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!

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