Aristocrat Leisure (ALL)

Stock: Aristocrat Leisure Ltd
Exchange: ASX Symbol: ALL
Date: 12-Dec-22 Latest price: A$33.64
Market Cap: A$22.2 bn Fair Value: A$25.21
Forward DY: 1.5% Payback (Years): 11
Financial Y/E: 30-Sep-23 Rating: HOLD
Sector: Discretionary Industry: Gambling
Investment Theme: LT Growth Macro Trends: Online Entertainment

Aristocrat is trading at a premium to our estimate of fair value while the stock is in a down-trend. Our recommendation is to HOLD.


We increased our fair value estimate for Aristocrat (ALL) by 66%, to A$25.21, based on the following long-term projections:

  • Real organic long-term revenue growth of 6%;
  • EBITDA margin of 30% (currently 33.2% in FY22);
  • Capital expenditure of 5.0% of revenue;
  • No increases in net working capital; and
  • An effective tax rate of 30%.

We selected a payback period of 11 years (formerly 10 years) to reflect Aristocrat’s strong market share but in a cyclical industry. The company recovered well from the pandemic but may have benefited from increased disposable income due to government transfers.

Business Profile

Aristocrat Leisure is an electronic gaming machine manufacturer, selling machines to pubs, clubs, and casinos. The firm is licensed in all Australian states and territories, North American jurisdictions, and essentially every major country. Aristocrat is one of the largest three players in the space along with International Game Technology and Scientific Games. Through acquisitions of Plarium and Big Fish, Aristocrat now derives a significant proportion of earnings from mobile gaming, under the Pixel United banner.


Revenue grew 12% in FY22, while EBITDA grew 13.7%, on a constant currency basis.


Pixel United

Capital structure

Aristocrat’s cash assets exceed debt plus lease liabilities.


Staff of The Patient Investor may directly or indirectly own shares in the above company.

Appen Ltd (APX)

Stock: Appen Ltd
Exchange: ASX Symbol: APX
Date: 05-Oct-22 Latest price: A$3.29
Market Cap: $406 m Fair Value: A$2.99
Forward DY: 3.16% Payback (Years): N/A
Financial Y/E: 31-Dec-22 Rating: HOLD
Sector: Technology Industry: IT Services
Investment Theme: Technology Macro Trends: A.I.


Appen (APX) is trading at a discount to our estimate of fair value. Our recommendation is HOLD in the current bear market.


We reduced our fair value estimate for Appen (APX) by 74%, to A$2.99 per share, based on the following projections:

  • real organic long-term growth of zero (formerly 15%);
  • EBITDA margin of 12% (formerly 15%);
  • capital expenditure of 5.2% of revenue (formerly 5.4%);
  • working capital of 0.4% of revenue (formerly 0.6%); and
  • an effective tax rate of 25%.

We selected a payback period of 10 years to reflect the company’s small cap size and a competitive industry.

Business Profile

Appen provides quality data solutions and services for machine learning and artificial intelligence applications for technology companies, auto manufacturers and government agencies. The company’s business segments are Relevance; Speech & Image and Others. Relevance generates the most revenue, providing annotated data used in search technology for improving the relevance and accuracy of search engines, social media applications, and e-commerce. Geographically, the majority of revenue is derived from the USA.


“Appen’s half year results reflect lower earnings due to challenging external operating and macro conditions, resulting in weaker digital advertising demand and a slowdown in spending by some major customers…” (1H FY22)

FY22 EBITDA margin is expected to be materially lower than FY21.

Capital structure

APX has net cash (after deducting capitalized leases) of $33 million.


Staff of The Patient Investor may directly or indirectly own shares in the above company.

Macquarie Group Ltd (MQG)

Stock: Macquarie Group Ltd
Exchange: ASX Symbol: MQG
Date: 11-May-20 Latest price: $108.50
Market Cap: $38.8 bn Fair Value: $125.42
Forward P/E: 15.6 FV Payback (Years): 11
Forward Dividend Yield: 4.09% CET1 Capital Ratio: 12.2%
Financial Y/E: 31-Mar-21 Rating: HOLD
Sector: Financial Services Industry: Capital Markets
Investment Theme: Dividends & Growth LT Trends: none


We consider Macquarie (MQG) to be priced at below fair value, but the technical outlook is bearish.

We rate the stock as a long-term HOLD because of its strong cash flows and competitive position. Weighting is 5.0% of portfolio value.


We project flat annual revenue growth in the next 12 months, recovering to 8% in the long-term, with a provision of $1.5 billion to cover further impairment charges and under-performance of market-facing businesses. Estimated fair value is $125.42 with a payback period of 11 years.

The payback period recognizes MQG’s strong market position but also the uncertainty of financial markets.

Technical Analysis

MQG is in a primary down-trend and we expect another test of primary support at 70 before the bear market is over. Trend Index and Momentum below zero both warn of bearish market sentiment. Respect of primary support would provide a solid base for a new primary up-trend. Breach is unlikely but would flag another decline and a strong bear market.

Twiggs Trend Index & Twiggs Momentum (13-week)

Company Profile

Macquarie Group is Australia’s only sizable investment bank. Internationally diversified, the group employs 15,849 people in 31 countries, with its head office in Sydney, Australia.

Macquarie was innovative in setting up large infrastructure funds which provided a captive client for the group but most of these were dissolved after the 2008 global financial crisis and have been replaced as an income source by other annuity businesses. FY20 net profit contribution by activity:

MQG Profit Contribution by Division - FY20

Asset Management (MAM) manages infrastructure and real assets and securities investments for both retail and institutional clients in Australia and the US, with a total of $A607 billion under management in FY20.

Corporate and Asset Finance (CAF), with an asset and loan portfolio of $A21.3 billion (FY19) was broken up and integrated into MAM, CGM and Macquarie Capital in FY20.

Banking and Financial Services (BFS) has a retail deposit book of $63.9 billion, an Australian loan and lease portfolio of $A75.3 billion and a wealth management platform with funds of $A79.1 billion (FY20).

Commodities and Global Markets (CGM) offers broking, trading, hedging and finance on global securities markets including equities, fixed income, foreign exchange and commodities.

Macquarie Capital (MC) provides corporate finance advisory and capital raising services to corporate and government clients.

International Income

MQG International Income - FY20

International income1 is net operating income excluding earnings on capital. Australia2 includes New Zealand.


Macquarie competes with local commercial banks, fund managers and securities houses, and — with 67% international income in FY20 — a multitude of international investment banks.


Annuity-based businesses performed well in FY20 but cyclical, market-facing divisions experienced a significant fall in net profit contribution.

Asset Growth

  • MAM assets under management grew 10% to $605.7bn in FY20, compared to $551bn in FY19;
  • Banking & Financial Services (BFS) loans and leases grew 20% to $75.3 bn, funded by a 20% increase in deposits to $63.9 bn.


Market-facing businesses under-performed in terms of net profit contribution1 in FY20:

  • Commodities and Global Markets (CGM) were level with FY19; while
  • Macquarie Capital (MC) fell 75% after a stellar 89% increase in FY19.

Annuity-style businesses improved in FY20:

  • Asset Management (MAM) was up 16%;
  • Banking & Financial Services (BFS) were up 2%.

Net Profit Contribution1 is calculated before unallocated corporate costs, profit share and income tax.

Return on Equity

Return on equity fell to 13.6% due to an 88% increase in impairment charges ($1.04 bn compared to $552 m in FY19), related to the COVID19 outbreak and weak results from market-facing businesses.

MQG Return on Equity and Return on Assets


Staff costs are Macquarie’s largest operating expense. Long-term growth in the ratio of Net Income to Employment Costs reflects Macquarie’s increased ability to leverage operating expenses.

MQG Net Income/Total Compensation

Assets under management

Assets under management have grown at a compound annual rate of 6.4% over the last 10 years (FY10 to FY20).

Earnings per share

Earnings per share (EPS) has grown at a compound annual rate of 8.6% over the last 10 years or 9.6% over the last 5 years.


We project long-term growth of 8% in annuity-based assets (AM, BFS & CAF) and in earnings per share.

Capital structure

CET1 (Common Equity Tier 1) Capital Ratio improved to 12.2% in FY20 (FY19: 11.4%) calculated on risk-weighted assets using APRA Basel III standards.

The unweighted CET1 Leverage Ratio, based on total credit exposure, however, weakened to 5.1% in FY20 .

Capital ratios are adequate but not strong by our standards.


Dividend payout of $4.30 (40% franked) for FY20 is down 25% compared to FY19 ($5.75 and 45% franked). We consider the dividend payout ratio of 56% (FY20) to be sustainable.

Forward guidance

Guidance for FY21 has been withheld because of uncertainty surrounding the COVID19 outbreak.

We have made a provision of $1.5 billion to allow for uncertainty over further impairment charges and under-performance of market-facing businesses.

Strengths & weaknesses

Macquarie is a world-leading infrastructure fund manager and in an excellent position to capitalize on massive expected investment in global infrastructure and renewable energy over the next decade.


Like most investment banks, Macquarie relies on market knowledge and resourcefulness to identify new opportunities and innovate existing businesses. While they have an excellent track record, they can still make mistakes.

Cyclical fluctuations may affect performance.

BFS exposure to the highly-priced Australian property market is a vulnerability.


Staff of The Patient Investor may directly or indirectly own shares in the above company.

Australia: Major banks


Our review of APRA’s June 2019 quarterly report on the four major banks — Commonwealth, Westpac, ANZ and NAB — concludes that they are collectively priced at a 16.5% premium over fair value.

Technically, the ASX 300 Banks Index ($XBAK) is experiencing secondary selling pressure and a correction is likely.

A correction would reduce the premium over fair value and may present buy opportunities.


We project:

  • long-term asset growth at 3.0% p.a. (down from 4.0%);
  • net interest margins at 1.65% of average total assets (down from 1.70%);
  • non-interest operating income of 0.5%;
  • operating expenses at 1.05% (previously 1.10%);
  • provisions for bad/doubtful debts averaging 0.2%;
  • additional equity capital required of $12 billion; and
  • a 30% tax rate.

That delivers a forward PE of 16.9 based on a market cap of $399 billion.

We estimate that the major banks are priced at a 16.5% premium over fair value, based on a 12-year payback period*.

*Note to readers: we have simplified our model by removing the margin of safety and use a lower payback period instead.

Technical Analysis

The ASX 300 Banks index retreated below its rising trendline, warning of a correction. Follow-through below support at 7600 would strengthen the signal, with a target of primary support at 6750.

ASX 300 Banks Index

Book Growth

Total assets are the primary engine of bank revenue. Heady growth of the last two decades ended in 2015, when the ratio of total assets to nominal GDP (right-hand scale) started to decline. Nominal GDP also slowed (5.4% p.a. in June 2019) and is likely to restrict future book growth.

Majors: Total Assets Annual Growth and compared to Nominal GDP

Household debt near saturation level, at close to 200% of disposable income, is another headwind to future book growth.

Australia: Household Debt to Disposable Income

Total asset growth of the major four banks slowed to 1.4% for the twelve months ended June 2019 and we have reduced our long-term projection to 3.0% per year.


RBA rate cuts are squeezing net interest margins, currently 1.73%, and we expect a long-term average of 1.65% of total assets.

Majors: Income & Expenses

Expenses declined to 1.09% of total assets but non-interest income, at 0.56%, is falling even faster.

Non-Interest Income

Fees and commissions — the major component of non-interest income — have suffered the largest falls. Transaction-based fees are the worst performer, while declining credit growth has reduced lending-based fees. The sharp drop in other fees, to 0.19%, is likely to be permanent as banks shed their wealth management operations.

Majors: Fees

We project non-interest income to average 0.50% of total assets in the long-term.


Operating expenses declined to 1.09% of total assets, as the majors attempt to cut costs in line with income, but personnel costs have proven sticky and are falling at a slower rate.

Majors: Operating Expenses

Non-Performing & Past Due Assets

Charges for bad and doubtful debts remain low at 0.09% of total assets but we expect a long-term average of 0.20%.

Majors: Charges for Bad & Doubtful Debts

Impaired loans are falling as a percentage of total loans and advances but past due loans have climbed to 0.6%, reflecting mortgage stress.

Majors: Impaired Assets

Provisions for impaired loans, however, are reasonable at 95.8% of impaired facilities including security held.

Majors: Provisions for Impaired Assets


Common equity Tier 1 capital (CET1) remains low, with a CET1 capital ratio of 10.8% in June 2019, based on risk-weighted assets. CET1 as a percentage of total assets is a low 4.96%.

The Reserve Bank of New Zealand has called for “more skin in the game“, asking the big four Australian banks to increase their capital holdings in New Zealand subsidiaries by $12 billion:

The RBNZ proposal calls for systemically important banks to hold a minimum of 16% Tier 1 capital against risk-weighted assets, of which 6% would be a regulatory minimum and 10% would act as a counter-cyclical buffer to absorb losses without triggering “resolution or failure options”.

A similar move by APRA is unlikely but RBNZ presents a problem for the big four banks as they will have to raise additional equity to capitalize their NZ subsidiaries. One alternative is to raise equity through a separate listing of their NZ subsidiaries but this is still likely to dilute returns on equity.

Return on Equity

Declining return on assets and increased capital requirements are both exerting downward pressure on return on equity (ROE), from a peak of 20.5% in 2007 to 9.7% in March 2019.

Majors: Return on Total Assets & Return on Equity

Management & Culture

Australian regulator APRA is suffering from regulatory capture. A 146-page capability review, stemming from David Murray’s Financial System Inquiry found APRA “slow, opaque, inefficient, and in urgent need of a culture and leadership overhaul.”


Staff of The Patient Investor may directly or indirectly own shares in the above companies.

Medibank Private Ltd (MPL) plunges on cost spike

Medibank Private (MPL) broke support at 3.20 and its rising trendline, warning of a decline to test primary support at 2.30. Closing of the gap at 2.90 would strengthen the signal.

Medibank Private (MPL)

We eliminated our exposure in July 2019 after the crisis facing Australian private health insurers was first highlighted. Rising costs force up premiums which in turn makes it difficult to attract new subscribers. A shrinking base of younger, healthier members — who subsidise older members with higher costs — threatens a self-reinforcing spiral.

Patrick Hatch at The Age reports on the latest cost spike:

Medibank Private chief executive Craig Drummond says an “alarming” and “curious” increase in surgeries involving prosthetic devices is driving up costs and threatening the stability of the private health sector….

Mr Drummond said claims were driven higher by the volume of prostheses — such as hip and knee replacements and other medical devices — which grew by 8.5 per cent last year, compared to 2 per cent and 4 per cent growth in the previous two years, respectively.

“We’ve got surgical volumes that are flat-ish, and we’ve got prostheses volumes that are close to double digits,” he told investors.

“We’re very curious about what’s going on. Something doesn’t feel right. It’s quite inverse to the situation that we’ve had over the last two or three years.”

A deal between government and medical device makers to put a cap on how much insurers had to pay for prostheses was supposed to deliver $200 million in savings last year. But Medibank said it only saved $13 million because of the rise in the number of devices being implanted.

WiseTech Global Ltd (WTC)

Stock: WiseTech Global Ltd
Exchange: ASX Symbol: WTC
Date: October 22, 2019 Latest price: $26.30 AUD
Market Cap: $8.3 bn Fair Value Estimate: $10.36
Forward P/E: 100 Fair Value Payback: 12 Years
Financial Y/E: 30 June Rating: Sell
Sector: Technology Industry: Software – Infrastructure
Investment Theme: Long-term Growth Structural Trends: Software as a Service (SaaS)


We consider Wisetech (WTC) to be over-priced and rate the stock as a SELL.

Wisetech enjoys dominant market share in a niche market, and is an attractive business at the right price. At present the stock is trading at a sizable premium to estimated fair value and is under attack from short-sellers.


In past updates we identified the capitalization of software development costs as a weakness and valued the stock accordingly.

Several recent articles in the press have raised questions over Wisetech (WTC) value:

“When a company is priced at these nose-bleed levels there can be no room for error. These companies need to grow revenue or profit exponentially to justify the share price.

Any suggestions that profit or revenue have been pumped by accounting treatment would be a concern.” (The Age)

Wisetech responded with a rebuttal but a second trading halt was called as the short-seller JC Capital responded with further attacks.


We revised our fair value estimate to $10.36 (AUD), based on 30% growth, as the company continues to benefit from acquisitions, and a reduced payback period of 12 years.

Technical Analysis

Wisetech is testing primary support at $26 after the attack from short-sellers. Trend Index dipped below zero, signaling a bear market. Momentum is falling but has yet to confirm the bear signal. Breach of support is likely and would signal a primary decline with a target of $14.

Twiggs Trend Index (13-week)

Company Profile

WiseTech is a leading global provider of logistics solutions through its SaaS platform. Founder Richard White is CEO and the largest shareholder.

WiseTech develop, sell and implement software solutions that enable logistics service providers to facilitate the movement and storage of goods and information, domestically and internationally. They service around 8,000 logistics organisations across 130 countries.

WiseTech’s flagship technology, CargoWise One, is an integrated global software solution for logistics service providers that enables customers to execute highly complex logistics transactions and manage their operations on one database across multiple users, functions, offices, countries and languages. They operate their own data centres and deliver CargoWise One software principally through the cloud, as SaaS, which customers access as needed and pay for usage monthly.

Markets & Competitors

WiseTech has built a dominant position in its niche market. Customers range from large multi-national companies to small and mid-sized regional and domestic players, including 24 of the top 25 global freight forwarders and 34 of the top 50 global third party logistics providers (Armstrong & Associates: Top 50 Global Third Party Logistics Providers List ranked by 2017 logistics gross revenue/turnover).

Customer retention is high, at over 99% per year.


Capitalisation of R&D expenditure assumes that expenditures can be scaled back in future years. This is not always achievable with software development.

Dependence on Richard White (founder, CEO, and majority shareholder) who may be difficult to replace if he loses the ability to effectively manage or attempts to execute a flawed strategy.

Financial Performance

Revenue Growth & Acquisitions

Revenue growth for the period FY15 to FY19 is close to 50% p.a., boosted by heavy spending on acquisitions in FY18 and FY19.

Revenue & Acquisitions

Organic revenue growth ranges between 20% and 30% p.a. according to a recent announcement.

Wisetech made 29 acquisitions at a total cost of $587 million in the two years FY18 – FY19, primarily logistics solutions businesses spanning new geographies (for local customs know-how) and new technology.


Net income (NPAT) grew at slightly above 50% since FY15, similar to revenue, exceeding revenue growth, indicating stable margins.


Research & Development

The company invests heavily in research and development, spending around 32% of revenue.

Cash Flow

Wisetech spends heavily on acquisitions and free cash flow, after investing activities, is negative in recent years.

Free Cash Flow

Capital structure

Wisetech has minimal borrowings, with acquisitions funded by stock issues, and a strong cash balance of $260 million (FY19).

Financial Outlook

Wisetech forecasts that revenue growth will slow to between 26% and 32% in FY20, while EBITDA growth is slightly higher at 34% to 42%.

FY20 Outlook

EBITDA is not a fair reflection of performance as the company capitalizes significant software development costs. EBITDA adjusted for capitalized costs is a more modest $90m – $98m.


Staff of The Patient Investor may directly or indirectly own shares in the above company.

Telstra Corp Ltd (TLS)

Stock: Telstra Corp Ltd
Exchange: ASX Symbol: TLS
Date: September 12, 2019 Latest price: $3.59 AUD
Market Cap: $42.9 bn Fair Value Estimate: $3.83
Forward P/E: 16.6 Fair Value Payback: 13 Years
Financial Y/E: 30 June Rating: Hold
Sector: Communications Services Industry: Telecom Services
Investment Theme: Dividends & Growth Forward Dividend Yield 2.81% (fully franked)


Telstra is a defensive stock with dominant market share in mobile, broadband and the rapidly shrinking fixed line market.

We assign a fair value of $3.83 based on an EBITDA of $7.7 billion (net of $3 billion hole from NBN roll-out less $1.3 billion in expected cost savings), 4% long-term growth, $10.7 billion compensation from the NBN rollout (net of expected future redundancy costs), a 10% margin of safety and a 13 year payback period.

Telstra would not be suitable for international investors who cannot take advantage of franking credits on dividends.

Our current rating is HOLD because of the correction on the chart below. We plan to upgrade this to BUY if Trend Index (13-week) forms a trough above zero.

Recommended portfolio weighting is 5% of portfolio value.

Technical Analysis

Telstra is currently undergoing a correction after an impressive rally since the start of 2019. We expect the correction to find support at $3.20. A Trend Index trough above zero would indicate buying pressure.

Twiggs Momentum and Trend Index (13-Week)

Company Profile

Telstra is the largest player in the Australian telecommunications industry and owns and operates an extensive telecommunications network. Telstra markets voice, mobile, broadband and pay television (35% of Foxtel) and enjoys strong brand recognition. They boast the widest mobile coverage and jealously guard competitor access to their network.

Competitors & Markets

Optus (a subsidiary of SingTel) competes mainly in mobile, broadband and voice. It owns and operates its own network but also uses the wholesale services of the NBN and Telstra. Optus was making inroads in the broadband and mobile markets, bundling services with free sports coverage of the 2018 Soccer World Cup, but this led to an embarrassing failure when their network proved incapable of handling the traffic volume.

TPG Telecom Ltd (TPM) is an Australian telecommunications company and one of the fastest growing domestic Internet service providers in Australia. Under the TPG, AAPT and iiNet brands, the group enjoys a 26% share of the Australian broadband subscriber market (or 1.9 million subscribers). Margins have suffered as migration to the NBN grows.

TPG proposed a merger with third mobile network provider Vodafone but this has so far been blocked by the Australian Competition and Consumer Commission (ACCC) on the grounds that the merger would lessen competition between mobile players. Vodafone has appealed the decision.

The ACCC found that TPG would have the capacity to roll out a new 4G mobile network in the coming years and therefore allowing the two parties to merge would remove this additional competitor from the market. TPG’s counsel Ruth Higgins told the court that TPG's ability to build a 4G network was already outdated with new 5G technology. "5G isn't just a possibility. It's a product." (The Age)

TPG is the second biggest player in fixed broadband and Vodafone ranks third in mobile. A deal would leverage Vodafone's existing underutilized mobile network and save TPG on infrastructure spending. A combined entity would still rank third in mobile but would be more able to compete with Telstra and Optus in the 5G market, spreading the large capital costs over a broader subscriber base.

5G Wireless Network

Extensive capital outlays required to implement 5G are only within the means of the largest players. Telstra's choice of Ericsson as its major 5G supplier has given them an advantage over Optus who had tied up with Huawei before the Australian government banned them from supplying 5G equipment:

Australia's secretary for foreign affairs and trade said her government's guidance to keep equipment from Chinese makers Huawei Technologies and ZTE out of 5G wireless networks was made after national security risks were assessed from "all possible angles." (Nikkei Asian Review)

Why Invest in Telecommunications?

The Australian telecommunications industry has gone through a torrid time in the past two years, with disruption from the National Broadband Network (NBN) eroding the competitive advantage of larger players and consequently margins. The ASX 300 Telecommunications Index fell more than 56% between 2015 and 2018.

ASX 300 Telecommunications Index

The Australian telecom industry occupies a unique defensive position. The industry is dominated by a few players, with low threat of competition from offshore because of the massive infrastructure investment required and high existing levels of penetration in a mature market.

Total number of broadband subscribers increased to 14.21 million in December 2017 from 13.64 m a year earlier (ABS), a growth rate of 4.2%. But data usage is growing exponentially, with downloads up by 38.6% to 3.6 million Terabytes (TB).

Australian Broadband Usage

Source: ABS

Mobile usage shows a similar pattern with subscribers up by 4.9% to 26.7 million by December 2017, while data downloads increased by 39.1%.

Structural trends show promise, with online services and the Internet of things — rising connectivity across devices from motor vehicles to television sets and refrigerators — expected to grow exponentially.

Wireless and mobile data usage are small (9%) compared to fixed line broadband but that is expected to change. Telstra has commenced roll-out of the 5G network which offers data rates of several tens of Mb/s and supports hundreds of thousands of simultaneous connections required for massive sensor deployments under the Internet of things.


Staff of The Patient Investor may directly or indirectly own shares in the above company.

Xero deep in overvalued territory (XRO)

From Morningstar today:

“Cloud-based accounting software firm Xero has booked a strong result but the WAAAX club member remains deep in overvalued territory, says Morningstar.

Xero this week reported a solid first half 2019 result, which included a 36 per cent boost in revenue and a 31 per cent jump in subscriber numbers.

But still, 2019 marks the 11th consecutive year of losses for Xero, which is a member of the so-called Australian tech stock club, known as the WAAAX, which include WiseTech, Afterpay, Altium, and Appen…..”

This supports our view, from January 2019:

“We consider Xero Limited (XRO) to be over-priced and recommend waiting until market price aligns with fair value.”

Xero is currently priced at $60.14, whereas our estimate of fair value, from January 2019, is $31.75, based on a 10-year payback period.

Rural Funds Group (RFF)

Stock: Rural Funds Group
Exchange: ASX Symbol: RFF
Date: March 6, 2019 Latest price: $2.27
Market Cap: $757.4 m Fair Value Estimate: $1.49 (Gordon’s Growth model)
Forward P/E: 15.4 Net (adjusted) Asset Value: $1.75
Financial Y/E: June 30 Rating: Underperform (LT)
Sector: Real Estate
Industry: REIT – Agriculture
Investment Theme: Dividends & Growth Structural Trends: Global population growth and rising middle class in Asia.

Company Profile

Rural Funds Group is a real estate investment trust (REIT) that specialises in agricultural properties which it leases to tenants on long leases.

Farming sectors include:

  • cattle
  • poultry
  • cotton
  • tree nuts (almonds and macadamias)
  • vineyards.

RFF also invests in water rights.


Strengths & Weaknesses

Long-term global population growth is expected to increase pressure on food and water shortages, driving up agricultural prices. Rising living standards in Asia have also led to increased animal protein consumption:

We are likely to face increasing scarcity of food and water. Advances in technology have improved crop yields, but increased meat consumption in China and other Asian economies will reduce overall output. The area of land required to produce an equivalent amount of edible protein from livestock is 4 to 5 times higher compared to traditional grains and legumes, and up to 10 times higher for beef. Diversion of land use for ethanol production may also restrict food output. (The Patient Investor: Structural Trends)

There is a common misconception that “Farms don’t really deteriorate or need updating in the same way that shopping centres, warehouses or office buildings do (Motley Fool).” There is a symbiotic relationship between the farmer and the land. Only by investing time, effort and capital is the land likely to yield the best return. A tenant is likely to have a shorter-term outlook, without the same sense of stewardship towards the land.

It is also a misconception that triple-net leases mean that the tenant bears all the risk, while the landlord collects a steady return. Agricultural prices are notoriously volatile and the value of the land is determined by the return that can be achieved by the farmer. If prices fall for example, tenants may be unable to meet their rental payments and may seek rental relief until the market recovers. Weather events (drought, floods, hail, etc.), pests and disease can also impact on crops and livestock, affecting the financial viability of tenants.

Large scale tenants may be able to diversify risk but are still vulnerable to pricing and other widespread events.


RFF has some strong tenants, although it appears that the fund is carrying operational risk through its lease to Cattle JV, a wholly-owned subsidiary. We also note that recent cattle properties acquired, totaling $58.5m, are leased to Stone Axe Pastoral Company whose board is dominated by private equity firm Roc Partners (also likely to have a shorter-term outlook).

Another misconception is that rural funds only hold investments in agricultural land that is at low risk of impairment. Here is a breakdown of RFF assets at fair value:


Almost 20% of assets are trees and vines (bearer plants), while investment property includes “buildings and integral infrastructure including shedding, irrigation and trellising”. Intangible assets (12.7% plus 6.1%) consist of water rights, while finance leases (7.7%) include loans to tenants to fund establishment of feedlots and breeding herds.

Financial performance


Distributions per unit have grown at a healthy 5% p.a. from FY15 to FY19 (forecast), with management targeting 4% future growth.


Forward dividend yield, based on consensus estimates, is 4.66%.

Capital structure

The fund has $301.9 million of debt at 1H19 (pro forma), with a gearing level of 32.7% (based on adjusted asset prices). I consider this high for an agricultural fund, considering the variability of operating cash flows in underlying farming enterprises, and would prefer to see a lower limit of no more than 25%.


Stated net asset value at 1H19 is $1.75 per unit, based on most recent valuations of underlying assets.

Using Gordon’s Growth Model and a required return of 11% p.a., with 4% growth, we arrive at a fair value of $1.49 per unit.

Technical Analysis

Long-term Momentum declined in 2018, after a strong up-trend, as RFF consolidated above support at $2.00. But yields on quality REITs have recently been falling as the prospect of interest rate rises (in Australia) fades.

Twiggs Momentum

Support at $2.00 has held firm and rising Trend Index troughs indicate buying pressure. Breakout above $2.30 would signal a fresh advance, with an immediate target of $2.60.

13-Week Trend Index


While RFF may present a short-term trading opportunity if it breaks above $2.30, we consider it too highly-priced for a long-term investment.


Staff of The Patient Investor may directly or indirectly own shares in the above company.

Wesfarmers – Coles Demerger

Wesfarmers announced their intention to demerge Coles, along with senior leadership changes, on 16 March 2018.

Wesfarmers will retain 15 per cent of Coles and 50 per cent of flybuys.

Eligible shareholders will receive one Coles share for every Wesfarmers share that they hold.

“Demerging Coles enhances Wesfarmers’ prospects of delivering satisfactory returns to shareholders by shifting our investment weighting and focus towards businesses with higher future earnings growth prospects,” Chairman Michael Chaney said.

In short, Coles does not meet Wesfarmers’ hurdle rate of return for capital employed (ROCE). A defensive, non-cyclical business, Coles on its own may justify a lower required ROCE.

Coles Demerger (November 2018)

Coles Group Limited (COL) commenced trading on the ASX on 21 November 2018, after the spin-off from Wesfarmers was approved by the Supreme Court of WA.

Trading is initially on a deferred settlement basis, with the demerger expected to be implemented on 28 November 2018.

  • Following the Demerger, Wesfarmers will continue to be one of Australia’s largest listed companies and private sector employers with around 105,000 employees.
  • Wesfarmers’ business operations will include Bunnings, Department Stores (K-mart & Target) and Officeworks retail divisions and the Industrials division with businesses in chemicals, energy and fertilisers, and industrial and safety products.
  • Wesfarmers will also have a number of other non-controlling interests, including a 15 per cent interest in Coles.
  • For the year ended 30 June 2018, Wesfarmers’ post Demerger pro forma revenue was $27.5 billion, pro forma EBIT from continuing operations was $2,734 million and pro forma EBIT from continuing operations and excluding significant items was $3,040 million.