Disclaimer: This is a high level conceptual exercise and all figures are approximations using the CY2020 accounts.


In early 2010, Berkshire Hathaway finalised the acquisition of BNSF (Burlington Northern Santa Fe), the largest US based railroad for the consideration of $26 billion for the stock it did not already own. This equated to a total deal value of $34 billion.

The consideration of $26 billion was paid with ~$16 billion in cash and the balance in Berkshire stock; with around $8 billion in debt drawn to partial fund the cash consideration. Broadly, this structure was in line with Berkshire's target leverage of around 30% against assets.

Berkshire's operandi modus is to let competent management teams run their businesses but enforcing strict capital discipline with a strong focus on cash generation to the parent company. Optimal capital allocation decisions result in a large advantage over time, which Berkshire personifies in many ways. 

Without digging too deeply into the operational performance since acquisition, it is clear that Berkshire purchased BNSF at a cyclical low with extraordinary timing; just as the post-GFC recovery was gaining momentum. The growth in top-line revenue has been anemic, with a rise of only around 25% over the 10 year period since acquisition. However, cost control, capital allocation and market conditions have been sound and allowed Berkshire to harvest outsized returns from the investment.

Since acquisition, Berkshire has invested $41 billion in capital expenditure offset by depreciation of $20 billion. This implies that BNSF may have been either 1) under-investing in capital items prior to Berkshire's acquisition or; 2) Berkshire have invested heavily in capital items due to a strategic rationale. 

The latest Berkshire shareholder letter provides some clues: "Railroading is an outdoor sport, featuring mile-long trains obliged to reliably operate in both extreme cold and heat, as they all the while encounter every form of terrain from deserts to mountains. Massive flooding periodically occurs. BNSF owns 23,000 miles of track, spread throughout 28 states, and must spend whatever it takes to maximize safety and service throughout its vast system."

Whilst depreciation is a relatively stable portion of fixed assets; year-to-year capital expenditures can fluctuate more broadly depending on capital allocation decisions and any externalities that may impact the operations. In addition, given the relatively long-life nature of heavy fixed railway assets and the inexorable push of inflation over time; this effectively means that a dollar spent today, could mean over a dollar saved tomorrow in aggregate holistic costs.
Accordingly, we anticipate that BNSF will require a relatively lower capital requirement going forward, probably a figure closer to BNSF's depreciation and amortization expenses.

Incidently, this aggressive capital investment program has come about despite almost $42 billion in dividends paid to Berkshire over this time period. No doubt that a reasonable portion of this has come from levering up the balance sheet against new fixed assets against which Berkshire has greater certainty around their effective life. None-withstanding, this is a fantastic result against Berkshire's cost base of ~$30 billion. 

The largest component of value attributable to BNSF is the terminal value. The company's claimed equity value on its books is around $65 billion which looks to be under-valued on a standalone basis. For instance, BNSF's competitor, Union Pacific Corporation (UNP), is valued at around $154 billion at a capitalised dividend yield of approx 1.8%. 

I cannot say whether UNP has invested the minimum requisite capital expenditure necessary to keep its operations running smoothly, but I can say that BNSF's heavy capital investments provides it a good degree of certainty around its future capital requirements; so it's appropriate to use UNP's dividend yield as a basis for our standalone terminal value. 

For CY2020, a $5.8 billion dividend was paid by BNSF to Berkshire; we expect this to grow over time largely dependent on the sustaining capital requirements. Capitalising this dividend at a yield of 1.8%, provides us with a terminal value of $322 billion. If we are even more conservative and decide to use a 3% capitalisation figure, this provides us with a terminal value of around $193 billion. Both figures are vastly higher that BNSF's claimed book value of $65 billion.

Berkshire's overall return on BNSF has been over 28% per annum in our upper case and almost 23% in our lower case. It's actual return on equity is significantly higher; circa 32% and 27% in upper and lower cases.

These are extraordinary returns considering the size of the investment and truly demonstrate why the Berkshire team are considered the world's pre-eminent living investors.




Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way. The author holds no exposure to the stock discussed

We did it! In August 2021 we achieved our 3-year mark for the Datt Capital Absolute Return Fund, which we consider to be a key stepping stone for the Fund.

​We began the Fund with a number of factors against us: we were fund management industry outsiders from non-conventional backgrounds who invested in assets typically outside the mandate of conventional equity fund managers. Despite these challenges, we have always had an initial 5-year plan in mind to develop a sustainable, high performing boutique funds management business. At the 3-year mark, we are well positioned to deliver on this original objective. I thank all our investors, staff and service providers for their faith and understanding despite the occasional hiccups all businesses sometimes experience.

In early February this year, we wrote a piece on Livewire asking why the market was valuing Dusk Group (ASX: DSK) so cheaply? The company had a less than spectacular debut in late 2020 and subsequently has flown under the radar of many investors. But since listing, Dusk has delivered three consecutive earnings upgrades, with the share price rising around 35% since we published our original article. 

As part of Livewire’s reporting season coverage, I have addressed some questions about Dusk’s latest results and explain why we still believe the shares remain attractively priced.  

1. Briefly explain what the company does and why you’re attracted to it (at a high level).

Dusk Group is a specialist retailer operating solely within the Australian market. While known mostly for its scented candles,  the company's range also includes diffusers, essential oils and other fragrance-related homewares. 

Historically, niche homeware retail segments have been largely a cottage industry with a long tail of small boutique merchants fulfilling demand. Dusk is the largest player in the local market, holding around 22% market share, while running only around 122 physical stores in Australia. The company foresee the potential to grow to around 160 stores throughout Australasia by 2024 and also plans to eventually expand into the UK and US markets.

Dusk has a combination of soft and hard factors that make it an attractive investment proposition. The products are orientated towards making homes and offices pleasant environments, which has become exceptionally important given the recent lockdowns. In addition, the majority of the company's products are consumables or products that use consumables. This means that every sale in the present has a high probability of further follow on sales in the future, assuming the buyer remains engaged with the product itself. This confers an enormous advantage over time vs other retail niches.

This "soft factor" advantage translates into hard benefits; for example, the company's loyalty program now boasts almost 700,000 highly engaged members. This translates into exceptional gross margins of almost 70%, while the team has maintained and exercised exceptional capital discipline and allocation decisions. We expect this outperformance to persist over time.

2. How did the current result compare to your expectations? What about market/analyst expectations?

Dusk is a recent listing, only being listed for less than 12 months. In that short period, there have been three consecutive earnings upgrades - something quite unusual. Accordingly, Dusk has outperformed its prospectus projections by a large percentage.

3. Were there any surprises in the result or management’s commentary?

Like all retailers, the first seven weeks of FY22 trade has been impacted by the Victorian and NSW lockdowns. Around half the company's store network is within these two states, but it has only affected top-line revenue by 28%. This relative outperformance demonstrates that the company's products are actively sought by its loyal customers, despite the state lockdowns. This also affirms that Dusk's products are differentiated enough versus competitors for customers to actively seek them out. This is confirmed by the statistic that 60% of the group's revenue by value is derived from Dusk rewards members

4. What do you think is the most important thing for investors to know about this company?

There is significant potential for Dusk to expand overseas. The management team is very disciplined in allocating capital and is taking a careful, prudent approach given the uncertainties around COVID and international travel. However, we expect that once the present situation normalises, the company will commence its international expansion.

5. What’s your outlook for the company?

While like-for-like growth sales are down slightly, we anticipate that Dusk may be able to achieve at least 80% of FY21's revenue, while maintaining an EBIT above $30 million. This assumes that social restrictions are loosened in Victoria and NSW prior to the Christmas shopping period, as well as being open during the key Mother's Day trading period. The company has also disclosed that "reopening" events generally have a large positive impact on physical stores' trading.

The company’s initial foray into New Zealand has been delayed by covid induced travel restrictions, and we believe there is significant scope and potential to begin examining larger international markets such as the UK and US for near-term expansion, despite the delays being experienced within the ANZ region.

6. Do you still think the company looks attractive following the result (and the price response)? Why or why not?

We believe that Dusk looks highly attractive at the current valuation.
The company has a number of highly attractive factors that are conducive to future returns.
These are: 

- Zero leverage, 
- High margins and cash generation,
- Global expansion potential,
- Broader tailwinds for their specific sector, and 
- An aligned and disciplined management team.


The company looks highly undervalued when you examine its valuation on a peer comparison basis. 
​
Additionally, it has paid a gross yield (including franking credits) of around 11% over the past financial year, based on today’s price. We expect the company to continue to pay a sustainable, reliable dividend stream in the coming years, while holding significant upside potential from further expansion in its activities.

We consider the fair value for Dusk to be around $5 a share, considering all the factors mentioned above. In a nutshell, we consider Dusk to be a Growth company that's priced as a Value stock.

Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way. The author holds shares in Dusk Group (DSK:ASX).

​Long-term portfolio holding, Adriatic Metals, recently delivered their Definitive Feasibility Study (DFS) over the flagship Vares Project which is the final study prior to a Final Investment Decision (FID).

The DFS demonstrated the following key project metrics:

• a 10-year mine life - reduced by 4 years by cutting out more marginal resources

 • an increase in project NPV8 to US$1.062 Billion at an IRR of 134% 

• Reduced project capex of US$168 million and a payback period of 8 months

• an NPV8/Capex ratio of 6.3x - this is a measure of capital efficiency and it is the highest we've ever seen from a greenfield mining operation

• a reduction of costs to US$7.3/oz of AgEq (silver equivalent) on an AISC (all-in-sustaining cost) basis - this is a 1st decile (bottom 10%) cost result relative to Adriatic's peer group

• 15 Moz of AgEq/year production with commodity revenue streams by value being silver dominant, followed by zinc, lead and gold

The study reaffirmed the world class nature of the project with a high level of confidence. Unusually, the company has managed a trifecta in terms of improving the economic outcomes of each sequential study; generally we see the opposite.
The changes that drove the most recent outcomes are:

• the removal of a lower quality deposit and lower value commodities such as barite which also had the benefit of reducing the number of concentrates produced to only 2 from 4 previously

• the vastly simplification of the project's processing flowsheet as a result of this decision which in turn reduces delivery risk

• Higher base metal prices relative to the PFS

• A modified mining sequence that prioritises mining the higher grade ore at an early stage from the core Rupice deposit

Importantly, the DFS demonstrates a robust project in any price environment. For instance, a 20% fall in metal prices would reduce the project IRR to ~100%; still a world class result by any metric.

The Vares Project is extremely important to Bosnia and Herzegovina, and will comprise over 30% of the nation's direct foreign investment over a 10 year period as measured since 2014; as well as being the nation's single largest exporter over the project's first 5 years. The project will also employ 350 staff with a strong commitment made towards workplace diversity - 30% of the present workforce are female. The company enjoy exceptional government and community support, legacy of a strong social licence-built up over years.

An exceptional gesture by the company was the formation of the Adriatic Foundation. This is a charitable trust that is focused on improving local community outcomes in 3 key areas: education, environmental protection & healthcare. The Adriatic Foundation will receive an ongoing share of project profits and was generously seeded by the founders and directors of Adriatic. 

Adriatic's strong ESG credentials have been recognised by the European Bank for Reconstruction and Development (EBRD) who have taken an equity stake in the company itself. This is an extremely strong point of validation, as the EBRD only participates in companies that demonstrate exceptional commitment towards best in class ESG principles.

A number of important catalysts are on the horizon for the company. These are:

• offtake agreements for the produced concentrate. We expect these to be agreed imminently.

• final environmental permits for the project, we expect these to be granted in the next month or so

• a project financing package for construction, we expect this will be delivered next month hi

• the commencement of construction, the company plan to break ground in October

Adriatic hold other promising assets aside from the Vares Project. The company recently hit an interval of over 20m at a grade similar to the main Rupice orebody to the north-west of the core deposit. Whilst still at an early stage, we consider that this could be a repetition of the Rupice orebody given the area is structurally controlled. This has the potential to be a real game-changer if further drilling proves this hypothesis.

Independently, Adriatic also control the rest of the mineral belt surrounding Vares which we consider highly prospective with many historical mineral deposits and occurrences. The company has a US$9 million exploration budget for this calendar year.

Adriatic's Raska project in Serbia also has strong economic potential in the current market environment. We believe that the project could be worth half of Adriatic's present market value on a risked NPV basis. Adriatic are targeting an MRE and scoping study to be delivered this year.

Any way we look at it, we believe the company is undervalued trading at only around 35% of the Vares Project's NPV, entirely ignoring its other assets. Similar assets have transacted for in excess of 80% of NPV. Another strong attraction is the company's strong commitment towards strong ESG principles which we believe are sound and essential business practices in today's world. We remain long-term shareholders of Adriatic Metals.

Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way. The author holds shares in Adriatic Metals (ADT:ASX).

Tin is a metal critical to maintaining a modern lifestyle. Tin is used extensively in solder for critical electronic components such as circuit boards for the machines we use every day. It is estimated that tin comprises between 1-5% of a circuit boards total weight, with more complex boards requiring higher portions of solder. There is substitute available for tin for soldering applications.

Tin usage and demand is expected to grow in line with technological progression. Rio Tinto in 2018 identified Tin as the metal most impacted by new technologies given the heavy reliance on advanced electronic controls and boards that the deployment of these new technologies require.

China and Indonesia are the largest sources of tin production, followed by Myanmar, Russia, Bolivia, Peru and the Democratic Republic of the Congo.

Global tin production has been relatively stable over the past, with demand exceeding supply for a number of years. This gap has been filled historically via the secondary refining of tin and the sell-down of historical strategic stockpiles by sovereign players.

COVID has exposed the fragility of global supply chains and tin has not been immune to supply disruptions. For instance, we have seen power cuts in the Yunnan region and volcanoes erupting in the DRC over the past week; both globally significant production areas.

In markets that are subject to supply constraints, we often see enormous moves in prices when a supply shock occurs. An example being the uranium markets in 2006 when the globally significant Cigar Lake uranium mine flooded; this triggered an increase in the spot uranium price of 350% over a 12-month period before spot prices began to retrace.

The futures markets are a great place to understand the dynamics of forward pricing for commodities. In usual circumstances, we can expect the term structure of a range of futures over a commodity to be in 'contango' which means that prices tend to be more expensive the longer the duration of futures contract. Intrinsically this makes sense, as for physical commodities there is a tangible cost in storing the materials.

In this case, tin futures are in 'backwardation' where the spot contract is the highest priced with longer durations priced more cheaply. This is a relatively rare situation that demonstrates short-term market supply stress. However, on the London Metals Exchange, this situation has persisted for the last 3 months and has now occurred on the second major commodity market in the Shanghai Futures Exchange.

The situation has been supportable in the short term on the LME, as commodity traders could source metals or perform arbitrage on the SHFE and deliver to the LME. With tin on both exchanges in backwardation, the arbitrage opportunity is not so obvious anymore. Across these two major commodity exchanges, less than 6 days of global tin demand remains in stock. Accordingly, we believe that tin spot prices have the potential to trade at significantly higher prices over the next 1-6 months.

We believe the best place to capture potential returns from tin, is by investing in existing producers. On the ASX, we have one of the best-listed exposures globally in Metals X (ASX: MLX).

MLX's Renison project is located in Tasmania. 50% of Renison is owned by Yunnan Tin (the world's largest tin producer) who picked up a stake in the GFC-era when MLX was distressed. Renison currently produces around 7,000t of tin per annum.

We expect that the quality of resource will improve over time at Renison with 'Area 5' reserves (a new deposit yet to be exploited) providing a 58% uplift in grade relative to recent ore processed. This translates to tin production in excess of 11,000t per annum on a 100% basis assuming all other factors remain constant. In addition, metallurgical recovery improvements expected via investment in process improvements. In particular, a thermal upgrade or tin fumer scoping study due in Q3 is likely to improve recovery rates materially and lead to a significant improvement in financial outcomes.

MLX also hold a significant growth opportunity in Rentails, a tailings stockpile accumulated from previous processing. Rentails is the second largest undeveloped tin deposit globally when measured by tin content in the mineral reserve. At current tin prices of US$31,000 a tonne and assuming no uplift from the tin fumer process, we value Rentails at a pre-tax NPV8 of circa $300 million net to MLX.

MLX has historically had a mixed record management-wise however, present management appear to be pragmatic and commercial in their decision making.

Non-core copper assets have been sold with non-direct exposure to potential upside via an equity and derivative holding in Cyprium Metals (ASX:CYM). 

A spinoff of MLX's nickel assets is expected to be completed this year with an in-specie distribution of stock planned for MLX shareholders. We have seen positive financial outcomes for holders of ILU & ALK who have conducted similar transactions in the past 12 months, and we expect the same case here.

Shareholders will also benefit from the large embedded tax losses from legacy operations. This is a hidden asset that is value accretive but not valued by the market.

We believe that MLX holds good takeover potential with its non-core assets now largely divested. Yunnan Tin would be the most logical acquirer of MLX however, given current geopolitical circumstances a transaction may be difficult in the short term.

On a sum of parts valuation, we consider that MLX is worth at least $350 million or circa 40c per share - with further potential upside of $300 million should Rentails proceed successfully into production and the tin price remaining at present levels.


Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way. The author holds shares in Metals X (MLX:ASX).
​

On Wednesday Australia's largest bank, Commonwealth Bank (CBA), announced that they were entering the buy now, pay later ('BNPL') space with the introduction of a new product, creatively named 'Commbank BNPL'.


CBA have been quiet investors in the BNPL industry since August 2019, where they made an initial investment of US$100 million into a private Swedish bank Klarna who offer their own BNPL product. This investment was increased by another US$200 million in January 2020 with CBA holding 5% of Klarna. Ostensibly, this investment was made with the perception that CBA could assist in Klarna's product rollout to Australian customers.


To date, Klarna's Australian launch has been largely an abject failure, barely making a dent in the local market. Merchant adoption has been minimal with many who offer Klarna as a payment option, prominently advertising their participation in AfterYaY Day - an annual sales day run by BNPL market leader Afterpay.


The launch of Commbank BNPL appears to be a blunt admission that Klarna's product has failed to gain traction in the local market. A cursory glance at the product design for Commbank BNPL reveals several fatal flaws that will almost certainly lead to the same outcome as Klarna locally.


Australian BNPL users span across the spectrum in terms of age as the industry has matured and hit the mainstream. A significant portion of BNPL users make use of multiple BNPL providers. In many ways, the BNPL has supplanted credit card penetration and usage especially for small-scale transaction values under $2000. This long tail of transactions and consumers is what has driven the incredible growth experienced by the broader BNPL industry as a whole over the last 4 or so years. This increase in demand from customers has led to a requisite increase in supply-side adoption of BNPL services by merchants. The key point here is that customer demand is what has driven supply.


Commbank BNPL fails in the sense that it focuses too heavily on the supply (merchant) side of the equation without any compelling proposition for the customer themselves. As a CBA executive is quoted saying "We are going to treat it like it is credit”. CBA has stated that it would conduct credit checks and would block customers if they were in arrears with other providers. This is in addition to higher proposed late fees than currently charged by Afterpay.


This level of intrusiveness and friction on the demand side coupled with the lack of lead generation tools on the merchant side leads us to conclude this proposed product will be just another commoditised fringe BNPL product unlikely to capture significant market share.


Interestingly, Afterpay are close to launching their own banking application, Afterpay Money, in an alliance with CBA's arch-rival Westpac (WBC). Afterpay intends on integrating the banking and BNPL services into a single interface in time.
As we first wrote 3 years ago, we consider Afterpay's BNPL offering to be the platform upon which additional financial services can be offered and it appears as though this forecast is coming true. 

Afterpay have commented that future product launches will not be interest-bearing, in line with its ethos of monetising its services from the supply side. Early indications are that Afterpay will launch another product directly competing with CBA's AdvancePay - a short-term payday lending facility. There is no question that the Afterpay brand is more highly recognised and respected amongst a broader swath of society than CBA.


Accordingly in this instance, we are inclined to back the entrenched, customer-centric market leader than the new entrant to the field coming out of a large conservative institution.

​

Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way. The author holds shares in Afterpay (APT)

Dusk Group (DSK.AX) are a specialist retailer operating solely within the Australian market. Dusk is best known for its scented candles however, its range includes diffusers, essential oils and other fragrance related homewares. 

Historically, niche homeware retail segments have been largely a cottage industry with a long tail of small boutique merchants fulfilling demand. Dusk is the largest player in the local market holding approximately 22% market share, whilst running only around 115 physical stores. 

The company foresee the potential to grow to around 160 stores throughout Australasia by 2024. Over the last 12 months, the company's online presence grew significantly making up at least 10% of overall group revenue.

Industry structure and Business model
We have observed many instances of formally sleepy niches being disrupted and consequently dominated by a best-in-class brand and operation. In most instances, the easy availability and distribution of the product act as a demand generator from the consumer side. 

There is no doubt that the effects of government stimulus and social restrictions have benefited Dusk. Broad swathes of Australian society have been forced to spend more time at home and as a result have had more time to consider and improve their living environment. Whilst Dusk was forced to close its physical stores for a short period of time, growth was barely dented with LFL (like-for-like) sales growth of >17% for FY2020.  

In terms of expansion, Dusk intends on penetrating its core Australian market fully and starting to roll out its stores in New Zealand. It aims to grow outside the ANZ region by establishing online stores in key geographies. We note that a significant portion of web traffic (1% or so) to the Dusk website originates from the UK & US - large markets where Dusk does not yet sell its products. In time and pending successful market entries, we would expect that Dusk may one day have larger international operations than domestic. The company intends to begin international order fulfillment and to test demand in overseas markets starting from FY2022. 


History and Team
Peter King, Dusk's CEO, joined in 2015 and has grown business consistently since. Store management is flexible and low cost, largely centered around a single central employee the manager, a part-time assistant manager and supplemented by casual staff. An online training platform ensures a consistent customer experience between stores. Rewards program signups are a KPI and bonus metric for store managers and on average 1 in every 5 casual shoppers joins the rewards program. Accordingly, customer acquisition costs are effectively an embedded sunk cost into the business itself. Senior employee turnover is exceptionally low in the low single digit percentages.


Financials and Valuation
The Dusk business is reasonably seasonal with its revenues consistently skewed towards the 1st half of the financial year. 58% of revenues are accrued in this period, with the balance in the 2nd half. EBIT Margins for FY2020 were circa 15% and this period incorporated a period of time where the physical store network was shutdown. Dusk released a market update on the 29/12/20 which smashed its previous guidance and upgraded its H1/FY21 revenue to an estimated $90 million. LFL sales grew circa 49% with online sales up 120%. Extrapolating this revenue guidance normalised for seasonal variance provides us with an estimated projected revenue for FY2021 of $155 million or overall revenue growth of 54% vs FY2020. Assuming H2/FY2021's EBIT margin falls back to FY2020's EBIT margin of 15%, this gives us a projected EBIT range of between $33-$36 million for FY2021. 

Dusk has an extremely simple balance sheet with zero long-term debt. The company guided that it would hold a cash balance of approximately $33 million at the end of December 2020. Assuming a market capitalisation of $145 million (share price of $2.30), this equates to a rough enterprise value of $112 million or an EBIT multiple of just over 3 times. This is extraordinarily cheap especially in the context of today's highly valued equity markets. 

We demonstrate this via the following basic peer analysis:

As we can see Dusk's valuation is significantly less than its public listed peers in the Australian discretionary retail sector. If we assume as a conservative measure that Dusk can achieve the lowest valuation multiple out of its peers at 8.1x, we could expect to see the company trade at an enterprise value of $267 million or $4.24 per share (84% more than the current price). Note that this figure excludes the company's existing significant cash balance.

No matter which way we examine the company, it still trades cheaply by any metric.

Risk factors
Our biggest question is why is the market valuing this stock so cheaply? 

Our guess is that the IPO was effectively a sell down by existing shareholders to the public rather than raising fresh funds for the business. It would not have made sense for Dusk to raise fresh capital considering the company was strongly capitalised at the time of the IPO. Accordingly, the IPO allowed the two largest holders, Catalyst and BBRC, to reduce their shareholding in the group. We are not concerned by this whatsoever, for a couple of reasons. Catalyst, being a private equity firm, need to cash out of their investments periodically to maximise the IRR metric for its fund investors. Catalyst still hold a controlling stake of over 25% in the listed entity. BBRC have also been invested in the company since 2010, and retain a 7.3% holding in the public entity. This is quite conventional for businesses that are listed or associated with BBRC from our observation.

Another factor that probably affected sentiment was the fact that the IPO was scheduled for March however, was pulled due to the severe equity market conditions at the time. One theme that is prevalent in the retail space is that the Job Keeper government subsidies have led to a one-off bump in demand from the consumer side as well as benefiting companies from the cost perspective. Whilst this is true to a degree, it does not explain fully the large surge in the broader retail sector as well as data suggesting that Jobkeeper payments received by staff recipients has been used by many to improve their own financial position. Our thesis is that people are spending more on themselves and their home environment in lieu of traveling overseas and interstate. Whilst we cannot say with certainty when travel will become commonplace, we expect this time of restricted physical movement to last at least another 12 months.

One company that reminds us of Dusk is Lovisa which was previously floated by BBRC. Lovisa listed at a market value of around $200 million; it is now valued at around $1.2 billion with normalised EBIT of around $30 million. This company itself, we consider to have lower growth potential than Dusk at this point given the product range and current geographic spread. 


In summary, we consider that Dusk offers investors a potential strong growth opportunity while being priced as a value stock when viewed in the context of the discretionary retail sector as a whole. Its low valuation offers the opportunity for significant value uplift over time that will be dependent on maintaining its current strong operation performance along with successful international growth.

​

This article is an extract of a detailed research note by Datt Capital. 

Wholesale/sophisticated investors may request a copy of the full analysis for a limited time HERE. Available only for 14 days post article publication.


Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way. The author holds shares in DSK.

In the last 3 months the price of Bitcoin, the 'gold standard' in cryptocurrencies, has more than tripled from circa US$10,500 to over US$37,000 per coin. Crypto evangelists make many claims about the future utility and value of bitcoins including its potential to replace existing currency systems along with grandiose claims of future value. It's decentralized and limited nature is an attraction for investors who have been jaded by endless bouts of issuance of fiat currencies by governments globally.

Much of the confusion around Bitcoin and other crypto-currencies stems from the question of whether these digital assets are an asset or a medium of exchange. A medium of exchange's core attributes are fungibility (standard and mutually interchangeable), portable, and commonly accepted. The key features of an asset are: that it is controllable (for the benefit of its owner), transact-able and has clear future value and utility. We believe that Bitcoin aligns more closely with being classified as an asset rather than a medium of exchange.

Which leads us to a simple question: what is the true future utility or value of Bitcoin? There is material uncertainty around this figure, even from the most hardened crypto advocates. This also explains to a large degree, the enormous volatility inherent in the asset itself including multiple draw-downs of over 50% over the years. There has been a strong correlation in Bitcoin price movements to more conventional liquid assets like stock indices, albeit at much higher rates of beta. This validates to some degree the notion that Bitcoin is being treated as an investment asset class by investors at large. Interest in Bitcoin tends to correlate heavily with its price; examining search trends and other sources of data we note that new entrants into the space tend to buy into the periods of highest price growth. I recall a colleague of mine during the crypto boom of 2017, asking me whether I thought Bitcoin was a sound investment, despite the utter lack of interest in any investment class previously from this individual. 

We have seen claims by some that Bitcoin is 'the new gold'; in our opinion, this is incorrect. I could go to virtually any individual living on our planet, irrespective of culture or creed, who would recognize that a single gold coin holds some form of monetizable intrinsic value. Despite Bitcoin's virtues, this would just not be the case in a similar instance. The asset's value is linked to its perceived utility between existing or new users. This leads us to a problem, which is the separation of utility from value. Bitcoin, for all intents and purposes, is useless in isolation. It relies heavily on a large number of 'nodes' around the world to operate the network and therefore by proxy, relies on free and open data flows between nations. This for us is a particular area of vulnerability, especially given the increase in geopolitical tensions over the past few years; is it too far-fetched to imagine that dataflow could one day be weaponized?

Ultimately, we believe that the rise in interest in Bitcoin and cryptocurrencies is driven by several factors: the ease of storage, perceived anonymity as well as the hope of making a quick dollar. Most prominently, I believe the most recent bump in Bitcoins value is driven by widespread distrust in government-issued fiat currencies and the lack of fiscal restraint by these entities. Many are worried about the extraordinary stimulus and 'money printing' activities being undertaken by governments worldwide and this has also been reflected in the pricing of other asset classes like precious metals and real estate. Whilst Bitcoin and other cryptocurrencies are uninvestable for ourselves, potential buyers should go in with their eyes wide open to the potential risks before investing in more exotic asset classes.


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Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way.

I’m often asked by clients and industry figures about Datt Capital’s position on ESG.

For a number of reasons, I have difficulty giving a black-and-white answer.

It’s fair to say that ESG, or its shorthand – ethical investing – has become part of the funds management zeitgeist, aided in part by much research pointing to better performance by fund managers that favour companies with good ESG policies and practices.

But what does ethical investing really mean?

For a start, there is no universal E (environmental sustainability); no universal S (social responsibility); nor universal G – corporate governance.

Ethics is a combination of morals, values and behaviour that is unique to each individual

When an investment is branded “ethical,” does it really mean the investments selected are consistent with the shared ethics of a reasonable swathe of society?

Another issue with so called “ethical” investing is the lack of truly ethical investments available. If we define “ethical” through the filter of “do no harm,” how many companies or businesses would qualify?

For some, the mainstays of ESG/ethical portfolio in the local context are the big four banks. Three out of four have been charged with a litany of historical offences, ranging from negligence to reporting suspicious transactions to government authorities, to facilitating payments for human trafficking and child exploitation. It is inevitable that mistakes will occur in corporate behemoths, but where does an “ethical” investor draw the line? 

The mining industry is often vilified for lack of ESG principles, although this usually a misguided belief. For instance, coal is demonised by some “environmentalists” despite it being a major contributor to the rapid elevation in human development outcomes in developing countries.

I recall having a meeting near a mining conference in Melbourne, where “climate protesters” were demonstrating. A number of protesters came into the cafe where I was seated, ubiquitously bearing smartphones which are the product of mines around the world – including cobalt mined by child labourers in Sierra Leone. They came in to order freshly ground, barista-made coffee – some of which may have been picked by “coffee slaves” in Brazil, Guatemala or Cote D’Ivoire, depending on their selection.

My personal opinion is that the core of any ethical consideration rests on the statement popularly attributed to Hippocrates: “Primum non nocere” (“first, do no harm.”)

Viewed through this lens, some industries that may be a more obvious fit for ethical investors could include: distribution, mineral royalty companies, retailers and food processors.

We also agree with the view of  some of our industry colleagues that the most effective way to give vent to your personal feeling on the E and the S  is either to donate to the cause in question, buy or boycott  products, or when investing, participate in a capital raising of a companies whose policies and actions in these areas you support. Purchasing shares in a favoured company on a secondary market does not have any meaningful impact on a company.

While I am sceptical about the rationale and impact investors can on the E and S we at Datt Capital believe that the G, governance, is the metric to focus on in deciding when to invest; as the research shows that poor corporate governance is usually related to performance.

Typical red flags include related-party transactions, not enough truly independent directors, and lack of diversity in management and staff.  

All of these points ultimately beget the question: what is the solution for ESG/ethical-oriented investors?

We believe the solution is for investors to “look deeply into what’s in the tin,” by performing research into their investments, rather than taking at face value “what’s on the label.”

We encourage using an inter-generational approach. This encourages the evaluation of investments taking a “whole of lifecycle” perspective, while also enabling investors to express their own subjective sense of ethics. For instance, some may find the lack of recycling for end-of-life solar panels to be unpalatable, whereas others may determine the shorter-term benefits to outweigh the longer-term consequences.

Finally, if in doubt about the criticality of corporate governance, the current drama being played out between the New South Wales government casino authorities and Crown Resorts reaffirms once again the primacy of getting the ‘G’ correct. Governance failures by the Crown board and management have finally caught up with the company and shareholders are suffering accordingly.

Happy investing.

Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way.

The ownership of a mineral royalty (a contractually established financial asset) over a producing or near-production mining asset has been the basis of many Australian fortunes. For instance, the iron ore royalties held in the Pilbara by the Hancock/Rinehart and Wright families coupled with prudent investment decision-making has allowed them to build enduring and significant wealth. Another well-known example is the Weeks oil & gas royalty encompassing a large portion of oil & gas production in the Bass Strait.

A mineral royalty provides the holder with the right to receive a portion of revenues from a particular mining operation or area. Royalties are reasonably bespoke, contractual agreements; accordingly, there are many variations and structures. We consider the most attractive royalty structure to be a 'gross overriding royalty' ('GORR') which entitles the royalty owner to a share of the market value of the commodity being produced less delivery costs borne to a point of sale.

The advantages of a GORR royalty structure are as follows:

• simple to calculate and audit
• lowest risk - with no ongoing capital expenditure required
• no exposure to cost or direct operational risks
• lowest volatility of cashflow, with a single variable input (the commodity price)
• a readily saleable and reasonably liquid asset
• leverage to increases in commodity price and exploration success

Other risk factors associated with royalty investments are primarily linked to the risk of the asset becoming non-productive which are:

• the particular commodity being produced
• the cost quartile of the producing asset (or relative production cost position)
• the location of the asset
• the mine life of the asset

Royalty companies have become big business, with a multitude of listed exposures available on global markets. These companies generally hold diverse portfolios of royalty interests and commodity exposures.

Franco-Nevada ('FNV') is the world's largest listed royalty company with a market cap of around US$26 billion (AUD$37 billion). Prima facie it positions itself as a gold royalty company, whereas in reality it has exposure to a range of precious and base metal longer-life projects with an average mine life of 20 years. It achieves top line revenue of approx. US$800 million whilst enjoying strong EBITDA margins in excess of 80% (typical of royalty companies).

It has a diverse board of mineral industry participants including Tom Albanese, Rio Tinto's former CEO. In a nutshell, it provides an ideal investment vehicle for institutions and individuals alike for lower-risk exposure to the commodity markets.

​The sole Australian royalty company of scale is Deterra Royalties ('DRR'), recently demerged from Iluka Resources. Deterra hold what we consider to be the best single royalty exposure available on the listed markets globally in the Mining Area C Royalty ('MAC Royalty').

The MAC Royalty is a GORR of 1.232% of Australian dollar denominated, free-on-board (FOB) revenue from product mined from Mining Area C, a major growth hub for BHP's Pilbara iron ore operations which are some of the largest globally. In addition, DRR also enjoys one-off $1 million per 1 million tonne increases in annual production capacity for the areas encumbered.
Main factors that contribute to the quality of this royalty interest are:

• one of the world's best operational and financial counterparties in BHP
• situated in world's best mining jurisdiction, Western Australia
• minority asset owners and other credit exposures are large Japanese conglomerates in Mitsui & Itochu
• mining assets are within lowest production price quartile, so will produce in virtually any circumstances
• low commodity risk in higher quality iron ore - essential and irreplaceable for further global development as well as politically insulated
• in built organic growth profile with production volumes expected to double by 2023 via development of South Flank mine
• Length of Mine ('LOM') currently 30 years with expansion potential to >50 years of mine life.

DRR have committed to paying out 100% of net profit after tax ('NPAT') to shareholders via dividends.

Given the valuation of global royalty peers, we contend that DRR would make a viable and attractive M&A candidate. For instance, in a scenario where FNV acquired DRR, we could expect FNV to increase their revenue by over 20% from 2023 (assuming spot FX and iron ore prices hold) and a likely value uplift of over US$5 billion (AUD$8 billion) should their multiple remain stable which we consider conservative given the sheer quality of the MAC Royalty. 

DRR trades today at a mere AUD$2.2 billion (USD$1.54 billion) or around a quarter of its potential value to a leading royalty company.

An alternative hypothetical scenario could see BHP purchase and internalise the royalty interest given the long mine life and the present rock bottom interest rates. Iluka Resources maintain a 20% interest in DRR, making them a king-maker in any M&A action. Given the holding is non-core to Iluka, we would expect a reasonable bid for DRR would see the major shareholder accept.
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In summary we believe that DRR provides a defensive, high quality annuity style equity exposure for investors; with potential for large capital appreciation via organic growth and potential M&A action.

Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way. The author holds shares in DRR.