent 12 to 18 months, i.e., the FY14 financial year.

Investors aren’t buying stocks like this predicated on this February’s numbers; they are buying it on the prospect of a recovering domestic economy – in response to falling interest rates - during subsequent financial periods.

“Couple this with a renewed price war (did it ever end?) between WOW and WES (see link below)and it affects margins significantly.”

Stefanis is spot on.

The “price war” between Coles and Woolworths is a phony one; merely a huge biggest con.

It’s a charade.

“We pick a few items and discount them to heck as part of a much-publicised campaign that suggests a fiercely competitive landscape and that silences the critics. But behind all the noise we are quietly more than compensating for this by ratcheting up prices on othe SKUs.”

And I’m not just making this stuff up: gross profit margins for both grocery retailing juggernauts have continued to rise every year since WES acquired Coles, “aggressive price war” and all.

What you’ve got here are two grown-up, disciplined boards and two management teams who understand the gig all too well...it’s a nice, cosy duopoly.

Without doubt.


“Hence, all-in-all i can't see how WES can continue growing earnings at the same phenomenal rate achieved over past several years.“

They will grow EPS ate double-digits every year for the foreseeable future. That you can bank on.

They have pricing power all over the place, and they also have tailwinds coming in the form of the macroeconomic landscape.


“Large super funds are seeking stks with growing dividend yields.”

Yes, indeed. You’re absolutely right, WES fits this mould perfectly.


“WES have being paying most of their earnings back as divs. There is limited amount left to pay for further development.”

Factually wrong. One thing WES is not, is suffering under a capital deficit.

These guys will generate over $4bn in OCF in the current year. The dividend – expected to be increased by 12% on the previous year - will cost $2bn. Stay-in-business capex is $800m.

That leaves over $1.0bn to either invest in the business for organic growth, or to return to shareholders.


“Finally price for coking coal has fallen substantially from 12 months ago. FY13 vols will be significantly higher but at reduced margins.”

Forget about coal. Its a distraction. Everyone knows that coal prices are low. And at 6% of Group Total EBIT, it’s not relevant at this stage of the cycle.

(In fact, and I’m not coal enthusiast – to be frank, I HATE it – I wouldn’t be surprised to see earnings increased sometime in 2012 as coking coal prices rebound)


Cam

PS. Needless to say, I am ensconced as a long-term shareholder in this cosy duopoly arrangement, being a long-term shareholder in both WES and its “pseudo-enemy”, WOW