Computer Hardware – Apple and Samsung

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 When we mention computer hardware we all have a pretty good idea of what it is. It’s all the nuts and bolts and gizmos that go inside a computer right? Well yes, but there’s so much more than just that. Computer hardware is the collection of physical parts of a computer system. This could include the LCD screen, hard disk, CPU, motherboard, video card, keyboard and mouse.  Basically Computer Hardware in short – is the physical components you can touch that make up a computer system. There are so many different kinds of hardware components that can be installed inside and connected to the outside of a computer. Certain hardware components are easy to recognise such as the keyboard or monitor. And then there are others that are more difficult such a RAM or Graphics cards. A computer system is made up however of not just hardware but also of software. Both are required for a computer system to work. The companies that design and manufacture these hardware devices are some of the most profitable and valuable companies in the world. These include companies such as Apple, Samsung, Hewlett Packard, Intel, Dell and IBM are some of the most recognisable brands. Unfortunately there aren’t any local hardware manufacturers most are either American, Chinese or South Korean.

Apple (NASDAQ:AAPL)
We all know who Apple is. Steve Jobs started Apple in 1976 in the garage of his house and it has since become a historic site. Apple’s very first computers were stacked in boxes in Steve Jobs’ bedroom when he was only 21 years old. Jobs and friend Steve Wozniak built 50 basic computers in Jobs’ parents’ house. The ‘Apple 1’ computer was built on order for a local computer shop before the duo shifted their makeshift operation downstairs to his garage. Now the company is worth well over $600bn and is the world’s most valuable brand. Headquartered in Cupertino, California, Apple Inc (AAPL) has been at the forefront of the computer hardware industry since its founding. It first produced the Apple Macintosh computer and then went on to create the MacBook, iPod, iPhone, iPad and Apple Watch smartwatches. Apple sells its products through retail and online stores such as JB Hi-Fi, direct sales and third-party network carriers such as Telstra and Optus. It has been dubbed as the most recognisable and popular brand in the world. With sales of $199.bn and assets of $261.9bn you can understand why. The company has come a long way from just manufacturing PC’s and iPods. Its flagship iPhone product is still the breadwinner. In-fact the iPhone contributes over 65% of the company’s total revenues and over 75% of its gross profits. 2016 was a difficult year for the iPhone which saw its first decline in sales which were down 12.5%. This was due to lower uptake of the iPhone 6S and higher competition from Samsung and other phone makes. But things are looking OK for 2017. Bulls

  • Apple’s flagship iPhone 7 product is expected to do well this year. The new phone comes with superb primary camera of 12MP, touch focus, geo-tagging , simultaneous 4K video and 8MP image recording , face/smile detection & HDR.
  • The new iPhones will feature Apple Pay which becomes available around the world. Apple critics say Apple Pay is innovation of the highest order and will become the future payment system.
  • Apple own its own platform – iOS unlike Samsung. Therefore telephony sales margins are high. The company is not required to pay fees to use a platform like Android.
  • Apple has its own ecosystem of interconnectable devices thereby avoiding competition from third parties. Recently it replaced the standard headphones with the AirPods.
  • The company has invested heavily in Artificial Intelligence which has many applications going forward.

Bears

  • Competition is rife. iPhone has very tough competitors such as the Samsung Galaxy and the Google phone. iPhone unit sales declining in fiscal 2016 but holding their margins.
  • All of Apple’s phones are manufactured in Taiwan and China. If Trump introduces an import tax, Apple’s costs will go up and it will need to restructure its operations or pass the costs onto the client.
  • Apple makes more money from iPhone than they make from any other product. Therefore there is downside risk in relying on one flagship product. Samsung on the other hand, is a conglomerate that produces phones, semiconductors, white goods to TVs.
  • Another seems to have hit a brick wall. With Jobs the company was innovative it produced so many wonderful products such as the iPhone, iPad, Apple Watch, and Apple TV. But where to now?

Unconventional View
The iPhone 7 is doing a lot better than its predecessor due to better features such an improved cameras and water resistance. Customers who have been burnt, literally, from the Samsung Note 7 are actively switching to the iPhone. To add to it, iPhone is expected to launch a brand new redesigned 10th anniversary iPhone towards the end of the year. Apple‘s new wireless headphones, the Airpods, went on sale towards the end of 2016 and is another area that’s creating a real buzz. Airpods are the headphones that come with the iPhone 7. They enable users to listen to music and phone calls wirelessly, much like other Bluetooth headphones do. That could be a game changer for Apple. On the fundamentals Apple trades on a PE of around 14.45x which is neither cheap nor expensive. Its ROE is quite high at 36% but its falling, which isn’t a good thing. On the chart APPL looks fairly attractive. The stock recently broke out on the upside and has formed a short term uptrend. Whilst Apple can be marked off as a mature business with limited upside, don’t write them off just yet. All it takes is for them to develop a new innovative whizz bang product and Apple will be back on top.

 Samsung (005930.KS)
The company grew from humble beginnings in 1938 as an exporter of dried fish to China, to being the world’s largest electronics company. Samsung was founded by Byung-Chull Lee in 1938 in Taegu, Korea and started off exporting fish and flour in Korea to China. He called it Samsung, which means ‘three stars’ in Korean. It then began to expand its offerings and ventured into life insurance and textiles during the 1950s and 1960s. Then in 1969 Samsung Electronics was formed as a division of the mammoth Korean chaebol Samsung Group. Samsung’s first black and white TV went on sale in 1970, PCs by 1983 as well as refrigerators, washing machines, microwaves, VCRs, colour TVs and tape recorders. By the 90s the company was developing the world’s first 64Mb DRAM which took the world by storm. Sales helped drive earnings to $14.94bn in 1994. Then as part of a new focus to diversify away from memory chips, Samsung ventured into telecommunications and its first mobile phone was released in 1995, which did not work. It then made a second attempt and released one of its first Internet-ready phones in 1999. Mobile would eventually grow into Samsung’s most profitable business. A lot of the company’s businesses were divested and the business restructured after the Asian crisis. Samsung started manufacturing HD TVs in the early 2000s along with Blu-Ray players and home theatre equipment. It’s now makes some of the best HD TVs you can buy. It was in 2010 that Samsung unveiled its first Android phone, the Galaxy S and the Galaxy Tablet. It sold over 24 million units worldwide and completely dominates the Android market.

Bulls

  • Is a conglomerate with multiple revenue sources from electronics to phones to white-goods. The company has been around for decades and is an effective product innovator.
  • Samsung dominates the smartphone market with the top selling Samsung Galaxy smartphone. It has the largest market share followed by Apple. The Galaxy series has huge demand among the customers with its special features, sophisticated look and good quality.
  • Samsung manufactures high quality televisions and also dominates this market along with LG and Sony. Its TVs are considered high-quality devices that offer unique features, such as the curved screens but they tend to be more expensive than sets produced by other brands.
  • Despite the phone disaster, Samsung’s profit rose 50% and at the highest level in more than three years due to its semiconductor business which is soaring due to strong demand. It contributes more than half of the company’s earnings.

Bears

  • The company’s reputation and brand was tarnished this year due to exploding batteries in its Galaxy Note 7. It was forced to recall every smartphone sold and stopped all sales and shipments. It was a costly mistake as Samsung worked with government agencies and carriers around the world to provide refunds and exchanges for the phone. Samsung’s exploding phones disaster could cost the company $17 billion.
  • The US Court of Appeals for the Federal Circuit has reopened a long running case between Apple and Samsung. Apple is accusing Samsung of copying the design of the iPhone for its Galaxy S series. If proven, Samsung could be up for hefty damages and will effectively have had to pay Apple a percentage of each sale. This could really be a game changer.
  • Samsung lacks its own platform. It uses Google’s operating system for its Galaxy products and therefore its margins are a lot thinner than Apples. Software and OS production has a high profit margin. Whilst Samsung is a hardware leader it’s too dependent on software from other parties. This is a major disadvantage.
  • Samsung is at disadvantage over its competitors because it loses a focuses on too many products.

Unconventional View
Samsung has a lead over Apple in phone sales. Samsung shipped 81.3m phones in the 1Q16 compared to Apple’s 42m phones during the same period. Samsung’s market share is 27.8% versus Apple’s 14.4% driven by its latest Galaxy S7 smartphone which sold 10 million units in March alone but the company has been inthe spotlight for all the wrong reasons. It’s been a tough year for Samsung Electronics with costly product recalls and exploding handsets. Samsung has not only lost market share as a result but the threat of injury or fire from its devices has damaged its reputation. It also led to a global recall of 2.5m units including unsold stock and revealed that it was faulty batteries that were the cause. The product was scrapped in the end wiping off roughly US$5.3bn off its operating profit in one of the biggest tech fails in history. Whilst the company survived the fiasco, Apple and other Android smartphone brands have taken advantage and gained market share. Samsung’s brand intent fell from 32% to 19% with interest shifting to devices such as the Google phone and Huawei. Apple remains the first smartphone for Aussies with brand intent having a 62% rating. Whilst its phone exploding problems have been a real headache for the company, it hasn’t dampened investor demand. Remarkably the company’s share price has continued its steady rise and is hitting all-time highs. The initial recall caused a fall in the share price, but the stock has since recovered. The reason being, phone sales aren’t the main revenue generator. Samsung not only sells phones but it sells TVs, display screens, semiconductors and consumer electrics. Up until 2014 phone sales made up the majority of the company’s revenue but now its main revenue source is semiconductors and display units. As handset profit margins shrink and competition rises, Samsung shifting its focus to display units and semiconductors. As it’s done in the past, Samsung is trying to stay ahead of the game and investors like what they see. 

 

2 stocks that are set to explode – MMJ & WTC

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In this section we look at two stocks that we think investors should keep an eye on. For one reason or another, these two stocks have announced a positive catalyst and as such are about to soar. We see whether the upside risks are worth investors gaining exposure or whether the stock are worth buying. We will look at company’s fundamentals, technicals and thematics.

MMJ Phytotech (MMJ) – Is a newly listed company that is establishing the development of medical cannabis developer systems in Israel, Europe, USA and Canada. These countries all have regulated medical cannabis laws. In the past ASX listed cannabis stocks have been the subject of debate but have only come to light since the Federal Government decided to lift a ban on growing cannabis for medical purposes. Since October last year, shares in many of these companies have tracked sideways due to the regulatory and licensing hurdles still needed to distribute its products here. This month cannabis stocks caught a lucky break with the Turnbull Government approving medicinal marijuana importation used to treat patients with chronic or painful illnesses including cancer. It could be available as soon as 8 weeks under the new scheme. Medicinal marijuana is currently imported but the new scheme will see importation fast tracked while local cultivation, which has been legal since October 2016 will increase. It’s a massive boost to stocks that cover this sector. Currently there are a few – Creso Pharma (CPH) shares rallied 8%, MMJ Phytotech (MMJ) shares rallied 9%, MGC Pharmaceuticals (MXC) shares up 8% and AusCann (AC8) shares up 24%. We think traders and investors should look to buy MMJ at these levels especially now that the Government has given the green light to medicinal cannabis. It’s the first time in history that the Government will facilitate an import process for the interim supply. We think MMJ is the best pick of the lot. The company is putting together a portfolio of patent applications in process for medical cannabis delivery systems and controlled dosages. It is also utilises decades of medical cannabis research and patient trials. It has significant alliances with medical research centres in Israel that will help it deliver human trials, international patents and licensing. The company has commenced Phase 2 clinical trials on its PTL101 capsules which help treat refractory epilepsy in children. The capsules contain cannabidiol. To date there has been no effective drug that can control seizures in patients with the disease. Phase 1 was highly successful. The Phase 2 study will highlight the safety and high performance of its capsules. On the chart the stock has broken out on the upside following this week’s announcement. We think this break out is a bullish Buy indicator. However the stock is looking a touch overbought on the RSI with a reading of 75. Nevertheless, we think it’s a buy.

Wise Tech Global (WTC) – Shares have been on tear this month rising some 9.2% on a bumper profit result. The software firm beat consensus expectations with a whipping 361% increase in profit and reaffirmation of FY guidance. Gross profit came in at $59.5m up 40.7% driven by new client wins. Fully franked dividend of 1c. So what does WiseTech Global do? It is an innovative, global developer of cloud-based software solutions for the international and domestic logistics industries. It has over 6,000 customers and 150,000 module users across 7,000 sites in more than 115 countries. It’s impressive. The company’s leading product – CargoWise One provides end-to-end logistics solution and forms a link in the global supply chain. Basically it uses software and hardware to solve problems and create new ways of working and living. It allows users along the freight chain to interact and streamlines their operations into a simple process. The company listed on 11 April 2016 and is one of the biggest tech listings this year and is currently worth $1.3bn. The stock listed at $3.35 a share and raised $168m. It’s now trading at $5.57. It’s a great business and providing software that helps companies with their logistics and improves efficiency is an attractive model. The company posted what was a solid result that only further highlights its strong operational performance. Analysts are expecting the stock to be well-supported this year due to the solid performance. On the chart the stock has broken out on the upside triggering a bullish buy indicator. Overall the stock is in a long term uptrend formation and its RSI indicator is hovering around 58 which is not overbought. We think this stock is set to soar.

3 stocks from the herd – MND, NEC, VOC

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In this section we provide readers with three stocks that have attracted the interest of the broking community or the ‘herd’. Broker recommendations tend to be biased and highly optimistic. We try and breakdown these barriers and give our own honest opinion. It is important to keep in mind that technical analysis is only one part of the investment process and any recommendations do not give consideration to the underlying fundamentals of each business.

 Monadelphous (MND) – Current Price $12.65 – Had a solid earnings result with the company posting a NPAT of $28.6m and sales revenue of $630.7m which was in line with guidance provided. Interim dividend was 24c. The company was also swarded new contractsof approximately $700m. Broker View: Macquarie (UNDERPERFORM $10.81) – The broker has released a rather bearish report on the company. Whilst results were in line, it expects flat revenue in the 2H as business activity has stabilised. As a result the broker has cut its forecasts by 2% for FY18 and by 4% for FY19.

  Unconventional View: We disagree with Macquarie and the rest of the brokers. There are currently 5 Sells and 1 Hold on MND. Not a single Buy. We’re definitely taking the contrarian approach here. Firstly we think this week’s results were right on the mark. NPAT came in at $28.6m which was in line with expectations and sales revenue at $630.7m also in line. The market cheered the result and shares rose 6.8%. The profit was lower than the pcp and that was due to lower construction activity levels. It was partially offset by a rising Maintenance and Industrial Services business. More positively the company announced that it had locked in $700m in new contracts which highlights the success of its expansion into the infrastructure services sector. All in all, MND has a strong balance sheet and a clear pipeline of opportunities in new and existing markets. MND has also received a letter of intent to award a major five year contract for engineering, procurement and construction services on Oil Search’s (OSH) oil and gas production facilities in PNG. Whilst most brokers say the outlook is challenging, we think markets are looking a lot healthier and company guidance was positive. The company even said market conditions in the Australian resources and energy sector continue to be challenging though the market environment is stabilising. Construction opportunities in iron ore and up stream coal seam gas continue to come about. In summary we think MND is in great shape and in a position to take on board new projects and opportunities particularly in the infrastructure & renewables sectors and to diversify away from mining and energy. On the chart the stock looks particularly attractive. MND has broken out on the upside and has already formed a reversal in trend. It’s tracking along a short term uptrend. The 50 day moving average has crossed above the 200 day, which is a bullish signal (golden cross). The RSI indicator is sitting at around 67 and is heading to that overbought area. So we advise investors look at picking up the stock now.

 Nine Entertainment Co (NEC) – Current Price $1.04 – Delivered a $75m profit which was down 4%. Statutory loss of $236.9m for the half due to an impairment charge of $260m and $85m settlement figure. Dividend 4.5c. Its strong performance was driven by The Block and Married at First Sight both very strong local franchises that delivered audience growth 5% and 19% respectively of total. FY17 Group EBITDA to fall within current analysts’ range for FY17 of $158m to $187m (average of $175m). Broker View: UBS (NEUTRAL $0.90) – The broker has released a Neutral report which praises the company for beating expectations but is unsure whether it can be replicated this year. It says FY18 is hard to measure with revenue tipped to rebound out of Olympics year but costs will rise for NRL and the studio lease.

Unconventional View: We agree with UBS. The earnings report was surprisingly strong. NPAT came in at $75m which was a beat on consensus forecasts. The result was hit by an impairment and other specific charges which came to $311.9m. But strip that out, the underlying result was in line. NEC delivers 87% of its revenue from free to air television and the remainder from Stan which is a digital streaming service like Netflix. It owns 50%. What impressed us, is that the company has really turned around their free to air business and it dominated all other TV producers. Nine won all prime time key demographics post the Olympics in 2016. But it doesn’t stop there Nine’s solid result came on the back of the successful launch of Married at First Sight which has continued Nine’s ratings leadership and growth in 2017. The 7.30pm battle between My Kitchen Rules and Married at First Sight has turned into a fierce battle. My Kitchen Rules is still winning but the gap has closed and Nine’s wedding reality show is destined to take over. On the 14th Feb, Married at First Sight averaged 1.024 million across the five capital cities, to top My Kitchen Rules (1.023 million) by the narrowest of margins. To add to this, The Block was a ratings success and crushed The X Factor. The Block finale averaged 1.812 million and smashed the record previously set by its biggest competitor over at Seven. So as you can see, Nine has been making massive inroads and has turned its ship around. Shares have been hammered over the past year and are looking attractive at its current levels. On the chart the stock is on the verge of a reversal in trend. Whilst there has been a small upside break out, you really need to see it hit around $1.30-$1.40 to be sure. At the moment momentum is Neutral on both the MACD and RSI. We like the story and the stock, but we think investors should hold off just until the break out is confirmed. Buy at $1.30.

 Vocus (VOC) – Current Price $4.59 – has beaten expectations and booked a HY profit of $47.2m on revenue of $888.2m. Underlying NPAT was up 235.6% to $91.85m. The company has completed its NextGen acquisition. Broker View: Deutsche Bank (BUY $7.05) – The broker has put out a bullish report following the Vocus result. It says 1H results were in line with their expectations with organic growth returning across all of the telco’s divisions. Guidance and targets for FY17 reaffirmed.

Unconventional View: We agree with Deutsche. There are currently 6 Buys on Vocus which is reassuring. We think the worst is now behind and Vocus is set for take-off. This week’s result was above most broker’s forecasts even though it was a low quality beat. Organic growth is returning and most of the telco’s earnings will be skewed to the 2H. Underlying NPAT came in at $92m which was a beat on forecasts driven by a number of transformative deals and acquisitions. The result did include contributions from its purchase of M2 and NextGen networks. What was impressive however was that the telco reaffirmed its guidance for EBITDA to hit $430m-$450m for the FY. We think it will reach its target when it reports later in the year. Overall it was a strong set of numbers and its acquisitions are starting to pay off. We think the stock has hit a turning point and investor confidence is returning. On the chart the stock looks to have bottomed. We have held back from writing anything positive on Vocus until we were sure that the stock had formed a reversal pattern. This looks to be happening. Vocus has clearly broken out on the upside and is on the verge of a new short term uptrend. It’s a risky buy. Some investors might want to wait a touch longer for confirmation. We think Vocus is attractive now and would be happy to buy at these levels.

 

You’re better off panning for gold than investing in your friend’s startup.

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Your friend or contact comes to you seeking funding for their startup. They say it’s a golden opportunity. You should invest right? Well, 90+% of the time, the answer is no. Venture capital is like panning for gold. 90% of startups fail, so most of what you see are clumps of brownish dirt, but occasionally you’ll come across one of the shiny nuggets that makes up most the sector’s earnings. So, is now the time stake your claim? The best time to dig is before others start looking. In 2015, Australian GDP was over USD$1.3T, yet total venture capital investment was ~$300M. India, with GDP of USD$2.0T did 12x that investment in the third quarter. “But India’s a developing country!” Look at the US – $20B went into early-stage VC investments there last year. In Australia – $120 million. As a percentage of GDP, the US puts ~12x as much into early-stage VC. “But Australia is a small market!”

Anyone that tells you that has rocks in their head. Australia is a hidden treasure, and its greatest natural resource isn’t coal or iron ore. It’s our consumers. They are educated, rich, and willing to take a punt on new services.  Uber launched its first Aussie city – Sydney – about four years ago. Today 1 in 10 Australians nationwide has an Uber account. What’s more, the Australian government provides incredible incentives to startup investors (with conditions and limits – talk to your accountant). These include a 20% (carry-forwardable) tax offset (for every $5 you invest in a startup, you reduce this year’s tax bill by $1), and gains that are shielded from CGT for 10 years once the investment is held for a year. Obviously, these incentives are most attractive if you find something of value; so how do you find the golden nugget?

Beware of Pyrite (Fool’s gold) 

Here’s three questions that will help you separate the gold from all that glitters: Q1) – “Describe your business in a sentence.” if the founder is calling themselves the ‘Uber/Tinder of X’, find a new claim. Besides it being a cliché, it usually means the founder hasn’t really thought through the problem they are trying to solve. Every market is different. The unique factors that helped precipitate Uber’s success are usually less relevant in other markets. Q2) – “Where do you see this business going?” Sift past founders that are too focused on quickly selling to an incumbent or competitor. It’s typically a sign of a lack of commitment. Founder economics are different to investor economics – you are diversified, and they are not. Founders of this ilk – especially ones who haven’t made money before –  are likely to jump too early from a good idea – which means you won’t get a meaningful return. If you are in early, don’t expect any liquidity for 7 years or more. Q3) – “How much money do you need and what will you do with it? Unlike Sovereign Hill, venture investment is not for tourists. If someone is asking you for tens (or hundreds) of thousands of dollars, and don’t have a clear idea of how it will be spent, or can’t justify how they arrived at those assumptions – you’ve found a claim jumper. Same goes for a pitch deck (or an awesome exec summary). It’s like a pick axe. If they are raising, they should have one. Spend your time with professionals. The 3 M’s If these questions haven’t led you to sift out a squatter, it’s time to dig into the 3Ms: Management, Market and Maths:
1. Management – Can they prospect?
Do they know how to build technology? – in early stage startups, team is the most critical thing. One good sign is a founder with a solid technical background (e.g., a product manager, or an experienced engineer). Teams that lack technical experience on the founding team often struggle to build great products, and product usually wins in the end. Do they understand the numbers? – Look for folks who really understand the economics of the business today, and can speak to how their product has better economics than incumbents (more on this later). Are their incentives aligned with yours? – How much are they paying themselves? Do they have any other side ventures taking their time away? Your money is working full time; your founder should be too. 2. Market – Is it worth digging? There might be a gap in the market, but is there a market in the gap? Make sure the market is TIGHTLY defined (e.g., if someone is selling beer, they measure relative to the beer market, not all drinks). If they think they’ll grow the market – ask them why – hope they have a good answer. Adjacent markets are great, but they usually need adjacent offerings. Startups are capital constrained, so it’s difficult to do more than one thing really well, at least in the short term. So the key question is: “how much market share do you need to support a 10x return on investment?” if the founder can’t answer this question, it’s fair to assume they don’t understand their market or competition. If they can answer, ideally the answer is small, perhaps a few percentage points (or far less, depending on the market). How does that number compare to the market leader’s share? If you need 30%, and the leader has 30%, you’re entering a knife fight. Once you’ve ascertained the market, ask them “who is winning today”. Is this a winner-takes-all market, like classifieds (e.g., realestate.com.au)? In these markets existing players have the advantage: they have a ton of users, and users bring suppliers. Startups can enter, but it takes a great product, and a LOT of capital to win. If your startup is entering a winner-takes-all market, with a strong incumbent, and they have no cash – dig elsewhere. 3. Maths – Diamonds are forever, is your startup?
A good startup is like a money machine. put a coin into marketing, get users, they stick around for a while, spend money and the company clips a margin. As an investor you are buying a stake of this money machine, so you need to understand whether it works. It’s helpful to look at three areas: Profit margin, customer acquisition and growth (in that order) 3a) Profit Margin – “what is the lifetime value of a customer?” Ask:

  • How much revenue do they make (or expect) on average per customer, per month
  • What margin do they make on that revenue? – it’s fine to consider margin at scale – not necessarily today; but ensure they understand what will drive margin improvement, and that their argument makes sense
  • How long do customers usually stick around?

Lifetime value = (Avg Monthly Revenue per Customer * Gross Margin per Customer) ÷ Monthly Churn RateN.b., Average customer life is 1/Churn rate. So if your mate’s business earns $100/m in revenue from the average user, at 30% margin, and they lose 5% of customers per month, then the lifetime value of a customer is: ($100 x 30%) / .05 = $600 3b) Customer acquisition – Ask “who are your ideal users and how do you plan to acquire them?” Anyone can get users, if they are willing to pay. The key is getting the right ones at the right price. Founders should have an idea of what their ideal customers are, and a plan for how will they acquire them, the cost, and what competitors spend to acquire their customers. The customer acquisition strategy should also fit the business model. In some categories, Google clicks can be very expensive. In Australia, when someone searches for “car insurance” a single click can easily cost $50. Some clicks (e.g., in law, finance) can be multiples of that. And that’s just a click! Only a fraction of those become customers. Startups stumble by getting funding and flittering it away on marketing, without discipline or oversight. If the business has any traction, an analytical founder should be able to tell you cold: how successfully they are converting customers, where those successful conversions are coming from, and their customer acquisition cost (or CAC). A useful rule of thumb is that the lifetime value of a customer is 5x the CAC. If the company is getting clicks at $50, converting 5% of those, and lifetime value is $600, there’s a problem. 3c) Growth – Finally, if they have traction, look for 15% MoM growth. Growth drives growth. If a company hasn’t shown rapid growth with early offerings, chances are they haven’t achieved product-market fit – and without a pivot, it’s a fair bet that growth won’t happen. Once you find your rough diamond If the company has convincing answers to these questions, you might have hit pay dirt. In venture, a big success can provide a 100x return, so when deciding to invest, your conviction about their likelihood of success should be paramount. Unlike public markets, private opportunities can disappear quickly. Don’t nickel and dime on valuation – lest someone else stakes your claim. If you decide to strap in, prepare for an exciting ride. It takes a lot of pressure to make a diamond, so if the company is still around in a few years, you may have found a gem.

Ruwin Perera is moving back home to start www.different.com.au. He spent the last 6 years in Silicon Valley, most recently as a Principal at Softbank. Before that, he was a Principal on Google’s Global Business Strategy Team at Google HQ, and a Consultant with the Boston Consulting Group in San Francisco.

2 stocks you’d buy your Grandma – NCK & CGF

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 In this section we look at two stocks that you could comfortably buy your Grandma. Whilst you may think conservatives are best suited to your Grandma’s portfolio, some of these safe stocks have been the most dangerous in recent times. Look at Telstra, it has fallen almost 15% in the year. So in saying that, we think adding a bit of calculated risk to your grandma’s portfolio can be a positive thing. We have assessed two stocks that have already posted their results this week and see whether the upside risks are far greater than the downside and if the story reads well. We will look at company’s fundamentals, technicals and thematics.

Nick Scali (NCK) – Is a well-known Aussie importer of quality furniture and has a long and proud history. It sources products from around the world, and imports directly from some of the largest and most respected manufacturers globally. The company is well known for the highest quality of its products. Nick Scali Furniture imports over 5,000 containers of furniture per year which gives it superior buying power and economies of scale. The Company operates two brands; the Nick Scali brand and the Sofas2Go brand and has 41 stores throughout Australia. Products include: Dining furniture (dining table and chairs), Lounges (lounges, sofas, couches, modular and recliners), Chairs (occasional chairs and recliner chairs), Entertainment Centers, Coffee Tables and Outdoor Furniture. The company has been kicking goals of late with its share price up 62% since this time last year. This week the furniture manufacturer did it again, by posting a ripping interim profit result. NPAT came in at $20.5m hitting an all-time record rising 45% in the pcp and was above a consensus forecast of $18.9m. Like-for-like sales growth was 10.1%. And to add to it the company came out and provided a rosy outlook guidance statement which had the broker’s licking their lips.

Overall it was a very impressive result that ticked every box possible. Whilst most retailers are doing it tough with some even closing down, NCK is one that has defied expectations. Boss Nick Scali expects the good run to continue with an even better 2H in store. Broker Macquarie released a report saying the result was strong than expected with positive guidance the highlight. It shows that management are confident. We think stocks that are beneficiaries of the housing boom should continue to do well this and next year. These include stocks such as JB Hi-Fi, Harvey Norman and NCK. It’s the wealth effect taking from rising house prices taking over. It’s giving people confidence to go out and splurge. Of-course the opposite is true if there is a housing collapse. On the chart the stock has broken out on the upside and is making higher highs. And yes it does look very toppy especially on the RSI which is reading 80. Overbought indeed. But in saying that, there’s no reason why you can’t buy on the back of this bullish momentum and set a tight stop loss in-case it does pull back. We think that’s the way to go.

Challenger (CGF) – Is an annuity provider for customers in retirement. The company invests in creating wealth in the accumulation phase of superannuation and by converting accumulated wealth into safe and reliable income streams for retirees. The business has two operations: a fiduciary Funds Management division and an APRA-regulated Life division. Its funds management division manages some $62.1bn. Its Life Company is Australia’s largest provider of annuities and is a registered life company. Challenger Life guarantees the capital and interest in annuitants’ regular payments. It provides reliable income to around 60,000 investors through its management of $14.3bn in assets. It’s been an OK week for Challenger following their profit result. NPAT fell by 14% to $202m but it beat estimates for a $193m figure. The company says the fall was due to a one off item in 1H16, profit from selling its stake in Kapstream Capital. But the highlight was its strong annuity sales increase of 34% to $2.2bn. Its annuity business is booming. The company’s core business is selling annuities to retirees and a vast majority of the country’s baby boomers are entering this phase. The company has also flagged a Japanese distribution deal which has enormous upside potential. Then there is the deal with MS Primary which is another leg up for the annuities business. With the Japanese potential and booming domestic annuities business, Challenger is on the right track. It is also actively writing longer-duration annuities rather than shorter duration, which achieves a better return. An interim dividend of 17c was declared, 6% higher. But the most important bit – CGF reaffirmed its cash operating guidance of $620 to $640m. Macquarie has an Outperform recommendation on the stock with a target price of $12.34. The too agree that the result was in line and that there are a number of catalysts that will support growth in its life investment assets as well as in the funds management division. On the chart, CGF continues to track along its uptrend support line. On the RSI the stock is neither overbought nor oversold. So we think investors should be adding CGF to their portfolios at these levels.

Under the Microscope – Wesfarmers (WES)

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In this section we place one stock under the microscope and give it the unconventional assessment. Wesfarmers (WES) – We’ve all been to a Coles and Bunnings before, but many aren’t aware that it’s Wesfarmers that owns and manages many of these large blue chip names. Wesfarmers is really a conglomerate of various businesses such as supermarkets, liquor, hotels and convenience stores; home improvement, office supplies and chemicals, fertilizers, industrial and safety products. It’s even got its hands in coal mining. The Company’s segments include Coles; Home Improvement; Department Stores, which includes Kmart and Target; Office Works; Industrials, which includes Resources, WIS and WesCEF, and Other. Coles is a supermarket retailer, which operates over 770 supermarkets. Bunnings is a retailer of home improvement and outdoor living products in Australia and New Zealand. Kmart is a retailer with approximately 210 stores throughout Australia and New Zealand. Target operates a network of over 300 stores and sells a range of products for the contemporary family, including apparel, homewares and general merchandise. Officeworks is a retailer and supplier of office products and solutions for home, business and education. The company is Australia’s 8th largest company by market capitalisation.

 Bulls

  • Is a conglomerate with many business units, which means it is diversified across a broad range of industries such as hardware, supermarkets, energy and fertilizers. So for example, when the supermarkets division is experiencing low growth and weaker earnings it has the benefit of other business segments to offset this softness.
  • Bunnings is the hardware leader and has a monopoly position over Mitre 10 and other independent chains.
  • Wesfarmers has always been a strong growth story with sound management.
  • It’s portfolio of easily recognisable blue chip names such as Coles, Bunnings Warehouse, Kmart, Target, and Officeworks give the company brand loyalty and respect.

Bears

  • Coles has been losing market to Woolworths and Aldi. Competition is rife. The Woolies turn around plan is starting to take off and it has widened the gap with Coles. Woolies has market share dominance.
  • Aldi is also putting the pressure on by opening more and more stores and Costco has just started.
  • Amazon is the next big concern. It is rumoured to have aggressive plans to ‘destroy’ Australian grocery chains and retail. It could be a natural threat to Coles and its business model.
  • The coal price has sky rocketed of late and most analysts are now calling for a topping out. Coal prices could tumble back their normal levels with the next year offsetting any potential upside that had been expected.
  • CEO Richard Goyder has resigned.

Fundamentals

On fundamentals Wesfarmers fares OK. Its forward PE ratio sits at around 16.79x which is forecast to fall to around 16.57x. It’s closest rival Woolworths has a higher PE which makes it look a little expensive, but it does trade on a higher ROE. Woolies is more profitable. Yield is good sitting at around 4.41%. The highlight this month was its earnings. Wesfarmers posted an interim profit of $1.58bn which was up 13.2% driven a strong performance at Bunnings, Kmart, Officeworks and its coal division.

Technical Analysis
The Wesfamers chart isn’t too compelling. The stock has largely traded sideways for the most of 5 years. It was around $44 back in May 2013 higher than it is today. It’s now midway in a slightly upwards moving channel and is really a traders stock. You could pick it up around $40-$41 and sell at $45.  

 Broker Views

  • Macquarie has an Outperform recommendation with a target price of $44.70. The broker was happy with the recent results and says profit came in above its expectations. Whilst Coles is the laggard and margins are being squeezed, earnings are growing at a group level.
  • Ord Minnett has an Accumulate recommendation with a target price of $45.50. The broker agrees results were ahead of what it was expecting. Bunnings and Industrials the highlight whiles Coles disappointed.

Unconventional View It’s been a bumper year for WES with the company posting an outstanding profit result. The conglomerate recorded an interim profit rise of 13.2% to $1.58bn which beat expectations and had the market punching the air. But it wasn’t just the result that has stoked us, there were a number of announcements that came with the result that have the company at the forefront of a new and exciting era. Long serving CEO Richard Goyder has hung up his dancing shoes and will retire after 12 successful years at the helm. He leaves his successor Rob Scott with a $4bn war chest to spend on acquisitions or to return to shareholders. That is if his plans to offload Officeworks and its coal mines come to fruition. The plan is to IPO Officeworks at around $1.5bn and sell off Curragh and Bengalla coal mines right at the top of the market when coal prices couldn’t be any higher. We think WES will hand a portion back to shareholders in the form of a special dividend, look to make a few acquisitions and reinvest into their existing businesses. This leaves them with Coles, Bunnings and Target. But why sell Officeworks you ask? Officeworks has been a profitable business and “is well positioned for future growth with a strong competitive position and ongoing initiatives to grow its addressable market”. Rumours are that the imminent arrival of Amazon has the company jumping ship right at the perfect moment. Amazon presents are real danger and it’s not known what they are capable of. The sale of the coal assets, we think is perfectly timed. The entire coal sector has been running hot driven by curbs to Chinese steel producers who are now scrambling for supplies. But analysts have warned coal prices are not sustainable, it’s all a cycle. The coal assets came to the rescue and saved WES this time around, offsetting weaker earnings from Coles, Target and losses sustained from the UK Bunnings venture.  So the question is, should you buy into WES? We think so. WES has a proud and enviable history and is the market leader in each of its businesses. Management are highly experienced and the incoming CEO is fit for the top job. The company has superior brand strength with Coles, Bunnings and Target, all well known, respected brands. Sure there are risks such as Amazon entering the foray, but that’s some time off and we think the hype is way overdone. Amazon aren’t going to launch and destroy Australian retail. You’d be kidding yourself if you think the big Aussie retailers will sit around and let it happen. Competition from existing rivals is probably more of an issue. Woolworths, Aldi and Costco are the ones to watch. We also think entry into the UK with Bunnings is an interesting move. Whilst it will take time for the British to get used to Sausage on bread, Bunnings UK might just work. On its fundamentals, the stock is trading on a PE of around 16x with a stable and rising ROE. It also pays quite a handsome dividend. The company has many appealing features and we think the sale of Officeworks and its coal assets are at the right time. Strong performances from Bunnings, Kmart and a potential recovery in Target and Coles could see the company in good stead. WES has a strong business. To add to it, if WES decides to offload its coal business, it can do so at quite a high price. Another big positive. There is short term risk that Coles may underperform is a problem, but the outperformance of its coal business will more than offset it. But don’t be fooled in thinking that Coles will sit back and let Woolworths take over. With the new CEO it will be one of his main priorities to get Coles back on track. So expect a quick recovery. The only downside is that the WES chart isn’t something to get overly excited about. As mentioned before the stock has largely traded sideways for the most of 5 years. It was around $44 back in May 2013 higher than it is today. For that reason we think it is trading at the bottom-mid way of its trading range. So you could buy it now and sell around +$45.

  

Fundie Review – Insurance Linked Securities (FERMAT)

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This week we were invited to Fermat Capital’s presentation on catastrophe bonds. It was an interesting talk by Dr.John Seo who is the CIO, Co-Founding Partner and Portfolio Manager for Fermat. Firstly what on earth are catastrophe bonds? Commonly called cat bonds they are Insurance-Linked Securities (ILS). Cat bonds transfer event risk from a Sponsor to Investor. Cat bonds are corporate bonds issued by a special purpose reinsurer or special purpose vehicle. Catastrophe Bonds typically carry a rating of BB or single B, a 3 to 5 year maturity at issuance, and a quarterly or semi-annual floating rate coupon of Reference Rate + 2%-20%. Depending on the bond, the Reference Rate is USD Libor, EUR Libor, or a US Treasury Money Market rate. Cat bonds are issued from a special purpose entity in order to make them insensitive to the bankruptcy of either the Sponsor or Investors, therefore creating a scalable, tradable framework for risk-transfer. Cat bonds were first created in the mid-to-late 1990’s in response to a severe property catastrophe insurance crisis in the US caused by Hurricane Andrew. Using cat bonds, an investor takes on the risks of a natural disaster or catastrophe occurring in return for an attractive return. Sounds pretty straight forward. If a catastrophe occurs the investors will lose the principal they invested and the issuer (Fermat) will receive that money to cover their losses. It’s a brilliant idea. It really is a unique and niche area of investing that not many investors consider. Here are the advantages and disadvantages:

Advantages

  • Cat Bonds allows the investors to diversify their portfolio by investing in securities that have no correlation to the economy or market movements.
  • Cat bonds are rated by Standard & Poor’s, Moody’s and Fitch and therefore have minimum exposure to credit risk.
  • Have minimal exposure to agency costs as compared with equity capital.
  • Are subject to lower tax costs versus equity capital, because overall debt financing has a tax benefits as compared to equity financing.
  • Yields on Cat bonds are quite high and are less volatile to stocks or other bonds.
  • Price is less likely to fluctuate.
  • Low risk to interest rate risk.
  • It’s a long-only market, fully-collateralised with cash

Disadvantages

  • In case a catastrophe occurs, an investor is at high risk of losing his entire principal.
  • Cat bonds can get burgeoned by regulatory constraints which means they must be issued by an offshore special purpose vehicle. That means transactions costs can be substantial.
  • Many institutions don’t purchase catastrophe bonds because it would not be cost-effective for them to develop the technical capacity to analyse the risks of securities as they are so different from other securities.
  • Catastrophe bonds are based on natural disasters, which is a game of chance rather than calculated risk.
  • The market in cat bonds generally suffers from lower levels of liquidity relative to mainstream bonds.
  • The dramatic recent growth in the catastrophe bond market has in turn spurred the launch of some new insurance related businesses which could potentially undermine the long term growth prospects of the cat bond market.

Reinsurance companies insure insurance companies but their maximum limit per zone is $35bn. So for example Australia is reinsured for a maximum amount of $35bn. There simply isn’t enough money to cover every city for the entire risk. That’s where catastrophe bonds come in and cover the remainder. Fermat Capital ILS Yield Fund is the insurance linked securities fund.

 Unconventional View: The fund has 107 positions. Its main exposure is in Florida (Miami) with 38.9% exposed to hurricanes and cyclones and then New York City with 9.6%. Dr Seo says that in this low yield environment, cat bonds are a great option for investors seeking immunisation from credit exposure and interest rate volatility without resorting to low yielding cash. Cat bonds are not risk-free but they do allow an investor to earn a decent yield against risks that are unaffected by volatile global market conditions. In essence, the biggest risk then is that a Hurricane Katrina strikes and causes severe damage. An event can cause a temporary loss of 25% in value to such a portfolio. But as Dr.Seo says, if you’re willing to be patient and hold on after such an event a well-run cat bond portfolio will recover losses within 2 to 3 year period as catastrophe re/insurance premiums go up after the event. The fund has returned 6.70% over the last 12 months which isn’t bad but in all honesty for taking on that much risk, you’d probably want a return of around 20%. Losing 20-25% of the bond’s value when a catastrophe occurs is quite a lot. And these natural disasters are occurring more and more often. All in all, it sounds good but it’s really gambling. There is no way of telling when the next natural disaster is going to hit.