17 November 2022
The signs indicate a substantial economic downturn, regardless as to how it is labelled. The globe’s major three economies—the US, the European Union and China—are all slowing. The fear of a rapid increase in inflation has finally caused the world’s major central banks to force up interest rates and begin running off stocks of bonds as they reach maturity rather than rolling them over. This process is referred to as quantitative tightening, i.e. removing money from circulation, and is anti-inflationary. The process is led by the US Federal Reserve (the Fed) and other countries’ central banks are forced to follow or place their currencies at risk. Meanwhile China has not bailed out its property markets choosing instead to let prices fall at the expense of huge property developers’ insolvency, and the destruction of Chinese local government finances of which land sales to developers are a substantial component. The reasons, perhaps, lie in a desire to deflate the housing bubble, making housing more affordable and encouraging young women to marry and start families in the hope that this will address the falling birth rate and aging population demographic. Europe is suffering severe impacts from the Russian war against Ukraine including massive energy dislocation entering the European winter.
Australian Impact
The impact on Australia is likely to include a substantial reduction in demand for iron ore exports, the price of which has fallen significantly and which will effect the profits of BHP, Rio Tinto and particularly Fortescue. There is a massive increase in the cost of agricultural inputs with higher farm fuel costs, much higher fertilizer costs and farm chemical costs. Hopefully demand for our coal exports and gas exports will remain high, but net export income for grain is likely to diminish as farmers reduce plantings due to widespread flooding in wheat growing areas.
Those who advocate cessation of coal and gas production choose to ignore the massive reduction in government tax collections and huge royalties, a regression to policy dead ends. Tax collections and royalties by federal and state governments would plummet, there would be a reduction in highly paid jobs, and a substantial reduction in Australian living standards would result.
Advocating applying an ever higher marginal tax rate to high income earners simply drives capital out of Australia and setting up businesses elsewhere is self-defeating. There are optimum levels of taxation on personal income, company profits and consumption tax (GST). Responsible economists agree that compared to leading economies Australia’s personal and company tax rates are too high and our consumption tax too low.
Superannuation Wrap Accounts Are Not Worth Their High Fees!
Wrap accounts are the go-to solution for heaps of financial planners which provide a mechanism for fees to be paid from the account. Wrap accounts tend to be very expensive options for managing your superannuation with further fees buried within managed funds held within the wrap account. Many will find it far cheaper, as a percentage of assets, to choose to have a self-managed superannuation fund once joint assets of a couple approach $500,000 in the year in which the SMSF is established. This will be particularly so for those who are sufficiently investment savvy to choose their own direct investments from listed shares, perhaps some international shares, bank hybrid securities and selected exchange traded funds with low management expense ratios (MERs).
Cost of Super Fund Administration is Falling
The continued improvement of superannuation fund administration software has made funds much cheaper to administer. If you pay substantial fees for a superfund administration and advice service and find that contact with your adviser is inadequate, it is worthwhile getting other quotes for the service and notifying your adviser that you require their administration and advice fees be reviewed.
Advice
It is only marginally more difficult to advise an SMSF with $5 Million of assets to advising one having $1 million of assets. The larger fund will tend to have mainly a similar selection of investments with perhaps a few more. A great deal will depend on the frequency of advice and your confidence in the adviser. If you are paying a heavy amount but receiving sparse advice, it is recommended that you demand of the adviser that you want the fees reviewed. Many organizations will give substantial fee discounts rather than lose a client. Do get other quotes to be better informed.
The Recent Federal Budget
The budget was widely regarded as a cynical exercise with surveys indicating that the majority of Australians were unimpressed! Energy Minister Bowen and Prime Minister Albanese were hoisted on their own petard as having promised on many occasions to cut the average household energy bill by around $275 per annum, but have since proclaimed that massive rises in energy costs are inevitable. Their excuse that this was due to the war in Ukraine was quickly dismissed as the opposition was able to point to 97 occasions when the claim about energy prices falling were made after Russia’s invasion of Ukraine.
Governments which get caught out making false campaign promises or breaking significant undertakings quickly lose the people’s trust as was the case with Tony Abbott’s first budget and Julia Gillard’s broken carbon tax promise.
The promise to build 1.2 million new houses over 5 years, mostly by the private sector, sounds impressive when first revealed except when compared with the 1.177 million new dwellings built in the previous five years. There is negligible change and given likely immigration we will be going backwards.
The Australian Financial Review described the Government’s activity to date as being a great regression to policy dead ends.
Impact Of Capital Markets on Dental and Veterinary Corporates
Corporate purchases of dental and veterinary practices are likely to diminish due to much higher interest cost and the virtual closing down of the Private Equity area of capital markets. The ability to dispose of such businesses by floating in the share market has dried up.
Buying a Home—Best and Worst Times
The worst time to have purchased a home was when interest rates were at the bottom of the cycle. Not only were house prices at their peak, but as interest rates have increased with more increases to come, the value of houses have fallen with a way to go. Houses bought at peak prices with large borrowings are beginning to be offered for sale indicating that some borrowers have over-committed. Some banks may have indicated that it is better for borrowers to put their houses back on the market rather than waiting for interest arrears to build up and forcing their bank to take possession.
The paradox is that the best time to buy is when interest rates are near the top of the cycle and house values have fallen significantly. This may be around April – June 2023. By then the housing market will have slowed significantly. As interest rates begin to ease from their peak, the housing market will begin to recover. But remember nobody rings a bell at the top of the housing market nor at the bottom. The best we can do is buy near the bottom of the market as we judge that interest rate increases imposed by the Reserve Bank of Australia are at or very near their end in the current cycle. As rates begin to fall there will be a gradual recovery in house prices in major markets.
Best Time to Upgrade to Second Home
If planning a home upgrade, the best time to do it is when interest rates are at their peak and the gap between the value of your present home and the new home is at its narrowest. It is important not to hold onto the existing home, but sell and place the proceeds of the sale into your new mortgage.
For those with sound incomes from practices or business, the interest rate cycle offers opportunity as well as threats.
Because fixed term loans take time to reach the point of compulsory conversion to market interest rates the full impact of Reserve Bank Official interest rate increases won’t be experienced until about mid 2023 and therefore there will be a lingering impact on house prices.
Pacific Smiles (Dental Corporate) under Fire from Founder Due to Declining Performance
Pacific Smiles founder Dr Alex Abrahams who sold down his majority shareholding several years ago at an impressive price has attacked the current company management over its recent poor performance. The performance per dental centre has deteriorated significantly. The more centres it opens, the worse the net profit after tax per centre.
In 2015 it produced $9.7 million NPAT from 49 centres representing $197,959 per centre.
In 2016 it produced $10.2 million from 58 centres representing $175,862 per centre.
In 2017 it produced $10.3 million NPAT from 70 centres representing $147,143 per centre.
In 2021 it produced $14.0 million NPAT from 109 centres representing $128,440 per centre.
In 2022 it produced a loss of $3.2 million from 133 centres. i.e. a loss of $24,060 per centre!
The obvious conclusion is that Pacific Smiles has long ceased to grow profit by purchasing/ establishing more dental centres, but the more centres it buys/establishes the less is its profit per centre (practice) culminating in this year’s disastrous result of an overall loss from many more centres than previously.
Its most recent expansion followed its $15 million institutional capital raising of 3/3/202, which was accompanied by a $5 million share placement plan and must be reckoned to have been a failure.
The institutions and assorted stockbrokers have long failed to understand the inherent challenges and flaws in aggregation of professional practices with their many failures and disappointments.
Lacking the motivation of owner operator dentists tightly controlling privately owned practices, many of which are far more successful than the average of corporate practices corporate models become unwieldy requiring additional layer(s) of managers and administrators and inevitably profit per practice declines. At a certain point applying more capital to growth is both profit and capital destroying.
Pacific Smiles Dental Ltd Best Business Option
I certainly would not consider buying Smiles Inclusive Ltd shares. Its present best business option in my judgement is to sell at least half of its practices to private dental owner-operators, thereby recovering some capital and then run a business of limited size and tightly controlled costs.
I spent the years from 1987 to my retirement from Synstrat Group (of which I was a founding partner) in 2020 advising large numbers of professional practice owners of whom the majority were dental practice owners. Advice included dental business strategy, practice performance benchmarking and identification of problems, practice valuation and financial advice. I witnessed many attempts at professional practice consolidation fail or have unintended consequences.
The Limitation on Corporate Dental Practices
Whereas big business has successfully substituted bigger and smarter machines and technologies for employees, there is no way that individual dentists can be equipped to treat more than one patient at a time with a chairside assistant (dental nurse) assisting. It is an inherently labour-intensive business. By contrast, large mining companies have employed gigantic machines to mine transport and process ore while major supermarket chains have largely eliminated check out staff and automated their warehousing processes. In reality, dental corporates are akin to a string of small businesses with a corporate overlay and the corporate model has severe limitations.
My comments on Pacific Smiles Dental are classified as ‘general advice’. Those contemplating buying or selling shares in a dental or veterinary corporate are urged to seek professional advice. Shareholders in Pacific Smiles dental should review annual financials over a number of years and take professional advice.
Dental Career Choice
Top dental graduates are best served career-wise by seeking employment in well-conducted privately owned practices, developing their skills while learning how a practice functions and in due course buying their own practice. Actual observation of the financial net worth of many older dental practice owners indicate that they are financially vastly better off over a full dental career than is possible from a career as a corporate dentist.
Is FTX’s Collapse the Beginning of the End for Crypto?
While it will be financially ruinous for many, the implosion of FTX serves as validation of my long-held view that cryptocurrency is just one large Ponzi scheme which is vulnerable to collapse following an unverified tweet about a crypto exchange or inevitably the emergence of proper government regulation. FTX is merely the latest in a series of crypto failings albeit that its size and rapid descent into liquidation makes it the most dramatic. FTX was officially headquartered in the Bahamas and managed by 30-year-old CEO Sam Bankman-Fried; far from being a crypto exchange it has been revealed that huge amounts of depositor’s funds were used for speculation including a reported $10 billion to Alameda Research, an organization reportedly managed by Bankman-Fried’s former girlfriend! As crypto is unregulated, it may not be possible to prove any actual wrongdoing—albeit that thousands of crypto investors have seen their crypto assets vanish.
Retirements Roger Armitage And Jenny O’Brien
Jenny was my long serving PA at Synstrat up until my retirement on 30 June 2020 and Roger worked closely with me in a senior advisory role. Jenny retired recently. Roger is going to retire in early December to spend time in his hobby as an artist. Both will leave huge holes. I wish them well in their retirement. Sadly, a substantial number of other long term Synstrat staff have also moved on to other employment or retirement.
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
