Would Warren Buffett link himself to this stock?

Founder and Publisher of the Switzer Report
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A few weeks ago I pointed to a stock the analysts thought had plenty of upside. It was a former darling of the market but had seemingly been caught out by the Brexit drama. Recently the company reported better than expected and it enjoyed a marking up by those who do the form on listed businesses.

The company in question is Link Administration Holdings (LNK) and I’m going to make this the first company to sit my test: Would Warren Buffett buy this stock? I intend to occasionally make numerous companies sit this test — those companies that analysts believe are under-priced.

The following charts tell the story for LNK. The first chart captures the fall from grace where Brexit was seen as the prime culprit for the company’s price decline.

On January 2018, LNK was nearly a $9 stock but it suffered along with most stocks, copping a sell off with the trade war and the fear of a Fed raising interest rates. This took stocks down in the second-half of that year. Then in late May, the stock market revised their view on LNK, as shown by the steep fall in the chart above.

Here’s what Motley Fool reported at the time:

“The Link share price plunged 30% on Friday, May 31 this year after providing the market with a trading and earnings update that downgraded the company’s FY19 earnings outlook.

“Link sighted a lack of finality regarding the Brexit outcome in the UK and regulatory changes in the superannuation sector as key influences on second-half earnings due to lower revenue activity. Link management also announced that the company’s full-year FY19 results will be released to the market on Thursday, 29 August 2019.”

The AFR agreed, with Misa Han reporting: “Australia’s largest superannuation administration company, Link Group, has fallen casualty to Brexit, posting lower-than-expected earnings due to the negative business conditions in Europe.”

One of the big issues is the Brit business — Capita‚ which it bought for $1.5 billion in 2017. This business lost some IPO opportunities because of the Brexit uncertainty, but you’d have to think one day this Brexit disaster will end.

The company copped a Federal Government curve ball from the Protecting Your Super package, which was going to add to costs for LNK. However, the Hayne Royal Commission is bound to be good for its biggest customers — Australian Super, HESTA, Hostplus and Cbus.

It looks like this company’s problems are more short-term than long-term (or permanent). Industry super funds are in a growth phase and, as I say, Brexit has to get sorted, eventually! And since reporting, the market has reassessed its negative view on LNK, as this chart shows.

LNK (one month)

The recent share price move has been from $4.96 to the $5.67 close on Friday.

The latest FNArena assessment is a target price of $6.71, which would be an 18.3% upside, if these guys are right. The stock has a 3.64% yield and at last count was 100% franked. But when the UK businesses start producing positive results, I guess that will change.

I reckon the story so far says this is a company that has potential but what would a Buffett test find?

When Warren Buffett goes after a stock the following markers are looked at:

  1. Does the company have consistent earning power?
  2. Does it have a good return on equity (ROE)?
  3. Does it have capable management?
  4. Is it sensibly-priced?
  5. How has the company performed?
  6. What’s its debt position like?

Does the company have consistent earning power?

Buffet puts a lot more into his assessment to work out a company’s intrinsic value than I will but let’s just see how LNK measures up on these general Buffett measures.

On consistent earnings power, LNK has a solid business locally, which explained its near $9 share price. But it has been brought undone by the Brexit problem. Eventually, the new business should add to earnings.

Source: WSJ

The chart above tells a pretty good income growth yarn.

Does it have a good return on equity (ROE)?

The statistics experts say a ROE between 15-20 is good and LNK comes in at 14.3, while the industry has a benchmark of 11.83. And while on measures you might want to know about, its Price/Earnings ratio is 10.12, which makes it price attractive but it’s not saying that the market is confident that the company is going to have a really good run. That said, the P/E assessment can be more short term and can lack a longer term take on a company’s potential. Here are some more figures on the company.

Does it have capable management?

On management, its CEO John McMurtrie is a highly- regarded manager who has been with the business for 18 years. McMurtrie took the operation to listing. I don’t think Warren Buffett would have many issues with the chief executive of LNK.

The AFR’s Hans Van Leeuwen recently reported that McMurtrie is hopeful of a rebound once Brexit is resolved. “London will still perform valuable functions as a global financial centre under any sort of Brexit scenario. The IPO market will come again, M&A will come again, capital raisings and returns of capital will come again. But it is true that those have been a bit subdued.”

Is it sensibly-priced?

The next issue concerns the sensible pricing of LNK. If the FNArena analysts can be believed, you’d have to think, on a long-term basis, that the current price is on the low side and isn’t sensible. Also, when the share price is still 37% below its all-time high, it does look like an attractive long-term punt. That’s especially so if you can trust McMurtrie, who I know to be a pretty straight bat player. (He was a cricketer of Shield standard as a youngster!)

How has the company performed?

On company performance, you’d have to say that until recently it has been a stellar performer. The EBITDA story shown in this WSJ chart is a positive one.

A good ROE over time is a pretty good guide for a company and recently the team at Simply Wall Street actually looked at LNK and its recent ROE performance. They showed the recent ROE is close to the industry standard for IT businesses around 13%. These very numerate types also looked at the company’s debt in relation to its ROE.

This was their conclusion: “Link Administration Holdings has a debt to equity ratio of 0.40, which is far from excessive. The combination of modest debt and a very respectable ROE suggests this is a business worth watching. Conservative use of debt to boost returns is usually a good move for shareholders, though it does leave the company more exposed to interest rate rises.”

(Interest rate rises are less likely in the modern setting, I’d say.)

What’s its debt position like?

So on the final Buffett test of debt, we can pretty well conclude that it’s not an issue, provided McMurtrie’s call on the future, post-Brexit, is right. The non-excessive borrowings of LNK leaves it in a fairly attractive position to be an improver.

I suspect LNK might make the shortlist as a company that Warren Buffett would look at. I think it has real potential because Brexit is giving it a bad assessment now, but, in the long term, the company’s true potential is likely to be acknowledged by the market.

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