Monday, January 2, 2012

Top Investments for 2012

2011 Year in Review

2011 proved to be quite an interesting year to say the least.  Looking back, the games played by the US government over the debt ceiling seemed to put the fear back in the markets.  Add to that the debt problems in Greece and the markets just unraveled until early October.   Since then they have recovered somewhat with the S&P 500 ending flat and the Dow Jones up just over 5% for the year.  Here in Canada the TSX Composite index was down 11% for the year.  These results don't surprise me as large caps were definitely cheaper than small caps going into the year. 

Looking back the recommendations from last year, they appears to be a mixed bag.


Company
Ticker
Return
Return (w/div)
Citizens Republic Bancorp
CRBC
85%
85%
Bank of America
BAC
-58%
-58%
Hardwoods Inc
HWD
49%
50%
Goldman Sachs
GS
-46%
-45%
Fairfax Financial
FFH
7%
9%




Average Gain

7.4%
8.2%


Compared to the broader market indexes this is a decent result.  The financial companies have been hit hard due the issues in europe despite the fact that US financial institutions are well capitalized and have little exposure to the European sovereign debt crisis.  Hardwoods Inc. is back on track and has started to pay a dividend again.  Citizens Republic was priced for disaster but the economy in Michigan has bottomed and loan losses have stabilized.  Fairfax, a holding company, mainly owns insurance businesses but they started to diversify this year by purchasing a number of other companies.  They include William Ashley (fine china), Sporting Life (sporting goods), & Prime Restaurants (Eastside Mario’s, Casey’s, & Prime Pubs).  Fairfax made billions owning CDS swaps a few years ago and now are now putting that capital to work. 

I have a large portion of my net worth in Fairfax.  In fact if I wasn’t interested in actively managing my investments, I would put 100% in Fairfax and sleep soundly at night.  The company is worth considerably more than its current quotation.  As I have mentioned before I have read every single letter to shareholders going back to 1986.  Prem Watsa openly discusses the positives and negatives which is quite refreshing compared to the typical sales pitch you get from most annual reports.  What is remarkable is that Fairfax has made their fair share of mistakes over the years but despite those mistakes they were still able to grow book value and thus the intrinsic value at a very fast rate.  Since Mr. Watsa doesn't do any promotion, I don’t mind shamelessly promoting the company for him.

Top Investments for 2012

Bank of America (NYSE – BAC)

I have written several times about BAC in the past and despite the 58% decline in 2011, it is my top pick.  The facts haven’t changed only the emotions on this stock.  Compared to a year ago, the company is much more soundly capitalized.  Tier 1 common equity should be over 9.5%  in Q4 if you include the recent asset sales (Basil 1).  Despite what the pundits say the assets are not marked to fantasy.  Level 3 assets, the ones with the most assemptions made by management are 2.9% of total assets.  The company still has a lot of litigation headwinds but the company has already set aside a lot of funds to cover most of these expenses already.  It may takes years before the results of the numerous lawsuits are known.

Management has a lot of credibility issues because of the numerous promises not kept during the past couple years.  Despite this they are well on their way shrinking the balance sheet and reducing risky assets.

BAC sells for around 25% of book value and 40% of tangible book value.  The lower the shares go the better the bargain.  BAC could double or triple from here and still be undervalued. 

Goldman Sachs (NYSE – GS)

I’m going to keep this one short.  Despite all the hatred, Goldman Sachs is still a premier global investment bank.  As emerging markets develop and require access to capital, Goldman's business opportunities will likewise grow.  To be clear, financial uncertainty is the biggest problem hurting the company.  The success of both the company and the financial markets hinge on investor confidence.  When it returns Goldman will return solid results.  Goldman is soundly capitalized.

GS sells for just over net working capital, 68% of book value, and 75% of tangible book value.

First Niagara Financial Group (Nasdaq – FNFG)

I know, I know... another financial company.  I can't seem to help myself as there are so many cheap financial companies to choose from.  If you can't see that you must be blind.  Like the CRBC pick from last year, FNFG is a cheap bank but unlike CRBC they don’t suffer from problem loans and mortgage issues.  Problem assets are very low compared to almost any other financial.  Despite these strong points the shares have been sucked to the vortex of the euro crisis.

The key highlights for FNFG is that they selling for less than of book value (a reoccurring theme for this value investor), and problem assets are minimal.   Numerous insider buys over the past 12 months is another big sign that the shares are cheap.  

Another interesting note is that FNFG was profitable throughout the recession and because of that they have gone on an acquisition spree.   Which raises one problem I hate to see.  Management recently raised equity for less than book value to purchase 195 branches from HSBC.  I personally hate it when management does this sort of thing but I will give them the benefit of the doubt.  Despite the bad deal on the equity the acquisition should still be accretive by 10% in 2012 and another 12% the following year to per share earnings.   If you do take a deeper look at FNFG, keep in mind that merger and acquisition expenses are masking at least $0.25/shr in 2011 so far, so their GAAP earnings are understated. 

FNFG sells for 65% of book value, and buying today gives you a 7.4% dividend yield. 

Sears Canada (TSE - SCC)

This is an interesting pick and to be honest, I can’t say that a strong conviction about it.   With that said, the company will likely muddle through the current slow patch and result should be satisfactory given the margin of safety.  Historically Sears Canada has been a strong business with good returns on equity.  Canada is a very large geographical country so their model of having small stores has in many small towns has worked well until Amazon and other retailers showed up.  The question is can they retain their market share. 

Financially the company is sound with virtually no debt and it has a very small float.   Sears Holdings (SHLD) owns nearly 94% of the shares outstanding.   No investment analysts cover the company.  Both SHLD and SCC have been buying (or buying back) shares at and around $20/shr for the past several years.  If the management of SHLD and SCC thought it was worth $20/shr they must feel it's a bargain at $10/shr.  I wouldn't be surprised if SHLD were to take SCC private as it wouldn't take much more than $85 million dollars to do it (6.2 million shares at book value of $13.80/shr).  SCC could then borrow $85 million on their credit line and pay back SHLD. 

Some negative include; falling same store sales, increased competition from online retailers and the brand appears to be on the decline.  This is a similar to what happened at Eaton’s or The Hudson’s Bay Company.   Obviously investors are worried about these negatives but given the strong financial position, the company is worth more than the current quotation. 

Sears Canada sells for 75% of book value (and has no intangibles or goodwill).  The real estate was recently reappraised due to the transition to IFRS accounting so the book value for these assets should be good.  With that said, management has no incentive to inflate the asset values so I would guess they are on the books at the bare minimum.  If you add the cash, real estate, half of the inventory and subtract all liabilities, the company is worth at least worth a billion dollars.   Downside risk is very, very low.

Speedway Motorsports (NYSE – TRK)

TRK is a small cap company that operates NASCAR motor speed ways in the southern US.  I particularly like the brand appeal and significant insider ownership.  Officers and Directors own 72% of the shares outstanding.  How's that for having skin in the game? 

Since the recession in 2008 revenues have dropped around 16% and profits have dropped by over 50%.  That has caused the stock to fall and stay down for he past 3-4 years.  However, if you annualize their Q3 2011 results the company is selling for a 6.6 times earnings or a 15% earnings yield.  The dropping attendance at race events is largely due to the strength of the economy and unemployment rates.  As the economy improves, so will the financial results.  It is interesting to note that television viewership of the NASCAR Sprint Cup Series is up year over year. 

Despite the recent run up in the share price, the company still only sells for 73% of book value.  Pre-recession the returns on equity were quite consistent at 12.5% or better.  Since the recession they have dropped to around the 5% mark.  If you annualize the third quarter 2011 results, ROE is back to around 11%.  TRK is on its way back to normal profitability.

Safe and Very Cheap (New Category)

Wells Fargo (NYSE –WFC)

Although not one of my top picks for 2012, I had to create a new category for Wells Fargo called Safe and Very Cheap.   Anyone who knows me personally is likely tired of me singing the praises of Wells Fargo.  Wells is a premier large-cap bank that really deserves to be in a category all-alone. 

Wells Fargo is really a plain vanilla bank and doesn’t come with all the other baggage that many of the other large banks do.  They aren’t a hedge fund, don’t have a huge derivative book, and don’t have any exposure to the euro crisis.  They also don’t try to make extra money by writing CDS insurance.  They make money the old fashioned way, by focusing on the customer and meeting the customer's needs.  Their net interest margin, the spread between loans and deposits, dwarfs most other large banks.  They have been buying up financial assets on the cheap lately, probably because they are one of the few companies with the means to do so. 

Financially the company is well capitalized and will report record earnings per share for 2011.  If the company paid out 50% of earnings they would be selling for a 5.3% dividend yield.  Given that they are under earning their potential, earnings will continue to grow over the next couple years.  Within a couple years I wouldn't be surprised to be getting paid a 7.5% dividend yield on the current price.  The downside risk is very low.  Sit back and enjoy the dividends.

Wells Fargo also gets the approval of Warren Buffett.  It's his third largest holding, behind Coke and IBM.  He has been consistently buying for the past couple years at prices up to and greater than $30/shr.  Given the current low price of $26.50/shr, take advantage of the bargain while it’s still available. 

Some Honorable Mentions – Intel (INTC), K-Swiss (KSWS), Pacific Sunwear (PSUN), Research in Motion (RIM), SunPower (SPWR).

For these stocks you will have to do your own homework.  All I will say is that they all have wide appreciation potential but results will depend on the operating results of each company.  Many of these companies have their own issues or problems that make the near future cloudy.  That is why people avoid them but without uncertainty they wouldn't be cheap.  Remember fear is your friend. 

Cheers to another great year!


Best Regards,

Kevin

Disclosure – I own BAC Class A warrants, WFC, FFH and GS.  Don't worry I own more than financial companies...

8 comments:

  1. Sears: "Downside risk is very, very low."
    LOL
    http://www.zerohedge.com/contributed/chickens-have-finally-come-home-roost-sears

    ReplyDelete
  2. Peter,

    Wrong Sears. They are talking about SHLD not SCC. Oops.

    Don't worry I haven't read the article. Anything over at zerohedge isn't worth reading.

    Regards,
    Kevin

    ReplyDelete
  3. http://www.theglobeandmail.com/globe-investor/sears-canada-cuts-70-jobs/article2252764/

    I saw you were interviewed by the Globe the other day, so please don't tell me that you don't read the Globe. Sears Canada is 92% owned by SHLD:

    "92 per cent owned by U.S. retail giant Sears Holdings Corp."

    What do you think the majority owners of Sears Canada will do to it when their company goes down the tubes? I shudder to think.

    ReplyDelete
  4. Kevin: Are you aware of the consequence of the FATCA legislation and how it will affect investments in the United States? As a Canadian you can easily protect yourself from these consequences by pulling your investments out of the United States. I am involved in a group blog, the Isaac Brock Society, which is dealing with the questions of US persons abroad and the attempt of the United States to crack down on alleged tax evaders living abroad, including Canada.

    I say this because you promote Well Fargo, and not a few other US equities as "safe". I am not sure that anything in the United States can be deemed "safe" and I recommend all investors to get out before the meltdown of the economy there. The other issue of course, is that the United States debt has no surpassed 100% of GDP. This seems to me to be a reason to be extremely cautious.

    ReplyDelete
  5. Peter,

    Seriously, why do you waste your time commenting here every ten minutes? I don't even read my blog that much.

    I could care less about FATCA, I am a Canadian.

    If you don't feel that US equities are safe then don't buy them, stop reading my blog, and go buy some guns and ammo.

    Just so you are aware, I will not tolerate any further political and personal comments of this nature to be posted. This is not your blog and I would advise everyone reading this not to waste his or her time reading anything you write.

    Why don't you write me, in an email, and tell me how and why the US economy is going to meltdown. I may respond on my blog why I think your crazy.


    Best Regards,
    Kevin

    PS. SHLD owns just shy 94% of SCC. Please read the third quarter financials from SCC and quit getting your information from the newspaper.

    ReplyDelete
  6. You don't care about FATCA cause you don't have a clue about it. I am a Canadian too. So are most of the folks that are being nabbed by it. What does that have to do with anything?

    It just occurred to me that as a Canadian living in Canada, you might want to know why your US investments could go sour. I don't apologize for commenting your blog. If you find it annoying, why do you leave the comment stream open?

    You seemed genuinely annoyed. I don't really understand that. I thought that as a blogger, you might actually like it when someone interacts with your posts. I don't see a lot of other folks coming here commenting. You know, I thought you were some kind of serious investor, with serious intentions. But you have the hardest time dialoguing with folks. That means that you could have major blind spots, because you are shutting the door to other people's criticism.

    I became interested, you know, in your blog because of your earlier interaction with Devon Shire, and therefore I like to look at people who substantially disagree with me. Also, the interview at the Globe and Mail made me think, hey this guy must take his investing and blogging seriously. Did you see I wrote about you today at my blog too?

    As for guns and ammo, sure. But I just became a Canadian and I don't have a gun permit. But I am bullish for Canada.

    You can go on pretending that everything is safe in the United States. But it isn't. I am happy to leave you in your make believe world.

    On the 92/94%, it doesn't change in any substantial manner my main point. SHLD is majority owner of SCC. I predicted that Sears would go bankrupt a couple of years ago when they refund my money for pair of pair of shorts, despite the option contract on the back of the receipt; I said aloud then that a company that doesn't honor it's option contract on the back of receipt could not last much longer. Perhaps they can come back but it doesn't look good now.

    ReplyDelete
  7. Peter,

    This is the problem. You are not interested in interacting with my posts. You are interested in self serving comments for which I don't have the time.

    My problem is that you haven't presented one reason why it's a bad decision to invest in Wells Fargo other than the unsubstantiated claim that the US is going to "meltdown". I asked for further clarification and I am still waiting. As for some piece of legislation that doesn't affect me, go promote your fear mongering somewhere else.

    The reason why you read my blog is because I was right and Devon Shire was completely wrong on PBG/PBN.

    Again please substantiate your claim the US is not safe and that they are closing the door to foreign investment. Do this in an email, for the last time as it has nothing to do with this post.

    Listen pal, we have a difference of opinion on the US and Canada. You feel Canada is safe and the US is not, and I feel the opposite. Why am I the one in the make believe world? And you call me narrow minded.

    I was on your blog a long time ago and because of the above comments I have no interest in reading further.

    Best Regards,
    Kevin

    ReplyDelete