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
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.


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
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.


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.