In the article on retailers, we examined the price/cashflow situation of several retailers. We did miss a few retailers and in this segment, we will look at DDS, COST and SHLD.
DDS - Dillards is a very cheap stock with a price/cash flow of around 4.5. Dillards has been hit by intense competition in the retail sector. With EBIT margin of around 2% and with low ROE, ROA ratios, Dillards main asset is property, plant and equipment. Dillard's equity is more or less the same in the past several years and the property value is most likely understated. A buyout by the likes of Lampert can help unlock the value in this company.
COST - Costco boasts of having Charlie Munger on the board of directors and is indeed a quality company. As is the case with Wesco Financial, costco is not cheap with a price to cash flow of about 15. It has done well compared to other retailers returning about 25% for the year and is overpriced compared to its business fundamentals. There are better bargains out there compared to Costco.
SHLD - SHLD should trade at a premium given that Eddie Lampert is allocating capital for the company. The company generares ample cash to the tune of about 800 million - 1 billion a year and the book value/price is very attractive at current prices. Barron's valued the company at close to $300/share. Even applying a healthy 50% margin of safety to that value will value the company at $150/share.
The current retail environment is offering some great bargains and a prudent investor can make a boatload of money by exploiting the current environment to the maximum.
Friday, November 23, 2007
Wednesday, November 21, 2007
Lowes vs Home Depot - part 2
In prior articles, we have looked at home improvement retailers - Lowes and Home Depot respectively. Let us compare the two again, based on most recently ended quarter.
Lowes currently sports a P/E of 11, market cap of 32.6 billion, price/cash flow of 6.91 and is trading close to its 52 week low at 22.11.
Home Depot currently sports a P/E of close to 11, market cap of 55.5 billion, price/cash flow of 8.29. Home Depot has better yield than Lowes at the moment.
In the most recent quarter, home depot's margins declined by 2% points from 11.3% to 9.3%. By comparison, Lowes gross margin declined by 1.42 bais points in the same quarter. Similarly, Lowes sales increased whereas Home Depot's sales declined. ( 3% increase to 3.5% decline )
Home Depot's outstanding shares decliend by 11.4%, helped by the sale of HD Supply. Lowes outstanding shares declined by 3.5% in the same period. Home Depot's book value per share is 9.64$/share where as Lowes is 10.9$/share. Clearly, buying back shares after selling Home Supply unit hasnt added more value to the book for Home Depot as the current share price for HD is around $28 where as it is $22 for Lowes.
Home Depot increased its square footage by 5.5% where as Lowes increased its square footage by 11%. Yahoo! quotes a PEG of 0.69 for Lowes and 0.99 for HD.
Lowes has advantage over HD regarding ROE, ROA and price/cash flow ratios. Lowes seems to be a better alternative to HD from both price and business point of view at this point in time.
Lowes currently sports a P/E of 11, market cap of 32.6 billion, price/cash flow of 6.91 and is trading close to its 52 week low at 22.11.
Home Depot currently sports a P/E of close to 11, market cap of 55.5 billion, price/cash flow of 8.29. Home Depot has better yield than Lowes at the moment.
In the most recent quarter, home depot's margins declined by 2% points from 11.3% to 9.3%. By comparison, Lowes gross margin declined by 1.42 bais points in the same quarter. Similarly, Lowes sales increased whereas Home Depot's sales declined. ( 3% increase to 3.5% decline )
Home Depot's outstanding shares decliend by 11.4%, helped by the sale of HD Supply. Lowes outstanding shares declined by 3.5% in the same period. Home Depot's book value per share is 9.64$/share where as Lowes is 10.9$/share. Clearly, buying back shares after selling Home Supply unit hasnt added more value to the book for Home Depot as the current share price for HD is around $28 where as it is $22 for Lowes.
Home Depot increased its square footage by 5.5% where as Lowes increased its square footage by 11%. Yahoo! quotes a PEG of 0.69 for Lowes and 0.99 for HD.
Lowes has advantage over HD regarding ROE, ROA and price/cash flow ratios. Lowes seems to be a better alternative to HD from both price and business point of view at this point in time.
Saturday, November 10, 2007
Overview of Retail Stocks from Cash Flow Perspective
In this segment, we will look at the retailers and see which ones offer the best value from the cash flow perspective. The last week has been pretty brutal on retail stocks and it has hurt several retailers in particular. This survey looks at some ( not all ) retailers of interest to the author. The author has positions in some of the retailers noted below.
AEO - American Eagle Outfitters
Price to cashflow is around 9. ( taking out the cash in the balance sheet ) Price to free cash flow this year is 4.8%. Even without increasing cash flow, this company can payout dividends, buy out shares at a better rate than US treasury bonds. The company has zero debt and it is likely that it will grow free cash flow at a decent rate making it a far more interesting buy than the treasury bond over the next five years.
ANF - Abercrombie and Fitch
Also offers a low price to cashflow ratio of about 9 after taking out the cash from the balane sheet. The company carries little debt but the price to free cash flow yield is around 3.8%. The dividend yield in ANF is less than that of AEO.
GPS - Gap
Gap offers price to cashflow ratio of about 9 and a free cash flow yield of about 5.8%. This is significantly better than AEO and treasury bonds. However, Gap's cash flow hasnt altered a whole lot since 1999.
LTD - Limited
Limited's cash flow has also been stagnant for a few years and free cash flow has been somewhat low compared to other peers this year. Analysts are expecting a turn around in the coming years. However, this year, the stock has taken a hit.
CHS - Chico's Fas Inc
Chico's is cheap and the stock price has fallen off dramatically in the last two yearsbecause of declining sales. Still, JOSB and AEO offer better bargains at this moment.
JOSB - Joseph A Bank
Josb offers a very attractive price to cash flow ratio of 6.38. The company does have some debt but price to free cash flow yield is around 9%. Even taking last years figures, it yeilds a figure of about 6%. Looks like a good buy at these prices.
BBY - Best Buy
Best buy also looks interesting at these prices. However, it seems as though best buy is getting serious competition from WMT and friends.
BBBY - Bed Bath and Beyond
This is not as cheap as some of the others in this list. Also, we looked at this in some detail in this blog.
KSS - Kohl's Corporation
Kohl's is a growth story. It cant be compared to the other retailers in the same way.
WMT - Walmart
WMT offers a price to cash flow ratio of 9. The price to free cash flow yield is 2.1%. While this is hardly spectacular, the company spends a huge amount of money on capex in foreign contries.
TGT - Target
Target is somewhat more expensive than Walmart. This is mainly because of the same store sales have been doing better at Target than Walmart.
JCP - J.C Penney
Looks cheap - cheaper than WMT from a cash flow perspective at this moment. The company has spent a lot of money on Capex this year - hopefully this should show in the coming years.
M - Macy's
Macy's had a decline in cash flow and free cash flow this year. This could turn around in the coming years. In that case, this is a turn around play.
LOW - Lowes
Lowes offers price to cash flow of 7.47. It also yields 2.5% on free cash flow. Incidentally, lowes expects to increase both cash flow and free cash flow this year compared to last.
HD - Home Depot
More expensive than Lowes from a cash flow perspective but better from a free cash flow perspective. However, HD's use of capital and growth are both being questioned by share holders.
One can also play the ETF XRT to play the entire sector.
AEO - American Eagle Outfitters
Price to cashflow is around 9. ( taking out the cash in the balance sheet ) Price to free cash flow this year is 4.8%. Even without increasing cash flow, this company can payout dividends, buy out shares at a better rate than US treasury bonds. The company has zero debt and it is likely that it will grow free cash flow at a decent rate making it a far more interesting buy than the treasury bond over the next five years.
ANF - Abercrombie and Fitch
Also offers a low price to cashflow ratio of about 9 after taking out the cash from the balane sheet. The company carries little debt but the price to free cash flow yield is around 3.8%. The dividend yield in ANF is less than that of AEO.
GPS - Gap
Gap offers price to cashflow ratio of about 9 and a free cash flow yield of about 5.8%. This is significantly better than AEO and treasury bonds. However, Gap's cash flow hasnt altered a whole lot since 1999.
LTD - Limited
Limited's cash flow has also been stagnant for a few years and free cash flow has been somewhat low compared to other peers this year. Analysts are expecting a turn around in the coming years. However, this year, the stock has taken a hit.
CHS - Chico's Fas Inc
Chico's is cheap and the stock price has fallen off dramatically in the last two yearsbecause of declining sales. Still, JOSB and AEO offer better bargains at this moment.
JOSB - Joseph A Bank
Josb offers a very attractive price to cash flow ratio of 6.38. The company does have some debt but price to free cash flow yield is around 9%. Even taking last years figures, it yeilds a figure of about 6%. Looks like a good buy at these prices.
BBY - Best Buy
Best buy also looks interesting at these prices. However, it seems as though best buy is getting serious competition from WMT and friends.
BBBY - Bed Bath and Beyond
This is not as cheap as some of the others in this list. Also, we looked at this in some detail in this blog.
KSS - Kohl's Corporation
Kohl's is a growth story. It cant be compared to the other retailers in the same way.
WMT - Walmart
WMT offers a price to cash flow ratio of 9. The price to free cash flow yield is 2.1%. While this is hardly spectacular, the company spends a huge amount of money on capex in foreign contries.
TGT - Target
Target is somewhat more expensive than Walmart. This is mainly because of the same store sales have been doing better at Target than Walmart.
JCP - J.C Penney
Looks cheap - cheaper than WMT from a cash flow perspective at this moment. The company has spent a lot of money on Capex this year - hopefully this should show in the coming years.
M - Macy's
Macy's had a decline in cash flow and free cash flow this year. This could turn around in the coming years. In that case, this is a turn around play.
LOW - Lowes
Lowes offers price to cash flow of 7.47. It also yields 2.5% on free cash flow. Incidentally, lowes expects to increase both cash flow and free cash flow this year compared to last.
HD - Home Depot
More expensive than Lowes from a cash flow perspective but better from a free cash flow perspective. However, HD's use of capital and growth are both being questioned by share holders.
One can also play the ETF XRT to play the entire sector.
Sunday, November 04, 2007
Microsoft Analysis
Microsoft released its quarterly report recently which beat the analyst estimates. It caused the stock to pop - we look in this section to see if Microsoft has further upside for the next couple of years.
Microsoft is expected to earn 1.81$/share in FY08 and $2.06 in FY09. The uncertainty with the EU has declined significantly after the recent deal. At a low end, Microsoft can trade at $36 - $41.2. At the high end Microsoft can fetch between $40 - $50 at the high end in the next two years.
Let us analyze each of Microsoft's businesses by segment in the latest quarter as reported.
Client: 80 cents of income for $1 of revenue.
Server: 33 cents of income for $1 of revenue.
Online: -39 cents of income for $1 of revenue.
Microsoft Business Division: 65 cents of income from $1 of revenue.
Entertainment and Devices: 8.5 cents of income from $1 of revenue.
Separately, -7.3 cents per dollar is spent on corporate level activity.
This table shows the usefulness of various Microsoft divisions. Windows client is by far the most profitable group followed by Microsoft Business Division. This is followed by Server and Tools. Entertainment and Devices and Online are losing money/marginally profitable as is corporate level activity.
Microsoft's strength is its windows (client,server) and office franchises. These businesses should continue to drive Microsoft for the next five-ten years. As the spending in corporate level activity shows, there is room for improvement in capital allocation. One can also expect stock buy backs to offset further stock dilution. On a positive note, the company is returning capital to the investors in the form of dividends which will allow the shareholders to deploy it in a more meaningful fashion.
However, for the next two years, the downturn in housing and financial sectors would continue to propel technology stocks. This should help Microsoft attain further peaks in its stock price.
Microsoft is expected to earn 1.81$/share in FY08 and $2.06 in FY09. The uncertainty with the EU has declined significantly after the recent deal. At a low end, Microsoft can trade at $36 - $41.2. At the high end Microsoft can fetch between $40 - $50 at the high end in the next two years.
Let us analyze each of Microsoft's businesses by segment in the latest quarter as reported.
Client: 80 cents of income for $1 of revenue.
Server: 33 cents of income for $1 of revenue.
Online: -39 cents of income for $1 of revenue.
Microsoft Business Division: 65 cents of income from $1 of revenue.
Entertainment and Devices: 8.5 cents of income from $1 of revenue.
Separately, -7.3 cents per dollar is spent on corporate level activity.
This table shows the usefulness of various Microsoft divisions. Windows client is by far the most profitable group followed by Microsoft Business Division. This is followed by Server and Tools. Entertainment and Devices and Online are losing money/marginally profitable as is corporate level activity.
Microsoft's strength is its windows (client,server) and office franchises. These businesses should continue to drive Microsoft for the next five-ten years. As the spending in corporate level activity shows, there is room for improvement in capital allocation. One can also expect stock buy backs to offset further stock dilution. On a positive note, the company is returning capital to the investors in the form of dividends which will allow the shareholders to deploy it in a more meaningful fashion.
However, for the next two years, the downturn in housing and financial sectors would continue to propel technology stocks. This should help Microsoft attain further peaks in its stock price.
Berkshire Hathaway Q3 Analysis
In this blog, we have analyzed Berkshire quarterly reports for quite some time. We will take a look at Berkshire Q3 earnings and take a look at few areas.
Morningstar had the following summary for Berkshire after Q3 in the article titled "Berkshire Puts Some Capital to Work"
On the investment side, it appears Berkshire put roughly $11 billion of its cash hoard to work in equity securities this year. This isn't overly surprising given the tumult in the markets, and chairman Warren Buffett's excellent track record of deftly deploying capital in times of financial stress. In spite of this, though, Berkshire still has more than $40 billion of cash on its balance sheet. While we recognize that roughly $10 billion is required for insurance regulatory purposes, Berkshire still has about $30 billion available for additional investment. We suspect that over time, this will be deployed into business acquisitions or situations requiring an injection of liquidity.
Since this article does an adequate job of summarizing the quarter for Berkshire, we will look at the areas this report doesnt cover.
The book value grew by 3.98% from Q2 to Q3 and by 10.9% for the first nine months of the year. So the stock is clearly on its way to better SP500 in book value growth for the year. Having beaten SP500 in four of the past six years in book value growth alone, (business value growth is greater ) looks like this is another year where Berkshire is going to out perform SP500.
The other metric to look at is operating cash flow. Last year, this came in at 10.195 billion dollars. This year in the first three quarters, this is at 11.351 billion dollars. The run rate is about 40% higher than last year. This excludes gains from investments which is a huge part of Berkshire's cash flow.
Despite investing heavily in equities in the quarter ( and the year ), the gushing cash flow continued to add to the liquidity of the balance sheet.
Morningstar had the following summary for Berkshire after Q3 in the article titled "Berkshire Puts Some Capital to Work"
On the investment side, it appears Berkshire put roughly $11 billion of its cash hoard to work in equity securities this year. This isn't overly surprising given the tumult in the markets, and chairman Warren Buffett's excellent track record of deftly deploying capital in times of financial stress. In spite of this, though, Berkshire still has more than $40 billion of cash on its balance sheet. While we recognize that roughly $10 billion is required for insurance regulatory purposes, Berkshire still has about $30 billion available for additional investment. We suspect that over time, this will be deployed into business acquisitions or situations requiring an injection of liquidity.
Since this article does an adequate job of summarizing the quarter for Berkshire, we will look at the areas this report doesnt cover.
The book value grew by 3.98% from Q2 to Q3 and by 10.9% for the first nine months of the year. So the stock is clearly on its way to better SP500 in book value growth for the year. Having beaten SP500 in four of the past six years in book value growth alone, (business value growth is greater ) looks like this is another year where Berkshire is going to out perform SP500.
The other metric to look at is operating cash flow. Last year, this came in at 10.195 billion dollars. This year in the first three quarters, this is at 11.351 billion dollars. The run rate is about 40% higher than last year. This excludes gains from investments which is a huge part of Berkshire's cash flow.
Despite investing heavily in equities in the quarter ( and the year ), the gushing cash flow continued to add to the liquidity of the balance sheet.
The intrinsic value of BRK A share is now in the 147 - 152K range when conservatively valued in my opinion. This should grow to 153-158K range by end of this year.
RDN Analysis
Radian operates in the following businesses:
Mortgage insurance business provides credit protection for mortgage lenders and other financial services companies on residential mortgage assets through traditional mortgage insurance as well as other mortgage-backed structured products.
Financial guaranty business insures and reinsures credit-based risks and provides synthetic credit protection on various asset classes through credit default swaps.
Financial services business consists mainly of our ownership interests in Credit-Based Asset Servicing and Securitization LLC (“C-BASS”)—a mortgage investment and servicing firm specializing in credit-sensitive, residential mortgage assets and residential mortgage-backed securities—and in Sherman Financial Services Group LLC (“Sherman”)—a consumer asset and servicing firm specializing in credit card and bankruptcy-plan consumer assets.
In 2006, MI provided 49% of revenue, Financial Guarantee 23% and Financial Services 28% of revenue respectively.
Following the collapse of the subprime market and the scandal with rating subprime debt a lot of the banks and insurers have taken a huge hit to their balance sheets. In this analysis, we look to see if Radian has a future and is an investment at these prices.
In the quarter ending June 30th, each of the above segments contributed to income as follows:
Mortgage Insurance: -28.2 million
Financial Guarantee: 22 million
Financial Services: 27.3 million
The company reported a profit overall despite a negative mortgage insurance segment.
Interestingly enough, MTG also reported a profit in this quarter. But MTG reported a loss in Q3 and issued the following guidance regarding FY08.
MTG is providing the following guidance for the remainder of 2007 and the full year 2008:
•2007 Fourth Quarter paid losses approximating $270 to $290 million
• 2008 paid losses approximating $1.2 to $1.5 billion
This is the worst case loss of 1.8 billion with a shareholders equity of 4 billion for MTG.
Let us now look at Radian Q3. In the business call on 9/5/07, management offered the following scenarios for book value from 2007 through 2010. Book value of $46.9 in 07, $49 in 08, $54 in 09 and $59 in 10.
The Q3 book value came in less than what management predicted at $42.86.
From Q3 onwards, the company will only have two lines of business, mortgage insurance and financial services. In both these sectors, the company took a loss by valuing the derivatives to the mark to market criteria. Excluding this, the loss in the MI division was about 200 million. Financial Services had a slight profit. The company booked a large loss in Q3 and wrote off all of CBass investment. The company also thinks it can pay off the mortgage liability from the reserves and has adequate capitalization.
The stock holder equity was 2.2 billion in the MI division and 1.3 billion in financial services division.
Now let us look at two scenarios. The first one is the normal case as outlined by the company. This involves about 10% loss in the bubble states such as California and Texas. This is also the worst case envisioned by some other independent groups as well. The stress case involves taking 20% loss in these states and the company should do fine in this case. The reduction in book value in Q3 came in as management had expected except for the mark to market of derivatives. In the worst case, one can expect the book value to go to $30 in this scenario.
In the second scenario, we can expect the losses to continue till end of 2008 and mid 2009 at the current rate and another write off of 1 billion from the book value. This should still leave 2.1 billion in book value about 3 times the current market price for the stock. Even writing off the entire mortgage insurance business off still leaves a value of around ~$19/share in Radian.
The great risk for the company is downgrading of its credit from AA to a lower grade by SP and Moody's. In this case, the business may be harmed beyond repair. In the conference call, management was confident that it will be able to maintain its rating.
This stock has high uncertainty and low risk built in. A patient investor may be rewarded handsomely for holding on to this asset.
Mortgage insurance business provides credit protection for mortgage lenders and other financial services companies on residential mortgage assets through traditional mortgage insurance as well as other mortgage-backed structured products.
Financial guaranty business insures and reinsures credit-based risks and provides synthetic credit protection on various asset classes through credit default swaps.
Financial services business consists mainly of our ownership interests in Credit-Based Asset Servicing and Securitization LLC (“C-BASS”)—a mortgage investment and servicing firm specializing in credit-sensitive, residential mortgage assets and residential mortgage-backed securities—and in Sherman Financial Services Group LLC (“Sherman”)—a consumer asset and servicing firm specializing in credit card and bankruptcy-plan consumer assets.
In 2006, MI provided 49% of revenue, Financial Guarantee 23% and Financial Services 28% of revenue respectively.
Following the collapse of the subprime market and the scandal with rating subprime debt a lot of the banks and insurers have taken a huge hit to their balance sheets. In this analysis, we look to see if Radian has a future and is an investment at these prices.
In the quarter ending June 30th, each of the above segments contributed to income as follows:
Mortgage Insurance: -28.2 million
Financial Guarantee: 22 million
Financial Services: 27.3 million
The company reported a profit overall despite a negative mortgage insurance segment.
Interestingly enough, MTG also reported a profit in this quarter. But MTG reported a loss in Q3 and issued the following guidance regarding FY08.
MTG is providing the following guidance for the remainder of 2007 and the full year 2008:
•2007 Fourth Quarter paid losses approximating $270 to $290 million
• 2008 paid losses approximating $1.2 to $1.5 billion
This is the worst case loss of 1.8 billion with a shareholders equity of 4 billion for MTG.
Let us now look at Radian Q3. In the business call on 9/5/07, management offered the following scenarios for book value from 2007 through 2010. Book value of $46.9 in 07, $49 in 08, $54 in 09 and $59 in 10.
The Q3 book value came in less than what management predicted at $42.86.
From Q3 onwards, the company will only have two lines of business, mortgage insurance and financial services. In both these sectors, the company took a loss by valuing the derivatives to the mark to market criteria. Excluding this, the loss in the MI division was about 200 million. Financial Services had a slight profit. The company booked a large loss in Q3 and wrote off all of CBass investment. The company also thinks it can pay off the mortgage liability from the reserves and has adequate capitalization.
The stock holder equity was 2.2 billion in the MI division and 1.3 billion in financial services division.
Now let us look at two scenarios. The first one is the normal case as outlined by the company. This involves about 10% loss in the bubble states such as California and Texas. This is also the worst case envisioned by some other independent groups as well. The stress case involves taking 20% loss in these states and the company should do fine in this case. The reduction in book value in Q3 came in as management had expected except for the mark to market of derivatives. In the worst case, one can expect the book value to go to $30 in this scenario.
In the second scenario, we can expect the losses to continue till end of 2008 and mid 2009 at the current rate and another write off of 1 billion from the book value. This should still leave 2.1 billion in book value about 3 times the current market price for the stock. Even writing off the entire mortgage insurance business off still leaves a value of around ~$19/share in Radian.
The great risk for the company is downgrading of its credit from AA to a lower grade by SP and Moody's. In this case, the business may be harmed beyond repair. In the conference call, management was confident that it will be able to maintain its rating.
This stock has high uncertainty and low risk built in. A patient investor may be rewarded handsomely for holding on to this asset.
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