Marlin Global (MLN)

Description: MLN discount to NAV
Last updated: 3-Jan-13

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Plenty of bargains, just not on the NZX

At the time of posting this blog, Stockcat has no trouble finding a bargain.

It's been like this for the last few years. That is, a retailer holds a Boxing Day Sale to clear excess Christmas stock. The stock fails to clear, so the sale is extended. The new year comes around and stock is still sitting. Time for a New Year's Sale. There's still excess inventory after the New Year's sale, so the retailer announces an 'Extended' New Year's Sale...

It seems there are bargains to be found well beyond Boxing Day. Perhaps it's a sign that the Global Financial Crisis is far from over. Whatever the reason, bargain hunting on the NZX is not so easy.

The NZX50 Gross Index has recovered to 4,094. To put this in context, the index peaked at 4,320 in 2007 and hit a low of 2,471 in 2009 (down over 40%).

A good chunk of this recovery took place over 2012, with the market rising ~24%. It's been a great year for investors, but Stockcat can't help wondering if the market is looking a bit pricey.

Many commentators attribute the rise to low interest rates. I.e. term deposits and bond rates look dismal, so investors buy high-yielding New Zealand stocks, which pushes up their prices. However, Stockcat can't get past:

• the New Zealand market is trading at 15.6x earnings. This compares to a 20-year average of 14.0x, a low of ~12.0x and a high of just over 16.0x;
• outlook still looks fragile, given a backdrop of ballooning government debt in Western economies and the resulting economic uncertainty; and
• over half the stocks are trading above Stockcat's broker's valuation. This screams over-valuation given that broker valuations are generally too optimistic

US markets and the ASX200 are trading below their 20-year average PE. This, combined with a solid NZD, may mean it's a good time to look overseas.

Three things to consider before buying Marlin Global

Stock: NZE:MLN
Market cap: $70.7m
Interesting because: 10.4% dividend yield, 19.4% discount to NAV, prior performance issues



Swasbrook goes all Gekko

For a long time, Stockcat has wanted to see someone kick up a storm at a shareholder meeting.

You know, kind of like Gordon Gekko's (in)famous speech in the original Wall St movie. A shareholder who holds management and the board to account if the company underperforms (afterall, accountability to the shareholder is the purpose of these meetings, right?).

On the polite and conservative New Zealand business scene, this is a rare occurance. So Stockcat was pleased to hear of Marlin Global's (MLN's) annual shareholder's meeting on 1 November where investor, Chris Swasbrook, proposed that the MLN fund be wound up and cash returned to the shareholder.

Swasbrook's proposal certainly struck a nerve with the fund's manager, Fisher Funds (not surprising since Fisher earns a substantial management fee from MLN). And the proposal to discontinue Marlin certainly seemed justified.

MLN generated a total shareholder return since inception of negative 12.8%. Compare this to the +52.7% return the fund would have made if it met its benchmark, and you have some seriously negative alpha...

Anyway, to cut a long story short, the proposal was denied. MLN lives to fight another day.

Stockcat noticed that MLN's discount to Net Asset Value (NAV) has steadily increased since the 1 November shareholder meeting (from 12.8% to 19.4%). This, combined with a dividend yield of 10.4% is likely to draw some investor attention.

Buying a fund below it's NAV can be an excellent play:

You get a portfolio for below the cost of constructing it yourself

You can make a gain if the discount decreases (even if NAV doesn't change)

However, if you are thinking about buying MLN, first check out the three observations below. Also, see links at end of blog.

1. Discount: high by recent levels, fair in light of issues

 

[click to enlarge chart]

MLN's discount to NAV has averaged 14.5% over the last two years, so the current discount, 19.4%, seems high. A discount of this magnitute has only been matched five times over the last two years (see chart).

This makes MLN seem like a good deal: you pay 67 cents and get a portfolio worth 83 cents. However, Stockcat can't help thinking that the market is 'pricing in' some of the funds issues.

There are many reasons why a fund trades at a discount to NAV. For MLN, two spring to mind:

• Costs - MLN's expense ratio averaged 2.5% p.a. This is high
• Future performance - based on the fund's track record, it seems fair to assume the market is not expecting great things from MLN in the future

For these reasons, it's hard to say MLN's discount represents good value with 100% conviction.


2. Dividend policy: a red herring

MLN's 10.4% dividend yield for the last twelve months looks great on the face of it. But let's dig deeper.

In August 2010, MLN introduced a dividend policy of 2% of NAV per quarter. This equates to ~8% p.a., depending on how NAV moves throughout the year.

For a stock trading at a large discount, this seemed like a great idea. Stockcat thinks the logic went something like this:

Pre-August 2010

• Discount on listing = 7.5%
• Average discount since listing = 24.5%
• Maximum discount = 44.8%
• = discount too high

August 2010

• Introduce dividend of ~8% p.a. on NAV
• At the current share price, yield = 12.8% (since share price < NAV)
• Investors will see this huge yield, start buying MLN
• Share price will go up, discount will close

And you have to give it to them, the dividend policy has certainly helped. The above chart shows an average discount of 24.5% prior to the policy, and 14.2% after. Even if the NAV of MLN's portfolio remained constant, the sheer reduction in the discount would have resulted in a double-digit gain for shareholders.

However, new policies often produce unexpected consequences, and MLN's dividend policy is no exception.

When a company makes a loss and pays a dividend, then the dividend is paid out of shareholders capital (since there is no profit to fund the dividend). So shareholders are essentially getting their capital returned to them - not a return on what they put in.

In effect, the policy can result in MLN having to exit positions at the bottom of the market to fund the dividend, and draws down the fund's capital base.

For most companies, the dividend is a signal of management's confidence in future earnings. For MLN, it seems to represent no more than a financial policy engineered to reduce the fund's discount.

Therefore, Stockcat thinks MLN's 10.4% dividend yield is a red herring.


3. Other discounts: try shopping around

Sometimes looking into an interesting stock can lead you to other stocks. A recent presentation by MLN has drawn Stockcat's attention to alternative funds trading at a larger discount:

 

[click to enlarge chart]


Stockcat has not looked at these funds in detail, but they may be worth exploring before buying MLN (the highest discount is Sunvest Corp, which is cut off by the chart).

There will almost certainly be a reason why the market is discounting these stocks so heavily, but perhaps one of them offers less reason and more discount than MLN?

None of these funds to your liking? Try:

Other Fisher-managed, close ended funds

• NZE:BRM
• NZE:KFL

Good-quality emerging-markets funds

• LON:TEM
• NYSEARCA:VWO
• LON:AAS

Recommended articles

• Chalkie
• Brian Gaynor
• Brent Sheather

About Stockcat

"To share quality commentary & analysis with New Zealand stock market investors"

The Stockcat blog was created to share good-quality commentary and analysis on all matters relating to investing in the New Zealand stock market, so you as an investor:

• can make more robust investment decisions;
• deepen your investing education; and
• have a place to share your views

Stockcat is a free resource for all.

What makes Stockcat different?

Stockcat blogs generally cover one of three topics:

• Companies - to help inform your decisions about companies to invest in
• Economies - to highlight risks to your portfolio's value and implications for investment timing
• Strategies - to share investment strategies that could benefit your portfolio

Whilst other market commentators share their views on these topics, Stockcat aims to be different by expressing a frank opinion that is supported by robust logical or empirical analysis.

Professional commentators are often restrained from expressing a frank opinion by legal risk or their firms internal policies. On the flipside, amateur commentators express a frank opinion, but often it's not supported by robust analysis. The Stockcat blog aims to marry the best of both worlds.

Stockcat also aims to differentiate by sharing excel models and analysis (see Spreadsheets).

What other commentary should I read?

Good investment decisions are underpinned by considering a broad range of views. As such, Stockcat suggests that investors read other commentary in conjunction with this blog.

Stockcat recommends any material by a good stockbroking firm and by the commentators found on the blog's links page.

What are Stockcat's credentials?

'Stockcat' is a pseudonym that allows the writer of the blog to express a frank opinion without identifying himself / herself.

The writer has a postgraduate Honours degree in Finance, experience working in investment banking and public sector finance, and invests in New Zealand stocks on a personal basis.

Stockcat is not a qualified financial adviser, and does not intend this blog to be construed as investment advice.

I welcome you to the Stockcat blog. Please feel free to share your views, and my commentary, with other readers

"Buy fear & panic, sell greed & hysteria"

An under-priced asset

Trading at only $5.00, Stockcat has identified an under priced asset. OK, it's not a stock. Nonetheless, Stockcat reckons it's an asset that should be held by every investor.

'The Book of Investing Wisdom' glues together writings from 10 of the world's best investors. You know, the usual suspects such as Warren Buffet, Peter Lynch... (full list at end of blog).

The beauty of the book (aside from being an audio book, making it aptly suited to lazy readers like Stockcat) is how it summarises the investment philosophy of the world's investment legends in one convenient place. It really is much easier than trawling through the whole library of publications by these authors / investors.

Well, that's enough promotion (which certainly is not the purpose of this blog).

What The Book of Investing Wisdom does not do is tie together all the common threads running through the book, and thus help readers form a coherent and robust investment strategy. So, here's Stockcat's crack at doing just that.

Stockcat has boiled the wisdom from these great investors down to five themes, aimed at guiding readers toward making robust future investments. These themes will be split across five blogs - one for each theme - starting with #1:

     "Buy fear and panic, sell greed & hysteria"

What does this mean?

The quote is from Jim Rogers' 'Get Smart & Make a Fortune'. Its meaning is simple: be a contrarian.

The contrarian rule aims to profit from having a contrary opinion (or opposite opinion, if you like) to the market. It exploits the market's tendancy overreact. It also helps investors identify extreme market tops and bottoms.

In short:

when the market is nervous and selling: BUY

when the market confident and buying: SELL

The 1987 stockmarket crash is a (somewhat extreme) example

Think of the lead-up to the October 1987 sharemarket crash. The NZX rose 99.2% in the prior year (1986), the market's performance often featured on the front page of The New Zealand Herald, share clubs were in vogue, and Kiwis were becoming rich. The mood was positively euphoric. "Greed and hysteria" were abound.

Sadly, what goes up must come down.

On 20 Oct 1987, following a bad day on the US markets, the NZX dropped 22.3%. To put this in perspective, the drop represents ~$10bn of wealth destruction. I.e. the total value of stocks listed on the NZX fell from $44.4 bn to $34.5 bn. By the end of the year, this figure was $23.4 bn.

For more on the crash, see this excellent article.

Arguably an investor following Jim Roger's "buy fear and panic, sell greed and hysteria" rule would have sold during the greed and hysteria phase, and avoided this drastic market decline. The investor may have then re-entered during the fear and panic phase, picking up quality stocks that had survived the crash for around half the price.

Follow three guidlines when being a contrarian

Right now, I can imagine a reader of this blog saying "well, that's OK with the benefit of hindsight. In reality it's not that simple". Fair enough. And I would like to add it's particularly hard to be a contrarian when all your friends are making money from an over-hyped market boom.

However, Jim Rogers does provide some insights to help with your market timing:

1. There is always certainty of market participants at extreme market tops and extreme bottoms. Think of the headlines during the depths of the Global Financial Crisis. The media knew that the 'end was nigh', and even speculated about the end of 'capitalism'. Capitalism did not end, and the NZX has since recovered to nearly reach its peak
2. Amateur investors enter at extreme market tops. Think of the number of share clubs leading up to the 1987 crash, vrs the number of share clubs today. Market tops tend to attract retail investors who otherwise would not enter the stockmarket
3. There's a general feeling that 'this time is different' at extreme market tops. Think the tech bubble. Investors were pricing dot com stocks at a 'squillion' times revenue, thinking there was something different about the dot com model that justified these insane valuations

Contrarian rule endorsed by other investing legends 

Many investors buy stocks during heated markets, even when they know the stocks are overvalued. They see the general public making money and don't want to be left behind, so they jump on the bandwagon.

Edward Johnson calls this the "bigger fool theory". You buy at a foolish price because you expect a bigger fool will buy off you at an even higher price. Stockcat agrees that this is a risky strategy, at best. If a stock's earnings or tangible asset backing don't justify the valuation, there is no price floor when the market's sentiment turns.

Even Warren Buffet went so far as to dissolve an investment fund when the market was overpriced. A bold thing to do, but an excellent endorsement for the contrarian strategy.

In another book, Peter Lynch did some high-level back testing which supported a contrarian strategy. He showed how investors who ploughed more cash into their portfolio every time the market fell would generate superior returns.

In summary, when timing your entry or exit, be a contrarian. "Buy fear and panic, sell greed and hysteria". Or, to put it another way:

     "Against the crowd, act boldly. With the crowd, act cautiously"
          - Edward Johnson

Appendix: The Book of Investing Wisdom contains excerpts from:

Warren E. Buffet: "Track Record is Everything"

Jim Rogers: "Get Smart and Make a Fortune"

Peter Lynch: "Stalking the Tenbagger"

Edward C. Johnson II: "Contrary Opinion in Stock Market Techniques"

Peter L. Bernstein: "Is Investing for the Long Term a Theory or Just Mumbo-Jumbo?"

Mario Gabelli: "Grand Slam Hitting"

Robert R. Prechter: "Elvis, Frankenstein, and Andy Warhol"

George Soros: "After Black Monday"

Leo Melamed: "The Art of Futures Trading"

Martin E. Zweig: "Selling Short - It's Not Un-American"