Monday, March 28, 2011

Hardwoods Q4 2010 - Sell

The company just released it's Q4 results and quite frankly they were pathetic. 

My Highlights:

- Inventory write downs continue to plague the company.  I think there could be some deeper issues here.  I thought they had them dealt with them in 2009 but obviously not.

- Worst gross profit margin in a long time (possibly ever) in Q4 at 16.6%.  Company seems to be chasing short term sales at any cost which is the wrong strategy.  How do you maintain market share with all of the branch closures over the past few years, especially in California? 

-They lost money in Q4 and didn't really discuss that fact at all in the report.  Why not just be candid with shareholders?  Embarrassing.

- S&A expenses were down big time... I guess they kept a solid lid on salaries and sales bonuses last year among other things.  Senior management is still getting compensated quite well despite the poor results.  Beyond that, management better take off the rose colored glasses and look at the receivables.  They reduced bad debt expense with growing 90+ days receivables... Why not deal with the problem debts?

- Receivables continue to rise.  They currently have $10+ million in 30+ days and $4 million in 90+ days.  The 90+ days receivables number has grown for 2 consecutive quarters while the economy has improved.  


They didn't make any money in 2010 despite the smoke and mirrors.  The loss in Q4 should have been more.  The company operates at the margin and is clearly not performing.  The housing market will remain slow for at least another year.  Isn't it ironic that the previous CEO used to state how Hardwoods wasn't tied to the housing market and the new CEO says that over 50% of sales are related to the housing market.  I wonder which one is right?

I recently sold my shares over the past week or so, booking over a 100% return annualized.  I just thought the price levels were getting high relative to performance of late.  I want to have some cash available if the market dives.  Now, the current results don't support the stock at these levels.  I would expect it to sell off over the next couple months.  I also don't like the incentive shares, and feel management isn't candid enough with shareholders regarding actual results.

The company is also involved in a fairly large lawsuit that wasn't mentioned in the notes of the financial statements.  They don't "feel" that it is material.  How we "feel" about things and reality can be two different things.  I've read the claim, the numbers involved are material, and quite frankly it will be quite interesting to see how it plays out. 

Sorry, but it's time to move on.

Best Regards,
Kevin Graham

Disclosure: No position

Tuesday, March 22, 2011

Biggest threat to US economy

I recently wrote to a friend regarding the biggest threat to the US economy so I figured I better put something up so individual investors can protect themselves as well.  The question was regarding an investment in a company that receives a large portion of their revenue from local governments. 

One key to understanding a business is to know where the revenue comes from.  Problems can and do arise when revenue it is concentrated with a few customers or a special type of customer.  Many of the for profit education firms in the US have been hurt hard because a large portion of their revenues come in the form of subsidies and student loans backed by the US government.  The government is currently reviewing these practices and likely will cut some funding... I guess likely is a poor way to put it, they will cut funding for these programs. 

The single largest threat to the economy right now is the US government spending.  Obviously the government is trying to prop up the US economy by spending trillions more than take in.  I don't have the recent data beside me but something like 7.5% of US GDP is being fabricated by government due to overspending.  I would guess the situation isn't much different in Canada but I haven't looked at any data our side of the border.  This number is down from a couple years ago when it was closer to 10% of GDP.  To put this is plain English, if the government balanced it's books and only spent what it takes in, GDP would fall 7.5% from current levels.  Perhaps that is why many of the large defense companies appear cheap.

The government is walking a fine line because they know they can't sustain this overspending forever and they are counting on a strong recover by the public sector.  Now the data is showing strong improvement in the public sector, particularly manufacturing, but growth takes time.  Don't get me wrong I am a large bull on prospects the US and Canada over the long term.  I know how capitalism works, and everyday we work smarter, improve productivity, thus increasing our standard of living. 

My only problem is how the government thinks they can smooth out the economy by messing with natural market forces.  I would strongly recommend a review of all companies in your portfolio to see if the derive revenue from the government.  Any company that derives a large portion of revenue from the government may be in for a large 20%+ haircut, or the best case scenario would be flat revenue for decades. 

Canadian Federal Budget

In other news the Canadian government announced their budget today.  Nothing out of the ordinary and it looks like we will have an election fairly soon as none of the opposition parties want to support the Conservative government. 

I always find it amusing that the government constantly puts little things into the budget that have an large effect on natural supply and demand of certain product or services.  This then encourages Canadians to spend their income in such a way that they wouldn't otherwise because they get a tax break.  Why not just leave the taxes in the hands of the individuals (and companies) and allow them to decide how to spend it themselves?  This interference will create artificial demand for certain products and when the tax break is taken away that sector will incurring huge revenue losses.  I guess the construction lobbyists got their way this budget with the reinstatement of the eco-energy retrofit program.  Encourage more Canadians to spend even more money they do not have. 


In conclusion, I highly recommend investors read Vito Maida's latest newsletter to clients (Click here).  I have the utmost respect for him and he notes some important concerns in the market.  He is currently at high cash levels and recommends against being foolishly invested just because of the low interest rate environment.  Many investors are only interested in making a buck, not the preservation of capital. 

You don't need to have very high returns on your portfolio so long as you don't suffer any significant losses.  If you are constantly having to make up for losses on investments you will find yourself treading water.  That is a secret that makes the like of Prem Watsa and Vito Maida such great investors.  Do you only focus on the upside?  Good question to ask yourself, be honest.  The easiest person to fool is yourself. 

Best Regards,

Monday, March 21, 2011

Goldman Sachs is Cheap - Buffett

I recently saw that Buffett told CNBC that he will not be exercising his Goldman Sachs warrants even though they are worth 2 billion today.

"I think the odds are that it goes higher," Buffett, the chairman and CEO of Berkshire Hathaway, said. "Over time most stocks will get more valuable, and I have no reason to think Goldman Sachs is an exception to that."

I think we can safely interpret the statement that "the odds are that it goes higher" to mean it is cheap and has a high likelihood to be worth more in the future. Given that these options are set to expire in 2013, Buffett believes that will happen between somehow between now and then.

I couldn't agree more. Goldman currently sells for P/B of 1.1 and is capable of earning very high returns on equity even with the new regulations. It is a fairly safe bet that as the economy improves, Goldman will lead the way in returns at investment banks if history is our guide.

Needless to say, I was long GS before this news and plan on being long GS for quite some time.

Best Regards,

Tuesday, March 15, 2011

GMO - The Gratuitous Use of Statistics

GMO release and interesting white paper today entitled "The Gratuitous Use of Statistics", written by Arjun Divecha.  The full article can be found at

To quote from the article.

Indeed, when one looks at the correlation between the FT Developed Multinational Index and the FT Emerging Markets Index over the last 10 years, the correlation of monthly returns was an amazing 87%. In fact, over the last 5 years, the correlation has risen to 92%!

Mr. Divecha then goes on to say a picture is worth a thousand words.  The statisticians often fail to mention the correlation is between the month to month changes and not in the total returns. 

Now for my comments.  I would totally agree with the author with the fact one must be careful when dealing with statisticians because you can make statistics say anything you want if you massage them enough.  My problem is why do you expect multinational companies to have similar total returns to the emerging market index?

First, the multinationals only have a portion of their sales from the emerging markets so to expect a 1:1 relative return ratio is simply unreasonable.  Their returns should be a combination of emerging and develop markets in their appropriate amounts.  Secondly, the relative valuations of the local markets compared to the large multinationals may be vastly different.  Many of the large multinationals in the Dow Jones Industrial Average are selling for very reasonable levels while many emerging markets can get well ahead of themselves in the short term. 

Lastly, the correlation definitely gives you confidence that you are getting some exposure via the large multinational companies.  Over the long term the growth in emerging markets will represent real returns.  Many of the large multinationals in the US have had their stocks go sideways for the past decade despite sales and earnings going up two or three fold.  Many of them have seen their P/E ratios drop from 30 to 10.  The emerging markets have likely seen the relative valuations go the opposite direction. 

Best Regards,


Wednesday, March 9, 2011

Peyto Q4 Results Due Today

We'll I've been extremely busy lately and haven't been able to comment on much.  Fairfax is reached a 52 week low yesterday.  Prem Watsa released his annual letter a few days ago and it is definitely an interesting read (Click here).  He's worried about about deflation and has entered some contracts to protect against that threat.  I think it's overblown but will be eager to see what he has to say further on the matter.

Peyto will be releasing their Q4 results today after the bell.  Don't expect any market moving news as AECO gas prices are currently $3.50/mcf.  Most gas companies are losing money, full cycle, at that price.  I have heard that the land retention shale gas drilling in east Texas should be complete by mid year.  Hopefully gas prices start to recover shortly following.  Regardless, Peyto can afford to be patient if required. 

I've been extremely busy with work and a few other concerns that I have been unable to post.  I have so much to write but so little time.  Ice fishing season is almost over and I've yet to even get out once this year.  The end of the season is usually the best time anyway and with all the cold we've had this winter I'm not overly about missing out on the cold weather.

I have comments from a number of good books I have recently finished reading.  A Short History of Financial Euphoria is an excellent short read if you have the time.  It's amazing how many of the financial panics share common characteristics.  Mostly all bubbles start on a sound premise but eventually people focus solely on the price action.  Once the focus is on the price action people stop acting rationally.  Leverage then is the final factor the puts prices through the roof.  In the stock market we will continue to have wide swings and bubbles as the vast majority of market participants tend to focus solely on the price action not the underlying economic value. 

Kevin Graham

Disclosure: Long FFH & PEY.