Learning from Disappointments – Penrice Soda
A regular commenter asked for my thoughts on Penrice and why I recently sold half our position at $0.80. Penrice closed at $0.58 yesterday after lowering their earnings guidance two days ago.
Penrice Soda Holdings Limited (PSH.AX) Disappoints Investors
Here is my original writeup from last December and follow up comments, in which I said the following.
Why I Bought
- Penrice is in my 5-10 P/E strike zone. Viable companies sporting those P/Es have higher average returns than any other group. Buying in that range increases my probability of success.
- High probability of earnings rising and ratio expansion. The simple combination which propels the low P/E’s out performance.
- Return on capital has lots of room to increase from 2009s low level of 9% . Orica for example returns mid to high teens.
- Boring, easily understood business. I consulted to chemical companies like Kemcor and Orica and numerous mining companies, so Penrice is in my wheelhouse. The fundamental story and performance make sense and management’s responses appear likely to bear fruits. This isn’t high tech, chemicals are already a commodity and the demand is strong.
- Good shot at 10% after tax dividend within 2-3 years and a possible capital double over the same time frame. [That's the target valuation, not the conservative valuation.]
So why did I sell out a few weeks back and why the forking hell did I only sell half!
Despite still owning a position in Penrice with a cost basis of $0.80 and the shares now selling at $0.58 I fell OK. Not because I have a lot of faith in Penrice, but because I was correct in changing my opinion. I’ve found that once I’ve established a position I tend to become married to it. Anyone else have that problem? I find it difficult to re-evaluate positions in an open, honest and fresh way. This is not an unusual tendency, I believe most investors have it. It is a terrible bias and one that I wish to overcome. Here’s what Less Wrong have to say on this problem. “Between hindsight bias, fake causality, positive bias, anchoring/priming, et cetera et cetera, and above all the dreaded confirmation bias, once an idea gets into your head, it’s probably going to stay there.”
Changing my mind on Penrice was a small steps on my path to conquering what I’m calling sedentary bias. I first became uncomfortable with Penrice in early February. I became more uncomfortable when I emailed the company some questions and they did not reply. That appalling lack of respect for shareholder communication did not sit well with me. I then re-read their reports and became uncomfortable with the language they used. There was no honest and frank discussion. They overemphasised what “they” did well without taking responsibility for what hadn’t been going so well.
Rather than dig into the past let’s take a look at the earnings downgrade from two days ago. Their headline, “GFC SLOWDOWN IMPACTS…”. The CEO Guy Roberts goes on to use phrases like “outside our control”. Wake up Guy, it’s always outside of your control! Do you think Apple control people and make them buy their products? Where is this mythical company that has total control over their supply chain? Why can’t you forecast a piddly couple months ahead? Why can’t you stand up and take responsibility for your problems rather than blaming the GFC and things ‘outside your control’? I won’t even start on the Open Briefing where Mr Roberts blames things like the strength of the AUD, as if that was a big unknown two months ago when he forecasted NPAT above $9M.
Woops, I got carried there, let’s get back to February. With the share price then up 15-20% in two months I thought I should take my profits and run. Alas I focused on my numbers and with the economy improving I thought their guidance of over $9M NPAT was in the bag and thus despite then not liking the management and having concerns over their aging plant and customer concentration I remained invested.
Fast forward a couple months to the beginning of April. I was running the ruler over our Australian positions and Penrice was the only one that didn’t measure up. While the possible returns still looked attractive I decided they simply were not worth a punch hole in my card and I’d sell. I didn’t like or trust the management, there were potential problems from the aging plant causing loss of production, customer concentration and an environmental pollution problem. The later of which I am uncomfortable with and can have financial implications. I was going on holiday and as our position was split over two accounts I decided to sell out of one of the accounts and dig deeper when I returned.
Will I be selling my remaining half today? No. Despite my concerns about management, their obvious inability to accurately forecast and possible maintenance issues, at the current price Penrice looks cheap. Part of the reason I kept half our position was that it’s a small position to keep me interested. While I often rally against the notion of needing to have skin in the game to bother digging deep and remaining alert to a company, at the moment it works for me.
By the Numbers
- Penrice now expect $5-6M NPAT for FY10 down from over $9M guidance and $9M last year.
- Net cash flow negative this year of $7-9M, missing major target of break-even net cash flow.
- Third line at Amcor’s Gawler plant will flow through to increased sales of soda.
- Dividend highly unlikely in the near term.
I hope that answers your question Sean.
Disclosure: Long PSH.AX
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You did well to realise something was amiss.
Last week WilsonHTM released a research report with Penrice as a Buy, with confidence in the company being able to get close to or spot on forecast earnings. Then came the infamous downgrade from management…and today out came a research report from WilsonHTM with Penrice as a Hold!
No mention of the fact that they completely missed the impending downgrade, despite having revisited their numbers only a week earlier. It was pretty clear some people did know, just have a look at the PSH price chart for the past couple of weeks. The market knew it, even if a couple of highly paid analysts didn’t.
It was pretty clear some people did know, just have a look at the PSH price chart for the past couple of weeks. Great point Justin. Insider trading is rife in Australia, I saw it constantly when I was a business consultant. I use insider trading generically rather than legally. People inside companies know a lot more than the market and people love to show of their knowledge. Take PSH as an example. People inside both Amcor and Penrice would have known about the slow down in sales. As sure as I breathe that information would have been passed on to some people. Perhaps at the pub, perhaps over a casual conversation. “Hey Pete, how’s business? I heard you were slowing production.” For those of us on the outside we must hope that our careful analysis is right more often than wrong and that the inside information balances out by the swings and roundabouts. While people may profit on the occasion inside knowledge, unless you are a dodgy hedge fund manager systemically trading on inside information, then it is not a long term path to success. Actually even if you are a dodgy hedge fund manager you still need to get out while the going is good!
Is the point of this to heed what the chart is telling you? It often seems to be post hoc.
Rather than single out WilsonHTM, I will say that I had fun on a Bloomberg terminal a couple weeks back looking at sell side analyst forecasts. Bloomberg presents them graphically on the stock chart. Anecdotally almost everyone I looked out had a terrible track record. So bad that the only way I could see to make money by following them was to do the exact opposite of what they say. All too often they upgrade near highs and downgrade near lows. I guess it is a tough job. It reminds me of my own recent atrocious record of selling calls on my long positions. AKAM and MMM (US companies) are about to make 4 out of 4 closing considerably above my sold calls. So perhaps people should simply buy the calls I’m selling! In my defense, when I sold the calls I was happy to sell all four and selling the covered calls maximised the potential profit at that time. Plus there’s a big difference between leaving money on the table and being flat out wrong. If I had thought all four were going to go down I would have sold them straight out. I thought they were going up, just not as fast and furious as they did.
PS Elders was below $1.20 yesterday as you foresaw.
I know WilsonHTM is no worse or better than the others, I only mentioned them due to the fact that their PSH report came out this morning and I read it just before seeing your post.
As I understand it a portion of sell-side analyst remuneration is based on stock call performance, so I am suprised that they are so often wrong (as we all are of course). Perhaps the trading volume commission outweighs the loss of income of making a wrong call
I agree with you regarding insider trading. As you say, not neccesarily absolute insider trading, which inevitably ends in tears, but the more subtle kind.
Hi Dean, I think you did well in identifying discomfort. If I had been in this trade, I would not have sold out in the rally to 0.95. My stoploss would have been 0.75 just above the equity raising. The company is a dissapointment from what I have seen and from my opinion. I think the ethics of managment is an important factor in stocks. In small business, it is not very difficult to pick up a small 100-500k business on a PE of 5-10, particularly with baby boomers wanting to offload their businesses before retirement. Why would you invest in a stock on a PE of that rather than 100% in a small business that you have complete control over? It’s mainly for the transparency of the balance sheet and hopefully the rigourousness of being listed. But that is not worth much in some instances. The company structure and listing is a double edged sword. Some companies have management that are there to benefit the management and not to the benefit of shareholders. This can drag on and on.
The main concern I have about PSH is that management are disguising a fundamentally flawed business. The bicarb process that they have is energy intensive. They have been operating on PE of 5-10 for the last how many years (?5). Yet the shareprice is going lower and lower and the dividend has been suspended. Where have the earnings been going? If the PE is actually that I cannot see how the shareprice is what it is. I maybe wrong, but that rings alarm bells.
I find myself with an interesting internal conflict with my TLS holding. It is an interesting exercise in dividend stripping. It satisfies 1 out 3 desirable features for me. It has compelling dividend value but fails the other 2 criteria which is a good long term business model and good management. Which is why I think I will slowly sell out of it into WOW. Or maybe get back in the resources story. Or both.
Again thank you for your blog, it is great to hear your analysis and thoughts. I learn a lot from it.
(*) my wife and I bought a small business last year on a PE of 5. It has been an interesting exercise. We managed to preserve the earnings after aquisition, which was challenging. What I learnt is that small business has some breaks. The small business investment tax break last year was a major bonus. You also get other breaks over larger companies such as exemption from payroll tax below a certain threshold.
Wow, I had a look at the proposed resources rent tax. I hadn’t thought about it before as I had got out of resources. It makes the NBN legislation look like a featherduster whipping. Maybe I won’t get back into resources after all…
It does make investing in ones small business more attractive though. Which is what I may do along with paying off debt.
Wow indeed! I’ve just been reading it now. While I have little empathy for the resource sector it seems pretty outrageous. Maybe banks will be next with their abnormal profits.
I think you’re right Sean, small business is looking more and more attractive.
I’ve only scanned the reports, but am left wondering what was the point of the Henry Tax review. It appears the government has gone ahead and done what they wanted with little regard to Henry.
As with most of these things, I think the outcome was pretty much decided in advance of Ken even putting pen to paper.
He must be gutted. I suspect it won’t be long before Ken moves on and takes up a nice paying, cushy job in the private sector.
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