Saturday, August 26, 2006

Conoco Phillips (COP) Analysis

Conoco Phillips(COP) is a big oil company that is mispriced compared to its peers in the market. reports Warren Buffett as owning 18 million shares in COP with average buys between 59 and 65. In addition, there was an article by Hilary Kramer on COP saying why COP is a good buy at the current prices with an upside in the 80 dollar range within a year. In this article, we will go through the balance sheet for a quick look at the company to see how the fundamentals look like.

From the 10-K, the COP is engaged in the following businesses.

Exploration and Production (E&P) —This segment primarily explores for, produces and markets crude oil, natural gas, and natural gas liquids on a worldwide basis.

Midstream—This segment gathers and processes natural gas produced by ConocoPhillips and others, and fractionates and markets natural gas liquids, primarily in the United States, Canada and Trinidad. The Midstream segment primarily consists of our 50 percent equity investment in Duke Energy Field Services, LLC (DEFS), a joint venture with Duke Energy Corporation.

Refining and Marketing (R&M) —This segment purchases, refines, markets and transports crude oil and petroleum products, mainly in the United States, Europe and Asia.

LUKOIL Investment—This segment consists of our equity investment in the ordinary shares of OAO LUKOIL (LUKOIL), an international, integrated oil and gas company headquartered in Russia. Our investment was 16.1 percent at December 31, 2005.

Chemicals—This segment manufactures and markets petrochemicals and plastics on a worldwide basis. The Chemicals segment consists of our 50 percent equity investment in Chevron Phillips Chemical Company LLC (CPChem), a joint venture with Chevron Corporation.

E&P is 57% of COP assets and 62% of net income. COP owns E&P facilities in many parts of the world.
Midstream has 2% of COP assets and 5% of income.
R&M makes up 29% of COP assets and 32% of income. The company is planning on investing more money in the next five years to handle heavy sour crude oil which should increase profit margins.
Lukoil constitutes 5% of COP assets and 5% of income.
Emerging businesses constitute 1% of COP assets and income.

COP has investments in the Canadian Tar Sands and quite a few international properties from Africa, Russia, South America and Asia. The company is very diverse. Although the current oil prices have pushed up the revenues and profits of all oil companies, a comparison of XOM and COP show that COP is mispriced compared to XOM.

As an online article comparing XOM and IBM shows that XOM outperformed IBM for a period of a about fifty years. The article has the following to say about IBM vs XOM.

In his new book to be released this spring professor and author Jeremy Siegal argues that one of the biggest mistakes made by investors is overpaying for stocks. In their enthusiasm to embrace the latest rage or fad, investors pay too high a price resulting in poor returns. Siegal illustrates this by comparing the total return on IBM and Standard Oil of New Jersey–now ExxonMobil–going back to 1950. Both stocks did well over this time period, however the returns on ExxonMobil were 14.4% per year versus IBM’s 13.8%. IBM was considered to be the premier growth stock of that era. Nevertheless, a $1,000 investment in IBM grew to 958,000. The same $1,000 invested in ExxonMobil grew to $1,260,000 some 25% greater.
The reason ExxonMobil outperformed IBM was because Exxon paid a higher return and sold for a much lower P/E multiple than IBM. The average P/E for Exxon was half of IBM’s. In addition to a lower P/E multiple, ExxonMobil (then Standard Oil of New Jersey) offered a higher dividend yield enabling an investor who reinvested those dividends to accumulate 15 times as many shares. The combination of higher dividends and lower P/E multiple resulted in far superior returns with less risk.

This is no secret to seasoned investors - the Warren Buffett formula is to be patient - patiently watch and jump in when the time is right.

XOM's market cap exceeds its enterprise value by about 6%. COP's trails by about 26%. If COP is to trade at XOM levels, we are talking of a stock price in the nineties. Given the white hot emerging markets, it is unlikely that the oil and natural gas prices will decline substantially over the next several years. The analyst estimates for 2007 expect the oil prices to decline but this is not likely. As Warren Buffett has rightly noticed, energy is a requisite for modern civilization and an energy company on the cheap is something to grab. COP is trading for a trailing P/E of 6 compared to XOM's 11 and PTR's 12. COP clearly fits the bill as the company to buy for the long term.

*Fixed the link to Hilary's post.

Sunday, August 20, 2006

Investing in India - Mutual Funds - Revisited

We looked at investing in emerging markets a few times in this blog. In particular, we have looked at India, China, Korea and Brazil. We have written quite a few articles about India including the one on Indian mutual funds. In this segment, we will look again into funds that a US based investor can access to invest in India.

First a view of Indian economy. India is predicted to grow around 7% or higher this year and next. India's exports and imports are expected to grow in the 20% range for the next two years. India's trade with US is also growing at a fast double digit rate but is miniscule compared to China. The total US trade with India was about 27 billion dollars in 2005 and it is expected to cross 30 billion dollars in 2006 with about 15-20% growth. This is still small compared to the US trade with China which offers a lot of room for growth.

To compare the charts of SP500 vs BSE Sensex index, please click on the following link. The difference between the two indices is close to 80% with the winner being BSE Sensex. Despite the down draft and lack of investor enthusiasm for emerging markets after some mid summer drop, it is a safe bet that the emerging markets such as India provide more upside than the U.S market in the next several years.

To assess the funds, we will follow a similar formula as the last article where we look at each of the funds, their holding, premium/discount to market value and expense ratio.

EEM is the iShares emerging market fund and has returned about 9% YTD. If one bought the ETF at the low 80's in the second quarter, the ETF has returned more than 20%. EEM has an expense ratio of 0.77% and has performed better than VWO thus far this year. EEM has 5% exposure to India.

VWO is the Vanguard emerging market fund and has returned about 7.5% YTD. This correlates highly with EEM but has a lower expense ratio of 0.3%. VWO has a 7% exposure to India.

IFN is currently trading at around 9.6% premium to the market price. This is down from the 28% premium it was trading to the market the last time we profiled this fund. IFN has returned 4.8% in 2006 till 7/31/2006. The expense ratio for IFN is about 1.5% excluding trading costs. The main holdings of IFN are

Infosys Technologies, Ltd.
Bharat Heavy Electricals, Ltd.
Oil and Natural Gas Corp., Ltd.
Reliance Industries, Ltd.
ITC, Ltd.
Tata Motors, Ltd.
Housing Development Finance Corp.
Hindustan Lever, Ltd.
Bharti Tele-Ventures, Ltd.
Satyam Computer Services, Ltd

IIF was trading for a premium of about 8% when we looked at this fund the last time. This time around, the situation is much better with the fund trading at around 3% premium to the market price of the underlying securities. Also, IIF has a smaller YTD gain of about 3% ( as of 7/31/06 ) compared to IFN. The expense ratio for IIF is about 1.4% excluding trading costs. The main holdings of IIF are:

Bharat Heavy Electricals
Siemens India Ltd
Hindustan Lever Ltd
ABB Ltd India
Infosys Technologies Ltd
Hdfc Bank Ltd
Hindustan Construction Co.
Associated Cement Co. Ltd
Housing Development Finance Co

MINDX - Mathews India Fund is a relative new comer to the block. The fund has returned 0.18% YTD. The fund carries an expense ratio of 2.75% and the top holdings of the fund as of 7/31/06 were as follows.

Dabur India
Ashok Leyland
HDFC Banking
Infosys Technologies
Housing Dev. Finance Corp.
Gail India
Sun Pharmaceuticals Industries
I Flex Solutions

ETGIX can be called a wealthy persons India fund. It has an initiation fee of 5.75% for small sums of money that declines to zero if the capital is greater than a million dollars. This is not targeted for individual investors but is targeted more towards institutional investors that want an exposure to India. The fund also has an expense ratio of 2.75% on top of the initiation fee.
Interestingly enough, ETGIX had a return of 5.6% as of end of July. The top holdings for ETGIX at end of March were:


Analysis It is interesting to note that the BSE Sensex index returned about 7% this year but none of the mutual funds have been able to keep pace. In fact, indexing is probably the best approach to India. If one has to get into the Indian market, IIF might be a good bet on a down day. It still is trading about 3% above the NAV but has a lower expense ratio than MINDX. Other than these funds, the traditional emerging market ETFs VWO and EEM are also available. VWO has a lower expense ratio than EEM and both the funds are well diversified amongst the emerging markets of the world. It is our hope that we will see an India ETF soon which will mimic the BSE Sensex index in the U.S markets.

Saturday, August 19, 2006

Dr. Reddy's Laboratories Limited Analysis

RDY or Dr. Reddy's Laboratories is an Indian company that is a generic drug and API (active pharmaceutical ingredient )manufacturer. In 2005 and 2006, a lot of the patents owned by large US pharmaceuticals have come off the patent protection. This opens the doors for generic drug manufacturers to produce similar drugs at much lower prices. This is an emerging market company that is listed in NYSE - as part of our continuing analyis of emerging market segment, we will look at this company in more detail.

Interestingly enough, the foreign ownership of the company is at 50.82% - through foreign institutional investors, non resident indians and american depository receipts. The ADRs account for ~20% of the company. The insider holding is only about 2%. The large foreign holding may be justified as the company earns more than 70% of its revenues through international markets. In 2005-2006, the company's revenues increased by 28% and the company swung to a profit from a loss in the prior year.

The company's growth in each of the business segments in 2006 was as follows. API segment saw a growth of +25%, the formulation sector saw a growth of +30%, generics were constant at 0% growth, critical care and biotechnology was up 32% and custom pharmaceutical services was up 721%. The net income was 6.7% of revenue.

In 2007 Q1 report, the company did significantly better. In addition to the growth in the API and branded formulations segment, the company also saw significant growth in the generics market in the European and the North American market. The company has exclusive contracts with Merck to market the generic version of its block buster drugs that are coming off of patent.
In Q1 2007, the company's revenues increased by 251% compared to the same quarter in the previous year. The profit margins have also increased to 10% of revenue in Q1 2007.

Does this mean the company is on a roll? The exclusive agreement with Merck should help the company extend its profit margins for some more time in the generics business. The growth in its core business is continuing to grow. The company is currently selling at a P/E of around 40 - the prospects for the company look good and should be part of the portfolio of Indian stocks. The list of Indian companies available as ADRs is noted in an earlier article in this blog.

Google catches a down draft?

In this blog, we have looked at Google several times. In one of the previous analysis, we made the following statement about Google.

The competition is definitely going to heat up in the second half of this year and next year. In the prior article we discussed Google and Yahoo and found that a price of $340=00 provided a rough upside comparable to investing in U.S treasuries for the next two years. Given that the sale of 5.3 million shares will dilute the shares by about 2%, the target price in 2008 falls to 372 dollars

Google is currently trading at 383.00 dollars a share above the 2008 target price. While predicting the future is a fools game, the warning signs about Google are everywhere. One thing that was a positive for Google for a while was gain in market share at the expense of its chief rivals Microsoft and Yahoo!. However, this seems to have come to a stand still of late. If the report from market watch is to be believed, Google's market share gains have peaked or are unlikely to increase further.

Google has a market cap of 120 billion, half of that of Microsoft. The cash flow per share in the last quarter for the two companies was ~120 million and 3.5 billion respectively. Interestingly enough, Yahoo! had a better cash flow than Google in the last quarter.

This means something has to give. Either Google has to increase its market share to justify the capex or Google's bets arent paying off in the way it anticipated. A worry about Google's business model is that it will end up paying content providers larger piece of the revenue pie to get the ad dollars. This can put pressure on its margins as Yahoo! and Microsoft start rolling out their own text ads.

The slope seems to be flat or down for Google in the next one year - unless the market watch report is incorrect and Google is able to continue to grow its ad market share.

Berkshire Hathaway (BRK) or USG?

In this blog, we have analyzed BRKA and USG quite a few times. BRK and USG are both iconic figures and have a close relationship. BRKA owns upto 16% of USG. It is well known that both the companies are undervalued. In this segment, we look at which one is worth one's dollars today.

From various analysis, the consensus values of intrinsic value for USG and BRK are as follows.

USG consensus intrinsic value - low 75, median 95 and high of $100. USG has top notch management, good prospects and a favorable demographic. In addition, it is also expanding its distribution business. USG's business is cyclical with highs and lows coinciding with the economic cycle.

BRK current intrinsic value is - low 120, median of 130 and high 0f 145K. BRK is a well diversified business with solid cash flows and outstanding management. It is a safe conservative bet that BRK will increase its intrinsic value at 8-9% a year for the next five years.

BRKA IV in five years at 8% IV growth is going to be: Low end 175K, median 191K and high of 211K in 2011. Even with share prices lagging the IV, it is likely that BRKA will trade significantly higher than where it is trading today.

USG on the other hand because of its cyclic nature, in 2013 is likely to have an IV of low 95, median 105 and high of 120. This is using BCarter's USG intrinsic value calculation and assuming that all earnings are retained by the company and translates to book value.

Both are conservative estimates but looks like BRKA is more stable as it is not as cyclical as USG is. With a lack luster hurricane season, it is a safe bet that BRKA's intrinsic value will reach or cross 130K by the time the annual report is released in Q1 2007. BRKA is also a safe bet in a recessionary environment as its businesses will continue to churn out cash and BRKA can find better investment opportunities.

USG on the other hand is back stopped by Warren Buffett. He has also been buying the stock and has increased his ownership to more than 16% of USG. This has put a floor on the price at around 45 dollars.

The short term sentiment is for USG to remain stable or drop a bit along with the housing market. The sentiment for BRKA is to go up depending on the Hurricane season, perhaps crossing 100K by end of this year.

BRKA offered a compelling opportunity at ~92K right after Q2 earnings and I loaded up on it. The comparable large cap value funds have done extremely well this year racking up gains of upto 10% already with four and a half months to go in the year. BRKA is lagging this category and this may not last long.

As new cash comes online, one would do well to look at all the available opportunities, the price points of different shares and the short term and long term sentiments prevailing at the moment to make the appropriate decisions.

Wednesday, August 09, 2006

Emerging Market Funds Revisited

In an article on the 6th of July we looked at emerging market funds. In that article, we noted

"The fundamentals in these countries are solid. In the late nineties, there was the Asian currency crisis where many countries didnt have enough dollar reserves to handle the capital exodus. Many countries have large foreign currency reserves and their balance of payment situation is good. The growth rate in the emerging markets is likely be several points higher than the U.S market for the next several years."

The housing market and high gasoline price induced slow down and inverted yield curve indicate a coming slow down or at worst a recession in the U.S. It is the growth in the emerging markets and the booming export sector that has to rescue the U.S from the coming slowdown. Many people argue that all the consumption is happening in the U.S and the recession will hit the emerging markets hard as well. However, the growth in China and India have been phenomenal and a slow down in the U.S is not likely to induce a slow down in these markets.

EEM dropped from a high of 111 to 82, a drop of 36%. It is a well known phenomenon that EEM does well in the November - April period and hits a slump in between. EEM has already recovered about 17% from its lows two months back. Comparing EEM and VWO, EEM has done slightly better than VWO by about 1% point or so in the last one month. EEM/VWO are well positioned to do well in the next year primarily because of the booming markets in India and China. Other emerging markets around China like Korea, Taiwan, Thailand and Singapore are increasingly being driven by exports to the Chinese market.

In the next few blogs, we will continue to look at some of the emerging markets and look at other opportunities in the U.S market.

Sunday, August 06, 2006

Berkshire or Ebay?

We have looked at Berkshire and EBay in this blog at different times in the past year. We have owned both EBay and Berkshire and continue to hold on to Berkshire at this time. In the article in December of last year, looking at all internet stocks - we made the following observation.

Of the lot, EBay looks the priciest for its growth followed by Google, Amazon and Yahoo!. Amazon's balance sheet doesnt look pretty with cash, cash equivalents and marketable securities declining year over year. The overall balance sheet looks better than last year and the growth is still good. Google's growth rate is going to decline slightly next year - as noted in an earlier blog, next year's growth is already priced into the stock.

Regarding Berkshire, we had the following to say in January of 2006.

The traditional analysts get carried away with the P/E ratios without really analyzing the underlying financials. The financials look very sound and solid. Given that it is highly unlikely that the company will ever be sold at liquidation value, it is safe to say that Berkshire provides a good safe base and alternative to SP500 index. In a diversified portfolio, one should consider having Berkshire in the mix.

Now that a good six months have elapsed since these were written, it doesnt hurt to take a look at both these companies and apply some analysis to see how each of this stock looks like.

Ebay traded at $44.46 on 3rd January 2006 and is currently trading at $24.2 as of 4th of August 2006. Berkshire on the other hand traded at 89700 on 3rd January 2006 and is trading at 91710 currently. Ebay's stock has declined 54% while Berkshire stock has gained 2.24% in the same period. Short term price movements hardly indicate stock fundamentals, so we will look at both these stocks from different perspectives.

First an overview of the two companies to look at no brainer issues. Ebay specializes in providing an online market place for buyers and sellers. This enables all sort of goods to be bought and sold. Berkshire on the other hand is a conglomerate operating in great many businesses in many different segments. Ebay has a market cap of 34 billion where as Berkshire has a market cap of 141 billion. Ebay's business is technology centric - major technological changes can cause headaches to Ebay. The proliferation of search and the presence of many websites that offer the online market place to buy and sell will enable the users to look for the best deals available without sticking to Ebay. I have bought DVDs and used books from Ebay but not before searching for the best deals in other web sites. What this means is that Ebay will have to continue to invest in technology to remain relevant.

Technology for the most part will help improve Berkshires businesses. The clothing can be produced cheaper and insurance issuance can also get better and faster with new technology. The Berkshire businesses that are vulnerable to technology are real estate agency and newspapers and represent a tiny fraction of the company.

Balance sheets
The cash flows from operating activities increased 11.5% in Berkshire for the first six months of the year to 3.4 billion. Berkshire also gets cash flows from investing activities. The cash flows from investing activity is uneven and Berkshire netted 1.5 billion in the first six months of the year from investing.

The cash flows from operating activities in Ebay was 1 billion for the first six months of 2006 a gain of 10.9% compared to 2005. The cash flows from financing activities was 175 million dollars in 2006.

The stock holder equity in Ebay is about 11 billion, about 33% of the stock value. Berkshire on the other hand has the stock holder equity of about 96 billion or about 70% of the stock value.

Ebay has cash and equivalents of about 2.6 billion on its balance sheet compared to about 40 billion for Berkshire. Berkshire had a stock dilution of 0.13% year over year compared to Ebay's 4.2% dilution year over year.

Management Clearly, Berkshire has a line of heavy hitters that cant be matched easily by anyone else. Ebay's management on the other hand is competent and is as good as any other dot com around. Berkshire is heads and shoulders above Ebay when it comes to capital allocation and investing and it is not likely to change even with the change of guard in Berkshire.

Long term view Thirty years from now, online market place for goods and services will certainly exist. However, it is not clear if Ebay will be the market leader in that segment or not. The presence and expansion of market players such as Google, Yahoo! and Microsoft could lead to convergence and elimination of some of today's leaders. Ebay's moat is from its web portal and technologies such as paypal. The Ebay moat is not as large as it seems as better deals and technologies can lead traders and customers elsewhere. Meanwhile, Berkshire's businesses in insurance, energy distribution and many low tech areas needed for human existence every day will be boosted by increase in U.S population and growth in investment value. Longer term, Berkshire is a better bet than Ebay.

Ebay is a good business . July to December time frame has always propelled Ebay stock higher and this year may be no different. Although Berkshire has higher overall capitalization and larger size. Berkshire boasts of better earning growth and cash flow growth at the moment than Ebay despite its size. Ebay also benefited from sale of stock options in its cash flow statements. Berkshire is a more compelling value than Ebay at the moment and possibly presents a bigger upside in the next ten years than Ebay does.

Friday, August 04, 2006

Berkshire Hathaway (BRK.A/BRK.B) Q2 Report

We analyzed Berkshire Q1 report three months back. After looking at Q1 results, we estimated Berkshires stock to trade significantly north of $90,000=00. We also estimated the stock to be a strong buy below $89,400=00. Interestingly enough, the stock did drop below that price. William Scoular also did a scholarly analysis of Berkshires various businesses and estimated the fair value of Berkshire at the moment to be some where in the 102-124K range per A share.

Let us quickly take a look at Berkshires balance sheets at Q2 and see how the business is performing. The book value increased by 2.4% in the quarter compared to Q1. This compares to 4% increase in book value in Q1. This is a 6.4% increase in book value. The comparable increase in value in SP500 thus far this year is 2.67%. If things go as they have thus far for the rest of the year, one can expect BRKA to beat SP500 handily this year.

Net earnings for the first six months this year increased by 65% compared to the same period in the prior year. The second quarter book value took a slight hit as the investments registered unrealized losses of 572 million. Comprehensive income for the first six months in 2006 jumped to 5872 million dollars compared to 2114 million dollars in the same period last year.

What does this mean for the stock price? The stock price should rise 5-6% in the next few weeks. We are looking at price targets of 96-97 thousand dollars in the next few weeks. The hurricane season is going to be a wild card. Even with a hurricane as bad as last year, a price below 91,700=00 is a steal. This translates to a B share value of 3056=00. I will look to add to my position in Berkshire if the price remains at or below these levels in the next several weeks.