Microsoft has finally begun to get some credit for the number of successful business lines it has.
Not only does it have the annuity-like Windows and Office products, it has claimed #1 in gaming, and has reached a near perfect margin on online search. This last bit is one of the areas the company has invested in massively, only to continuously lose money. However, with increasing share of a growing business, MSFT may finally be able to break even on an operating basis sometime in 2013 - there is light at the end of the tunnel.
The biggest value factors, however, are the options on Windows 8 and the new Windows Phone platforms.
My own view is that the stock is worth about $34 per share, excluding the value of the Windows Phone option, and if everything works well, the stock could fetch $40. There is ample room to raise the dividend and buybacks are good for investors at anything up to $30, because of the low valuation.
The big concern one has to have is the massive resistance in the chart from here. Since 2000, the best strategy in MSFT was to sell whenever the stock hit $30. It did make a brief run to $35 in 2008, and might make it there again, but further priec appreciate will be difficult to capture.
Thursday, February 09, 2012
Buffett article in Fortune
Warren Buffett, picking up on themes he has discussed many times before has a remarkably clear argument for the long term power of investing in real assets.
While I think his argument is persuasive, I have written a short reply questioning one of his core assumptions: that popular governments will always pursue inflationary policies. I am not so sanguine. Popular governments have often found deflation fighting more difficult than one would assume, and it is not clear whether an aging population, such as in Japan, is not a significant and contributory factor to deflationary policies.
You can read the article here.
My response:
As always, Buffett has a clarity which is refreshing and insightful.
The core assumption that Buffett makes that he does not explicitly clarify (though he hints at it) is he believe that ultimately, governments will always prefer inflation, and therefore over any extended period, he rules out the possiblity of deflation, which is the one scenario in which nominal assets could outperform real assets, even under conditions of low rates.
That he does not consider this possibility is a real weakness in his argument, as several societies have indeed experienced prolonged bouts of inflation, including the US between about 1870 and 1892 and again between 1928 and 1940. These were admittedly periods of extreme economic turmoil, as overleveraged households and firms folded, and bank failures encouraged credit and monetary contraction.
More recently, Japan is undergoing the same experience, even as the rest of the world has boomed. What would be interesting, from my perspective, is Buffett's view on the affect of aging on asset prices and a tendency toward deflationary policies. After all, old folks tend to have assets (and usually want nominal assets with steady, predictable cash flows, not lumpy albeit fast growing ones) - so their stronger voting power can encourage politicians to support policies favorable to creditors. Moreover, consumption declines with age, which may lead to an environment of falling prices and lower economic activity generally.
Since most people in the world now live in countries that are either at or below the replacement rate, most countries are expericing significant aging. Is it not possible as we look out over the 21st century that growth itself may grind to a near halt? In which case, might nominal assets outperform after all?
While I think his argument is persuasive, I have written a short reply questioning one of his core assumptions: that popular governments will always pursue inflationary policies. I am not so sanguine. Popular governments have often found deflation fighting more difficult than one would assume, and it is not clear whether an aging population, such as in Japan, is not a significant and contributory factor to deflationary policies.
You can read the article here.
My response:
As always, Buffett has a clarity which is refreshing and insightful.
The core assumption that Buffett makes that he does not explicitly clarify (though he hints at it) is he believe that ultimately, governments will always prefer inflation, and therefore over any extended period, he rules out the possiblity of deflation, which is the one scenario in which nominal assets could outperform real assets, even under conditions of low rates.
That he does not consider this possibility is a real weakness in his argument, as several societies have indeed experienced prolonged bouts of inflation, including the US between about 1870 and 1892 and again between 1928 and 1940. These were admittedly periods of extreme economic turmoil, as overleveraged households and firms folded, and bank failures encouraged credit and monetary contraction.
More recently, Japan is undergoing the same experience, even as the rest of the world has boomed. What would be interesting, from my perspective, is Buffett's view on the affect of aging on asset prices and a tendency toward deflationary policies. After all, old folks tend to have assets (and usually want nominal assets with steady, predictable cash flows, not lumpy albeit fast growing ones) - so their stronger voting power can encourage politicians to support policies favorable to creditors. Moreover, consumption declines with age, which may lead to an environment of falling prices and lower economic activity generally.
Since most people in the world now live in countries that are either at or below the replacement rate, most countries are expericing significant aging. Is it not possible as we look out over the 21st century that growth itself may grind to a near halt? In which case, might nominal assets outperform after all?
Earnings: Cisco, Diamond Foods, Groupon
Well, CSCO had a positive surprise today, in which we saw higher sales of networking equipment leading to faster revenue growth for the quarter. Happily for CSCO common stockholders, or at least Ralph Nader, the company has also decided to increase its quaterly dividend by 33% from 6 cents to 8 cents. Because of strong bottom line growth, this actually represents a decline in the payout ratio from 22% to 20%, indicating plenty of room for further dividend increases, as Ralph Nader has encouraged. Nader, self-reported holder of 18,000 CSCO shares, will take home an extra $360 a quarter.
In the short-term at least, the rally in the price and the improvement in the company's performance suggest that investors think CEO John Chambers is doing the right things. If these results continue, they will be right. I still have deep reservations about his leadership, and so even though the stock is cheap (although much less to than in the August selloff) I continue to stay away. My own tech sector bets - MSFT and INTC - have performed admirably and both still have upside.
Diamond Foods, maker of those yummy Diamond nuts, and also owner of Kettle Chips and Pop Secret popcorn had terrible news. The common is down over 40% in after hours trading, due to the announcement that the CEO and CFO have been placed on administrative leave, and that earnings will have to be restated after an ongoing internal investigation indicated that several payments to suppliers had been missated. This looked like a bit of an overreaction to me, since core products are customer favorites and the company is making money, but it turns out there is a good reason for the decline.
The company is involved in a "purchase" agreement with P&G to acquire the Pringles potato chip business. This sounds incredible - since it is hard to see why P&G would part with such an asset. Incredible that is, until you realize that in buying this busienss, they are issuing P&G (together with any other Pringles shareholders) some 26mn shares, which provides P&G a majority stake in return for Pringles. This is not exactly what I would call a sale, since, ultimately, P&G will retain a majority stake in its signature snack brand and acquire a majority stake in several other brands. As the majority owner, P&G will be in a position to set dividend policy and also be in a good position to tender for the remaining shares of Diamond Foods sometime in the future. This is really a sale of Diamond Foods to P&G, albeit an installment sale, in return for minority pariticipation in the earnings streams of Pringles for some period.
And that makes this misstatement incredibly significant - because it may be the case that the misstatement was intended to improve margins at DMND while the value of the company was being determined for the sale. The number of shares received by P&G is dependent on the share price, the higher it is, the lower P&G's post-transaction stake. Now, even if the transaction goes through, Procter is likely to get an even larger stake, possibly more than 60%, and current shareholders stake in both the existing business, and any future flows from Pringles will be commenurately lower. If the deal were to fall through, DMND would probably be worth $26-30 purely based on the existing business, provided there aren't additional misstatements that have to be taken.
Finally, Groupon seems to be conducting a firesale of its own stuff. The company's business model is based heavily on spending lavishly on marketing and sales, so much so that SG&A exceeds gross margins. This can go on for awhile, and in fairness to Groupon, revenue was up something like 194% over the prior year quarter, so the money spent is having an impact. But management is going to have to show that that it can continue to grow while maintaing cost controls.
The interesting question is what happens with LinkedIn, which reports on Friday, as both are indicators of the potential growth of social media: which all points to the prospects of Facebook achieving what, in my mind, is a ludicrous $100bn valuation, even if Steven Altucher disagrees.
In the short-term at least, the rally in the price and the improvement in the company's performance suggest that investors think CEO John Chambers is doing the right things. If these results continue, they will be right. I still have deep reservations about his leadership, and so even though the stock is cheap (although much less to than in the August selloff) I continue to stay away. My own tech sector bets - MSFT and INTC - have performed admirably and both still have upside.
Diamond Foods, maker of those yummy Diamond nuts, and also owner of Kettle Chips and Pop Secret popcorn had terrible news. The common is down over 40% in after hours trading, due to the announcement that the CEO and CFO have been placed on administrative leave, and that earnings will have to be restated after an ongoing internal investigation indicated that several payments to suppliers had been missated. This looked like a bit of an overreaction to me, since core products are customer favorites and the company is making money, but it turns out there is a good reason for the decline.
The company is involved in a "purchase" agreement with P&G to acquire the Pringles potato chip business. This sounds incredible - since it is hard to see why P&G would part with such an asset. Incredible that is, until you realize that in buying this busienss, they are issuing P&G (together with any other Pringles shareholders) some 26mn shares, which provides P&G a majority stake in return for Pringles. This is not exactly what I would call a sale, since, ultimately, P&G will retain a majority stake in its signature snack brand and acquire a majority stake in several other brands. As the majority owner, P&G will be in a position to set dividend policy and also be in a good position to tender for the remaining shares of Diamond Foods sometime in the future. This is really a sale of Diamond Foods to P&G, albeit an installment sale, in return for minority pariticipation in the earnings streams of Pringles for some period.
And that makes this misstatement incredibly significant - because it may be the case that the misstatement was intended to improve margins at DMND while the value of the company was being determined for the sale. The number of shares received by P&G is dependent on the share price, the higher it is, the lower P&G's post-transaction stake. Now, even if the transaction goes through, Procter is likely to get an even larger stake, possibly more than 60%, and current shareholders stake in both the existing business, and any future flows from Pringles will be commenurately lower. If the deal were to fall through, DMND would probably be worth $26-30 purely based on the existing business, provided there aren't additional misstatements that have to be taken.
Finally, Groupon seems to be conducting a firesale of its own stuff. The company's business model is based heavily on spending lavishly on marketing and sales, so much so that SG&A exceeds gross margins. This can go on for awhile, and in fairness to Groupon, revenue was up something like 194% over the prior year quarter, so the money spent is having an impact. But management is going to have to show that that it can continue to grow while maintaing cost controls.
The interesting question is what happens with LinkedIn, which reports on Friday, as both are indicators of the potential growth of social media: which all points to the prospects of Facebook achieving what, in my mind, is a ludicrous $100bn valuation, even if Steven Altucher disagrees.
Tuesday, February 07, 2012
Good Commentary on Bill Gross' FT Article
Foriegn Policy has a discussion about Bill Gross's article in the FT that discusses what is happening with the ZIRP and how it can trap people in cash.
The comments are more insightful than the blog post, actually, and I think this goes a long way to understanding the Japanese malaise, which I have always believed was caused by low interest rates. In theory, lower interest rates should favorably improve the risk/reward ratio of risk assets and always encourage additional borrowing. However, at some point, low, low interest rates can actually CREATE risk, because the price of credit becomes so unattractive that the risk/reward ratio actually skews in favor of holding cash, even though it earns nothing.
This is the flaw in the "Greenspan put". It works, so long as there is room to reduce interest rates and steepen the yield curve sufficiently to enable financial intermediaries (banks) to borrow short and lend long. But when short term rates hit the lower bound of zero, further reduction in long term rates (as in Japan) flattens the yield curve, reducing the value of the carry trade (and discouraging further purchase of long bonds). Moreover, with interest rates very low, the probability of both price, inflation and interest rate risk increases significantly. Few people want to lend large sums of money over an extended period to a deeply indebted government, running massive deficits for as far as the eye can see. The probability of inflation producing negative real returns is too great. Speculators and traders might be willing to buy bonds if they believe that there is room for significant price appreciation (yet lower rates), but again, the risk/reward profile of low rates is that there is limited upside (as the curve flattens, fewer buyers will materialize for the reasons mentioned above) while the the downside risk (higher rates due to inflation or default concerns) is massive.
In short, investors are truly concerned about ensuring that they can get their capital back - and bonds do not look like a relatively safe place to preserve one's capital, let alone a place to earn a modest return in the form of coupons.
Having made bonds unattractive, however, has not made equities or risk assets attractive, really, as they are also subject to significant risks. Instead, people park their money in demand accounts earning nothing, and low rates actually reduce incomes, resulting in lower spending, resulting in lower final demand, resulting in less economic activity, which increases investors risk aversion and the availability of attractive risk assets.
If you couple that with massive missmatches between generations in terms of assets - with older generations, benefitting from massive expropriation in the form of transfers to themselves from younger, more risk-seeking savers - you receive a double whammy in which retirees and near retirees hold all the financial assets and are petrified of capital loss.
Pretty soon, you wind up with decades of slow growth.
All of which suggests deflation in our future, in which case, the smart money is on nominal assets. In other words, buy Treasuries. I am not sold, as I believe most governments are out to increase inflation and if they really want to, they can succeed, but I would be cautious about companies that rely too much on debt financing.
The comments are more insightful than the blog post, actually, and I think this goes a long way to understanding the Japanese malaise, which I have always believed was caused by low interest rates. In theory, lower interest rates should favorably improve the risk/reward ratio of risk assets and always encourage additional borrowing. However, at some point, low, low interest rates can actually CREATE risk, because the price of credit becomes so unattractive that the risk/reward ratio actually skews in favor of holding cash, even though it earns nothing.
This is the flaw in the "Greenspan put". It works, so long as there is room to reduce interest rates and steepen the yield curve sufficiently to enable financial intermediaries (banks) to borrow short and lend long. But when short term rates hit the lower bound of zero, further reduction in long term rates (as in Japan) flattens the yield curve, reducing the value of the carry trade (and discouraging further purchase of long bonds). Moreover, with interest rates very low, the probability of both price, inflation and interest rate risk increases significantly. Few people want to lend large sums of money over an extended period to a deeply indebted government, running massive deficits for as far as the eye can see. The probability of inflation producing negative real returns is too great. Speculators and traders might be willing to buy bonds if they believe that there is room for significant price appreciation (yet lower rates), but again, the risk/reward profile of low rates is that there is limited upside (as the curve flattens, fewer buyers will materialize for the reasons mentioned above) while the the downside risk (higher rates due to inflation or default concerns) is massive.
In short, investors are truly concerned about ensuring that they can get their capital back - and bonds do not look like a relatively safe place to preserve one's capital, let alone a place to earn a modest return in the form of coupons.
Having made bonds unattractive, however, has not made equities or risk assets attractive, really, as they are also subject to significant risks. Instead, people park their money in demand accounts earning nothing, and low rates actually reduce incomes, resulting in lower spending, resulting in lower final demand, resulting in less economic activity, which increases investors risk aversion and the availability of attractive risk assets.
If you couple that with massive missmatches between generations in terms of assets - with older generations, benefitting from massive expropriation in the form of transfers to themselves from younger, more risk-seeking savers - you receive a double whammy in which retirees and near retirees hold all the financial assets and are petrified of capital loss.
Pretty soon, you wind up with decades of slow growth.
All of which suggests deflation in our future, in which case, the smart money is on nominal assets. In other words, buy Treasuries. I am not sold, as I believe most governments are out to increase inflation and if they really want to, they can succeed, but I would be cautious about companies that rely too much on debt financing.
Tuesday, January 31, 2012
CSCO: Ralph Nader and I agree
Hard for me as it is to believe, Ralph Nader, "Consumer Advocate" sometime presidential candidate and general left-loony gadfly and I agree about Cisco Systems (CSCO): John Chambers is bad for shareholders.
In an editorial for Reuters, Nader - apparently a CSCO shareholder with 18,000 shares - complains of the poor use of company cash, which has primarily gone to counteract dilution from the excessive equity compensation the CSCO management team, led by Chambers, has handed itself over the years.
Nader is arguing that with massive cash balances and $3bn a quarter in operating cashflow, the dividend at 6 cents is really insulting and represents hostility towards shareholders.
I myself have written an article detailing my own view that CSCO as a business is cheap, worth probably $30 a share, or even a bit more, but that the business carries a risk that merits the discount - "John Chambers risk" which is the risk that all of the shareholders money will be used for management compensation
While I agree with Nader that management could and should take some near term steps to enhance shareholder value, the fact is, as long as Chambers is there, the stock will price the risk of his management into the stock price
In an editorial for Reuters, Nader - apparently a CSCO shareholder with 18,000 shares - complains of the poor use of company cash, which has primarily gone to counteract dilution from the excessive equity compensation the CSCO management team, led by Chambers, has handed itself over the years.
Nader is arguing that with massive cash balances and $3bn a quarter in operating cashflow, the dividend at 6 cents is really insulting and represents hostility towards shareholders.
I myself have written an article detailing my own view that CSCO as a business is cheap, worth probably $30 a share, or even a bit more, but that the business carries a risk that merits the discount - "John Chambers risk" which is the risk that all of the shareholders money will be used for management compensation
While I agree with Nader that management could and should take some near term steps to enhance shareholder value, the fact is, as long as Chambers is there, the stock will price the risk of his management into the stock price
Monday, January 23, 2012
2012 Theme: Inflation vs. Deflation
In the embedded video, "Bond King" Bill Gross discusses the outlook for inflation and deflation and shows why getting the right answer to this question is a major factor for investors: asset classes perform quite differently under "reflation" (increasing inflation), disinflation (lowering inflation) and deflation.
Mind you, most financial assets, both nominal and real, perform best under periods of falling inflation, the "30 fat years" described by Gross. Under reflation, both nominal and real assets perform badly, but real assets perform much less badly, as they can "keep up" with rising prices, albeit slowly. Finally, nominal assets do well in deflation and real assets do very poorly in deflation. The problem for nominal assets (e.g. bonds) is default, which rises sharply and can lead to a permanent impairment of capital.
The real question is: which are we likely to have. While Gross doesn't say - he makes it clear that the jury is still out - he does help to deconstruct the problem and lay out some of hte markers.
Mind you, most financial assets, both nominal and real, perform best under periods of falling inflation, the "30 fat years" described by Gross. Under reflation, both nominal and real assets perform badly, but real assets perform much less badly, as they can "keep up" with rising prices, albeit slowly. Finally, nominal assets do well in deflation and real assets do very poorly in deflation. The problem for nominal assets (e.g. bonds) is default, which rises sharply and can lead to a permanent impairment of capital.
The real question is: which are we likely to have. While Gross doesn't say - he makes it clear that the jury is still out - he does help to deconstruct the problem and lay out some of hte markers.
Thinking about M&A Strategy
The McKinsey Global Institute has just published a study that looks at different M&A patterns or strategies that large (non-bank) firms employ to grow the business. The blow matrix shows how McKinsey thinks about what firms are actually doing. Not all strategies are created equal, and McKinsey is quick to note that different industry segments have tended to different strategies.
It is perhaps not a big surprise that the largest companies are the most likely to use acquisitions to grow, as organic growth in mature markets (which large firms dominate) have difficulty growing at faster than the rate of inflation.
Smaller companies are relatively more likely to focus on organic growth or on "selective" deal making, where usually few deals are done, which deals may be transformative (target represents a significant share of acquirerr market cap). McKinsey has found that companies that employ a programmatic approach to acquisitions do best. This may be due to the expertise gained in evaluating and integrating such deals, or it may reflect good discipline in purchaing without overpaaying.
HELE is a bit too small to qualify here, but it too could be said to be selective or perhaps "programmatic". It has looked diligently for additional reveneu and has only really been able to generate organic growth with the OXO brand (thought OXO itself was one of a series acquisitions.
It is perhaps not a big surprise that the largest companies are the most likely to use acquisitions to grow, as organic growth in mature markets (which large firms dominate) have difficulty growing at faster than the rate of inflation.
Smaller companies are relatively more likely to focus on organic growth or on "selective" deal making, where usually few deals are done, which deals may be transformative (target represents a significant share of acquirerr market cap). McKinsey has found that companies that employ a programmatic approach to acquisitions do best. This may be due to the expertise gained in evaluating and integrating such deals, or it may reflect good discipline in purchaing without overpaaying.
HELE is a bit too small to qualify here, but it too could be said to be selective or perhaps "programmatic". It has looked diligently for additional reveneu and has only really been able to generate organic growth with the OXO brand (thought OXO itself was one of a series acquisitions.
Sunday, January 22, 2012
Helen of Troy (HELE) successfully integrating Kaz
In TSI’s most recent post about HELE, we noted that the big
question mark for the company was the effectiveness of the Kaz, Inc.
integration. This was a big
transformative deal, on par with the OXO acquisition, as Kaz would account for
about 40% of the revenue of the combined company. Based on the most recent earnings release,
HELE has done a magnificent job of turning that business into a success, and if
the stated goals of increasing gross margins to reflect those of the historic
HELE are achieved, the acquisition will be a dirt cheap out-of-the-park home
run.
Until this latest earnings release, it was hard to get a
flavor for the success of management in reducing costs and improving operating
performance in the Kaz business.
Clearly, the company was having some success. The pro-forma for Kaz, (which was privately
held) had a full year operating profit of about $4m, or a measly 1% of
sales. Some of this may have been a
function of Kaz’s prior status as a private company, in which several benefits
for senior manager/owners may have been borne by the company, it is hard to
tell from the financials.
HELE demonstrated already in the first quarter that they
intended to improve operating performance.
The Kaz business (which is conveniently listed as separate own segment)
had no reported operating income – HOWEVER – that was after a $1.5m allocation of
operating expense from traditional HELE segments. On a stand-alone basis, Kaz had earned $1.5m
in the first quarter. Ignoring seasonal
effects, this implied a $6m operating profit, or a 50% improvement. This level of enhanced earnings would be just
enough to pay the interest on the additional financing, but not to also count
for the equity, but was encouraging enough that the market bid up the stock to
all-time highs (at which point, management decided to unload its options, and
the stock tanked).
The second quarter earnings report brought additional good
news on the Kaz front. Thru the second
quarter, Kaz managed to earn $7m operating, again, after a $3m allocation of
overhead from traditional HELE. Thus,
after two quarters, HELE management had succeeded in increasing operating earnings
by 2.5 times – with two quarters to go.
Better yet, management indicated that operating profit at Kaz was highly
seasonal, that the first two quarters were not representative and that the
third and fourth quarters would produce far more operating income than the
first two quarters. They delivered.
Kaz earned $13.5m operating in Q3, again, before $1.5m in
reallocated expense – or $15m as a stand-alone entity. The 9 months figures are $20m and $26m, 5 and
6.5 times full year operating as a private company. While I expect the fourth quarter to be
somewhat weaker than the third, an additional $7-$10m operating is not out of
the question, for full year operating of $27-$30m ($33-$36m before allocation
of $6m in corporate overhead). This is a stunning improvement. In 14 months of ownership, management will
have increased operating income of the Kaz business by a factor of somewhere
between 8 and 10! With $194m price tag,
the company will be earning (pre-allocation) something on the scale of 18% on
investment, against a WACC of 12-15%.
Note that much of the purchase was financed with debt issuance of $100m,
at 3.9%, and expansion of the company’s credit line. Cash on hand was also used, and as the credit
line has been paid down, a greater portion of the financing is now coming from
equity, but this is certainly a terrific start.
Were management able to increase margins even five or six percentage
points, they could add another $20m in gross, which should, all else equal,
flow directly to operating profit.
(Management has stated repeatedly its intent to lift Kaz margins from
the mid thirties to the traditional HELE margins of the mid forties, but this
seems unlikely, and in any event a long term goal at best. Were they successful, there would be yet
another $20m in operating, even before any volume growth from market growth or
new product introduction).
Either of these events would increase operating earnings per
share by 60 cents. Kaz, as a US entity,
has a higher tax rate than traditional HELE, which is a Bermuda company, but based
on my expectation of Operating profit for FY2012, NOPAT should be a healthy
$20-$22m or about 60 cents above FY2011.
Figures for the fourth quarter in the Kaz segment will be
distorted by the acquisition of PUR Water.
This will raise gross margins, as the business had high gross, but
operating is less clear at this stage. Advertising
revenues around PUR will increase SG&A.
However, management has identified several opportunities to grow the
business, and given the incredible cost control HELE has been able to exercise,
this looks like another good opportunity to reinvest the company’s growing cash
flows in high return activities. Indeed,
operating earnings are now rising so rapidly that the company can now purchase
a $100m business every year simply from internally generated funds.
PRICE TARGETS
Analysts have begun to argue that the stock could be worth
as much as $50 per share, as EPS will likely top $4 in FY2013. This is based on continued strong performance
from Kaz, continued high single digit growth in the OXO brand and modest growth
in sales of the personal care segment. I
think a price of $45 is quite reasonable, as I believe HELE is entitled to a
11x multiple. This is low for a consumer
staples company, in part because there are several risks.
RISKS
The first risk is that management is becoming overly focused
on growth through acquisition and takes its eye off the traditional HELE
business segments. This would be a
problem because the traditional business is both strong and profitable, and at
60% of revenue, and an even greater share of operating profit, these segments
are crucial to the performance of the company.
Thus far in FY2012 they have disappointed some, as revenue has grown but
only as a result of heavy promotional activity.
This could mean that management has been somewhat distracted and is not
executing as sharply, and is thus relying more heavily on promotion to move
product.
The second major risk is that management makes a poor
acquisition, either by purchasing a product or business unit whose competitive
position is too weak, or by simply overpaying.
Fortunately, HELE tends to acquire mature products, within establish
markets and along with a license for or outright ownership of brand names. Often these have been built by major firms
(e.g. P&G) but are either too mature or too small to get the attention they
need. HELE then focuses relentlessly on
cost and on using the HELE sales force to increment sales. Still, the company’s record is not without
some black eyes. Some years back they purchased
an infomercial business (with a goal of promoting HELE product, I think) and
were forced to close down the business within two fiscal years. More recently, the company massively overpaid
for its acquisition of Belson, and had to take a huge impairment on Goodwill
and intangible assets. TSI hopes that
the increased earnings and cash flow of the business enable the company to look
at a greater range of deals and to be able to be even more successful buying “gems”. (Of course, as a company grows, scale can
also reduce the range of opportunities one can look at, by making many deals “too
small” to have material impact on earnings, but HELE is probably a few years
away from this point).
Third, one has to be concerned about input costs. As a products maker, HELE is subject to
significant commodity cost exposure.
Moreover, many of HELE products are made in China, where labor costs are
experiencing significant inflation. This
matters, because with a managed-fixed exchange rate, labor costs in USD, GBP
and EUR are rising, which could constrain margins. Furthermore, over time, the yuan is rising
against other currencies, compounding the effect. There are ways of combating this, including
increasing scale as the business grows, and moving production to yet lower cost
markets, or even sourcing in the local market.
Again, as the business grows, it has more options.
The fourth major risk is heavy dilution. In FY2012, HELE revised the compensation for
executives, and expanded the number of options available by 3 million, to about
10% of shares outstanding. Not all
available options need be distributed, of course, but TSI assumes that
substantially all will be. The question
is, over what time period – if this is done over 10 years, such that management
only receives about 1% of outstanding equity each year, things will be
fine. If it is more aggressive, current
shareholders should assume dilution and slower growth in EPS.
OUTLOOK
Even with these risks, TSI expects that HELE will continue
to grow revenue and profit at strong rates.
Organic growth will never be super fast, as the company competes in
mature product categories, but the company executes well and, if it remains
selective, it should be able to grow the bottom line even faster than the top
line.
While the company has never paid one before, I look forward
within the next five years to seeing the company begin to pay a small dividend
to attract the value-growth retail investors it needs to expand its
multiple. Most of these will be retail
investors looking for a means to have a decent yield with growth potential.
Finally, if the company can continue to grow revenue and
market cap as it has, it is not unreasonable to believe that it can join the
midcap S&P400 within the next five years, which would certainly give it a
boost, as would an inclusion in the Russell 1000. But one step at a time.
At this point, I am looking forward to seeing the full year
results for the quarter ending the end of Feburary, at which time I fully
expect the company to exceed $100m in net income for the first time, to see how
Kaz and the PUR acquisitions are faring and to hear about management’s next
plans.
Thursday, December 08, 2011
Thoughts on the Evolution of Warren Buffett's Investment Style
Readers of this blog know, I am a big fan of Warren Buffett - hard not to be if you aspire to investing excellence.
Over at "Can Turtles Fly" there is an excellent post on Buffett's investment choices. The author breaks his investments into three phases, each of declining productivity, as assets under management and more expensive (and more efficient?) markets increasingly limited his investment choices.
I think the author mostly has it right, and it is definitely worth a read.
Over at "Can Turtles Fly" there is an excellent post on Buffett's investment choices. The author breaks his investments into three phases, each of declining productivity, as assets under management and more expensive (and more efficient?) markets increasingly limited his investment choices.
I think the author mostly has it right, and it is definitely worth a read.
Tuesday, November 22, 2011
China vs. India vs. US - more details
I focus a great deal on demographics and the interplay between macro regions on this blog. There is a reason for this: I believe that apart from individual firm analysis, the most important structural questions an investor has to ask himself are about the future nature of markets - particularly financial markets. Moreover, I believe that the investing climate in which we are operating is and will remain, driven by macro questions as governments rewrite social contracts that have mostly been stable since the 1940s.
Changing demographics influences work, output, production, consumption and ultimately the propensity to save, invest and to assume risk - these are the key factors for the investment environment. Within that environment, of course, we also have to pick firms with good economics, but these factors will help to understand the ever-uncertain future prospects of a firm.
I also write about demographics and about global growth becuase I believe that much of the information in the public sphere is written with particular agendas in mind - and that most of that is not aimed at investors. Most people are China bulls - either because they think it good that the US lose its preeminence or because they are horrified at the prospect and want to issue cautionary tales to Americans to avoid a declinist destiny. Mostly the arguments are political, or are driven by investment banks who want to have an easy job of selling securities to gullible investors.
I am decidedly on the side of the China bears - and mostly because of demographics. There seems to be increasing evidence that my forecast makes sense.
Awhile back I made a prediction about China, India and the US. I argued that China will become the worlds largest economy before 2030, and based this on some simple calculations from the Economist. I further argued that China would only hold this position for a short time before it was eclipsed by India, which has grown slower, and started later, but is recently accelerating and which also has better demographics (and a better education system) than China.
But perhaps my most surprising prediction was that by 2050 China would rank third, because it would again be passed by the United States. Now, I have some more evidence that this may indeed happen.
An economic think tank that focuses on demography and economics has concluded that China's growth rate, which has already slipped from double digits to high single digits (with the usual investment banks and bulls arguing that slowing growth is an indication of economic health. Funny, I never hear them saying this about the US). According to John Mauldin, this think tank Global Demographics, has further argued that growth will slip to the high sevens, about the level India is experiencing now (though India's economy is much smaller than China's) and after 2016 will likely fall to the 5% range - and to the 3% range after 2021. (Higher ínflation means that China's economy will still grow larger than the US in nominal terms).
But this means that the US will have a chance (if it can restore historical growth rates) to essentially keep pace with China. Likely the US will grow at slightly less than 3% because its own demographic profile will be less favorable than that over the past nine decades, but China will not keep outstripping US growth significantly, and the long-term favorable demographics of the US, coupled with its strong R&D and productivity gains mean that the US will be poised to surpass China by 2050. India will be a bigger challenge for the US.
Of course, such dramatic slowing of economic growth will no doubt lead to significant political unrest, as Chinese, having grown accustomed to a world in which everyone is much better off each year than the year before (at least among the urban middle class) will find the economy's inability to keep up with their expectations a sore point - and one which will undermine the legitimacy of the CCP.
It also means that beyond 2021, investors will have to look to other regions for economic leadership. Of course, China will be a very large economy and growing solidly, but so will the US - except that the US will not have the political risks associated with China. Expect asset prices and investor appetites to wane.
Changing demographics influences work, output, production, consumption and ultimately the propensity to save, invest and to assume risk - these are the key factors for the investment environment. Within that environment, of course, we also have to pick firms with good economics, but these factors will help to understand the ever-uncertain future prospects of a firm.
I also write about demographics and about global growth becuase I believe that much of the information in the public sphere is written with particular agendas in mind - and that most of that is not aimed at investors. Most people are China bulls - either because they think it good that the US lose its preeminence or because they are horrified at the prospect and want to issue cautionary tales to Americans to avoid a declinist destiny. Mostly the arguments are political, or are driven by investment banks who want to have an easy job of selling securities to gullible investors.
I am decidedly on the side of the China bears - and mostly because of demographics. There seems to be increasing evidence that my forecast makes sense.
Awhile back I made a prediction about China, India and the US. I argued that China will become the worlds largest economy before 2030, and based this on some simple calculations from the Economist. I further argued that China would only hold this position for a short time before it was eclipsed by India, which has grown slower, and started later, but is recently accelerating and which also has better demographics (and a better education system) than China.
But perhaps my most surprising prediction was that by 2050 China would rank third, because it would again be passed by the United States. Now, I have some more evidence that this may indeed happen.
An economic think tank that focuses on demography and economics has concluded that China's growth rate, which has already slipped from double digits to high single digits (with the usual investment banks and bulls arguing that slowing growth is an indication of economic health. Funny, I never hear them saying this about the US). According to John Mauldin, this think tank Global Demographics, has further argued that growth will slip to the high sevens, about the level India is experiencing now (though India's economy is much smaller than China's) and after 2016 will likely fall to the 5% range - and to the 3% range after 2021. (Higher ínflation means that China's economy will still grow larger than the US in nominal terms).
But this means that the US will have a chance (if it can restore historical growth rates) to essentially keep pace with China. Likely the US will grow at slightly less than 3% because its own demographic profile will be less favorable than that over the past nine decades, but China will not keep outstripping US growth significantly, and the long-term favorable demographics of the US, coupled with its strong R&D and productivity gains mean that the US will be poised to surpass China by 2050. India will be a bigger challenge for the US.
Of course, such dramatic slowing of economic growth will no doubt lead to significant political unrest, as Chinese, having grown accustomed to a world in which everyone is much better off each year than the year before (at least among the urban middle class) will find the economy's inability to keep up with their expectations a sore point - and one which will undermine the legitimacy of the CCP.
It also means that beyond 2021, investors will have to look to other regions for economic leadership. Of course, China will be a very large economy and growing solidly, but so will the US - except that the US will not have the political risks associated with China. Expect asset prices and investor appetites to wane.
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