How I Look To Have Affected Bab Inc, Big Apple Bagel, $BABB, With My Recent Article On Them.

In the past two months while I have been working on getting our business started I pretty much blacked out everything investing related.  I did this for three reason; so I wouldn’t be tempted to go back to researching companies because that is where my heart lies, so I could concentrate on getting the business going, and because I needed to take a break physically from the amount of work I was doing.

In the past week or so I have been going over the companies I have written articles on, especially the ones I am interested in or own, to see if I have missed any news in the past two months that is very important and it looks like I have with Bab Inc (BABB.)

My recent article series on them, part 1 and the conclusion, laid out how overall I thought BABB was a very interesting company and how I would love to invest in the company, and possibly becoming activist in the company to help fix its major problem of overly excessive executive pay and overall excessive payroll in my opinion.  In my opinion this is the only major problem with the company and if executive pay and overall payroll was lowered it would help raise the companies earnings and cash flow, and would most likely help to unlock the underlying value of the company that I see beneath the excessive pay.

When looking back to see if I missed anything on the companies I am interested in I found this link.  Since I do not believe in coincidences, apparently BABB management noticed my article somewhere or were threatened by another investor, and have decided to adopt a “Stockholder’s Rights Plan.”  This allows the company to issue rights to current shareholders in the event that someone buys 15% of its shares (20% in the case of an institution) to “Protect Shareholders best interests” from outside investors. These rights would be issued to shareholders as of May 13th if someone were to purchase 15 or 20% of BABB and look to essentially be a way to keep people from making too much noise about change at the company.

There is also this line from the announcement:

BAB’s Board of Directors may redeem the Rights for $0.001 per Right at any time before an event that causes the Rights to become exercisable. The Rights will expire on the third anniversary date of the Agreement, unless the Rights have previously been redeemed by the Board of Directors.

This gives a further advantage to insiders over regular shareholders and is again put in there to keep outside investors from making changes in the company, and is completely ridiculous in my opinion.

 

It looks to me that current BABB management likes the status quo of taking giant payrolls, losing market share, and losing restaurant counts and does not want to have things shaken up by outside investors who may want to lower overall pay, help the company become more profitable, and help the company potentially grow again.

This is my first experience with a company doing something like this and I knew it would eventually happen because of how most nano caps are managed by only a small number of individuals who control the company.  It is still surprising and disappointing that they would do something like this, but apparently they would rather just keep milking the company instead of putting some of that excessive pay towards growing the company or growing earnings and cash flow.  Suffice it to say that I am glad I did not buy into BABB as this shows that in my opinion management does not care about the best interests of shareholders.

This does make me want to buy into the company though to change things even more for the betterment of all shareholders and not just the few at the top of the pyramid, maybe I will at some point.

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A Company I Have Been Researching And Really Like Potentially Being Bought Out

Ark Restaurants Being Bought Out

Over the past couple weeks I have been researching and discarding dozens of companies to write articles on and potentially buy into.  Of those dozens of companies I decided to do further research on seven of the companies.  I ended up valuing three of the companies.  Of those three I ended up doing in depth research on two of the companies reading 5-10 years of annual reports and doing various other research so far.  One of the companies I am still doing research on and plan to write an article about.  The other was Ark Restaurants mentioned in the Readers Investment Ideas and Analysis Page above by reader DTEJD1997.

After discarding a bunch of other companies I remembered ARK being mentioned on the blog after I found them in a screen I did, found information that looked promising and started doing my normal in depth research on them.  I actually ended up starting to write an article about them, as I really liked their operations and management, and found them to be undervalued currently.  Valuing the business at 8X EBIT, adding cash, cash equivalents, short term investments, and $1 per share of NOL’s, and subtracting almost $1 per share in debt got me to a value of $26.91 per share which is the estimate I use for its intrinsic value.  This is the base estimate of value I was basing my article around.  So overall I thought very highly of the overall business as a potential investment.

I decided to scrap the article for now and wait to write the article and potentially buy into the company until the share price dropped though because I found ARK to be overvalued by my worst case scenario which estimated what I think the company would be worth if it dropped back down to its profitability levels from 2009-2011 when the company was struggling more.  Using the same basis as above, I found at 8X EBIT that ARK would be worth $10.13 in that situation, which is actually 20% higher than the low it reached during 2009-2011, as its EBIT % was only 2.23% on average over those three years.  In comparison this year ARK’s EBIT % jumped back up to pre-recession levels at 7.2% in 2012.

Got an email from DTEJD1997 this morning with this news that the company is potentially being bought out by Landry’s for $71 million or about $22 a share so it looks like I have missed out on this potential opportunity.  Actually I think that is a bit low and the buy price should probably be in the $23-$26 range for a truer intrinsic value but it is still a 22% premium to what the stock closed at yesterday.

Congratulations to DTEJD1997 on the find and hopefully the company can push for a little bit higher purchase price if they decide to sell.  For now I am off to keep researching another company I found but if you have any ideas you would like to share please feel free to post them in the Readers Investment Idea page above.

Questions For You All And Some Observations About Insurance Companies

I just stopped researching what is probably the tenth insurance company I have done at least cursory research on and I have come to a few conclusions after looking at insurance companies of all sizes.  I stopped research on this company because of its massive underwriting losses again.

  1. UNAM is the only company I have looked at that has had consistent consecutive underwriting profits for almost a decade now.
  2. The best companies besides UNAM have generally only had underwriting profits for 3 out of the past 10 years.
  3. Almost all of the other companies have had consistent underwriting losses over the past decade.
  4. Underwriting losses have generally gotten worse over the last few years.

Having noticed all of this I realized in my previous UNAM analysis write up that maybe I was making things too complex and wanted to ask your opinion on the matter.

  1. How truly difficult is generating consistent underwriting profits over the almost past decade during a soft insurance market which is what UNAM has done?
  2. Are the other insurance companies managements complete morons or are UNAM’s management and discipline just exceptional?
  3. Should the consistent underwriting profit override the low ROE and low investment returns at UNAM?

Also just out of curiosity, does anyone else find researching insurance companies and other financials tedious with the amount of lawyer talk and useless crap that fills the pages of the annuals and quarterlies just to make sure they do not get sued?

Looking forward to some discussion on this topic.

Notes From Phone Conversation With the CFO of $UNAM

The new company I have been researching is $UNAM, a small property and casualty insurance company whose operations are in California.  I still have further research that I am going to do on the company and I still need to value them, but to this point UNAM looks like a potentially good investment after reading its annual reports back to 2004 so far.   I have come across a few concerns that I wanted to talk with IR about so I decided to call its IR department and I frankly wasn’t expecting much from because every other time I have called a company’s IR department I have either gotten no answers or they said they would call me back and still months later have not.

Once the nice lady I talked to at UNAM’s IR department heard that I was a prospective investor and had some questions that I would like to ask, she patched me right into the CFO, treasurer, and director of UNAM, Mr. Lester Aaron.  Over the time of our conversation, between 15-30 minutes, he took the time to answer all of my questions and he talked with me a bit about UNAM’s philosophy as it pertains to how the company invests shareholder and company money.  Below are my notes from the conversation.

Yesterday I had a conversation with the CFO of UNAM and had my first ever pleasant experience with a companies’ IR department.  He took the time to answer all of my questions and laid some of my concerns to rest about the company.   The bulk of my questions were about the company’s investment portfolio, currently only yielding around 1%, no investments in equities since at least 2004, and why there is a $2 million limit on equity investments.  Some highlights are below.

  • Multiple times he said that the company treats shareholder money as their own, that they concentrate on the long term, and doing what is right for shareholders.  This was his major point of emphasis during the call.
  • He thought that some of the other insurance companies were a bit crazy for writing premiums that led to an underwriting loss.  UNAM has had an underwriting profit since 2004 during a “soft” insurance market.  UNAM not compromising on the price of their policies to sustain the underwriting profit has led to a reduction in the number of premiums written in recent years.  An underwriting profit every year since 2004 is especially impressive due to the “soft” or unfavorable trend in recent years in the insurance industry, and of course I would rather the company be profitable than it wanting to expand premiums recklessly.
  • He did not want to “Gamble investor’s money” and he seemed to think that with all the risks around the world currently (Europe, currency, sovereign debt in the US and abroad, political issues, issues in the P&C insurance industry, etc) that UNAM felt that it would be gambling people’s money in the short term if they were to become a bit more aggressive with their investments.
  • They think about what is best for shareholders “Not five months from now but five years from now” and that they would rather earn 1% on investments than take unwarranted risks with the capital it has at its disposal.

All of which are some of the reasons why UNAM has become very defensive with its investment portfolio in recent years, currently only yielding around 1%, as the company is mostly invested in short term US treasuries, cash, and cash equivalents.  At least in part that it is also why the company has chosen to buy back shares in recent years and paid special dividends on occasion because “We think that the shareholders can put the dividends to better use than I think that we can currently in the market.”

The company has remained very disciplined over the years with its continued underwriting profits, having its insurance ratios well in excess of what they need to be, and well above the minimum required.  UNAM seems very shareholder friendly to say the least

The one quibble I had was that I think you can make more than 1% on investments without taking on a bunch of risk and still be able to pay insurance out when it needs to be paid, but he has a lot more experience in the P&C insurance industry than I do so I will trust their more experienced judgment.   I trust that they will keep their investment money in low risk short term investments as dry powder waiting for an opportunity to pop up or the insurance industry to turn more favorable.

Overall I came away very impressed with his answers and how he emphasized over and over again that they wanted to do what was best for shareholders over the long term.

I still need to do further research and value the company but up to this point it looks very promising and I am impressed with the company’s shareholder friendliness and discipline.  I will have my article written on UNAM as soon as possible and decide at that time whether or not to buy into the company.

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.

122112_0045_NumberofRes1.png

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.

122012_0603_BOBSRevenue1.png

122112_0359_BOBSCOGSand1.png

122012_1741_BOBSMargins1.png

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.

122012_0555_WCSEandAD1.png

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.

Strattec Security Corporation $STRT: Potential Double From Today’s Stock Price

Introduction, Overview of Operations, And Brief History

The company I will be focusing on in this article is Strattec Security Corporation (STRT).  Strattec is a nano cap with a current market cap around $75 million and it is in the very boring and shunned automotive parts industry.  The company has expanded to become a worldwide auto parts supplier through its various joint ventures and alliances.

The company makes and sells various automotive parts such as: Keys with radio frequency identification technology, bladeless electronic keys, ignition lock housings, trunk latches, lift gate latches, tailgate latches, hood latches, and side door latches.  With its acquisition of Delphi Corporation’s Power Products in 2009 it is now also supplying power access devices for sliding side doors, lift gates and trunk lids.

In 2001 Strattec formed an alliance with Witte-Velbert Gmbh.  The alliance allowed Strattec to sell Witte’s products in the US, and allowed Witte to sell Strattec’s products in Europe.  In 2006 the alliance expanded to include ADAC plastics and a joint venture with all three companies owning 33% was formed called VAST or Vehicle Access Systems Technology.  ADAC makes such products as door handles.  The VAST Alliance has helped Strattec become a worldwide auto parts supplier as the alliance allows all companies involved to market and sell each other’s products in various jurisdictions around the world including in the US, Europe, Brazil, China, Japan, and Korea.  The VAST Alliance should have its first profitable year as a company this year which would help Strattec’s bottom line.  Full complement of VAST’s products can be viewed here.

VastPlacemat

Picture taken from ADAC Plastics which shows how the VAST Alliance is structured.

ADAC and Strattec have formed a separate company, ADAC-Strattec de Mexico, ASdM,  whose operations are in Mexico due to cheaper labor prices, where the two companies separate expertise are combined to manufacture some of the above products for sale. In Strattec’s fiscal years ending 2012 and 2011, ASdM was profitable and represented $31.0 and $25.2 million, respectively of Strattec’s consolidated net sales.

With the help of VAST and its other joint ventures, Strattec’s export sales have risen to 37% of total sales which amounts to $107 million.  In 2001 exports only accounted for 14% of its sales which amounted to $29 million, which illustrates Strattec’s worldwide growth since then.

During the recession three of Strattec’s biggest buyers filed for bankruptcy protection, and the overall auto industry went to the brink of death before being saved by the US federal government.  Because Strattec’s major buyers were having so many problems, it also faced some very serious problems and had its only unprofitable year in 2009, lost more than $40 per share in value during the recession, about 2/3’s of its share price in total, and its share price has not recovered since.

Since that time Strattec restructured, improved its operations and expanded its product lines, signed various joint venture and alliance agreements which have allowed the company to become a worldwide auto parts supplier.  The restructuring, expanded product lines, and worldwide operations have helped Strattec become a more diversified auto parts manufacturer and has grown its sales and margins in the ensuing years.  With the help of VAST and its other joint ventures Strattec is a truly worldwide company with operations now in the US, Europe, Brazil, China, Japan, Korea, Canada and Mexico.

Strattec was spun off from Briggs & Stratton in 1995 as an independent company.  After Strattec was spun off from Briggs & Stratton, and through most of its entire history, it enjoyed massive market share of over 60% in the US and a 20% market share of the world’s vehicle lock and key operations.  With its huge hold of the market the company was able to dictate high prices to its buyers which enabled the company to enjoy a competitive advantage for a long period of time.

However, shortly after Strattec was spun off there were massive changes in the lock and key industry which deteriorated the company’s market share and competitive advantages. Due to Strattec’s managements excellent foresight and planning, it was well prepared for the change from basic locks and keys and the diminishing of the amount of locks and keys needed per vehicle, and has transitioned into the electronic key arena as well as expanding its operations into various fields though its partnerships with the VAST Alliance including: Door handles, power doors, trunk latches, lift gate latches, tailgate latches, hood latches, side door latches, ignition lock housings, sliding side doors, lift gates and trunk lids.  Since Strattec’s restructuring during the Great Recession, along with its VAST Alliance and other joint ventures, improved operations, and expanded product lines, Strattec’s sales and margins have both been growing and improving.  The trend of growing sales and margins should continue unless another recession hits.

Excellent Management

Due to the excellent leadership of Harold Stratton II, former CEO and current chairman, current CEO and board member Frank Karecji, and the other members of Strattec’s management team and board of directors, it has been able to adjust its original lock and key operations and changed massively to become a truly worldwide auto parts supplier with the products listed above.

Normally I do not talk much about management in my articles because I usually deem management to be either average or subpar, and as Charlie Munger says I want the business to be simple enough to be able to be run by the proverbial “idiot nephew” so management is generally not a factor in my analysis unless they are doing things that bother me quite a bit.

In this case I wanted to point out that I believe Strattec’s management to be excellent and I think that will continue now that Mr. Stratton has transitioned out of the day to day operations and handed the handling of those over to Mr. Karecji.  For the full view of why I believe Strattec’s management to be excellent I recommend reading its annual reports from 1999 to the present to get the true view of why I think its management has been fantastic, and to get a glimpse of the obstacles management has helped the company overcome to become an even stronger company.  Here is a profile of Mr. Karecji, Strattec’s new CEO from 2010 right after he joined the company.

For those who do not want to read all that information I will list a few pluses from management in recent years that I have not already talked about.

  • Strattec has bought back and reduced its shares outstanding by 3.66 million, or more than 50% of its original shares outstanding after being spun off, at a cost of approximately $136 million.
  • Most purchases have been at what I think are good prices to do buy backs.  I think now would be an even better time to buy back more shares (Strattec management has authorization to buy back more shares) because of Strattec’s current undervaluation which I will get to later, but I understand that it wants to put money into expanding its operations and product lines.
  • Another reason Strattec has not bought any shares back in the past couple years as it has been concentrating on reinstating its dividend and expanding its VAST Alliance operations. The company currently only has 3.3 million shares left that are outstanding.
  • Management compensation is fair and straight forward in my opinion which is another plus for management.

Insider and Fund Ownership

  • GAMCO Investors-Collectively Mario Gabelli’s Funds-Own 18.6% of Strattec.
  • T. Rowe Price and Associates through its Small Cap and Small Value funds own-15.5% of Strattec.
  • FMR-Fidelity Management and Research Company own-12.2% of Strattec.
  • Vanguard Horizon Funds own-6.2% of Strattec.
  • Dimensional Fund Advisors, a Small Cap Value Fund, owns-5.8% of Strattec.
  • Insiders Own-7.82% according to Reuters.
  • The above insiders and funds own a combined 66.12% of Strattec which partially explains why there is a very low average daily trading volume of around 2,000 shares per day in the stock.

Like I have said in my various other articles I love to see high insider and value oriented fund ownership of the companies I invest in so this is another plus for me.  Another possibility that might arise in the future is that due Strattec only having 3.3 million shares outstanding, its small overall size as a company, and some of the other factors I will mention or have mentioned in the article, I think that Strattec could be taken private or become a potential buy out target for one of the bigger automotive supply companies.

Competitors

The company faces stiff competition from the following three companies.

  • Magna International (MGA)-I talked about Magna a bit in my Core Molding Technologies (CMT) article and how I did not think that Magna was a major threat to CMT’s area of operations.  The story as it pertains to Strattec’s operations is different however.  Magna competes with Strattec in several of its product lines including the power access area and Magna appears to be a major player in those areas.  In 2009 Strattec bought the Power Access portion of Delphi’s business segment after it went bankrupt and renamed the unit Strattec Power Access.  For fiscal years ending 2012 and 2011, Strattec Power Access was profitable and represented $62.7 and $62.8 million, respectively of Strattec’s consolidated net sales.  Just for comparison Magna did $1.2 billion in sales just in its closure systems (power access) business in 2011.  Magna could present a problem for future growth of Strattec’s product lines as it will have to compete vigorously on price and quality for contracts.  It could also present a potential opportunity as with CMT, I could see Magna possibly buying out Strattec to expand its operations into more product fields.  This makes further sense since Strattec is such a small company in comparison to Magna and it being an $11+ billion market cap company.
  • Huf huelsbeck & fuerst-Huf and its various subsidiaries including Huf North America is a privately held company with operations worldwide and whose product lines compete directly with Strattec’s on almost every product around the world.  This company presents the same problem as Magna does to Strattec, but the same potential buy out opportunity exists as well.
  • Tokai Rika-This is a Japanese publically traded company who competes directly with Strattec on several products and who also has operations around the world.  Tokai Rika, like the two companies mentioned before, also dwarfs Strattec in size which could present problems to Strattec’s growth.

Strattec faces much stiffer competition from multiple much bigger competitors, sometimes directly on the same products than CMT did, who I thought carved out a bit of a niche in its industry.

Strattec’s Margins

Gross Margin TTM 18.50%
Gross Margin 5 Year Average 15.32%
Gross Margin 10 Year Average 18.25%
Op Margin TTM 6.20%
Op Margin 5 Year Average 0.44%
Op Margin 10 Year Average 5.18%
ROE TTM 12.11%
ROE 5 Year Average 3.59%
ROE 10 Year Average 9.91%
ROIC TTM 11.90%
ROIC 5 Year Average 3.49%
ROIC 10 Year Average 9.85%
My ROIC Calculation With Goodwill 25.90%
My ROIC Calculation With Goodwill If EBIT% Reverts to 3 Yr Avg 15.41%
My ROIC Calculation Without Goodwill 25.82%
My ROIC Calculation Without Goodwill If EBIT% Reverts to 3 Yr Avg 15.37%
FCF/Sales TTM 2.25%
FCF/Sales 5 Year Average -3.49%
FCF/Sales 10 Year Average 1.71%
Cash Conversion Cycle TTM 54.43 days
Cash Conversion Cycle 5 Year Average 48.97 days
Cash Conversion Cycle 10 Year Average 42.42 days
P/B Current 0.9
Insider Ownership Current 7.82%
My EV/EBIT If EBIT% Reverts to 3 Yr Avg 5.77
My EV/EBIT Current Unadjusted 3.43
My TEV/EBIT If EBIT% Reverts to 3 Yr Avg 8.09
My TEV/EBIT Current Unadjusted 4.81
Working Capital TTM $46 million
Working Capital 5 Yr Avg $48.6 million
Working Capital 10 Yr Avg $60 million
Book Value Per Share Current $25.25
Book Value Per Share 5 Yr Avg $24.54
Book Value Per Share 10 Yr Avg $24.78
Float Score Current 0.53
Float Intensity 0.77
Debt Comparisons:
Total Debt as a % of Balance Sheet TTM 0.88%
Total Debt as a % of Balance Sheet 5 year Average 0.66%
Total debt as a % of Balance Sheet 10 year Average 0.33%
Current Assets to Current Liabilities 1.79
Total Debt to Equity 45%
Total Debt to Total Assets 22%
Total Obligations and Debt/EBIT 2.1
Total Obligations and Debt/EBIT If EBIT Reverts To 3 Yr Avg 3.53

All numbers were taken from Morningstar or Yahoo Finance unless otherwise noted.  Final four debt calculations are including total debt and obligations.

Margin Conclusion Thoughts

  • The very first thing that popped out to me from the above margins is that across the board Strattec has improved its margins, sometimes by multiple percentage points, in comparison to its 5 year and 10 year averages.  Looks like the restructuring that took place during the recession, the various joint ventures including the VAST Alliance, and branching out to new product lines has helped the company immensely.  Improvements in operating margin, ROE, and ROIC have all been especially impressive
  • My ROIC calculations make the company look even better as even if Strattec were to revert to its 3 year average EBIT, which I don’t think it will unless another recession happens, I am estimating it to have an ROIC of 15.37% without goodwill.  If Strattec is able to keep up its EBIT margin to current levels I estimate that without goodwill its ROIC is 25.82%, an astounding ROIC margin.
  • Also positive as it pertains to ROIC is that in Strattec’s case it is not being artificially inflated by high amounts of debt.
  • The cash conversion cycle has gotten worse over the years, meaning less efficiency in the company, which I generally do not like.  That is to be expected in a company that has expanded operations overseas though so no red flag there.
  • Its P/B ratio at 0.9 is less than half that of its industry P/B at 2 which means that at least on a relative basis Strattec is undervalued in comparison to its industry.
  • My current unadjusted EV/EBIT ratio estimate for Strattec is 3.43.  Unadjusted TEV/EBIT estimate is 4.81.  Generally I like to buy companies selling at an EV/EBIT ratio of 8 or less so again Strattec appears to be undervalued.
  • Even if Strattec’s EBIT margin were to revert back to its three year average, which as above I do not think it will do unless there is another recession, its EV/EBIT ratio is 5.77 and TEV/EBIT is 8.09, again undervalued or about fairly valued at worst.
  • Book value per share has grown slightly over time, and should grow further with its improved operations.
  • The company has minimal debt and even if we include its total contractual obligations and debt its total obligations/EBIT ratio is a paltry 2.1.  Much improved from some of the other companies I have evaluated and its current total debt and obligations should be nothing to worry about going forward.

Below numbers in graphs are taken from Morningstar.

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121012_2114_1.png

121012_2115_1.png

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As you can see in the above graphs Strattec’s share price has not improved as its operations and sales have.  The last year Strattec had comparable margins to what it had this year is 2006, when Strattec was selling for between $33 and $50 a share. As I found after doing my valuations, which I will show below, I think Strattec should be selling somewhere in that range now.  Sales are actually almost $100 million more than they were in 2006, and margins should continue to improve as Strattec’s now worldwide operations and expanded product lines become more efficient.

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 2012 10K and 2013 first quarter 10Q.  All numbers are in millions of US dollars, except per share information, unless otherwise noted.

Low Estimate Of Intrinsic Value

Numbers:
Revenue:

284

Multiplied By:
Average 3 year EBIT %:

3.77%

Equals:
Estimated EBIT of:

10.71

Multiplied By:
Assumed Fair Value Multiple of EBIT: 8X
Equals:
Estimated Fair Enterprise Value of STRT:

85.68

Plus:
Cash, Cash Equivalents, and Short Term Investments:

12.94

Minus:
Total Debt:

1.5

Equals:
Estimated Fair Value of Common Equity:

97.12

Divided By:
Number of Shares:

3.3

Equals: $29.43 per share

Base Estimate Of Intrinsic Value

Assets:                  Book Value:                    Reproduction Value:
Current Assets
Cash And Cash Equivalents

16.3

12.94

Accounts Receivable (Net)

45.1

38.34

Inventories

25.5

15.3

Other Current Assets

17.1

8.6

Total Current Assets

104

75.18

Deferred Income Taxes

9.7

4.9

Investments In Joint Ventures

8.4

4.2

Other Long Term Assets

0.5

0

PP&E Net

47.6

28.6

Total Assets

170.6

112.88

Number of shares are 3.3

Reproduction Value

  • 112.88/3.3=$34.21 per share.

High Estimate Of Intrinsic Value

Cash and cash equivalents are 12.94

Short term investments are 0

Total current liabilities are 57.8

Number of shares are 3.3

Cash and cash equivalents + short-term investments – total current liabilities=12.94-57.8=-44.86

  • -44.86/3.3=-$13.59 in net cash per share.

Strattec has a trailing twelve month EBIT of 18.

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

  • 5X18=90+12.94=102.94/3.3=$31.19 per share.
  • 8X18=144+12.94=156.94/3.3=$47.56 per share.
  • 11X18=198+12.94=210.94/3.3=$63.92 per share.
  • 14X18=252+12.94=264.94/3.3=$80.29 per share.

From this valuation I would use the 8X EBIT+cash estimate of intrinsic value of $47.56 per share.

I discounted the cash a bit in the above valuations because about 55% of Strattec’s cash is in Mexico so if Strattec wanted to bring the funds to the US it would have to pay taxes on that portion of cash.

  1. Strattec is undervalued by 23% using my low estimate of value, which assumes that Strattec will revert back to its 3 year average EBIT margin, which as I stated above, I do not think will happen unless there is another recession.  This is the absolute minimum I think Strattec should be selling for.
  2. Strattec is undervalued by 33% using my base estimate of intrinsic value on a pure asset reproduction basis.
  3. Strattec is undervalued by 52% using my high estimate of intrinsic value with EBIT and cash at current levels.  Now that Strattec has restructured itself and made itself a worldwide company with expanded product lines and improved operations I actually think that EBIT should rise over time meaning Strattec’s intrinsic value could continue to grow and it would become even more undervalued.

Pros

  • Strattec has excellent management.
  • The company is undervalued by every one of my estimates of intrinsic value above and relative valuation estimates such as P/B, EV/EBIT, and TEV/EBIT.
  • Strattec restructured before and during the recession to cut costs, expand product lines, and became more efficient and less dependent on one single product line.
  • Strattec signed joint ventures, and created the VAST Alliance with two other companies that now allow Strattec to compete on a global scale.
  • Strattec’s margins have improved across the board in comparison to its 5 and 10 year averages and margins should continue to improve.
  • Sales have also been improving along with margins.
  • Strattec has almost zero debt.
  • Strattec management owns just fewer than 8% of the company.
  • Most importantly as it pertains to management is that I trust that they have shareholders best interests in mind.
  • Various value and small cap oriented funds own more than 50% of the company, including Mario Gabelli’s funds.
  • The VAST Alliance as a company should have its first profitable year this year which should help Strattec’s profitability even more.
  • My personal estimates of ROIC show that Strattec is even more profitable than I originally thought while looking at Morningstar’s numbers.
  • Strattec has a $25 million revolving credit facility if it wants to do any acquisitions, which the new CEO has said he will look into, or the $25 million could be used in an emergency situation if one arises.
  • Margins are not artificially inflated by debt so margins show a true picture of how Strattec is running.
  • Strattec has drastically reduced its share count in the past decade at what I think were good prices to be buying at.
  • Strattec is currently authorized to buy back more shares if it chooses to.
  • Strattec recently reinstated its quarterly dividend.

Cons

  • Strattec is highly dependent on only a few customers for its orders as General Motors, Ford, and The Chrysler Group combine for 68% of sales.
  • Strattec is highly dependent on how well the automotive industry and the overall economy as a whole are doing which can be seen in the above graphs.
  • Due to the cyclical nature of Strattec, if there is another recession or major problems in the auto industry again, its sales and profitability will be highly affected.
  • The company has some very stiff and much bigger competition.  The competition could possibly mean further price cuts on products in Strattec’s product lines if some kind of price war starts.
  • Due to competition and the overall cost reduction plans put into place by the big automotive companies, Strattec has had to drop prices on its products in recent years.
  • At this point I do not see any kind of long term sustainable competitive advantages within Strattec.

Catalysts

  • Since Strattec is very small in comparison to its competitors it could become a potential buy out candidate.
  • Strattec’s margins should continue to grow which could lead to the unlocking of value.
  • The new CEO Frank Karecji has said that he would like to do some kind of acquisition in the short term.
  • Strattec is authorized to buy back more shares.

Conclusion

With all of the above taken into account, I think that the absolute minimum Strattec should be selling for is $29.43 per share which assumes that Strattec’s EBIT margin will revert to its 3 year average.  I think that Strattec’s true intrinsic value is somewhere between $35 and $45 per share.  None of that is even taking into account that its sales and margins should continue to grow which would also grow the company’s intrinsic value.

The company does face some headwinds to future growth as I outline above, the biggest ones in my opinion is that Strattec has to compete with various bigger companies and I do not see any kind of long term sustainable competitive advantages within the company.

Normally I would want some kind of sustainable competitive advantage within a company that I am buying as a long term value hold, but at current valuations, with Strattec’s good and rising margins and other factors listed throughout the article, I think the risk/reward is in my favor by a substantial margin and I have already bought shares for my personal account and the accounts I manage making this only the fourth company I have bought into this year.

Dole Article Update and My Investment Checklist

Since my last post I have been doing a lot of research on Dole and its history and operations.  I have the sum of the parts valuation almost completely done and am just waiting for its next quarterly report so that I can finish all my valuations and analysis and get the article together.

I also have a call in to Dole investor relations about something that I came across that could be potentially problematic for current shareholders if I understand the situation correctly.  After I hear back from Dole IR tomorrow, I will let you know about the situation and how it could affect my valuations and analysis, if at all.

In between doing research I have also finally put together my buying investment checklist and wanted to share it with you to see if I missed anything.  I still need to organize the checklist better but wanted to get your input first.

Investment Checklist-Buying

  1. Can I in a short paragraph explain what the company does?
  2. Is the company undervalued?  If so by how much and does it reach my minimum 30% margin of safety threshold?
  3. Does the company create FCF?  If it does, how long has it created positive FCF?
  4. Does the company pay a dividend and is the dividend safe?
  5. Does the company buy back shares?  If the company does buy back shares is it at a discount to intrinsic value?  Does the company take advantage of its shares being overvalued by issuing shares?
  6. What is the EV/EBIT ratio?
  7. What are the company’s margins? (EBIT, Net, Gross, FCF/Sales, ROIC, ROE, etc)  Are the company’s margins getting better or worse?
  8. If ROIC and ROE are high is it because they are inflated by debt?
  9. What are the company’s debt ratios and are they getting better or worse?  Are they sustainable in your eyes?
  10. What are the company’s total debt and contractual obligations?  When are these obligations due?  Is this sustainable?
  11. Is there some kind of catalyst to unlock the value in the shares if the shares are undervalued?
  12. What is insider ownership?  Have insiders and institutions been buying or selling?
  13. Do any value investing partnerships, hedge funds, or activist investors own shares in the company?
  14. What is the company’s book value per share and is it selling for less than book value?
  15. Has book value been growing or declining?
  16. Does the company have any kind of sustainable competitive advantages?  If so what?  Same questions with barriers to entry into the industry?  Does the company have pricing power?
  17. What are the current and quick ratios?
  18. Has there been recent dilution in the stock?  If so why?
  19. Do I trust Management?  Have any directors or executives had problems in the past legally or ethically with companies they have been a part of?
  20. Does the company require a lot of cap ex to maintain?
  21. Are the company’s prospects good into the future?
  22. Is the company’s business essential?  Can the company’s operations becoming outdated fast by technology?  Can the company’s operations be destroyed by Amazon, EBay, or Wal Mart?
  23. Have cost of goods sold as a % of revenue been going up or down?
  24. Is managements pay too high?  Is management pay structure convoluted?  Do management and other insiders own a decent portion of the company?  Are managements goals aligned with shareholders?
  25. Is the company in an unloved boring sector?
  26. Has the company been having problems it can overcome?  Has it recently dropped out of an index or is there irrational selling in the stock?  Is the company dealing with any other kind of irrational fear that could lead to a buying opportunity?
  27. If this is a spinoff have company insiders been buying shares in either company?
  28. Are you comfortable holding the company for at least 5 years?  If this is a spin off or other special situation, how long are you comfortable holding the company for?
  29. In your opinion is the company able to compound its returns over time without acquisitions?
  30. Which portion of the portfolio will this company go into Special Situations, Long Term Compounders, or Net Net/Asset plays?
  31. Are you willing to go all in on this company; at least a minimum 20% of the portfolio?
  32. Is the company better than having cash in the portfolio?
  33. How long is the cash conversion cycle, has it being going up or down?
  34. How big is the downside if you buy into the company?
  35. How much cash and other assets does the company have in case of problems?
  36. What potential problems does the company face in the near future?  Are those problems big enough to keep you from investing?  What are risks to the company and how likely are those risks to disrupt your investment thesis?
  37. How robust is the company’s competition?  What is the company ranking in its industry?  Can the company out compete?
  38. Is this investment better than buying stock in companies that are already in your portfolio?  If so why?  If not why should it be added to the portfolio?
  39. How many customers does the company have?  If it is only a few are you comfortable with those customers?
  40. Does the company have any underlying undervalued assets that could be sold/spun off/put to better use to unlock value; land, intellectual property, buildings, etc?

Other than organizing it better which I am going to do, let me know if I missed anything that you use in your own checklists.

Hopefully I will hear back from Dole IR tomorrow so I can update that situation as well.

Professional Analysis Versus My Amateur Analysis Of Jack in the Box

This first link from MarketFolly contains the presentation from the winner of the Value Investors Congress contest whose presentation and analysis was a bull case for Jack in the Box.

The above analysis is actually the one I voted for in the contest as I thought it was the best, and the analysis he did in his article is actually what led me to research JACK as a possible investment for myself as he laid out a very good bull case for the company.

This second link is my analysis which is a bear case for Jack in the Box.

We came to the same conclusions about future possibility which he counts on more than I like to.  I generally only count in my analysis what I can see now and do not base my valuations on speculation of what could happen in the future.

Please feel free to leave comments on the two articles: Where I might have gone wrong, what I could have done better, etc.  I would really appreciate your thoughts.

My Plan for Deliberate Practice, fixing a problem, and free books

I first mentioned a problem I have been having about how to budget my time in this post at the beginning of August.

I have been doing a lot of thinking and reading lately and I wanted to share my thoughts here to see if anyone has any input.

After my post on Aceto, which is now an article on Seeking Alpha for those who want to follow the discussion in the comments section, I went straight into evaluating another company.  It has been my first time in truly trying to evaluate a bank, and about half way through its annual report, I quickly realized that I did not know enough about banks or the banking industry to fully evaluate its prospects properly.

I finished up reading its most recent annual and quarterly reports, did a P/B valuation where I found the company to be fairly priced, and was going to do a full valuation and analysis write up like I have been doing. However, my evaluation up to this point is pretty poor, and I realized I need to learn more about banks and the banking industry before I do the write up.

I have been seeing a lot of sites lately talking about deliberate practice and how to constantly get better, and I have been trying to figure out how best to personally accomplish my goals, and here is what I have come up with so far.

My Plan For Deliberate Practice and How to Fix My Time Budgeting Problem

Here are my ideas so far.

  1. I look at multiple companies as potential investment ideas on a daily basis, but I am fully committing myself to completely evaluating at least one new company every two weeks.  By fully evaluating I mean researching the company and its competitors, valuing the companies, evaluating its investment potential at this time, and writing an article about the company.  I think this will help me become a better investor on several levels: Thinking about and bettering my investment process, becoming better at putting my ideas into writing, better and more thorough investment write ups, and this will enable me to learn more about new industries and companies. Originally I wanted to fully evaluate a new company every week but that left little time for learning new things, which gets me to my second idea.
  2. I have known for a while now that I have a lot to learn still but after my foray into the banking industry, I realized I needed to set up some more time where I would specifically be learning, instead of trying to write an article or research another company.  The remainder of the two week period after I have finished up my article(s), I will spend learning: New techniques, new industries, reading books, finding better ways to think, etc.
  3. While I am researching and learning, I will again be posting more links that I think we all could learn from.
  4. I would also really encourage you the readers to post some ideas on The Readers Investment Ideas and Analysis Page.  If you are not comfortable doing an entire write up, I would be fine with your stating which company you have researched and giving a few points on why they are a buy or sell at this time in your opinion.  Again, I do not care if you are a beginner or have advanced knowledge, all ideas are welcome.  Also the free book giveaway is still in tact so the first person to put an idea on the page will receive a free book from my collection, and I will also continue to give free books away to other investment ideas that are put on the page as well. That page is also for any questions anyone might have.  I want us to all learn from each other, and since I am relatively new to investing I hope some of the more experienced viewers give some of their advice.
  5. I am giving you my email here as well if you would like to contact me for any reason.  I would be extremely excited to meet new people and discuss ideas or address any questions you might have in the privacy of email if you are not comfortable posting them on the site.  JMRiv1986@gmail.com

So far these are my ideas and I would like to hear your feedback on them.  I will be adding to, and tweaking the list periodically when I come across something that I think will help this process.  I will stick to the time frame as best as I possibly can, but will allow for some flexibility if some kind of issue, good or bad arises.

I am excited to see what kind of feedback I get as lately I have felt that my investment process has been lacking something that I cannot quite put my finger on.  I do feel that I have been getting better with every article I write and I am hopeful that I will find whatever it is that I think I am missing though my version of deliberate practice.

In the meantime I cannot wait to hear from you and to discuss your ideas and thoughts.

Kirklands Valuations and Analysis

In this article I will be analyzing and valuing Kirklands (KIRK).  I will also be comparing margins between KIRK and some of its competitors to see how good KIRK stacks up and decide if it looks to be a good buy now.

Kirkland’s is a specialty retailer of home décor and gifts in the United States, operating 299 stores in 30 states as of January 28, 2012. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, wall décor, candles and related items, lamps, decorative accessories, accent furniture, textiles, garden-related accessories and artificial floral products. Our stores also offer an extensive assortment of holiday merchandise during seasonal periods as well as items carried throughout the year suitable for gift-giving.  Description taken from its website here.

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

All numbers are in millions of US dollars, except per share information, unless otherwise noted.   Valuations were done using KIRK’s 2011 10K, and 2012 first quarter 10Q.  Valuations were done on July 19th 2012.  Its reports can be viewed here.

Asset valuation:

Assets: Book Value: Reproduction Value:
Current Assets
Cash and Cash Equivalents 73.2 73.2
Inventories 47.5 23.75
Deferred Income Tax 1.7 0
Prepaid Expenses and Other CA 8.1 2
Total Current Assets 130.5 98.95
PP&E Net 61.4 30
Other Assets 2.6 0
Total Assets 194.5 128.95

Total number of shares are 18.2

Reproduction Value:

  • 128.95/18.2=$7.09 per share.

Normally I would use this estimate of value as my base case since I am an extremely conservative investor.  After honing, and learning some new valuation techniques I have found that almost every company I evaluate is selling for quite a bit more than its reproduction value.

Stating that I will be using one of the below estimates of intrinsic value as my base case.

EBIT and net cash valuation:

Cash, cash equivalents, and short term investments=73.2

Total number of shares=18.2

Total current liabilities=38.6

Cash, cash equivalents, and short term investments-total current liabilities=34.6

  • 34.6/18.2=$1.90 in net cash per share.

KIRK has a trailing twelve month EBIT of 30.57-5.2+3.2=28.57.

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

  • 5X28.57=142.85+73.2=216.05
  • 8X28.57=228.56+73.2=301.76
  • 11X28.57=314.27+73.2=387.47
  • 14X28.57=399.98+73.2=473.18
  • 5X=216.05/18.2=$11.87 per share.
  • 8X=301.76/18.2=$16.58 per share.
  • 11X=387.47/18.2=$21.29 per share
  • 14X=474.58/18.2=$26.00 per share.

Market cap is 192.83

Enterprise value is 122.4

  • EV/EBIT=4.28

From this valuation I like that they have positive net cash per share and that they have a very low EV/EBIT, even in comparison to their competitors, which we will get to later.  From this valuation I would use either the 8X or 11X EBIT as my estimate of intrinsic value.  Both of which make KIRK pretty undervalued as it now sits at $10.30 per share.

These next three valuations are some of the new techniques I have been working on.

Revenue and EBIT valuation:

This valuation is using trailing twelve month numbers.

Trailing twelve month revenue=98-94+430=434

Multiplied by:

Average 6 year EBIT percentage:4.1%

Equals:

Estimated EBIT of 17.79

Multiplied by:

Assumed fair value multiple of EBIT: 8X

Equals:

Estimated fair value of enterprise value of KIRK: 142.32

Plus:

Cash, cash equivalents, and short term investments: 73.2

Minus:

Total Debt: 0

Equals:

Estimated fair value of common equity: 215.52

Divided by:

Number of shares of 18.2

Equals:

$11.84 per share.

Base case estimate of value.

My low case estimate was $8.95 per share, and my moderate to high case was $14.82 per share.  Using this estimate of intrinsic value KIRK still appears to be undervalued.

Book value and P/B valuation:

Book Value: 117.57

Minus:

Intangibles: 0

Equals:

Tangible book value: 117.57

Multiplied by:

Industry P/B ratio: 3.22

Equals:

Industry multiple implied fair value: 378.58 ($20.80 per share.

Multiplied by:

Assumed multiple as a % of industry multiple: 75% (2.42 X the multiple of Tangible book)

Equals:

Estimated fair value of common equity of KIRK: 283.94

Divided by:

Number of shares: 18.2

Equals:

$15.60 per share.

Base estimate of intrinsic value.

My low case estimate of value was $10.40 per share, and my high estimate was $20.80 per share.  Again, KIRK looks to be very undervalued.

EV/EBIT valuation:

KIRK is currently selling at an EV/EBIT of 4.28.  The average EV/EBIT ratio of its main competitors is 7.55, I will get back to the competitors in a bit.

If KIRK was selling at the industry average EV/EBIT ratio of 7.55, it would be worth $18.69 per share.  Again, very undervalued.

After five valuations, KIRK appears to be very undervalued except by the very low case estimates of intrinsic values.  Now I am going to check out their competitors margins and see how KIRK stacks up that way.

Margin Comparison:

Williams-Sonoma (WSM) Gordmans (GMAN) Bed Bath and Beyond (BBBY) Pier 1 (PIR) Kirklands (KIRK) Industry Avg (Most recent qtr)
P/B 2.87 4.11 3.61 3.86 1.65 3.22
ROE (TTM) 19.14% 35.61% 26.01% 38.67% 14.94% 26.87%
Op Margin 6.60% 5.30% 12.50% -0.20% 8.60% 6.56%
EV/EBIT 8.55 7.41 7.86 9.75 4.28 7.55
ROIC (5yr average) 12.07% 33.44% 19.98% 5.92% 12.72% 16.83%
ROIC TTM 18.27% 34.92% 26.01% 37.86% 14.94% 26.40%
FCF/Sales (5yr average) 5.64% 2.25% 7.57% 1.86% 3.71% 4.21%
FCF/Sales TTM 6% -0.07% 9.97% 3.79% 2.15% 4.37%
Insider Ownership 12.41% 72.07% 13.06% 13.12% 15.30% 25.19%

The first thing that jumped out at me about this table was Gordmans (GMAN) gigantic margins and insider ownership.  The margins are a little bit skewed though because they only go back 4 years instead of the 5 for the others, which take the other companies back farther into the recession.

The second thing was the ROIC margins that were surprisingly high to me.  I was expecting them to be lower since all of these companies depend on discretionary spending from consumers, which supposedly dropped quite a bit during the recession.

The third thing was the FCF/Sales margin numbers, anything over 5% is very good.  Gordmans numbers again are a bit skewed since they only have four years of data.  However, two of the companies still had margins over 5%, even through the recession, and the average is at 4.2%.

The fourth thing is that KIRK is selling at about half the P/B value of the rest of the companies.

KIRK has total contractual liabilities of $335 million coming due over the next 5 years.

One thing you can definitely tell from looking at the margins is that Kirklands and Pier 1 (PIR) seem to be the most effected by the cyclical nature of spending that is accompanied by this industry.  William-Sonoma (WSM), and Bed, Bath, and Beyond (BBBY) seem to be more resilient as the margins did not drop nearly as much in the recession.  With GMAN again not being as effected as much because its numbers only go back 4 years.

Kirklands Pros:

  • By almost all of the valuations I did they look to be pretty undervalued.
  • KIRK keeps its inventory levels pretty low, meaning they can change out products faster if they aren’t selling well or order more if they have something that is selling well.
  • They have positive net cash.
  • They have been repurchasing shares over the past several years and are authorized to purchase more.  Since 2009 KIRK has reduced its share count by about 2 million shares.
  • Insider ownership of 15.3%.

Kirklands Cons:

  • The consumer industry it is in, is highly cyclical and KIRK appears to be more effected than some of its competitors.  So if there is another economic crisis, which looks entirely possible, KIRK could struggle again.
  • It leases almost 100% of its properties, and a lot of the leases are still for the long term: $45.2 due in 2012, $42 due in 2013, $38.3 due in 2014, $35 due in 2015, $28.5 due in 2016, and a total of $83.4 due thereafter.
  • It only has one major distribution facility that is located in Tennessee.  If there is some kind of natural disaster that hits the distribution center or the surrounding area, KIRK could be crippled for a while.
  • KIRK gets most of its items made in China, whose economy looks like it is slowing down and could affect KIRK.
  • KIRK has some strict covenants in place to prevent a takeover of any kind.

Kirklands Potential catalysts:

  • At this time I do not really see a potential catalyst to unlock the value of the shares.
  • Since it does not own its own properties KIRK could not sell those to unlock the value of the company.
  • While KIRK’s stock is owned by some small cap value investing funds, with my research I did not find them to be activists investors.
  • In my opinion a BBBY and KIRK merger looks like it could be a good thing, but KIRK has some very strict anti-buyout covenants that might prevent something like that from happening.

Conclusion:

With all of the above stated, I am going to be using the book value and P/B valuation as my base case estimate of intrinsic value.  If KIRK gets its own P/B up to 75% of the industry P/B, it would be worth $15.60 per share.  Current share price is $10.70 per share, leaving an upside potential of 69% and about a 31% margin of safety if I were to buy now.

Normally with all of the above stated and KIRK meeting my minimum 30% margin of safety I would be a buyer.  However, I will not be buying at this time due to two reasons mainly:

  • 1) Since KIRK is a very cyclical company, I would want a bigger margin of safety of at least 50%.
  • 2) Another reason I would want at least a 50% margin of safety is because 95% of its suppliers are in China, whose economy looks like its slowing down at best, and at worst looks like it might crash completely, which would affect KIRK quite a bit.

When and if KIRK gets to a 50% margin of safety and/or I see some kind of catalyst, such as an activist investor getting involved that could unlock the value of the company, I would have no hesitations buying at that time.

As always feel free to give some feedback.