Craig Martin: The Old Friends Investment Club decide to avoid gold and buy IT

Megan was arguing with Christo about how we missed out by not investing in Woolworths [JSE:WHL] last week, but I interupted, wanting to get the meeting off to a more official start. “Order! Order!” I called.

“I’ll have a cheese burger and chips!” replied Christo.

I ignored Christo’s sarcasm and continued, “So we managed to acquire 4 000 KAP last Friday at 470c, or with costs it came to around 474c per share. We still have just over R26 000 to invest this week. I would like to propose that we look at either a gold miner or a gold ETF,” I said confidently, “as there is clearly momentum behind the yellow metal.”

“Do you know the golden rule?” Christo enquired.

Megan fell right into his trap and responded, “do unto others, as you’d like done to you!”

Christo smiled, “The golden rule is, those who have the gold, make the rules. Unless you are on the inside track with bullion banks and central bankers, then you stay away from gold. In my view there has been some serious naked short-selling in gold and the biggest participants have been the US Fed and the Swiss National Bank.”

“Christo is right,” I said looking at Megan, “there is a consortium of traders manipulating the gold price with Santa Claus as ring-leader.”

“… And the Illuminati” laughed Megan, who obviously also thought that Christo has been smoking his socks.

“When did the gold price reach its high?” Christo looked at me, ignoring our mocking.

“In September 2011,” I answered knowing the month, but forgetting the exact day.

“Gold is a safe-haven currency, not a commodity,” Christo attempted to explain, “and the other safe-haven currency is the Swiss Franc. On the 6th of September 2011, the Swiss National Bank instituted a peg to stop the Franc from appreciating against the Euro and that was the day that the gold price topped at $1 922 per ounce. The Swiss know all about the flow of physical gold and when the Swiss Bank  gave a surprise announcement that it was abandoning its cap against the Euro, last Thursday, gold immediately advanced in US Dollars and the gold spot price jumped from CHF800 to CHF1200 in a day. You might think that it is one giant coincidence, but I think that gold is manipulated by Central bankers.” said Christo quite seriously.

“Well, I’ve always shared the view that a gold mine is a hole in the ground owned by a liar,” said Megan.

I seemed to be the only one bullish on bullion, so I decided to take the conversation in a different direction. “Megan and I were both lamenting our bad decision to avoid retail shares, as it was one of the best performing sectors last week. “Interestingly, the PSG backed education company,  Curro, is also listed in the General Retail sector. What do you think of Curro?” I asked.

Christo pretended to fall of his chair. “You not serious about investing in the most expensive share on the JSE, on a PE heading for 200?”

“Actually, it is one of Anthony Clark’s top five picks for 2015,”added Megan. “He believes that it should end the year at around R38 and he has had pretty good success with his past stock picks.”

“It’s got hockey-stick growth prospects,” I said, “it achieved HEPS of 7c in 2012, then nearly doubled to 13,1c in 2013 and for the year to December 2014, it should achieve at least 22cps,” I uttered confidently.

“Hockey sticks are best left on ice or Astro turf, not in financial projections,” said Christo rather cynically. “Companies always underestimate competition and fail to take into account unknowns, like legislative changes. Advtech operates in the same sector, they are paying dividends, have strong cash-flow, but aren’t nearly as expensive. Since Leslie Maasdorp has taken over as CEO, it seems like they have been making acquisitions, not just locally, but they’ve just brought a school in Botswana. Maybe the market only expects growth of only 15% instead of Curro’s 90%, but the downside potential is far lower if Advtech disappoints than if Curro doesn’t meet their targets.”

Megan had brought her own tablet to this meeting and she was looking at Advtech’s last financial results. “I see that with Advtech the schools are the most profitable part of the group,” she said, “with around 47% revenue and 59% of operating profit, but they also have tertiary education and a resources division, which gives the company some diversification.”

Christo seemed unusually enthuasiatic about Advtech, e added, “Late last year, the group announced that their schools division will grow student numbers by around 70% in 2015, there will be some earnings dilution because of issuing new shares, but I think that HEPS growth could easily be above the current PE of around 21. The return on equity has been between 20 and 21, but there is flexibility to ramp-up debt on the Balance Sheet and get that ROE even higher. The cash flow is good, I would be prepared to look at Advtech as an option for this week.”

Megan, was still looking at her tablet. “Advtech has the code ADH, and right next to it on this list, with the code ADI,  is Adapt-IT. I remember seeing a trading update from them a day or two ago, saying that HEPS would be up between 23% and 43% higher for the six months to end of December 2014. This company has had very good results over the past few years.” She added, “It’s still a very small company turnover of just over R400m, but they are operating on gross margins of 43-44%, which means that any increase in turnover could have a significant affect on the bottom-line. It has also recently acquired the cloud-linked business AspiviaUnison, which should help it get growth north of 20% and maybe as high as 40% for the year ahead.”

“I do like companies that aren’t scared to make acquisitions, but I can’t help but think that there is more value in a Datacentrix on a PE of 7 and a Pinnacle on a PE of 6.5 than Adapt-IT on a multiple of over 25,” added Christo, who seemed to be hang-up on PE multiples.

“The difference is that ADI is moving in the right direction and PNC and DCT have been under selling pressure.” I used the share codes to imply that I had seen the charts for these companies. “However, I must say that the candlestick action, together with yesterdays volume on PNC looks quite encouraging. It is always hard to pick a bottom, but I would think that between 1080c and 1100c it looks like there is some support coming through.”

“I noticed that Ellies has also been moving up quite nicely since the rights issue. I think it could have been the worst performer last year, with Pinnacle probably not far behind it.” said Megan. “Pinnacles first six months ran to the end of December, so a trading statement or at least the interim results should be out within the next two months. I can’t see how they would not have been selling tablets and smart phones. Maybe this is the retail story that everyone has missed out on.” offered Megan.

“The reason that this share price has been under pressure is not just a corporate governance issue, but their gross margins and cash flows were also under pressure last year. However, I do think that the market has overreacted on the selling,” added Christo.  “Even if they don’t manage to grow earnings this year, I think that the group is worth more than the R1,8bn the market is valuing it at. Can EOH really be worth more than eight times Pinnacles value?”

“What do you mean?” I asked, a bit unsure about EOH’s market-cap.

“EOH has a market-cap of R14,8bn and even Adapt-IT is valued at over R1bn. Surely Pinnacle must be worth more than R1,8bn, considering that its revenue is more than R7bn a year?” explained  Christo.

Megan seemed a bit concerned. “We would be taking a bit of a chance on a company that has been out of favour,” she said.

“I’ve never been scared of being contrarian. Let’s grab 2 000 PNC at under 1 100c.” Christo offered decisively.

I lifted my hand in agreement and added, “I second that!”

“I feel like I’m been bullied a little,” cried Megan, “but, I think that this is the closest I’m going to get to a retailer from you lot. Let’s go with Pinnacle.”

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