I have from time to time written about natural gas. I wrote about a possible upside case and then wrote some musings about looking for investments tied to natural gas. While my radar is always attuned to any opportunity, I think I have shelved the idea of finding some natural gas investment mecca. It simply doesn't suit sound investment principles to bank on far from foregone conclusions. Here are some of my thoughts/conclusions.
1. One idea I was looking at was Fuel Systems Solutions, which makes the parts for vehicles to run on natural gas. They have a $500m market cap, net cash position, and have been growing in profitability. It definitely is headed in the right direction. It has profitable operations in Europe that a) make the company a strong contender to continue to bide its time and b) give it a track record of applying its knowledge to give it a lead in convincing auto companies to include their products in large scale production. The company doesn't have a long history of profitability though and the past 4 years have seen tremendous growth. It's definitely not a very expensive stock, especially if natural gas gets adopted as a transportation fuel. Operative word is 'if.' I'm no tech guru, but what is to stop electric cars from emerging as a major player and natural gas only plays a role through electricity generation? The downside just seems too great.
2. People bandy about a lot of numbers in regard to future natural gas production. I don't want to get into numbers, mostly because I don't understand it completely, but the range is wide. It's also based on future predictions. There's plenty of upside potential in more finds and applying fracking technology outside the US, where shale plays are even more nascent. I'm not raining on the shale parade, but future predictions might be proven a stretch, as many predictions tend to be. When the US reaches the juncture of having a serious discussion about incorporating natural gas into the economy to a greater degree (hopefully its serious), the big elephant is whether or not the supplies of natural gas will justify the investment in a whole new set of infrastructure. I only say this in regard to electric vehicles vs. compressed natural gas (CNG) vehicles. There are other ways this could play out, but vehicles would embed a lot of recurring demand for natural gas that could potentially grow exponentially as a CNG based network is built out.
3. There's a lot of horse betting in the natural gas sector broadly speaking and being an average guy, its hard for to honestly believe I have an edge in the sector. Whenever I see information related to natural gas and listen to managers or various commentators, there is always some hidden agenda. The overwhelming majority of the time, its people talking their own book. Just as an example, the CEO of Chesapeak Energy was on CNBC (which is quite often) touting using natural gas as a transportation fuel. He touted how he paid the equivalent of $0.75 a gallon to fill up his CNG car. This would be expected of a CEO of a natural gas company. But what happens to that price when demand increases 5 fold? Then it isn't quite the panacea everyone thought it would be, but Chesapeake doesn't care because now it has huge recurring demand for its natural gas. When people talk their book, I ask myself if a neutral person would naturally reach the same conclusion. Investment banks would have a hard time convincing me their lobbying is for the net benefit of America. In the case of Walmart, they save people money if you ask people or Walmart. The same applies for GEICO and Progressive. Although there are plenty of other reasons, one can be more comfortable investing in a company that is fundamentally aligned with its consumers in the service/product it offers.
And as a side note, the site has surpassed 70 readers, which is a lot more people than I thought would care what I had to say about much of anything. I'm pleased with the progress I'm making as an investor, writer, and the two combined. If there's anything you find particularly interesting that you would like me to elaborate on, shoot me an email and I'll try to if it is within my circle of competence. I'm trying not to write about every stock I look at, because sometimes its in passing or gets a once over but goes on the back burner, but I enjoy writing about what I think on various market topics even if I'm not always right.
Talk to Andrew about natural gas.
Monday, February 28, 2011
Sunday, February 27, 2011
Is Green Mountain Coffee Roasters too successful for its own good?
Businessweek ran an article in the most recent issue on Green Mountain Coffee Roasters speculating about a takeover, albeit a very pricey one. These types of things are always thrilling "journalism" but tend to indicate an investor should move in the opposite direction. There are grander examples of Businessweek doing it with their "Death Of Equities" cover in 1979, but this focuses on a specific stock, so I decided to write my thoughts.
A brief overview of the company/market consensus: Just think razors and blades. GMCR has patented technology called the k-cup. You buy a moderately priced machine that you insert single serve coffee packets that are high margin. It's quick and convenient. All you have to do is put water in the machine. Mr. Market has decided to value this company at a phenomenal valuation. After all, "razors and blades" is what that dude from Omaha invested in and made a bundle, right?! Coffee has caffeine. GMCR is selling a better product than Gilette because coffee is more addictive and habit forming and people use more of the coffee pods/"blades" so it must be worth as much if not more. The company has had explosive growth and trades 4x sales and 80x earnings, although management claims earnings will double this year. They definitely have made a great product with a great value proposition both in convenience and cost, but history should tell us that the odds are they won't be the ones to profit the most off of their idea.
Interesting enough, Alice Schroeder talks about another idea of Buffett's that is worth noting in this video I harp about all the time on the blog. She discusses the competitive position of IBM and how Buffett knew how hard it was to enter a business that IBM was involved in, such was their size and operational prowess. You can observe this idea throughout Buffett's investments and any business with a competitive advantage. Microsoft was not much of an innovator, but it has been damned good at staving off the competition until recently. Walmart was not the first big box discount retailer.
Is GMCR in the position of these giants? After all, it does have about 80% of the market for its k-cup coffee pods. Will it vaunt itself to the heights of corporate America and dominate its market? This type of advantage is call the first-mover advantage. It can be a decisive factor, although not always. Did Henry Ford invent the car? Did Microsoft invent anything? No and no. They perfected it and they crushed the competition. Google was not the first search engine. People don't try to compete with it anymore, they try to make companies they can sell to them.
Does this type of industry dynamic confront GMCR? Yes. Getting Dunkin Donuts on board with k-cups is definitely a huge victory, because that brand is huge. While many PE deals have been adventures in financial engineering and cutting costs to the bone, the DD takeover has been a wild success from a consumer standpoint. The stores are cleaner and the coffee has a strong following. This is definitely in favor of GMCR.
The problem with GMCR is that it isn't the IBM, Microsoft, Google, or Ford. It faces competition from real serious companies. Nestle and Starbucks are savvy. They know whats up. Nestle has been growing its Nespresso brand organically. They have a huge stable of billion dollar brands they've built up over the years. They bought Kraft's frozen pizza segment for a shade over 10x pretax, not a crazy multiple. The combination of disciplined management and savvy operations means they a) aren't going to buy GMCR and b) they are going to grow their Nespresso organically and take it to GMCR. They won't become poor capital allocators overnight. The historical success of Nestle is a strong indicator that they are going to have the mettle to bring the heat through their scale and pricing power.
The elephant in the room seems to be Starbucks, which the tea leaf readers have all sorts of predictions about. Like Nestle, they have savvy management that doesn't seem very acquisitive. Even more similarly, they have a history of growing strong brands. The Via extension has been a wonderful success on every front. It also indicates management is competent enough and determined to roll out new products that extend the brand. It's always 50/50 when a founder-CEO returns, but Howard Schultz has proven a lot more Steve Jobs than Michael Dell. When it comes to coffee, Starbucks knows what its doing. One might argue that the target demographic of GMCR/Dunkin Donuts is different than Starbucks, but one can't dispute the power of the brand and marketing an affordable luxury. You can pull up taste tests and whatever proof about the taste of Dunkin Donuts vs. Starbucks vs. McDonalds, but the profitability, growth, and traffic that Starbucks generates is undeniable. Their size and scale make them formidable competitors as well.
Coca-Cola is an interesting wildcard. People seem to believe they will attempt to acquire GMCR. Looking at history, this isn't too far fetched. The Glaceau deal was done to acquire a fast growing new segment. Coffee, with its caffeine component, makes it the kind of business Coke would love to get into. PepsiCo has historical ties to Starbucks as distributor of some of their ready-serve cold beverages. This leave Coca-Cola open to a possible move in the sector. While the Glaceau valuation was aggressive, VitaminWater did and still does face a lot less competition in its direct segment. GMCR doesn't appear to possess the same long term competitive dynamics.
Economics 101 is that high profit margins attract competition. Where it gets more complicated is when companies are capable of defending their markets from competition. The unfortunate factor to consider about GMCR is that it is heading full speed ahead to the train wreck that is known as trying to compete with Starbucks, Nestle, and potentially other brands. It's valuation seems too dear to attract any sane buyers. Of course there in lies the risk. While I have no position in the stock, it is interesting to think about what business history can show us about today's growth stocks.
The 1940 edition of Security Analysis by Ben Graham has this Horace quote at the beginning that always leaps to the front of my mind in cases like this:
A brief overview of the company/market consensus: Just think razors and blades. GMCR has patented technology called the k-cup. You buy a moderately priced machine that you insert single serve coffee packets that are high margin. It's quick and convenient. All you have to do is put water in the machine. Mr. Market has decided to value this company at a phenomenal valuation. After all, "razors and blades" is what that dude from Omaha invested in and made a bundle, right?! Coffee has caffeine. GMCR is selling a better product than Gilette because coffee is more addictive and habit forming and people use more of the coffee pods/"blades" so it must be worth as much if not more. The company has had explosive growth and trades 4x sales and 80x earnings, although management claims earnings will double this year. They definitely have made a great product with a great value proposition both in convenience and cost, but history should tell us that the odds are they won't be the ones to profit the most off of their idea.
Interesting enough, Alice Schroeder talks about another idea of Buffett's that is worth noting in this video I harp about all the time on the blog. She discusses the competitive position of IBM and how Buffett knew how hard it was to enter a business that IBM was involved in, such was their size and operational prowess. You can observe this idea throughout Buffett's investments and any business with a competitive advantage. Microsoft was not much of an innovator, but it has been damned good at staving off the competition until recently. Walmart was not the first big box discount retailer.
Is GMCR in the position of these giants? After all, it does have about 80% of the market for its k-cup coffee pods. Will it vaunt itself to the heights of corporate America and dominate its market? This type of advantage is call the first-mover advantage. It can be a decisive factor, although not always. Did Henry Ford invent the car? Did Microsoft invent anything? No and no. They perfected it and they crushed the competition. Google was not the first search engine. People don't try to compete with it anymore, they try to make companies they can sell to them.
Does this type of industry dynamic confront GMCR? Yes. Getting Dunkin Donuts on board with k-cups is definitely a huge victory, because that brand is huge. While many PE deals have been adventures in financial engineering and cutting costs to the bone, the DD takeover has been a wild success from a consumer standpoint. The stores are cleaner and the coffee has a strong following. This is definitely in favor of GMCR.
The problem with GMCR is that it isn't the IBM, Microsoft, Google, or Ford. It faces competition from real serious companies. Nestle and Starbucks are savvy. They know whats up. Nestle has been growing its Nespresso brand organically. They have a huge stable of billion dollar brands they've built up over the years. They bought Kraft's frozen pizza segment for a shade over 10x pretax, not a crazy multiple. The combination of disciplined management and savvy operations means they a) aren't going to buy GMCR and b) they are going to grow their Nespresso organically and take it to GMCR. They won't become poor capital allocators overnight. The historical success of Nestle is a strong indicator that they are going to have the mettle to bring the heat through their scale and pricing power.
The elephant in the room seems to be Starbucks, which the tea leaf readers have all sorts of predictions about. Like Nestle, they have savvy management that doesn't seem very acquisitive. Even more similarly, they have a history of growing strong brands. The Via extension has been a wonderful success on every front. It also indicates management is competent enough and determined to roll out new products that extend the brand. It's always 50/50 when a founder-CEO returns, but Howard Schultz has proven a lot more Steve Jobs than Michael Dell. When it comes to coffee, Starbucks knows what its doing. One might argue that the target demographic of GMCR/Dunkin Donuts is different than Starbucks, but one can't dispute the power of the brand and marketing an affordable luxury. You can pull up taste tests and whatever proof about the taste of Dunkin Donuts vs. Starbucks vs. McDonalds, but the profitability, growth, and traffic that Starbucks generates is undeniable. Their size and scale make them formidable competitors as well.
Coca-Cola is an interesting wildcard. People seem to believe they will attempt to acquire GMCR. Looking at history, this isn't too far fetched. The Glaceau deal was done to acquire a fast growing new segment. Coffee, with its caffeine component, makes it the kind of business Coke would love to get into. PepsiCo has historical ties to Starbucks as distributor of some of their ready-serve cold beverages. This leave Coca-Cola open to a possible move in the sector. While the Glaceau valuation was aggressive, VitaminWater did and still does face a lot less competition in its direct segment. GMCR doesn't appear to possess the same long term competitive dynamics.
Economics 101 is that high profit margins attract competition. Where it gets more complicated is when companies are capable of defending their markets from competition. The unfortunate factor to consider about GMCR is that it is heading full speed ahead to the train wreck that is known as trying to compete with Starbucks, Nestle, and potentially other brands. It's valuation seems too dear to attract any sane buyers. Of course there in lies the risk. While I have no position in the stock, it is interesting to think about what business history can show us about today's growth stocks.
The 1940 edition of Security Analysis by Ben Graham has this Horace quote at the beginning that always leaps to the front of my mind in cases like this:
"Many shall be restored that now are fallen and many shall fall that now are in honor."Talk to Andrew about Green Mountain Coffee Roasters
Saturday, February 26, 2011
Allied Healthcare International, a cheap international company
Allied Healthcare International (AHCI) is interesting company. It’s a UK company that does no business in the US but only has a listing on the NASDAQ. As a result of the exchange rate of GBP:USD, earnings and revenue seem a lot more volatile than they really are. The company is cash rich and a consistent earner as a result of operating on 3-5 year contracts. The sector it operates in is going through a period of consolidation and recent buyouts have been at valuations much higher than the current price of Allied. The company is a consistent earner, has a strong balance sheet, generates high returns on capital, is scalable, and is benefting from many trends in the UK healthcare sector, economy and demographics.
Business Overview:
Allied Healthcare is a provider of domestic healthcare staffing. They get contracted to provide the staff for home visits to elderly and special needs individuals to assist them with basic living functions such as bathing and dressing through 115 branches around the UK. The company operations are mostly decentralized with branch managers tasked with meeting targets for operations. The contracts through which services are provided are negotiated on 3-5 year basis with local government social services. The government comprises 80% of the company’s revenue with private work making up the remainder. Government revenue is much more fragmented than first glance, as it is comprised of many contracts at the local level with local governments. The company derives its revenue entirely from the UK and Ireland.
Business Risk
The company derives the bulk of its revenue as a result of government spending on healthcare. Like the United States, the UK is looking to cut back healthcare spending. This is a combination of rising healthcare costs and UK government deficits. The healthcare rules, like the US, are constantly changing. The risk to Allied Healthcare is minimal. The service it provides is itself a cheap alternative to other forms of healthcare that would be picked up by the state. Their homecare services reduce the need for full time residential housing of elderly, which is more expensive. There are also the increasing trends of outsourcing the work to private firms as well as aging demographics. The most recent quarter saw pressure on earnings as a result of these changes, but the long term outlook is favorable considering the low cost option that homecare offers.
Valuation:
There are 43,923 fully diluted shares outstanding and a current market price of $2.40 per share for a market capitalization of $105m. There is net cash of $35m on the balance sheet. The enterprise value is $70m. The company has earning $8.8m in the past twelve months. The company trades at 8x earnings net of cash and 5x EV/EBITDA.
The company disposed of its last non-homecare business at the end of 2007, paying off all its debt and positioning the company on its current path. The periods of 2008, 2009, and 2010 saw earnings of $8.7m, $9.9m, and $9.8m respectively, averaging $9.5m. The numbers lie when it comes to the telling potential investors about the growing earnings of the company. The GBP:USD exchange rate fell from an annual average of 1.85 to 1.54 over this period. In GBP, revenue has been steadily growing. When translated into USD, the revenue looks very volatile, although that is the exchange rate, not the underlying business.
Acromas, a company looking to consolidate the homecare industry through its Saga subsidiary, recently acquired Nestor Healthcare Group, a competitor of Allied Healthcare, for £124m or £136m including debt. Nestor generates more than two thirds of its revenue from social care of patients in their home and about a third from primary care of patients. Three private equity groups own Acromas: CVC Capital Partners, Charterhouse and Permira. Below is a table comparing the valuation of the buyout based on annualizing the first six months of Nestor’s results in 2010. The initial offer was made in August 2010. The deal closed in January 2011 offering an optimal comparison for Allied.
Nestor Healthcare* AHCI Implied AHCI Share Price Upside
Price/Sales 0.8 0.4 $4.54 89%
EV/EBITDA 11.5 5 $4.32 80%
EBITDA 10.5 8 $3.22 34%
P/E 16 12 $3.20 33%
EV/E 18 8 $4.40 83%
Upside/Downside
The downside would be management spending the $35m cash balance on an acquisition. Done at a valuation similar to Nestor, an acquisition at 16x earnings would add $2.2m to net income. Using the current cash adjusted market multiple, the company would be worth $2.00, a downside of 16%.
A buyout scenario is addressed above, with upsides ranging from 30-90%.
Even if the company is not bought out, it trades at an absolute low valuation. The cash on hand could be put to good use in a buyback and management currently has $5m more on its current buyback. It would be nice to see management focusing on further decreasing the share count.
There would be more upside if the company listed on the UK exchange as well and moved entirely out of the US. They delisted from the AIM in London due to lack of investor interest. If you look at the conference where management has presented in the past years though, they are entirely focused on getting a US shareholder based. This is problematic though since generally speaking the US market doesn’t understand the UK healthcare system and there is currency risk.
Some things to look out for:
Board compensation has doubled since 2007 from $350,000 to $870,000. It is the equivalent of 10% of the TTM net income of the company, quite substantial. Additionally, while I do not know if they officially constitute a “poison pill,” there have been “shareholder rights” amendments to the bylaws that make it harder for the shares to be acquired. Management’s stated intent was to make sure that a buyer didn’t steal to company on the cheap. Judging from the Nestor acquisition valuation, and the deep pocketed investor behind it, there is ample interest in the sector and respectful premiums being offered. Despite this reducing the possibility of a buyout as a near term catalyst, the substantially higher valuation indicates the private market value of the firm.
Disclosure: Long AHCI
Talk to Andrew about Allied Healthcare International
Business Overview:
Allied Healthcare is a provider of domestic healthcare staffing. They get contracted to provide the staff for home visits to elderly and special needs individuals to assist them with basic living functions such as bathing and dressing through 115 branches around the UK. The company operations are mostly decentralized with branch managers tasked with meeting targets for operations. The contracts through which services are provided are negotiated on 3-5 year basis with local government social services. The government comprises 80% of the company’s revenue with private work making up the remainder. Government revenue is much more fragmented than first glance, as it is comprised of many contracts at the local level with local governments. The company derives its revenue entirely from the UK and Ireland.
Business Risk
The company derives the bulk of its revenue as a result of government spending on healthcare. Like the United States, the UK is looking to cut back healthcare spending. This is a combination of rising healthcare costs and UK government deficits. The healthcare rules, like the US, are constantly changing. The risk to Allied Healthcare is minimal. The service it provides is itself a cheap alternative to other forms of healthcare that would be picked up by the state. Their homecare services reduce the need for full time residential housing of elderly, which is more expensive. There are also the increasing trends of outsourcing the work to private firms as well as aging demographics. The most recent quarter saw pressure on earnings as a result of these changes, but the long term outlook is favorable considering the low cost option that homecare offers.
Valuation:
There are 43,923 fully diluted shares outstanding and a current market price of $2.40 per share for a market capitalization of $105m. There is net cash of $35m on the balance sheet. The enterprise value is $70m. The company has earning $8.8m in the past twelve months. The company trades at 8x earnings net of cash and 5x EV/EBITDA.
The company disposed of its last non-homecare business at the end of 2007, paying off all its debt and positioning the company on its current path. The periods of 2008, 2009, and 2010 saw earnings of $8.7m, $9.9m, and $9.8m respectively, averaging $9.5m. The numbers lie when it comes to the telling potential investors about the growing earnings of the company. The GBP:USD exchange rate fell from an annual average of 1.85 to 1.54 over this period. In GBP, revenue has been steadily growing. When translated into USD, the revenue looks very volatile, although that is the exchange rate, not the underlying business.
Acromas, a company looking to consolidate the homecare industry through its Saga subsidiary, recently acquired Nestor Healthcare Group, a competitor of Allied Healthcare, for £124m or £136m including debt. Nestor generates more than two thirds of its revenue from social care of patients in their home and about a third from primary care of patients. Three private equity groups own Acromas: CVC Capital Partners, Charterhouse and Permira. Below is a table comparing the valuation of the buyout based on annualizing the first six months of Nestor’s results in 2010. The initial offer was made in August 2010. The deal closed in January 2011 offering an optimal comparison for Allied.
Nestor Healthcare* AHCI Implied AHCI Share Price Upside
Price/Sales 0.8 0.4 $4.54 89%
EV/EBITDA 11.5 5 $4.32 80%
EBITDA 10.5 8 $3.22 34%
P/E 16 12 $3.20 33%
EV/E 18 8 $4.40 83%
Upside/Downside
The downside would be management spending the $35m cash balance on an acquisition. Done at a valuation similar to Nestor, an acquisition at 16x earnings would add $2.2m to net income. Using the current cash adjusted market multiple, the company would be worth $2.00, a downside of 16%.
A buyout scenario is addressed above, with upsides ranging from 30-90%.
Even if the company is not bought out, it trades at an absolute low valuation. The cash on hand could be put to good use in a buyback and management currently has $5m more on its current buyback. It would be nice to see management focusing on further decreasing the share count.
There would be more upside if the company listed on the UK exchange as well and moved entirely out of the US. They delisted from the AIM in London due to lack of investor interest. If you look at the conference where management has presented in the past years though, they are entirely focused on getting a US shareholder based. This is problematic though since generally speaking the US market doesn’t understand the UK healthcare system and there is currency risk.
Some things to look out for:
Board compensation has doubled since 2007 from $350,000 to $870,000. It is the equivalent of 10% of the TTM net income of the company, quite substantial. Additionally, while I do not know if they officially constitute a “poison pill,” there have been “shareholder rights” amendments to the bylaws that make it harder for the shares to be acquired. Management’s stated intent was to make sure that a buyer didn’t steal to company on the cheap. Judging from the Nestor acquisition valuation, and the deep pocketed investor behind it, there is ample interest in the sector and respectful premiums being offered. Despite this reducing the possibility of a buyout as a near term catalyst, the substantially higher valuation indicates the private market value of the firm.
Disclosure: Long AHCI
Talk to Andrew about Allied Healthcare International
Wednesday, February 23, 2011
PMC Trust and agitation for change
A reader recently informed me of REIT Redux's FixPMC initiative which is related to my recent write up of PMC Commercial Trust. Their rumblings for change date back to 2009. They have remained muted in the recent months. Their plan essentially boils down to calls for PMC to either sell itself or liquidate. At current market prices, the company is selling for a lot less than what I suspect either of those ultimate values will be.
It is always difficult to invest in a situation where management is so intent on ignoring their shareholder's. One of the problems is that there are some family members on the board. 3.3% owner Martha Greenberg is the sister of former CEO and 2% owner Lance Rosemore. Neither play an active role in the company anymore, but collect decent income from ownership as well as their duties as directors. Martha never played a role and is a doctor, a completely irrelevant background for the responsibilities of a board member. This isn't exactly foul play, because they do have an ownership stake in the company and are as deserving of representation as anyone else. Lance can argue he is an owner and has a lot of familiarity with the company. Martha's presence on the board though is definitely obnoxious and irresposible.
In the past 6 months or so since I've put more effort into my investing and casting a wider net in my research on companies, I've really been shocked at the total farce and racket that is corporate directorship. Yes, you hear and read it about it plenty, but without looking at specific examples, its difficult to really understand just how abusive a lot of these arrangements are.
The Fix PMC initiative is simultaneously a drag on the stock and a possible catalyst. It is a drag because their attempts at change ultimately failed. It is a possible catalyst though if they renew their efforts for change in the company.
The initiative points out these problems with PMC:
- Increasing overhead as a percentage of revenue
- A broken business model
- Shrinking loan portfolio over the years
- Deteriorating competitive position
Overall I agree with Reit Redux that the company has seen better days and should be engaged in some type of value unlocking action. At the same time, I'd question the intellectual honesty of the presentation. Such instances, in my opinion, are bothersome because they undermine what is a good idea by taking it in the wrong direction. At the same time, it is necessary to go to an extreme to convince people of things.
In reference to criticizing the compeitive position, RR says:
Competitive conditions are deteriorating – CIT recently announced an effort to put $500 million to work in the SBA loan business and will waive 7(a) application fees in order to get this volume done. On a sidenote, CIT has had a small cap REIT ($150 million in market cap or about double PCC’s current market cap) specializing in the healthcare finance for a number of years. After their strategic alternatives process, Care Investment Trust’s board announced “our board of directors’ belief that the liquidating distributions that we will make … would likely result in a greater return on investment to our stockholders relative to other strategic alternatives.”
PMC focuses almost exclusively on budget motels, so I do not know if the competition is really heating up. Also, the healthcare sector has an easier time finding willing lenders because it has more consistent revenues than a motel would. There is more competition in healthcare finance overall. The CIT effort to put $500m to work in SBA 7a loans is also misleading, because in 2010, $12.6bn in SBA 7a program loans were made. The CIT statistic is a lot less damning in this context and seems to only provide a loose tie in for the liquidation of a small cap REIT, which is the path the activists would like PMC to follow.
Increasing overhead as a percentage of revenue is something to remain cautious of, but to always keep in context. Revenues are down a lot over the past several years due to decreasing interest spreads. While it would be ideal for the cost structure to be 100% variable, that is not the case. Due to the effect of interest rates, it also means that overhead isn't always reflective of productivity. At the same time, the decreasing size of the loan portfolio indicates that there is less demand for their services, so fewer loan officers and employees would be a reasonable expectation.
The shrinking loan portfolio, and lack of new loans being written, is not an automatically disturbing trend. The motel industry is not going gangbusters with the economy in its current state, and now the increasing price of oil, which will affect travel. In one respect this is comforting because the portfolio is seasoned. It has an established payment history and borrowers have an increasing amount of equity. From what I understand, this makes selling the loans easier, which would bode well for the company going into liquidation or runoff. I question the headline risk in such a strategy though, because financiers looking to break up a company and put people out of work and decrease lending is a difficult sell.
The most recent filings show very little new business being written, which should really become apparent as the boost from the SBA 7a program disappears. I certainly don't expect the motel industry to rebound and grow again within the next year. This should really begin to weigh on the company. It is possible that Reit Redux will reemerge in its attempts to bring change at PMC. With few new loans being written, cash should start to build on the balance sheet as old loans are repaid. I think the company is cheap even barring this catalyst, so I remain comfortable owning it, but Reit Redux might be able to unlock the value at a faster rate.
Disclosure: Long PCC
Monday, February 21, 2011
More meta on investing
I realize that I haven't discussed specific companies lately, but focused more on how/what/when/where/why to look for them. This is more of the same, but hopefully it will be useful. I don't fancy myself as much of a link aggregator, despite regarding my reading selection as highly a Williamsburg hipster does their "indie bands you never heard of" selection. I've collected a couple different links/resources that one might find useful not for analyzing companies, but uncovering resources that will help you to invest.
One thing I've become a big fan of lately is adding things to my RSS reader (I use Google, I'm sure there are better more "techy" ones out there, its all the same). You can add SEC filings by company, filing type, etc. This is a huge time saver because you don't have to check for anything that is not there. I've done it with all of my holdings. You will get a by the minute update of filings. Maybe I'm just an old fart who hasn't fully embraced web 2.0, but hopefully this is of some help to people. I recently found this through Special Situations Monitor. It doesn't look fancy, but a link under the "Links" section on his page has this. It searches the SEC for any 10-12b filing, which is the documents for spinoffs. It's nothing revolutionary, but adding this to your RSS can help you originate your own stock ideas as quickly as anyone else interested in the field.
On SSM, there is also this link which is a search for a Bloomberg writer who writes about bankruptcy issues. For the layman, such as myself, scouring bankruptcy filings is neither fun nor entirely comprehensible. While this may be an indicator to stay away, it can let you know when companies are edging closer to listing a post reorg equity where you comprehension will increase exponentially. Other than huge fans of the blog, Warren Buffett and Seth Klarman, I suspect most readers don't have the resources to invest in distressed debt. It's all interesting to follow nevertheless. I'd also give SSM a ringing endorsement, as the author uses the above resources and usually has quite quick posts on many spin offs among other special situations.
Valued Uncovered had a recent post about his journey through the Pink Sheets. It is along the lines of what I have written above. It doesn't offer any specific investing ideas, but it does set up a blueprint through which one can find attractive investments. It requires a lot more legwork, which may seem daunting. It was well worth his time to go through this effort. Some of the rewards included this:
Happy hunting.
Talk to Andrew about other great investing resources/tools
One thing I've become a big fan of lately is adding things to my RSS reader (I use Google, I'm sure there are better more "techy" ones out there, its all the same). You can add SEC filings by company, filing type, etc. This is a huge time saver because you don't have to check for anything that is not there. I've done it with all of my holdings. You will get a by the minute update of filings. Maybe I'm just an old fart who hasn't fully embraced web 2.0, but hopefully this is of some help to people. I recently found this through Special Situations Monitor. It doesn't look fancy, but a link under the "Links" section on his page has this. It searches the SEC for any 10-12b filing, which is the documents for spinoffs. It's nothing revolutionary, but adding this to your RSS can help you originate your own stock ideas as quickly as anyone else interested in the field.
On SSM, there is also this link which is a search for a Bloomberg writer who writes about bankruptcy issues. For the layman, such as myself, scouring bankruptcy filings is neither fun nor entirely comprehensible. While this may be an indicator to stay away, it can let you know when companies are edging closer to listing a post reorg equity where you comprehension will increase exponentially. Other than huge fans of the blog, Warren Buffett and Seth Klarman, I suspect most readers don't have the resources to invest in distressed debt. It's all interesting to follow nevertheless. I'd also give SSM a ringing endorsement, as the author uses the above resources and usually has quite quick posts on many spin offs among other special situations.
Valued Uncovered had a recent post about his journey through the Pink Sheets. It is along the lines of what I have written above. It doesn't offer any specific investing ideas, but it does set up a blueprint through which one can find attractive investments. It requires a lot more legwork, which may seem daunting. It was well worth his time to go through this effort. Some of the rewards included this:
- A business with 50 years of history trading at 1.5x EV/EBIT & less than working capital
- A sub $50m stock that grew revenues through 2008/2009 with an average FCF yield of 27%
- A $300m in sales company selling for 0.65x book value, with positive net income for 9 out of 10 years
Happy hunting.
Talk to Andrew about other great investing resources/tools
Friday, February 18, 2011
Looking for investment opportunities related to natural gas
While macro calls are only somewhat relevant in stock picking, it is worth considering macro factors. Natural gas has been a topic I've explored on the blog before. From a macro perspective, natural gas is going to play a role in the energy infrastructure of the company for a long time. At this point in time, it looks like it will be playing an increasing role. I don't think this is an outlandish statement - although maybe I need to be put in my place.
The difficult part of translating the future role of natural gas into investing insight is the price of natural gas. This will dictate returns on capital for drillers, its relative attractiveness, and the time line for its adoption for broader economic usage. At this point in time it appears to be winning both the real and nominal pricing relative to oil, but acting on such a conclusion would be ill advised. Science is increasingly reaching the point where solar, wind, thermal, wave, etc will become competitive.
One kicker an investment can have is the option to benefit from the "natural gassification" of the economy. The investment would have to be cheap from a valuation standpoint and be capable of generating an attractive return independent of natural gas becoming anything than it already is. To an extent, the recent write up of Pulse Data on Above Average Odds Investing fits this category.
One sector I would not look to would be drillers themselves. The shale plays are supposedly tremendous in potential, but according to Ken Peak, they will be short on investment returns. This is from an interview he did a year ago, almost to the day, with Fool.com. When asked about the company's disposal of shale assets, he responded:
As I was saying with asset management companies, the ultimate variable will come down to price. I do think that there can be a lot of embedded upside in a company that can continue to thrive in the status quo, but would just explode if natural gas makes its way into transportation fuels, a greater electricity generating role to balance out the fluctuations in solar/wind generation, or whatever else people come up with. Such investments are definitely out there, and because natural gas is so low currently and the market isn't focused on what will happen in 5-10 years, there are probably some stocks with a good margin of safety.
Talk to Andrew about investment opportunities related to natural gas
The difficult part of translating the future role of natural gas into investing insight is the price of natural gas. This will dictate returns on capital for drillers, its relative attractiveness, and the time line for its adoption for broader economic usage. At this point in time it appears to be winning both the real and nominal pricing relative to oil, but acting on such a conclusion would be ill advised. Science is increasingly reaching the point where solar, wind, thermal, wave, etc will become competitive.
One kicker an investment can have is the option to benefit from the "natural gassification" of the economy. The investment would have to be cheap from a valuation standpoint and be capable of generating an attractive return independent of natural gas becoming anything than it already is. To an extent, the recent write up of Pulse Data on Above Average Odds Investing fits this category.
One sector I would not look to would be drillers themselves. The shale plays are supposedly tremendous in potential, but according to Ken Peak, they will be short on investment returns. This is from an interview he did a year ago, almost to the day, with Fool.com. When asked about the company's disposal of shale assets, he responded:
The growth in natural gas shale reserves is the best thing that has happened to America in terms of energy independence in my 37-year career. The challenges with shale plays -- from Contango's perspective -- are: the large negative cumulative capital required for 3-5 years, (upfront acreage costs and dozens and dozens of wells before cumulative capital switches from being negative to being positive) in combination with 60-80% decline curves (the "Red Queen" syndrome), and the sheer manpower intensity -- hundreds of wells are required. The analogy of "manufacturing reserves" is often made to shale plays, and in truth there are some legitimate similarities, but it was never a desire of mine to be in the manufacturing business. I'll take the excitement and the disappointment of drilling high risk, high return wildcat exploration wells. In a football analogy it's like 3 yards and a cloud of dust vs. the West Coast offense -- both can be successful.Contango Oil & Gas is hell bent on being a low cost producer, because Peak realizes (and he has stated directly in the past) that in order to be a successful commodity producer, one must be the lowest cost. While high risk, high return wildcat exploration wells don't exactly make eager to be a shareholder in Contango, the high capital intensity of shale gas drilling makes it an equally unattractive environment to go searching for stocks. Yes, there can be special situations that offer value, but I've said before that I possess no real edge when it comes to analyzing energy stocks strictly speaking. The only exception being special situations with a lot of forced sellers, or hidden assets, or a non sector specific factor that makes it attractive.
As I was saying with asset management companies, the ultimate variable will come down to price. I do think that there can be a lot of embedded upside in a company that can continue to thrive in the status quo, but would just explode if natural gas makes its way into transportation fuels, a greater electricity generating role to balance out the fluctuations in solar/wind generation, or whatever else people come up with. Such investments are definitely out there, and because natural gas is so low currently and the market isn't focused on what will happen in 5-10 years, there are probably some stocks with a good margin of safety.
Talk to Andrew about investment opportunities related to natural gas
Thursday, February 17, 2011
Great stuff from Tim McElvaine
I found this talk through Simoleon Sense, whose Sunday linkfest is definitely one of the betters ones out there. I wrote about Tim McElvaine as an investor I admired a while back and his ABBA investment process. If you are just looking for his stock picks, you can just look at the pdf of his presentation. I don't recommend that. The only other video I've recommended on this site is by Alice Schroeder on how exactly Buffett invests. This talk is worth your time as well. He is down to earth and starts off by talking about his mistakes, generally the mark of an intellectually honest and humble guy. You can just copy the top picks of a lot of successful managers, but if you want to do everything on your own, its important to look at other people's processes and pick and choose what works for them and what you can incorporate into your process. His ABBA process is really golden both for its simplicity and thoroughness.
Aspiring investment analysts, starting around 39:30, he shares his advice for getting a job. This isn't just armchair wisdom advice, because it is how he got his job with Peter Cundill. Just on this topic, here is a real old article written by Whitney Tilson on getting a money management job that is along the same lines of what McElvaine says.
Aspiring to running a hedge fund? At 59:30 he shares some of the nitty gritty of getting things up and running. It's a lot less glamorous than you think. As with investing, patience is key to running a money management business.
The Q&A overall is actually really good. There are some oil and gold questions as I would expect, but on the whole there is a good interaction. He spends almost an hour answering questions, and only 30 on his presentation.
Aspiring investment analysts, starting around 39:30, he shares his advice for getting a job. This isn't just armchair wisdom advice, because it is how he got his job with Peter Cundill. Just on this topic, here is a real old article written by Whitney Tilson on getting a money management job that is along the same lines of what McElvaine says.
Aspiring to running a hedge fund? At 59:30 he shares some of the nitty gritty of getting things up and running. It's a lot less glamorous than you think. As with investing, patience is key to running a money management business.
The Q&A overall is actually really good. There are some oil and gold questions as I would expect, but on the whole there is a good interaction. He spends almost an hour answering questions, and only 30 on his presentation.
What are the risks of investing in asset managers?
The first post I wrote was on a tiny asset manager named Hennessy Advisors. I think asset management is one of the more attractive business models out there. The business is scalable, has high barriers to entry, recurring revenue, and throws of free cash flow. Nothing is without its risks those. I originally found out about Hennessy from a Zeke Ashton's 2007 presentation at the Value Investors Conference. While it turned out to be a bad call at the time, I still like what he has to say. He has been bullish on equity asset managers for a while now, and this article in Kiplinger's discusses two of his picks: Artio Global Investors and Calamos Asset Manager. While I haven't yet delved into the companies, my previous experience with Hennessy has me thinking about the risks in investing in asset managers. I'm going to just talk about asset managers in general, and one of the underlying assumptions below is that their results are correlated with the overall market.
Asset management is inherently leveraged to the stock market. The two ways a company gets more assets under management (AUM) are by increasing the value of the assets they are already managing or attracting more assets to manage. The beauty of this is that in good times, the funds go up AND more people pour money into these funds. In the bad times though, the funds go down in value AND more people pull money out of these funds. Redemption of these funds can force managers to sell assets, further driving down the value of their holdings. At the same time, the tail end scenarios are truncated because the stock market can't (hopefully) go to zero and it can't go to the sky. Assuming an asset management company has no debts, its cost structure is pretty flexible. I am exaggerating only slightly when I say an asset manager is just a building with people in it.
Just because the stock is good for investors does not mean the business is good for the customers, which can be dangerous to own. At the same time, I can't really conceive of a better system, because while I don't trust a mutual fund manager to invest on my behalf, I don't think Uncle Steve is doing himself any favors by picking stocks. The problem is that on the whole, mutual funds aren't doing Uncle Steve a favor either. The historical performance of mutual funds is pretty shabby, and it would be more beneficial to own a market index ETF. That isn't to say there aren't good fund managers out there, and asset management companies that have strong records of performance (The Sequoia Fund reopened to new investors in 2008 and they have just under $4b in it, but this represents fractions of a basis point in the trillions invested in funds) . While this is essentially a benefit, because I can't see this happening, a human's inherent optimism prevents them from investing in a less sexy ETF, so there are few threats from alternative investment vehicles.
I think the risk boiled down to one thing is the dual effect (I just made one thing into two, financial alchemists look on in awe) of a falling market and outflows from funds. One could argue at this point, AUM for the industry are at a low point from an inflow/outflow perspective adjusting for the changes in market value due to the reluctance of retail investors to jump into the market (this might just be a CNBC meme I've picked up, but the asset managers I've looked at seem have slowing rates of net outflows, or are getting slight net inflows from the 2008-10 period). While the general market sentiment is hard to factor for when analyzing a company, one can just plug in a bunch of scenarios of degrees of bear markets to look at their downside scenario excluding outflows. Human psychology is usually something not to consider when making an investment, unless you are taking advantage of the manic episodes of Mr. Market. I think it would be easy to convince oneself that they have a solid model of the company, but get walloped on the investor psychology aspect.
One incredibly arbitrary way of looking at the downside scenario of investing in an asset manager would be to say every 1% decline in the market results in a .5% increase in outflows. So when the market is down $1, people also withdraw $.50 from the fund. This is incredibly arbitrary though, but I don't know if historical data in this case would be effective. The events driving market action are unique to the time. While there are similar things occurring that drive the market higher and lower, economic realities always differ. Comparing the current US economic position to Japan in the early 90s is not an awful comparison, but there are differences. The same would apply for the stock market in general and the different causes behind the movements.
Another risk is the volatility of the market. A mutual fund can start and end the year at $1000 but spend most of the year at $600 due to uncertainty in X. An asset manager is exposed to this because they are paid on average AUM. They can't do anything about the market movement in general. While a manager's alpha will incrementally improve results and take advantage of alpha, the volatility will still affect the calculation of average assets under management. I do not know if this is standard practice, but Hennessy earns revenue based on average assets under management.
Another risk is 12-1b fees, which allow mutual funds to pass on marketing costs to customers without actually telling them. This is pretty sleazy. A mutual fund investor is basically paying to be advertised to. This is coming under increasing scrutiny from lawmakers, so any asset manager I look at would have to be capable of surviving the hit. Somewhat cynically, there could be upside from this angle because of the increasingly successful endeavors of corporations to influence lawmakers. This ties into my above comment about many mutual funds not providing a net benefit to their investors. Implicit, I hold the belief that I can outperform the market and mutual funds. While I think the product is crappy, the general population, judging from AUM, does not think so. Even if they do believe the product is crappy, they really have little alternative. Aunt Millie will not be picking stocks any time soon.
As with any investment, fundamental value is going to be the driver of investment decisions. I definitely think that asset managers are attractive as a business, despite the risk. One thing that I find curious about Buffett commentators harping about "X Company: Why Buffett Would Love This Company and You Should Too!" that they never talk about the business he is in. He tends to call himself a "capital allocator," but that is just another term for asset manager. As one person, he has proven adept at managing his initial hundreds of thousands to now many many billions, showing just how scalable and high return the business can be. Instead of sourcing funds from retail investors, he does it through insurance float and free cash flow from subsidiaries, but there are many fundamental similarities.
I don't think this post has been too rambling, but it could have been put a lot more succinctly. Only buy things with a margin of safety. Zeke Ashton believes that he is getting a good margin of safety in asset managers. My interest is piqued in his choices, because as I've written above, the risks seem manageable and obvious.
Talk to Andrew about asset management companies and what he might be missing
Asset management is inherently leveraged to the stock market. The two ways a company gets more assets under management (AUM) are by increasing the value of the assets they are already managing or attracting more assets to manage. The beauty of this is that in good times, the funds go up AND more people pour money into these funds. In the bad times though, the funds go down in value AND more people pull money out of these funds. Redemption of these funds can force managers to sell assets, further driving down the value of their holdings. At the same time, the tail end scenarios are truncated because the stock market can't (hopefully) go to zero and it can't go to the sky. Assuming an asset management company has no debts, its cost structure is pretty flexible. I am exaggerating only slightly when I say an asset manager is just a building with people in it.
Just because the stock is good for investors does not mean the business is good for the customers, which can be dangerous to own. At the same time, I can't really conceive of a better system, because while I don't trust a mutual fund manager to invest on my behalf, I don't think Uncle Steve is doing himself any favors by picking stocks. The problem is that on the whole, mutual funds aren't doing Uncle Steve a favor either. The historical performance of mutual funds is pretty shabby, and it would be more beneficial to own a market index ETF. That isn't to say there aren't good fund managers out there, and asset management companies that have strong records of performance (The Sequoia Fund reopened to new investors in 2008 and they have just under $4b in it, but this represents fractions of a basis point in the trillions invested in funds) . While this is essentially a benefit, because I can't see this happening, a human's inherent optimism prevents them from investing in a less sexy ETF, so there are few threats from alternative investment vehicles.
I think the risk boiled down to one thing is the dual effect (I just made one thing into two, financial alchemists look on in awe) of a falling market and outflows from funds. One could argue at this point, AUM for the industry are at a low point from an inflow/outflow perspective adjusting for the changes in market value due to the reluctance of retail investors to jump into the market (this might just be a CNBC meme I've picked up, but the asset managers I've looked at seem have slowing rates of net outflows, or are getting slight net inflows from the 2008-10 period). While the general market sentiment is hard to factor for when analyzing a company, one can just plug in a bunch of scenarios of degrees of bear markets to look at their downside scenario excluding outflows. Human psychology is usually something not to consider when making an investment, unless you are taking advantage of the manic episodes of Mr. Market. I think it would be easy to convince oneself that they have a solid model of the company, but get walloped on the investor psychology aspect.
One incredibly arbitrary way of looking at the downside scenario of investing in an asset manager would be to say every 1% decline in the market results in a .5% increase in outflows. So when the market is down $1, people also withdraw $.50 from the fund. This is incredibly arbitrary though, but I don't know if historical data in this case would be effective. The events driving market action are unique to the time. While there are similar things occurring that drive the market higher and lower, economic realities always differ. Comparing the current US economic position to Japan in the early 90s is not an awful comparison, but there are differences. The same would apply for the stock market in general and the different causes behind the movements.
Another risk is the volatility of the market. A mutual fund can start and end the year at $1000 but spend most of the year at $600 due to uncertainty in X. An asset manager is exposed to this because they are paid on average AUM. They can't do anything about the market movement in general. While a manager's alpha will incrementally improve results and take advantage of alpha, the volatility will still affect the calculation of average assets under management. I do not know if this is standard practice, but Hennessy earns revenue based on average assets under management.
Another risk is 12-1b fees, which allow mutual funds to pass on marketing costs to customers without actually telling them. This is pretty sleazy. A mutual fund investor is basically paying to be advertised to. This is coming under increasing scrutiny from lawmakers, so any asset manager I look at would have to be capable of surviving the hit. Somewhat cynically, there could be upside from this angle because of the increasingly successful endeavors of corporations to influence lawmakers. This ties into my above comment about many mutual funds not providing a net benefit to their investors. Implicit, I hold the belief that I can outperform the market and mutual funds. While I think the product is crappy, the general population, judging from AUM, does not think so. Even if they do believe the product is crappy, they really have little alternative. Aunt Millie will not be picking stocks any time soon.
As with any investment, fundamental value is going to be the driver of investment decisions. I definitely think that asset managers are attractive as a business, despite the risk. One thing that I find curious about Buffett commentators harping about "X Company: Why Buffett Would Love This Company and You Should Too!" that they never talk about the business he is in. He tends to call himself a "capital allocator," but that is just another term for asset manager. As one person, he has proven adept at managing his initial hundreds of thousands to now many many billions, showing just how scalable and high return the business can be. Instead of sourcing funds from retail investors, he does it through insurance float and free cash flow from subsidiaries, but there are many fundamental similarities.
I don't think this post has been too rambling, but it could have been put a lot more succinctly. Only buy things with a margin of safety. Zeke Ashton believes that he is getting a good margin of safety in asset managers. My interest is piqued in his choices, because as I've written above, the risks seem manageable and obvious.
Talk to Andrew about asset management companies and what he might be missing
Wednesday, February 16, 2011
What to look at when looking at companies for reasons to look out
This past summer, I decided to up my investing game by reading some accounting books. I had a good handle on the basics, but the kind of knowledge to really cut right to the bone of a filing was lacking. Accounting really should count as a foreign language in school. I was actually quite surprised when I opened up Thornton O'glove's Quality of Earnings. My impression that it would be a painful, but necessary experience. I don't know if I would call it a beginner level book, but anyone with some SEC file reading experience would not find it cryptic. I haven't read any accounting textbooks, but I found this book approachable and worth my time.
The first chapter of the book is one of the best short descriptions of the pitfalls of the Wall Street analyst community. Reading it, the phrase plus ça change, plus c'est la même chose kept going through my head, because this was written in the 80s and really, the more something changes, the more it is the same thing.* All the same conflicts of interest and bullish biases existed then as they do now. I realize that this isn't anything novel, but evidence of it solidifies what was previously just a strong intuition that Wall Street is any better/worse than it ever was. There's also a story about a 24 year old analyst named Jim Chanos making a controversial short call on Baldwin-United, which induced a "its a small world after all" chuckle out of me. Obviously he has stuck to his knitting all these years and called Enron and was one of the first to start calling China out of being on a "treadmill to hell."
One of the types of analysis O'glove highlights is looking at what the balance sheet indicates about the quality of earnings. When a company's accounts receivables are growing faster than sales, that can be foreshadow problems to come. He looks at the increases in percentage terms, so that everything is proportionate. The same can also be said for inventory. If sales seem to be growing at a slower pace than inventory, that can indicate that a company will have to markdown the inventory and its earnings will be lower than indicated. It is important to look at the raw material/finished products components of inventory gain insight into disproportionate changes in inventory. A large increase in finished products inventory can indicate that new products aren't selling. These are by no means rules, and O'glove provides plenty of examples to show how to understand the nuances of what he is talking about. I definitely found that it upped my investing game with a bunch of small stuff to make my analysis of a company better. I will highlight some more stuff from the book in the future, and highly recommend adding it to your investing library.
While these are the bread and butter of accounting analysis, Bronte Capital has been doing some neat things to note when analyzing (Chinese) companies. While the intention of his posts is to highlight a Chinese fraud that he is shorting, there are lessons worth learning in the process he conducts in his analysis. In this post, Hempton, the author, breaks down the company's employees and assets to establish that its stated productivity levels are not achievable.
While in this case it is evidence of a fraud, one could use this approach to compare companies operating in the same industry. I often see companies talk about how they are such lean operators and devout followers of kaizen. Without factory visits or really good industry knowledge, it is hard for an individual investor to have direct knowledge if the company really walks the walk. This could be one way to check it. Sales volume/employees or sales volume/machinery and equipment would be one approach, although it would clearly have to be tailored to the type of business and would be aided by more transparent filings.
This post is equally interesting. Hempton looks at where the company says its facilities are, as well as their size. He finds a discrepancy between a quarterly report and the annual report stating the size of the lease of a facility. He also finds that the exact amount of square footage from one of the filings matches a leasing ad in a newspaper, indicating that the company does not use the facility at all. He also compares a contract that the company has compared to the overall stated production of the company, which appears minimal in the grand scheme. All of these conclusions are ones an individual could reach with an internet connection. The problem is knowing what you would be looking for, and in this respect the post is helpful. I find that my biggest problem in investing is trying to figure out where and how to find information that I believe is out there. I highly recommend checking out his posts to see how/what he does to analyze a company, the informational aspect of (Chinese) frauds, and the overall logic presented.
Talk to Andrew about using accounting to analyze companies
*This is irrelevant to the general gist of this blog, but the movie Network was made in 1976 and rails on the infotainment inclinations of a corporate media. Other than being one of the more spectacular products of the golden age of film making, it has the similar effect as reading Quality of Earnings for a greenhorn like me (there's also the irony of a studio produced film railing on corporate media, and the film did have some trouble finding backing initially). From a very broad perspective, market history and history in general are invaluable tools, because these two examples clearly demonstrate that so much that is "wrong" with society today, has always been wrong with society. Being keenly aware not only of this phenomenon, but how problems have presented themselves in the past equips one to identify them in the future. While it doesn't make it any easier to predict outcomes, it can certainly let you know when to back away from an idea. Even though you aren't reading this for movie recommendations, I now have it in my head to discuss some other market history that has parallels to current events.
The first chapter of the book is one of the best short descriptions of the pitfalls of the Wall Street analyst community. Reading it, the phrase plus ça change, plus c'est la même chose kept going through my head, because this was written in the 80s and really, the more something changes, the more it is the same thing.* All the same conflicts of interest and bullish biases existed then as they do now. I realize that this isn't anything novel, but evidence of it solidifies what was previously just a strong intuition that Wall Street is any better/worse than it ever was. There's also a story about a 24 year old analyst named Jim Chanos making a controversial short call on Baldwin-United, which induced a "its a small world after all" chuckle out of me. Obviously he has stuck to his knitting all these years and called Enron and was one of the first to start calling China out of being on a "treadmill to hell."
One of the types of analysis O'glove highlights is looking at what the balance sheet indicates about the quality of earnings. When a company's accounts receivables are growing faster than sales, that can be foreshadow problems to come. He looks at the increases in percentage terms, so that everything is proportionate. The same can also be said for inventory. If sales seem to be growing at a slower pace than inventory, that can indicate that a company will have to markdown the inventory and its earnings will be lower than indicated. It is important to look at the raw material/finished products components of inventory gain insight into disproportionate changes in inventory. A large increase in finished products inventory can indicate that new products aren't selling. These are by no means rules, and O'glove provides plenty of examples to show how to understand the nuances of what he is talking about. I definitely found that it upped my investing game with a bunch of small stuff to make my analysis of a company better. I will highlight some more stuff from the book in the future, and highly recommend adding it to your investing library.
While these are the bread and butter of accounting analysis, Bronte Capital has been doing some neat things to note when analyzing (Chinese) companies. While the intention of his posts is to highlight a Chinese fraud that he is shorting, there are lessons worth learning in the process he conducts in his analysis. In this post, Hempton, the author, breaks down the company's employees and assets to establish that its stated productivity levels are not achievable.
While in this case it is evidence of a fraud, one could use this approach to compare companies operating in the same industry. I often see companies talk about how they are such lean operators and devout followers of kaizen. Without factory visits or really good industry knowledge, it is hard for an individual investor to have direct knowledge if the company really walks the walk. This could be one way to check it. Sales volume/employees or sales volume/machinery and equipment would be one approach, although it would clearly have to be tailored to the type of business and would be aided by more transparent filings.
This post is equally interesting. Hempton looks at where the company says its facilities are, as well as their size. He finds a discrepancy between a quarterly report and the annual report stating the size of the lease of a facility. He also finds that the exact amount of square footage from one of the filings matches a leasing ad in a newspaper, indicating that the company does not use the facility at all. He also compares a contract that the company has compared to the overall stated production of the company, which appears minimal in the grand scheme. All of these conclusions are ones an individual could reach with an internet connection. The problem is knowing what you would be looking for, and in this respect the post is helpful. I find that my biggest problem in investing is trying to figure out where and how to find information that I believe is out there. I highly recommend checking out his posts to see how/what he does to analyze a company, the informational aspect of (Chinese) frauds, and the overall logic presented.
Talk to Andrew about using accounting to analyze companies
*This is irrelevant to the general gist of this blog, but the movie Network was made in 1976 and rails on the infotainment inclinations of a corporate media. Other than being one of the more spectacular products of the golden age of film making, it has the similar effect as reading Quality of Earnings for a greenhorn like me (there's also the irony of a studio produced film railing on corporate media, and the film did have some trouble finding backing initially). From a very broad perspective, market history and history in general are invaluable tools, because these two examples clearly demonstrate that so much that is "wrong" with society today, has always been wrong with society. Being keenly aware not only of this phenomenon, but how problems have presented themselves in the past equips one to identify them in the future. While it doesn't make it any easier to predict outcomes, it can certainly let you know when to back away from an idea. Even though you aren't reading this for movie recommendations, I now have it in my head to discuss some other market history that has parallels to current events.
Tuesday, February 15, 2011
Odds and Ends: Tech companies, post reorgs
Yesterday, I posted about investing in tech companies. Lo and behold I find some more stuff that ties into it today. The click whores over at Fortune have a piece on turnarounds. If you want to spare yourself to annoyance, the companies are Yahoo, Myspace, AOL, Nokia, and Digg. I don't want to relegate these guys to the trash heap, but they all are victims of change in the technology world. I don't think Myspace or Digg were ever fantastic businesses, but Yahoo, AOL, and Nokia all have had their moments in the limelight. While companies on the decline are not unique to the tech sector, the aforementioned companies have all fallen from the peaks quite quickly.
I've been doing a lot of digging around with post reorgs. They're all the rage these days. Dan Loeb has some interesting thoughts, especially on AbitibiBowater, in his most recent letter on post reorgs. One thing that has been part of the learning curve was locating financial information on the companies. Kurtz Carson Consultants has info on the court proceedings, but the financial disclosures are lacking. I did some digging and came across this older post on Distressed Debt Investing. The entire post is a pretty good primer on post reorg equities and why they offer value. I found my answer to the financial data part there as well:
Talk to Andrew about tech companies and post reorgs
I've been doing a lot of digging around with post reorgs. They're all the rage these days. Dan Loeb has some interesting thoughts, especially on AbitibiBowater, in his most recent letter on post reorgs. One thing that has been part of the learning curve was locating financial information on the companies. Kurtz Carson Consultants has info on the court proceedings, but the financial disclosures are lacking. I did some digging and came across this older post on Distressed Debt Investing. The entire post is a pretty good primer on post reorg equities and why they offer value. I found my answer to the financial data part there as well:
Gathering information on post-reorg equities might be challenging as well. During the bankruptcy process, companies generally don’t host conference calls, rarely make public appearances at the conferences and sometimes do not file 10Ks and 10Qs with the SEC. To understand the company’s post-emergence capital structure and newly issued securities, it is imperative for an analyst to read the Disclosure Statement filed with the bankruptcy court which includes financial projections, the company’s new capital structure as well as liquidation and valuation analyses. Analysts can also look at the company’s Monthly Operating Reports, also filed with the court, for more detailed monthly financial data. All these documents are available to the public from the electronic court filing system PACER (http://www.pacer.gov/) for a small fee. However, even though the information is accessible, most non-distressed investors tend to be unfamiliar with PACER and bankruptcy documents, thus often neglecting post-reorg equities altogether.And so the answer is PACER (Public Access to Court Electronic Records. It costs $.08 a page, capped at $2.40 per document. I suspect that this is one of the more worthy costs to stomach when it comes to investing considering the rewards that can be reaped with post reorg investing. I'm going to sit down and dig around PACER and figure out how to use it. The market dynamics of post reorgs are so compelling to nimble individual investors. The DDI article does a good job discussin the benefits. As always, Greenblatt's You Can Be A Stock Market Genius is the best book for this subject and a couple other good investing techniques.
Talk to Andrew about tech companies and post reorgs
Monday, February 14, 2011
American Greetings – A stock for Valentine’s Day....only cause they making greeting cards
American Greetings is a company that primarily produces gift cards and wrapping paper. This company currently trades at 11x earnings, and adjusting for certain charges in 2009, 06-10 averaged around $70m in net income, with a low of $38m. Profit peaked in 2003 at $120m. The company appears to be transforming somewhat though, making the past a less reliable indicator of future performance.
The company disposed of its retail operations in 2009 and took a huge charge against it. The stock dropped to the $3 range, although the company was generating enough cash to cover its costs. The share count has fallen from 66,000,000 in 2006 to 41,000,000 in the most recent quarter, so it appears that management acted shrewdly. They spent $250m on repurchases in 08 and 09. The dividend has grown over the past 5 years as well. Debt has decreased. A lot of factors seem to be going in the right direction for value creation.
The company is ~40% owned, but completely controlled through special voting shares by the Weiss family. The company seemed to take a good long-term perspective in buying back shares over the years. Their actions deserve closer scrutiny though as there are several family members in high-level positions.
The company has fairly concentrated sales. Walmart and Target account for 30% of sales, which is always something to monitor. From a personal perspective, large retailers would be the location that comes to mind to purchase a greeting card. Walgreens and CVS also chip in with a good chunk of sales. The only other major competition is Hallmark, which is privately held and family controlled.
From a reducto ad absurdum standpoint, putting cute words on some nice paper seems like a low barrier to entry business. I haven’t really done enough research yet, but it seems like there are really only 2 major players. I suspect economies of scale have something to do with it. It also helps the business is not very sexy.
I don’t view the company as overwhelmingly cheap, but there might be some value in its inexpensive multiple. I would like to find evidence that the company does deserve a higher multiple before I just assume multiple expansion will happen by virtue of me dictating it. The company has been returning cash to shareholders and increasing value over the years and the cash flow is fairly steady. I’d like to further investigate why the market perceived the company so poorly that the price dropped to $3 per share. Is the company less capital intensive now and can the company grow any larger? I will dig further this week.
Talk to Andrew about American Greetings
The company disposed of its retail operations in 2009 and took a huge charge against it. The stock dropped to the $3 range, although the company was generating enough cash to cover its costs. The share count has fallen from 66,000,000 in 2006 to 41,000,000 in the most recent quarter, so it appears that management acted shrewdly. They spent $250m on repurchases in 08 and 09. The dividend has grown over the past 5 years as well. Debt has decreased. A lot of factors seem to be going in the right direction for value creation.
The company is ~40% owned, but completely controlled through special voting shares by the Weiss family. The company seemed to take a good long-term perspective in buying back shares over the years. Their actions deserve closer scrutiny though as there are several family members in high-level positions.
The company has fairly concentrated sales. Walmart and Target account for 30% of sales, which is always something to monitor. From a personal perspective, large retailers would be the location that comes to mind to purchase a greeting card. Walgreens and CVS also chip in with a good chunk of sales. The only other major competition is Hallmark, which is privately held and family controlled.
From a reducto ad absurdum standpoint, putting cute words on some nice paper seems like a low barrier to entry business. I haven’t really done enough research yet, but it seems like there are really only 2 major players. I suspect economies of scale have something to do with it. It also helps the business is not very sexy.
I don’t view the company as overwhelmingly cheap, but there might be some value in its inexpensive multiple. I would like to find evidence that the company does deserve a higher multiple before I just assume multiple expansion will happen by virtue of me dictating it. The company has been returning cash to shareholders and increasing value over the years and the cash flow is fairly steady. I’d like to further investigate why the market perceived the company so poorly that the price dropped to $3 per share. Is the company less capital intensive now and can the company grow any larger? I will dig further this week.
Talk to Andrew about American Greetings
Investing in technology companies
One of the steadfast rules for investors is not to invest in technology companies. While one would do well to heed the words of Warren Buffett blindly on this front, there's plenty of evidence that investors can turn to to avoid getting burned. For every Apple at $7/share there are plenty of Palm's, and companies that can't fight the waves of disruptive innovation. A while back, the Sequoia Fund did an interview with Morningstar discussing a range of topics. The most interesting segment was their discussion on Google being a value investment (as an aside, reading the transcript instead of watching the 5 minute video takes a fraction of the time, a reason I hate watching informational videos). It is always intriguing to see when value investors dabble in technology investments.
As far as Sequoia goes, these guys are good. They've profitably invested in companies like TJMaxx, Fastenal, and Idexx. These are all really great businesses in every sense. The other company they highlight in the video, Perrigo, has all the hallmarks of a great business as well, although the market seems well aware if the stock is priced at 25x earnings. Sequoia's annual investor conferences are phenomenal lodes of wisdom filled nuggets. The most recent transcript can be found here. You can search for the rest of the transcripts through Google or you can just change the 2 numbers in the URL after transcript to the year (09, 08, 07, etc). They discuss in depth about a lot of the scuttlebutt they've done on managements and industries. While I mentioned OMI as a stock that could be an attractive long term investment, anything these guys mentions is a great stock to put on your watch list and follow. That they have invested in Google is interesting in respect to their historical record.
Part of Sequoia's reasoning for liking Google:
This brings me to this TechCrunch article from the weekend that was hating on Google titled "Search Still Sucks":
A la confirmation bias, picking out AltaVista from the search company trash heap as the sole path for Google to follow is misleading as far as investment implications go. It does highlight the inherent risks though in technology. It seems as entrenched as Microsoft is in operating systems, so clearly it won't topple overnight and would be capable of making fixes. This to a degree seems to form one of the key points of Sequoia's thesis. All of the inherent assumptions are complex and dependent on a deeper understanding of the technology than I believe I can comprehend (maybe I'm giving them too much credit though).
Research in Motion is an interesting "battleground" stock (I don't like that name, but I don't know how else to describe it) that demonstrates how leaders are certainly fallible. There's plenty of arguments out there for and against the survival of the company and its merits as an investment. Yet for every Palm to compare RIM to, there is the newly reinvigorated Motorola. I just don't know how you go out picking the winners and those who fade into obscurity. Google seems very far, at this point, from being in a situation that resembles RIM. To continue the dumb metaphor, I think an investor can only be caught in the crossfire.
I'm curious where Sequoia thinks it has an edge in this investment relative to others cover the sector (I'm not just referring the negartive sentiments of the TechCrunch article). While tech commentary is usually very narrative based, Wall Street commentary on the sector might be too quantitative to comprehend shifts except in hindsight. You have to constantly be exploring the latest innovations and comparing them back to the incumbent technology. It seems like a fool's errand, because this innovation can really come from anywhere (judging from my limited and far from in depth observations of tech companies). The hurdle to overcome is just needlessly complex compared to the wider field of investments one can explore. My feeling towards technology companies is that unless you know everything, you know nothing.
While this might not be the best example of why investors should shy away from technology investments, Google will be an interesting example to continuously examine as evidence of such. There is a sentiment that I am agnostic about, that the tech industry is maturing and there will now be entrenched players for many years to come. I don't know if I buy this, so I will not be buying any tech stocks any time soon.
Talk to Andrew about investing in tech companies
As far as Sequoia goes, these guys are good. They've profitably invested in companies like TJMaxx, Fastenal, and Idexx. These are all really great businesses in every sense. The other company they highlight in the video, Perrigo, has all the hallmarks of a great business as well, although the market seems well aware if the stock is priced at 25x earnings. Sequoia's annual investor conferences are phenomenal lodes of wisdom filled nuggets. The most recent transcript can be found here. You can search for the rest of the transcripts through Google or you can just change the 2 numbers in the URL after transcript to the year (09, 08, 07, etc). They discuss in depth about a lot of the scuttlebutt they've done on managements and industries. While I mentioned OMI as a stock that could be an attractive long term investment, anything these guys mentions is a great stock to put on your watch list and follow. That they have invested in Google is interesting in respect to their historical record.
Part of Sequoia's reasoning for liking Google:
The search engine is extremely powerful. I think it's got about 65% market share. Microsoft has invested several billion dollars in Bing and not really been able to move Google's market share, so it looks like a defensible position to us. And it just creates an enormous amount of value, both, I think for the user, as somebody who does a Google search probably 30 times a day, but also for the advertiser.I've kept this in the back of my head, because Google is interesting company that intersects with all our daily lives. It is definitely at the lower end of its historical valuation and I certainly understand where it holds the traits of a good potential investment. It is definitely a company with a major moat and anyone looking to topple it would have to be capable of pouring in an infinite amount of resources to do so and even then success is not guaranteed(or so the current thinking goes). Everyone seems to enjoy using their products, and the more users it has, the better the company's searches becomes.
This brings me to this TechCrunch article from the weekend that was hating on Google titled "Search Still Sucks":
Is there actual evidence of Google failing at search? Probably somewhere, but certainly not in the search share numbers. They maintain a healthy, almost monopolistic, lead in search despite huge efforts by Microsoft to compete. But then again, AltaVista had huge search share too, right before they suddenly didn’t any more.The author continues how Google searches are increasingly muddled with links that game the system using search engine optimization, which the NYT had an article on this weekend as well. The TechCrunch author is essentially noting some kinks in the armor, that may prove fatal if a competitor can properly exploit the opportunity to provide a better product. Microsoft (not in the above search engine context) is dominant in operating systems despite having a less than lovely product, which is essentially what the author is hinting at with Google. The Reformed Broker posted on Google and its search results too, with some additional links today.I use Google plenty, and I wouldn't use anything else considering this blog and my email are all on the same platform. I wonder though, if laymen that are not part of the technorati feel that the results they are receiving on Google aren't satisfactory. I don't necessarily know if that is the case, because even without blogger or gmail, I don't know if I would jump ship to bing or yahoo.
A la confirmation bias, picking out AltaVista from the search company trash heap as the sole path for Google to follow is misleading as far as investment implications go. It does highlight the inherent risks though in technology. It seems as entrenched as Microsoft is in operating systems, so clearly it won't topple overnight and would be capable of making fixes. This to a degree seems to form one of the key points of Sequoia's thesis. All of the inherent assumptions are complex and dependent on a deeper understanding of the technology than I believe I can comprehend (maybe I'm giving them too much credit though).
Research in Motion is an interesting "battleground" stock (I don't like that name, but I don't know how else to describe it) that demonstrates how leaders are certainly fallible. There's plenty of arguments out there for and against the survival of the company and its merits as an investment. Yet for every Palm to compare RIM to, there is the newly reinvigorated Motorola. I just don't know how you go out picking the winners and those who fade into obscurity. Google seems very far, at this point, from being in a situation that resembles RIM. To continue the dumb metaphor, I think an investor can only be caught in the crossfire.
I'm curious where Sequoia thinks it has an edge in this investment relative to others cover the sector (I'm not just referring the negartive sentiments of the TechCrunch article). While tech commentary is usually very narrative based, Wall Street commentary on the sector might be too quantitative to comprehend shifts except in hindsight. You have to constantly be exploring the latest innovations and comparing them back to the incumbent technology. It seems like a fool's errand, because this innovation can really come from anywhere (judging from my limited and far from in depth observations of tech companies). The hurdle to overcome is just needlessly complex compared to the wider field of investments one can explore. My feeling towards technology companies is that unless you know everything, you know nothing.
While this might not be the best example of why investors should shy away from technology investments, Google will be an interesting example to continuously examine as evidence of such. There is a sentiment that I am agnostic about, that the tech industry is maturing and there will now be entrenched players for many years to come. I don't know if I buy this, so I will not be buying any tech stocks any time soon.
Talk to Andrew about investing in tech companies
Friday, February 11, 2011
Seahawk Drilling, egg on my face
Well that was quick. The first frog to be kissed that turned out to be a frog and nothing more, possibly less. Seahawk is entering bankruptcy. Two weeks ago I commented how it was too hard to kill, and seemed like a good opportunity. Apparently it was all too easy. I do not understand the need for a bankruptcy process at this time or a $105m price (75% stock, 25% cash) for rigs that the CEO said " if we were to just start cutting them up, you could, over time, sell the drilling equipment of a rig to generate $6 to $8 million in income by doing that." Hercules is getting 20 rigs for $5.25m a piece. Even more shocking is that the CEO sold shares last week!
With a $35m DIP facility from DE Shaw and $124m in total liabilities compared to $105m from Hercules, it appears there will be nothing left for shareholders. Kudos to Hercules for getting a great deal and DE Shaw making a quick buck. The only possible upside exists in a better offer for the assets, but I won't be banking on that.
Looking back, it appears I took way too much away in a positive sense from the failed attempt at selling a rig. I thought the company really was turning the corner and had the assets to do so in a way that created shareholder value. It appears that the cash burn was just too great for the company to act in time. I failed to properly anticipate this problem and properly extrapolate out the financial situation of the company. I was too attached to the idea that they were debt free when I bought the company and that the revolver they had started to take money out on as of last filing was a signal that things were not dire because there were covenants on the revolver. Their last 10-Q was filed in November, and apparently things have only gotten worse. I should stop using the term too hard to kill unless it is with treasury bonds or things that are already dead. I have a bad taste in my mouth because the CEO got to sell his shares and it seems like this would be the kind of thing he would know about in advance. Mostly though, I'm disappointed in myself for losing money, possibly losing readers money, and for being dumb. As you can now see all too clearly, I make mistakes and you should question me and do your own research.
Tell Andrew how much of a moron he is
Edit - I think the fundamental error here was trying to predict how much money the company would lose. If trying to predict future earnings is a fool's game, predicting losses is about 10x harder. Frog's Kiss Fail.
With a $35m DIP facility from DE Shaw and $124m in total liabilities compared to $105m from Hercules, it appears there will be nothing left for shareholders. Kudos to Hercules for getting a great deal and DE Shaw making a quick buck. The only possible upside exists in a better offer for the assets, but I won't be banking on that.
Looking back, it appears I took way too much away in a positive sense from the failed attempt at selling a rig. I thought the company really was turning the corner and had the assets to do so in a way that created shareholder value. It appears that the cash burn was just too great for the company to act in time. I failed to properly anticipate this problem and properly extrapolate out the financial situation of the company. I was too attached to the idea that they were debt free when I bought the company and that the revolver they had started to take money out on as of last filing was a signal that things were not dire because there were covenants on the revolver. Their last 10-Q was filed in November, and apparently things have only gotten worse. I should stop using the term too hard to kill unless it is with treasury bonds or things that are already dead. I have a bad taste in my mouth because the CEO got to sell his shares and it seems like this would be the kind of thing he would know about in advance. Mostly though, I'm disappointed in myself for losing money, possibly losing readers money, and for being dumb. As you can now see all too clearly, I make mistakes and you should question me and do your own research.
Tell Andrew how much of a moron he is
Edit - I think the fundamental error here was trying to predict how much money the company would lose. If trying to predict future earnings is a fool's game, predicting losses is about 10x harder. Frog's Kiss Fail.
Ownes & Minor - a stock to watch
The general intent of this blog and my investing is to focus on smaller companies where an individual investor can gain an edge. As I always say though “size doesn’t matter, price does.” While I’ve discussed bigger companies, such as Loews, Owens & Minor is a company that is already recognized for its strong business judging by its valuation. Sporting a PE of 15.5, a dividend yield of 2.6% and trading at 2x book value, it is nothing to get excited about. It would be an exciting opportunity though if it were to encounter short-term business issues or the stock drops due to an earnings miss or broad sell off.
Owens & Minor is a distributor of medical care products – gloves, tubes, exam table paper, shoe covers. They operate on razor thin margins but have high inventory turnover. They sell products that hospitals need, and develop deep relationships with healthcare providers. They have a logistics business which helps their customers reduces inventory to operate in a leaner fashion. While this might seem counter intuitive for the company, it entrenches them as the provider for a lot of that inventory. The company is one seventh and one tenth the size of its competitors Cardinal Health and McKesson respectively, but has managed to carve out its own niche and boasts higher net and operating margins.
The company has been around for over 100 years, a reassuring sign. The past 5 years have seen double digit growth in sales and earnings, while the past 10 years have averaged high single digit growth in sales and earnings. For such a boring company, the results have definitely been noteworthy. The company has consistently increased its dividends, a small indicator that the company is shareholder friendly and not too capital hungry. Although the theme is well worn in the investing world, the demand for these products will only go up as healthcare use increases with an aging population. It is hard to imagine the very minimal cost items O&M sells coming under scrutiny for cost cuts, especially when it helps its customers maintain lows costs through its logistics business.
While it doesn’t appear to offer a good investment opportunity currently, one never knows when a good company like O&M will find itself on sale courtesy of Mr. Market, a dear friend to us all. While better bargains might emerge in such an occasion, it is always worthwhile to be aware of businesses that have consistently increased their earnings over time and through whatever the economy has in store. While there are better businesses out there, I think every investor should be familiar with what companies they can. When the market gets dicey, from a psychological standpoint it is much better to already have an idea of what companies you would buy at a cheaper price. It is also much better from a time standpoint because you don't have to hurry through research on top of having your mind clouded with recent events.
Talk to Andrew about stocks to watch
Owens & Minor is a distributor of medical care products – gloves, tubes, exam table paper, shoe covers. They operate on razor thin margins but have high inventory turnover. They sell products that hospitals need, and develop deep relationships with healthcare providers. They have a logistics business which helps their customers reduces inventory to operate in a leaner fashion. While this might seem counter intuitive for the company, it entrenches them as the provider for a lot of that inventory. The company is one seventh and one tenth the size of its competitors Cardinal Health and McKesson respectively, but has managed to carve out its own niche and boasts higher net and operating margins.
The company has been around for over 100 years, a reassuring sign. The past 5 years have seen double digit growth in sales and earnings, while the past 10 years have averaged high single digit growth in sales and earnings. For such a boring company, the results have definitely been noteworthy. The company has consistently increased its dividends, a small indicator that the company is shareholder friendly and not too capital hungry. Although the theme is well worn in the investing world, the demand for these products will only go up as healthcare use increases with an aging population. It is hard to imagine the very minimal cost items O&M sells coming under scrutiny for cost cuts, especially when it helps its customers maintain lows costs through its logistics business.
While it doesn’t appear to offer a good investment opportunity currently, one never knows when a good company like O&M will find itself on sale courtesy of Mr. Market, a dear friend to us all. While better bargains might emerge in such an occasion, it is always worthwhile to be aware of businesses that have consistently increased their earnings over time and through whatever the economy has in store. While there are better businesses out there, I think every investor should be familiar with what companies they can. When the market gets dicey, from a psychological standpoint it is much better to already have an idea of what companies you would buy at a cheaper price. It is also much better from a time standpoint because you don't have to hurry through research on top of having your mind clouded with recent events.
Talk to Andrew about stocks to watch
Wednesday, February 9, 2011
Interest Rates
First of all, interest rates and monetary policy are something I only have a general understanding of. Unless someone starts bringing up arcana on the subject, I can get a good handle on what someone is saying or make an honest effort. Interest rates play a role in two companies I have discussed previously: Bank of Internet and PMC Commercial Trust. While Wittgenstein's Proposition Seven of his Tractatus Logico-Philosophicus might apply to the following, I thought I would put some words on the page to clarify my thoughts and highlight an interesting blog post I saw.
While this blog is not intended to offer much in the way of macro commentary, it appears obvious to me that the only place for rates to go is up. While there are numerous factors that affect interest rates, when they remain low for long enough it creates many of the reason such as inflation or economic growth. Japan over the past two decades has proven an exception to this rule. I say rule, because such things are meant to be broken. According to this post from The Big Picture, it appears I am not alone in believing interest rates will rise. Interestingly enough though, people have thought they would rise eventually for the past 2 years:
The market has been expecting that rates would rise by the end of the year for quite some time now. It appears that the expected degree of the increase is now expected starting at the end of 2011 but starting a sustained march upwards in 2012. Timing is a bitch. As it applies to the aforementioned investments I've discussed, such timing is not an issue. Things would only get worrisome if a rate increase was the result of really rampant inflation starting to kick in a la hyperinflation.
From a general viewpoint, waiting on interest rates to rise for an extended period of time would really eat into return. In the case of PMC Commercial Trust, interest rates can remain low, but an investor will still receive a satisfactory return. As with Bank of Internet, while they benefit from the current ZIRP, the outsized profits they currently generate are compressing the time frame of their next phase of growth and increasing their normalized earnings as assets that generate income increase.
Talk to Andrew about interest rates
While this blog is not intended to offer much in the way of macro commentary, it appears obvious to me that the only place for rates to go is up. While there are numerous factors that affect interest rates, when they remain low for long enough it creates many of the reason such as inflation or economic growth. Japan over the past two decades has proven an exception to this rule. I say rule, because such things are meant to be broken. According to this post from The Big Picture, it appears I am not alone in believing interest rates will rise. Interestingly enough though, people have thought they would rise eventually for the past 2 years:
The market has been expecting that rates would rise by the end of the year for quite some time now. It appears that the expected degree of the increase is now expected starting at the end of 2011 but starting a sustained march upwards in 2012. Timing is a bitch. As it applies to the aforementioned investments I've discussed, such timing is not an issue. Things would only get worrisome if a rate increase was the result of really rampant inflation starting to kick in a la hyperinflation.From a general viewpoint, waiting on interest rates to rise for an extended period of time would really eat into return. In the case of PMC Commercial Trust, interest rates can remain low, but an investor will still receive a satisfactory return. As with Bank of Internet, while they benefit from the current ZIRP, the outsized profits they currently generate are compressing the time frame of their next phase of growth and increasing their normalized earnings as assets that generate income increase.
Talk to Andrew about interest rates
Tuesday, February 8, 2011
PMC Commercial Trust - A large margin of safety
PMC Commercial Trust (PCC) is similar to Seahawk Drilling when it comes to attempts at killing the company. While the discount to book value is not as steep, quite a discount exists and the company has been consistently profitable. Even substantial markdowns on the company’s assets would leave plenty of value left over at current prices. While Bank of Internet, a company I previously profiled, has benefited from the current zero interest rate policy of the Fed, PCC has seen its revenue and profits shrink dramatically. While PCC will benefit from an increase in interest rates, the assets are very secure and are trading at a discount to their liquidation value.
PCC makes small business loans primarily to budget motels operating under brands such as Comfort Inn, Hampton Inn & Suites, Holiday Inn Express and Best Western. The loans are typically in the $1-2m range, so there is diversity in the portfolio. The loans are secured by first lien on the property and personal guarantees, as well as being capped at 80% LTV. This gives the loans a margin of safety because they are backed by hard assets, as well as incentivizing the borrower to pay the loan off. For a small business owner, a motel is likely a main source of income, but no property means no income. Assuming everything is well in the world, these assets are solid.
But let’s ask what if all is not well in the world. The company has $230m in loans receivable on the balance sheet. The most recent 10-Q has total impaired loans at $7m, which is net of reserves, leaving $223m in loans/assets. There is $85m in net debt leaving $138m in loans for shareholders compared to a market cap of $90m. The market is implying that the loans (excluding noncurrent ones) the company has made are worth 35% less than stated. This is quite a statement. At the end of 2009, the company had 90% satisfactory loans, 9% watch list (loans that have other liens on them such as taxes or franchise fees, which shows that the rent is the very last thing to go unpaid and the company pays attention to its loans), and 1% reserved. Assuming this ratio stayed constant even though 2010 was much better than 2009, that implies $200m in problem free loans, less $85m in neet debt or $115m in loans for shareholders, an implied 20% haircut.
There are two reasons I believe the market would perceive this other than the little attention played to small cap stocks. The first being a concentration in the limited service hospitality (motel) sector. Over the past years, travel has been down and with that RevPAR (revenue per available room, a common hotel metric). Here is a graph showing the growth in RevPAR courtesy of Calculated Risk:
While RevPAR is down from years past, it has recovered from its lows. The company has so far indicated some impairment and losses on its loan book, but nothing nearly as dramatic as the stock price would indicate. While the motel industry will certainly not coast on through with the current economy, it is not in dire straits and it has so far proven resilient. Furthermore, borrowers are incentivized to remain current on loans backed by their earning assets.
The second reason is interest rates, a theme whose effect I recently discussed in regards to Bank of Internet. The loan book is 75% variable rate fixed to either LIBOR or prime. As those rates have decreased over the years, so has revenue from loans. Interest rates cannot go any lower at this point in my opinion, with the combination of being close to zero (the Fed might defy maths and push them even lower) and the specter of inflation from commodities.
Seeing as how RevPAR has improved in the sector and interest rates can’t get any lower, PCC is traded at a trough multiple of earnings and a depressed asset valuation. As I said before, this company is quite hard to kill. It should continue to be profitable and the downside is very limited at this point, while just the realization that the company’s assets aren’t greatly impaired could result in upside of 50% in addition to any dividend income received. Since the stock has already been pummeled, the worst case is that an investor collects 8% a year until interest rates rise. While a company catalyst has yet to rear its head, the underlying value and dividend provides a margin of safety for investors while compensating them for waiting. If the net loan book is valued at $115m or $138m the shares could be worth between $11-13.
I found this stock via this screen, which I highly recommend for any curious investor looking to do their own searching for stocks trading at big discounts to their net current asset value (NCAV). You likely won't find anything fancy - PCC is a dull asset based investment - I think it is a useful tool from beginners to experts because subjective calculations and predictions of earnings are not crucial to successful investing in this area.
Long PCC. Do your own research before investing. This site is purely informational.
Talk to Andrew about PMC Commercial Trust
PCC makes small business loans primarily to budget motels operating under brands such as Comfort Inn, Hampton Inn & Suites, Holiday Inn Express and Best Western. The loans are typically in the $1-2m range, so there is diversity in the portfolio. The loans are secured by first lien on the property and personal guarantees, as well as being capped at 80% LTV. This gives the loans a margin of safety because they are backed by hard assets, as well as incentivizing the borrower to pay the loan off. For a small business owner, a motel is likely a main source of income, but no property means no income. Assuming everything is well in the world, these assets are solid.
But let’s ask what if all is not well in the world. The company has $230m in loans receivable on the balance sheet. The most recent 10-Q has total impaired loans at $7m, which is net of reserves, leaving $223m in loans/assets. There is $85m in net debt leaving $138m in loans for shareholders compared to a market cap of $90m. The market is implying that the loans (excluding noncurrent ones) the company has made are worth 35% less than stated. This is quite a statement. At the end of 2009, the company had 90% satisfactory loans, 9% watch list (loans that have other liens on them such as taxes or franchise fees, which shows that the rent is the very last thing to go unpaid and the company pays attention to its loans), and 1% reserved. Assuming this ratio stayed constant even though 2010 was much better than 2009, that implies $200m in problem free loans, less $85m in neet debt or $115m in loans for shareholders, an implied 20% haircut.
There are two reasons I believe the market would perceive this other than the little attention played to small cap stocks. The first being a concentration in the limited service hospitality (motel) sector. Over the past years, travel has been down and with that RevPAR (revenue per available room, a common hotel metric). Here is a graph showing the growth in RevPAR courtesy of Calculated Risk:
While RevPAR is down from years past, it has recovered from its lows. The company has so far indicated some impairment and losses on its loan book, but nothing nearly as dramatic as the stock price would indicate. While the motel industry will certainly not coast on through with the current economy, it is not in dire straits and it has so far proven resilient. Furthermore, borrowers are incentivized to remain current on loans backed by their earning assets.
The second reason is interest rates, a theme whose effect I recently discussed in regards to Bank of Internet. The loan book is 75% variable rate fixed to either LIBOR or prime. As those rates have decreased over the years, so has revenue from loans. Interest rates cannot go any lower at this point in my opinion, with the combination of being close to zero (the Fed might defy maths and push them even lower) and the specter of inflation from commodities.
Seeing as how RevPAR has improved in the sector and interest rates can’t get any lower, PCC is traded at a trough multiple of earnings and a depressed asset valuation. As I said before, this company is quite hard to kill. It should continue to be profitable and the downside is very limited at this point, while just the realization that the company’s assets aren’t greatly impaired could result in upside of 50% in addition to any dividend income received. Since the stock has already been pummeled, the worst case is that an investor collects 8% a year until interest rates rise. While a company catalyst has yet to rear its head, the underlying value and dividend provides a margin of safety for investors while compensating them for waiting. If the net loan book is valued at $115m or $138m the shares could be worth between $11-13.
I found this stock via this screen, which I highly recommend for any curious investor looking to do their own searching for stocks trading at big discounts to their net current asset value (NCAV). You likely won't find anything fancy - PCC is a dull asset based investment - I think it is a useful tool from beginners to experts because subjective calculations and predictions of earnings are not crucial to successful investing in this area.
Long PCC. Do your own research before investing. This site is purely informational.
Talk to Andrew about PMC Commercial Trust
Sunday, February 6, 2011
Bank of Internet - neither tech stock nor financial black box
Banks are not the typical businesses that catch my fancy. Banking is a leveraged commodity business by definition. Many of them are currently still sorting through their balance sheets, face headwinds from regulation, are exposed to risk from derivatives and have not undertaken the steps to ensure future solvency. I also tend to shy away from internet or tech companies as well. This makes Bank of Internet
Bank of Internet (BOFI) is in many ways different from the crowd. While it is inherently levered, it is in a low cost position due to a lack of brick and mortar branches. While normally perceived as a detriment to business, a lack of fee based income removes most regulatory risk. The balance sheet is straightforward with conservative underwriting standards and no derivative exposure.
The stock is currently trading at less than 8x TTM earnings, despite doubling earnings in the past year. The reasons for this are likely two-fold. First, around 40% of the loan portfolio is concentrated in California. Need I elaborate? Second, the earnings growth has resulted from the huge expansion in net interest margin, a result of the Feds monetary policy of helping banks repair their balance sheets with cheap capital. For this reason the market believes future earnings will be less than present earnings.
Seeing as how interest rates can either stay the same or go up from here on out, it is likely that future earnings will be lower or the same. Managements normalized target is 2% NIMs and an efficiency ratio of 35% or lower. On their current $1.5B in interest bearing assets, that’s revenue of $30m, leaving $12.5m of net income after expenses and taxes of 35% each. That leaves the company trading at 12x normalized earnings, not mouthwatering cheap.
Management states that their current plan other than maintaining an efficiency ratio of 35% or lower is to increase assets to more than $3b. Using similar assumptions as above that translates into earnings of $25.3m in however long it takes for assets to double. Looking at historical growth, it could taken anywhere from 3-5 years, although each dollar it earns now with widened NIMs decreases the time frame because a dollar earned can translate in an additional ~$12 of interest bearing loans at current leverage rates.
Additionally, out of necessity and a product of the business model, BofI offers higher interest rates on a lot of deposit products than other banks. Deposits are very sticky, which is why so much promotional offers from banks exist that seem odd to the layman. It always struck me as odd that a bank would give you $50 or $100 in your account if you signed up for an account and used it. Now it makes perfect sense, because deposits are unlikely to leave in most situations, and large incentives are needed. Due to this phenomenon, BofI has to offer higher interest rates if it has any hope of attracting deposits. It is able to cushion some of this expense through being a low cost operator.
I view the higher interest rates BofI is offering particularly important in an environment horrendous for people living on fixed income. Just looking at growth in interest bearing demand and savings from 2008-10, the balance grew from $76m to $447m even though the interest paid on those accounts dropped from 3.59% to 1.42%. Other banks are offering their customers that much less that such a decrease actually resulted in an increase in deposits.
It is important to get back from the future though. The currently loan portfolio requires scrutiny to examine if potential upside in the future growth of the company can be realized. As mentioned earlier, the company has a lot of exposure to California. Due to the simplicity of the bank overall, the breakout of their balance sheet is quite thorough and therefore easy to investigate.
The company is a plain vanilla bank. The bulk of the portfolio is in single and multi family. There was a poor expansion into RV loans, but that has been scaled back. Non-performing loans currently stand at 1.64%, although allowances to NPLs currently stands at 41%, indicating future charges to earnings in the vicinity of $15m. The weighted average loan to value stood at 52% in the most recent quarter. This is generally more conservative than most loans, which indicates realized losses on the portfolio will be lower relative to peers. Homeowners have more skin in the game through greater equity in the home, and the bank has less at risk.
The company also holds a portfolio of residential mortgage backed securities (RMBS) valued at $561m. Management purchased these in the height of the financial panic and the portfolio has fared well. The loans are either GSE backed or super senior first lien, meaning the real estate backing them would have to absolutely crumble for them to take a hit. Judging from the loan book that they have generated, this pool of securities is likely to be well chosen and conservative.
Directors and officers own 16.8% of the stock, so there is an alignment of incentives. Especially when dealing with a leveraged institution, it is good to see skin in the game to know nothing crazy will happen.
The bank currently trades at 1.2x tangible book value and 8x TTM earnings. On a more normalized basis , the company trades at approx 12x earnings. This seems fairly inexpensive for a growing business that has a properly incentivized management and low cost business model.
Talk to Andrew about Bank of Internet
Bank of Internet (BOFI) is in many ways different from the crowd. While it is inherently levered, it is in a low cost position due to a lack of brick and mortar branches. While normally perceived as a detriment to business, a lack of fee based income removes most regulatory risk. The balance sheet is straightforward with conservative underwriting standards and no derivative exposure.
The stock is currently trading at less than 8x TTM earnings, despite doubling earnings in the past year. The reasons for this are likely two-fold. First, around 40% of the loan portfolio is concentrated in California. Need I elaborate? Second, the earnings growth has resulted from the huge expansion in net interest margin, a result of the Feds monetary policy of helping banks repair their balance sheets with cheap capital. For this reason the market believes future earnings will be less than present earnings.
Seeing as how interest rates can either stay the same or go up from here on out, it is likely that future earnings will be lower or the same. Managements normalized target is 2% NIMs and an efficiency ratio of 35% or lower. On their current $1.5B in interest bearing assets, that’s revenue of $30m, leaving $12.5m of net income after expenses and taxes of 35% each. That leaves the company trading at 12x normalized earnings, not mouthwatering cheap.
Management states that their current plan other than maintaining an efficiency ratio of 35% or lower is to increase assets to more than $3b. Using similar assumptions as above that translates into earnings of $25.3m in however long it takes for assets to double. Looking at historical growth, it could taken anywhere from 3-5 years, although each dollar it earns now with widened NIMs decreases the time frame because a dollar earned can translate in an additional ~$12 of interest bearing loans at current leverage rates.
Additionally, out of necessity and a product of the business model, BofI offers higher interest rates on a lot of deposit products than other banks. Deposits are very sticky, which is why so much promotional offers from banks exist that seem odd to the layman. It always struck me as odd that a bank would give you $50 or $100 in your account if you signed up for an account and used it. Now it makes perfect sense, because deposits are unlikely to leave in most situations, and large incentives are needed. Due to this phenomenon, BofI has to offer higher interest rates if it has any hope of attracting deposits. It is able to cushion some of this expense through being a low cost operator.
I view the higher interest rates BofI is offering particularly important in an environment horrendous for people living on fixed income. Just looking at growth in interest bearing demand and savings from 2008-10, the balance grew from $76m to $447m even though the interest paid on those accounts dropped from 3.59% to 1.42%. Other banks are offering their customers that much less that such a decrease actually resulted in an increase in deposits.
It is important to get back from the future though. The currently loan portfolio requires scrutiny to examine if potential upside in the future growth of the company can be realized. As mentioned earlier, the company has a lot of exposure to California. Due to the simplicity of the bank overall, the breakout of their balance sheet is quite thorough and therefore easy to investigate.
The company is a plain vanilla bank. The bulk of the portfolio is in single and multi family. There was a poor expansion into RV loans, but that has been scaled back. Non-performing loans currently stand at 1.64%, although allowances to NPLs currently stands at 41%, indicating future charges to earnings in the vicinity of $15m. The weighted average loan to value stood at 52% in the most recent quarter. This is generally more conservative than most loans, which indicates realized losses on the portfolio will be lower relative to peers. Homeowners have more skin in the game through greater equity in the home, and the bank has less at risk.
The company also holds a portfolio of residential mortgage backed securities (RMBS) valued at $561m. Management purchased these in the height of the financial panic and the portfolio has fared well. The loans are either GSE backed or super senior first lien, meaning the real estate backing them would have to absolutely crumble for them to take a hit. Judging from the loan book that they have generated, this pool of securities is likely to be well chosen and conservative.
Directors and officers own 16.8% of the stock, so there is an alignment of incentives. Especially when dealing with a leveraged institution, it is good to see skin in the game to know nothing crazy will happen.
The bank currently trades at 1.2x tangible book value and 8x TTM earnings. On a more normalized basis , the company trades at approx 12x earnings. This seems fairly inexpensive for a growing business that has a properly incentivized management and low cost business model.
Talk to Andrew about Bank of Internet
Tuesday, February 1, 2011
Funny places to find stocks
I was reading this article in Wired earlier purely out of curiosity and/or the hope that I could give up investing and just beat the lottery every day. There are plenty of nice tidbits to sprinkle into intellectual conversation such as "Lotteries were used to fund the American colonies and helped bankroll the young nation. In the 18th and 19th centuries, lotteries funded the expansion of Harvard and Yale and allowed the construction of railroads across the continent." The part of the article which yielded a payout for my investing side was:
As a side note, GTech is part of Lottomatica, an Italian company that is much larger than the rest of the competition.
The article gives a good overview of the lottery business in general. This is a niche market, an oligopoly, requires investment in security technology, an entrenched part of government revenue, has strong recurring revenues, and a strong psychological pull. Lottomatica, Scientific Games, and Pollard Banknote make for a good place to start looking for stocks. Scientific Games has a market cap of $965m, not exactly a big fish, although it might look big compared to Pollard's market cap of $54m.
There is the general maxim in investing that finding the best stocks requires one to look where nobody else is looking. I find this to be especially true with my investing approach, which entails combining my general curiosity and willingness to read anything combined with a value investing philosophy. There is plenty of insight on investing that is not printed in traditional investing or financial publications. Articles written more for the nerd factor of a guy spending his time figuring out the patterns of lottery tickets offer a completely different level of insight into an industry.
Talk to Andrew about funny places to find stocks
In North America, the vast majority of lottery tickets—everything from daily draw Pick 4-style games to small-stakes tic-tac-toe and bingo scratchers—are produced by a handful of companies like Scientific Games, Gtech Printing, and Pollard Banknote. These publicly traded firms oversee much of the development, algorithm design, and production of the different gambling games, and the state lotteries are largely dependent on their expertise. Ross Dalton is president of Gtech Printing, and he acknowledges that the “breakability” of tickets is a constant concern. (Several other printing companies declined to comment.) “Every lottery knows that it’s one scandal away from being shut down,” Dalton says. “It’s a constant race to stay ahead of the bad guys.” In recent years, Dalton says, the printers have become increasingly worried about forensic breaking, the possibility of criminals using sophisticated imaging technology to see underneath the latex. (Previous forensic hacks have included vodka, which swelled the hidden ink, and the careful use of X-Acto knives.) The printers have also become concerned about the barcodes on the tickets, since the data often contains information about payouts. “We’re always looking at new methods of encryption and protection,” Dalton says. “There’s a lot of money at stake in these games.”
As a side note, GTech is part of Lottomatica, an Italian company that is much larger than the rest of the competition.
The article gives a good overview of the lottery business in general. This is a niche market, an oligopoly, requires investment in security technology, an entrenched part of government revenue, has strong recurring revenues, and a strong psychological pull. Lottomatica, Scientific Games, and Pollard Banknote make for a good place to start looking for stocks. Scientific Games has a market cap of $965m, not exactly a big fish, although it might look big compared to Pollard's market cap of $54m.
There is the general maxim in investing that finding the best stocks requires one to look where nobody else is looking. I find this to be especially true with my investing approach, which entails combining my general curiosity and willingness to read anything combined with a value investing philosophy. There is plenty of insight on investing that is not printed in traditional investing or financial publications. Articles written more for the nerd factor of a guy spending his time figuring out the patterns of lottery tickets offer a completely different level of insight into an industry.
Talk to Andrew about funny places to find stocks
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