Value search in the world of inflated PE
February 7th 2006,
The Canadian stock market is rightly priced considering the great long term potential of the new oil sands exploding growth. Iran jitters and the street response to small drawings will ensure that the oil addicts will move near Alberta fields.
Nethertheless oil plays are due for volatile tremours which are not for the nervous investor. So how to profit from the oil bonanza without losing sleep.
RUSSEL METALS (RUS-T)
Get a glimpse of the oil sands suppliers. One of them is Russel Metals (RUS-T), the largest canadian distributor of steel products with unique and efficient point of use inventories, a concept similar to Facility Management Centers typical of the repro sectors.
When Tricast first bought this stock @ $18, the Price Earning Ratios were around 5 which was rather weird considering its EPS at the time of $3,64 and dividend of $0,50.
Conversation with finance old timers showed me that this stock was considered as cyclical with a lot of inventory risk because of the volatile nature of the commodity steel market. Sometimes it is even difficult for Russel management to know exactly its inventory exposure due to the very wide extent of its product offering and multiple sizes and grades.
This is where old timer management might have made a difference. I suspect that Siegel & Al are not at their first cycle and have outlasted multiple cycles of financial analyst covering their stock. So what made the difference this time?
First the just in time delivery methods are reducing the inventory risk somewhat.
Second, oil sands require pipeline steel, preferrably stainless steel which is one of Russel specialty.
So their inventory management has reduced the cyclical component of its stock value and the oil sand business brings a longer term horizon with pent-up demand in the 2 years to come.
Now the stock is at $25 and PE of 10. Time to sell? Not really, the estimated value of the stock is still @ $28 and this if the price of steel comes back under its 1997 level which is unlikely considering the China-India hunger for steel.
The recent Merger saga between Arcelor and Mittal is there to indicate that steel was a despised commodity for the last 20 years because of the overcapacity cycle. Every one wanted to build steel plants, a macho thing to do in an era of nationalized industries. Now that every government has divested itself of the steel dogs, demand is growing faster than capacity and consolidation has given some price leverage to the producers. The reflex of the steel companies nowadays is not to build new plants but to acquire capacity abroad which makes sense in view of the undervalued stocks of steel producers.
The upside of Russel could go up to $30 in 2006 which would be a good profit taking target for Tricast.
One could allways want to stay on for the long shot and keep all those nice dividend checks and get 1$ per share (5% return) in the next 5 years.
So even if Russel goes back in 5 years to its starting base of low earnings of $0,50 , the stock will still command value of $12 which gives us a downside risk of 10% after dividend inflow.
ATCO INDUSTRIES (ACO-T)
The exit strategy from Russel Metals will depend on another oil sand supplier, namely ATCO INDUSTRIES which supplies those construction site trailers that are the mainstay of remote oil sands working community. At $37 the stock is a bit higher than its long term value justified by 3-year earnings growth of 8% from a base of $2,68 and dividend of $0,76. Tricast will wait for a buying opportunity if the stock goes down to $34 which might be the case if oil goes down because of unrealized middle east instability. The move from Russel to Atco is not necessarly less risky since ATCO has diversified in energy utilities while Russel is selling in infrastructure markets not correlated to potential oil downturns. The beta correlation of ATCO with the stock index is 0.49 while Russel seems very closely aligned with the market with a beta of 0,99.
February 8th 2006
MOSAID (MSD-T)
Hi-tech stocks are still not very popular even 6 years after the dot com bubble. Lots of investments in hi-tech were based on the race to invent business model without real consideration with earnings and instant renumeration to stockholders. But in every bad story companies will make the passage and survive the meltdown experience. This seems the case with MOSAID (MSD-T) which has accumulated more than 500 patents in memory semi-conductor design which are licensed by force or by negotiation to firms like SAMSUNG and other semiconductor manufacturers. Mosaid estimates that 50% of the memory semiconductor market is now using their patent portfolio. Getting the rest of the market is likely to be easier now that they have a legal war chest to pursue patent infringers. So in addition to reccurrent revenue from their current licensees there is potential for even higher earnings in the coming years above the current $3,39 per share. The money will also be used for innovating further and perfecting their design innovations an activity which shouldn't be to costly in investment costs since they also have a memory test equipment business that probably pays for the internal R&D. The business model doesn't try to compete with the big semi-conductor fabs but rather to copy the great licensing model of Dolby Sound. Of course the stock doesn't pay dividends, but my feeling is that they have an innovation growth dividend that will drive earnings growth in the next 3 years.
February 9th 2006
ECOLAB (ECL-NYSE)
Low capital expenditure, stable earning growth, some upside theme that is what Ecolab looks like. A major provider of biocide chemicals used in pools, agriculture, hospitals, institutions with $4 Billion + sales and $8 B capitalization value. Price Earning ratio of 27 might make it look pricey but if we assume that earning growth stays around 12% and a dividend of $0,40 the long term price should be around $39 instead of its current pricing of $35. Tricast believes that this stock is undervalued at 11% or 22 % if market conditions stays as is. Ecolab heavy duty management aims at earning growth of 15% so long term value should be around $44. Factor in unexpected scares of avian flu, emerging diseases, disinfection standards are bound to increase in hospitals and institutions alike. The barriers to entry are not impossible to bypass but approval of products by FDA takes time and the actual product pipeline should take care of potential competition. A thorough analysis of patents will be done in the future by Tricast staff to estimate this additional upside factor.
As a defensive play the stock seems relatively uncorrelated with the market (Beta = 0,71). This is because sales are relatively safe from corporate and institutional cuts when business cycle comes down again. Usually cutting cleaning costs are not worth it because of its relatively low share in total operating expenses and the risk of litigation when people get ill because of lower cleaning activity.
The long term charts shows this stock as non-cyclical http://finance.yahoo.com/q/bc?s=ECL&t=my&l=on&z=m&q=l&c= and generating strong and stable cash flows.
February 20th 2006
Softchoice (SO-T)
A dividend paying hi-tech stock with a PE ratio of 11 and EPS growth of 25%. How come? Probably because this computer service company is generating 630 Millions in revenue with less than 500 employees. At $ 0,75 EPS and $ 0,40 dividend the stock should be worth around $16 if nothing changes. Factor in the current growth in earnings and could be worth 45$. If you have experienced computer problems recently you know that computer and software service markets are not going to fade soon. Software complexity makes it difficult for corporations not to outsource this function. On the downside there is no real protection against competition except the nimbleness of Softchoice management. Tricast should learn more about management vision and behaviour in the coming months.
February 22nd 2006
COURIER (CRCC)
Printing industry stocks have been considered at best as bad breath dogs for the last 5 years. Even Transcontinental which has excellent management has been down 33% since September. Capital costs in that industry are great cash eaters, growth is impossible to attain with diminishing prices every year, rising transport costs, oversupply, name it.
One company though, has had a stellar performance in that field by focusing on a single niche and sticking to old equipment that does the job. Courier a Massachusets based company (CRRC) trading on Nasdaq used to be around $15 in the mid 1990's. It's now worth around $40. Not bad for a dying industry. Courier has low debt to equity ratio of 24% and generates earnings of $1,80 with clockwork precision. The reason : they print books for publishers in small runs but many titles. They have bought Dover Publications which was one of their main customer. This publishing house is reknowned in engineering trades where some of their editions are bibles for mechanical trades. So earnings forecast are pretty much a demographic play. North America is becoming a complex, sophisticated society where division of labour benefits described by Adam Smith are also creating wealth in the knowledge industries. Knowledge fields split every now and then so that the number of titles multiply. Specialty book printing knowledge is thus becoming more valuable to publishers.
Furthermore Courier has just built the newest infrastructure in color textbook market and plans to expand in that growing market. The integration of Man-Roland web presses went particularly smoothly, a sign of excellent execution skills of the manufacturing teams. Printing press ramp-ups are often making or destroying earning forecasts as Trancontinental experienced in the last quarter because of a delay in press equipment delivery.
Operating margins at 15% of revenues are much bettter than in mass-market volume printing.
This stock is a little overvalued short term with actual earnings of $1,80 per share and $0,48 dividend rate. But over the long term and in view of the quality of earnings as well as cash flow per share of $1,60 the long term value should be around 50$ in the next 5 years assuming 10% growth in earnings compared to actual growth of 15%.
While not a growth stock I view this stock as a great defensive play in the non-cyclical category (see 10 year graph at http://finance.yahoo.com/q/bc?s=CRRC&t=my ).
It pays dividends and has a management team with vested interest in the company (17% of stocks held by insiders). If we have a bear market this spring Tricast will buy the target price of $25 to capture 50% discount over its long term value. If nothing happens it will be bought to reduce overall risk of the portfolio.
March 15 2006
WATER INDUSTRY viewed as key investing sector.
It's been in the air for a while. Water is the next commodity with promising returns in the next ten years.
We all know the drivers - population spreading, limited supplies, drought from global warming, emerging pathogens, higher water standards, complex technological problems, relatively few players. The water sector is a key target for private equity investment firms and multinational firms. GE's recent acquisition of Zenon environmental at high multiples is just the first step towards the next financial run-up. This sector is intimately correlated with another sector : FEAR FACTOR. Avian flu, C Difficile, crypto sporidium bugs are there to get us. The chance of getting hit individually are quite low but the individual elasticity of demand for such products is infinite, giving good margins to specialized corporations that offer proven technological recipes to reduce contamination risks. The recipe takes time to learn and must pass a lot of regulatory steps which is a barrier to competitors. Most of the solutions involves consumables, chemical stuff that generate constant recurrent and stable revenues making most of the companies non-cyclicals investments.
TRICAST will leverage its know-how of water treatment technologies and electrochemical processes to evaluate the best investment vehicles.
Companies that will be evaluated will be PALL CORP (PLL-NYSE), ECOLAB (ECL-NYSE)
Valuation of these companies seem to be cash based. PALL for instance is priced at 29$, which makes sense since cash per share is 1,83$ times 15,4 plus 0,4$ *5 dividend = 30$.
So no bargains there, except that if all hell breaks loose on the epidemy front they should be of good protection value with reasonable potential upside. If it can be of comfort for the hypocondriac, the market doesn't expect any breakout soon.
The Canadian stock market is rightly priced considering the great long term potential of the new oil sands exploding growth. Iran jitters and the street response to small drawings will ensure that the oil addicts will move near Alberta fields.
Nethertheless oil plays are due for volatile tremours which are not for the nervous investor. So how to profit from the oil bonanza without losing sleep.
RUSSEL METALS (RUS-T)
Get a glimpse of the oil sands suppliers. One of them is Russel Metals (RUS-T), the largest canadian distributor of steel products with unique and efficient point of use inventories, a concept similar to Facility Management Centers typical of the repro sectors.
When Tricast first bought this stock @ $18, the Price Earning Ratios were around 5 which was rather weird considering its EPS at the time of $3,64 and dividend of $0,50.
Conversation with finance old timers showed me that this stock was considered as cyclical with a lot of inventory risk because of the volatile nature of the commodity steel market. Sometimes it is even difficult for Russel management to know exactly its inventory exposure due to the very wide extent of its product offering and multiple sizes and grades.
This is where old timer management might have made a difference. I suspect that Siegel & Al are not at their first cycle and have outlasted multiple cycles of financial analyst covering their stock. So what made the difference this time?
First the just in time delivery methods are reducing the inventory risk somewhat.
Second, oil sands require pipeline steel, preferrably stainless steel which is one of Russel specialty.
So their inventory management has reduced the cyclical component of its stock value and the oil sand business brings a longer term horizon with pent-up demand in the 2 years to come.
Now the stock is at $25 and PE of 10. Time to sell? Not really, the estimated value of the stock is still @ $28 and this if the price of steel comes back under its 1997 level which is unlikely considering the China-India hunger for steel.
The recent Merger saga between Arcelor and Mittal is there to indicate that steel was a despised commodity for the last 20 years because of the overcapacity cycle. Every one wanted to build steel plants, a macho thing to do in an era of nationalized industries. Now that every government has divested itself of the steel dogs, demand is growing faster than capacity and consolidation has given some price leverage to the producers. The reflex of the steel companies nowadays is not to build new plants but to acquire capacity abroad which makes sense in view of the undervalued stocks of steel producers.
The upside of Russel could go up to $30 in 2006 which would be a good profit taking target for Tricast.
One could allways want to stay on for the long shot and keep all those nice dividend checks and get 1$ per share (5% return) in the next 5 years.
So even if Russel goes back in 5 years to its starting base of low earnings of $0,50 , the stock will still command value of $12 which gives us a downside risk of 10% after dividend inflow.
ATCO INDUSTRIES (ACO-T)
The exit strategy from Russel Metals will depend on another oil sand supplier, namely ATCO INDUSTRIES which supplies those construction site trailers that are the mainstay of remote oil sands working community. At $37 the stock is a bit higher than its long term value justified by 3-year earnings growth of 8% from a base of $2,68 and dividend of $0,76. Tricast will wait for a buying opportunity if the stock goes down to $34 which might be the case if oil goes down because of unrealized middle east instability. The move from Russel to Atco is not necessarly less risky since ATCO has diversified in energy utilities while Russel is selling in infrastructure markets not correlated to potential oil downturns. The beta correlation of ATCO with the stock index is 0.49 while Russel seems very closely aligned with the market with a beta of 0,99.
February 8th 2006
MOSAID (MSD-T)
Hi-tech stocks are still not very popular even 6 years after the dot com bubble. Lots of investments in hi-tech were based on the race to invent business model without real consideration with earnings and instant renumeration to stockholders. But in every bad story companies will make the passage and survive the meltdown experience. This seems the case with MOSAID (MSD-T) which has accumulated more than 500 patents in memory semi-conductor design which are licensed by force or by negotiation to firms like SAMSUNG and other semiconductor manufacturers. Mosaid estimates that 50% of the memory semiconductor market is now using their patent portfolio. Getting the rest of the market is likely to be easier now that they have a legal war chest to pursue patent infringers. So in addition to reccurrent revenue from their current licensees there is potential for even higher earnings in the coming years above the current $3,39 per share. The money will also be used for innovating further and perfecting their design innovations an activity which shouldn't be to costly in investment costs since they also have a memory test equipment business that probably pays for the internal R&D. The business model doesn't try to compete with the big semi-conductor fabs but rather to copy the great licensing model of Dolby Sound. Of course the stock doesn't pay dividends, but my feeling is that they have an innovation growth dividend that will drive earnings growth in the next 3 years.
February 9th 2006
ECOLAB (ECL-NYSE)
Low capital expenditure, stable earning growth, some upside theme that is what Ecolab looks like. A major provider of biocide chemicals used in pools, agriculture, hospitals, institutions with $4 Billion + sales and $8 B capitalization value. Price Earning ratio of 27 might make it look pricey but if we assume that earning growth stays around 12% and a dividend of $0,40 the long term price should be around $39 instead of its current pricing of $35. Tricast believes that this stock is undervalued at 11% or 22 % if market conditions stays as is. Ecolab heavy duty management aims at earning growth of 15% so long term value should be around $44. Factor in unexpected scares of avian flu, emerging diseases, disinfection standards are bound to increase in hospitals and institutions alike. The barriers to entry are not impossible to bypass but approval of products by FDA takes time and the actual product pipeline should take care of potential competition. A thorough analysis of patents will be done in the future by Tricast staff to estimate this additional upside factor.
As a defensive play the stock seems relatively uncorrelated with the market (Beta = 0,71). This is because sales are relatively safe from corporate and institutional cuts when business cycle comes down again. Usually cutting cleaning costs are not worth it because of its relatively low share in total operating expenses and the risk of litigation when people get ill because of lower cleaning activity.
The long term charts shows this stock as non-cyclical http://finance.yahoo.com/q/bc?s=ECL&t=my&l=on&z=m&q=l&c= and generating strong and stable cash flows.
February 20th 2006
Softchoice (SO-T)
A dividend paying hi-tech stock with a PE ratio of 11 and EPS growth of 25%. How come? Probably because this computer service company is generating 630 Millions in revenue with less than 500 employees. At $ 0,75 EPS and $ 0,40 dividend the stock should be worth around $16 if nothing changes. Factor in the current growth in earnings and could be worth 45$. If you have experienced computer problems recently you know that computer and software service markets are not going to fade soon. Software complexity makes it difficult for corporations not to outsource this function. On the downside there is no real protection against competition except the nimbleness of Softchoice management. Tricast should learn more about management vision and behaviour in the coming months.
February 22nd 2006
COURIER (CRCC)
Printing industry stocks have been considered at best as bad breath dogs for the last 5 years. Even Transcontinental which has excellent management has been down 33% since September. Capital costs in that industry are great cash eaters, growth is impossible to attain with diminishing prices every year, rising transport costs, oversupply, name it.
One company though, has had a stellar performance in that field by focusing on a single niche and sticking to old equipment that does the job. Courier a Massachusets based company (CRRC) trading on Nasdaq used to be around $15 in the mid 1990's. It's now worth around $40. Not bad for a dying industry. Courier has low debt to equity ratio of 24% and generates earnings of $1,80 with clockwork precision. The reason : they print books for publishers in small runs but many titles. They have bought Dover Publications which was one of their main customer. This publishing house is reknowned in engineering trades where some of their editions are bibles for mechanical trades. So earnings forecast are pretty much a demographic play. North America is becoming a complex, sophisticated society where division of labour benefits described by Adam Smith are also creating wealth in the knowledge industries. Knowledge fields split every now and then so that the number of titles multiply. Specialty book printing knowledge is thus becoming more valuable to publishers.
Furthermore Courier has just built the newest infrastructure in color textbook market and plans to expand in that growing market. The integration of Man-Roland web presses went particularly smoothly, a sign of excellent execution skills of the manufacturing teams. Printing press ramp-ups are often making or destroying earning forecasts as Trancontinental experienced in the last quarter because of a delay in press equipment delivery.
Operating margins at 15% of revenues are much bettter than in mass-market volume printing.
This stock is a little overvalued short term with actual earnings of $1,80 per share and $0,48 dividend rate. But over the long term and in view of the quality of earnings as well as cash flow per share of $1,60 the long term value should be around 50$ in the next 5 years assuming 10% growth in earnings compared to actual growth of 15%.
While not a growth stock I view this stock as a great defensive play in the non-cyclical category (see 10 year graph at http://finance.yahoo.com/q/bc?s=CRRC&t=my ).
It pays dividends and has a management team with vested interest in the company (17% of stocks held by insiders). If we have a bear market this spring Tricast will buy the target price of $25 to capture 50% discount over its long term value. If nothing happens it will be bought to reduce overall risk of the portfolio.
March 15 2006
WATER INDUSTRY viewed as key investing sector.
It's been in the air for a while. Water is the next commodity with promising returns in the next ten years.
We all know the drivers - population spreading, limited supplies, drought from global warming, emerging pathogens, higher water standards, complex technological problems, relatively few players. The water sector is a key target for private equity investment firms and multinational firms. GE's recent acquisition of Zenon environmental at high multiples is just the first step towards the next financial run-up. This sector is intimately correlated with another sector : FEAR FACTOR. Avian flu, C Difficile, crypto sporidium bugs are there to get us. The chance of getting hit individually are quite low but the individual elasticity of demand for such products is infinite, giving good margins to specialized corporations that offer proven technological recipes to reduce contamination risks. The recipe takes time to learn and must pass a lot of regulatory steps which is a barrier to competitors. Most of the solutions involves consumables, chemical stuff that generate constant recurrent and stable revenues making most of the companies non-cyclicals investments.
TRICAST will leverage its know-how of water treatment technologies and electrochemical processes to evaluate the best investment vehicles.
Companies that will be evaluated will be PALL CORP (PLL-NYSE), ECOLAB (ECL-NYSE)
Valuation of these companies seem to be cash based. PALL for instance is priced at 29$, which makes sense since cash per share is 1,83$ times 15,4 plus 0,4$ *5 dividend = 30$.
So no bargains there, except that if all hell breaks loose on the epidemy front they should be of good protection value with reasonable potential upside. If it can be of comfort for the hypocondriac, the market doesn't expect any breakout soon.
posted by Pierre Castegnier @ 12:35 PM
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