Well, the interim result has come and gone and the key features...

Well, the interim result has come and gone and the key features of it was that the dividend was suspended - the first time since 1999, I think - and, related to that, net debt was higher than I had expected (by around $70m, explained by around $20m increase in working capital, as well as higher-than-expected interest and tax payments, and $26m in relation to the cps special dividend, which I - negligently - failed to account for in my balance sheet modelling.).

I note the accompanying result commentary that $40m of deferred receivables were banked in the days after the FY2019 balance date.


So while that was all new information, what is also new is that the share price is now 20% lower than it was at the time of that post.

It is therefore a useful exercise to re-visit valuation (based on my preferred measure of Free Cash Flow Yield on Equity):

But to start the conversation, by way of recap, ABC's Free Cash Flow (FCF) attributes are worth reviewing:

Chart A shows a history of reported FCF for ABC:



However, it warrants mentioning that the chart is calculated based on Operating Cash Flows less all Payments for PP&E, which would include not just "stay-in-business" capex, but also capital investment for the expansion of capacity (for example, the muted 2011 and 2012 Free Cash Flow figures in the above chart reflect the more than $100m in expansions in cement capacity in WA and in SA that occurred over those two years).

When looking at "Adjusted" Free Cash Flows (which uses depreciation as a proxy for stay-in-business capital expenditure, as well as strips out working capital movements) the FCF picture looks like this:



For valuation purposes, this indicates to me an underlying FCF level these days of around $140m to $170mpa.

For the sake of conservatism, I'll use the bottom-end of that range, i.e., $140m, which represents a 7.5% yield on the current $1.89bn market value of the company's equity.

And, for context, that FCF Yield on Equity Value places the stock in what I consider to be undervalued territory (refer chart below), the first time it has been in that attractively priced zone since 2015.



And, as can be seen besides now, ABC was also in what I consider to be undervalued territory in 2002, 2003, 2004, 2009, 2010 and 2015

By way of logical extension of the exercise, the following table provides a summary of investment returns generated in the ensuing 12 months, 24 months, and 36 months, assuming one had acquired ABC shares during those years in which the stock was priced in that shaded "Attractive Valuation Range" area.



As can be seen, over the subsequent 12 months, 24 months or 36, months following an investment being made when the stock was situated in the undervalued area, subsequent investment returns were always overwhelmingly positive, averaging 27% over the following 12 months, 46% over 24 months, and 63% over the ensuing 36 months [*]


And while, compared to its history, ABC looks attractive to me on a fundamental valuation basis, what is missing from that FCF Yield valuation chart above is any reference to the significant change in one of the major determinants of equity valuations today, and that is the collapse over the past several years in the return on offer from risk-free investments.

It therefore seems instructive to look at the history, not only of FCF Yield isolation, but the spread of FCF Yield over the risk-free rate of return, using the 10-Year bond as the proxy for risk-free returns.

The FCF Yield spread over Australian 10-year bond yields is plotted below:



As can be seen, compared to the yield on government debt, ABC currently appears to be cheaper than it was at any stage for the past 15 years (with the exception of the GFC, although that is objectively not really a representative point in time).

Accordingly, I have begun buying ABC shares in recent days.

It warrants mentioning that I have a propensity to buy cyclical and turnaround stocks early, often too early, and it will not surprise me if I'm doing the same here.

Because improvement in the demand cycle for ABC's products feels like it is still a long way off. But that's the thing about value investing: timing the point at which share price performance starts to close the assessed valuation gap is difficult.

It is not uncommon for me to own a company, that I consider to be undervalued, for 18 to 24 months, before something unexpected happens to trigger to delivery of the true value of the company in terms of the share price.

And of course, it also warrants saying that no two business cycles are precisely alike so this sort of study should be considered to be indicative, rather than prescriptive (just like all valuation matters).


[*] And it warrants noting that that investment return attribution excludes dividends that were received which for ABC, were not immaterial