A Portfolio Update And Two Powerful Insights Every Serious Investor Should Read

Portfolio Update

Yesterday I made some adjustments to my portfolio and the portfolios I manage and I just wanted to update those positions.

Personal Portfolio and Portfolios I Manage:

  • Bought Strattec Security Corporation $STRT

Personal Portfolio:

  • Sold Altria $MO up 18%.
  • Sold Philip Morris $PM up 24%.
  • Sold Intel $INTC up < 1%, could have sold a while ago up 30%, doh!

All sold positions are after fees but before taxes.  I never bought any of the above three positions for the portfolios I manage and I bought Altria, Philip Morris, and Intel before doing any kind of valuations or any kind of in depth research so I am a bit fortunate to end up anything in those positions.

I said a couple months ago that I planned to hold the above positions for the foreseeable future because I felt that I could have my results compound well over time in all of the three companies.  I still think that is true for all of the above companies but have still decided to sell them all.  Lately I have been gaining confidence in my abilities to analyze companies, and I now think that I am at the point where I am getting pretty good at analyzing companies and think I can find better opportunities in the smaller mid to nano caps that I am concentrating on now.

Also as Red reminded me of the other day, why would I try to compete with the millions of people who are invested in and analyze those massive companies when I can find less competition, potentially less efficiency, and more upside, in the much smaller companies.

After selling those companies to free up cash for future opportunities, my current portfolio stands as follows, ranked by position size.  Portfolio does not add up to 100% because of rounding:

  1. $VIVHY.PK-28% of portfolio.
  2. Cash-26% of portfolio.
  3. $STRT-16% of portfolio.
  4. $MAIN-11% of portfolio.
  5. $CMT-8% of portfolio.
  6. $DOLE-8% of portfolio.

Two Powerful Insights Every Serious Investor Should Learn From and Reread.

Fundoo Professor-Presentation On Moats And Floats.

The Red Corner Blog-Kfaftwerk; A look at economies of scale and how Wal-Mart changed its industry and made a ton of money.

I hope you enjoy the above links as much as I have.

I have already started researching another company and tomorrow I will post some links and ask your advice on something I have been thinking about quite a bit lately.

Portfolio Update and A New Dole Article Planned

I just sold my entire position in Taseko Mines (TGB).  TGB released its most recent quarterly report yesterday and yet again it was a disappointment.  It seems that ever since I bought into this company every quarter has been a disappointment at least on some level with excuses being given by its management for why it is not performing as good as it could.  Also of note is that TGB had to resubmit its New Prosperity mine assessment report at the end of September and now a decision will not be made until sometime in 2013 about if the mine will be approved or not.  The original plan was to have a decision by this month which was the only reason I had even held onto it this long.

This is yet another company I bought before doing any kind of valuations and only minimal research and again I paid the price with a total loss of 47%.  The only thing that again saved me was that at least I was smart enough to make my positions pretty small when I first started out so I didn’t lose a ton of money.

My portfolio is now 23% in cash and I am down to owning stock in only six companies. After clearing out the only remaining company that I knew for sure I was going to sell at some point, I now only own stock that I think are good companies and have the potential to continue to compound into the future.

The three remaining companies I own from before doing valuations and anywhere near the amount of research that I am doing now: $MAIN, $MO, and $PM, are all by my estimates either fairly valued or overvalued by quite a bit and I may sell stock in each of these three companies if I detect deterioration in any of their businesses.  If I do not see deterioration in the businesses I will most likely hold these companies for years because I think each of these companies will compound their results well into the future, unless of course I find a better company to put my money into.

The three companies I have bought into since doing valuations and the amount of research I am doing now are: $CMT, $VIVHY, and $DOLE.  At this point I still think that CMT and VIVHY are undervalued and will let you know if I decide to buy any more stock in either of those two.

This gets me to Dole.  I got a request from one of the readers of my original Dole article that I posted on Seeking Alpha who liked my original analysis series on Dole, Chiquita, and Fresh Del Monte and he was asking if I would do an updated valuation and analysis article on Dole now that it has sold some of its assets and is able to pay off most of its debt.

The reader asked if I would do an updated article giving my thoughts on how Dole stands now after it sold some of its assets and paid down debt, if I still think that it is undervalued, and what I think of its operations going forward now that it eliminated its biggest problem.

I have learned a lot since that time and hope to use some of my new knowledge to see what I think about Dole now, if I still think they are undervalued after rising in price as much as 75% at one point and currently still being up 47% since I originally bought into it.  I am researching its land, other assets, and history more fully now in preparation so that when its next quarterly report comes out on November 15th I am ready to value the company with updated numbers and post the article shortly after that.

In the mean time I will continue to post any updates and links that I think contain knowledge.  I may also every once in a while ask some questions of you since I know some of you are more knowledgeable in certain areas than I am.  Since I am planning on adding some new things to this article I may need some feedback making sure I am applying the new techniques correctly.

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

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

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

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

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

Risks I saw then:

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

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

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

Analysis now

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

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

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

Valuations:

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

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

Net cash and EBIT valuation:

Altria has cash and cash equivalents of 1,528.

Its number of shares outstanding are 2,027.

Altria has total current liabilities of 6,081.

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

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

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

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

  • 5X6753=33765+1528=35293
  • 8X6753=54024+1528=55552
  • 11X6753=74283+1528=75811
  • 14X6753=94542+1528=96070
  • 5X=35293/2027=$17.41 per share.
  • 8X=55552/2027=$27.41 per share.
  • 11X=75811/2027=$37.40 per share.
  • 14X=96070/2027=$47.40 per share.

Current price is $35.63 per share.

Market cap is 72.44 billion.

Enterprise value is 84.44 billion.

  • EV/EBIT=12.50

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

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

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

Revenue and EBIT valuation:

Using Trailing twelve month numbers:

Revenue: 16,670

Multiplied By:

Average 4 year EBIT percentage: 34.13%

Equals:

Estimated EBIT of: 5,689.47

Multiplied by:

Assumed fair value multiple of EBIT: 10X

Equals:

Estimated fair value Enterprise value of MO: 56,894.7

Plus:

Cash and Cash equivalents: 1,528

Minus:

Total Debt: 13,089

Equals:

Estimated fair value of common equity: 45,333.7

Divided by:

Number of shares: 2,027

Equals:

$22.36 per share.

Low estimate

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

Free cash flow valuation:

Again using Trailing twelve month numbers.

Operating cash flow: 3,388

Minus:

Capital expenditures: 108

Equals:

Free cash flow (FCF): 3,280

Divided by:

Industry median FCF yield: 6%

Equals:

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

Multiplied by:

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

Equals:

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

Divided by:

Number of shares: 2,027

Equals:

$25.62 per share.

Low estimate

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

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

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

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

Concerns:

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

Pros:

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

How I think they could improve further:

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

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

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

Conclusion:

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

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

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

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

Some weekend reading, and an update on my Altria write up

I thought everyone would enjoy these three articles to read over the weekend.

Warren Buffet’s Winning Ways 50 Years On.

Klarman Vs Tilson

This is The Trait That Makes Seth Klarman One of The Greats of Hedge Fund Management

I have finished my Altria write-up this morning and I now just need to edit it before posting it by the latest Monday morning.  Originally I wanted it to be just a mini write-up on my thoughts then vs now, but it turned into a full-fledged article which is why it has taken so long.  I hope it is something that you enjoy and can learn from.