Cortina Holdings is a distributor and retailer of luxury watches like Rolex, Patek Phillipe, and Tag Heuer. Established in 1972, Cortina has now grown to 28 outlets in Singapore, Malaysia, Thailand, Hong Kong, and Taiwan.
Since its peak in September 2018, Cortina’s share price has fallen 12% to 95 cents recently:
As I was going through Cortina’s latest financial statements, something jumped out at me – the company’s current market capitalisation is worth less than its net current assets.
Net-net investing was developed by Benjamin Graham (the mentor of a certain Warren Buffett) who preached that investors who bought stocks at such low prices would come out ahead, even if the company was shut down and liquidated.
A net-net stock is traditionally defined as a company that’s trading below its net current assets (current assets minus total liabilities). Expressed as a formula, it is:
Market Capitalisation < Current Assets – Total Liabilities
So let’s have a look at Cortina’s latest Q1 FY2019 figures:
From the above, Cortina’s current assets are $237.5 million, its total liabilities of $71.5 million, and its current market cap is $157.3 million.
Market Capitalisation < Current Assets – Total Liabilities
$157.3 million < $237.5 million – $71.5 million
$157.3 million < $166 million
Cortina is currently worth just 0.95 times its net current asset value (NCAV). This means if the company were to hypothetically shut down, liquidate all its current assets and pay off all its liabilities, it’d still be worth more than what you pay for it today.
It’s not every day you see a stock trading below its NCAV and, understandably, net-net stocks are few and far between.
Net-net working capital
There is a second definition of net-net which is known as net-net working capital. During his career, Graham realised that only a certain portion of current assets could be readily converted into cash.
For example, a company selling shoes may have $1 million worth of inventories on its balance sheet, but in reality may only be cleared for half that value. Therefore, Graham added a discount to certain assets, and everything else is excluded:
- Cash & cash equivalents x 100%. Cash is always fully valued as it is already… cash.
- Trade receivables x 75%. Trade receivables are marked down for doubtful accounts.
- Inventories x 50%. Inventories, especially those with short shelf lives, are treated as if they are on a fire sale.
The discounted value of these assets minus total liabilities is known as net-net working capital (NNWC). As you can see, this is even more conservative and a company trading below its NNWC is certainly undervalued.
So now let’s calculate Cortina Holdings’ NNWC:
Cash & cash equivalents = $44.0 million x 100% = $44.0 million
Trade receivables = $17.5 million x 75% = $13.1 million
Inventories = $173.2 million x 75% = $129.9 million
Total liabilities = $71.5 million
NNWC = $44.0 million + $13.1 million + $129.9 million – $71.5 million = $115.5 million
Cortina Holdings’ market cap is $157.3 million, which means the stock is trading at 1.36 times its NNWC. So based on NNWC, Cortina is not undervalued at the moment.
You may have noticed that I discounted Cortina’s inventories at 75% instead of 50%. Why so?
In Cortina Holdings’ annual report, it indicates:
This basically means that Cortina’s balance sheet already lists its inventories at cost or net realisable value, whichever is lower. Inventories may also be written down due to decline in demand, physical damage, or old age.
But because Cortina’s inventories are luxury watches, they should, in my opinion, be able to hold onto most of their value even in a hypothetical liquidation event (unlike if Cortina sold, erm, bananas, for example). So it’s unlikely we’ll see Rolexes or Tag Heuers going for half off and I actually think the watch brands themselves wouldn’t want their brand equity to be hurt in a fire sale either. On the flip side, some luxury watches even increase in resale value due to their demand among collectors. So I consider a discount factor of 75% for inventories here to be reasonable.
A fair business at a fair price
Net-net investors typically look for stocks that trade less than 0.66 times their NCAV or below their NNWC. These are usually companies facing highly distressed situations or terrible businesses that the market tends to ignore. Investors are less concerned about the quality of the business than its cheapness. Because even if the business were to fold and liquidate all its assets, you’d still come out profitable if you have a significant margin of safety.
In Cortina’s case, its core business is doing moderately well with revenue, net profit, and operating cash flow rising in the last three years:
Source: SGX StockFacts
Therefore, even though Cortina is trading higher near its NCAV, you’re buying a business that’s chugging along nicely and generating steady earnings.
At the same time, the business doesn’t have any real economic moats and faces stiff competition from other luxury watch retailers like The Hour Glass; shoppers can easily shop anywhere they like for luxury timepieces. Cortina’s growth is also limited to the number of outlets it can open and it must continually spend more on expensive inventory just to expand; inventories already account for 65.7% of Cortina’s total assets.
So while Cortina is not a bad business in any sense, it’s also not a highly scalable business with significant competitive advantages. Overall, you’re getting a fair business at a fair price.
The fifth perspective
Net-net investing is a useful way to evaluate certain companies, especially those with a poor to fair business model that is unlikely to scale or grow stronger over time.
In that case, you want to look for deep value where you profit from buying a stock extremely cheap today than wait for it to possibly grow in value over time.