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Investor Letter to Santa
Funny letter to Santa I found that I mostly agree with.

Dear Santa,
Thanks for the decent haul last year. We particularly liked the surprisingly strong global economic growth. It went nicely with the benign global interest rates you got us the year before and the bull market we’ve received for five years straight. Sadly, the reindeer sweater’s energy-efficient fluorescent red-nose light bulb malfunctioned. But thanks anyway.
Speaking of which, we’ve been especially good this year. We didn’t panic during the W-bottom correction and regularly encouraged our readers to invest globally. We uncovered media hype and battled market misperceptions. We did our very best to point out myriad reasons to remain true to stocks this year, which is why we think we really deserve a pony. Or a yacht. Or a pony on a yacht. Failing that, below is our list of holiday wishes:
High oil prices. We’ve enjoyed firm oil prices the last few years, mostly because of increased demand from a growing global economy. More of that please!
Long-term interest rates . . . right where they are. The benign long-term interest rates we’ve had for the last few years are the gift that keeps on giving. We wouldn’t mind if you renewed our subscription. Plus, benign global interest rates make equities look that much more undervalued, relatively.
Short, sharp market drops. No, Santa, we haven’t been hitting the eggnog before lunch. Short, sharp corrections are healthy for sustained bull markets. We’d argue corrections help shake out positive sentiment and can prolong a bull market. Bull markets die with a whimper, not bang—so please send us more volatility and no rolling, grinding bull market tops.
More dour sentiment. Grouchy investors make our hearts gleeful—euphoria is what we fear. Investor sentiment simply doesn’t match the many positive economic fundamentals we see, telling us ample upward buying pressure exists to push this global bull market still higher. So be grumpy, you Scrooges! It will make our 2008 all the more merry.
A strong economy . . . overseas. We don’t need a healthy US economy, Santa. The one you gave us five years ago is still working fine. What we’d really like is continued global strength. Plus, since the US is just about 35% of the world economy and correlates with the non-US world, a growing global economy means the US can’t slow much.
A totally feckless government fix to subprime. We might get to open this one early. The Bush-Paulson plan is increasingly looking like the “Yeah . . . What he said!” government bailout plan—recommending what many lenders are already doing to mitigate increasing foreclosure rates. Aggressive government intervention nearly always leads to unintended negative consequences—frequently making the “fix” far worse than the “problem.” So thanks for working your holiday magic early, Santa!
More do-nothing Congress! Santa, you really delivered last year, but we’re asking for this again—a shiny package of Congressional gridlock under the tree (though it might be a little difficult to unwrap—all that red tape). This is Bush’s last year of his last term, so it shouldn’t be hard—Congress historically hasn’t passed much material legislation in “fourth years.” Easing legislative risk aversion could help stocks to another positive year. We’d like that.
A bigger trade deficit and total obliteration of trade barriers. We really like America’s trade deficit—it’s symptomatic of our healthy, efficient, productive economy. A bigger one would be even better—signaling we can import goods built cheaply overseas to fuel efficiency, increased shareholder value, more competitive prices, and greater societal wealth at home!
Maybe the trade barrier thing is a bit much, considering you’d have to battle politicians world-wide, but everything else should be easy to deliver. Individually, some of us would like an R2 D2 Interactive Droid and a new pair of Jimmy Choos for our stockings. Oh, and world peace, but we’ll settle for the trade deficit. Thanks Santa.
By biscosc at 2007-12-18 17:06 | Stocks | 3 comments
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Best long-term market timing newsletters still bullish
Linked below is one reason I remain bullish. 

The bottom line? None of these nine top timers is bearish. The average equity allocation among all nine is 86%.
To be sure, this 86% is slightly below the level from early August, when it stood at 90%. But the current reading is still quite high. And it is particularly bullish relative to the average forecast of the 10 stock market timing newsletters with the very worst risk-adjusted performances over the past decade. Their average recommended equity exposure right now is 40%.
In other words, the best market timers are, on average, have more than double the equity exposure of the 10 worst market timers.


By biscosc at 2007-10-08 12:37 | Stocks | login or register to post comments
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Stocks better than gold as inflation hedge?
I thought with all the writings about gold on this website, there might be some interest in this article.  I haven't studied gold too much but it seems they are bearish on it, what are they missing?

``Gold is often described as an inflation hedge, but in fact there are few instances in the past 20 years when gold has moved in sync with either core or headline inflation,'' says James Gutman, a London-based commodity economist at Goldman Sachs International. Thus, gold ``should not be used as an inflation hedge,''

"Investors -- and there are many of them -- who buy into these suppositions might as well believe in the tooth fairy. Here's why. Gold reached a record high of $850 an ounce in January 1980. If since then the spot price of bullion kept pace with U.S. inflation as measured by the consumer-price index, gold would now be selling for $2,119.84. Instead, it stood at $732.05 in London trading yesterday, only about a third of what it should be if it were truly an effective inflation hedge. "


By biscosc at 2007-10-05 08:23 | Stocks | 5 comments
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Mark Hulbert: Contrarian analysis remains bullish
A great article outlining continued bearish sentiment from short-term market timing newsletters.  Recommended equity exposure is only 17.4% currently, down from 50.9% from mid-July when the Dow was around 14,000.  Mark points out that even 50.9% is not close to the level from the year 2000 highs.  He also points out that back then, in the months following the top (a true bear market), the bullish indicator went up not down as it has recently. 


By biscosc at 2007-09-20 13:59 | Stocks | 5 comments
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Mueller Water Products (MWA/MWA-B) analysis
Mueller Water Products (MWA/MWA-B) analysis






I recently read an article from Whitney Tilson on the Financial Times website where he talks about recent spin-offs he
perceives as good values.  Mueller Water is the second stock he mentions and he adds that he believes it’s worth in the
mid-20’s.  Currently the stock is selling at $15.65.  I own MWA-B because I was distributed its shares when it was spun off
from Walter Industries (WLT).  I never paid too much attention because an undervalued WLT was my original investment
thesis pre-spin off.  Recently, I got the 10-K in the mail and determined to do a little more research. 
First off, as it’s been noted on other blogs, MWA has a few good things going for it:

1. Sales rose 10% in the last year.

2. It holds a commanding position for every product it manufactures.

3. It’s in the process of realizing synergies from consolidation of its businesses.  Estimates have been increased

    from $35 million to $40-50 million.

4. A big chunk of their business comes from repair and replacement of an aging US water infrastructure system. 
    Estimates are for 11% spending increase in 2007.  It’s so bad the American Society of Civil Engineers rated it
    a D- in 2005.

5. They are able to pass on raw material costs in the form of price increases.  From the 10K (“The Mueller Segment
    was able to pass much of these cost increases through to its customers by means of price increases in the middle
    of the fiscal year of approximately 22% on certain brass products, and approximately 12% on hydrants and iron
    gate values containing brass components. 

6. They are able to increase prices annually.  From the 10K (“These product price increases were in addition to the
    regular, annual Mueller segment product increases of 5% to 8% made earlier in the fiscal year.”)

 
There is one huge risk I see:
1. New infrastructure (Housing) represents an estimated 40% of total revenues.

 
Valuation:
The first thing I did was adjust their gross income amounts from each segment for one-time charges incurred.
 
Adjusted gross income for one time charges
 
 
 
Mueller Segment
$223.00
unadjusted
+
$52.90
amortization expense resulting from the purchase accounting adjustment to increase acquired inventories to fair value on the date of acquisition
=
$275.90
 
 
 
 
US Pipe Segment
$62.50
unadjusted
+
$11.40
inventory obsolescense write-offs
+
$9.90
costs associated with plant closure
=
$83.80
 
 
 
 
Anvil Segment
$122.60
unadjusted
 
$17.30
amoritization expense resulting from the purchase accounting adjustment related to valuing inventory acquired in the Acquisition at fair value
 
$139.90
 
 
 
 
Overall
$407.70
unadjusted
+
$70.20
purchase accounting adjustments related to valuing inventory acquired in the Acquisition at fair value
+
$21.30
inventory write-offs and unabsorbed overhead costs resulting from close of the US Pipe Chattanooga manufacturing plant
=
$499.20
million
 
Next I calculated their adjusted Operating Income and adjusted Net Income:

Adjusted Operating Income = Adjusted Gross Income - SG&A - Corporate charges
Adjusted Operating Income = 499.2 - 242.1 - 8 = 249.1
 
Adjusted Net Income = (Adjusted Operating Income - Interest) - Taxes
Adjusted Net Income = (249.1 - 115.9) - Taxes = 133.9 - Taxes
Adjusted Net Income = 133.9 * 30% tax rate = $93 million or $.81/share
 
This gives me an adjusted P/E:

Adjusted P/E = 15.65/.81 = 19.32
 
They also give an adjusted EBITDA in the 10-K and using that we can calculate EV/EBITDA:

Adjusted EBITDA = $346.6 million

Enterprise Value = Market Cap + Debt
Enterprise Value = 1.8 + 1.1 = $2.9 Billion
EV/EBITDA = 2.9B/346.6m = 8.62
 
I might be missing something, but these income statement related valuation metrics don’t
scream bargain to me.  It is very difficult to find a comparable company.  Can anyone make
any suggestions?
 
I did manage to calculate EV/S ratio for what Walter Industries paid when they bought Mueller originally
in 2005.  They bought Mueller for $1.9 billion of which $860 million was cash and $1.05 billion was debt. 
Mueller had $1.1 billion in revenues when they were bought.  Here is a link to the story containing the price
and revenue info: http://www.sptimes.com/2005/06/20/State/Walter_Industries_to_.shtml

EV/S in June 2005 = 1.9 billion / 1.1 billion = 1.73
EV/S currently = 2.9 billion / 1.9 billion = 1.49

Therefore, Mueller is a little undervalued based on this multiple that Walter paid almost 2 years ago.

Now let’s calculate cash flow and free cash flow:

Cash from Operating Activities = Adjusted Net Income + Depreciation + Amortization
Cash from Operating Activities = $98.8 + $68.8 + $28.1 = $189.9 million
 
Free Cash Flow = Cash from Operating Activities - CapEx
Free Cash Flow = $189.9 - $71.1 = $118.8 million
 
FCF Yield = Free Cash Flow / Enterprise Value
FCF Yield = 118.8 / 2900 = % 4.1
 
Things are starting to look up at this point.  FCF yield is pretty good because they generate a
good deal of free cash.

 
Finally, we’ll do the Discounted Cash Flow analysis.  Let’s take that free cash flow number from above
and add 5% growth for next year, 10% growth for the next 9 years and 3% growth to perpetuity.  I’m using a
 10% discount rate and shares outstanding reflect both class A and B shares:

DCF Analysis
Current Stock Price15.65         
Shares Outstanding114.6         
Next Year's FCF123.9         
Perpetuity Growth Rate0.03         
Discount Rate0.1         
           
10 Year Valuation ModelYr 1Yr 2Yr 3Yr 4Yr 5Yr 6Yr 7Yr 8Yr 9Yr 10
           
Assumed Growth Rate 0.10.10.10.10.10.10.10.10.1
Free Cash Flow123.9136.3149.9164.9181.4199.5219.5241.4265.6292.1
Discount Factor1.101.211.331.461.611.771.952.142.362.59
Discounted Cash113112.636112.64112.636112.636112.64112.64112.64112.64112.636
           
Perpetuity Value = (Yr 10 FCF x (1 + Perpetuity Rate)) / (Discount Rate - Perpetuity Rate)    
Perpetuity Value =4299         
Discounted =1657         
           
Total Equity Value =Discounted Yr 1-10 Values + Discounted Perpetuity Value    
Total Equity Value =2784         
           
Per Share Intrinsic Value =24.29         
% Discount to Intrinsic Value35.57%         

Hmmm..  Maybe Whitney isn’t too far off thinking mid-20’s is the correct price after all.  ;)

Conclusion:

It seems like any risks in the housing market could be offset by replacement of aging infrastructure.  I feel that
this company has a lot more going for it than it has risks working against it.  It looks much cheaper when
doing a DCF analysis opposed to a relative analysis. 

I think the final aspect that makes me love this company is that some very smart dudes have been buying recently. 
Firms that added or started a new position include Fairholme Capital Management, Witmer Asset Management,
Dreman Value Management, Keeley Asset Management, Citadel LP, T2 Partners, Eminence Capital and Royce.
By biscosc at 2007-02-25 20:13 | Stocks | MWA-B | 1 comment
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HNR thesis
All data taken from 8-K filed Dec. 1, 2006 unless otherwise noted  
      
South Mongas Unit (SMU)      
Harvest's production under the old Operating Service Agreement came from these 3 fields
Fields were abandoned by Majors and Venezuelan govt in 1987  
Operated by Harvest since 1992     
Had 18 MMBbls proved reserves in 1992    
Harvest produced 124 MMBoe since 1992    
Proved reserves at April 1st are 128 MMBoe   
      
March 2006, Harvest signs MOU for conversion to mixed company to be call Petrodelta
HNR will own 32% of this mixed company with Venezuelan govt owning the rest. 
20-year market contract     
Market based oil pricing     
      
April 2006, National Assembly terminates Operating Service Agreement. 
      
Venezuelan government signs MOU to add 3 new fields to Petrodelta mixed company in August 2006
Isleno (0 proved MMBoe), Temblador (14 proved MMBoe), El Salto (68 proved MMBoe) fields are next door to SMU
HNR is planning on applying the same technologies to improve recovery on new fields, but on a broader scale
      
 Unrisked (MMBoe)   
Operating Service AgreementProvedProbable Possible  
Reserves (includes proved updeveloped reserves)90    
Net to Harvest72    
      
Petrodelta Mixed Company210145344  
Net to Harvest453174  
Discounted Future pre-tax Net Income$617 $317 $792   
      
2007 Petrodelta development plan    
Objective: Gross proved reserve target increase of 100 MMBbls in 18 months 
      
Valuation:     
$220 million cash balance estimated for end of 2006   
$308 Discounted Future pre-tax income after 50% tax rate  
38.8 million diluated shares (taken from 10/26/2006 8-K)  
$528 million / 38.3 million shares     
= $13.62 / share or a 37% discount to $9.95 current price  
      
Other:     
This is not taking into consideration Probable or Possible reserves for 3 additional oil fields.  (2007 development plan)
Technology applied to SMU accounted for 252 MMBoe additional reserves from initial estimate of proved reserves.
Risks obviously include the Govt, but they stand to make big bucks as well if Harvest can work the same miracle on these 3 new fields
Mohnish Pabrai has 10% of his portfolio in HNR.  He increased his holdings from 3141232 to 3479603 in 1Q 2007 (2/14/70 SC13G/A).

Let me know what you guys think.
By biscosc at 2007-02-21 16:07 | Stocks | HNR | 6 comments
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WMT DCF Analysis
Current Stock Price48.03         
Shares Outstanding4173         
Next Year's FCF12774         
Perpetuity Growth Rate0.03         
Discount Rate0.1         
           
10 Year Valuation ModelYr 1Yr 2Yr 3Yr 4Yr 5Yr 6Yr 7Yr 8Yr 9Yr 10
           
Assumed Growth Rate 0.080.080.080.070.070.070.070.070.05
Free Cash Flow12774.013795.914899.616091.617218.018423.219712.921092.822569.223697.7
Discount Factor1.101.211.331.461.611.771.952.142.362.59
Discounted Cash1161311401.61119410990.81069110399101169839.99571.69136.49
           
Perpetuity Value = (Yr 10 FCF x (1 + Perpetuity Rate)) / (Discount Rate - Perpetuity Rate)    
Perpetuity Value =348695         
Discounted =134437         
           
Total Equity Value =Discounted Yr 1-10 Values + Discounted Perpetuity Value    
Total Equity Value =239391         
           
Per Share Intrinsic Value =57.37         
% Discount to Intrinsic Value16.28%         

To get my Next Years FCF estimate:
Income from Q1, Q2, Q3 of 2006 from latest 10Q -> 7.345 billion
Add back loss from discontinued operations of 894 million -> 7.345 + .8934 =  8.239 billion
Add Income from Q4 2005 -> 8.239 + 3.589 = 11.82 billion
Add 8% income growth for next year -> 11.82 * 1.08 = 12.77 billion

Discount Rate
I'm using is 10%, which is standard.

I think this is a conservative estimate and believe 16.28% will outperform the market over the next 12 months while taking on less risk.
By biscosc at 2007-02-13 15:34 | Stocks | WMT | 19 comments
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Mills Corp (MLS) Analysis
I know I've already posted this under a comment but with the news today about Farallon and Mills I thought it might be relevant again.  I'd also like to capture this analysis in my blog.

Mall NameSquare Footage GLA (in thousands)% ownedSquare Footage GLA owned
Arizona Mills1,23450.00%617
Arundel Mills1,23859.30%734
Cincinnati Mills1,456100.00%1456
Colorado Mills1,10156.30%620
Concord Mills1,30359.30%773
Discover Mills1,18350.00%592
Franklin Mills1,727100.00%1727
Grapevine Mills
1,612
59.30%956
Great Mall of the Bay Area1,28275.00%962
Gurnee Mills1,8281.00%18
Katy Mills1,21862.50%761
Ontario Mills1,49150.00%746
Opry Mills1,14375.00%857
Potomac Mills1,595100.00%1595
St. Louis Mills1,05775.00%793
Sawgrass Mills
2,170
100.00%2170
The Block at Orange69750.00%349
Briarwood Mall97450.00%487
Broward Mall998100.00%998
Columbus City Center1,06650.00%533
Del Amo Fashion Center2,09575.00%1571
Dover Mall887100.00%887
The Esplanade901100.00%901
The Falls82650.00%413
Galleria at White Plains878100.00%878
Gwinnett Place1,27850.00%639
Hilltop Mall1,06950.00%535
Lakeforest Mall1,08650.00%543
Marley Station1,06750.00%534
Meadowood Mall89350.00%447
Northpark Mall961100.00%961
The Shops at Riverside Square627100.00%627
Southdale Center1,335100.00%1335
Southridge Mall1,239100.00%1239
Stoneridge Mall1,29750.00%649
Town Center at Cobb1,27350.00%637
The Mall at Tuttle Crossing1,13350.00%567
Westland Mall820100.00%820

 Total Square Footage GLA$ per Square Foot GLA EstimateSquare Foot GLA * $ Estimate
Low 31,922,372$323$10,310,926,156
High31,305,372$400$12,522,148,800

Let's assume a low-ball offer of $323 per Gross Leasable Area or GLA:
10B sale price - 5.1B debt = 4.9B

Now subtract 30% in taxes that Mills would pay to the government:
4.9B - (4.9B * .3) = $3.4B

$3.4B/56M shares = $60/share

In my opinion Mills is EXTREMELY undervalued even based on a conservative sale price.

By biscosc at 2007-01-16 09:41 | Stocks | MLS | 4 comments
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Capital One (COF) analysis
Just recently I started keeping records of some of the financial ratios of companies being sold.  This is something I started doing after reading Christopher Browne's "Little Book of Value Investing". 

Below I've listed the ratios for three credit card companies.  Both Providian and MBNA have been sold in the last few years and these were the metrics I gathered from Morningstar the last day they traded. To keep things consistent, Capital One's numbers are the current numbers from Morningstar. 

Providian (PVN)
P/E = 9.8
Forward P/E = 10.1
P/S = 2.3
P/B = 1.7

MBNA (KRB)
P/E = 16.4
Forward P/E = 13.5
P/S = 3.2
P/B = 2.6

Capital One (COF)
P/E = 10.4
Forward P/E = 9.9
P/S = 2.0
P/B = 1.4

I consider Capital One smack dab in the middle of Providian and MBNA.  They seem to take on more credit risk than KRB but less than PVN did.  To account for this, I will average the PVN and KRB metrics and compare these against COF.

P/E -> (9.8+16.4)/2 = 13.1 avg P/E
      -> (13.1-10.2)/10.2 = .284
      -> COF is a 28.4% discount when looking at P/E

Forward P/E -> (10.1+13.5)/2 = 11.8 avg FP/E
                 -> (11.8-9.9)/9.9 = .192
                 -> COF is a 19.2% discount when looking at Forward P/E

P/S -> (2.3+3.2)/2 = 2.75 avg P/S
      -> (2.75-2.0)/2.0 = .375
      -> COF is a 37.5% discount when looking at P/S

P/B -> (1.7+2.6)/2 = 2.15 avg P/B
      -> (2.15-1.4)/1.4 = .536
      -> COF is a 53.6% discount when looking at P/B
           
In addition to being a glaring bargain based on companies recently sold, the largest shareholders of COF have good long term track records (except maybe Putnam). 
Have a look:

DODGE & COX INC 7.43% owned
LEGG MASON INC. 5.52% owned
PUTNAM INVESTMENT MANAGEMENT 4.46% owned
CAPITAL RESEARCH AND MANAGEMENT COMPANY 3.68% owned
BARROW, HANLEY MEWHINNEY & STRAUSS, INC. 3.47% owned
WELLINGTON MANAGEMENT COMPANY, LLP 3.23% owned

It should also be noted that Second Curve Capital has COF as their 5th largest holdings.  Second Curve is a hedge fund specializing in only financial stocks that has 20% annualized returns after fees since inception.

By biscosc at 2007-01-14 23:05 | Stocks | COF | 17 comments
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Recent Activity Update
I wanted to highlight some of the stocks I've been buying recently.  I have a strategy where I keep track of the holdings of a number of hedge funds and mutual funds and buy stocks that they have large ownerships in that are cheap (I try to buy within 15% of their 52 week lows).

BSX - Maverick Capital, Farallon Capital and Highfields Capital combined own 1.7% of the shares outstanding.  I acquired the shares at 14% above the 52-week low.

HSP - Greenlight Capital owns 3.83% of the shares outstanding making them the largest shareholder.  I acquired the shares at 11% above the 52-week low.

MU - Appaloosa Management owns 3.21% of the shares outstanding making them the 8th largest shareholder.  I acquired the shares at 4.6% above the 52-week low.

GY - Pirate Capital and Steel Partners II own 9% and 7% respectively of the shares outstanding making them the largest and second largest shareholders.  I acquired the shares at 16% above the 52-week low.

ELNK - Steel Partners II owns 5.65% of shares outstanding making them the second largest shareholder.  I acquired shares at 6% above the 52-week low.

By biscosc at 2007-01-02 11:53 | Stocks | 3 comments
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