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Trading Diary

Trading Diary – 16 October 2019

We’ve sold our position in Magellan Financial (MFG) and replaced it with a new position in Imdex Limited (IMD). The market is back exploring the top side of its range. We’ll now get a chance to see if there’s enough demand to follow-through to new highs.

Sell

Magellan Financial (MFG)

We exited our position in MFG with a 38% capital gain and collected a further ~4% in dividends during our holding period.

MFG had been in a three-year-long trading range that began in January 2016, when the stock suddenly emerged in January of this year. The breakout from the trading range was confirmed on February 14 with a 9% gap-up when the company released their 2019 interim results. The gap-up kicked off a new uptrend in the stock that lasted until the end of July. The stock now appears to be forming a new trading range having fallen back close to 20% from the interim high.

We purchased the stock at the end of March following a minor pullback on what was the first base of the new uptrend. The uptrend promptly resumed and put in another two basing points before it was disrupted and brought to an end for now.

The announcement of the institutional capital raising in August has given the market cause for a pause. Magellan management understand valuation. They would not have sold new shares in the company if they thought those shares were undervalued. They are far more likely to issue new shares if they thought the company to be temporarily overvalued.

The market has heeded this cue from management. As a result, the stock looks likely to spend some time moving sideways again to allow time for the performance of the business to play catch up.

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Buy

Imdex Limited (IMD)

Imdex is a leading mining equipment, technology and services company to the global minerals industry. The company’s products improve the process of identifying and extracting what’s below the earth’s surface for resource companies.

Technicals

Imdex has been in a trading range since May 2018. The stock has tested the bottom of this range multiple times. Demand appeared to emerge at around the $1 level at each of these tests.

A shakeout occurred in April, where there was deep penetration of the support level followed by a quick recovery back into the range. Another test quickly followed the shakeout and finally a sign of strength rally. This rally was characterised by increasing spread and volume that took the stock to the top of the range.

The stock then showed signs of being at the last point of support where it entered a short period of higher lows and showed an inability to move lower. Finally, the stock broke above the resistance level at the beginning of September.

These are all classic Wyckoffian technical events.

Since breaking out, the stock has been backing up around this resistance level which is now acting as support. This backing up action in Wyckoff parlance is typically the last big reaction in the stock price before a new uptrend begins. We have established our position around these levels.

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Fundamentals

Value

Imdex ranks in the 50th percentile for value in the All Ordinaries Index. When compared against its peers in the mining services industry, IMD trades at higher multiples of revenue and earnings. However, this phenomenon corresponds with Imdex having higher gross margins and EBIT margins than many of the other mining services companies.

Growth

Imdex ranks in the top decile for growth, which also accounts for its higher trading multiples. Margins and returns on assets have both improved year on year. EPS grew by 30% during the last 12 months, and free cash flow improved significantly.

Financial Strength

The company has significant balance sheet strength with a net cash position of $23.2m. Debt has not increased in the last year, and the company is back paying dividends with little need for additional external financing.

Narrative

Historically Imdex has focused on the exploration and development phases within the global minerals industry. Exploration and development currently represent 80% of revenue. They’ve established a strong market presence within these industry segments and are on approximately 70% of rigs globally.

Exploration budgets are recovering and analysts expect them to show steady growth. This recovery, along with enhancing technical leadership, technical integration and increasing share of client spend, will help the company to continue growing in its core business.

The company generates the remaining 20% of revenue from the mining phase and is planning on further expansion into this segment. This move is logical as they can leverage existing technology and engineering expertise. Mining represents a broader addressable market with excellent growth opportunities and is also less cyclical than exploration and development.

The resource industry is embracing innovation and new technologies to lower cost, increase safety and achieve higher productivity. This change is showing up in Imdex’s operating metrics. The company expects revenue growth to continue, and margins to continue to expand as the company scales.

By Danny Sandler

Founder of Ocean Asset Management.