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© 2025 First Samuel Limited
Following a week’s hiatus, this week’s Investment Matters is chock full of topics relating to portfolio positions, the market overall and updates from the Australian Bureau of Statistics.
Each topic highlights opportunities for reflection, celebration, caution and patience.
In no particular order, the rundown is as follows:
- The announced takeover of a portfolio significant position, De Grey Mining.
- Promising AGM update from long-held portfolio position in EarlyPay
- A brief analysis of recent moves by famed US investor Warren Buffett and how that relates to both clients’ portfolio positions and the Australian market overall.
- Unfortunately a disappointing update from the small Alternatives position in Hemideina.
- ABS National Accounts – a sombre read for citizens but not all bad news for equities.
The Market
Another takeover – bright outcome for gold miner – De Grey Mining?
We received wonderful news for clients early this week with the announcement that prospective gold miner, and Top 10 position in client portfolios by size, De Grey Mining was to be acquired in an all-scrip deal by fellow listed WA gold miner Northern Star.
- Transaction consideration represents 37.1% to last close and 43.9% premium to De Grey shareholders based on the 30-day Volume Weighted Average Price (VWAP)
- Each De Grey shareholder will receive 0.119 new Northern Star shares, implying a value of $2.08/sh for each De Grey share held
- Post Implementation, Northern Star and De Grey shareholders as of the Scheme record date will own approximately 80.1% and 19.9% respectively
In effect the new combined Northern Star would be four-fifths the existing business and one-fifth the De Grey Mining project.
Since purchasing stock in the company in 2021, not long after De Grey had found the amazing Hemi Project, our patience has been rewarded with an implied price of almost $2 per share, a significant premium to our average entry price of around $1.10 per share.
The stock rose almost 30 per cent on the announcement day this week.
We valued the De Grey assets at almost $2 per share without a takeover premium, but also assuming the company successfully raised the funds to finish the project which was not certain. Net the transaction appears favourable.
Both companies released a joint presentation highlighting the value of the combined company.
Figure 1: Merits of Northern Star takeover of De Grey.
Source: Company presentation
Northern Star (ASX: NST) owns and operates the Kalgoorlie Super Pit, a huge open-cut mine on the edge of the Kalgoorlie township in WA’s Goldfields-Esperance region, which produces about 437,000 ounces of gold annually. It also operates the Thunderbox, Orelia, Carosue Dam, Jundee and Porphyry mines in Australia and the Pogo mine in Alaska’s Yukon.
Figure 2: Northern Star is the owner of the Kalgoorlie Super Pit which sits next to town in WA.
Source: Company presentation (www.superpit.com.au)
Whilst the combination of assets in the new Northern Star is appealing, and we generally appreciate the Northern Star assets, the dilution of the future upside we owned outright in the De Grey assets is problematic.
Once combined, the merits of retaining our holding in the new Northern Star on a 1:1 basis are compromised.
In the coming months, there may be opportunities for a further bid to emerge at a higher price for De Grey Mining’s world-class assets. Otherwise, our overall exposure to the new company will likely be reduced – it is time to book some profits.
EarlyPay AGM update – resuming momentum and dividends
EarlyPay is a leading provider of working capital finance to Australian SMEs with its Invoice, Equipment and Trade Financing products. Invoice Financing helps SMEs bridge the gap between issuing invoices and receiving payment from customers by providing early payment of up to 80% of the invoice value. First Samuel clients own 14 per cent of this ASX-listed company.
Coinciding with the EarlyPay AGM on 28th November, the company released a trading update including the following.
“New originations have started strongly in FY25 across both the invoice finance and equipment finance segments. This underpins the Company’s confidence in the ability to rebuild overall Funds in Use (FIU), albeit the net increase across invoice finance has been somewhat offset by the active reduction of trade finance exposures in line with the Board’s risk appetite.
As the portfolio rebuilds, the Company expects to receive the benefit of the inherent operating leverage in the business to drive increasing profits and cash flow in coming years.”
At the same time, the company outlined it expected to earn 2.2 cents per share in FY25 earnings and that it would resume paying a healthier dividend. The company did pay 0.15 cents per share in September 2024, but this was the first since 2022, and it was a far cry from the potential dividend capacity. Paying out an expected 60 per cent of earnings would imply 1.3 cents per share in dividends or a healthy fully-franked dividend yield approaching 8 per cent.
With the stock trading at 16.5 cents per share before the announcement, the forward PE was as low at ~7.5 times. Not surprisingly, the stock has rallied 27 per cent in the period since then.
The company remains worth considerably more than its current share price; however, it also likely needs to grow through corporate activity, whether a full takeover by the 20 percent owner COG or another business combination.
Well executed rebound
For two years following the RevRoof debacle the company has found growth elusive as it undertook the necessary work on internal processes, client selection and product mix. The new CEO and significant shareholder James Beeson had many elements to juggle.
We were supportive of the need to undertake such change but remained conscious that EarlyPay’s balance sheet was no longer optimised, and the lack of growth constrained both the opportunity to garner support from the market, as well as limited the capacity to invest.
The management task was to eke-out growth it could both manage and afford. The Timelio acquisition and its subsequent integration was a good example of how to successfully execute growth within such constraints.
Expanding growth in FY25 became the challenge. Hence demonstrating growth in early FY25 is a very encouraging sign. The capacity for this earnings momentum to continue through FY26 is supported by structural improvements made to the balance sheet. In addition, with the company engaging in an active on-market share buyback of up to 10 per cent of the company’s outstanding shares, the possibility that the company has materially higher earnings in FY26 is likely to generate support.
Recent changes in the share register is indicative of the company once again being on the radar of those looking for interesting opportunities in the smaller diversified financials universe. We may find profitable opportunities to reduce our holding in coming years or at the least hold a smaller share of a larger company.
Future growth options
Expanding the service proposition will be critical to driving business momentum in coming years. Whilst invoice financing is a more meaningful part of SME business activities in other nations, it has historically had a limited role since the major banks stepped back from this business almost 2 decades ago.
Figure 3: EarlyPay’s service proposition
Source: AGM CEO Presentation
With emerging technologies and service improvements EarlyPay is now well place to benefit.
The AGM presentation highlighted three trends worth repeating for clients.
Technology advancement – integrations with accounting software and now third-party platforms and payments platforms is making Invoice Financing (IF) simpler and more efficient – Operational intensity is expected to reduce significantly and increase the appeal of the product.
Embedded Finance – integration of financial services (including IF) directly into non-financial platforms, enabling clients to access finance seamlessly within their existing workflows. This will broaden distribution and client acquisition opportunities.
Mainstream – as the product proposition improves, Invoice Finance will become a more mainstream SME product – positioned between traditional bank loans and unsecured non-bank products.
The second and third opportunities could provide a step change in the value of this company. Considering the price EarlyPay stock currently trades at fails to value even the traditional part of the business fairly, to secure these additional options (Embedded Finance and Mainstream take-up) for free is a compelling proposition.
Buffett Valuation Indicator – a time for caution?
Late November saw the news from the most recent round of SEC Filings that Warren Buffett’s investment firm Berkshire Hathaway has continued to sell US equities over the previous months.
Buffett (through Berkshire) sold off $133 billion worth of stock through the first nine months of 2024. Most of the sales were in Apple stock but the continued build up in cash holdings in the Berkshire fund caused people to note that not only was Buffett raising cash rather than reinvesting, but that the Buffett Valuation Indicator was also suggesting that stocks have become overvalued.
Buffett Valuation Indicator – what is it?
The Market Cap to GDP Ratio (also known as the Buffett Indicator) is a measure of the total value of all publicly-traded stocks in a country, divided by that country’s Gross Domestic Product (GDP). It can be used as a broad way of assessing whether the country’s stock market is overvalued or undervalued, compared to a historical average.
Figure 4: Buffett Valuation Indicator – USA – hitting a new peak
Source: Macro Micro
Berkshire Hathaway’s more than $320 billion in cash and equivalents on hand and streak of selling stock suggest Buffett could be hesitant about putting more money into either a seemingly overvalued market or similarly overpriced market for potential acquisitions in private markets.
Is the US market expensive? The short answer is YES both compared to other markets and its own history. But the more nuanced answer would also note that the US market has achieved significant earnings growth in recent years. In other words, the US market has partly risen because US companies have performed much better than the rest of the world.
The chart below shows the distinction between the index’s relative performance (in red) and the companies’ relative performance (in EPS growth (earnings per share) in the index, in blue).
Figure 5: US share market outperformance
Source : Minack Advisors
Until the past year a good deal of the outperformance could be explain by the companies, with the blue and red line growing together. But over the past couple of years the US market has simply become expensive regardless of earnings growth. When we further break the market into the “Magnificent Seven” companies and the remainder, the distinction is stark: most of the price growth and earnings growth are very concentrated. Historically higher periods of concentration lead to lower future returns.
Historically, the Buffet indicator has provided an essential context to a market’s overall position; with hindsight, it can identify periods in which stocks, especially in the US.
Buffett acknowledged that the ratio “has certain limitations.” Still, he called it “probably the best single measure of where valuations stand at any given moment.”
Buffet has historically displayed a “home country” bias in which he prefers to invest in companies that ultimately generate US dollar earnings, even when these companies have global reach. Rarely does Buffet search for companies beyond the scope provided by the US. This makes sense, considering the circumstances of his investors and the vast array of options the US provides.
Buffet has historically chosen cash or US treasury bonds to invest in during periods when stocks were expensive instead of explicitly looking for alternative markets.
Global markets have always offered scope beyond what could be provided locally for a smaller nation and a smaller market like Australia’s. In one market is expensive, including our own, we usually have options to invest elsewhere.
Relating the Buffet Indicator to clients’ portfolios and the ASX.
The first point to note, shown below in Figure 6, is that the Buffet Indicator for Australia is not at peak levels. This is critical for four reasons.
- Our market is not dominated by a small range of euphoric stocks, although companies such as CBA do have elevated share prices.
- The overall earnings power of the ASX is relatively aligned with the income generating capacity of the economy. After all the health of our index including our banks and miners is correlated with the health of the economy.
- A significant amount of support for the economy is coming from the government sector which is indirectly assisting with the growth in demand for a large part of the non-export related sectors in the ASX.
- The Australian market generates significant value from demand that is outside of Australia, and from earnings from internationally focussed companies in healthcare, consumer discretionary as well as mining sectors.
Figure 6: Buffett Valuation Indicator Australia – expensive but not nearly as stretched
Source: GuruFocus.com
The current ratio of total market cap over GDP for Australia is 114.71%. The recent 20-year high was 153.89%, the recent 20-year low was 74.65%, and the 20-year mean was 107.3%.
So, while we are wary of the highest-priced companies in the ASX market, we are comfortable investing in a wide range of companies trading at “normal levels”.
Regarding clients’ international exposures, we are actively reducing our exposure to the same sectors of the US market that Warren Buffet is now avoiding.
We are concentrating our investments in the more reasonably-priced S&P400 and taking opportunities to find better value in Europe and Japan.
Conclusion
The Buffett indicators remind us to consider the economy’s overall wealth when assessing the market’s vigour. This measure creates caution in US equities and more comfort closer to home.
Hemideina: Equity Raise and Valuation Write down
This week, the formal process for a new Series A equity raise in Hemideina (HEMIDEINA.UNL), a small company clients own in the Alternatives sub-portfolio, was completed.
Under new management, we are making a small follow-up investment in Hemideina. The company is developing a novel cochlear implant, that aims to provide superior hearing through a strategy of stimulating the cochlear. The company was raising a Series A3 funding round to continue to develop the device and demonstrate superior hearing outcomes in human trials but has had to restructure its technology, from its earlier path.
We anticipate that the time taken to develop and prove the technology will be approximately three years.
Originally representing approximately 2 per cent of the Alternatives sub-portfolio, the current funding round has been completed at $12 per new share, a significant discount to the $50 per share price originally paid in previous rounds. The amount funded in this round is also significantly reduced (1/7th of the original investment); however, we do maintain a similar percentage holding of the company (around 1 per cent).
Clients will notice the write-down in value to $12 per share in their portfolios.
Background and investment rationale
Since first developed in the late 70s and early 80s, cochlear implants have revolutionised hearing in the hearing impaired. Under direction from Hemideina founders, a novel, transformative path to success was being pursued. A review post 2+ years of funding assessed that the business was unlikely to achieve all its aims with the capacity afforded by likely funding. The goals have been scaled back with a more limited but more commercially-viable outcome, the new aim.
The business is now operating under a new CEO (neuroscientist Gerrit Gmel) but is being guided by John Parker, a long-time Cochlear scientist (Chief Technology Officer) who produced much of the formative work for that organisation and the closed-loop feedback technology developed at NICTA.
There remains a significant opportunity to improve hearing outcomes. The device can be redesigned and developed with improved range, more frequencies, and a cross-canal approach. But what is now being undertaken is less transformative than what was previously pursued. This approach should cater to more variance in the size of patients’ cochlear rather than treating everyone as ‘average’.
While it is disappointing that all the company’s original aims are unlikely to succeed, we understood this possibility upon initial investment and sized such an investment accordingly—that is, we invested only a small amount.
The company’s progress in rebuilding and improving its technology will likely result in the acquisition of Hemideina by one of the larger players in the industry.
ABS National Accounts
Wednesday saw the release of the Q3 National Accounts data from the Australian Bureau of Statistics (ABS). The National Accounts are a nation’s principal set of economic indicators, compiled quarterly consistently over the decades and globally.
The data isn’t the timeliest; the delay in its construction usually means the information is somewhat stale. Nor are National Accounts the most straightforward concepts for the media or layperson to understand. Regardless, they tell a concise story from a historical perspective and, from the perspective of policymakers the implications are hard to avoid.
This quarter’s accounts didn’t really tell us anything new, certainly nothing we have harped upon in Investment Matters for the past couple of years. But they are so stark that the implications are worth considering once again.
Headlines:
- Australia’s GDP came in weaker than expected in Q3, rising +0.8% year on year
- GDP fell by 0.3% on a per capita basis, the only basis that matters for citizens, marking the seventh consecutive quarter of decline.
- Australian households are firmly in recession.
- Softness was driven by private final demand, which grew by only 0.1% across the quarter. Private Final demand is the sum of consumption and investment of the private sector.
- Effectively, all economic growth was driven by government spending and investment, with the public share of the economy reaching record levels (outside of COVID).
- Housing investment was positive, but business investment continues to fall, an extraordinary indictment on Australian business given strong profits, and the level of migration-led population growth.
We summarise these trends using a series of charts from Macquarie Research. The first compares real growth over the past 12 months across the globe—overall growth in RED and per capita growth in GREY.
Figure 7: Recent GDP growth (major advanced economies), real and per capita
Source: ABS, Macrobond, Macquarie Macro Strategy
Australia’s overall growth is weak—at less than 1 percent, the economy is close to stalling. Compared to the US and Japan, we are achieving exceptionally weak overall growth.
The results are even worse on a per capita basis in grey. In the US, strong overall growth is converting into real-world success for its citizens; per capita output is growing more than 3 per cent faster than in Australia.
Europe (Germany, France and the UK), with slow overall growth in RED, is still delivering real growth per capita.
Government spending – filling in the gaps
Readers will have divergent political views on the merits of public spending and will all have views on which areas could experience spending cuts. Regardless, the economy would have stalled without high levels of government spending cushioning the impact of higher interest rates on households.
One problem appears to be the lack of a connection between population growth’s impact on infrastructure and government service demand and its impact on driving business investment. Under different circumstances, massive population growth and falling real wages would have created an environment for business investment to grow.
But on a per capita basis, business investment isn’t growing; it is barely keeping pace with depreciation. Government investment is backfilling infrastructure and services shortfalls. Still, businesses through their lack of investment are suggesting that there is no level of profitability, population growth, government support, or wage contraction that will lead them to invest.
We ask a straightforward question. Is the economy finally feeling the effects of harmful long-run wealth destruction from the massive duopolies and near cartels that dominate the nation and over investment in non-productive housing stock?
The chart below shows Business Investment as a percentage of nominal GDP. Since population growth began to accelerate in 2007, there has been no increase in investment share. Between 2008 to 2015, the narrative suggested that the mining investment boom (in red) was crowding out the non-mining sector.
Figure 8: Business investment since 1959 – share of the economy – mining and non-mining
Source: ABS, Macrobond, Macquarie Macro Strategy
Through COVID the decline in investment could have been explained by uncertainty regarding the impact of the pandemic. But since COVID, we have only rebounded to levels seen through the 2010’s, regardless of the acceleration in population growth.
Part of the explanation lay in the nature of the investment being undertaken. The following chart highlights the real (adjusted for inflation) business investment (mining and non-mining combined) by category. For instance, the purple line shows the machinery and equipment investment in $bn since 2004.
Figure 9: Levels of business investment by components, $bn real since 2004
Source: ABS, Macrobond, Macquarie Macro Strategy
Machinery and investment levels are around $27bn per quarter, only slightly higher than those seen between 2008 and 2012, despite Australia’s 20 per cent larger population and more than 40 per cent larger economy.
The boom in engineering construction between 2008 and 2012 (in red) was mining-related, and now, despite the huge government investment, overall engineering construction is smaller than it was in 2008, near the beginning of the mining boom.
The only area of investment growth is intellectual property investment, the grey line, which includes R&D and computing resources. We can see the real growth in that category—doubling in size (inflation-adjusted) since 2012 more than reflecting the rise in population and overall economic growth.
The world is now entering a new period of intellectual property investment as we harness the power of AI and cloud computing. We already see this investment in the US economy. It will be critical for Australia to continue to grow this investment.
The questions for Australia are clear. Is population-led growth designed to support duopoly-like industries (supermarkets, banks and domestic energy) the type of growth that will generate wealth in the future? Is low-skilled migration built around education that drives wages lower, the model for wealth creation?
Or do we need to restart growth through investment and reform?
Equities – winning regardless of the path
In some regards, the outlook for ASX-listed equities is indifferent to the path chosen. Should business investment remain subdued, the government sector retains the capacity to debt fund investment for a number of years. In these circumstances, we will continue to concentrate our exposure on companies that benefit from the overall growth in the economy, regardless of the productivity or investment outcomes.
In these circumstances, inflation will remain slightly higher, increasing the risks of holding income securities and increasing the value of pre-existing businesses with pricing power. That is, the profits to the duopolies and industries with higher concentration will continue to grow nominally, leading to higher share prices.
Should Australia choose to promote investment or new competition through microeconomic reform, equities will reward the new entrants and the businesses that benefit from productivity improvements.
In this future, inflation will be lower, and subject to household debt and house prices, credit creation is more likely to lead to higher business investment. Lower interest rates should be a benefit of pursuing such a path. In these circumstances, equities will also outperform. Different equities will be the winners in this scenario, but equities will be the winners.
So, while the National Accounts are a sombre read for policymakers and, hopefully, the political class, they once again highlight that there are many paths to success in investing in businesses.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.