Summer Series: Washington H. Soul Pattinson and Co. Ltd (ASX: SOL)

Bryce: [00:01:15] Welcome to another episode of Equity Mates, a podcast, or we help you learn to invest in 45 minutes or less. We break down the world of investing from beginning to dividend so that you can hopefully make some returns. My name is Bryce and as always, I'm joined by my equity buddy Ren. How's it going, bro? [00:01:30][15.0]

Alec: [00:01:30] I'm very good, Bryce. That's good. At this point, we are enjoying our Christmas break. We are, yes. And we are right now enjoying going deep on a few different stocks. [00:01:43][12.4]

Bryce: [00:01:43] We are. So this is part of our Christmas series where we've crowdsourced 10 stocks from our Equity Mates community and digging a bit deeper than we normally would in an episode. [00:01:53][10.2]

Alec: [00:01:54] I've got to say, it seems our listeners love small caps with no profits. And so I'm very glad we're changing it up a little bit for this episode. [00:02:03][8.7]

Bryce: [00:02:03] We have been on a bit of a small cap run recently with some of the interviews we've been doing. So it is [00:02:08][4.3]

Alec: [00:02:08] true. That is true. [00:02:08][0.6]

Bryce: [00:02:10] So today is a stock that we're going to be Deep Dive ing on and apologies for not recognising the name of our listener who suggested this one. But it is Washington H. Soul Patterson and Co. Ltd. ASX Ticker s OEL. [00:02:25][15.2]

Alec: [00:02:26] The pharmacy. [00:02:26][0.1]

Bryce: [00:02:27] The pharmacy. Yes. Well, its roots are in pharmacy Ren. Yes. So what we'll be doing is we'll have a bit of a look at the company. We'll go through some of the key facts, I guess, that define it and that we found interesting. Have a brief squiz at the financial summary and perhaps a crack at its valuation and then we'll close out. I have a question for you at the entrance. A reminder us. [00:02:49][22.0]

Alec: [00:02:50] It's not all safely outside, guys. [00:02:52][2.5]

Bryce: [00:02:53] All right. Well, what is so well, if you want to check it out on Google or ASX as we go through this, then its ticker is Summerell and Ren. So Patison is an investment company founded I think it's been listed for about hundred and ten years now. So, yeah, [00:03:10][16.2]

Alec: [00:03:10] it listed in 1993. So it's 116 [00:03:12][2.5]

Bryce: [00:03:14] quite a long time. So it started out owning and operating Australian pharmacies. [00:03:20][6.1]

Alec: [00:03:21] Yeah, I think a lot of people would be familiar with Soul Pattinson pharmacies. Yes. The confusing thing is that sold patents in pharmacies is actually owned by API, which I believe is Australian Pharmaceutical Industries, also a listed company, and then sold patents. And the company we're talking about today only owns 19 percent of API. So there's a complex shareholding there. Yes, but the important thing to take away right from the top is we're not talking about the chemist per se, although they are exposed to pharmacies which will get into there is an [00:04:01][40.8]

Bryce: [00:04:02] element of that. [00:04:02][0.5]

Alec: [00:04:03] We are talking about essentially diversified holding company. Yes. [00:04:07][4.1]

Bryce: [00:04:07] So since the days of running pharmacies, they've now gone on to invest in portfolios around natural resources, building materials, telecom. I think they're a massive or large shareholder of TPG. So retail agriculture investments and all sorts of different things. So, yeah, to your point, Ren, they are now a diversified, almost a listed investment company, really. [00:04:32][25.0]

Alec: [00:04:32] I mean, the the best analogy you can probably think of is a company like Berkshire Hathaway, Warren Buffett's company. It's it's probably not it hasn't reached the illustrious heights and it probably doesn't have the same quality of companies, although some of them are pretty bloody good. Yeah, but it's that it's that concept. It's it's used as a holding vehicle for a whole bunch of other both public companies and then private companies as well. The most strange one that I found in its holdings is I learnt to swim company. Okay, so it's got everything from coal mining to telecommunications to teaching kids how to swim. You go. Yeah, yeah, exactly. [00:05:15][43.1]

Bryce: [00:05:16] And is that teaching kids how to swim company listed as well? [00:05:19][2.9]

Alec: [00:05:19] No. So that would be funny. Yeah. Yeah. I mean there's a lot of books and a lot of kids, a lot of swimming pools out there. Maybe there's a business, the public business there. But no, it's it's a private company. So it's one of the private companies that Soul Pattinson owns. [00:05:35][15.3]

Bryce: [00:05:35] Right. Because Soul also major shareholders in a number of public companies that a lot of our listeners would be aware of. As I said, the 25 per cent shareholders, they own 25 per cent of TPG Telecom, which over the last few years has done really well. Yeah, they own 50 percent of new hope. Is an energy company big coal miner? Big coal miner. Yeah, they own 43 percent of brickworks. Yeah. Which is cement and bricks. Yeah. And then also eight per cent of BKB investment. Brickworks invested to listeners who have been with us for a while. I also own a bit of B.K.. I'm not eight per cent worse yet, but. A lot of their revenue is driven from dividends that they get from these companies. So if anyone's wondering, you know, how they actually make money on this without selling, that's one of the reasons, one of the ways in which these companies, these holding companies make a lot of their revenue is through the dividend payments. Anything from your Ren. [00:06:30][54.4]

Alec: [00:06:30] So just on in terms of that list, the companies that you just listed were the main ones that I had. There's two more that I think are quite relevant. One other minor round, OK, which it owns, 100 percent of which does a bit of gold and some rare earth metals. And in the last one is Australian Pharmaceutical Industries, which is publicly listed as well, ASX, API, and they own Soul Pattinson and also Priceline pharmacies. So some retail, some mining, some manufacturing in terms of brickworks and some telecoms. Nice, pretty diversified. [00:07:04][34.1]

Bryce: [00:07:05] Yeah, absolutely. So how do you think it's performing from a financial point of view, Reg? [00:07:11][6.2]

Alec: [00:07:11] So I think when you start your research process and you read the annual report and some of the investor presentations, you start getting blown away by some of the numbers. They they tell a good story. So over the past 15 years, the company has increased its dividend, an average of eight point three percent per year and delivered total shareholder return, which is the share price increase, plus dividends of thirteen point nine percent per annum, which is great. That outperformed the Australian All Ordinaries Index by five point four percent per annum in that 15 year period. So you'd be pretty happy with that. Another thing that they talk about is that a thousand dollars invested in the company 40 years ago. So in nineteen seventy eight is now worth over half a million dollars. [00:08:02][50.9]

Bryce: [00:08:03] Solid returns, solid returns. [00:08:04][1.2]

Alec: [00:08:05] I think as we get into the numbers and into the valuations a little bit further, there are potentially some red flags, but it's it seems pretty interesting to begin with. [00:08:16][10.9]

Bryce: [00:08:17] So, however, the last year to the 31st of July 2019, I think from what I can see, was a year that they actually didn't beat the All Ordinaries Index, total shareholder return six and a half percent, whereas the All Ords we know has been on fire twelve point nine percent. So performance wise, their portfolio is probably not matching or isn't matching the index of late. But yeah, to your point, 15 year return for shareholders and eleven point six percent. So pretty phenomenal [00:08:43][26.1]

Alec: [00:08:43] stuff from that portfolio value. They get revenue of about one point six dollars billion and they earned a profit of two hundred forty eight million. So pretty strong, you would say. Yes. [00:08:57][13.9]

Bryce: [00:08:58] One thing that confused me, I guess, Ren, when I first started looking into this is the sector. They're marked down as being in the energy sector, you would think that they'd be in the diversified financials or probably that [00:09:11][13.1]

Alec: [00:09:11] would be it. Yeah, yeah, yeah. But I mean, they've got a lot of holdings in energy. I guess you got to put them somewhere rooted in pharmacies. Yes. Yes. So I think, as you know, they've got they've got a massive number of assets. They've got strong revenue, they've got strong earnings. But if we get into the valuation side of things, there's an argument to be made that potentially they are slightly overvalued at this point. OK. And I think if you look at the actual growth rate of light, it probably hasn't been stellar. Their earnings per share last financial year is about the same as it was two years ago. And the money that they're deploying. So their return on equity isn't isn't great. It's sort of high single digits, which is not really what you'd want to say. So if we start to talk about how you can value this company, given it's generating cash, we can do something like a discount cash flow. So if we start with its price to earnings, we can say that it is trading at about twenty one times earnings, which probably isn't well out of line of the market. Obviously, if you comparing it to other companies in this sector, you don't want to compare it to other energy stocks, per say. Well, the [00:10:24][73.0]

Bryce: [00:10:24] sector average I've got is sixteen point two. OK, so yeah. To your point, a bit a price. [00:10:30][5.6]

Alec: [00:10:33] But they might if we move from price to earnings ratio to valuing the company specifically, and if people haven't listened to the valuation episode we did in early December, definitely go back and refresh it one, because it's a good episode, but also because it's relevant here. So the first thing we spoke about was a discount cash flow. And this comes with all the usual caveats around the unreliability of this measure. You know, you start changing the assumptions and you can get really whatever number you want. But in saying that, you know, just for the point of doing the exercise, I guess. So I have the company's earnings per share without non-recurring items. So without one of bumps to profitability, I have a dollar and three cents. So there you go. Yes. So then if we just plug in some basic assumptions, so for 10 years, it grows at those earnings at 10 percent, which is probably generous given the last couple of years. And some of the companies that it holds, you know, you wouldn't maybe wouldn't expect it's coal mining business to grow at 10 percent a year and stuff like that. But let's just say for the purposes of this exercise, then after that, it just grows at the rate of inflation. And we say the 10 percent discount. Right. And if you remember, back to our valuation episode, we spoke about how both Warren Buffett and Roger Montgomery say just use 10 percent as you discount. Right. And if it's good enough for them, it's good enough for us. So for the purposes of this exercise, let's plug in those assumptions, put it in discount cash flow calculator online and it spits out a number of seventeen dollars and sixty cents. So you compare that to its current share price. When we're recording this on the 7th of December of twenty one dollars and seventy eight cents, it's a little bit overpriced. The flip side of the discount cash flow is if you use all those same assumptions that we used, the 10 percent discount rate and the earnings per share, you can do a reverse discount cash flow. And essentially what that's asking is based on the current share price and based on your discount rate, what growth is priced into the company? Like what growth does the company need to achieve to justify the share price that it's currently trading at? And if you do that, you get thirteen point three percent, which isn't unrealistic. But given its history, it probably isn't. [00:12:59][145.1]

Bryce: [00:12:59] For what period of time for [00:13:00][1.2]

Alec: [00:13:01] the 10 years that you put [00:13:02][1.3]

Bryce: [00:13:02] in 30 percent a year for 10 [00:13:04][1.7]

Alec: [00:13:05] years. [00:13:05][0.0]

Bryce: [00:13:05] Yeah. And your initial discounted cash flow, you plugged in 10 percent past 10 years and then it dropped to inflation growth. [00:13:12][7.5]

Alec: [00:13:13] Yes. Yes. And so this is saying keep inflation growth after the 10 years, keep the 10 percent discount rate and keep the starting point. And then tell me what the current share price is, assuming so probably overpriced. [00:13:26][13.5]

Bryce: [00:13:27] Interesting. So I'll add some flavour to that Ren from a quantitative standpoint, which is. Well, let me let me go back. Morningstar release a quantitative report through Comsec on a number of the major stocks obviously sold. Patison is one of them and they run their algorithms based on a few key metrics to your point around revenue, operating income, cash flow, discount rate, that sort of stuff. But they also incorporate looking at things like economic moat and financial health of the company, something, you know, those sorts of metrics. Their latest one, which was the 6th of December. So run yesterday at the time of recording, they've actually come back and said that fair value from their point of view is twenty four point twenty seven. There you go. Yeah. So that's they're saying at current prices and valued. Yeah. Afterpay ratio against the sector suggests that it's overvalued. And the assumptions that we've put in here today also suggest that Galeazzo just goes to show how confusing it can. [00:14:31][63.8]

Alec: [00:14:31] No one has any idea before we close out, I've got another valuation method. [00:14:35][4.1]

Bryce: [00:14:36] OK, awesome. I just want to. OK, well we'll leave this for another company just as an exercise can. No, what is it. I just want to show the difference to a valuation using a cash flow DCF when you just play with the numbers. [00:14:50][14.0]

Alec: [00:14:50] Oh yeah. Nice. Okay, so [00:14:52][1.6]

Bryce: [00:14:52] let's do that in another episode. [00:14:53][0.8]

Alec: [00:14:53] We're going to have to stay tuned. So the other valuation method we spoke about in the valuation episode was from Roger Montgomery's book value table. I don't know what you label it, but essentially as a quick refresher, you take the book value of the company and then you look at the returns that the company gets on its its equity, the money in the assets and everything it has that it owns. And then you essentially value the money that it would generate over time. And Roger Montgomery's book has some tables that you can basically look at and you say, all right, it's earning. This return on equity, so you just multiply what it's earning by the number that it tells you to without going through all the numbers, it spit out a pretty low valuation, extremely low, six point sixty one, which is just so far below the like the asset value of the company. Yeah, like if the book value is five and a half billion and its current market cap is like five point two billion, you would say that taking 75 percent off the share price is a little bit too much. But essentially the reason that it's coming out like that is because the companies earning such a low return on equity that are putting your money there rather than putting your money in a company that's earning a consistently high return on equity on a relative basis. Because, you know, everything in investing is an opportunity cost. If you're putting your money here, you're not putting it elsewhere on a relative basis. It appears to be not that good an investment to take your money and compound it over time and generate a really good long term return. [00:16:35][102.2]

Bryce: [00:16:36] How is eleven point six percent shareholder return over the last 15 years? Not a good return [00:16:42][5.8]

Alec: [00:16:42] in Roger Montgomery's book. A company that is Take is earning good money every year and is keeping it and is reinvesting it in. The business is better than a company that's paying it out in dividends. Yeah, last year, Washington Soul Pattinson dividend payout ratio is 82 percent. Wow. And I think what you can say is because you see how its dividend payout ratio is dividend number just is a consistent, unnatural trend up like there's obviously a lot of focus on every year incrementally growing that dividend. So it's like a perfect table going, you know, bottom left to top right. [00:17:18][35.2]

Bryce: [00:17:18] Well, their website clearly states our objective is to deliver superior returns to shareholders by creating capital growth along with steadily increasing dividends. Yes. [00:17:28][9.4]

Alec: [00:17:28] So so I don't think that's great. But then the other thing is, why would you put your money with a company that earns a low return on equity? [00:17:36][7.7]

Bryce: [00:17:36] Valid point, something that Buffett often talks about. [00:17:38][2.2]

Alec: [00:17:39] Yes. [00:17:39][0.0]

Bryce: [00:17:39] This way of looking at it as well. [00:17:40][1.0]

Alec: [00:17:41] And I guess like when you when you strip back what we're talking about here, away from these abstract numbers and into the companies that we're talking about, I mean, retail pharmacy is I'm sure it's an okay business, but retail staff and chemist warehouse is big. That's a competitive industry to ban coal mining, not that great, although they make some big points in their annual report around South East Asia and India, continuing to demand coal. And they're selling thermal coal, which is called energy, rather than the coal used in the production of steel, coking coal or whatever. That is not a great business to pay. So like, yeah, TVG is not bad, but, you know, currently saying that they need to merge with Vodafone to stay competitive. So there's a lot of headwinds. I guess maybe that sort of points to their reasons why they're getting a low return on equity. [00:18:30][49.9]

Bryce: [00:18:31] Nice. So I guess from what we've discovered, General feel is that it's probably below it's worth a little bit below its current trading price just from the assumptions that we've made here. So pretty interesting company. I hadn't I'm not invested in it. Are you invested in that room? [00:18:46][15.6]

Alec: [00:18:47] I'm not. [00:18:47][0.3]

Bryce: [00:18:48] Although unless it's an index, if it's in [00:18:50][1.9]

Alec: [00:18:51] the top 100, top [00:18:51][0.7]

Bryce: [00:18:51] 100, I would be by virtue of being an index. But any fun facts to close it out? And then I'll ask you at my [00:18:58][6.3]

Alec: [00:18:58] standard, are you closing? Well, one, I guess comparative. So we spoke about at the top that it's similar to Berkshire Hathaway and that holds a bunch of diversified companies. And when I was doing that valuation exercise and seeing a low return on equity, I was curious what Berkshire's numbers looked like. And their return on equity numbers are pretty shocking as well. So potentially because of the structure of this company, using that valuation method isn't correct. And well, clearly it's not correct because the market and the answer that it spread out so far apart. So potentially you'd better value valuing it based on its book value because that incorporates like all of its shareholdings and stuff like that. I don't know how fun a fact that is, but I guess that's a grain of salt in terms of some of those valuation methods. Nice. [00:19:50][51.9]

Bryce: [00:19:51] Yeah. So to close out, where does this fall, do you think this company fall in your circle of competence, thinking about all the companies that we're doing in this tense 10 episode? Where do you think this falls in terms of. Yeah, your circle of confidence [00:20:04][13.3]

Alec: [00:20:05] compared to some of the other companies in this 10? I mean, [00:20:08][3.3]

Bryce: [00:20:09] it's comparatively and then more generally, [00:20:11][2.4]

Alec: [00:20:12] OK, comparatively more than, you know, some of the biotech ones we're talking about. Yeah, I think the retail stuff is bread and butter for us. We both work in big, big box retail. A lot of the other stuff I think we can learn like, you know, type J, these coal mining companies. I would feel confident that if I gave myself enough. And did enough work that I would I would be able to properly understand those businesses. So, yeah, I would say it's in the wheelhouse. [00:20:41][29.4]

Bryce: [00:20:42] Nice from the point of view. Well, comparatively, to some of the other ones that we've been doing definitely in the warehouse. And I think in terms of understanding how soul itself works as a holding company and generates revenue and that sort of stuff. Absolutely. It's it's pretty straightforward to your point. If you're going to go down and actually understand whether their investing strategy and what they're investing in is right, then you probably need a bit more time to do so. But reasonably comfortable. [00:21:10][28.3]

Alec: [00:21:11] And that's why. Right. [00:21:11][0.7]

Bryce: [00:21:11] Well, we'll leave it there. Ren always good to chat stocks enjoying this series that we're going through and looking forward to the next one that we dive into.