This is a summary of this week’s show. Listen in at Value Line Observer – Jan 15 2010
Note: This Blog is for Entertainment Purposes Only and should not be relied on. See all our disclosures at www.thevalueguys.com.
Val’s Three Best Ideas This Week
Hudson City Bancorp (HCBK)
OK, with a policy of full disclosure, we own this stock in the shop. It’s historically been a decently run bank, with a book primarily built around upper end single family homes in New York, Connecticut, and New Jersey, etc. The stock got beat up with the rest of the financials over the past few years as bank capital collapsed and the market had to price in a scenario of a historically high number of bad loans and significantly lower earnings for years to come. At this point, it appears the doomsday scenario was overblown, with write downs to book beginning to flatten out, and reserves reaching levels that may be honing in on the right level. The stock is trading at a discount P/E multiple after years of trading at a premium, which may simply be because competitors earnings have been worse and these banks are typically priced on book. With a $10.50 book value projected for next year, the stock is at a 30%
premium to book after years of trading at greater than 1.5x and occasionally over 2x. And while you’re waiting for that to happen, there is a 4.6% yield.
Endo Pharmaceuticals (ENDP)
I own this one, and it’s pretty hard to argue that i’m swimming with the tide. Pharma in general has been under tremendous pressure since patents are expiring faster than they are being assigned. This means that in about 10 years, all the leading edge drugs that many industry critics feared would drive pharma prices out of reach for average patients will be off patent. Instead of driving patients to financial ruin, it appears that the pharma industry itself is being driven to ruin. If it isn’t price controls, it’s the lack of new inventions in the lab. A pharma company CFO told me that it is a better return on capital these days to hire a lawyer than to hire a scientist. Needless to say, with patent portfolios expiring, investors need to tread carefully in this area. Sure, the Mercks, Pfizers, Lillys of the world are al about 9x earnings and have 5% dividend yields, and that’s hard to pass up when banks are paying even less on money markets. But, when a stock trades at 9 times earnings, that means you need to get paid this years earnings 9 times in order to break even, and that’s before the time value of money. Normally, earnings growth leads to a shorter payback than the P/E, but in the case of the pharma industry, one can’t be too sure.
In the case of ENDO, they appear to have a strong position in the market for pain medication, and while their patent portfolio is also due to expire in a few years, management tells me that the delivery system for the medicine is as proprietary as the drug itself, and is much better protected than the drug. Often in pharma, the delivery system is as valuable as the drug, and in the case of pain medicine that needs to act fast and in a specific location, that’s the case, I’m told. There also is a little hair on this one due to the FDA warning doctors about the potential toxicity of these medications, which came along a few months ago at the same time that excessive Tylenol dosing and the potential risks of that were on the news. Evidently, while the FDA can yell all they want, there really aren’t a lot of alternatives to Percocet and the drug family it stems from, or there will be yelling coming from hospitals and doctors’ offices as well. There are a couple other products that are making there way through the back hallways at ENDO, but it appears that a lifting of the concerns for Percocet and Lidoderm, will help this stock to move closer to a market P/E from the 35% discount it trades at today.
Prudential Financial (PRU)
I’ve talked about this stock before, so if you’re inclined you can go to www.thevalueguys.com/thevalueguys.xml, and pull that file into the most current version of internet explorer. If you enter the ticker symbol off to the right, the relevant shows pop up on the left. I tend to list the tickers in order, so you should be able to find it.
I’m revisiting this one because it still looks like a good value, even if it is off the scary, scary lows of late 2008 and early 2009. At that time, the mark to market rule was playing havoc with the capital of all financial firms, including life insurers. With highly rated bonds on the balance sheet, the company felt confident in the safety of it’s capital, but during the crazy times last year, all mortgage related bonds became suspect as the rating agency ratings lost all credibility. With the disappearance of the liquid markets for these bonds, insurance regulation required a mark down in the value to a level that a CFO could reasonably believe could be sold. This obviously collapsed capital, which is the driver of insurance capacity. As potential bond losses mounted along with the collapse in the ability to write business, Prudential and other insurers were left for dead.
I got conviction in this name because of the enormous asset manager that sits inside the insurance company. While it was lower last year, the assets under management are listed right now as $558 billion, or just over $1000 per share. The company has a wonderful franchise of managing corporate IRA plans, and has won the right to manage post retirement assets at many Fortune 1000 companies. Money is coming in on a weekly basis as employees sweep assets into Prudential plans out of their weekly paychecks. This sort of annuity is hard to turn off.
I don’t know the numbers, so do some homework, but if Prudential is able to generate a 1% fee off these assets somehow, of which half to three quarters is an asset management fee and the rest is an account/IRA processing fee, etc, then the $1000 in assets under management (AUM) per share at a 1% fee would deliver $10 per share in operating profit from that business. With the stock trading at 5x that number currently, that means I get the life insurance business for free, despite having a book value of $52. It’s likely that very little of the asset manager business, which has little need for capital, is accounting for much of the book value. So if the life business is worth book, and the asset manager is worth 3x revenue, then I may have a stock worth somewhere around $80.
Thanks for reading my new blog, which simply summarizes my weekly podcast headquartered at www.thevalueguys.com. While this blog may be a time saver, please do your own work. I’m sleepy and may have (OK, it’s quite likely really) overlooked some obscure but critical element of the story.
Best,
Val Hughes
