McRae Reports Lackluster Q2, Sterihealth Gets Takeover Offer

Sterihealth at Buyout
Buyout Price	AU $ 1.75
Market Cap	AU $ 34.20 M ($ 31 M USD)
P/E TTM	8.9 x
Div yield	4.0 %
LT Debt/TBV	3.96
EV/EBITDA	5.35

McRea Industries reported Q2 revenue was up 3% but income was down 20% yoy. However Q1 was a great quarter. So H1 revenue was still up 14% and income was up 20% yoy. Profit margin was still a decent 8% in H1.

The company blamed the worse Q2 numbers primarily on 1) higher consumer sales in Q1 offsetting the Q2 consumer sales and 2) lower margins due to higher import shipping costs and consumers shifting away from premium boots, among other factors.

The stock went as high as $36 before the earnings report. Now it is $31 due to the lackluster Q2 results. I believe the Q2 numbers are more likely the norm than the exception. McRae has had a great recent run of improving sales and earnings. It's time for them to stop growing and maybe even fall back a bit. The boot business is not high tech. One reason I first bought the stock was the balance sheet. The company has no debt. With returns on equity around 15%, the company is simply growing book by 15%. The price to book ratio is currently at about 1.25. I am hoping the stock goes back to the $36 level before I contemplate selling.

In other news, the Steriheath board has accepted a $1.75 AU per share buyout offer from Dan Daniels. Dan Daniels currently owns almost 50% of the shares. After buying the stock three months ago at $1.30, I'll gladly take my money and run!

Know What You Don't Know

Over the past Christmas holidays I had some free time to pursue an intriguing project. I wanted to get some insight into the what is the best cash-stock allocation mix. In today's world of virtually zero interest yield we can think of this as the classic bond-stock allocation problem. The traditionally accepted to invest is through diversification of between stocks and bonds and also diversification within stocks. For example, Benjamen Graham devotes part of The Intelligent Investor to explain the percentage allocation of each under different circumstances. His advice is intuitive and conventional. When the market appears overvalued, allocate more to cash, up a maximum of 75%. And when the market is undervalued, put the money back in stocks. The 75% number is a bit extreme in my opinion, but I follow his advice otherwise.

As far as I have seen, though, everyone gives this advice in a heuristic manner. I want to change that. I want to find some mathematical confirmation that the conventional cash and stock mix yields a better result than just all stocks. To this end I will need to make some assumptions of the market behaviour. Under these assumptions I put in a mechanical cash-stock allocator algorithm and repeated simulate it. Each simulation is a possible realization of the stockmarket outcome over say 30 years, using my assumptions. My findings were quite surprising (to me). Try as I might, I could not beat a 100% stock strategy over the long run. So, I gave up. Though, I did not shake my belief that one must have ample cash at any time. Cash saved me in 2008-2009, and many a wise investor such as Buffett, employ this strategy. Then recently while thinking about it again, I think I answered this mystery.

Any probabilistic mathematical analysis requires some assumptions to create a model. I assumed that the stockmarket will return the same as it has for the last one or two hundred years, which is an average of about 10%. But the last two hundred years has been a resounding success for the markets. And no theory says it will continue. To assume a 7 or 10% return for the market is to put total faith in one possible scenario. We shouldn't put too much faith in the assumption because we really don't know! If we don't know what we don't know, bad things happen.

As one example consider one of the most elegant theoretical results in use in finance: the Black-Scholes formula for pricing options. It is a piece of mathematical elegance to price the option on an underlying stock assuming that stock behaves in a simplistic theoretical manner. Some blame Black-Scholes for the financial crises of 2008-2009. But I feel the problem is not the formula. The problem is with the investor who forces real world stocks to fit the Black-Scholes assumption. The Black-Scholes assumption is just one possible way of modeling stocks. This formula certainly does not factor in the human psychology that is part of every market transaction. When market participants overuse the Black-Scholes formula they can then change the behaviour stocks such that the assumption no longer holds. It is like the Truman Show. The Truman show only works if the participating is unaware of his world. If he is aware, then he will change his behaviour unpredictably.

So now back to the cash-stock mix. I realize we should always reserve some cash because we do not know the future of markets. Though I tend to think it will be somewhat like the past, the best approach given this uncertainty is to have a portion in stocks and also hedge the stocks with cash. The cash portion is like a call option on some stock at some cheap price in the future. The cost of this option is the opportunity cost. However I cannot quantify this opportunity cost because I don't know what the market will do. But I do know that the higher the market value, the less is my opportunity cost. And so I would allocate more to cash.

For me then, it is hedging for maximum benefit under all unforeseen scenarios. I know this is a bit contradictory, saying there is a optimal way to operate in a unknown world. But we have to admit we don't know something. That's a lot better than not knowing what we don't know. Investors who ignore this fact do so at their peril.

Seaboard Reports 2013 Results

SEB
Price	$ 2620
Market Cap	$ 3127.18 M
P/E TTM	15.2 x
Div yield	0.0 %
P/BV	1.26
ROE	8.3 %
LT Debt/Equity	0.13

Seaboard Corp (SEB) reported that Q4 was the best quarterly result in 2013, but for the year income was lower than 2012. Revenue for 2011 2012 and 2013 were 5746M 6189M and 6670M, respectively. Income for 2011 2012 and 2013 were 346M 282M and 205M, respectively This appears to indicate that margins are dropping. SEB has many businesses segments, all of which are cyclical commodities. So I wouldn't read too much into the drop.

The pork segment is Seaboard's largest at 1/4 of total sales. This segment made up 3/4 of the company's profit however. The marine segment turned in a loss, though it was profitable last year. Shipping is suffering from a glut of ships and rates don't appear to be improving much. Seaboard is committed to shipping however and it is investing in several new ships. I believe Seaboard wants to stay in shipping to be a vertically integrated food company.

Overall I feel the company's management has a very long term view. They allocate capital prudently with little debt. And this shows in their consistent revenue growth. The last year's numbers came in a bit lower than I would like but in my eye this is a company that is trading at 10 times forward earnings.

In other news from my portfolio, Sterihealth (ASX:STP) resported H1 earnings were $0.10 AUD, which is the same as a year ago. However, sales were up 9%. This indicates some margin pressure. Still the company trades at 6.5x earnings.

Tachibana Eletech (TSE:8159) recently announced the company will expand into Indonesia. But at the same time, Tachibana Eletech will sell ¥ 1 B (about $10 M USD) new and treasury shares! They say the purpose is for buying office buildings which would save on leases. What the heck?? What is that about?? This company has ¥ 13 B in investments, of which ¥ 8 B is marketable equities and ¥ 2 B is bonds. And yet they are issuing shares to raise a relatively small amount. Several possibilities come to my mind. Maybe it is patriotism; the company wants to keep its government bonds. Maybe management management feels the stock price is overvalued; but the company is very profitable. Maybe the company is allocating the shares to favoured shareholders. But I can't find a very plausible reason really. I am baffled. What do you think?

On the other hand, the company seems to be doing great. Sales are up, exports are up. The company just raised guidance for the year to ¥ 179 which means the company trades at 7.2x earnings. The company also raised the dividend payout for the year from ¥ 20 to ¥ 22.

ITIC Reports Decline in Q4

Price	$ 79.90
Market Cap	$ 163.00 M
P/E TTM	11.1 x
Div yield	0.4 %
P/BV	1.27
ROE	11.5 %

Investors Title Insurance Company (ITIC) reported year end earnings that were lower than expected due to disappointing Q4 results. Premium revenue dropped by about one million yoy, or 3% of total. This along with about another million drop in realized investment gains meant Q4 net income was $1.8 million versus $3.2 million a year earlier. Note, however, that a year ago interest rates were at record lows.

Still, for the entire year, revenue was up 12% yoy. Earnings was up 34% yoy. The stock has dropped a few percent since I bought it two months ago. It went down as much as 10%. I do not regret owning it. But of course I wish I had slowly accumulated to take advantage of the dips instead of buying it all at once.

The recent results show that ITIC had a good recent run due to the low interest rates. Banks require title insurance when purchasing and when refinancing. So title insurance companies get a cut of each mortgage transaction! Even though refinancing activity may slow due to rising rates, I feel housing is bound to pick up in the coming years. Single home sales are about one million below what I would consider normal for the current population.

ITIC is also a balance sheet play. ITIC's most important metric to me is the book value, and it increased 12% yoy.