Here at Farnam we are always on the lookout for companies that represent value from a fundamental perspective. While companies like this can come in many forms, often the best place to start looking is with the classic “turnaround” story.
We’re all familiar with the idea; a company that has been beaten down by the market makes a strategic decision to implement change and attempt to find new avenues for growth. It often comes in the form of divesting non-core assets or making an acquisition of another business.
When management gets the turnaround process right, it represents a great opportunity to invest in a company with strong future growth that isn’t factored into the share price at the time.
Peter Lynch includes Turnarounds as one of 6 types of companies that can make money for investors in his book One Up on Wall Street. He uses the example of buying Chrysler in 1982 after the price went so low some investors on Wall Street thought it might never come up again. Of course, it did rebound eventually and made investors who got in early a lot of money.
One important lesson from this tale is that if you’ve identified a turnaround and it has already tripled in the last few years, it may still have a lot of growth left. The price bottom of Chrysler was $1.50 in the late 1970s, and even though Lynch bought at $6, he still made a 1500% return in 5 years.
Elders: from behemoth to turnaround story
One of the best domestic examples of a turnaround story in recent years has been the agriculture business Elders (ELD). Prior to the GFC in 2007, Elders was a conglomerate with a share price trading at over $200 (based on current shares on issue after a 10:1 consolidation), with many different business units including agribusiness (livestock, grains and farm supplies), real estate, home loans, insurance, financial advice, automotive manufacturing and forestry assets.
By 2012, Elders share price was trading at less than $1. The company was valued at a market capitalisation of about $100m, but they had over $400m in debt. With the assistance of their banks and advisors, Elders management began the long road back towards being a consistently profitable business by divesting non-core assets and paying down their debt. By 2014, Elders had gone back to their 175 year old roots as a pure agribusiness company, providing services and assistance to Australia’s agriculture sector.
In April 2014, Elders announced the appointment of Mark Allison as CEO and Managing Director. Shortly after being appointed to the role, Mark released an “8 Point Plan”, a clear and focused plan to drive future growth for the company. Since the implementation of the plan, Elders has performed very strongly, reporting a 2015 net profit of $38.3m, greatly up on the $3m reported in 2014. The share price has also climbed strongly to over $4.50, despite a small pullback recently on fears of a lower cattle export price.
In 2014, Elders represented the classic turnaround value play that we look for at Farnam. Despite suffering many years of structural decline, new management had come into the company and refocused back into what the company did best. They had a clear plan to drive growth, and had paid off all debt. Best of all, due to underperforming the market for many years, the share price was trading on single digit forward price to equity ratios.
At Farnam, we look at this situation as potentially providing asymmetric returns, which Daniel Sims’ discussed in this article on Yahoo! here. The potential downside risk can be limited with the company already trading at low multiples, while the upside potential can be very high if management executes their plan correctly.
Pacific Brands: start divesting non-core, then divest the lot
Another similar turnaround story to Elders was Pacific Brands (formerly PBG). A manufacturer of classic Australian clothing, manchester and footwear, Pacific Brands owned brands such as Bonds, Hard Yakka, Berlei, Sheridan, Clarks and Hush Puppies. Despite producing some of Australia’s most recognisable brands, Pacific Brands’ net profits over the decade to 2015 was around negative $600m. This saw the share price languish between 50c and $1 between 2011 and 2015, after peaking above $3 back in 2007.
However, in 2015 some things started happening similar to what we saw with Elders. Management divested a handful of their non-core brands. Pacific Brands sold off their shoe and workwear brands, and focused back onto their core brand of Bonds. Also similar to Elders, Pacific Brands management used the proceeds of divesting their non-core brands to pay down debt, which had climbed to over $350m in 2014.
The market recognised the potential turnaround for Pacific Brands, and the share price rose more than 100% over the past year before large American clothing company HanesBrands issued a takeover offer of $1.15 per share which was accepted by the Pacific Brands board and management.
When we look at these two examples, we see some similarities. Both companies had expanded beyond their means, acquiring businesses or attempting expansion that ultimately failed to drive business growth, and left both companies heavily indebted. However, in both cases management (old or new) made tough decisions to divest non-core assets, pay down debt and refocus their business efforts into profitable areas with strong forecasts for growth.
Ok, we know investing with hindsight is always easy, but are there any companies out there that may fit the characteristics of the turnaround stories we have looked at here?
One that has caught our eye here at Farnam is APN News and Media (APN). Similar to Elders and Pacific Brands, the APN share price has collapsed since the GFC from a high of over $30 to lows below $1.50. At the end of 2015, APN had over $400m debt with a market cap of just over $700m.
Since then though, APN has announced they are demerging their New Zealand assets, have sold their regional newspapers to News Corp and have raised capital from shareholders to pay down debt. The new APN business will be focused on the high growth areas of outdoor media and radio, instead of being heavily reliant on the declining business of newspapers. There is still a long road ahead for the management of APN; however it appears they could be headed down the right path towards becoming another turnaround story on the ASX.
What else should you look for?
There are many, many factors that go into a good value play like the turnaround. The company still needs to be in profit, actively paying down debt and imroving their ROE to name a few. To see the whole checklist of what makes a good value investment, read this post here.
This document has been prepared by Farnam Investment Management Pty Ltd (Farnam) ABN 15 149 971 808 AFS Licence 430574. While every care has been taken in the preparation of this document it does not contain any recommendations to buy or sell any particular stock(s) noted. Farnam makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation and needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.