Harvest Investor

The Coppock Guide

2022-12-01T08:44:00.000-07:00

A couple of the lesser known technical indicators that I follow closely are the Advance/Decline line and the Coppock Guide.

I like to watch the A/D line (as measured by the daily NYSE advancing stocks less declining stocks, plotted cumulatively) for signs of divergence throughout a bull market. This happened in textbook fashion during the second half of 2021. The market (S&P 500) continued to rally, but it was being led by a smaller and smaller group of stocks. This divergence was a warning of weak leadership in the market, and a good time to move more defensive.

A lesser known, but still valuable technical indicator is the Coppock Guide. The Coppock Guide doesn’t do much good during bull markets, but it has a terrific history of indicating when the market has bottomed. The story goes that Sedge Coppock, the inventor and namesake, felt market setbacks mimicked mourning periods for people. A religious man, he asked his church bishop how long a typical bereavement period lasted when someone lost a loved one. The bishop responded 11 to 14 months, so Coppock developed a momentum oscillator using the 10 month moving average of the 11 and 14 month rate of changes.

Here is how it works: once the moving average of the rate of change goes negative (the red line goes below zero), the oscillator has reset. Then, when it bottoms and starts to move back up, this is viewed as a “buy” signal. So in the graph below, ignore everything above zero. When it drops below zero, as it has 14 times since 1960, including earlier this year, pay attention. Once it bottoms and shows a positive month, it’s a strong indication that a new market expansion has begun.

This isn’t to say it will call the market bottom. It’s a momentum oscillator, so by definition it will lag the actual bottom. On average, it reverses 4.2 months after the market bottom.

In 62 years of history, we have had 14 signals (not including the current downturn). That averages a signal once every 4.4 years. Only one of those signals was false (January 2001), leading to a false signal ratio of 1/14th (7.1%).

We also see that the average gain post signal is impressive. On average, one year after a signal, the market is +17.6% higher (this includes the January 2001 false signal).

The Coppock finished November at -9.975. To get it to signal by year end (December 31 being the next reading point), we would need the S&P 500 to rally to 4,400.

While the Coppock isn’t a short-term indicator, and won’t help with your day trading, it is a reliable indicator of long-term market health. I wouldn’t advise using either the A/D line or Coppock Guide to time the market, but they can be useful in helping get your hands around market risk and portfolio positioning.

Please let me know if you’d like to discuss the Coppock in more detail.

Harvest Investor © 2022. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Long-Term Industry Returns

2020-12-30T12:29:00.001-07:00

Inspired by the recent Ash Park on Tobacco and Transformation whitepaper, which came to my attention via @JonFell73 on twitter, I decided to take their analysis that global staple stocks have never lost money in any rolling 5 year period (since 1977) and extend the analysis further back in time.

I downloaded the Ken French 12 Industry Portfolio data (monthly), and ran out the analysis since 1926 (first rolling 5y begins in 1931). Since I was there, I decided to run out some additional industries as well, both on a market value basis and an equal weight basis. Here are the charts. Enjoy!

Consumer Nondurables (Staples)

Durable Consumer (Discretionary)

Manufacturing (Industrials)

Energy

Business Equipment (Technology)

Utilities

Healthcare

Finance

Harvest Investor © 2020. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Eastern Bankshares (EBC)

2020-06-25T11:00:00.002-06:00

Eastern Bankshares filed an IPO registration on June 18. Here are a few of my notes from reading the S-1.

Eastern is a mutual holding company (never did a first step conversion) that is converting to a full stock form organization. They are targeting an issuance of 175 million shares at $10, for an IPO of $1.75B (can be up or downsized). Will list on the NASDAQ under ticker EBC. Upon completion of the offering, 4% of shares will be donated to the bank's charitable foundation. The plan is to use the IPO proceeds to expand the bank through both organic growth and bolt-on acquisition opportunities.

Eastern is a full service community bank headquartered in Boston. They have over 200 years of history since founding in 1818. They currently have 89 branches throughout eastern Massachusetts and southeast New Hampshire. They have 2.4% ($8.7B) deposit share in Boston, which they say is the greatest market share for any full service bank headquartered in the Boston area (which is a fancy way of saying they're actually #6 in Suffolk county).

Eastern Insurance is a subsidiary that is an independent agent in the Property & Casualty and Life & Health segments for both retail and commercial clients. There are 22 non-branch insurance offices built through a roll-up of 31 independent agencies over the last 16 years. The insurance business contributes 15-19% of total net income, and helps boost the bank's fee income ratio to near 30%.

Selected Financial Conditions
Eastern is a $12B (will be close to $14B after the IPO) community bank. They run a fairly traditional balance sheet with a diversified loan portfolio (see below) funded by core deposits. Loans/Deposits are 87%. Deposit costs (as of 3/31) were 0.23% vs. 0.84% for peers (peer group chosen by management).

Nonperforming assets to assets have come up slightly in recent quarters to 0.4%, but that's still a very healthy level. The jump in NPA from 2018 to 2019 was attributed to a "loan participation, through our ABL [asset backed lending] portfolio, in a SNC [shared national credit] program portfolio that had a balance of $16.3 million as of 3/31/20."

Expect credit ratios to continue jumping higher in coming quarters with COVID related delinquencies. Management used 1Q to boost ALLL to 1.20% of total loans. I would expect more provisions in coming quarters.

CET1 has been running in the 12% range in recent years, and will be boosted to 26% with the IPO proceeds.

Loans

Commercial & Industrial make up 19% of the total portfolio. They focus on middle-market companies inside of geographic footprint. They do participate in syndications and Shared National Credit Program. SNC was 26% of C&I loans. Asset Based Lending Portfolio (ABL) was 10% of C&I. Portfolio appears diversified across sectors - see below for concentrations.
Commercial Real Estate is 39% of total. Diversified portfolio with 19% of CRE in multi-family. Poses a risk due to COVID rent negotiations?
Commercial Construction is 3% of total.
Business Banking, which focuses on small businesses (under $1 million) is 8.6% of total.
Residential real estate is 16%. They seem to be selling half or more of originations to secondary market, and don't retain servicing rights.
Home Equity is 10%.
Other Consumer is 4.5%. Of this, 60% are auto. They did discontinue an indirect auto loan program in 2018, so expects some of this portfolio to runoff. They did note they do "auto and AIRCRAFT" loans under "other" - curious why they specifically noted aircraft?

Deposits

Pleasantly surprised by the strength of the deposit portfolio. Focus on Demand and MMKT is what gives them the 0.23% average cost. CD's are a minor part, with $156 million of CDs are over $100k.

Rate Sensitivity
Eastern is asset sensitive, with a projected 5.7% increase in NII for a 200bps shock upward.

Income StatementCan see the drivers of the 30% fee income ratio. Insurance as well as a fairly healthy Trust/Investment department (AUM of $2.7B, implying a revenue rate of 0.73%). Salaries seem a little high to me (but that's often the case when I look at stocks). Bank rents all of its properties, so occupancy expense is higher than some peers. I think (but am a little unclear) that the charitable donations line item should go away after IPO due to donating 4% of stock to foundation (which, although is significant dilution, comes with a nice carryforward tax deduction).

Price to earnings ratio on 2019 numbers and issuing max number of shares at $10 would be: 14.5x.

Management
Management is as expected for a metropolitan community bank - lots of non-profit exposure on their lists. None seem to have big M&A backgrounds, but that's not expected for a community bank of this size. They have led Eastern through some bolt-on acquisitions over the past two decades.

Compensation seems high to me, but a lot will be tied to new stock offering going forward, so properly incentivized.

Board of Directors seems weighted toward health care / elder care. That didn't show up in their loan portfolio.

Officer and Director participation in the IPO: they max out at 200k shares. Glad to see a few maxing out their allocation (specifically CEO Rivers), but would have liked a little better uptake. Wish CFO Fitzgerald had maxed out allocation.

Valuation / Outlook
At a $10 price, EBC will IPO at a P/TBV of 0.65. This compares with its hand selected peer group average of 1.05.

However, EBC will be running a capital ratio 23% after IPO. I would love for them to turn around and immediately start buying back shares at 0.6x book, but I don't think that will happen.

I see EBC over time approaching peer group valuation, but the crux will be how well and how quickly they put excess capital to work. Acquisition target banks are cheap right now, so that's a tailwind.

As of today, I really like EBC and their prospects. A high quality community bank converting at a good time. We will have to watch closely as the IPO approaches and see how the stock responds in early trading.

Harvest Investor © 2020. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Thrift Conversions

2020-06-16T09:41:00.000-06:00

Thrift conversions are considered by some the ultimate value investment. A mutual bank, which is communally owned by the depositors, decides to convert to stock ownership. When you buy a share in the new institution, there is no selling shareholder and no shareholder dilution. Your capital is added to the existing capital base, all of which you (the new shareholder) now own. It's akin to buying a house, but when you walk into your new home, your purchase cash is lined up neatly on the kitchen counter, ready to be put to work on new home improvement projects.

Conversions have a long and storied history on Wall Street. Seth Klarman in his famous book, Margin of Safety, outlined their attractive economics ("as long as the preconversion thrift has a positive value"). Peter Lynch did likewise in Beating the Street. Yet since you're often dealing with small- and micro-cap names, they remain a cult investment.

I have historically dabbled in this market with some successes and a few not so successes. Finding a good, repeatable, strategy when it comes to Thrifts has, however, alluded me. Strategies that I have seen recommended by other investors include:

Buy the whole complex (i.e. buy every new Thrift IPO).

Lingering questions: how long do I hold these positions? What causes me to sell? How to I manage portfolio allocations?

Focus on the takeover candidates.

Lingering questions: Do I wait until the IPOs are seasoned for three years (regulatory rules usually prohibit acquisitions for 3 years)? How long do we wait for an acquisition? What key criteria are acquirers looking for?

Follow the activists (Stilwell, Seidman, etc.).

Lingering questions: What are their criteria for ownership? Is coat tailing sustainable, or will I panic at an inopportune time since it's not "my" idea?

While the answers to most of the above lingering questions is old fashioned, in the trenches, due diligence, I still feel I need some quantitative backing to get my hands around a strategy that better fits my investing personality.

For that reason, I went back and looked at every single mutual bank IPO (as listed on bankinvestor.com) from 2005 to today. I then looked at those banks performance in the first three years after IPO, years 3-5, and an overall performance (IPO to 5yr). I also looked at how many were acquired, how long it took for them to be acquired, and their performance.

A few caveats: this is an "in bulk" analysis - glossing over the vast differences between all of these banks. It also ignores the differences between 1st step conversions (to a Mutual Holding Company structure) and 2nd step conversions (from MHC to stock company). Also, there is some survivorship bias. I wasn't able to get price data on every single bank (the farther bank you go, the worse my data capture became).

For ease of comparison, I grouped them by year - creating Thrift IPO vintages. See the following table.

A few takeaways:

From 2005 to the end of May 2020, the S&P 500 total return was 8.4% per year. Thrift IPOs (assuming you held for 5 years and kept rolling your portfolio into new names) returned 6.7% per year [in fairness, this is a price only return - dividends may have added to the performance]. Right off the bat, we're behind just buying an index fund.
Thrifts, like most all of the market, are subject to cycles. Buying vintages 2005-2009 (IPO'd into or during the Financial Crisis) did very poorly. Vintages 2010-2014 did very well.
Whether by cause or effect, the 2010-2014 vintages had very high acquisition rates. In a strong economy acquirers were looking for solid deposit bases and growth opportunities.
In recent years (vintages 2014-2016), you would have done better buying new IPOs and holding for three years. Historically, however, that trend reverses, and you would have done (marginally) better buying seasoned banks three years after IPO (opening the acquisition window).
There is some (limited) evidence that buying seasoned banks after a drawdown may have merit. The 2007 & 2008 vintages recovered nicely from the Financial Crisis in years 3-5 of their lives.
37% of all thrift IPOs are eventually acquired, but the average time from IPO to acquisition was 6.9 years (or 3.9 years from when the acquisition window opened).
If you can identify the acquisition targets (a very big IF), their average return from year 3 to acquisition was 17.5% annually for an average of 3.9 years.

Bottom line:

Understand the banking cycle. There is a delay between when the banking cycle turns up, and outperformance in Thrift IPOs (due to them being acquisition targets). This is evidenced in the vintage 2010-2013 IPOs. They saw their best performance in the calendar years 2013-2016 as acquirers sought them out. Put another way, momentum for the whole community bank complex matters.
Valuation and fundamental analysis are important. Buying the whole complex may work in certain instances, but it needs to be paired with attractive valuations and strong fundamentals. You need to understand the bank, its geographic region, and management incentives.
Perhaps the biggest takeaway is that each of the strategies listed above: buy them all, focus on takeover candidates, follow the activists, etc., may each work at different points in the cycle. Be adaptable and disciplined enough to adjust for economic circumstances. Be willing to walk away from the sector when the stars don't align (and conversely, be willing to build positions when they do).
I think there is value in going back and studying each of the banks that have been bought out over the last 15 years - I will add that to my research list.

If you have any other historical or quantitative evidence on thrift conversions and trading strategies, I would be happy to discuss. Thanks!

Harvest Investor © 2020. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Bayer: Forget about Monsanto

2020-06-03T11:46:00.001-06:00

In 2012 (using the year ended 6/30/12 data), Microsoft was trading at 12.5x trailing earnings of $2.00. And this didn't account for the $7.16/share in net cash they had on the balance sheet. Net that out*, and shares were trading at 8.9x earnings.

The concern at that time had to do with the Windows segment. iPhones, Apple in general, and Androids were all chipping away at the once dominant Windows operating system. Would people even be using desktops in the future?

To account for this, I decided to net out the Windows segment from operating earnings - pretend it didn't exist. So I took full year operating income of $21.7B and subtracted off $11.9B to get $9.8B in ex-Windows income. Adjust income taxes (proportionally), and you're left with $7.9B in net income, and EPS of $0.93.

Without Windows, Microsoft was trading at 27x earnings. Adjusted for cash*, the company was trading at 19x earnings, which wasn't bad considering the growth potential of Servers / Cloud. I was very confident that Windows was worth more than $0 to the operating income line, so this analysis gave me the confidence to continue holding my MSFT shares (which I had bought in mid-2009 and was becoming disgusted with by 2012).

While this type of analysis - looking at a company's weak point and leaving it for dead - is just a form of semantics, it helps me get my hands around the fundamentals, and is also a way to make sure it really is an attractive valuation.

Today, I'm seeing a similar situation in Bayer (BAYN.DE, or the ADR in the US BAYRY). Bayer closed on the acquisition of Monsanto in the summer of 2018. Almost immediately, they walked into the glyphosate (Roundup) buzz saw when, in August 2018, a California jury awarded $289 million in a single cancer lawsuit.

To say this has weighed on Bayer's share price is an understatement. Since summer 2018, shares are down -40%. The market cap of the entire company is now 62B euros ($68B), which is roughly what they paid for Monsanto.

So here is my thesis on Bayer: remove the crop science unit (mostly Monsanto) - assume it goes to $0 EBITDA. 2019 EBITDA was 11.5B euros. Crop Science was 4.8B euros, so net (Pharma and Consumer health) EBITDA was 6.7B euros.

Enterprise value is 97.5B euros (61.6B market cap, debt of 39.1B, cash of 3.2B).

This is an EV/EBITDA (netting out the companies larges division - Crop Science) of 14.6x. Compare that to another health care company with three large divisions: Johnson & Johnson (Pharma, Consumer, Medical Devices), which is trading at an EV/EBITDA multiple of 14.0x today (Glaxosmithkline is at 11.6x, while Novartis is at 13x)

Today we can buy legacy Bayer for the same value as Johnson & Johnson, and get Monsanto for free.

While Bayer has been cheap for a while, what really got me interested was the announcement recently that they are in talks to settle 40-70% of the outstanding 125,000 glyphosate lawsuits. I think this is a major step forward for the company.

Also, anecdotally, none of the farmers I talk to are overly concerned about the cancer risk of glyphosate. Most view it as a chemical used to kill living organisms (plants), so of course you need to use precautions. But on the whole they continue to use it as a primary weed control device. Their biggest complaint isn't the cancer risk, but the fact that they've used so much glyphosate over the years that weeds have built up an immunity to it, and they're being forced to use other, more dangerous chemicals (like Paraquat).

Caveats:

I don't view Bayer as on par with JNJ. JNJ's Consumer division has better brands that Bayer does. It may not be the best comparable stock.
Bayer is a pharmaceutical stock. I've read up on their patents, pipeline, and portfolio. Most seem to think it has good potential, but let's be honest - I have no idea what I'm talking about on the pharma potential.
The company will have major litigation expense going forward. Maybe Monsanto is worth less than $0? That's a risk I'm willing to take.

Bottomline, I think Bayer is trading at too steep a discount for the quality of their underlying assets and earnings potential. Happy to hear feedback.

*I'm not a big fan of doing net of cash valuations as, in my experience, $1 cash is rarely worth $1 of share price, but I'll break my own rule in this example.

Harvest Investor © 2020. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Searching for Bank Acquistion Targets

2019-06-06T11:56:00.000-06:00

I was looking at an Idaho based bank the other day, and noticed that there were only 13 FDIC insured institutions in the state. This led to me thinking about which states have the least number of banks, which led me to thinking about which states have the most banks relative to population, which led to me wondering about banking assets per state versus population.

All this resulted in the following table.

This table was more informational - to satisfy my own curiosity - but a couple of takeaways when thinking about bank consolidation and investing opportunities:

Areas with a low assets per bank seem poised for M&A. This is the low hanging fruit of the industry - banks looking to consolidate to remain competitive, afford new technology, and lower overall expenses. This is the light green area of the above table.
Insides of these areas, the best states would be those with a high asset to population number (these are the slightly darker shade of green). States with above average customer deposits (assuming that higher assets to population is funded by core deposits) may present a value play for cheap bank funding.

If my logic is correct (always a questionable assumption), then the Midwest is an area to look for more bank mergers.

Harvest Investor © 2019. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Growing population - Growing Farmland Productivity

2016-06-29T15:35:00.003-06:00

The idea that world population is steadily growing is often cited as a reason to be long (bullish) agriculture technology / farmland / anything food & protein related. While I may not necessarily disagree with this logic (although, as someone who's seen a number of farm cycles up close and personal, I think some skepticism is warranted), the idea of food scarcity is often treated as self evident - excusing the need to cite hard evidence and facts. This has created a lot of distortion around the issue.

One of the biggest misnomers I see is that farmland productivity is a new issue. As I'll show below, the number of farmable acres per person has been steadily declining since at least 1960 (as far back as worldbank.org data went back). And if you want to go back further, the Reverend Malthus did his writings in 1798 (218 years ago, but who's counting?).

So, here is a quick overview of the world's food/farming situation in 5 quick graphs. All data was sourced from worldbank.org.

1. World population is growing - as it has been for centuries. As of 2015, global population had broken above 7.3 billion. Many analysts estimate there will be 9.5 billion men, women, and children on the planet by 2050, and more than 10.3 billion by 2100. That is a lot of mouths to feed. So where will all that food come from?

2. Arable acres (i.e. land suitable for agricultural production) peaked in 1992, and despite a recent uptick from 2011-2013, has held fairly steady for the past 24 years. It hasn't been more acres farmed feeding all those people . . .

3. As a result of rising population and slow (1960-1992) to flat (1992-2014) growth in worldwide farmable acreage, arable acres per person has been declining. In 1961, there were 1.2 arable acres for each person on this plant. Today, there are just 0.6 arable acres per person.

4. However, yield per acre has been steadily rising. Now this isn't a direct proxy, but looking at yield per acre for cereal grains gives us a good indication in the improvement in farmland productivity. Since 1961, yield per acre has jumped 173%. Acreage has been flat, but rising productivity per acre has kept the masses fed.

5. This all leads to looking at productivity (yield * arable acres) per person. Again, I'm using cereal grain yields as a proxy for the improvements in all of agriculture. What we see is that productivity per person has been rangebound since the early 1980s. In other words, the amount of "product" that an acre of farmland produces per global population member hasn't been declining - it has been in a fairly steady range for 36 years. Not the ominous downtrend (population outpacing productivity) that many would have you believe.

I'm not arguing that all is well in agriculture and we can just sit back and relax. Nor am I addressing some of the uses of ag commodities (i.e. ethanol) that are large beneficiaries of farmland productivity.

What I am saying is that yes, yields will need to be improved, but unless your investment time frame is 30-40 years (many will say yes, few will follow through on that commitment), be prepared for a wild ride along the way as the ag boom/bust cycle can be particularity viscous.

Harvest Investor © 2016. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Stocks with low earnings volatility per unit of growth

2016-05-19T14:51:00.000-06:00

The following tweet from Eddy Elfenbein (www.crossingwallstreet.com) prompted me to run a quick analysis on all the stocks in the S&P 500:

The criteria:

Companies currently in the S&P 500
Positive earnings in every year for the past 21 years
Calculate (simple) average 20 year annual EPS growth rate
Calculate standard deviation of 20 years annual EPS growth rate
Coefficient of variation = Standard Deviation / Mean Return (the lower the better)

Here, ranked by coefficient of variation, are the S&P 500 stocks with the lowest risk (standard deviation) per unit of growth. Enjoy!

Harvest Investor © 2016. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Historic Wheat Prices: Real vs. Nominal

2016-05-13T10:33:00.000-06:00

I was playing around with some wheat price data from the USDA NASS (found here, hat tip to Political Calculations) and wanted to share a couple of quick graphs.

First, here is a graph of wheat prices going back to 1866. Anytime you can show 150 years of data in a chart, it's pretty cool.

However, if we put wheat prices into "real" terms, the chart changes dramatically. Rather than a run-up in prices since ~1950, we actually see the "real" inflation adjusted value of a bushel of wheat declining from 1950 to a bottom in 2000.

I don't show this data to argue that wheat is historically cheap. You can't make a judgement call on cheap or expensive without analyzing the numerous other factors influencing price including substitute products, production costs, or yields. Rather, I just find it a fascinating truly long-term series of data.

A couple of quick observations:

The World War I price spike stands out as the pinnacle of wheat prices, peaking at over $42/bu. (in 2015 dollars) in 1917. Interestingly, for many farmers in the northern great plains, the fallout from this (along with poor weather patterns / yields) in the 1918-1928 time frame made the "roaring 20s" a worse economic period than the Great Depression.
While World War II drove a second major run-up in wheat prices, it was nowhere near the levels of WWI.
The Great Grain Robbery of 1972 (when the USSR bought a large quantity of U.S. wheat at subsidized prices) also stands out. This and a good overall history of the largest grain merchants is well covered and worth reading about in the book Merchants of Grain.

Where do wheat prices go from here? I can honestly say I have no idea. One quote, however, has always stuck with me, and that is "wheat is a weed." Many of the old farmers say this to indicate that wheat is easily grown anywhere (prompting the joke "I can grow in on my land, so it must be a weed") and if a substitute commodity can be grown, it probably will be.

The Longest Dividend Streaks in the S&P 500

2016-05-06T14:52:00.000-06:00

Out of curiosity, I recently spent 10 minutes seeing which stocks in the S&P 500 had the longest streak of consecutive dividend increases. I ran my list on the S&P 500 Dividend Aristocrats since that immediately culled my screen to those companies that have increased for at least 20 consecutive years.

I had no real reason beyond curiosity for running this analysis. Many of these companies have great “moats,” but only a handful will appeal to the “compounding aficionados” (or is it the “compounders mafia”) since the majority have limited reinvestment opportunities (hence the dividends). The opposite argument also crossed my mind - that the longer the dividend streak the greater the potential for a value-trap. You could argue it either way.

I present the following list without comment or judgement on valuation/attractiveness of any individual stock or the group as a whole. With that:

Note: All data taken from www.dividendinvestor.com and www.dividend.com. Unfortunately, even high-end data providers like Bloomberg only report individual stock data back 20 years, so, these online databases were key to compiling the data.

Harvest Investor © 2016. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

S&P 500 Sector Weightings: A Historical Perspective

2015-12-09T12:17:00.000-07:00

There has been a fair amount of talk recently about Energy falling to a 6.5% weight in the S&P 500. While this is a big move from ~16% of the S&P 500 back in 2008, it is not outside of historic norms and only ~1 standard deviation from its long-term mean.

It hasn't had the attention of Energy, but Health Care earlier this year peaked at 15.5% of the S&P 500, nearly +2 standard deviations from its average. Is the recent pullback a warning of reversion to the mean for Health Care, or has the industry undergone a secular shift (aging population, longer life expediencies, Obamacare, etc.)?

Presented without further comment, here are the charts of all 10 S&P 500 sector weights vs. long-term averages and +/- standard deviation bands. Enjoy.

Harvest Investor © 2015. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Vehicle Loans, American Workers, and Car Prices

2015-10-08T11:19:00.001-06:00

I’ve seen some recent reports on the record amount of auto debt in the U.S. financial system floating around the web. Most of the reports reference, in one form or another, the following chart showing motor Vehicle Loans held by U.S. financial institutions.

While this measure arguably misses some of the vehicle loans in the “non-traditional” lending channel (shadow banking anyone?), it’s still a good representation of the growth in auto debt in recent years. Since the last peak (which was 12/31/05), auto loans have grown just over 21%.

However, what we also need to mention is that population has grown as well. Below I show the amount of motor vehicle loans divided by the civilian labor force. I used labor force under the assumption that only people with a job can qualify for a car loan (a dubious assumption I know, but just go with me here).

What this chart tells me is that the average working person in America has $6,356 worth of auto debt. This compares to about $100 of auto debt per American worker back in 1950.

Since the last peak (12/31/05), auto debt per worker is up just shy of 16%. While still a sizeable jump, it's better than the 21% headline growth since 2005.

Of course, thinking about the growth in debt per American worker since 1950 got me to thinking about how much a car cost in 1950. The internet (they have that on computers now) tells me that a new car cost $1,510 in 1950. Today, the average new car costs $33,560. A 22 fold increase in car prices has been met with a 64 fold increase in vehicle debt per worker.

So I downloaded consumer price index (CPI) data on new vehicles. Unfortunately, the data only goes back to 1984. Nonetheless, if we normalize the auto debt per worker for the CPI on New Vehicles (debt/workers/(Auto CPI - 100)) we get the following chart:

Normalized for inflation, the average U.S. employee had $4,010 of auto debt in December 2005 (previous peak) vs. $4,309 today, for an increase of 7.4%. While still growth, a 7% increase in the last decade is a far cry from the 21% growth in the headline number above.

I’m not sure what the takeaway is here - I need to think more about these numbers and what they actually mean. Probably the best takeaway, as usual, is that this business of investing is simple, but not easy.

Please feel free to respond and/or correct any gaps in my thinking.

Harvest Investor © 2015. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Buhler Industries (TSE:BUI): Inventorying this Net-Net

2015-04-16T09:38:00.000-06:00

I have to admit, Buhler Industries (TSE:BUI) calls to me like a siren’s song. What can I say, I have a weakness for net-net stocks. And in many ways, BUI is my ideal net-net:

It’s in an industry I (sort of) understand: Farm Equipment Manufacturing.
It has a long history of profitability: EPS have been positive in every single fiscal year going back to at least 1993.
Its foray into 4WD tractors has been initially successful based on reviews of its Versatile DeltaTrack models.
Best of all, it trades at a discount to net current asset value (NCAV). As of December 31, 2014, NCAV was $5.56 per share, compared to the current quote of $5.20.

A historically profitable company trading at a discount to liquidation value - a rare find in this market.

Now, admittedly, there are issues surrounding BUI that give one pause, not the least of which is the ownership structure:

Despite having a market cap of C$130,000,000, BUI has a very low float.

In 2007, Combine Factory Rostselmash Ltd, a Russian manufacturer of combines, bought 80% of Buhler. The company remains headquartered and operated in Canada (with some U.S. manufacturing facilities), but the new owners have provided a potential growth avenue into Russia and Eastern Europe through co-marketing with Rostselmash.

John Buhler (the retired CEO, current Board member and namesake of the company) still owns 14.5% of outstanding shares as of the most recent proxy.
The company’s deferred profit sharing plan owns another ~1%.

All told, BUI has a float of only ~4.5% of shares outstanding. This is 1,125,000 shares, or less than C$6 million at current prices. To say we would be minority shareholders in this stock seems like an understatement.

While these issues certainly play into any purchase analysis, more concerning to me is the growing imbalance between revenues and inventories. In fact, many short sellers will use slowing sales and continued additions to inventory as a textbook screen for short ideas.

Now, arguably, some of this growing disparity is likely priced into shares considering they are trading for slightly less than NCAV. Yet, when we compare BUI’s numbers to peers, it is staggering how large its stockpiles of inventory and accounts receivable have become:

Among peers it has (usually by a wide margin):

The longest receivables collection period
The most days inventory on hand
The highest inventory per employee
And, despite a slowing ag economy, saw both its accounts receivables and inventory grow over the past twelve months.

In other words, I have some doubt that BUI could liquidate itself for NCAV. Additionally, BUI is having trouble converting working capital assets into cash (it has virtually no cash on hand), as evidenced by the receivables aging trends shown below:

As the above table from the 2014 annual report (year ended 9/30/14) shows, there has been a dramatic spike not just in accounts receivable, but particularly in the accounts receivable delinquent. In total, 17.2% of receivables are past due, with 10.1% of the total over 30 days delinquent. Comparatively, 6.4% of receivables were past due at the end of fiscal 2013, and a more manageable 3.5% were over 30 days delinquent.

Finally, due to balance sheet leverage, the margin of safety associated with this net-net could quickly disappear. Current Assets / Total Liabilities come to only 1.89 as of Dec. 31, 2014. Although not a hard and fast rule, I use the rule of thumb that a net-net should have CA/TL of at least 2.0 to lessen the impact of financial leverage on my margin of safety. At a reading of 1.89, even a small receivables write-off and/or inventory discount could significantly impact Buhler's book value and NCAV:

So all this leads me to the question: what is Buhler Industries worth?

Over the past 10 years, BUI has averaged annual EPS of $0.43. Assign a 13x multiple to this (not sure why I chose 13, but it seems right given minority shareholder status) and we get an intrinsic value of $5.59.

Backing into valuation a slightly different way, over the last decade ROE has averaged 9.0%. To get a 10% annual return on a 9.0% ROE stock we should pay 0.9x book value. Again, assume we take a discount for minority status, and we could in theory pay 0.8x book value for shares. At a recent book value of $7.79, this comes to $6.23 (and assumes there will be NO write-downs in accounts receivable or inventory, which I’d be surprised to see happen).

If we feel intrinsic value is somewhere between $5.50 and $6.00 per share, and since I like to buy at a discount, I’m not going to get too interested in Buhler until I see a price in the low $4 range (and even then, I’ll still need to get comfortable with my standing as a minority shareholder and who is the marginal buyer of BUI).

Ironically, a price in the low $4's would be pretty close to the old Benjamin Graham rule of buying a net-net at 2/3rds of NCAV. So all that work I just did in the preceding paragraphs could be summed up by a very simple quantitative rule developed over 80 years ago. Maybe there's a lesson for me there?

Full Disclosure: I own a handful of BUI shares (mainly for tracking purposes). I do not consider BUI a position in my portfolio.

Harvest Investor © 2015. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

P&C Insurers and Net Investment Per Share: The 1 Column Approach to Valuation

2015-04-03T07:52:00.000-06:00

A recent post by The Brooklyn Investor on Markel (MKL) got me thinking about the two column approach to valuing hybrid insurance / capital allocation companies like Berkshire Hathaway or Markel.

The two column approach says that an insurance company with a history of profitable underwriting (i.e. a combined ratio consistently below 100%) has two sources of valuation (actually three, but the third is an intangible aspect difficult to estimate):

The value of net investments per share (since investments are funded with “float,” which at a well underwrote insurer is a perpetual negative cost source of funding and therefore not a true liability).
Earnings (at an appropriate multiple) from non-insurance operations.

As you would expect, Warren Buffett does an immensely better job of explaining this valuation method. See the 2010 Berkshire Annual Report, page 6.

For almost all insurers, #2 above can be ignored since very few have non-insurance operations. Even Markel, which is considered a “mini-Berkshire” by many investors, earns such a small amount (at least currently) from its “Markel Ventures” subsidiary that non-insurance operations can be thought of as a rounding error (The Brooklyn Investor addressed this in a subsequent post).

So, for most insurers out there, this leaves us with 1 column: net investment per share. Many analysts feel comfortable using this metric for Markel, but it is hardly ever used when looking at the run of the mill P&C insurer. I've often wondered why that is, so I decided to run the “1 column” valuation for a group of large P&C insurers. Net investments per share = ((cash + total investments - short-term debt - long-term debt) / shares outstanding). (Please Note: Net Investments in the table below do not adjust for deferred acquisition charges, reinsurance agreements, and other line items that may distort comparisons among companies).

The results show that Markel is not cheaper than peer P&C companies. In fact, it is above average (higher priced) when we look at the price/investments column (i.e. you’re paying $0.68 for every dollar of net investments at MKL, and only $0.575 at the average peer).

Is it justified to pay more for MKL? Many would argue yes. It has a history of solid investment portfolio performance, book value growth, and underwriting. Yet, at least over the past decade, its peers also have a history of solid underwriting (average combined ratio of 92.1% although, admittedly, many insurers have higher volatility in their combined ratio than MKL and the last decade has been somewhat benign in terms of catastrophic losses).

Will Markel's management be able to continue growing book value at double digit rates and finding attractive investment opportunities? That is the $64,000 question isn't it? While valuation relative to net investments per share can give us a feel for how richly priced shares are, like almost all Financial companies with no competitive advantage outside of people/culture, it all comes down to our faith in management.

And that brings me to the main point of thinking about this. Why don’t more large P&C insurers follow the hybrid / capital allocation model? The benefits of negative cost “float,” the inherent leverage in using unearned insurance premiums, and the virtuous cycle of reinvesting cash flows from high quality investments are all well documented. Wouldn't the entire insurance industry benefit from skewing in this direction?

Of course, this is a little bit like asking why don’t more people buy stocks when they’re cheap (or as Will Rogers once wrote: “Buy stocks that go up; if they don’t go up, don’t buy them”). Finding a really good capital allocator (like Warren Buffett or Tom Gaynor) is beyond needle in a haystack difficult. On top of this, finding an insurance organization with the discipline to consistently underwrite profitable policies (and more importantly walk away from unprofitable policies) is just as difficult.

But still, there is room for improvement. Couldn't an activists target Allstate to capture some of the value of its investment portfolio? I see hedge funds going to the trouble of starting their own reinsurance companies to get “permanent funding” . . . isn't W.R. Berkley a ready made target for permanent capital (I do realize there would be plenty of conflicts of interest in being an activist in a P&C insurer and then inserting yourself into the management of said insurers investment portfolio). Conversely, why hasn't a large insurer scooped up MKL in an effort to capture its hybrid business model on a larger asset base? (obvious answer: why would you buy a smaller company just to replace yourself and your entire executive team?).

Maybe I’m just way off base and don’t understand insurance accounting well enough. Maybe the hybrid model only works when its built from the ground up (Warren Buffett does spend a lot of time discussing culture and partnership in his writings). Or, Maybe I've been brainwashed by the value investing communities infatuation with all things Buffett.

Whatever the answer, the “1 column” valuation approach seems to show that MKL already has some premium built in (compared to peers) for its capital allocation and underwriting skills. Is the premium high or low? Time will tell.

Disclosure: Long MKL

Harvest Investor © 2015. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Return on Invested Capital: Adding a Grain of Salt

2015-03-25T08:52:00.001-06:00

I typically don’t post on the more theoretical aspects of value investing, but wanted to make an exception for a quick rant related to Return on Invested Capital (ROIC).

Follow any number of financial blogs and you might be tempted to say that ROIC has developed a cult following. It is spoken of in hushed tones, as the holy grail of investing (after all, Buffett endorses it, right?). It has been referred to as the key to finding “moats” (a concept itself so overused as to have lost all meaning); a guide to companies with high and sustainable profits.

Now don’t get me wrong - I’m as big a fan of a high ROIC company as the next guy. Who doesn't like to find a company that makes lots of money on very little investment? And when I've gone back and looked at the best performing stocks of the past 10, 20, and 30 years, high (and almost more importantly consistent) ROIC, while not universal, had a clear correlation among the top performers.

Where my issue with the ROIC zealots lies is in the interpretation of the output. Like almost every financial metric, ROIC suffers from the garbage in, garbage out limitation. It’s a snapshot in time indicator, and, for the better or worse, encumbered by the rules of GAAP accounting.

Perhaps I should use an example. My feeble brain needs simple examples, and since I’m a bit of a farmer at heart, lets talk about a farm consisting of 1 acre. The farm has no other assets (all machinery is rented, etc.), and no liabilities.

In my neck of the woods, that one acre would cost you $1,000. In that respect, your invested capital would be $1K.

Now just ballparking some figures here, but we can average 50 bushel winter wheat on that land once every two years (we have to let the land lie “fallow” every other year to catch up). So at $5.80/bu., we get revenue of $290. Knock off $170 for operating expenses, and you get operating income of $120 on your one acre. But remember, we have to divide that by two since the above numbers are for a two year operating cycle. Annually, our operating income averages $60/yr. Take away 30% for taxes, and we’re left with $42/yr.

We can quibble about my numbers (and argue about the economics of farming) some other time, but my main point is that the ROIC of my 1 acre farm is 4.2%.

Let’s assume now that you bought that 1 acre 15 years ago. Back then, you would have paid $400 for the land. The farm has no need to retain earnings (which, if I’m analyzing the business, is its core advantage, but that’s a topic for another day), so over the past 15 years all income has been paid out as dividends.

In this scenario, your “invested capital” is $400, and the ROIC is now 10.5%. Exact same business. Exact same economics. Yet, one has a much higher ROIC just due to semantics.

My point is that, while high (and consistent) ROIC is important, it’s a starting point, and in many cases a misleading one. Age of assets, cash levels, dividends, share buybacks, goodwill, intangibles, financing arrangements, depreciation, amortization, tax structure, type of assets, structure of competitors, industry dynamics, and a host of other line items need to be looked at before dismissing a stock as . . . shudder . . . low ROIC.

This is closely related to a developing investment theme that overpaying for a high ROIC company is somehow okay. The future earnings power of that business will bail you out no matter what you pay, so who care about current price.

Can this (mathematically) happen? Absolutely. But it’s a slippery slope from that thought back to the “nifty-fifty” of the 1960s or the tech bubble of the 1990s. In both instances, and increasingly among ROIC aficionados, an infinite future earnings stream discounted back (at any discount rate) is still infinite, so it doesn't matter what you pay for a stock today. At the risk of stating the obvious, this is a mistake. (Read about the St. Petersburg Paradox, which is also discussed in the excellent Fortune’s Formula).

And while both Charlie Munger and Warren Buffet espouse the benefits of investing in high ROIC companies, I can find no evidence in the writings of either gentlemen that overpaying for anything is ever a good idea. In other words, finding high ROIC companies may be a good investment strategy, but it should never be confused with a “margin of safety.” ROIC is about the future (i.e. competitive advantage), while margin of safety is a fallback for being wrong about the future. Confusing the two as one in the same is a dangerous shortcut.

Bottom line, don’t let someone convince you to pay three times capital for “farm #2” above (the one with invested capital of $400) when you can get farm #1 at $1,000.

As the saying goes . . . Price is Paramount.

Harvest Investor © 2015. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

A “Smooth” Screen for Cheap Stocks

2015-03-13T08:28:00.001-06:00

The concept of “smoothing” earnings is nothing new to value investors. Finding a company that has been thrown in the bargain bin after one or two bad years, with no regard for true (long-term) “earnings power,” has been the bread and butter of many great track records.

Yet, I’m surprised how often the “CAPE” ratio (cyclically adjusted price to earnings ratio), as it has come to be known, is applied to general market indexes while its application to individual stocks is largely ignored. This is somewhat ironic since, long before Professor Robert Shiller made the metric famous, Graham and Dodd were looking at the “average earnings” of individual stocks in their classic tome Security Analysis.

Now, admittedly, using a 10-year average P/E on raw data comes with a whole host of problems/issues, not the least of which are:

A company with rapidly growing earnings may have an unfairly high CAPE (i.e. its earnings from 5-10 years ago may be incredibly small, and not representative of its current earnings power).
A company with rapidly declining earnings may have an unfairly low CAPE (i.e. its earnings from 5-10 years ago may be too high and not representative of its current earnings power).

Yet, I would argue that most fundamental investors would want this type of “messy” data - an idea screen where there a lot of false positives, and where analytical ability can be used to pick diamonds in the rough (or is it nickels in front of bulldozers?).

So, with that background, I decided to run a screen to find the stocks with the lowest current CAPE ratios. My criteria:

All data is from Bloomberg as of March 12, 2015
CAPE is defined as: Current Price / 10 Year Average Diluted EPS

Note: Diluted EPS does not adjust out discontinued operations. This (good or bad) adds to the “messiness” of the data.

Minimum market cap: $15 million
Stocks traded on a U.S. exchange and domiciled in the U.S.

As usual, I have not scrubbed the data. There may be incredible inaccuracies. Please do your own research and due diligence.

Without further delay, what follows is a listing of the 100 cheapest U.S. stocks based on a 10 year CAPE. Happy hunting!

Cheapest 10 Year CAPE Securities as of March 12, 2015
RANK	COMPANY	TICKER	CAPE	MARKET CAP
1	RADIOSHACK CORP	RSHCQ	0.30	$18,629,942
2	YASHENG GROUP	HERB	0.85	$74,446,728
3	FIRST MARBLEHEAD	FMD	0.85	$72,064,624
4	ITT EDUCATIONAL	ESI	1.49	$175,393,152
5	LIGHTING SCIENCE	LSCG	1.53	$65,083,476
6	OTELCO INC-A	OTEL	1.64	$15,022,044
7	SPECTRUM GROUP	SPGZ	1.90	$16,890,048
8	MILLER ENERGY RE	MILL	1.99	$59,692,124
9	MMA CAPITAL MANA	MMAC	2.01	$67,262,992
10	DOVER DOWNS GAMI	DDE	2.91	$37,511,552
11	HANDY & HARMAN L	HNH	2.94	$466,910,592
12	ALASKA COMM SYS	ALSK	3.26	$86,199,224
13	WEIGHT WATCHERS	WTW	3.58	$554,638,784
14	CREXENDO INC	CXDO	3.69	$26,036,280
15	MCDERMOTT INTL	MDR	3.74	$755,999,040
16	ENZON PHARMACEUT	ENZN	4.04	$45,949,388
17	APPROACH RESOURC	AREX	4.08	$270,270,208
18	CIM COMMERCIAL T	CMCT	4.20	$1,727,194,240
19	QC HOLDINGS INC	QCCO	4.54	$34,603,476
20	DIAMOND OFFSHORE	DO	4.76	$3,749,623,552
21	AEROPOSTALE INC	ARO	4.78	$292,753,408
22	AMBASSADORS GRP	EPAX	4.81	$42,097,752
23	BOOKS-A-MILLION	BAMM	5.08	$38,678,260
24	GULFMARK OFFSHOR	GLF	5.56	$369,037,760
25	NATURAL RESOURCE	NRP	5.63	$913,579,712
26	HARVEST NATURAL	HNR	5.84	$22,372,442
27	TIDEWATER INC	TDW	5.93	$1,136,976,640
28	WEBCO INDS INC	WEBC	6.09	$57,836,000
29	EMERSON RADIO	MSN	6.13	$35,268,780
30	FULL HOUSE RESRT	FLL	6.13	$28,126,254
31	COMDISCO HOLDING	CDCO	6.19	$25,986,734
32	DAWSON GEOPHYSIC	DWSN	6.20	$103,464,000
33	BP PRUD BAY-RTU	BPT	6.24	$1,260,460,032
34	MARATHON OIL	MRO	6.28	$17,352,826,880
35	MITCHAM INDS	MIND	6.28	$65,133,060
36	NEW ULM TELECOM	NULM	6.42	$40,300,540
37	FIRST INTER/MT-A	FIBK	6.51	$1,235,635,328
38	INTL SHIPHOLDING	ISH	6.53	$95,034,152
39	CNB CORP	CNBW	6.62	$83,050,352
40	PEABODY ENERGY	BTU	6.64	$1,584,323,456
41	INTERNET PATENTS	PTNT	6.73	$17,683,220
42	CRESTWOOD EQUITY	CEQP	6.88	$1,154,074,624
43	CONTANGO OIL & G	MCF	7.03	$429,474,080
44	FRIEDMAN INDTRY	FRD	7.10	$43,651,752
45	ROWAN COMPANIE-A	RDC	7.11	$2,378,658,816
46	PROSPECT CAPITAL	PSEC	7.13	$3,064,334,080
47	ADDVANTAGE TECH	AEY	7.17	$23,486,380
48	US ENERGY CORP	USEG	7.17	$34,633,812
49	INCOME OPP RLTY	IOT	7.38	$29,594,320
50	SAN JUAN BASIN	SJT	7.48	$604,516,096
51	INSIGNIA SYSTEMS	ISIG	7.49	$35,639,948
52	KOSS CORP	KOSS	7.64	$17,054,050
53	CASH AMER INTL	CSH	7.68	$700,230,464
54	MVC CAPITAL INC	MVC	7.71	$221,352,512
55	DENBURY RESOURCE	DNR	7.77	$2,746,093,312
56	AMBASE CORP	ABCP	7.80	$87,586,168
57	NORTHEAST BANCRP	NBN	7.92	$82,408,760
58	ALLIANCE SEMICON	ALSC	8.05	$26,603,548
59	ITT CORP	ITT	8.07	$3,643,640,064
60	UNIT CORP	UNT	8.11	$1,320,100,864
61	ANNALY CAPITAL M	NLY	8.16	$9,837,822,976
62	GUESS? INC	GES	8.30	$1,506,866,688
63	NL INDUSTRIES	NL	8.37	$347,595,776
64	INTERSECTIONS IN	INTX	8.39	$66,432,296
65	YUMA ENERGY INC	YUMA	8.40	$95,723,688
66	SERVOTRONICS INC	SVT	8.42	$15,312,430
67	COMSTOCK RES INC	CRK	8.43	$218,129,632
68	ATWOOD OCEANICS	ATW	8.50	$1,846,573,696
69	EMPIRE RESOURCES	ERS	8.62	$40,482,800
70	SCHNITZER STEEL	SCHN	8.84	$441,139,712
71	HORNBECK OFFSHOR	HOS	8.88	$693,716,864
72	EZCORP INC-A	EZPW	8.91	$578,700,544
73	ABERCROMBIE & FI	ANF	8.91	$1,462,987,520
74	JPS INDUSTRIES	JPST	8.96	$99,746,984
75	GEOSPACE TECHNOL	GEOS	9.09	$222,042,960
76	BRINK'S CO/THE	BCO	9.10	$1,302,278,272
77	APOLLO EDUCATION	APOL	9.11	$2,914,203,648
78	ACRE REALTY INVE	AIII	9.16	$27,079,310
79	US GLOBAL INV-A	GROW	9.19	$46,531,976
80	AVON PRODUCTS	AVP	9.39	$3,628,035,584
81	JOY GLOBAL INC	JOY	9.39	$3,851,165,952
82	MURPHY OIL CORP	MUR	9.46	$8,305,296,896
83	PATTERSON-UTI	PTEN	9.47	$2,538,122,240
84	EDUCATIONAL DEV	EDUC	9.59	$16,854,016
85	PARKER DRILLING	PKD	9.62	$362,480,576
86	OIL STATES INTL	OIS	9.65	$2,127,773,312
87	MESABI TRUST	MSB	9.73	$225,654,992
88	CAPSTEAD MORTGAG	CMO	9.76	$1,118,605,696
89	REPUBLIC BNCRP-A	RBCAA	9.84	$495,420,800
90	NATL PRESTO INDS	NPK	9.88	$401,178,720
91	VISKASE COS I	VKSC	9.89	$207,551,872
92	GRAFTECH INTL	GTI	9.97	$532,219,360
93	DYNEX CAPITAL	DX	10.21	$448,844,896
94	ARES CAPITAL COR	ARCC	10.23	$5,264,451,072
95	WINDSTREAM HOLDI	WIN	10.23	$4,676,486,656
96	GENCOR INDS INC	GENC	10.23	$92,623,472
97	RESOURCE CAPITAL	RSO	10.27	$612,742,720
98	AMPCO-PITTSBURGH	AP	10.33	$178,801,184
99	VALUE LINE INC	VALU	10.39	$153,571,392
100	OCWEN FINL CORP	OCN	10.52	$1,181,401,088

Disclosure: Author may hold a position in securities listed in the table.

Harvest Investor © 2015. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Bakken Resources: A Net-Net That Doesn’t Net Out

2015-03-04T15:29:00.000-07:00

I was excited to recently stumble across a company selling for less than net current asset value that’s based in my home state of Montana (because geographical proximity is a good reason to invest in a company, right?). Since there are only about a dozen publicly traded companies in all of “Big Sky” country, it was intriguing that one might be trading so cheaply as to be priced at less than liquidation value. With a name like “Bakken Resources Inc.”, however, I had a feeling I knew why it might be so cheap.

Bakken Resources (BKKN) is a $5 million market cap pink sheet company which describes itself as a “non-operating participant in the Bakken play in western North Dakota. The Company plans to focus on evolving into a growth-orientated independent energy company engaged in the acquisition, exploration, exploitation, and development of oil and natural gas properties.”

While the name “Bakken Resources” brings to mind a clear picture of where the company has acreage, BKKN has recently been selling some of its North Dakota assets and entering into leases in Idaho.

It was the sale of mineral rights in North Dakota, and the corresponding cash inflow, that put the company firmly in the net-net category. As of September 30, 2014 (the most recent financials), BKKN had:

Cash	$7,396,974
Accounts Receivable	1,037,186
Other Receivable	198,509
Prepaids	37,897
Total Current Assets*	8,670,548
Total Liabilities	2,187,417
Net Current Assets (NCAV)	6,483,131
Shares Outstanding	56,735,350
NCAV/Share	$0.1143
Current Share Price	$0.089
Discount:	22%

*Note: Current Assets do not sum correctly; an $18 discrepancy is not explained in the 9/30/14 10Q.

This kind of valuation might spur me to dig a little deeper on their leases, acreage, mineral rights, and royalties had it not been for three quick concerns that made this a firm PASS.

$6,000,000 of the cash on hand is “reserved for a future acquisition of oil and gas properties.” There goes our net-net status. Now maybe the company is still cheap if we believe management can go out and find some phenomenal acreage with these funds (especially since they should be buying on the cheap with the recent drop in oil prices), but now you’re investing in management, not the company. And to that thought . . .
There seems to be a spider web of related party transactions, payments to management, and general overlap in the business. These relationships are so convoluted that the company itself has become confused - having to disclose a restatement with the September 30th 10Q where revenue paid to BKKN should have gone to Holms Energy Development, a related party controlled by the CEO of BKKN. While these types of relationships may be common in the oil and gas industry (see: McClendon, Aubrey), its not my game.
For a company with a $5 million market cap, BKKN is battling a whole host of lawsuits. While a number of these cases seem to be in the process of being settled (and to be fair, most seem to have gone BKKN’s way), a number are still on appeal and there is a shareholder class action suit still pending that alleges managerial breach of duty and other malfeasances.

Bottomline, BKKN may be cheap, but there are enough question marks surrounding management and the operating structure of the company that I’ll devote my time and energy elsewhere.

Disclosure: No Position

Harvest Investor © 2015. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

The Best of the Best: Top Performing Stock of the Past 30 Years

2014-07-25T15:44:00.001-06:00

Lately I have been contemplating what makes a company great. What are the building blocks that set a stock up for truly phenomenal long-term performance? Can we, as investors, find a trail of crumbs that lead us to the proverbial “great” company? A simple construct, but a lot of work for my feeble brain.

A lot of people much smarter than myself have tackled this topic, spent lifetimes researching it, and written volumes on the subject. I am not going to break any new ground. Rather, I simply want to share my starting point - a list of the top performing stocks over the last 30, 25, and 20 years (criteria: end date of 12/31/2013, traded on a U.S. exchange, ending market cap greater than $2 billion).

By going through some old Value Line manuals, I've been able to step back in “real” time and see what was happening and how the company was performing before it began its phenomenal run. It has been an enlightening experience (hint: as Buffett/Greenblatt/(insert other great value investor) has said, ROIC really is important).

Hopefully you too can get some use out of the list. If you have thoughts or ideas on what made these companies great, or want to discuss them in more detail, please feel free to email (email on the right).

Rank	30 Yrs.	Ann. Return	25 Yrs.	Ann. Return	20 Yrs.	Ann. Return
1	Amgen Inc.	25.20%	Brown & Brown	27.10%	Monster Bev	35.40%
2	Danaher Corp.	23.70%	Drew Industries	25.30%	USANA Health	33.80%
3	Kansas City Sthrn	22.70%	Kansas City Sthrn	24.50%	Biogen Idec Inc.	33.80%
4	HollyFrontier Co.	21.70%	UnitedHealth Grp	24.00%	Keurig Gr Mtn	33.60%
5	Paychex Inc.	21.20%	Jack Henry	23.40%	Celgene Corp.	33.00%
6	The Gap Inc.	21.10%	Polaris Industries	22.10%	Gilead Sciences	31.20%
7	Nike Inc.	20.60%	Micros Systems	21.70%	Middleby Corp.	30.20%
8	Altria Group	20.30%	Balchem Crop.	20.50%	Astronics Corp.	28.90%
9	Precision Castparts	20.30%	EMC Corp.	20.20%	Cooper Comp.	28.20%
10	Stryker Corp.	20.20%	Charles Schwab	20.00%	Balchem Corp.	27.30%

Data: Bloomberg

Harvest Investor © 2014. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Surveying the Net Net Landscape

2014-06-18T14:14:00.001-06:00

This morning, right after I brushed my teeth, I went to my trusty Bloomberg terminal and punched out “Bloomberg, Bloomberg, computer on my desk, who’s the fairest of them all?” (10 points* if you knew that was an Other People’s Money reference).

What Bloomberg brought back to me was the following list of of net current asset value stocks. Criteria:

Stocks Trading on North American Exchanges
Domiciled in either Canada or the United States
Market Cap greater than $5 million
Market Cap is 120% or less of NCAV
Net Current Asset Value = (Cash & Marketable Securities + Accounts Receivable + Inventory – Total Liabilities – Preferred Equity – Minority Interests).

Please note, I have done no due diligence to check or verify this data. Financial data may be out of date, there may be multiple share classes, or (and I don’t mean to alarm you) there may be a bogeyman or bogeymen in the details. In other words, do your own research.

A few interesting facts:

According to Bloomberg, there are 62 companies in the U.S. and Canada trading below NCAV (with market caps >$5 million).
Of the 95 stocks in the table (trading at or below 120% of NCAV):
49 are Canadian (51.6%) and 46 are U.S. (48.4%)
32 (33.7%) are in the Materials sector, with the vast majority of those in the mining/gold/silver sub industries.
The average market cap of the group as a whole is $28.5 million, with the largest company being Buhler Industries at $156 million.

And now, with no further delay, the table. Happy hunting!

NCAV Securities as of June 18, 2014

Ticker	Name	Country	NCAV	Market Cap	Market Cap / NCAV
UNRH	UNR HOLDINGS INC	US	$83,759,418	$19,571,840	23%
KGHI	KAISER GROUP HLD	US	$16,639,000	$5,084,752	31%
CLWA	CALLWAVE INC	US	$32,406,000	$10,388,392	32%
AAB	ABERDEEN INTL IN	CN	$37,660,350	$12,665,666	34%
HERB	YASHENG GROUP	US	$382,362,961	$130,902,168	34%
LKII	LAZARE KAPLAN	US	$44,982,000	$16,422,831	37%
ALSC	ALLIANCE SEMICON	US	$71,248,000	$28,090,700	39%
SRTI	SUNRISE TELECOM	US	$11,273,000	$5,134,906	46%
KZX	KAZAX MINERALS I	CN	$19,020,073	$8,722,319	46%
SPCO	STEPHAN COMPANY	US	$12,328,000	$5,953,745	48%
TAIT	TAITRON COMPONEN	US	$11,043,000	$5,373,564	49%
BXLC	BEXIL CORP	US	$36,822,806	$18,555,432	50%
UPGI	UNIVERSAL POWER	US	$16,280,000	$8,283,000	51%
BAT	BATERO GOLD CORP	CN	$16,128,889	$8,796,129	55%
LN	LONCOR RESOURCES	CN	$9,300,400	$5,140,781	55%
TSPT	TRANSCEPT PHARMA	US	$67,885,000	$39,218,728	58%
ARL	AFRICO RESOURCES	CN	$55,532,501	$33,873,736	61%
PDQ	PETRODORADO ENER	CN	$27,086,067	$16,889,148	62%
SPGZ	SPECTRUM GROUP	US	$27,793,000	$17,652,448	64%
TWMC	TRANS WORLD ENTM	US	$163,232,008	$103,897,384	64%
SVU	SPUR VENTURES	CN	$29,187,887	$18,726,228	64%
NUX	NEW PACIFIC META	CN	$25,483,641	$17,069,248	67%
DNV	DUNAV RESOURCES	CN	$11,670,345	$7,889,375	68%
NRE	NAMIBIA RARE EAR	CN	$13,155,038	$8,950,278	68%
MUN	MUNDORO CAPITAL	CN	$13,073,487	$9,121,723	70%
INV	INV METALS INC	CN	$21,052,514	$14,826,293	70%
KRN	KARNALYTE RESOUR	CN	$49,040,879	$34,623,552	71%
TSRI	TSR INC	US	$8,410,689	$5,945,048	71%
ORG	ORCA GOLD INC	CN	$85,898,869	$61,221,280	71%
KXM	KOBEX MINERALS I	CN	$34,138,818	$25,140,932	74%
RYG	RYAN GOLD CORP	CN	$20,338,569	$15,228,192	75%
AMR	AMAROK ENERGY IN	CN	$21,647,702	$16,312,676	75%
IDEA	INVENT VENTURES	US	$9,158,679	$7,053,286	77%
MWC	MEDWELL CAPITAL	CN	$12,230,000	$9,467,366	77%
MSN	EMERSON RADIO	US	$61,967,000	$48,019,804	77%
OEG	ONENERGY INC	CN	$15,885,000	$12,556,398	79%
RDU	RADIUS GOLD INC	CN	$13,613,703	$10,834,452	80%
STC	SANGOMA TECH COR	CN	$10,275,470	$8,216,496	80%
PRLS	PEERLESS SYSTEMS	US	$11,873,000	$9,523,083	80%
IGOI	IGO INC	US	$11,385,000	$9,275,827	81%
SODI	SOLITRON DEVICES	US	$10,973,000	$9,071,203	83%
JLMC	JLM COUTURE INC	US	$6,909,564	$5,718,955	83%
SPRS	SURGE COMPONENTS	US	$8,757,133	$7,257,071	83%
PTNT	INTERNET PATENTS	US	$29,299,000	$24,418,648	83%
CRV	COAST DISTR SYS	US	$20,442,000	$17,094,982	84%
ECC	ETHOS GOLD CORP	CN	$8,731,667	$7,388,015	85%
SWD	SUNWARD RESOURCE	CN	$29,261,302	$24,907,284	85%
MBS	MOBIUS RESOURCES	CN	$14,834,000	$12,673,688	85%
RELL	RICHARDSON ELEC	US	$159,301,000	$140,253,328	88%
TCCO	TECHNICAL COMM	US	$9,502,425	$8,514,204	90%
IDC	INTL DATACASTING	CN	$6,397,125	$5,850,629	91%
STLY	STANLEY FURNITUR	US	$43,303,000	$39,635,320	92%
ZC	ZIMTU CAPITAL	CN	$7,307,772	$6,759,292	92%
COSN	COSINE COMMUNIC	US	$19,938,000	$18,865,714	95%
CRG	CORONA GOLD CORP	CN	$10,124,632	$9,635,355	95%
ADI	ADRIANA RESOURCE	CN	$28,886,625	$27,571,992	95%
SN	SENNEN POTASH CO	CN	$8,041,069	$7,780,039	97%
MSV	MINCO SILVER COR	CN	$60,367,081	$58,415,924	97%
UGD	UNIGOLD INC	CN	$7,489,165	$7,311,397	98%
CNDO	CORONADO BIOSCIE	US	$80,217,000	$78,863,000	98%
GENC	GENCOR INDS INC	US	$104,459,000	$103,743,824	99%
ELR	EASTERN PLATINUM	CN	$93,425,000	$92,818,784	99%
PARF	PARADISE INC	US	$15,594,532	$15,691,920	101%
CDCO	COMDISCO HOLDING	US	$19,952,000	$20,144,756	101%
VII	VICON INDUSTRIES	US	$11,556,038	$11,710,101	101%
DCTH	DELCATH SYSTEMS	US	$25,620,000	$26,158,662	102%
BSHI	BOSS HOLDINGS	US	$23,260,000	$23,895,528	103%
GIC	GENTERRA CAPITAL	CN	$13,798,496	$14,217,792	103%
EPL	EAGLE PLAINS RES	CN	$6,485,414	$6,699,094	103%
SDOI	SPECIAL DIVERSIF	US	$23,578,000	$24,392,062	103%
ORBT	ORBIT INTL CORP	US	$12,832,000	$13,341,849	104%
GRG	GOLDEN ARROW RES	CN	$8,634,103	$8,981,204	104%
BEV/H	BENEV CAPITAL IN	CN	$67,968,188	$71,740,960	106%
AEY	ADDVANTAGE TECH	US	$28,510,396	$30,453,292	107%
BLT	BRILLIANT RESOUR	CN	$10,491,009	$11,209,108	107%
SMGI	SMG INDIUM RESOU	US	$17,597,740	$18,836,394	107%
HCI	HARTCO INC	CN	$38,901,000	$41,649,628	107%
LVN	LEVON RESOURCES	CN	$46,520,825	$50,013,604	108%
HMM/A	HAMMOND MANUF-A	CN	$15,236,000	$16,434,734	108%
FRD	FRIEDMAN INDTRY	US	$50,786,076	$55,484,144	109%
AXTI	AXT INC	US	$61,276,000	$68,470,408	112%
BUI	BUHLER INDS	CN	$139,210,992	$156,000,000	112%
PCO	PHOENIX CAN OIL	CN	$7,087,715	$7,970,527	112%
DL	DANIER LEATHER	CN	$32,380,000	$36,421,888	112%
MLR	MELIOR RESOURCES	CN	$21,574,998	$24,318,928	113%
SMIT	SCHMITT INDS	US	$7,391,043	$8,374,548	113%
GDL	GOODFELLOW INC	CN	$73,631,000	$83,789,560	114%
ATX	ARGENTEX MINING	CN	$5,241,142	$5,970,570	114%
TRGT	TARGACEPT INC	US	$122,479,000	$140,206,048	114%
OPST	OPT-SCIENCES	US	$11,939,854	$13,689,075	115%
FOS	PHOSCAN CHEMICAL	CN	$41,946,905	$48,596,944	116%
HYD	HYDUKE ENERGY SE	CN	$14,597,455	$17,028,384	117%
BVSN	BROADVISION INC	US	$40,715,000	$47,950,592	118%
SUP	NORTHERN SUPERIO	CN	$6,320,701	$7,546,196	119%
SVT	SERVOTRONICS INC	US	$14,418,000	$17,286,616	120%

Full Disclosure: Author may hold a position in securities listed in the table.

*Points have no cash value, are redeemable for nothing, and in every sense of the word are “pointless.” Now puns on the other hand . . .

Harvest Investor © 2014. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Unsolicited Advice for Community Bankers

2014-02-20T16:13:00.000-07:00

From time to time I like to pitch a business idea that appeals to me since . . . well, it’s my blog and I can.

One area that I've been thinking about recently is community banking. I've come to the conclusion that many local banks (some much smaller than you’d think) could benefit greatly by expanding into the money management business.

Many of the larger banks (regional, super-regional, money center) have long capitalized on cross-selling services and using investment products to boost fee income (look at a bank like BB&T which boasts a fee income ratio near 44%). Yet, when you look at the smaller, more community based banks, they are lacking in this area. I contend that this is a major misstep for those institutions.

Historically, many community banks allowed 3rd party brokers (such as Investment Centers of America, Inc.) to place offices in their branches. In exchange, the bank received a revenue sharing agreement and the ability to tell customers it had a broker in the bank. Unfortunately, due to the inherent conflicts of interest (not a bank employee, not a customer fiduciary, paid on account turnover, 12b1 fees, etc.), this was equivalent to a doctor telling his patients “great news, I’m now sharing offices with a mortician.” (OK, bad analogy, but I’m going with it nonetheless). Like most 3rd party fixes, it left customers confused and alienated when problems arose.

A better fix, in my opinion, would be for a bank (bank holding company technically) to create an SEC Registered Investment Advisor (RIA). This model, although embraced by some of the larger regional banks (often paired with a trust department) is more downward scalable than most community bankers realize. The benefits for community banks are numerous:

It’s a low capital intensity / overhead business (high margins). Start up costs are minimal (the registration process is cumbersome, but not expensive) and ongoing overhead (employee costs, compliance) are manageable.
RIAs are fiduciaries for their clients. They charge fees based on account size, not asset turnover. As such, they are (in theory) incentivized to do as well as possible for clients (higher account size = higher fee).
For family owned community banks, an RIA subsidiary can basically function as a quasi-family office. Instead of the controlling family having to find an outside money manager, why not have your own in-house RIA that can manage family funds, bank holding company excess capital, the bank’s bond portfolio (more on that below), and portfolios for bank customers.
By funding the RIA with “seed capital” from the banks owners, the investment advisor immediately starts with an asset base (don’t have their backs against the wall), and it creates a nice selling point to potential customers: “the owners of the bank invest their funds with us, you should too".
Many banks have to hire outside investment consultants to administer their 401k plans. With an RIA sister company, this service can be internalized (leading to cost savings) and a nice cross-sell opportunity (by doing 401k education with bank employees, the RIA is also educating on the services they can provide to external customers).
There can be overlap / efficiencies between the banks bond portfolio and investment customer accounts. Too many community banks outsource their bond buying to 1 or 2 brokers (i.e. “I bought a new bond – Vining Sparks said it was cheap”). Having a full time investment professional searching for bonds for the bank as well as investment customers can create a nice cost savings / efficiency gain.
Having the bankers and portfolio managers be on the same team (owned by the same company) alleviates (some) conflicts of interest – both are paid from the same pool, so if a client is more comfortable in bank CDs, the RIA sends them there (and vice versa). There is no (or minimal) fighting over customers.
With the low overhead structure, the RIA business could probably be break even with $10 - $15 million AUM (depending on employee compensation structure, fee schedule, etc.).

Bottomline, for the cost of 1-2 employees (with one of those employees possibly being an already underutilized staffer), a bank can create a new fee income source, create internal cost savings (bond portfolio, 401K management), build brand awareness (new services for customers, all under one roof), and have its own “family office,” all with very little cost/overhead.

I remain confused as to why more banks haven’t taken this route (although am in no way so confident that I don't think there must be a good reason). Obvious reasons in my mind would be:

A lack of qualified employees / candidates to run the RIA.
The philosophy (which I usually agree with) that a bank should stick to what it knows best – lending and deposit gathering.

However, as the regulatory environment becomes more restrictive (higher capital requirements), compliance costs skyrocket, and bigger banks continue to pressure community banks on loan rates, a little fee income diversification might not be a bad thing, right? As usual, this is just my off the cuff thoughts on the business. I’d be glad to hear the thoughts of others, especially those in the community banking world.

Harvest Investor © 2014. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

PhosCan Chemical: Slow Burn, No Return

2014-02-13T11:00:00.002-07:00

There’s something about a net cash stock that gets me excited. I guess it goes back to the old value concept of being offered $1.00 worth of something for $0.50 (or, as you’ll see below, $0.8146). With that in mind, I submit to you PhosCan Chemical Corp. (FOS on the Toronto Stock Exchange, or PCCLF on the U.S. OTC market).

FOS is a Canadian company with only two real assets:

~C$57million in cash and short-term investments.
100% ownership of a mining claim (called the Martison Phosphate Project) which covers over 20,000 acres northeast of Hearst, Ontario.

The Cash
If we look at FOS as a cash box, netting the cash and short-term investments against total liabilities*, we get net cash per share of C$0.356 as of 10/31/13 (most recently reported financials). Shares closed today at an ask price of C$0.29.

*I am assuming that the ~C$16 million deferred tax liability will never be payable, and will be wiped out by writing off a portion of the mine development costs.

With most “development” stage companies, they burn through cash in the process of research & development, making what appears to be a net cash stock nothing but an illusion. As the above chart shows, FOS has bucked this trend, managing to hold net cash roughly steady over the past two years by offsetting operating costs with (1) interest earned on the investment portfolio and (2) buying back shares (i.e. management is buying $1.00 for $0.80555). A company trading at a 23% discount to net cash and a slow to nonexistent burn rate on that cash is what piqued my interest in FOS.

The Mine
FOS other key asset is the Martison Phosphate mine (as of yet undeveloped) in Ontario. The potential mine is currently valued on the balance sheet at just shy of C$94 million (C$1.5 million for the land, C$92.4 in development costs). That’s right, over the last 30 some years, investors/speculators have poured nearly C$100 million into trying to find and develop a phosphate rock mine (with more recent rumblings about the nioubium potential of the property) on this claim. As of yet, they have nothing ($) to show for it (but Columbus had nothing to show for years of work and preparation the day before he spotted the “New” world, right?).

I’ll be honest – I have very little knowledge of the mine. There are some good arguments for why the mine has value:

Expected high grade phosphate deposit at 23.55% phosphate and an indicated resource of 62.2 million tons.
Agrium (AGU) is winding down a nearby phosphate mine in Kapuskasing, leaving a gap in local/Canadian phosphate production.

However, there are good arguments for why the mine has little value:

Agrium has already sourced replacement phosphate production from Morocco.
Global phosphate reserves are not in short supply (304 years at estimated 2012 worldwide production capacity [assumes 100% capacity utilization] according to 2013 USGS data book).
The price of phosphate rock is not encouraging to new mine development:

Source: http://www.indexmundi.com/commodities/?commodity=rock-phosphate&months=120

The Conclusion
What I find more instructive than what FOS is doing with its cash (buying back shares in a shareholder friendly manner) is what they aren’t doing. They aren’t returning what is, almost inarguably, an overcapitalized balance sheet to shareholders (observe what Selwyn Resources [SWN.V] did with cash, albeit after a testy and somewhat amusing removal of management by activist investors). This tells me that either:

Management plans to spend cash to fully develop the mine at some point in the unforeseen future.
Management plans to continue milking compensation out of FOS for the foreseeable future.

Either way, without some insight on the mine (of which I have none), sitting and waiting for an undetermined amount of time for management to become benevolent –even with a slow/nonexistent burn rate– does not look like a good risk/reward in my opinion.

The key here isn't the value of FOS (it’s a great value!). The key is the time value of money. “Waiting for an undetermined amount of time” for the return of cash is a speculation. The IRR can span from 23% in year 1 down to 5% if we don’t see any cash until year 4. For me to become interested (no real objective reasoning here), I want to see a 4 year IRR potential of at least 10% (~C$0.24/share for those keeping score at home, and coincidentally ~67% of net cash). Until then, I play the waiting game.

Disclosure: No Position

Harvest Investor © 2014. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

The Dangers of Coattailing

2013-11-08T08:16:00.001-07:00

In her Warren Buffett biography, The Snowball, Alice Schroeder details how Buffett viewed the idea of borrowing ideas from other investors:

“ . . . he also felt honored to borrow ideas from Graham, Pritzker, or any useful source. He called that riding coattails and did not care whether the idea was glamorous or mundane.” (The Snowball, Schroeder, pg. 111)

Although Buffett took the idea and then went on to do in-depth research, many people skip the research, leading almost every blog and investment professional to recommend the now ubiquitous “this is not a recommendation, do your own research” disclosure in an effort to cover their rears (who would be so spineless you ask? . . . ahem . . . please see my disclosures below).

In my own personal investment process I take pride in doing my own research, no matter where the idea originated. However, upon some recent post-mortem analysis of my stock selections, I have to admit my experience with taking other people’s ideas has been nothing short of abysmal (it was so bad that I honestly didn't even need to do the post-mortem analysis, it was a glaring sore thumb). With a little introspection, I chalk my poor coattailing experience up to a weakness of mine (and perhaps, arguably, a strength): Laziness.

With coattailing, I often find that my objectivity gets swayed. A stock that, after detailed independent research, might rate as average to slightly above average suddenly becomes a search for what did I miss – there must be a reason XYZ fund or great investor so-and-so is buying. This takes me from a balanced view of the company to the lazy mindset of looking for what’s good about that company (because there must be something, right?) – a subtle shift, but a devastating frame of reference for an investor.

Even the big boys can get things wrong.
No one is immune from the occasional investing mistake. Take for instance the following quote from a July 2011 investor letter that I recently ran across while researching Mosaic (MOS):

“While we were drawn to Mosaic by the catalytic event of the Cargill sale, our position is now largely sustained by two main drivers. The first is our belief that grain and corn fundamentals are extremely positive. . . . The second is our belief that potash fertilizer has yet to recover to trend-line levels of demand.”

That quote comes from one of the most well known (and most successful, so don’t take this as an insult to them) hedge funds in the world. In the text, they clearly and concisely lay out their thesis for why MOS has “significant upside” at their cost of $65.

For an investor on the fence about MOS it would probably have been the push they needed to start buying. The nudge of a well respected firm/investor would move their psyche from “it’s an OK stock, but I just can’t get my hands around it” to one of “I must have missed something in my review, let’s go back again (and specifically focus on the talking points I've now heard).”

Here is what MOS has done since that letter was published:

Source: Yahoo! Finance

(Full disclosure: I have no ideas when/if the hedge fund exited the MOS position. For all I know they may have exited with a profit).

Now as a long-term investor, I’m open to the fact that $65 may still be a great entry point, and the ability to buy on this weakness may be a gift from Mr. Market (in the form of a breakdown of the BPC potash cartel). [As an aside I've put MOS in the “too hard” pile (at least for now). Even though I think the balance sheet is strong and the valuation is somewhat attractive, I don’t have a good enough grasp of the potash cartels and the global reserves and mineable resources of P & K.]

All of that aside, if you had limped into MOS on what I’m calling a “laziness coattail” – one where your objectivity was swayed by someone else’s analysis and not backed up by your own – you’d be staring at a near 30% loss on a stock that you originally would have passed on. If your objectivity was cloudy at the onset there is almost no possibility that it’s any clearer now.

This issue closely relates to money managers talking their book. I have no problem with investors highlighting their best ideas. What becomes a problem for me personally (since it clouds my objectivity) is when they become stock salesmen and women. They talk up the stock’s growth prospects, the potential size of the global market, and the whiz-bang technology the company possesses. Yet, when it comes to the company’s risks – and make no mistake, every company has multiple risks – all you hear are crickets.

Again, these are subtle shifts, but I’d much rather hear what can go wrong (and the defenses the company has in place to offset) than what can go right (and be left guessing what risk will derail the company [if Donald Rumsfeld is out there, we can talk about unknown unknown risks another time]). To me this is what competitive advantages are: defining corporate characteristics that protect the company from risks.

To offset my own laziness and stupidity (I was going to say “improve my objectivity and discipline,” but those aren't the risks; laziness and stupidity are the risks) I’m changing my coattailing routine. No more chasing down prepackaged positive leads. No more limping into mediocre ideas on the back of “gurus.” Basically, no more laziness (I wish I could say no more stupidity, but a zebra can’t change its spots).

If I can’t study a company and say “wow . . . that’s stupid cheap,” I won’t buy it. I still plan to coattail and take ideas from anywhere and everywhere I can find them, I just need to be careful in how I react to those recommendations. [As an aside, “stupid cheap” doesn't mean I only buy net-nets; quality stocks can also qualify.] If I can do a better job of remaining objective, the old axiom of “focus on the downside and the upside will take care of itself” should allow my “stupid cheap” ideas to outperform over the long-term.

Harvest Investor © 2013. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Gladstone Land: A Farmland REIT Emerges

2013-05-24T12:05:00.000-06:00

Gladstone Land (LAND) is a recently public farmland investment company. After publishing an off the cuff tirade about farmland REITs back in 2011 (this blog's most popular post ever - by a wide margin), I decided that LAND deserved a look. Of course the 8.5% dividend yield may have piqued my interest as well, but more on that below . . .

LAND 5-24-13 -

Harvest Investor © 2013. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Rocky Mountain Dealerships (RME)

2013-04-23T08:46:00.002-06:00

Summary

After reviewing my holding in Rocky Mountain Dealerships (RME) I continue to hold my position but am no longer accumulating shares. I am willing to swap-out the position if I find a better value opportunity, but I am not at this point liquidating shares to move to cash.

Background
I originally purchased RME 2 ½ years ago and since then it has been a good (but not great) holding for me. However, after Titan Machinery’s (TITN) bloodbath recently, and after seeing a number of analysts upgrading RME in recent months (which frankly scares me), I thought now would be a good time to step back and review my thesis on the stock, its valuation, and what could go wrong.

Company History
RME is an agricultural and construction equipment dealer. It primarily sells Case IH, Case Construction, and New Holland brands (as well as a number of “short” lines) through its 39 locations across Alberta, Saskatchewan and Manitoba.

Back in 2006, Matt Campbell (CEO) and Derek Stimson (President) merged their respective Hammer Equipment (primarily construction) and Hi-Way Service (primarily ag equipment) into one company and IPO’ed the firm in late 2007. Since then, the company has been on an acquisition spree, purchasing 15 independent dealerships since 2008. In 2012, sales broke down as (from 2012 annual report):

The strategy behind RME is beautifully simple. A larger dealer network can command better operating efficiencies and cost management than smaller, independent (“Mom & Pop”) dealerships. Management has noted that their target performance is a 15% (maybe up to 17%) gross margin with ~10% SG&A expense netting a 5% operating margin. This compares to small dealerships which typically have ~11% gross margins and an 8-9% SG&A overhead for a 2.5% operating margin.

Now I’m usually very skeptical of economies of scale arguments, and this alone wouldn’t have gotten me to invest in RME. However, the economy of scale argument with a clear path to market share growth was more compelling. With its ability to dramatically improve margins, RME has been able to aggressively acquire its competitors, while still keeping acquisitions accretive to earnings.

Most importantly (in my mind), RME’s primary supplier (Case New Holland) supports a roll-up of small dealerships. Comments from equipment executives show that the big manufacturers (Case, Deere, Cat, etc.) want larger dealer networks for their own efficiency and operational reasons. When you have a better operational structure than the competition (higher margins), a deep pool for market share growth (acquisitions), and a franchisor (who effectively controls market share) in favor of a dealership roll-up, that’s a powerful business model.

All of this led to 2012 being a banner year for RME. Same-store sales were up 16.3% on the year. The company posted record EPS of $1.28, up 24% year-over-year. On top of this, there was a fair sized debt conversion expense in the year. If I try to adjust for this, I get “normalized” EPS of $1.45 (up 41% yoy). Suffice to say, the ag economy on the Canadian prairies is booming ($8.00 wheat creates a nice cash flow). But are these types of EPS numbers sustainable?

Risks/Concerns
The problem for RME is that acquisitions have fueled their growth, and those acquisitions are getting harder to come by. A quick search of the Case IH website reveals 27 ag dealerships listed in Alberta, and 18 of them belong to RME (67%). Saskatchewan may be an opportunity with 25 dealers listed and RME accounting for only 5 (20%), but there are other fairly entrenched dealerships in the province to compete with. Manitoba is similar to Albert, with 12 dealerships listed and RME accounting for 7 (58%). The company could jump south of the border into the U.S. for growth, but there is intense competition there from companies like TITN. There may also be room for RME to grow its New Holland presence, but that remains to be seen.

Beyond growth, there is the always present worry that a downturn in the ag economy will hurt the company. We can argue about long-term ag environment and Malthusian trends, but that’s not the road I want to take today. What concerns me about a slowdown in ag spending is the following slide that RME management has often used regarding combine sales and the lifecycle of a combine:

Combines are at the top end of the agricultural equipment food chain. New machines are running at or near $500,000 depending on options – in other words a major capital outlay.

As the industry shifted away from leasing machines a few years ago (because that put the risk back on the equipment manufacturers [i.e. Deere, Case, Cat] balance sheet), dealers devised this ingenious lifecycle pyramid. The problem with pyramids, if my memory of stacking blocks in pre-school serves me right, is that it’s not the top of the pyramid that is important, but rather the base.

I pulled some of the data from the above slide to generate the following table. Some of the estimates are my own / backed into to make the math work.

What we see is that there are ~3,000 ~2.1 yr old machines sold annually (in Canada). There is demand for ~3,500 of those machines (from midsized farms). Basically, the slide is saying that there is a market imbalance. As an aside - I see this demand discrepancy as responsible for allowing the corporate farms to buy new machines annually, run them for a year (on warranty), and then sell them 12-24 months later without seeing much depreciation in value (strong demand from midsized farms). Basically the corporate farms are profiting on the backs of the small farmers (wow . . . doesn’t that sentence sound very Marxist). But . . . if this is happening, why aren’t midsized farms jumping up and buying new machines? Is this what happened in 2012 – boosting RME’s EPS?

How real the top-end demand discrepancy is (the market clears doesn’t it) isn’t what concerns me the most – what concerns me is the bottom end of the pyramid. Play with the numbers even slightly (change the avg. years in use of machines for small farms from 7.6 to 8, 9, or 10) and the demand drop for combines reverberates up the pyramid (i.e. at 10 years, the “small” farms only demand 2,675 machines per year). As this manifests up the pyramid it would be ugly for farmers and devastating for RME. I have a tough time quantifying how likely this risk is, but common sense would argue that a decline in the ag economy (whether macro, price driven, or even short-term weather driven) would bring on a lengthening in the life cycle of a machine (yes, I know, the lifecycle for a combine is not 13.4 years – you can buy a 2000 model machine for ~$80,000 right now – not $0, but the theory/math holds no matter how you slice the lifecycle).

Also, rival TITN machinery (based just across the U.S. border in Fargo, ND, and with 106 U.S. based dealerships) showed us recently what happens when the roll-up strategy stalls and margins contract (Midwest drought). The risk of margin contraction is inherent in the tight working capital situation of dealerships. Financing inventory on a floor plan is great when the business is booming, but floor plans add insult to injury when inventory turns slow and the bankers start demanding payments or additional collateral to maintain the line of credit.

All of this leaves me asking what will drive growth in the future? As acquisitions dry up, market share will be hard to grow, and without market share growth, overall sales shouldn’t grow at much more than GDP type rates.

Valuation
The rub with RME is that it is cheap. Whereas TITN whiffed its earnings and investors are punishing it by rerating its P/E down from 14-15x to the current 11x, RME only trades at 9.3x my normalized $1.45 2012 EPS (adjusted for debt conversion expense, new long-term debt, 28% tax rate, etc.). If we look in terms of EV/EBITDA (adjusted for the debt conversion in 2012), RME trades at just over 3.0x. Of course, this assumes that the company’s floor plan is a payable (not included in EV) and not debt (included in EV). If I include the floor plan in EV, the ratio jumps to 9.5x.

Free-cash-flow is also strong. If we assume depreciation/amortization and capex offset one another, than FCF is equal to net income. Last year an adjusted $1.45 in EPS would equate to a FCF yield of 10.7% - not too shabby.

Catalyst
I have a tough time coming up with readily achievable catalysts for RME:

Further acquisitions are an opportunity, but the low hanging fruit has already been harvested. Growth into the New Holland line or geographic expansion might surprise me, but these come with new risks and the possibility of cannibalization.
Margin expansion may be an opportunity. Management argues that 5-6 years after an acquisition the company’s gross margin should increase from ~15% to ~17% on a “larger installed equipment base” driving an “increase in high-margin product support revenue.” However, like acquisitions, the low hanging fruit is already gone and a 15% gross margin is consistent with what peers earn.
Long-term growth in the ag sector is an arguable catalyst, but with 16.3% same-store sales growth last year and my own worries about things like the combine lifecycle identified above, the industry may have pre-run this catalyst.
Free-cash-flow is the most obvious catalyst, with management conservatively being able to throw off $1.00 - $1.50 a year in FCF (7.5% - 11% yield), but this is somewhat offset by the risk of a low margin business in a cyclical industry using a floorplan payable for a large part of its financing.
Value is often ridiculed as its own catalyst (cheap can get cheaper), but it’s hard not to argue that RME is a better value than peers.

Updated Thesis
My thought process is all over the place in this post – you can see me blindly stumbling around looking for an answer on this one. It just goes to show you that the sell decision is often much harder than the initial buy decision.

Although I’m no longer an accumulator of RME shares, I am not at the point of liquidation either. For my portfolio, I will replace RME shares with better opportunities as they present themselves, but I won’t sell RME to move to cash (yet). Maybe that’s just a cop out (a “hold” recommendation . . . really . . . I’m disappointed in myself), but I continue to view management’s ownership (~22%) and the value as weighted against the risks of slowing or declining sales, weakness in the ag economy, and the overall tight margins of the business.

Disclosure: Long RME

Harvest Investor © 2013. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Eagle Bancorp Montana, Inc. (EBMT)

2013-04-05T08:37:00.000-06:00

Eagle Bancorp (EBMT) is the bank holding company for American Federal Savings Bank, a community bank based in Helena, MT. The company has 13 branches, primarily along the I-90 corridor in southern MT. As of Dec. 31, 2012, the company had ~$508 million in total footings and a market cap of roughly $40 million.

EBMT has twice been written up on Value Investor’s Club, and the analysis put together by the two authors shames my feeble attempt, so I urge you to review those write-ups (both are available to “Guests” who register for a password). The most recent write-up from February 2013 does a nice job of explaining what’s happened recently with EBMT, specifically the acquisition of 7 branches from Sterling Financial in July 2012.

To recap, EBMT purchased:

7 Branches (Missoula [2]; Hamilton, Bozeman, Livingston, Big Timber, Billings)
These complement the bank’s existing 6 branches (Helena [3], Townsend, Butte, Bozeman)
$44 million in performing loans.
$182 million in deposits.

Management paid a 4.3% deposit premium for the acquisition (EBMT paid Sterling $7.92 million for $182 million in deposits). The acquisition put to work excess capital that was raised with the second-step conversion back in 2010 (Equity/Assets dropped from 16.4% in June 2012 to 10.5% as of Dec. 31, 2012).

Beyond the branch acquisitions, another notable point regarding EBMT is its anniversary. On April 5, 2010, the bank completed its second-step conversion from a mutual holding company to a fully publicly-owned stock holding company structure. Without getting into the fascinating world of bank regulations (ZZZZzzzzzzzzzz), we can sum up to say that the OCC (savings bank regulator) severely limits a mutual company’s ability to be acquired in the three years following conversion. As of April 5, 2013 (what a coincidence – that's today!) those restrictions are eased (I say eased because this is still a bank, and the Federal Reserve Board (holding company regulator) / OCC (bank regulator) would still need to sign off on any acquisition).

Now, my 2 cents:

The Sterling acquisition is not the slam dunk it appears at first blush. The cost of the deposits acquired ($182 million) was 0.72%. Doesn't sound like much does it? Yet, ~57% of those deposits were money markets, DDA, NOW, and savings. Those should be yielding ~0%. The ~43% in CDs would then have an implied yield of 1.67% - not exactly cheap money (I know, I know, 1.67% is cheap money in a normal environment, but the Fed’s ZIRP is anything but normal). Consider that a quick internet search reveals that I have to go out 5 years to get in the 1.50 – 1.75% on a CD right now. The reason for the heightened cost of acquired deposits is due to Sterling Financials problems in the financial crisis. Sterling was literally trying to avoid a run on its banks, and jacked up deposit rates to avoid insolvency (go look at its stock chart). Although I think EBMT can hold on to many of these deposits, it might not be perfectly smooth/easy/cheap.
Although I like the idea of a potential acquisition catalyst, I’m not sure how high a probability we should assign such an outcome. From conversations with Montana bankers, there isn't a good in-state acquirer. Most of the other local institutions already have significant footprint overlap with EBMT. On top of this, the Sterling branches were shopped to everyone. EBMT didn't so much score a coup by grabbing them, but rather they were one of only a handful even interested in the branches (which makes the 4% deposit premium look a little expensive in my mind). Still, I'm not much good at identifying potential acquirers beforehand. Perhaps a mid-sized out of state institution wants into Montana, but I'm not building an investment thesis on it.
EBMT held up remarkably well in the financial crisis. I love a bank with solid underwriting. Just look at the ratios:

	Jun 05	Jun 06	Jun 07	Jun 08	Jun 09	Jun 10	Jun 11	Jun 12	Dec 12
NPL/Loans	0.47%	0.32%	0.13%	0.02%	0.75%	1.65%	1.57%	1.83%	0.70%
ALLL/Loans	0.53%	0.38%	0.33%	0.31%	0.31%	0.64%	0.96%	0.93%	0.85%
ALLL/NPL	114.4%	116.6%	244.3%	1641%	41.9%	32.1%	44.0%	29.1%	121.4%

NPL = Nonperformg Loans; ALLL = Allowance for loan and lease losses

Close (geographic) peers like GBIC and FIBK saw NPL/Loans spike to 4.5% to 7.8% in the 2009-2011 timeframe.

Now some people are criticizing EBMT because they won’t be able to juice earnings with reserve releases as NPLs come down and the economy improves (FIBK/GBCI are now running ALLL/Loans at 2.5% - 3.85%, with ALLL/NPL of 100% - 130%). Although technically true, that’s just an accounting game. Games can influence short-term investors (a catalyst), but over the long-haul, I prefer the bank that never had to jump on the reserve/release roller coaster.

The stock looks moderately cheap if we think a number of things can go right:

(A) Leverage improves. As noted above, EBMT has now deployed some of its excess capital. This should help improve ROE levels by up to 50% (Assets to Equity improvement from 6.1x to 9.5x = 56% improvement).
(B) The potential to write-new loans. Right now, EBMT is under-loaned at a loan/deposit ratio of 52%. Historically, the bank has run at ~75% loan/deposits. If they jumped up to a 75% ratio, this would be $97 million in new loans. I do not want them to do this quickly (I worry about underwriting standards), but even assuming a 5-10% increase in new loans annually that’s a $450,000 benefit to the bottom line and a 9bps boost to ROA annually (assumes $15 million in new loans annually, a 3% margin on new loans [consistent with most recent 10Q loan yield of 5.4% less securities yield give-up of 1.4% and a 1% hit for oversight costs = 3% yield increase] divided by $508 million in footings).
(C) Now the question of what is a normalized ROA confronts us. Over the last 10 years, the bank has averaged 0.83%. Over that same time, the bank has posted an average efficiency ratio of 72%. This is inexcusable – peers (no, not management cherry picked peers, but rather banks right across the street from EBMT) are sub 60%, with a number below 50%. Whether through its new larger size, or just better control of the purse strings, EBMT needs to get down to 60% (as a side note, this is where I think an acquirer might salivate – it should be feasible to buy EBMT and quickly improve the profitability). A drop from 72% to 60% in the efficiency ratio would foster a 40% increase in ROA. Using the 10 year average 0.83% ROA, a 40% increase would indicate an ROA of 1.16%. Let’s use 1.0% to be a little more conservative.
(D) Let’s put it all together. Now points B & C overlap somewhat (historically, EBMT has run at a loan/deposit ratio of 75%, so I can’t assume loan growth will increase ROA above the 10 year average). However, just looking at point A, which is an Asset/Equity ratio of 9.5x, and point C, which is an implied ROA of 1.0%, we get an ROE of 9.5%. If we want a 10% return on our investment, we can afford to pay 0.95x book value. At 0.8x right now, we’re buying EBMT at a near 20% discount.
(E) If we look back at the good old days before the financial crisis (2002-2008), EBMT had an average ROA of 0.89%. A 40% efficiency ratio improvement would get this to 1.25%, ROE to 11.88%, and an implied P/B ratio of 1.2x, which is 50% above current.

Bottomline, I think EBMT is undervalued trading at 0.8x book value. It’s not incredibly cheap on an absolute / right now basis, but it has solid long-term potential, as well as a number of catalysts (acquisition integration, efficiency ratio improvement, improving economy, etc.) that should help it improve operations. Most importantly, management has historically been a top notch underwriter, which provides downside protection (margin of safety).

The importance of solid underwriting brings to mind an old J.P. Morgan quote. In December, 1912 Morgan testified before congress and was asked how he decided whether to make a loan. He replied, “The first thing is character.” One of the esteemed congressman suggested that perhaps factors like collateral might be more important, but Morgan retorted, “A man I do not trust could not get money from me on all the bonds in Christendom.”

Disclosure: Long EBMT

Harvest Investor © 2013. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.