I can't ever recall a time over the past 3 decades when there...

I can't ever recall a time over the past 3 decades when there has been such a wide valuation spread between high-quality, and not-so-high quality, companies.

World-class businesses operating in fast-growth sectors are being afforded unprecedented valuation multiples (e.g. ARB, BRG, CAR, REA, RMD, SNL, TNE, PME, XRO) often a few times higher than long-term averages.

By contrast, businesses involved in comparatively "un-sexy" areas of business, such as building materials, capital goods, distribution, engineering construction and services, packaging, retailing, traditional media and telcos, are not - on the whole - excessively valued.  

With over 20% of my family's capital now held in cash - a figure which is higher than I care for it to be - I spent the past two days trawling around about 30 mediocre quality companies (Refer [*] below), to see if I might identify any that weren't value traps (which most of them appear to me to be).  Trouble is, the majority of the stocks in that list are just plain crap or mediocre companies, so they deserve to have their valuation multiples marked down.

I find very few of them - despite them having underperformed chronically over the past 18 to 24 months - are even close to valuation levels that present investment returns that offer appeal on a risk-adjusted basis.

Of that mediocre group, LAU emerged as one of the most attractive (or should that be one of the "least unattractive"?).  

For what it is - essentially a trucking company, no matter what fancy MBA-school adjectives get applied - LAU's financial pedigree is most respectable, which suggests that the business and the company's capital are well-managed.

There is evidence of the LAU board having respect for the share capital account, with Shares on Issue rising by a modest 11% over the past decade. By contrast, growth in Revenue and EBIT have increased by factors of 2.6x and 4.2x, respectively, over that period.

As a consequence, the benefits of larger scale have materialised with ROE rising over time; now sustainably at a level well above the group's cost of capital (although it has understandably eased back from the bumper 2023 year, when the agricultural sector was booming):

   

Of course, this is accompanied by relatively high level of financial leverage - not in the form of borrowings (the company operates with a modest level of Net Cash), but in the >$200m of leases the company utilises to finance itself.

This is has cash flow implications about which I sense a number of LAU investors are unaware, given these lease payments are recorded not as Operating cash flow items (which I think they should be), but as part of Financing cash flows.  And these lease amounts are not insignificant, either - $57m, $35m, $37m, $38m and $44m, respectively, in FY2020, FY2021, FY2022, FY2023 and FY2024.

So while at first glance of the cash flow statements, LAU might appear to be a supreme cash flow generator, it is not nearly as strong as it appears due to the lease payments.  The business still generates free cash flow, mind, but not excessively.

Note that this high reliance on leasing, as opposed to borrowings, to fund the business is not to an extent that it risks being unmanageable; the liquidity metrics are still undemanding, with Net Debt-to-EBIT close to the lowest it has been in the company's history, despite coming off the aggressive capital investment program of the past 18 months.




Even under the current high and stubborn interest rate regime, EBIT Interest coverage is comfortable at 4.0x, which is meaningfully than the company's history:




So the balance sheet is in fine condition (important in underwriting the ~6% dividend yield), there is no past evidence of management doing any dumb things with shareholder funds, the company plays an integral part in the functioning of various aspects of the economy and it has a demonstrated ability to defray rising input costs and to win and maintain market share.  

All this bodes well for shareholder value creation across the economic cycle, suggesting the stock is an attractive investment today.

The only residual matter to consider is a tactical one, namely the impact of the upcoming result which I suspect will appear optically weak, with a possible large negative delta on DH2023's result, which was a record.

I think the market will ultimately be mature enough to look through that dynamic, but there is likely to be some sticker shock on the day and/or day after when holders with hot hands get spooked by the big negative variance.

But I suggest that will be the signal for the stock's bottoming.


[*]
ALD
ANN
AZJ
BAP
CKF
CYG
DOW
EDV
ELD
FBU
HLS
HVN
GNC
IPL
JLG
LAU
MND
MTS
NUF
ORA
ORI
RFG
RWC
SGM
TPG
TRS
VEA
WOR