Hunter Hall International Limited (HHL.AX) Analysis and Valuation
In my last post, David and Goliath: Hunter Hall and Platinum Asset Management, I mentioned Hunter Hall International Limited looks like good value, so let’s dive in a bit deeper.
Valuation
I normally don’t use the Dividend Discount Method (DDM) for valuing a company, the only time I have used it was for a valuation of Telstra. If you’re not familiar with the DDM then Digging Into The Dividend Discount Model is an excellent overview. The theory is a stock is worth all of its future cash flows discounted by an appropriate risk adjusted rate. DDM is DCF from an investors perspective where dividends represent the cash flows. “The classic dividend discount model works best when valuing a mature company that pays a hefty portion of its earnings as dividends, such as a utility company.” While that may not characterise HHL, I’ve decided to use the DDM as a first pass, as HHL does pay almost all of its earnings out as dividends and over time it’s dividend should grow at at least a steady rate.
I could use a multi-stage DDM, but that requires even more assumptions to be made than the three major assumptions I have to make to use a simple constant growth model. Assumptions make an ass of you and me may be an an oldie, but it’s still a goodie. To use the DDM I have to forecast this years dividend, the dividend growth rate and an appropriate discount rate. I’ll tackle those in reverse order.
Discount Rate: I’m going to use 10% as the discount rate. I have read arguments for increasing the discount rate at the moment to allow for increased equity risk or for the possibility of increasing inflation. As I perceive there to be less equity risk now than a year or two ago and I used 10% then, it does not make sense to now increase it. As for inflation, that is yet another assumption and I’m not comfortable predicting future inflation rates.
Dividend growth rate: I’ll use the dividend history as a starting point and then cross check it with my own estimation of future growth based on my own rough assumptions. The following chart shows the annual dividend since 2002. HHL was formed in 1993 and debuted on the stock market in February 2001. The 2009 figures are estimates, the eps is analysts consensus and the dividend is my estimate based on FUM. Based on the history and my estimate the dividend has had an average growth of 33%. However, averages are funny beasts, so I’ll smooth out the volatility by using the compound annual growth rate. The CAGR in dps over the last seven year is 11.4%. I believe that is a historically conservative figure as if we were to take what is arguably trough to trough years of 2003 to 2009 the CAGR in dps rises to 24%.
Another way to think about the dividend is to estimate when the future dividend will surpass the 2008 figure of 77.3 cents. If that takes six years that would be a CAGR of 10.7%, five years 13% and seven years is 9.1%. As I’ve set my discount rate at 10% I need to settle on a figure less than that. I’m going to be conservative and say 7%, which is also less than my growth assumptions of 9%.
Dividend: Did I give that away already? I’m forecasting a final dividend of 23 cents bringing the 2009 dividend to 41.6 cents, let’s call it 42. With analysts estimating eps of 62.9 that implies a payout ratio substantial less than normal. At the moment I have no idea what analysts are basing their estimates on, my estimates are based on a discussion with a knowledgeable investor in HHL and previous dividends in years with comparable FUM. Speaking of which here is a chart of FUM.
That the garbage in, now here comes the garbage out (yes, it fair to say I’m not an ardent admirer of DCF or DDM).
Price = dividend/(rate-growth) .42/(.10-0.7) = $14. With HHL last trading at $5.12 that sure is some margin of safety. Before you rush out and buy let’s play around with the figures a little. First what is the market assuming based on the DDM. The market must see a total dividend of 26 cents (HHL already paid 18.6c) and a discount rate 500 basis points higher than the growth rate or some equivalent combination. That seems highly unlikely to me, but then again analysts are estimating 2010 earnings of 26.8 cents so maybe I’m missing some massive fly in the ointment.
Before I go looking for flies here is a quick matrix of prices based on the DMM. (As always decimals places are merely a reflection of a spreadsheet and should not be confused for accuracy.)
| Dividend | DR – GR | Price |
| 0.23 | 0.06 | $3.83 |
| 0.26 | 0.05 | $5.20 |
| 0.42 | 0.05 | $8.40 |
| 0.35 | 0.03 | $11.67 |
| 0.42 | 0.03 | $14.00 |
For the record the yearly low of $2.61 was on March 3rd. I’m pretty sure no-one was thinking about the dividend discount method then. HHL’s high was $18.50 back in November 2007. I do want to dive even deeper and see if I can find out why analysts are predicting 2010 to be annus horribilis. However, HHL comfortably exceeds my 3:1 reward to risk hurdle. Using the high and low from my table above gives a 7:1 reward/risk profile and my Kellyesk spreadsheet is positively wetting itself with excitement. Don’t take that 7:1 too seriously, while it may play out like that over the next few years 3:1 is a more realistic target to shoot for.
A few more thoughts to close. In their mid year update Hunter Hall reported they were not seeing an exodus of funds. FUM only have to grow at 8% a year for six years to hit new highs. That seems achievable as from 2001 to 2009 FUM grew at a CAGR of 31%.
Using my Hewitt Heiserman style P/IV spreadsheet gives a weighted intrinsic value of $9.20 based on eps of $0.50, book value of $1.29, 5 year growth rate of 7% and a discount rate of 10%. (Note: as of 31/12/08 NTA was $1.36)
As I said in my last post on Hunter Hall they are selling at almost a third of the value of their larger competitor Platinum Asset Management. Perhaps a pair trade is in order? At the very least that is another indication that HHL is being overlooked by the market. Checking the chart below I see possible ratio expansion boasting any uptick in earnings.
Who the heck are Hunter Hall?
Hunter Hall prove that ethical funds manager is not an oxymoron. Not only are their funds managed in an ethical manner they donate 5% of pre-tax profits to charity each year. Their ethical philosophy dictates they avoid companies with activities detrimental to people or the environment. HHL operate five investment trusts and a listed invested company; Value Growth Trust, Global Ethical Trust, Australian Value Trust, Global Deep Green Trust, International Ethical Fund and Global Value Limited.
Hunter Hall have an excellent track record and their funds are well regarded by Morningstar. Their flagship fund, Value Growth Trust (VGT), has achieved a positive absolute return and out-performed the MSCI World index in 12 out of 14 years. If that level of performance continues FUM will grow much faster than my 8% estimate. They also have a strong balance sheet with $33M in short and long cash and investments and no debt as of December 2008.
But Wait, There’s More
On 24 April HHL announced a share buy-back under the 10/12 rule, i.e. buy up to a maximum of 10% of outstanding shares (25,804,999) over the next 12 months. Their stated reason is capital management. While HHL are not obliged to buy any of those shares, it is an indication that management view their shares as under-priced. Back in March the founder, chairman and CIO, Peter Hall topped up his large holding with 220,000 shares at $3.20 in a off market transfer. Interestingly he purchased those shares from the CEO, David Buckland, who also sold 35,00 shares back in January. Another director Mark Forstmann sold a large chunk of his HHL holding in the low $3s, in late February and early March. While there are many reasons for insiders to sell shares I do wonder if those trades may have been a classic weak hands selling to a strong hand. No doubt I’m being too harsh on David and Mark and they just wanted to buy some nice new toys or pay for their kid’s education. It is also noteworthy that the major holder HGL (HNG.AX) has ceased to be a substantial holder. However, those sales are in line with HGL’s stated intention to move away from funds management and focus on their import businesses.
I have now spoken to a HHL employee and he confirmed that there has been no release to the market for analysts to base their dire 2010 predictions on. The person I spoke to confirmed that management believed FUM had bottomed and that the last couple months saw inflows. I want some of whatever the analysts are smoking as it must be wicked stuff for them to estimate 2010 eps of 26.8 cents!
Confession time: Funds managers are not in my circle of competence, though I have followed a few US based mangers like GROW for a few years. So please do your own research. In my valuation I place a lot more emphasis on EV/FUM rather than the DDM. If you’ve read this far you must be really interested in Hunter Hall, so here’s your bonus. HHL is currently trading at an EV/FUM of 0.063 or 6.3% while Platinum Asset Management are trading at 16%. PTM is trading at a 2.5x premium to HHL.
Chart
Earlier analysis on Hunter Hall.
This is not a recommendation, do your own due diligence, this is for my amusement only etc etc. I have a small position in HHL and may increase it. Heck I’ll probably even sell it one day.
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