The rules of doubling down

Shares in RNY Property Trust have taken a dive since I bought them, down 25%. That does raise the question of whether I got the price right when I bought them, but that mistake, if it was one, is already made. The next question is, should I buy more?

Typically the advice goes ‘if you wouldn’t buy more shares today, you should probably sell them‘. Well that’s true, but it’s only partly true. Speaking for myself I think 2.4 cents is a great price, and I would find 2 cents per unit nearly irresistible. Even so, it’s necessary to consider the potential outcomes of the investment. There are really only 2 possibilities with RNY:

  • I am right about the property values and I will make money
  • I am wrong about the property values, and will lose money

 

There are shades of grey in there where the properties are worth more than the debt, but I make back less than I invested, for example, but this broadly sums up the investment. Either it’s worth more, or it’s worth close to zero. Let me say I would consider owning a portfolio of multiple companies in the same situation as RNY.

But in this specific situation if I were to buy more shares, I would be doubling my bet on a binary outcome without having any idea of whether I am correct.

That magnifies both the potential wins and the potential losses, but the drivers of the win or the loss have not changed. I think that on balance I have a good chance of winning. But if I was wrong in the first place, I am still wrong, and I don’t know it yet. I have not seen any additional information that would confirm or refute my initial thesis.

Let’s say that there’s a 30% chance that I’m wrong. Initially I’m risking 5% of my capital. Say I want to double down, making it 10% of my capital. Now imagine that someone said to you:  “There is a 30% chance that you will lose 10% of your capital on this investment“.

‘Err, no thank you’, you stammer.

I don’t think a prudent investor would buy more in these circumstances. I would have to see more information, for example some more sale data and prices realized for the properties that would tend to either confirm or refute my thesis, before considering doubling up.

For another business that was earning cash and had the prospect of growing or paying that cash out to shareholders, I would be more likely to consider doubling down. I’d be highly likely to double down on Thorn Group Ltd (ASX: TGA) and Eureka Group Holdings Ltd (ASX: EGH) if they fell to 25% below my buy price. However, I don’t think it would be wise to do that with RNY.

Bronte Capital has a great post about when to average down which I think many readers facing a similar dilemma would find valuable.

Disclosure: I own shares in RNY Property Trust, Thorn Group, and Eureka Group.

Thorn Group results

Thorn Group Ltd (ASX: TGA) released its annual results last Friday. Being busy last week investigating other companies meant that I didn’t get a chance to look at it until now. Going forwards, I’ll likely slow down the pace of announcements regarding the companies I hold. There’s no point writing little releases about Thorn’s change of CEO, for example. If anyone wants to know that sort of info they can just read the ASX release, and if its relevant but not time-critical I can always comment on it in when i write about the results..

I’m also aiming to cut down the ‘wall of text’ that accompanied my earlier posts. With this in mind I’ve created a simple table to compare Thorn’s results:

Thorn Group Ltd (ASX: TGA) Thesis expectations What actually happened My thoughts:
Revenues: Effectively flat Up 3%
NPAT: ~$24m profit $25m profit ($31m underlying)
Full-year dividend: 10 cents 8 cents Is OK, was lowered to support strong growth in biz leasing
Consumer leasing: Down somewhat Revenue up 2%, EBIT down 20% Worse than expected but acceptable
Equipment leasing: Modest growth due to reallocation of resources here Revenue up strongly, almost doubled EBIT Far better than expectations. Stellar.
Delinquencies: Effectively flat Up slightly Not ideal but not concerning (yet?)
Debt headroom: No real change *see below Mixed
Outlook: Flat Outlook is ‘subdued’
Share price: bought at $1.32 $1.15-$1.20 in recent days

*Company gearing increased, but so did the securitised debt load due to the strong growth in equipment finance. I would like to see the company strengthen its balance sheet, although overall I thought the result within acceptable bounds.

“Over the medium term Radio Rental’s large and loyal customer base, prices that are already under the proposed legislative caps, and the efficient cost base will position it for industry leadership and growth.” – Thorn CEO/CFO Peter Forsberg.

In summary, the results were more or less in line with expectations, except the business division which was an obvious standout. I was mildly concerned about the talk of reputational damage to Radio Rentals, as well as the modest increase in delinquencies, although both were acceptable at this point.

Specific thoughts about the business

  • Thorn’s Cashflow IT franchise finance biz appeared to be one of the leading causes of growth in the equipment finance division. I am a bit wary that the company was able to achieve such rapid growth to this group of customers. Are they not being serviced by other financiers? In general I’m deeply bearish on franchisees so I have to ask whether I’m seeing warning signs or if I’m just a negative Nancy. Will watch for signs of trouble here.
  • I also found it strange that management claimed “Consumer Leasing is facing a period of transition with some short term challenges from adverse publicity, weaker general retail market conditions, the deferral of returning customers due to the launch of the 4 year contract 3 years ago” as a reason for weak leasing results.

If you switch from 3 year to 4 year leases, there will be one year where you have weaker originations, yes. But if you are leasing the same item for 4 years instead of 3 years you are getting 4 years of cash flow where previously you only received 3.

Given that the company leases its items with a pricing cap of 1.8x their annual value, they would be getting 7.2x the item value (1.8 times 4 years) instead of 5.4x.  I would think in general that this would be highly favourable, since you’re getting more mileage out of the same tank, as it were. I found that comment vaguely disingenuous, (though it’s also true) and worth noting.

Outlook

I’m pretty bearish on Australian finance businesses at this point. In that sense, Thorn is an edgy investment for me and it is hard not to be super-critical of it. I’ve been nit-picking probably more than is constructive.

The thesis continues to play out more or less as expected, and I continue to hold my Thorn shares.

I hold shares in Thorn Group.

Automotive Solutions Group: The gift that keeps on giving

I keep telling myself ‘this is the last time I’m writing about ASG’ but the Automotive Solutions Group Ltd (ASX: 4WD) saga has been too good to pass up. AMA Group Ltd (ASX: AMA) today offered to buyout the ~80% of Automotive Solutions it doesn’t own – at a 0% premium to yesterday’s close.

Pretty rough on shareholders, who would be accepting a 65% haircut to the listing price. However, the way the saga has played out has made such a situation nigh-on unavoidable. In between underperformance, sacking the CEO, suing their own employees, and making errors in quarterly forecasts, the company has not endeared itself to a takeover at a premium.

In fact AMA is taking on a considerable amount of unknown risk, plus potentially heavy short term costs (e.g. in terms of cash outflows) by making the bid. Yet it has the deep pockets and experience to weather the short term losses of turning around ASG. Plus I believe that AMA management is going to be a lot easier for the business operators to get along with compared to ASG.

In one sense I think Automotive Solutions shareholders are getting robbed, as the business does look very cheap. On the other hand, there have been a lot of red flags which prevented me from investing. Still, I think it will be better for all involved if this story is brought to a quick close.