In this article, we examine Berkshire Hathaway's Q1 numbers and try to put an intrinisic value around the business. First, we will look at Berkshire's performance relative to SP500. Secondly, we will look at the strength of operating businesses. Then we will take a look at new investments. Lastly, we will take a look at overall outlook for the business.
The SP500 index dropped by about 7% in Q1 of 08. Compared to this, Berkshire's share holder equity dropped by 1.2% in the same period. So Berkshire handily out performed SP500 in Q1.
Let us next look at the operating businesses and cash flow. The insurance premiums earned declined by half - this is primarily because of the decline in premiums in the Berkshire Hathaway ReInsurance Group. Overall, there was a 22% drop in revenue. In the utilities sector, there was a slight gain in the mid american unit. In the finance/financial products sector, there was a mark to market loss of 1.6 billion. It is unlikely that this loss will be realized as the losses are on a logn term PUT option that is unlikely to be paid out. Taking this out, the Q1 earnings are roughly comparable to Q1 of last year.
Of all the businesses reported, Berkshire Hathaway Reinsurance Group has reduced the number of policies it is underwriting which contributes to the decline in revenue. Other operating companies have continues to do well in the face of a tough economy. Not writing insurance policies when the pricing environment is not right is a good way to operate the business. So, this points to good underwriting practices.
Then, the last piece of the puzzle is investments. From the balance sheet, the cash flow from operating activities declined to 3.3 billion from 4.6 billion for the quarter. On the other hand, 10.5 billion dollars were deployed in fixed income securities in the quarter. 1.5 billion was spent on equities. 4.8 billion was deployed to acquire Marmon group with further capital outlays in the future. Cash and cash equivalents declined by about 9 billion dollars in the first quarter. It declined by about 10.5 billion on a year over year basis. With another six billion pledged for the Wrigley deal, the 30 billion dollar barrier is close to being broken. If the bear market is prolonged as Buffett thinks, it is likely that more investment opportunties will arise for Berkshire and money will be deployed.
The IV of the company is 147K per my estimates as of end of Q1. It should be around 155-160K range as of now because of the stock market rebound. If the stock drops, it should provide a great entry point this year.
In case of a dip in the markets next week, it may present a great buying opportunity for a company which will continue to grow in the 10% range in the long term.
Saturday, May 03, 2008
Saturday, March 01, 2008
Berkshire Hathaway FY2007 Analysis
Berkshire Hathaway (BRK) reported its yearly earning on Friday, 29th of February. The comapny did well, advancing its book value by 11% compared to 2006 and beating SP500 handily. SP500 returned 5.5% in the same period. Berkshire has beaten SP500 for three years in a row now.
Some special notes from Buffett's letter:
Return on invested capital on See's candy - 200+%
Return on capital in Flight Safet - 27%
Return on capital in Microsoft - ~100%.
See's candy is a better business than Google or Microsoft, though a lot smaller in scale :-). Microsoft's profit margins and return on capital likely will continue to erode.
The other point of interest is the value of stocks owned by Berkshire is now 75 billion dollars. There are several that will do well in the next three-five years, some probably by a huge margin. In the mean time, they will kick in dividends to Berkshire in the range of a billion+ dollars a year. The stock portfolio will be at 95 billion with just 8% return in the next three years.
Warren Buffett has invested about 27 billion dollars in the last two years. All the free cash generated in the last two years has been deployed and will continue to get deployed in the next two-three years. I expect the free cash on the balance sheet to decline on a year over year basis in the next two-three years. The way cash is generated, even if the cash is deployed in the last three year's pace, we are looking a total of around 65 billion dollar investment from 2005-2010 inclusive. If one gets a return on capital of 10%, ( 10.8% is Berkshire historical record ), one an look at earnings going up by about 30%. Meanwhile the stock portfolio should also increase by about 25-30% excluding dividends.
I put my intrinsic value between 148-156K for berkshire at the end of 2007. It should be possible for the IV to go north of 200K by the end of 2010. This is a conservative estimate and the actual returns could be much higher.
Some special notes from Buffett's letter:
Return on invested capital on See's candy - 200+%
Return on capital in Flight Safet - 27%
Return on capital in Microsoft - ~100%.
See's candy is a better business than Google or Microsoft, though a lot smaller in scale :-). Microsoft's profit margins and return on capital likely will continue to erode.
The other point of interest is the value of stocks owned by Berkshire is now 75 billion dollars. There are several that will do well in the next three-five years, some probably by a huge margin. In the mean time, they will kick in dividends to Berkshire in the range of a billion+ dollars a year. The stock portfolio will be at 95 billion with just 8% return in the next three years.
Warren Buffett has invested about 27 billion dollars in the last two years. All the free cash generated in the last two years has been deployed and will continue to get deployed in the next two-three years. I expect the free cash on the balance sheet to decline on a year over year basis in the next two-three years. The way cash is generated, even if the cash is deployed in the last three year's pace, we are looking a total of around 65 billion dollar investment from 2005-2010 inclusive. If one gets a return on capital of 10%, ( 10.8% is Berkshire historical record ), one an look at earnings going up by about 30%. Meanwhile the stock portfolio should also increase by about 25-30% excluding dividends.
I put my intrinsic value between 148-156K for berkshire at the end of 2007. It should be possible for the IV to go north of 200K by the end of 2010. This is a conservative estimate and the actual returns could be much higher.
Sunday, February 17, 2008
CarMax KMX Analysis
KMX is mostly a used car dealer with attention to quality, no haggle pricing and low prices. It offers to remove the hassle in used car buying. I checked out the carmax.com website and the prices for the cars I saw were cheaper than the ones available with the dealer. KMX also has four new car selling facilities. Given the mix of new vs old cars ( 30-70 ) as well the expansion plans of KMX, it is likely that KMX will continue to see volumes of scale as it expands.
KMX was spun off from circuit city stores in 2002 as an independent entity, KMX was founded in 2002 in Virginia and currently has 81 stores in the country with most stores in Florida, Texas followed by California. Florida and California are hit heavily by the falling house prices and the general economy continues to cool off with impact on consumers. Let us see how this impacts KMX. The new car sales dipped in 2007 ( 11%) where as the used car sales went up (20+%). As the economy cools, it will be interesting to see how the mix changes in the first couple of quarters for KMX.
KMX has another revenue stream through auto financing operations. The company provides the following guidelines for 2008.
Fiscal 2008 Expectations
The fiscal 2008 expectations discussed below are based on historical and current trends in our business and should be read in conjunction with “Risk Factors,” in Part I, Item 1A of this Form 10-K.
Fiscal 2008 Sales. We currently anticipate comparable store used unit growth for fiscal 2008 in the range of 3% to 9%. We also expect wholesale unit sales growth to be consistent with our total used unit sales increase. Total revenues are expected to climb by between 14% and 20%, reflecting our expectations for comparable store used unit growth, new store openings, a modest increase in used vehicle average selling price, and a continued decline in our new vehicle sales.
Fiscal 2008 Earnings Per Share. We currently anticipate fiscal 2008 earnings per share in the range of $1.03 to $1.14, representing EPS growth in the range of 12% to 24%. We expect modest improvement in both used vehicle and wholesale gross profits per unit in fiscal 2008, as we continue to refine and improve our car-buying processes.
We expect CAF income to increase modestly, but at a pace slower than anticipated sales growth, primarily reflecting the challenging comparison created by the $13.0 million of favorable CAF items reported in fiscal 2007. The CAF gain percentage is anticipated to be slightly above the midpoint of our normalized 3.5% to 4.5% range in fiscal 2008, assuming no significant change in the interest rate environment.
The stock is not cheap but has potential for further growth in a vast market. The price to cash flow and P/E are somewhat high and the growth will be low this year. The ROA and ROE are not very high compared to other established businesses. While the concept clearly holds potential, the bet here is nation wide expansion of KMX over a period of time will increase efficiencies and EPS.
Valueline expects the company to post reduced margins over the next few quarters but do well over the long term as KMX is one of the finest companies in this category. Value line expects double digit bottom line growth for the next three-five years.
KMX was spun off from circuit city stores in 2002 as an independent entity, KMX was founded in 2002 in Virginia and currently has 81 stores in the country with most stores in Florida, Texas followed by California. Florida and California are hit heavily by the falling house prices and the general economy continues to cool off with impact on consumers. Let us see how this impacts KMX. The new car sales dipped in 2007 ( 11%) where as the used car sales went up (20+%). As the economy cools, it will be interesting to see how the mix changes in the first couple of quarters for KMX.
KMX has another revenue stream through auto financing operations. The company provides the following guidelines for 2008.
Fiscal 2008 Expectations
The fiscal 2008 expectations discussed below are based on historical and current trends in our business and should be read in conjunction with “Risk Factors,” in Part I, Item 1A of this Form 10-K.
Fiscal 2008 Sales. We currently anticipate comparable store used unit growth for fiscal 2008 in the range of 3% to 9%. We also expect wholesale unit sales growth to be consistent with our total used unit sales increase. Total revenues are expected to climb by between 14% and 20%, reflecting our expectations for comparable store used unit growth, new store openings, a modest increase in used vehicle average selling price, and a continued decline in our new vehicle sales.
Fiscal 2008 Earnings Per Share. We currently anticipate fiscal 2008 earnings per share in the range of $1.03 to $1.14, representing EPS growth in the range of 12% to 24%. We expect modest improvement in both used vehicle and wholesale gross profits per unit in fiscal 2008, as we continue to refine and improve our car-buying processes.
We expect CAF income to increase modestly, but at a pace slower than anticipated sales growth, primarily reflecting the challenging comparison created by the $13.0 million of favorable CAF items reported in fiscal 2007. The CAF gain percentage is anticipated to be slightly above the midpoint of our normalized 3.5% to 4.5% range in fiscal 2008, assuming no significant change in the interest rate environment.
The stock is not cheap but has potential for further growth in a vast market. The price to cash flow and P/E are somewhat high and the growth will be low this year. The ROA and ROE are not very high compared to other established businesses. While the concept clearly holds potential, the bet here is nation wide expansion of KMX over a period of time will increase efficiencies and EPS.
Valueline expects the company to post reduced margins over the next few quarters but do well over the long term as KMX is one of the finest companies in this category. Value line expects double digit bottom line growth for the next three-five years.
Sunday, February 10, 2008
Microsoft and Yahoo! Merger
Microsoft is trying to buy Yahoo! at a price of $31/share. Barrons analyzed this deal and said the price Microsoft is paying is low when compared to the Acquantive acquisition. Henry Blodget, the former internet analyst has this to say about this deal in his blog.
"The first problem with Microsoft's online services division is the name: Microsoft's online services division. MSN, Windows Live, Office Live, MSNBC.com, aQuantive...we'd feel better about the company's chances if it could begin by settling on a brand (or at least a couple of brands).As for last quarter...Online revenue jumped 38% to $863 million, for an overall annual run-rate of a respectable $3.4 billion. Of that, $623 million was advertising ($2.5 billion run rate), making Microsoft's ad business one-seventh of Google's size and about one-third of Yahoo's size.Of the advertising business, which also grew 38% year over year, $112 million came from the aQuantive acquisition. Excluding this, the division's ad revenue grew 24% vs. 25% last quarter. This means Microsoft almost certainly lost more share to Google in the quarter, but may have picked up a small amount against Yahoo.Most importantly, despite the acquisition of profitable aQuantive, Microsoft's online business is still burning money--$800 million a year (after factoring out some non-cash charges). This is an improvement vs. Q207, when it was losing $1 billion a year, but it's still horrible. Even walloped AOL is still printing money. Microsoft's online successes, such as they are, won't be taken seriously until the company is running a large, organically growing, profitable business."
Let us look at the latest numbers from Q2 of 2008. The numbers thus far in 08 is 1.5 billion in revenue with 500 million dollar loss. Yahoo! on the other hand had revenues of ~7 billion with approximate profit of 660 million. Combining the two entities by themselves would result in about 10 billion in revenue with about 340 million in loss. This is without adding any cost saving, talent loss and special incentive packages to retain executives and employees. If one billion is cut from costs it will result in about 600 million in profits. This is not including the increase in cost structure to retain key employees and managers.
This compares to 16 billion in revenues and 4 billion in net income at Google. As can be seen, from the business stand point, Google is ahead and continues to pull ahead as Microhoo! gets bogged down in getting the merger to work.
"The first problem with Microsoft's online services division is the name: Microsoft's online services division. MSN, Windows Live, Office Live, MSNBC.com, aQuantive...we'd feel better about the company's chances if it could begin by settling on a brand (or at least a couple of brands).As for last quarter...Online revenue jumped 38% to $863 million, for an overall annual run-rate of a respectable $3.4 billion. Of that, $623 million was advertising ($2.5 billion run rate), making Microsoft's ad business one-seventh of Google's size and about one-third of Yahoo's size.Of the advertising business, which also grew 38% year over year, $112 million came from the aQuantive acquisition. Excluding this, the division's ad revenue grew 24% vs. 25% last quarter. This means Microsoft almost certainly lost more share to Google in the quarter, but may have picked up a small amount against Yahoo.Most importantly, despite the acquisition of profitable aQuantive, Microsoft's online business is still burning money--$800 million a year (after factoring out some non-cash charges). This is an improvement vs. Q207, when it was losing $1 billion a year, but it's still horrible. Even walloped AOL is still printing money. Microsoft's online successes, such as they are, won't be taken seriously until the company is running a large, organically growing, profitable business."
Let us look at the latest numbers from Q2 of 2008. The numbers thus far in 08 is 1.5 billion in revenue with 500 million dollar loss. Yahoo! on the other hand had revenues of ~7 billion with approximate profit of 660 million. Combining the two entities by themselves would result in about 10 billion in revenue with about 340 million in loss. This is without adding any cost saving, talent loss and special incentive packages to retain executives and employees. If one billion is cut from costs it will result in about 600 million in profits. This is not including the increase in cost structure to retain key employees and managers.
This compares to 16 billion in revenues and 4 billion in net income at Google. As can be seen, from the business stand point, Google is ahead and continues to pull ahead as Microhoo! gets bogged down in getting the merger to work.
Friday, November 23, 2007
Retailers - DDS, COST and SHLD
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.
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 $150/share.
The current retail environment is offering some great bargains and a prudent investor can make a boatload of money by exploiting the current environment to the maximum.
Wednesday, November 21, 2007
Lowes vs Home Depot - part 2
In prior articles, we have looked at home improvement retailers - Lowes and Home Depot respectively. Let us compare the two again, based on most recently ended quarter.
Lowes currently sports a P/E of 11, market cap of 32.6 billion, price/cash flow of 6.91 and is trading close to its 52 week low at 22.11.
Home Depot currently sports a P/E of close to 11, market cap of 55.5 billion, price/cash flow of 8.29. Home Depot has better yield than Lowes at the moment.
In the most recent quarter, home depot's margins declined by 2% points from 11.3% to 9.3%. By comparison, Lowes gross margin declined by 1.42 bais points in the same quarter. Similarly, Lowes sales increased whereas Home Depot's sales declined. ( 3% increase to 3.5% decline )
Home Depot's outstanding shares decliend by 11.4%, helped by the sale of HD Supply. Lowes outstanding shares declined by 3.5% in the same period. Home Depot's book value per share is 9.64$/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.
Thursday, October 18, 2007
Four pillars of Tech
The four pillars of tech according to Kramer are:
1. RIMM
2. AMZN
3. GOOG and
4. AAPL
Let us look at each of these to see if they offer good bargains at current prices.
1. RIMM carries a P/E of 76, PEG of 1.56, Price to cash flow of 90.
2. AMZN carries a P/E of 124, PEG of 3.54 and price to cash flow of 42.
3. GOOG carries a P/E of 50, PEG of 1.22 and price to cash flow of 46.
4. AAPL carries a P/E 49, PEG of 2 and price to cash flow of 32.
AAPL is the cheapest from the P/E and P/CF point of view. Google is the cheapest by PEG point of view.
From a discounted cash flow point of view, none of the stocks look cheap and each of them look quite expensive. In the long term, the value is likely to catch up with price - this can happen through stagnant or declining share price.
1. RIMM
2. AMZN
3. GOOG and
4. AAPL
Let us look at each of these to see if they offer good bargains at current prices.
1. RIMM carries a P/E of 76, PEG of 1.56, Price to cash flow of 90.
2. AMZN carries a P/E of 124, PEG of 3.54 and price to cash flow of 42.
3. GOOG carries a P/E of 50, PEG of 1.22 and price to cash flow of 46.
4. AAPL carries a P/E 49, PEG of 2 and price to cash flow of 32.
AAPL is the cheapest from the P/E and P/CF point of view. Google is the cheapest by PEG point of view.
From a discounted cash flow point of view, none of the stocks look cheap and each of them look quite expensive. In the long term, the value is likely to catch up with price - this can happen through stagnant or declining share price.
Saturday, October 06, 2007
HOG (Harley Davidson) Analysis
Harley Davidson (HOG) is the iconic American motor cycle manufacturer. It is more than a brand in many ways - many people tattoo HOG on their bodies. It is difficult to find many companies that people are willing to tattoo on their bodies. Of late, HOG stock price has declined because of stagnant or slightly declining year over year sales. Let us analyze the stock in further detail in the rest of this blog. HOG embodies a lifestyle and in some sense beyond a brand.
HOG has a P/E of ~12 and price to cash flow of about 13. Price to book value is about 4. The dividend yield for the stock is about 2%. While the stock is undoubtedly cheap as it is very difficult to replicate the Harley brand for the market cap of the company which is about 13 billion. While the intangibles add significantly to Harley's book value, let us see if the company is a buy at the current prices.
First let us analyze Harley. The number of outstanding shares has been declining by about 1.6% per year for the last ten years. The EPS has grown by about 20% per year for the past ten years - which is clearly not sustainable.
Let us look at the cash flows and return on equity to see how HOG looks like from this perspective. The cash flow from operations for the last five years have been respectively - 936, 970, 960, 762 and 998 million dollars respectively. The free cash flow has varied from 708 million to 782 million respectively. The return on equity has varied from 29% to 39% of late.
The company's YoY sales in the US has declined by about 5% and the company is hoping to expand internationally further. Like other consumer staples such as Coke and Pepsi, HOG will probably see more revenue and profits internationally in the future.
The stock looks cheap compared to its historic P/E of about 19. Even given the stagnant cash flows, the company is returning money to the share holders in the form of dividends and share buy backs. HOG is a good long term buy but may not see immediate upside.
HOG has a P/E of ~12 and price to cash flow of about 13. Price to book value is about 4. The dividend yield for the stock is about 2%. While the stock is undoubtedly cheap as it is very difficult to replicate the Harley brand for the market cap of the company which is about 13 billion. While the intangibles add significantly to Harley's book value, let us see if the company is a buy at the current prices.
First let us analyze Harley. The number of outstanding shares has been declining by about 1.6% per year for the last ten years. The EPS has grown by about 20% per year for the past ten years - which is clearly not sustainable.
Let us look at the cash flows and return on equity to see how HOG looks like from this perspective. The cash flow from operations for the last five years have been respectively - 936, 970, 960, 762 and 998 million dollars respectively. The free cash flow has varied from 708 million to 782 million respectively. The return on equity has varied from 29% to 39% of late.
The company's YoY sales in the US has declined by about 5% and the company is hoping to expand internationally further. Like other consumer staples such as Coke and Pepsi, HOG will probably see more revenue and profits internationally in the future.
The stock looks cheap compared to its historic P/E of about 19. Even given the stagnant cash flows, the company is returning money to the share holders in the form of dividends and share buy backs. HOG is a good long term buy but may not see immediate upside.
Sunday, September 30, 2007
Proctor and Gamble Analysis
PG ( Proctor and Gamble ) is in the consumer staples business. It was the best performing dow jones stocks for the recently ended quarter. Let us quickly take a look at the financials to see if it is a buy at current prices. With a P/E of 23 and Price/Cash flow of close to 18, the stock doesnt appear cheap at current prices. Let us take a deeper look at the numbers to see how things look like.
The company bought Gillette recently, which has helped its cashflow and net margins. The EPS has grown at the rate of 9% a year for the past ten years and is likely to grow at that rate in the future.
The business is doing well on all fronts as noted in the company's 10-Q:
Net sales fiscal year to date increased 14 percent to $57.20 billion behind 11 percent volume growth, including an additional three months of Gillette results during the current fiscal year to date period versus the comparable year ago period. Organic volume grew five percent with broad-based growth across the business. Every reportable segment delivered year-on-year organic volume growth driven by product initiatives including Tide Simple Pleasures, Febreze Noticeables, Pantene Color Expressions, Olay Regenerist and Definity and the Head & Shoulders and Herbal Essences restages. Price increases taken across several segments added one percent to sales growth while favorable foreign exchange trends had a positive two percent impact. Product mix had no net impact on sales growth as the favorable mix impact from the additional period of Gillette results was offset by disproportionate growth in developing regions, where unit selling prices are below the Company average. Organic sales increased six percent fiscal year to date.
Additionally, the per share growth has been impressive partly because of the accretive nature of Gillette's business.
Net earnings increased 19 percent to $8.07 billion behind organic sales growth, the impacts from the addition of Gillette, including financing and other acquisition-related expenses, and profit margin expansion. Diluted net earnings per share were $2.37, up 13 percent versus the prior year. Earnings per share growth lagged net earnings growth due to a net increase in the weighted average shares outstanding in the current year to date period (incremental shares issued in conjunction with the Gillette acquisition on October 1, 2005, net of share repurchases, primarily under the Gillette repurchase program).
The fastest growing business segment was health care products. The gillette razors and blade segment is growing impressively in the developing countries.
Overall, PG is a great business. The current price levels are a bit too high - the right time to buy this was during the summer months during the peak of the credit crisis.
The company bought Gillette recently, which has helped its cashflow and net margins. The EPS has grown at the rate of 9% a year for the past ten years and is likely to grow at that rate in the future.
The business is doing well on all fronts as noted in the company's 10-Q:
Net sales fiscal year to date increased 14 percent to $57.20 billion behind 11 percent volume growth, including an additional three months of Gillette results during the current fiscal year to date period versus the comparable year ago period. Organic volume grew five percent with broad-based growth across the business. Every reportable segment delivered year-on-year organic volume growth driven by product initiatives including Tide Simple Pleasures, Febreze Noticeables, Pantene Color Expressions, Olay Regenerist and Definity and the Head & Shoulders and Herbal Essences restages. Price increases taken across several segments added one percent to sales growth while favorable foreign exchange trends had a positive two percent impact. Product mix had no net impact on sales growth as the favorable mix impact from the additional period of Gillette results was offset by disproportionate growth in developing regions, where unit selling prices are below the Company average. Organic sales increased six percent fiscal year to date.
Additionally, the per share growth has been impressive partly because of the accretive nature of Gillette's business.
Net earnings increased 19 percent to $8.07 billion behind organic sales growth, the impacts from the addition of Gillette, including financing and other acquisition-related expenses, and profit margin expansion. Diluted net earnings per share were $2.37, up 13 percent versus the prior year. Earnings per share growth lagged net earnings growth due to a net increase in the weighted average shares outstanding in the current year to date period (incremental shares issued in conjunction with the Gillette acquisition on October 1, 2005, net of share repurchases, primarily under the Gillette repurchase program).
The fastest growing business segment was health care products. The gillette razors and blade segment is growing impressively in the developing countries.
Overall, PG is a great business. The current price levels are a bit too high - the right time to buy this was during the summer months during the peak of the credit crisis.
Saturday, September 08, 2007
Bed Bath and Beyond (BBBY) Analysis
In this blog, we have looked at retailers such as Walmart, American Eagle and Joseph A Bank. Let us analyze another specialty retailer, BBBY and see if it is a good investment opportunity at this time.
BBBY is a retailer specializing in bedding, bath and kitchen products. It also sells electronics, electrical equipment ( kitchen electrics ), furniture, wall and home decor. It targets the rich to upper middle class customer and competes with a slew of other retailers in this space. Its closest competitors are Target ( which targets the middle class customer ) and Linen and Things. In each of the segments it operates in, there are a slew of speciality retailers that compete for the same business.
Let us look at the latest 10-Q report and past reports to see how BBBY stacks up against some of the other retailers. In the most recent quarter, BBBY saw increase of sales (~11%) through store expansion and through the acquisition of buy buy BABY. Meanwhile, the gross profit margin declined because of rising inventory costs and selling, general and administrative cost went up. The result was a decline in operating profit margins to 9.9% from 10.7% from the same period a year ago. Does the declining profit margins show a fiercer competitive environment? Let us look at the profit margins for the past five years to figure this out.
The operating income for the past five years are as shown below with a compound annual growth rate of 7%.
639.3
792.4
879.2
889.4
895.0 (expected for this year )
The operating margin has declined sharply this year and last compared to the previous two years to the 2003 levels. This is a bit early to say if this is because of fiercer competition. The reduction in margins could also be because of the decline in the housing market. However, this should have been more pronounced in 2007 as opposed to 2006 which is not the case.
The company has decided to buy back about a billion dollar worth of shares in December 2006 and the total number of outstanding shares has declined in the most recent quarter by about 7 million compared to the same period a year ago. The company has about 20 million shares outstanding (options) and about 6 million shares in restricted stock. While many of the options are under water at the moment, the addition of close to 9% of additional shares can dilute the impact of buy back.
On a positive note, the company carries no debt and is funding its expansion through operating cash flow.
From a cash flow perspective, there are cheaper alternatives such as Walmart and Target and a slew of other retailers noted earlier in this blog such as AEO and JOSB.
While the company is healthy, the impact of housing slow down and competitive pressures is not fully clear at the moment. It is our view that there are other retailers that offer a better discount to intrinsic value than BBBY.
BBBY is a retailer specializing in bedding, bath and kitchen products. It also sells electronics, electrical equipment ( kitchen electrics ), furniture, wall and home decor. It targets the rich to upper middle class customer and competes with a slew of other retailers in this space. Its closest competitors are Target ( which targets the middle class customer ) and Linen and Things. In each of the segments it operates in, there are a slew of speciality retailers that compete for the same business.
Let us look at the latest 10-Q report and past reports to see how BBBY stacks up against some of the other retailers. In the most recent quarter, BBBY saw increase of sales (~11%) through store expansion and through the acquisition of buy buy BABY. Meanwhile, the gross profit margin declined because of rising inventory costs and selling, general and administrative cost went up. The result was a decline in operating profit margins to 9.9% from 10.7% from the same period a year ago. Does the declining profit margins show a fiercer competitive environment? Let us look at the profit margins for the past five years to figure this out.
The operating income for the past five years are as shown below with a compound annual growth rate of 7%.
639.3
792.4
879.2
889.4
895.0 (expected for this year )
The operating margin has declined sharply this year and last compared to the previous two years to the 2003 levels. This is a bit early to say if this is because of fiercer competition. The reduction in margins could also be because of the decline in the housing market. However, this should have been more pronounced in 2007 as opposed to 2006 which is not the case.
The company has decided to buy back about a billion dollar worth of shares in December 2006 and the total number of outstanding shares has declined in the most recent quarter by about 7 million compared to the same period a year ago. The company has about 20 million shares outstanding (options) and about 6 million shares in restricted stock. While many of the options are under water at the moment, the addition of close to 9% of additional shares can dilute the impact of buy back.
On a positive note, the company carries no debt and is funding its expansion through operating cash flow.
From a cash flow perspective, there are cheaper alternatives such as Walmart and Target and a slew of other retailers noted earlier in this blog such as AEO and JOSB.
While the company is healthy, the impact of housing slow down and competitive pressures is not fully clear at the moment. It is our view that there are other retailers that offer a better discount to intrinsic value than BBBY.
Monday, September 03, 2007
Infosys Q1 Analysis
In this blog, we have looked at Indian outsourcer, Infosys quite a few times. We found Infosys to be the best run of the Indian outsourcers with solid management. In the first six months of the year, the Indian currency appreciated by about 10% against the US dollar. This appreciation was partly precipitated by the Indian central bank keen to cut inflationary pressures. The exchange rate of the Indian currency is artificially maintained as the currency is not freely traded. This is similar to the way the Chinese government maintains its peg against the US dollar.
The problem for Indian companies that are exported focussed is that it increases their cost of operations. While some of the cost can be passed on to the customers, it will not be possible to pass on all the costs to the customers. In addition, Infosys and other Indian companies are facing increase in operating costs with wages increasing at double digit rates of 15%. This impact is probably not fully felt yet and show up further in the coming year. The wage increase is expected to be about 15% in the coming year as well.
The operating income margin in Q1 of 2006 for Infosys was 25.75%. The operating margin in Q1 of 2007 was 24.67%. In general, the business did well, with revenues and profits growing strongly. As usual, the stock market looks at future prospects as opposed to past results. Infosys is expected to continue to do well with growth in the 28-31% range for FY2008.
Other points of note is attrition rate of 4% in the quarter and 10% new employees in Q1 alone. Infosys expects to pay new employees higher wages compared to the ones hired before. Infosys now employs about 75000 people world wide. The increase in cost will increasingly be felt in the next couple of years which is reflected in the stock price.
The company has a strong balance sheet with about $1.6 billion in cash. The company is run well and this is reflected in the stock price. However, we feel that the company is fairly valued at current price levels.
The problem for Indian companies that are exported focussed is that it increases their cost of operations. While some of the cost can be passed on to the customers, it will not be possible to pass on all the costs to the customers. In addition, Infosys and other Indian companies are facing increase in operating costs with wages increasing at double digit rates of 15%. This impact is probably not fully felt yet and show up further in the coming year. The wage increase is expected to be about 15% in the coming year as well.
The operating income margin in Q1 of 2006 for Infosys was 25.75%. The operating margin in Q1 of 2007 was 24.67%. In general, the business did well, with revenues and profits growing strongly. As usual, the stock market looks at future prospects as opposed to past results. Infosys is expected to continue to do well with growth in the 28-31% range for FY2008.
Other points of note is attrition rate of 4% in the quarter and 10% new employees in Q1 alone. Infosys expects to pay new employees higher wages compared to the ones hired before. Infosys now employs about 75000 people world wide. The increase in cost will increasingly be felt in the next couple of years which is reflected in the stock price.
The company has a strong balance sheet with about $1.6 billion in cash. The company is run well and this is reflected in the stock price. However, we feel that the company is fairly valued at current price levels.
Sunday, August 26, 2007
Value vs Growth
We are looking at this again after a short gap. Given the disaster in the financial sector and the dominance of financials in the value fund, the value fund hasnt done too badly.
The chart below shows how value, blend (sp500) and growth compare in the large cap arena. The chart below shows the iShares ETFs - IVE, IVV and IVW.
The top stocks in IVE (value etf) are:
AT&T,
GE,
Citigroup,
BAC,
JP Morgan Chase,
Conoco Phillips
The top five stocks in IVW ( growth ETF) are:
Exxon Mobil,
Proctor and Gamble,
Cisco Systems,
Johnson and Johnson and
AIG
The difference between value and growth is not wide with iShares ETFs.
http://finance.yahoo.com/q/bc?t=6m&s=IVE&l=on&z=m&q=l&c=ivv%2Civw
The second chart compares the vanguard funds in the same category. The vanguard funds of interest are VTV, VV and VUG respectively. The mix of stocks in vanguard funds is different than the iShares funds - so the difference in performance is also different. As an example, Berkshire is in vanguard growth fund but not in the value fund. Comparing to iShares ETFs, the stocks and their weights are also different.
The top holdings in VUG are:
Microsoft,
Proctor and Gamble
Johnson and Johnson
Cisco
Intel
The top holdings in VTV are:
Exxon Mobil,
GE,
A&T,
Citigroup and
Bank of America
http://finance.yahoo.com/q/bc?t=6m&s=VTV&l=on&z=m&q=l&c=vv%2Cvug
While the companies in both the lists are good, citigroup and BAC may have to take some charges on the buy out transactions still pending for which commitments are made. While this is a good time to buy - it may be in the doldrums for some time.
The differentiation of stocks to value and growth is quite arbitrary and one should do ones due diligence before selecting one sector over the other. It also depends on which funds one selects and what cost advantages an ETF or a bunch of ETFs provide over the other.
The chart below shows how value, blend (sp500) and growth compare in the large cap arena. The chart below shows the iShares ETFs - IVE, IVV and IVW.
The top stocks in IVE (value etf) are:
AT&T,
GE,
Citigroup,
BAC,
JP Morgan Chase,
Conoco Phillips
The top five stocks in IVW ( growth ETF) are:
Exxon Mobil,
Proctor and Gamble,
Cisco Systems,
Johnson and Johnson and
AIG
The difference between value and growth is not wide with iShares ETFs.
http://finance.yahoo.com/q/bc?t=6m&s=IVE&l=on&z=m&q=l&c=ivv%2Civw
The second chart compares the vanguard funds in the same category. The vanguard funds of interest are VTV, VV and VUG respectively. The mix of stocks in vanguard funds is different than the iShares funds - so the difference in performance is also different. As an example, Berkshire is in vanguard growth fund but not in the value fund. Comparing to iShares ETFs, the stocks and their weights are also different.
The top holdings in VUG are:
Microsoft,
Proctor and Gamble
Johnson and Johnson
Cisco
Intel
The top holdings in VTV are:
Exxon Mobil,
GE,
A&T,
Citigroup and
Bank of America
http://finance.yahoo.com/q/bc?t=6m&s=VTV&l=on&z=m&q=l&c=vv%2Cvug
While the companies in both the lists are good, citigroup and BAC may have to take some charges on the buy out transactions still pending for which commitments are made. While this is a good time to buy - it may be in the doldrums for some time.
The differentiation of stocks to value and growth is quite arbitrary and one should do ones due diligence before selecting one sector over the other. It also depends on which funds one selects and what cost advantages an ETF or a bunch of ETFs provide over the other.
Saturday, August 18, 2007
Jos A. Bank Clothiers (JOSB) revisited
Now that all the retailers are in a funk thanks to the subprime mess as well as the Walmart warning, let us look at this section again.
We have looked at JOSB before in this blog and noted that P/E contraction was a major risk to both JOSB and Chico FAS. True enough, even though the sales have done well, people have been dumping JOSB as well as other retailers enmasse creating an opportunity.
Let us look at JOSB business and macro factors first. Jos. A. Bank Clothiers, Inc. is a nationwide retailer of classic men’s clothing through conventional retail stores and catalog and Internet direct marketing. What are the factors that can go right and what are the factors that can go wrong for JOSB?
Things going right:
1. Good job market - always a plus for JOSB. It is unlikely this will falter given the strong growth in emerging markets, europe and Japan. The U.S export growth continues to grow and the dollar will probably decline further if there is a rate cut. This bodes well for JOSB.
This not going well:
1. The housing market. A bunch of ARMs are scheduled to be reset next year - this can cause problems to JOSB and other retails if it impacts the US consumer abnormally.
If the job growth continues and the ARM resets occur in an orderly way - the consumer mix for JOSB is going to determine how well it will do.
For this, let us look at the financial statements.
First cash flows - JOSB has a price to cash flow ratio 0f 7. What this means is that the business can pay out the entire capital back in seven years if nothing is reinvested in the business. However, a part of the capital will have to be reinvested to keep the business going. Another part to look at is the sustainability of the cash flow. Let us look at the balance sheets to gain further insight into these factors.
First let us look at the free cash flow growth. It has been far for uniform - in fiscal 2002 and 2004, the company had negative cash flows. The company is excpected to have free cash flows of ~40 million this fiscal year. So the cash flows are not even meaning some dependency on the economic cycles are present.
Let us look at the latest 10-Q for more details. The company is planning to add more stores this year to expand the number of stores from 366 to close to 500. The company would put the store expansion plans on hold if there is a chance to lose money on the investment or if it is very risky. As noted by other retailers, the sales havent fallen off the cliff yet but people are expecting catastrophe to hit when the ARMs reset.
JOSB looks attractive at this price, with book value of approximately $12/share - it is definitely selling below its intrinsic value and can offer some good upside if the ARM reset doesnt hobble the economy badly. Note: please see the disclaimer part of this blog.
We have looked at JOSB before in this blog and noted that P/E contraction was a major risk to both JOSB and Chico FAS. True enough, even though the sales have done well, people have been dumping JOSB as well as other retailers enmasse creating an opportunity.
Let us look at JOSB business and macro factors first. Jos. A. Bank Clothiers, Inc. is a nationwide retailer of classic men’s clothing through conventional retail stores and catalog and Internet direct marketing. What are the factors that can go right and what are the factors that can go wrong for JOSB?
Things going right:
1. Good job market - always a plus for JOSB. It is unlikely this will falter given the strong growth in emerging markets, europe and Japan. The U.S export growth continues to grow and the dollar will probably decline further if there is a rate cut. This bodes well for JOSB.
This not going well:
1. The housing market. A bunch of ARMs are scheduled to be reset next year - this can cause problems to JOSB and other retails if it impacts the US consumer abnormally.
If the job growth continues and the ARM resets occur in an orderly way - the consumer mix for JOSB is going to determine how well it will do.
For this, let us look at the financial statements.
First cash flows - JOSB has a price to cash flow ratio 0f 7. What this means is that the business can pay out the entire capital back in seven years if nothing is reinvested in the business. However, a part of the capital will have to be reinvested to keep the business going. Another part to look at is the sustainability of the cash flow. Let us look at the balance sheets to gain further insight into these factors.
First let us look at the free cash flow growth. It has been far for uniform - in fiscal 2002 and 2004, the company had negative cash flows. The company is excpected to have free cash flows of ~40 million this fiscal year. So the cash flows are not even meaning some dependency on the economic cycles are present.
Let us look at the latest 10-Q for more details. The company is planning to add more stores this year to expand the number of stores from 366 to close to 500. The company would put the store expansion plans on hold if there is a chance to lose money on the investment or if it is very risky. As noted by other retailers, the sales havent fallen off the cliff yet but people are expecting catastrophe to hit when the ARMs reset.
JOSB looks attractive at this price, with book value of approximately $12/share - it is definitely selling below its intrinsic value and can offer some good upside if the ARM reset doesnt hobble the economy badly. Note: please see the disclaimer part of this blog.
Saturday, August 04, 2007
Berkshire Hathaway FY07 2nd quarter results
Berkshire Hathaway, the holding company run by Warren Buffett, reported its 2nd quarter earnings yesterday. In this blog, we will go through the earning report and look at the earnings and the company.
The company had 1,088,878 class A shares and 13,753,590 class B shares for a market cap of approximately 169 billion dollars. Total shareholder equity was 115.27 billion dollars. So the price to equity ratio is less than 1.5. This is a low number for a company that grew the operating earnings and total earnings in the low 20s and 30 percentage respectively showing that the stock is quite undervalued.
There are a few things of note to observe in the consolidated statement of earnings. Let us look each segment and compare it to the perception of analysts and market commentators.
In the insurance and other segment, sales and service revenues increased as well as investment gains. Geico increased its market share managing to increase profits in an environment of falling insurance premiums. General Re and BRK Reinsurance did particularly well. General Re is doing well overall and should continue to do well for the rest of the year. BRK Reinsurance is doing well in the multiline business segment but megacat insurance premiums will decline in the next year. This should be offset to a certain extent by investment gains on the equitas portfolio.
Utility and Energy section saw revenue and earning growth. This section is doing well as expected.
In the finance and financial products section, interest income slightly increased, investment gains declined compared to the year ago period, derivative gains increased and the other section was flat.
The important thing to point out here is that the interest income from treasuries is not significantly higher than last year as many analysts were expecting. In the first six months of the year, 3.3 billion of fixed maturity securities were bought and another 11.5 billion of equity securities were bought. The important thing to note here is that the securities delivered as part of the equitas deal is listed separately in the cash flow statement. The cash and cash equivalents stood around 39.9 billion. This figure is different in the cash flow statement as some of the money is borrowed for mid american subsidiary.
Interestingly enough, the break down of fixed maturity securities showed 3.7 billion of mortgage backed securities. This number should increase in the coming months as the market remains illiquid and the yield spread widens.
As an intelligent investor may recognize, this is Buffett and Munger time. Irrational fear and illiquid markets plays perfectly into the hands of worlds great investors. In addition, many of Berkshires core holdings like P&G, Walmart, HD etc. dont have liquidity problem and are buying back stock. This should help increase the book value and networth of Berkshire in the coming years.
My breakdown of intrinsic value is around 142 - 145 K per A share after Q2. In fact, the stock deserves a premium for the opportunities available at the moment. One should have part of ones portfolio in this stock as it allows for capital preservation and appreciation at the same time.
The company had 1,088,878 class A shares and 13,753,590 class B shares for a market cap of approximately 169 billion dollars. Total shareholder equity was 115.27 billion dollars. So the price to equity ratio is less than 1.5. This is a low number for a company that grew the operating earnings and total earnings in the low 20s and 30 percentage respectively showing that the stock is quite undervalued.
There are a few things of note to observe in the consolidated statement of earnings. Let us look each segment and compare it to the perception of analysts and market commentators.
In the insurance and other segment, sales and service revenues increased as well as investment gains. Geico increased its market share managing to increase profits in an environment of falling insurance premiums. General Re and BRK Reinsurance did particularly well. General Re is doing well overall and should continue to do well for the rest of the year. BRK Reinsurance is doing well in the multiline business segment but megacat insurance premiums will decline in the next year. This should be offset to a certain extent by investment gains on the equitas portfolio.
Utility and Energy section saw revenue and earning growth. This section is doing well as expected.
In the finance and financial products section, interest income slightly increased, investment gains declined compared to the year ago period, derivative gains increased and the other section was flat.
The important thing to point out here is that the interest income from treasuries is not significantly higher than last year as many analysts were expecting. In the first six months of the year, 3.3 billion of fixed maturity securities were bought and another 11.5 billion of equity securities were bought. The important thing to note here is that the securities delivered as part of the equitas deal is listed separately in the cash flow statement. The cash and cash equivalents stood around 39.9 billion. This figure is different in the cash flow statement as some of the money is borrowed for mid american subsidiary.
Interestingly enough, the break down of fixed maturity securities showed 3.7 billion of mortgage backed securities. This number should increase in the coming months as the market remains illiquid and the yield spread widens.
As an intelligent investor may recognize, this is Buffett and Munger time. Irrational fear and illiquid markets plays perfectly into the hands of worlds great investors. In addition, many of Berkshires core holdings like P&G, Walmart, HD etc. dont have liquidity problem and are buying back stock. This should help increase the book value and networth of Berkshire in the coming years.
My breakdown of intrinsic value is around 142 - 145 K per A share after Q2. In fact, the stock deserves a premium for the opportunities available at the moment. One should have part of ones portfolio in this stock as it allows for capital preservation and appreciation at the same time.
Sunday, July 15, 2007
Four pillars of Tech
Kramer classifies these four companies as the four pillars of tech. According to him these are the standard bearers for the first decade of the 21st century. It is anyone's guess if their dominance will last till the next decade - most likely it wont if we look at tech wonders from the nineties - Intel, Microsoft, Cisco, Dell and Yahoo!
Here are the four companies:
RIMM - blackberry a must for corp execs.
AAPL - iphone and ipod. iphone is getting to be a competitor to blackberry in the longer term.
GOOG - 'nugh said. Goog is planning a free google cell phone with its own apps. Going against apple? May be.
AMZN - virtual warehouse, S3 and EC2 services.
AMZN - market cap of 30 billion and free cash flow of 500 million - ratio 60
GOOG - market cap of 172 billion and free cash flow of 1.8 billion - ratio 95
AAPL - market cap of 120 billion and free cash flow of 3.9 billion - ratio 31
RIMM - market cap of 40 billion and free cash flow of 480 million - ratio 83
Let us take another swap by looking at stock dilution at each of the companies.
AMZN - has remained flat in the last few years probably because of buy backs.
GOOG -should be 6-7% range or higher
AAPL - about 2.5% dilution per year
RIMM - no dilution in last year - most likely because of buy backs.
Berkshire (BRKA/BRKB) on the other hand throws off cash better than most companies in America. Its price to cash flow ratio is less than ten making it a bargain compared to any of these tech stalwarts. Moreover, the stable of businesses that are part of Berkshire are likely to remain solid and kicking long after today's tech titans make way for another round of upstarts in the next decade.
Here are the four companies:
RIMM - blackberry a must for corp execs.
AAPL - iphone and ipod. iphone is getting to be a competitor to blackberry in the longer term.
GOOG - 'nugh said. Goog is planning a free google cell phone with its own apps. Going against apple? May be.
AMZN - virtual warehouse, S3 and EC2 services.
AMZN - market cap of 30 billion and free cash flow of 500 million - ratio 60
GOOG - market cap of 172 billion and free cash flow of 1.8 billion - ratio 95
AAPL - market cap of 120 billion and free cash flow of 3.9 billion - ratio 31
RIMM - market cap of 40 billion and free cash flow of 480 million - ratio 83
Let us take another swap by looking at stock dilution at each of the companies.
AMZN - has remained flat in the last few years probably because of buy backs.
GOOG -should be 6-7% range or higher
AAPL - about 2.5% dilution per year
RIMM - no dilution in last year - most likely because of buy backs.
Berkshire (BRKA/BRKB) on the other hand throws off cash better than most companies in America. Its price to cash flow ratio is less than ten making it a bargain compared to any of these tech stalwarts. Moreover, the stable of businesses that are part of Berkshire are likely to remain solid and kicking long after today's tech titans make way for another round of upstarts in the next decade.
Saturday, July 14, 2007
A case for power
PWER - better known as PowerOne is a California based company that specializes in building AC and DC power conversion systems. The stock has seen a high of about 100 during 2000 and has fallen to about 4 at the current time. The implosion in the market caused by dot.com bust played a big part in this plunge.
The company has not been run properly for the larger part either. The company's acquisitions havent really panned out atleast not yet. This caused a sudden plunge in company's stock price from $5.5 to $3.5. Although the stock has recovered somewhat, the stock hasnt recovered fully yet.
However, there are signs that the company is finally on track to recovery. Several factors should help the company.
1. The power market is on the rebound with imprving semiconductor business.
2. The server farms in the US are expanding, so much so that the total power consumed by server farms outstrip the power consumed by all TVs in US homes. Minimizing such power usage is critical is containing operational expenditure of running large data centers.
The company believes it will be profitable in the final quarter of 2007. If so, it would be first such event in the past several years. Sustained profitability can boost the company stock significantly above the current levels.
Even if the company is not profitable, I estimate the lower end of the price to be about $5 for the company's assets. A lot is riding on current earning announcement and a prediction to return to profitability can turbo charge the stock. Another lackluster announcement can present a significant buying opportunity.
Also on a positive note, insiders have been buying at $3.69 levels though in small quantities.
P.S: Please be sure to check the disclaimer of this blog.
The company has not been run properly for the larger part either. The company's acquisitions havent really panned out atleast not yet. This caused a sudden plunge in company's stock price from $5.5 to $3.5. Although the stock has recovered somewhat, the stock hasnt recovered fully yet.
However, there are signs that the company is finally on track to recovery. Several factors should help the company.
1. The power market is on the rebound with imprving semiconductor business.
2. The server farms in the US are expanding, so much so that the total power consumed by server farms outstrip the power consumed by all TVs in US homes. Minimizing such power usage is critical is containing operational expenditure of running large data centers.
The company believes it will be profitable in the final quarter of 2007. If so, it would be first such event in the past several years. Sustained profitability can boost the company stock significantly above the current levels.
Even if the company is not profitable, I estimate the lower end of the price to be about $5 for the company's assets. A lot is riding on current earning announcement and a prediction to return to profitability can turbo charge the stock. Another lackluster announcement can present a significant buying opportunity.
Also on a positive note, insiders have been buying at $3.69 levels though in small quantities.
P.S: Please be sure to check the disclaimer of this blog.
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