Tuesday, December 17, 2013

McRae Q1 Earnings Up 55%


McRae Industries reports revenue up 27%, earnings up 55% yoy. See below. The company reported the diluted earnings per class A share as $1.33 for the quarter.

Last 5 Quarters (mils)

A significant contributor was the military segment; the company now produces boots for the Israeli military! The good news just doesn't stop.


For the last few years the company has been on a tear. See below.




But the company has said that western/lifestyle segment, which is the most discretionary, typically goes on a 3-4 year cycle, and we are on the 4th year of this cycle. So McRae investors must be wary. That said, I feel much of the world today has an overabundance of life's necessities, and consequently many are moving beyond necessity to luxury. Thus there will be more demand for goods such as pet products, alcohol, healthcare, recreational drugs such as marijuana, high-end watches and the western/lifestyle boots that McRae sells. I am trying to profit on all of the aforementioned areas - well, all except except marijuana.

In other news, I found this thought-provoking article on Shiller's CAPE. I wrote, and so have many others, that the CAPE is an excellent historical measure and that the CAPE indicates the market is overpriced now. However,  this article argues that this conclusion is incorrect because accounting rules have changed and therefore CAPE values are based on inconsistent rules over time. This article's argument has huge ramifications for me because I am reducing my equity exposure as the market continually hits new highs. But if I can be convinced that the market is not overvalued I will have to reverse course! I recommend this article to any serious investor.


Monday, December 16, 2013

Why I Own Insurance Stocks


Over my investing years, I have tried to make some general rules to hopefully help me avoid trouble. Currently, my general minimum critera are:
  1. low PE
  2. profitable over last several years
  3. low debt requirement for operations, and
  4. domiciled in a developed country

I have other requirements which are desirable but not necessary: I prefer small caps, and I have touched on it extensively in this blog.

When I initially invested and wrote about it last year, AIG fits the criteria except that it hasn't been profitable recently. But that was last year. In the year plus since, it has earned money consistently. In all, AIG has been profitable the last 9 consecutive quarters. I feel that companies that don't regularly need tons of capital expenditures are in general better investments. That's in general Warren Buffet's strategy up until recently when he bought Burlington Southern.

I bought AIG over a year ago when it was $30, and was trading at around 0.6x book. Since then it has run up to $50. A year after I bought AIG I tried to find a small cap company like it. I found Kansas City Life Insurance to be a small cap that also trades at 0.6x book; 0.6x is just about the lowest book I could find for insurance companies. KCLI has since run up 30%. The following table summarizes KCLI and AIG today



AIG does primarily Property and Casualty and Life Insurance and Annuities. KCLI only does Life Insurance and Annuities. AIG also owns ILFC, which is a aircraft leasing business. Just today, AIG announced it will divest ILFC to another company, AerCap. Although I don't think AIG will have any gains or losses from this transaction, I think it is yet another sign that AIG's dark days of five years ago are behind them.

My other insurance holding is Wellpoint; but then again WLP is not really an insurance company as much as a healthcare company. I have written many times about WLP as my bet on Obamacare. I have never really heard of any other investor taking my view. Until I saw a Forbes piece on Larry Robbins. Larry Robbins runs a hedge fund that is one of the best performers this year because he made a big contrarian bet on the healthcare sector. After following the hedge fund moves in the last year, it seems like to me the hedge funds are just being too conventional when their name implies that they should act contrarian.

My bottom line is, I am really liking insurance right now!



Thursday, December 5, 2013

Why I Own Fujimak



I found Fujimak (5965:TSE) while looking for small Japanese net-nets. Although Fujimak is not a net-net, it got my attention for its great earnings. The stock trades at only 5 times trailing earnings. I have only seen this in very special situations. But from what I have seen Fujimak can earn this type of earnings regularly, and without much leverage. The only negative that stands out to me is that this is a Japanese microcap. Its current market cap is only $55 mil USD.

Fujimak makes kitchen equipment for commercial use. The company has been around since 1950. The company only provides investors online information in Japanese. The online data only go back six years. Their equity and earnings per share are shown below.

Equity and Earnings per share (yen)


I don't have any information prior to the six years. I can only assume that the company was just humming along when earnings took off around 4 years ago. The stock price currently is 860 yen. The expected income for fiscal 2014 is 130 yen.

But digging deeper, the data is peculiar. The income increase did not come from greater sales, it came from greater margins. And what an improvement this makes.

The following table shows the gross margin is relatively constant, but the profit margin benefited greatly from improved SG&A expenses. So the improved performance comes from selling possibly less and more profitably products. Other than that, I don't have much more to add because I can't read the reports in Japanese, and even if I could I don't think they would reveal much. But whatever the reason, the numbers, if true, is compelling enough reason to buy Fujimak.



Fujimak should also benefit from the current Japanese resurgance. The USD is worth 102 yen now. Between 100 and 110 is a wonderful sweet spot for Japanese exports. And I can tell that Fujimak is pushing its expansion into Asia. They recently opened an office in Vietnam.

Monday, November 25, 2013

Installux Reports Good Q3

Installux SA continues the string of good news from my small caps. I had mentioned that the company had 10% less revenue yoy in Q1 and Q2. However, Q3 revenue was flat compared to a year ago. I hope this is a sign of a turnaround for the company. However to counter this, recent news suggest France is still struggling to get out of recession. I suppose this is why the stock jumped 13% on the revenue numbers and then gave it all back the next day. I think Installux is still a work in progress. That is, the stock is still depressed due to uncertainty, but I am betting when the uncertainty is over the stock will jump, as has happened with my other smallcaps.

In other portfolio news, I sold about 15% of my WLP holding. I had held it since the days when it was still called Anthem. I don't remember ever selling through last 7 years. But I have bought it regularly in that time. Now the stock is at an all time high of $93 and at around 10 times earnings. At this multiple I no longer regard see WLP as seriously undervalued anymore. The Obamacare discount of a year ago — which I mentioned here — is gone. So it is time for me to finally take some off the table. In addition I also sold some Berkshire Hathaway. Berkshire is a fine company run by the best CEO in the world. However, it is a huge holding company. I just don't believe it has much growth opportunity above the market as a whole anymore.

And finally, I recommend this great tutorial on basic valuation metrics. I believe the first thing a beginner value investors should learn is the set of basic valuation metrics. However, although they are mentioned a lot in the media, there are very few knowledgeable people who have explained them well. And not only does this article explain them well, the author also compares the pros and cons of each in a table, which I have never seen before.  

Thursday, November 21, 2013

IEHC Jumps on Q2 Earnings


IEHC stocked jumped two quarters in a row on positive earnings. I am not totally clear on the exact reason for the rise though. Revenue and income was flat quarter over quarter. However, last quarter was an exceptional quarter and maybe the stock jumped on confirmation that the current rate of income is sustainable. At the current pace, IEHC will have its best year ever. I did not find anything worthy of note in the report. The report wording was almost exactly the same as last quarter (other than the actual numbers). The company reiterated that they have new products in the pipeline. It isn't clear to me whether the company has generated revenue yet from the new products, but it appears that sales will ramp up in the coming quarters. I am eager to see how much of an impact this will have on the overall revenue, and the market is anxious too, I am sure. But right now, my margin of safety lies in the stock price which still trades at 7 times my projected earnings.

The following chart shows the revenue, earnings and the stock price. As you can see, the stock only moves four times a year, when he earnings reports come out. I find that is the case for all the small and microcaps that I follow. This is great for the small time investor, there is little room for manipulation and hype such as what happens with the more universally followed stocks (for an recent example, think Tesla!). The small cap stock price is more likely to follow fundamentals.

Revenue and Earnings (mil) and Share Price (dollar) over last 12 months

Friday, November 15, 2013

McRae Industries Income Up 55% in 2013

McRea Industries reported great earnings for the fiscal year 2013. Net income was up 55%. Their first paragraph says it all:

Consolidated net revenues for fiscal 2013 amounted to approximately $97.1 million as compared to $75.7 million for fiscal 2012. This 28% increase in net revenues was primarily attributable to strong performance in both of our boot product segments. Our western/lifestyle products business grew from $52.5 million for fiscal 2012 to $62.8 million for fiscal 2013 as demand for both men and women's products continued to be heavy.


The report also mentioned the fourth quarter was the biggest contributor to the year's results. This could be a good holiday shopping season in US overall

I originally bought McRea as a simple value play (see my original post here). In the following 1¼ year, its operations have also grown beyond expectations. And the stock is up 65%. That's the beauty of a margin of safety, low expectations means any surprise will most likely be on the upside.

I have read or heard many great investors say that when you score in investing it isn't all your doing. A lot of luck plays into it. And the converse is also true, when you lose, it isn't always your fault. In the case of McRea, the company is doing well now because it is riding a mature bull market. Consumer confidence has risen in the last few years as housing and employment have stabilized. This has meant more demand for the luxury and fashionable items such as women's cowboy boots. This is definitely a cyclical event.

McRea also is doing well in the military boots department. McRea is has focused on this for fifty years and that is still its bread and butter. The stock jumped 13% yesterday on the earnings. However, it is still trading at 6 times earnings! I am drooling at the potential 33% gain if the stock were to go to just 8 times earnings!

Thursday, November 14, 2013

My Japanese Holdings in H1

In February this year, I documented my initial purchases of two Japanese small caps here and here. The initial reason was 1. the Japanese market is oversold, 2. the economy was due for a rebound. I think a lot of investors under-estimate how often the market will revert to the mean. I think Japan will rebound, maybe not to its 1989 glory, but it will get its day soon. And even if I am wrong, I have a big margin of safety with my two particular stocks.

At the time, I did not really know Abenomics, but Shinzo Abe the Japanese prime minister has had a great effect on the economy. The market has been up about 66% during his tenure — in local currency. However it is still a lot even in US currency terms. But whether Abenomics will help Japan in the long term is still unknown.

Abenomics has directly pushed the Japanese Yen from 80 yen per USD to 100 per USD. This dramatic change has made many big Japanese exporting companies profitable, such as Hitachi and Toyota. I have read, however, that the lower yen has not resulted in more export volumes. This is somewhat worrisome, as greater volume is what will drive growth for the longer term. Furthermore, many Japanese companies are repatriating money and assets from overseas because of the increased value of foreign currencies. This can dramatically effect profitability but only temporarily.

If I had time I would analyze the financial reports of major Japanese exporting companies to carefully analyze the recent effect of the lower yen. But I don't, so instead I just analysed the results my Japanese holdings in the first half year.

Firstly, Tachibana Eletech reported increased earnings for both quarters. Tachibana is a factory automation company that exports about 20% of sales, based on my estimates. The following shows their results for the first half fiscal year. The results were much better in the second quarter compared to the first. This may be a delayed reaction to Abenomics. Operationally the company is doing better although management is still concerned about the slowdown in China and rest of Asia. But a big chunk of the delta was non-core earnings. I grouped them as non-operational earnings and extraordinary earnings.

Secondly, Riken Keiki reported similar results for the two quarters; with the second quarter better than the first. Riken Keiki must export a large percentage of their products. I even see their products on ebay.

So operationally, both are better and the same period last year but Tachibana's results were greatly affected by non-core income. The operational aspect could be both directly the result of Abenomics or indirectly, such as a more positive economic outlook.

These two companies are up around 35% since I first wrote about them, in local currency terms. But I think they are still way undervalued, if one simply looks at the books. However, I do understand that they are at their current price mostly because of the Japanese economic climate. My biggest concern is the huge Japanese debt. This debt is owned by the Japanese people and Japanese companies. I am still figuring out how this will all play out. If the Japanese cannot service the debt, then Japanese will default to themselves, or the Japanese can depreciate their currency so that they can afford to service it. In the latter, more realistic case, the resulting inflation will cause their goods to be more competitive in the world. The key difference between Japan and other countries with high debt is that the world wants Japanese goods! This, in my opinion, will allow for stable calm devaluation of the Japanese Yen, if it does happen.

The conclusion is, I am still very much long my Japanese holdings. In fact, I even bought a new Japanese microcap: Fujimak (TSE:5965). I hope to post a about it soon.


Wednesday, October 23, 2013

My Take on the OIBr and PT Planned Merger


It has been a while since I posted. In part because of work, and in part due to a dearth of news from companies in my portfolio. BTW, the debt ceiling and government shutdown are not what I consider material news.

The only big news is the recent planned merge of OiBr and Portugal Telecom (PT). I have owned OiBr for about 7 years. And in that time, I found it very hard to follow. For one thing it is in a country I have never been to, and it has an extremely complicated ownership structure that has gone through many restructurings. I was drawn to the stock because of the 10%+ dividend yield and the the BRIC story. Stocks from developing countries haven't been very kind to me. I have lost on Cemex (CX) and OiBr. I do have a nice gain in PK Telecom of  Indonesia, but the gain couldn't match the S&P 500. In the future, I will only invest in developed countries.

The PT and OiBr merger is interesting. Both companies command a huge customer base, and both are saddled with high debt. The merger is complex involving both companies as well as many companies that own parts of both companies. I won't try to explain the transaction, but I summarize the bottom line as I understand it. 

  • New company is call Corpco
  • PT share becomes 0.63 Corpco share
  • OiBr common shares becomes 1 Corpco share, preferred shares becomes 0.92 Corpco share, I'll simplify this by saying each old OiBr share is worth a weighted average of 0.95 Corpco share
  • OiBr will issue new shares which in turn will become 0.95 share Corpco in order to generate around 8 billion reais new cash
  • The number of shares issued is yet to be determined
  • PT shareholders will get R$5.5 bil worth of the new shares because they will give OiBr more than R$5.5 worth of equipment as part of the merger
  • PT owns 13% of OiBR
  • OiBr own 10% of PT (confusing enough yet?)

So the bottom line is a new company with containing OiBR, PT and R$8 billion. First, I estimated my dilution by estimating the eventual number of Corpco shares. I assume a weighted average common and preferred Oi share price of R$4.2, which is at the recent trading range.

                                                                                Corpco Shr
PT share conversion 855 PT shr x 0.63 539
    -10% owned by OiBr(54)
PT equipment contribution R$5500 ÷ R$4.2/shr1310
    -10% owned by OiBr      (131)
Total attributed to PT shareholders 1663
OiBr share conversion 1640 OiBr shr x 0.95 1561
    -13% owned by PT(193)
OiBr Capital Raise R$8000 ÷ R$4.2 /shr1905
Total attributed to OiBr shareholders 3198
Total 4861


Note, that the above factors in the cross-ownership of the two companies: I assume the cross-ownership shares will be retired. This is very likely wrong but it is my best guess at what will happen. The merger announcement said the goal is 38% PT shareholder ownership of Corpco. My above calculation winds up with 34%. This means there is probably something wrong with the above assumptions and calculations. But for the purposes of this article, my estimates are close enough.

The above results in a market cap of R$20.4 bil. And I did some valuation calculations on Corpco. The company would have a trailing Ebitda of R$12.8 bil. A net debt of R$41.2 bil, post capital raise. Which means an EV/Ebitda of 4.8. This is a reasonable number. And as a OiBr shareholder, for each of my weighted average shares I have R$8.47 of debt and R$2.60 of Ebitda. Currently each OiBr shares has about R$16 of debt and R$4.50 Ebitda. So the merger is a good idea because it reduces OiBr debt profile. But the debt profile was bad before the merger, and it is still not so great after.

On the operational side, this merger will hopefully give the combined company a better debt profile so that they will get better interest rates. Right now it is running at the 9% range for new debt. And hopefully the two companies can take advantage of synergies so that their fortunes will turn around by 2015. Nonetheless, OiBr is in a complex situation, and both PT and OiBr are in countries that are suffering a downturn or worse,. In the end, I think my time is better spent with easier to understand small and microcaps. Currently, I am reducing my position and hopefully I'll be rid of OiBr completely before the merger.

For more in-depth analysis, I recommend this article

The other news, I found a thorough article on IEHC. Considering the company's tiny market cap ($9 mil) any analysis is wonderful. I didn't get any new information on OiBr — after all, how much news can you get on a $9 mil company — but it did mention some useful facts about the connector business and its competitors. I didn't know the connector business is actually big business! The press is probably helping the stock too. At $4.20, the stock is 40% up from my initial purchase earlier this year.


Sunday, September 8, 2013

My 2nd Annual Schedule of Investments

It has been a year since I listed my holdings. So it is time to update. Below is a list of my 12 largest holdings, in order of size.

Position Category
Cash and equivalents
Wellpoint (WLP) US Large cap
McRea Industries (MCRAA) US Microcap
Seaboard (SEB) US Mid cap
Chevron (CVX) US Large cap
Tachibana Eletech (TSE:8159) Japanese Small cap
Philip Morris International (PM) US Large cap
AIG (AIG) US Large cap
Petsmart (PETM) US Large cap
Oi SABrazilian Mid cap
Installux SA French microcap
Bruce Fund (BRUFX) Mutual fund
Berkshire Hathaway (Brk.b) US Large cap

The big change from a year ago is a big allocation to small and microcap stocks. Up to a year ago, I had never bought an small cap, OTC or foreign exchange stock. I purchased my first two small/microcap stocks almost exactly a year ago. MCRAA has gone up 55% since then. But it isn't all that great for me as I slowly built up my large position in the last year. Globus Maritime (GLBS) has dropped -8% in a year. However I sold about three months ago when it was lower. If I had kept it, I would have a 10% gain.

The other big change is that I sold virtually all my tech holdings. I felt that in the last few years tech was simply too undervalued. But now it has probably reached reasonable levels. I don't believe tech is something to hold unless it is really undervalued. I think tech is structured too much for the benefit of employees. Even today, some thirteen years after the dotcom bust, Cisco still reports and focuses on the non-GAAP earnings. In the Q3 announcement, earnings were $0.46 GAAP and $0.51 non-GAAP. The non-GAAP is higher because it strips out the cost of stock options and amortization of goodwill, among other things. But like Warren Buffett says, if stock options isn't an expense, then what is it? And Cisco has been a serial acquirer. If the company doesn't write down goodwill, then it must stay in the books. But doing so would totally distort the equity value versus market cap. And the value of goodwill doesn't stay forever, it dies down many years after the acquisition.

I also bought a few cheap Japanese stocks within the last 12 months. These stocks have not budged much in USD terms. They are trading considerably lower than my estimate of their intrinsic value. I just don't get why. Tachibana Eletech for example trades well below net-net and has 8% ROE. Why? But despite my bewilderment, I am ready to stick with them for two or three years. I am not a believer of catalysts. I prefer to put my faith in the efficiency of markets. If the companies' fundamentals and the Japanese economy and monetary policy stay on track, the companies' stock price will eventually get to my value.

Speaking of efficiencies, IEHC reported first quarter earnings recently. When the company reported year end results, the stock price didn't budge. But on the first quarter results, the stock price jumped some 15%, for good reason. Earnings were up 64% yoy ($0.23 vs. $0.14), and revenue was up 11%. I could not find any insightful explanation for the increase in revenue and profits. However they did say that:

The circular product line of connectors introduced several years ago for the medical industry continues to be very rewarding for the Company. The line has been expanded to include connector cable assemblies utilizing the circular connectors.

A new product line featuring high density connectors is being added to the Company’s product offering. This offering should be available within the next few months. The Company expects the new product line to bring additional revenue.


The sudden price movement taught me a lot. IEHC is a $9 M market cap company. For its stock to move like that means the market can be efficient even for such a tiny company; investors like me are watching the stock.


Friday, August 16, 2013

Oi Reports Disappointing Q2 2013


Oi (OIBR) just announced their Q2 results. And the news didn't improve. Revenues increased slightly QoQ but EBITDA decreased significantly to 1797 M reais from 2151 M reais a quarter ago — 1 USD is approximately 2.2 reais. This meant earnings came in at -124 M reais (-0.08 reais per share) versus 262 M reais a quarter ago. This is the first losing quarter since 2011.

Management said the 354 M reais drop in EBITDA was because of three main expenses. The followings shows all their operational expenses.

The first problematic expense is personnel. Management said the increase was due to an one-off wage benefit (100M) and a 6% inflation increase to wages. The second is marketing expenses. Oi is the official sponsor of the just completed Confederation Cup and spent 66M. The third one is bad debts (115M) which was due in part because of the downturn in Brazil's economy. So the management emphasized that the drop in net income can be explained by one-off special expenses and bad credit requirements. Bad debt is running at about 300M a quarter and should be half that. But if the sales department get picky with customers, how will that affect revenue?

To me, the crux of the problem is the margins, EBITDA margin is now 25.4% versus 30.5% a quarter ago. This is clearly unacceptable. But can the company change that, or is it that the company needs low margins to sustain the revenue? The jury is out. But from a revenue perspective the company seems to be doing ok. The newly appointed CEO Bava did emphasize costs as his first priority. The media is very positive about him, if he is that good, I think he should be able to fix the cost problem.

Debt and Dividends

The company's net debt level is now at 29.5 B reais. That is a 2 B increase over a quarter ago despite 1 B in asset disposals! The company paid 900 M reais in various fees that are not quarterly recurring. Capex was 1506 M reais. Bava said that capex will be lower next year, below 6 B reais. The company has 12 B reais of liquidity so I don't think it is an issue over the next year or two.

To help manage the debt problem, the company will now pay the legal minimum of about 500M reais a year in dividends. That works out to about $0.14 USD per share. The preferred stock last traded at $1.61 USD per share.

In addition, in the coming two quarters the company will realize more than 1 B reais cash for previously mentioned asset sales.

Final Thoughts


My original reason for buying Oi many years ago was to participate in the rise of the BRICs. Many developing countries are now hitting a speed bump. But emerging ecomonies will be the growth of the future. Brazil has a fast rising middle class that will very much need telecom services. Oi I feel is a company that just needs to get its act together. It has been under medicore mangement for too long.

Portugal Telecom, Bava's previous company and Oi's parent company, also reported poor earnings recently. In the coming weeks, I will, look into PT to see if Bava is really that good and what he did at PT. I may post my findings.
 
As another note, Fitch just downgraded Oi from BBB to BBB-. This is the last rating before junk.

Sunday, August 11, 2013

Installux SA H1 2013 Update


Just after my recent post on Installux SA, the company reported their first half-year earnings. The company earned € 13.69 / shr, which is a 14% drop yoy. Revenue dropped 10% yoy. Gross margin was 56% versus 53% a year ago. EBIT margin remained constant at 11%. So the company appears to manage costs well in light of the downturn in France. And this year the company will continue to increase book value — which is larger than market cap — and pay a 5% dividend.

Friday, August 9, 2013

One Year Anniversary and Contrarian Indicators

Horray, I have consistently kept up my blog for a year.

The other day I read this in an online article:


It's just about the most audaciously optimistic investment opinion one could utter, yet a relative handful of Wall Street voices is beginning to say it, out loud and assertively: This market has passed through a 1982 moment.


1982 was the end of stagflation of the 1970's and it signalled the beginning of a two-decade roaring bull market. When I saw this I thought bingo, contrarian indicator! I think of macroeconomic considerations as just one factor in my investing strategy, but I take any individuals opinion with a big dose of skepticism. Macroeconomic issues are notoriously difficult to predict because they involve inputs from many factors and many individuals. Take currencies for example. Currencies is a huge market that is controlled by interest rates and inflation rates. It would seem so easy to bet on future direction of currencies, but it yoyos and often catch people by surprise. I would never directly trade currencies, though I would buy stock in another country without hedging.

But I have to think that now is nearing the crest of a bull market. And when I read that we are heading to a bull market like 1982, I just have to mutter, while shaking my head, "you've got to be kidding me!" The article goes on to remind us that the market went up 14-fold in the next 18 years. Meanwhile, Grantham at GMO is predicting negative returns for US stocks over the next 7 years. I hate to predict market direction, but I am thinking it is very likely that this article is a harbinger of the bull market peak. I think S&P 500 will be below 1700 for a while after the current run.

In other news, Seaboard (SEB) is the latest of my stocks to report earnings. The company reported Q2 2013 earnings of $33.07 versus $41.68 a year ago. For the first half of 2013, earnings were $81.06 versus $109.63 a year ago. Revenue was up about 10%.

Pork is Seaboard's largest segment and corn is the largest part of feed. Corn prices were reasonable in the quarter coming off last year's drought, but now, corn is starting to return to the levels of 2010-2011 when Seaboard profits were good. The power segment did well also. The remaining segments combined lost money. So this confirms my view that Seaboard will constantly struggle with thin margins. Recently the stock reached an all time high of $2948. The stock now has about a $2000 tangible book value and has a projected fiscal year P/E approaching 20x. So I think overall this stock is fair to slightly overpriced at $2948. I have sold some of my position but SEB is still my second largest holding.

Sunday, August 4, 2013

2013 is a Tough Year for Installux SA

While I await Installux SA's 2013 semi-annual earnings report, I found this company report published in June. It is a message from the CEO regarding the company. I am going to paraphrase parts of the report it here in English because the report, like everything else from Installux, is in French. If you can read French, please disregard this post and read the report instead.

Revenue (2012)€ 113 M
EBITDA€ 13.6 M
Net income€ 6.7 M
EV / EBITDA2.1x
P/E7.1x
Price shr€ 156
Dividend yield5.1%
Total shr outstanding303k
In it, the CEO Christian Canty discusses how the company did quite well in 2012 despite the bad economic conditions in France. The company's sales has been flat for the last five years. And the CEO has been aggressively trying to take market share from competitors. However, the company cannot expand given the overall economic situation. So the company will wait for the European recession to pass, wait for better days.

Preliminary results for the first four months of 2013 are bad, but not unexpected given the economy. For the first four months ending in 30 April, 2013, the company's sales are down 10% and operating profit down 24% compared to a year ago.

My biggest worry with this company and my Japanese holdings is the difficulty of gathering information; I can only read English. But this report sooths my nerves a bit. Installux makes aluminum products for housing in France and some other countries. I feel this is a solid , boring, small company. The perfect type for a small-time value investor like me.


Disclaimer: the information on this post was the result of Google Translate and my interpretation, neither is guaranteed to be accurate.

Saturday, August 3, 2013

WLP, AIG, KCLI and CVX Earnings

More earnings releases from my holdings:

Wellpoint (WLP) reported Q2 earnings of $2.64 and raised the year's earnings forecast to $8.00. Since the news, the stock has barely budged at around $85. In their conference call, they emphasized they are expecting excellent growth in their medicare business because of Obamacare. Overall, management expects revenue to grow from the current $71B to $90B by 2016, in no small part due to Obamacare! This is the first quarter under the new CEO Joe Swedish. I liked hearing his plans to squeeze more efficiency out of the company.

AIG reported quarterly earnings of $1.12. AIG stock jumped to $48.33 on the news. AIG book value is $66 per share. In the earnings release, the company generated a lot of press when it declared a $0.10 dividend. This marks a milestone as this is the first time AIG returned capital to shareholders since the bleak days when it was bailed out.

Kansas City Life Insurance (KCLI) reported earnings of $0.98 for Q2 2013. They earned $1.45 for the half year. The stock trades at $42.88 which is only about 2/3 of book value. The stock has risen about 15% since I first wrote about it and bought. I am waiting the stock price to inch closer to book.

Chevron (CVX) reported Q2 earnings of $2.77 per share versus $3.66 a year ago. Earnings for the half year is $5.95 per share versus $6.93 a year ago. The company is diversifying into natural gas. The company needs new sources of revenue. This is just the volatile business of energy (or any other resource). CVX is one of my oldest holdings and I am not concerned about the earnings blip.

Friday, August 2, 2013

My OI S.A. Fiasco

May a year ago I found a Brazilian telecom company that paid more than 10% dividends. I was amazed, and bought it without understanding too much about it. The company ticker was TNE. I watched the stock as it climbed while still giving me 10%. And even when it dropped I thought oh ok I still made good money on this stock considering the huge dividends I got over the year. Then about a year ago, the stock started a incredible slide. And being comfortable being an owner for many years, I bought some more earlier this year. But it continued the slide. The stock has dropped some 80% to date.

Background


Before I continue the story, let me recap the company's history. Brazil is a country with quite a lot of regulations. And company's have complex structures as a result. The company was Tele Norte Leste Participacoes. In 2008 it merged with Brazil Telecom, and after several reorganizations, the company became Oi S.A. (OIBR ticker). Oi is the brand name of the mobile phone service they provide. Oi is one of the four biggest cell phone providers in Brazil, and it has biggest landline network in the country. It is also the second largest telecom company in South America.

As of last year, the company was losing customers. So the company hired a Franciso Valim as the CEO and initiate a turnaround effort with heavy capex spending. In turn the company has slowly started to increase its customer base. But today still, the company's mobile business is not great compared to the other three big mobile providers in Brazil. It's landline business is losing customers, although the company is trying hard attract new business with its internet offerings. In January, Valim was suddenly ousted and replace with an interim CEO.

But the company's biggest problem is its debt. This debt is the result of paying for its acquisitions and its huge dividend. The company currently has net debt of 27.5 billion reais — 1 USD equals 2.2 reais. The company calculates net debt to be total debt minus cash and equivalents. In addition, the company plans to pay about two billion reais per year in dividends. This is the primary reason the stock is depressed: the company's net income is only about a billion reais a year! The company can only dole out such high dividends by adding to debt, and the debt is nearing its limit.

The dividend and debt is this screwed up because the company is majority owned by Telemar and Telemar needs the dividend payments to finance its own debt. And I never realized this until recently! This is a very hard lesson on doing my homework.

 

Recent Events


The recent bad news started with the first quarter's results in April. Earnings came in at 0.16 reais. But most disappointing was the 2.5 billion reais increase in debt. About 1 billion reais was for dividends, but that still leaves a 1.5 billion reais cash burn. That was the cause for the stock's slide for the recent months.

Then in June came news that a star CEO Zeinal Bava will run Oi. Apparently, Bava is famous in Europe. He ran Portugal Telecom and apparently did a good job. Portugal Telecom is also part owner of Oi and Bava was on Oi's board.

EBITDA9.0 billion reais
EV / EBITDA3.8x
P/E3.9x
Interest coverage>1.75x
Price preferred shr$1.85 USD
Price range Apr'13 $1.44 — $2.50
Total shr outstanding1.6 billion
1 USD2.2 reais
Next, in quick succession, the new CEO did the following:
  1. ousted the CFO and some other key executives 
  2. canceled a planned 2 billion reais debt raise
  3. raised 2.4 billion reais by selling company assets 
  4. and stopped the coming planned billion reais dividend 
With each piece of news the stock yoyo'ed. It was a sickening ride. The table on the right shows the key stats based on the last 4 quarters.

In times like this with so much negative sentiment regarding a stock, it pays carefully and objectively look at the facts. The company's funding has been a persistent issue, but disregarding that company is profitable enough. EV / EBITDA is a common metric to gauge a company's value for a takeover. For Oi it is 3.8x. As a comparison Sprint, which is in buyout talks, is at 6.4x. So, if someone could pay the enterprise value that person would get a profitable business.

And buyout isn't the only option, an equity raise is another, this is just an illustration to put it all in perspective. If the company can fix it's debt problems, what remains is a good company and the stock will naturally appreciate.

Debt


But seeing that debt is the key issue, it's good to know how Oi got here. The following shows the increase in debt over recent quarters. Clearly the dividend was a big chunk and removing that from now on will help. It isn't clear what the working capital drain is for, but it should be matched by something else on the balance sheet. The escrow item is mostly judicial deposits. I am amazed at how much Oi is being sued. Maybe that's just how things work in Brazil. Escrow is the requirement by law and is not the same as provisions, and could be reversed in the future. But by far, the largest items that affect the debt are EBITDA and capex. EBITDA has to improve, hopefully Bava will make it happen. Capex was targeted at 6 billion reais this year. Oi needs the capex to be competitive. But hopefully it will go down next year.



And so now, after hearing all the negative sentiment online, I know much more about the company. And now I must objectively decide what to do regarding my Oi position. So, I ask myself, if I didn't own any Oi stock, would I buy? And my answer is I am not sure. Oi has screwed up operationally, but the company has turnaround potential. In addition, the Brazilian stock market has fallen close to a five year low. My feeling is that it is oversold. So, part of Oi's fall was in sympathy with the market, and it will rise also when the market reverses.

In any case, investing in Oi takes faith. I believe that Bava knows what's going on in Oi after having been on its board and he took the CEO job because he was confident that he can turn the company around.

Tuesday, July 30, 2013

Tachibana Eletech, Pfizer and IEH Corp Report Solid Earnings

Earnings season is in full swing. And my holdings are doing well.

Tachibana Eletech (TSE:8159), a small cap factory automation company reported a great start with 1Q 2013. The company reported EPS of 34 yen, a 60% increase yoy. Revenue increased 10% yoy. I presume that the yen's recent drop contributed to the company's results. Management projects 134.75 yen EPS for the year. Which translates to a PE of 7x! In addition, this is a netnet company (see previous post).

The only disappointment with the company is the paltry 20 yen annual dividend (2% dividend yield).

Pfizer reported Q2 adjusted EPS of $0.56. This adjusted EPS leaves out special items such as the Zoetis share sale. For the year, the company projects adjusted EPS of $2.10 - $2.20 and actual EPS $3.07 - $3.22. This is all not surprising. With shares trading at around $30, Pfizer has a healthy P/E in the low teens (adjusted earnings). Recently, I have sold some shares in my tax-sheltered account. But, I'll leave the rest alone. Pfizer is one of those solid stocks in a great industry that you can just leave alone without worry.

IEH Corp (IEHC) reported full year earnings of $0.40 vs $0.48 a year ago. That is a PE of 7x also. Total revenue for the last two years were almost identical. So, it seems margins slipped a bit. IEHC is also a netnet (see previous post).

IEHC is a tiny company with a market cap of $8M. They only do one thing, electrical connectors, and they do it well.  The company has very few customers. The company sells 31% to the corporate world, 63% to the military. All this is little changed from last year.

Friday, July 26, 2013

Taxes and Investment Returns

Often we think about investment as an abstract exercise: simply maximize return at the cost of reasonable risk. We often don't give enough weight to the three real-life handicaps: fees, inflation and taxes. Fees are the most manageable. With enough time and effort one can control of his own investment decisions and reduce fees to simply a few trades a year. Inflation is a double edge sword. The stock market performs best under mild inflation. But high inflation, say above 3%, is definitely damaging to the market. Inflation is something that is a inherent part of the economy and stock market which we can think of as "necessary evil", and which we have the least control. Taxes, on the other hand can have a big negative impact on returns. And it is in our control. The best way to avoid taxes is by using a tax sheltered retirement account. I know that Canada, USA and Britain all have such plans. These plans do not tax the capital gains or dividends while funds are used for investment. But they may tax during withdrawal. These accounts can take only a limited amount of money however, and so there is still the tax question for the funds that cannot be in a tax shelter.

For non-tax sheltered funds, I can think of 4 ways to mitigate taxes:

  1. move to a place with a cheaper tax rate
  2. reduce one's active income
  3. reduce turnover
  4. harvest losses.

In the USA, the federal government taxes long-term capital gains at 15%. However, the state can impose an additional tax which can be as much as 10%. So an American could choose live in a state with little or no capital gains tax.

Reducing active income to reduce taxes may seem silly, but there is a good reason to do this. If a person has a full time job and invests on the side, he may be able to achieve higher net worth by focusing on investment full time instead. In this manner, he reduces his fees to a certain extent, and also he improve his investment rate of return (ROR). So, even though initially his income is may be lower, it could result in higher net worth over a lifetime because of a higher compounding ROR.

The last two ways are related to turnover. Turnover is defined as a rate that is the proportion of one's portfolio that is sold and bought in a year. If one has a turnover of 25% that means he turns over his entire portfolio once every four years. The less the turnover, the longer funds can compound before the taxman takes it.

Harvesting losses is one argument for diversification. In this method, an investor with a large portfolio has a large number of holdings, which increases the chances of having at least some losing holdings every year. Thus, he can selectively realize the losses to cancel out the gains. The net result is to reduce the turnover rate that will trigger capital gains.

So far this is all straightforward enough. But I haven't found any detailed analysis of the effect of the turnover on the taxes paid. So I decided to do it myself.

To do this, consider a investor with a hypothetical scenario starting with $1000. We'll compare the effective return after taxes after 25 years for different turnovers. First, assume that he maintains a constant 9% rate of return (ROR) and he turns over the entire portfolio every four years. To achieve, he invests the entire portfolio initially, then he "flip" 25% of the portfolio every year. In this discussion, flip means he sells a quarter of the portfolio pays the taxes and reinvests the remainder. In the first year, he flip 25%, in the second and third year he flips the 25% of the portfolio that he didn't flip before. By the fourth year onwards, he flips the portion of the portfolio that have been in the portfolio for exactly four years. In the last year, the investor sells all.

The following table shows the amount that the investor has after 25 years and the after-tax CAGR in parenthesis.
9% pre-tax ROR
Tax Rate 0% 15% 25% 35%
every year 8623 (9.0%) 6315 (7.7%) 5119 (6.8%) 4143 (5.9%)
every 2 years 8623 (9.0%) 6383 (7.7%) 5202 (6.8%) 4225 (5.9%)
every 3 years 8623 (9.0%) 6447 (7.7%) 5281 (6.9%) 4305 (6.0%)
every 4 years 8623 (9.0%) 6507 (7.8%) 5356 (6.9%) 4383 (6.1%)
every 5 years 8623 (9.0%) 6563 (7.8%) 5428 (7.0%) 4458 (6.2%)
every 6 years 8623 (9.0%) 6616 (7.9%) 5496 (7.1%) 4530 (6.2%)
every 7 years 8623 (9.0%) 6666 (7.9%) 5561 (7.1%) 4599 (6.3%)


And the following tables shows the same for 12% and 15% pre-tax ROR.
12% pre-tax ROR
Tax Rate 0% 15% 25% 35%
every year 17000 (12.0%) 11338 (10.2%) 8623 (9.0%) 6538 (7.8%)
every 2 years 17000 (12.0%) 11546 (10.3%) 8861 (9.1%) 6763 (7.9%)
every 3 years 17000 (12.0%) 11740 (10.4%) 9089 (9.2%) 6983 (8.1%)
every 4 years 17000 (12.0%) 11921 (10.4%) 9307 (9.3%) 7196 (8.2%)
every 5 years 17000 (12.0%) 12091 (10.5%) 9514 (9.4%) 7403 (8.3%)
every 6 years 17000 (12.0%) 12248 (10.5%) 9710 (9.5%) 7602 (8.5%)
every 7 years 17000 (12.0%) 12395 (10.6%) 9894 (9.6%) 7793 (8.6%)


15% pre-tax ROR
Tax Rate 0% 15% 25% 35%
every year 32919 (15.0%) 20087 (12.8%) 14371 (11.3%) 10236 (9.8%)
every 2 years 32919 (15.0%) 20638 (12.9%) 14970 (11.4%) 10770 (10.0%)
every 3 years 32919 (15.0%) 21151 (13.0%) 15545 (11.6%) 11297 (10.2%)
every 4 years 32919 (15.0%) 21628 (13.1%) 16094 (11.8%) 11812 (10.4%)
every 5 years 32919 (15.0%) 22070 (13.2%) 16615 (11.9%) 12313 (10.6%)
every 6 years 32919 (15.0%) 22478 (13.3%) 17107 (12.0%) 12797 (10.7%)
every 7 years 32919 (15.0%) 22854 (13.3%) 17570 (12.1%) 13261 (10.9%)

The results do make sense, although it was a bit surprising at first. I expected the effect of turnover to have a greater effect that the tables show. The greatest effect is at high return, high tax rate and high turnover; i.e., at 15% pre-tax ROR at 35% tax rate, the difference between high and low turnover is 10.9%-9.8%=1.1%. But, this leads me to think, hmmm, maybe I shouldn't worry about turnover so much, and focus more on reducing the tax rate by moving?

Anyway, the table is food for thought for now. I am sure I'll refer to it later.

Saturday, July 20, 2013

How Benjamin Graham Actually Invested

I have been intensifying my research on the internet and I have been surprised at the little gems of info you can find by looking hard. I have found the annual reports of the Graham-Newman Corp, hedge fund letters, and even free copies of financial books. From this experience, I have gained valuable insight into the opaque money management world. And I am going to share my conclusions here because I don't think any other bloggers have expressed such views.

Benjamin Graham is the father of value investing. Money managers try to make money using various styles of investing. But a huge subset of these managers use the value investing style.

To me, value investing is buying a equity at below some intrinsic value which is calculated based on current earnings and balance sheet. Many investors try to follow Graham's methods with their own individual touch. For example, Warren Buffet buys top notch firms for good value. However, not everyone can have success being a value investor. I like the following quote by Charlie Munger:

I think the idea that everyone can have wonderful results from stocks is inherently crazy. Nobody expects everyone to succeed at poker."


But some money managers are failing not only because of the law of averages. I see that some hedge fund managers are losing at the value strategy also because they aren't truly following Graham. And I am expounding on that here mainly to remind myself how I can go wrong and to avoid it.

Benjamin Graham ran the Graham-Newman Corporation as a investment partnership between 1936 and 1956. It beat the market on average by 2.5% and it could be a template for hedge fund managers. Benjamin Graham wrote The Intelligent Investor and in it he described how he invested for his firm. His value approach practically assumes the future is unknowable and thus to discount future growth projections. He devotes a chapter to Margin of Safety, which covers outcomes that may go against his investment.

Graham eventually closed his firm because he wanted to move to California and focus on other interests. He wasn't challenged by investing anymore because it became mechanical. That's the holy grail! To beat the market by 2.5% without creative thought required! That should be the investment strategy of any long term investor. Graham and Walter Schloss have done that.

But many of the the value money managers out there do not follow this strategy. One big reason is the incentives. A hedge fund's management fees is based on its performance each year. They typically get 20% of the profits from the previous year. And if the fund has losses the previous year, the manager must recoup the loss before collecting his 20% fee. So the manager is motivated to shoot for the moon, and if he fails at it, especially if the fund blows up, then just close it. And this strategy is especially effective when starting a hedge fund in the middle of a bear market, because a bear market is the easiest time to make money.

An investor cannot make good money long term investing this way because this investing style is too risky. It is almost like gambling. But I think many investors fall into this because they are impatient. Long term investing means waiting over a entire bull and bear market for the above average returns.

As an example I came upon the letters of Seller's Capital, a value hedge fund. Seller's Capital started in 2003 in the middle of a bull market and had tremendous returns, until 2008. Shortly after, the management started talk of winding down the fund. It finally did in 2010. At 2008, it had concentrated positions in Contango and Premier. Contango is a driller of oil and natural gas. The pros for Contango sounds great, it has low cost, rights to great sites, etc. But each trade involves two sides, a buyer and a seller; thus, the trade must involve a pro and a con. So I have heard the pros but what is the con? In hindsight one con appears to be the crash in gas prices due to the proliferation of fracking. Premier also went very wrong in part due to a lawsuit over the rights to the Titanic wreckage. Both these cases teach us what can happen to a portfolio if we do not invest with an adequate a margin of safety.

When I looked closely at Graham's partnership, I was most surprised at how diversified his investments were. His disciple Schloss was even more so. Some have said diversification is a defense against ignorance. But this is not. If one diversifies to the extreme across all sectors and all markets and all types of companies then that's investing to match the market. Graham and Schloss invested in many companies of a peculiar class as an added margin of safety. Graham mostly invested in four types of securities:

  1. Arbitrages: e.g., mergers
  2. Liquidations: e.g., company shutdown
  3. Related hedges: for convertible bonds or preferred shares
  4. Net-nets: as in value of the equity minus intangibles and long term assets; buying companies with net-net less than market cap

Schloss mostly liked #4, which is my favourite, also called picking up cigarette butts. In this manner Graham and Schloss are taking luck out of the equation, and they made money because their investment strategy was right.

This is the Graham style of value investing, which I want to emulate. I am not saying it is the only way to be a value investor, because the notion of value investing is subjective. But this is how the father of value investing did it very successfully.

I also like to read fund letters and the histories of famous investors who made big mistakes, because life is too short to make all the mistakes yourself. The investing world is full of the carcasses hedge funds that have blown up. A good post-mortem can save ourselves the same grief.

As a final note, below is the Graham-Newman Corp Annual letter from 1950. Enjoy.


Wednesday, July 3, 2013

Wellpoint and Obamacare Today

The White House announced today that the Affordable Care Act (aka Obamacare) would extend the deadline for medium to large companies to provide health insurance by one year; from Jan 2014 to Jan 2015.

This is an interesting development but I believe the Obamacare is proceeding mostly as planned. I have followed Obamacare closely because Wellpoint (WLP) is my biggest holding. The stock has run up 50% since the lows of last year. So, this stock is becoming an ever larger portion of my portfolio.

WLP is the managed care organization (MCO) with the largest number of individual subscribers. And Obamacare will have the biggest effect on uninsured individuals. The individual mandate will take affect Jan 1, 2014. As that day approaches, I pay more and more attention to WLP.

Coming in 2014, each state will offer an exchange for individuals to choose health insurance offered by private MCOs like WLP. I think the exchanges are ready for 2014 and will not be delayed like the company mandate. Parts of Obamacare have been in force since 2010, but the individual mandate is the most significant part of Obamacare for WLP because WLP is a large provider of individual insurance. And the mandate was challenged all the way the supreme court, but it survived. The individual mandate means an additional 30 million Americans who otherwise don't have insurance must either now go to an exchange to get one, or pay a penalty tax.

I see two big possible risks to WLP in the coming year. The first is fear of government oversight of the managed care industry which would restrict profits. One part of Obamacare dictates that the portion of premiums that at least 85% of premiums must go back to pay for costs (this is called the medical loss ratio). This law reminds me of the government's taxation of tobacco companies to pay for health problems resulting from smoking. The resulting effect of that law is actually greater market share by the dominate tobacco companies. This part of Obamacare, like other government regulation of businesses, will fatten the big dominant companies (like WLP) at the expense of the smaller ones, because of their greater scale.

The second is the possibility of losses from serving sick individuals who previously don't have health coverage. WLP voluntarily participates in the exchange system because it relies on individual customers for a large portion of its business. This is a known issue and WLP, like all participants, enter exchanges with their eyes wide open. They should be able to judge the risks and begin conservatively. Also, the biggest positive is that the government designed the individual mandate to spread out the risk by forcibly adding a previously uninsured pool of 30 million people.


Getting a Bigger Piece of the Pie


When I invest I like to think contrarian and not overweight headlines. With MCO companies the statistics and information about demographics and costs can be overwhelming. I think the market tends to get too caught up in the numbers while failing to look at the big picture. The bottom line is the US spends 17% of GDP on healthcare. And much of that 17% goes through MCOs. The following illustrates the coverage of all people in the US. As one can see 69% of people are covered by MCO. About 16% are uninsured, and time will tell how much of this 16% will participate under Obamacare, maybe 8%? maybe 10%. The other 15% are various government agencies such as Medicare and Medicaid. But both of those have private MCO options. At the time the chart was made, in 2010, 12 million people use Medicare through MCOs, by 2015, it is projected to be 16 million. So the MCOs are eating into the government's piece of the pie, and the government is ok with it! In any other industry where the market is growing by millions of customers per year, the market would drool. But, it doesn't seem so with managed care.


Health Coverage for all US Persons



Sunday, June 30, 2013

5 Years After Great Recession, What's Next?

As I have mentioned in other recent posts, this summer season feels like the calm before the coming storm.

I am not predicting a September/October market crash, nor am I saying the market will shoot higher while we climb a wall or worry. I cannot predict Mr. Market. But this season is a milestone because five years ago this time we were getting close to the start of the Great Recession. The last five years covered the full force of the Great Recession as well as a seemingly miraculous recovery.

It is often said the true measure of an investor or money manager is how he does through at least one full boom and bust economic cycle. No great investor has been called great without showing that he has weathered several such cycles. Think of the likes of Benjemin Graham, Warren Buffett, Walter Schloss, Seth Kalman, John Neff, John Templeton, and on and on.

Furthermore, many investing sources will give you the past 1, 5, 10 year period performance of any mutual fund or hedge fund. So I have collected the a list of some prominent equity funds, as shown below:

Fund Manager(s) Last 5 YR Annualized Return
Bruce Fund Bruces8.6%
Yacktman Fund Yacktmans 14.0%
Davis New York Venture A Davis/Feinberg 2.7%
Fairholme Berkowitz 5.2%
Pabrai Investment Fund 2 Pabrai 3.0%
FPA Crescent Romick/Rodriguez 6.5%
Legg Mason Cap Mgmt Value C Miller/Peters 1.0%
Hussman Strategic Growth Hussman -4.0%
T2/Kase QualifiedTilson/Tongue -2.9%
S&P 500 Total Return (Jan 2013) 3.1%
Returns include fees. Period is Jan 2008 to Jan 2013, or if not possible then a close period to it.

The list includes hedge funds, mutual funds, US equity funds and international equity funds. So, the list isn't meant to be a direct comparison but as a gauge of how various funds and their manager's strategies have fared.

The fund managers in the table are some of the most prominent fund managers in the US. They are all probably in their 40s and 50s. These are going to be our thought leaders in the coming five years. It will be very interesting to see five years from now how these funds and their managers fare!

In the last fives years we have learned a lot about ourselves and our world. One of the biggest is that our world is not going to grow as much as we would like. In the past the typical investor like myself were too optimistic about the long term stock market growth. We thought 10% to 12% is achievable. That I feel is one of the biggest reasons for two horrific market corrections in the last 15 years. Investors were sold on the idea that we can achieve high growth, if we just knew where to go. So first it was high-tech in late 1990's and when that failed, well, we'll just go to housing.

Now I, and a lot of other retail investors, are much more jaded and are much more wary of equities. I am more resigned to the overall market achieving 7% long term, rather than the 10% to 12% I expected before. This, coupled with the fact that we had a run up in stocks in the last 4 years, leads me to think we should expect much lower than 7% in the coming 5 years.

The rise of formerly developing countries like China is creating ever greater demand for commodities. I am talking about better foods, like meat, oil, water, etc. This fact by itself isn't really surprising, but its consequences can be surprising. For example, higher oil prices and innovations have caused the US to produce more oil than any other time in recent memory. And as the US produces ever more oil, the US will be able to reduce its trade deficit and the dollar will get stronger.

Next Five Years


The US Fed actions of the last five years have shown that the US dollar is a debased currency. But the Euro isn't much better with all the problems in the EU countries. Meanwhile, developing countries like China also have fundamental problems. I feel the conventional thinking is that China is a country with a tremendous amount of "animal spirits". And the country has a command economy that can direct whatever necessary for the greater good. However, I feel the conventional thinking doesn't give enough weigh to the roadblocks to China's success. China does not have long history of rule of law, nor does it have a long history with a large vibrant middle class. These and various other negatives, which developed countries do not have, can lead to corruption, discontent and distrust of the local financial system. This can have a dramatic effect on Chinese household asset allocation.

The average Chinese cannot cannot rely on the equity markets for returns because the Chinese equity markets have not proven themselves to be good allocators of capital. China's GDP grew at around 9% annually in the period from 2000 to 2013. Yet the Shanghai Composite Index has only returned about 2.1% annually over that time! Yes there are many elite and powerful people in china who have become extremely wealthy through equities, but these are mostly through connections which are closed to the average household.

In addition, the Chinese get low rates on deposits. So recent articles have pointed to a "shadow banking" sector whereby the average person can deposit money for loans to corporations through less regulated banks or institutions. The Chinese are starved for yield to combat their inflation.

It is quite interesting that the last few years of easy money all over the world has not resulted in excessive inflation. Wages are kept low and companies are achieving record margins. Money is growing faster for shareholders than wage earners. Maybe that's why inflation for everyday items are low. But we may soon see inflation of financial assets, such as bonds and equities. But it has to be quality financial assets.

According to this report, the world owns $198 trillion USD in financial assets in 2010. One third of this amount ($67 trillion) is equities. The report expects the world's financial assets to reach $371 trillion in 2020. That is a reasonable 6.5% annual increase. But the report stresses that developing countries do not invest in equities nearly as much as developed countries. This is a case of distrust of the equity markets and less sophisticated equity markets in those developing countries. But I think good equity markets are necessary for an advanced economy.

Now is only 7 years to 2020 and how is it playing out for China? Well, either the article is off the mark, or the China market is going to explode, or the Chinese will have to invest in bonds or other alternatives, or they will have to move money overseas. I feel the latter will be a big factor; that is, they will invest more and more in real estate overseas, as well as equities and bonds overseas. If they are restricted from moving money overseas, they will face lower returns. You can see this in the low returns of the stock market, bank deposits and the high price of real estate in China. And when they move money overseas, they want more to preserve capital rather than generate cash flow.

And China isn't the only developing country with growth and reform issues, as we have seen from protests in Turkey and Brazil.

So my conclusion here is that the coming five to ten years will see a resurgence of asset values in developed areas of the world; i.e., North America, Japan and Europe. And based on this I think the CAPE (10 year PE) of the US markets can remain above average for the next five years. But considering the fundamentals of the US, I don't see the market going 20% higher in the next year or two. But, I also don't see a prolonged correction in the near future.

Thursday, June 13, 2013

Why I'll Pass on the Pfizer-Zoetis Exchange

I am an Pfizer (PFE) shareholder and the company is making an interesting tender offer of its animal meds division call Zoetis (ZTS).

Zoetis up until a year ago was a wholly owned division of PFE. Then it IPO'ed this year. PFE tendered 20% of its shares in ZTS, so it still owns 80%. Then PFE realized that the market was strong and this is the time to unload all of its remaining stake in ZTS. It is doing this via a exchange offering to PFE shareholders.

The exchange offering expires June 19. It gives the PFE shareholder the right to get ZTS at roughly a 7% discount to the ZTS market price. To get the ZTS shares, however he must exchange his PFE shares. This is a non-cash exchange. So the discount gets reflected in the exchange ratio between ZTS and PFE. Suppose the market price of ZTS and PFE are equal, then the PFE shareholder can get 107 shares of ZTS for each 100 PFE shares tendered.

The market price for the exchange is considered to be the average of the two stock's trading price in the three days before and including June 19.

The Pfizer shareholder has the right to get up to 0.9898 ZTS shares for each PFE shares owned. The number of shares that Pfizer will actually exchange may be different from what the shareholder asked for because ZTS is a much smaller company than PFE. If PFE shareholders oversubscribe (i.e., there wouldn't be enough ZTS shares to go around) the ZTS shares will be distributed proportionally to the number of PFE shares tendered.

So, the amount of benefit to a PFE shareholder is dependent on how much other PFE shareholders tender. If plotted on a graph this would be a straight-line relationship. I didn't bother plotting a graph but instead calculated the benefit at the endpoints if I tender to exchange $100 worth of PFE shares. The endpoints are the least and most favourable cases.

In the least favourable case, we all subscribe all our shares. The market cap of PFE and ZTS are $204.8B and $15.6B, respectively. And PFE is putting up 80% of ZTS shares. So the ratio is $204.8:$12.4, or $100:$6.05. Then to get $6.05 worth in ZTS shares I must exchange about $6.05 &divide 1.0752 = $5.63 worth of PFE. And in the end for each $100 PFE I had before exchange, I would have $94.37 worth of PFE and $6.05 of ZTS, for a $0.42 gain in the least favourable case.

In the most favourable case, few people beside myself subscribe. Then for each $100 of PFE I would get about $100 * 0.9898 * 1.0752 = $106.42 worth of ZTS. And in the end for each $100 PFE I had before exchange, I would have $1.02 worth of PFE and $106.42 ZTS, for a $7.44 gain in the most favourable case.

So, it is a guessing game between PFE shareholders; the payoff is a possible 7.44% gain. The more people exchange thinking they can get the 7% the more likely they will end up closer to 1%. The more people give up and think it isn't worth the trouble, the more likely that those who do exchange will get 7%. This is a arbitrage situation. I am sure someone in some hedge fund must be dreaming of a way to make a small gain. But one major downside is the transaction cost of executing such a trade. I don't want to do such a thing because of the small gains involved. The other reason for exchanging could be because I want to own ZTS long term. But again, I don't want to because Zoetis trades at a PE of more than 30. I wouldn't own such a stock with such a tiny discount.

So I will keep my PFE shares. Tell me what you think.


Disclaimer: please look at the disclaimer section on the right column. If in doubt about what to do, please consult a qualified financial advisor.

Wednesday, June 12, 2013

Now Is Always the Most Difficult Time to Invest

I have heard that saying somewhere. A few weeks ago, I wrote an open-ended post that reflected this uncertainty. I wasn't sure of whether to load up more aggressively or lighten up on stocks. I used to think that this kind of strategy is somewhat like trying to time the market. And I know I cannot and should not try to do that.

But recently, upon reading Benjamin Graham's books again. I realize his conservative strategy is really centered on the allocation between bonds, which reflects a pessimistic view, and stocks, which reflects a bullish view. Graham says that one should allocate between 25% to 75% stocks, with the remainder in bonds. In bullish times, when stocks are undervalued, he would allocate closer to 75% stocks. In times when stocks are more speculative, he would allocate closer to 25% stocks. This has the effect of moderating the big returns in bull markets and mitigating the huge drops during bear markets. The net result of this is better return in the long term which is over cycles of bull and bear markets.

I want to follow this strategy because I don't have a crystal ball as to the direction of the market, especially now. In fact I don't even know whether stocks are overpriced or not. But if I am forced to take a position, I'd say we are most likely in an overpriced market right now.

I am not a financial guru on market valuation, so I look to others for guidance. The mutual fund filings are a good source of information. But the funds must be balanced funds that hold both stocks and bonds. My only fund holding is the Bruce Fund. I have a lot of respect for this fund because of its staying power over 30 years. They say past performance is not guarantee of future gains. But I believe the Bruce fund has the best idea of how to handle the current market. So I look back over the last 15 years when the annual reports are available on the SEC website. The following chart shows their bond and cash allocations over that period. The remainder of their fund was invested in securities, including common, warrants and preferred shares. The chart shows the bond position from the safe portion (cash) to the riskier portion (corporate bonds).



One can see how the Bruces correctly called the recession of 2000 and 2008. The fund's cash and the safer government bond positions were high in the periods before 2000 and 2006-2007. I believe this is the key to the Bruce Fund's outstanding return. But most important goal of this exercise is to figure out what to do now. It is appears that the Bruce Fund is in a holding pattern for the last 4 years. The fund is cautious but not so much like the periods before the last two recessions.

Warren Buffett is another great investor who likes to keep a cash hoard as insurance for a rainy day. His cash position is substantial but difficult to interpret as he has a big conglomerate and insurance business to run. Seth Klarman of the hedge fund Baupost is another defensive investor and he has recently said he keeps more than 30% cash.

But there there is also some compelling arguments to the opposite view that this is the time to allocate more to stocks. The current overall investor sentiment just isn't strong. The current market is full of investors running scared. Since 2009 investors have been consistently moving money from equities to bonds. Furthermore, the consumer confidence index is at 70, which is still below the normal 100 of the pre-recession days. These are contrarian indicators that makes it hard for me to imagine a bubble and the inevitable crash.

Another compelling data point is the graph I posted earlier. The graph shows the 10-year cyclical adjusted PE , the 10-year treasury yield and the inflation rate. A high inflation rate forces a high interest rate. But today we have the enviable position an of big government stimulus without high inflation and without high interest rate. And, for this reason, Fran├žois Rochon of the Canadian Giverny Fund then concludes: "We believe that equities will be the best asset class in the coming years for the simple reason that it seems to be the most undervalued."

So there you have it, both sides of a compelling argument. Never is the adage that now is the most difficult time to invest been so true.

Friday, June 7, 2013

McRae Industries Reports Third Quarter Earnings up 46%

McRae Industries (MCRAA) reported revenues up 22% and earnings up 46% from the same quarter a year ago. Operating margins were the same as a year ago, but SG&A expense was 18.6% of revenue this quarter versus 21.4% a year ago. This made the difference in the tremendous improvement in earnings.

The company earned $1.3M in the quarter. In each of the first and second quarter the company earned $1.9M. I consider the drop in earnings acceptable. From what I hear about earnings this year, companies that sell domestically have outpaced the market as a whole. That would explain McRae's outstanding results this year. Consumer sales now account for about 2/3 of sales. McRae's biggest product is women's cowboy boots. And the recession's effects must have depressed earnings last few years. But this year they appear to be back in a big way. The earnings for the first 3 quarters are $5.1M. Projected over the year that is $6.9M. The company market cap is approximately $54M, for a PE of 7.8!

Granted women can be fickle and earnings could go south very quickly. But with the end of the recession (hopefully) and consumer confidence back I think the upside is much greater than the downside. Furthermore, the balance sheet offers protection for the investor. The following chart shows their balance sheet numbers:



The company is a netnet and it is earning good money, money which goes straight into making a bigger and bigger netnet! My intrinsic value on this stock is $32. It trades at $22.35 today.

How McRae Reports EPS

The company's financial statements are straightforward, except for the EPS calculations which has myself and otcadventures stumped. But today I finally solved the mystery by speaking with Marvin Kiser, the CFO. Marvin explained to me that the formula for the EPS calculation came from the SEC and was blessed by their auditor. So they just go with it.

The cause of the EPS anomaly comes from the treatment of the class A and class B shares. The class B shares are the big voting shares, and they are like preferred shares and they mostly lies in the hand of the insiders. Class A is what us common folk own. There are about 5 class A shares for each class B share.

The reported basic and diluted class A EPS is:



Now if you think like me, the reported EPS just makes no sense. Is the dividend somewhere in the income statement as an expense? No it isn't. So, it appears the reported EPS is double counting the dividend amount, which was $0.09 last quarter. Go figure!

From now on, I will ignore the company's reported EPS and use my own EPS, as I have given above as the net income divided by total class A shares. But it isn't a big deal, as the EPS has no real bearing on the shareholder's bottom line. What really matters to the shareholder is his dividend and his share of the equity.


McRae Industries is one of my largest positions.

Sunday, May 19, 2013

Investing in Tachibana Eletech Isn't Hard

Tachibana Eletech (8159:TSE) recently reported impressive earnings for year ending March 31, 2012. Earnings increased 18% yoy, despite revenue increasing only 4%. I had worried that the company is a low margin business, but now the management appears to be tackling the margin issue.

I summarized the 2012 results in the chart below.


In an earlier post I mentioned the company as a net-net with good earnings. I calculated net-net or net current asset value (NCAV) as current assets minus current liabilities. But Tachibana, and possibly all Japanese companies, reports assets as the sum of the following components:

  1. current assets
  2. property and equipment and
  3. investments and other assets 
And I had previously considered the last component as non-current. However, upon reading the 2012 report I realized 90% of it is marketable securities or government bonds. They are very liquid and therefore should be treated as part of net-net. When I did this, the net-net value is much better than I previously thought! The above chart reflects this.

Tachibana Eletech is an industrial company specializing in supporting manufacturers. The Factory Automation (FA) Division is its main division accounting for almost half of its sales. The other main division is the Semiconductor Division. The Japanese expertise in manufacturing could be very useful for developing Asian countries. And the company is trying to increase exports. However, its Overseas Division is only 17% of sales right now.

For 2013, the company is targeting a 3% increase in revenue and 5% increase in income. In good times this is achievable, however an economic downturn could easily make both numbers negative as was the case in 2009 and 2010.

The company's ROE is 6.8% and its earnings yield is 10.7%. Its dividend yield is 2%. In summary, I think Tachibana 1) has a decent growth story, 2) trades at small P/E multiple and 3) its book value is not priced into the stock. I estimate its intrinsic value as 1450 yen per share. It is trading at 1100 today. To me, investing in Tachibana is a no brainer.


Disclosure: I added to my position in Tachibana after reading their earnings report.

Saturday, May 18, 2013

Seaboard First Quarter Earnings $47 per Share

Seaboard Corp reported earnings of of $47 per share, which is a 21% drop yoy. However, Seaboard Corp is a diversified agriculture company with five main segments. So, to understand the company, one should break down the operating results by segments. I decided to analyse the segments by detail.

The following table shows the most recent quarter's results, as well as that of the same quarter a year ago. And it shows the yearly results for the last three years.


Segment Q1 2013Q1 2012201220112010
PorkRevenue409.3400.71638.41744.61388.3
Income32.352.9122.6259.3213.3
Margin7.9%13.2%7.5%14.9%15.4%
Commodity Revenue800.8724.53023.52689.81808.9
Income12.325.771.943.234.4
Margin1.5%3.5%2.4%1.6%1.9%
MarineRevenue230.2233.7969.6928.5853.6
Income-3.30.526.1-3.947.6
Margin-1.4%0.2%2.7%-0.4%5.6%
Sugar Revenue66.2 73.6 288.3 259.8 196
Income16.51760.265.131.7
Margin24.9%23.1%20.9%25.1%16.2%
PowerRevenue7335.5255.4111.4124
Income12.95.85560.813.4
Margin17.7%16.3%21.5%54.6%10.8%



Total quarterly revenue was up indicating the company is growing and/or higher prices for commodities. However, profits are down due to the Pork and Commodities Segments.

Pork Segment

Looking at the Pork Segment, the company indicated corn (feed) prices were higher yoy. This may explain the lower margin. Pork cost is very dependent on corn prices. The following table shows the pork and corn price indices over the same periods. Unfortunately, in Q1 2013, the price of pork dropped at the same time that the price of corn rose. But good news is coming, the good rainy season we have now will mean corn prices will drop in the coming summer and fall. So, I anticipate the Pork Segment's profits to rise.




Commodity Trading and Milling Segment

The biggest subsidiary is the Commodity Trading and Milling Segment which is like a middle man for wheat, corn, soy and etc. Commodities for this segment are generally higher than last year, however the profits are down. That is troubling. In the report, the company states


...The decrease primarily reflects lower margins on commodity trading sales to third parties and non-consolidated affiliates, especially on sales of wheat and corn. The decrease is primarily the result of unfavorable market conditions and certain inventory positions negatively impacted by the decrease in commodity prices in the first quarter of 2013 compared to favorable market conditions and certain inventory positions positively impacted in 2012 from increasing commodity prices.


which seems to indicate that commodities purchased in Q4 2012 were sold in Q1 2013 as commodity prices dropped. Indeed, wheat prices dropped 20% from Q4 2012 to Q1 2013. Similarly, corn prices dropped 15% over the same period.

Management said in the report it cannot predict the results from this Segment for this year. Most of this Segment is in less predictable foreign countries.


Sugar Segment

The following chart shows the price of sugar. The results of the Sugar Segment follows sugar prices. Unfortunately, sugar prices were down in the quarter.



Other Segments

The Marine and Power Segments shouldn't be the main sources of income for Seaboard, although a newly introduced power facility did help in the quarter. In addition, their 50% interest in Butterball suffered a $5 million loss, versus a $8.9 mil gain in the same quarter a year ago.

So overall, the first quarter has been a disappointing start. But even if all other Segments run at the current rate, and pork prices rise and corn prices fall, the company could still earn more than $200 per share.

Seaboard is my largest holding and I bought this stock many times at below $2000 per share. Now the stock trades at $2700. My estimated intrinsic value is also about $2700. So, I may reduce my holding soon as I feel it is fully valued.