Val’s Three  Best Ideas This Week

McGraw Hill (MHP)

Despite being wrong on newspapers for many years, i’m forging ahead with the view that McGraw Hill is an attractive stock at current prices. Largely, the results speak for themselves. Rather than have to bet that things will get better at some point, with MHP you simply have to believe they won’t start to deteriorate. Admittedly, this is for entertainment purposes only, but I think the business and educational markets that MHP serves might be a bit more stable than the fickle public consumer of newspapers and magazines. The company owns the Standard and Poor’s business data and credit ratings business, which while bruised from the financial crisis, appears to have seen its revenue stream stabilize. On the education side, I believe there is a book business, and perhaps more, it’s not entirely clear from the report exactly what’s in the education division. But what is clear is that the company has been earning stable operating margins in the 30%’s for years, and that has translated into a mid-20’s% return on capital. With modest leverage the company earnings a return on equity nearly 40%. As far as valuation, it’s cheap enough to make me want to do more work, at an enterprise value to EBITDA multiple of 7x. I might look at that as a 14% (1/7) cash return on cash price for the business, plus with just a 6% annual growth in value, I’m at a 20% annual return.

Harte-Hanks (HHS)

This one seems pretty simple. The company is a grass roots generator of information used by direct marketers to prospect for new customers. This data is increasingly valuable when many traditional sources for marketing prospects have become less successful than in the past, namely list rental from publication subscriptions combined with driver’s license data. Meanwhile, the recent environment has been one that can easily mask any long term trends going on in advertising or marketing, since almost everyone simply stopped spending any money on anything, period. Since history suggests that business is comfortable spending about 5% of sales on advertising, and since direct marketing is demonstrably a higher return on investment vehicle than mass marketing, my underlying thesis here is that HHS is serving an industry gaining share, and is gaining share within it. I like the fact that the company has been consitently profitable with a mid-teens operating margin at a minimum, and has maintained nearly a 10% return on total capital during one of the weakest advertising periods on record. The valuation of 5x EBITDA seems to reflect the on-going concern that advertising, or specifically, prospecting, is unsustainable, yet I think it is. There’s your stock market!

Value Click (VCLK)

This story is similar to HHS in that you have a specialty provider of services to a niche advertising market, in this case online advertising, and yet big-picture trends combined with the current valuation make this at least a compelling homework assignment for someone. Sure, internet advertising is down, so is everything. The trends to bet on would seem to me to be the notion that internet impressions will continue to gain share of overall impressions, including things like TV, newspapers, magazines, billboards, in-store, etc. That seems like a safe bet. Secondly, the value of internet impressions would seem likely to grow to the level of print and TV medium as those impressions become more apparent as a driver of buying behavior. As they gain share of impressions, that seems likely. The combination should make everyone in the business better off, including the middle man between advertisers or ad firms, and the websites where the ads go. I don’t know what else could be wrong here to make the valuation 5x EBITDA beyond just the concern that the Internet isn’t coming back. It may just be that at an $800 million market cap, it’s simply off the radar.

Val Hughes

2-12-2010

www.thevalueguys.com

In large part because I couldn’t think of my own rant, I took the suggestion of listener JimmyYukka who asked if I was concerned about hyper-inflation, a recent concern expressed by politician Ron Paul.

I’m not sure if I ranted quite enough to call this a rant, versus just an uninformed opinion, but, no, I’m not concerned with the possibility of hyper-inflation for several reasons.

First, the bond market, which seems to have been inflation sensitive since Paul Volcker wrestled inflation to the ground in the 1980’s, is showing no sign of inflation concern. The 10-year treasuries are around a 4% yield, which barely offers much of a current real return, not to mention the next 9 years after that. Sure, that could represent a discount yield for safety, but then even the better corporates are around 6% – again no sign of inflation fears in that number.

Second, if the typical cause of hyper-inflation is runaway money supply growth by way of a run-away printing press, then while I appreciate the concern, the data suggests it’s not quite that bad yet. While there was a spike in both money supply proxies M1 and M2 last year, both settled down in 2009, with M1 year-over-year growth around 6% and M2 growth around 0% most recently. Longer term, that shouldn’t be cause for alarm if the long term nominal GDP growth rate is in the same ballpark.

There have been some unusual shifts in some monetary indicators, and I talk at some length about how little I know about this, and frankly, how little anyone seems to know about it. I encourage listeners or readers to go to the St. Louis Federal Reserve website and download a copy of National Monetary Trends. This has numbers such as the Adjusted Monetary Base, which after decades of flatlining at a few percentage points per year, jumped at a 350% annual rate at one point in 2008 only to then fall at a 100% annual rate in the following quarter. These changes are unprecedented, and I have no idea what they mean. There are several other, equally unusual changes that I also know nothing about. I encourage listeners that do to write me at val@thevalueguys.com. I will share the discussion on a future show.

My summary is that hyper-inflation takes action on all sides that would be unlikely now. A well informed consumer base is unlikely to pay prices growing at hyper-rates when online price shopping is a click-away, or when money market yields are soaking up some former demand for goods, putting downward pressure on demand and prices. But, that said, the long term bond rate, less a few percent of real return, may be the best indicator of inflation expectations that we have.

Val Hughes

2-12-2010

www.thevalueguys.com

Val’s Three  Best Ideas This Week

Carter’s Inc. (CRI)

Carter’s has brand in a retail niche in children’s clothes where it seems like it could matter. With a focus on quality and service, maybe you can build some loyalty with moms who like don’t mind if they can do all their baby shopping in one spot. Improving operating margins to the mid-teens, and a mid-teens return on capital suggest good management. The stock looks undervalued probably due to some accounting issues that may have put a cloud on the valuation multiple, combined with several top level management changes. The accounting issue ended up being a 1.5% of equity deal, or about 7% of last year’s earnings – certainly within most investors projection zone in any case. Still, the combination could keep some potential buyers out while they sort through it. I like the roughly 7x multiple of Enterprise Value to EBITDA, or a roughly 14% operating cash return on the invested enterprise value.

Family Dollar (FDO)

This company along with its long time competitor Dollar General, have been earning above average margins and returns on capital for decades. While one can argue that saturation will put a damper on future sales growth rates, that isn’t necessarily bad for returns when management not only pays a dividend, but consistently buys back stock. I’m not sure I thought of this during the show, but one of the company’s secrets to its consistently high return on invested capital is to use discipline in capital investment projects, while returning excess cash to shareholders. There would be more great companies if this simple principle were more widely followed. The stock has recovered off the lows, but the valuation remains below historical multiples and offers a private buyer a good return at a 7x Enterprise Value to EBITDA multiple, or, like Carter’s above, a roughly 14% cash return on investment.

Children’s Place (PLCE)

Similar to Carter’s, Children’s Place appears to have niche in children’s apparel that may be more grounded on quality and service as perceived by the mom, rather than any fashion element to the end customer. Results were historically more volatile at PLCE, which may suggest a bigger fashion element than at Carter’s or simply be a result of the weak performance of the Disney stores, which PLCE operated until 2008. Recent return on capital and operating margin have both moved to the 12% range since then. The company is recently showing better performance, yet trades at just a 4x Enterprise Value to EBITDA multiple, or a 25% cash on cash return. How can it be 12x earnings, just like Carter’s, yet 4x EBITDA? Not sure, but it very well may have something to do with the shutting down of Disney, and how assets may have been written down. There has also been a change in the CEO office, that could also keep pressure on the valuation. Whatever the case, PLCE is cheap.

Val Hughes

February 5, 2010

www.thevalueguys.com

Wow, I thought. Thank goodness, it’s not a tax increase! My college study of the 1930’s left me with two impressions, and this was as a 21 year old. First, if you find yourself on the bad side of the collapse of an asset bubble (how to avoid it is clearly a different subject) then make sure you don’t cut lending capacity. (Oops, we badly messed up on this one with an accountant led plan to change the mark to market rules for banks and insurance companies that directly affect regulatory capital…ouch!)

Secondly, and particularly if you don’t successfully maintain lending capacity, don’t raise tax rates.

Now, on this one, we still have a chance to stop it. It does not matter if we call it an expiration of an unfair tax cut for the rich, or have the guts to call it a tax increase, either way, it’s bad, very bad.  On top of a 20-40% decline in asset values, the people who are supposed to hire and invest our way out of this are also facing an increase in the capital gains tax rate from 15% to 20% and an income tax rate increase from 35% to 40%, while simultaneously having deductions phase out and Medicare contributions go up. After something that sounded almost as bad in the early 1930’s, the economy and the stock market tanked for five years.  Yeah, that’s right — that’s why it’s a rant.

I may have actually said some of this on the show, but now i’m not sure.

Listen in at Value Line Observer – Feb 5 2010

Val Hughes

Val’s Three  Best Ideas This Week

Sara Lee (SLE)

This stock is off the low’s, like everything else, but I”m attracted to the competitive advantages that brand can bring in a slow growth, non-tech, consumer business.  With advertising driving share  and size, the company can build economies of scale in manufacturing and distribution, creating barriers to competitors earning a competitive ROI under SLE pricing.  Recent results have been poor, masked in part by divestitures of non-core businesses, but certainly hurt by the consumer recession.  At 6x EBITDA, i’m a buyer.

Phillip Morris International (PM)

This is the international arm of the old Philip Morris, with marketing rights to the brands Marboro, Philip Morris, Chesterfield, Parliament, etc, to all non-U.S. markets.  OK, I’m not too sure about Canada.  The big advantages are that the company is no longer under the jurisdiction of U.S. laws, meaning no U.S. lawsuits, and the right to advertise.  Doing the math, that would seem to translate into higher growth and higher margins.  The valuation is pretty good, for a moat as wide as this one, at 9x EBITDA, with this stable of brands driving upper teens operating margins and mid 20’s% return on capital.  That’s an 11% cash on cash return, so with growth of even 5%, I’ve got a pretty good total return.

Avid Technology (AVID)

This company’s been under pressure, but I’m attracted to the rare valuation of a price per share below the revenue per share.  On the surface this perhaps looks appropriate, given the revenue declines and recent losses.  But with just a little study, you find that the core digital video products are the core production tools for all the top movies in the world, with the founder of the company having invented digital video production software.  The learning curve on this type of software combined with the large market share create enormous customer barriers to change.   That gives me confidence that the recent slowdown is simply movie production companies holding back on upgrades until they learn if anyone will ever attend another movie rather than competitor share gains.   There is also good data on consumer leisure trends, and they have tended to grow faster than GDP or consumer wealth, as incremental wealth goes to leisure.  Video is also in an uptrend, with more content available more places likely to drive record revenue, providing pricing power to the utilities that drive the process.

The valuation is interesting, because once you study the financials, you see that while there are reported losses, if I add back non-cash depreciation of $30 million, and I add back discretionary Research and Development Expense of $130 million, I generated decent cash flow per share, i think on the order of 50c per share ( I don’t have a calculator handy).  Why would I add back R&D you may ask?  Certainly it’s a cash expense.  True, but I might look at R&D as an investment that will lead to future earnings.  In that sense, R&D is a positive contributor to the value of the company, not a negative.  If I subtract it as an expense, I am most certainly detracting from the company’s value, not adding as I might believe is more appropriate.  While R&D often should be expensed, since there is no guarantee that it will in fact ever pay off, in this case, with the market share and pricing power, I believe they will get their money back and then some on all their R&D.  I’m a buyer.

Val Hughes

The Value Guys!

www.thevalueguys.com

Why shouldn’t we treat government the same way.  Let’s first set the amount to spend before we talk about what to buy.   Doesn’t this make some kind of sense?  Set the allowance FIRST.  Then talk about what to spend it on.  We should do this by voting on the tax rate.  This tax rate would apply to everyone.  A regressive tax code puts incentives on our most productive workers to work LESS.  This is crazy.  Our most successful business reward sales people with an increasing commission as they hit higher production levels, NOT LESS!!   Why is our government taking wealth building incentive ideas from the worst performing organizations instead of the best!!  But I digress, a regressive tax is counter productive to the goal of building wealth for all.  If we vote on the tax rate, we will set the allowance the government can spend.  This tax rate should apply to all ages, all races, all incomes, all wealth.  It should take the equal opportunity provided to us as U.S. Citizens, and tax the fruits of the equal opportunity equally.

We should VOTE THE TAX RATE.

Val Hughes

www.thevalueguys.com

1-29-2010

This is a summary of this week’s show.  Listen in at  Value Line Observer – January 22 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:

Chemed Corp (CHE)

I rambled on a little bit about this one on the show, so you are definitely saving time by reading this. I’m attracted to the valuation at 14x earnings and 7x EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). But it’s not just that. The company has two businesses: Roto-Rooter, which is, according to Value Line, the largest plumbing company in the U.S, and VITAS Healthcare, a hospice business. What I like about this is that as among the largest competitors in stable commodity markets, these companies should be able to keep their competitive edge by simply maintaining it’s share of mind with consumers. They will have economies of scale in advertising because of size, will be in a position to do accretive acquisitions with private competitors, and are unlikely to be out flanked by new technology or a new entrant. So, at 7x EBITDA, you have a 14% (1/7) earnings yield plus growth, which Value Line estimates at 9%, but I only need 5% to make it a buy in my book.

Valmont Industries (VMI)

I’ve watched this company for over 25 years, and i’m actually surprised it hasn’t been bought out. It’s a leading provider in the agriculture irrigation business, and it has leveraged that manufacturing skill into a pole business for the electric grid, cell phone tower business, lighting and traffic, and maybe even the plain old telephone pole business, although i’m not sure about that last one. I’m attracted initially to the low valuation, at 8x EBITDA and a 20% discount to the market P/E, it deserves a second look. They have been improving return on capital for several years, which means something incremental is going on that’s generating outstanding marginal returns on capital. The return on equity has moved over 20%,

and while the stock is off the lows, it seems cheap for a best of class provider in a core world market, with clear advantages in several growth markets. The balance sheet is in great shape, and insider ownership is meaningful. Not a great dividend yield, but at least lately, management has had a good use for the money.

Hillenbrand (HI)

This is the casket business, which was formed as spin out from the old Hillenbrand, which also owned a hospital bed business, Hill Rom. For some reason, Value Line doesn’t even rate this, maybe because it’s less than 2 years old, although the former Hillenbrand was a public company for many years. What I’m attracted to is, like the Chemed story, a stable, low risk, business, that offers an earnings yield significantly above bonds of like risk. Hillenbrand trades at an enterprise value of $1.2 billion, the price we’d have to pay to own all the stock and debt, less the cash. We can look at the ebitda divided by the enterprise value as a yield I often refer to as cash on cash yield – the cash we get divided by the cash we pay – and we can reasonably compare this to a bond yield of like risk as a benchmark for relative valuation. In the case of Hillenbrand, with $200 million in ebitda, I have a 16.6% cash on cash yield plus, admittedly, tiny growth. Not only is the death rate even lower than population growth, but you have cremations taking share from caskets, so it’s not great. But with a 16.6% cash on cash yield, I don’t need a lot of growth to be attractive, and this seems pretty low risk. With a strong brand and economies of scale in manufacturing and distribution – not to mention their state of the art training center for funeral home directors – in an industry that is pretty much unchanged for a thousand years, unseating their leadership position would be a daunting task.

This week’s rant (Value Line Observer – Jan 22 2010) is a salute to Massachusetts for restoring faith in democracy as an agent to protect the people against the encroachment of government economic power. The same strong convictions that allowed Massachusetts to take on the economic encroachment of a king were on display as the people voted down the encroachment of government management of an additional 15% of the U.S. economy.

I’m not sure I put it exactly this way on the show – I completely ignored my notes – but we get worked up about this because as a capitalist, we like a system that maximizes wealth through the efficient allocation of capital. We like free markets and level playing fields. We like a system where customers vote by buying the best products and services at the best prices, and those that best provide it win the right to stay in business and may make a few bucks as a societal reward, attracting more talent to the invention profession to boot. It’s a system where failure is quickly identified by it’s lack of customers, and those very resources are recycled into productive systems. The honing of this process has brought us to the edge of the envelope on the efficient use of resources, particularly in those industries where customers are allowed to shop for best service and/or best price.

So, the takeover of nearly 20% of the economy by a management team that is unproven and non-profit seeking means that nearly 20% of the economy will earn a return on capital that is below the level that would be earned by business professionals who understood how to maximize the return on that capital. The gap is a very real societal cost even before we examine the likely changes in quality of service. As we compound the lower return on capital for 20 or 30 years, the age at which your young children will be seeking to own the comforts of a civilized life, the wealth per capita available to society will be vastly below what it would otherwise have been. If 20% of the growth in the U.S. capital base earns a 0% return instead of 4%, that shaves 0.8% off of GDP growth. Compounded for 20 years a 2.2% growth rate instead of a 3.0% growth rate leaves per capita GDP 33% lower. That means smaller homes, fewer vacations, less energy use, ironically less medical care, etc.

Val Hughes

www.thevalueguys.com

]]> http://valuelineobserver.thevalueguys.com/2010/01/23/weekly-rant-massachusetts-again-stops-an-encroaching-government/feed/ 0 http://valuelineobserver.thevalueguys.com/2010/01/18/value-line-observer-jan-15-2010-hcbk-pru-endp/ http://valuelineobserver.thevalueguys.com/2010/01/18/value-line-observer-jan-15-2010-hcbk-pru-endp/#comments Tue, 19 Jan 2010 03:16:05 +0000 Administrator http://valuelineobserver.thevalueguys.com/?p=20 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

A tax on banks?! Come on! They are already paying tax, it’s called income tax!  Once the tax rate is over 50%, isn’t that an incentive to make — wait — less money?  Wasn’t the government just a year ago begging banks to take TARP financing with the argument that shoring up bank capital was they key to saving the planet? But with an odd approach to reward and punishment, the same healthy banks that have been encouraged by the government to lend more aggressively as capital ratios improved, are now going to have those capital ratios eroded – by the same government. Do these different departments actually talk to one another?

How are the banks responsible? Because they sold their loans to Fannie and Freddie as they were encouraged to do – by the same government? Had Fannie and Freddie not bought the loans, the banks would have made fewer loans, which on average would have had better credit, and fewer homes would have been sold at inflated prices. Excuse me if i’m repeating myself, this is outrageous.

Val Hughes

www.thevalueguys.com

Jan 15 2010