Brazil Fast Food Company Is Substantially Undervalued and Has A Moat

In this article I will be talking about Brazil Fast Food Company (BOBS.OB).  Bob’s was founded in 1952 by American tennis player Bob Falkenberg and serves hamburgers and sandwiches with a Brazilian twist, shakes, French fries, and other typical fast food offerings.  BOBS has grown to become the second biggest fast food chain in Brazil with operations in every state of the country, Angola, and Chile.

When I talk about BOBS in all capital letters I mean the company as a whole.  When I refer to Bob’s it means just the fast food burger chain.

A fellow value investor mentioned on my blog that I should research BOBS as a possible investment since I have already researched and written articles on a couple fast food companies; Jack In The Box (JACK) and Wendy’s (WEN).  Also with my recent turn towards concentrating on micro caps he thought I might find this company interesting.

I have found BOBS to be very interesting and it has turned into only the fifth company I have bought into this year as it meets most of my criteria for things I look for in a potential investment.  Some main points of interest are: I have found BOBS to be substantially undervalued, I believe BOBS to have a competitive advantage, or moat that has been growing in the past several years, the company is very small and under followed, and its sales and margins have also been growing in recent years.

Introduction

For the better part of the last 60 years Brazil Fast Food has been operating and franchising only its Bob’s fast food burger chain and expanding the chains reach throughout Brazil.  Here is a history of BOBS up to 2004 that goes over its many struggles and near death multiple times. Very interesting read especially when you consider what they have become now.  After updating its stores, changing the Bob’s logo, enacting cost cutting and efficiency measures, and changing its strategy to become a multi-brand restaurant company with partnerships to bring KFC and Pizza Hut restaurants to Brazil, and through acquiring Doggi’s and Yoggi’s, BOBS has expanded its restaurant count dramatically and expanded from just selling burgers, sandwiches, shakes, and fries, into selling KFC’s chicken related products, pizza’s, hot dogs, frozen yogurt and smoothies to become the second largest fast food chain in Brazil.

As we found out in my Wendy’s article, growth is not always a good thing if your cost of capital is very high due to debt and other costs.  Luckily, BOBS debt is at a very manageable level and BOBS has been lowering its costs over the last few years.  The growth in the amount and type of products along with the growing restaurant count has helped grow revenues and margins at pretty substantial percentages over the last several years.  Most importantly of all, I believe BOBS is growing at less than its cost of capital because as it has grown its store count and sales it has become more profitable.

Also helping to grow BOBS as a whole is that I believe that it has at least some minor competitive advantages which it has had for a while now but has only recently been fully unleashed due to BOBS growing scale as it pertains to its growing number of restaurants, and its cost cutting and efficiency measures over the last several years.  At this point I cannot say for certain whether the small moat I see for BOBS is sustainable for the long term, but this is the first company I have evaluated in a while where I see some kind of very clear moat.

Overview of Operations and Subsidiaries

Before 2007, Brazil Fast Food Company just comprised of Bob’s burger chain which I described above.  In 2007 BOBS as a whole started on its path towards becoming a multi-brand restaurant operation as it agreed with Yum Brands (YUM) to open KFC restaurants in Brazil.  In 2009 BOBS further expanded to include operating some Pizza Hut’s in Brazil and it also acquired Doggi’s hot dog chain.  In 2012 BOBS further expanded as it acquired Yoggi’s frozen yogurt and smoothie company.  Since its beginnings as a regional company in Brazil with the bulk of its operations in the Southeastern portion of the country, BOBS has grown into the second biggest fast food chain in Brazil behind only McDonald’s (MCD) with operations in every state in Brazil.  BOBS has also started to grow outside of Brazil as it now has operations in Chile and Angola.  Below is a chart showing how BOBS has grown its restaurant count since 2007.

Restaurant count has grown by 7% annually since 2007.  Its growing size and now countrywide operations have enabled BOBS to sign some very favorable agreements with suppliers.  Here are some direct quotes from BOBS 3Q 2012 10Q about the favorable relationship with its trade partners.  Emphasis is mine.

“We enter into agreements with beverage and food suppliers and for each product, we negotiate a monthly performance bonus which will depend on the product sales volume to our chains (including both own-operated and franchise operated). The performance bonus can be paid monthly or in advance (which are estimated), depending on the agreement terms negotiated with each supplier. The performance bonus is recognized as a credit in our Consolidated Statements of Operations (under “Revenues from Trade Partners”). Such revenue is recorded when cash from vendors is received, since it is difficult to estimate the receivable amount and significant doubts about its collectability exists until the vendor agrees with the exact bonus amounts.”

‘The rise in the number of franchisees, from 774 on September 30, 2011 to 916 on September 30, 2012, together with the expansion of the multi-brand concept, has given the Company’s management greater bargaining power with its suppliers. Such increase of point sales did not derived an increase on Revenue from Trade Partners from 2011 to 2012, because the Company had agreements with new trade partners during 2011 and 2010 which originated bonus paid in advance. The bonus recorded during 2012 was from the regular business since no further advances were received during 2012.”

BOBS also has several exclusivity agreements including with Coca-Cola (KO).

“We participate in long-term exclusivity agreements with Coca-Cola, for its soft-drink products, Ambev, the biggest Brazilian brewery company, Farm Frites, the Argentinean producer of French fries, and Sadia, one of the biggest meat processors in Brazil, as well as with Novartis Nutrition for its Ovomaltine chocolate. These agreements are extensive from four to five years. The Coca-Cola agreement was amended in 2008 to extend the exclusivity period to April 2013.”

“Amounts received from the Coca-Cola exclusivity agreements (see note 12) as well as amounts received from other suppliers linked to exclusivity agreements are recorded as deferred income and are being recognized on a straight line basis over the term of such agreements or the related supply agreement. The Company accounts for other supplier exclusivity fees on a straight-line basis over the related supply agreement. The Coca-Cola agreement was amended in 2000 to extend the exclusivity period to 2008.  Later amended and extended until April, 2013. Performance bonuses may also include exclusivity agreements, which are normally paid in advance by suppliers.”

Due to its growing size and economies of scale BOBS has gained a competitive advantage over competitors by being able to receive “bonus payments” in advance from some of its suppliers.  Its size and scale has enabled the company to sign these preferential and exclusive agreements, which have helped expand BOBS competitive position and moat in my opinion.  Another reason I think BOBS has at least a minor moat is because it has been able to raise prices in recent years without losing sales which has helped to raise margins.

BOBS has had these preferential agreements in place for years, and hopefully will be able to continue them for years to come.

Due to BOBS growing store count, the agreements above, and the moat that I think it has, BOBS has been able to improve its sales, reduce its costs, and improve margins in recent years.  Numbers in below charts are taken from Morningstar or BOBS filings.

As you can see in the above charts as BOBS restaurant count has grown, it sales have gone up, costs have gone down, and margins have gone up, substantially so since 2008.  As BOBS continues to grow the same three things should continue to happen as BOBS should continue to compound its economies of scale: More restaurants means more sales, more restaurants means more compact grouping of restaurants which means lower costs and higher margins.  It seems that BOBS has taken some lessons on how to cultivate and grow competitive advantages from companies such as Wal-Mart (WMT).

Margins

All numbers are taken from Morningstar, Yahoo Finance, or BOBS financial reports unless otherwise noted.

Gross Margin TTM	28.00%
Gross Margin 5 Year Average	24.12%
Gross Margin 10 Year Average	24.53%
Op Margin TTM	8.43%
Op Margin 5 Year Average	7.26%
Op Margin 10 Year Average	5.39%
ROE TTM	31.64%
ROE 5 Year Average	31.35%
ROIC TTM	23.76%
ROIC 5 Year Average	21.43%
My ROIC Calculation With Goodwill	45.10%
My ROIC Calculation Without Goodwill	48.30%
My ROIC TTM With Goodwill Using Total Obligations	15.56%
My ROIC TTM Without Goodwill Using Total Obligations	15.25%
FCF/Sales TTM	-3.54%
FCF/Sales 5 Year Average	-1.43%
FCF/Sales 10 Year Average	-1.39%
P/B Current	2.5
Insider Ownership Current	70.36%
My EV/EBIT Current	2.72
My TEV/EBIT Current	6.75
Working Capital TTM	22 $R Million
Working Capital 5 Yr Avg	0.4 $R Million
Working Capital 10 Yr Avg	-3.1 $R Million
Book Value Per Share Current	$3.17
Book Value Per Share 5 Yr Avg	$1.89
Float Score Current	0.88
Float Intensity	0.6
Debt Comparisons:
Total Debt as a % of Balance Sheet TTM	16.78%
Total Debt as a % of Balance Sheet 5 year Average	16.40%
Current Assets to Current Liabilities	1.56
Total Debt to Equity	1.71
Total Debt to Total Assets	72%
Total Obligations and Debt/EBIT	4.36

Margin Thoughts

Please reference my Wendy’s or Jack in the Box articles linked above to see how BOBS compares to the other fast food companies.  TEV/EBIT and last three debt numbers talked about also include total obligations.

• Almost across the board BOBS margins have been improving over the 5 and 10 year periods I looked at.  Especially impressive are its ROE and ROIC.
• In comparison to the other fast food companies I have evaluated, BOBS margins are at worst about at the industry average or better than those companies.
• My estimates of ROIC make the company look absolutely exceptional as I estimate that without total obligations its ROIC is 45.1% with goodwill, and 48.3% without goodwill.  Even if I count total obligations its ROIC with goodwill is 15.25%, and without goodwill is 15.56%.  Numbers that are close to McDonald’s ROIC.
• Even if we just count BOBS 5 years average ROIC using Morningstar’s numbers of 21.43%, which is what I used when I evaluated the other fast food companies, its margin is 6.35% points better than the industry average, and better than McDonald’s by 4.05% points.  Its ROIC is only bested by Yum Brands ROIC which is inflated by debt unlike BOBS.
• FCF/Sales for BOBS is worse than the industry average by 8.78% points and regularly negative over the past several years, and still negative this year.
• I think that its FCF/Sales margin is negative due to cap ex related to renovating and updating some of its restaurants.
• BOBS P/B is lower than the other fast food companies by a substantial margin.  The only company with a lower P/B is Wendy’s which as I talked about in my article on them, should be higher.
• Insider ownership above 70% for BOBS is fantastic, especially in comparison to the other fast food companies.  BOBS is effectively a controlled family run company as four individuals own a combined 63.2% of BOBS as of the 2011 annual report: Ricardo Figueiredo Bomeny; the CEO and CFO of BOBS.  Jose Ricardo Bosquet Bomeny; father of Ricardo and brother of Gustavo, business partner with Romulo and owns 20 of BOBS franchised restaurants.  Romulo Borges Fonseca; owns 22 of BOBS franchised restaurants and business partner with Jose.  Gustavo Figueiredo Bomeny; brother of Jose and uncle of Ricardo.
• I am estimating BOBS EV/EBIT to be only 2.72 and it’s TEV/EBIT to be only 6.75.  BOBS EV/EBIT is lower than any company I have evaluated thus far and it is lower than the other fast food companies I have evaluated whose EV/EBIT average including Wendy’s is 20.12.  As I have stated before, I like to buy companies that have EV/EBIT and TEV/EBIT ratios lower than 8 so BOBS on a relative basis looks very cheap, especially when you consider it’s very high ROE and ROIC and other margins that have been growing.
• Book value has been growing and BOBS debt levels look very sustainable to me.

Due to the sales and margin growth mentioned above, working capital has gone from negative for the better part of the past decade to now being solidly positive, BOBS accumulated deficit has almost disappeared and shareholders equity has improved drastically, all of which can be seen in the chart below.

Other Things Of Note

• BOBS intends to focus its efforts on expanding both the number of its franchisees and the number of its franchised retail outlets, neither of which are expected to require significant capital expenditure. In addition, the expansion will provide income derived from initial fees charged on new franchised locations.
• BOBS franchise agreements generally require the franchisee of a traditional Bob’s burger restaurant to pay us an initial fee of $R 60,000, which is lower for kiosks and small stores, and additional monthly royalties fees equal to 5.0% of the franchisee’s gross sales.  Bob’s fast food burger restaurants make up the vast majority of total restaurants in BOBS system.
• Lowered franchise fee in recent years from $R 90,000 to $R 60,000 to help attract more franchisees.
• BOBS has bought back shares recently and is authorized to buy back more shares.  I think management has bought back shares at reasonable prices and I think now would be a good time to buy back even more shares.  On December 5th, 2012 Mr. Romulo Borges Fonseca bought an additional 30,500 shares in the open market.  I love to see buys from insiders who acquire their shares in the open market.  Insiders generally only buy for a couple reasons: They think the company is undervalued, and/or that the company is going to perform well into the future.
• Operating margin for franchises used to be over 80%.  Recently it has dropped into the mid 60% range and it seems to have stabilized in that area.  It looks like the drop in franchise operating margin is due to franchise related costs rising.
• BOBS has been an OTC listed company for years, and this year it deregistered its shares with the SEC to save money every year, approximately $300,000.  BOBS management says that it will continue to provide quarterly and annual reports to shareholders and that it will retain its reporting standards at the level they are at now.  BOBS management has been in place for nearly 20 years so these things do not bother me that much as management has done a good job running the company over the years.
• There are only 51 current shareholders of BOBS stock so the company is very under followed.
• BOBS has substantial tax loss carry forwards NOL’s: As of December 31, 2011 relating to income tax were R$31.6 million, $1.88 per share, and to social contribution tax were R$57.6 million, $3.42 per share.  Social contribution tax is similar to the corporate tax here in the US.
• Due to its small size with a market cap around $65 million, only 51 shareholders, and it being a controlled company with 70% of BOBS owned by insiders and/or affiliates of the company, average daily volume is only 2,000 shares, and in the past two weeks about half of the days the market has been open there have been no shares traded.
• Same store sales have been rising in the 4% range every year since 2007.

Intrinsic Valuations

These valuations were done by me, using my estimates and are not a recommendation to buy stock in any of the companies mentioned. Do your own homework.

Valuations were done using BOBS 2011 10K and 2012 third quarter 10Q. All numbers are in millions of Brazilian Real, except per share information, unless otherwise noted.

Low Estimate of Intrinsic Value

				Numbers:
Revenue:				237
Multiplied By:
Average 5 year EBIT %:				7.26%
Equals:
Estimated EBIT of:				16.99
Multiplied By:
Assumed Fair Value Multiple of EBIT:				8X
Equals:
Estimated Fair Enterprise Value of STRT:				135.92
Plus:
Cash, Cash Equivalents, and Short Term Investments:				28.4
Minus:
Total Debt:				21
Equals:
Estimated Fair Value of Common Equity:				143.32
Divided By:
Number of Shares:				8.1
Equals:				17.69 R$ per share.
Equals:				$8.48 per share.

Base and High Estimate of Intrinsic Value

EBIT and net cash valuation

Cash and cash equivalents are 28.4

Short term investments are 0

Total current liabilities are 38.7

Number of shares are 8.1

Cash and cash equivalents + short-term investments – total current liabilities=

• 28.4-38.7=-10.3/8.1=-1.27 R$ per share=-$0.61 per in net cash per share.

BOBS has a trailing twelve month EBIT of.

5X, 8X, 11X, and 14X EBIT + cash and cash equivalents + short-term investments:

• 5X21.2=106+28.4=134.4/8.1=16.59 R$ per share=$7.93 per share.
• 8X21.2=169.6+28.4=198/8.1=24.44 R$ per share=$11.69 per share.
• 11X21.2=233.2+28.4=261.6/8.1=32.30 R$ per share=$15.45 per share.
• 14X21.2=296.8+28.4=325.2/8.1=40.15 R$ per share=$19.20 per share.

From this valuation I would use the 8X and 11X estimates of intrinsic value as my base and high estimates of intrinsic value respectively.  None of the above valuations takes into account BOBS $5.30 per share worth of NOL’s or BOBS future growth.

Relative Valuations

• As I said above, I like to buy companies whose EV/EBIT and TEV/EBIT ratios are lower than 8 and BOBS ratios are at 2.72 and 6.75 respectively.  BOBS EV/EBIT ratio is the lowest I have found out of the companies that I have done full evaluations on.
• Its P/B ratio is also quite a bit lower than other fast food companies.
• BOBS P/E ratio of 9.1 is less than half of the industry P/E of 19.8.

I found BOBS to be cheap on an intrinsic value basis and it also looks to be equally cheap on a relative valuation basis.  On an EV/EBIT basis, BOBS is the lowest valued company I have fully analyzed which is a bit shocking considering its high ROIC and other margins, and the moat that I think it has.

Competitors

• McDonald’s (MCD): The number one fast food chain in Brazil and fast food behemoth around the world always provides stiff competition to smaller companies.  Here is some information on Arcos Dorados (ARCO)the largest operator of McDonald’s restaurants in Latin America and the world’s largest McDonald’s franchisee.  As of its 2011 10K it had 662 McDonald’s restaurants in Brazil.  Arcos Dorados’ margins are quite a bit worse than BOBS margins.  Overall McDonald’s has more than 1,000 restaurants in Brazil.
• Giraffas: A private company with around 400 restaurants most of which are in Brazil, it has recently started opening restaurants in South Florida.  Serves similar food as Bobs burger chain.
• Yogoberry: Another private company who has more than 100 restaurants in Brazil.  Will be competing with BOBS latest acquisition Yoggi’s in the frozen yogurt and smoothie arena.
• Various other fast food offerings including from Japanese, Middle Eastern, and other typical fast food restaurants.

The fast food service industry is very competitive in Brazil as it is here in the US with peoples income being sought after by a plethora of restaurants and fast food companies.  I think the major threat is of course McDonald’s as BOBS other local competitors are generally quite a bit smaller than it.  I think that due to the moat I see within BOBS, along with its growing size, and expansion into pizza, frozen yogurt, and chicken, that it can compete very well with the competition it has in Brazil, and continue to grow its store count profitably.

Pros

• BOBS is cheap on an intrinsic value and relative value basis.
• I think BOBS has a small and growing moat that should continue to grow as BOBS restaurant count gets bigger.
• BOBS margins generally have been growing over the past five years.  In some cases by multiple percentage points.  Some of BOBS margins are even better than McDonald’s and quite a bit better than Arcos Dorados’ run McDonald’s restaurants in Latin America.
• BOBS has signed exclusivity agreements with several companies including Coke, and also enjoys preferential agreements with its suppliers.
• BOBS has $5.30 per share worth of NOL’s that are not even counted in any of my valuations.
• BOBS has a low and sustainable amount of debt.
• Its book value per share has been growing.
• BOBS has almost eliminated its accumulated deficit, made its working capital positive after it being negative for most of the last decade, and substantially increased shareholders equity.
• COGS and total restaurants costs and expenses as percentages of sales have been lowered by multiple percentage points in recent years.
• The company is effectively controlled by four individuals who have thus far done a very good job of running the company.
• BOBS has bought back some shares and has the authorization to buy back more shares.
• BOBS can grow its restaurants through franchisees at minimal cap ex expenses.  Franchise operating margin has been in the mid 60% range recently.
• Brazil has a growing middle class that should help grow sales further.

Cons

• Although I think BOBS has a small and growing moat, it may not be a long term sustainable competitive advantage due to competition and possible loss of exclusivity and preferential trade partner agreements.
• BOBS does not create consistent positive FCF.
• BOBS FCF/Sales margin is below the average of the other fast food companies I have evaluated and it is also negative.
• Franchise operating margin has dropped from over 80% to the mid 60% range in recent years.
• Stiff competition including McDonald’s in Brazil.

Potential Catalysts

• Confederations Cup in 2013, FIFA World Cup in 2014, and the Olympics in 2016, all of which are in Brazil, will bring millions of tourists to Brazil which should help grow BOBS revenues further in the short and medium term.
• BOBS growing franchise store count will help grow BOBS moat as margins are very high and cap ex is very low when opening new franchised restaurants.
• BOBS moat may not be sustainable over the long term due to competition and possible loss of exclusivity and preferential trade partner agreements which would most likely hurt the company.
• Brazil’s growing middle class should also help grow sales.

Conclusion

Brazil Fast Food Company, BOBS, has turned out to be a very interesting company to me. From its near death experiences in the mid 90’s and early 2000’s, to now being the number two fast food chain in Brazil, its growing store count and margins, and the various other things I have talked about in this article I have come away very impressed with BOBS as a whole and its management.

I think that BOBS is very undervalued on an intrinsic value and relative value basis and I think that it should conservatively be valued somewhere between $11.50 and $16.00 per share, not including the $5.30 per share in NOL’s that it currently has.  Adding the NOL’s to my estimates of value would take its estimated value up to between $16.50-$22 per share which is the range that I think BOBS should be selling at, and what I think its private market value is.  Even leaving the NOL’s out of the equation, BOBS is selling currently at only $8 per share which is a 32% discount to the absolute minimum I think BOBS is worth at $11.50 per share.  I think that BOBS has a moat that could possibly grow over time, and that the company has catalysts in the short and medium term that could help unlock some of its value.

Warren Buffett always says that if you buy good companies that have some kind of moat at fair prices, that you will do very well investing over the years.  I think BOBS is a good company with a moat that is currently selling at a very cheap price and I think I will do very well holding it over the years as I have bought its shares in my personal account and the accounts I manage.

Advertisement

Intel Brief Thoughts and Valuations

Intel (INTC) is another company I bought before doing any type of valuations.  Intel is one of the first companies whose annual and quarterly reports I actually read, and it was noticeable even then with my limited knowledge to see its massive competitive advantages, huge margins, the free cash flow it creates, etc.  The following are descriptions taken from Morningstar.

Intel holds long-term advantages over smaller rival Advanced Micro Devices AMD in the microprocessor industry. While there have been rising fears that Intel may have trouble competing against emerging processor design firm ARM ARMH, we believe such panic has been blown out of proportion.

Intel is the largest chipmaker in the world. It develops and manufactures microprocessors and platform solutions for the global personal computer market. Intel pioneered the x86 architecture for microprocessors.

Asset Valuations

• With intangible assets and goodwill: $7.95 per share.
• Without intangible assets and goodwill: $6.71 per share.

EBIT and Net Cash Valuations

• Intel has $0.60 in net cash per share.
• 5X=$19.00 per share.
• 8X=$28.82 per share.
• 11X=$38.65 per share.
• 14X=$48.47 per share.

Revenue and EBIT Valuations

• 5X=$14.23 per share.
• 8X=$22.03 per share.
• 11X=$29.82 per share.
• 14X=$37.61 per share.

Operating Cash Flow and Free Cash Flow Valuations

• Low estimate=$12.05 per share.
• Base estimate=$17.62 per share.
• High estimate=$23.18 per share.

Price to Book and Tangible Book Valuations

• Low estimate=$11.51 per share.
• Base estimate=$16.82 per share.
• High estimate=$22.14 per share.

Debt Ratios

• Current assets to current liabilities=2.45.
• Total debt to equity=14.7%.
• Total debt to total assets=9.9%.

Intel’s current only competitor in the computer chip area is AMD who has always been a distant second place to INTC.  Also of note is that AMD’s CFO just resigned which is never a good sign.  Intel has also been increasing its business in the server arena where it also has huge competitive advantages and controls a big chuck of the space.

The only area where Intel has been struggling recently has been in the tablet and smart phone arenas, with Intel having to play catch up to Arm Holdings (ARMH) who was first and best in those areas.  Intel appears to be catching up to ARMH in the tablet and smart phone business segments as it currently has its chips in three smart phones, it will also have its chips in the upcoming Motorola Razr I, the Razr I will launch in October in Europe and Latin America, and its first Intel Powered tablets are going to be coming out in November.

Intel’s huge competitive advantages, size, and balance sheet, have enabled it to catch up to ARMH and I think it will soon surpass Arm Holdings in the mobile processor arena and extend its dominance into new profitable business segments.

Knowing what I know about Intel, its huge competitive advantages, gigantic margins, etc, I have decided to use the 11X EBIT and cash valuation, $38.65 per share, as my estimate of intrinsic value, a 40% margin of safety as its current share price is $23.32 per share.

Even if I were to use the 8X EBIT and cash valuation as my estimate of intrinsic value just to be safe, $28.82, that gets us to a 19% margin of safety.  I think the 8X estimate of value is too conservative with Intel’s massive competitive advantages however.

My current cost basis in Intel is $19.90 per share.  Again a bit fortunate to be up anything since I did not do any type of valuations before I originally bought into them.  With all of the above stated I am going to continue to hold Intel for the long term and have my investment compound hopefully years and decades into the future.

I will also look for opportunities when the stock price is at a healthy margin of safety to continue to add shares to my portfolio and for the portfolios that I manage, now looks like it would be a good entry point, and I will update when and if I buy any more stock in INTC.

Philip Morris Brief Thoughts and Valuations

Philip Morris International’s (PM) premium positioning of its strong brands, global scale, and addictive products give the firm a wide economic moat, in our opinion. While some of the company’s more mature markets are experiencing lower cigarette demand, we expect that the company’s Asian operations will continue to be an engine for the firm’s future growth.

Philip Morris International is the world’s second-largest tobacco company, behind only China National Tobacco, and holds 28% of the non-U.S./non-China global market. The firm owns seven of the leading 15 international brands. Marlboro, the company’s flagship brand, accounted for about one third of total volume in 2011. Other key brands include: L&M, Philip Morris, Bond Street, Chesterfield, Parliament, and Lark.

Both of the above descriptions were taken from Morningstar.

Asset Valuation

• With intangible assets and goodwill $11.73 per share.
• Without intangible assets and goodwill $8.34 per share.

EBIT and Net Cash Valuation

• Philip Morris currently has -$7.59 in net cash per share.
• 5X is $42.07 per share.
• 8X is $65.97 per share.
• 11X is $89.86 per share.
• 14X is $113.76 per share.

Revenue and EBIT Valuation

• Low estimate is $27.09 per share.
• Base estimate is $49.29 per share.
• High estimate is $71.50 per share.
  

Operating Cash Flow and Free Cash Flow Valuation

• Low estimate is $76.24 per share.
• Base estimate is $111.43 per share.
• High estimate is $146.62 per share.

Debt Ratios

• Current assets to current liabilities=0.92
• Total debt to equity is not applicable because PM has negative equity.
• Total debt to total assets=58%.

As with Vodafone, Philip Morris’ valuations are all over the place.

Philip Morris was spun off from Altria so that it could get away from the massive amount of litigation that is involved in the United States tobacco industry. Foreign countries are increasingly bringing litigation and sanctions upon tobacco companies that operate in their  respective countries such as Australia and Norway, but at this point it does not look to be a massive problem for PM.  It is something to watch for continuing into the future however as the proposed plain packaging could really hurt PM’s results as it would deemphasize the Marlboro brand and packaging.

Knowing what I know about its massive competitive advantages, which are generally the same as those I outlined in my Altria article, its risks, which are also generally the same as Altria’s, I would use the 11X EBIT and cash valuations, $89.86 per share, as my estimate of Philip Morris’ intrinsic value.  Philip Morris is currently selling at $89.48 per share meaning that there is absolutely no margin of safety.  My current cost basis for PM is $69.38 per share, up 27% since I bought in June of 2011.

Again, PM is one of the companies I bought before doing any kind of valuation so I am very fortunate to be up anything at this point. Philip Morris has gigantic competitive advantages, huge margins, creates a lot of free cash flow, pays a very good dividend, and buys back its shares.  My main concerns with PM long term are the same as Altria, a lot of debt, pensions, etc.

With my cost basis being so low I plan to hold onto my PM shares for years and hopefully decades and hope to have my investment compound well into the future.

Valuations and Brief Thoughts About Vodafone

Recently I decided it was probably time for me to value and analyze each of the companies remaining in my portfolio from before I truly dedicated myself to learning and becoming a “true investor.”  I had never valued any of the companies I am going to be writing about in the next several days.  I have read at least one annual report and one quarterly report, along with a myriad of other articles about each of the companies in the time since I bought them, and I am going to offer my brief thoughts on each.

I am also going to decide if I should keep, buy, or sell any of the companies after determining if I think any of them are under or overvalued.

Vodafone Valuations and brief thoughts

Vodafone (VOD) valuations done on September 10th, 2012.  Valuations in millions of GBP, except per share information, unless otherwise noted.  Valuations done using 2012 10K.

Asset Reproduction Valuation

Assets:			Book Value:		Reproduction Value:
Current Assets
Cash and Cash Equivalents			7138		7138
Short Term Investments			1323		1323
Accounts Receivable (Net)			3885		3302
Inventories			486		243
Prepaid Expenses			3702		1851
Other Current Assets			3491		1746
Total Current Assets			20025		15603
PP&E Net			18655		9328
Equity and Other Investments			35899		17950
Goodwill			38350		15340
Intangible Assets			21164		8466
Deferred Income Taxes			1970		1000
Other Long Term Assets			3482		1741
Total Assets			139545		69427

Number of shares are 5096

Reproduction Value:

• With intangible assets and goodwill: 69427/5096=13.62 GBP per share = $21.80 per share.
• Without intangible assets and goodwill: 45621/5096=8.95 GBP per share = $14.33 per share.

EBIT and Net Cash Valuation

Cash and cash equivalents are 7,138

Short term investments are 5,096

Total current liabilities are 24,025

Cash and cash equivalents + short-term investments – total current liabilities=

• 7,138+1,323-24,025=-15,564
• -15,564/5,096=-3.05 GBP per share=-$4.78 in net cash per share.

Vodafone has an EBIT of 11,187.

5X, 8X, 11X, and 14X EBIT + cash and cash equivalents + short-term investments:

• 5X11,187=55,935+8,461=64,396
• 8X11,187=89,496+8,461=97,957
• 11X11,187=123,057+8,461=131,518
• 14X11,187=156,618+8,461=165,079

• 5X=64,396/5096=12.64 GBP per share=$19.79 per share.
• 8X=97,957/5096=19.22 GBP per share=$30.09 per share.
• 11X=131,518/5096=25.81 GBP per share=$40.41 per share.
• 14X=165,079/5096=32.39 GBP per share=$50.71 per share.

Revenue and EBIT Valuation

				Numbers:
Revenue:				46417
Multiplied By:
Average 6 year EBIT %:				15.87%
Equals:
Estimated EBIT of:				7366.4
Multiplied By:
Assumed Fair Value Multiple of EBIT:				5X
Equals:
Estimated Fair Enterprise Value of VOD:				36832
Plus:
Cash, Cash Equivalents, and Short Term Investments:				8461
Minus:
Total Debt:				34890
Equals:
Estimated Fair Value of Common Equity:				10336
Divided By:
Number of Shares:				5096
Equals:				GBP 2.03 per share=$3.27 per share

The $3.27 per share is my low estimate of value.  My base estimate of value using an 8X multiple was $10.16 per share, and my high estimate of value using an 11X multiple was $17.25 per share.

Price to Book and Tangible Book Valuation

				Numbers:
Book Value:				126431.8
Minus:
Intangibles:				23806
Equals:
Tangible Book Value:				102625.8
Multiplied By:
Industry P/B:				1.7
Equals:
Industry Multiple Implied Fair Value:				174463.8
Multiplied By:
Assumed Multiple as a Percentage of Industry Multiple:				65%
Equals:
Estimated Fair Value of Common Equity:				113401.5
Divided By:
Number of Shares:				5096
Equals:				GBP 22.25 per share=$35.62 per share.

The $35.62 per share is my low estimate of value.  My base estimate of value using a 95% multiple was $52.05 per share and my high estimate using an 125% multiple was $68.49 per share.

FCF and Cash Flow Valuation

				Numbers
Operating Cash Flow:				12755
Minus:
Capital Expenditures:				7852
Equals:
Free Cash Flow:				4903
Divided By:
Industry Median FCF Yield:				6.17%
Equals:
Industry FCF Yield Implied Fair Value:				79465
Multiplied By:
Assumed Required FCF Yield As A % of Industry FCF Yield:				65%
Equals:
Estimated Fair Value of Common Equity of VOD:				51652.25
Divided By:
Number of Shares:				5096
Equals:				GBP 10.14 per share=$16.23 per share.

Vodafone’s FCF yield is 5.41%.  The companies I used as comparisons are Verizon, China Mobile, and AT&T.

The $16.23 per share is my low estimate of value.  My base estimate of value was $23.71 per share and my high estimate was $31.20 per share.

Vodafone’s debt ratios are as follows:

• Current assets to current liabilities: 20025/24025=0.83
• Total debt to equity: 34957/76935=45%
• Total debt to total assets: 34957/139576=25%

Brief Thoughts and Conclusions

Vodafone’s valuations are all over the place from a low of $3.27 a share to a high of $68.49 per share.  My cost basis for VOD is $27.37 per share.

After looking at its margins, reading its annual report and all that I have read since buying into Vodafone, I would use either the 8X EBIT and cash valuation, $30.09 per share, or my low estimate of value in the price to book and tangible book valuation, $35.62 per share, as my estimate of intrinsic value.  I would probably lean towards the $30.09 estimate of intrinsic value just to be safe, meaning that I think Vodafone is about correctly priced.

Knowing what I know now, I would not have bought into Vodafone when I did, or at this time, as it does not meet my minimum 30% margin of safety.   Others reasons I would not buy into it at this time are:

• The high debt levels.
• Massive amounts of cap ex needed constantly.
• The problems that it has had in India and other countries lately
  .

I do not think that Vodafone is a bad company by any stretch of the imagination, I just bought into them at too high of a price and for the wrong reasons; mainly its dividend.

I really like that it is a truly global company with some very good assets, including being a 45% owner of Verizon.

For now I am going to hold onto Vodafone until there is some kind of clarity from Verizon on its dividend payment strategy towards Vodafone, and/or until I find another company to buy as I think I will have a hard time making money at my currently too high cost basis in Vodafone, and I will possibly look to sell my stake in VOD when I find another attractive company.

Vivendi News, Aswath Damodaran Valuing the Iphone Franchise, Warren Buffett, Great Investors, and Memory

Vivendi Studies Strategy After Two-Way Split Ruled Out is an article from Bloomberg Businessweek about what Vivendi might do now that it has allegedly ruled out breaking the company into two separate entities.  The interesting part of this article is that one of the scenarios states that Vivendi is looking at breaking up the entire company which would mean a sum of the parts valuation would be used.

My sum of the parts valuation done on 4-21-2012, written in my article here, came to a per share estimate of intrinsic value of $43.07 per share.  Looking back on the post now, I think that is a very conservative estimate.

Also on the Vivendi front, while I was reading Martin Whitman’s Third Avenue fund 3Q shareholder letter, I found that they have bought into Vivendi.  Here are their reasoning for buying into Vivendi at this time:

Also during the quarter, the Fund initiated a position in the shares of Vivendi S.A. (“Vivendi”), a company that has intrigued various members of our team for more than five years. The Fund had avoided investing in Vivendi’s shares for a variety of reasons, not the least of which were the company’s long-running addiction to debt-financed acquisitions and the absence of any discernible strategy for building shareholder value. In retrospect, the discipline paid off. The stock has performed very poorly over a long period of time. Vivendi spent much of its life as a French water utility, but in the mid-1990s was set on a path to become one of the world’s largest media and telecom empires. The improbable but very rapid transformation of Vivendi into a telecom and media giant was driven by a number of audacious debt fueled acquisitions. By the early 2000s, the tech, media and telecom bubble began to burst and the Vivendi empire famously came crashing down under a mountain of debt. The company spent much of the next decade languishing in the absence of strong management and a reasonable strategy. Most recently, though, considerable change is afoot at Vivendi. The company dismissed the CEO of its largest subsidiary, SFR, which is the second largest telecommunications company in France. SFR had been one of the epicenters of Vivendi mismanagement; the telecom company performed particularly poorly in the areas of cost management and in its failure to adequately address and confront the threat of new and increased competition. Shortly after the dismissal of SFR’s CEO, Vivendi’s board dismissed Vivendi’s own CEO, apparently as a result of irreconcilable strategic differences. Vivendi’s Chairman, who, during his own brief stint as CEO of Vivendi in the early 2000s, deleveraged the company considerably, has become the public face of the company and declared a strategic about-face. It appears that none of Vivendi’s underlying operating businesses are sacred any longer. As part of a broad restructuring effort, a number of its businesses have become subject to possible disposal in the effort to reduce Vivendi’s debt load and make headway in closing the gap between the share price and the underlying value of the company’s investee businesses, several of which are crown jewels within their respective industries. As it stands today, the company controls France’s second largest telecommunications company which, when combined with its control of the incumbent telecommunications company in Morocco and a highly successful Brazilian telecommunications company, would comprise a formidable global telecom business were they to be separated into an independent entity, as has been speculated. Vivendi also controls Canal +, France’s largest television business, as well as Universal Music and ActivisionBlizzard, the world’s largest music and video game businesses, respectively. There is considerable scope for dispositions as well as a sensible reconfiguration of the business into various components, all of which seem increasingly likely. Shares of Vivendi are trading at a considerable discount to our conservative estimate of its net asset value, essentially the current liquidation value of the company, and it appears that the mounting pressure on the company’s board has made value enhancing transactions and debt reduction increasingly probable.

 

Always nice to see a big time value fund buying into the companies you own.

Aswath Damodaran’s: Apple’s Crown Jewel: Valuing the Iphone Franchise is amazing valuation piece which could be used as a template to value other powerful franchises.

Warren Buffett Reflects on why he stayed in Omaha.

How to Gain an Investment Edge with Quotient’s Andre Bertolotti is a 4 minute video clip from The Manual of Ideas on how Bertolotti gains an edge in his investments.

How I got Religion and Dropped My Series 7 is a very interesting 6 minute video interview with the Reformed Broker about what he sees as the failings of holding the series 7 and the problems it can create in investment firms and Wall Street.

The Science and Psychology of Memory is a short write up from Farnam Street on things that you can do to improve your memory.

More links to come until I figure out if either of the two companies I have found to research deserve full article treatment.

Why I am holding my Altria shares for now, but would not buy at current price.

When I first started reading about Altria (MO) its dividend is what initially got me very intrigued.  Altria was the first company that I bought where I actually read an annual report so it was my starting point for the research I am doing now.  However, I was not doing any type of valuation or near the amount of research I am doing now so I got a bit lucky that my position is now up around 30%.  I started doing this write-up and research of Altria mainly to see how far I have come since I originally bought.

However, now that I have just read its most recent 10K and 10Q I have found many things that bother me about the company.

First I will give the reasons why I originally bought more than a year ago:

• Big dividend in a low yield environment, the dividend has been growing as well.
• Huge competitive advantages that I noticed even then: Addicted customers who were willing to keep paying higher and higher prices.  A government sponsored mini-monopoly since there aren’t likely to be any new entrants due to litigation and taxes.  Massive brand recognition and market share.
• They were producing about $3 billion in FCF per year, which I thought was enough to cover the dividend.

Risks I saw then:

• Massive debt load over $12 billion.
• Litigation expenses.

Those were literally the only two concerns I had, and the only major concern of the two was the debt.  Altria seems to win a lot of its lawsuits or if they do lose, they end up having the amount to be paid out cut substantially, so that did not worry me too much.

The above are literally the only things I looked at before deciding to buy MO last year.  Not very in-depth thinking, and definitely not enough to get me even close to a buy or sell decision today.

Analysis now

Altria comprises Philip Morris USA, U.S. Smokeless Tobacco Company, John Middleton, Ste. Michelle Wine Estates, and Philip Morris Capital Corporation. It also owns a 27.1% interest in SABMiller, the world’s second-largest brewer. Through its tobacco subsidiaries, Altria holds the leading position in cigarettes and smokeless tobacco in the United States and the number-two spot in cigars. The company’s Marlboro brand is the leading cigarette brand in the U.S.

Having sold its international segments and the bulk of its nontobacco assets, Altria now operates primarily in the challenging U.S. tobacco industry. U.S. cigarette volume is in secular decline, and the Food and Drug Administration, having assumed regulatory control, has been quick to assert its authority. The threats of regulation and taxation have now overtaken litigation as the most significant risks to an investment in tobacco, in our view. Despite these headwinds, tobacco manufacturing is still a lucrative business, and we think Altria is poised to generate steady medium-term earnings growth. The addictive nature of cigarettes and Altria’s dominance of the U.S. market is the key reasons behind our wide economic moat rating.

The two descriptions above are taken from Morningstar.com.  You can view Altria’s SEC filings here.

Valuations:

These valuations are done by me, using my estimates, and are not a recommendation to buy any stock in any of the companies mentioned.  Do your own homework.

Valuations were done using 2011 10K and second quarter 10Q.  All numbers are in millions of US dollars, except per share information, unless otherwise noted. Valuations were done on July 27th 2012.

Net cash and EBIT valuation:

Altria has cash and cash equivalents of 1,528.

Its number of shares outstanding are 2,027.

Altria has total current liabilities of 6,081.

Cash and cash equivalents-total current liabilities=1528-6081=-4553.

• -4553/2027=-$2.25 of net cash per share.

Altria has a trailing twelve month EBIT of 3519+6068-1295-1539=6753.

5X, 8X, 11X, and 14X EBIT+cash and cash equivalents=

• 5X6753=33765+1528=35293
• 8X6753=54024+1528=55552
• 11X6753=74283+1528=75811
• 14X6753=94542+1528=96070

• 5X=35293/2027=$17.41 per share.
• 8X=55552/2027=$27.41 per share.
• 11X=75811/2027=$37.40 per share.
• 14X=96070/2027=$47.40 per share.

Current price is $35.63 per share.

Market cap is 72.44 billion.

Enterprise value is 84.44 billion.

• EV/EBIT=12.50

My average unit cost including dividends is currently $27.10 per share for the MO shares I currently own.

Only the 14X EBIT valuation would get me a reasonable margin of safety if I were to buy now.  If I were to buy MO shares now I would be using either the 11X or 14X EBIT valuations as my base case.

A couple things of note:  Altria has a negative net cash number which I generally do not like.  Altria’s EV/EBIT is higher than the companies I usually evaluate, which is another sign that it might be fairly or overvalued currently.

Revenue and EBIT valuation:

Using Trailing twelve month numbers:

Revenue: 16,670

Multiplied By:

Average 4 year EBIT percentage: 34.13%

Equals:

Estimated EBIT of: 5,689.47

Multiplied by:

Assumed fair value multiple of EBIT: 10X

Equals:

Estimated fair value Enterprise value of MO: 56,894.7

Plus:

Cash and Cash equivalents: 1,528

Minus:

Total Debt: 13,089

Equals:

Estimated fair value of common equity: 45,333.7

Divided by:

Number of shares: 2,027

Equals:

$22.36 per share.

Low estimate

My high estimate of value, which I would use as my base estimate of value in this case, was a 15X estimated EBIT multiple which came out to $36.40 per share, about evenly valued.

Free cash flow valuation:

Again using Trailing twelve month numbers.

Operating cash flow: 3,388

Minus:

Capital expenditures: 108

Equals:

Free cash flow (FCF): 3,280

Divided by:

Industry median FCF yield: 6%

Equals:

Industry FCF yield implied fair value: 54,666.67 ($26.97 per share.)

Multiplied by:

Assumed required FCF yield as a percentage of industry FCF yield: 95%

Equals:

Estimated fair value of common equity of MO: 51,933.34

Divided by:

Number of shares: 2,027

Equals:

$25.62 per share.

Low estimate

My high estimate, where I changed the assumed yield from 95% to 125% came out to $33.71 per share.

I would estimate its intrinsic value to be the 11X EBIT multiple from the net cash and EBIT valuation, $37.40 per share.

Through these valuations I have found Altria to be either overvalued or about fairly valued at current prices.  Looks like I got a bit lucky when I was doing no valuations, or the amount of research I am doing now, when I bought MO around $27 per share.

I was mainly doing this exercise to see how far I have come since I originally bought MO, doing no valuations and minimal research.  My intention when I started this was not to do a complete analysis, but I found a few things that gave me some pause while reading its SEC filings that I wanted to highlight.

Concerns:

• All the litigation, which I will not detail here since it takes up at least 50 pages of the 10K.  If you would like further information please read Altria’s annual reports.
• Altria has been issuing debt and drawing on its short-term credit line to in part sustain its stock repurchasing and dividend.
• Debt of around $13 billion, around $11 billion of which came from its acquisition of US Tobacco in 2009.  Altria almost immediately charged about $5 billion of the transaction price to goodwill, meaning that that they paid almost double the price of the assets.  Quoting from the 10K “The excess of the purchase price paid by Altria Group, Inc. over the fair value of identifiable net assets acquired in the acquisition of UST primarily reflects the value of adding USSTC and its subsidiaries to Altria Group, Inc.’s family of tobacco operating companies (PM USA and Middleton), with leading brands in cigarettes, smokeless products and machine-made large cigars, and anticipated annual synergies of approximately $300 million resulting primarily
  from reduced selling, general and administrative, and corporate expenses. None of the goodwill or other intangible assets will be deductible for tax purposes.” To me paying almost double the price of the assets for supposed synergies does not make much sense and will also make it take longer for Altria to earn back its investment.
• Altria has projected pension and health obligations of around $6.5 billion.  The projected amount has been rising by around $500 million a year for the last few years as well.
• Altria has total off-balance sheet arrangements and aggregate contractual obligations of $33.7 billion, most of which are coming due after 2017, with around $4 billion a year needing to be paid over the next few years.  The total obligations include: Debt, Interest on borrowings, Operating leases, Purchase obligations, and other long-term liabilities.
• Altria’s fair value of total debt as of the most recent 10K is $17.7 billion.  A 1% increase in market interest rates would decrease the fair value of Altria Group, Inc’s total debt by approximately $1.1 billion.  A 1% decrease in market interest rates would increase the fair value of Altria Group Inc’s total debt by approximately $1.2 billion.  This risk is taken directly from its 10K on page 95 of the final section of the 10K.  Since interest rates cannot go any lower, and will not stay low forever, rising rates are going to crush the debt of Altria, unless it can refinance portions of the debt, which could also make it harder for them to issue debt in the future.
• The above are not even including the dropping rate of smoking in the US, and state and federal governments around the country regulating the tobacco industry so strictly that it has turned into a prohibition like industry.
• People have been piling into the stock recently for the high yield, which could be turning into a mini bubble around the stock and other high yield companies.
• Will not grow outside of the US.  That was the whole reason for the spin-off of Philip Morris (PM) so that Altria would have the US market, and PM would have the international markets.
• Insiders only own 0.08% of company stock.
• Since Altria does have a high debt load, it could preclude them from acquiring companies until it pays down some of the debt.

Pros:

• Altria has ownership of one of the most recognized brands in the world, Marlboro.
• Altria has 50% market share of the cigarette market in the US.
• Altria has 55% market share in the smokeless products in the US.
• Altria also has 30% market share in the cigar market in the US.
• Altria own a 27% interest in SABMiller, valued currently at about $19 billion.  Altria could sell this asset if they needed to pay down debt.
• Altria creates about $3 billion a year in FCF.
• Its margins are gigantic: Gross margin at 54%, EBIT margin at 37%, ROIC at 19%, and FCF/Sales margin at 20%.
• Addicted customers.
• Because governments regulate the tobacco industry a lot, Altria will not have to deal with any new entrants any time soon.
• Competitive advantages: Economies of scale, quasi government sanctioned monopoly.

How I think they could improve further:

Paying down the substantial debt would be a great step in the right direction.  In my opinion Altria should become a conglomerate, kind of a Berkshire Hathaway sin stock conglomerate.  Altria already owns a wine company subsidiary, and it owns part of one of the biggest beer producers in the world, and I think that MO could get further into that arena if they wanted to.  Altria could produce and sell marijuana when and if that ever becomes legalized since it would have the distribution lines already available.  Altria could also buy a company like Star Scientific (CIGX).  Here is Morningstars description of them, Star Scientific, along with its subsidiary, Star Tobacco, is a technology-oriented tobacco company seeking to develop, license, and implement technology to reduce the carcinogenic toxins in tobacco and tobacco smoke.

I remember reading a while ago that there was a rumor that either Altria or Philip Morris could buy CIGX to develop next generation cigarettes that did not have the carcinogens in them, thus alleviating the main concern with smoking.  I have not read any more rumors of that in a long time though.

One thing that is for certain, although smoking will never go away no matter how much governments regulate and tax the industry, Altria in my opinion, will eventually have to branch out at least a little bit due to declining rates of smoking in the US.

Conclusion:

Altria is one of the most dominant companies in the world.  It has a virtual monopoly in the United States in the cigarette and smokeless product segments, with at least 50% market share in both of those two industry segments.  The company has incredible competitive advantages that enable it to continue to have huge margins even with all the litigation, taxes, and regulation.

The company is not perfect as it has a myriad of issues that I outlined above.  If you were to buy Altria at the current prices, it appears that you would have no margin of safety and I would not recommend buying at this time.

However, I think the positives outweigh the negatives at the $27 price that I bought at, and I plan to hold onto my shares of Altria for hopefully decades, and hope to have my money compound well into the future.  If Altria can get its debt and pension obligations under control that should be no problem.

As always comments, concerns, and critique are welcome and would be appreciated.

Whopper Investments third weekly challenge, Altria, Greenlight Capital, and a Free Moat Webinar

Altria

Here is this weeks valuation and analysis challenge from Whopper Investments if anyone would like to try their hand.

This weeks challenge is McDonald’s from 2005 before Bill Ackman bought into them.  While I will be waiting to see what the readers post and see what I can learn from their analysis.  I will not be participating in the challenge this week.

Instead I will be researching, analyzing, and valuing Altria (MO) which I hold in my portfolio.

When I originally bought Altria I was not doing any type of valuation and I was not doing anywhere near the amount of research or analysis I am doing now.

I want to see:

• A) What I would value them at to see if they are under or overvalued now.
• B) I got a bit lucky as my position in them is now up about 30% since I originally bought, and I want to see if I would still buy them knowing what I know now.

I am interested to see how far I have come since then and hope to have my mini write up on the blog within a week.

Greenlight Capital

This is Greenlight Capital’s second quarter letter to shareholders.  They talk about Europe and some of its positions.

Free Moat Webinar

I cannot vouch for how good this free webinar on Moats from Morningstar is going to be since I have not watched it, but I thought I would put it on here for anyone who might be interested in it.

Enjoy

Dole VS Chiquita VS Fresh Del Monte (Part 4)

This article is the fourth and final article in the series detailing the businesses of Dole (DOLE), Chiquita (CQB), and Fresh Del Monte (FDP).  If you want to see the valuations and brief descriptions of these companies please view these articles: DOLE, CQB, and FDP.

In this article I will go over the margins of all the companies to determine if there are any sustainable competitive advantages.  I will decide whether I would buy any of these companies as they currently stand, without the possibility of any kind of merger, spin off, or massive asset sales.  I will also look into whether or not a merger between any of the companies would be a good thing.

Before I start with my analysis of the three I need to go back and look into Dole’s total contractual obligations in comparison to Chiquita’s and Fresh Del Monte’s.  At the time I did Dole’s valuations I wasn’t doing as thorough of research as I am doing now, and did not talk about their total obligations in the original article I wrote.

On page 40 of Dole’s 2011 10K they list their total obligations and commitments as of December 31, 2011.  The total obligations and commitments, including debt is $4.68 billion, and over the next two years it comes out to $2.661 billion.  Their current market cap is $765 million. Not a great ratio, but not terrible like Chiquita’s. The total obligations/market cap ratios for all of the companies are:

• Dole: 4680/765=6.12
• Chiquita: 3167/220=14.40
• Fresh Del Monte: 1992/1310=1.52

Fresh Del Monte has by far the most sustainable ratio in my mind and should have no problems if another crisis hits them individually or the economy as a whole.  Dole might be able to make it through another crisis, even if they don’t decide to do some kind of asset sale or spin off like they are looking into right now.  Chiquita’s ratio is horrendous and I would be worried about them if I was a shareholder of theirs.

All of these companies have low amounts of cash and cash equivalents on hand, which is another thing to possibly worry about with Dole and Chiquita if something bad were to happen in the economy.  In any kind of emergency they would most likely either default on some of their obligations,  have to draw down their credit facilities or, try to take on some more debt if they could, most likely on unfavorable terms.

Now let us get to the margins of all three and try to determine if any of them have a competitive advantage.

			Dole (DOLE)		Chiquita (CQB)		Fresh Del Monte (FDP)
Gross Margin (Current)			10.5		12.9		8.8
Gross Margin (5 years ago)			9		12.4		10.8
Gross Margin (10 years ago)			16		16.1		16.1
Op Margin (Current)			2.7		-0.3		3
Op Margin (5 years ago)			1.9		0.7		5.2
Op Margin (10 years ago)			6.5		2.2		10.3
Net Margin (Current)			0.75		0.69		2.84
Net Margin (5 years ago)			-0.83		-1.05		5.34
Net Margin (10 years ago)			0.83		0.91		9.34
FCF/Sales (Current)			-0.58		0.12		2.66
FCF/Sales (5 years ago)			N/A		-0.08		2.42
FCF/Sales (10 years ago)			N/A		2.37		11.86
BV Per Share (Current)			$9.30		$17.42		$30.41
BV Per Share (5 years ago)			N/A		$21.03		$23.65
BV Per Share (10 years ago)			N/A		$15.80		$13.51
ROIC (Current)			2.16		1.53		5.21
ROIC (5 years ago)			-2.12		-2.72		11.66
ROIC (10 years ago)			1.98		1.63		22.56
Insider Ownership (Current)			59.06%		3.33%		35.72%

These companies for the most part all have operations in the same segments and the next table will be showing the margins of those comparable operations.

			Dole		Chiquita		Fresh Del Monte
Total Fresh Fruit EBIT			172		N/A		N/A
Total Fresh Fruit Revenues			5,024		N/A		2,721
Fresh Fruit EBIT Margin			3.42%		N/A		N/A
Total Vegetable EBIT			31		N/A		N/A
Total Vegetable Revenues			1,002		N/A		523
Vegetable EBIT Margin			3.10%		N/A		N/A
Packaged Food EBIT			96.5		N/A		N/A
Packaged Food Revenues			1,197		N/A		355
Packaged Food EBIT Margin			8.10%		N/A		N/A
Total Operations EBIT			300		33.7		116
Total Operations Revenues			7,224		3,139		3,590
Total EBIT Margin			4.15%		1.07%		3.23%

In a perfect world Chiquita and Fresh Del Monte would have broken their operations out further like Dole does.  Instead they choose to combine their operations reporting data, especially the Operating Margin data, otherwise known as EBIT.  So at this point it is impossible for me to break out the data further than it is in the above table.

Taking the above information, combined with the information in the previous articles, I think that I have enough information to make some judgements on the companies.

As things currently stand I would NOT buy Chiquita under any circumstance, not even with the possibility of a spin off or asset sale.  Their low margins, combined with their huge amount of total obligations, and low cash on hand scare me too much to invest in them.  That is not even taking into account the fact that in my valuations I found them to be about fairly valued to slightly undervalued, not nearly enough of a margin of safety for me considering all the risks. I also do not see them being bought out by anyone due to their high amount of total obligations.  The only thing going in their favor is that they are selling for less than book value by a good margin, which is currently $17.42 per share, but at this point it looks to be justified.

Fresh Del Monte is interesting.  They are selling for less than book value by a good margin, which is currently at $30.41 per share, they generally have the best margins of the three companies, and they also have high insider ownership, which I always love.  However, by my estimates they appear to be slightly overvalued at this point, and have low cash on hand.  They are also the company out of the three in the best position to make some acquisitions, in my opinion a merger between Dole and Fresh Del Monte could possibly be a good thing. They have already been buying back a lot of shares and are the only one out of the three to pay a dividend, which are more pluses.  At this point I am not going to buy Fresh Del Monte, but I will wait for an opportunity when they are undervalued and will reassess at that time whether or not I will be a buyer then.

Without the possibility of a spin off or asset sale that I outlined in my original article on Dole, I would not be a buyer into their company right now either.  Pretty much the same problems as Chiquita: high debt/total obligations, low cash, low overall margins.  However, they do have high inside ownership, they are selling at a slight discount to book value, and by my valuations are extremely undervalued.  I do stick to my original assessment about Dole though, that they are a great spin off opportunity if they decide to do a spin off or asset sale.  If they do what I suggested in the original article I think they could unlock value, get rid of a lot of their debt, and become a much more focused and profitable company.  Especially if they put a lot of their resources into the packaged fruit portion of the business, as it has the highest margins in Dole’s operating structure.  Dole also has the 88,000 acres of land that they could sell some of to pay down debts as well.

I did buy half of a position in Dole based on the spin off thesis in my original article.  I am waiting to see if they announce a spin off or asset sale to jump fully into Dole at this point.  They are in the spin off portion of my portfolio which I plan to hold for 6 months to several years.  I do not consider them a long term buy and hold for decades company.

It also appears to me that none of the companies have any kind of sustainable competitive advantage, with their wildly fluctuating margins over the past 10 years, and no one becoming dominant.

I hope everyone has enjoyed and learned something from the analysis and valuation series on Dole, Chiquita, and Fresh Del Monte, and I look forward to some feedback.

What I am learning, and need to learn to become better in the short term.

Over the past several days I have been reading annual and quarterly reports for a couple companies I am researching.  Tonight I am going to start reading some of the competitors annuals, and hopefully when I am done I will have enough information to value the companies and see where that takes us.

With the information in my previous post, and the experience I gained from that, I have gotten pretty good at spotting the bad companies and have been obviously staying away from them.  Too bad that is the easy part of investing.  Now I need to get a lot better at deciphering which companies are the good ones and which ones have the potential to become great, the ones with a so called Franchise.  I also need to get better at finding companies with legitimate, sustainable competitive advantages.

So for Father’s Day I got Bruce Greenwald’s Competition Demystified which will hopefully help me learn a lot in those two departments.

Those are my plans for the next week or so, now lets see how that plays out.