Value Investor Insight

Transcription

ValueInvestor
January 31, 2016
INSIGHT
The Leading Authority on Value Investing
On the Radar
Inside this Issue
FEATURES
D
avid Brown readily admits that he may not have
been 100% ready to start his own hedge fund in
October 2005 at the ripe young age of 27. But
what he lacked in experience, he made up for in enthusiasm. “I didn’t really know how to create a hedge-fund business,” he says, “but what helped me more than anything
as I figured it out is that I just love the process of investing.
That helps you go further than you might otherwise.”
He’s proven well up to the task. His Hawk Ridge Partners L.P. since inception has earned a net 12.4% per year,
vs. 6.7% for the Russell 2000. Focused on overlooked
small caps, he sees upside today in such areas as real estate
See page 2
services, non-oil MLPs and medical devices.
Investor Insight: David Brown
Mining the poorly followed and
under duress to find value today in
RMR Group, Enviva, SeaSpine and
Transmontaigne.
PAGE 2 »
Investor Insight: Masa Takeda
Looking for high quality at reasonable prices and finding it in Japanese-company stalwarts SoftBank,
Asics and Unicharm.
PAGE 9 »
David Brown
Hawk Ridge Management
Safe and Sound
Uncovering Value: Methanex
Have falling oil prices had too
indiscriminate an effect on shares of
this chemical producer? PAGE 21 »
J
apan may not have a prominent value investing culture, but Masa Takeda had free rein to develop his
passion for it upon joining Tokyo-based Sparx Asset
Management in 1999. He studied great active value investors – including Warren Buffett, Charlie Munger, Bill
Ruane, Marty Whitman and Jean-Marie Eveillard – while
also learning the trade from Sparx founder Shuhei Abe, an
investing innovator in his own right in Japan.
The Hennessy Japan Fund that Takeda has long comanaged has earned a net annualized 8.4% since 2003, vs.
4.4% for the Russell/Nomura Total Market Index. Among
areas in which he’s finding value today: mobile telecom,
See page 9
consumer products and running shoes.
Investor Insight: Michael Browne
Navigating Europe’s troubled waters to find upside in Ryanair, BIM,
Pandora and CIE.
PAGE 15 »
Editors’ Letter
Reminders of the “humility side” of
the investing equation. PAGE 22 »
INVESTMENT HIGHLIGHTS
INVESTMENT SNAPSHOTS
Masakazu Takeda
Hennessy Japan Fund
PAGE
Asics
12
BIM
19
CIE Automotive
20
Enviva
6
Continental Thrift
Methanex
21
Pandora
18
hen asked if investors in his home base of Europe and elsewhere are facing unprecedented
uncertainty, Michael Browne of Scotland’s
Martin Currie Investment Management recounts the period after the U.S. Civil War when a railroad boom led to
a banking crash followed by 30 years of sluggish growth
and general economic unease. “Sound familiar?” he asks.
Benefitting from historical perspective and modern-day
insight, the European long/short strategy Browne has comanaged since 2001 with Steve Frost has earned a net annualized 6.7%, vs. 2.6% for the MSCI Europe Large Cap
index. Today he’s seeing opportunity in such areas as airSee page 15
lines, jewelry, auto parts and grocery retail.
RMR Group
4
Ryanair
17
SeaSpine
8
SoftBank
11
Transmontaigne
7
Unicharm
13
W
January 31, 2016
Other companies in this issue:
Deutsche EuroShop, Kao, Keyence,
Mitsubishi, Mizuno, Nokia, Perry Ellis,
Michael Browne
Martin Currie Investment
www.valueinvestorinsight.com
Pigeon, Ryohin Keikaku, Shimano, Strattec, Uni-Select
Value Investor Insight 1
I N V E S T O R I N S I G H T : David Brown
Investor Insight: David Brown
David Brown of Los Angeles-based Hawk Ridge Management LLC describes the situations he finds most conducive
to market mispricing, why he doesn’t screen for ideas based on valuation, why his strategy has particularly shined in
troublesome markets, and what he thinks the market is missing in RMR Group, Enviva, Transmontaigne and SeaSpine.
Key to any successful investment strategy is knowing where the market is most
likely to be getting it wrong. Where is that
for you?
David Brown: The simplest way to put it
is that we try to play in securities where
we can develop a competitive advantage.
That means finding companies that are
not well researched, so that we have a
higher likelihood through our research
process to arrive at a differentiated understanding of the business that we can use to
our advantage.
The companies we find interesting are
relatively small – the average market cap
in our fund today is around $750 million
– and not well followed by Wall Street. We
also try to focus on situations conducive
to mispricing. That can be anything from
technical selling pressure in a broken IPO,
to stocks transitioning from a growth to
value shareholder base, to misunderstanding around a large acquisition or divestiture, to temporary business setbacks or
negative headlines that cause the market
to overreact.
It sounds very simple, but the first thing
we’re trying to define is what the business is. How does it work? Who are the
customers? What drives purchase decisions? What are the costs? What are the
competitive dynamics? We stick to industries where we think we benefit the most
from answering those types of questions,
which tend to be in areas like technology,
healthcare, business services and consumer products. We don’t invest in areas
that I think require specialization that I
don’t have, such as anything tied directly
to commodity prices, banks and insurance
companies, or biotech.
How do you source ideas?
DB: This is something we spend a lot of
time on. I think it’s hard to be successful
January 31, 2016
in the public markets unless you’re constantly looking through a whole bunch of
securities for the very few that will be significantly mispriced and provide the most
opportunity.
Our screening is situation, not valuation, focused. We conduct it on a daily
basis, flagging companies based on any
number of events, including M&A trans-
ON MULTIPLES:
I own stocks trading at low
multiples, but haven’t seen
any correlation between low
multiples and less downside.
actions, significant management changes,
earnings beats and misses, major new customer wins or losses, dividend changes,
spinoffs, etc. All of those can be interesting starting points for research.
Uni-Select [UNS:CN], which we talked about last year [VII, June 30, 2015],
got on my radar when it announced it
was selling its U.S. auto-parts business to
Icahn Enterprises. That business had been
dragging down the results, but the news
prompted us to look at what we had to
pay for the primary remaining business,
called FinishMaster, which sells paint to
North American auto shops. After digging
in and doing the work, we decided that
was an excellent business with a lot of potential that the market wasn’t recognizing.
[Note: At just under C$47 when the VII
article appeared, Uni-Select shares now
trade at around C$61.]
In addition to our screens we also just
think intuitively about areas with significant market dislocation, where the right
fundamental research isn’t being done for
whatever reason. Two of the ideas we’ll
talk about later are master limited partwww.valueinvestorinsight.com
nerships, not an area we’ve focused on in
the past, but one where there seemed to
be a lot of indiscriminate fear and selling
going on. We thought that made it a good
place to look for value.
You mentioned not doing valuation
screens. Why not?
DB: I’ve observed over time that the companies that screen well on a multiple basis typically have nothing else going for
them other than that they trade at a low
valuation multiple. Here I’d make the important distinction between focusing on
companies that are unresearched versus
those that are actually widely researched
and hated. I’m much less interested in the
latter, and want to focus on situations that
are just not well researched from the get
go. We have to understand something that
other people don’t understand.
I had a recent conversation with another investor who was making the case that
paying a lower multiple meant you had
less downside. I own a lot of stocks trading at low multiples, but in my experience
I haven’t seen any correlation between low
multiples and less downside. My biggest
mistakes have actually been in securities
that I’ve originally defined as being the
cheapest.
You described focusing first in your research on defining what the business is.
How do you go about doing that?
DB: For whatever reason I love reading
10-Ks, which is where I personally start
in learning about a business. We do all
the fundamental work you’d expect, going through all the SEC filings, getting to
know management well, reading as much
as we can about the company and industry, and speaking at length with suppliers,
competitors, industry experts and former
employees.
We’re really trying to do two things:
First, understand how the company’s business works, how it’s performing, how the
industry is evolving and who is and isn’t
doing well. Second, we’re looking for consistency from multiple sources in what
we’re hearing about the business. For example, if management is telling us something different than what we’re hearing
from experts in the industry, that’s going
to be a big problem for us. But if things
line up across multiple sources, that gives
us much more confidence in the validity of
our research.
If we make an investment and it hasn’t
worked in 18 months, I would say from
a practical perspective that we’ve been
wrong. That doesn’t mean we sell it, but it
means there was probably a problem with
our work in the first place.
Describe generally how you approach
valuation?
ON SHORTING:
DB: We tend to look at businesses from
a private market value perspective. As a
buyer with all cash, what kind of cash
flow could I generate from the business
and what would I be willing to pay for
that cash flow? We don’t project out five
or ten years – I think those types of forecasts are unrealistic – but want to fully understand current free cash flow and try to
make a reasonable forecast of normalized
earnings power one to two years ahead.
From there we can look at the levered and
unlevered free cash flow yield at the current share price.
Describe your approach to shorting, starting with why you do it.
DB: We’re researching so many securities
that from time to time we come across
great ideas on the short side and want to
We avoid shorts in highgrowth companies owned by
investors whose methodology we don’t understand.
What’s your typical holding period?
take advantage of them as a way to generate additional alpha. Having a short book
also helps us through tough market environments, preserving liquidity at a time
when we may want to be a bigger buyer.
We’re cognizant of the fact that shorting has the risk of unlimited capital impairment, a risk which is higher in certain
situations. For that reason we try to avoid
valuation-based shorts in high-growth
companies owned by momentum, growth
or other investors whose methodology we
don’t understand. We also want to avoid
companies in industries with substantial
M&A activity, where buyers tend to be
price insensitive.
We prefer shorting stocks owned by
either GARP [growth-at-a-reasonable
price] or value investors because if profits
go down, their view of value goes down
as well. We’re also sensitive to maximizing our return on time, so we try to focus
on declining or poorly run businesses we
can be short for years, or on industries in
decline where we can short multiple small
positions.
DB: There’s a wide range, but the average
for us works out to be about 18 months.
Can you give a representative example of
a short idea?
Is there a hurdle you need to clear before
buying?
DB: Not really. Different businesses have
different risk characteristics associated
with them. We’re evaluating a contract
coal miner right now – which doesn’t take
commodity risk – that we’d be underwriting at a 25-30% unlevered cash flow yield,
and I’m as on the fence about it as I am
on an IT licensing business, with excellent
fundamentals, trading at a 7-8% yield. So
many things go into having enough conviction for me to buy – the valuation is just
one piece.
January 31, 2016
DB: A perfect example would be a company like Strattec [STRT], which we
originally shorted in 2014. It was an autoparts supplier whose traditional business
in making keys and locksets was secularly
challenged, but its earnings at the time
were unsustainably high due to one-time
work associated with the General Motors
ignition-switch recall. There was minimal analyst coverage, the company held
no conference calls, and the institutional
ownership tended toward un-concentrated plain-vanilla mutual funds.
At a time when recall revenues – which
we knew were going away and when – accounted for nearly one-third of the company’s trailing EPS, the shares had gone in
nine months from $45 to $100 and traded
at a historically high P/E multiple above
20x. Our thesis was simply that there was
considerable downside when the business
returned to normal and the valuation returned to normal on a lower EPS number.
It was fairly obvious to us, but no one
seemed to be paying attention to specifically what was going on. [Note: From a
high of $107 in November 2014, Strattec
shares trade today at around $48.]
Any current short ideas of note?
DB: I’d rather not talk about specific
names, but we have been finding poorly
followed retailers whose share prices we
don’t think fully reflect either the current challenged retail environment or the
companies’ ongoing vulnerability to losing business as people shop more online.
Marginal retailers that don’t have a really
strong reason for being and ability to drive
people to their stores are just going to disappear. We’ve been shorting some of the
weaker ones.
Do you manage your portfolio to a particular net exposure level?
DB: We’ve maintained a steady level of net
long exposure in the 50-60% range, which
when beta adjusted relative to the Russell
2000 is more like 35-40%. (The primary
factor driving our exposure lower when
beta adjusted is that our long book tends
to not be nearly as volatile as the market.)
My philosophy is that we’re good at analyzing businesses and making long and
short calls on individual stocks. Trying
to position my fund from a net-exposure
perspective based on my prediction of the
market’s direction is not in my skill set and
likely to result in bad decisions and a loss
of money. I want to be net long, but consider these exposure levels to be fairly balanced. They’ve worked nicely in up and
down markets.
Has the market volatility of late given you
more ideas to look at?
DB: Until probably about three months
ago I would have told you the small-cap
space was very picked over, but there’s
been a pretty sharp reversal of that. It feels
a tiny bit like 2008, when a lot of smalland micro-cap companies traded like they
were in liquidation mode and you saw
funds selling every single day just to get
out. There’s just a lot more fear in the
market in general.
While I just said I don’t put a lot of
weight on my opinions on market direction, it doesn’t feel like the right time to
be investing aggressively on more levered
capital structures or equity-option bets
where risk premiums have really blown
out. I will say, however, that after some
time seeing our cash on hand rise as our
ability to find new ideas lagged our profittaking on existing positions, we’re starting
to see that reverse. Today we’re buying a
lot more than we’re selling.
Let’s talk about some of those you’ve been
buying, starting with real estate services
company RMR Group [RMR].
DB: This is an asset management business.
The company came public last month in
a spinoff transaction in which the four
publicly traded REITs it manages (Hospitality Properties Trust [HPT], Senior
Housing Properties Trust [SNH], Government Properties Income Trust [GOV] and
Select Income REIT [SIR]) each distributed their proportionate stakes in RMR to
their shareholders. It was kind of a perfect
January 31, 2016
storm for potential mispricing: four separate, much larger companies spin off the
same security at the same time, during the
holiday season, with very little investor
communication.
The business is fairly simple. RMR
has long-term management contracts in
place with the four REITs as well as a
healthcare-properties company, Five Star
Quality Care [FVE], and a travel-center
company, TravelCenters of America [TA].
The REITs have no employees, so all aspects of the business – including managing
properties, buying and selling properties,
administration and finance – are run out
of the management company. The management contracts with the REITs run for
20 years and are exceptionally difficult to
terminate.
RMR earns base management fees tied
to the acquisition cost of the real estate
managed or the REIT’s total enterprise
value, whichever is lower, as well as to
the rent stream of the REIT, which should
grow over time. It can also earn incentive
fees tied to each REIT’s market-cap outperformance relative to the relevant index
over rolling three-year periods. The company has little capital expenditures, earns
50%-plus EBITDA margins, and there’s
an unusual level of visibility on cash flow
generation for years into the future.
What’s not to like?
DB: RMR and its two key principals,
Barry and Adam Portnoy, were widely
criticized during the activist fight over
INVESTMENT SNAPSHOT
RMR
(Nasdaq: RMR)
Business: Newly public provider of real estate investment and management services to
entities including real estate investment trusts,
operating companies and mutual funds.
Financials (TTM):
Share Information
Valuation Metrics
$164.7 million
49.1%
4.4%
(@1/29/16):
(@1/29/16):
Price20.85
52-Week Range
Dividend Yield
Market Cap
Revenue
Operating Margin
Net Profit Margin
11.89 – 22.75
0.0%
$333.6 million
RMR Russell 2000
P/E (TTM)
n/a108.4
Forward P/E (Est.)n/a 15.0
RMR PRICE HISTORY
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THE BOTTOM LINE
Market concern over the company’s management seems to be overshadowing both the
high quality of the business as well as management’s actual track record, says David
Brown. Valuing its base fee-revenue stream in line with comps and its future incentive
fees at what he considers a conservative present value, he pegs the shares worth at $42.
Sources: Company reports, other publicly available information
Clos
CommonWealth REIT led by Corvex
Management. Corvex actually won a
proxy fight in 2014 and dumped RMR as
CommonWealth’s management company,
claiming that RMR was acting in its own
best interest rather than in the interests of
shareholders, and that those conflicts had
led to the REIT’s serial underperformance.
It called into question the external management of REITs in general, and caused
significant damage to RMR’s and the Portnoy’s reputation.
priate multiple is the 10x EV/EBITDA that
the best comp, Northstar Asset Management, has, which is also where strategic
transactions have occurred in the space.
The incentive fees the company will
earn are much more difficult to predict. In
fact, they haven’t earned any such fees in
the past few years. That will change soon
when they report earnings for the fourth
quarter of last year, as the company will
earn a $62 million incentive fee from just
How are you processing that when investing in RMR today?
ON MLPS:
DB: I would agree that external management of a REIT can create an imperfect
alignment of interests between the management company and the REIT’s shareholders. But I don’t believe that has to be
the case, and based on our research, the
Portnoy’s have created a stable, well-run
organization with a strong core competency in managing real estate and making real
estate investments. The CommonWealth
situation notwithstanding, they have over
a long period paid huge dividends to the
shareholders of the REITs they manage.
We think there’s a very large gap between
the perception of RMR and the reality,
and we expect that gap to close in the
coming years.
Most importantly, I should also point
out that the Portnoys own 50% of RMR.
As a shareholder of RMR, our incentives
are exactly aligned with theirs.
The shares have already risen nicely since
being spun off. How are you looking at
further upside with the stock trading at
around $21?
DB: At its current run rate, the business
generates around $95 million in annual
EBITDA, basically management-fee revenue less costs. Against the current $580
million enterprise value (including the
cash from the incentive fee), you’re paying
a 6x multiple of EBITDA for that, which is
exceptionally low for 20-year contractual
revenue streams that generate cash flow
like clockwork. We think a more approJanuary 31, 2016
We have canvassed the entire space, focusing on those
that are the least exposed to
commodity prices.
one REIT, Hospitality Properties Trust, after its market value handily beat its benchmark and triggered the incentive fee based
on three-year outperformance. If you look
just at the four big public REITs, RMR
has the potential, based on the asset sizes
of the REITs today, to earn maximum annual incentive fees of $150 million or so.
We obviously can’t count on that, but we
can assume it will earn its fair share of
incentive fees and then decide what we’re
willing to pay for that potential. We’ve
concluded that’s worth $300 million conservatively. Add that to the $950 million
enterprise value we put on the base-fee
stream and that implies a share price of
around $42.
We assume you have to worry here about
the health of the underlying REITs.
DB: About 70% of RMR’s revenues are
tied to the enterprise values of the REITs, so there is clearly leverage to how
well those REITs are doing. In our view
all the REITs are conservatively managed,
with stable, investment-grade capital
structures. We also have a view that the
RMR-managed REITs are trading at very
attractive prices and are likely to be outperformers going forward.
You mentioned looking for value among
MLPs. Describe what you found in Enviva
Partners [EVA].
DB: Responding to the fear we saw in
MLPs generally, we canvassed the entire
space of roughly 150 names, segmenting
them by type of business and focusing on
those that were the least exposed to commodity prices. Enviva was the first one we
invested in. It also had the distinction of
being a recent IPO, having come public in
April of last year at $20 but trading poorly
out of the gate and falling to $12 by September. Nobody was paying attention.
The company is the largest player in the
business of selling wood pellets to electric
utilities in Europe that are transforming
from coal-fired to biomass power plants
to satisfy various regulatory requirements.
If you have a coal-fired plant in Europe,
your options for converting it to something else are relatively limited. There isn’t
enough natural gas. Nuclear has its own
regulatory challenges. Wood pellets have
proven a viable alternative, so there’s a
deep pipeline of utilities that are looking
to make the switch.
These tend to be steady, long-term
supply deals, with passthroughs for rawmaterials costs that essentially guarantee
Enviva a very stable margin over time.
The company doesn’t build capacity without firm customer commitments in place.
I didn’t know this going in, but virtually
all wood-pellet production is done in the
southeastern U.S., which apparently has
just the right combination of trees and
business environment for companies making wood pellets.
In any event, we look at this as a
growth industry, not levered to energy
prices, where we can have high confidence
in the underlying long-term profitability. It
doesn’t make sense to us that Enviva came
public at $20, has had only good things
happen since then from both a regulatory and operational perspective, and still
trades below the IPO price.
The shares have come back quite a bit to a
recent $19. How are you looking at valuation today?
INVESTMENT SNAPSHOT
Enviva Partners
Valuation Metrics
(NYSE: EVA)
(@1/29/16):
Business: Master limited partnership that
processes and distributes utility-grade
wood pellets sold to power-generation and
industrial customers primarily in Europe.
P/E (TTM)
Forward P/E (Est.)
Share Information
Largest Institutional Owners
(@1/29/16):
(@9/30/15):
Price18.94
52-Week Range
Dividend Yield
Market Cap
11.85 – 22.46
9.3%
$468.9 million
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
EVA Russell 2000
17.6108.4
11.7 15.0
$562.7 million
9.1%
4.2%
Company
Morgan Stanley Inv Mgmt
ClearBridge Inv
Goldman Sachs
GSO Capital
Hite Hedge Asset Mgmt
% Owned
15.6%
9.1%
8.2%
4.3%
4.1%
Short Interest (as of 1/15/16):
Shares Short/Float
2.8%
EVA PRICE HISTORY
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THE BOTTOM LINE
David Brown believes the broad-based sell-off among MLPs has gone too far in this
case, given the company’s growth prospects, high visibility into long-term profitability,
and lack of leverage to energy prices. If the stock traded at what he considers a reasonable yield on the distribution he expects this year, the share price would be around $30.
DB: At today’s price you’re paying an
enterprise value of nearly $685 million,
consisting of a $470 million market cap
and close to $215 million in net debt. In
2016 we’re projecting EBITDA of $85
million, so EV/EBITDA is 8x. (All of these
numbers, by the way, are on a pro-forma
basis for a dropdown from the LP sponsor in December of an additional production plant in Virginia.) As an MLP there
are no taxes, and capex is modest because
the production facilities are new and fairly
simple. Run all the math and the shares
trade at an unlevered free cash flow yield
of 12-13%.
January 31, 2016
We expect distributions to unitholders
this year of $2.30 per share, which implies
a 12% well-covered dividend yield on today’s price. We believe for an MLP like
this, with long-term contracts, excellent
growth prospects and high returns on capital, you could invest at a 7.5% dividend
yield and still have a solid investment.
That would give you a share price of $30.
Explain your thesis for a more traditional
MLP, Transmontaigne Partners [TLP].
DB: This is technically considered a midstream energy asset, operating in the storwww.valueinvestorinsight.com
age business for refined products like gasoline, diesel fuel and bunker fuel. You can
think of Transmontaigne’s storage facilities, which are well located along refinedproduct pipelines, as being the gas station
for gas stations. The fall in energy prices
has little bearing on a business like this,
and should actually provide a modest benefit as lower prices improve demand for
refined product.
This isn’t really a growth business, but
we think it’s quite an attractive one. The
assets are in high-demand areas, there’s
little unused capacity, new build is hard to
get permitted, and customers have healthy
businesses and tend to value long-term
supply relationships. The investment thesis is basically that these are rock-solid
assets that have sold off with sentiment
and now trade at a significant discount to
Closethey’ve traditionally been priced.
where
With the shares trading at $31.75, walk
through what you think they’re more reasonably worth.
DB: One nuance I’d mention first is that
the company has a large storage-development project called Bostco underway
along the Houston ship channel. Phase
one of these types of projects takes a huge
capital commitment, and then they’re underearning as the facilities become filled
and productive. Bostco is doing well, but
it’s currently in ramp mode. Because of
that, we back it out in our enterprise value
and EBITDA calculations and just assume
it’s worth its cost basis. It should end up
being worth much more than that, but we
don’t want to build that in yet.
Without Bostco, the remaining business at today’s share price trades at just
7.6x EV/EBITDA on our 2016 estimates,
versus a long-term range of 10-12x. That
range is also consistent with where acquisitions have been done over time. If we assume an 11x multiple, adding back Bostco
at cost, the shares would trade at around
$46.50 per share.
While we wait, at today’s dividend level
of $2.68 per share we’re earning an 8.4%
yield. We not only think that’s safe – the
payout ratio today is already conservaValue Investor Insight 6
INVESTMENT SNAPSHOT
Transmontaigne Partners
Valuation Metrics
(NYSE: TLP)
(@1/29/16):
Business: U.S. provider of storage and
transportation services to distributors and
marketers of petroleum products, crude oil,
chemicals, fertilizers and other liquids.
P/E (TTM)
Forward P/E (Est.)
Share Information
(@1/29/16):
(@9/30/15):
Price31.75
52-Week Range
Dividend Yield
Market Cap
20.26 – 43.00
8.4%
$512.0 million
Financials (TTM):
Revenue
Net Profit Margin
TLP Russell 2000
17.9108.4
13.9 15.0
$149.1 million
22.5%
19.2%
Company
Oppenheimer Funds
Energy Income Partners
Advisory Research
Goldman Sachs
First Eagle Inv Mgmt
% Owned
16.7%
8.7%
2.6%
1.9%
1.8%
Shares Short/Float
1.1%
TLP PRICE HISTORY
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201420152016
20
THE BOTTOM LINE
The quality of the company’s business, given the location of its assets and the health and
durability of its customer relationships, is much higher than what is reflected in its share
price, says David Brown. At a forward EV/EBITDA multiple more in line with its historical level and where deals have been done, he says, the shares would trade above $46.
tive – but we’d be shocked if the dividend
didn’t go up next year. A private equity
firm just paid a very high price to buy the
general partnership interest in Transmontaigne, and the only way their purchase
price makes sense is if they significantly increase the dividend in order to drive more
distributions to the general partner.
Turning to something quite different,
describe the upside you see in SeaSpine
Holding [SPNE].
DB: This is a former division of Integra
LifeSciences that was spun off last July. It
January 31, 2016
makes products used in spinal surgery, including hardware and what are called orthobiologics, which are moldable materials used in conjunction with the hardware
to fuse parts of the spine together. Based
on our work, the product line is well regarded in the marketplace, but not as wellknown as it should be.
If you take a five-minute glance at the
financials, you’d wonder why we want to
own this thing. Trailing 12-month revenues of $130 million are stagnant at best,
and the business has been losing money.
What caught our eye, though, is the background of the CEO, Keith Valentine. He’s
young, in his late 40s, but is well known
and well regarded in the spinal-products
industry, having served as president of the
highly successful NuVasive [NUVA] from
2004 until he joined SeaSpine in May of
last year. He was one of two people most
instrumental in NuVasive’s success and we
were intrigued that he’d chosen SeaSpine
as the platform to build something in the
industry on his own.
So this is more than anything a bet on
people. The new CEO has brought in a
number of top executives from NuVasive,
and they’re giving attention to all aspects
of the business, which wasn’t always the
case under Integra’s ownership. They’ve
concluded the existing product line and
product pipeline are strong, and the emphasis is on going out into the spinal-surgeon community to expand existing relaClose
tionships and build new ones. Distributors
we talk to have been extremely impressed
so far with the new energy and focus of
the company’s sales and marketing effort.
They’re very much in investment mode
now, but we’re quite confident that effort
will start to pay off in growth in the notdistant future.
How are you valuing such to-be-realized
growth?
DB: This may sound unsophisticated, but
we’re basically looking at revenue multiples in the industry. The closest comps –
Globus Medical, K2M Group, LDR Holding and NuVasive – trade at an average of
3x enterprise value to revenues. At today’s
price, Seaspine shares on the same basis
are trading at only 0.9x trailing revenues.
The product line today has 70% gross
margins, so there’s no reason that if the
products are as good as management
thinks they are, and management is as motivated and good as we think they are, that
the company can’t grow into profitability
on par with industry peers. At that point,
3x revenues on a much larger revenue base
is not unreasonable to expect. Even on
today’s annual run-rate of revenues, that
would translate into a $45 share price.
[Note: SeaSpine shares closed recently at
$14.50.]
INVESTMENT SNAPSHOT
SeaSpine Holding
Valuation Metrics
(Nasdaq: SPNE)
(@1/29/16):
Business: Design, development and
marketing of surgical devices and materials
used in the treatment worldwide of patients
who are suffering from spinal disorders.
SPNE Russell 2000
P/E (TTM) n/a108.4
Forward P/E (Est.)
n/a 15.0
Share Information
(@1/29/16):
(@9/30/15):
Price14.46
52-Week Range
Dividend Yield
Market Cap
12.93 – 26.00
0.0%
$160.5 million
Financials (TTM):
Revenue
Net Profit Margin
$133.6 million
(-18.3%)
(-37.4%)
Company
% Owned
Broadfin Capital
9.0%
Bridger Mgmt
5.6%
UBS Global Asset Mgmt
5.6%
Healthcor Mgmt
4.5%
BlackRock4.2%
Shares Short/Float
5.2%
SPNE PRICE HISTORY
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201420152016
THE BOTTOM LINE
While a first glance at the company’s shares would likely generate little interest, says
David Brown, he believes its product portfolio under a new, highly accomplished management team has the potential to produce unexpectedly strong results. If he’s right and
the stock eventually trades at peer-level revenue multiples, he says, “the sky is the limit.”
We believe we’re well protected on the
downside. No one in the industry trades
for 1x revenue, so even if the new efforts
don’t really work, it’s very likely we could
get out basically intact. If it does work, it’s
more the sky is the limit.
How would you describe your general
selling discipline?
DB: We want to sell when something
reaches fair value, but I’ve learned over
time not to rush in selling businesses and
securities that are performing well. They
typically run far higher and longer than
January 31, 2016
one might presume. I tend to sell successful positions in thirds: when it’s getting
close to my view of fair value, when it’s at
fair value, and then dribbling the rest out
over time.
The things I want to exit quickly are
those that aren’t working from a business
perspective and where our investment thesis is not panning out.
Can you give a fairly recent example of
one of those?
DB: A good example would be Perry Ellis [PERY], the wholesale apparel manuwww.valueinvestorinsight.com
facturer. Our bull thesis in mid-2014
was that despite it being mismanaged for
many years – resulting in by far the lowest margins among its peer group and a
bloated cost structure – the company still
had strong brand franchises and a healthy
and substantial stream of licensing revenue. We thought the problems were fixable and all that was needed was a catalyst
for change, which an activist hedge fund
at the time was actually providing. With
better management, we saw considerable
upside in the stock.
Unfortunately, we ultimately concluded
that existing management had entrenched
itself and was unlikely to make the changes necessary to improve the business.
When that became clear, it became a very
easy and quick decision to exit. [Note:
Trading at around $18 in July 2014, Perry
Close
Ellis shares hit nearly $28 in May of last
year and now trade at $19.]
Like most value investors with good longterm records, you have particularly shined
in weak markets. To what do you attribute that?
DB: I think our ability to not lose money
is primarily a result of staying within our
circle of competence and recognizing when
our research can give us an advantage and
when it can’t. When it can, that not only
tends to limit research mistakes, but it also
gives us a pretty good sense of how things
can go wrong and what the investment
outcome would be given the economics of
the business, the capital structure of the
company and the valuation of the stock.
We size our positions accordingly, trying
to limit potential losses to 100 basis points
on any individual position. When you do
all of those things decently well, you get
relatively consistent outcomes.
Last year I had a position nearly go to
zero, but I knew that was a distinct possibility at the outset and for that and other
reasons sized it at only 50 basis points. I
realize I’m rationalizing a really bad outcome, but while it was an unsuccessful investment, it was fairly successful risk management. Sometimes we’re wrong, but it’s
been helpful that we’re rarely surprised. VII
I N V E S T O R I N S I G H T : Masakazu Takeda
Investor Insight: Masakazu Takeda
Masa Takeda of Tokyo-based Sparx Asset Management explains why his investment opportunity set is so small, how
the ongoing implementation of “Abenomics” impacts his investment approach, the industry sectors where he believes
Japanese companies have an advantage, and what he thinks the market is missing in SoftBank, Asics and Unicharm.
Describe how you’ve customized your value approach to investing in Japan.
Masa Takeda: I’m firmly in the growthat-a-reasonable-price camp, looking for
companies with sustainable competitive
advantages, run by smart management,
when their stocks are trading at attractive
prices.
There are several qualities we look for
in companies. First is a simple and intelligible business model that I as an individual can easily understand. We also want
inherently safe and sound businesses,
meaning we have to believe the companies in which we invest can prosper over
very long time horizons, through adverse
conditions. That’s why we gravitate toward firms with well-capitalized balance
sheets and durable competitive advantages stemming from things like strong
consumer-brand franchises, scale and low
costs. They typically earn above-average
returns on equity and have above-average
sustainable earnings-growth potential. Finally, they have exceptional management,
which to us primarily means allocating
capital with a good understanding of cost
of capital. In Japan this isn’t as widely appreciated as it is in the U.S. and Europe.
A good example of a company we find
interesting would be Shimano [7309:JP],
which has been in our portfolio since
2007. It controls 70-80% global market
share in high-end gear and braking systems for bicycles. It has strong relationships with the top racers in the sport, who
provide regular feedback that consistently
leads to new product technology, which
helps strengthen the company’s consumer
brand image. It has a time-tested business
model, consistently earning high margins
and returns on equity and capital for decades. Looking ahead, there are no signs
of dramatic structural change in the industry, and the number of bicycle riders
should continue to rise on the back of inJanuary 31, 2016
creasing health consciousness. I can with
some confidence predict that over three,
five or even 10 years the company will
continue to do very well. Management
also has proven to be good at capital allocation, even aggressively buying back
stock at the right times in a way that few
companies do in Japan.
ON REFORM IN JAPAN:
Things are changing, but
slowly. More management
teams talk in terms of return
on equity, for example.
Given your standards, is your opportunity
set at any given time pretty small?
MT: Yes. We may only have 50 stocks at
any given time that meet our criteria for
quality, and that group doesn’t change
very often. As a result we run concentrated portfolios, with only 10 to 15 names
in our most-concentrated portfolios, and
20 to 25 names in the Hennessy Japan
Fund we manage for U.S. investors. Once
we invest in a name we also tend to stay
invested – our annual turnover rate runs
around 10%, plus or minus. Most of the
time we just stay on the sidelines, trying to
be patient and waiting for the right opportunity. We may have one new idea every
year or two.
What tends to make the rare name attractively priced?
MT: It usually has to do with shorttermism, which is prevalent in Japan (just
as it is in other countries) and can cause
the market either to significantly undervalue a company’s long-term prospects or
overreact to a short-term difficulty. We’ll
also likely be more active when the market
sells off across the board in a more or less
indiscriminate way.
It’s not a typical investment for us
in every way, but last August we took a
position in SoftBank [9984:JP]. We had
followed the company for years and the
share price was badly lagging in large part
due to the struggles at Sprint, in which
Softbank took a majority stake in 2013.
In August the company made several
announcements that caught our attention. Mr. Son [Masayoshi Son, SoftBank’s
founder] spoke publicly about his commitment to turn around Sprint within the next
two to three years, and SoftBank increased
its ownership stake in the company from
79% to 83%. SoftBank announced that it
was buying back ¥120 billion, or $1 billion, of its own stock, and it also said its
new President, Nikesh Arora, who came
from Google, was buying SoftBank shares
with his own money amounting to ¥60
billion. I’ll describe our analysis in greater
detail later, but we concluded the market
was overemphasizing the problems at
Sprint relative to the rest of the company
and bought an initial stake. Short-term,
our timing hasn’t been good.
Part of the structural-reform effort under Prime Minster Shinzo Abe in Japan
is for corporate management to be more
shareholder focused. Are there signs that’s
working?
MT: I definitely think things are changing
for the better, but still very slowly. More
management teams talk in terms of return
on equity, for example, which was unheard of five or ten years ago. Companies
are taking a more shareholder-focused approach to mergers and acquisitions, are
more proactive on things like share buybacks, and have become more receptive to
activist investors. I don’t want to overstate
the case, but there is progress.
I’d add that the best intentions don’t always have the expected results. A focus on
return on equity is important, of course,
but can be dangerous if it’s used to focus
too much on cost efficiency at the expense
of investing in growth. Share buybacks
can be great investments, but only when
done at the right times and when financed
intelligently. As reforms take hold, assessing these types of issues will become increasingly important.
Do you consider Japan’s broader regulatory and political reform efforts, known
as Abenomics, a success so far?
MT: I’d first answer that question with
a disclaimer, which is that our strategy
doesn’t bank one way or the other on initiatives like Abenomics. Japan has been in
a difficult macroeconomic environment
for decades, so we’ve trained ourselves
to look for investment opportunities that
promise growth regardless of prevailing
economic conditions. That’s fundamental to our approach and it doesn’t change
based on government policy initiatives.
Having said that, Japan in my opinion
is moving in the right direction. Compared
to pre-Abenomics times, the difference is
night and day. Reflationary measures
based on monetary easing and fiscal stimulus have had an impact. The yen’s weakness has pushed exporters to all-time-high
earnings, which are being reinvested in
R&D, domestic production facilities and
expanding overseas capacity. That should
improve the competitive strength of Japan,
Inc. and produce benefits for some time
even if the currency stabilizes at today’s
levels. I don’t mean to imply the economy
is robust – as evidenced by the recent central-bank move to negative interest rates
– but it at least appears to be at the surface
after for so long being underwater.
The structural-reform efforts also underway are broad-based and designed to
improve the potential long-term growth
rate of the economy, through things like
cutting corporate taxes, reducing regulatory burdens, increasing employment participation by women and retirees, encouraging better corporate governance, and
January 31, 2016
encouraging more individual stock ownership. It won’t be good enough for just
one or two initiatives to work, success will
require progress on multiple fronts. These
types of reforms will take longer to enact
and have an impact, and it’s too early to
gauge their success.
More practically, how do you manage currency risk?
MT: Short-term, our view is that currency
exchange rates almost never reflect their
ON INDUSTRY THEMES:
The world increasingly needs
factory automation and we
expect Japanese companies
to continue as global leaders.
theoretical fair value, based on relative
interest rates or purchasing-power parity.
For that reason we take no real position
on the direction of exchange rates.
Part of our definition of a safe and
sound business, however, is one that is
relatively insulated from currency volatility. That may come from having extremely
high margins, as in the case of Keyence
[6861:JP], for example, which makes sensors used in factory automation and does
a majority of its business outside Japan.
It has 50% operating margins, so even if
a dollar buys 10 fewer yen tomorrow, the
negative impact on Keyence’s short-term
profitability is quite negligible. For an automaker like Toyota, with at best 10% operating margins, the impact is much more
prominent.
The other way to mitigate currency risk
is by investing in companies with extensive local-market production capabilities.
We want to own companies with broad
geographic cost bases that naturally insulate them from the impacts of currency
swings.
Are there industry sectors you’ve tended
to favor?
MT: We’re focused on finding strong individual franchises, but one broader area
we’re bullish on is factory automation,
where Keyence is an important player.
Japan has been dealing with high labor
costs, labor shortages and an aging workforce for decades, so companies have been
forced to emphasize factory automation
in order to increase productivity. In a
world that increasingly needs factory automation – in developed countries facing
demographic challenges and in emerging
markets facing higher labor costs – we believe Japanese companies can continue to
be global leaders.
Another area we are big on is personalcare goods, including skin care, cosmetics, hair care, oral care and baby care. We
observe that Japanese brands have strong
appeal to Asian consumers and are generally perceived as being of higher quality
and better value for the money. As emerging Asian markets grow and middle-class
populations expand, we believe branded
consumer-products companies like Unicharm [8113:JP], which makes diapers and
sanitary napkins, and Kao [4452:JP],
which is like the Procter & Gamble of Japan, are very well positioned for success.
Given all the attention being paid today
to China, do you have any investmentrelated insights on it you’d like to share?
MT: I’m not a macroeconomist and don’t
profess to know what is going to happen
in China. If I apply common sense, I expect the economy to go through shortterm – and even sharp – self-correcting
mechanisms, but over time to be OK. It
gets back to what I said earlier about investing in Japan. Our goal as investors is
to find opportunities that don’t rely heavily on the macroeconomic situation going
your way to succeed. One of our holdings,
Ryohin Keikaku [7453:JP], is a specialty
retailer selling household products and
apparel under the brand name Muji. Despite all the negative news out of China, it
is revising its earnings guidance upward,
in large part due to success in China. The
Muji brand has strong appeal to Chinese
consumers and there’s a very long runway
for growth as those consumers continue
to increase their spending on the types of
things Muji stores sell.
Why is your investment in SoftBank not a
typical one for you?
MT: Normally I don’t invest in situations
this complicated, with so many different
moving pieces. It’s also in this case less a
bet on the business per se, and more a bet
on Mr. Son, who I think is one of the best
CEOs – if not the best CEO – of all time
in Japan. He started this business in 1981
and opportunistically built it from scratch
into a company with a ¥6.3 trillion market cap. He’s 58 and shows every sign that
he wants to continue growing Softbank
globally for many years to come.
The company has three main business
lines, mobile telecom in Japan, Sprint in
the U.S., and what is essentially a venture-capital business investing primarily
in Internet-related companies around the
world. When we value each separately we
arrive at an intrinsic value significantly
higher than the current market value.
Walk through how you arrive at an estimate of intrinsic value.
MT: Mobile telecom in Japan is a mature
business that we value more like a perpetual bond with a fixed coupon. It generates
about ¥600 billion in annual operating
profit. After interest costs of ¥160 billion
– including costs for debt carried on the
domestic balance sheet that was taken on
INVESTMENT SNAPSHOT
SoftBank Group
(Tokyo: 9984:JP)
Business: Technology holding company with
operating mobile-telecom businesses in Japan
and the U.S., as well as a large portfolio of
Internet-based venture-capital investments.
Share Information
(@1/29/16, Exchange Rate: $1 = ¥121.12):
Price¥5,265
52-Week Range
Dividend Yield
Market Cap
¥4,540 – ¥7,827
0.8%
¥6.32 trillion
Financials (6 mo. FY2015, annualized):
Revenue
Operating Margin
Net Profit Margin
¥8.85 trillion
15.5%
11.5%
Valuation Metrics
(@1/29/16):
9984:JP
S&P 500
P/E (TTM)
11.520.9
Forward P/E (Est.)10.6 15.9
SOFTBANK PRICE HISTORY
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201420152016
THE BOTTOM LINE
Masa Takeda believes the company’s high-profile struggle to turn around Sprint is, one,
not as doomed as the market seems to expect, and two, is obscuring considerable asset
value it possesses elsewhere. His sum-of-the-parts analysis would indicate 25% upside
from today’s share price if Sprint were valued at zero, and nearly 60% upside if it weren’t.
January 31, 2016
to buy Sprint – and assuming corporate
income taxes of 30%, it earns a net profit
of ¥300 billion. Depreciation and capital
spending in the business are now more or
less the same, so free cash flow is roughly
equal to net profit. Using a discount rate
of 6% on the low end and 10% on the
high end in our discounted-cash-flow
model, we arrive at an intrinsic value for
this business of ¥3 trillion to ¥5 trillion.
Sprint, which is going through a particularly tough time, is very difficult to value
because the turnaround is far from certain.
Prior to the most recent commitment to
the business on Mr. Son’s part I probably
would have put the value at zero or even
negative. But there’s clearly value there
if he’s able to do in the U.S. with Sprint
what he did in Japan after acquiring Vodafone Japan in 2006. Vodafone Japan at
the time was dead third in the sector, with
a leader, NTT Docomo, that was more
than 10x bigger. Mr. Son focused first on
network quality and speed, investing in a
cost-efficient manner in the infrastructure
necessary to provide top-notch voice and
data service. Next he turned to marketing,
securing the exclusive rights to the iPhone
when it first came to Japan, introducing a
number of attractive rate plans, and building recognition for the SoftBank brand.
He’s trying to replicate all this with Sprint.
There’s plenty of reason to be skeptical.
Sprint’s balance sheet is quite weak and
the company continues to burn through
cash.
At this point though, I’m still willing
Close
to ascribe a ballpark estimate to Sprint’s
value. Its subscriber base is larger than
SoftBank’s in Japan, 57 million versus
around 38 million, and its average revenue per user [ARPU] is also higher. So
if they can straighten Sprint out, couldn’t
it one day be worth the ¥3 to ¥5 trillion
value of the Japanese business? We’re not
assuming that, but are valuing Sprint now
at ¥2 trillion. We think that’s conservative,
especially when you consider that Sprint
has $20 billion worth of tax loss carryforwards that we estimate have a present
value of roughly one third of that ¥2 trillion value estimate.
The next source of value is the venture-capital business. The primary pubValue Investor Insight 11
licly traded holdings are a 32% stake in
Alibaba Group and a 36% stake in Yahoo
Japan. There are also a large number of
prominent unlisted holdings, including
Snapdeal, a leading online marketplace
in India, Ola, a taxi-app company like
Uber in India, Didi Kuaidi, an Uber competitor in China, Grab Taxi in Singapore,
and Coupang, an e-commerce company in
South Korea. Some of these private holdings may not prove to be successful, but
some may be very successful. To be conservative, we value this part of the business using only the publicly traded holdings on an after-tax basis, which comes to
around ¥5 trillion.
That brings our full-company intrinsic
value estimate for SoftBank to ¥10 to ¥12
trillion, again, assuming no value for most
of the venture-capital holdings. That compares to a current market value of around
¥6.3 trillion. So even if Sprint blows up,
we believe we’re investing with a large
margin of safety in an entrepreneurial
company with an exceptional track record. We think the risk-return profile here
is very much in our favor.
Describe the upside you see in runningshoe company Asics [7936:JP].
MT: We like sport-related businesses in
general, as I touched on earlier with Shimano, and the running-shoe business in
particular. The customer tends to be brand
loyal and a serious runner goes through
four pairs of shoes a year, creating strong
replacement demand. Running is one of
the cheapest forms of exercise, so it’s fairly recession-resistant and we also expect a
tailwind from more and more people all
around the world taking it up as exercise.
The business also generates a lot of cash
because it doesn’t require heavy capital
spending.
The shoe business is also attractive because of the lack of exit barriers. If you are
a laggard in a capital-intensive business,
you may stay in the game much longer and
make things miserable for your competitors in order to avoid the heavy losses of
shutting down. That’s not the case in athletic shoes, which is a positive for industry
January 31, 2016
winners like Nike, Adidas and Asics that
rarely have to engage in price wars.
Where does Asics fit in the market from a
competitive standpoint?
MT: Asics is #1 in the high-performance
running-shoe segment. I don’t have the
number for last year, but in recent years almost one of every two runners in the New
York City Marathon who finished the race
in less than five hours wore Asics shoes.
The company principally serves hard-core
runners and I’d say is more focused on
functionality than fashion, which is more
important for Nike and Adidas.
The bulk of Asics’ business today is
in Europe and the U.S., although Asia is
growing rapidly, primarily due to bur-
geoning demand in China. The base started small, but revenue in China in local
currency terms has been increasing at better than 50% per year. Asics has also done
well in recent years in developing what it
calls its sports-style business, primarily in
sports-related apparel and non-running
shoes. This business should continue to
benefit from the trend, led by the U.S. but
happening everywhere, toward increasingly casual dress in almost all occasions.
The stock, at a recent ¥2,200 is off 45%
from its 52-week high. Why?
MT: In December the company revised
earnings guidance downward, citing two
primary reasons, a currency-related hit
from Brazil and a 3% slowdown in U.S.
INVESTMENT SNAPSHOT
Asics
(Tokyo: 7936:JP)
Business: Manufacture and sale worldwide
of athletic shoes, athletic apparel, sporting equipment and outdoor equipment, sold
primarily under the Asics brand name.
Share Information
(@1/29/16, Exchange Rate: $1 = ¥121.12):
Price¥2,211
52-Week Range
Dividend Yield
Market Cap
¥1,955 – ¥4,000
1.1%
¥442.12 billion
Financials (2015 guidance):
Revenue
Operating Margin
Net Profit Margin
¥425.00 billion
6.3%
2.1%
Valuation Metrics
(@1/29/16):
7936:JP
S&P 500
P/E (TTM)
25.720.9
ASICS PRICE HISTORY
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1000
1
THE BOTTOM LINE
Focused somewhat more on functionality than fashion compared to its higher-profile
global competitors, the company has a strong track record of growth that Masa Takeda
expects to continue. Assuming it can compound earnings at 10% over the next ten years,
his discounted-cash-flow analysis yields a per-share intrinsic value estimate of ¥3,100.
Clo
running-shoe sales. The shares had been
trending down before that, but after the
announcement we concluded the correction had been overdone and added to our
position. This is something we’ve owned
for a long time and we’ve had success
trimming when it gets more expensive and
adding when it gets less expensive. The
business has been more stable and solid
than the share price sometimes reflects.
The company has increased earnings
over the past ten years at around 10% a
year, and we expect that to continue for
a number of years going forward as it
maintains its position in a growing running-shoe business, expands geographically, and selectively builds out its product
lines. Based on our DCF analysis, assuming a discount rate of 10%, we estimate
intrinsic value at around ¥3,100 per share,
roughly 45% above the current price.
Expand on your investment case for diaper-maker Unicharm.
MT: We consider Unicharm more of an
emerging-markets play, based on the positive appeal its brands have in high-growth
and relatively unpenetrated Asian markets. The current profit mix is roughly
30% from baby diapers, under the brand
names MomyPoko and Moony, 40%
from sanitary napkins, 20% from adult
diapers, and the rest from smaller product
lines such as pet care.
The company’s market shares in all areas are very strong. It’s the biggest seller
of disposable baby diapers in Japan, with
a 35% share. In India, which it entered in
2009, it now has 30% of the overall-country diaper market, but more than 50% of
the business in big cities like New Delhi.
In Indonesia and Thailand they have more
than 60% market share. The Chinese market is still fragmented, but Unicharm is #2
there, with just over 10% of the market.
The numbers are comparable across Asia
in sanitary napkins and adult diapers.
It’s interesting to note that management
has been content to be latecomers to new
markets. They study the first movers and
refine the company’s marketing and distribution strategy to take market share once
January 31, 2016
it’s ready to enter a market. That’s always
been their approach and it’s proven both
prudent and successful.
As with Asics, Unicharm’s share price
has been weak over the past year as well,
in this case due to some growing pains in
certain emerging markets and the stock
market overall pulling back on its enthusiasm for emerging-markets exposure. But
we see a very long growth runway for this
business. If you’re a young mother raising
a newborn, your family’s rising disposable
income will make high-quality disposable
diapers increasingly within reach, and
you’ll be less likely to sacrifice quality for
a lower price. Usage levels will continue
to grow – in Japan market penetration for
disposable diapers is close to 100%, while
in China it’s 20% and in India it’s only
3%. Birth rates will also be an important
tailwind. Only one million babies are born
per year in Japan. In China that number
is more like 17 million, and in India it’s
over 20 million. The details are obviously
different, but the feminine-care and adultdiaper businesses have their own similar
tailwinds that should benefit high-quality
branded products.
How do you see that translating into
upside for the company’s shares, now at
around ¥2,270?
MT: The trailing P/E multiple today looks
quite stretched. Earnings have been negatively impacted by accounting adjustments related to merger transactions in
years past, as well as by things like curren-
INVESTMENT SNAPSHOT
Unicharm
(Tokyo: 8113:JP)
Business: Global manufacturing and sale of
branded consumer products primarily for the
baby care, feminine care, personal care, pet
care and household cleaning markets.
Share Information
(@1/29/16, Exchange Rate: $1 = ¥121.12):
Price¥2,268
52-Week Range
Dividend Yield
Market Cap
¥2,035 – ¥3,398
0.7%
¥1.37 trillion
Financials (2015 guidance):
Revenue
Operating Margin
Net Profit Margin
¥760.00 billion
11.3%
5.8%
Valuation Metrics
(@1/29/16):
8113:JP
S&P 500
P/E (TTM)
50.4108.4
UNICHARM PRICE HISTORY
3500
3500
3500
3000
3000
3000
2500
2500
2500
2000
2000
2000
1500
1500
201420152016
1500
THE BOTTOM LINE
Benefitting from the favorable halo that Japanese consumer-products brands tend to enjoy throughout Asia, the company is well positioned to grow as disposable incomes rise
in places like India and China, says Masa Takeda. Assuming it can achieve the 10% annual cash-flow growth he expects, he estimates fair value for the shares today at ¥3,000.
Clo
cy headwinds in Indonesia and increased
price competition in China. Looking beyond those, however, we assume Unicharm can increase or maintain its current
market-share levels and can compound
cash flow at 10% per year over the next
ten years, and at 5% annually from there.
Based on our DCF, again with a 10% discount rate, we estimate intrinsic value at
around ¥3,000 per share.
Risks?
MT: There’s always executional risk when
a company is expanding in new markets.
But one thing we like about consumer
brands is that once they establish consumer mindshare, the business tends to be very
sticky. It’s also a positive that technology
is unlikely to significantly disrupt these
types of businesses. Baby diapers are not
going to go away.
Given your propensity to hold stocks for
a long time, what will prompt you to sell?
January 31, 2016
MT: If the business continues to do well
and generates high returns on equity, we
are not quick to sell even when a stock
we own reaches intrinsic value. But that
has its limits. A few years ago we invested
in Pigeon Corp. [7956:JP], which makes
bottles and other baby-care items. It had a
very strong market share in Japan and was
growing strongly outside of Japan, particularly in China. Over the next 18 months
earnings grew something like 40%, but
the stock went up nearly 6x. That was just
too much and we ended up selling most,
but not all, of our position.
A different example would be Mizuno
[8022:JP], which is in the sporting-equipment business, primarily in Japan. We first
invested in the company in 2006, under
the assumption that the family running
it would realize it was in too many businesses and would refocus it on its strongest brand franchises, resulting in significantly improved returns on equity and
capital. Years passed and that effort never
really materialized, so I ended up throw-
ing in the towel. The good news is that
we didn’t lose much on the stock – a clear
advantage of trying to own safe and sound
businesses.
Have you reexamined the bullish view
you shared with us last year [VII, May 31,
2015] on conglomerate Mitsubishi Corp.?
MT: This unfortunately is a stock I’ve
owned for many years and my bullishness
has yet to really be vindicated. I still believe the company owns interesting assets
and will benefit from recasting its portfolio to rely less on resource-based businesses and more on emerging-Asia investments in such areas as fertilizer and retail.
The problem over the past year has been
a still-high exposure to energy, but with
the shares now trading at less than 60%
of a book value that continues to grow, I
see no reason to exit the position. Successful investing is all about batting average.
I haven’t given up hope that this will one
day be a hit. VII
I N V E S T O R I N S I G H T : Michael Browne
Investor Insight: Michael Browne
Michael Browne of the U.K.’s Martin Currie Investment Management explains the early-warning systems he uses to
identify coming market trouble, the investable themes he sees on both the short and long sides today in Europe, what he
means by keeping things simple, and why he sees mispriced value in Ryanair, Pandora, CIE Automotive and BIM.
The macro picture in Europe has been
challenging for years. How do you address that in your investment approach?
Michael Browne: First principles, we build
our portfolio piece by piece by trying to
identify companies that are mispriced relative to the cash they produce. We don’t
believe in things like net asset value stories or takeover ideas, we care only about
the stream of cash flows a company can
earn over the next one to three years and
whether that appears misunderstood by
the market.
We gravitate toward companies with
relatively simple business models that
produce sustainable cash-flow returns on
investment in excess of the cost of capital. They typically have real growth opportunity, with what we consider both the
leadership and balance sheets necessary
to enable them to take advantage of that
opportunity. We do very little short-term
trading and don’t use derivative products.
In many respects we’re proudly plain-vanilla in our approach.
That said, we’d argue that anyone
who says they can ignore the top down is
wrong. Top-down impacts, based on history, have a nasty habit of biting you as
an investor. So we do have a macro view,
which is expressed in how we set our net
and gross portfolio exposure at a given
moment.
Describe how you build that macro view.
MB: We have two early-warning systems
for the primary macro question we ask:
Are we in a period of capital destruction
or not?. In one, which we call our trafficlight system, every month we assess the
expected trend over the next year on eight
business-centric metrics: earnings revisions, credit spreads, financial gearing,
corporate costs, corporate asset bases, capital-raising activity, valuations and overall
January 31, 2016
investor exposures. Today, for example,
areas of some concern are widening credit
spreads and sluggish earnings growth. On
the positive side, balance sheets in Europe
are getting better and corporate costs are
under good control. We consider most of
the lights right now to be yellow, not red
or green, so the signal is caution, not indicative of either a bull or bear market.
More quantitatively, we track 21
broader credit and economic measures we
consider highly correlated with European
equity-market movements, rating them
based on historical experience as positive
or negative. If 30% or fewer of the indicators are positive and it stays like that for
two or three months, we believe that’s a
strong signal of impending capital destruction. Today we’re at around 33%, so skating on thin ice would be the right phrase.
Given all this, we’re running much
more conservative gross and net exposures
than usual. We’re currently 73% long and
34% short, giving us a gross of 107% and
a net of 39%.
How do you target ideas worthy of a closer look?
MB: As a first step, we screen European
companies with at least $1 billion in free
float on three basic criteria: earnings momentum, share-price momentum and valuation. First decile means high earnings
momentum, high price momentum and
great value. Tenth decile would be stocks
with negative earnings momentum, negative price momentum and poor relative
valuation. It’s a snapshot in time, based
only on historical information, and what’s
most interesting to us is when companies
and sectors are moving up or down in the
rankings. A company may move from
ninth decile to sixth – so maybe not exciting in an absolute sense at the moment
– but that can trigger our wanting to find
out what’s going on. That’s often where
ideas start.
A few years ago U.K. house builders
were screening in the eighth decile. Everybody hated them because earnings were
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weak and the market for new homes was
bad. They started moving up in our screens
and upon closer inspection we found balance sheets that had been cleaned up and
saw the very early signs of a natural process of margin growth, as the companies
sold off impaired inventory and used the
cash to build new homes in more desirable
locations for which demand was just starting to turn up. It didn’t take complicated
math to conclude that if that trend continued there would be massive earnings
momentum two to three years out. We’re
now four years on from our initial investment in the sector and we continue to find
it attractive.
We also pay careful attention when
structural issues holding a company back
are being addressed. A great example here
would be Nokia [NOKIA:FH]. We were
actually short the stock prior to the company announcing it was looking to sell
its mobile-handset business, which in our
view was permanently disadvantaged relative to competitors Apple and Samsung.
If that problem went away, however, we
thought the company’s remaining network
technology and services businesses were
well positioned with great intellectual
property and strong cash flows that would
no longer be gobbled up by the terrible
handset business. We went long the stock
soon after the announced sale of the hand-
ON POSITIVE THEMES:
One would be companies
that are best positioned to
benefit from higher consumer spending in Europe.
set division to Microsoft in September of
2013. It did very well for us prior to our
selling it earlier last year.
Are there any themes reflected in your
portfolio today?
MB: One positive thematic would be
companies that should benefit from higher
consumer spending in Europe tied to em-
ployment growth, particularly in the service sector, and falling oil prices. Because
of the hedging programs they had in place,
low-cost European airlines like Ryanair
[RYA:LN] didn’t really benefit last year
from lower oil prices. This year we believe
they will and will take market share in an
improving leisure-travel market as they
pass the cost savings partly on to customers in lower prices.
A second related positive theme is
companies with consumer-focused real
estate, particularly in northern European
countries. A good example here would
be Deutsche EuroShop [DEQ:GR], which
owns all or parts of around 20 shopping
malls in Germany, Austria, Hungary and
Poland. It has proven to be an excellent
operator and its performance is nicely levered to the higher consumer spending we
expect. Stocks like this shouldn’t be yielding 3-4% at a time when 10-year German
bunds yield 0.5%. They may not be the
highest flyers, but we can see them from
these prices ticking away at low-teens annual returns. Real estate is actually our
largest net sector exposure at the moment.
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January 31, 2016
Any themes of interest on the short side?
MB: One would be in traditional U.K.
retailing. Consumer expenditures in the
U.K. have been quite strong over the past
twelve months, but the recent holiday
period for High Street retailers [those located in a city’s or town’s main shopping
district] was one of the worst in memory.
U.K. shoppers have always been among
the fastest in the world to adopt Internet
retail – 20% of all non-food shopping is
done online – so part of that weakness just
reflects an ongoing shift in buying behavior, especially among people with the most
money to spend.
While the issues are fairly well known,
we don’t believe the stocks of traditional
High Street retailers that we’re short reflect the extent of the structural problems
they face. What do you do? You can’t raise
prices on the Internet to force people to
go to your bricks-and-mortar stores, or
you’re going to give away business. Your
labor costs are going up as the state raises
the minimum wage. You can close your
weakest outlets to preserve cash flow, but
sales keep going down and the cost of future divestment goes up. We think we’re at
a tipping point for some of these types of
retailers – especially those with leveraged
balance sheets – and the market is going to
realize sooner rather than later that there’s
no credible way out.
Isn’t this theme at odds with your betting
on shopping malls on the Continent?
MB: One joy of being a European investor
is that the stages of development across
the various economies are different. An
investable theme in the U.K. may not be
applicable to Germany and a theme in
Germany may not be applicable to Spain.
You try to learn from your experience in
all countries, but recognize and capitalize
on geographic differences when they exist.
Walk in more detail through your thesis
for Ryanair.
MB: Ryanair is Europe’s direct copy of
Southwest Airlines, with the same operatJanuary 31, 2016
ing business model focused on low operating costs and discounted fare prices. It’s
still aggressive about keeping seat prices
cheap – a few years ago it made some noise
about charging people to use the bathroom, but that ended up going nowhere
– but the company has also grown up in
many respects, such as providing a much
better website, filling out its schedule and
moving to standard booking systems.
The cost base of the company will fall
significantly for the fiscal year beginning
in March as a result of old oil-price hedges unwinding, taking average prices paid
per barrel from $90 last year, to $65 this
year and around $45 per barrel next year.
Being Ryanair, they won’t take that all
in margin, but will give much of it back
to the consumer in price. Management is
targeting a 9% decrease in ticket prices
this year, but we actually believe it will be
less than that, maybe 4-5%. We think the
pickup in leisure travel I spoke about earlier will allow them to fill capacity more
quickly than others and more quickly than
they expect. The company is guiding for
load factors of 92% this year, which is
perfectly fine but can be even better. Even
with lower fares, we expect revenue to increase 7-8% this year.
I’d also mention that the company has
net cash, currently €975 million, which is
unusual for an airline. That allows it to
continue to expand capacity across Europe – they’re opening four new route
bases over the next year, in Berlin, Corfu,
Milan and Gothenburg – while also returning cash to shareholders. The latest
INVESTMENT SNAPSHOT
Ryanair
(Dublin: RYA:ID)
Business: Provider of low-cost passenger
airline services primarily on short-haul routes
for travel between Ireland, the United Kingdom, Continental Europe and Morocco.
Financials (6 mo. FY2016, annualized):
Share Information
Valuation Metrics
(@1/29/16, Exchange Rate: $1 = €0.9233):
Price
52-Week Range
Dividend Yield
Market Cap
€13.69
€9.17 – €15.57
0.0%
€18.05 billion
€8.08 billion
31.2%
26.9%
Revenue
Operating Margin
Net Profit Margin
(@1/29/16):
RYA:ID
S&P 500
P/E (TTM)
12.620.9
RYA:ID PRICE HISTORY
20
20
20
15
15
15
10
10
10
5
5
201420152016
5
THE BOTTOM LINE
Michael Browne believes the company will benefit from increased consumer travel in
Europe this year as well as from market-share gains as it lowers fares to reflect its lower
fuel costs. He expects above-consensus earnings growth of 17-18% next year and a
valuation re-rating from today’s historically low levels to provide significant share upside.
Clos
share buyback, totaling €400 million, was
completed in August of last year.
How do you see all of this translating into
share upside from today’s price of €13.70?
MB: We’re looking for above-consensus
earnings growth of 17-18% for the year
ending March 2017, resulting in EPS of
around €1.50 per share. If our numbers
are right, the stock trades at 7.2x estimated fiscal-2017 EV/EBITDA and a P/E of
only 9x. Even if the valuation doesn’t improve, we should benefit nicely from rising
earnings. But we also see upside from multiple expansion. The stock has traditionally traded in a P/E range between 13x and
20x, and given the earnings-growth prospects, there’s no reason it can’t revalue to
at least the middle of that range over the
next year.
If you expect Ryanair to be taking market
share, are you by chance short big European flag carriers you expect to lose market share?
MB: Not at the moment, but that is something we continue to look at. The overall
market is unlikely to grow enough for bigger airlines with higher cost bases not to
see their margins hurt as low-cost carriers like Ryanair take share. There are also
some big flag carriers that, unlike Ryanair,
are largely unhedged on oil prices going
forward. If oil prices revert in any meaningful way, those airlines’ ability to compete will be even further compromised.
We’re watching them particularly carefully on the short side.
Is jewelry maker Pandora [PNDORA:DC]
more of an outside-Europe story?
MB: The company is based in Denmark
and has built a highly successful global
franchise in selling simple, affordable silver jewelry, 80% of which is bracelets and
charms. More than 75% of revenue comes
from company-owned stores or “shop-inshops” within third-party retailers, and
one of the over-arching strategic goals is
to continue to build a powerful brand in
January 31, 2016
what has traditionally been a less brandfocused industry sector. They cite research
estimating that the branded share of the
global jewelry industry will increase from
20% of the business today to 30-40%
over the next five years, and they want to
be a key driver and beneficiary of that.
This is a story about rolling sales out,
both in Europe and elsewhere. The company is expanding its product line, first
primarily into rings but also to necklaces
and earrings. It expects to open between
200 and 300 company-owned stores per
year over the next three years, 60% in Europe, 20% in the Americas and 20% in
Asia Pacific. It’s also expanding partnerships with large jewelry retailers – such
as Jared recently in the U.S. – for in-store
Pandora-branded shops.
I also should mention e-shopping,
which has been more successful than even
the company expected. Almost overnight
online has gone from naught to 6-7% of
sales in the markets they’ve targeted so far.
For some reason many men seem to prefer
buying jewelry gifts that arrive beautifully
wrapped through the post than actually
going to the shop. Even better, the company says it believes these online sales are
mostly incremental.
We’re looking for revenue growth,
which has been averaging 8-10% per year,
to accelerate over the next few years to 1012% per year, half from new-store openings and half from like-on-like sales. Falling silver prices have been helpful and the
company also has kept production costs
down by basing its production facilities
INVESTMENT SNAPSHOT
Pandora A/S
(Copenhagen: PNDORA:DC)
Business: Designs, manufactures and sells
hand-finished and contemporary silver jewelry
sold through company-owned and third-party
channels in more than 90 countries.
Financials (9 mo. 2015, annualized):
Share Information
Valuation Metrics
(@1/29/16, Exchange Rate: $1 = 6.89 Danish kroner):
Price
52-Week Range
Dividend Yield
Market Cap
DKK 917.00
DKK 408.50 – DKK 918.00
1.0%
DKK 112.15 billion
Revenue
EBIT Margin
Net Profit Margin
DKK 14.74 billion
34.5%
20.8%
(@1/29/16):
PNDORA:DC S&P 500
P/E (TTM)
33.520.9
PNDORA:DC PRICE HISTORY
1000
1000
1000
800
800
800
600
600
600
400
400
400
200
200
200
0
00
201420152016
THE BOTTOM LINE
Michael Browne expects the company’s sales and earnings growth to accelerate as it
expands in underpenetrated markets and introduces new product lines. If it achieves his
above-consensus earnings estimate for 2017 and the shares then trade at even the midpoint of their historical P/E range, he’s counting on an excellent return from today’s price.
Clos
in Thailand. Overall we expect EBITDA
to grow 20-25% this year over last, with
earnings growing even faster than that.
At a recent share price of 920 Danish kroner, does the market appear to be building
in similar optimism?
MB: There’s another 10-15% in earnings
looking forward that we don’t think the
market is picking up, but even on consensus 2017 estimates the shares trade today
at only a 15.5x P/E, which is at the low
end of the historical 15-20x range. If we’re
right on earnings and the P/E moves even
to the mid-point of its range, we’d have a
nice return. That’s not a stretch multiple at
all for a company with this growth potential, return on equity – in the mid to high
40s – and a balance sheet that within the
next year or two could be debt free.
Is there fashion risk here?
MB: They’ve had growing pains at various times in their history with respect to
production and distribution, but in their
core business of selling moderately priced,
$100-a-go bracelets, the consumer demand seems not to be so volatile. You always worry about it, but it hasn’t been a
big issue so far.
From Denmark to Turkey, describe the
upside you see in discount retailer BIM
[BIMAS:TI].
MB: We’ve owned this stock longer than
any other in our portfolio, going back to
2005. Sometimes you get it right and find
a company with a self-reinforcing business
model that generates significant cash flow
that can consistently be reinvested at high
incremental returns. That’s been our experience with BIM, and those are the stocks
you want to hold on to.
The business here is quite simple. The
company operates corner stores selling
food and associated grocery goods. The
typical store has only 600 SKUs – 60% of
which are under its own label – and aims
to combine the convenience of a 7-11 with
price points that are 15-25% less than traJanuary 31, 2016
ditional supermarkets. It is a copy of the
format used by Germany’s Aldi, which is
one of the world’s largest food retailers.
The founders were a Dutch/Turk and a
German, who saw the opportunity because Aldi had chosen not to operate in
Turkey.
When we first invested in it, the company had 1,200 shops, principally in Istanbul. They’ve continued to execute, store
by store, region by region, and now have
4,500 stores throughout Turkey, with an
ultimate capacity of probably 6,000 to
7,000. They’re also in the relatively early stages – with good success so far – of
expansion outside Turkey, into Morocco
and Egypt. It’s proven to be a disruptive
competitive model, taking share from
both big hypermarkets and the guy in the
stall at the local market, neither of which
can match BIM’s prices.
The self-reinforcing aspect of the business is that as the company grows and generates incremental cash flow, it reinvests
much of what would be margin expansion back into lower prices. Back in 2005
BIM’s price advantage in Turkey over the
big supermarkets was maybe 10% on average. Today it’s more like 25%, which
has driven more traffic, higher basket sizes
and increased cash flow.
Trading at 29x trailing earnings, the stock
at 50 Turkish lira doesn’t appear particularly cheap.
MB: The issue here has always been more
about earnings and cash-flow growth.
INVESTMENT SNAPSHOT
BIM
(Istanbul: BIMAS:TI)
Business: Low-price convenience retailer
of food and consumer goods with more than
4,500 stores in Turkey; current expansion efforts also underway in Morocco and Egypt.
Share Information
Valuation Metrics
(@1/29/16, Exchange Rate: $1 = 2.955 Turkish lira):
Price
52-Week Range
Dividend Yield
Market Cap
TRY 49.96
TRY 42.40 – TRY 63.00
1.6%
TRY 15.17 billion
Revenue
Operating Margin
Net Profit Margin
TRY 17.19 billion
4.1%
3.4%
(@1/29/16):
BIMAS:TI S&P 500
P/E (TTM)
28.920.9
BIMAS:TI PRICE HISTORY
8080
80
7070
70
6060
60
5050
50
4040
40
30
3030
201420152016
THE BOTTOM LINE
The company’s “self-reinforcing” business counts on expanding its competitive price
leadership as it grows, says Michael Browne. Though not optically cheap, he says the
shares are undervalued relative to their long-term valuation and should return at least the
20% annually he expects in company earnings growth over the next three to four years.
Adj C
Given the company’s ongoing ability to
open stores and increase basket sizes, we
expect earnings to increase 20% per annum over at least the next three to four
years. The valuation today on a simple
P/E basis is around 23x consensus 2016
estimates, which is at the very low end of
the long-term range. If we’re buying at the
low end of the valuation range, we expect
to benefit as shareowners at least in line
with earnings growth. From that perspective, the stock doesn’t look so expensive
after all.
Is your interest in Spanish auto-parts
maker CIE Automotive [CIE:SM] more of
a cyclical bet?
MB: The company is a relatively small
player in the European auto-parts industry, but counts almost all of the major
manufacturers as customers. It operates at
the dull end of the market selling necessary products like plastic fuel tanks, fenders and engine casings.
There is certainly a case to be made for
somewhat of a rebound in European car
sales. The average vehicle age is the oldest on record and overall annual sales are
bouncing around near generational lows
of around 14 million, down from a peak
of nearly 18 million in 2007. Higher auto
sales would also fit with our theme around
increased consumer spending.
But in this particular case we’re not
counting on a revival in the car market
to generate our returns. The prime driver
will be earnings improvements from the
2013 deal the company made with India’s
Mahindra Group to combine forces on
the foundry side of the auto-parts business. That’s a specialized, capital-intensive
business that has taken time to integrate,
but the integration should result in significant cost savings. Largely from that, we’re
expecting the company’s overall EBIT
margins to increase from 8% in 2014 to
around 10% by 2017. Free cash flow over
the same period should increase from €125
million to around €230 million.
How are you looking at valuation with
the shares now trading at €13.40?
January 31, 2016
MB: The free-cash-flow yield on our 2016
estimates is around 10%, which we consider quite attractive for a company that
can grow earnings over the medium term
at low-double-digit rates per year. That
cash flow can come back to us in dividends
and buybacks, but even better would be
if the company continues to make accretive acquisitions, which they’ve done quite
well on consistent basis.
One other component of value is an ITservices business the company owns called
Dominion, which operates very much outside the core auto-parts business and is
likely to be spun off or sold over the next
year or two. At the multiples similar businesses command, Dominion itself is likely
worth close to 25% of CIE’s market value.
We don’t see nearly that value discounted
in the current share price, which makes
the auto-parts business even less expensive
than it appears.
You may notice that the companies
that attract us are relatively simple and
straightforward. They stick to their knitting and generate high cash flows and high
returns on equity. We keep things simple
as investors as well. We’ve concluded
we’re good at assessing businesses, so all
we do is go short and long underlying equities. We’ve also through trial and error
arrived at what we believe is a sound understanding of the medium-term general
environment, which we address by adjusting our balance sheet accordingly – again,
just through short and long equities. Complexity isn’t the virtue many seem to think
it is, in business or in investing. VII
INVESTMENT SNAPSHOT
CIE Automotive
(Madrid: CIE:SM)
Business: Manufacturer of automotive parts
and sub-assemblies, with focus on chassis
and steering, engines/powertrains, roof systems and exterior/interior trim.
Share Information
Valuation Metrics
(@1/29/16, Exchange Rate: $1 = €0.9233):
Price
52-Week Range
Dividend Yield
Market Cap
€13.41
€11.37 – €15.46
1.9%
€1.73 billion
€2.63 billion
9.4%
5.0%
Revenue
EBIT Margin
Net Profit Margin
(@1/29/16):
CIE:SM Russell 2000
P/E (TTM)
20.5108.4
CIE:SM PRICE HISTORY
2020
20
1515
15
1010
10
55
5
00
0
201420152016
THE BOTTOM LINE
The market is underestimating the company’s earnings upside from a large acquisition
on the foundry side of its auto-parts business, says Michael Browne. Its shares trade at a
10% free-cash-flow yield on his 2016 estimates, which he considers quite attractive for a
company that can grow earnings over the medium term at low-double-digit rates per year.
Clos
U N C O V E R I N G V A L U E : Methanex
Good Chemistry
Falling oil prices have clearly impacted share prices in a number of sectors beyond energy. Has the impact been
too indiscriminate in this particular company in this particular slice of the global chemical industry?
Falling oil prices typically prove to be
bad news for chemical-company earnings.
Chemicals producers who use oil and oil
derivatives as feedstock often ratchet up
price competition when oil prices fall,
bringing down market prices and squeezing margins, especially for those companies who don’t use oil as a raw material.
Methanex, the world’s largest independent producer of methanol, currently
finds itself in such a bind. Based in Canada
but with plants worldwide, the company
can provide 15% of the total global annual methanol supply, using natural gas
as its primary feedstock. Two years ago
its shares traded in the $60s, when Brent
crude oil fetched around $110 per barrel
and methanol sold on the global market
at $630 per ton. As oil prices have collapsed, methanol now sells for $300 per
ton, dragging down Methanex’s earnings
and share price, which now sits at $26.50.
That plunge has caught the attention of
Goodwood Capital’s Ryan Thibodeaux,
who argues that the company deserves
better. For one, he’s bullish on the longterm prospects for methanol. The clear
liquid’s traditional use has been in the production of intermediary compounds such
as formaldehyde and acetic acid, but it has
been increasingly used as a fuel additive
to reduce engine emissions and as a cleanburning fuel for household cooking and
heating. From 2005 to 2014 global methanol demand grew 6.3% per year, while
industry estimates project annual growth
of 7.8% over the next three years.
Thibodeaux also argues that the company is well-positioned to maintain its industry leadership. Key to that is the opening over the past year of two new U.S.
plants along the Mississippi River in Louisiana, which he says are among the lowestcost methanol production facilities in the
world. Accounting for 25% of the company’s active capacity, the plants were built
on the cheap by using equipment from
closed facilities in South America. They
January 31, 2016
also take full advantage of abundant supplies of low-cost, cleaner-burning natural
gas and an efficient U.S. transportation infrastructure. The resulting cost advantage
should serve the company well in fending
off expansion-minded competitors and in
solidifying already-strong positions in key
developing markets like China.
At what he considers a normalized
methanol price of $350, Thibodeaux says
the company should generate around $500
million in annual free cash flow and close
to $1 billion in EBITDA. While the shares
have traded at a median 7.5x EV/EBITDA
over the past ten years, assuming 6.5x and
subtracting $1.3 billion in net debt would
result in a $5.2 billion market value, or
$58 per share. When “normal” returns is
open to question, but he says the company
is uniquely qualified to ride out the storm.
Its net debt to EBITDA on a trailing basis
is only 2x, and the next big maturity on its
investment-grade bonds isn’t until December 2019. VII
INVESTMENT SNAPSHOT
Methanex Corp.
Valuation Metrics
Business: Largest producer of methanol,
a liquid chemical used in the production of
industrial chemicals and fuel additives.
(Nasdaq: MEOH)
(@1/29/16):
Share Information (@1/29/16):
Price26.52
52-Week Range
Dividend Yield
Market Cap
23.08 – 61.40
4.1%
$2.38 billion
Financials (TTM):
Revenue
Net Profit Margin
$2.23 billion
7.8%
9.0%
MEOH
Russell 2000
P/E (TTM)
13.2108.4
(@9/30/15):
Company
Prudential plc Wellington Mgmt Fidelity Mgmt & Research
% Owned
19.0%
14.0%
10.8%
Shares Short/Float
14.3%
MEOH PRICE HISTORY
80
80
2080
70
70
70
60
60
1560
50
50
50
40
40
1040
30
30
30
20
20
2014 20152016
520
THE BOTTOM LINE
While beaten up as most peers have been due to falling oil prices, the long-term fundamentals of the company’s specific business and its ability to maintain market leadership
in it should eventually translate into nice share-price upside, says Ryan Thibodeaux. At
6.5x EV/EBITDA on his normalized estimates, the shares would trade at closer to $60.
Cl
EDITORS’ LETTER
The Humility Side of the Equation
Schadenfreude is a wonderful word
for a miserable practice, which is taking
pleasure in another’s misfortune. It’s not
uncommon in the world of investing,
where flash-in-the-pan and legendary investors alike make big news when they hit
a difficult patch of returns. There’s been a
lot of that going around lately.
As avid readers of investor letters,
we’ve been going through the latest batch
deriving no pleasure from the pain frequently described, but more to look for
lessons and insights from smart investors
who have just had a terrible year.
David Einhorn of Greenlight Capital
would fall in that category, as his fund in
2015 fell 20.2%. In his new letter he lays
bare what went wrong while still keeping
his sense of humor, noting that one of his
children tried to help, saying, “Dad, why
don’t you just short your longs and long
your shorts?” He also offered this assessment of the value-investing environment:
It has been a difficult environment for
value stocks. This is the fourth time in
our history where we’ve had a period of
outsized losses, and in each of the prior
periods [1998, early 2000 and the third
quarter of 2008], the macro environ-
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ment was unfavorable to value investing. The last seven months of 2015 resembled these periods. In this instance,
a few overvalued story stocks did well
while most stocks – especially value
stocks – declined. Our view is that over
time, value investing is more successful
than investment strategies that ignore
value. On balance, we benefit from
tailwinds more often than not. However, there have been and will be periods when that isn’t the case. We know
that in each prior period when the environment was challenging for our style,
things eventually turned and we did
well. We don’t know when the winds
will change, but we know that they will.
Bill Ackman’s Pershing Square Capital
had a comparably bad 2015, down 20.5%.
His latest letter also recounts big mistakes
of the year, highlighting one particular lesson of note concerning valuation:
Our biggest valuation error was assigning too much value to the so-called “platform value” in certain of our holdings. We
believe that “platform value” is real, but,
as we have been painfully reminded, it is a
much more ephemeral form of value than
pharmaceutical products, operating businesses, real estate or other assets, as it depends on access to low-cost capital, uniquely talented members of management, and
the pricing environment for transactions.
Ackman closes his letter with a section
titled “Humility,” which should probably
hit home for many of us:
I have often stated that in order to be a
great investor, one needs to have the confidence to invest without perfect information
at a time when others are highly skeptical
of the opportunity you are pursuing. This
confidence, however, has to be balanced
by the humility to recognize when you are
wrong. While no one here is enthusiastic
about delivering our worst performance
year in history, it certainly does a good job
reinforcing the humility side of the equation that is necessary for long-term investment performance. In 2016, we would like
to generate results that reinforce the confidence side of the equation. Humility and
skepticism will help get us there. VII
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January 31, 2016
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January 31, 2016

Value Investor Insight

Transcription

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