Sunday, August 16, 2015

Buffett Partnership Investment: Stanrock

Stanrock Uranium Ltd. was one of the bigger positions in the Buffett partnerships in 1962. It was 5% of the partnership. Stanrock Uranium Ltd. was a Canadian mining company with rights to uranium around Elliot Lake in northern Ontario.

In the 50's uranium was a hot commodity with the proliferation of nuclear weapons in the cold war and the advent of nuclear power. The company traded on the American Stock Exchange as well as in Canada.

The company incorporated in 1956 and declared bankruptcy and went into receivership in early 1959. For some reason which escapes me, the uranium industry hit on hard time in the turn of the decade. Many miners went under. Before bankruptcy the stock traded at around $ 1½. The company fully operated in the early 60s but did not get out of receivership until 1964. During that period the company paid some $41 M to their lenders. In 1961 the company earned $0.9M.

My guess is that Warren Buffett bought the stock just after bankruptcy in 1960 when it traded at around ½ . He must have seen something in the bankruptcy that indicted the company was valuable and the market will see that once it emerges from bankruptcy. When that happened he probably had a easy double in a few years.

Buffett biographer Alice Schroeder mentioned Stanrock in the book the Snowball briefly. But the Buffett Partnership's 1962 statement showed the partnership owned 36760 shares at 13½. Where that price came from is a mystery to me. I know I have the correct company. But the partnership may have not have owned the common stock but the defaulted bonds. Unless Warren Buffett speaks up, this fact will probably be lost to time. The following is the information available from the receiver for 1961.

Sunday, August 2, 2015

Why I Bought Lewis Group Ltd.

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 mature 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 and consumer confidence are all up. 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 all a drastic change from 5 years ago, when news pundits were saying that the US premier position in the world will be eclipsed by China and Europe. Well there is a saying I keep: 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 find it also 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. 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. The commodity slump and mismanagement have meant that Brazil, Indonesia and South Africa all have 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.

So, it is with this idea in mind that I decided to dive into my third South African stock: Lewis Group Ltd (JSE:LEW). Lewis Group is a large furniture retailer in South Africa and nearby countries. The company is extremely profitable and very shareholder friendly. I know of no other company that regularly pays a 8% dividend. The down side is that the company is very susceptible to the South African consumer. The company serves lower and middle class South Africans, and 70% of them buy from the company on credit. The company makes relatively low margins on the sale and makes most of its money from financing, interest and insurance on the debt. This model has worked well for Lewis as well as its competitors. But recently, over expansion has hurt furniture retailers. One big competitor with a thousand stores, Ellerine, filed for bankruptcy last year. Its one thousand stores have been sold to various competitors. Lewis Group bought 63 stores under the Beares name.

Price ZAR 57.800
Market Cap ZAR 5178.01 M
(USD $ 424 M)
P/E TTM 6.2 x
Div yield 8.9 %
P/BV 0.89
Debt / Equity 0.27
ROE14.4 %
Now critics of companies like the Lewis Group may point out that such companies take advantage of those less well-off. I can't say I disagree with such critics. And now government is on to the company. In early July, the South Africa National Consumer Tribunal, fined the company ZAR10M for misrepresenting the insurance they sold. This apparently was the catalyst for the stock to drop by 40%! The fine was only 1% of last year's earnings but it reminds us there is regulatory risk. And that's all. It shouldn't be significant. But in reality it has had a big impact on the stock price, which gives me a buying opportunity.

Today at ZAR 58 it is back where it was a year ago before Ellerine's bankruptcy. Since then I feel things are much more clear for the industry and Lewis group. The company has had record earnings, although the economic situation in South Africa is considered negative because of the global slowdown in commodities.

Lewis Group Stock TTM in ZAc

Lewis Group has over 700 stores in three segments. The largest with 80% of sales is the Lewis chain of furniture stores. The Best Home and Electric chain sells electronics. And the just-purchased Beares chain sells furniture to slightly wealthier demographic.

The company's balance sheet looks strong. The largest asset item on the balance sheet is accounts receivable, which stands at ZAr 5400M. That is almost equal to the company's equity. Needless to say, customer debt management is a crucial aspect of the business. Almost 70% of the debtor customers pay their obligations in full. The company bad debt / impairment costs are about 13% of total debt. I am not an expert on consumer finance, but 13% seems like a very adequate number for a developing country like South Africa.

Below is part of the credit summary from Global Credit Rating Co., a local credit rating agency.
Lewis´ liquidity has strengthened over the past year. This has been a result of the initiation of its listed debt programme, which has increased its financial flexibility and enabled it to increase unused bank funding lines. Note is also taken of the sizable cash balances reported at FYE14, as well as the fact that the group´s asset base is entirely unencumbered; further boosting financial flexibility. In addition, the ability to tighten underwriting criteria and reduce credit origination is a tool available to management to improve cash flows if needed. Thus, despite continued working capital pressure associated with growth, Lewis has reported positive operating cash flows over the review period. With limited capex (as stores are typically leased and not owned), this has enabled moderate gearing levels and sound debt serviceability to be sustained. Further to this, net gearing and net debt to EBITDA were slightly lower at 24% and 105% respectively at FYE14 (FYE13: 30% and 111%), while net interest cover remained sound at 10.5x (F13: 12.8x).

I think Lewis Group is the financially healthiest furniture retailer in South Africa. Any shakeout would make the company stronger. Any bad macro economic scenario is covered by the company's cheap valuation.