Sunday, November 30, 2014

I Just Bought My Second South Africa Stock

In the last year or two the US economy has been looking stronger and stronger. It is quite clear by now that it is in the middle stages of a recovery from the recession that began in 2008. Unemployment is going down as smoothly as a plane coming in to land. The fiscal deficit is down from the abnormal levels at the height of the recession. Housing inventory is no longer full of bank-owned foreclosures. US manufacturing is making a comeback and US is producing record amounts of oil. Consequently the US dollar is at the highest level in four years. The market appears to be fully aware of this and the US market valuation reflects this economic situation. So though the economy still has room to run, US companies are probably fully valued. Indeed, I am finding it harder and harder to find those knock-out bargains of two or three years ago. That is why I have been buying outside the US recently. This is all a drastic change from 5 years ago, when news pundits were saying that the US will become a banana republic. Well I have a saying: You're never as good as everyone tells you when you win, and you're never as bad as they say when you lose.

I also find it interesting that the market has taken the opposite view of the emerging markets six years ago and today. In the last year or two, money has consistently flowed out of emerging countries. The headlines are full of bad news everywhere you look. Greece has 20% unemployment. Russia doesn't respect shareholder's and will steal or confiscate at will. China has a colossal property bubble. Hong Kong is too close to China to be immune. In fact that goes for every other country in Asia. Japan is growing old and will forever be in recession. Brazil, Indonesia and South Africa all have their own problems which has resulted in high inflation and capital flight. This juxtaposition of emerging markets and the US may be partially based on fact but I think it is also very much a matter of psychology. Someone always has to be a darling and someone always has to be the dog.

One often overlooked market is South Africa. South Africa is the second largest economy in Africa, which is the most underdeveloped continent. Parts of Africa have the most potential to achieve spectacular growth in the coming decades, possibly like what China achieved in the 80's and 90's. South Africa is also friendly towards foreign shareholders. It has an Anglo-Saxon system of law and corporate governance. All financial documents are in English.

Price R 13.000
Market Cap R 1216.80 M
($ 107 M USD)
P/E TTM 7.8 x
Div yield 6.0 %
P/BV 2.15
ROE27.7 %
ROIC 12.8 %
South Africa does have the drawback that it is a relatively mature economy. Its GDP growth has slowed in the last year. And the country has suffered some major setbacks in the last year. South Africa is known for having a restive labour force. Strikes are common and can get violent. But this year has seen the most damaging strikes in South Africa history. The economy even shrunk in the first quarter because of the strikes. By now, however, the strikes have ended and the media seems to indicate that South Africa will have a more productive coming year. In view of this, I want to maximize my exposure to the South African consumer. And so I bought Combined Motor Holdings (JSE:CMH).

Combined Motor Holdings owns several related businesses, with the majority of revenue and profits coming from car retail. Car retail in a developing country caters to wealthy and upwardly mobile consumers. In any up and coming country, the people yearn for a taste of the luxuries that they have only seen from afar in the past. In addition, they want to differentiate themselves from their less well-to-do peers. Furthermore, cars in South Africa are even more critical than in more developed countries because South Africa has a primitive road and public transport system.

The Group's other subsidiaries are Car Hire, Marine and Leisure, Financial Services and Corporate/Other. These other businesses are 12%, 0%, 13% and 5% of profits respectively. The Marine and Leisure subsidiary is troubled and it accounts for only 1% of total revenue of the group. Management hinted that it may be sold or closed down.

In the the company report, the CEO describes the company philosophy:
The Group’s management style remains one of decentralised operating and marketing complemented by centralised cash flow monitoring, accounting controls and internal audit. Remuneration of management and staff is linked to performance benchmarks, all of which are closely monitored using internally-generated measurements, and peer group review. The Group operates in sectors which produce very low margins, so tight control over expenses and cash flow is vital to success.
This kind of operation reminds me of Buffett's operations and the businesses described in The Outsiders by William Thorndike. The company focuses on cash generation and increasing value for shareholders.

CMH is a company with good profits but also with a large balance sheet. At any given time the company has more than a billion Rand of inventory. But this is still just a month's turnover. The company has an impressive 27% ROE. And I estimate the company's ROIC is 13%. These numbers hint that the company is profitable in part because of a high debt exposure. However, management has said that all debt is short term. Most of the company's R$ 1.5 bil liabilities is accounts payable or short term borrowings. And all the borrowings are in Car Hire division, secured by its car fleet. I take this to mean that the parent CMH does not guarantee the debt. The rest of the liability is mostly payables for their cars held for sale.

I read the annual reports going back the last five years. The management consistently articulates the company's situation well. The CEO and Chairman have run the company since 1976 when it was a single car dealership.  The directors combined own 70% of the company. They have aggressively used cash to increase shareholder value; they pay a high dividend (6%) and earlier this year, the company bought back 15% of the float at R 13. Share buybacks is a second trait that Buffett likes, and it is the MO of The Outsiders . I think it is possible that this company can be the type of exceptional company described in The Outsiders.

The following shows the per share performance of the company:

CMH - units of Rand per share

As one can see, the company does pretty well for all shareholders even though it is very closely owned.

Monday, November 17, 2014

Riken Keiki Q2 Update

Price ¥ 1036.000
Market Cap ¥ 24.04 B
($ 208 M USD)
P/E TTM 9.2 x
Div yield 1.7 %
P/BV 0.77
ROE8.4 %
ROIC 12.2 %
Gross Margin47.4 %
Riken Keiki recorded yet another outstanding quarter. That is a string of improving results over that last few years. The first half sales increased 7% but income increased 32%. And what strikes me about the recent company performance is the steadily improving margins. So far this half the gross margin is 47.4%. And from 2009 to 2014 the margins were 40.3%, 42.9%, 40.0% 42.6% and 46.7%, respectively. Operationally, the company must be doing something right, or it could be favourable effects of the exchange rate, or both. Foreign sales are just 22% of total sales.

For any foreign investor in Japanese stocks, any recent good news is overshadowed by the terrible Q2 GDP numbers. The country slipped into recession as it followed the previous quarter's 7.3% GDP drop with a 1.6% GDP drop. This caused a even further slide in the exchange rate. Today a dollar costs ¥106. However, I am stinking to Japanese investments for now because I don't think there can be sustainable pressure on the Yen. The Japanese current account is still positive this year, meaning that more money flows into Japan than out. In fact, I think I am going to buy some more Riken Keiki shares!

Saturday, November 15, 2014

IEHC Q2 Update

Price $ 4.910
Market Cap 11.31 M
P/E TTM 9.0 x
Div yield 0.0 %
P/BV 1.04
ROE11.5 %
ROIC 15.6 %
IEHC reported Q2 earnings that I felt was quite reasonable. The company EPS for the 6 months this fiscal year is $0.35 versus $0.44. Revenues fell slightly (3%) but the bigger reason for the earnings drop is that margins fell from 63% to 61%. But last year earnings petered out in the second half and year-end EPS was $0.63. I expect earnings this year will be at least as good. So this is a long-term growth stock that is trading at 8x forward earnings. Apparently, other shareholders didn't agree with me and sold off the stock after the earnings. The stock dropped 10% on the news and I used this opportunity to double my position.

In other news, I closed my KCLI and ITIC positions. KCLI has run up a bit and it is a cigar butt that probably has one or two inferior puffs left. But I think I can better deploy my capital elsewhere. And I sold ITIC because I felt my original thesis was a mistake. The company had great margins in 2013 due to unusually low claims, and not surprisingly, this is not looking to be the case in 2014.

Wednesday, November 12, 2014

McRae Posts Second Consecutive Strong Year

McRae Industries reported year end earnings that was flat compared to a year earlier. Both 2013 and 2014 earnings were $7.5M despite a revenue increase from $97.1M in 2013 to $103.6M in 2014. The reason was that margins fell from 70.9% in 2013 to 69.6% in 2014 which negated the $ 6.6M increase in sales. The margin compression was due to higher cost of imported products, and management feels this will continue next year. However, I wonder if management is too pessimistic as the recent higher US exchange rate should lower import costs.

Price $ 31.500
Market Cap 76.55 M
P/E TTM 10.1 x
Div yield 1.7 %
P/BV 1.23
ROE12.1 %
ROIC 18.7 %
The company's two sales segments were both strong. The western/lifestyle products business grew from $62.8M to $66.3M and work segment sales grew from $33.3M to $37.0M. Management foresees both segments continuing their strong performance in 2015. Management expects strong demand in the lifestyle segment which is not surprising considering that the US consumer is coming off five years of deleveraging and high unemployment. As the US economy rebounds in the coming year, consumer optimism will only increase pent-up demand for fashionable items such as boots. The work segment relies heavily on just a few military contracts and so this segment is more predictable short-term. And here management feels the current contracts will give this segment a strong 2015.

At current valuation, the numbers for McRea are quite impressive. The ROIC is 18.7% ! This number shows that the company has a lot of ancillary investments and cash on hand and the company is a lean operation. McRea does minimal advertising, if at all. This means the company cannot drive its growth; it just goes with the flow of the business cycle. I am just happy after an awesome 2013, the company maintained its results in 2014. If the company keeps this up, it will grow book value by $7M a year. Then, they will probably have to give a special dividend. I estimate this company's intrinsic value at $40.

Tuesday, November 11, 2014

2014 Good Year for Insurance

My insurance holdings are all doing well in 2014. I am not a swing-for-the-fences type of guy. I'd much prefer staid consistent returns. And insurance companies give me that — for now. Insurance companies are strictly regulated in the US. An insurance company requires a license from state regulators in whatever state it wants to operate. The regulators set guidelines for drawing up the liabilities, i.e., the reserves. This is especially true for life insurance companies. People's life expectancies are very well understood, and when a company combines thousands of policies together, the result is a very predictable income and payment stream. Life insurance is also a commodity because there is little room for innovation. For these reasons, life insurance companies are in a competitive low-margin business. On the other hand, many trade considerably below book. Kansas City Life (KCLI) is a case in point. The company's 3 month and 9 month earnings so far this year are in line with last year. But this is just a 4% return on equity! This is a paltry return for a company with no top line growth.

I also own AIG. AIG specializes in both life and property and casualty (P&C). The company's third quarter results was pretty much inline with a year ago period. AIG is now in its first quarter without Benmosche as CEO since 2009, when he steered the company out of the financial disaster. AIG's return on equity is better than KCLI but its relative market to book value is about the same, as shown below. But AIG is a more dynamic company and has much greater potential to improve results despite its larger size.

For comparison purposes, I have also included in the table two life insurance companies that I do not own. Independence Holdings (IHC) sells life and health insurance, and National Western Life (NWLI) sells life insurance along with a lot of annuities. The final insurer in the table is European Reliance (EUPIC). This company sells life, health and car insurance, among other services. It looks better than the others by all metrics. The downside to the company is that it is in Greece. But I bet few would know that after four years of negative GDP, the country is poised to be positive again in the coming quarter. And in my opinion, the dirt cheap stock price gives me ample margin of safety against the company's risks; I EUPIC is a much better stock to own than KCLI. And therefore, I plan to close my KCLI position and use the proceeds to add to my EUPIC position.

Price $ 50.000 $ 54.000 $ 14.220 $ 271.970 € 1.440
Market Cap 548.40 M 75.60 M 249.96 M 988.88 M € 39.60 M
($ 49 M USD)
P/E TTM 19.5 x 8.5 x 10.9 x 9.4 x 3.9 x
Div yield 2.2 % 0.9 % 2.5 % 0.1 % 0 %
P/BV 0.72 0.70 0.85 0.64 0.60
ROE3.7 % 8.2 % 7.8 % 6.9 % 15.5 %
ROA0.62 % 1.68 % 1.95 % 0.94 % 3.25 %

ITIC also reported earnings. The company earned $7.0M for the first 9 months versus $13.0M last year. This dramatic drop was not because of a drop in revenue, which was only slightly down, but due to positive effects of claim provisions last year. ITIC sells title insurance; however, I don't really think of it as an insurance company like the other five mentioned in the earlier table. Title insurance claims are a tiny fraction of the premium — less than 10% — and they don't take long to occur. If a claim is made on a policy it usually happens within a few years after purchase. Also, part of the cost of the title insurance policy is the title search that the insurer must perform. So, ITIC can be considered a service company as much as an insurance company.

And my fifth and final insurance company, Wellpoint, reported Q3 revenues up 4% and income up 3%. And most importantly, year end EPS guidance is now around $8.88, up from $8.81. The stock has gone up almost 40% year-to-date. Even the midterm elections last week couldn't drag it down. The Republicans now control both houses of Congress and now can ram through legislation to repeal Obamacare. Their rhetoric says they will too. Of course if they do president Obama will veto it and the Republics do not have the votes to override the veto.

Still, I was pleasantly surprised at the lack of reaction from the market. But I am really not at all concerned by the election results. Obamacare is most widely know for the individual mandate, which is mostly provided by the public exchanges. But the public exchanges only provide 750k customers out of 37M. Wellpoint is doing well now mainly because of better management and the benefits from medical insurance expansion through many aspects of Obamacare. If the Republicans do succeed somehow in changing healthcare, it will only be to tweak this system of private insurance with subsidies for the poor. But the spirit of Obamacare is here to stay. So Wellpoint will benefit no matter which party runs the government after Obama leaves in 2017.

Saturday, November 1, 2014

Seaboard Q3 Earnings

Price$ 3072.000
Market Cap$ 3594.24 M
P/E TTM10.2 x
Div yield0.4 %
ROE13.4 %
LT Debt/Equity0.00
Seaboard Corp (SEB) recently reported Q3 results. Revenue was $1622.6 M versus $1648.1 M the previous year. Income was $104.7 M versus $26.0 M the previous year. So revenues dropped slightly but profit quadrupled. This was not a total surprise because of the jump in pork prices over the last several months. The pork division increased its operating income by $45M. The recent disease that hurt the pig industry has subsided. And pork prices have pulled back from the highs of the summer. However, my reading of the industry tells me that the pig crop won't be much higher next year because of the low birth rates this year. So, I expect higher pork prices for another year or so resulting in continued good performance from this division.

But pork wasn't the only division benefiting from commodity prices. Poultry prices are also at record highs this year, and so the Butterball operating income increased by $18M. Both meat divisions are benefiting from lower feed prices also.

The marine division and the sugar division increased their incomes by $10M and $6M, respectively. The marine division narrowed its loss this quarter in part because of cheaper fuel.

I have held this stock for close to a decade and have watched its performance ebb and flow with commodity prices. However, I think we are at a good point in the cycle. Feed crops such as soy and corn are now lower because of increased production and less emphasis on ethanol, which I think was a tremendously misguided effort by American government to use more renewable energy sources. At the same time, I don't think commodity prices are so low that producers like Seaboard will be unprofitable. So, Seaboard is going to a few more good years yet!