14/05/2015 - 13:44

From one extreme to the other

14/05/2015 - 13:44

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Western Australia’s resources boom drove asset values too high, just as the bust is driving asset values too low; but to best understand that point it’s worth taking a trip to Canada, where the sale of a machinery distributor contains an interesting message for Australian investors.

From one extreme to the other

Western Australia’s resources boom drove asset values too high, just as the bust is driving asset values too low; but to best understand that point it’s worth taking a trip to Canada, where the sale of a machinery distributor contains an interesting message for Australian investors.

Kramer Ltd is the Caterpillar equipment dealer in Saskatchewan, home to world-class potash and uranium mining industries, which are heavy users of the same sort of gear sold and serviced by WesTrac in WA for use in the iron ore, bauxite and goldmining industries.

The parallels between Kramer and WesTrac, which once traded as Wigmores, goes back to the 1920s when Caterpillar of the US was just starting to sell its range of earthmovers and other items of industrial equipment to customers around the world, creating unique franchise structures wherever it went.

Last week, the Kramer family decided it was time to cash out of the 70-year-old business, selling it to Finning International, the world’s biggest Cat dealer with operations in most Canadian provinces other than Saskatchewan.

For the Kramers it was a chance to pocket $C230 million on their exit, or around $A240 million on current exchange rates.

The interesting part about the transaction is that the sale price appears to have been based on Kramer’s annual revenue of $C275 million, or around C83 cents in the dollar.

Because Kramer and WesTrac are in the same business, selling the same sort of equipment made by a common supplier with a tight grip on the profits of its franchisees, it is notionally possible to apply the value put on the Kramer business to WesTrac.

However that produces a surprising result because it indicates that WesTrac, which is part of the listed Seven Group, is being significantly undervalued.

Or, the flipside of the undervalued case is that the other big asset in Seven, a television network and newspaper publishing business, are being assigned a negative value – which is unlikely as both are profitable.

The WesTrac valuation, using the Kramer sale as a guide, runs like this.

• The C83 cents in the dollar transaction value implies that WesTrac could be sold on the same basis, which is A86 cents in the dollar.

• In the 12 months to June 30 last year, WesTrac in Australia generated revenue of $2.4 billion with a further $621 million generated by WesTrac China.

• The Australian revenue was 42 per cent less than the $4.1 billion generated in 2013, reflecting the impact of the mining downturn. China revenue was up 28 per cent.

• On a sale at 86 cents in the dollar, WesTrac Australia could theoretically fetch $2 billion; if combined with the Chinese business it could theoretically fetch $2.6 billion.

• Seven Group was valued today on the stock market at $2.15 billion.

Valuation exercises like that are interesting, though possibly meaningless, because there is no indication that Seven wants to sell WesTrac; and if it did, the buyer would have to be approved by Caterpillar, which takes a very close interest in who gets to sell and service its equipment.

But if the Kramer deal has been correctly reported, and if the same valuation methodology is applied to WesTrac, the WA Cat dealer has a value close to $500 million more than its parent company, Seven Group.

Two interesting observations can be made about the WesTrac/Seven situation.

Firstly, that the value of WesTrac is being heavily discounted by investors because of its close association with the resources sector.

Secondly, when the value implicit in the Kramer deal is applied to WesTrac, it appears to indicate that the Seven television network and its newspaper assets have no value at all.

In other words, you can buy a share of Seven purely for its WesTrac business and get a television network and newspaper tossed in for free.

Investing, of course, is not that simple and there are reasons to question the assumption about Seven being a heavily discounted stock; and to ask if it is being discounted, what’s the reason?

One possible explanation is that Seven is a poorly researched company by investment banks because it is 70 per cent owned by one man – Kerry Stokes.

Or it could be that the Kramer deal, and what it says about WesTrac, is an example of the WA discount in a post-boom environment being overdone.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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