Wednesday 7 May 2014

Vision Eye Institute and a Portfolio Shakeup

I'm happy to report that on Monday I went on a bit of a shopping spree (on stocks of course), adding some Vision Eye Institute (ASX:VEI) and topping up on my existing holdings, which I'll talk about later. Many Australians in New South Wales, Queensland or Victoria will have either heard about Vision Eye Institute or have utilised their ophthalmic services. These eye related services are broken down into three categories: consultations, refractive surgery (better known as laser eye surgery), and other surgical procedures performed in a day surgery. In the last decade, the company experienced rapid growth as it bought more clinics and attracted ophthalmologists on the east coast, but poorly structured deals eventually led to an exodus of ophthalmologists. In combination with a high debt load, the company was brought to the brink of bankruptcy but has fortunately managed to stage a recovery recently. 

Instead of rambling on for many paragraphs about why I believe VEI is an attractive investment, I thought I'd try to keep my reasoning as concise as possible this time. Many of the most successful investors such as Peter Lynch and Warren Buffett suggest that investors be must able explain why they are purchasing a stock in a succinct manner, which makes perfect sense to me. It focuses your attention on the most important factors, encourages you to be rational, and ensures that you clearly understand the rationale. Alright, here we go!

Around 90% of VEI's revenues are non-discretionary due to the essential nature of its services to its customers. This stability in revenue was demonstrated throughout the global financial crisis and the years afterward which were spent addressing the decline in ophthalmologist numbers. Better still, with the ageing population, demand for VEI's services should continue to grow at a nice 5%+ p.a over the foreseeable future. The past issues of ophthalmologists leaving appear to be largely resolved, with the number of doctors increasing from 68 in October 2013 to 77 doctors currently. With management indicating that they will recommence the search for organic growth by expanding the number of clinics/ophthalmologists, economies of scale should help boost margins and build its competitive position. The cost of interest payments has also been dramatically cut in the most recent half, which will boost profits and reduce risk. Regarding the all important price, I estimate that VEI is trading on 7x to 8x its FY14 earnings and a DCF calculation confirms that it seems cheap enough for me. Finally, with a 20% stake in VEI, Primary Healthcare (ASX:PRY) may look to acquire the whole business, perhaps providing a nice catalyst for a re-rating in VEI's share price. 

On the flip-side, I think it's also a good idea to balance out that optimism by writing down the main risks which could result in a poor investment. To my mind, the main two are the bargaining power of ophthalmologists which is putting pressure on gross margins, and the gearing level. As the most important assets of VEI's business, the ophthalmologists have been able to push for an increasingly higher share of profits. Although gross margins have fallen from more than 50% to 43% in the first half of 2014, management have warned that this margin compression will continue. Although I believe that this trend will come to a stop in the next couple of years to balance with the benefits of VEI's business model to the ophthalmologists, I could be completely wrong, in which case the earning power of VEI may not be able to justify its current valuation. Despite reductions in net debt from $105 million in 2008 to $30 million today, this is still a relatively high 40% net debt/equity ratio. Furthermore, there are very few tangible assets to back its borrowings, so shareholders and creditors are solely reliant on the continued cash flow generation of VEI to sustain that $30 million of debt. Given the banks require $3 million to be repaid this year, management need to be careful with balancing their growth and dividend intentions in order to avoid another debt debacle. 

Although I don't think VEI is going to shoot the lights out in terms of share price performance from its current level and the risks outlined above are concerning, the case for investment was still tempting enough for me to purchase 2,786 shares at $0.61 on Monday. Speaking of temptations, it was difficult to resist making one of the endless lame puns on 'vision' that I was thinking of, but if that's your thing, take a look at the VEI attempts in their older annual reports (how about the 2005 line: 'focused on the future'). 

On a less positive note, I decided to finally exit my position in Antares Energy (ASX:AZZ) at a loss of around 23% on Monday after the proposed takeover offer of US$300 million fell through. Even though a number of investors I highly respect either recommend or hold Antares, holding onto this kind of business for the medium to long term is simply outside my circle of competence and I don't feel comfortable relying on the opinions of others. I think that the initial reason for purchasing was still valid, as it appeared more likely than not that the deal would go ahead, in which case the net cash per share would have been almost double my buy price. Unfortunately, chance has an annoying habit of making rational decisions look silly from time to time, but that's just a part of investing you have to deal with. 

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In addition to the above transactions, I added $6,600 to my portfolio and used most of it to purchase existing shares so their weighting in the portfolio stayed in line with what I think is reasonable. These purchases were 331 TGA at $2.11, 482 IMF at $1.86, 7,096 BOL at $0.155, and 12,000 ACG at $0.125. Consequently, my portfolio value currently stands at just over $16,000 with around $2,000 in cash that will hopefully be invested in a new stock if my buy order gets executed soon. This means that I've more than doubled the size of my portfolio in less than a month, and to account for my additional contributions, I'll be calculating a time-weighted return (the measure used by professional fund managers to adjust for inflows and outflows). Although portfolio performance over the past few months has been disappointing, I feel much more comfortable going forward with AZZ gone and the additions of ACG, BOL, NOD and VEI. It is probably for the best that my investing ego isn't inflated so early on by excellent portfolio performance, and it's also a good reminder that the index (All Ordinaries Total Return) is a tougher benchmark to beat than most people expect. To the right are the full gory details of my portfolio. 

For those of you seeking more detailed analysis of VEI, I can once again highly recommend The 8th Wonder - who incidentally posted just after I bought shares - and Intelligent Investor Share Advisor. After completing a six week internship at Intelligent Investor Funds Management (who are the second largest shareholders of VEI according to the 2013 annual report) and the guys at Share Advisor, I can definitely vouch for their ability and integrity. And no, unfortunately I was not paid to say all that. 

9 comments:

  1. Hello, would you mind sharing how you track your monthly portfolio performance? Did you build this yourself or is there a free tool available online?

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    1. I built this spreadsheet for my own convenience, but I'm sure there's software out there that can do something similar. I'd be happy to share my spreadsheet, but it would probably be a little tricky for anyone beside myself to figure out how everything works. I've heard that Sharesight is quite good, but it's only free if you have up to 10 shareholdings.

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  2. Thanks, seems as though google offers something as well for free. Sharesight was very easy to use, except for the 10 stock limit. However, the problem with both Sharesight/Google etc. is survivorship bias. The database does not include all delisted businesses (whether they went bankrupt or taken over). I really dont want to reconstruct my monthly portfolio going back in time from scratch!

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    1. Yeah I used Google Finance as a sort of comparison with my spreadsheet but I found that it doesn't track cash and total portfolio value very well (among other things), so now I just use it as a watchlist. I'd be very hard pressed to find any offering that is able to accurately reconstruct a portfolio on a monthly basis, taking into account information such as delistings, stock splits, dividends, brokerage, tax, cash inflows/outflows etc. Depending on how far back you're going, it won't be very fun to do it in a spreadsheet, but it will give you the most flexibility to calculate and visualise everything the way you want to, without needing to look at irrelevant information. Hope that helps.

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  3. thanks, looks I'm building it from scratch! Historical shareprices for delisted companies seem hard to find which is a problem. Also, where did you get the All Ords total return (XAO is easily available but that doesn't include reinvestment of dividends). And lastly, I'm curious to know how close the XIRR function applied to your portfolio transactions rightly approximates the time-weighted-return that you calculate by chaining the monthly returns -ie are they similar answers? thanks for your help!

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    1. Those delisted companies will probably be quite a pain, unfortunately I don't know of any free services that provide that information. Delisted.com.au may have that information on some of the companies you're interested in, but they'll charge you a small fee. On the other hand, premium services from providers such as Morningstar and Thomson Reuters will have that data but it certainly won't come cheap. S&P likes to make the total return information quite difficult to find, but you can get the current index value from http://au.spindices.com/indices/equity/all-ordinaries (click on the three horizontal bars). I have access to Commsec IRESS, which handily allows you to search up the historical values of the total return indices - if you need the historical data, send me an email and I'll see if I'm able to export it for you. The XIRR function calculates a dollar (or money) weighted return, whereas I prefer to calculate a time-weighted return, but there are decent arguments for either method if you have control over the cash flows. Applying it to my portfolio, the dollar-weighted return is about 0.5% lower (I hope I've used the XIRR function correctly, but it sounds about right).

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  4. Excellent blog post. I incidentally just visited back today and note that since you wrote this, Vision Eye institute is up about 20% on no news. I think at least in part that is because the market was too pessimistic about the company, as you pointed out. If anything, I think you've been quite conservative when you state demand will grow at 5%, which makes the thesis all the more convincing.

    As a small shareholder of the Intelligent Investor Share Advisor I can only hope that they can tempt you back in due course.

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    1. Thanks Claude, yeah Mr Market is just doing his thing - it's far too early to claim credit for that 20% appreciation in the absence of any material news. To balance things out, you could look at Nomad Building Solutions that has decreased roughly 17% since its last announcement over three months ago (although my loss is confined to 12%). Perhaps I am oblivious to some significant insider information, but those price movements are most likely routine variations, no skill, just luck.

      Speaking of skill and luck, I've recently finished The Black Swan and am currently reading Fooled By Randomness by Nassim Nicholas Taleb. He's quite a thought provoking author, I'll probably write something up about it soon.

      Funny you mention that, I will actually have the privilege of working with the Intelligent Investor Funds guys in July. I wonder if you've got any insider information...

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  5. Haha no... I'd prefer if you were working for the newsletter! They need a shakeup - good quality service but not enough subscribers. Owned by ASX:AWI. I took a small position because I like the business model of the share newsletters, but I have to say Intelligent Investor share adviser doesn't do enough to get new readers. Meantime the fund is the one getting young talent interested. It's a pity really because now there are split incentives between the fund (renamed now) and the share advisor. On the upside the potential for the share advisor to improve marketing is there if they only realise how much more profitable the company could be.

    Anyway if I had to guess I'd say that Vision Eye institute has another 15% - 30% in it in the short-medium term before it reaches fair value or potentially overvalued. It's a pity I didn't read your blog before the share price moved, I probably would have bought.

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