Category Archives: Value Stocks

Short cuts: Greenlight Re, Hornbach & TGS Nopec

Greenlight Re:

One reader Emailed me that I had made a mistake in my initial post with regard to the book value and P/B ratio. This is what I wrote in December:

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2007 2008 2009 2010 2011 2012 2013 2014 2015
P/B Ratio 1,24 0,96 1,23 1,23 1,08 1,03 1,19 1,05 0,78
P/B Ratio adj. B Shares 1,48 1,15 1,46 1,47 1,29 1,23 1,42 1,25 0,93

For some reason, the official Bloomberg ratios do not include the class B shares held by David Einhorn, so I adjusted them accordingly.

Actually, the B shares are included in the stated Bloomberg Ratios despite showing the wrong number of shares, so the “true” P/B ratio is around ~0,79 which then of course makes the “mean reversion” story even more compelling.

Additionally, Greenlight already released the monthly investment return for December which was -0,1% against -1,6% for the S&P 500. So at least its going into the right direction.

Maybe one quick point on comparisons of Greenlight Re to Berkshire, Markel or Fairfax: Although it is true that the other companies have better track records, I do think that Greenlight has one big advantage: The company is transparent and relatively easy to value as the whole investment portfolio is marked-to-market. And as I pointed out, Greenlight for me is not a long-term compounding story but a mid-term special situation betting on a David Einhorn outperformance.

Hornbach

After Hornbach’s profit warning in December, a lot of people asked me: What are you going to do ? Are you selling now ? Why do you own Hornbach at all ?

First thing: I wil do nothing and watch. For me , the profit warning was very surprising as I thought that they are on a good track and have the right strategy, although the business they are in is very tough.

For me, Hornbach is a pretty low risk position. My expectation was that I can make around 10-12% p.a. with very little risk. Until Q3 2015, that was on track but now of course it looks like a clear underperformer.

One of the reasons for this is clearly the fact that in contrast to almost any other stock in Germany, Hornbach did not enjoy any multiple expansion over the last 5 years. For a capital intensive, real estate dominated business like Hornbach, book value is one of the relevant measures. If we look at this we can clearly see that Hornbach now is valued at the low end of the historical range of P/B which ranged from ~0,8 – 1,8 in the past 15 years:

P/B BV/Share
30.12.1999 1,86 8,335
29.12.2000 1,46 8,679
28.12.2001 1,07 11,654
30.12.2002 0,99 11,642
30.12.2003 1,09 12,103
30.12.2004 1,10 13,201
30.12.2005 1,17 13,661
29.12.2006 1,33 15,182
28.12.2007 1,31 16,441
30.12.2008 0,81 18,784
30.12.2009 0,89 20,584
30.12.2010 1,09 22,947
30.12.2011 0,93 24,900
28.12.2012 0,99 25,881
30.12.2013 1,03 27,101
30.12.2014 1,04 29,023
Jan 16 0,84 31,230

Obviously, Hornbach does have some issues. Personally I think one needs to watch the E-Commerce issue most closely. So far I thought that DIY does not have big issues with Amazon & CO but this now needs to be tested.

TGS Nopec

Tgs Nopec released preliminary 2015 figures and a first outlook for 2016. Naturally, the outlook is rather subdued. Combined with the drop in oil prices, the stock got hammered. For shareholders, the only positive aspect is that TGS still is doing a lot better than its capital-intensive competitors, for instance PGS or CGG:

For the moment I will not do anything. Clearly the oil price went lower than I ever thought but TGS has net cash and will manage the cycle conservatively. So I don’t think one has to panic now.

Overall I think the best advice in such a situation is: Either you panic early or you don’t panic at all. For the early panic it is already too late for oil related stocks in my opinion, so the only alternative is to sit it out.

My 27 investments for 2016

Over the years I found it quite helpful to list my current investments at the end of each year and try to explain (to myself) the investment case in a few sentences.

Former posts can to be found here:
My 28 investments for 2015
My 24 investments for 2014
My 22 investments for 2013

Compared to last year, Sberbank, Gronlandsbanken, Cranswick, Trilogiq, KAS bank and Energiedienst were sold, the Depfa LT2 matured. New positions bought in 2015 are Aggreko, Partners Fund, Lloyds Banking, Gagfah, Pfandbriefbank and Greenlight Re. With 27 stocks, the portfolio is still maybe a little bit too diversified, my preference would be to have not more than 25 positions. Interestingly, only 5 stocks of the 2013 list are still in the portfolio, so there has been some turn around.

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Banking update: Handelsbanken, Lloyds Banking & Gronlandsbanken (sale)

Although I usually don’t care that much about quarterly earnings, let’s start with two interesting ones:

Handelsbanken

Handelsbanken is on my watch list, I consider them as one of the best bank franchises globally but still a little bit too expensive. Officially, “Mr. Market” was disappointed because earnings were below expectations. The stock dropped around 8% on that day:

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Fossil Group (FOSL) – A great value stock with only temporary problems ? (part 1)

Fossil is a relatively well-known, US-based company which sells mostly watches and other accessories across the world, under its own brand but also under licenses from other famous labels (Michael Kors, Armani etc).

The stock has been hit hard in the last months and has lost more than 50% since its peak in 2012/2013. The Stock chart is a typical “falling knife”:

Fundamentally the stock looks very cheap, especially compared to historic profitability and growth:

Market cap: 2.660 mn USD (55 USD per share)
P/B 3,2
EV/EBIT 7,8
P/E Trailing 7,8
P/E est (2015) 10,7

10 year averages:
– P/E 17,7
– Profit margin 9,9%
– ROE 23%
– EPS growth 19,1%

So only looking at those historic numbers, Fossil looks like a high growth, capital light and highly profitable company at a bargain price. But as I have written before: Especially in an environment like now, cheap stocks are cheap for a reason.

Why is the stock cheap ?

There is a pretty decent Value Investor’s Club short thesis from late 2014 which lists a lot of the issues issues nicely. I would summarize it as follows:

1. The watch market in general is cooling down rom a high growth period
2. One of the main drivers, the Michael Kors brand (~1/4 of Fossil’s total sales) is having problems and the license agreement was expiring
3. The potential impact of Smart Watches.

I would personally add another fundamental issue which is:

4. Changes in the distribution structure & Social media branding

Let’s look Smart Watches first

Smart watches (and other wearables) are clearly a threat for established watch makers. It is hard to say if they will replace a significant share of traditional watches. With regard to Fossil one can make however the following observations:

a) Fossil is clearly NOT a first mover. They unveiled some first models in August and want to be on the market before Christmas but Sony ,Samsung, Motorola and of course Apple were much faster. Samsung now has 2 years experience and the new Gear S2 looks pretty good.

b) However the BIG question for Fossil is: If Smart Watches are succesful, will “Branding” work for Smart Watches the same way as for normal watches ? Fossil makes most of its money with branding, i.e. buying the stuff cheap in China, getting a license and putting a fancy name like Michael Kors on it and sell it expensively.

If you look at smartphones, branding for smartphones doesn’t really work. There was the Prada phone from LG but this seems to be not worked very well as I haven’t seen any new Prada phones since 2012. Most phones are sold under the name of the producer more like “regular” electronics. Why doesn’t branding work for smart phones ? I am not sure but I think it has to do with several factors such as rapid technological change. A brand like Samsung or Sony stands for technical excellence and people won’t pay more for a fancy name. If you want something fancy then you buy yourself maybe a Hermes Iphone case for 340 USD but not a Hermes branded phone.

I could imagine that Sports branding could work, as Smart Watches seem to focus on health and activity. For some reason however, adidas seems to have launched their first version of a smart watch already 2 years without the help of Fossil. So it seems that the Adidas license does not cover automatically all kind of watches.

Finally an interesting quote from the Michael Kors CEO with regard to slowing watch sales under the Michael Kors brand (from Bloomberg):

“A slowdown in our watch business, that has been significant and it happened very, very quickly. While I think many people think it is a result of the Apple Watch, it’s actually not. I think it is a result of the iPhone 6 where we did see some softening in our business when iPhone 6 was introduced. There’s clearly a younger customer, in particular, in America who is wearing watches less because they view the iPhone as something that they tell time with and watch becomes slightly less relevant.”
John D. Idol – Chairman, CEO, Michael Kors, Deutsche Bank db Access Global Consumer Conference, June 11, 2015

It could easily be that the Michael Cors CEO tries to blame the Iphone for the decline of his own brands but interesting nevertheless.

Changes in distribution & Social media branding

Historically,the distribution system of Fossil was clearly one of the competitive advantages. They did have own stores but most of their watches were sold in department stores like Macy’s or JC Penney plus Walmart. However as the department store format works less well, they have to adapt. They seem to do this by opening more and more own stores. They also clearly try to sell more online. However, as I experienced with Piquadro more than 3 years ago, moving from a more wholesale oriented model to a direct one is not easy.

Renting and running own stores is very different from delivering watches to a department store. It is riskier, you need more inventory and you need expertise in real estate.

Another threat is that the internet and social media seem to have lowered the barriers to entry. I had linked a few days ago to a story about Brandtech, the way some companies like Tesla use social media to create powerful brands.

If you go on Amazon and search for watches, the first page is dominated by “Daniel Wellington” watches. On the German site Amazon.de, the 20 most sold Watches are dominated either by super cheap no names below 10 EUR or Daniel Wellington. 6 of the 20 most sold watches are Daniel Wellington with an average price of 100 EUR, only 2 are Fossil watches. Amazon’s US top selling watches are interestingly allmost all very cheap models with Casio dominating the rankings.

Daniel Wellington is an only 4-year-old Swedish company which managed to go from zero to more than 200 mn USD sales in 4 years. The trick seems to be aggressive promotion via social media as outlined in the Brandtech article:

Tysander refuses to pay for traditional advertising, instead working with thousands of bloggers, celebrities, and other “influencers” worldwide. One of them, Blake Scott, 27, has been collaborating with Daniel Wellington for a little more than a year, sharing the watches with his 318,000 Instagram followers. “I first found out about Daniel Wellington via Instagram: Everyone outside the States was wearing one, and it seemed so cool,” he says. Soon after, someone from the brand reached out and said he wanted to give Scott a couple of watches to post on his feed. Eventually he negotiated a deal with the company, which paid a few hundred dollars for a multiweek campaign.

Other than that, they do exactly the same thing as Fossil:

Although DW bills itself as a Swedish company, the watches are manufactured in China, which is how the company keeps prices so low. The internal quartz movements—a battery and vibrating crystal to keep the time, essentially—come from Miyota, a Japanese supplier popular with lower-price brands, because their products are reliable and they always have a massive inventory. The rest of the components are made and assembled in Shenzhen, a manufacturing hub.


So clearly Fossil does not have anything like a moa
t, even the wholesale distribution network seems to be quite open for newcomers like Daniel Wellington. If you can build fresh brands as quickly as that, one also needs to think about how this changes the value of licenses of “famous” brands at least in the fashion category. One needs yet to see if Daniel Wellington is only a short-lived outlier or if more is to come.

What I like about the company

In general I found their annual reports pretty good and informative. If a company is in a situation like Fossil, with growth going away and cash flows still coming in, the danger is always that they do something stupid and/or incentives of management and shareholders are not aligned.

At Fossil however I found two statements which are quite impressive and indicate an above average management quality of the company.

This is a statemnt from the annual proxy statement about Kosta Kartsotis, Co-founder, CEO and 13% shareholder:

The Board believes that this structure is effective and best for the Company at this point in time for several reasons. Mr. Kartsotis joined the Company in 1988 and has been a director since 1990. He holds a significant number of shares of our Common Stock, and since 2005 he has refused all forms of compensation for his service as an executive officer, expressing his belief that his primary compensation is met by continuing to drive stock price growth.

Compared to this, Warren Buffett looks quite greedy in earning 100 K a year for being CEo. Mr. Kastsotis is basically working here for free. He has reduced his stake over time but in the last few years very little. Clearly without a salary he needs to sell some shares in order to get cash, but it would be quite easy for him to command a normal salary which could be at lest a mid single million USD number and no one could complain.

There was another great statement in the annual report on capital allocation and dividends:

Cash Dividend Policy.
We did not pay any cash dividends in fiscal years 2014, 2013 or 2012. We expect that for the foreseeable future, we will retain all available earnings generated by our operations for the development and growth of our business and for the repurchase of shares of our common stock

Fossil has bought back massive amounts of its own stocks in the last few years, around 1/3 of the outstanding shares have been bought back and they continue to buy more. Although part of thse stocks have been bought at 100 USD or more, I prefer this kind of capital allocation to doing stupid M&A transactions.


Summary part 1:

Fossil clearly has some fundamental issues to cope with. A general slow down in the industry combined with expiring license agreements has had direct and short-term negative effects on margins. The thread of smart watches adds further uncertainty. On top of that new competitors like Daniel Wellington seem to have no problems to enter the market and quickly gain market share.

Such a uncertain situation would normally be a clear reason NOT TO INVEST and stop researching as any margin of safety could quickly disappear.

On the other hand, Management seems to be properly incentivised and the capital allocation looks top notch. So I will digg a little deeper and try to come up with a valuation in a second post.

Value Investing Strategy: Cheap for a reason

Value investing is all about investing into stocks where the current price is “cheaper” than the underlying value.

The problem is clearly that although we know the price of the stock at any point in time, we can never be sure about the “true” value of a company as the future is uncertain.

So quite logically many value investors start searching for undervalued stocks within the group of “optically” cheap stocks. I often get emails like ” What do you think of stock xyz, it’s only trading at a P/E of 3 or P/B of 0,2 – isn’t this a great opportunity ?”. Isn’t it a great BARGAIN ?

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Driverless cars + Uber –> Death of Car Insurance ?

As this became a long post, a quick management summary upfront:

The case for 100% self driving cars without accidents is not so clear for me
1. Based on current facts, the Google car doesn’t seem a lot better than human drivers
2. From other areas (Airplanes, chess) we can learn that a human-machine combination is often better than a “machine” alone
3. Driving cars is also an emotional experience, many people might not fully sacrifice this
4. Some innovations take longer than one thinks, especially if they take away freedom from consumers
5. A gradual decrease of claims could actually be positive for car insurers over an extended period of time

Additionally, I don’t see a combination of driverless cars with a service like Uber replacing private cars anytime soon. There are a lot of practical issues with renting out private cars to complete strangers. However, taxi driver might not be a job with a big future either.

So from my perspective, as shareholder of a car insurer like Admiral there is no reason to panic, however for traditional insurers this might be one more nail in their coffin.

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