17 September 2021

What Decisions Would Warren Buffett Make if He was Investing in Australia? 

If readers have not already done so, I recommend that you read Warren Buffett’s annual report to Berkshire Hathaway shareholders (available on the internet). You could also go back through some former years. The 91-year-old Buffett has been an enduring success for over 50 years. A question I pose to myself is which Australian stocks would Buffett buy?

Buffett’s investment strategies have been long term and overwhelmingly successful. He has the good sense to own up to mistakes quickly.

Would Buffett buy the four major Australian banks?  He would possibly view them as being too captive of Reserve Bank of Australia monetary policies. He would see them as being advantaged by their shedding of their difficult financial advisory arms.  Perhaps he would be attracted toward the Commonwealth Bank because of strength in the home lending market. We own three of the banks but recognize that they are not as well-placed as was the case prior to the Banking Royal Commission.

Would he be attracted to the resources market? This is unlikely because his history indicates otherwise. Probably he would view it as being too cyclic. However, we own BHP, Rio Tinto, Fortescue and Mineral Resources—but in more modest quantities than our favored stocks below.

His annual letters to shareholders indicate a strong affiliation with proven, quality management and with what he terms strong franchises or what others might term as having strong protective moats around a business. This can be in a variety of forms.

To my mind three companies listed on the ASX stand out with Wesfarmers being a possible fourth. My three standouts are:

1.     ARB Corporation.

2.     CSL

3.     Xero.

ARB Corporation

 ARB has shown pleasing growth increasing its net profit after tax by approximately 15.56% compound per year over the past 20 years and currently has zero net debt. In the recent financial year to 30 June, it produced profit after tax of $150.023 million from sales $623,072 million. ARB invests heavily in new product development and stocks a substantial range of accessories for 4WD vehicles. It is widely recognized as the market leader in its field. It protects its brand by marketing its vehicle accessories through specialized ARB sales and fitment centres in Australia. ARB’s product development, warehousing, distribution and branding mean that it dominates the Australian market and has developed increasing penetration into United States, Middle East, European and African markets. It has periodically bought providers of compatible products and integrated their businesses. ARB represents a difficult target for would-be competitors, particularly given the breadth of its product range. It is the sort of stock which you buy and tuck away long term. It is important to dial back through its yearly and half yearly reports and market briefings and to gain a thorough understanding of its business.

CSL

 CSL is the sort of stock you buy for the long term. It has become a leading international pharmaceutical business with strength in blood plasma products and influenza vaccines. CSL spends a substantial amount of income on research and is well placed to continue growing its suite of products and its income in an era where ageing populations and an increasing suite of products lead to strong business growth. Readers should access its announcements and look back through a series of yearly and half-yearly reports and market briefings. Expect modest dividends and solid growth.

Xero

 Xero is a business software supplier. The software is based around accounting but an increasing number of other business service packages can be added. The number of customers signed up has been increasing at a spectacular rate in Australia, New Zealand and internationally. At this stage Xero remains a long-term growth option with all of its cash flow reinvested in business development rather than generating profit to pay dividends. The nature of Xero’s business services is such that long term relationships are created. As more features are added to its software it becomes increasingly difficult for competitors to slow its growth.

Wesfarmers

 I previously flagged Wesfarmers as worthy of consideration, but perhaps not quite to Buffett standard.

This is general financial advice and while I own the above stocks in my family superannuation fund it is important that readers do their own due diligence and seek other advice as required. The more familiarity you have with the financials and business strategies of companies before investing the better. It is important to recognize that financial markets fluctuate and investment carries risk. This applies to even the greatest of companies. 

Vital Steps When Buying a Practice

 Consider two potential practice acquisitions. I will call them Practice A and Practice B. Practice A is well presented. It has sound profit but close examination indicates that its fees are a bit above average and it is generally booked between a week and two weeks in advance but with gaps. Close examination of its patient invoicing indicates a significant amount of discretionary dentistry of an advanced nature. Very little treatment is referred out. Its invoicing suggests that every opportunity has been taken to offer advanced treatment options to patients. An experienced dentist might conclude that it may be difficult to improve practice performance.

Practice B’s presentation is satisfactory but could do with a facelift. It is booked well in advance and its fees are below average. It has less profit than Practice A. Close examination of its invoicing indicate that most treatment is of a basic drill and fill nature. It is located in a middle suburb <or could be in a substantial town>. Further investigation indicates that it has a much larger patient base of long standing. Socio economic indicators for the surrounding area indicate a high level of home ownership and low unemployment. Many within its patient base could afford more advanced dental treatment options if properly presented to them. 

Practice A has a higher asking price and most accountants would advise dentists to buy it in preference to Practice B based on its annual financials but accounting advice can be very wrong. A discerning buyer looking closely at Practice B should note that it has a much larger patient base than Practice A; that it has a huge scope to offer patients more comprehensive dental care, that the duration of patient’s affiliation with the practice indicates loyalty; that the degree of home ownership and low unemployment in its surrounding area indicate that the practice can safely increase fees and that the absence of advanced treatment options indicates substantial scope to improve treatment of patients. 

In reality Practice B is a far better buy than Practice A but accountants would generally recommend Practice A based on respective financials. There is much that financials don’t tell a buyer’s accountant. Only a discerning dentist knows where to look inside the practice records.

Identifying Hidden Gold Mines

 Smart practice buyers do their own research on the patient data that accountants never see.

Many years back a dentist, now long retired, indicated that he and his associate were selling their combined practice. They had agreed a sale price. Both were past normal dental retirement age and were keen to give up dentistry after a short handover. A year or two later I met the buyer, a competent dentist with an array of advanced skills, who likened his purchase to acquiring a lucrative gold mine. The patients were very receptive to high quality restorative dentistry but this need had been ignored by the previous practice owners. A substantial portion of the practice patient list were willing and able to pay. The practice buyer had been wise to take a long look into practice records and had made a brilliant purchase. 

Treat Accounting Advice Cautiously

Treat accounting advice with caution and do your own research. Time spent in examining patient records before signing a practice purchase contract is essential. If you don’t do a searching analysis of treatment invoices you do not know what you are buying?  Remember many accountants want their client to buy a practice because it leads to increased accounting fees but too often accounting advice on practice purchase is ill-informed! Recent patient records are critical. It is also essential to check the appointment book to determine how far forward are substantial bookings.  A superficial accounting review of the last three years accounts usually misses vital information. Remember the current state of the practice is far more important than what occurred in July three plus years ago. Current data is vital. This means checking monthly bankings into the current financial year and comparing them with corresponding months of the last financial year.

When dealing with practice brokers you will be required to sign a confidentiality agreement and show genuine interest in purchase. Remember that there is no deal until you actually sign a purchase agreement and pay a deposit. Thorough due diligence must be insisted upon; be polite to broker and practice owners but insist that before signing an unconditional contract, you have proper access to practice records and be painstaking in examination of practice invoices and a large sample of treatment records. Examine the appointment book carefully and compare the number of forward appointments with those that you are familiar with. Check the Australian Bureau of Statistics data on home ownership and employment for the area. Be careful to estimate the amount of additional treatment you can provide commensurate with your dental skill set. Also check equipment and which items are approaching the need for replacement. Ask yourself how you can lift the appearance of the premises. 

If the premises are not for sale a long lease is essential and this must be locked in before signing a practice purchase contract.

For a lot more about buying dental practices and conducting them successfully read “Financial Success for Dentists.” 

To obtain a copy:

Go to the Delany Foundation website at http://www.delanyfoundation.org.au

Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.

Email financialsuccessfordentists@gmail.com confirming that your donation has been made, as well as your name and mail address

A copy of the book will be mailed directly to you

All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.

The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.

A complete and comprehensive career guide for mature and aspiring dentists.

Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.

—Merv Saultry, Founder Dental Innovations Network

Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owning their own practices and for those aspiring to own practices. Among the topics included:

·      Understand key practice valuation criteria.

·      Learn how some dentists inadvertently reduce the value of their practice by $500,000

·      Avoid long term errors when purchasing your practice.

There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value. 

I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.  

TPG Considering Sale of Greencross! Buyers Beware! 

TPG, which bought out Greencross, is looking to take advantage of the surge in pet ownership to sell out at a large profit. As per Australian Financial Review of 13 September 2021, TPG Capital has hired investment bank Credit Suisse to identify the options including a potential $ 4 billion-plus sale.  Whether it is actually worth $4 billion is unknown, but the reasoning is probably to throw up large numbers and whet potential acquirer’s appetites. After all they can always come down in price but it is well nigh impossible to go up. TPG paid about $1 billion for Greencross about 2.5 years ago and it is highly unlikely that the profit of the business has quadrupled in that short time, even acknowledging the surge in the number of pets during Covid lock down periods.

Stretching the Numbers!

I spent 33 years advising Veterinary and dental practice owners and benchmarking financial performance. Veterinary profits don’t quadruple in such a short period even allowing for some continued practice acquisitions.

Hidden Veterinary Truths 

What the (obviously brief) AFR article doesn’t talk about is the chronic shortage of fulltime veterinary surgeons in Australia. Despite additional veterinary schools, the demographics have changed dramatically. As veterinary school enrolments have changed from overwhelmingly male to heavily female over the past 35 years, far more Vets now only work part time because of family choices. Long-established practices struggle to attract and hold onto sufficient vet staff as predominantly full-time male vets have retired and been replaced by a current vet workforce which is substantially part-time.  Anecdotal evidence from established, privately-owned practices regularly point to a surge in clients after a competing nearby practice is sold to a veterinary corporate. This is often accompanied by observations that the corporate practices concerned have had to restrict opening hours due to shortages of veterinary staff. I have heard these observations too many times from practices located in most Australian major cities for them not to be true. Selectively briefed articles in the financial press do not deal with all of the critical issues. The critical issue for Veterinary Corporate Owners is veterinary staffing.

It has been the case for a number of years that the best place for vets to start a privately owned and conducted practice is near to a large practice which has been purchased by a corporate owner. This is particularly so where two vets open a new practice in partnership and are prepared to work the hours in which the corporate practice has staffing difficulties. Being full-time owners, they build up long term relationships with pet owners and their animals where the frequent complaint about corporate practices is that clients rarely get to see the same vet. The bonds between animals, their owners and their vet is such that pet owners much prefer to use a privately owned practice where they establish a long term relationship vis a vis a corporate practice with ever changing veterinary staff. I have seen new practice start ups in areas where practices have recently been purchased by a corporate grow rapidly and profitably. The veterinary corporates are coming to recognize that the time is near when they should sell and run. The surge in pet ownership during Covid will inevitably stall as present restrictions ease and the populace resumes normal work conditions. The Veterinary staffing problem shows no sign of abating.

The Vital Veterinary Practice Numbers

The key to assessing the Greencross business, whether by a trade buyer or by share purchase via an IPO, is seeing a breakdown of salary/wage costs including superannuation for veterinary staff compared to non-veterinary staff and as a percentage of total sales. Corporate owners cannot buy machines which do surgery nor which permit a busy veterinary surgeon to desex two dogs simultaneously. Veterinary practice remains a staff intensive business regardless as to equipment.

General Advice

Advice on investments is general advice and readers must do additional research of their own accessing broker reports and taking professional advice as necessary. All investors must have a deep knowledge of individual company financial performance, business strategy and economic risk. Investment decisions must also relate to individual circumstances including net assets, annual income and years to retirement.

I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. I own, via my family superannuation fund and investment portfolio, some of the stocks mentioned in this newsletter. Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.

Best wishes to all 

Graham Middleton