Category Archives: Anlage Philosophie

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

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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 moat, 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.

SunEdison (SUNE) – Deja vu all over again

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SunEdison, a US based renewable energy company popped up 2 times on my radar screen. Once a year ago as one of David Einhorn’s top picks and last week as one of the very few published long investments of John Hempton at Bronte.

I try to sum up Einhorn’s 2014 thesis in four bullet points:

– Solar energy is competetive, strong growth almost guaranteed
– SUNE has a moat and will grow strongly by maintaining its margins
– extra value is created via the “YieldCo” subsidiary
– investors don’t understand the company especially the fact that most of the debt is “non-recourse”

The “Moat”

From Einhorn’s slide deck:

As an experienced project developer, SUNE’s financial, legal, and due diligence expertise gives it a competitive moat. It has opened offices in the most attractive international markets several years before anyone else, giving it a first mover edge and unique geographic diversity in an industry that faces capricious governments, currency fluctuations, sovereign risk and competition.

Well, now it is pretty easy to point out that this thesis might have some flaws after the stock cratered in the last weeks:

Let’ just look at the annual report where SUNE reports on competition:

Competition. The solar power market in general competes with conventional fossil fuels supplied by utilities and other sources of renewable energy such as wind, hydro, biomass, concentrated solar power and emerging distributed generation technologies such as micro-turbines and fuel cells. Furthermore, the market for solar electric power technologies is competitive and continually evolving. We believe our major competitors in the renewable energy services provider market include E.On, Enel, NextEra, NRG, SunPower Corporation, First Solar, Inc., JUWI Solar Gmbh and Solar City. We may also face competition from polysilicon solar wafer and module suppliers, who may develop solar energy system projects internally that compete with our product and service offerings, or who may enter into strategic relationships with or acquire other existing solar power system providers.
We also compete to obtain limited government funding, subsidies or credits. In the large-scale on-grid solar power systems market, we face direct competition from a number of companies, including some utilities and construction companies that have expanded into the renewable sector. In addition, we will occasionally compete with distributed generation equipment suppliers.
We generally compete on the basis of the price of electricity we can offer to our customers; our experience in installing high quality solar energy systems that are generally free from system interruption and that preserve the integrity of our customers’ properties; our continuing long-term solar services (operations and maintenance services) and the scope of our system monitoring and control services; quality and reliability; and our ability to serve customers in multiple jurisdictions.

If you compete mainly on price, then there is obviously not much of a moat. There are no network effects, they don’t have any patents and clients don’t care about the brand of a solar project company. In contrast, a strongly growing markets attracts many new entrants which will drive down margins especially if it is relatively easy to enter the market. or even if there would be an “econimies of scale advantage”, in a strongly growing market this is not worth much

Germany is here maybe already some years further in the experience curve and one learning here was that there wasn’t any first mover advantage. In contrast, many of the first movers made some real mistakes like contracting solar modules for fixed prices and were then wiped off by the followers who bought cheaper.

Success metrics

If you look at SunEdisons investor presentation, you don’t see any GAAP numbers, only adjusted EBITDAs and self created metrics like MW and GW delivered etc. The reason is clear: GAAP numbers look awfull, both earnings and cashflows at all levels. The company is using boatloads of money under GAAP reporting.

Overall, the accounts are pretty much incomprehensible not only on the financing side but also cash flow wise. So non-recourse debt sounds great but without earnings it will be a quite difficult investment case.

The YieldCo – TerraForm Power

TerraForm Power is a consolidated subsidiary of SUNE but has a stock listing and minority shareholders. The sole function of TerraFrom power is to buy the projects from SUNE, leverage them up ~4:1 or 5:1, hold them and pay out dividends. The stock price got hit hard along SUNE as this chart shows:

However according to Einhorn the participation is extremely valuable due to 2 reasons:

1. A Yieldco structure is value enhancing per se as Yieldco investor require much lower returns on investment as stock investors
2. Terraform and SUNE have a structure in place where SUNE retains much of the upside of the YieldCo, so the worth to SUNE is much higher than the market value of the shares

Einhorn makes some remarkable comments in his presentation, but I was struck mostly by this one:

In the recent sell‐off, Terraform’s shares declined with the oil and gas MLPs. Because most MLPs pay out cash flows from depleting oil and gas reserves that need to be replaced with new wells, these companies need continued access to cheap capital just to sustain their dividends. Terraform doesn’t face that risk because solar assets don’t deplete. So Terraform will only raise capital for growth.

Well, this is clearly wrong. Of course do Solar panels deplete. They seem to deplete clearly slower than oilwells but the problem is that there are not that many old solar panel installed to actually get statistical relevant numbers. Some studies show that there is a relatively high loss of power in the beginning (~5%) and then a depletion of capacity of around 1% per year. Additionally, most of the funding and the electricity take-off agreements have to be renewed at some point in time which includes some significant “roll over” risk ithin the YieldCos.

Another thing that struck me is the fact that both, SUNE and Einhorn assume ~8,5% p.a. unlevered return on their renewable assets going forward which then can be levered up nicely even if you have to pay 6% interest on your bonds. I don’t really know the US market, but assuming such a yield in Europe would be completely unrealistic. Unlevered yields for renewable energy projects are at 4-6% p.a. max and you can only lever them up with “low cost” leverage for instance pension or insurance liabilities, it doesn’t really work with long term more expensive “subordinated” capital as many companies have found out the hard way.

Maybe the US market is less competitive to allow such returns ? I find that hard to believe. Just by chance I have been involved in some uS wind projects and the returns are nowhere near 8% unlevered but rather similar to European yields.

Another thing which is different to European projects: In Europe, you don’t have specific credit risk in the projects as the electricity has to be taken off from the grid, which means that basically all grid user guarantee your return. SunEdison’sproject contain undisclosed credit risks because if the client default there will be no backstop.

That leads to the question: Who on earth is actually buying into those YieldCos ? In TerraForm’s case any upside is capped and equity holders are fully exposed to any problems that could show up like increasing interest rates, defaults of off-takers, debt roll risk etc. So who is prepared to take equity like risk but accepting bond like returns ? I do know but my guess is that many yield starved private investors will most likely not care about the risks as long as they get a “juicy” dividend. In Germany something similar but on a lower scale happened. a lot of the renewable companies financed themselves with “participation rights” and promises of high dividends but most big cases ended in spectacular failures. I covered some here for instance

To shorten this: Yes, at the moment the Yieldco structure could actually generate some value because for the time being there seem to be enough stupid investors out there who buy something with equity risk in exchange for bond like returns. But this could go away quickly especially if some of them blow up spectacularily. It’s the same old reason why people on Wallstreet earn so much: Pretending that repackaging an asset increases its value.

Financing structure

Although the complicated financing structure attracted me to the stock in the first place, based on what I have written above I don’t think it’s worth the time to dig deeper. One thing that John Hemption seems to have missed in his post is the fact SUNE has implemented a margin loan with TerraForm Power shares as collateral. Such a strcuture alone for me already indicats that either those guys don’t know what the are doing or that they are really desperate.

In such a case the only “safe place” in the capital structure is within the senior secured paper, everything else in my opinion is more a gamble than a value investment.

Summary:

At the first glance Sun Edison looks interesting. You can buy into a (still) strongly growing company at around 1/3 of the price David Einhorn paid a year ago. From my point of view however the business relies on two fundamental assumptions to perform as planned:

– the ability to continously source renewable energy projects with really high yields (“risk free” plus 6% or so)
– enough stupid investors who buy into YieldCos with equity like risks and bond like returns to subsidize the development company

If Germany as one of the renewable power pioneer markets is any indication, both assumptions will not hold for very long. In Germany’s case, the yield for the projects went down very quickly especially after government subsidies were reduced and the “yield investors” got fleeced massively as a consequence.

Clearly, in the short run SUNE and TERP could make massive jumps up and down in price but mid- to long term I don’t think that they will be great investments.

P.S.: It might look like I want to bash David Einhorn, as this is already the third time that I strongly disaggree with him after Delta Lloyd and Aercap. But on the contrary, i do still think that he s one of the best investors in the hedge fund area, he just had some bad luck and a lot of money to manage which makes things difficult.

Arcadis NV (ISIN NL0006237562) – One deal too many ?

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Arcadis is a stock which popped up in my “BOSS score model” which I still use regularly to find ideas. It is a Dutch based Design, Consulting & Engineering company with global reach and a diversified business. Historically, they have consistently produced ROE’s of 20% and grown nicely.

Some key figures:
Market cap 1,7 bn EUR
P/B 1,7
P/E 19,5 (2014), 11,6 (2015 est)
EV/EBITDA 10,4

The company trades at a ~20% discount to Peers like AF AB, Ricardo or SWECO.

What I did like about Arcadis at “first sight”:

+ consulting is capital light business
+ potential growth areas like infrastructure, water, urbanization
+ ROIC as relevant measure for compensation
+ organic growth as target for compensation
+ well-regarded in the industry

What I didn’t like so much:

– large project exposure
– China / EM Exposure (26%)
– Utility exposure (22%)
– big M&A transactions in 2014
– annual report focuses on adjusted numbers
– debt significantly increased, far above target

Hyder Consulting acquisition in 2014

In 2014, Arcadis did several larger acquisitions, the largest one being the UK listed Engineering company Hyder Coonsulting Plc. After the first bid, a Japanese bidder emerged and at the end they had to pay around 300 mn GBP for a company that earned around 6 mn GBP in 2014. This really looked expensive and is maybe one of the reasons why EPS in the first 6 months 2015 fell from 0,77 EUR to 0,70 EUR per share.

Looking into historic annual reports one can see that there was little organic growth for many years (page 15) and growth was driven by acquisitions:

arcadis

Arcadis looks pretty much like your typical “roll up”, gobbling up competitors one after the other. However with the Hyder deal, it looks like that they made maybe “one deal too many”. Debt is now clearly above their own targets and business is not doing well. They acquired Hyder for their Asian presence which maybe looked like a good idea last year.

Management incentives: The reality test

When I did read the annual report 2014, I really like the fact that management seems to be incentivized on ROIC and organic growth. However, this is the score card they presented with their half-year numbers:

arcad sct

At first sight the source card looks, great, everything green, only organic growth “orange”. A closer look actually shows that the only target they hit was actually external growth which in itself is a pretty stupid target. All the other targets were either misses or not available.

This slide alone to me indicates that management doesn’t take its stated goals that serious. Yes, on paper it looks great but such a “target achievment assessment” is clearly a joke.

Summary:

Although the “roll up” strategy seems to have worked for some time, in my opinion there is the risk that the 2014 acquisition spree was maybe too much. If they can make the acquistions work, the stock would be relatively cheap, but combined with the current debt load the stock is now much riskier than it was in the past. Bilfinger is a good example how a seemingly working “buy and build” strategy can implode over night.

It is also a good lesson in checking if a compensation system which looks good on paper is actually implmented and followed or if management just adjusts everything to look good despite not achieving the targets.

So I will watch this from the sidelines although I like the business and industry in general.

New investment: TGV Partners Fund ( ISIN DE000A0RAAW6)

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Full Disclosure:
This is not investment advice or advertisement. Do your own research. The fund manager did not ask me to write this post, it was the sole decision of the author. The author is personally and with real money invested in the fund and knows the fund manager for many years. The author will get a symbolic “liquid commission” for any new investors coming through the blog which will be disclosed at the end of the post.

In March I already wrote a “prequel” to a potential new fund investment, listing the requirements I see for giving money to another investment manager. Now I have done it.

The fund is called “TGV Partners Fund” managed/ sub-advised by “MSA Capital”. The website of the fund and more information can be found here, the website of the sub-advisor can be found here: MSA Capital.

Back then I listed the following criteria which were important to me in order to trust part of my money to someone else::

1. The manager has to be trust worthy
2. The manager should have most of or even better all his money in the fund
3. the manager has a different skill set than oneself or just better skills or access to different assets
4. The manager should still be “hungry”
5. The fund manager is not only in for the money
6. The investment vehicle should be a “fair” structure

So let’s check the TGV Partners fund against it:

1. The manager has to be trust worthy
Well, I have an unfair advantage here as I have done “due diligence” on Mathias Saggau the fund advisor/manager for the last 8 years or so, constantly exchanging ideas and talking about everything (and drinking some cold beers together…). Mathias himself has a very good “credo” to ultimately decide if he invests into a company. He asks himself the question: “Would I trust my wallet for safekeeping to the CEO ?”. If there is the slightest doubt, he will not invest. Period. Would I trust my Mathias with my wallet ? Yes, absolutely.

2. The manager should have most of or even better all his money in the fund
That’s the case, Mathias invests all of his money in the fund alongside his clients.

3. the manager has a different skill set than oneself or just better skills or access to different assets
The thing I admire most is his ability to really dig really deeply into to companies and industries. I think he is very good in judging if there are competitive advantages in the long run. His deep research combined with a long time horizon allows him to have very high convictions and run a concentrated portfolio. Personally, I think I can pretty well identify what doesn’t work, but I am less able to identify what actually works, so I do think it makes sense to “outsource” some money to someone who has this skill. We do have some overlaps but I can live with this …..

He is also connected to other great investors via the “Investmentgesellschaft für Langfristige Investoren TGV” which contains an enormous amount of investment wisdom. I know all the people there personally as well and had the privilege to attend some of their events such as the 2 day conference in Omaha before the annual meeting of Berkshire.Rob Vinal from RV Capital works under the same “roof” and with a similar structure.

4. The manager should still be “hungry”
He is just starting the fund and will “work his but off” to succeed. I know that he is thinking about stocks most of the time, including weekends…..

5. The fund manager is not only in for the money
I know that Mathias has transformed his hobby into his job. He is an absolute “stock maniac” in the most positive sense.

6. The investment vehicle should be a “fair” structure
The TGV structure is a rarely used structure, sometimes it is called the “German Hedge Fund structure” even though it is open for public investors and similar to a Sicav. One of the key features is that the fund’s interesting share class is open only on a quarterly basis. Many investors might feel uncomfortable with this. But if you run a concentrated portfolio with potential illiquid stocks, you definitely don’t want someone to call and ask for his money back the next day, especially in bad market environment. Also as an long term investor, investor you want to make sure that the manager doesn’t have to dump his shares cheaply just because another investor gets nervous because this hurts all investors. I also know the main seed investor personally and he is in for the long-term. It also helps enormously NOT to see daily movements in the value of investments.

The TGV structure allows more flexibility than normal funds, especially with regard to instruments (shorts, derivatives) and more importantly, more concentrated portfolios. One of the major disadvantages for the fund manager is the fact that this structure is much harder to sell to investors such as fund-of-funds because of the unfamiliarity and lack of instant liquidity. As an investor I find this positive because you can be pretty sure that if someone choses this structure, he will not be in for pure “asset gathering” but for performance.

Portfolio & Investment style

The portfolio composition as of 30.06.2015 can be found here. The largest position is Google with a 15% weight followed by National Oilwell Varco (11%) Distribution NOW (9%) and Verisign (7%). As one can easily see by looking at some of the stocks (Amazon, Morning Star etc,) this is clearly no Graham style “deep value” portfolio. I would describe his investment style as “Munger meets the 21st century with a contrarian angle” kind of investing which means using the underlying framework of competitive advantages (“Moat”) and good management but transporting it into relatively new sectors such as software or internet related companies. As Mathias is still in a relatively early stage of his carreer I expect that his investment style and “circle of competence” will further evolve and he will become even better than he is now.

For any further information I can only recommend the freshly published shareholder letter (Englisch, German). He discusses his philosophy and three specific stocks: Admiral, Amazon and TGS Nopec.

Let’s talk about “commissions”
Normally I don’t take any kick backs etc. for recommending something on my blog. But in this case and based on my special relationship with Mathias, I had to make an exception. The deal is the following: For every new investor who mentions my blog before (or after) investing with him, I will receive one “Kölsch” (0,2l) at a bar of my choice in Mathias hometown, independent of the amount invested.

Just to be clear: Mathias has to pay this out of his own pockets (not from the fund) and neither Mathias nor I will receive or pay any other “commissions”.

Portfolio transaction:

For the portfolio, I assume I have bought a 4% position at the price of 30.06.2015. As this is a “special” position, it does not count towards my 1 transaction per month limit.

Value Investing Strategy: Cheap for a reason

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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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Peyto Exploration & Development Corp – Canadian Cowboys or “Outsider” company ? (part 1)

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A few days ago, I linked to a shareholder letter where the CEO of the Canadian NatGas Fracking company Peyto discussed his opinion on the book “The outsiders”.

As some readers might have noticed, I started to look into the energy sector some time ago. First reading some books (Exxon, The Frackers) and a quick look into Cheniere Energy, the NatGAs liquification play.

As I try to expand my knowledge in the energy sector and a CEO reading and discussing “The Outsiders” made me very curious, I started to read the CEO’s monthly letters (going back to December 2006). They are 2-3 pages reports which cover various topics. Although some things are repeated, the information content was extremely high.

I found myself reading report after report until I had read all 105 (!!) of them (you’ll find notes on the memo at the end of the post).. I found them fascinating for 3 main reasons:

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Deutsche Pfandbriefbank AG “forced IPO” – “Superbad” or interesting special situation ?

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Management summary:

Oh my god, a bank again…. But Deutsche Pfandbriefbank is actually a pretty simple case: As a “forced IPO” of the good part of Hypo Real Estate, the bank is comparable cheap (P/B ~0,61) against its main peer Aareal bank (P/B 1,0). In my opinion, the risk is limited despite the recent HETA losses as the German Government has absorbed all of the really bad stuff in the bad bank. Similar to cases like Citizen’s, NN Group and Lloyd’s, PBB offers an interesting and mostly uncorrelated risk/return profile for patient investors provided that valuation multiples normalize at some point in time. Positive surprises like M&A are potentially on the table as well.

DISCLOSURE: THIS IS NOT INVESTMENT ADVISE. Do your own research. The author might have bought shares already.

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My 8 word investing philosophy: Be patient, think independently and protect the downside

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Morgan Housel from Motley Fool (one of the best financial writers in my opinion) had a great post on short investing philosophies. Boiling down rather complex “animals” like a whole philosophy on the one hand is a little bit dangerous, on the other hand, a good philosophy like a good red wine based gravy gets better and better the more you reduce it. I did write down my general investment rules here but it is much more a description than a (short )philosophy. Before moving to my own short version, I liked those 3 statements best:

Eddy Elfenbein, blogger, Crossing Wall Street: “Be patient and ignore fads. Focus on value. Never panic.”

Barry Ritholtz, Bloomberg: “Keep it simple, do less, and manage your stupidity.”

Bryan Hinmon, Motley Fool Asset Management: “Own compounders. Buy smart. Be patient.”

So my own statement doesn’t look that innovative: Be patient, think independently and protect the downside Actually this statement is the combination of 3 very basic principles: 1. Be patient The most important of all: Think long-term, invest long-term and let the “Magic of compounding” work for you. Cancel out the noise like quarterly earnings, monthly macro statistics or weekly employment figures. Don’t trade in and out of stocks frequently, this will save costs and nerves. Don’t market time. Make sure you don’t need the money you invest elsewhere. I am still in the learning phase which regard to this but achieving true patience is maybe the ultimate “black belt” of investing. 2. Think independently I would say that trying to think independently is the fundamental character trait which then helps to prevent of falling for fads, manias and panics. The hard thing is to actually to do it. For me it helps enormously NOT to read broker research but focus on original information first (annual reports, balance sheets, original press releases) and then read comments etc. later when researching an investment. Also reducing the amount of input can help. Don’t look at real-time price changes and ignore “real-time news”. Twitter is not a good investment advisor. Do read financial news with a time lag. I read the FT for instance more often than not with a 1 week time lag and annual report often several month after they were released. Avoid “Hot stocks” and “crowded trades” as a matter of principle. 3. Protect the downside No one can avoid losses, even Warren Buffett makes the occasional mistake (Tesco). However you can try to minimize this risk by doing a good Due diligence and focus on what can go wrong first. Try to “kill the investment” first and then look at the potential upside. If there is any doubt on the validity of the business model or of the industry make sure you understand it better than everyone else before investing. If there is any doubt with regard to the financials and/or integrity of management, stay away. As Charlie Munger said it “Stay out of trouble”. If you estimate the upside, stay conservative. For me this also means not being to concentrated on single positions. Anyway, I can only recommend any reader trying to come up with a short “philosophy statement” as well, it is definitely a very god exercise.

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