Sunday, April 22, 2018

Covered FMG Short

Covered my FMG short at on 20th April at AUD 4.69.
It had closed above the 4.50-4.55 support level for several days.
Loss of AUD 2.8K.

Monday, April 2, 2018

Short Fortescue Metals Group

I am expecting Iron Ore to drop.  Most IO is used by China for building and infrastructure.

In the long run, China is trying to move away from infrastructure and manufacturing.  Over the years they brake, accelerate, brake, accelerate...as they try to slow down without causing a recession.

In the medium term, I think they are in the brake stage now.  They will be slowing down now, so they can stimulate in 2020 for Xi's election the year after.  China's growth credit (Total Social Financing plus Bonds) is slowing:


Source: MB Webinar - Nucleus Wealth Mgt (abt 30 mins in).

In the short term, there are record iron ore stocks at Chinese ports.   Most of it is low grade ore, unused because of China's pollution restrictions.

FMG is the 4th largest global iron ore supplier after Vale, BHP and Rio, and also 4th place on the cost curve.  It produces mostly lower quality 58% ore, versus high-quality 62% ore from the other three, and low quality 30+% from domestic Chinese producers.  Upgrading their mix will take time - meanwhile they have have to accept discounts.

FMG's stock price has recently broken support:

I am short 6,600 shares of FMG at AUD 4.27.  This is a short term trade, hoping to make 20-30%.

Main risks are:
  • In the short term, the market shoots upwards if the correction ends.
  • China may rescind their pollution curbs.
  • In the long term, steel may be used for OBOR.  Or for buildings/infrastructure for the booming US economy.  Including a big, beautiful wall.

US Drug Wholesalers again

Another look at US Drug Wholesalers: Cardinal Health (CAH) and McKesson (MCK).  These companies are part of an oligopoly in an industry not affected by recessions or trade wars, and are cheap now.

Cashflows

These 2 companies have been highly profitable.   Lets look at their past numbers.

I use Cashflows From Operations (CFO).  Since they are distributors with large yearly swings in working capital, exclude working capital changes:




Sustaining capex (mostly PPE) is extremely low, so free cashflows almost matches CFO:



But both companies spend a lot on acquisitions, which consists of the majority of their Cashflows from Investments (CFI):



Here's a look at CFO vs acquisitions and disposals.  In some years, all CFO is used for acquisitions:


Why are they spending so much on acquisitions?

I wonder if some of the acquisition spending is actually part of sustaining capex.  In a fast changing industry that is constantly growing, do you need to constantly acquire new companies to maintain market share?  Running to stand still...

Valuation

FCF per share is below.  Again, I'm excluding working capital changes to smooth things out - this will inflate CFO a little, as more and more working capital (eg: inventory) is required as a business expands over time:



At $140, MCK is trading at ~11X estimated FCF, and at $60, CAH is around 12X.

Risks

Although their past numbers are really good, there are some risks not reflected in them.  Most of these are from the DrugChannels 2017-18 Economic Report on Pharmaceutical Wholesalers and specialty Distributors.

Their pharmacy end customers have been consolidating, putting pressure on Margins.  Operating margins for large pharmacy chains are estimated at ~ 0.5%, versus 1.5% for independent pharmacies.

Generic drugs account for an estimated 70% of their operating profits.  Pricing is horrendously complex, and is a set percentage of the Weighted average Cost price (WAC) - see pages 11 and 13 for examples - which means that rising generic drug prices boost profits.   Starting in 2011-12, there was a boom in generics drug prices due to an artificial shortage.  This has since been resolved, and prices have been coming down since 2016.  We need to keep this in mind when looking at the charts of the historical profits/cashflows above.  The report estimates that 1 in 5 generic drug prices have yet to fall, and that generic drug prices will continue on average to fall in the next 6-18 months.

Although spending on specialty drugs in set to increase, this is not expected to help wholesalers as most specialty drugs are prescribed through large chains and hospitals.  ie: their low margin clients.

Finally, there is a risk of litigation due to the opioid crisis, where the wholesalers were not monitoring - or just ignoring - suspicious orders.  I think McKesson is more vulnerable as they've been sued a lot before.

Conclusion

The positives are: this industry is an oligopoly with a defensible moat.  And pharmacy spending is not affected by recessions.

MCK has better historical numbers and trades at a slightly lower valuation.  But has more litigation risk. 

The stocks are trading at low valuations now due to:
  • A price war last year, bought on by a consolidating customer base.
  • Falling profits in 2016 dues to generic drug deflation.
These trends may continue.  I see no catalyst to move the stocks higher now.  But the industry is cheap.  Are the above risks already priced in?

Sold losing positions

Sometimes I take small speculative positions.  Either to bet a small amount for a possible large gain, or to begin investigating a company.  These 2 didn't work out, I don't have the confidence to hold them or the time to investigate further.

Bought 490 shares SECO at late Jan, sold them 29th Mar.  Loss of USD 850.

Sold 785 shares STNG  on 20th Feb at 2.34.  Loss of USD 1.1K.

Friday, February 9, 2018

Bought Boustead

I've followed Boustead for a while.  Also see TTI's blog for a more detailed look.

Here's my valuation for a stock price of 83c:

First, net cash is 28c/share.  This includes some cash required for working capital.  Gives a stock price of 55c.

Next, the segments with recurring earnings:

  • I estimate Geo Spatial earned 2.8c/share in the last 12 months.  After estimating taxes subtracting some HQ costs
  • (Boustead Singapore's share of) Boustead Project's Leasing Segment's after-tax earnings were 1c/share.
So 3.9c/share of recurring profits.  That gives an ex-cash PE of 14.

And we are getting the Engineering and Design&Build segments for free.  These should be coming off multi-year cyclical lows.

The risks are:
  • Long term: Much of Boustead's past success is from the old CEO's capital allocation skills.  Will this continue under the next generation?  The company has been looking to deploy cash for a long time, without success.  Hopefully they will remain conservative.
  • Short term: Geo-Spatial's revenues would drop if the AUD dropped.  Also if the Australian Government cut spending.

Bought 36000 shares at 82.5c on 6th Feb.  Thats half my position, will buy more if the stock price drops to 75-76c.  I'm content to hold them long term, and - at this stage in the business cycle - may end up holding them through the next crash/recession.

This stock does not seem to be affected much by the current correction.



Friday, January 5, 2018

Sold LBrands

2 days ago the stock dropped 15% on a bad sales report, breaking its uptrend:

This is not a Buffet-like stock that I want to hold for years, so I sold at $50.20.  Profit around USD 800.

I am now just under 60% in cash:


Friday, November 10, 2017

L Brands (NYSE:LB)

Quick look at L Brands:
  • Owns 2 major brands: Victorias Secret (underwear) and Bath & Body Works (like Body Shop).  
  • 2/3rd of operating profit is from Victoria's Secret, 1/3rd from B&BW.  
  • 97% of profits from US & Canada.  They have only recently started expanding e.g.: opened flagship stores in China and Singapore last year.
  • While B&BW has been growing, Victoria's Secret has suffered declining sales in the past 2 years, causing their stock price to drop almost 50%.  Last week they reported their first positive monthly comparable-sales number in ten months, driving the stock up 8%.

Competitive Position

They are the largest player in the US: IBISWorld estimates they have over 60% of the lingerie market, Bernstein gives around 30% of the women's underwear market (and increasing).

Victoria's Secret is in the mid-to-slightly-expensive range.  They sell at the $35-50 price point, compared to:
  • La Perla ($100+ to $700) range
  • Gap ($17-$70)
  • Target ($10-20)
  • Walmart ($8-15)
  • Amazon's Iris & Lilly brand ($10) - at these prices, Amazon is not competing with VS.

Changing fashion and Trends

Bralettes - a cheaper bra with no wiring - have become popular recently, hurting VS's profits.  However these are only suitable for B-cups and below.

A major competitor is American Eagle's Aerir brand.  Its aimed at teenagers, and rather than the airbrushed model look, they have the girl-next-door look.


Aerie has has has 15-25% quarterly same-store sales growth for the past 5 quarters.


Source: eMarketerRetail

Victoria Secret's competing brand, Pink, is also growing, but at a lower rate.  Their Annual Report states "low double-digit sales growth over last year" (not same-store sales).   So Aerie is beating them.

Can this industry be disrupted by online competitors, especially when it comes to offering a better fit and greater variety?  I would guess not, but who knows?

The Numbers

L Brand's profits dropped in 2016 and 2017:


Profit breakdown:


Because the "COGS, Buying and Occupancy" costs are one line on the income statement, we can't model their operating leverage (e.g.: An x% drop in sales leads to a > x% drop in profits, due to fixed costs - mostly rental).

ROE is meaningless because the company has long periods of negative shareholder equity!  Due to share buybacks and dividends, leaving minimal retained earnings.  Shares outstanding have steadily decreased:



Debt is a bit higher than I'd like, at around 6X projected 2017 earnings.  Its also been increasing:


I don't like the way they have borrowed in order to buyback shares and pay dividends.  Smells like financial engineering.  But they are still safely able to pay the interest.

Most of it is fixed rate debt:


    Source: Company presentation

Off-balance-sheet liabilities look OK: Negligible operating leases at 12m.  104m of real-estate guarantees as contingent liabilities. 

Conclusion

Buying this is a bet that their 2-year losing streak is over and same-store-sales keep recovering.  I'm betting on this because of VS' long history of growing market share, and I think that selling high-priced lingerie online will be difficult.

The stock is cheap, and a recovery is not priced in.  Its trading at 13X trailing earnings, and 20X projected 2017 earnings - trough earnings, hopefully.  I think it should trade at 15 to 20X earnings.  I think the US economy will be strong over the next few years.

I don't want to hold a retail company for years, due to recession risk and changing consumer trends.  If same-store-sales and earnings increase over the next year, the stock should be re-rated, and I'll sell.

Misc