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.
Blue Sky Alternative Investments (BLA) – On March 28, BLA went into trading halt at the request of the company so that it could review and respond to a research report released by short seller Glaucus Research. You may remember the company after it first targeted Quintis Ltd (formerly TFS Sandalwood) via a scathing research report alleging the sandalwood company of having a Ponzi-like structure and that it faces bankruptcy and the stock is worthless. Quintis rejected the report saying Glaucus was a shorter of the stock and it was a self-serving report by a shorter. Shares in the company fell 72% and early this year the company went into administration.
Glaucus have their eyes set on BLA and have released a damning report which notes “a large number of factual inaccuracies throughout, including the assertions raised in relation to how Blue Sky calculates and reports its fee-earning assets under management, its investment performance and its fees.” Its main argument is that its fee earning AUM of $3.9bn is significantly overstated because the gross value of certain assets as AUM is reported instead of the fair value of the capital invested. Blue Sky’s real fee earning AUM is at most $1.5bn, 63% less than Blue Sky’s reported figure. It also claims that BLA has been overstating its financial performance by aggressively, and unjustifiably, marking up the value of its unrealized assets, which in turn generates higher fees and drives the share price higher and capital inflows. The report goes on to say “BLA compares itself to US-listed alternative asset managers; Apollo, KKR and Blackstone have an enterprise value which is on average 13% of their fee earning AUM. If we apply the same ratio to Blue Sky, and factor in a corporate governance discount, we estimate that the Company’s shares are worth at most $2.66 per share.”
Broker View: So far there are no broker reports yet covering this story. There will be next week.
Unconventional View: We read through the Glaucus report and it was quite a brutal report, heavily aimed at smashing BlueSky’s credibility and instilling doubt into the minds of its shareholders. All the necessary ingredients to demolish a share price from $11.45 to $2.66. Which is exactly what they’re trying to do. If you read the disclaimer on the back page, it’s their main prerogative. Their disclaimer says “We are short sellers. We are biased. So are long investors. So is Blue Sky. So are the banks that raised money for the Company…You are reading a short-biased opinion piece. Obviously, we will make money if the price of Blue Sky stock declines. This report and all statements contained herein are the opinion of Glaucus Research Group California, LLC, and are not statements of fact.”
Put that all aside, Glaucus have outlaid quite a convincing report with compelling evidence. There a long list of inaccuracies not only from BLA wildly exaggerated reported fee earning AUM, but also from:
- Its private equity AUM has been marked up.
- Blue Sky misrepresents the performance of its investments.
- Ballooning Receivables and Deteriorating Cash Flows.
- Foundation Early Learning is 10.8x levered.
- Its Beach Burrito chain is valued at $5m per chain which is laughable.
- Vinomofo is strapped for Cash and Missing Growth Forecasts.
- Its Thrive health food stalls is flailing, and that Blue Sky has overstated the performance of its investment.
- Viking Rentals, an Australian renter of portable toilets, is under performing.
- Lenards chicken is similar to Viking, despite the fact that Lenard’s had performed disastrously, Blue Sky significantly marked up the value of its initial investment.
- HeyLet’s overstate performance.
- Blue Sky consistently charged Australian investors extortionate management fees as high as 17%.
- As AUM grows, Blue Sky’s overstatement of its fee earning assets and returns gets bigger and bigger. Glaucus expects that this scheme will soon collapse. The chart below shows how it works.
It’s compelling evidence and a great argument but in all fairness, BLA could have rational and proper explanations for all these allegations. Three reputable brokers helped raised $100m at the start of the month and they will have all done due diligence on BLA. The company will release its response on Tuesday 3 April which we’re expecting to be quite a detailed response. It will be an interesting week. BLA shares traded for only 43 minutes and fell 9% to $10.40 before going into a trading halt. It wiped almost $80m from the company’s market value. In the weeks following BLA’s recent capital raising, short positions in the stock have been increasing. There’s no denying the power of shorters and market sentiment. The two combined together destroyed Quintis even after it strongly denied anything was wrong. Shares went into free fall and the rest is history. When shares come back out of trading halt, we’re expecting a savage fall despite what-ever BLA announces. There will be shareholders who may have been burnt from Quintis or simply want out and will sell without hesitation. Combine that with shorters and you may see a good 20-30% fall next week. Glaucus has ripped apart the validity of the entire BLA business model to date. There will be some angry shareholders. BLA may even face class action after the report. Law firm Gadens is investigating a potential class action on whether failed to comply with its statutory obligations and misled the market. It could get ugly.
For that reason buying BLA is a high risk gamble. Shares could follow Quintis and go into free fall. If it falls in the hands of the shorters, it becomes a sentiment game. Once the share price bottoms, BLA could be worth a punt. On the chart the support line intersects around $9.00. We recommend investors sit on the sidelines for now.
A2 Milk (A2M) – $11.46 – Last week A2M shares fell $12.84 to a low of $ 11.260 (12.30%) following reports dairy giant Nestle was launching a rival product aimed at the Chinese market. The report claims that Nestle’s product contains the A2 beta-casein protein that is the backbone of A2 Milk’s products. The A2 product has been launched under the brand Illuma and that it is already available in China. The product will be called ‘Atwo’ pronounced ‘A2’. A2M shares closed at $ 11.46.
Broker View: Deutsche Bank (BUY $14.00) – The broker says Nestle has entered the Chinese market with its “Atwo” – a2 protein infant formula product. Assuming A2M retains its market leading position and competition increases from there on in, A2M’s stake may remain stable at 7.5% instead of hitting 10%. That means Nestle’s entry into the sector will put a cap on A2’s growth. The broker says it could reduce A2’s share price by 15% but at the moment it’s retains its buy rating because there are no details on what Nestle has planned.
Unconventional View: We disagree with Deutsche. Now we’ve been avid supporters of A2 Milk ever since it listed. In-fact we’ve had a Buy on the stock since it was trading in the $4’s (click here). It reached all the way to $13.78, which is a tripling of your money had you held it since. A2M shares have been on a tear since its February 1H profit results where profit more than doubled and it landed a deal with Fonterra to produce new products. But after having such a good run, trading on an astronomical PE of 61.50x, all it takes is a little bad news and the stock can come crashing down. We think this Nestle news may bring A2M back to earth. All of A2M’s strong sales have come on the back of its A2 Platinum infant formula product in Australia and China. It’s had relatively no competition because of its niche A2 protein. Nestlé are the world’s largest food and beverage company and aren’t ones to be pitted against. Its products already include infant formula, to cereals, to dairy products. Because of its sheer size and distribution networks, Nestle will be able to offer the same products at lower prices with lower costs.
Sure, A2 Milk were the pioneers of the A2 protein and they’ve always had the first move advantage and their share price reflects it but with Nestle setting up shop, A2M won’t be able to hit their 10-15% target market share. A2M doesn’t have a monopoly on the process and most of its patents are expired making it possible for competitors to create their own a2 cow herds and manufacture products. Nestle is serious competition and is ranked No. 64 on the Fortune Global 500 in 2017. With this in mind, we’ve seen how quickly Bellamy’s (BAL) and other high PE stocks derail back to their true value in very quick fashion. Looking at the chart, the stock looks like it has bounced off resistance and is on its way back to $8.00. For that reason, we think those that are sitting on handsome gains, should lock in profits and sell. Buy back once the dust has settled.
Rural Funds Group (RFF) – $2.25 – Is a real estate investment trust (REIT) which owns a diversified portfolio of high quality Australian agricultural assets that are leased to experienced agricultural operators (tenants). This quarter RFF acquired three neighbouring cattle properties in Queensland for $53m. The acquisition was funded by balance sheet capacity. To fully utilise the increased carrying capacity, RFF will provide a livestock lease facility of $5 million to the lessee. The facility allows the lessee to acquire trade cattle, with RFF retaining ownership of the cattle, and the lessee contributing 20% of the value of the cattle at the time of purchase.
Broker view: UBS (BUY $2.39) – The broker has initiated coverage with a Buy rating. It says the business shows strong momentum, high quality management, and compelling growth prospects. The driver for share price performance is future acquisitions, specifically cattle properties in Northern Queensland.
Unconventional View: We agree with UBS. RFF has been by far the best performing REIT over the past 3 years and has returned 152%. UBS expects these good returns to continue. The broker also sees RFF execute $150m acquisitions over five years with an upside case of $500m. With RFF being the only farmland REIT on the ASX and one of the very few globally, the fund operates in a very niche space. We understand that various institutional investors have been buying up shares in RFF to gain an exposure to agricultural, which has seen the shares trade well above net tangible asset value. We think this trend will continue.
RFF’s business model is to grow via acquisitions which it has been doing extremely well. It is backed by a quality manager and has compelling growth prospects. We agree that there are favourable opportunities such as Northern Queensland cattle properties which can generate highly accretive returns. UBS are forecasting a 2019 NAV of $2.39. The current share price is at $2.25 which doesn’t leave a lot of room for growth. But with a gross yield of 6.30% you can’t complain. The company also reaffirms FY18 AFFO and distribution guidance of 12.7 cpu and 10.03 cpu respectively. Forecast FY19 distributions totalling 10.43 cpu representing a 4% increase on FY18. It’s quite an attractive company and it’s the only REIT on the market that will give you a exposure to a collection of agricultural assets such as cattle, cotton, poultry, almonds and vineyards.