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World Acceptance Corporation (WRLD) offers short-term small loans, medium term larger loans, credit insurance products, tax services, financial software, and ancillary products and services to individuals in the United States and Mexico. WRLD’s average gross loan made in fiscal 2011 was $1,134 with an average maturity of 11 months. The company services sub-prime borrowers in particular and during fiscal 2011 loaned $2.6B making it one of the bigger companies of its type in the US.
Recent Performance
Over the last 10 years WRLD has grown EPS from $1.00 to $5.63 representing a rate of almost 19%. Revenue of the same time has grown just under 14%. The difference between the revenue growth rate and the EPS growth rate has come about due to the combination of increased margins and share repurchases. $53M was spent on share-repurchases during fiscal 2011.
Looking at its numbers over the past 10 years, importantly none of the company’s earnings growth, profitability, or margins suffered even slightly during the GFC. WRLD’s 10 performance has been not only impressive but remarkably consistent.
We like to see Free Cash Flow meet or exceed Net Income and for WRLD their total net income over the past 10 years has totaled $471M while total Free Cash Flow over that time has exceeded $1B. WRLD is a wonderful generator of cash which has allowed it to expand at a rapid rate (more on that below).
Quality Rating
Source: www.usastockvaluation.com
The company scores an admirable quality rating of 70/100. Its net debt to equity score is poor, though its balance sheet is still reasonably strong with total assets of around $800M (of which goodwill is negligible) and total liabilities of around $360M. The company also scores poorly in terms of return on retained earnings which is a function of its rapid expansion – opening new stores doesn’t bear much fruit, relatively speaking, for the first few years until revenue from the initial loans issued is materialized.
Intrinsic Value
Source: www.usastockvaluation.com
Regulatory uncertainty surrounds the company and the industry it is in. This regulatory uncertainty forces downward pressure on the share-price, creating possible buying opportunities. Companies like WRLD provide an important service to those American people who do not have access to credit through traditional channels, so it is unlikely the regulatory uncertainty will materialize negatively on WRLD’s business. We expect that the newly created “Consumer Financial Protection Bureau” will focus on preventing the sub-prime real-estate bubble from ever happening again, and look at ways to minimize unethical exploitation of the government student loan system. But concerned investors who have trouble sleeping at night during some uncertainty may want to wait for some clarity from policymakers prior to an investment in a company like WRLD.
The wonderful performance of WRLD over the past 10 years is clearly illustrated in the above graph. With huge scope for further growth (see below), this trend is likely to continue for many years. Now appears to be a reasonably good time to buy.
Investment Grade Table
Source: www.usastockvaluation.com
WRLD ranks only at number 120 on the USAStockValuation.com Investment Grade Table due to the relatively low margin of safety on offer. Investors need to consider also that Intrinsic Value is expected to rise significantly in the coming years.
Drivers of Future Growth
WRLD has been opening new offices at a hefty rate over the past 5 years. Fiscal 2011 saw 77 new branches open, an increase of 7.8%. The below illustrates the rapid rate of growth for the company in terms of establishment of new offices:
Source: www.worldacceptance.com
Fiscal 2011 also saw the company enter Wisconsin for the first time, bringing the number of US states in which WRLD has a presence to 12. With so many states not yet entered, huge scope for growth still exists for the company. WRLD is also growing in Mexico, proving that their business model is successful outside of the US, which bodes it well should it wish to expand into other countries.
WRLD’s goal for 2012 is to open a further 63 offices in the US and a further 10 in Mexico. It is uncertain how many offices the company will eventually have in the US, but with a business model that produces great profits as well as profitability, there is no reason why the company won’t continue to expand geographically into many more states around the country.
Conclusion
Management clearly treat shareholders as owners of the company through their language in annual reports and other official documentation. And they have created a very successful business model which allows for significant geographic expansion. The future looks nothing but bright for the company even considering the lingering regulatory uncertainty (which we see as a very low risk for WRLD). Investors may see a good opportunity at current prices to buy a part ownership in a fast growing business.
The business of selling computers is now a tough one to be in and everyone knows it including DELL. Selling basic computers to individuals and businesses with windows software preinstalled was once a thriving business for DELL, but as things now stand in order to achieve future growth the company is expanding its offerings.
Yesterday the company announced it is developing a smartphone in China using a software platform developed by Chinese search-engine operator Baidu Inc (BIDU). The smartphone is expected to hit the shelves in China early next year, after which DELL will look to launch the smartphone in other markets. DELL is shifting its focus not only to smartphones and tablets, but it has also been growing its enterprise solutions and service business materially in recent quarters.
Quality Rating
Source: www.usastockvaluation.com
DELL has grown its EPS from $0.46 to $1.35 over the past 10 years, representing an annual compounded increase of 11%. Over that time it has achieved a return on retained earnings of 8% which is not a great result. A company that cannot achieve a decent return on its retained earnings should consider the introduction of a dividend.
The formula to derive the Free Cash Flow score includes a provision for Free Cash Flow growth, which explains why DELL only scores 4 on its Free Cash Flow. Its Free Cash Flow generation over the last 10 years has been extraordinary, albeit at a small growth rate. It has generated over $33B in Free Cash Flow over the past 10 years versus total net earnings over the same period of over $24B.
Intrinsic Value
Source: www.usastockvaluation.com
DELL in its recent results – both annual results issued in Jan 2011 as well as the 3 quarterly results since then – have silenced their critics. They are producing some great numbers, making the forecast Intrinsic Value even more attractive than the existing. But the market still has its doubts – a decent Margin of Safety is currently on offer.
Coming out of the dot com bubble, DELL remained well over-valued. The share-price has gone sideways since then while the value tries to catch up. As can be seen, DELL’s performance suffered while it was slowly reacting to the challenges facing its simple PC business. But in fiscal 2011 the company started what looks to be a turnaround. Since the GFC in 2008, DELL’s share-price has been reasonably depressed and this year market has not given the company enough credit yet for its fiscal 2011 performance.
Investment Grade Score
With a Margin of Safety of 33 and a Quality Rating of 55, DELL achieves an Investment Grade Score of 33 x 55 ÷ 100 = 18. This places DELL at number 99 on the USAStockValuation.com Investment Grade Table.
Capital Management
If DELL struggles to achieve a decent return on retained earnings, the company may introduce a dividend. Let’s look at 2 scenarios, and let’s assume the fiscal 2011 EPS performance can be maintained into the future.
Scenario 1: A Payout Ratio of 50%: The dividend yield based on the current share-price of $14.68 would be 4.6%.
Scenario 2: A Payout Ratio of 75%: The dividend yield based on the current share-price of $14.68 would be 6.9%.
Similar value would be created if the company used the money in the above examples to buy back shares. The company has a history of repurchasing shares.
Conclusion
With declining PC prices, and stiff competition to its traditional business model, DELL is starting to reinvent itself with its new offerings. The company is achieving significant growth in its enterprise solutions and service offerings, and is entering the tablet and smartphone markets, all providing encouraging upside potential. And the company generates extraordinary Free Cash Flow which limits the downside risk (cash flow provides flexibility for a company - pay dividends, buy back shares, acquire other businesses etc). Many investors will find the downside risk versus upside potential for DELL attractive at current prices.
Total S.A. (TOT) is one of the six supermajor oil companies in the world. It is a French company established in 1924.
The company is rather diverse with interests in LNG, LPG, gas and nuclear power generation, coal, solar, refining, shipping, and chemicals manufacturing to complement is dominant upstream activities. It operates in more than 130 countries and is one of the biggest producers of natural gas.
Most of the “easy” oil in the world has been produced, sold and consumed. Companies like TOTAL are forced to explore for oil in deeper water and in higher risk countries, and this trend will continue into the future. TOTAL has a number of operations in Africa as well as Iran and Russia, and has invested heavily in deep water, oil sands and LNG.
In the future, EPS growth will come predominantly from an increase in the price of oil (and the price of natural gas) as growth in production is getting harder and harder to come by. In the shorter term the price direction of oil is not clear. As Europe slides into a recession, demand for oil, at least from that region, will decline and the price of oil may drop as a result. But over the longer term it is hard to see the price of oil going anywhere but up. Oil production is becoming a more expensive exercise as time goes by, and new oil discoveries are mostly a lot smaller than the sort of discoveries enjoyed in the 20th century.
As with most resource companies, the larger the company the lower the cost to produce per unit volume. These economies of scale often make the bigger oil & gas producers more attractive an investment. That and their enormous cashflow. TOTAL has generated total Free Cash Flow over the last 5 years of over $87B versus total net earnings over the same period of $76B. Its net debt to equity is a very manageable 26%.
Quality Rating
Source: www.usastockvaluation.com
TOTAL achieves a poor quality rating predominantly due to lack of growth and declining profitability. Chevron (CVX), ConocoPhillips (COP) and Exxon Mobil (XOM) all have similar Quality Ratings to TOTAL.
Intrinsic Value
Source: www.usastockvaluation.com
Value Investing involves, at the basic level, the buying of high quality companies at a share-price that is at a meaningful discount to Intrinsic Value. Neither criterion is met with TOTAL, so Value Investors would likely not be interested in the stock.
The above graph indicates that TOTAL has lifted its game recently after a few years of declining performance. The future performance of TOTAL is heavily dependent on the price of oil – if the price of oil sky rockets as many predict it will over the next 5 or 10 years, so does the performance of TOTAL. If the oil price drops, stays the same or increases only slightly, TOTAL will struggle to achieve decent growth or profitability.
Conclusion
Investors who believe the price of oil over the longer term (10 years+) is going up will be interested in TOTAL due to its large amounts of proved oil and oil equivalents and its aggressive exploration and project development. The stock is paying a dividend yield of 2.7% on current prices. Value Investors will be keen to see a Margin of Safety prior to an investment, and as such will want to wait to see how things play out with the impending European recession.
EBay Inc (NASDAQ: EBAY) manages eBay, an online auction and shopping website. EBAY was founded in 1995 and now has a presence in 40 countries. Over the years it has expanded to include standard shopping, barcode shopping (Half.com), online classified advertisements (Kijiji or eBay Classifieds), online event ticket trading (StubHub), online apartment listing (Rent.com), online shopping comparison (Shopping.com) online money transfers (PayPal), local sales (Milo.com) and fashion sales (Brands4Friends). EBAY has 17,700 employees and is based in San Jose California. The company generates revenue through various fees including a fee to list an item and another fee once the item is sold. PayPal also charges fees to the seller for payment processing services.
EBAY is cashing in on the growth in e-commerce and will continue to do so for years to come. E-commerce has grown massively particularly over the last 10 years, and it is expected to continue to grow at a decent rate many years to come. This massive growth in the e-commerce marketplace is being fought over between EBAY, Amazon (AMZN), Google (GOOG), and Yahoo (YHOO).
As a technology company EBAY needs to keep evolving in order to keep up with ever changing trends and demands. EBAY, through its numerous acquisitions (both large and small) gains revenue through a variety of sources which the company categorizes under 2 business segments – Marketplaces and Payments. Importantly, the company is a good generator of cash – over the last 10 years the company has reported net earnings of over $10B, and achieved Free Cash Flow of over $14B. This cash allows the company to acquire smaller companies that have perhaps come up with a new solution that will complement EBAY’s existing operations – it helps allow EBAY to keep up with the competition.
Consumers are shopping more and more on mobile devices, and EBAY has positioned itself well to capitalize on that growing market. By the end of 2010, EBAY mobile apps had been downloaded more than 30 million times, in eight languages, across 190 countries. In 2010 mobile payment volume was 5 times that of 2009. More than 2.5 million people have downloaded PayPal’s mobile apps.
PayPal’s earnings have been a bit erratic over recent years probably due to acquisitions being bought (increasing revenue), and other acquisitions being sold (decreasing revenue). The sale of skype benefited EBAY through a big wad of cash on the balance sheet, but the sale also reduced revenue.
Quality Rating
Source: www.usastockvaluation.com
The glaringly obvious issue with EBAY’s Quality Rating is its poor Normalized Return on Equity. A company with a poor Return on Equity is not one that is particularly profitable with the use of Shareholders Equity. EBAY’s reported Shareholders Equity is around $16, and it also reports goodwill of $8B. It may need to write down some of its goodwill over the coming years. Its poor NROE has serious implications on the calculation of Intrinsic Value:
Intrinsic Value
Source: www.usastockvaluation.com
If an investors’ Required Return for the stock is higher than its Return on Equity, such as the case here (EBAY’s Forecast Average Normalized Return on Equity is 12.6%, rounded up in the Intrinsic Value display), then the Intrinsic Value of the company is less than its book value. The easiest way to explain this is for you to consider a business that is available for you to buy for $1M in cash, and it makes $100K per year (10% return on your equity), but you want to receive a 12% return on your $1M. In this case you wouldn’t pay the $1M because the $100k per year does not meet your required return of investing in the business. This is obviously a simplified example, but important none-the-less.
EBAY has been popular with market participants because it is one of the leaders in e-commerce, an industry in the spotlight and one likely to continue to grow. The performance of EBAY has not matched the expectations of the market. If EBAY can achieve higher rates of Return on Equity in coming years its Intrinsic Value will appreciate considerably.
Regulatory Uncertainty
A lot has been written recently regarding the likely introduction of an online sales tax bill which will bring online retailers in line with traditional retailers.
The rules as they currently stand are: For the majority of states, if an individual or entity sell goods via the internet and ship them to the consumer in the same state, then they will need to collect sales tax from the buyer, and in turn pay that tax to the state. This applies when the seller has a physical presence in the state. The reason that the rule typically only applies when the seller has a physical presence in the state is that for a small online retailer, collecting sales tax from all buyers, then distributing the correct amount to each of the 50 states would be a nightmare.
Already around 5 states have introduced requirements that out of state retailers collect sales tax and pay those states the amount collected, but this practice is messy and is not commonly adhered to.
The new legislation in the US Senate proposes that internet retailers collect sales tax on all purchases from all states, regardless of whether or not they have a physical presence in the state. The bill proposes to simplify and streamline the process and give more authority to the states in enforcing the payment of sales taxes from online sellers. The states would need to adopt the standardized administrative procedures laid out at Federal level. Each state would have the option of joining the new system or keeping things the way they are.
If passed, the new bill will create more paperwork for eBay sellers (although the intent of the bill is to make it simple – there will certainly be some headaches for smaller online retailers, at least initially), as well as making purchases more expensive (due to the additional tax) and hence slightly less attractive to the consumer.
Under the current proposal, sellers with less than $500k in sales per year would be exempt, but there aren’t many businesses that have less than $500k in sales. At a 10% net margin, $500k in sales provides net income of only $50k. It would only be Moms and Dads selling their used goods on eBay who won’t be affected by the bill.
Amazon is all for the bill – they know that they offer the best prices with or without sales tax added on. Amazon knows that the sales tax bill would be applied also to all of its competitors – such as retailers on eBay. The bill would make Amazon’s competitive position stronger, and every small online retailer slightly weaker.
Both eBay and PayPal collect fees based on a percentage of the total purchase price, so with the additional price caused by a sales tax, their fees and margins would actually increase.
The new legislation would have implications to EBAY, as a lot of its retailers would be affected. The competitiveness of online retailers as a whole would not be expected to change dramatically though – due to other cost advantages, online retailers would still provide better prices than traditional retailers. And though the increase in prices due to the tax will bring online prices closer to that of physical retailers, the convenience of buying online is not diminished. Currently consumers enjoy the convenience of buying online paying prices at a large discount to physical retailers, and if the bill is passed consumers will still enjoy the convenience of buying online but will be paying prices at a smaller discount to physical retailers.
Conclusion
Based on the premise that as time goes by more and more people will shop online, EBAY will be expected to continue to grow their business. But investors keen on EBAY will be looking for 2 things before they consider a purchase – 1) the company increases its profitability as measured by Return on Equity, and 2) a decent Margin of Safety emerges through either a decrease in the share-price, or an increase in the Intrinsic Value of the business (which will come about if point 1 comes to fruition).
Apple - Is Now a Good Time to Invest?
Apple’s recent results are extraordinary. Few other companies, if any, have achieved the business performance that Apple has achieved over the past 10 years. It has grown EPS from $0.09 to $27.66 representing a compounded annual growth rate of 77%. Over the last 10 years it has created total net earnings of over $60B and total Free Cash Flow of over $76B. It currently has no debt and almost $10B in the bank.
The future of Apple, like any big tech company, depends on how well they continue to innovate. Growth will need to come from the continuous development of new products that consumers want to buy, as their existing products will only provide a certain amount of growth. Few people know the products that Apple is currently working on, and even fewer people know if they will be successful or not. These are the reasons why tech companies are next to impossible to forecast more than a year or 2 out, and why Warren Buffett typically doesn’t invest in them.
A lot has been written on Apple, including predictions on future performance. The purpose of this article is to determine if now looks to be a good time to buy Apple shares, from a Value point of view.
Quality Rating
Source: www.usastockvaluation.com
Apple scores one of the highest Quality Ratings in our database. Over the last 10 years, the company has increased EPS each year, but not only that it has increased profitability as measured by Normalized Return on Equity as well.
Intrinsic Value
Source: www.usastockvaluation.com
Based on the Margin of Safety calculation method of (Intrinsic Value – Shareprice) / Intrinsic Value, Apple scores a very reasonable 30% Margin of Safety.
During the Global Financial Crisis, as with almost all companies, the shareprice of Apple dropped and since then the shareprice has been trying to catch up to Intrinsic Value. The graph illustrates that now looks to be a good time to invest from a Value point of view.
Capital Management
If Apple is unable to grow, and continues to earn around $26B in net earnings each year as it did in FY2011, how would the company look? If the company was unable to use their huge volumes of cash to further grow the business, they may look towards paying a dividend or buying back shares. This is a bit of a hypothetical exercise, as nobody expects Apple to start paying a dividend in the near future, at least not a significant one. But it’s important to consider various scenarios so as to understand downside risk. A point worth making here is that most tech stocks, Apple included, have considerable downside risk, as it is difficult to keep inventing new products that take the world by storm. The absolute worst case scenario for Apple is that something terrible happens and they are unable to achieve a profit of $26B into the future. But for this example, let’s consider that they are able to achieve the $26B, as a minimum, into the future.
Scenario 1: Payout Ratio of 50%: The Intrinsic Value would reduce to $475 (to understand why Intrinsic Value would decrease as a result of the introduction of a dividend, see this article: www.usastockvaluation.com/articles/PERatioFallacy). And the dividend yield based on the current shareprice of $376 would be 3.7%.
Scenario 2: Payout Ratio of 75%: The Intrinsic Value would reduce to $364, and the dividend yield based on a share-price of $376 would be 5.6%.
Similar value (3.7% and 5.6%) would be created if the money in the above 2 scenarios was used to buy back shares instead of paying dividends.
Conclusion
It is rare to find a company with such a wonderful 10 year performance as Apple trading at a meaningful discount to its Intrinsic Value. The future growth of Apple depends on their ability to invent new products that consumers will want to buy, and with the passing of Steve Jobs, stockmarket participants may be skeptical as to how well Apple can continue to innovate.
Investors who believe that Apple will continue to invent new successful products would see a wonderful investment opportunity at current prices.
G-III Apparel Group Ltd (NASDAQ: GIII) is a diversified distributor of apparel and accessories in the US. The company’s range includes suits, jackets, dresses, coats, sportswear, performance wear, luggage, handbags, leather goods, footwear, eyewear, and watches. Some of its brands include Andrew Marc, Jessica Howard, Eliza J, and Black Rivet. It also holds licenses to produce apparel under Calvin Klein, Guess?, Tommy Hilfiger, Levis, Dockers, Jessica Simpson, and Sean John among others. The company also holds sports licenses with the NFL, NBA, NHL, MLB, and others.
GIII was founded in New York in 1956 by Aron Goldfarb, and his son Morris Goldfarb is now the current CEO. The company went public in 1989. Throughout the last 10 years in particular, GIII has undergone aggressive expansion including expanding its licenses and acquiring the other businesses. The company has proven itself capable of buying businesses at a reasonable price and integrating new businesses into its existing. This skillset will serve them well as they continue to seek acquisitions to complement its organic growth. The company has zero debt of any kind, and current assets of $379M including cash of $10M. Its strong balance sheet puts the company in a great position to take advantage of any acquisition opportunity that they uncover.
Quality Rating
Source: usastockvaluation.com
The big disappointment from the Quality Rating table is GIII’s Free Cash Flows. A Value Investor is unlikely to consider investing in a company that doesn’t generate good Free Cash Flows. Looking at the financials closer, in its fiscal year ending Jan 31st 2011, GIII reported a Free Cash Flow of negative $-48M, against a reported net income of $57M. The biggest changes were the change in inventory which we’ll give them the benefit of the doubt on – we will interpret that as positive in that they are growing, and the inventories they need to purchase to meet demand keeps rising. The other biggest change was the accounts receivable which has gone from negative $4M in FY 2010 to negative $65M in FY 2011. This increase in accounts receivable is huge – perhaps prior to FY 2011 the company did not offer its products on credit, and the change in strategy has only just started in FY 2011. Accounts payable is also increasing, so perhaps it is just a sign of the times for the business – more things are sold and bought on credit. But regardless, GIII’s lack of Free Cash Flow is a serious concern. To the end of July 2011, GIII’s Free Cash Flow is even worse, raising a big red flag on the consideration of GIII as an investment. Without generating cash the company cannot grow, let alone buy-back shares, or pay dividends. By having a negative Free Cash Flow, the company is draining its lifeblood.
Intrinsic Value
Source: usastockvaluation.com
The above graph indicates that for an investor interested in a position in GIII, now looks to be a reasonable opportunity from a purely Margin of Safety point of view.
Drivers of Future Growth
Growth is expected in part through expansion of its existing product range. Recently GIII expanded its license with Calvin Klein to include handbags and other accessories, and intends to continue to build on its extensive licenses. In 2008 the company acquired Wilsons Leather and in doing so branched into retail for the first time. To further expand on its retail business the company is moving into owning and operating footwear and accessory retail outlet stores and is planning to open a number of these stores under the name “Vince Camuto”. The roll out of these stores will begin in early 2012 and 10 stores are expected to open in 2012.
97% of sales of G-III are made in the US. The company is now marketing its products in Canada and Europe, and huge scope for growth exists through geographic expansion of sales.
The business is divided into 3 segments – wholesale licensed apparel which makes up around 68% of revenue, wholesale non-licensed apparel and retail operations. Its retail operations are still small, but expansion is underway and GIII will continue to focus on growth in this arena.
GIII is heavily exposed to the cost of raw materials required to make their apparel and accessories, but being a large, well-diversified player with infrastructure around the world (GIII utilizes independent manufactures in China, Vietnam, India, Indonesia, Thailand, Sri Lanka, Taiwan, Central and South America, Pakistan, Bangladesh and the US) the company is in a better position than most of its competitors to withstand cost pressures.
Conclusion
GIII has performed reasonably well and does appear to have a bright future, but investors may wish to sit on the sidelines and monitor the company for the time being while the company gets its accounts receivables, and ultimately Free Cash Flows in order. An investor will want to see a higher Margin of Safety than that currently on offer also.
Analysis of Warren Buffett's Recent $11B IBM Investment.
Warren Buffett announced on CNBC on Monday of last week that he has invested $10.7B into IBM. Buffett has also recently invested an amount of money in Intel. Let’s look at what Buffett sees in IBM in particular.
In 2007, IBM laid out a roadmap to achieve $10-$11 of earnings per share by 2010. At that time the EPS was $6.11 for 2006. In 2010 IBM achieved an impressive EPS of $11.53, thereby exceeding their target. Now, in 2011, IBM has laid out a roadmap for 2015 of $20 per share. If they achieve this target, their EPS would increase by a compounded annual growth rate of 11.6%. This target is based on a conservative base revenue growth of 2%, plus revenue growth achieved through strategies such as shifting to a faster growing business mix, further growth through acquisitions, and their EPS values will enhance through continued large share repurchases.
IBM is buying back a lot of shares which adds value to shareholders. When a company repurchases its own shares, they have 2 options – they can either retire the shares, or report them as “treasury shares” and keep them in their coffers for possible future issuance. In the case of IBM they have kept all its share repurchases such that on the balance sheet the company has a negative number of $100B (that is not a typo – it is a “B”) which makes its shareholders equity smaller and hence return on equity higher. We see this as slightly misleading – its return on equity certainly looks better than if they simply retired the shares as most companies do.
As Buffett touched on in the interview, IBM’s competitive advantage lies in the switching costs of its customers. Even ignoring the expense, it is too much of a hassle for large companies to change over their IT service provider. Buffett also mentioned in his interview on CNBC that IBM recorded double digit growth in 40 countries in 2010. IBM is positioning itself well to take advantage of the development of emerging economies, and the majority of IBM’s organic growth will be achieved in that area.
Quality Rating
Source: usastockvaluation.com
IBM’s quality rating is not as great as one might expect. The reason is perhaps due to the fact that IBM is so big, and hence growth rates are not as high as a smaller company. Having said that, other big tech companies such as Apple (AAPL), Google (GOOG) and Microsoft (MSFT) enjoy much higher quality ratings. The other reason is IBM’s persistently high net debt to equity ratio – though as mentioned above, IBM’s reported shareholders’ equity is perhaps lower than it should be, resulting in a misleadingly high net debt to equity ratio.
Intrinsic Value
Source: usastockvaluation.com
A reasonable Margin of Safety exists at the moment for IBM. For a big strong company such as IBM, an investor will almost never see a really large Margin of Safety, and so apart from exceptional circumstances (such as March 2009), the current Margin of Safety is around about as big as it gets.
We recently analyzed Microsoft (MSFT) and it had a similar looking graph to IBM. During the dot com bubble all tech stocks became well overvalued, and once the bubble burst some of the bigger and better companies such as MSFT and IBM were spared in the slaughter, relatively speaking. So as a result, their share-price remained overvalued. Since then the share-price has gone sideways while Intrinsic Value catches up. As can be seen from the above graph, it didn’t take long for IBM’s Intrinsic Value to catch up to its share-price, and over the last 7 years or so the Intrinsic Value has stormed ahead and left IBM’s share-price in its wake. Now does look to be a fantastic opportunity to buy into a big strong 100 year old company. From a value point of view, Buffett looks to have nailed this one on the head. But how could a company trading at around 52 week highs be “in value”? The answer?: 52 week highs & lows tell you absolutely nothing about a company’s business performance relative to its share-price.
Investment Grade Score
With a Margin of Safety of 30, and a Quality Rating of 59, IBM achieves an Investment Grade Score of 18 which places it at number 104 in the USAStockValuation.com Investment Grade Table. By multiplying the Margin of Safety by the Quality Rating (then dividing by 100), only those companies with a good combination of quality and value make the upper echelons of the Investment Grade Table.
Conclusion
Warren Buffett in his role at Berkshire Hathaway (BRK) has to invest huge amounts of money. In 2010, BRK generated an average of $1B per month in free cash flow and that is $1B per month that Buffett has to find a home for. Buffett only investigates huge companies because it is only huge companies that have enough market capitalization to be able to absorb the huge dollars that Buffett has to invest. The average investor such as you and I have a massive advantage over Buffett in this case. We can invest in young up and coming companies with wonderful growth prospects (one that springs to mind immediately is MED), whereas Buffett can’t. In terms of percentage returns, this gives us an extraordinary advantage over Buffett. Because he has to invest large amounts of money, it is impossible for Buffett to earn the sort of percentage gains that he enjoyed 30 or 40 years ago. Buffett has to invest in the best of the big companies, whereas we can invest in any listed company.
For you and I, we can analyze medium cap and small cap stocks to find companies with wonderful long term growth prospects. Companies that are yet to be covered by mainstream analysts, and hence yet to be recognized by the market. We at USAStockValuation.com like to see portfolios focused on investing over the long term (5-10 years) in these young up and coming companies (just a Buffett did 30+ years ago). Extraordinary long term wealth can be generated this way. But the idea of portfolios holding one or two “stalwarts” in there as well so as to smooth out volatility has merit also. There are plenty of other more attractive investment opportunities available at the moment to the average investor, but an investor who is looking to add a big, high quality “stalwart” to their portfolio may like what they see in IBM at current prices. For Buffett, who can only invest in large cap companies, IBM looks to be a great choice. The master is back in form.
Intel
And just a few quick notes on Intel – it has zero net debt, a USAStockValuation.com Quality Rating of 69/100, a current Intrinsic Value of $23.39 (vs a shareprice of around $24.30) rising to $25.62 next year and $28.37 in 2013. It’s NROE for 2010 was an excellent 25%. Without conducting further analysis, it is hard to see what entices Warren Buffett to invest in Intel given the lack of Margin of Safety. Back in August and September (which is perhaps when Buffett bought into it?) it was around $20 which was better value than the current share-price.
Rio Tinto Plc (RIO) is a diversified mining company involved in finding, mining, and processing resources such as aluminum, copper, diamonds, thermal and metallurgical coal, uranium, gold, industrial minerals (borax, titanium dioxide and salt) and iron ore. The company has a number of major operations in Australia and North America, with other significant operations in Asia, Europe, Africa and South America.
The company was founded in 1873 with its first operation being on the Rio Tinto river in Spain. Throughout its history, the company has acquired whole and partial stakes in a myriad of smaller companies allowing the company to diversify both in terms of commodities as well as geographical presence. The largest acquisition was in 2007 which was a purchase of Canadian aluminum company, Alcan for $38.1B which took RIO’s net debt to equity to a dangerously high 180%. RIO is about the 4th largest publicly listed mining company in the world based on market capitalization.
RIO has now got its balance sheet in order, which puts the company in such a stronger and safer position. RIO was highly leveraged in 2007 which put them in a very difficult situation once the global financial crisis set in and commodity prices took a dive. The company was almost taken over by BHP Billiton during that period, and in the end accepted a large investment by Chinalco, a Chinese mining enterprise, in order to meet its debt obligations.
The company is broken down into 5 business units as follows:
Aluminum: includes bauxite, alumina and aluminum. RIO is the largest bauxite producer in the industry. A lot of these operations are self powered by hydroelectricity
Copper: includes gold, molybdenum, silver, nickel and copper. RIO is the worlds 5th largest producer of copper
Diamonds & Minerals: includes diamonds, borates, titanium dioxide feedstocks, talc, high purity iron, metal powders, zircon and rutile. RIO has a number of projects in the pipeline in this business unit.
Energy: includes thermal coal, coking coal and uranium. Much of its products are sold in Asia in close proximity to their mines in Australia.
Iron Ore: includes iron ore and salt. RIO is the 2nd largest producer supplying the global seaborne iron ore trade. Much of its iron ore comes from Western Australia which is in close proximity to China.
Source of Data: riotinto.com
Recent Performance
2010 was a stellar year for RIO with net income increasing from $4.9B in 2009 to $14.3B in 2010. Most of this increase came due to much larger volumes of iron ore produced as well as the high price of iron ore. The revenue of the Iron Ore division, which is by far the largest, doubled from 2009 to 2010.
The company faced challenges in early 2011 due to severe weather conditions which hampered some of RIO’s operations but the company bounced back well in 3rd quarter 2011, which was another record quarter.
By the 12th October this year, 69 million RIO shares had been bought back at a total cost of $4.4B. While the shareprice is below Intrinsic Value, buying back shares is a good idea as it adds shareholder value. RIO announced that it intends to spend a further $2.6B in share buy-backs by the end of 1st quarter 2012.
RIO’s balance sheet is healthy with a net debt to equity of 9%, with $14B of long term debt, $1B of short term debt, and almost $10B in the bank. It also generated an impressive $13.7B in cashflow during 2010. RIO is a wonderful generator of cash which places it well to purchase other assets, pay down debt, pay a dividend, or buy back shares.
Quality Rating
Source www.usastockvaluation.com
Interestingly, RIO only scores a moderate quality rating score. This is due in part to the serious effect that the Global Financial Crisis had on RIO and also its aggressive capital expenditure regime. Importantly RIO scores a perfect 10 on cash flow.
Intrinsic Value
Source: www.usastockvaluation.com
RIO is well positioned to capitalize on the China growth story should it continue. Unless China falls in a heap, RIO’s IV will continue to rise dramatically in the coming years.
The performance of RIO is in general dependent on the price of iron ore. The hiccup in performance of RIO during the Global Financial Crisis is plain to see. For the last few years though, with the price of iron ore and other commodities strong, the performance of RIO has improved drastically. For stock market participants interested in investing in RIO, the graph illustrates that now looks to be a good time. The value has stormed ahead, and the price has yet to catch up.
Investment Grade Score
The Margin of Safety of RIO is 44% based on the USAStockValuation.com method of calculating Margin of Safety which is: (Intrinsic Value – Share Price) / Intrinsic Value. And the Quality Rating of RIO is 65/100.
This gives an Investment Grade Score of (44 x 65) / 100 = 29 which places RIO at number 54 on the USAStockValuation.com Investment Grade Table. By multiplying the Margin of Safety by the Quality Rating, only those companies with a good combination of quality and value make the upper echelons of the Investment Grade Table.
Drivers of Future Growth
On the back of a stronger balance sheet, RIO is investing for its future by ramping up its capital expenditure. RIO’s capital expenditures of $5.1B for the first half of 2011 already exceed the total capital expenditure for all of 2010 which was $4.6B. The below production profile gives an illustration of the expected increase in production up to 2015 as a result of the current and future projects in RIO’s portfolio:
Source: riotinto.com
With mining companies, the general rule is the bigger they are, the lower the costs per unit to produce. This is because high production means economies of scale and lower cost per unit measure of the resource being produced. Another advantage of large mining companies such as RIO is their project execution capabilities which have been proven time and time again over many years.
The major risk on RIO is its large iron ore division and its subsequent dependence on the price of iron ore, which in turn is dependent on the China growth story continuing. 28% of RIO’s sales come from China, but more importantly the urbanization of China is propping up the price of iron ore. If China were to fall in a heap it would be disastrous for RIO, at least in the short term. See below an illustration on the urbanization of China with the US as a point of reference.
Source: zdlaw.com
Conclusion
Through operating large scale operations, RIO produces at a lower cost per unit volume/weight than most of its peers. It enjoys strong cash flows and its future looks bright. RIO is also paying a $1.07 dividend which based on the current shareprice of $55.5 provides a yield of 1.9%.
The risk to investors in RIO is a downturn in the Chinese economy and for those who believe the Chinese economy may dive will want to stay away. Conversely, the current price of RIO should be very attractive for investors who believe the China urbanization story will continue.
BBVA Banco Frances S.A. (BFR) Analysis
BBVA Banco Frances S.A. (BFR) was founded in 1886 in Buenes Aires and is the oldest private bank and the 3rd largest bank in Argentina. Through a network of over 280 branch offices, the company is one of the main providers of financial and non-financial services to businesses and consumers in Argentina. It is currently owned and controlled by Banco Bilbao Vizcaya Argentaira SA (BBVA) which is a multinational Spanish banking group and the 7th largest financial institution in the Western world.
BFR is very conservatively run with unusually high levels of liquidity and solvency for a bank. It has cash of over $1B and no net debt.
BFR & the Argentine Economy
From its inception in 1886, BFR has ridden through all the highs and lows of the Argentine economy and come out the other side in one piece – and with a superb balance sheet. It has developed into a strong, stable and conservative financial institution.
The graph below shows the ups and downs of the Argentine economy. Few other countries have had such a volatile economic history.
Source: SSPE Ministry of Economy
Today
The Argentine economy grew around 9% in 2010, and the 1st and 2nd quarters of 2011 were similarly impressive. But Moody’s has a negative outlook on Argentina’s banking sector citing unsustainable government policies and general political risk as the source of the strain on the sector. And according to Routers, many private economists suggest inflation is running at over 20% whereas the government’s official number is around 10%. It seems the Argentina’s turbulent high growth high inflation story is set to continue.
The biggest risk to the Argentine economy remains the high inflation rate. Exports will lose their competitiveness with higher prices, and private consumption will gradually decrease as the price of goods and services becomes too expensive. The flow on effects could result in lower economic activity throughout the country which in turn will have negative flow on effects to Argentine banks such as BFR. With its impeccable balance sheet, and over 125 years operating in Argentina, BFR is certainly well positioned to ride out challenging economic periods.
BFR is a wonderful generator of cash. For the last 10 years, BFR has reported total net earnings of $690M while free cash flow has totalled $1.8B over the same time. Since 2003 BFR has enjoyed zero net debt, and today enjoys a sublime balance sheet with over $1B in cash. We like to see this sort of net cash position for a number of reasons. It allows the company to ride through any challenging times that might lay ahead, and it allows the company to take advantage of any opportunities to acquire distressed competitors to further strengthen their position. It also allows the company to buy back shares and pay dividends.
2010 was a great year for BFR, increasing net income from $188M to $301M and achieving a 35% NROE. $121M of the net income was distributed to shareholders providing shareholders with an attractive yield. Based on the current shareprice of around $6.30, the dividend yield for 2011 currently sits at over 17%, but investors should not rely on the dividend too much. The payout ratio over the last 10 years has been 100%, 0%, 0%, 0%, 0%, 8%, 28%, 43%, 4%, and 39% so a shareholder certainly cannot rely on the dividend. The payout ratio for 2011 is not far off 100%, so though the yield looks attractive at the moment, it almost certainly won’t last – at least not above 17%!
Quality Rating
Source: www.usastockvaluation.com
The Quality Rating of BFR is not too bad at 65. The company had a terrible year in 2002 posting a loss of $367M which is especially bad considering they posted an impressive gain of $301M last year. The terrible year in 2002 dragged some of the quality rating scores down considerably. The performance of BFR from 2007 to 2010 in particular has been good though.
Intrinsic Value
Source: www.usastockvaluation.com
The Intrinsic Value is going sideways for the next few years, but the IV is way above the share price. Indeed the shareprice is only about 15% above the reported book value.
For most of the last 10 years, the shareprice has been well above the IV, but that trend reversed in 2008. The shareprice went as low as $2.2 in late 2008/early 2009. The shareprice started to take a pounding in 2007 during the start of the credit crunch where all financial stocks fell out of favor. During the 2009/2010 market recovery the shareprice headed up again towards the IV line before dropping significantly in 2011 due once again to the general downward pressure on all financial stocks. The dramatic drop in shareprice in 2011 has created the potential opportunity we see today.
Investment Grade Table Position
Source: www.usastockvaluation.com
BFR takes position number 33 this week on the USAStockValuation weekly Investment Grade Table. The investment grade table multiplies the quality rating and margin of safety together before dividing by 100 to get the Investment Grade Score. This allows only those companies with a good quality rating and margin of safety combination to make the table.
Conclusion
The Argentine economy has endured extreme highs and lows, and for over 125 years BFR has not only endured those extremes, but has actually thrived on them. During periods of economic slumps BFR has grabbed the opportunity to take over its distressed competitors, while during periods of economic prosperity BFR has built up its balance sheet ready for another acquisition.
BFR has over $1B in the bank (compare this to its market cap which is also slightly over $1B), zero debt, has proven itself over 125 years, is currently paying an above 17% dividend yield (though that won’t last), and is trading only slightly above book value. The upside potential vs downside risk for BFR is attractive, and many investors will see good value at current prices.