Wednesday, April 27, 2011

Twenty one international high dividend & high ROE stocks

As I've been researching international stocks it's struck me how many pay a dividend, and often how high the payout is.  It seems an investor looking to build an income portfolio might find some good deals in the following list.

My criteria was
-Yield greater than 4%
-No debt
-Profitable
-Payout ratio less than 80%
-5yr avg ROE greater than 15%


Here is the Google Spreadsheet version: view spreadsheet


Tuesday, April 26, 2011

International net-net #7 Astron Ltd

Astron Limited (ATR.Australia)

Trading at AU$2.60 (4/26/2011)

Astron Limited is involved in the mining of rare earth minerals and has mines and facilities in both Australia and China.  The rare earth minerals are extracted from mineral sands, one of the biggest metals they extract is zirconium.  Most investors might not be aware of what a rare earth mineral is, but anyone reading this is using hardware that is assembled out of them.  Rare earth minerals are used in iPads, cell phones, computers, aerospace components, lasers and batteries among other things.

The rare earth mining sector was in the news recently when China announced that it was limiting export of rare earth elements causing a bit of a squeeze on the market.  What's interesting about the rare earth mining business is that the actual elements are not all that rare, it's just that mining them is very costly.  Most rare earth mines in the US closed years ago before demand ramped up, news has been floating around that some of the old mines might be reopened.

Astron operates two main locations, they have the Donald Mineral Sands project, and a project to produce titanium dioxide in Shenyang China.  The Donald sands is both a mineral extraction site, and a processing plant.  The China location is a processing plant only.  The company operates out of China, and built up the largest zirconium chemical business in the world.  A few years ago the company sold it's China extraction site which is the source of it's cash on the balance sheet.

Highlights
-The company states they have AU$2.85 in tangible assets per share, and AU$3.24 net assets per share.
-Astron Ltd is profitable, net profit increased 92% in the latest half year report.
-P/E ex-cash of 4.18
-China is restricting rare earth exports, and Astron Ltd is already operating in China, giving them an advantage.  An article in Mining Weekly discusses that demand is exploding while supply outside of China is nonexistant.
-Almost all of it's net current assets are in cash or short term investments earning interest.
-At the current development run rate they have cash to last 13 years.
-The company is debt free and is funding development from it's cash and investments.
-Astron can be purchased for just slightly more than the cash at hand.

Valuation
I have my net-net worksheet below


I did a workout for cash flow accruals and took into effect the loss due to currency translation.  Looking at how much of the profit is accrual revenue vs cash helps determine the quality of earnings. Astron's accrual percentage is 8.86% which is about average.


Risks
-There are a few risks to an investment in Astron, the first and biggest is they have stated they plan on using their cash to continue to develop their mining sites.  This means there is little chance the cash will be distributed to shareholders as a dividend, or that the company will liquidate.
-Astron operates out of China which adds an element of political risk to the investment.
-The company is cash flow positive, yet is spending a considerable amount for investment, as of the last quarter they spent AU$5.64m on mine development and PP&E acquisition.
-The commodity boom could come quickly to an end and demand for the metals could wear off leaving Astron with a hefty investment in a product no customers.

Why is it cheap?
-The company is small, with a market cap of AU$168m there is not much visibility.
-The company is listed on the ASX but has most of it's operations in China, this creates a confusing situation for potential investors.
-The market seems unsure about the development potential for the Donald Mineral Sands.
-While the company is cash flow positive and profitable they are burning considerable cash to develop the new sands.

Additional Information
Company website
Annual report
Half year report (most recent)

Disclosure: I don't own any of the issues mentioned in this post.

Thursday, April 21, 2011

How to research foreign stocks

Recently most of my postings have been about foreign stocks, and for the near future this trend will probably continue. Most investors have a strong home country bias where they invest an irrationally large portion of their assets in the country from which they're from. Part of this bias is due to investors feeling comfortable with what they know. While there are undeniable advantages to investing close to home there also shouldn't be a fear of investing abroad either.

As I've researched foreign companies I've developed a bit of a process which will hopefully be useful to other investors as well. I feel like the best way to describe my process is through the use of an example. Most recently I've been researching stocks in Portugal, so this will be a case study of investigating a Portuguese stock, but these steps apply to any country.

Finding the stock

There are two approaches, the first is to screen for companies. To screen for stocks in Portugal one could use screener.co or use the FT.com global screener. Both screeners can limit by markets.

I took a different approach, I went to the Lisbon Euronext website and went one by one looking for profitable Portuguese companies, I found one worth considering Brisa. I took this approach because Portugal has 50 stocks listed on the Lisbon exchange, a small enough list to dig through one by one.

Finding general information

After identifying a company the first thing I want to find out is what line of business they're in, and any recent news events. Reading recent news about a company is a great way to familiarize myself with what the company is involved with, and what issues they're currently dealing with. Unfortunately in most cases it's very hard to find information in local papers if you don't speak the language. The best resource I've found is using the Reuters Key Developments tab for the issue I'm researching.

Both Reuters and FT.com usually have a good paragraph or two about the company and the industry they're involved in. For Brisa FT states:

Brisa Auto Estradas de Portugal SA (Brisa) is a Portugal-based holding company engaged in the construction, maintenance and operation of highways. The Company also provides services associated to road safety and driving assistant both in highways and urban environments. Brisa holds six road concessions in Portugal, namely Brisa, Atlantico, Brisal, Douro Litoral, Baixo Tejo and Litoral Oeste, comprising a total of 23 highways and covering 1,705 kilometers. Abroad, Brisa is present in the United States, controlling the Northwest Parkway concession; it operates in Brazil through CCR that holds seven road concessions (1,571 kilometers) and an underground railway concession; it also operates in the Netherlands, where it is active in electronic toll systems. As of December 31, 2009.The Company's wholly owned subsidiaries include Brisa Internacional SGPS SA, Brisa Finance BV, Brisa Servicos Viarios SGPS SA and Via Oeste SGPS SA, among others.
After reading some general summary information I try to visit the company's website. I have made the observation that if a company is located in a dominant European country (France, Germany, Italy, Spain) it's likely the website will be in the native language only. On the other hand if the company is located in a smaller European country in most cases the website will also be provided in English. In the case of Brisa they offer an English version of the website. I'll usually take a chance to surf the website and read how the company describes their own business.

Digging into the financials

Now that I'm acquainted with what Brisa does, and where they operate I want to take a look at the financials and see if this is an investment I'd consider for my portfolio.

The first source I want to investigate is any financial reports and presentations listed on the company's website. In Brisa's case they have a lot of investor information available.

In the United States most investors are used to companies reporting results quarterly, as well as reporting material events as often as they happen. This level of transparency is quite rare in the investing world, in Europe all companies report annually, and some report half year results. Brisa is a larger company and actually reports quarterly, all of the reports for the last year can be found here.

If a company doesn't publish English language reports on their website a second place I look is the local securities commission. In Portugal it's called Comissao do Mercado de Valores Mobiliaries or CMVM. I searched for Brisa, and ended on the page contained all of their reports to the commission.

Another resource for getting a nice general overview of the company financials is the detailed statements page of FT.com. FT.com also has summary level data for the past few years of statements.

Financial statement oddities

Once I find the financial statements the first thing I do is read the annual report. The annual report contains great background information that's essential to understanding any subsequent reports. I feel that reading the annual report is preferred to jumping straight to the financial statements.

Most investors will find IFRS statements fairly normal to read, but there are some real differences between IFRS and GAAP. Some of the big items:
  • IFRS is principles based where as GAAP is rules based. 
  • Criteria to recognize revenue is different. 
  • Differences in inventory accounting (GAAP allows LIFO and FIFO, IFRS only FIFO) 
  • Differences in how items are classified on the cash flow statement. 

Tying it all together

I'm not going to walk through how to value Brisa because each investor has different things they look for in an investment but hopefully I've shown how to gather enough information to help an investor feel comfortable venturing beyond their home country. By going global an investor greatly expands their investment universe. There are many gems beyond your borders and in the age of the internet the information is much easier to find than it ever has before.

Talk to Nate about researching foreign stocks.

Wednesday, April 20, 2011

Cheap Portuguese stock Novabase with a catalyst

Novabase (NBA:PL)

Trading at €3.05 (4/20/11)

Novabase is a Portugese IT services firm that also hold subsidiaries that run a ticketing system and German direct TV, they also run a venture capital fund.  They state that their goal as a company is to make people's lives simpler and happier through the use of technology.  Novabase is a company that appeared in my list of cheap profitable stocks I posted about here, and I wanted to dig in deeper to see if this was an opportunity.

I first off need to apologize because Novabase isn't in fact a net-net as I made it out to be in the Cheap in Portugal post.  The cause of my mistake is I used the line capital shares as the number of shares, I pulled this from the annual reports.  As I dug further I realized capital shares is subscribed capital, something we don't have much of in the US because most companies issue stock with a par value of $.01.  I should also mention, I couldn't find the share count in any of the annual reports, I pulled the number of shares I use from Bloomberg and FT.com, which was 31,401,000.  While Novabase isn't as cheap as I originally thought on a asset basis I still believe they offer a relatively good value on an earnings basis, I detail why below.

What I like about Novabase is that the IT services business has a low cost of business and high margins. Novabase is in the IT services business which means they don't have to carry much inventory, and they are not a capital intensive operation, both good things from an investment viewpoint.  Novabase breaks out their segments as following:


Consulting: IT integration services, enterprise application services, business intelligence, contracting
IMS: Integration services, network infrastructure, ticketing system.
Digital TV
Venture Capital


The venture fund is partially funded by the EU ERDF regional development fund.  The ERDF is a development initiative of the EU to stimulate local regions by investing in companies in the area.  Novabase runs a venture fund that has about five investments from what I can tell.  The nice aspect of the EU as an investor is most likely the EU won't run to pull their money out at the first whiff of trouble, they are a long term investor.  Investments in the fund include home automation, telecom firm, media analysis and business intelligence, two CRM companies.

The digital TV segment is interesting, prior to 2008 the German digital TV division was consolidated along with the rest of their earnings, but in 2008 it appears they disposed of enough of the company to unconsolidate the financial statements.  This is a good development from a business perspective while the German TV division brought in a lot of revenue it wasn't really profitable, and was a drag on earnings.  For the financial statements I developed below I took out the German TV segment prior to 2008, Novabase breaks this out in their statements as well.

One thing I appreciate is that Novabase breaks out all of it's income into segments and reports on those segments.  There is a lot more detail in the annual reports, but I wanted to highlight revenue, and EBITDA by segment.

Segment Revenue EBITDA
Consulting35%49%
IMS44%39%
Digital TV21%10%
Venture Capital1%2%

What the breakdown by segment shows is that the Consulting and Venture Capital segments are have a much smaller cost structure than IMS and Digital TV.  The second aspect is that it shows the Venture Capital fund isn't a huge part of their business, some investors might get a bit frightened seeing a venture capital fund as part of an IT services business, but if anything it looks like a sweetener not something to worry about.  The last thing the breakdown shows is that 79% of revenue, and 88% of EBITDA comes from IT services which is their core line of business.

Highlights
-Novabase is trading at a EV/EBIT ratio of 4.23
-15% of revenue is international, the international segment is growing at 20% a year.
-The financial statements are excellent, very transparent, and available in English through the CMVM.
-Novabase has positive retained earnings, and has been consistently profitable even in this tough environment.
-The company has issued guidance for 2011 of €245m in revenue with €20-22m EBITDA, this is in line with their 2010 results.
-Novabase's balance sheet accruals ratio is 1.2% which is excellent, higher accrual ratios indicate lower quality earnings.
-ROE of 14% and ROIC of 18.3%


Catalyst
The company initiated a dividend policy in 2010 and issued their first dividend of €.308 per share which equals around a 10% yield.  The company also did a return of capital distribution of €.172 in July 2010.  The company has stated that for 2011 the dividend amount will be €.13/sh for a yield of 4.26% at current prices.  They have further stated that going forward they'll continue to pay a dividend of 30-40% of net income.  Using the 2011 guidance numbers a dividend in 2012 could be in this range:

30% of NI .125 a yield of 4%
40% of NI .1669 a yield of 5.4%

Why is it cheap?
With any stock trading at a low valuation I think it's important to examine possible reasons for the cheapness.  Here are a few reasons I identified.


-It's a very small company with a 98m euro market cap.
-The company derives most of it's revenue from Portugal which is in turmoil currently.
-The company strongly identified with it's German direct TV business which was a large drag on earnings.
-The earnings are not stellar, or growing like crazy, but they are undervalued.
-The stock is down significantly in the past year, momentum rules in the short term.
-Net income and revenue were growing nicely up to 2008 but have stagnated since.


Valuation

When I first approached this I thought it was a net-net so I put the figures into my net-net worksheet, although it isn't trading at a discount to NCAV it provides a nice read on the balance sheet.


Here is my accruals worksheet


Here is my breakdown of the income statement elements for the past five years.


To value the common if we take the .90 in cash and add earnings at a 10x multiple we get €5.  Using the more common average multiple of 15x we get €7.05.

Risks
-In 2010 the company reported the highest net profit ever, are margins at peak?
-There is significant margin shrinkage in the digital tv area of business.
-Cash flow statements aren't published, they need to be constructed by the investor.
-The company has 10.472m of debt for a approx 10% debt to equity ratio.
-The company also has lease obligations 1.67m per annum.
-Most of the business is in Portugal which has one of the lowest high school graduation rates in the EU, along with a stagnating business environment.

More Information:
Novabase website
2010 Annual report
CMVM filings
FT.com information

Disclosure: Long Novabase

Sunday, April 17, 2011

Cheap in Portugal

When a country is negatively in the news my ears perk up, Portugal is no exception.  I ran a quick screen for companies trading at EV/EBIT < 8 and pay a dividend, I got three.  Three isn't terrible considering there are only around 65 stocks that trade on the Euronext Lisbon.  I have a quick summary of the companies below, and will have a follow on post about one of them.

I should note Portugal is a great country to tackle if you want to take a list of stocks and start with the As and work to the Zs.  The Euronext Lisbon exchange page has enough financial information for each listed company to see if it's worth proceeding.

Two of the stocks are selling below NCAV where the working capital is greater than market cap.  All three of the companies are profitable and have nice ROEs.  Companies like these are fertile hunting grounds for deals.  For an investor who is maybe a bit wary of investing in Portugal or overseas buying equal amounts of each of these stocks will probably give good returns, along with a nice margin of safety.


Conduril Construtora Duriense S.A. 
Revenue: 380,767,966
P/E: 1.42
Market Cap/NCAV: 87%
ROE: 44.93%

COPAM - Comp. Portuguesa de Amidos, S.A.

Revenue: 38,595,795
P/E: 7.24
Market Cap/NCAV: 278%
ROE: 18.34%

Novabase SGPS SA

Revenue: 337,726,681
P/E: 7.12
Market Cap/NCAV: 83.5%
ROE: 14.02%

Here are the companies and a bit more information in Excel:

Thursday, April 14, 2011

International net-net #6 Craig Wireless

Craig Wireless (CWG:CN)

Trading at C$.395 (4/14/11)

I was very hesitant to do this post for a few reasons, the first being that this is a Canadian penny stock, the second is that the latest financials are from August 2010.  As I reviewed the financials and the background of the company and figured I'd post my worksheet and a few comments.

Craig Wireless owns 4G and WiMAX spectrum licenses and leases out the spectrum to internet and wireless companies.  Craig Wireless owns spectrum in the United States, Canada, Greece, and New Zealand.  What's strange about Craig Wireless is they are headquartered in California but trade on the TSX, most of their operations are not in Canada.

What makes Craig Wireless attractive is that it's trading at 50% of the cash on it's balance sheet, and even less if you consider it's spectrum assets.  Here is my net-net worksheet:


Pros:
-The company is selling at an undeniable discount, less than 50% of identifiable assets.
-Management has shown to be shareholder friendly, on the sale of a division they returned cash to shareholders as a dividend.
-4G and WiMAX spectrum assets could be very valuable as phone networks face bandwidth capacity constraints. 

Risks:
-Craig Wireless sold off their profitable operations and now only holds cash and spectrum licenses, the company is not cash flow break even.
-The company conducts most business outside of Canada but uses the Canadian dollar as it's functional currency, currently the loonie is very strong providing a currency headwind to forex hedging contracts.
-The CFO resigned last year and was replaced in early 2011.
-A member of the Board resigned just before Christmas, no detail was given as to the reason.
-The company's financials are current as of the end of August 2010.

While this company proves that markets aren't always efficient I am taking a pass on investing with them.  The biggest issue that turned me away is that the company still has operating expenses but no way to generate revenue outside of selling spectrum.  While selling spectrum might turn out to be a lottery ticket type of reward I don't have the patience to accept the risk while waiting.  There are also too many risk factors as I mentioned above to make me comfortable even with the significant margin of safety.

Filings can be found on SEDAR: http://www.sedar.com/
SEDAR is the Canadian version of EDGAR, unfortunately I can't figure out a way to link directly to a SEDAR filing.

I'd be interested in here a bullish story for this stock, if you have one leave it in the comments.

Disclosure: I don't own any issues mentioned in this post.

Tuesday, April 12, 2011

International net-net #5 Ace Aviation

Ace Aviation (ACE/A:CN)

Trading at C$11.64 on the TSX (4/12/11)

While digging through companies left for dead and trading below their net asset level an investor is due to stumble upon some strange creations, Ace Aviation is one of them.  Ace was created in 2004 as a sort of spinoff from Air Canada in a bid to unlock shareholder value.  It appears that Air Canada dumped some assets such as Aeroplan, Air Canada Jazz, and Air Canada Cargo amongst others in a way to improve the share performance of Air Canada.

Over the years Ace Aviation has sold off all of the assets that were given to it upon the 2004 creation and now the company is left holding Air Canada shares and cash.  What's interesting is in many companies similar to Ace they would sell off assets and then use the cash to make a foolish acquisition.  In the case of Ace as they've sold assets they have returned the money to shareholders.

This is a pretty simple investment, Ace is trading at slightly above cash (C$378m market cap vs C$363m cash) holds a considerable investment in Air Canada and is in the process of winding down and paying out to shareholders.

Before going on I should note there are two share classes, class A and B.  Class A is only able to be held by non Canadians, and if the ownership transfers to a Canadian the share converts to a B share.  Likewise B shares are only able to be held by Canadian citizens and will convert to an A share if ownership transfers to a non-Canadian.  This share structure seems confusing but due to the convertibility of shares it's easy to ignore, just examine the total common shares ignoring the class they belong to.

Valuation

My net-net worksheet is below, I used the 2010 annual report for cash, and the current value of the Air Canada shares for the equity portion.





Pros:
-Ace has been actively winding the company down and distributing cash to shareholders.
-Ace has also been slowly buying back shares, for a company trading below book value share buybacks increase the book value of the company.
-The value of the company is accurate due to the liquidity of the holdings.
-The Air Canada holdings are fairly easy to hedge with either options or by shorting Air Canada common.
-17% upside to get Ace to the market value of it's holdings.

Risks:
-In 2009 the value of the Air Canada equity holding went from a book value of C$721m to C$107m a significant loss.
-The Air Canada holdings have fallen in 2011 already reducing the value of the equity holding to around C$80.
-Air Canada is a fairly volatile stock so the holdings could fluctuate quite a bit, as they have in the past.

Disclosure: I do not hold any of the issues mentioned in this post.

Monday, April 11, 2011

Is Huntington Ingalls cheap?

Huntington Ingalls (HII:NYSE)

Trading at $38.50 (4/10/11)
Market cap $1.8b

A spinoff is when a company decides that a portion of itself might operate better as an independent company so it splits itself apart and the two or more companies begin to operate separately.  Investing in spinoffs was popularized by Joel Greenblatt in his book "You Can Be a Stock Market Genius".  Recently it seems that investing in any and all spinoffs has become quite the rage, and while I love market beating returns as much as anyone investing indiscriminately doesn't sit well with me.  In light of this I decided to take a look into the most recent spinoff Huntington Ingalls.


Huntington Ingalls describes itself as follows
 For more than a century, we have been designing, building, overhauling and repairing ships primarily for the U.S. Navy and the U.S. Coast Guard. We are the nation’s sole industrial designer, builder and refueler of nuclear-powered aircraft carriers, the sole supplier and builder of amphibious assault and expeditionary warfare ships to the U.S. Navy, the sole builder of National Security Cutters for the U.S. Coast Guard, one of only two companies currently designing and building nuclear-powered submarines for the U.S. Navy and one of only two companies that builds the U.S. Navy’s current fleet of DDG-51 Arleigh Burke-class destroyers. We build more ships, in more ship types and classes, than any other U.S. naval shipbuilder. We are the exclusive provider of RCOH (Refueling and Complex Overhaul) services for nuclear-powered aircraft carriers, a full-service systems provider for the design, engineering, construction and life cycle support of major programs for surface ships and a provider of fleet support and maintenance services for the U.S. Navy. With our product capabilities, heavy industrial facilities and a workforce of approximately 39,000 shipbuilders, we believe we are poised to continue to support the long-term objectives of the U.S. Navy to adapt and respond to a complex, uncertain and rapidly changing national security environment.
 The best place to start with in looking at Huntington Ingall's business is under the lense of Porter's five forces for competitive and business analysis.  The five forces examines different threats to a business or industry and by doing so can help an analyst realize potential strengths or weaknesses.


Five Forces:


Threat of new entrants - There is very little to no threat of new entrants in the government contracted ship building business. I believe there are two reasons for this, the first is the capital and knowledge investment is too big, and secondly the profits for that investment in resources is very small. There are currently two major players in the shipbuilding market, and if a third entered it's likely that none of the three would be able to be profitable.

Bargaining power of suppliers - This is not much of a threat, this force can be threatening when suppliers are concentrated. In the case of Huntington Ingalls they deal with hundreds if not thousands of suppliers for the raw material they use to build their ships. In some instances the supplier might be concentrated in the case of a specialty part, but even in that case it's not threatening to the business.

Bargaining power of buyers - This is a major threat to Huntington Ingalls, they only have one buyer the US Government. If the government decides to reduce defense spending or stop building ships Huntington Ingalls will be unable to continue as a going concern.

Threat of a substitute product - A good example of when this threat might apply is in the case of an iPod being a substitute for someone going to a concert. At first glance it seems this threat might not exist for Huntington, but I believe it does. A substitute product could be that instead of building light ships to patrol costal waterways the military begins to purchase drones which are far cheaper. A change in military strategy away from heavy navies would be a substitute product.

Rivalry amongst existing competitors - This is a threat but not a large one. There is only one other company who does the same work that Huntington does and they are competing for a range of products that accounts for 32% of Huntington's revenue.
Taking a look at the total it seems Huntington gets a 2.5/5 which isn't bad. What makes Huntington interesting is they hold a mostly monopoly position on their market. While that's great that they have a monopoly what isn't great is that the monopoly is on a mediocre business. It's like the old saying "He's a giant among trolls".
Huntington Ingalls has a great business in the sense that they have a proven backlog of projects, they are the only company who is able to execute on the projects, they have experience in the marketplace. The current business backlog is $18.5 billion dollars, which at their current revenue run rate is about 2.8 years worth of worth.
What attracted me to this spinoff is how great the business is, it's very steady and predictable, and it's a monopoly. When I first heard the details I was excited, I felt Huntington Ingalls was a perfect business what could go wrong with buying a monopoly? What can go wrong is an investor can pay too much..
Valuing the business
Just a few notes before I start, in my income statement worksheet I removed the goodwill impairment in 2008. Secondly I built out my spreadsheets using the filing, information from the credit rating documents, and the pro forma statements the company provided. I'm saying this because if you do a 3 minute check some of my numbers don't appear in the filing, this is the analysis part of my research.

The best place to start is the balance sheet. Their balance sheet as of the spinoff looks like this:


Cash 300m
Notes 1200m (600m at 6.875% and 600m at 7.125%)
Bank Loan 546m
Existing Debt 105m
Total Debt 1851m

The biggest issue is that the company is highly levered. The company has gross debt to EBITDA at the end of 2010 at 7.25x. What's interesting is the credit rating agencies expect Debt/EBITDA to be 3.5-4x in 2011 which gives us a bit of earnings insight.

I put together an income and cash flow worksheet with the data they provided, I have it below.

The first thing that stuck out to me is the margins are terrible, they had a net margin of 1.41% in 2010, this is plainly a capital intensive business.  The company spent $1 to make $1.01 which is not a very good deal.  Even if we look at the last five years the highest their net income margin peaked was in 2007 which it hit 4.85%.  Over the last five years the company has experienced revenue growth of 4.8% but net income hasn't kept up, it actually has been falling.

The company defines free cash flow as cash from operations less capital expenditures.  This is a generally accepted method for calculating FCF, I would prefer maintenance expenditures but that value isn't broken out at all.  I will usually also normalize cash flow, but in Huntington Ingalls case this wasn't necessary because their cash flow items remain very steady.  There are few working capital changes from quarter to quarter and year to year which is a byproduct of the government business.

Return on Invested Capital

I plugged the income and cash flow numbers into my ROIC worksheet as well, the result is below:

I include two calculations, the first is what most analysts would consider ROIC, the second considers purchase obligations as well.  It's usually enough to only include operating leases but in Huntington's case they have contractual purchase obligations that they must honor regardless of the business environment, in this situation it's much more like debt.

As you can see in either case the ROIC is not very good, both are less than their cost of debt (7% on the notes) and much less than their cost of capital.  This is not a good sign, this means that the company is consuming resources unproductively, they are borrowing at 7% to get a 2.42% return.

I also did a DuPont analysis to determine the composition of their ROE.  A DuPont analysis measures three things
1)Profit margin
2)Asset turnover
3)Financial leverage

Here is what we get:


.0141 * 1.29 * 3.67 = 6.68% ROE

The result shouldn't really be a surprise, the profit margin is small, they make effective use of their assets turning them more than once, and finally the ROE is juiced by the leverage.


What does this mean?


I thought about the question are the shares cheap a few different ways, I'll break those down into scenarios.


Scenario 1: Standard 4.8% growth
If the company continued to grow at the 4.8% rate and nothing else changed this is not a good investment. The reason being that they're not covering their cost of capital or earning a good return for shareholders. A shareholder would be better off purchasing a Treasury bond, they would earn a guaranteed yield higher than the ROIC of Huntington Ingalls, and the bond is guaranteed.


Scenario 2: Costs are cut
The company is revenue constrained to what the military will send its way, so the only way to become more profitable is to cut costs. As of now the company has already announced the Avondale yard is scheduled to be discontinued in 2012/2013 which should result in some cost savings. I put together a few scenarios of what different cost savings levels would do for profitability:
As you can see even a small savings of 2% bumps the gross margin above 5% and the net to 2.59%.  But a bigger savings of 5% gets the net close to 4.5% which is in respectable territory.  At the 5% savings level I estimate the ROIC would stand around 8% which would still be less than it's cost of capital, but at least greater than it's debt.

Which of these scenarios is likely?  Based on what the company told the credit rating agencies I'm led to believe they expect to achieve around 5% cost savings in 2011.  At the 5% savings level Debt/EBITDA is at 3.2 which is what the company said would be likely.  At the 5% savings level their ROE would increase to 21% as well.

Another measure of cheapness is to look at where the shares are trading today with price divided by the last five years earnings average.  With this measure the shares are trading at a P/E5 of 12.62 which isn't all that high.  If the company is able to hit their cost reduction targets it could earn them 302m in 2011 which would be EPS of $6.10.  Assuming no multiple expansion the shares would trade at $76.

What are the risks?

Huntington Ingalls isn't a risk free investment, even though their contracts are guaranteed and they have a monopoly on the market there are two issues that I see as the biggest risks.

The first is government funding for defense initiatives.  As of now funding is guaranteed through 2012, but it's anyone's guess what happens after 2012.  If the Congress or President decides to cut defense spending Huntington will feel the pain, and with the large debt load their survival could be at risk.

The second risk is the issue of liabilities specifically environmental liabilities.  Building ships and refueling nuclear vessels is not a clean task. 


Additional Resources:
Here is the spinoff filing
Here is a copy of the credit agency writeups

Any comments are appreciated!

Talk to Nate about this stock.

Disclosure: I do not own any Huntington Ingalls shares, but I'm considering purchasing them in the next few days.

Friday, April 8, 2011

International net-net #4 SFC Energy

SFC Energy (F3C:Xetra)

Trading at €5.25 (4/8/11)
€37m market cap

I took a look at SFC Energy because it was one of the bigger German net-net's based on market cap.  The company was also trading at approx 50% of book value so I figured it was worth a look.

The company is interesting, they have developed a fuel cell technology which they manufacture in Germany and sell across Europe.  The fuel cells are marketed to many different segments such as military, industrial and recreational.  One market they seem to highlight is the RV market, they tout fuel cells as a reliable and portable way to take energy with you.  I'm not sure I'd want to be lugging a fuel cell with me on vacation, but maybe that's just me.  The fuel cells can power up to 250 watts and there's a very cool worksheet showing the energy savings by switching small power needs to a fuel cell technology.

What's great is SFC has a nice English version of their website here.  They also have English copies of their annual reports and news releases.  This appears to be a byproduct of the fact that they sell product in the UK.  For such a small German company to publish in English is very rare in my experience.

Valuation:

I have my net-net worksheet below.


The shares are trading a little bit above NCAV but not much.  When I first ran my screen a few weeks ago they were below, but the shares are volatile.

Profitability

The company isn't currently profitable and has a net retained deficit.
What is killing the company is they have a completely unstable cost structure:
13m revenue
4m COGS
8.6m SG&A + R&D

It appears the company is hoping to grow revenue quick enough to outgrow this problem, this is risky at best.  There are many companies in the green space hoping to strike it big, I'm not sure what would set SFC apart.

Balance Sheet Strength

The balance sheet is really the only bright spot for SFC, they have most of their current assets in cash with little receivables and little inventory.  The concern is that the company has a very high cash burn rate currently.  In 2010 they had -€4.7m CFO, -€2.3m CFI and negligible CFF for a total burn rate of €7m a year.  At this rate their cash hoard could last up to five years, but even so a discount should be applied to the cash to reflect the high burn.

A big positive is that the company doesn't have any debt on their balance sheet, their liabilities consist of trade payables

Summary

SFC Energy seems to be trading at an appropriate value in light of their circumstances.  The company is in a startup stage and is well capitalized if they can find success in the next few years, but this is a big risk.  For this stock there isn't enough of a margin of safety for me to invest.  For someone who wants a way to get in on the ground floor of the green movement in Europe SFC Energy might be that vehicle, but that's not how I invest.  I look for a safety of capital, that doesn't exist in this case, it's very likely SFC Energy could never reach escape velocity with their revenue and burn through their cash hoard.

Just a quick side note, some readers might wonder why I post 'junk' companies such as this.  I treat this blog as my journal, and since I spent some time looking into it I want to record my thoughts for the future.  This means I won't only be posting the best ideas I find in the markets, instead I'll be posting most ideas I decide are worth more than an initial 10 minute review.  Even if it turns out to be a bad investment I believe there are things to be learned, it's the process that matters, and practice improves the process.

English site: http://www.sfc.com/en/

As always I'm open to comments or opinions to the contrary.

Disclosure: I do not hold a position in any issues mentioned in this article.

Tuesday, April 5, 2011

International net-net(sorta) #3 Societe Francaise de Gestion et d'Investissement

Societe Francaise de Gestion et d'Investissement (SOFR:FP)

Trading at €1487.99 (4/5/11)

This is a bit different than most net-nets because Societe Francaise de Gestion et d'Investissement (Sofragi) isn't a business selling at a discount but is a closed end fund.  The business description of Sofragi notes that it holds a combinations of shares, warrants, options, and bonds of companies trading on the Euronext Paris.  In addition it can also own foreign shares and hold cash as well, this sounds awfully similar to a mutual fund to me.  

So what makes this a unique opportunity?  To start with Sofragi is owned by two majority holders, 55.44% by Aviva Vie, and 22.58% by Agrica which leaves 21.98% in the public float.  And considering there are only 100,000 shares total we're talking about a total of 21,980 shares available for purchase which isn't a lot.  Secondly the net asset value is ascertainable and liquid.  It would be simple for Sofragi to distribute the shares and cash in-kind to each Sofragi shareholder to realize actual asset value.

You might be wondering how do we know the fund still trades at a discount?  Sofragi is nice enough to post the valeur liquidative (NAV) on a fairly often basis.  As of this post the NAV is posted for 4/4/11 showing €1833.12 vs the trade price of €1487.99 a 18.8% discount.

Upside
The upside to this investment is technically unlimited, the fund could soar but a more realistic goal is the discount to NAV closes giving an investor a 23.3% gain at todays values.

Downside
The risk to this sort of arbitrage purchase is that the discount persists for some time before it closes and the value of the fund drops.  Some of this risk is reduced by the fact that the fund holds a conservative allocation, as of 12/31/2010 the fund held 54.51% shares, 41.05% cash, and 4.44% bonds.

Conclusion
Investing in a closed end fund at a discount to it's NAV is a fairly safe investment with a predictable outcome.  No fund trades at a discount forever, but will usually drift closer to NAV over time.  A factor that could be helping persist the discount is that Sofragi has a very low float, and two large majority shareholders.  As a value investor I make money betting on mean reversion, and an investment in Sofragi is just that.

Disclosure: I don't hold a position in any issue mentioned above although I might consider purchasing Sofragi in the future.

Sunday, April 3, 2011

International net-net #2 Vianini Industria

Vianini Industria (VIN:IM)

Trading at €1.423 (4/3/11)
€43m market cap

Summary:

Vianini Industria is a construction manufacturing company based in Rome.  Vianini Industria (not to be confused with Vianini Lavorni) is part of the Caltagirone family of companies as I discussed in this post.

The biggest project Vianini Industria is involved in is construction of the new Line C of the Rome metro.  The Rome metro's 17 mile Line C extension is the first metro line which will extend beyond the city proper.  The line was originally supposed to be opened in 2011, but there have been work stopages due to finding antiquities along the line that have put the timing of the opening into question.  The Line C expansion's total cost is expected to be around €4.3b, of which Vianini Industria plays a small part.

In 2010 Vianini Industria had €12m in revenue down from €18m in 2009, the Line C expansion is billed as a €15m project with an extra €7m extension possible at the client's choice.

Highlights:

The depressed value of Vianini seems to be due to decreasing revenues and a halting of the Line C project which is accounts for most of their revenues.

Vianini Industria also owns equity interests in other companies, this isn't uncommon for a company in the Caltagirone family.  I'm going to take the value of these equity interests at face value, it doesn't seem like they're publicly traded so it's unclear if they're marked accurately.

The company has a contract in 2011 to provide €15m of railroad sleepers (railroad ties to Americans).

The company pays a two eurocent dividend which amounts to about a 1.4% yield.

Valuation:

-€2.02 cash & investments per share
-€1.93 NWCC (NWCC discounts receivables and inventories as seen in the spreadsheet)
-€2.02 NCAV

I have my net-net worksheet below.


Since the company is an operating and profitable business I put together a small worksheet showing some key income statement stats.  As a note Vianini Industria doesn't distribute a cash flow statement with it's reports, it would be very easy to build one based off the income statement and balance sheet, but I didn't undertake that for this issue.








A few things stick out, the first is that income from equity investments is a very large part of their net income each year.  The second is earnings are very streaky, which is why the market isn't placing much value on them.  

While the company is trading cheap to assets it's expensive when looking at the earnings of the business, with a P/E of 35 and a EV/EBITDA of 18.

Final Thoughts:

While this is a cheap asset play I'm not sure if there is enough of a margin of safety for me to invest.  My main concern is that the business on it's own isn't strong enough and will eat into the capital cushion over time.  My other concern is that most of the companies earnings come from it's equity investments, as I have mentioned in my last post this is common in this family of companies, but I don't think investing in Vianini Industria is the best way to play it.  

Resources:
Annual Reports: http://www.vianiniindustria.it/2009/32.html
Main website: http://www.vianiniindustria.it

Disclosure: I do not hold a position in any issue mentioned in this post.