Portfolio Earnings Reports and Macro Musings

A slew of earnings reports have come in. I will summarize them in 60 seconds.

McRae Industries reported earnings that were flat compared to last year. But looking at last year's fantastic results, this is an accomplishment. If the company can show that last year was not an anomaly, then we have a new normal for this company. If so, I feel the company should trade around $40 instead of $30 now.

Wellpoint reported decent earnings. But the market pays more attention to the company's guidance because it is so committed to Obamacare. The company raised its 2014 earnings guidance from $8.20 to $8.50 per share. The new CEO Joe Swedish seemed to have aimed low with this guidance earlier and he is carefully managing the expectation upwards.

Wellpoint is spending considerable money to upgrade its IT systems for Obamacare. The company has already spent $550M. This leads me to believe that the company will have an advantage over other smaller competitors who do not have the scale to do such large upgrades. Wellpoint's success will be tied to Obamacare and the first year Obamacare enrollment numbers do not look so bad. People can slice it or dice it in many ways, but I think the Obamacare enrollment is as good as one could have expected a year ago. The bottom line is, people who don't have healthcare will buy it at a reasonable price.

I think the mainstream is starting to agree with me on this one. Barron's just published a bullish piece on Wellpoint. But I think when the mainstream starts to tout a company, watch out! The stock probably hasn't got much more room to run, and it is time to be contrarian on the stock. I definitely wouldn't add to my position, the only thing I will do in the future is selling.

Petsmart reported mixed first quarter results and they also lowered the year-end guidance. Same store sales this year will be flat compared to a year ago. The stock has tumbled 20% off its peak of a year ago. Today it trades at 14 times forward earnings. But here again, Barron has a positive piece on the company recently, which help the stock recover a bit. I wouldn't buy any more but I also don't want to sell because I dislike the capital gains tax.

In other news, Seaboard Corp completed their tender and announced that it was not fully subscribed. Therefore the buyback price will be $2950, which is the maximum price. I tendered about 15% of my shares.

And ITIC is down more than 20% since I started buying 5 months ago! And I don't really have an explanation for it. I have looked over the company a bit further to see if there is something about it that I missed in my initial analysis. I cannot find anything. Overall the housing market is stable and near-term should improve. The job market is improving which will do wonders for the housing market. Interest rates are up a bit but still near 12 month lows. So, in the absence of red flags, I have added to my position on the way down.

The US has seen inflation pick up to 2.1% yoy in May. Inflation directly affects interest rates and I'll be watching both closely. I own ITIC and four other insurance stocks. Insurance companies have large bond portfolios which would take writedowns if interest rates rise. But everything considered, inflation is a heck of a lot better than deflation.

PetSmart Performing to Expectations

I have owned PetSmart for six years and it has tripled in that time. My earlier writeup was a year ago, so I think an update is in order.

PetSmart is the the largest pet retail chain and it owns 40% of the US market. The pet industry is a $53 B industry. About 62% of household have pets and I estimate that Americans spend about $250 on each cat and dog annually. I think our pet owners can and should do better than that!  The pet industry has been growing at about twice the rate of GDP, and trend should continue. Although I don't believe we will have much more pets in homes, I do feel that as a wealthy society, we will gradually spend more than $250 on each pet annually. So even if PetSmart does not grow market share, which it has done successfully in the past, earnings should still outgrow the GDP. The following supports this point.

Revenue and Earnings (mil)

Div yield	1.2%
P/E	18x .
PTBV	6.8
Debt/Equity	0.41

Note that the chart shows the total earnings growth. Per share earnings growth is even greater due to regular share buybacks.

The downside to this stock is the relatively high earnings multiple. I generally stay away from anything with a multiple above 20. And PetSmart is close. But I am keeping it for two reasons. One is that I hope PetSmart will do what Coke did for Warren Buffett. Buffer bought Coke in the 80's and it has returned about 12% annually for 30yrs. He also bought Coke at a high multiple, but the company's moat was worth it. PetSmart doesn't have quite a moat, but it is the leader in a superb industry. The second reason I am keeping the stock is I want to avoid capital gains tax.


In other news, we have just ended a memorable year with the US markets up 30%. Who would have predicted that twelve months ago! But 2014 is another year and another chance for the pundits to redeem themselves. The following by Tren Griffin is the funniest though.

CNBC will continue to lose viewers by trying to make its programming similar to ESPN’s Sports Center, even though that approach is *exactly* what sends ordinary investors to their financial doom and *ensures* that ordinary investors will stop watching CNBC (i.e., the CNBC ratings death spiral will continue).

That does make me a bit sad. Now that is one less media outlet to goad suckers to take the other side of my trades *sigh*. Well, I hope Jim Cramer will find another network to hire him on after CNBC dies!

A Tale of Two Retailers: PETM and SHLD

Petsmart (PETM) recently announced very impressive earnings. The company earned $0.75 a share vs $0.50 the same quarter a year ago. When a company earnings rises by 50%, it earns a high P/E multiple. The expected P/E for the current year is 20. The company's revenue rose 9%.

PETM is the country's largest pet retailer; the company has 1,200 stores. It is unclear to me how much more it can expand. On top of that, I heard Jim Cramer of CNBC has been touting PETM all year. Jim Cramer is as big a contrarian indicator as I have seen. When he says buy, I hear sell! I really want to unload PETM but now that it is up 2.5x, but I am reluctant because of capital gains.

While PETM is flying high, Sears Holdings (SHLD) is going in the opposite direction. The company's sales declined yet further in the most recent quarter. Comparable store sales was down 1.6% for Sears and 4.8% for Kmart. The company lost money yet again but it does not have liquidity problems. I trust Eddie Lampert to keep the company afloat and extract the most value. They have recently spun off Sears Hometown and Outlet and then Sears Canada in two transactions. Despite Eddie Lampert saying repeatedly that he didn't invest in Sears to sell its real estate, he is selling the company piece by piece to unlock value. When just the core Sears is leftover he just may shutter the best locations and sell their real estate. That's fine by me, but many would feel sad to see the decline of an iconic retailer.

---

Disclosure: I am considering selling some PETM and my Sears Canada position but I haven't made up my mind.

Why I Own PETM

I own Petsmart (PETM) but I don't really follow it much these days.  I don't follow it because it has risen to 70 for a P/E of 24.  And it isn't a good value to me anymore.  Petsmart is a nationwide pet product retail chain.  PETM is not small, it has around 1300 stores.  Yet PETM can get such a high P/E because it has had phenomenal growth.

I got into investments of pet specialty stores back in 2005 with Petco.  Petco was (and is) the number two chain and I bought it because I wanted to get into the pet industry. The main reason is demographics, people in general have less children and more wealth. So pets are more and more pampered like children. Pet retail is a huge growth industry. And what could go wrong?  Well, in 2006, one year after I bought Petco, it  went private at a 33% gain.  Although 33% sounds great, I hated the idea of being forced to realize a gain. And that would leave only one public pet retailer: FETM.  So in 2007 I said what the heck, pet retail worked for me once, I'll try it again.  So, I bought some PETM. Today that position is up about 180% !  The following chart explains PETM's past growth and current valuation.

I would have sold it probably at 100% gain if not for capital gains taxes.  But as often happens the thought of capital gains taxes makes me hold longer.  It has worked out really well so far.

As for the future, I don't know what to do with PETM, I want to deploy my capital elsewhere. But I can only get away from capital gains taxes by cancelling the gains with all my available capital losses. And I really want to save those capital losses for other gains in a rainy day.

As a final side note, I will have a future post "Sins of Commission, Sins of Omission" where I discuss how I arrived at the aforementioned capital losses. This blog isn't just about how I have been making good investments.  I have had my share of bad ones too, all will get their full attention on this blog!