3 September 2023

Changing investment outlook 2023/2024

Australia meeting its clean energy targets by 2030 is impossible say lots of experts.

The pace of adding renewable energy, back-up capacity and transmission is falling further behind the schedule of what is needed to achieve the targets. The national transmission rollout is already 1200 kilometers behind schedule. According to AFR 10 July 2023 by 2030 only 3,000 kilometers of the total 10,000 kilometers will have been completed. Nowhere have I seen an informed expert who says that our targets can be met. Meanwhile Victoria has quietly contracted to have the planned closure of its Loy Yang brown coal fueled power station postponed by several years due to the impossibility of producing sufficient renewable powered electricity production.

The reported high cost of nuclear generating plants will be massively offset by the huge saving in high voltage transmission lines if nuclear plants are built alongside old coal fired electricity generating plants and the existing transmission networks are used. Rational informed debate is required.

In the short-term indecision and delays mean electricity costs will rise steeply risking destruction of a horde of manufacturing and fabrication businesses. 

Have our big banks passed their market peak? 

The Commonwealth Banks annual results announcement of 10 August 2023 showed that while full year profit was up, that was due to the first half-year to 31 December and the second half was disappointing. Overall net interest margin (or NIM) was down. In addition to its $2.40 fully franked dividend the CBA has indicated that it will buy back $1Billion of its shares on the market over the next 6 months. The CBA is finding difficulty in employing its capital. Lots of analysts rate it as sell. Analysts are also cool on ANZ, NAB and Westpac.

 A quick look at analyst recommendations indicates the following:

·       ANZ trading on a Price to earnings ratio 0f 16.66, 11 analysts rate as buy, 5 are hold and 3 say sell.

·       Commonwealth Bank trading on a Price to earnings ratio 16.9,   no analysts rate as buy, 6 are hold and 5 sell recommendations.

·       National Australia Bank price to earnings ratio 12.4, 5 analysts rate as buy, 7 as hold and 9 as sell.

·       Westpac price to earnings ratio 12.6 only 2 analysts rate as buy, 9 as hold and 9 as sell. 

This an uninspiring view of the four major traditional banks.

We do not hold any of the four in our superannuation fund. We do hold Macquarie group which is a vastly different business being predominantly a global asset owner manager with a mix of traditional funds management and home lending done without a branch network. We continue to hold Commonwealth Bank outside of super because its embedded unrealized capital gain requires holding. 

Is China’s economy in deep trouble? 

The largest property collapse in global history, shrinking demand for steel, over 21 percent youth unemployment in its big cities, shrinking imports of iron ore, an aging population and shrinking exports of finished goods are leading to predictions of deflation as scared consumers hang onto money rather than spend. China consistently announces substantial growth percentages but economists doubt the accuracy of its figures. This spells bad news for Australia’s major iron ore producers BHP, Rio Tinto and Fortescue. In turn this is a reason for Australia’s weakening currency. In a sign of worsening youth unemployment China has recently stopped updating the number of youth unemployed.

Real estate investment trusts (REITs)

 The REITs which are heavy in office space are facing the progressive reduction in tenancy as businesses with heavy work from home staffing reduce their space requirements when lease renewal options fall due.

Shopping centers are suffering from reduced consumer spending as higher mortgage payments occur.

Industrial property REITs heavy in warehousing are in demand.

Office conversions to housing not easy or quick. 

There are not a lot of totally vacant office towers ready for conversion despite reduced demand for office space. Where a building owner wants to redevelop but the building is partly occupied by a residue of tenants with lengthy leases and renewal options, those tenants have to be induced to move which invariably means offering significant financial incentives to relocate. This takes time and is expensive. Only then can the major work of converting a building into individual units on a strata plan commence.

The commercial property crash of 1990/91 produced costly lessons.

1.     Unlisted property trusts were found to be unsuited to an environment of overbuilt office supply, high interest rates and a weaker share market. Many imploded.

2.     The better ones listed onto the stock market and the market created a new but lower value for which units could be bought and sold.

3.     Some office buildings in Melbourne’s CBD did not regain their pre collapse value for over 20 years.

4.     Conversion to housing was quite rare.

Vet Partners for sale! Timing the market?

Recent Australian Financial Review Street Talk reports that Vet Partners US owners are looking to sell. This means investment banking advisers are working through the options of possible trade sale or initial public offering (IPO) and ASX listing. It has 267 practices of which 14 are emergency facilities. Fees for 2023 Financial year are reported as $661 million.

The explosion in pet numbers during the Covid era may well have run Its course with cat and dog shelters overwhelmed with pets handed back. Increasing interest and lifestyle costs are being felt by pet owners. While traditionally pet owners have been prepared to place pet welfare before personal needs there are limits. Those facing sharply increased home mortgage payments and an array of increased living expenses may sacrifice their pets. Veterinary fees in corporate predominantly small animal related practices are likely to have passed their zenith. Australia is undergoing a substantial retraction of discretionary spending power.

The myth about corporate veterinary practice.

Contrary to what corporate owners would like potential buyers to believe, corporate ownership is

beset with a multitude of problems. The economies of scale have often proved negative across corporatization of professional practices including accounting, dental, medical and veterinary practices. I spent 26 years as founding partner of an accounting and financial services group with its two major client bases being dental and veterinary practices. I observed a great deal of evidence that rather than there being economies of scale, there are more likely to be diseconomies of scale. I once made a newsletter observation that the best place to start a privately owned practice was close to a large corporate practice. A vet rang me up about 18 months later to tell me that he had followed my advice and his start up had gone from zero to a $1 million of veterinary fees in its first twelve months! I have seen the experience replicated many times. A veterinary company buys a practice and the vendor Vet completes their handover employment period, which these days can be as short as twelve months. Personal relationships with long term clients are severely impacted; the employees relax and have longer consultations. The staff become reluctant to have appointments close to end of shift so as to guarantee early finish. Treatment that was done in house is referred out and clients find themselves paying more for inferior service! Pretty soon many long- term clients are asking their friends whether they can recommend another vet practice. A corporate practice ‘manager’ is often a former vet nurse or sometimes a dental nurse which is a big step down in knowledge from an experienced vet leading a practice and knowing many of its clients! While the former veterinary owners did a lot of surgeries themselves now lots more is referred out while the former owners often provided more treatment than two other vets. Meanwhile remote higher-level management tend to be unaware of the erosion of service and profit in previously privately owned practices.

Question.

Would I buy shares in a Vet Partners float?

Answer 

I definitely would not but a person wiser than me observed that “there’s a sucker born every minute!” so I will not be surprised if it is polished up with a good story and sold at IPO at a big multiple of profit only to subsequently disappoint investors.

Passing the Vet Partners parcel! 

The AFR 21/08/23 reports that that Swedish private equity investor EQT is considering whether to bid for Vet Partners but its local advisers have to decide hurriedly whether to lob an offer because of its own impending IPO. This begs the question as to how changing ownership from one company to another can improve performance? In reality in a business very heavily dependent on three-way relationships between vets, pet owners and pets there is no magic ‘pixie dust’ that new owners can sprinkle.

Back to the 1980s? 

Australia’s long discredited 1980s entrepreneurs played “passing the parcel” until the October 1987 global stock market collapse revealed them to have grossly overvalued assets mired in huge debts and one by one they collapsed. Many of the most prominent 1987 entrepreneurs had sad endings, some dying in exile, some jailed and a number bankrupted. 

The real limitations on corporatizing health professionals. 

Whereas types of big business create efficiencies by replacing human labor with bigger machines (e.g. mining) or with elaborate computer systems such as self-service checkouts in supermarket chains veterinary surgeon can only treat one patient at a time and a dentist can only drill one patient’s teeth at a time. In reality corporate veterinary and dental practices add to labor costs. There are diseconomies of scale rather than economies of scale. Corporatizing of medical practices relies on the ability to harness the outward referral of valuable pathology and radiology testing as well as milking Medicare. Effective veterinary practices contain most treatment internally and there is no Medicare for them to milk. The real fee growth of dental and veterinary growth has simply come from buying up more practices rather than organic growth. That is finite in scope as other vets and dentists start or build up privately conducted practices which more often than not give better service and have owner operators who build up long term relationships with dental patients and with pet owners. 

Financial Success for Dentists 

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.  

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

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 graham.george.middleton@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.

Please Pass On

If you like these newsletters, please pass them on to colleagues. Past newsletters and articles in Australasian Dental magazine on business issues are at grahammiddleton.com. I can be contacted directly at graham.george.middleton@gmail.com

Independence And Disclosure

I am not a representative of any accounting practice, financial planning firm, business or marketing consultancy. I spent 33 years as a business and financial adviser to mainly dental, medical and veterinary specialist and general practitioners. Since I retired as a director of a financial services group, of which I had been a founder, on 30 June 2020, I am no longer licensed as an investment adviser. Readers should treat the above as general advice and take professional advice as required.

General Advice

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. My website is now available at grahammiddleton.com.

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 readers

Graham Middleton