Brace for attack!

  • Danger lurks
  • Seen it all before
  • Vern’s warning

Today’s Australian has a warning for all investors, ‘Brace for short-sellers’ attack’.

It’s a worthy warning.

Not because it’s something you should fear (unless you’re fully invested in stocks), but because it highlights the excessive valuations of many Aussie stocks.

And that, based on those valuations, along with the Aussie house price bubble, many international investors consider Australia to be at a tipping point.

The first, perhaps of many, in the sights of international short sellers, is ASX-listed timber company, Quintis Ltd [ASX:QIN]. But for the presence of a ‘u’ in the name, we couldn’t help wonder if the company name sought to closely resemble the name of another listed stock, Qantas Ltd [ASX:QAN].

But we’re sure it’s purely coincidental.

As for the stock itself, the Australian reports:

Meet the new face of activist short-selling in Australia.

Soren Aandahl, a Harvard-educated former corporate lawyer, is one of the founders of Glaucus Research, the US-based fund behind yesterday’s blistering research report on Perth-based sandalwood grower TFS Corp.

The report — which said TFS was “worthless”, had made “highly misleading statements and disclosures”, was involved in “Ponzi-like marketing materials” and had “festering uncertainties” in its business model — is one of the most visible examples to date of activist short-selling in the Australian market.

Ouch!

The company was previously known as TFS. Its new name is Quintis. Although, judging from the excerpts of Glaucus Research’s report, the old saying, ‘Same ****, different shovel,’ springs to mind.

To at least temporarily show the effectiveness and impact of short sellers, the Quintis stock is down almost 19%, as we write.

So, is the analysis fair? Or is it no more than a short seller’s version of a ‘pump and dump’ exercise?

Our take below. First…

Markets

Overnight, the Dow Jones Industrial Average fell 6.71 points, or 0.03%.

The S&P 500 gained 4.43 points, for a 0.19% rise.

In Europe, the Euro Stoxx 50 index fell 8.92 points or 0.26%. Meanwhile, the FTSE 100 dropped 0.73%, and Germany’s DAX index lost 0.48%.

In Asian markets, Japan’s Nikkei 225 index is up 7.13 points, or 0.04%. China’s CSI 300 is up 0.39%.

In Australia, the S&P/ASX 200 is up 8.19 points, or 0.14%.

On the commodities markets, West Texas Intermediate crude oil is US$48.22 per barrel. Brent crude is US$50.64 per barrel.

Gold is trading for US$1,247.64 (AU$1,626.66) per troy ounce. Silver is US$17.53 (AU$22.86) per troy ounce.

The Aussie dollar is worth 76.69 US cents.

Danger lurks

You can see the effect of today’s price action on the right hand side of the chart:



chart image

Source: Bloomberg
Click to enlarge


According to the Bloomberg description of Quintis:

Quintis Ltd operates as a forestry management company. The Company focuses on the hosting and cultivation of sandalwood album. Quintis offers sandalwood oil products, as well as oil-bearing wood that is used to create fragrant jewelry, exquisite carvings, and ceremonial items for worship and furniture globally.

Nice.

Although, we’re not sure that it’s a nice enough business to justify a $460 million market capitalisation.

Of course, the first thing we think of when anyone mentions Australian forestry and plantation businesses, is Great Southern Plantations.

That particular operation listed in 1999, to great fanfare. It hit a high of $4.76 in 2005. It then collapsed, and went bust in 2009. The shares last changed hands for 12 cents apiece in 2009.

While we’re sure there are many differences between Quintis and Great Southern Plantations, our bearish nature can’t help but notice the glaring similarity.

And for that, we need look no further than the respective cash flow statements. Everything else — the income statement, balance sheet, and even an intimate knowledge of the company’s business — is irrelevant.

All we need to see is that, but for the issuance of new shares on a regular basis, Quintis would be cashflow negative. That means, its outgoings would exceed its incomings.

That too, was a significant feature of the Great Southern Plantations’ cashflow statement in the years leading up to its bankruptcy.

Yet, despite Quintis’ inability to make more money than it spends, don’t for a moment think that it doesn’t pay the one thing every Aussie investor loves — dividends.

During the 2016 financial year, Quintis generated positive cashflow from its operations of $20.2 million. That was offset by negative cashflow of $80.1 million from ‘investing activities’.

That gives it a net cashflow so far of -$59.9 million.

But magically, and thankfully for the business, the capital and financing markets come to the rescue, to deliver cash from ‘financing activities’ of $94.2 million.

Overall then, a positive cashflow of $34.3 million.

Naturally, if the company didn’t pay dividends totalling $7.5 million during the year, its need for debt and equity financing would be less.

The problem there, as you may already imagine, is that without the dividend, there are no investors. Given the company’s woeful financials, we can hardly bear to look at Quintis’s 3.6% dividend yield.

It’s a yield that would suggest the company’s health is greater than that of Telstra Corp Ltd [ASX:TLS], Commonwealth Bank of Australia [ASX:CBA], and BHP Billiton Ltd [ASX:BHP].

All three of which yield greater than Quintis.

As you know, we’re no fan of the Australian banking system. The Aussie banks deserve their relatively high yields. The Aussie banks, in our view, represent an extraordinary level of risk — especially if, as we believe, the Aussie housing market is readying for a collapse.

But investors do often look at dividend yields as a sign of company health. Most certainly when they’re investing in a stock for the dividend income.

So it’s not unreasonable to think that, while investors prefer higher dividends over lower dividends, they may consider Quintis’s low yield as a sign of strength.

Based on our cursory analysis of the company, we see no strength. We see weakness. A lot of weakness.

As further evidence, we can keep tabs on the number of shares the company has had on issue. As if to the beat of the drum, the number of shares outstanding rises each year:

2007: 162.5 million

2008: 187.8 million

2009: 191.8 million

2010: 228 million

2011: 276.5 million

2012: 279.6 million

2013: 279.6 million

2014: 324.2 million

2015: 327 million

2016: 388.1 million

Only once did the drum skip a beat, 2012–2013, when the company’s share issuance didn’t grow. But since then, boy, has Quintis made up for it.

The shares on issue has grown by more than 100 million since 2013.

And what do the shareholders have to show for it?

An annual three cent, fully franked dividend and — unaccountably, to our mind — a share price that has doubled since mid-2013.

What are shareholders seeing that your editor is missing, and vice versa?

Our biggest guess is that shareholders are seeing or have seen a representative from a financial planning company, who so often push such schemes.

The Quintis website explains why this may be so: ‘Investments in sandalwood can be tax effective.

Ah, the biggest alarm bell with any investment. If a financial product provider can’t sell a product any other way, the fall-back position is to extol the virtues of tax-effective investments.

As you’ll know, your editor is no fan of paying taxes. And when it comes to tax deductions, we follow the wise words of the late Kerry Packer: ‘If anybody in this country doesn’t minimise their tax they want their head read.

But when it comes to minimising taxes, it’s important to make sure that there is substance to the investment that’s helping you minimise your taxes.

As we say, we’re no fan of paying tax. But if given the choice of (say) paying 48% tax on $10,000 and having a 100% chance of keeping what’s left, or paying no tax on $10,000 but having less than a 50% chance of holding on to any of it, we’ll begrudgingly pay the tax.

We’ve been in the investing game for 20 years. We’ve seen tax effective schemes come and go with regularity. Yet, for the life of us, we can’t think of a single one where in hindsight we’ve regretted missing out.

Our analysis on Quintis is cursory, superficial, and quite possibly it’s wrong.

But we don’t think so. Consider the cashflow again. Without financing activities, the company would soon be out of cash. All it takes is another ‘credit crunch’, or banks, investors, or other creditors to stop handing over cash, and that’s it…it would be all over.

We hope for the sake of Quintis investors that we are wrong. But something, (it’s called ‘experience’) tells us we aren’t.

Seen it all before

It’s not just the plantations businesses that have this issue.

We’ve seen the same setup in many listed infrastructure companies, too. Not all, mind you. We’re specifically thinking about the type made famous by Macquarie Group during the 2000s.

That is, Macquarie would overpay for an infrastructure asset. It would then bundle that asset into a listed fund. It would then arrange a contractual management deal (for a whopping fee) between the fund and Macquarie.

Each year, the fund would get an ‘independent’ valuer to value the assets. The assets, amazingly, would rise in value each year. The fund would then report the rising value as a profit in its income statement, and borrow against the increased value.

It would then use those borrowings to pay a dividend (or ‘distribution’, as it was neatly called). And so on it went…until the 2008 crash. When it stopped.

As always, caveat emptor.

If you don’t know what that means, you should. Look it up.

Vern’s warning

Remember to check out Vern Gowdie’s latest research and book. It’s not unrelated. Details here.

Cheers,
Kris