Should You Hold or Sell Seek Ltd?

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You wouldn’t necessarily think of getting rich at a party.

You just want to have a good time.

But when some of the world’s most successful money managers host dinner parties, it pays to bring a notepad.

Rather than bringing a bottle of wine, guests bring their best ideas. This could be a stock to buy or one to sell.

As each manager presents their idea, the other guests shoot holes in their thesis.

The only annoying part about these dinners is that we’re all not invited.

If you have a group of friends who also invest, I highly encourage you to host your own ideas dinner party.

Not only will it help you solidify your own ideas, you’ll receive a whole bunch of new ideas that may turn out to be highly profitable.

As an alternative, you can also look at what money managers are buying and selling today. Many times they’ll talk publicly about their trades, which could give you an idea of what to look out for.

Today I’m going to share with you an idea from Tribeca Investment Partners.

Why has Seek’s profit dropped?

Before we go further, it’s important to point out that no one has a crystal ball. Not fund managers, not analysts, not even Warren Buffett.

So even if the ‘experts’ say you should buy this or sell that, always apply some scepticism.

Having said that, I love to read why investors are buying X or selling Y.

Like an ideas dinner party you can sometimes gain extremely valuable insights.

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According to the Australian Financial Review (AFR), many short-sellers are eyeing companies like Afterpay, Appen, Altium and WiseTech.

However, that’s probably no surprise. These stocks have risen between 50% and 190% in just 12 months. And some of the PEs on the stocks above are well over 100-times.

But at a hedge fund conference last week, Tribeca Investment Partners wasn’t advising to sell Afterpay or Appen.

Portfolio manager Jun Bei Liu believes investors should sell SEEK Ltd [ASX:SEK].

At first glance, this short seems a bit puzzling.

The stock is only up 12% for the year. Profits have declined due to rising costs, which has pushed their PE ratio above 100-times.

On a five year basis, however, Seek trades for less than 30 times average earnings.

But it’s the lack of short-term growth that’s troubling, according to Bei Liu. The AFR writes:

Since 2009, Liu explains, Seek’s revenues have grown 7.5 times from $200 million to an estimated 2019 figure of more than $1.5 billion.

And while Seek’s share price has tracked its revenues higher, profit has not followed. The bottom line has remained flat for the past two years and is expected to stay so for another.

Seek, which listed in 2005, has been one of Australian tech’s great success stories, gaining 10 times. Along with REA, it redirected “the rivers of gold” that once flowed into the coffers of Fairfax Media shareholders as its online jobs portal captured a huge share of the classified market.

To maintain the growth story, Seek expanded and invested in large and particularly lucrative offshore markets. But the analysis presented by Liu questioned the quality and sustainability of Seek’s capital allocation.

Because of lagging earnings, returns on capital employed have also come down. This is the return Seek generates on assets and short-term liability. The AFR continues:

A decade ago Seek was a “highly lucrative” business generating returns on capital of 25 per cent but that had gradually dwindled to just 10 per cent, well below global peers of 15 per cent. 

That, she concludes, is evidence that “M&A had been dilutive to its core business”.

That “core business” — the Australian and New Zealand operation — has benefited from a sustained pick-up in companies recruiting.

But now that the jobs market has recovered to more long-term levels, growth in its core business could be harder to come by for Seek in future.

Liu’s short thesis largely centres around the valuation. She points to a PEG ratio (price-earnings to growth ratio) of 4.6 times as evidence the stock has run too hard.

(While not a perfect measure of value for a growth stock, a PEG ratio above 1x is typically considered expensive).

These are all valid points. But what should investors holding SEEK do?

Well, they may want to hold off on following through on Ms Liu’s guidance.

Let me explain why.

Should you sell Seek Ltd?

Yes, profits aren’t growing (over a two-year stretch).

Long-term debt is also up 62% over the same period.

But two years is not nearly enough time to establish a new average.

That’s because it takes time to invest in projects and find profitable ventures. Usually this will be a trial and error approach, making performance lumpy.

But when Seek finds something that works, they load up.

An example is Seek’s Online Education Services (OES) business. Seek is now a leader in a still relatively adult online education industry.

Their OES business generates $119 million in sales. And they only spent $10 million to get it off the ground.

Once Seek piles up a few of these projects, earnings tend to take care of themselves.

So why have profits dropped 75% to $91 million?

If we take a deeper look at Seek’s performance in 2018…

Included in that figure is a one-off $181.7 million write down to their Brazil business. Operating expenses also increased 29%.

The former won’t likely reappear, as it’s a one-off charge. The latter might partly be inefficiencies. But a good chunk is likely due to efforts to scale their business.

If we look at what Seek spent their cash on, we can see more evidence of that.

Cash payments for property, plant and equipment, investments in other businesses and intangible assets grew from $77 million in 2017 to $202 million in 2018.

This was cash, according to management, that increased their ownership in the Seek Asia business from 86% to 100%. It also shows cash spent on new projects in the human capital management industry.

While this means Seek is spending cash, its money spent for growth sake. Again from the AFR:

Seek CEO Andrew Bassat continues to believe that offshore markets are there for the taking, and the fact that the share price is holding up is evidence the “market gets it”.

That is why Morgans analyst Ivor Ries says they are spending $2 in China for every $1 in Australia.

Seek, he says, is a polarising stock because its expansion strategy, particularly in China, isn’t that well understood. It’s a small cog now but soon it will be by far and away the biggest part of the Seek machine.

If Seek is modestly successful in China, that business could be worth twice the value of the Australian business, which roughly accounts for 70 per cent of its total value at present. If it is “hugely successful” China could be worth 10 to 15 times the value of the local business.

So while in my view Seek doesn’t look like an obvious buy today, they don’t seem to be an obvious sell either.

Your friend,

Harje Ronngard,
Editor, Money Morning

PS: Aussie finance expert reveals four Aussie stocks he believes could be top performers in 2018. Get your free report now.

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