Learning from Laserbond (ASX:LBL)
02/07/2019
Trav Mays
Follow @MaysTrav
LaserBond (ASX:LBL) recently hit an inflection point, after
some excellent management decisions and some tailwinds, shareholders have been
rewarded with a 244% gain over the past year. Today we will be investigating if
there are gains still to be made and to see if there is anything we can learn.
LaserBond first come to my attention whilst researching XRF Scientific (click here for that post). A
number of excellent articles, such as Mr. Joshua Baker’s on Livewire titled “A platinum crucible in the rough”,
compared XRF to Laserbond. So ever keen to learn more, especially about
inflection point investing, I decided to dive deeper to see what nuggets of
knowledge I could uncover.
Company
LaserBond, originally called HVOF Australia P/L, was founded
by Mr. Gregory Hooper (Currently Executive Director) in 1992, working out of a
small workshop in Ingleburn NSW. (HVOF stands for High Velocity Oxygen Fuel,
which is a type of thermal spray system that uses combustion to heat and propel
particles near supersonic speeds. These high flying particles collide with a
material, forming an extremely high density low oxide coating.) Gregory’s
brother, Mr. Wayne Hooper (Currently Executive Director) joined HVOF in 1994
and together they were at the forefront of laser cladding innovation, building
one of the first high-powered cladding systems using a 6kW CO2
laser. In 2007 they listed on the ASX and changed their name to LaserBond
Limited, listing for $0.2 per share and a market cap of just over $13 million.
The capital raised from their listing was quickly put to
use, they invested in R&D and purchased Peacheys Engineering in Gladstone
Queensland for $3m in 2008, as an attempt to capitalise on the growing gas
industry. Unfortunately for LaserBond, the Queensland division wasn’t able to
get any traction, the global financial crisis hit and then the large increase
in activity within the Gladstone region pushed both rents and employee expenses
up immensely. After a number of bad results, in 2013 they sold off 5 large
pieces of equipment and their order book for $750,000, ceased all machining and
fabrication work within the area, moved a number of other pieces of equipment
to NSW and continued to do surface engineering work for the region from their
NSW premises.
Whilst the Queensland division wasn’t doing very well, the
rest of the business was, in fact they were doing so well, they had to move
their NSW facility from the original workshop to a larger facility in Smearton
Grange, just to keep up with orders. Not only that, but after 12 months of
trials, LaserBond had signed a Memorandum of Understanding (MoU) with Gearhart
United, within which, Gearhart committed to exclusively commissioning LaserBond
for all their laser cladding work. To accommodate this large influx of work (estimated
at the time to increase revenue by $1.2m, a 12.75% increase to FY2013’s revenue),
LaserBond established a South Australian branch and to ensure the success of this
branch, Mr. Gregory Hooper was later relocated to head it up (October 2014). Whilst
the business was doing well, it wasn’t enough to compensate for the Queensland
divisions loss; in 2013 LaserBond wrote off the remaining $3.6m in goodwill and
posted an adjusted Net Profit after Tax loss of $0.72m.
It was shortly after all this (February 2014) that the
chairman, Mr. Timothy McCauley decided to step down. Having started back before
LaserBond had IPO’d, he had done an excellent job during some extremely
difficult times. Mr. Allan Morton was appointed his successor in March 2014,
which in my opinion, is when the seeds for the 2018 inflection point were
planted.
Mr. Allan Morton an Engineer by Trade, obtained his Bachelor
of Mechanical Engineering from the University of Technology in Sydney, later going
on to obtain an MBA from Harvard Business School. Prior to starting at
LaserBond, Mr. Morton had worked as an engineer at CSR and successfully moved
up the ranks to the operations manager role. After this he worked at a number
of companies in high executive roles and/or founded a number of his own companies.
Not of any real importance but interesting nonetheless, he worked for 3 years
as a general manager for a company called Quickflix limited, which had the very same idea as
Netflix. Having started out as a company that shipped the latest DVD’s and
Blu-ray’s through the mail (they still do this), they have evolved into a
streaming website, offering all the latest blockbusters, on a subscription
basis, either online or via the mail! I had never heard of these guys and I am
not sure if they are still operating, as they delisted from the ASX at the
start of 2017, but their website is still up and running and it looks like they
have some new movies on there, so it looks promising. Might be worth checking
out if you are looking for another subscription or have had enough of Netflix.
Anyway, one very interesting and relevant role he had, was as a founding
partner of Waypoint Strategies (Founded in 2010), a consulting group that specialises in
turnarounds. Which is just the type of manager LaserBond needed at this time in
its history.
LaserBond started off as an innovator at the cutting edge of
the surface engineering industry, they had however become complacent, drunk on
the profits from the mining expansion, they had taken their focus off the
company’s vision, “To be a global
leader in the research, design and implementation of advanced surface
engineering technologies”. This is clearly seen in their R&D spend
below, after spending $0.57m (16% of revenue in 2007), the R&D spend for
the 5 years between 2009 and 2013 was reduced to almost nothing, with 2013
actually being $0.
Mr. Morton came on board and
changed all that, with the following couple of years reading straight out of a
turnaround play book. Having divested the unsuccessful QLD branch, they reduced
expenses (they implemented Lean Manufacturing in 2014), they focused on organic
growth and started to reinvest in themselves, more specifically, the core of
the business, its research and development department.
LaserBond kicked a lot of goals
over the next couple of years, so to keep this post short, I have condense them
to dot points:
- Feb 2015: They created a new class of Down-the-Hole (DTH) hammers and associated drilling components that last 2.44 times longer than the average DTH hammer, which equates to a 7% saving on the total drilling cost.
- The lean manufacturing techniques they implemented in December 2014 improved the 2HY 2015 gross margin of the NSW division from 49.3% to 53.2% pcp.
- April 2015: DTH hammers begin testing in European geothermal wells
- July 2015: Laser bond splits into three divisions, Services, Products and Technology. The Services division continues their core surface engineering work, the Products division to continue to manufacture specialised products and the Technology division to oversee the licensing of its technology to non-competitive international markets.
- October 2015: Lodged two international patents on a ground breaking laser cladding process, using the laser deposition method
- FY2016 Increased investment in themselves, more specifically employment, Advertising and research and development
- May 2016: Entered an agreement of collaboration with the University of SA
- August 2016: Awarded $3.22m over three years from the Commonwealth Government to fund the design, building, installation and commission of a dual robotic multi-axis handling system, which included a 16kW laser.
- September 2016: Enters first technology licensing contract with a crushing equipment manufacturing company in China. LaserBond is to deliver a turnkey package with all work done in-house from design to commissioning for $1.45m. The contract also includes 5 years of training and support, in return for a revenue based fee.
- February 2017: Awarded $2.616m as part of a three year collaboration with the University of South Australia and Boart Longyear (total govt fund $8.266m) to extend wear life of critical pieces of mining equipment.
- February 2017: Signed a non-binding strategic partnership to pursue mutually beneficial commercial products and services with Boart Longyear
- FY2017 report: Products division became profitable
Other
includes R&D and Technology divisions
- September 2017: Mr Allan Morton steps down as Director
- August 2018: Signed a Technology licensing agreement with a UK multinational engineering company
- December 2018: LaserBond breaks into the US Steel Industry market with their Composite Carbide Steel Mill Rolls, which typically deliver 5 to 15 times the life of a standard roll.
All of this laid the groundwork for the huge increase in
earnings per share for the first half of 2019, see above. Before I go into my
evaluation of LaserBond, I would like to take a moment and see if there was
anything that should have stood out, in the hopes of spotting the next company
about to hit an inflection point.
The Pursuit for Baggers
LaserBond’s share price ,after hovering around the mid-teens
for the past couple of years, exploded around the mid of 2018, gaining 244%
between the 24/06/18 and 17/02/19.
I for one didn’t see this coming, but that doesn’t mean
others didn’t, take the person who goes by the handle Wini on Strawman.com (If you
aren’t familiar with Strawman.com, I highly recommend you check it out,
excellent source of investment ideas and you get to see what some beasts of the
investment world, such as Wini are currently interested in. Think of Hotcopper
without the trolls), this person literally posted about LaserBond three days
before it started its climb, Talk about timing!
So what should we be looking for? Mr. Christopher Mayer in
his book “100 Baggers: Stocks That Return 100-to-1 and How To Find Them”, studied all of the stocks that
where at least a 100 bagger (when you see bagger after a number, in this case
100, it is referring to a return of 100 – 1, I think it was coined by Peter
Lynch, feel free to correct me if I’m wrong in the comments) between 1962 –
2014, of which he found a total of 365 that weren’t tiny to begin with. He then
investigated these 365 companies further, in the hopes of finding commonalities
and found that they all had some if not all of the following 6 ingredients.
1.
Start small (but not too small, median sales
figure was ~$170m)
2.
Low multiples preferred
3.
High returns on capital
4.
Owner operators
5.
They invested in themselves and
6.
Long time horizon; compounding
So I thought it would be fun to explore each of these six to
see which, if any LaserBond had leading up to the huge increase in share price.
1. Start Small
LaserBond in 2018 generated $15.6m
in revenue, a profit of 1.25m (excluding the inventory write-off) and had a
market cap of $12m, so they had the first characteristic covered. Revenue and profit
both had been increasing since 2015 (2016 profit decreased due to their large
investment in themselves) with HY2019 alone producing $10.5m in revenue and
$1.2m in profit. They have a goal to increase revenue to $40m within 3 years,
still a long way to go, but there have been some quite encouraging developments
recently. After taking a large dip in 2016, their profit margin has returned to
their historical average of the high 7s and in HY2019 had actually increased it
to 10.8%.
2. Low Multiples preferred
Starting from a low multiple
gives any earnings growth an extra boost to the share price. As opposed to
starting from high multiples, where a slight decrease in the earnings growth
rate, can place 2 downward pressures on the share price. Starting from a low
base helps to slingshot the share price higher. It’s like an alley-oop in
basketball, the increase in the growth rate puts up the shot and the increase
in the multiple slams it in the net.
In 2017-2018, LaserBond had a P/E
of around 10, a price to sales of less than 1 and an EV/EBITDA of around 5, all values that a typical value investor
would purchase the share. This is especially true if you are a fan of Tobias
Carlisle as he says an EV/EBITDA score of 5 or below is cheap, not quite as
cheap as the deep value stocks he typically looks for, which have a score of 3
or less, but a cheap stock nonetheless. If we look back to 2014’s values, we
can see that they are very similar to those seen in 2017 – 2018, which makes we
wonder if I had of bought at this time, would I have continued to hold for
those 4 – 5 years, especially with the 2016 drop in earnings?
3. High Returns on Capital
High returns
on capital is about the quality of the business and management’s ability to
find and execute projects that generate high returns. Clearly to get a return
of 100 – 1 the company will need to be able to generate good returns on capital
over a long period of time. There are a number of ways to calculate returns on
capital, I prefer Returns on Invested Capital (ROIC) and as you can see above,
LaserBond has been able to generate quite high values in recent years. The same
can be said about their Returns on Assets (ROA) and their Returns on Equity (ROE).
So again, they have this one covered.
4. Owner Operators
A leadership
team that conducts its self as an owner operator is far better at creating
shareholder value than a team that is purely motivated by money. This is
because by motivating the executives with purely monetary gain, you are
essentially shifted the focus from the longer term projects that produce real
and lasting shareholder value to the short term goals that bring about no
shareholder value but ensure the executives are hitting their KPI’s and
receiving their bonuses. If you have ever had a side gig or run your own
business, you know the difference you feel about the work when you are doing it
for yourself, as opposed to doing it because you are paid.
One way to
look for an owner operator leadership team is to look for companies that are
still being run by the founder. LaserBond was no longer being run by the
founder, he had been put into a position that better suited his skills, as the
head of R&D, but his brother, one of the original company employees was
still running it.
Another way to
see if the executives are shareholder focused is to see if they own a large
percentage of the company, this way, both shareholders and executives gain when
they generate shareholder value. LaserBond’s executive team at the time owned
23 – 24% of all outstanding shares, with the Hooper brothers making up the bulk
of the owner ship. This is very encouraging.
5. They invested in themselves
LaserBond,
after a couple of years of neglect have been continuously investing in themselves
since 2014, with another big investment in 2016. The fruits of which can
clearly be seen.
6. Long Time Horizon
This one has
to do with it taking a long time to reach a return of 100 – 1 as it takes time
for the company to capitalise on its previous good work and then build on it
and capitalise and then build on it and over and over. Clearly LaserBond have
done well to continue to build on the momentum they started back in 2014, with
the share price now showing a more realistic valuation of the company than in
the past.
Mr. Mayer’s research emphasises
the power of small cap value investing, look for well run small companies, that
are currently mis-priced (low multiple), with a management team that is aligned
with the same goals as the shareholders and hang-on through all the ups and
downs, simple J
(Disclaimer: I don’t believe you should buy a company and just hang on, if you
see changes to the fundamentals and/or the story has changed, a re-evaluation
is needed). LaserBond was this type of company in 2017 and 2018. I think this
is one that a typical value investor would have purchased if they had turned
over the right rocks, it’s just a manner of overturning enough rocks until you
find one as good as LaserBond. Easy to say in hindsight, I know, but it doesn’t
help to beat yourself up over missing a stock.
Evaluation
LaserBond is a great company,
well run, good returns on capital and have had some large wins in recent times,
most notably their expansion into the American Steel industry, but that doesn’t
mean that they are currently miss-priced enough to warrant purchasing.
LaserBond has stated on a number
of occasions that they are aiming to generate $40m in revenue within the next 3
years, using this, their NPAT margin and the trailing 5 year EV/EBITDA multiple
we can try and approximate a figure the market would place on this result.
LaserBond in 2018 had a EBITDA margin of just 14.3%, they have however said that
they are working on increasing this margin (it was 17.9% in 2017), so I have
instead used 16%. I have also increased the number of shares using the past 5
year growth rate and also used the trailing 5 year EV/EBITDA multiple of 7.5.
As you can see below, if they are able to achieve their revenue goal of $40m
and the market assigns a historical margin, we are looking at a 9% gain on
today’s prices, 5% if they miss it by 10% and 14% if they exceed it by 10%. If
they instead assign a multiple of 10, we are looking at gains of 20%, 26% and
33%, respectively.
Whilst I have calculated that the
share price is currently between priced about right and a number that I believe
doesn’t offer enough of a safety margin for me to purchase, I am reminded of Matt Joass article on inflection point investing,
where he explains the human brains inability to extrapolate anything other than
linear forecasting very well, see below. I am wondering if I am falling into
this trap now, maybe I am working off estimate 2 or 3, when I should be working
off estimate 4.
| Image source: https://mattjoass.com/2018/11/10/inflection-point-investing/ |
Conclusion
Mr. Morton did a great job helping to refocus LaserBond on
their core business, the results of which are clearly beginning to bear fruit.
They have divested the non-profitable parts of the business and grown
organically whilst reducing expenses and have achieved a HY2019 EPS just shy of
the EPS produced for FY2018. I do however believe the market has repriced the
company about where it should be, given the recent developments and their
growth. They did generate $10.5m of revenue (45% increase pcp) in the first
half, but given that their revenue is close to 50% first half 50% second half,
they will still need to double that in both halves before they reach $40m
revenue, not an easy task, but definitely achievable.
I set out to do this post to try and learn from other people’s
successes. Instead it has reignited my belief in value investing, but at the
same time, emphasised the need to look for companies going through inflection
points. Missing a small percentage of the upside is better than purchasing and
holding out for years in the hopes the market might see the mistake it has
made. It has also shown me that I need to spend more time on Strawman watching
what other great investors such as Wini are doing, reading their reviews on
companies and learning what I can from them.
Whilst I missed the ship with LaserBond, it’s great to see
that there are potentially still mispriced companies out there, especially
given how long this expansion has been going on for.
If you liked this and would like to read more, I have started working on a
series about inflection point investing, read my first post about XRF Scientific here, the
second post about Korvest here, the
third about Paragon Care here and don't forget to subscribe, so you don't miss out on my
upcoming posts. I am on Twitter Follow @MaysTrav and Linkedin if you’d like to connect, feel free to send me a msg, it’s always great to meet other ASX investors, especially those who have a different view point
if you’d like to connect, feel free to send me a msg, it’s always great to meet other ASX investors, especially those who have a different view point
Thanks for reading
Just Culture Investor
Trav Mays
Sources:
The author is
not a current owner of a portion of LaserBond, they may however still be
subject to one or a number of biases, more specifically anchoring and/or
confirmation bias. This article is neither general nor personal advice and
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