31 October 2005

Just Let It Flow

I came across this article by J. Alex Tarquinio in the Times on water stocks. Here are some excerpts:

OIL and gold have had a great run in the markets this year. So, too, has water.

While most of what flows through the nation's water taps is supplied by publicly run municipal systems, a growing number of rural and suburban water systems are owned by a handful of publicly traded utilities, like Aqua America. The shares of these companies have skyrocketed this year, and despite a selloff earlier this month, they are still at levels that might seem more appropriate for rarer commodities, like precious metals or petroleum.
[I]nvestors who are bullish on the industry say that it is about to undergo a historic change - moving oceans of municipal water into the hands of for-profit companies.

The catalyst for the transformation will be the final draft of new water quality regulations, which the Environmental Protection Agency is expected to issue later this year, said Michael Gaugler, a stock analyst at Boenning & Scattergood, a brokerage firm in West Conshohocken, Pa., near Philadelphia. The new rules will require water systems to further reduce levels of substances like arsenic and chlorine. Many small towns will discover that they cannot afford the pricey ultraviolet reactors they will need to meet these stricter limits, Mr. Gaugler said.
About 85 percent of the nation's nearly 55,000 municipal water systems serve fewer than 3,300 homes each, and Mr. Gaugler said that many small towns had too few customers to be able to afford the infrastructure improvements. But, he said, companies like Aqua America - which is based in Bryn Mawr, Pa., and has 2.5 million customers in 15 states - could cover the costs without sharply raising rates. While large cities have continued to operate their own water systems, publicly traded water utilities tend to buy small rural and suburban water systems.

Mr. Gaugler predicted that more small towns would begin selling their water systems to the for-profit companies in 2006 and 2007, and that the pace might pick up as the deadlines for compliance - which range from 2011 to 2013 - drew near. He predicted that the big water companies "will pay less for acquisitions as time goes on, because municipalities are going to get desperate to sell."
Aqua America, the only publicly traded water company with a market capitalization of more than $1 billion, started trading this year at less than $25. The stock peaked at around $39 on Oct. 4. Then, on Oct. 12, more than four times the usual number of shares traded hands, and the stock fell to $32. It now trades at $32.92. Trading in the California Water Service Group , the second-largest water utility stock, and American States Water, the third largest, has followed similar patterns.
There is money to be made from the growing demand for clean water - but the best opportunities are not in the water utilities, said Neil Berlant, a consultant to the water industry, who also runs a private water investment portfolio at the Seidler Companies, an investment firm in Los Angeles. He said the biggest opportunities would come from selling water filtration systems to industry.
He likes two companies that are now primarily manufacturers of water treatment systems - Pentair, in Golden Valley, Minn., and Watts Water Technologies, in North Andover, Mass. Both companies' stocks have fallen this year. Pentair trades at $31.33 and is off 28 percent for the year, and Watts is at $26.62, down 17.4 percent. Mr. Berlant, who said that he consulted for both companies in the past but does not do so now, holds both stocks in the separate accounts that he manages for institutional and wealthy individual investors.

Some thoughts and points:

Government will intervene on behalf of its constituents on essentials. Water availability and pricing epitomizes "essential".

A highly-regulated market can be dangerous to profit-seeking shareholders. Small market caps and their attendant volatility and risk are also noteworthy.

Analysts are finding the water stocks expensive after their run-ups. With those run-ups, the dividend yield has shrunk to below the S&P 500 average. Slow-growth companies, like utilities, historically attract investors with generous dividend yields.

This ship has already sailed on water, if I'm reading about it in the paper of record. The recent pull-back of the largest water stocks doesn't seem all that relevant to me, in that the entire market seemed to pull back over October. The Conshohocken analyst predicts profitable changes for the water industry between 2006 and 2013. I'm not investing anything based on a prediction that spans eight years, and is so dependent on governmental action/inaction.

One small-cap water stock caught my attention after I checked out the competition to WTR on Smartmoney.com. Beside the other big players, CWT and AWR, was ARTNA. Let's take a quick look:

ARTNA, Artesian Resources Corp, services approximately 232,000 people in Delaware. Its PEG, at 2.32, is significantly lower than its competitors (CWT=3.19; WTR=3.92; AWR=4.02). Its Price/Book ratio is 1.8, versus 4.2 for WTR, 2.3 for CWT, and 2.1 for AWR. And its dividend yield is around 3%, like AWR and CWT, but double that of WTR. While ARTNA has a comparable ROE to its competitors, its ROA and ROIC lag behind.

Fine, I admit it. I just can't get excited about investing in Delaware water. Maybe I should leave them all behind. If I want to invest in a boony commodity, I'll take Albertan oil sands.

The end of the piece discussed an alternative to straight-up water stocks, water treatment systems. Is this where a value-minded investor can get exposure to water?

Pentair (PNR) and Watts Water Technologies (WTS) look pretty good (data from Smartmoney.com):
ROE - (PNR)12.65%; (WTS)10.24%
ROA - 5.95%; 5.43%
ROIC - 8.43%; 7.42%
PEG - 1.09; 1.47
Dividend Yield - 1.6%; 1.15%

PNR has had free cash flow go from $6.9M in 1995 to $85.4M in 1999 to $219.3M in 2003. However, in the trailing twelve months, that FCF has dropped to $128.2M, according to Morningstar. WTS has positive free cash flow, but it declined from $43.5M in 2000 to $19.2 in 2004. In the trailing twelve months, FCF has increased to $25.4M.

I think this data warrants doing a bit more research on these two companies:

28 October 2005

Satellite in my eyes, like a diamond in the sky, how I wonder...

Wednesday night, between innings, I quickly flipped by Cramer's Main Event II on CNBC. I would have stayed and watched some Mad Money, but baseball beckoned, and I had seen the first live Main Event and found it somewhat embarassing. He tries just a little too hard to ham it up in front of a live audience.

I digress. In those two minutes of avoiding Levitra commercials on Fox, a woman asked Cramer if she were nuts to invest 40% of her portfolio in Sirius on the run-up to Howard Stern's pending arrival on the network.

Cramer thankfully said yes.

But it got me thinking. And I came up with some questions; some hypothetical, some rhetorical, some downright answerable:

Is Sirius a trade worth considering?
Or is the better-run, higher-subscriber-base XM a better trade?
Are either of these stocks investible, as opposed to tradeable?
Should investors flee Viacom/Infinity Broadcasting?
Stern's over 50; Is 50 the new 30 or is Stern getting old?
What about Stern's recent ratings decline?
Will enough listeners follow him to Sirius?
Will the questionable talent that's replacing him on Infinity, Diamond David Lee Roth and Adam Carolla, drive more people to plunk down a monthly subscription to Karmazin?

First off, I checked out Morningstar's free analyst reports on SIRI and XMSR. They are both considered risky speculative stocks. Both received one-star ratings and were priced way above Morningstar's "fair value" and "consider buying" numbers. My guess is that speculative investors have long been involved with these stocks, and their inflated prices demonstrate it. Here's more evidence of Morningstar's wariness of satellite radio stock valuations:

Holding all of our other assumptions equal, XM would need about 33 million subscribers (50% more than our estimate) within 10 years to justify its recent stock price.

In our opinion, the subscriber growth necessary to justify Sirius' current stock price is highly unlikely. Holding all of our
other assumptions equal, Sirius would need close to 35 million subscribers (about 50% more than our estimate) within 10 years to justify this price.

These quotes should answer the question: Are either of these stocks investible, as opposed to tradeable?

No, neither SIRI nor XMSR seems like a prudent investment, but they could be tradeable.

Let's next look at the bulls and bears cases for each, again excerpted from Morningstar:

Bulls Say
XM's subscriber growth has jumped from 1.3 million in December 2003
to 4.4 million in June 2005.
XM currently has factory-installation deals with companies that
encompass a larger share of the U.S. auto market than Sirius. XM's
factory-installation agreement with Toyota begins in the 2006 model
XM is able to offer local weather and traffic to over 20 major radio
markets in the United States, invading terrestrial radio broadcasters'
Bears Say
At the company's recent stock price, XM's stock trades at over 25
times its 2004 sales.
In addition to substitutes for satellite radio, XM must compete with
Sirius for subscribers. This has the potential to further increase
programming, advertising, and customer acquisition expenses.
General Motors-related customers will become more expensive, as XM's
revenue-sharing agreement increases over time.


Bulls Say
Factory-installation agreements with Ford and DaimlerChrysler,
presently less mature than XM's relationships with General Motors GM
and Honda HMC, should boost Sirius' subscriber growth over the next
several years.
Sirius' revenue-sharing agreements with its automakers are believed
to be less expensive than XM's agreement with General Motors.
Starting in 2006, Howard Stern, a dominant morning radio personality,
will be broadcasting exclusively on Sirius.
Bears Say
Sirius' stock recently traded at more than 100 times 2004 sales.
The chips used in XM's radio units are smaller and cheaper to
produce. This has allowed XM to sell smaller devices and has helped
keep XM's cost of adding subscribers lower than Sirius'.
In addition to competing with terrestrial radio and other substitute
products, Sirius must also compete with XM for new subscribers. This
has the potential to keep expenses for programming and advertising
higher than expected.

I'd like to think it comes down to baseball versus football. XMSR carries Major League Baseball, while SIRI carries the NFL.

Then again, perhaps deciding between the two satellite radio services should come down to one's shock jock preference. XMSR has Opie and Anthony. SIRI will have Howard.

Or what if you're a Ford man, or a Chevy kinda guy, or you've grown up preferring Japanese quality? SIRI is installed in Ford and Chrysler automobiles, while XMSR is found in GM, Honda, and next year, Toyota vehicles.

Did you notice that XMSR recently traded at 25 times its 2004 sales, while SIRI traded at 100 times its 2004 sales? You could pay less for sales and earnings with XMSR, or more for sales and earnings with SIRI.

I also think the approximate $6 per share price of SIRI attracts more speculation than the $28 per share price of XMSR, even though the market cap of SIRI ($8B) is quite a bit higher than XMSR ($6.25B).

I can pose a bunch of questions, and some either/or situations, and still not come up with a really satisfying answer. Choosing between the two is more a matter of preference.

I happen to prefer the Phils over the Iggles. O&A got me through some excruciating document review early in my legal career. I'll take a Honda over an American car, though the Hondas built in Ohio suit me just fine. And if I'm going to speculate, I'm going to take the satellite radio company with more subscribers and better sales figures. All this leads me to XMSR, over SIRI.

P.S., Here's an excerpt about Stern's recent ratings decline, as reported, sort of, at mediaweek.com: I just had to snarkily point out the beginning of the second paragraph, where the reporter basically gave up on figuring out why Howard's ratings declined, and settled on writing that they just did "for whatever reason".

Stern's Ratings Fall in Many Major Markets
October 24, 2005
By Katy Bachman

Howard Stern’s year-long commercial for Sirius Satellite Radio, and continuous rant against traditional radio and the FCC, may be costing him a few of his 6.5 million weekly listeners. Or, it may be that the 50 plus-year-old graying shock jock’s schtick needs to take a new turn.

For whatever reason, since Stern announced a year ago he was leaving traditional radio for an irresistable $500 million, five-year contract with Sirius, his ratings on the whole have slid in nearly every one of his major markets, according to Arbitron ratings for Stern in New York, Los Angeles, Chicago, Philadelphia, San Francisco, Washington, D.C., Boston, Detroit and Dallas.

Among Adults 25-54, Stern’s audience share was down in the just-released Summer survey by double digits in 6 of his 9 top markets compared to a year ago. Stern's total number of weekly listeners also took significant hits in 7 of the top 9.

Even more astounding, Stern’s losses were worse among his target 18-34 year-old audience where his audience share was down in 7 of the 9 top markets. Compared to a year ago, the number of weekly listeners decreased in 7 of top 9 markets.

Some of Stern’s biggest audience losses were in perennially strong Stern markets, New York and Philadelphia. Even though Stern retained the No. 1 position among the 25-54 and 18-34 year-old demo, his weekly audiences dropped by double digits. His weekly audience among 18-34 year-olds dipped by 17 percent in New York and 21 percent in Philadelphia.

Cendant Redux

Now that I think of it, I was a little harsh on Cendant.

I'm not thinking about backtracking much on the bearish anecdotal case on Cendant's businesses. I'm not optimistic about the growth prospects of Cendant's varied businesses. But let's assume that Wall Street has also been quite pessimistic about Cendant's businesses and has priced that into the stock. Let's also assume that the conglomerate discount is priced into Cendant.

As you may have gathered, this is an apologetic post. But I'm not the only one at fault. Morningstar had some bum numbers that put me over the top in my criticism of CD. So let's excuse Morningstar's FCF numbers and look at some figures from SmartMoney.com:

Net Cash from Operating Activities (in $Billions)
2000 - 1.436
2001 - 2.784
2002 - 1.331
2003 - 7.202
2004 - 5.417

Capital Expenditures (in $Billions)
2000 - -.217
2001 - -.349
2002 - -.399
2003 - -.463
2004 - -.469

So if you deduct CapEx from Net Cash from Operating Activities, you should end up with FCF for CD:
2000 - 1.219
2001 - 2.435
2002 - 0.932
2003 - 6.739
2004 - 4.948

So Cendant didn't have a negative $50B cash flow over the past five years; it had a volatile, but positive cash flow in each of the last five years.

If I can let Cendant off the hook, I can cut Morningstar some slack. Especially when they are offering free premium analyst reports this week. Sanjay Ayer, a Morningstar analyst, currently rates Cendant five stars, with a "Fair Value Estimate" of $27.00, and a "Consider Buying" figure of $20.80. Cendant closed today at $17.64, a good $3+ below the bargain-y "Consider Buying" number.

I'm feeling a bit of whiplash, but I'm pulling Cendant out of the proverbial trash (dung heap perhaps?) and placing it onto the Stock Watch List.

This is a good lesson. One should be careful when considering stocks. I neglected to corroborate some damning data. I failed to consult a broad enough array of information resources. Bad me.

24 October 2005

What a damn mess

From today's New York Times (my bold, of course):

October 24, 2005
Cendant to Spin Off Many of Its Business Units
Cendant, the $18 billion conglomerate that was built through the acquisitions of dozens of the nation's most prominent businesses like Century 21, Avis, Days Inn and Orbitz, is planning a radical breakup into four different companies.

The move, which company announced today, is perhaps the most vivid acknowledgment that the latest era of conglomerates built through mergers and acquisitions may be over.

Under the plan approved by Cendant's board Sunday, the company will be divided into four parts - one each for Cendant's real estate, travel distribution, hospitality and vehicle rental businesses. Each unit will be spun off into a separate publicly traded company. Current Cendant shareholders will receive shares in each and will continue to receive dividends. For customers and employees, the change should mean little, at least in the near term.
The breakup of big conglomerates like Cendant is being driven in large part by investors' newfound desire for companies to be more focused and narrow - what bankers and analysts like to call "pure plays" - as opposed to large empires with disparate businesses. The stock prices of many big companies, like General Electric and Citigroup, have suffered in recent years, and some analysts attribute their sluggishness to what is often called a "conglomerate discount."
For Cendant, which also owns the Budget rental car system, Ramada and Super 8 hotels and the Coldwell Banker real estate business, among others, the breakup is a complete about-face aimed at reviving its lagging stock price, which has remained stagnant ever since the company merged with CUC International in 1997. It was later discovered that CUC had been involved in what was then considered the largest accounting fraud in history. Cendant's stock price has hovered from $20 to $25 over the last two years and closed Friday at $20.90 a share.
Mr. Silverman, the company's largest shareholder, called his conglomerate strategy a "financial success, but a stock market failure," noting that the company is financially strong, but that investors have not rewarded the company's stock price.

"You can have a great business strategy, but if it's not moving the stock price, it's not working," he said. "This is a classic case of the sum of the parts is worth more than the whole."
Still, not all breakups or spin-offs have worked. Viacom's stock price, for example, has not moved much higher since it announced its plan to split in two, leading some investors to question whether such moves really "unlock shareholder value." Even Mr. Rietbrock mentioned in his note about Cendant that, "we're typically cynical of financial engineering that only rearranges the pieces of the puzzle."

However, Mr. Rietbrock and Cendant may have reason to believe that its split will increase the company's share price. Over the past year, Cendant has spun off three different units; in both cases, investors benefited. Other historical examples, like the breakup of Dun & Bradstreet , resulted in huge gains.

Cendant traded up briefly, then tanked on an otherwise bullish session, down 6.77% to $18.77. So is this a buying opportunity? Will the value of the underlying companies be unleashed?

I question that premise. What underlying value? The travel industry has been terrible, and that's basically three out of the four parts of the new Cendant. And profitable units, like income tax preparer Jackson Hewitt have already been sold off. TheStreet.com today discussed Cendant's terrible performance.

The company said the market's valuation doesn't reflect its businesses' strong operating and financial performance, but Cendant delivered a weak third-quarter report card Monday and an ominous forecast about its consumer travel businesses. The company said earnings will be 44 cents a share, at the low end of guidance and below the 46-cent consensus from Thomson First Call.

Yeah, sign me up for that.

TheStreet.com pointed out that Expedia is down since Barry Diller spun it off. Why would Wall Street treat Orbitz any differently? Personally, I'm finding that more companies are offering their lowest rates on their own websites. I use Orbitz for a quick comparison on flights and car rentals. I find the cheapest option, and then go to that company's own website to pull the trigger on the transaction, saving me a few bucks. I'm using Orbitz, in the worst sense of the word, using their tools and bandwidth, leaving them nothing. Sounds like a money maker to me.

How about the real estate holdings (Century 21 and Coldwell Banker)? Yeah, I want to throw money into that industry after its peak. With Craigslist, more people are selling FSBO, or with cut-rate firms like Foxtons. I have a feeling the money's been made here already.

With all these good feelings about Cendant in mind, I pulled the Free Cash Flow numbers for CD off of Morningstar.com. I admit I'm new to this, but these numbers are a horrific sight to behold. I assume that much of Cendant's free cash went into its diverse array of acquisitions, but still, check 'em out:

96 - 93.8
97 - (1042.7)
98 - (1993.8)
99 - 377
00 - 1168
01 - (12,486)
02 - (16,310)
03 - (8043)
04 - (7620)
TTM (5249)

Yes, that's three positive FCF years out of ten. Since 01, Cendant's free cash flow has been NEGATIVE 50 BILLION DOLLARS. Ooof. Say it with a Dr. Evil voice. $50B is just not funny.

So we're left with two piddling positive arguments:
1. The new companies will not be sullied with the controversial Cendant name; and
2. The new companies will be easier to value independently, as opposed to being valued in conglomerate form?

I'm not sure I want to be around next summer when the market values these travel and real-estate companies on their own. It could get uglier than this mashed-up mess called Cendant.

21 October 2005

Peaty Goodness

Just back from Scotland, where I did my best to neglect the Pig. I visited Edinburgh and Glasgow, with a tour of the Highlands in between. What does a tourist do in the Highlands, apart from gawk at the ubiquitous sheep and bison-like brown cows? Visit Scotch whisky distilleries.

Walking by huge copper pot stills and oak vats, I felt as though I was in an oversized chem lab, but instead of precipitating out para-dichloro-benzene, the workers here were making spirits, sweet spirits. As you moved along the whisky-making process, the scents, or really, smells dominated my senses. Bright beery yeast in one room, alcohol in another, and finally the cool mustiness of the storage cellars where casks of ageing whisky lie dormant, slowly absorbing the flavors of the former sherry casks.

My tastes run the spectrum of whiskies, across Scottish geography. My preferences also cross various distillery parent companies. The lighter Speyside whiskies I enjoy, Macallan and Glenfiddich, are owned by the Edrington Group and William Grant & Sons. Edrington also owns the vile Cutty Sark, a.k.a. "The Shark" for its unwelcome bite. Glenlivet is pretty good, and is owned by Chivas Brothers, now a subsidiary of Pernod Ricard. Moving westard and peatier, Oban and Lagavulin are both excellent and operated by Diageo. LVMH Moët Hennessy Louis Vuitton owns Glenmorangie, a light single malt often mentioned as one favored among women whisky drinkers.

Investing in most of these companies is more difficult than finding a bottle of Glenfiddich's 21-year-old Havana Reserve here in the US. Edrington and William Grant are privately-held. LVMH and Pernod Ricard are public... in France.

That leaves Diageo, which happens to trade on the NYSE as DEO. Diageo smartly markets its diverse range of single malts under the mark "Classic Malts of Scotland" pictured atop this post. Diageo also owns unrelated booze that's quite popular in my home: Guinness, Tanqueray, and Baileys.

I worked through a quick discounted free cash flow model for DEO from my vacation reading, using the following figures:

current stock price = $57.80;
shares outstanding = 762.592 million;
current year free cash flow = $2456 million;
next year free cash flow = $2701.6 million (10% increase);
perpetuity growth rate (g) = 3%; and
discount rate (R) = 10%

Morningstar only had FCF figures for DEO since '02. FCF increase from '02-'03 was 62.4%, and '03-'04 was 31.1%. The lack of additional data led me to make up the 10% annual increase for the model. Using these assumptions, I came up with a per share value for DEO of $79.69. This is 37.9% higher than the current market price for a share of DEO. My model could be a bit dear, a wee bit optimistic.

Looking at some data from Smartmoney.com, DEO has a PEG of 1.32, a bit lower than its competition. It also sports a dividend yield of 3.81%. That seems a generous number for this industry.

Now I don't feel so bad that my only Scotch investing option is Diageo.

20 October 2005

Vacation Reading

I'm back from a wonderful vacation in Scotland (plus a whirlwind weekend in Paris). I brought one book with me for the flight, since we were trying to keep our bags light. Our jaunt to the Continent on Ryanair, the bargain European airliner, required us to keep our luggage under approximately 35 lbs, or we would have been charged hefty fees depending on how much heft we brought with us from the States. So I left the hardcover Potter books at home, and took with me The Five Rules for Successful Stock Investing by Pat Dorsey at Morningstar. I thank John Coumarianos for the excellent recommendation.

The investing philosophy espoused by Dorsey is prudent, long-term, value-based, and research-intensive. It's not a book on trading, nor will its lessons help me discern wonderful speculative plays. The first half examines how to evaluate companies and stocks, culminating in applying a valuation method. The second half (which I have left mostly unread) analyzes individual industries. I will be using Dorsey's book as a reference onward in this blog, specifically on figuring out core long-term portfolio positions.

So let's see what I may have learned over my vacation.

The remainder of this post is a straightforward nerd-o-rama focusing on stock valuation. My next post will get into some of the really fun things I did in Scotland and how those experiences may have triggered some pursuable investment ideas. So unless your name is Louis, Gilbert, or Booger, you should have stopped reading already.

I tried out the Discounted Cash Flow model described in chapter ten on Wal-Mart, since that's the stock with which I started down this slippery slope. I'll try to be as clear as possible, in case you want to play along.

My starting assumptions for WMT were culled from data at Morningstar.com and Marketwatch.com:

Current stock price: $45.60
Shares outstanding: 4160 million
This year's free cash flow (millions): $2151
Next year's free cash flow (millions): $2688.75
Perpetuity growth rate (g): 3%
Discount rate (R): 9%

I arrived at next year's free cash flow figure of $2688.75 by multiplying this year's free cash flow of $2151 by 25% and adding to $2151. Why 25%? I looked at WMT's free cash flow figures for the past five years and calculated how much they changed year to year. The average change was +26.6% ('01-'02 = 20.2%; '02-'03 = 69.3%; '03-'04 = 79.0%; '04-'05 = -62.2%). 25% is just an easier number to use than 26.6%, and it's only a model.

Taking these numbers, I calculated the free cash flow (FCF) forecast for the next ten years assuming the 25% growth rate:

Year 1 = 2688.75
Year 2 = 3360.94
Year 3 = 4201.17
Year 4 = 5251.46
Year 5 = 6564.33
Year 6 = 8205.41
Year 7 = 10256.76
Year 8 = 12820.95
Year 9 = 16026.19
Year 10 = 20032.74

Still with me? I then calculated the discounted free cash flow (DFCF) by taking the above free cash flow numbers and dividing them by the discount factor of (1+R)^N, where N = year being discounted. For example the discount factor in year 2 is (1 + .09)^2 = (1.09)(1.09) = 1.19. In year 4, the discount factor is (1.09)^4 = (1.09)(1.09)(1.09)(1.09) = 1.41.

Year 1 = 2266.74
Year 2 = 2824.32
Year 3 = 3231.67
Year 4 = 3724.44
Year 5 = 4262.55
Year 6 = 4884.17
Year 7 = 5604.79
Year 8 = 6442.69
Year 9 = 7385.34
Year 10 = 8452.63

Next, I calculated the perpetuity value and discounted it to the present: Year 10 FCF x (1+g)/(R-g)

(20032.74 x 1.03)/(.09-.03) = 343895.37
Discounting the perpetuity value = 343895.37/1.09^10 = 145103.53

The total equity value is the sum of the ten DFCFs and the discounted perpetuity value:
89408.70 + 145103.53 = 234512.23

The per share value is total equity value divided by shares outstanding:
234512.23/4160 = $56.37

So according to this model, applying my somewhat-informed assumptions, WMT is worth $56.37. So WMT is $10.77 or 19.1% undervalued according to its current price of $45.60. My earlier attempt at a valuation of WMT came to $76.98, making WMT look like the 50-cent dollar. This model adapted from my vacation reading makes WMT an 80-cent dollar.

06 October 2005

Chinese Hot Mustard Potato Chips

Poore Brothers made a Chinese hot mustard flavored potato chip variety way back in 1996. I discovered this delicacy at America's best-named supermarket, Schnucks. This was the yummiest variety, spicier than the jalapeno chips, and more interesting than barbecue. It was a flavor unique to Poore. I remember these chips ten years hence. Then the Chinese mustard chips disappeared. Couldn't even drum up an image of them from Google.

And I basically stopped buying Poore Brothers snack foods. I later tried their habanero chips pictured to the left, but they just weren't the same. They weren't special.

Isn't this a great introduction to a company? Makes you want to go out and buy 1000 shares, just on this anecdote alone. Fortunately, I'm no Cramer. All five of my readers, (six, maybe seven) require much more than a pronoucement from the Pig to make a stock move.

Apparently, Poore Brothers has moved onto making snack foods with the TGI Friday's brand, and as you'll read below, the Cinnabon brand. I've seen the TGI Friday's potato skin snacks in the firm's vending machine. I am now avoiding most starchy, carby foods in a so-far-successful attempt to get back to my law school fighting weight. But I can indulge in stocks of salty snack peddlers like Poore Brothers (SNAK). I just can't take another disappointment like back in '96.

Here's a piece by Will Ashworth from fool.com, posted on September 15, A Stock to Snack On

Investors looking for small-cap stocks tend to seek out companies
whose sales and profits are growing faster than the market as a whole,
or have the potential to do so. One such company is Arizona-based
Poore Brothers (Nasdaq: SNAK), which manufactures snack products such
as chips, potato skins, and cookies.

I'm constantly looking for opportunities to invest in products that I
either use or am familiar with.
Snack-food manufacturers have
historically carried low profit margins, so I wasn't really searching
for this type of business when I ran across it. Why, then, did I have
a change of heart?

Seems as though the writer of this piece and I came around to Poore Brothers as an investible company in a similar fashion. Full disclosure, I was taking a break from patent study, perusing the NASDAQ losers list today (which was quite lengthy) and came across the familiar logo of Poore Brothers. The mix of hunger and law study must've prompted memories of eating their spicy chips during my first year of law school.

Hidden among the company's various press releases for the past year
was an award it received for its new Cinnabon cookie line. The press
release implied that the rollout had achieved a level of retailer
interest the company hadn't expected. Poore Brothers had a potential
hit on their hands, and small-cap growth stocks are sometimes driven
by these types of business anomalies -- the sort that launch a company
into the stratosphere of growth. Poore Brothers might be poised for
such a dramatic rise, but not yet; Cinnabon cookies still make up a
relatively small portion of sales.

Also worth noting: the new business strategy the company began in late
2004. In a press release, CEO Thomas Freeze stated the company's
intent to expand beyond salted snack products in an effort to broaden
its product portfolio.

The company's plan has five basic points:

Develop, acquire, or license additional niche food brands like the
Cinnabon cookies. According to the company, the initial reaction has
been overwhelmingly positive.

Seek additional distribution for existing brands. To that end, Poore
Brothers has begun shipping products into Canada, although I've yet to
encounter them in the stores. I suppose I'll have to look more closely
the next time I'm out shopping.

Develop product extensions for existing brands. For example, the
company introduced TGI Friday's-branded meat snacks in May to
complement its existing TGI Friday's potato skins.

Increase the capacity of its two plants, which currently operate
between 40% and 50% of capacity. To that end, Poore Brothers is
securing private-label potato chip business with local grocery stores.
It's too early to determine whether this effort has been a success.

Make a concerted effort to increase margins. The company seeks to
improve efficiencies wherever possible and focus on higher-margin
products. Second-quarter operating margins increased from 23.5% to
A quick check on financials reveals decent second-quarter results,
with revenue up 34% and profits up 7.3%. (That's net of the costs
associated with discontinuing their Crunch Toons brand of salted
snacks in 2004.) Those trends should continue to improve, assuming the
company is able to improve capacity utilization.

Poore Brothers is making a compelling case for growth, provided it can
license brands in a cost-effective and scalable way. Their five-point
plan has some merit, but at the end of the day, the snack-food
industry is littered with casualties that tried taking on Pepsi's
(NYSE: PEP) massive Frito-Lay division.

The major drawbacks to investing in the company at this point are
twofold. Licensing is a risky proposition, as evidenced by the $2
million writedown that accompanied the shuttering of the Crunch Toons
line. In addition, an awful lot has to go right for their five-point
plan to work. It's anything but a sure thing.

So the question remains: Will Poore Brothers live up to its namesake?

There are some interesting brands discussed here. I performed some extensive polling in my living room and found that the Cinnabon brand scores very highly. The TGI Friday's brand less so, but I'm a New York Snob that frowns upon casual dining chains. That bit of poll data is probably skewing a bit negative.

Buffett is quite the fan of brand value. I know I'm putting myself out there for criticism for siding with the Oracle, but I too appreciate the intangible value of branding, except when the brand is World Poker Tour (see yesterday's post, as well as today's NASDAQ new 52-week low list). Poore's brands are enticing.

Expanding distribution into Canada seems like another good idea. Wonderful country with a booming economy. The Economist says Canada is at the beginning of a seven to ten year investment cycle. And the NHL is back, which means Canadians (and perhaps a few Flyers fans) will be excitedly watching the games and hopefully upping their snack intake.

Fine, fine. That last argument was quite a stretch. I think it's time I brought in the numbers:

Ticker/Share Price(as of whenever I checked during the evening of 10/5/05)/PEG/ROIC/Enterprise Value/CNBC Stock Scouter Score (Data is from smartmoney.com, unless it's from CNBC)

SNAK - $4.89 - 0.77 - $4.58 - 9/10
Its 52-week range is $2.56-$6.88, with the 52-week high coming less than one month ago.

These are pretty solid numbers. I wouldn't be thrilled with the near 30% drop over the last four weeks if I had a position in SNAK, but it means the stock is getting cheaper by the day. It also means that this is a volatile micro-cap stock that is a much riskier proposition than many of the other WershovenistPig Stock Watch List choices. Nevertheless, I'm throwing TGI Friday's-branded meat snacks (and Cinnabon snacks for dessert) into the trough.

04 October 2005

Visiting the Casinos

Thought I'd virtually visit some casinos since I have been withholding any trips to AC until I pass the pesky patent bar. And no, I don't touch online poker. I derive pleasure from many aspects of the game. I enjoy the tactile feel of the chips, cards, and felt. I savor the face-to-face competition. You meet such memorable characters at a $6/12 table (and especially at a $2/4). And you can't get cheesesteaks from the White House on the internet.

I would read some articles and re-evaluate my casino stock picks.

I found one piece on thestreet.com on the potential revitalization of Trump's recently bankrupt casinos, and another on the freefall of World Poker Tour's stock. Neither article convinced me to take another look at TRMP or WPTE. Instead, I'm feeling much more confident about all three current picks, BYD, HET, and IGT.

First off, the Trump piece:

The competition has run away from Trump, leaving his collection of ragged casinos littering the boardwalk. And the AC Marina, too. The Marina has three casinos, the Borgata, Harrah's Marina, and an unrenovated dump owned by Trump. I don't see how Trump can catch up, refinanced debt or not.

From 2000 through 2004, total capital spending at Trump's Taj Mahal on the northern end of the Atlantic City boardwalk was $110.3 million, according to figures from the New Jersey Casino Control Commission. Over the same period, capital spending at Aztar's (AZR:NYSE) Tropicana was $374.4 million and $262 million at Harrah's Entertainment's (HET:NYSE) Showboat.

That period also saw the July 2003 grand opening of the Borgata, a $1.1 billion joint venture of Boyd Gaming (BYD:NYSE) and MGM Mirage (MGM:NYSE) that upped the ante in Atlantic City. With 2,000 room and suites, 11 restaurants, 11 boutiques, a spa and theater, the Borgata draws well-heeled overnight visitors interested in a multifaceted experience.

The resort has vaulted to the top of the pack, with net revenue for the first six months of this year outpacing the closest competitor, Bally's Atlantic City, by $50 million. Bally's is owned by Harrah's.
Perry and his lieutenants are working on a capital spending plan, which they hope to share with investors by the end of the year. It could include renovations to casino floors and restaurants, as well as new concept restaurants. They're also working on plans for a new hotel tower at the Taj Mahal, which could add 1,250 rooms, although such a project would take about three years to complete.
After addressing some of its immediate challenges, Trump Entertainment might seek to expand into other markets, Perry said in the second-quarter call. The company's announcement Monday that it had entered into an option to lease an 18-acre plot in Philadelphia shows it's already making plans to do that.

However, even as Trump's new executives roll up their sleeves, competitors aren't standing still. The Borgata is planning a $200 million public-space expansion to be completed next spring and a $325 million 800-room hotel expansion scheduled for the fourth quarter of 2007.
Next year, Caesars plans to open "The Pier," a 500,000 square-foot dining, shopping and entertainment complex on the boardwalk.
As for the stock, which has navigated a range of $12 to $21.50, Noland considers it fully valued around $19 and has encouraged investors to buy it on significant dips. Shares closed at $18 Monday. Noland owns no positions in Trump Entertainment and Gimme Credit does no business with the company.

So as a potential investor, I have to wait three years for the possibility that the Taj Mahal will be expanded. And I have to hope that the city-that-elected-John-Street-mayor-twice will get its act together to do what? Throw together some slot machines?

Too many maybes for me. What excites me, moreso than pocket aces, is the revitalization of Caesars and Showboat, the revenue generation of the centrally-located Bally's, and the much-needed expansion of the Borgata. This is the future of Atlantic City. And which companies are behind these moves? HET, BYD, and MGM.

Before I move onto the numbers that justify my beliefs, let's take a quick look at a fool named Jeff Hwang, from Motley Fool who somehow attempts to justify considering WPTE:

Does WPT have a business or doesn't it? If so, is parent Lakes Entertainment (OTC BB: LACO.PK) the better value? And if so, should you be willing to touch Lakes with a 10-foot pole? I gotta confess: As soon as I wrote that, I lost all interest in both stocks.

I mean, why even bother looking at a company where I have to ask those kinds of questions? After all, I've been buying three other high-quality companies for my own portfolio lately: Barry Diller's InterActiveCorp(NYSE: IACI), IAC's recently spun-off online travel leader Expedia(Nasdaq: EXPE), and slot machine giant International Game Technology(NYSE: IGT). All of them have legitimate businesses, generate bucketloads of cash, and look very much like values at current prices.

Last time, I concluded that if WPT's currently deserted online gaming business ends up being worth anything at all, the stock has legitimate upside, but that the rest of the business was worth only about half the stock's market price.

As it turns out, the stock closed yesterday at $8.84 per share, a mere 10.5% premium to WPT's $8-per-share IPO price in August 2004. A big reason for the decline was online gaming leader Party Gaming's (LSE: PRTY)prediction earlier this month that growth rates would slow. If the online gaming market isn't going to be as big as everybody thought, then obviously WPT's potential in that area is slimmer, particularly if it can't shake its current status as a fringe player.
On the other hand, despite the questions surrounding the potential of its online gaming business, WPT is starting to look interesting. The company's media and product licensing business is legitimately profitable. (That said, I also think that Harrah's Entertainment(NYSE: HET) -- another stock that is starting to look attractive after its recent pullback -- represents a much tougher competitor than I previously believed, especially since its acquisition of Caesars extends the reach of its World Series tournament circuit.) In addition, I believe that WPT's brand value is increasing as the company continues to further penetrate international markets, which should support the online business, at worst, as a means of cheap and effective marketing.

Should the stock fall much further, I think that investors may be able to purchase WPT's media and product-licensing businesses -- plus the brand -- at fair value and get the online business for free. To me, that looks a lot like a value opportunity.

I'm having a bit of trouble taking this writer's views seriously. The World Poker Tour is an entertaining bit of television, but is it a brand worth hundreds of millions of dollars? Even more than the Trump brand, there's a whole lotta nothing backing the WPT.

The World Series of Poker brand is just as marketable and valuable, and has a fundamentally strong company backing it up, Harrah's.

Side note: I reluctantly find myself in agreement with Jeff Hwang about IGT.

I'm letting it ride over on the WershovenistPig Stock Watch List, not making any changes in the casinos. So let's quickly get the numbers out of the way:

Ticker/Share Price(as of whenever I checked during the afternoon of 10/4/05)/PEG/ROIC/Enterprise Value/CNBC Stock Scouter Score
(Data is from smartmoney.com, unless it's from CNBC)

TRMP - $17.85 - na - na - na - na
HET - $66.26 - 1.27 - 3.71% - $172.32 - 6/10
BYD - $42.85 - 0.99 - 5.79% - $65.73 - 4/10
MGM - $44.33 - 1.53 - 4.01% - na - 7/10
AZR - $31.43 - 1.86 - 3.17% - $47.03 - 5/10
PENN - $31.48 - 1.16 - 6.27% - $35.38 - 3/10
IGT - $27.92 - 1.44 - 15.15% - $24.95 - 10/10

HET has a decent PEG, and a surprisingly high enterprise value. Might have to check smartmoney.com's numbers on that. BYD has a PEG just below 1, a high ROIC compared to its peers, and a share price below its enterprise value. And IGT has an even higher ROIC and some significant recent insider buying.

Now I got to get some studying done and get this whole patent attorney thing squared. And then I can go satisfy my poker jones.

03 October 2005

Do Buybacks Equal Greenbacks?

I was perusing the Times business headlines while taking a quick break from patent bar study. (Yes, posts should be fewer this week. If they aren't, I'm not studying enough.) A piece by Amy Feldman, excerpted below, caught my greedy eye. Its premise: that companies doing share repurchases, or buybacks, offer a higher return for investors than owning shares in companies that do not announce buybacks.

Sending Out a Message by Buying Back Shares

Companies have been repurchasing their own shares at record levels,
and the trend shows no sign of letting up. In the first half of this
year, share buybacks reached $163 billion, according to Standard &
Poor's, up 91 percent from the first six months of 2004. Howard
Silverblatt, an equity market analyst at S.& P., estimates that they
will surpass $300 billion for the year. That would be well above the
$197 billion for all of 2004.

Companies are splurging on their own shares for a simple reason: they
have a lot of cash and need to do something with it.
"Companies have more cash than they know what to do with," Mr.
Silverblatt said. "The number is just huge, especially in an
environment where it is cheap to get money. So companies have plenty
of money to do buybacks."

In general, buybacks are good for investors. After all, they represent a vote of confidence by management in the company's stock. And all things being equal, buybacks increase the earnings for each share by decreasing the number of shares held by investors.

Ok, so the Times is recognizing a huge trend among companies. Buybacks are the cool thing among CEO's and CFO's. But when something becomes cool, poseurs tend to follow along. So one should be on the lookout for which companies have the fundamentals to back up the stock repurchase versus the poseurs puffing up their chests and attempting to look strong.

David L. Ikenberry, a finance professor at the University of Illinois
at Urbana-Champaign who studies corporate buybacks, found that the stock price of companies that announced buybacks tended to outperform those that did not.

In an unpublished study of 7,725 announced corporate buybacks from 1980 to 2000, Mr. Ikenberry and three other researchers found that investors who held those stocks for four years earned a return that was 15.6 percentage points higher than that of a similar basket of stocks from companies that might or might not have announced repurchases. The results were consistent with a similar study
published in the Journal of Financial Economics in October 1995 by Mr. Ikenberry and two other academics that focused on stock buybacks from 1980 to 1990. The study is at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=686567.

A 15.6% difference over four years isn't an outsized megamillions-style gain. But there could be something to this. On a $50,000 portfolio, that comes out to a difference of $7,800. Nice.

Sorry for the interruption, let's continue with the Times. They don't really care for the rude interruptions.

"It is a phenomenon that is fairly robust," Mr. Ikenberry said.
"Companies buy back stock for all kinds of reasons. The biggest one is
a perception of mispricing. So these stock buybacks are considered
signals that management is confident of where the stock prices should be headed.
But not every buyback announcement is significant. Not all companies that say they will buy back shares actually do. And many buybacks - particularly among technology companies - are simply a way of offsetting the dilution that would otherwise accompany the exercise of stock options. "So many companies are doing buybacks, but they may not all be doing meaningful buybacks in the sense that they are big enough to give the company a reduced share count," said David R. Fried, president of Fried Asset Management in Pacific Palisades, Calif., and editor of the online newsletter buybackletter.com.

That said, more companies are doing meaningful buybacks these days and
some in huge quantity. Consider Exxon Mobil, the world's largest
energy company. As oil prices have soared, it has accumulated cash,
and it has been sharply increasing its share repurchases, up to $5
billion in the third quarter from $3.7 billion in the second quarter.
AND the buyback announcements keep coming, sometimes from companies
that have gone through tough times - like Time Warner and Motorola.
"They've had some problems recently, and they're trying to do some
signaling to the market," says Timothy Loughran, a finance professor
at the University of Notre Dame.

If you're interested in investing in companies that have had buybacks,
Mr. Fried recommends looking at valuations as well as the size of the
buyback programs. Among the stocks he likes are AutoZone, the auto
parts retailer, trading at 12 times earnings; Intuit, the maker of
Quicken software, trading at a multiple of 22; and Cigna, the insurer,
at a multiple of 8. "We look for situations where you've got the
buybacks and the valuations," he said.

I left out some of the boring parts for a change. But not too many.

I also remembered Cramer discussing this topic on his radio and CNBC show, back on September 23. Here's a recap:

Goldman Sachs "knows how to buy back stock," said Cramer. The company
bought back stock last quarter, and the stock is now trading 12%
higher than it was during the buyback, he said. Goldman just announced
another buyback this week, and Cramer expects similar results.

Lockheed Martin (LMT:NYSE - news - research - Cramer's Take), on the
other hand, also announced a buyback this week. But Cramer said
Lockheed's track record isn't so rosy. Last quarter, Lockheed bought
back stock, and the stock is now trading about 5% lower, he said.

The bottom line, said Cramer, is not all buybacks are created equal.
Goldman Sachs knows how to do a buyback. Lockheed Martin failed with
its last buyback and will "probably fail again," he said.

Cramer has a point that one needs to examine the company doing the buyback. I also think Cramer drank the Kool-Aid/read Dianetics/learned the secret handshake while at Goldman, meaning he's a sentimental booster of GS. Of course, the stock did jump recently.

I read on Marketwatch this morning that a company I ignored in my Discount Shopping Thesis posts, Dollar General (DG), announced a plan to repurchase up to 10 million shares over the next year. I checked the number of tradeable shares available in DG. Thestreet.com says there are approximately 321 million. This amounts to a buyback of 3% of outstanding shares.

The big question for me, as you may have seen in the title of this post: Do buybacks equal greenbacks?

How to separate out the good stocks from the wannabes?

Might as well throw out some usual numbers for the diverse array of stocks I culled from my reading:

Ticker/Share Price(as of 10/2/05)/PEG/ROIC/Enterprise Value/CNBC Stock Scouter Score
(Data is from smartmoney.com)

XOM - $63.54 - 1.89 - 27.74% - $59.82 - 9/10
AZO - $83.15 - .80 - 26.56% - $104.00 - 9/10
INTU - $44.81 - 1.32 - 21.53% - $42.27 - 6/10
CI - $117.86 - 1.37 - 24.84% - na - 9/10
TWX - $18.11 - 1.76 - 2.76% - $20.95 - 5/10
MOT - $22.03 - 1.66 - 18.02% - $22.03 - 10/10
DG - $18.34 - 1.06 - 17.88% - $18.40 - 6/10
GS - $121.58 - .87 - 4.01% - na - 9/10
LMT - $61.04 - 1.49 - 11.90% - $64.80 - 6/10

AZO has the best PEG, came in a sweet second on ROIC, and has an enterprise value about 25% higher than its share price. I don't need any more retail stocks on the WershovenistPig Stock Watch List, but this one's too good to ignore.

XOM has the nice ROIC, but I already have my eye on plenty of superior oil and gas stocks. I've got commodities covered.

DG has numbers comparable to FDO, currently residing on the Discount Shopping Thesis list. WMT is currently my pick among those choices, but between DG and FDO, I like the fact that DG is doing the buyback, however meager the 10 million shares authorization turns out to be.

TWX, so maligned (just check out Jeff Jarvis' Buzzmachine for embittered talk of TWX.) It will be interesting to see what TWX does with its AOL subsidiary. Otherwise, the PEG and ROIC are crap. And I'm not excited about media stocks. This stock could be the big poseur in this group.

INTU and CI have nice ROIC numbers. But INTU's enterprise value is below its share price. CI doesn't have an enterprise value, at least on smartmoney.com. Yahoo! Finance has CI's enterprise value below its market cap to the tune of $1B. And CI is at its 52-week high.

MOT and GS have had nice runs as of late. I think a little too rich for me right now, but these are leading companies that could pullback over the next few months. MOT certainly has come off its 52-week highs.

Here's my Buybacks = Greenbacks Basket for the WershovenistPig Stock Watch List:
AZO, INTU, CI, MOT, and GS. Talk about cohesion: an auto parts retailer, accounting software company, health care insurer, cell phone and telecommunications bigshot, and premier investment bank. It's an instantly diversified portfolio. Go me!