Always a great place to look for ideas. I tend to check filings from those funds that run more concentrated portfolios. Some of my favorites:
Arlington Value – Allan meachem
Atlantic Investment Management
Brave warrior
Chou Funds
Dalal Funds – pabrai
Fairfax
Leucadia
Arbiter partners
Fairholme
Chieftan
Mittleman Brothers
Wallace Weitz
Yacktman Asset
Akre focus
Pershing square
SPO Advisory Corp
Grisanti Value
Longleaf
Aquamarine
Martin capital management
Oceanstone fund
American Greetings makes greeting cards. Conventional wisdom says this is a dying business – the world now revolves around email and Facebook, not old fashioned greeting cards. Revenues mirror this wisdom to an extant – ten years ago the company brought in just shy of $2B which slowly declined until 2010 they brought in ~$1.6B before rebounding to $1.7B in FY11.
While the stock has remained range bound throughout the last several years, large amounts of free cash flow allowed management to quietly buy back 44% of the shares allowing earnings to grow from $1.54/share to 2.64/share over the last 10 years.
These buybacks are evidence of a management team that puts share holder interests first… and they should, because the CEO and COO are brothers Jeffrey and Zev Weiss whose family founded the company and first took it public in 1958. Together with assorted family trusts they control 51% of the voting rights of the company.
Despite being a cash cow the share price has lagged due to the above mentioned “conventional wisdom” and the fact that in recent quarters capital spending has come under question. The most egregious example of this questionable spending is management’s plan to spend up to $200M building a world headquarters building.
The thought of future cash flows being spent on projects with questionable return had the shares trading below $15 before management announced plans to take the company private for $17.18 a share on 9/25.
Wednesday morning a law suit was filed by a share holder to halt the take private proposal because it is greatly under values the company.
With average free cash flow over the past 4 years of ~$3 / share, I would tend to agree.
This is a company in decline, but it is not terminal. Despite the advent of email etc, people will always appreciate the more human touch of an actual hand written card. I think it is fair that a company like this is worth at least 7 or 8x free cash flow, which puts us in the $21-24 range, significantly above management’s $17.18 bid.
At this point the situation begins to look like a reasonable risk reward trade. Considering the psychology of the buyer – 2 guys who want to restore the legacy of their 100 year old family business by taking it private – 2 guys who want to empire / ego build $200M headquarter buildings for a greeting card company without being yelled at by pesky outside shareholders – I think it is reasonable to assume that the downside on an investment at this point is break even. It is of course entirely possible that they just decide to walk away from their bid, but it seems unlikely.
On the upside, I don’t think there is huge potential – like I said above, maybe the company is worth $21-24 / a share, but its difficult for me to imagine that management will boost their bid by 40%. I don’t think they would be bidding at all unless they thought they were getting a deal.
They control 51% of the voting power so they can pretty much tune out the complaints of outside shareholders if they want to – they don’t NEED to take it private to build their fancy headquarters building. That being said, I could see them boosting their bid by a dollar or 2 to the $19 level to bring the company back within the family fold. From today’s prices that would be a bit over an 11% return net of expenses. Not a huge return, but a relatively safe return.
Of course one could also think about juicing those returns by buying calls rather than equity, but again, who knows if they will actually raise their bid? By getting involved with options you risk total capital loss. If they don’t boost their bid or if they pull their bid. If you stick with the equity and they pull their bid you risk owning a company with a strong record of FCF generation and a management team that has a strong history of returning capital to shareholders that has apparently temporarily lost their way.
Deckers is a footwear company most well known for the Ugg brand, although Teva and Sanuk are other well known brands in their portfolio. The company has been a growth darling with sales rising from less than $100M in in 2002 to over $1.3B in 2012. The stock is down more than 50% YTD as a litany of problems has thrown a wrench in the growth story and attracted a large contingent of short sellers (short interest currently 31%).
Despite these problems, Deckers represents strong brands, maintains a pristine balance sheet, has been expanding its suite of offerings, returning capital to share holders via buy backs, and the CEO bought stock for the first time in 6 years at prices ~30% higher than current prices.
The below represents short term and long term characteristics of the company.
To quote well known consumer products investor and sister of Joel Greenblatt Lynda Greenblatt, ”what is relevant is if this company gets past these issues, can the company be back to normalized margins and earnings and when they do, what is this company worth?”
I believe the company will get past these issues and the stock will eventually be worth a lot more than current prices.
DECK reported FY 2011 earnings of 5.07 a share, and currently trades at 7x that number. Recent sell side downgrades have cited Ugg products showing up at discount websites as they work through their inventory missteps, and this year’s earnings are essentially guaranteed to be significantly lower than last year’s.
Sell side consensus estimates put 2012 FY earnings at 4.327 per share. Lets assume that they fall even further – a full 33% YoY to the 3.40 level…. At today’s prices, that would mean DECK was trading at just a touch over 10x trailing FY earnings. This for a company that has earned an average ROE of over 20% over the last five years, without the use of leverage.
Additionally, there is still ample room for growth as the company expands its direct retail presence to a targeted 200 stores in 2015 – up from 45 at the beginning of 2012.
So…… am I rushing out to catch the falling knife and buy DECK today?
NO.
I am confident that sometime in the next 2-3 years the strength of the brand will over power short term inventory management problems, but a quick look at the holders list shows what looks to be A LOT of weak hands.
8 of the page 1 holders bought the majority of their position in Q1 or Q2 or of 2012, meaning they are all potentially sitting on big losses (assuming they haven’t sold out already). With tax loss selling season right around the corner and only one analyst being vocally negative in recent days, it seems like the knife still has a fair way to fall as tax losses are harvested and analysts cut their price targets (which are on average 65% higher than today’s price).
As of now I’m putting DECK down as a leading candidate for a January effect bounce.
I haven’t really encountered any new ideas lately partly because of the market’s strong move upward, and partly because of spending more time studying for the CFA, but given my last post and my thoughts on catching falling knives this quick post from Saj Karsan is worth a quick referral from me.
http://www.barelkarsan.com/2012/08/conventional-wisdom-falling-knife.html
As it has been about a year since i first started to put some effort into tracking my thoughts on investing, I have been spending time thinking about investments I have made over the last year with a critical eye focused on improving my process and results and understanding what I have learned.
The first lesson that really jumps out to me is tied to RSH, which at down 76% from my purchase point as of today has been nothing short of a disaster investment. When I bought this company i was entirely too focused on the past record of high ROEs and a history of returning money to shareholders via buybacks and dividends and not nearly focused enough on the lack of a clear moat, increasing competition, and a shifting business mix toward lower margin products. On several occasions I thought about selling the stock, but my firm’s trading rules prevented me from doing so because we were actively involved in the name at the time. I was also emboldened by the fact that Francis Chou and other buy and hold investors had purchased stock.
I still own the stock because at this point it is a net net… sort of… and to be honest I still have faith in my original thesis that outside of major metropolitan areas where branded stores are common RSH’s all under one roof mobile business model makes sense. I am tempted to sell it just to get rid of it, but at these prices, I would probably buy it even w/o a clear moat. However, the lesson remains the same: FOCUS ON THE MOAT unless you are buying assets at a discount.
The second lesson that jumps out at me is my attraction to falling knife turn around situations such as RSH, KSWS, and EA. Each of these companies is cheap… but that is because they have all encountered serious changes in recent years and their businesses have seriously declined. I have found myself focusing too much on the past and not enough on changing environments. If they are able to just normalize their operations they will all do very well, however, these companies are not suffering from short term earnings misses or the like – they need to adjust their business models to regain their former strength – a process that may take years. There is nothing wrong with this, and I suspect that out of these 3 names two of them (not sure which too) will wind up as successful investments on a longer time line, but on a shorter time line, the falling knife situations are difficult to endure. As such I will have to pay more attention to position sizing and gradually enter positions of this nature rather than just picking spots.
The third lesson is the natural corollary of the second lesson, and that is rather than spending time on turnarounds, I should focus on companies that have a consistent record of 1) growing book value or 2) increasing their earnings power and operate in change resistant industries. More recent investments such as FLIR, WWE, and the cruise lines, are representative of this. Additionally, I recently purchased entry positions in GS and LUK. I am not going to go into my reasoning in depth, but short versions are:
GS – over the last 5 years CAGR of book value has been 10%, and current P/B is basically at the lowest levels since the depths of the crisis in 2008. Clearly the issue here is what does that book value consist of… suffice it to say that I am reasonably certain that the assets on the books now are of higher quality than they were a few years ago. ROE has come down over the last year partially due to declines in trading and banking volumes, but if you compare GS’s ROEs to their competitors ROEs, GS is lagging the group vs. the historical spread. This may be partially due to business mix, but I believe a large part of it is due to management being extra conservative. At some point management will reengage, capital markets will rebound, and the stock will enjoy serious multiple expansion coupled with the growth in book value in the interim period.
LUK – over the last 3 years book value has grown at a CAGR of 12%, and more importantly over the last 30 years book value has grown 20% per year. Without getting into details, this growth has often been choppy due to the vagaries of GAAP, but the longer term record is unimpeachable. Currently the stock trades at a discount to book as the market prices of several of their investments have suffered for various reasons and because the 2 founders are approaching the end of their careers (Ian Cumming has said he will retire in 2015 when he is 75 years old). However, this is a firm that for 30 years has taken the principals of value investing and successfully applied them. Their current investments are under performing (in terms of market price), but these investments were not made for short term reasons and will likely work out in the long run. Additionally, while the founders are clearly masters of their craft, I find it unlikely that they are not surrounded by extremely capable like minded individuals who will carry the flame long after the founding members are gone. As Buffett has said, “with value investing, you either get it in the first five minutes, or you never get it all.” After 30 years of running their business, I am reasonably certain that the folks at LUK have found plenty of people who got it in the first five minutes, and then spent the last 10 or 20 years perfecting their craft. At some point, the long term value of their present holdings will shine through, and in the mean time, new investments will continue to allow book value to grow. When the market applies an average multiple to this success, the investment will be a success.
The point is that these are companies in defensible industries that can grow their intrinsic value over time that are currently trading at cheap prices. The market price may get cheaper before it appreciates, but the core businesses are sound, and at some point in the future will ascribe a higher multiple to these strong businesses. As Buffet said, “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.” However, unlike Buffett, I would be quick to take profits if multiples expanded to their historical average.
That brings me to the next lesson, which is to not be afraid to take profits when they come quickly. In the past year I have seen 4 of my investments go from 30-40% gainers to flat or losing positions without taking any off the table. I have collected dividends in the mean time, but I would be happy to at least have taken 50% of my investment off the table if it ran 33% percent in 3 months or matched some other arbitrary level of return. I am much more comfortable with a longer timeline and thus did not sell, but in a world of sideways markets, I will have to spend more time considering taking profits quickly if they come quickly.
In summary, this exercise has been a success in terms of forcing me to think about investments and document my process so that I can learn from it. Additionally, the many emails from readers have helped me think outside the box. There is much work to be done, and I wish that I was able to dedicate more time and resources to this forum, but it is serving its purpose to date.
Quality Systems develops and markets computer systems designed to automate records keeping, billing, etc etc in doctor’s and dentist’s offices.
The fact that many doctor’s still rely on a system of manila folders rather than an integrated technology solution has provided a strong tailwind over the last decade, with revenue growing from 54.8M in 2002 to 429.8M in 2011. Over that period the company has produced mean ROEs of 27% while maintaining a strong cash position and zero debt.
Share holders were richly rewarded throughout this period of growth and the stock traded at an average PE of 35x.
The stock has traded off ~66% over the last few months following a series of earnings misses. Despite missing street expectations the company is still strongly profitable, and has a pristine balance sheet so I took quick look.
Management explains away the earnings disappointments by pointing to the fact that while many of their sales are made to small private practitioners, they also compete for large sales with hospitals and other large scale medical organizations. These large sales lead to lumpy earnings quarter to quarter. That makes perfect sense… but I have to believe that almost all of the large medical organizations have computerized their records and billing at this point, meaning that if the easy big sales aren’t gone completely, they will be soon. Large sales in the future will depend on convincing a large organization that it is worth migrating all of their information to a new system, and training all of their people on a new system… something that will be very difficult to do.
As for the smaller sales to private practitioners, it seems as if the runway is still long, but without any clare network effects what if any moat the company may have is difficult to identify. There are already several publicly traded competitors, and with limited barriers to entry, new developers can introduce a new system at any time.
With a 9% short interest and the tendency to have lumpy earnings reports it is likely that the stock will spike at some point which may make the stock attractive to some, but I don’t see how this company will grow its intrinsic value effectively in the longer term, making it a poor investment at these prices.
MEA is an industrial company operating in 3 segments, scrap metal recycling, platinum and other minor metal recycling, and lead fabrication. At its most basic level, their business is buying scrap metal, processing/stripping it, and then selling it to steel mills for ferrous materials, and other end users for higher end metals. On the surface this sounds like a straight commodity business, and the fact that the market is defined by over 500 independent recyclers operating 1,000 locations lends evidence to this thought.
While historical ROEs average out to ~10% making MEA at best a marginal business, MEA can make claims to having somewhat of a geographic moat due to the low value to weight ratio of most ferrous metals and the company’s geographic concentration (operating primarily in Western NY, Pennsylvania, and Northern Ohio). Additionally, MEA is able to maintain lower supply costs than their competitors because they own a network of scrap yards directly.
That being said, it may be premature to consider MEA a true low cost producer. While their recent management presentation points to their “industry leaning margins,” the metric they choose to measure is EBITDA. Unfortunately, interest expense costs are very real, and potentially fatal for a companies in cyclical businesses.
For some time the stock posted impressive growth through acquisitions, however the stock has been cut in half in the last few months and is down almost 66% in the last year and change thanks to commodity businesses as a whole suffering from fears of a Chinese slow down, continued depressed utilization in the steel industry, and no real evidence that the commercial construction or auto sales are about to take off. These demand side issues are compounded by supply side issues such as driver reluctance to upgrade their vehicles (old cars are a major input), growth in the number of yards bidding for scrap, and an expansion in total metal shredding capacity.
The auto upgrade cycle will work itself out eventually, but currently low oil prices are compounding the delay as driver’s are more tolerant of holding on to older gas guzzlers. The growth in the number of yards biding for scrap and the expansion in metal shredding capacity are more secular issues to which MEA is exposed.
MEA is not a good business and thus should be valued on a Book basis. I first noticed the stock because it is trading at .55 book, but ~30% of that asset value is goodwill and other intangibles, meaning that the company is trading for 1.3x tangible book… more than I would pay for this business.
However, what is interesting to me is that MEA is a roll up. With more than 20 acquisitions since the company was founded, they have greatly increased the number of facilities in their portfolio over the last 15 years. Each of these facilities is fairly liquid and could be sold to raise cash in the event of a distressed type situation.
If the operating environment remains challenging in the near to intermediate term, investors will become increasingly wary of MEA’s ability to meet their debt payment obligations and debt covenants, and it is not hard to imagine a scenario under which the company trades like it is extremely distressed.
In this situation, I could see the stock trading down another 30-50% from these levels. At those levels the stock would likely be very attractive as the assets could be sold to payback creditors. Adding to my watch list and hoping for a distressed type situation.
CAP STRUCTURE:
COMPANY OVERVIEW
Rockwood Holdings (ROC) is a US based global specialty chemicals company operating 81 facilities in 23 countries across five business segments (recently expanded from 4 as seen below):
1) Specialty Chemicals (37% of 2011 net sales) includes leading global supplier of surface treatments products and solutions for metal processing industries and leading global producer of lithium products.
NOTE: as of Q1 ’12 the company separated surface treatments and lithium. For Q1 ’12 these segments were 20.7% and 12.6% of net sales. Previous annual levels should be updated upon the filing of their next K.
2) Performance Additives (21% of 2011 net sales) includes color pigments for concrete products, paints, and a leading provider of a new generation of alternative timber treatment chemicals, and clay based additives used for coatings, inks, household products and other applications.
3) Titanium Dioxide Pigments (25% of 2011 net sales) operated as a 61% owned JV with Kemira Oyj and includes a leading producer of specialty grade TiO2 produced through the sulfate process, rather than the chloride process, which allows production of both anatase products and rutile products rather than only rutile. Most global production is rutile, but anatase results in less wear and tear on application machinery, and is typically used in synthetic fibers, rather than coatings, inks, plastics etc where rutile is used.
4) Advanced Ceramics (16% of 2011 net sales) a leading global producer for end markets including medical, electronics, industrial, and automotive focusing on niche applications. Almost all advanced ceramics products are made to order based on specific customer requirements.
The company provides products that they believe are generally critical to the success of their customer’s final products, but account for a small portion of the total cost of the final products. No single customer represented more than 2% of sales in 2011.
While the company is economically sensitive, this is somewhat mitigated by the fact that the company has more than 60,000 customers across a variety of end uses as demonstrated by the following breakdown of 2011 net sales by end use markets:
INVESTMENT HIGHLIGHTS / CATALYSTS
1) Demand growth for Lithium is expected to remain strong
The runway for iPhones, tablets, and other consumer products that depend on lithium based batteries remains long as global consumers continue to upgrade their mobile devices. Additional demand comes in the form of portable power tools and other consumer electronic items.
The real step change will come from the eventual adoption of hybrid / battery powered vehicles, with some analysts expecting a 500% increase in demand for lithium associated with vehicles in the coming years.
Today batteries represent ~30% of total lithium demand. Sell side estimates put battery demand at 50% of total demand by 2020. Other uses include ceramics, glass, and lubricants.
Currently, lithium producers enjoy an oligopolistic pricing environment and have been able to consistently raise prices (up 300% since 2000) as demand increases. Of course, global supply is increasing as demand increases, but with a 3-4 year lead time before new mines/plants can become operational, the current pricing structure will remain in place for some time.
Additionally, when new entrants are able to come online, ROC should be able to maintain their status as a low cost producer. Unlike lithium used for ceramics, glass, etc, battery grade lithium must undergo significant refinement through techniques which ROC has been perfecting for years, and new entrants will have to attempt to replicate.
While the trend will likely be for battery grade lithium to drift toward a pure commodity pricing structure over time, I believe ROC will enjoy customer loyalty for some time. For example, historically a major complaint from AAPL users has been related to battery life. This hurdle seems to have been cleared in recent years, but the company is likely aware that customers remain suspicious of battery life, and AAPL will likely want to stick with a known and proven source of high quality lithium.
2) The company has long noted that TiO2 is not a core business, and has engaged a bank to examine strategic options for the TiO2 business.
While management contends that their Ti02 business is adequately specialized to demand a higher multiple than other Ti02 businesses, market perception is that Ti02 is a straight commodity business, and thus less valuable than ROC’s other business lines. On the Q1’12 conference call management announced that they had engaged Lazard to examine strategic alternatives for the business, with the likely outcome being either an IPO or a sale. Regardless, this business is probably worth somewhere around $900M to ROC (4.1x 2012 EBITDA, with minority interest backed out) – money which can be used to pay down debt, or returned to share holders. The pro forma business should command a higher multiple as claims that other product lines enjoy oligopolistic pricing are easier to justify than the Ti02 business.
3) Continued Debt Reduction / Return of Cash to Share Holders
Management has consistently stated that cash use priority would be 1) expanding Li production capacity, 2) paying down debt, and 3) returning cash to share holders. They have been true to their word, aggressively paying down debt, and implementing a dividend (3.3% yield) for the first time in the most recent quarter.
Net Debt/LTM Adjusted EBITDA Source: Presentation at DB Industrials Conference, 6/13/12
4) Motivated Management
Not only is management excellent from an operational standpoint, but they own more than 9% of the company (#2 holder KKR has 2 board seats). Conference calls indicate a clear preference for profit over revenue growth, and margin maintenance against a difficult macro background and rising input cost environment has been impressive. They have consistently stated that priority use of FCF would be to expand the lithium business, pay down debt, and return cash to share holders. Debt has been significantly reduced, and a dividend was instituted for the first time in Q2’12.
RISKS / WHY IT IS CHEAP
1) European Exposure
Approximately 63% of 2011 net sales were denominated in Euros, and current share prices reflect continued macro / European concerns. However, it is important to recognize that while production takes place in Europe (primarily Germany), sales are largely generated via exports, meaning that continued weakening of the Euro may help accelerate sales to some extent.
Additionally, a substantial portion of the company’s total debt is denominated in Euros (448.2 Euros), allowing the company to more easily pay down debt in the event of continued Euro weakness.
Worst case scenario would be a return to the Deutsch Mark, which would likely be the strongest currency in the region, and thus negatively impact exports.
In summary, despite very real Euro related concerns, demand for ROC’s products will continue to rise over time independent of the macro outcome in Europe, and patient investors will be rewarded.
2) The Ti02 Business Is Seen As A Drag By The Investment Community
Ti02 demand remains strong, but input costs are rising faster than producers can raise prices leading to margin squeeze. Additionally, Ti02 is not as specialized as ROC’s other business units, leading to a lower multiple. However, the company intends to divest the Ti02 business. Short term this may lead to dilution, but longer term, it will lead to a stronger pro forma company.
3) Asian / Luxury Exposure
Many of the company’s products are sold into the German luxury auto market, with an eventual destination of Asian buyers. Recent commentary from luxury retailers has indicated a softening in demand from Chinese buyers as the Chinese economy cools and as new government rules meant to reduce bribery in the form of luxury gift giving are set to go into effect.
However, over the course of the global recession luxury sales have proven to be resilient, and I believe luxury auto demand is independent of luxury demand attached to gift giving, which is more likely focused on smaller, less conspicuous items like watches and other fashion accessories than automobiles.
While I believe that continued slowing in China is a likely scenario in the near term, I believe luxury spending will remain robust on a longer time line.
VALUATION
ROC is a business with strong growth in front of it that is currently trading at historically low multiples.
Historical EV/Consensus forward EBITDA, and P/Consensus forward Earnings:
Assuming growth in line with recent performance and multiple expansion to levels in line with historical performance, ROC is currently priced with a large margin of safety, and should significantly outperform indexes over the next 2-3 years.
Given the high quality mix of ROC’s business, and based on comparative multiples for other specialty chemical companies, I believe a 7.5x EBITDA multiple is appropriate, indicating significant mispricing.
On an EPS basis, the mispricing is more pronounced. While like most industrials there is some variability in ROC’s earnings, their record of strong growth, excellent management, and long runway likely deserve at least a 14x multiple.
KICKERS
The company has consistently made it clear that lithium and surface treatments are their primary focus. However, while not central to the thesis, other business lines are well run and should add value on a longer time line. Additionally, ROC would make a nice tuck in acquisition for a larger competitor in the chemical space.
1) ROC is one of the more likely takeover candidates in the chemical industry
2) The performance additives business is tied to construction, and an eventual rebound in the housing market will be a strong tail wind.
3) The advanced ceramics business is tied to solar panels, and has suffered due to uncertain subsidy environment globally. However, longer term increased production of solar panels seems likely.
4) The advanced ceramics business is FDA approved for ceramic hip joints – as metal on metal joints face increasing criticism, and the global population ages, demand for this high margin business should improve.
SUMMARY
While European concerns are weighing on all investor’s minds, ROC is a solid company with an excellent operating history, long runway of growth, and a motivated management team. Patient investors that can look past near term European uncertainty will be rewarded by significant EPS growth and multiple expansion.
I briefly discussed CRESY after the Argentine government appropriated YPF. At that time I focused on the market value of the non Argentine assets thinking that in the event of an appropriation of the Argentine assets, share holders would come out just fine based on the value of their non Argentine holdings.
The stock has dropped about 20% since I last looked at, so I am taking another look. To remind you, CRESY is a conglomerate domiciled in Argentina that owns a variety of assets – most of them Argentine real estate. Much of this is through a controlling position in IRSA Inversiones y Representaciones (ADR ticker IRS) which owns shopping malls and hotels, again mostly in Argentina. More interesting to me are CRESY’s agricultural land holdings, which include more than 685,000 hectacres of land split between:
The company fashions itself as a developer of sorts, and buys land with the intention to improve it and re-sell it. For example, using land for corn or soy is more profitable than using land for grazing, so they try to buy land that has been traditionally used for grazing and improve it so that it can be used for agriculture. Given the company’s balance sheet and personnel, they believe they can increase the yield from the land through modern farming techniques and equipment that previous land owners may not have had access too. Basically they are just taking traditional land and applying modern, industrial farming techniques to the land.
This is an asset heavy business, but unlike railroads or cruise lines, the assets (the land) don’t have to be depreciated and replaced. Rather, land typically appreciates over time. However, accounting conventions do not adequately address the upward revaluation of land holdings, meaning that their book value is likely understated by a fair measure. The Brooklyn Investor did a brief writeup on CRESY a few months back and demonstrated that CRESY has effectively grown book value in the past. According to the company’s 3/31/12 6K the book value of the company is 2,192,778,000 pesos, or $488,783,000 USD (according to google’s exchange rate). With current non-diluted ADR shares outstanding of 55,891,537, that is a BV / share of about $8.75 per share vs current ADR prices of around $7.50 / share… a ~14% discount to a likely understated book.
So – what does the book value consist of, how defensible is its value, and should this company trade below book?
According to the recent 20F roughly 64% of the total assets fall under “real estate” and 36% fall under “agriculture/feedlot.” Unfortunately the components of those assets (ie PP&E vs intangibles etc etc – obviously PP&E is what we really care about here) are not split out, but PP&E is about 55% of the total asset base and 21% is “investments” which is not defined, but I believe to be capitalized improvements to PP&E. There is also cash and inventories, but the point is that the vast majority of the balance sheet is hard assets, not intangibles or good will. In fact, the company carries negative goodwill which represents the discount purchase prices they have paid on assets in the past – evidence of skillful capital allocation.
First, the “real estate” business which consists of shopping centers, offices and non shopping rental properties, hotels, and development property held for sale. My big fear here would be that a lot of this property was acquired in the mid 2000s at inflated prices and is now at risk of being written down in the event of a renewed global slow down. However most of the shopping centers were acquired in the 1990s, with a touch more than 25% of the total appraised value of shopping centers having been acquired in 2009-2010. This is somewhat comforting as the company was not on a shopping spree in an overheating market, reducing the likely hood of a write down.
Additionally, the company believes that Argentina is still going through an evolution away from neighborhood shops and towards fully developed malls… sort of like the US in the 50s or 60s. I doubt that any area that has not yet fully embraced a mall culture will reach the amount of malls that the US presently has due to the advent of internet shopping, but the point is that Argentina is not “over-malled” like the US is, and there is still an opportunity to refine and centralize shopping destinations in Argentina – despite internet sales.
Additionally, the properties they buy for development and sale are in under or undeveloped areas of densely populated areas, or on the outskirts of Buenos Aires with convenient access to the city. Again the company is not top ticking the market as these properties often lack even basic infrastructure which the company then puts in before selling the properties. This is basically a play on a continued population / urbanization trend in Argentina.
The hotel and office building businesses are slightly more concerning as they are more attached to premium parts of the market, but again, the company was not on an acquisition binge through the early 2000s. These investments are basically a play on Buenos Aires continuing to develop as an international city for both business and tourism – longer term I think both are likely, however, there is a chance all of the above could be written down in a global slow down.
The agricultural business is less concerning. As stated above, the company buys agricultural lands and increases their yield. In the longer term, I am very positive on South American farm land. The global population is bound to grow, and food demand from a growing global middle class will make total food demand grow exponentially. In order to meet this demand the world needs arable land. In order to grow crops in a price competitive way this land needs to be close to water. South America is really the only place that will be able to meet this need on a kind of large scale.
In the shorter term, if there is a global slow down farm land is unlikely to lose much value. People still need to eat, and farm land should benefit from a flight to safety affect as both an inflation hedge and the source of non discretionary food. That is not to say that CRESY’s stock won’t sell off – it likely will, especially given the high debt load and fears of a freezing credit environment – but I think the value of the actual land is pretty safe.
In summary, I think that the book value of the property and land is reasonably safe from being written down, so I feel comfortable looking at this as a ROE / book value story. Over the last 10 years ROE has averaged 6.4%, and over the last 3 years it has averaged 8.6%.
The ROE numbers are not all that impressive, but there are a few things to think about here. First, assuming our cost of capital is 10%, returns of 6 or 8% can be just fine if you’re buying the assets at a discount, which we would be. Second, the story here isn’t really about the year to year income – its more about the appreciation of land over time. The year to year income will reflect some property sales, but it is more representative of sales of beef, milk, crops, and income from tenants. Third, how has the composition of ROEs changed over the years?
A quick look at 10 years of Dupont break down show that leverage has been the contributor to ROE in recent years which is of course less than ideal.
But is it a problem? More on that later.
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