ATP and EDF just announced closing the £265MM agreement for the Tors and Wenlock transaction. That’s around $400MM vs a market cap of around $275MM. They are required to use 75% of this towards debt reduction, the rest can go towards share buybacks or such. With luck the stock prices will remain depressed while ATP implements their stock buyback.
In general I would put E&P (exploration and production) oil and gas companies in the “too hard” pile. They usually trade at a multiple that reflects people’s hope for what they might find in the future, and what that might be worth. You have multiple variables to predict – the size of the holdings they find, the cost of extraction, flow rates (a dollar today is worth more than a dollar 5 years from now), and future commodity prices. In short, what some people call prediction I call guessing or making things up. Too hard.
However, recent market events have placed the prices of these companies well below their NAV – the calculated worth of oil&gas they have already discovered and have a way to extract. More on how those calculations are done later We have a special situation here; companies are being priced at a fraction of the proven worth of their assets in the ground. This gives us a huge margin of safety, as we are buying assets at a fraction of their value, and valuing everything else at $0 – i.e. all future earnings, all new finds, all infrastructure - $0.
ATP is a small oil and gas company working in the GOM (gulf of Mexico) and the North Sea. They are not a pure E&P company – they are not exploring new ground. Instead, they buy leases with reserves from companies that don’t want them for one reason or another (need to raise cash, shifting operations to another area, whatever). They have a 98% success rate at turning these leases into producing fields, which is unheard of in this business. They achieve this largely by having a very focused business model. 22% of the company is owned by senior executives – they are eating their own cooking, and have a very vested interest in making the company succeed.
They start by acquiring properties from other companies. For example, they acquired their Telemark property from a company that acquired Spiniker. The company had no use for the Telemark company, and sold it to ATP. It’s not that the field has no value, it’s that it was not part of the strategic vision of the company. So a change of ownership, a shift of strategy, etc., all brings valuable blocks to market for ATP to bid on.
ATP buys blocks close to each other, developing “hubs”. This is a key part of their strategy, at it keeps costs very low. Deepwater reserves are very expensive to produce and then transport. Having a bunch of small blocks strewn all over the place would be very expensive to produce and deliver. If you look at a chart of ATP’s properties, you will see they are clustered. ATP then develops the infrastructure to deliver these reserves to market. Then, any new acquisition can be delivered to market for the incremental cost of drilling and pumping, keeping costs very low. For example, when they purchased Canyon Express they got a 62 mile pipeline with a capacity of half a billion cubic feet per day. In a sense, they got that pipeline for free since they bought the property for the reserves, and they carry it on the books at $0. However, this pipeline is the closest interconnect point for all the properties they bought in 2008. This pipeline, valued at $0 with GAAP accounting, is adding tremendous value to the company by minimizing costs. Any other company buying blocks in that area either has to create/buy their own infrastructure, or lease the pipe from ATP. And, because ATP has hubs in these locations, the blocks are less valuable to their competitors.
The next part of their strategy is to maintain production control over all their properties. As they grow, they sell developed assets to generate cash for new acquisitions. This often leads to ATP owning part of a property, and another company owning the rest. By retaining control of operation, ATP can ramp up/down production in response to commodity costs and need for capital to develop other areas. This gives them nearly complete control over their Capex, and allows them to operate profitably with oil at $20.
The final part of their strategy was alluded to in the last paragraph. While they get their cash flows from producing and delivering reserves, they will also bring a property to producing status and then sell it to produce cash for new acquisitions.
E&P companies have stringent standards for terms such as “proved reserves”, “probable reserves”, etc. They are industry standards, audited by outside companies, and used to establish sale prices of assets and companies. Proved reserves means what it sounds like – oil or gas that has been proven to be in the ground and recoverable (it does us no good if you can’t get it out). Probable is the next step out – not as solidly proven, but the seismic, geology, etc., are there. A buyer has to decide how much to write that down to value it. These get packaged together into a number called the PV-10 value, which means present value minus 10%. The estimate is beyond the scope of this, but it looks at current oil/gas prices, figures out how much it will cost to get the assets out of the ground, how long (a dollar today is worth more than a dollar 3 years from now), discounts those future cash flows by 10% back to the present. A standard DCF, in other words, all to an industry standard for the field. It doesn’t mean that the assets are worth that exact amount today; after all, oil could go up or down, but it does reflect about what another company will pay for the assets. They have the same knowledge about future gas prices as anyone else, after all.
Almost every year ATP has improved their proven reserves (all # in Bcfe unless stated otherwise)
2000: 116
2001: 235
2002: 230
2003: 303
2004: 275
2005: 527
2006: 637
2007: 716
They are adding new blocks in 2008, which we will get to soon.
Right now they have 468 proved undeveloped, 248 proved developed, 119 probable developed, and 256 probable undeveloped. By 2012, they expect to have 95% of the undeveloped to developed. Note that the 98% success rate mentioned earlier refers to this – okay, we have it in the ground, can we successfully develop it? If you look at their history in creating developed reserves, they have increased it by 310% from 2004 to the end of 2007.
The recently calculated PV-10 value of the proven and probable reserves is $7.2 Billion. Remember that these numbers are produced by independent third parties, not ATP. You can buy the company today (market cap) for $266 million. That estimate was done on June 30th, with oil at $100 and gas at $7.5MCF. As we know oil is down, but gas is not too far from that price. I’m not going to tell you what value to give oil going forward, but I think you can see we can cut oil prices a lot and still be waaay undervalued here, assuming there aren’t other problems.
ATP is estimating what they think they will actually produce based on new blocks that they have added to their operation. This is an estimate, but the last time they published an estimate they met that estimate and then some. They estimate that there is an additional 76MMBoe of recoverable oil and gas. When you add this to the analyst’s estimate, you get 7 barrels/share. If you take the analyst’s words for it, you get 5 barrels/share. In that case, you are paying from $1 to $1.5/barrel at current share prices. I can afford that, can you? Of course, ATP has to pay to extract and transport the oil, but their costs for this are very low, as I’ll discuss soon. In short, they can easily make money with oil at $20/barrel. And remember, this places the value of everything else at $0 – pipelines, drilling platforms, future discoveries and cash flows resulting from them.
Two things to look at left: 1) should we believe these prices, and 2) is ATP healthy? A no to either one would have us not buying the stock no matter what the possible reward. Rule 1 – don’t lose money, which means don’t take risks.
Should we believe these prices? The market does. ATP is carrying more debt than they should (which I will address in the second point, are they healthy), and introduced a program to pay it down by $600M. This payback is part of the debt covenant they have with their lender. The company even initiated a competition: if they achieve this in 2008 (and I believe they will), they will pay the mortgage of all the employees for a year! To do this, they have to monetize their assets, i.e. sell off some of their drilling leases. The downside to that is of course they don’t get the future profits, but they will be in a very strong situation from a credit point of view.
To this end they recently sold a block for $82M ($102/bbl and $9/Mcf). This block was 0.8% of their proved reserves and 0.5% of their proved and probable. This suggests that the company as a whole was worth $10 Billion dollars, if we assume that none of the probable reserves work out. This ignores the extra 40% that ATP estimates that they will produce. $10Billion on proved reserves alone, vs a market price of $266 million. This is not my estimate. This is not an analyst’s estimate. This is what a competitor paid ATP for their proved reserves. As a side note, and this is way beyond the scope of this post, the price paid was completely in line with other sales by the industry. No one got ripped off here. And, if anything, this suggests that the PV-10 calculations were pretty conservative, which put it at $7.2 Billion. Or, decide the PV-10 is correct. Your choice. Companies usually trade at a small multiple of the PV-10, say 1.3x or so, because after all these are E&P companies, and we should expect them to discover more reserves in the future. Recall that ATP just buys reserves that already have been proven, so “discover” is misapplied in this case. But I’m not going to go down that road, I think you can see a bit of a margin of safety in these numbers.
In October they announced a deal with EDF. They sold 80% of 2 fields for $416MM, and have an option in place to sell the last 20% by the end of the year, which would add to the $600MM required by the debt agreement. The purchase has been approved, and final signatures are expected to happen between Dec 10th and 20th, though there is a small possibility of missing that date. This sale does not make a significant impact on the 7 barrels/share that ATP owns (or 5 barrels if you want to stick with the Jan 2008 numbers), yet the sale price was 1.5x the market cap for the entire company. A sliver of the company for 1.5x what you can buy the entire thing for on the open market. So, a second competitor that values ATP at an extreme multiple over the current stock price.
There debt agreement requires them to put at least 75% of the monetization proceeds towards debt reduction. ATP has announced plans to buy back stock with the rest of the money as soon as the debt is paid. They also have stated that they should have further asset sales to announce sometime soon after the new year. I will show some computations on the effect of share buybacks on shareholder value in a bit.
Is ATP healthy? That is the big question. As noted above, they are carrying debt . I am going to skim a bit over the numbers – you must read the recent report and the last several presentations by ATP (aug 11, Oct 7, and Oct 10th, here: http://phx.corporate-ir.net/staging/phoenix.zhtml?c=123846&p=irol-presentations). Briefly, right now ATP has the capacity for 95 M Bbls/d and 250 MMcf/d. From that you can calculate cash flow. Useful life for the facilities runs from 20 years to 50 years. They are located in hubs to reduce costs. Their reserve replacement ratio has been 223%; the last 3 years was 438%. Their success rate in developing their assets has been 98%. They have a huge inventory of undeveloped reserves to drive growth in 2008-2012. They recognized that the debt was a bad idea, and are deleveraging. 22% of ATP is owned by senior management. Year to date cash flow from Gomez alone is $219M (compared to the company selling for $266M), with net revenue of $236M. You can add up the rest: we are trading for under 1X 2008 cash flow. This is not a cash flow story, as the cash flow will be used to purchase new leases and convert undeveloped into developed, but it shows that the money is there and coming in fast. Furthermore, they plan to reduce Capex by $200M next year, and increase production flows.
In the end, you have to decide how you feel about that debt. Certainly the turmoil in the market could make it hard to sell things off quickly, but remember the pressure is coming from within – management – not without – the banks. So ask yourself: what is the risk of cash flows stopping to an extent that ATP cannot service their debt? Given how fungible their reserves are, and that they have $278M in cash on the books as of 6/30/2008, it would either require a catastrophe at a major hub coupled with a financial market where they could not sell off any of their leases, or oil dropping to a few bucks.
Let’s look at the enterprise value. Market cap is $266. Preferred stock is $0. Debt is $1609, cash is $278. 266+1609-278= $1.7B. ATP could be bought for $1.6B today, vs $7B if they never aquire any more reserves and do nothing but spin down the company, and just let the infrastructure rust. After the monetizations, debt should be around $1B, leading to an enterprise value of $988MM.
This is not an investment story that requires calculation of the value of the infrastructure. But, to put some color on that, consider some of their major projects. Gomez cost them $300MM, with a useful life of 20 years. Telemark I is 91% complete, has a 50 year life, and has cost $515MM to develop. The extremely valuable pipeline they own is carried on the books at $0. Cost of development and sale prices are different things, but it is trivial to see there is a lot of value being carried here that the NAV calculations are ignoring.
In short, a company with a market cap of $266 Million has been valued as having $7B in reserves by external auditors, and $10B by a competitor when oil was at $100. I call that a margin of safety, and then some.
Interest costs are around $100M a year. This will vary quarter by quarter as interest rates fluctuate, and of course will lower as they pay down the debt. The terms require that 75% of any asset sales be used to pay down debt. They refinanced in June, at LIBOR + 5.25, and this loan has several conditions relating to the asset sale, maintaining Debt/EBITDAX radios, etc. They are good terms for shareholders - as it forces the company to keep the company healthy, but of course they have to maintain cash flow. The debt agreement is in effect to 2012, which should insulate them from the current credit market. Call it luck that they did this in June if you want (Al Reese, CFO calls it that), but the result is a company insulated from the credit crisis being priced as if on the verge of bankruptcy.
On cash flow, their sales are hedged, so sales are somewhat predictable. You can get the latest information from the quarterly reports. Of course, as each quarter rolls around, the oldest hedges expire and they have to contract new hedges at current market rates, but this still provides visibility into cash flows for the near term future. The cash flow for the first 6 months of 2008 was $292M. 2009 should yield around $700M, depending on where oil/gas prices fall at the time. In 2009 new projects are coming on line which should boost production around 40%.
On the other hand, in response to the credit landscape and lower oil&gas prices, they have planned to reduce Capex in 2009 by $200M. Since their whole business is changing undeveloped proved into developed proved, they can slow down or speed up development at whatever rate they want. That’s an important point. While Capex is high for this company, they have almost total control over it. There is Capex for actually pumping and transporting from the well, but that all results in a profit. The major Capex is due to development - drilling, etc. This will result in lower cash flows in 2010 then expected. Still much higher than now, but lower than originally calculated.
Finally, let’s look at value/share. I don’t try to predict share prices, since the market is crazy, but it’s worth seeing what kind of value is locked up in the shares, and what kind of return we might expect from a share buyback.
PV-10: 5.3 Billion
Debt: 1.6B
cash: 300M
shares: 35.9M
5.3B + 300M - 1.6B / 35.9M = $111/share
Now, companies don’t trade at PV-10. A lot depends on what people think the future might be, etc. But that is a simple ballpark, and it doesn’t include the 40% extra that ATPG thinks it will recover beyond the PV-10 conducted by outside auditors, but it also doesn’t consider Capex, taxes, etc. Still, I’d be happy buying shares up to $40-50 or so.
Okay, as I noted, they will start a share buyback once the 600M debt is paid back. Of course, this requires that the prices stay this irrational while they execute the buy. But, let’s dream, shall we:
$70M buyback = 3.5 million shares $20 (> 2x current prices)
Debt: 1B (debt paid off)
Cash 230M (less 70M buyback)
PV-10: 4.7 (less the 600M sale)
Shares: 32.4
4.7B - 1B + 230 / 32.4 = $121/share
Such is the beauty of share buybacks when share prices are low.
It you want to break your heart, try making it a bigger buyback, or at a lower share price. Break it from the heart palpitations, I mean!
What are the risks? A storm would cut production. I ask myself, what will the impact be on the bottom line in 10 years? Short of the “perfect storm” which hits all their various hubs (in two entirely different places in the world, I’d say the impact would be small. Naturally, the stock price would take a great hit for awhile, but I would welcome that. Even if every well was destroyed in some kind of global capacity, their reserves would still exist, and they would just endure the incremental costs of rebuilding the infrastructure.
The real risks I see are more along an ecological disaster followed by a multibillion dollar lawsuit. That would be tough to recover from, and would permanently destroy value.
So there you are. A company trading at a huge discount to their value if they closed up shop tomorrow, with positive cash flows, and the ability to make a profit even if oil is cut in half. 22% of it is owned by company executives, and they will be announcing deals in the coming days whereby they are selling a sliver of the company for 1.5x the current market cap. The valuation of their reserves was calculated by independent third parties, and competitors have shown they support those valuations by paying hard cash for assets from ATP.
First, unless I specify otherwise, I have read the annual and quarterly reports, viewed/listened to whatever presentations they might have made, and looked at some of the competitors. My assumption is that no one, at least not a real investor, will buy a stock without the same due diligence. Hence, I am not going to talk much about the balance sheet, how the business is structured, etc. You can get all that info from the reports. What I try to do is pick out what is being missed by Wall Street. After all, the central thesis of value investing is that we can value a business, and that Wall Street often misprices securities. I don’t feel like sitting here and typing for a week. To an extent, that’s laziness, but it is also reflective of a few deeply held convictions of mine. First, the value should slap you in the face, as Buffett says. If you have to reach for a calculator to run a DCF, the value isn’t that apparent. I’m not going to post ideas that require that sort of thing. (Admittedly, my E&P oil/gas ideas are based on valuations of proved and probable reserves, which depends on DCFs. However, these are run by third parties, and are buttressed by recent sales of assets, by which you can gauge if the industry considers these valuations correct or not). Second, I feel too much information is somewhat confusing. This is well documented in both research and in books written for the general public, such as Blink. After you have a few pieces of relevant information, more pieces of information tend to just cloud the issue. I’ve posted ideas elsewhere showing a $300MM company holding several billions of dollars worth of oil/gas, with sufficient cash flow to not only service, but reduce debt, only to get innudated with questions about issues that just don’t change that valuation equation. Why???? People like to worry, second guess, and try to integrate every piece of information. But some pieces of infomation are far more important than others. I like ideas where I don’t have to predict future earnings, guess that a commodity is going to go up or down, guess that Apple is going to invent the next great product (Apple looks like a great investment to me, but what about 3 years form now - are they going to make the next iPhone? I dunno, and thus won’t invest with them).
So, I strive to give you the information that I consider relevent, to be kept in mind while reading the quarterly and annual reports. Take my previous entry on IPHS. I guess I should have posted the % of their business that is phosphates for detergent, the amount that is food additives, their exposure to ag phosphates, etc. But that is all in a pie chart in the annual report. It’s trivial to see that they are being priced like an ag phosphate producer in the face of a recession, when in fact they make a high moat, high margin product for basic foods. That should hit you in the face after looking at it for a bit. Would it change your decision if the ag business was 10% vs 12% vs 14%? If you are making decisions based on those ratios, honestly, it’s way to close to call.
Anyway, that’s how I write these up. Detailed information on any company is available a short google search away, should you need the info, or want to double check what I wrote. Actually, let me amend that. You’d better double check what I wrote. A simple error like # of shares outstanding could completely skew a calculation. These posts are intended as a starting point, not an ending point.
On disclosure, I haven’t decided what to do about that yet. Suffice to say the ideas I post here are generally stuff I’m putting money in, generally make/break levels. I have a few stocks which are a bit of a ‘flutter’ for me - the prices are insanely low, but the future of the company is cloudy. If it survives, it could be a 20 bagger, if it fails, it’s total loss of capital. I’m not going to be posting about that kind of stuff. Generally, if I write about it, unless I strongly specify otherwise, it’s an idea that either I have 10%+ invested in, or would if I had the cash (I’m pretty much fully invested right now). I don’t see the point in posting second tier ideas, and I don’t see how I could reasonably keep track of 20+ companies in detail. OTOH, I’m certainly not going to post my buy/sells, nor notify if I close a position. I will try to be fair and post if a previous idea has soured for some reasons, but I don’t promise to do so. I’m not responsible for your investment decisions. If you can’t quote The Intelligent Investor chapter and verse, the intellectual foundation of this blog, these posts are more likely to hurt than help you.
I will also assume significant sophistication on your part. I’m not going to opine on buying options/leaps vs equities, how to create a stub through shorting or other means, hedging against commodities, etc. I am trying to present undervalued companies, not instruct you in how to manage money at a professional level. Okay, lecture over.
IPHS is a quite small, underappreciated, underfollowed specialty chemical business. Who cares? A small chemical business – how good could it be?
Simple. IPHS sells food additives to the major food and beverage manufacturers in the United States. These additives add flavor and shelf life to products – products like Bisquick, Oscar Meyer, and Coca Cola. They also produce phosphates for things like detergents, toothpaste, asphalt, etc. In short, pick up a name brand food product from your grocery shelf, and there’s a very good chance that IPHS has a tiny piece of that product (and thus, profit). Go to the cosmetics counter, and IPHS is there.
Before we look at the numbers, let’s look at the business as a business. Who do they sell to, do they have a moat, what are their sales prospects in this environment, and do they stand to grow.
The specialty chemicals business has several very large barriers to entry. First, these are largely food additives with a relatively low cost/lb. A China upstart couldn’t easily enter the business because 1) cost of shipping would eat into the margins, and 2) freshness – you don’t want food additives intended to enhance flavor, purity, clarity, or shelf life sitting around on a cargo ship. China is trying to compete, read the latest conference call transcript for details, but to date it is not a significant factor, and it will always be a difficult environment for them.
Second, and far more importantly, these are food additives for very identifiable products (Coke!) which are regulated by the FDA. Say I wanted to start a competitor to IPHS. No problem (ha)! First I have to figure out a flavor profile identical to what Coke currently uses. Then, I have to get FDA approval for my additive. After that, I have to go to Coke and convince them to switch suppliers, a supplier they have been happy with for decades. I have to do all this, then sell at a lower operating margin than IPHS, and somehow pay off the expenses incurred in all the R&D. Finally, the cost of these additives on a volume basis is quite small – it represents a very small fractional cost for the final product. Maybe a penny for a box of Bisquick. You’d have to undercut IPHS quite a bit to get a customer to switch to an unknown company and product. Finally, you’d be undertaking all this risk to get part of a market share from a $300 million company – who in their right mind would do that? No one, so far, in the multi-decades that IPHS has been in business.
Third, this moat and relative low product cost gives IPHS very strong leverage with their customers. Say they doubled the price of an ingredient that currently costs 1 cent per box. This represents a huge increase in IPHS’ operating margin. OTOH, the customer is basically unable to balk – they have no alternative to IPHS’ additives. Sure, they could either go develop the additive themselves, or to a competitor of IPHS (there are a couple), but this will be at least a couple year lead time, all to avoid a 1 cent increase in the cost of the product. To date, since the spinoff, IPHS has not exerted this leverage on their prices, but in their most recent conference call they said this is in the plans for the following quarters. The only risk is raising prices so high that they alienate their customers. A doubling of prices overnight would probably do that, but a quarter by quarter modest increase of prices will be absorbed easily. This is a better moat then Buffett’s See’s Candy has. They raise prices every January 1st, and people keep buying. IPHS can do the same, and their customers need the product far more than a candy eater needs See’s Candy. Against this we have to balance the cost for IPHS to do business. It’s no advantage to raise prices if operating costs are skyrocketing. As a chemical company, they have to buy raw materials. What does that landscape look like? Well, first, they have a long history of passing along increases in raw prices to the buyer. This is an easy thing to do, partly because of the moat, and partly because all of their competitors face the same raw price increases. These additives are going into consumer staples, so it’s not like the buyer can slow down production in the face of added costs. Everybody is going to buy toothpaste, detergents, bread (IPHS sells bread leavenings) and Coke no matter the price of phosphate rock (the raw material). But IPHS has negotiated long term supply agreements for their phosphate rock. The long term nature allows them to predict costs raises and raise product costs in plenty of time to avoid losing money. IPHS has raised prices several times this year already in light of developments in phosphates (more about that later).
The stability of the business should be clear. They have been selling these chemicals to the same buyers for decades. Bisquick is going to sell this year, it is going to sell next year, it is going to sell ten years from now, regardless of the economy. No one is going to stop washing their undies. I remember when I was a starving grad student – I dug into my couch cushions to find the 50 cents needed to buy a can of Coke. I went without almost all niceties, but I still supported by caffeine habit. Over 20 years later, and I still drink Coke (not Pepsi). 40 years from now, if I’m still alive, it’ll still be Coke. That’s a moat.
While I don’t like trying to predict macro conditions, they have been favorable to IPHS. China has been clamping down on phosphate exports, recognizing how important the chemical is. Phosphates rose, and IPHS passed the cost along to the customer. Demand for agriculture phosphates was way up in 2008. This has gone back down, and I think the market has misinterpreted IPHS as an agriculture phosphate business, because the stock price has been pummeled, back to near the IPO price.
Okay, the numbers. Is it a compelling buy at these levels? 2007 EBITDA was $105MM. In comparison, EBITDA for the last quarter was $112.9MM!! EPS for 2008 should run somewhere over $9/share. In comparison, IPHS is trading at $14.86 at the time of writeup. That’s about 1.5x trailing earnings. The future is hard to see, but their exposure to the ag business is not what Wall Street is thinking (given that low share price). If they hold on prices, they should earn at least as much, and if they start putting in price increases due to their moat, they stand to earn quite a bit more. But let’s not get greedy. Even at 2x earnings this is a screaming buy.
Another way to look at earnings: I don’t have the numbers for the most recent quarter, but this summer they were getting around $12-14MM a month as a spread between what they bought materials for and what they sold them for. Their ROE is 119.5%! Free cash flow should be around $100MM. In that light, they are trading at 3x FCF – an absurdly low multiple for a company with such a large moat in a economically defensive industry. While you wait for the stock price to normalize, you get rewarded with a quite nice 4.5% dividend.
I could make up a detailed spreadsheet for projected earnings, document all kinds of assumptions, but why? If you have to reach for a calculator, move to the next stock. $100MM FCF in a $300MM company.
The naysayer will point out I’m doing computations on market cap, not enterprise value. As part of the spinoff, quite a bit of debt was passed on. This is a typical strategy with spinoffs – create a company with huge cash flows to service the debt, and the returns are very significant. The cash flows will allow them to deleverage, adding shareholder value. Make what assumptions you want on forward enterprise values, and you can come up with a yield, forward PE, whatever. The bottom line is they had around $383MM debt at the start of the year, and should have paid it down to around $327MM as of Sept 30th, and expect to have it down to around $250MM by year end, with a cash balance of around $125MM.
A growing business with an extremely strong moat, selling products to Coke, Bisquick, toothpaste, deodorant, laundry soap manufactures, at a 2.1PE and 4.5% yield. No calculator needed, this is an obvious buy.
I have not investigated this one in detail. However, the facts as I know them:
Magna is an auto parts supplier. As such, it’s stock price has been hammered, like the rest of the industry. However, they have almost no long term debt, and $21.29 cash per share, compared to a ticker price of $31.50. So, you are buying the business for about $10/share. Compares that to last year’s free cash flow - $14.75. At that, it is trading at less than 1x trailing FCF.
Now, I haven’t looked at their future prospects in detail. ValueLine projects FCF of $13.95 this year, and $15.65 next year. I put little stock in predictions, even ValueLine’s. The question is, how much of their business depends on Detroit? In the medium to long term there is no way the world is getting rid of autos, so to my way of thinking now is the time to buy so long as you aren’t betting on a specific auto manufacturer to survive. Some are going to fail. Chrysler is 13%, Ford is 15%, BMW is 19%, and GM is 24%.
With this huge cash flow and no real exposure to the credit market, MGA stands to make acquisitions of it’s flailing competitors.
I haven’t sorted out the risk/reward equation for this in my mind yet, so I have not purchased shares. Given the number of riskless investments in this environment, I find it hard to take on much risk right now. However, the FCF yield is extremely compelling right now.
This is NOT A RECOMMENDATION TO BUY. Information only. Really. Also, note that I wrote this awhile ago, when the market wasn’t offering such compelling ideas.
Bexil corporation is the easiest company in the world to value, and the hardest to talk yourself into buying.
Cash on hand: $43.71/share
debt: $0
income: $100K/quarter, net taxes (income from cash invested in treasuries)
other assets: none worth mentioning.
Share price: $23
Buy $44 in cash for $23
What gives?
They sold off their previous business (York Insurance Services Group, Inc) in 2006 for cash. Since then, they have been looking for a new company to buy. So far, bupkiss. Nothing. They just have the money sitting in treasuries and money market funds. From that they are deriving a bit of income, and paying the meager salaries. Essentially treading water, neither adding or diluting value.
Since the sale they have been stating that they want to buy a new business. Their criteria are Buffett-like:
However, while Buffett has been snatching up companies, they have done nothing. Come on, already!
Bexil is largely owned (well 25%) by a parent company Winmill, which basically runs some funds, owns some subsidiaries. They seem to have let this languish for some time. The stock trades OTC, and has zero press or interest.
upside:
Scenerio 1: they decide to go out of business, and issue a 1 time dividend.
ROI: 83%
Scenerio 2: They buy an average company for what it is worth. Stock price adjusts to company’s value. ROI: 83%
Scenerio 3: They take advantage of the unique market we are in, and buy a company at a significant reduction. We get 2 multipliers here: the crazy stock price of Bexil itself ($44 for $24), and then the discount of the company bought (say 50% discount). ROI 160%+
Scenerio 4: Same as scenerio 3, except the company they buy has appreciation potential of 15-20% yearly. ROI: sky is the limit.
Downside:
1. They buy a bad company for too much money, frittering away the value. They would have to pay 2x what the company is worth for us to break even, > 2x for us to lose money. ROI: 0% to worse than 0%.
2. They issue or incur a lot of debt to buy a bigger company, reducing the enterprise value down to about the stock price. ROI: 0%.
Difficulties:
They only have $38M in cash, so they are restricted to micro-caps. This market is turning some good companies into microcaps, however. It’d be pretty exciting to buy an already extremely undervalued company for nearly half off that price.
Catalyst:
Buying a company, or issuing a special dividend. Winmill puts the pressure on them to realize value.
There is no way to know what they will do. They talk the Buffett talk. Will they walk it? Who knows. Work out what you think the probabilities of each the scenarios are above, and you can put an expected value on the stock (with large margin of error).
Value? Value trap? I dunno. I just thought it was interesting to share - pretty darn rare to ever be able to buy $44 for for $23. Schloss would be all over it. Buffett would pinch his nose and walk away (unless he could buy majority control). In this market I’m finding 10-20 baggers (more about those in future posts. Why put cash in a company that has done nothing with their cash in 2 years?
I’m drowning in ideas and data - more ideas than money to invest. That is not so hard in this market, but I had the same problem when the Dow was at 14K. So, I decided to share my sources. N.B. I am very much a Buffett style investor of the partnership years - arbitrage, special situations, workouts, etc. After that, I’m the Munger/Buffett style investor, great businesses at a good price.
Ride their coattails
There are a few money managers I really respect. Most money managers run mutual funds with 50-100 stocks, and who wants to follow that example? While I don’t usually buy the exact shares that the people I research buy, it’s a great starting point. Find out what they are buying, try to figure out why they are buying those issues. Study the competitors.
So, the first step is figure out who you want to copy, or learn from.
The first person should be Buffett. Studies have shown that riding his coattails - blindly buying whatever he buys at a comparable price, will allow you to handily beat the market. Buffet has almost never lost money in the market - his biggest loss is 2%. OTOH, his investments are limited to very big companies with a lot of stock; he has a lot of restrictions that you don’t. There is no point in him buying shares in a company worth $1B; it’s not enough to even move the needle.
From there you have to decide who you want to study. My current favorite is Bruce Berkowitz. while he runs a mutual fund, he is pretty unique in that he only holds a few stocks, and may be invested up to 10% in one company. He always carries a lot of cash. Most importantly, he is a Buffett style investor, and is a great communicator - better than Buffett, in my opinion. That’s a strong statement, in that Buffett is a great communicator. However, Buffett keeps his own ideas close to his chest. I find Berkowitz’s explanations crystal clear, and they give me the confidence to invest like him.
There are many other people, depending on how you like to invest. Like the cigar butt investing style of Graham. Follow Schloss and his son. Like more Buffett style investing? There’s Marty Whitman. Etc.
How do you find out what they are buying/selling?
First, the site Gurufocus.com tracks many famous value investor purchases. They will only give you the information on a time delay (unless you subscribe, which I haven’t done), but it is very interesting to track what your favorite people are doing quarter to quarter. If 3-4 of your favorite people are all buying the same issue, that should be a strong indication that you just might want to research that stock.
It’s a bit more work, but you can get the data from the horses mouth. Gurufocus finds out these buys from the SEC, which runs a website with all available filings. Since you have to file when you buy a certain percentage of a company, or file if you are a money manager, you can find out what these guys are buying. Go to SEC Filings & Forms (EDGAR), click search, and enter the name of the manager, or their fund name. For Buffett, you can either enter Warren Buffett or Berkshire Hathaway.
Next, I set up google alerts for any person I am interested in. I have alerts set up for buffett, Mark Sellers, Berkowitz, and many others, along with any company I currently own or am thinking of owning. Google Alerts Each day you will get an email for any news item, blog write up, etc., that matches the search term. You get a lot of duplicates, the same link reported on multiple days, but pretty quickly you will learn to recognize the new ones. This service is invaluable to me.
Other sources of information
I don’t use forums much. Almost all of them are pretty weak, IMO, for finding new ideas. With one exception. Joel Greenblatt is a value investor with historical returns in the 40-50% range. He has written two books, and I can’t overemphasize reading his first book, How to be a Stock Market Genius. A silly title, but the most information packed book that I have read. It’s 1 of my 2 bibles in this biz. More on that later. He started a forum for professionals. You have to apply by writing up an idea, and believe me, they don’t read like “the 3 arrows are green, and analysts have projected a 30% growth rate.” They are extremely sophisticated analysis’ based on looking at the balance sheet, etc., projecting out future returns (both the best and worst cases), etc. You can only post if your ideas has been accepted. Each week he awards $5000 to the best idea that week. Every idea is voted on by members, you’ll see ranges from around 3 to 6, where 6 is an extremely high value idea (according to the opinions of the members). Most of the members run money; they ain’t “the little guys”. It’s an inside look at the best minds in finance. I’m not suggesting applying, unless you are the best of the best. However, you can read the forums for free, at a 45 day delay. All you can do is read, not post, but you are reading great ideas by great minds. It’s not a typical forum - they don’t chit chat, all you can do is post a writeup of a specific stock. You have to post between 2-6 ideas a year; no more, no less, so he gets the best ideas from each member. If you get low ratings on your ideas, you can be kicked out. For awhile the posts will probably go right over your head, they did mine, but in time they will start to make sense and you will find yourself thinking about investments in the same way. I don’t know a better information source on the web, period. I read it daily. You should too.
Value Investors Club
For professional services, I use Value Line. I subscribe, but it is pretty spendy. However, most larger public libraries will carry it for free, and even allow you to use the online version. If you don’t recognize the name, it is the service that Buffett uses. Most of the other value guys uses it, and only it, as well. Schloss, etc. It doesn’t review every stock in the US, but around 3500 of them. they also have a small & mid cap edition, which covers another few thousand, though in less detail. A new publication comes out each week, with each stock being updated 4 times a year. It’s a great education to just leaf through each new edition each week. Over 13 weeks you will learn about all the major market segments, learn all the major competitors in each segment, and be able to directly compare them one another. It’s an invaluable education - allocate an hour or two each week to the library for the next 13 weeks.
As for books, I think there are 2 that are must reads. The first I mentioned: Greenblatt’s “How to be a Stock Market Genius”. The second is Browne’s “The little book of Value Investing”. Unlike any other of the popular books, he tells you how to go down a balance sheet line by line, evaluating the company. I wrote this up in the book section of the website. It’s an absolute must-have if you want to be able to read an annual report and really figure out the company.
And that is about it. I get tons of ideas from these simple sources, more than I can act on. I don’t bother with things like blogs, the Wall Street Journal, etc. I don’t want to know what the rest of the world is reading and thinking, because I am trying to beat them. I want to know what the best of the best is thinking and buying, because they are the handful beating out the other 99% of the population.
————-
These are my ideas and source, and they work together far better than the sum of the parts. What value is reading Investors Business Daily when the investors I strive to learn from don’t read it, and don’t invest in that way? I’m not putting down IBD, just pointing out it makes no sense for my style. Rather than trying to read anYhing/everything that others thinks are good, I’m trying to concentrate and distill information. You can read all day, every day, and only read a fraction of what is available. If you want to invest like Buffett, what makes more sense? Reading IBD, etc., or reading exactly what he reads - Value Line, the Wall Street Journal, etc. If you are a technical investor, reading the Value Investors Club makes no sense. Sure, you stumble across stocks you can trade, but why not read what the best in your business is reading?
I’m going to start by seeding this blog with some stuff that I have written and posted elsewhere.
N.B. I haven’t studied this in depth, I’ve just looked it over quickly, and wrote this up more to clarify my thinking than to make a solid recommendation. Do your own homework on this one.
Boulder Total Return fund is a closed fund that invests in a collection of stocks we’d recognize as value plays - Berkshire, Walgreens, Yum!, Wal-Mart, Eaton, BUD, etc. Ordinarily I’d never recommend buying a closed fund - why pay somebody else to pick your stocks, and have to live with decisions you may disagree with - who knows when they will buy a stock you don’t want them to buy, or sell something before it reaches intrinsic value? However, this provides a unique opportunity to buy stocks such as BRK, YUM, etc., at a significant discount to their already depressed rates.
NAV of BTF as of Nov 28 is $12.80, and the shares were trading at $9.17, a 27.8% discount. In other words, if you were to buy the shares owned by BTF on the open market on Nov 28th, it would cost you $12.80. By buying BTF, you get them for $9.17 (and under $9 today).
BTF had a yield of 36.5%. Note that the payouts are not dividends, they are partially return of capital. As such, it is a tax free cash flow. However, you do need to deduct it from your cost basis. I.e., consult a tax professional. However, it is important to know that they announced ending the distribution. to me this is a smart move - they have a great opportunity to invest in this market, why put the money in the hands of shareholders? My answer is, well, I can invest it as well as they can, but in general sophisticated stockpickers aren’t buying this fund. So, for the average shareholder it’s a positive decision. I would expect them to do the same thing for BTF, though they have not announced it. Until they do, you will get a juicy return for holding BRK.A, WAG, etc., at depressed rates.
At the time of the announcement, the discount to NAV was 9%, compared to the current 27.8%. Clearly the market was unhappy about losing the distribution.
Holdings
——–
1 Berkshire Hathaway Inc, Class A $80,454,000 27.06%
2 Yum! Brands Inc $42,102,400 14.16%
3 Berkshire Hathaway Inc, Class B $ 35,898,400 12.07%
4 Wal-Mart Stores Inc $21,855,900 7.35%
5 Eaton Corp $11,013,590 3.70%
6 Anheuser-Busch Companies $8,625,006 2.90%
7 Cheung Kong Holdings $7,403,711 2.49%
8 Claymore Preferred Securities Income $7,370,264 2.48%
9 Walgreen Co $6,448,110 2.17%
10 Burlington Northern Santa Fe $6,444,000 2.17%
cash equivelents: $8,806,792
There are another 28 holdings, but they are all at under 2%. Some are a real disapointment, such as Washington Mutual, but that is more the problem of old shareholders, not new shareholders. The top 10 stocks, plus cash, equals 80% of the holdings.
Anheuser-Busch was acquired by InBev for $70/share, so BTF should now have nearly $18M in cash which they can either deploy in the market or return to shareholders via the monthly distributions.
Conclusion
———-
Owning this fund will pay you in three ways. First, eventually the fund will close the discount to NAV. They haven’t traded at a premium to NAV, but a return of 25% should be expected.
Second, you will be paid by the eventual appreciation of the holdings.
Third, once distributions are reinstated, you will earn around 15%/year. These cash flows are a tax free way to participate in the increase the appreciation of the assets under control.
For this, you will be paying a 2% fee/year to management to manage the investments. I’d ordinarily do no such thing - why pay somebody to buy BRK, WAG, etc for you?
I wouldn’t call this my best idea, but if you were looking to buy several of the stocks in the top 10, and consider them good long term holdings, why not get them at a huge discount to today’s depressed prices?
This is a blog that I’ve decided to start mostly for myself, to document my ideas about value investing, mainly thoughts about specific companies. The term value investing encompasses many different investing styles, but for most it all starts with Ben Graham. The most popular method discussed today seems to be that developed by Warren Buffett and Charlie Munger. While that is how I came about value investing, I find I’m not very good at figuring out what multi-billion dollar company will have a decades long competitve advantage. Plus, I don’t have the “problem” of deploying billions, nor am I trying to establish a reputation for holding a company forever (a useful reputation for Berkshire Hathawy, useless for me). On the other hand, when I read Joel Greenblatt’s book “How to be a Stock Market Genius” (terrible name, tremendous book) I found a way that was sympathetic with my way of thinking. Looking at spinoffs, restructures, buyouts, and identifying value is much easier, for me, then guessing that Coke will maintain it’s edge for another 5o years. And, of course, the rewards can be much higher - in the range of 40-50% returns per year. On the other hand, this strategy has a greater risk of loss of capital.
Lately I’ve been thinking about risk a lot, partly prompted by reading Taleb’s publications, and partly just by the volutility of the market. Higher returns, even over a decade, mean little if you blow up. I’ve felt strong urges lately to buy these mega-cap, safe companies, but then I find a microcap trading at half the cash in the bank, with no debt and 20% ROE. How do you walk away from that? Even though I will have to find another investing idea in a year or two to replace this stock when it reaches fair value, I’d rather chase 50% profits than the 15% huddle rate that Buffett has.
Well, that is a not well explained stream of conscious, but I want to get an inital post out, mainly to see what it looks like and figure out how I want to structure this site.
I don’t plan to post often, just when I have a really intriguing idea.