This was one of my big calls, and I was quite excited about the potential for Enero Group (EGG) up until the FY23 results. Then something strange happened which I could not understand. OBMedia, the jewel in Enero’s crown, was growing like a mushroom…until it didn’t. It all seemed to unravel at the end of 2H23. One slide in the FY23 report tells it all, it confused analysts on the call, and it put up a huge red flag for me.

In the space of one month OBMedia’s revenue almost halved (on an annual basis). The reasons management gave for this huge drop were:

Huh! This explanation was well above my pay grade, so at that point I decided to start reducing our holdings. Of course another strategic review followed to work out what to do with OBMedia to maximise shareholder value.

The 1H24 report revealed that earnings per share had fallen by 54.3%. Management said they were continuing the strategic review with respect to OBMedia and were considering sale of the business with indicative offers due by the 25 March 2024. Well, the 25 March has come and gone…and so far crickets!

I’m probably a bit impatient and a really great deal is about to be announced for long suffering shareholders. However, I’ve taken the opportunity of a run up in the share price in anticipation of some good news to get out completely. We are very fortunate to come out of this retrieving our cost price plus a few dividends, less brokerage. Now watch for the huge offer for OBMedia! I hope so for the sake of others still holding Enero.

No longer held and relieved

I’m still here, but not as EGGcited as I was eight months ago :) I haven’t posted any straws on Enero Group (EGG) for months.

This was one of my favourite picks at one stage. However, over the past year there has been some strange things going on with the jewel in the crown - OBMedia. Over recent years it has been growing like a mushroom with metrics to envy. The strength of the OBMedia business was why I built a position in Enero (EGG) in the first place.

Buts what’s the go now? I have no idea. First management tell us that the quality of the revenue from some clients of OBMedia was poorer quality than others, so they were pausing these accounts to improve the quality of the earnings overall. Then we were told they decided to drop those clients altogether preferring to maintain only the clients returning the superior metrics. I don’t understand the logic, I don’t understand how things will improve from here, but we’ve been told they have been improving and will keep improving even as the US technology sector improves. This sounds like “Hope” to me, and we all know hope is not a strategy.

Then there is another strategic review, this time to look at how management can maximise the value of the OBMedia businesses to it’s shareholders. One option to be considered is selling off OBMedia. What the???

To be honest I’m confused, I don’t understand what’s going on with OBMedia, and I’m starting to get a whiff of rotten EGGs. I have a suspicion I’m not alone here given some of questions coming up at the shareholder meetings.

Management keep telling us the market significantly undervalues the business as they use our cash to support the on-market buy back. However, if the shares are so cheap and the outlook is so good why isn’t management buying them up on-market? The last insider buying was by independent non-executive director Ian Rowden in August when he bought 15000 shares @ $1.43 per share, totalling $21,450. To my knowledge CEO Brent Scrimshaw, who’s on a $2 million package, hasn’t bought any shares on market using his own money for a long time, even though he currently holds shares to the value of $774,300 or 0.54% of the business. Part of Brent’s package comes as shares.

I’ve been reducing our holding of Enero at opportune times to limit our exposure in case Humpty has another great fall. Currently faith and hope is my strategy. Let’s see how that plays out!

Disc: Held IRL and SM

I’m a fundamental investor at heart, however, I’ve been caught too many times buying undervalued falling knives too early and selling over-valued stocks caught in an updraft too early. So now I do take some notice of the charts and the MACD to make Buy, Hold and Sell decisions.

I noticed today that Enero has broken through the 50 Day Moving Average for the first time since January. The share price has nudged it several times in the past few months, but has retreated each time. The MACD has also broken into positive territory for the first time since January.

My fundamental brain tells me charts mean nothing, but charts mean something to a lot of traders, so because of this there is pricing inefficiency and charts do have an influence on the short-term share price. In the long-term charts mean nothing and share price is always drawn towards the fundamental value.

I think Enero has been well undervalued for months (I think mostly driven by the charts) and perhaps this is the break out investors have been waiting for… or it might just have a double digit fall tomorrow. Owning this stock has been like riding a roller coaster. It’s not for the faint hearted! Who knows what tomorrow will bring? It’s an exciting stock to hold…if you like that type of excitement! :)

Disc: Held IRL 9%, SM 11%.

Enero provided its FY2023 Trading Update on the 8th June 2023.

Enero expects net revenue of between $241 million and $244 million, representing 24% to 26% year-on-year growth.

It also expects EBITDA (excluding significant items) of between $78 million and $81 million, representing 18% to 22% year-on-year growth.

Since the trading update the share price has shed a further 20% closing at $1.365 today (14/06/2023).

I thought guidance for FY2023 looked reasonably solid. I’ll go through this in more detail below. I think the biggest concern is slowing growth and weaker EBITDA margins for OBMedia due to a tougher economic climate, and fears this might get worse.

Enero said “Creative Technology and Data is expected to deliver net revenue in the second half of FY23 of between $51 million and $53 million, representing 8% to 12% year-on-year growth albeit with lower than anticipated growth rates due to reduced traffic in OBMedia. EBITDA Margins are expected to be in the high 50s range in the second half (from 63% in H1 FY23).

Traffic quality continues to be OBMedia’s key priority. During the second half, OBMedia proactively reduced its traffic purchases from certain publishers in order to maintain its quality metrics. As a result, OBMedia’s revenue has been affected with the largest impact expected in Q4. OBMedia is committed to continuing to build trust and long-term business relationships with our key advertising partners.”

In 1HFY23, the Creative Technology and Data (CT&D) segment contributed 78% to the group EBITDA from 48% of group revenue with an EBITDA margin of 63%.

In the second half the CT&D segment is expected to contribute about 75% to group EBITDA from 46% of group revenue with an EBITDA margin in the high 50s. There is a slight deterioration in earnings contribution and the quality of earnings compared to the first half.

Second half revenues and EBITDA on a shareholder economic interest basis I estimate to be c. $90 million and c. $26 million respectively. My calculations (below) are based on the revenues and margins for the CT&D and BT segments provided in the trading update (Workings below)

FY23 Revenue (Economic Interest to shareholders)

CT&D Revenue = $52 million (mid point) x 51% (economic interest) = $30 million

Brand Transformation (BT) Revenue = $60 million (mid point)

Total 2H Revenue (economic interest) = $90 million.

FY23 EBITDA (Economic Interest to shareholders)

CT&D EBITDA = $52 million x 59% (margin) x 51% (economic interest) = $15.6 million

BT EBITDA = $60 million x 16.5% (margin) = $9.9 million

Total 2H EBITDA (economic interest) = $25.5 million.

I’ve compared my estimated 2H23 revenue and EBITDA to the previous 6 years on the economic interest basis charts provided in the Enero Strategy Presentation (4/04/23).

If these assumptions are correct, we should still see revenue and EBITDA growth for FY23 on an economic interest to shareholders basis.

I used a spreadsheet (copied below) to model FY23 NPAT and EPS based on last years costs. This may not prove to be accurate, however it is in the ball park (but lower than) updated analyst forecast consensus.

Analyst Forecast Consensus (3 analysts, Simply Wall Street data)

At the current share price of $1.37 the following metrics apply for FY23 forecasts:

PE = 5

EBITDA margin = 32.5%

Dividend = 9.5% fully franked (46% payout ratio)

PB ratio = 0.8

FY23 ROE = 14%

Valuation

Valuation needs to be based on forward earnings and ROE which is difficult to estimate with economic conditions worsening.

Using McNivens StockVal formula and assuming 3 tough years with flat earnings growth, ROE down to 14%, and requiring a minimum annual return of 15% (a higher margin of safety), I get a valuation of $2.04 per share.

Disc: Held IRL (7.5%), SM (10%), Adding.

Trading Update

Enero Group Limited (ASX:EGG) today provides a trading update, expecting to deliver the following results for the 12 months ending 30 June 2023 (FY23):

Net revenue of between $241 million and $244 million, representing 24% to 26% year-on-year growth

• Creative Technology and Data net revenue of between $113 million and $115 million, representing 30% to 33% year-on-year growth
• Brand Transformation net revenue of between $127 million and $129 million, representing 19% to 21% year-on-year growth

EBITDA1 (excluding significant items) of between $78 million and $81 million, representing 18% to 22% year-on-year growth.

Creative Technology and Data Segment

Creative Technology and Data is expected to deliver net revenue in the second half of FY23 of between $51 million and $53 million, representing 8% to 12% year-on-year growth albeit with lower than anticipated growth rates due to reduced traffic in OBMedia. EBITDA Margins are expected to be in the high 50s range in the second half (from 63% in H1 FY23).

Traffic quality continues to be OBMedia’s key priority. During the second half, OBMedia proactively reduced its traffic purchases from certain publishers in order to maintain its quality metrics. As a result, OBMedia’s revenue has been affected with the largest impact expected in Q4. OBMedia is committed to continuing to build trust and long-term business relationships with our key advertising partners.

Brand Transformation Segment

Brand Transformation is expected to deliver net revenue in the second half of FY23 of between $59 million and $61 million, representing 12% to 16% year-on-year-growth.

As indicated in the first half of FY23 results, Enero has remained focused on managing near-team margins. In the second half of FY23, cost-saving and restructuring initiatives are expected to deliver consistent margins for the Brand Transformation segment around 16-17% (H1 FY23:17%) despite a challenging macroeconomic environment.

Enero will announce its FY23 financial results on 18 August 2023 and will provide further disclosures on the finalisation of purchase accounting and contribution to earnings of the ROI DNA and GetIT acquisitions.

Enero has certainly been smashed this year, but it is hard to pin point why. The board thinks the market has it wrong and is undergoing a 10% on-market buy back. It couldn’t have picked a better time to buy back shares with the share price ($1.64, book value is $1.90) at the lowest point since October 2020.

I think the market has been cautious about Enero’s high exposure to the US Tech stocks.

Some of the FAANG stocks are amongst Enero’s blue chip US clients. The FAANG index took a beating last year, but it has beenrapidly recovering. The FAANG+ index is up 55 per cent this year. I am wondering if Enero’s outlook is as dire as the market thinks it is?

Enero’s growth has been exceptional over the last 6 years, yet the business is being punished.

Analysts are forecasting earnings to grow at 13%, and the forecast ROE is 18%, yet the PE is sitting at less than 6. The business has net cash on the balance sheet and should continue to have strong free cash flows. The current dividend yield is 8% fully franked while it continues to reinvest 46% of its earnings. After the buy back the ROE could approach 20%.

I really don’t get it, but I might find out why when the FY23 results are announced. I might also find myself with not only ‘EGG on my face’ but EGG all over our portfolio as well!

Disc: Held IRL 9.5%, SM 9.4%

Thanks for your straws on Enero’s Investor Strategy Webinar and the On-market Share Buyback @loshell. Your comments about whether the 10% on-market share buyback is the best use of capital has got me thinking. My immediate reaction was YES I like this! But now I want to explore this further.

At the end of December 2022 Enero had $38 million (or 21%) of $178 million (total shareholder equity) sitting in cash. As a shareholder this is not ‘their equity’, it is ‘my equity’! Am I happy to have 21% of my invested equity in Anero sitting in cash? I don’t particularly like my own equity sitting in cash if I can find a better use for it. Especially when inflation is eating it away at 6% each year! If I could find an investment that returns over 15% per year at a relatively low risk, I would rather put it there!

If the analysts forecasts turn out to be correct, Enero will be highly cash generative over the next three years. Free cash flows are forecast to be $115 million in FY23, $80 million in FY24, and $80 million in FY25 (Simply Wall Street data). If this turns out to be correct, Enero will be spewing cash and will be trying to find a use for it.

So yes, I think Enero should find a better use for ‘my cash’ then letting it accumulate. The question is, what should they do with it? I can think of two options for the cash that are better than letting it sit on the balance sheet:

1. Return excess cash to shareholders
2. Aquire a businesses that is immediately earnings accretive with ROIC higher than 20%

Why have I been so specific for option 2? My investment thesis for Enero is based on future returns on equity of at least 18%. I don’t want Enero to risk ‘my cash’ acquiring a business that might dilute these returns. With Enero shares currently trading at $1.86 per share I am getting $1.92 worth of equity in the business. That makes Enero at the current share price sound incredibly good value.

However, there is something management can do to make my returns even better, and that is Option 1…Return my cash!

There are two ways for Enero to return my cash:

1. Share buyback
2. Special dividends

I would be happy with either of these options, but let’s do the sums on each to see which would be better.

Share BuyBack

The Anero board has announced that they will buy back up to 10% of its shares over 12 months starting in May. Now, if there was ever a case where I was hoping for the share price for a company I own to stay low, this would be it! If Enero buys back 10% of the shares outstanding using ‘my cash’ to do it, I want them to be cheap. At $1.86 I would be happy for them to buy as many as they can get hold of. That’s what I’ve been doing under $1.85.

However, there is something magic that happens when Enero buys back shares that I can’t do when I buy additional shares in the business.

When the Enero board uses excess cash on the balance sheet to buy back shares it further improves ROE. How does that work? There are a few things that happen when Enero uses spare cash to buy back shares. Firstly, as the cash is used to buy back shares the total shareholder equity goes down (final equity = starting equity - cash used for the share buyback). Secondly, because they are using ‘lazy’ money the total profits will remain about the same, but they are now shared with 10% fewer shareholders (a bigger slice of the pie). So after the share buyback on a per share basis the NPAT per share will go up by 11% per share (100/90 - 100) The equity will remain about the same, providing the shares can be bought back at $1.90 per share (10% less equity over 10% less shares).

Analysts (SWS data) are forecasting FY24 earnings to be 37 cps. I notice this forecast has not changed since Enero announced the on market share buyback. In effect if Enero buys back 10% of its shares by June 2024, the forecast earnings should increase by 11% to 41 cps. Now over the next 12 months equity per share will also increase by the earnings reinvested to $2.08 ($1.92 x 1.083, reinvesting 46% of 18% return) On that basis Anero’s ROE in FY24 should increase to 20%. That makes Enero a better quality business and investors are likely to pay a higher PE ratio than the current 5.8x. This is how the share buyback magic works. I would struggle to find a better investment anywhere else.

Now, how much will the share buyback cost Enero? If Enero can buy back 9.3 million shares (10% of 93 million outstanding) at $1.90 per share, the 10% share buyback will cost $17.67 million (10% of the current total equity). Enero currently has $38 million sitting in cash. So after the buyback they will still have $20 million left over plus any free cash that has accumulated in FY23 and FY24. It seems Enero will not be left short of cash, and will have plenty left over to continue paying between 40% to 60% of its earnings as fully franked dividends, and also pay down some debt. In fact in future they might need to buy back more shares or pay higher fully franked dividends. Such a problem to have! :)

Special Dividend

At the current share price it doesn’t make sense for Anero to pay out spare cash as a special dividend. Paying out a 10% dividend would reduce the total shareholder equity by 10% to $1.73 per share. With reinvested earnings we would end up with equity of $1.87 per share in FY24. With forecast NPAT of 37 cps, ROE would be 19.7% (Similar ROE to the share buyback). However my equity in Enero would be 10% less. Given there will be some tax to pay on the dividends I think I would prefer to leave my cash with Enero where it has the potential to return 18% to 20% per year.

Disc: Held IRL (2.5%), accumulating below $1.85

For interested investors Enero Group has just announced it will hold a Strategy Webinar on Tuesday, 4th April 2023 - ASX Announcement

Investors will hear details of Enero Group’s recent transformation, Group strategy, a deeper understanding of the portfolio brands and business models, and Group capital management framework. Investors will be able to participate in a live Q&A following the presentation.

Date: Tuesday 4th April 2023

Time:10.00 am to 11.45am AEST

Registration: By Friday 31 March

https://us02web.zoom.us/webinar/register/WN_uKNmcA95StmtDmDkWtsQMA

As I build conviction in the Enero Group (EGG) I’m trying to dig up more information on the risks to explain why Enero’s share price is down 54% in less than 12 months when it’s 5 year performance has been outstanding.

Management refer to macro headwinds they have been experiencing this year in the 1H23 Results Webcast . Shame there were no questions at the end. Either the analysts were all happy, they were all on other webcasts, or they just were too busy pushing the sell button! :)

I think the market is expecting the macroeconomic climate to have a devastating impact on advertising budgets. I don’t think it will be as bad as the market is expecting. Analysts are still forecasting earnings growth to continue, albeit slower at 14% per year. When it comes to advertising and cost cutting, businesses are damned if they do and they are damned if they don’t! I haven’t seen Aldi pulling back on the ads lately…nor Nick Scali!

They do expect advertising to drop back in the Health Care sector after being boosted by government spending during COVID. However, Health Care only makes up 8% of its revenue.

Anero has high exposure to the technology and telco sector (43%) and there has been widespread cost cutting by technology companies, especially in the US where Anaero has 53% of its business. So it could be a tougher year for them.

BMF, a subsidiary of Anero Group, have a long history of successful ad campaigns with Aldi including the latest “Shop Aldi First” campaign. Aldi has recently renewed their contract with BMF, and why wouldn’t they? You have just got to love the award winning creativity and quirkiness of the Aldi ads. They always make me chuckle! I don’t mind shopping there either. Where else do you go in for a banana and come out with a robotic vacuum cleaner (true story)! :)

Disc: Held IRL (2%)