Value Investing Experiments

Hewlett-Packard (HPQ) Is Still Good Without a PC Business

noreply@blogger.com (Jimmy Munyemana) — Tue, 23 Aug 2011 02:26:00 +0000

After the release of it's most recent quarterly earnings, and the conference call that came with it. HP's CEO Leo Apotheker has been under constant strain because of the seemingly ill time proposed acquisition of Autonomy. Investors are getting pessimistic about the future of the company and it reflects in the recent selloff that has hit HP's stock. Maybe is it time to take a break from the unending stream of information and be rational about the real long term potential of this company.

For those not in the know, and Reuters provides a very detailed description, Hewlett-Packard Company (HP), incorporated in 1947, is a provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses (SMBs) and large enterprises, including customers in the government, health and education sectors. Its operations are organized into seven segments: Services, Enterprise Storage and Servers (ESS), HP Software, the Personal Systems Group (PSG), the Imaging and Printing Group (IPG), HP Financial Services (HPFS), and Corporate Investments. Services, ESS and HP Software are reported collectively as a broader HP Enterprise Business. In April 2010, the Company completed its acquisition of 3Com Corporation. In July 2010, the Company completed the acquisition of Palm, Inc. (Palm), In September 2010, the Company acquired Fortify Software. In September 2010, the Company acquired 3PAR Inc., a global provider of utility storage. In October 2010, the Company acquired ArcSight, Inc., a security and compliance management company. The Company’s offerings include multi-vendor customer services, including infrastructure technology and business process outsourcing, technology support and maintenance, application development and support services and consulting and integration services. It also provides enterprise information technology infrastructure, including enterprise storage and server technology, networking products and solutions, information management software and software that optimizes business technology investments; personal computing and other access devices, and imaging and printing-related products and services. It is interesting to note that, at current prices, the company offers the best long term potential among the components of the Dow Jones Index.

An unfortunate chains of events leading to a 33%+ decline in the stock price of an established company can only mean two things. For one, it could mean that investors might be thinking that the company has seen it's share of growth and are anticipating that the coming years will see a major drop in the company's earnings. Another more frequent reason might be that investors are overreacting to a series of what they assume to be very bad news for the firm.

Time will tell which of those two scenarios fits best to reality, but in the meantime, I adhere to a contrarian camp who thinks that HP still has room for even modest growth. Assuming a reasonable P/E ratio of 10, the current price assumes a decrease of HP's earnings of 0.5%% annually over the next 5 years, giving us a 2016 price of 35$. A 8% discount rate would then justify the current 24.45$ at the end of the August 22nd. However, we know that HP has been growing earnings at about 8% a year over the past 10 years, and they went through two recessions over that period. Let's make another assumption and let's say that the acquisition of Autonomy puts some breaks on the growth of HP's earnings and that the company is only able to grow EPS at 5% per annum. We find ourselves with a 2016 price of 48$ per share.

For the long term investor who is knowledgeable of the tech industry, this must be a great entry price into a company that has rewarded investors with a solid performance in the past 10 years, considering it's seize. With my limited knowledge of this particular industry, I used four different measurements and I came to the conclusion that the current price of HP's stock is overly pessimistic. The earlier stated P/E method gave me a 48$ price tag on shares of HP.

Interestingly enough, HP has managed to grow it's book value per share over the past 10 years at about 7.5% per year. Assuming they can manage to keep that pace, we end up with a book value of nearly 23$ per share in 2016. At the current depressed Price/Book ratio of 1.6, we end up with a price per share of 38$.

We can also look at free cash flow per share, which I calculated to have grown about 7% per year over the same period, even if it has been swigging wildly as it can be seen on the above chart. Keeping HP's stock for 5 years and using a 8% discount rate, I ended up with a present value of 49$ per share for HP. Free cash flow per share would end up being about 4$ per share in 2016, If we use a reasonable Price/Free cash flow ratio of 10, we end up with a 2016 price per share of 40$ per share.

Assuming that my assumptions are not too flawed, it seems to me therefore that the market is being overly bearish on the long term prospects of Hewlett-Packard. Investors are assuming that the current change of strategy will have negative effects on the company, without taking into account that HP might come out of this crisis as a more profitable company. And it will certainly be more profitable if it dumps it's hardware business and stops acquiring companies at absurd premiums to the current price.

Disclosure: The author has no position in HPQ and does not intend to initiate one in the near future.

Microsoft Corporation (NASDAQ: MSFT) and Windows 8 Are On Sale

noreply@blogger.com (Jimmy Munyemana) — Mon, 06 Jun 2011 09:44:00 +0000

There is a consensus in play right now in the technology sector and it could be very profitable for investors willing to get in now and position themselves for the revaluation of an opportunity. Microsoft has a dominant position in the technology industry and with Windows enjoying almost a 90% market share in the operating systems business and the Microsoft Office Suite camping on a big chunk of the professional software market, this company is poised to experience growing profits over the coming years.

Investors appear to be anticipating a big drop in the market share of the company because of the rising threat arising from sales of tablets. Analysts seem convinced that iPads and Android tablets will eat the market share of PCs, thus reducing the overall grasp of the market by Microsoft.

Lets take a closer look at what the future has in place for Microsoft. First, Windows 8 is in the pipeline and according to the teaser preview provided by the company last week, this version of Windows promises to be quite different from it's predecessors. If you haven't seen it yet, take a look on their official website here. Windows 8 seems more exciting and more intuitive, showing that the company is working to create products that are more in line with what the competition, namely Apple and Google, are currently doing. Also they are not just imitating their competitors, they are innovating and bringing something new to the marketplace. The big news with Windows 8 is that it will be compatible with the touch technology, we will therefore expect to have an announcement in the coming months of a Windows 8 tablet.

EPS for 2011 is an estimate and data for 2012 and after are projections.

The current attractiveness of the company is phenomenal from a fundamental standpoint. Over the past 10 years, Microsoft has been able to grow sales by roughly 10% per year because of good pricing power and an average 4 year product cycle. Assuming the company can grow it's sales by 7% over the next ten years and that most other expenses grow in line with sales, we end up with a company valuation of 33$ per share. At current prices, this provide investors getting in right now with a 40% return as the market starts to realize how undervalued the company is.

The recent price of 23.91$ implies that Microsoft will be able to grow EPS by only 3% per year over the coming 10 years! We know that in reality the company has been able to grow this metric by an average of 13% over the past five years.

Also, you are paid to wait, as the shareholders currently enjoy close to a 3% dividend yield and Microsoft certainly has enough cash on hand, even following the recent acquisition of Skype, to sustain a healthy growing dividend. Long term investors should see the current price levels of the company as a great buying opportunity.

Using a price-earnings multiples valuation, we also come to the conclusion that the company is undervalued. The P/E ratio of the company is currently at 9.47. Over the past fire years, the average P/E ratio of Microsoft was 16, with a high of 23.7, which doesn't seem very much out of this world. With a trailing twelve months EPS of 2.52, we end up with a price per share of 40$ using the five years historical average P/E of Microsoft.

In my humble opinion, EPS for FY 2012 of Microsoft will hover around 3$ per share as the company finally catches up with it's competition and sales of Windows 8 pick up. By using once again our historical P/E of 16, we come up with a stock price of 48$. It is clear that current prices grossly undervalue the profit potential of the company as it is able to generate an incredible amount of profits for it's shareholders.

As you can see, these two methods allowed me to come to an approximate value for the shares of Microsoft ranging from 33$ to 48$ one year from now with fairly conservative assumptions. Acquiring a position now will be very beneficial to shareholders as those intrinsic values allow them to reap substantial profits. There is very little downside left and any good news by Microsoft will have a positive effect on the stock price.

Full Disclosure: The author is Long MSFT

The Comeback of the US Dollar?

noreply@blogger.com (Jimmy Munyemana) — Sun, 15 May 2011 02:05:00 +0000

The following graph of the US Dollar Index tells a story that can be summed up in the following terms. There seems to be change in sentiment regarding the way people perceive their positions relative to the US Dollar. This is all translating into a major change in the way Forex traders are positioning themselves regarding the future of the US Dollar.

Recent economic news on each side of the Atlantic have heavily influenced the strength of the American currency. In the US, it is clear that talks by the Federal Reserve to end of quantitative easing, QE2 on time, and that there probably is no QE3 in sight. Economic data on employment is improving and recent speeches by Fed's Chairman Ben Bernanke lead to think that the US economy is getting stronger.

Expect for the specific cases of Germany and France, economic data for Europe is coming in short of expectations and the continued Greek sovereign crisis is weighting on the Euro. As long as the market has no certainty as to what will happen with Greece's debt, forex investors will keep expecting the worse as time passes by and will fly back to the US Dollar.

Looking at the chart at the beginning of this post, there a long term reversal is in place for a comeback of the US Dollar that should last many weeks. Shorting the Euro and getting long on the US Dollar will prove to be a winning trade as long as a bond crisis still looms over Greece.

Google (NASDAQ: GOOG) is Releasing it's Chromebook

noreply@blogger.com (Jimmy Munyemana) — Sat, 14 May 2011 02:51:00 +0000

I recently fell on a pretty interesting article from the Street.com: The 5 Dumbest Things on Wall Street: May 13 - TheStreet. It is about major blunders made by big public companies or people employed by them.

I was mostly intrigued by the article relating to Google (GOOG) and their newly issued Chromebook, described by Google on the Chromebook website in the following terms:

A Chromebook is a mobile device designed specifically for people who live on the web. With a comfortable full-sized keyboard, large display and clickable trackpad, all-day battery life, light weight, and built-in ability to connect to Wi-Fi and mobile broadband networks, Chromebooks are ideal for anytime, anywhere access to the web. They provide a faster, safer, more secure online experience for people who live on the web, without all the time-consuming, often confusing, high level of maintenance required by typical computers.

It will come in two models, one manufactured by Samsung and the other by Acer and will be available on June 15th. The author of the article on TheStreet.com discusses the fact that the Chromebook comes at a time when mini-notebooks are simply outdated and that linking the product to a 3 years contract on a data plan was a silly move to take.

This point of view seems to be adopted a long time before the product has even had a chance to get going in the marketplace. The target costumers of the Chromebook are people who spend most of their time on the web and do not us their computer for much other use. Google seems to be targeting a niche market and it is reasonable to think that the people in the marketing department saw at least a medium term opportunity for Google.

These notebooks will be well adapted for people who are already accustomed to the Google product line but they still need to offer some features that many people are still looking for when acquiring a computer. First, Java is not supported by the Chromebook. If it is supposed to appeal to regular Internet users, this is a functionality that will have to be addressed.

The Chromebook doesn't yet support networks that require security certificates and this is an issue considering that most enterprise wireless networks are secured. As noted on TheStreet.com, it's not currently possible to transfer owner privileges of your Chrome notebook to another user account unless it is set back to back to it's set back to it's initial state, loosing all previously recorded data.

There are only some of the few drawbacks of the Chromebook but I am pretty sure it will provide Google with a business segment that will constantly expose it's users to the advertising distributed by the company, thus increasing revenues.

Full Disclosure: The author does not have a position in GOOG.

The One Good Reason Why David Sokol Is Clean (NYSE: BRK; LZ)

noreply@blogger.com (Jimmy Munyemana) — Thu, 31 Mar 2011 13:47:00 +0000

Even if it is widely discussed that the former Berkshire Hathaway (NYSE BRK.A, BRK.B) executive David Sokol acted in an unethical manner in the Lubrizol Corporation (NYSE: LZ) deal, people seem to forget one important matter.

A lot of the buzz is generated by the fact that Sokol took his position after that meeting with investment bankers at Citigroup on December 13th 2010. those who are in such a ruch to throw accusations at Sokol seemed to miss that there were 18 companies proposed to David Sokol on that day.

Even if he acknowledged that Lubrizol was the most interesting company out of that list. There is no way he could have known in advance which of those 18 companies Berkshire Hathaway's Chairman Warren Buffet would come to chose in the end. It is also interesting to note that Buffet was pretty cold about buying Lubrizol until near the end of January 2011.

A way to know that Sokol acted in a way to profit from an acquisition by Berkshire Hathaway would have been for him to buy all of the 18 companies. One must remember that before the acquisition, as he said in an interview on CNBC, David Sokol purchased those Lubrizol stocks for his own account because he thought that the company had a good long term potential. He also mentioned that he trades pretty rarely. That is also the same reason why he was pressing for a deal between Berkshire Hathaway and Lubrizol. He was just acting in the interest of Berkshire Hathaway shareholders according to his duties.

This all just seems to be a matter of bad timing and probably bad judgement about the perception of those moves from David Sokol if we take into account that his portfolio turnover is dismal on a yearly basis.

On the right is a timeline of the deal between Berkshire Hathaway and Lubrizol from an article provided by the Wall Street Journal.

Marauder Ressources East Coast (MES.V): An Overrated Penny Stock?

noreply@blogger.com (Jimmy Munyemana) — Sun, 27 Mar 2011 02:21:00 +0000

Investing in a penny stock is a bad ideas most of the time, they are very risky and are pretty easily manipulated. It seems however that one can come across interesting companies trading on the TSX Venture Exchange. Going through some screenings recently, I came across this company with some impressive valuations. Marauder Ressources East Coast principal business is the exploration for and the (potential future...) production of pretroleum and natural gas reserves off the east coast of Canada (for now) and elsewhere.

What is interesting to notice at first is that a lot of populat sites like google finance do not provide a lot of information about the financials of the company. Looking deeper on the website of SEDAR for their most recent quarterly earnings report, dated september 30th 2010. The company seems under valued. Here are some summary financial information about the company. All amount are in thousands of dollars.

Balance Sheet for the year ended 2009

Evolution of Liabilities and Equity over the last five years

Income Statement for the year ended 2009

Cashflow statements for the year ended 2009

Currently, the company does not sell any of the ressources that are on their fields. If they manage to find a way to exploit those fields of if s company comes to acquire a part of their assets, This would be greatly valuable for shareholders of the company.

One good example is the sale of it's interests, in July 2009 of certain zones in Production License 2901, Offshore Nova-scotia, to Encana Corporation, operator of the Deep Panuke Natural Gas field. Marauder Ressources East coast received 3.5 Million CAD in the transaction, plus an overriding royalty on the future production from two currently non-producing exploration licenses offshore of Greenland.

As the company will not have enough cash fo finance it's own exploration of the area and that their principal sources of cash is the issuance of debt or equity. The first option has not been used yet, and probably will not be used since the company doest not generate enough cashflows from it's continuing operations to justify a loan from any right minded bank or investor.

Their main assets are currently their petroleum and natural gas properties, with an aggregate value of a little over 32 million CAD. With liabilities mainly composed of a differed

It seems that investors have been very discouraged with this company. To the point that they have left the company for dead. As it can be seen from the company's balance sheet. Equity stands at 27 million CAD. With the 63 millions shares currently trading, that makes for a book value per share of 0.39$ and the stock is trading at 0.07$ that makes for over a possible 450% return for investors willing to be patient enough for a favourable event to happen to the company. At current prices, the company can't issue many shares for fear of massively diluting current shareholders.

Another interesting fact is that insiders of the company have been exercising options over the last couple of months to acquire about 4.4 million shares in the company when the company's stock was trading at around 0.05$ per share. This might be good news for the stock.

This is a very risky position but the reward might justify the risk. Keep in mind however that investing in penny stocks is extremely risky.

Disclosure: The author is long MES.V

Buffett's Successor Revealed (NYSE: BRK.A, BRK.B)

noreply@blogger.com (Jimmy Munyemana) — Sat, 26 Feb 2011 20:40:00 +0000

For those who have already had the opportunity to get through the 2010 Letter to Shareholders by Warren Buffett, it is obvious that a plan to his succession is clearly taking shape. It has made sense for him that there will have to be a split for his position in the coming years and there has been great mystery as to who will be in charge of investment decisions when Buffett retires.

As he had already officially revealed in October 2010, it seems that the position of chief investment officer will be split into many persons and the first person to be nominated for the task is former hedge fund manager Todd Anthony Combs. As Berkshire Hathaway revealed results for 2010, he went into great lengths to explain his choice of manager, as this person is relatively unknown to the financial markets.

Here is what Warren Buffet had to say about Todd Combs in his 2010 Letter:

Four years ago, I told you that we needed to add one or more younger investment managers to carry on when Charlie, Lou and I weren’t around. At that time we had multiple outstanding candidates immediately available for my CEO job (as we do now), but we did not have backup in the investment area.

It’s easy to identify many investment managers with great recent records. But past results, though important, do not suffice when prospective performance is being judged. How the record has been achieved is crucial, as is the manager’s understanding of – and sensitivity to – risk (which in no way should be measured by beta, the choice of too many academics). In respect to the risk criterion, we were looking for someone with a hard-to-evaluate skill: the ability to anticipate the effects of economic scenarios not previously observed. Finally, we wanted someone who would regard working for Berkshire as far more than a job.

When Charlie and I met Todd Combs, we knew he fit our requirements. Todd, as was the case with Lou, will be paid a salary plus a contingent payment based on his performance relative to the S&P. We have arrangements in place for deferrals and carryforwards that will prevent see-saw performance being met by undeserved payments. The hedge-fund world has witnessed some terrible behavior by general partners who have received huge payouts on the upside and who then, when bad results occurred, have walked away rich, with their limited partners losing back their earlier gains. Sometimes these same general partners thereafter quickly started another fund so that they could immediately participate in future profits without having to overcome their past losses. Investors who put money with such managers should be labeled patsies, not partners.

As long as I am CEO, I will continue to manage the great majority of Berkshire’s holdings, both bonds and equities. Todd initially will manage funds in the range of one to three billion dollars, an amount he can reset annually. His focus will be equities but he is not restricted to that form of investment. (Fund consultants like to require style boxes such as “long-short,” “macro,” “international equities.” At Berkshire our only style box is “smart.”)

Over time, we may add one or two investment managers if we find the right individuals. Should we do that, we will probably have 80% of each manager’s performance compensation be dependent on his or her own portfolio and 20% on that of the other manager(s). We want a compensation system that pays off big for individual success but that also fosters cooperation, not competition.

When Charlie and I are no longer around, our investment manager(s) will have responsibility for the entire portfolio in a manner then set by the CEO and Board of Directors. Because good investors bring a useful perspective to the purchase of businesses, we would expect them to be consulted – but not to have a vote – on the wisdom of possible acquisitions. In the end, of course, the Board will make the call on any major acquisition.

One footnote: When we issued a press release about Todd’s joining us, a number of commentators pointed out that he was “little-known” and expressed puzzlement that we didn’t seek a “big-name.” I wonder how many of them would have known of Lou in 1979, Ajit in 1985, or, for that matter, Charlie in 1959. Our goal was to find a 2-year-old Secretariat, not a 10-year-old Seabiscuit. (Whoops – that may not be the smartest metaphor for an 80-year-old CEO to use.)

He hints that there will probably other managers added to the team and even a compensation structure already in place. The investment results of Berkshire Hathaway's equity portfolio will therefore present the performance of Todd Combs.

Another interesting part of his letter is the update on the equity put contracts that Berkshire Hathaway carries in his books.

You can access his full letter here.

Jim Chuong's 2010 Letter to Partners

noreply@blogger.com (Jimmy Munyemana) — Wed, 16 Feb 2011 23:43:00 +0000

A couple weeks ago, I came out with an article depicting the performance of the stock portfolio of Canadian value investor Jim Chuong for the past decade. With a lot of humility, he attributed his outstanding 2010 57% performance to just sitting there and watching his portfolio rise. Here are of his own words:

The return I achieved in 2010 is not repeatable, should not be considered a reflection of my investment skill and, if anything, foreshadows a very bad 2011 for me.

In fact, in 2010, aside from picking up a small handful of shares in The Buckle, my activity was non-existent. Readers should expect inactivity in the face of rising prices. For me, it makes no sense to buy at increasingly higher prices. In fact, it appears more profitable to start looking in areas where prices are declining or, even better, have collapsed.

This year my letter will be short because nothing happened – everything rose in price and I sat dumbfounded - gawking at all the businesses that I was suddenly priced out of.

He his very modest indeed and as many will have guessed, his task has not been so easy. In his 2010 letter, he explains his views about investing and the method he uses to find attractive stocks for his portfolio.

He talks about the effect of diversification and asset allocation. He shines the light on the reason why many companies decided ti distribute a special dividend in 2010. As a value investor he shuns companies that have debt on their balance sheets and he gives a lengthy argument to support his view.

He also candidly compares poker to investing in a very light way. And reminds us of the effect of taxes on different ways to earns money, ranging from earned income to dividends.

He also insists on the importance of retirement and what it implies for any person facing the dilemma of immediate gratification versus long term wealth. He thankfully ends with a description of the performance of his portfolio, and the companies in it.

Here are his holdings at the end of 2010:

Company	% of Portfolio
Fossil (NASDAQ: FOSL) K-Swiss (NASDAQ: KSWS)	49.5% 14.6%
The Buckle (NYSE: BKE)	12.0%
Columbia Sportswear (NASDAQ: COLM)	8.8%
American Eagle (NYSE: AEO)	6.6%
Berkshire Hathaway (NYSE: BRK.B)	6.4%
Cash	2.1%
General Employment (AMEX: JOB)	0.1%

You can access his full letter and his insights right on his website.

The Egypt Crisis Play: Transglobe Energy Corporation (TGA)

noreply@blogger.com (Jimmy Munyemana) — Tue, 08 Feb 2011 06:18:00 +0000

Here is an interesting article about how value investors can benefit from technical analysis. Even if it has not been that publicized today, the political crisis that was happening in the past days over in Egypt proved to be very beneficial for investors who were able to fairly assess the level of potential danger arising from this situation..

There seems to have been some situations that offer great opportunities to investors. The case of TransGlobe Energy Corporation (NASDAQ: TGA, TSE: TGL) sheds some light on events of this king. This Canadian company conducts oil well drilling operations in the Arab Republic of Egypt and in the Republic of Yemen, solely or in partnership with local companies.

Those two regions were recently affected by an uprising of the population to the political regimen in place. This proved to be a great buying opportunity for those who could take advantage of it. In the days before the unfolding of the situation in Tunisia and in Egypt, many investors in the company showed little faith in it's future prospects. This fact can clearly be concluded from the declining stock price fo TransGlobe energy Partners before January 31st 2011 that went from over 20$ a share in December 2010 to a mere 12.25 just two months later.

As the company showed in a recent update of their operations, it seems that people were too pessimistic about the outcome of the situation in Egypt and the repercussions it would have on the company:

To date, the Company's West Gharib production operations have not been affected by the recent political demonstrations in Egypt. The Company continues to the monitor the situation and has daily communication with our Cairo staff and our Joint Venture operating company. All employees are safe and accounted for. The Company will take all steps to adapt to the situation and will attempt to mitigate any adverse consequences.

Moreover, the recent turmoil in the Middle-East is such of insignificant effect that the company's production has actually increased over the month of January.

For my part, I purchased shares of the company on February 1st 2011 on market open for an average price of 12.13$ per share and my oversold thesis has been clearly validated. I am only left to see if there will be any upside left since the stock of TransGlobe Energy Corporation is getting very close to it's target value of 16$ per share.

Disclosure: The author is Long TGA

Fairfax Financial (TSE: FFH) is a Buy Once Again

noreply@blogger.com (Jimmy Munyemana) — Mon, 31 Jan 2011 14:24:00 +0000

For people who have ha the opportunity to follow my posts: my first report on the company, when I commented on the company taking it's subsidiaries private or on a recent acquisition over the past two years, know how much we are fond of Fairfax Financial Holdings limited. This Canadian based insurer has provided great returns for it's shareholders through astute acquisitions and massive gains on credit default swaps derivative contracts in 2008. I am very pleased with it's performance for the past two years I have held at the company's stock.

The company announced on January 18th 2011 that the 99% of the shareholders of First Mercury Financial Corporation that cast their vote had visibly almost unanimously voted in favor of the friendly takeover bid proposed by Fairfax Financial. This acquisition is very typical of the way the company's CEO, the great investor Vivan Prem Watsa manages these operations. For those who are not accustomed to the company, it's name stands for Fair and Frieldly Acquisitions and should not be mistaken with Fairfax county in Virginia. The company will generally come with a bid for a company that is usually higher than the target's current price and win the approval of shareholders.

It is interesting to note that acquisitions and major investments are managed at the holding company level by Vivam Prem Watsa and his small team. As of the last quarterly earnings release, the company stated that it had $32.5 billion of assets and close to $8.9 billion of shareholder's equity or 416$ per share and this is certainly the first reason to buy the stock. We also know from the 2010 annual meeting slide presentation that when current management took over in 1985, the company's book value was 1.52$ per share. They have to be doing something right in the tough insurance business.

Many other factors have to be taken into account, but I have noticed that when the company is trading under book value per share, it tends to rally back to this value. At the current price of 383$ per share, that implies at least an 8.3% return if book value doesn't change by the next quarterly filing on February 17th 2011.

10 year target price: 910$

Disclosure: The author is long FFH.TO

Investing Performance for 2010

noreply@blogger.com (Jimmy Munyemana) — Wed, 19 Jan 2011 03:44:00 +0000

2010 proved to be a very favorable year for me and as I will explain a little further, it is mostly due to the high concentration of almost half of my holdings in one specific company and the use of options contracts that were severy undervalued. More on that later.

The broad rally experienced by stocks during the year is fundamentally attributable to the quantitative easing measures by the Federal Reserve in the US and the rising price of commodities. Because of the intricacy of the canadian economy with the US economy and also because the canadian economy is so greatly influenced by the price of commodities. Provident Energy Trust helped fairly while providing a nice 10% dividend yield during the holding period.

My biggest position was certainly Winalta Inc. The company was going through a tough restructuring process and the uncertainty surrounding the company got it's price gyrating at historic lows during the summer of 2010.

There is also something new this year, options were a fair part of the performance. I acquired them at the end of the month of august as it seemed to me that the investment community was pretty pessimistic about earning results that would be soon announced by several companies and two of them had unfair bearish sentiment surrounding them. I was greatly rewarded as those position took full advantage of the earnings surprise inherent to those companies.

I also managed to commit some mistakes. My position in Le Chateau Inc. did not perform the way I expected and it ended up slowing my performance. I also succumbed to greed at some extent when I decided to hold my position in my November out-of-the-money call options of Dryships Inc. after the earnings announcement, which caused them to decay as their maturity was getting closer, this proved to be a great error since the stock started sliding in the days following their earnings release. Ironically, I departed myself from my options on Microsoft, which went to get deeply in the money.

Here are my positions for the year:

Long:

Provident Energy Trust (TSE: PVE.UN)

Winalta Inc. (CVE: WTA.A)

Le Chateau Inc. (TSE: CTU.A)

Call options long:

Dryships Inc. (NASDAQ: DRYS)

Microsoft Corporation (NASDAQ: MSFT)

Taking those positions into account, my performance in 2010 was a surprising 80.4%, and the S&P/TSX did 14.4%, so it makes it that I over-performed it by 66%. This is very encouraging but I remain cautious, this performance might be due a great deal to chance and it is very improbable that I will be able to replicate it in the future. The downside is that even if I showcased a better performance than this index, it will get harder in the coming year to find such attractive opportunities and repeat a relative performance of this magnitude.

Jim Chuong Investing Performance in 2010

noreply@blogger.com (Jimmy Munyemana) — Thu, 06 Jan 2011 02:01:00 +0000

A little over a year ago, I wrote an article about a young canadian investor who had been showcasing outstanding returns over the past decade. It seems than he fared very well since the last time I wrote about him.

As stated previously, Jim Chuong started seriously managing funds in 1998 with a staggering 68% return for the period. His objective was to beat the S&P 500 index and he has managed to do it 9 times since then. An investor who started with 10 000$ invested with him at the beginning of his career would have found himself with a whooping sum of more than 66 000$ at the end of 2010.

As can bee seen in the chart below, his fund got hit in 2008, as many did, but Jim Chuong still managed to generate positive returns even for investors who got in at the beginning of 2008.

For those who have not done it yet, his website contains the annual letters he provides to explain his performance for the year. They are very insightful as he even adds explanations about the topics that prevailed during the year. He has not yet completed the 2010 letter but he will post it shortly. One can also find the rare copies available on the internet of the partnership letters of Warren Buffett and Benjamin Graham.

FairFax Financial Spots a Deal

noreply@blogger.com (Jimmy Munyemana) — Wed, 29 Sep 2010 14:23:00 +0000

Fairfax spots a deal - The Globe and Mail

After months of issuing preferred shares and debentures, the insurance giant Fairfax Financial Holdings Limited is initiating one of the largest share buybacks of it's history. At yesterday's closing price, it would be valued at over $600 million. Over the next 12 months, the company will buy close to 1.6 million shares, almost 10% of the current float. This means that the average daily volume of the company will be greatly influenced by the actions of the company.

The company's Chairman and CEO, Vivan Prem Watsa, has developed a reputation of value investor over the past 20 years. Having the company dedicate more than half a billion dollars to buying it's own shares instead of increase it's current investments is a clear sign that the FFH is currently trading under or close to it's book value. This is an hypothesis that will be confirmed on the next quarterly filing of the holding company. Note also that this move will greatly increase the seize of the CEO's control stake in the company, which is already pretty close to 50%.

However, before buying the stock, one should consider taking this news with care, as the final amount of the operation is not yet known. Some companies will issue such statements to stimulate a downbeat stock price. Fairfax is up a mere 2% for the year, this is therefore another possibility. If the transaction is completely filled, the remaining shareholders will be greatly rewarded as the company will showcase higher EPS.

This might not be a good time to buy the company's stock, but for those who already own it, it is definitely a great idea to hold on to it.

Full disclosure: Long FFH.TO

Ridley Inc. Reports Preliminary Results for Fiscal 2010 Fourth Quarter

noreply@blogger.com (Jimmy Munyemana) — Thu, 29 Jul 2010 20:08:00 +0000

Ridley Inc. (RCL.TO) Reports Preliminary Results for Fiscal 2010 Fourth Quarter

As stated in that MarletWatch article, the 4Q results of Ridley showcase improved operational performance for the company.

As they state it in their quarterly report, their loss has been narrowed compared to a year ago. This is good sing for a company on it's way to profitability.

Let's remind that Ridley Inc., the former subsidiary of it's Australian parent company, was sold to Fairfax Financial Holdings Limited in 2008. since then, the stock of the company has been pretty illiquid because of the large block owned by the Canadian insurer.

Their short term results have been altered by the critical conditions present in the current financial environment. Exempt from them, the company is on track for great success for their shareholders.

Depending on right assumptions, the company should yield great returns, since the parent company, Fairfax Financial Holdings Limited, should proceed to a complete buyout of the roughly 20 millions shares of that company that are still publicly traded on the Toronto Stock Exchance under the symbol RCL.TO.

Untill then, I will keep acquiring more stock in this interesting value play.

Full disclosure: Long RCL.TO

Institutional Investors and Stock Prices

noreply@blogger.com (Jimmy Munyemana) — Thu, 29 Jul 2010 19:22:00 +0000

In their quest to generate impressive returns to their clients, institutional investors shape the financial world. An average investor will tend to get heavily influenced by their investment choices.

Institutions generally tend to be banks, insurance companies, pension funds, mutual funds, investment trusts, unit trusts or hedge funds. They are very meaningful invertors because of the sheer size of assets that they manage.

Any individual wandering in the financial arena should consider getting more acquainted with those entities. If you are playing in the small capitalization and mid capitalization field, you should know that some of those investors shun companies that expose their stock prices to levels that they deem too low. In fact, some if those institutional investors establish minimum buying prices; in order to avoid the frequent price manipulation that incurs from companies have a too low stock price.

For most of those investors the minimum price will be set at 5$. This will explain why some companies experience huge gain in their stock price as soon as it hits that minimum price. A good example is DryShips over the past two years. However, some funds will go as low as 1$ per share.

Mass market movements are often the consequence of actions by those investors. If we take that market plunge of September 2008, one of the conclusions implies a chain reaction in the financial market.

Like any companiy, institutional investors have balance sheets and obligations towards their lenders and must maintain some capitalization levels in order to stay solvent. When news about a financial crisis were gaining grounds, many individual investors, who had their money managed by mutual funds, pension funds or companies, began redeeming their investment, thus causing a lot of stress on the cash position of those companies. Those institutional investors were forced to sell promising positions to fulfill their cash balances that were dwindling because of redemptions from clients or investors.

The investing world is a challenging one for value investors. Even if you get the right assumptions about the value of a company, institutional investors can dramatically affect your results because of their specific needs.

Agruim Inc (AGU): An Undervalued Fertilizer Company (Part 4)

noreply@blogger.com (Jimmy Munyemana) — Wed, 10 Mar 2010 04:58:00 +0000

This is the fourth part of a series of posts relating to a thorough analysis of Agrium and what led to conclude that it was a company worth your attention for a further analysis. Part one can be found here.

Agrium Inc is a Canadian retailer and manufacturer of agricultural chemicals. Its main products are fertilizer and crop protection products. Although the company operates globally, the bulk of its operations are in the US and Canada. This, however, is bound to change due to Agrium’s recent acquisition of CMF and an increasing focus on foreign markets. After evaluating Agrium Inc from different perspectives, we have come to the following conclusions:

Economic analysis: global supply and demand for crops, as well as economic conditions determine crop prices which in turn determine fertilizer prices. Crop prices, although negatively affected by the financial crisis, have been rising due to the expansion of the Asian middle-class, and the recent focus on biofuels. The world population is growing and every year there are an extra 80 million people to feed. Thus, we foresee an increase in the demand for fertilizer and also in fertilizer price.

Industry analysis: the industry as a whole was negatively affected as a whole, but things are expected to return to normal in the short to medium term with moderate growth for the sector thereafter.

Company analysis: the firm has an aggressive acquisition strategy, has shown robust growth, and has a strong management team in place.

Financial analysis: We were not able to calculate intrinsic value because ROE growth is too high! The average annual return for an investor who bought in 1995 and is still holding the stock is 13.5%. This return is higher than the expected return required by CAPM. We therefore conclude that, assuming that this growth rate is sustainable, investing in Agrium stock yields a higher expected return than that warranted by its risk. In addition, the company’s P/E ratio is lower than it’s peers, leading us to belive that it is undervalued. The stock is also currently in an uptrend: a bullish sign.

Based on all of the above information, our conclusion is that shares of Agrium Inc. are underpriced and should be bought.

Agruim Inc (AGU): An Undervalued Fertilizer Company (Part 3)

noreply@blogger.com (Jimmy Munyemana) — Tue, 02 Feb 2010 21:39:00 +0000

This is the third part of a series of posts relating to a thorough analysis of Agrium and what led to conclude that it was a company worth your attention for a further analysis. Part one can be found here.

Dupont Model analysis

Net profit margin:
Between 2007 and 2008, the net profit margin went from 8.37% to 13.18%, a significant increase of almost 5%. In 2008, the industry had an average profit margin of 5.19%. This increase in profit margin is mainly due to savings in general and administrative expenses, depreciation expenses and other non-operating income. (Annual report 2008)

Asset turnover:
The asset turnover increased from 1.16 to 1.28 between 2007 and 2008. Each dollar invested in the asset generates 1.28$ of sales. The industry’s ratio in 2008 is 1.02. Hence, Agrium’s asset was used efficiently.

Financial leverage (Asset/Equity):
2007-2008: It went from 1.89 to 2.39 meaning the company incurred more debt. This is due to the acquisition of CMF.

2008
EBIT/Assets: 0.2
Interest/Liabilities: 0.018
Positive leverage, it’s a favourable debt, so when asset on equity increases ROE increases

Profitability

Both EBITDA Margin and Gross margin increased from 2007 to 2008 and both are above the industry level thanks to the growth in sales.

ROA (net profit margin x asset turnover):
Almost doubled from 9.69 (2007) to 16.84 (2008) because of net profit growth.

Liquidity Management

Current Ratio:
Between 2007 and 2008, Agrium’s ratio decreased from 2.83 to 1.82, while the industry average raised from 2.26 to 2.94.

Quick ratio:
2007 and 2008 the ratio decreased from 1.84 to 0.57 and a constant 1.3 for the industry.

The company may have some liquidity problems after the new acquisitions. To begin with, the company’s ratio is lower than the one of industry. The difference between the current ratio and the quick ratio demonstrates that the company holds to many inventories which are often less liquid. As a result, Agrium may face short term reimbursement challenges.

Debt Management

Interest Coverage:
2008: 18.91 ≥ 1, therefore Agrium is able to pay the interest.

Total Debt to Equity:
An increase from 0.25 (2007) to 0.39 (2008) with an almost constant industry ratio of 0.29
This is due to the new issued long term debt. As we observe an raise in the LT Debt to Equity ratio from 0.25 to 0.39.

Asset Management/productivity

Receivable turnover:
Still below the industry because of high accounts receivable

Inventory turnover:
Diminished from 6.17 (2007) to 4.99 (2008), and it’s still below the industry’s ratio (7.6). The reason of the low inventory turnover ratio is because of the high amount of inventories.

Property Plant & Equip Turnover:
Both ratio in 2007 (3.39) and in 2008 (5.24) are higher than the ones of industry. This represents 1$ of capital assets generates 5.24$ of sales.

Cash & Equivalents Turnover:
In 2007, 6.39, lower than the industry (14.78)
In 2008, 13.04, got better, but still lower than the industry (16.15)
This shows possible liquidity problem.

Quality of managers

Evaluating management quality objectively is quite a difficult task. If we compare the performance of Agrium to its peers, we can see that Agrium is much more efficient. Given Agrium’s stellar performance, we assume that management must be doing something right. In addition, we watched Agrium’s conference call and we found that they left a good first impression. They seemed like diligent and competent people. It is also worth noting that Agrium’s CEO, Mike Wilson, was honoured as business person of the year by Calgary Inc magazine for his various accomplishments that made Agrium a “strong, vibrant international corporation.” Last year, Agrium’s CFO, Bruce Waterman, was nominated Canada’s CFO of the year by PricewaterhouseCoopers LLP.

Company prospects

Despite of the unprecedented bad year for fertilizer in 2008-2009 that was due to the economic downturn, Agrium is expecting strong future growth in its retail and wholesale divisions. Indeed, Agrium is poised to benefit from the strong agricultural forecast. Based on its growth strategy and value-creation throughout the supply chain, the company plans to expand wholesale operations to further optimize earnings. It has planned strategic acquisitions and other expansion/growth initiatives across the agricultural value chain: 9 acquisitions ($3.5 billion invested) and other growth initiatives (Potash expansion of 40% increase in capacity by 2013 well on its way, nitrogen production facility in Egypt on schedule, ESN expansion, etc.), in addition to its 4 acquisitions in Retail in North and South America (over $3 billion invested). As shown in the graph below, Agrium’s goal is to double earnings from stable Retail and AAT base, and significantly grow capacity across all three nutrients.

Agruim Inc (AGU): An Undervalued Fertilizer Company (Part 2)

noreply@blogger.com (Jimmy Munyemana) — Fri, 22 Jan 2010 15:38:00 +0000

This is the second part of a series of posts relating to a thorough analysis of Agrium and what led to conclude that it was a company worth your attention for a further analysis. Part one can be found here.

Agricultural market fundamentals remain strong

As we know, the price of fertilizer is closely related to the price of grains. The cereal harvest reached world record levels in 2008. The United States Department of Agriculture (USDA) estimates that 2,225 million metric tonnes (Mt) were harvested and that cereal inventories went up slightly. The Food and Agriculture Organization of the United Nations (FAO) and USDA estimate that the 2009 cereal crop was 1.5 to 2.0% lower than the 2008 record. Because of the recession, world grain demand will increase only modestly in 2009/10 and the world output would match demand, resulting in relatively stable inventories. Affected by the economic context, crop prices dropped in the second half of 2008 before slightly firming in the first half of 2009. Most international prices for agricultural commodities are currently relatively strong compared to pre-2008 levels.

Global Fertilizer Demand

After years of increasing demand, fertilizer use slowed in 2008. Like other commodities, the worldwide economic downturn is the primary reason for the declining fertilizer use, dropping prices and mounting inventories for the year 2008-2009. World fertilizer consumption seen as dropping 5% in 2008/09, negatively affecting the demand compared with the previous year. Nitrogen has been much less affected, as this nutrient is vital for crop yields. Nitrogen, Phosphorous and Potassium fertilizer demand is estimated to drop by 1.6, 7 and 14%, respectively. The largest contractions in volume are observed in Western and Central Europe, North America and Latin America which, coincidentally, are all of the areas in which Agrium operates.

Global Fertilizer Supply

The world fertilizer markets experienced a period of huge volatility in 2008 despite strong demand fundamentals. The global economic downturn and tight credit dampened short-term prospects for fertilizer consumption. Fertilizer market conditions worsened considerably in the fourth quarter of 2008 as sales collapsed, driven by weakening financial and economic conditions, tight credit access and, to a certain extent, loss of fertilizer demand or purchase deferral in a large number of consuming countries.

In 2008, global nitrogen production rose by a meagre 1.7% compared with 2007 while the output of phosphate fertilizers and potash declined by 7.5% and 2.8% respectively, due to a drop in exports and weak import demand. Entering 2009, the fertilizer industry was confronted with poor market conditions, marked by lack of sales and weak prospects for production and trade this year. However, stocks of soft commodities and cash crops remain low compared with historical levels. Fertilizer demand will therefore recover, although the pace of recovery is uncertain. The International Fertilizer Industry Association forecasts the balance of supply and demand for the next four years, from 2009 to 2013. For the three main nutrients, Nitrogen, Phosphorous and Potassium the supply is projected to grow at an average annual rate of 6%, 8% and 23% respectively.

Price of inputs

Here is a brief description of a few factors that have an impact on production costs. Because ocean shipping rates have been in free fall since May 2008, delivery costs have fallen. Energy prices, notably those of crude oil and natural gas, have fallen by more than half compared to their levels in mid-2008, offering some relief to nitrogen producers. However, in the medium term it appears that natural gas prices in key exporting and importing countries may increase again. The cost of sulphur has an impact on the cost of producing phosphorous.

Since Agrium and other companies in the industry operate internationally, currency valuations may affects costs of inputs and price of outputs. Indeed, as a result of the weakening of the Canadian dollar during the fourth quarter of 2008, Agrium experienced significant foreign exchange gains of $98-million.

Important variables for the industry and their business cycle sensitivity

The most important variable that affects fertilizer demand and price is commodity prices such as corn and wheat. Commodity prices affect the farmers’ revenue and thus willingness and ability to pay for fertilizer. The price of corn is currently around $4 per bushel, double its 2005 price of $2. We must note however, that in the summer of 2008 just before the financial crisis, corn peaked at a price of $7.88 per bushel. High commodity prices are an incentive for farmers to plant more, thus increasing the acres of land cultivated. In addition, higher commodity prices increase the farmers’ willingness and ability to pay for fertilizer.

Prospective Demand

With the prevailing strong agricultural market fundamentals and anticipated progressive recovery of the world economy, world fertilizer demand is seen as slightly rebounding in 2009-10 (+3.6%) to 165.4 metric tons, with growth rates of 2.6% for nitrogen, 6.1% for phosphorous and 4.1% for potassium, as it is shown in the table below. Strong recovery is anticipated in East Asia and in Western and Latin America. Consumption would further increase in South Asia and East Asia going into 2013-14. Although slower growth rates than other regions are anticipated for North America and Western Europe, these regions are still expected to expand. Slower growth in these key areas could diminish Agrium’s future performance compared to other foreign firms.

Disclosure: The author has no position in AGU but intends to initiate one in the coming weeks

Agruim Inc (AGU): An Undervalued Fertilizer Company (Part 1)

noreply@blogger.com (Jimmy Munyemana) — Fri, 22 Jan 2010 00:38:00 +0000

This is the first part of a series of posts relating to a thorough analysis of Agrium Inc. and what led to conclude that it was a company worth your attention for a further analysis.

Agrium Inc. was founded in 1931. It started out as a fertilizer company called Cominco Fertilizers, Ltd. Over the years, Cominco grew larger and larger and started to diversify its range of products. The company went public in 1993 and decided to change its name to Agrium Inc two years later. Its Headquarters are located in Calgary, Alberta.

Products & services

Agrium is one of the leaders in the sector of agricultural nutrients, industrial products and specialty products in the international market. The structure of the company is divided in three business segments: retail, wholesale and advanced technologies.

Agrium’s retail division supplies agricultural products and services directly to growers in North and South America. The wholesale division produces, markets and distributes the three primary nutrients for fertilizer production, which are nitrogen, phosphate and potash, directly to agricultural and industrial customers. The Advanced Technologies business segment, which rests on its production and sale of controlled-release nutrients, micronutrients as part of its specialty products and plant protection products such as pest control marketed to residential and commercial consumers.

Strategy

As a mission, the enterprise will continue to provide ingredients for growth. Although Agrium is already one of the world leaders in its field, their vision is still to become the leading supplier of agricultural chemicals in the world. Following its IPO in 1993, the company grew by making important international investments and undertaking multiple acquisitions. For instance, Agrium owns three foreign subsidiaries that are located in Belgium, China and Argentina. In addition, important investments were made in Hanfeng Evergreen Inc (China) and MISR Oil Processing Company, S.A.E. (Egypt).

Its corporate growth strategy consists of three aspects that are: to invest through the value chain, to continue to provide with the lowest cost in the wholesale segment, and to diversify internationally. With regards to different geographical market and international opportunities, China, Brazil and India are the three major emerging markets for potash exportation; South Korea, Mexico and Taiwan are some targeted markets for nitrogen. In addition, these markets express great concern about environmental issues, and thus are prepared to pay a high price for innovative products and solutions.

The firm's market position

According the Agrium’s 2008 company fact book, the company manufactures fertilizers and crop protection products based on 3 different main chemicals: nitrogen, phosphate and potash. Most of Agrium’s competitors are also produce products that contain those three elements because they are found in all fertilizers (at least one of the three and sometimes all three). Agrium is more diversified than its competitors, producing and all three elements as well as controlling distribution channels in North America, South America and Europe. Based on output in metric tonnes, Agrium comes third in nitrogen based products with 2 403 000 tonnes. That puts it right after Yara International ASA and Terra industries inc., producing 7 032 000 tonnes and 2 519 000 tonnes respectively. For phosphate based products, Agrium comes in 4th, with a production of 720 000 metric tonnes after Mosaic Co., Potash Corporation of Saskatchewan and CF Industries Inc. They produce 4 488 000 tonnes, 2 209 000 and 998 000 tonnes respectively. Finally, Agrium is recognized as a global leader in advanced technology, innovation and environmental solutions in the agricultural industry.

Disclosure: The author has no position in AGU but intends to initiate one in the coming weeks

Fairfax Financial Holdings (FFH) to Acquire another Subsidiary

noreply@blogger.com (Jimmy Munyemana) — Sat, 19 Sep 2009 14:24:00 +0000

A couple months ago, I wrote an article about one of Canada’s main reinsurance companies. Namely Fairfax Financial Holdings Limited, I also elaborated on how the company had been incredibly positioned to benefit from the financial meltdown of 2008. Through the sale of its large credit default swaps portfolio and a recent $1 billion public offering, the company has built an impressive cash position that it has used to invest in numerous ways, mainly by investing in the stock market but more importantly by acquiring the minority interest of two of its jewel subsidiaries.

At the beginning of December 2009, Fairfax Financial made an offer to the minority shareholders of it’s Canadian subsidiary Northbridge Financial Corporation. The details of that transaction were quite simple and very attractive to any single one of the company’s shareholders at the time.

It was an offer to acquire all of the outstanding common shares of Northbridge, other than those shares already held by Fairfax, for $39.00 in cash per common share, representing total cash consideration of approximately $686 million. At the time, $39.00 per Northbridge common share represented a premium of approximately 28.9% over the $30.25 closing price of Northbridge common shares on the Toronto Stock Exchange on November 13th, 2008, the day Fairfax approached Northbridge’s board of directors to consider the proposed transaction.

As Fairfax’s press release underlined it, the proposed transaction also represents a 31.8% premium over the 30-trading day volume-weighted average closing price for the period ended November 28, 2008 of $29.59 and a 160.0% premium over the May 21, 2003 initial Northbridge public offering price of $15.00 per common share, it was pretty rewarding for long term as well as trading shareholders of Northbridge Financial. At the time, Fairfax owned 30,111,306 common shares or approximately 63.1% of Northbridge’s outstanding common shares.

It seems that Vivan Prem Watsa is striking again; this time with Northbridge’s American sibling, Odyssey Re Holdings Corporation. According to the September 18th press release, the price of $65 per share in cash represents a 29.8% premium over the closing price on September 4, 2009 (the date on which Fairfax publicly announced that it was proposing to acquire all outstanding shares of common stock of Odyssey Re that Fairfax does not currently own for $60 per share) and a 33.4% premium over the 30-day average closing price for the period ending on September 4, 2009. The complete transaction would amount to about $1.8 Billion. Based on Odyssey Re’s initial public offering price of $18.00 per share in June 2001, the purchase price represents a compounded annual return of 17.3% through the date of the merger agreement.

The acquisition of those two reinsurance powerhouses and the investing incredible investment ability of Fairfax’s CEO Prem Watsa reinforce my conviction in the future growth of the company. I remain convinced that even at a price of 398$ per share at market close on September 18, 2009, this company is clearly undervalued by the market.

10-year target selling price: 651$

Disclosure: The author is long FFH.TO

The High Yield Royalty Trust

noreply@blogger.com (Jimmy Munyemana) — Thu, 10 Sep 2009 15:22:00 +0000

During the past five years, Canadian legislation has been pretty rough on companies that have decided to convert to income trusts. In the past, this had been a very advantageous situation for them, since distributions were not taxes by any government, whether it would be federal or provincial.

Royaly trusts tend to work a lot like income trusts, except that they must operate in the oil and gas business. Their most appealing similarity is that almost all of the income generated by their assets is distributed, on a monthly or quarterly basis and at a very advantageous 10% tax rate, to unitholders, thus generating a very interesting form of income.

As it happened for income trust, legislation has been passed by the conservative government to fully tax realty trusts starting in 2011. Depending of the result of the next federal elections, investors still have about a year to still take advantage of the their incomes from realty trusts.

The one that has charmed to me the most is Provident Energy Trust, which is, according to their financial statements, an open-end investment trust created to hold, directly and indirectly, all types of petroleum and natural gas and energy related assets, including without limitation facilities of any kind, oil sands interests, electricity or power generating assets and pipeline, gathering, processing and transportation assets. The Trust’s business activities are conducted through two business segments: Canadian oil and natural gas production (Provident Upstream) and Provident Midstream. Provident Upstream includes exploitation, development and production of crude oil and natural gas reserves. Provident Midstream includes processing, extraction, transportation, loading and storage of natural gas liquids, and marketing of natural gas liquids. The Trust’s oil and gas production business segment operates in Canada, and Midstream business operates in Canada and the United States.

With a 0.06$ monthly distribution and a unit price of hovering around 6$, this gives this trust a yield a little bit over 12%, which is a very reasonable rate of return in the current economic conditions. In the past, the unit price change has matched the changes in the distribution amount, always keeping the distribution yield between 10% and 13%. As the economy recovers and energy consumption increases, I expect to see the distribution amount raise back to historical levels, consequently making the yield even more interesting.

10-year target selling price: 13$

Disclosure: The author is long PVE.UN

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The Best Player in the GPS Devices Market?

noreply@blogger.com (Jimmy Munyemana) — Sat, 13 Jun 2009 13:32:00 +0000

Many car drivers have been noticing the increasing popularity of GPS navigators, they are offered optionally on many new models, but most people get them by purchasing them in a specialized electronics store. Investigating companies with a very low amount of debt made me fall on a very familiar company: the GPS maker Garmin Ltd.

Garmin Ltd. was incorporated in the Cayman Islands on July 24, 2000 as a holding company for Garmin Corporation, a Taiwanese corporation, in order to make possible a public offering of Garmin shares in the U.S. Credit Suisse, First Boston and Merrill Lynch were the lead underwriters of their 2000 initial public offering, selling 21.0 million shares at $7 per share. Garmin owns all of the operating companies in the Garmin group.

As stated by the company, Garmin Ltd. provides navigation, communications, and information devices, which are enabled by global positioning system (GPS) technology. Garmin has two segments: consumer, which accounted for about 91% of their 2008 revenues and the remaining 9% from the aviation industry. Consumer products include handheld GPS receivers, portable automotive navigation devices, and fixed-mount GPS/Sounder products, which are used in automotive, marine, and recreation applications. Aviation products include GPS and VHF navigation enabled receivers.

What makes this company very interesting is the fact that the it has been growing very impressively, and at the same time gaining a big market share of GPS receivers. At the end of 2008, the company had no long term debt. The common shareholders' equity of the Garmin Ltd. has been growing by 29% over the past five years. There is little probability that the company will achieve such levels but it is a great point to start from. The last five years 30% profit margin also ensures that their profits will remain strong even after such difficult economic conditions as we witnessed in 2008 and throughout the rest of 2009.

2008 was, as for many companies, a very difficult one for Garmin Ltd. Still, longer-term growth generators will aid profits. The company has quite a lot of new and improved software devices to be introduced shortly. These improvements will boost the features of existing items in its mapping, aviation, and other business segments, thus giving the company an even greater competitive edge and market-share lead. It also has launches for two new phones within the next couple of months. These actions will likely increase advertising costs, but should increase awareness about the company, too. Also, Officers and directors own a cumulative amount of 45.8% of common shares. This ensures that they are very likely to take actions that will be favorable to the shareholders of the company.

At current prices, I estimate Garmin Ltd. To be a great long term buy and should provide satisfactory performance over the next 10 years.

10-year target selling price: 73$

Disclosure: The author has no position in GRMN but intends to initiate one in the coming weeks.

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A Small Year for iStar Financial

noreply@blogger.com (Jimmy Munyemana) — Sun, 31 May 2009 04:32:00 +0000

A couple of weeks ago, I wrote an article about a REIT I am currently invested in that goes by the name of iStar financial (NYSE: SFI). The position of a long term investor gives the advantage of having quick access to financial statements as soon as they are issued. This year, I have been very disappointed by the performance of the management of, this REIT, which was, before 2008, the soundest of such companies in my opinion.

In the upper stated previous article, I elaborated on the attractiveness of iStar, which unfolded to be a yield trap, meaning by that a dividend so attractive that it cannot be sustained forever. At the time of my first analysis of iStar, their average quarterly dividend for the last five years hovered around 70 cents per share. This amounts to roughly $2.80 per year. With an average cost per share of 3.98$ such a dividend would provide a staggering dividend yield of 70%! Such a yield is mouth-watering for a value investor and many dividend investors have probably noticed the same phenomenon. The only problem is that the board of directors decided to suspend the company dividend during the last half of 2008, at the same time making the company’s stock less attractive relatively to the initial reasons that made iStar Financial so appealing.

The annual letter by chairman of the board and chief executive officer Jay Sugarman was more of a desperate call for shareholders not to leave the company’s beaten down stock than a real explanation of what happened. Plus one of the matters that had to be voted in the annual shareholder’s meeting was the board of directors proposed vote in favour of the 2009 Long-Term Incentive Plan and Performance-Based Retention Award to the chairman and Chief Executive Officer. The plan allows Jay Sugarman to get compensated in stock about every three years relative to the performance of the company. They justify the plan by with the fact the company purchased about 32.6 million shares between July 1st 2008 and March 31st 2009. The only reason I disagree with the plan is that in three years, iStar’s performance will be significantly better than in 2008. Jay Sugarman will be automatically awarded for the good performance of the company. I just hope the stock price will be significantly up enough to ensure little dilution of shareholders’ wealth. This is another good example of the institutional imperative.

My only solace is that the company proceeded to a huge share buyback program, thus bringing the common stock count from 133 million shares to 105 million as of December 31st 2009. This is great news since it will allow the company to spend proportionally about 21% less cash when they reinstate their dividend. At the time of making the investment in iStar, or in any dividend paying company for the long term, a yield of 10% is enough to justify a 10 year commitment from my capital. Taking this into assumption, iStar needs to have a quarterly dividend of at least 10 cents per share to make a long-term investment worthwhile.

Disclosure: The author is long on SFI

Liddy Intends to Step Down

noreply@blogger.com (Jimmy Munyemana) — Fri, 22 May 2009 22:56:00 +0000

As it is now common knowledge, AIG (NYSE: AIG) has been considered by the US government as being the only company that was not involved in the banking business, but was big enough to affect the global financial system due to the seize of its credit default swaps portfolio. It thus acquired the critically recognized expression of being too big to fail in November 2008, at the moment the whole financial world got scrambled. At that precise moment, the US government was forced to bail out AIG, providing it the staggering rescue amount of $185 billion. That is an amount larger than any single bank received to better manage the financial crisis. In exchange for the 80% ownership stake that the government got at that time, the Obama administration appointed Edward Liddy as the chairman and CEO of the troubled firm.

Liddy used to be the chairman of the insurance company Allstate and served on the board of Goldman Sachs. He has been a seasoned leader for insurance and financial companies and was definitely the right person to occupy such a critical position in the leadership of AIG. His announcement about his pending resignation after the end of the restructuring at AIG was quite surprising. It is happening sooner than expected, but it is fully understandable for two reasons. First, due to all the scandalous events surrounding former AIG executives, Edward Liddy got a total compensation of... $0. That includes his salary, stock options and warrants. His only financial solace came from about $500000 of tax advantages from a government who wanted to make sure Liddy did not end up paying to work as chairman and CEO of AIG, which would have been pretty embarrassing for the treasury department. A second reason that would justify a resignation is that Liddy was actually in retirement at the time he was asked to step up to the plate.

However, the task he faces seems to be a lot more impressive than expected. In his opinion, AIG will be able to reimburse the US government after about 3 to 5 years. From a value perspective, that makes AIG a company that has nothing interesting to offer to investors. Also the fact that AIG might be reverse-splitting their stock is only a short term solution to keep the stock from being unlisted from the NYSE as soon as they reinstate their tough guidelines.

From all that information, I would lead to assume that AIG is currently fairly valued by the market. Even after they managed to showcase $20 billion of revenues in their filing for Q1 2009, they are still a long way from their profitability of previous years. There is also a lot of uncertainty about AGI’s earning power. According to Liddy, the company still has to be spitted; which would respond to the US government’s need to have very few companies “too big to fail” under their oversight. In the meantime, for a value investor, AIG seems to be a company to pass over, at least for the next 3 years, or when they start to be profitable again.

Disclosure: The author has no position in AIG.

A Stock Investing Methodology

noreply@blogger.com (Jimmy Munyemana) — Wed, 20 May 2009 20:17:00 +0000

When investing in a company, I am usually looking at the price of the stock at the end of my analysis and it makes total sense. As many value investors know, price is only a way to figure out if you are getting a bargain relative to the underlying value of a business. That value is almost always an estimate, but when you compare it to the price of the company some bargains become screaming bargains. By that I mean that their price is so attractive that even the most pessimistic estimate of their future earnings offers a margin of safety. Let’s look at the process:

The best tools an investor can use while searching for interesting stocks is usually a stock screener. The best performing one I have used to date is the one provided by Yahoo! Finance.

When searching for a new stock to invest in, the first ratio I look for is return on equity. The higher it is, the better. After reading many books written by famous investors, it has appeared to me that most of them tend to choose companies with an average return on equity for the last 5 years of at least 10%. Because they had a better track record than me, I tend to overlook companies with a return on equity of less than 10%. When he uses a stock screener, this will clear almost 50% of publicly listed companies’ from your investment possibilities, since most of them fail to sustain such a high return on equity for prolonged periods. An important point to raise here is that the company must preferably be very lightly leveraged, because that is the corporate equivalent of performance enhancing drugs, as investor Jim Chuong puts it.

Another determining factor is the net profit margin of the company. Once again we look over that metric for the last five years to get an average number. This shows me the strength of the earnings of the company. Investors with a great track record tends to choose companies with a net profit margin of about 8% to ensure that the company’s profits will not be affected much by an increase of their costs (inflation).

My holding period for a stock will usually range from 3 to 10 years. I start by estimating the free cash flow per share of the company over the next 10 years and discount them to their present value. My objective, when doing that, is to get an estimate of the intrinsic value of the stock. Then, I want to know if I have a margin of safety. It is only at this step that I will need the current price of the stock. If the stock is trading at 70% or less of its intrinsic value per share, I will be tempted to make a purchase, as long as the price remains attractive.

I also want to have a target for a price at which I will be selling the stocks that I own. To get that figure, I use a modification of the Gordon Model. Using a predetermined capitalization rate, I will divide the present value of the free cash flow at the year following the year I intend to sell and then. I then add the value I just got to the sum of present value of free cash flow per share of the company. Now we have a long term target selling price.

After that, what is left to do is to check those stocks on a periodic basis and make the necessary adjustments. Buy if the price gets even more interesting. I acquired my definition of the time to sell from Philip Fisher; who advised to sell at the moment the stocks reach a high price because of mass market speculation. For more on the reasons that would really justify selling a position, I recently provided an article explaining the methodology of the late Phil Fisher. There is a lot to be learned from this successful investor and the way he went at finding attractive stocks at fire sale prices.