3 Years of Value & Opportunity

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Sometime it is scary how fast time flows. 3 years have passed since the first post appeared on this blog.

According to the statistic tool of WordPress, in 2010, the blog had 310 “hits” which translates to around 20 per day. In 2013 this number has increased by the factor of 50.

This might be the right place to say a big “THANK YOU” to all readers and an even bigger “THANK YOU VERY MUCH” to everyone who has contributed either via comments and or EMails.

Top 10 posts this year

1. How to correctly calculate Enterprise Value
2. My 22 investments for 2013
3. Operating Cash Flow and interest expenses – (ThyssenKrupp vs. Kabel Deutschland, IFRS vs. US GAAP)
4. Risk free” rates and discount rates for DCF models
5. Kurzanalyse Prokon Genußrechte
6. TGS Nopec ( ISIN NO0003078800) – an “Outsider” Company Buffet would buy if he could ?
7. P/E, EV/EBITDA, EV/EBIT, P/FCF – When to use what ?
8. Berkshire Hathaway 2012 listed stocks performance
9. Piquadro SpA – Competitors, market analysis and strategies
10. Spin off watch: Osram Licht AG

Interestingly, the “general interest” posts generate a lot of traffic. My guess is that many business administration students are using Google instead of reading their books……

Why I (still) blog

For me, this form of writing is the single best way to focus and structure my investment ideas. As I can spend only a limited time per day on this and my “physical” record keeping abilities are quite limited, the blog enables me to effectively organise my research and quickly revisit each thought.

The second most important issue of blogging is feedback. I am a big believer in getting “challenging” feedback. Yes, there are also forums etc. but via the blog it is much easier for me to keep track of discussions. I am also very proud that the comments I get are on average of much much higher quality than the discussions in many investment forums.

How I do it

Sometimes I get asked how I have so much time for blogging. To me this is surprising, as I spend “only” around 1-1.5 hours (week ends included) per day on my private investments in total. For me, researching stocks and writing a blog post has become an almost seemless process. I mostly read electronic documents. For instance, when I was researching the Metso/Valmet Spin off, I make notes already into the blog. It then takes maybe 10-15 minutes to structure the notes into a blog post. So overall, the effort of writing the blog itself is not so big and only around 10-20% of my “private investment time”. However, I have to admit that I spend the rest of the day with somehow related finance topics 😉

Interestingly, the “structuring” part is also the part where I sometimes have to change my initial opinion. I guess this is some kind of “second level” thinking. Several times, I had a pretty solid opinion early on when looking into the stock, which then changes before actually releasing the post.

On going “professional”

Sometimes I get also asked, why I am not ging into “professional” investing. One of the big issues in my opinion is the institutional set up of many investment organisations. In many cases, time horizons of such institutions are rather short and analysts are forced to specialize within categories and sectors. This leads to the strange situation that even passionate investors often don’t really enjoy working in such environments, because more often than not Asset Managers are run by “business persons” which want to increase AuM before anything else.

I sometimes dream of setting up my own fund, however so far I did not have the courage to actually do so. I guess it is not easy to find enough investors for the kind of “go anywhere, invest in potentially everything” style I prefer without a “formal” track record.

Lessons learned (hopefully)

I am not sure of my investment approach has “evolved” but it has clearly changed since I started the blog. A few subjective observations:

– I trade a less than before. I am down from around 30-40 changes in portfolio constituents per year to 10-20. That doesn’t sound much but is effectively a doubling of the average holding period
– 4-5 years ago my portfolio would have been 97% German, now it is around 25%
– I used to focus mainly on price/tangible book value, today this is a rather secondary criteria
– looking at business models has become a much more important part of my analysis. I still don’t like to pay for growth but it prevented me from investing in some potential value traps
– “special situation” investing has become a bigger part of my portfolio

Personal highlights

Finally a few personal highlights from the last year:

1. The real high light was clearly my trip to Omaha to see Charlie and Warren live.

2. The biggest learning experience was clearly the IVG case. Although I lost money with that I think I gained a lot of insight for potential future distressed situations. Especially when to stay away….

3. My goal to establish and further develop my qualitative investment checklist has worked out very well. Having such a tool really adds a lot to the investment process.

4. Finally, Dart Group, my first “triple” while writing the blog was great fun and a great success for my “boring company” philosophy.

So before it is getting too boring, once again a big THANK YOU for reading and commenting and I am looking forward to the next 3 years.

Edit: I often get mails or comments lie “I think share xyz is undervalued, can you write a post about it”. I am very sorry, but usually I will not and cannot contribute a lot of meaningful answers. Unless it is a stock which I have analysed in the past, usually my own “pipeline” is so big that I do not have the time to look at each and every stock in a meaningful way. So unless it is connected in some way to my existing portfolio or there is a special “twist” or something, don’t expect much of an answer. I am not Jim Cramer or some simlar guy who has an opinion of each and every stock in the market.

Some links

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If your have time for only one item this week, then read the latest memo from Howard Marks

Joel Greenblatt on value investing and patience

Very good interview with Marc Adreessen, one of the “pioneers” of the WWW

Good review about a new book called “”The Frackers: The Outrageous Inside Story of America’s New Billionaire Wildcatters””

Discovered by chance: Walter Schloss video on value investing (first 3 minutes).

Interesting article in the Ecominst on the Bitcoin Mining Industry

One more: Frenzel & Herzing with a new Vetropack analysis

TGS Nopec ( ISIN NO0003078800) – an “Outsider” Company Buffet would buy if he could ?

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Disclaimer: This is not an investment advice. The author will most likely own the stock already and sell it without telling anyone as well….

As the post is rather long, a short Elevator pitch:

– TGS Nopec is a potential “outsider” style oil services company with a distinctive and capital efficient business model
– currently cheap because of cyclical issues, negative sentiment for the oil and natural resources and top line decline yoy
– underlying business much less sensitive to oils price than the market believes and yoy top line decline is due to “outsider” behaviour

Read more

Book review: “Short stories from the stock market” – Amit Kumar

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Books about short selling are few and rare so I decided to buy the Kindle version, which around 7,50 EUR is fairly cheap. The author, Amit Kumar runs an independent research firm called Artham Capital Partners and used to post occasionally on Seeking Alpha. There is also a “Manual of Ideas” interview with him to be found at Beyond Proxy.

The book itself is fairly short with 167 pages, which in itself is not bad. The book covers many aspects of short selling, including some case studies from the author himself.

However what is completely missing in my opinion are for instance references to existing books like the “Financial Shenanigans” classic from Howard M. Schilit. He also mentions David Einhorn’s Allied Capital Short thesis and Bill Ackman’s fight with MBIA, but again he does not reference to the book about Ackman and MBIA.

Jim Chanos, the most famous short seller, is mentioned once with in the context of Enron but nowhere else. Chanos made some great presentations for instance with regard to value traps.

It is also strange that in the beginning, the author explain the P/E ratio over a full page, but later on assumes quite some advanced accounting know how like knowing what Comprehensive Income is.

The best parts of the book are the sections where he lists the various areas in Balance Sheets and Income statements where to look for trouble and the interview with the guy behind “Off Wall Street”. Strangely enough, in his list he doesn’t mention the Cash Flow statement as another place to detect “Shenanigans”, but he gets a special point from me for mentioning differences between Net income and Comprehensive Income as a warning sign.

I would have also expected something about Chinese Reverse mergers, but it seems that the author somehow was not interested in that part of the market although it might have been one of the “Life time” short gold mines in the last few years.

So overall, I have some mixed feelings about the book. Yes, it covers a lot of stuff and there are not many books out there which cover the topic. On the other hand, a lot of important stuff and sources are missing. the book could gain a lot, by referencing more to existing works of other short sellers like Chanos, Block, Bronte etc.

Nevertheless, for the price offered I think the book looks like reasonable good value for investors who are generally interested in short selling, although in its current form it will be clearly not an “investment classic” anytime soon. T e fair, the author mentioned that there will be future editions of the book, so maybe he will add some of the missing parts.

Some fun with Enterprise Value – E.ON AG Decommissioning Liabilities

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This is a follow-up to both, my recent post about EV/EBIT & Co as well as a discussion in a forum about how cheap German utility stocks really are.

German utility stocks are clearly in many lists for cheap stocks. Here is for instance a list of large utilities in Europe sorted by EV/EBIT:

Name Mkt Cap Curr EV/T12M EBITDA EV/T12M EBIT
       
ENDESA SA 23038.45 4.43 7.17
RWE AG 16827.67 3.06 7.27
E.ON SE 27849.92 4.89 7.64
PGE SA 8340.95 4.55 7.74
GDF SUEZ 41669.47 5.31 10.04
VERBUND AG 5739.31 4.93 10.07
EDF 49364.74 5.83 11.08
GAS NATURAL SDG SA 18052.44 6.91 11.26
DRAX GROUP PLC 3286.74 9.41 12.12
NATIONAL GRID PLC 34397.63 10.20 14.02
ENEL SPA 30805.4 6.22 14.94
A2A SPA 2562.72 7.52 15.16
ROMANDE ENERGIE HOLDING-REG 1066.69 9.56 18.64
SSE PLC 15811.63 12.01 18.76
IBERDROLA SA 29309.16 9.92 21.69
PUBLIC POWER CORP 2343.2 6.87 21.72

Apart from Endesa, EON and RWE really look like bargains. Even most “club Med” Italian utilities are trading at twice the EV/EBIT or Ev/EBITD levels than RWE and EON. A “mechanical” investor will say: I don’t care if they have issues, I will buy them because they are cheap.

However, there is a small problem: As many people know, following the Fukushima incident, the German Government decided in 2011 to speed up the exit from nuclear power and switch off the last nuclear power plant in 2011. Funnily enough, only in 2009, they decided to extend the licenses significantly.

Anyway, just switching of a nuclear power plant is not enough. Especially in a densely populated country like Germany, you don’t want to have those nuclear ruins everywhere. So the utilites are required to fully “decommission” the reactors and also all the nuclear waste. Decommissioning is expensive, for instance it is estimated for instance at currently 70 bn GBP for all UK nuclear power plant.

In order to avoid that utilities just go broke before they close their nuclear power plants, the are required to build up reserve accounts in their balance sheet. Let’s take a look into their 2012 annual report page 159:

eon nuclear

EON has 16 bn EUR of reserves on its balance sheet for the decommissioning of nuclear power plants. Those 16 bn are clearly already reserved in the balance sheet, but as they will be due in cash rather sooner than later, they should be clearly treated as debt and added to Enterprise value.

However, there is a second issue with them: For some reasons, they are allowed to discount those amounts with 5% p.a. This is around 2% higher than for pension liabilities which in my opinion is already quite “optimistic”. They do not offer any hint about the duration of those liabilities, but if we assume something like 10-15, just adjusting the discount rate to pension levels would increase those reserves by 3-5 bn and reduce book value by the same amount.

So all in all, net financial debt for EON more than doubles if we take into account a realistic value for the nuclear waste removal obligations.

Interestingly enough, E.on presents its own “economic financial debt” calculation on page 45 of the annual report, including pensions etc.:

EON net debt

If we adjust the nuclear liabilities for the unrealistical discount rate, we get around 40 bn “economic” finanicial debt. So let’s look how EV/EBIT and EV/EBITDA change if we use those debt figures:

Before adjustment:

Enterprise Value of 48 bn (28 bn Equity, 3 bn minorities, 23.5 bn debt minus 6.8 bn cash)
EBITDA ~ 9.8 bn
EBIT ~6.3 bn

Adjusting for economic debt, we get an EV of 71 bn and the ratios change as follows

EV/EBITDA adj = 7.2 v. 4.9 unadj.
EV/EBIT adj = 11.3 vs. 7.6 unadj.

So adjusting for economical debt already eliminates most of the “undervaluation” compared to the peers. All things equal, a Verbund for instance which only produces “clean” power at the same valuation seems to be a much much safer bet than EON.

Summary:

Even quite useful metrics like EV/EBIT and EV/EBITDA can be misleading if a company has large other liabilities which turn out to be very similar to debt. If a company looks cheap under EV/EBITDA, always check if there are pensions, operating leases or in the case of utilities Decommissioning liabilities which are not captured by the standard formula.

In this case, the company evene presents its “true” debt, but it is still not adequately reflected in almost every investment database.

Finally a quick word on “mechanical” investment strategies: I cannot prove it, but I am pretty sure that a mechanical strategy based on EV which adjusts for “obvious” shortcomings like operating leases should perform even better than the published results from O’s et al. However It is almost impossible to backtest this.

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