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.

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.

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.

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Wendy’s: Great Fast Food, Bad Investment

About a month and a half ago I wrote an article stating that I believe Jack In The Box to be overvalued despite the recent positive hype around the company.  Lately I have been researching Wendy’s $WEN because it has had JACK’s opposite problem; very negative recent press and wanted to see if this might turn out to be a potential contrarian value play or a value trap.

I will be referencing and comparing Wendy’s to Jack In The Box and the other fast food companies I wrote about in my $JACK article so if you would like to see how Wendy’s compares to other fast food companies please reference my JACK article that I link to above.

Wendy’s Overview

Wendy’s is an owner, operator, and franchiser of 6,543 fast food restaurants, 1,447 of the restaurants are owned directly by Wendy’s with the remaining amount owned by franchisees.  Wendy’s offers hamburgers, chicken sandwiches, salads, wraps, fries, and the rest of the typical fast food restaurant offerings but at a higher quality profile than most of its other fast food competitors.  Higher quality also leads to higher prices for its individual product offerings and meals which greatly affected the company during the recession with customers generally looking for cheaper food.  In the past several years to combat the low cost offerings of its competitors, Wendy’s has brought out its own value and extra value menus with prices generally under $2 per item.

Since the recession Wendy’s has streamlined operations by selling off its Arby’s subsidiary, enacting cost cutting measures,  updating its menu to offer new products including breakfast at some locations, and has started reimaging some of its restaurants by starting its Image Activation Program.  The program has been put into place to update its restaurants making them look more modern, offering more amenities to get customers to stay longer at its restaurants, and making the food ordering and cooking process more efficient so customers can get their food faster.

Unlike JACK who has recently finished up its reimaging of its restaurants and who should see at least small margin growth due to lower capital expenditures, Wendy’s has only just started this process with only a few dozen restaurants having been updated thus far.  Wendy’s hopes that by 2015 about half of its company owned restaurants will be reimaged so this process is going to take a while.  As we saw with Jack In The Box that will lead to generally higher cap ex for the foreseeable future, most likely lower or stagnant margins, possibly more debt, and potential loss of sales due to having some of its restaurants closed for construction periods of as long as eight weeks currently.

Valuations

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

All numbers are in millions of US dollars, except per share information, unless otherwise noted. The following valuations were done using its 2011 10K, 3Q 2012 10Q, and its 3Q 2012 investor presentation slides.

Asset Reproduction Valuation

Assets:	Book Value:	Reproduction Value:
Current Assets
Cash And Cash Equivalents	454	454
Accounts Receivable (Net)	65	55
Inventories	12	8
Prepaid Expenses & Other Current Assets	32	16
Deferred Income Tax Benefit	95	48
Advertising Funds Restricted Assets	75	50
Total Current Assets	734	631
Properties	1241	745
Goodwill	877	439
Other Intangible Assets	1315	658
Investments	118	89
Deferred Costs & Other Assets	57	29
Total Assets	4340	2591

Number of shares are 390

Reproduction Value:

With goodwill and intangible assets:

• 2591/390=$6.64 per share.

Without goodwill and intangible assets:

• 1494/390=$3.83 per share.

EBIT and Net Cash Valuation

Cash and cash equivalents are 454

Short term investments are 0

Total current liabilities are 344

Number of shares are 390

Cash and cash equivalents + short-term investments – total current liabilities=454-344=110.

• 110/390=$0.28 in net cash per share.

WEN has a trailing twelve month EBIT of 120.

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

• 5X120=600+454=1054/390=$2.70 per share.
• 8X120=960+454=1414/390=$3.63 per share.
• 11X120=1320+454=1774/390=$4.55 per share.
• 14X120=1680+454=2134/390=$5.47 per share.

TEV/EBIT and EV/EBIT Valuation

Total enterprise value is market cap+all debt equivalents (including the capitalized value of operating leases, unfunded pension liability, etc) -cash-long term investments-net deferred tax assets.

• TEV/EBIT=3310/120=27.58
• TEV/EBIT without accumulated deficit counted=2833/120=23.61
• Regular EV/EBIT=2946/120=24.55

The average EV/EBIT in the fast food industry that I found when analyzing JACK was 15.68 and the only company to have a higher EV/EBIT than Wendy’s is Chipotle Mexican Grill $CMG which had an EV/EBIT of 26.53.

I usually like to buy companies that have an EV/EBIT multiple under 8 so the fast food industry as a whole appears to be massively overvalued to me.  Not only that but Wendy’s current EV/EBIT multiple is comparable to Chipotle’s which generally has very high margins, which is exactly the opposite of Wendy’s.  As we will see later Wendy’s margins do not even come close to Chipotle’s and are generally much worse than even the rest of the fast food companies margins, so its extraordinarily high EV/EBIT multiple is astounding and I will explain later why it is so high.

I also did my normal other valuations but they did not work because after you take out the company’s debt and or goodwill and intangibles from the other valuations you get negative estimates of intrinsic value for Wendy’s equity.

Margin comparison

Please reference my JACK article above to see my thoughts on each of the other company’s margins as I will only be commenting in this article about Wendy’s margins.  The below chart has been updated to include Wendy’s margins for comparison to the other fast food companies.  The industry averages are still only including the previous five companies I talked about.

All numbers in the table were put together using either Morningstar or Yahoo Finance.

	Jack in the Box (JACK)	Sonic Corp (SONC)	McDonald’s (MCD)	Yum Brands (YUM)	Chipolte Mexican Grill (CMG)	Company Averages	Wendy’s (WEN)
Gross Margin 5 Year Average	16.28%	34.30%	37.94%	26.20%	24.28%	27.80%	25.70%
Gross Margin 10 Year Average	17.08%	43.38%	40.42%	35.59%	11.73%	29.04%	39.86%
Op Margin 5 Year Average	7.46%	16.24%	27.42%	14.22%	12.76%	15.62%	-1.70%
Op Margin 10 Year Average	7.07%	18.05%	22.62%	13.50%	6.64%	13.57%	0.21%
ROE 5 Year Average	20.16%	66.33%	30.26%	131.56%	18.55%	53.37%	-6%
ROE 10 Year Average	18.77%	43.71%	23.19%	105.85%	10.27%	40.36%	-4.68%
ROIC 5 Year Average	11.17%	3.38%	17.38%	24.97%	18.49%	15.08%	-3.77%
ROIC 10 Year Average	10.91%	8.97%	13.37%	23.54%	10.22%	13.40%	-2.45%
FCF/Sales 5 Year Average	-0.26%	6.48%	15.90%	7.70%	6.92%	7.35%	1.07%
FCF/Sales 10 Year Average	0.80%	7.10%	12.86%	6.70%	2.26%	5.94%	-3.74%
Cash Conversion Cycle 5 Year Average	0.78	1.23	0.91	-36.35	-5.24	-7.92	-4.18
Cash Conversion Cycle 10 Year Average	0.27	1.14	-1.22	-49.02	-5.21	-10.81	-4.53
P/B Current	2.9	12.4	6.7	14.3	8.2	8.9	0.9
Insider Ownership Current	0.38%	6.12%	0.07%	0.50%	1.64%	1.74%	6.83%
EV/EBIT Current	14.25	9.65	12.16	15.81	26.53	15.68	24.55
Debt Comparisons:
Total Debt as a % of Balance Sheet 5 year Average	30.78%	80.91%	35.28%	45.24%	0	38.44%	34.03%
Total debt as a % of Balance Sheet 10 year Average	26.84%	50.77%	35.22%	40.72%	0.14%	30.74%	38.58%
Current Assets to Current Liabilities	1.02	1.38	1.24	0.97	4.13	1.75	2.13
Total Debt to Equity	1.03	9.69	0.97	1.6	0	2.66	0.81
Total Debt to Total Assets	30.50%	71.20%	41%	37.21%	0	35.98%	36.87%
Total Contractual Obligations and Commitments, Including Debt	$2.6 Billion	$1 Billion	$27.20 Billion	$11.42 Billion	$2.20 Billion	$8.88 Billion	$1.9 Billion
Total Obligations and Debt/EBIT	21.67	8.85	3.15	5.4	5.82	8.98	13.33

As you can see from the above margin comparison, Wendy’s margins are almost all quite a bit worse or at best about even with industry averages in comparison to its fast food competitors.  Even if we were to exclude Wendy’s absolutely horrible 2008 from its numbers, its margins are still quite a bit lower than its competitors.

Especially of note are the horrible in comparison to its competitor’s margins: ROIC, ROE, FCF/Sales, EV/EBIT, and Total obligations and debt/EBIT ratios, which are all a lot worse than its competitor’s ratios.  Wendy’s EV/EBIT is especially inflated due to its high amount of debt in comparison to its profitability which is why it has a comparable EV/EBIT to the much higher margin Chipotle.  My calculations of ROIC are a bit different than Morningstar’s numbers and help out Wendy’s a bit, but even at 5.4% without goodwill and 3.85% with goodwill those numbers are still generally quite inferior to its competitors.

About the only thing that Wendy’s has in favor for itself out of the entire above table is that its P/B ratio of 0.9 is a lot lower than its competitors.  A P/B ratio that low generally means that the company could be undervalued. That P/B ratio in this case is a bit of a farce because goodwill and other intangible assets make up the vast majority of current book value as just those two combine for an estimated $2.2 billion in value.  After subtracting goodwill and intangible assets tangible book value is actually negative.  The $2.2 billion is actually more than the current market cap so I think that it is fair to say that those values are probably massively overstated and may soon have to be restated or written down to a more reasonable level, thus eliminating some further perceived value and bringing the P/B value up closer to its competitors.

I also think that Wendy’s debt levels and costs are too high in comparison to its profitability as 83% of operating profit (EBIT) goes to interest expenses.  Costs and other expenses, not including interest expense and loss on extinguishment of debt, take up 95% of total sales.  Other expenses include general and administrative, depreciation and amortization, etc.  If you include interest expenses and loss on extinguishment of debt that takes total costs and expenses over 100% of sales, which is why Wendy’s recent earnings have been negative.

Pros

• Pays a dividend and recently upped it 100%.
• After a lot of the stores are reimaged margins should improve due to lower cap ex and higher same store sales.  Of the stores that have thus far been reimaged Wendy’s says they have seen 25% increases in sales.
• Has positive net cash.
• Has a good amount of cash on hand.
• Same store sales have risen for 6 straight quarters and a total of 2.3% in the past 9 months.
• Wendy’s has recently paid off some of its 10% coupon debt by taking out lower interest debt, which should lead to lower interest expenses going forward.
• Wendy’s recently overtook Burger King as the second biggest fast food burger chain.
• Owns a lot of its restaurants and the property underneath the buildings so Wendy’s does hold some valuable assets in case it has some problems.
• Just fewer than 80% of its restaurants are owned by franchisees that pay a 4% royalty to Wendy’s.  Collecting franchise royalty fees is a very high margin business.
• The company produces positive FCF excluding cap ex.

Cons

• Wendy’s is overvalued by every one of my valuations, sometimes in extreme cases, except when including the massive amount of goodwill and intangible assets.
• Wendy’s margins overall are generally a lot worse than its fast food competitors.
• Book value is only positive because of goodwill and other intangible assets.
• The company has had recent negative earnings.
• 83% of operating profit went to interest expense.
• The company’s equity has negative value after subtracting goodwill and intangible assets on various valuations.
• The company has been buying back a lot of stock at what I think are overvalued prices.
• The company’s debt levels and costs are too high in my opinion in comparison to its profitability levels.
• Wendy’s will have higher cap ex for the foreseeable future due to the reimagining of its stores.
• The reimaging of Wendy’s stores could be going on for at least a decade if not more as it hopes to have around 750 stores reimaged by 2015 leaving around 5,750 stores to be reimaged after that, not including new stores that are opened by Wendy’s itself or its franchisees.
• Cap ex this year has been around $225 million and will likely stay close to that elevated level for many years due to the reimagining of its stores and which should either lead to lowering or stagnating margins for the foreseeable future.
• The company has negative FCF when including cap ex.
• This year the company spent $126 million in cash on cap ex with the remaining $99 million coming from other sources.  To me that means Wendy’s will have to either increase its margins and FCF to pay the remaining cap ex costs, or more likely it will continue to have to issue debt to fund the reimaging of its stores.
• While sales have been rising within Wendy’s, costs have also been rising at about the same amount which is why margins have not been increasing much as sales have improved.
• The company has quite a few, what seem to me questionable related party transactions within the company, including with Mr. Peltz (former Wendy’s executive and current chairman) and Trian Partners the investment fund Mr. Peltz has formed with a couple Wendy’s other board members.
• Just one example of the questionable transactions is that Wendy’s paid just under $640,000 in security costs for Mr. Peltz who is a billionaire and could easily pay these costs himself.
• Trian Partners currently owns just under 25% of Wendy’s and has three members on Wendy’s board of directors so Trian could exert a lot of pressure on Wendy’s if it saw fit to do so.
• Due to some of the what seem to me to be questionable transactions; I do not trust management to do what is right for shareholders and to increase shareholder value.

Potential Catalysts

• The reimaging of its stores will most likely eventually lead to margin and sales growth.
• If Wendy’s can get its costs under control, which it is trying to do now, it could achieve some margin growth.
• In my opinion Wendy’s has overstated its goodwill and other intangible assets and may have to restate or write down some of the value of each.  Wendy’s warns it may have to do this in its most recent annual report, which would lead to less perceived value in the company, and would probably drop the price of the stock further.

Conclusion

Wendy’s has recently overtaken the number two spot for hamburger fast food chains in the United States from Burger King.  Growth in this case appears to be bad for shareholders as its costs have been rising about in line with sales which are why margins have not seen much growth as Wendy’s sales have been growing.  Wendy’s margins are also generally quite a bit worse than its other fast food competitors, in my opinion its debt levels and costs are too high, and I do not trust its management to do what is right for shareholders.

Wendy’s appears to be destroying shareholder value with its high costs and debt levels, buying back its stock at overvalued prices, and continuing to grow its restaurant count and sales but not improving its margins.  Because Wendy’s margins have not improved as sales have been rising, it looks like Wendy’s is growing at less than its cost of capital which in my opinion has led to value destruction for shareholders.  The destruction of shareholder value will not reverse unless Wendy’s can cut its costs and debt levels and or improve profitability which probably will not happen for a while due to some of the reasons stated above.  Unless something drastic happens, in my opinion shareholders of Wendy’s stock can only look forward to further value destruction of their shares into the future.

Having stated all of the above I would estimate Wendy’s intrinsic value to be my 5X EBIT and cash valuation of $2.70 per share.  Due to all of what I stated in the above article I do not think that Wendy’s is even worth its reproduction value and I would not even be a buyer of the company at my $2.70 per share estimate of value.

Even if Wendy’s margins and sales do rise after reimaging of its stores, which should happen, that will not take place for many years as Wendy’s has only recently started to reimage its restaurants.

I hope I am wrong about Wendy’s because food wise it is by far my favorite fast food restaurant.  I hope it can fix its problems, and hope that it starts to thrive as a company.  However, as an investment I think Wendy’s is the proverbial value trap and I plan to keep my investment funds far away from the company.

Jack In The Box Overvalued Despite The Recent Hype

Recently I have been seeing quite a bit about Jack in the Box (JACK) and its long term potential through a possible spin off down the road of its subsidiary Qdoba, the entire company being bought out by one of the bigger fast food chains, or though its margin growth now that it has about 72% of its Jack in the Box fast food restaurants being owned by franchisees.  Franchise royalty margins I have seen estimated as high as 80%.

After seeing all of the above and how undervalued everyone seems to think JACK currently is, I decided to research the company myself.  Most of what I have read about JACK from other people is that it is undervalued because of the “Future potential” of the company with what I talked about in the first paragraph given as reasons; there are a lot of ifs in every pro JACK article I have read thus far.

If you have read any of my previous valuation and analysis articles, you know that is not how I operate.  For those of you who have not seen any of my previous articles I do not base my buy or sell decisions on ifs.  I value the company’s assets and operations as it is now, and future potential is only icing on the cake to me in most cases.  Here is an overview of my investment philosophy.

With the rest of this article I will be showing you why I think JACK is overvalued and give you reasons why I will not be investing in it at this time.

Jack In the Box Overview

JACK owns and operates a total of 2,247 Jack in the Box fast food restaurants, about 72% of which are owned by franchisees. Jack in the Box is one of the largest hamburger chains in the US with operations in 19 states, with the vast majority of its operations in California and Texas.  JACK also owns Qdoba and has 614 total restaurants, about half of which are owned by franchisees. Qdoba is a fast food Mexican restaurant with operations in 44 states currently.  For further information on JACK please visit its website here.

Jack in the Box has recently finished up reimaging some of its restaurants by changing the logo, updating the menu, and making its restaurants look more modern.  The recent reimaging of Jack in the Box restaurants has led to higher capital expenditures and sometimes lower revenues over recent years.  Now that the bulk of the reimaging is done, Jack in the Box is hoping to become even more profitable.

In recent years Jack in the Box has under gone the process of selling some of its restaurants to franchisees so it can get into the higher margin area of collecting royalty and franchise fees.  Jack in the Box currently has around 72% of its restaurants owned by franchisees with plans to eventually have 80% of its restaurants owned by franchisees.

Qdoba has been going through a rapid growth phase since being acquired by JACK in 2003 and JACK management states that it believes there is future potential of between 1,800 and 2,000 Qdoba restaurants in the United States.

As of the most recent 10Q, JACK gets 56.9% of its revenue from sales at its restaurants, 27.7% from distribution sales, and 15.5% from franchise and royalties.  Total company costs are 83.5% of total revenues which come from food and packaging 32.3%, payroll and employee benefits 28.7%, and occupancy and other 22.5%.

Valuations

These valuations are done by me and are not a recommendation to buy stock in any of the following companies mentioned.  Do your own homework.  All numbers are in millions of US dollars, except per share information, unless otherwise noted.  The following valuations were done using its 2011 10K and 3Q 2012 10Q.

I did my other normal valuations as well but from now on plan to only post the ones that I think are most relevant.

Low Estimate of Value:

Assets:			Book Value:		Reproduction Value:
Current Assets
Cash & Cash Equivalents			10.8		10.8
Accounts Receivable & Other Receivables (Net)			84.9		72.2
Inventories			37		18.5
Prepaid Expenses			32.2		16
Deferred Income Tax – Deferred Tax Liability			39		19.5
Assets Held For Sale & Leaseback			62.4		31
Other Current Assets			1		0
Total Current Assets			267.3		168
PP&E Net			825.5		495.3
Goodwill			140.5		84.3
Other Assets Net			241		120
Total Assets			1474.3		867.6

Number of shares are 45

Reproduction value:

• Without goodwill: 783.3/45=$17.40 per share.

Base Estimate of Value:

Cash and cash equivalents are 10.8

Short term investments are 0

Total current liabilities are 266

Number of shares are 45

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

• 10.8+0-266=-255.2/45=-$5.67 in net cash per share.

Jack in the Box has a trailing twelve month EBIT of 120.

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

• 5X120=600+10.8=610.8
• 8X120=960+10.8=970.8
• 11X120=1320+10.8=1330.8
• 14X120=1680+10.8=1690.8

• 5X=610.8/45=$13.57 per share.
• 8X=970.8/45=$21.57 per share.
• 11X=1330.8/45=$29.57 per share.
• 14X=1690.8/45=$37.57 per share.

From this valuation I would use the 8X EBIT and cash estimate of intrinsic value, $21.57 per share.

High Estimate of Value:

				Numbers:
Revenue:				2165
Multiplied By:
Average 5 year EBIT %:				7.50%
Equals:
Estimated EBIT of:				162.4
Multiplied By:
Assumed Fair Value Multiple of EBIT:				11X
Equals:
Estimated Fair Enterprise Value of JACK:				1786.4
Plus:
Cash, Cash Equivalents, and Short Term Investments:				10.8
Minus:
Total Debt:				451
Equals:
Estimated Fair Value of Common Equity:				1346.2
Divided By:
Number of Shares:				45
Equals:				$29.92 per share.

I will explain my reasons for picking these valuations in the conclusions portion of this article, but by my estimates JACK Is currently either fairly valued or overvalued by almost every valuation technique I did, except for the valuations with very high multiples.

Margins and Debt In Comparison To Competitors

				Jack in the Box (JACK)		Sonic (SONC)		McDonald’s (MCD)		Yum Brands (YUM)		Chipotle Mexican Grill (CMG)		Company Averages
Gross Margin 5 Year Average				16.28%		34.30%		37.94%		26.20%		24.28%		27.80%
Gross Margin 10 Year Average				17.08%		43.38%		40.42%		32.59%		11.73%		29.04%
Op Margin 5 Year Average				7.46%		16.24%		27.42%		14.22%		12.76%		15.62%
Op Margin 10 Year Average				7.07%		18.05%		22.62%		13.50%		6.64%		13.57%
ROE 5 Year Average				20.16%		66.33%		30.26%		131.56%		18.55%		53.37%
ROE 10 Year Average				18.77%		43.71%		23.19%		105.85%		10.27%		40.36%
ROIC 5 Year Average				11.17%		3.38%		17.38%		24.97%		18.49%		15.08%
ROIC 10 Year Average				10.91%		8.97%		13.37%		23.54%		10.22%		13.40%
FCF/Sales 5 Year Average				-0.26%		6.48%		15.90%		7.70%		6.92%		7.35%
FCF/Sales 10 Year Average				0.80%		7.10%		12.86%		6.70%		2.26%		5.94%
Cash Conversion Cycle 5 Year Average				0.78		1.23		0.91		-36.35		-5.24		-7.92
Cash Conversion Cycle 10 Year Average				0.27		1.14		-1.22		-49.02		-5.21		-10.81
P/B Current				2.9		12.4		6.7		14.3		8.2		8.9
Insider Ownership Current				0.38%		6.12%		0.07%		0.50%		1.64%		1.74%
EV/EBIT Current				14.25		9.65		12.16		15.81		26.53		15.68
Debt Comparisons:
Total Debt as a % of Balance Sheet 5 year Average				30.78%		80.91%		35.28%		45.24%		0		38.44%
Total debt as a % of Balance Sheet 10 year Average				26.84%		50.77%		35.22%		40.72%		0.14%		30.74%
Current Assets to Current Liabilities				1.02		1.38		1.24		0.97		4.13		1.75
Total Debt to Equity				1.03		9.69		0.97		1.6		0		2.66
Total Debt to Total Assets				30.50%		71.20%		41%		37.21%		0		35.98%
Total Contractual Obligations and Commitments, Including Debt				$2.6 Billion		$1 Billion		$27.20 Billion		$11.42 Billion		$2.20 Billion		$8.88 Billion
Total Obligations and Debt/EBIT				21.67		8.85		3.15		5.4		5.82		8.98

My thoughts on the above comparisons:

• McDonald’s is by far the most profitable company of the five as it far outdistances the competition in gross margin, operating or EBIT margin, FCF/sales, etc.
• Sonic and Yum Brands’ ROE and ROIC are astounding but are inflated by both companies high levels of debt in comparison to the other three companies.
• JACK’s margins have generally declined in the last five years in comparison to the entire 10 year period.  Most of the other company’s margins during that time have been improving.
• Chipotle’s margins are pretty amazing, especially when you see that it does not have any debt so the numbers are not inflated like Sonic and Yum.
• On an EV/EBIT basis Chipotle looks to be very overvalued currently with a ratio of 26.53.
• The insider ownership of all the companies is horrendous.
• The P/B of this industry is by far the highest I have seen since doing in depth research.
• The EV/EBIT ratios are also much higher than the companies I have been researching lately.
• The P/B and EV/EBIT ratios being much higher than what I have been finding lately leads me to believe that this entire industry is either fairly valued or overvalued currently.
• The entire industry has some very high debt levels due to the costs of food, restaurant leases, etc.  Debt levels have risen quite a bit recently as all of the companies, with the exception of CMG and MCD, have taken on more debt in the past five years.
• MCD, YUM, and CMG’s total obligations and debt/EBIT ratios look very sustainable into the future.
• JACK’s total obligations and debt/EBIT ratio is dangerously high at 21.67.  Especially of concern is that the bulk of its obligations and debt are due before 2016.
• Sonic’s debt levels also seem to be too high to me.
• Helping out SONC, MCD, YUM, and CMG is that most of the four company’s debt and total obligations are coming due after 2016.

Let us now get back to JACK.

Pros

• JACK has been buying back a lot of shares and has reduced its share count by 13 million since 2009, down to 45 million as of the most recent quarter.
• JACK has decent margins that have been consistently positive over the past decade.
• Now that the reimaging of Jack in the Box is done cap ex should go down and profit margins should go up over time.
• Qdoba is a high growth asset that is also currently more profitable than Jack in the box.
• JACK’s debt ratios, excluding total obligations, all look very good compared to its competitors.
• Selling restaurants to franchisees will get JACK into the higher margin business of collecting royalty and franchise fees.
• Fortunately most of JACK’s debt has low interest rates.
• JACK owns the land underneath some of its restaurants which provides at least partial downside protection due to the possible sale of the land if it was facing dire problems and was forced to sell some of its assets.

Cons

• JACK’s debt ratios above are very misleading as they do not include contractual obligations and commitments.
• JACK’s total obligations and debt in comparison to its profitability levels are way too high in my opinion with a total obligations/EBIT ratio of 21.67, which is by far the highest of the group and dangerously high in my opinion.
• Most of its debt and obligations are due within the next 5 years further exacerbating the debt situation in my eyes.
• Margins have been declining at JACK over the past five years, in part due to the reimagining of its Jack in the Box restaurants.
• JACK’s margins while decent and relatively steady over the past few years, are also generally quite a bit lower than its competitors.
• JACK’s FCF/sales margin is negative over the past five years while the industry average is 7.35% over that time.
• JACK is overvalued by almost every one of my estimates of intrinsic value.
• The entire fast food industry appears to be either fairly valued or overvalued at this time.
• About 85% of its revenues go towards paying costs, greatly affecting margins.
• JACK will continue to put a lot of its resources towards opening and running restaurants and food costs.  Some of the cost of new restaurants is paid by the developer however.
• A 1% point increase in short term interest rates would result in an estimated increase of $3.6 million in annual interest expense.  Interest rates can only go higher from where they are at now.
• Has a low amount of cash on hand.
• Managements pay seems too high to me.
• How JACK management structures the pay, bonuses, and awarding of options and restricted stock is very convoluted.  The most recent proxy is longer than the most recent annual report, most of which is spent explaining how management is awarded some of its compensation.
• Horribly low insider ownership.
• I do not see any kind of moat or competitive advantages within JACK.

Potential Catalysts

• Margins should rise now that the store reimaging of Jack in the Box restaurants are done, which could eventually lead to a higher estimate of value.
• The total obligations and debt situation could be a negative catalyst if JACK should have any problems.
• As of the most recent proxy, Fidelity Management & Research Company owns 14.9% of JACK.  If FMR decides to liquidate a portion or all of its position in JACK there could be a big sell off in the stock.
• If JACK management decides to sell or spin off Qdoba it would send the stock price higher.
• JACK could be bought out by a bigger fast food chain.

Conclusion

The reason I chose the above estimates of intrinsic value, that I am sure the JACK bulls will say are too low, are because of the problems I found with JACK as it currently stands: Its huge amount of total obligations and debt, the bulk of which is coming due before 2017, its relatively low and decreasing margins in comparison to its competitors, along with all of the other reasons I outlined above.

I need as big of a margin of safety as possible and for the most part only value what I see in the company as it presently stands.  All of the other articles I have seen have been talking about how much JACK could be worth if it spun off or sold Qdoba, or the entirety of JACK gets bought out.

To my knowledge JACK management has not said anything about spinning off Qdoba so to me valuing a company on speculation of what could happen in the future is very dangerous.  I saw an article the other day where someone wrote that if Qdoba was spun off could sell for 30X EV/EBITDA because that is what Chipotle sells for.  Buying any company at 30X EV/EBITDA is insane to me, especially potentially Qdoba as I do not think it has any discernible sustainable competitive advantages.  I do not even know how someone would make money on that transaction, especially since Qdoba would most likely not pay any dividend as it needs to grow its store count.

Even if JACK management does decide to spin off or sell Qdoba, the valuations and analysis that I laid out above were encompassing the entire company, and I still found JACK to be overvalued on almost every count.  I do expect JACK’s margins to rise over time now that the bulk of its reimaging is done, but the debt and total obligations scare me too much to be a buyer even if that happens.

Speculating is no longer what I do when investing, and to me buying into JACK now is almost purely a speculation play in the hopes that it gets bought out or spins of Qdoba.  In my opinion JACK is overvalued, has no discernible moat or competitive advantages, and has some huge problems with its debt and total obligations.  Combined with the rest of my above analysis, I think JACK is a bad investment currently.

For me personally, how I invest, what I need as a margin of safety, and the problems I outlined in the article, lead me to the conclusion that the risks far out way the pros as JACK currently stands, and I will not be a buyer of it at this time.

Some Fantastic Links

Before I get back into research and finishing up my checklist I wanted to give you some links that I thought held some kind of insight or knowledge that we all could learn from.

Warren Buffett on his Investment in See’s. See’s is one of his favorite all time investments and I think his reasons for investing should be studied by every investor. Article is from Valuewalk, @Valuewalk on Twitter.

The Secret’s of See’s Candies is an extensive profile of the business, why Buffett bought it, why it is such a good business, its new expansion plans, and how Buffett and Munger almost blew the investment.

Visiting Warren Buffett are notes from someone who visited Berkshire Hathaway on a trip from Columbia Business School in 2006.  These notes are from an interview and speech that was given while on the trip where Buffett gives some very valuable lessons.  The most fascinating thing to me was that Buffett was the following quotes from the article: Emphasis mine.

Question 12: What would you pay for a solid company that is growing earnings at 8-10%/year?

Not many companies will do that. You see a lot of garbage about EBITDA. Depreciation is the worst kind of expense in that it is prepaid. He looks at EBIT/EV. He’ll generally pay 7x for a decent business. For insurance companies, he looks at float and the cost of float.

Looks like that could be a very good starting point for valuations.

Masters of Compounding: Walmart ($WMT) 1968-2012 is an exceptional article from Student of Value on the history of Walmart and what has made it such a fantastic company over time.  I would also recommend following @dgenchev on Twitter if you would like to see his future write ups as they have so far all been fantastic.

How an Average Business Can be a Great Investment by Oddball Stocks has some interesting thoughts about average businesses and their investment potential.  There is some great back and forth in the comments section as well.  I would also recommend reading his two write ups about Hanover Foods that he links to in the article as the analysis he presents is very detailed.

4 Mistakes When Valuing Companies With Large Cash Holdings, and How to Avoid Them is another fantastic write-up by Simple Value Investing.  I would also highly recommend following him on Twitter @SimpleValue as all of his write ups thus far have also been fantastic.  His write ups on Ibersol were very detailed and he laid out a very good investment case for them. Part 1 and Part 2.

I hope you enjoy the links over the next few days as I am now off to finish up my own investment checklist and to research some more companies.