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.

Dole Is Still Undervalued: Updated Valuation And Analysis Article After Sale To Itochu

Earlier this year I completely dedicated myself to learning the techniques, process, and proper mind set to become an excellent value investor.  I wrote my first full article back in June about Dole Food Company (DOLE).  Here are my thoughts on Dole back in June, and my conclusion thoughts after comparing Dole to Chiquita (CQB) and Fresh Del Monte (FDP).  Due to its big change since that time I have been asked by a reader what my thoughts about New Dole are now that it has eliminated what was its biggest problem; its debt.  Here is just one of the many articles outlining the sale to Itochu for $1.7 billion that is expected to close by the end of the year.

The reader wants to know what I think about New Dole’s prospects going forward, if I still think the company is undervalued, or if I would think about selling now if I find it to be overvalued.

The reader also asked me about the 2009 Dole Food Automatic Common Exchange Security Trust which I talk about here.

Since the transaction has not closed still, most of the information in the above articles remains intact as it pertains to margins and debt levels about Dole’s current state.  I will first value the business as I see it after the sale of its worldwide operations and then comment on what I think about New Dole’s prospects after the transaction closes.  When I refer to Dole as a whole I mean Dole before the sale of its worldwide operations.  New Dole is in reference to my estimates of Dole’s operations after the sale of its worldwide operations.  I have a call into Dole investor relations to get exact revenue and EBIT numbers for New Dole, but to this point I have not received a call back.  I am estimating that New Dole will lose about 36% of its EBIT after the sale of its worldwide operations.  I came to that estimate from looking at Dole’s sale to Itochu presentation from September which can be viewed here.

These valuations were 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.

All numbers are in millions of U.S. dollars, except per share information, unless otherwise noted. Valuations were done using Dole’s 2011 10K, second quarter and third quarter 2012 quarterly reports and presentations, and Dole’s presentation of what it should look like after its asset sale.

The main thing I was worried about with any asset sale is that Dole would have to unload some of its very valuable land assets.  Thankfully after the transaction is completed New Dole will still own 113,000 acres of land including some very valuable land in Hawaii.  All assets below are being kept by New Dole.

Sum of the Parts Valuation

Land Holdings

Dole owns 25,000 acres of noncore land in Oahu valued by Dole at $500 million or $20,000 per acre.  Dole also owns 22,100 acres in Costa Rica, 3,900 acres in Ecuador, and 25,500 acres in Honduras.  Only part of each countries acreage are being used for growing fruit: 8,200 in Honduras, 7,300 in Costa Rica, and 3,000 in Ecuador meaning the rest could presumably be sold without interfering with current operations, about 33,000 acres.

• All Costa Rica land valued at $5,000 per acre equals $110.5 million.
• Al Ecuador land valued at $3,500 per acre equals $13.65 million.
• All Honduras land valued at $3,500 per acre equals $89.25 million.
• Remaining 36,500 acres valued at $5,000 per acre equals $182.5 million.

Adding total land value estimates up equals $895.9 million just in land value or $7,928.32 per acre, which comes out to $10.18 per share in total land value.

Estimated value of unused noncore land 33,000 acres in the above three countries at $5,000 an acre for Costa Rica and $3,500 for Honduras and Ecuador land is $75.7 million.

Total noncore land assets that could be sold valued at $575.7million total, or $9,925.86 per acre; $6.54 per share in land assets that could be sold.

Ship and Ship Related Equipment

Dole owns 13,300 refrigerated 40ft containers at a very conservative $5,000 each equal $66.5 million.  This is a very conservative estimate as these containers can sell for as much as $50,000 a piece.  I am using $5,000 per unit as my estimate because I want to be extra conservative and because I have not been able to find an exact break down on how many of the 13,300 container units are the 40ft refrigerated units as Dole’s also has some 20ft refrigerated, and completely unrefrigerated containers, so I wanted a very conservative estimate of price to be safe.

Dole also owns 11 ships which I am very conservatively valuing at $1 million each.  I found a few container ships selling for under $1 million but most were well over that price, with some reaching prices over $100 million.  I am again just being conservative here because I do not have vast knowledge on the prices of Dole’s ships.

Adding all of the land, ship, and container value up gets us to a total of:

• All land, ship, and container value=$973.4 million, or $11.06 per share.
• Only noncore land that could be sold, ship and container value=$653.2 million, or $7.42 per share.

None of Dole’s operations, cash, debt, or any of its building or other equipment is counted in the above calculations.  I will include Dole’s cash in the below valuation.

I did not include any of its buildings or other equipment in the above valuation because I could not find any concrete information and again did not want to speculate on numbers.

Now I will value Dole’s operations.

EBIT and Net Cash Valuation

Cash and cash equivalents are 82 and it has 0 in short term investments.

Dole as a whole has a trailing twelve month EBIT of 180.7 for its entire current operations.  Per Dole’s sale to Itochu presentation I am estimating that it will lose approximately 36% of EBIT after the sale of its worldwide operations which leads to a trailing twelve month EBIT estimate of 115.65 for New Dole’s operations.

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

• 5X115.65=578.25+82=660.25/88=$7.50 per share.
• 8X115.65=925.2+82=1007.2/88=$11.45 per share.
• 11X115.65=1272.15+82=1354.15/88=$15.39 per share.
• 14X115.65=1619.1+82=1701.1/88=$19.33 per share.

Combined Valuation Of New Dole

All values are per share values.

	Total Land, Ship, and Container Value	Only Non Core Saleable Land, Ship, and Container Value
5X EBIT	$18.56	$14.92
8X EBIT	$22.51	$18.87
11X EBIT	$26.45	$22.81
14X EBIT	$30.39	$26.75

The only thing the above values are not containing is the debt.  The reason I am not including the debt in any of the estimates of intrinsic value is because Dole as a whole now has total debt of $1.4 billion but will be able to pay off all of it if it chooses to after it receives the $1.7 billion from Itochu.   Thus making the above very good estimates of what New Dole should be worth after selling its worldwide operations and ridding itself of the debt.

I had an additional two paragraphs written about Dole’s TEV/EBIT and ROIC margins but those had to be scrapped since I have still not heard back from Dole investor relations about New Dole’s exact numbers and I did not want to speculate.

New Dole is also forecasting that after the sale is finalized it will be able to save around $100 million in cap ex and corporate expenses by the end of fiscal 2013 which supposedly are going to be yearly savings going forward, and to be able to improve its overall business operations.  Even leaving improvement in operations, possible future acquisitions, and money savings out of all my calculations, New Dole should be selling at a very conservative minimum of $14.92 per share, and I actually think quite a bit higher.  Current share price for the whole of Dole is $10.70 per share, a 29% margin of safety.

Dole management has also stated that after the sale to Itochu is finalized that it may look to sell or spin off further assets, or make some acquisitions to bolster its operations within New Dole, any of which may help unlock further value in its shares.  This is pure speculation, but I could see Mr. Murdock who owns around 40% of Dole, possibly looking to take the New Dole private again now that its major problem has been eliminated so he can control its operations again, which would also help unlock shareholder value.

Why after all of the above has Dole as a whole been dropping in price lately?  My guess is that people have been selling for a combination of the following reasons:

• That Dole just released bad quarterly numbers that missed analyst estimates and which sent the herd running.
• Before that people were probably selling some personal shares that they owned to lock in profits since the stock has run up from around $8.50 a share to over $15 a share at one point.
• A lot of it may also be that people are still treating this as a highly indebted, risky, poorly operated, and marginally profitable company that it is without looking deeper at the assets that it will still hold after receiving the $1.7 billion from Itochu, and how New Dole will now be a much healthier and less risky company.

However, even if you do not count any of its operations at all, Dole as a whole is selling now for less than JUST a conservative value of the land, ship, and containers that it owns.  Meaning the downside is covered by hard saleable assets even if New Dole’s operations were to become massively unprofitable, which I think is very unlikely.

New Dole looks to be massively undervalued, will still hold very good high value assets, especially saleable land, has some future potential catalysts that could help unlock value, it should be able to compete better with Fresh Del Monte and Chiquita, and New Dole will now be freed up to make acquisitions and improvements to its business and operations after the transaction with Itochu closes as it will not be burdened by the massive amount of debt that it has carried for years.

I plan to buy shares for my personal account and add more shares back into the accounts I manage after selling some Dole shares up 70% in September.

Here is a last minute update as Dole has set the shareholder meeting for December 6^th to approve this transaction.

Update and Links From Mark Lin, Oddball Stocks, Guru Focus, Farnam Street, ValueFolio and Old School Value

The most recent company I was researching turned out to be another no go as I found it to be overvalued at the low end by as much as 30%.  Since then I have turned my attention to Dole and have been getting my updated article on them prepared.  I have already written a portion of the article and with Dole releasing its most recent results later today I should be all good to go and have the whole article up by early next week.

Until then here are some links.

The One Thing That Can Kill Your Portfolio

ROE, ROIC, and CROIC

All Roads Lead To Rome: Bridging the Graham Buffett Divide

Alternative Information Sources

Analyzing Working Capital-The Key To Successful Investing In Net Nets

Why Net Cash Is The Most Misleading Indicator Of Balance Sheet Strength

Characteristics of Value Stocks and Value Traps

The Principle of Incomplete Knowledge

Charlie Munger…..”If I Were Teaching Business School”

Psych Plays and Bayesian Probability