Monday, January 28, 2013

Richard Ivey - Pershing Square Event

Since I have started blogging I have been pleasantly surprised to meet many people who share my passion of value investing.  Recently, I was asked by one follower of this blog to both attend and promote an event being put on by the Investment Club of The Richard Ivey School of Business.  I said I would be honored and would gladly post the detail here. 

Event Details (Click Here for the Event Brochure):

The Investment Club of The Richard Ivey School of Business cordially invites you to The CPR Activist Campaign and the Implications for the Canadian Establishment 
Featuring iconic author Peter C. Newman and Pershing Square Capital Management, L.P. Partner and Canadian Pacific Director Paul Hilal. 
Date & Time:
February 27th, 2013, 6:00 pm - 9:00 pm 
Ivey ING Direct Leadership Centre 130 King St West, Toronto 
*Admission is free
6:00 pm – 7:00 pm
Networking and Cocktails 
7:00 pm – 8:00 pm 
Keynote Address: 
"The Eclipse and Rebirth of Canada's Business Elite: From Aristocracy to Meritocracy" by Peter C. Newman
8:00 pm – 9:00 pm
Q&A with Peter C. Newman and Paul Hilal (30 min)
with Audience (30 min) 
(Moderated by Wes Hall of Kingsdale Shareholder Services) 
Please RSVP to by February 8th, 2013. 
*This event is open to MBA and Law students, Richard Ivey Alumni and distinguished members of the Ivey business network. The event is not open to the press and will be conducted off the record. 
The Richard Ivey School of Business would like to thank the Pershing Square Capital Management, L.P. for their generous sponsorship of this event.


When I first heard Pershing Square was involved with this event, I immediately said I was not interest in attending.  I don't have a huge amount of respect for Bill Ackman, especially in like how how he's handled himself with the whole Herbalife fiasco.  I was relieved to hear that Paul Hilal would be attending instead of Mr. Ackman. 

While I would have loved to attend this event I unfortunately will not be able to.  I am on vacation for the first couple of weeks in February and as soon as I return I am heading down to our USA operations for a week.

Now this event should be quite interesting.  As some may be aware the CPR railway played a monumental role in the founding, development and industrialized of the nation and its board of directors has always been composed of the most eminent, and 'untouchable' members of the business/financial/political elite in Canada.

The fact that a foreign hedge fund (Pershing Square) was able to successfully win shareholder support (particularly from other establishment players like Canada Pension Plan, Teachers pension plans, etc) to depose the CPR board members proved to be a watershed event in the history of Canadian business and will have implications for many other organization and investors. 

Peter Newman has been advancing the idea that the Canadian Establishment, an old boys club that rules many Canadian corporate boards, is dying.  The CPR event may well be he last nail in the coffin, marking the rise of a new class of businessmen and entrepreneurs. His keynote address will be centered on this.  The Q&A session will allow the ideas to be explored in greater detail. 

It promises to be a great event.

Best Regards,

Sunday, January 20, 2013

Arkansas Best

At the beginning of 2012 I recommended Arkansas Best (ABFS), a trucking company.  I noticed a fellow blogger has also picked up on the idea. So to save time I thought I would share a link. 

You can read his commentary here:

It's a good analysis and hits on the cost side of their business.  ABFS has huge upside if they get costs get under control and the economy picks up.  They have been floundering since 2008 but they will get things figured out. 

Best Regards,

Disclosure - None

Wednesday, January 9, 2013

2013 Investment Commentary

Bank of America (NYSE – BAC, $11.61)

BAC was a huge percentage gainer last year but don’t let that fool you. As I pointed out in the post on comparing Canadian & US banks, BAC sells for 1/3 of a comparable Canadian bank on an apples to apples basis. Some of that valuation gap has narrowed, but don’t kid yourself there is still a lot of money on the table.

To begin, BAC has a tangible book value of $13.48/shr at the end of Q3 2012. The company still sells for below that level despite the fact the bank is soundly capitalized. At the end of the Q3 2012 the capital level was 8.97% on a Basel 3 basis. The bank only requires 8.5% so it is now over capitalized and Q4 should add further to this capital buffer.

The bank has been drastically shedding assets during 2012. Now that it has taken care of business they are now in great shape to start growing again and the CEO has stated he has finally instructed bankers to aggressively lend to both mortgages and business segments.

To me the biggest news in Q3 for those who listened to the conference call was that the legacy asset servicing (LAS) group will see expenses fall by $10 billion over the next 5 quarter. That is huge and will greatly add to the bottom line in 2012. Here is part of the Q3 conference call: 

Brennan Hawkins - UBS

"Okay. Just to make sure I understood, Brian I think you had said that, as far as the trajectory of the decline in expenses overall when you’re looking at the entire thing at LAS taking a step back, moderate improvements in 2013, but the big lever there is 2014. Is that right or are we reading too much in to it?"

Brian Moynihan - CEO

"No, I think I was saying, that you’ll get the improvement sort of on a quarterly basis all though ’13 and in ’14 you’ll have the run rate of all that accumulated and for you, in year-over-year comparisons, but it’s going to come all during ’13.

We can debate about moderate when we are that [expense base]. The other question was discussing but it will come every single quarters, so it’s not going to be held up and wait, it’ll come as fast as it can.

So the word we’re getting out this quarter has to do with the clients and the 60 plus day in the second quarter into the third quarter came out in the third, and the third quarter comes out in the fourth, it will take just little time, because you actually have to finish the work, reassign accounts and go on. 

So it will come, it’s not in quarter-by-quarter, it will come month-by-month, week-by-week all to the ‘13."

Enough said.

The company has a huge low cost deposit base and the huge earnings power of this bank will appear once the LAS expenses come down and interest rates normalize.

The economy is improving and the improvement in the housing market will be a huge tailwind for BAC. Fair value is closer to $20/shr.

***Recent update: The recent legal settlements, particularly with Fannie Mae, settle a large portion of the legacy issues related to Countrywide.  While the company still faces some legal issues they have settled $45 billion dollars worth of issues over the past 2 years. 

A person I know recently put it this way...  BAC is selling for $99 billion below book value.  You can argue that they are under reserved but come on now, that is valuation gap is ridiculous. 

Investing only requires grade 5 math and rational thinking.  The problem is the rational thinking. 

Berkshire Hathaway (NYSE - BRK.b, $89.70)

This is perhaps the easiest investment decision a rational person with reasonable expectations can make. Warren Buffett, the CEO, has made it clear the stock was undervalued when he first bought back shares at 110% of book value (BV). He has always treated his shareholders as partners so he doesn’t buy back shares without first letting them know that he feels it's a cheap price.

Since then Buffett, along with the blessing of the board of directors, has bought back 1.2 billion in stock.   He also raised the price he is willing to pay to 120% of BV.

Now anyone with half a brain should realize:

1)  Buffett believe the shares are cheap and represent great value at 120% of BV.

2)  The shares have a type of “floor” underneath them at that level. That doesn’t mean the stock can’t go lower but it does mean there will be a big buyer below 120% of BV.  Buffett has over $40 Billion in cash and is looking for somewhere to invest it. 

3)  Berkshire has huge exposure to the housing market

4)  Buying today at historic low valuation will ensure you benefit from both the growth in earnings and the valuation adjustment as the stock moves higher.

An investor really only has two levers from which to make returns. The first is growth in earnings and the second is an increase in valuations. Some people include dividends but I don't since dividends are merely a percentage of earnings. So with Berkshire you will benefit from increasing earnings power and possibly a higher valuation.  Over the past decade the valuation has hovered around 170% of BV.

Lastly Berkshire will also greatly benefit from the improvement in the economy, particularly in housing. Berkshire also does not pay a dividend so all of its earnings are plowed back into the company. They also own a number of outstanding companies that can generate very high returns on capital.

If you put all your money in one stock, Berkshire would provide adequate diversification in one security while generating acceptable returns.

The reason most people won’t buy BRK is because they “think” they can generate a higher return than what Berkshire can generate.  For those who hold that belief may I suggest two words, “good luck.”

Sony Corporation (NYSE - SNE (ADR), $11.20) 

Sony is an interesting company I initially looked at last summer but I was too stupid to connect the dots at that time. I know, I know at times I am a little slow.

Examining the 2011 annual report for a second time I noticed a couple things? First of all of you took the cash on the balance sheet ($19.2 billion) and subtract the long term debt ($9.3 billion) you were left with just shy of $10 billion in cash. Then if you look at the market capitalization of the company, you could purchase the entire thing for around $12 billion. Now assigning $2 billion for all of Sony is quite ridiculous.

Now to be fair the company lost quite a bit of money in fiscal 2011 year and they are still losing money in 2012. Secondly, the company has never earned very high return on equity which is a reoccurring theme for Japanese companies.

So what do I like. First the new CEO just stated they are going to right size their operations in an attempt to achieve a 10% ROE in 2014. Second, they have a very strong brand name and have strong ties into a number of markets. I realized this after my wife started looking for a stereo with a docking station for her iPod touch. I then realized I had two other Sony stereos in my own house. I also notice Sony speakers in a friend’s new Ford pickup truck. Then I realized that the Sony Playstation and handheld Playstation Vita are popular video game systems.

Then upon investigation, I discovered Sony Pictures Entertainment owns Columbia Tristar and Metro-Goldwyn Mayer.   On top of that, Sony Music is the second largest music recording company in the world and owns full rights to Michael Jackson & The Beatles, among others.

It should be clear that Sony owns some very valuable and unique assets. I would bet with some American style management Sony could be worth 5x of the current quote. As Peter Lynch once said, “Go for a company that any idiot can run – because sooner or later any idiot probably is going to run it.” Well, Sony has been run by idiots for a while now and with some decent management they would be worth much, much more.

Wellpoint (NYSE - WLP, $60.92)

Wellpoint is a company I have been watching for a while and finally got around to reading the annual report.  For my Canadian readers, Wellpoint is one of the largest US healthcare organizations with 33.5 million members at the end of Q3.  They are an independent licensee of Blue Cross and Blue Shield in a number of US states.

Let’s begin by looking at the positives and the negatives.


WLP is a very interesting investment candidate because they aren’t the most efficient operator in the sector. They seem to constantly have among the higher medical loss ratios compared to competitors. The medical loss ratio, or sometimes referred to as the benefit expense ratio, is the benefits expense as a percentage of revenue.

They also appear to be floundering as they don’t have a CEO. They have also just purchased Amerigoup which will increase exposure the Medicaid customer base. The downfall here is a lower margin business.  I would have preferred them to buyback more shares.

Next they have been experiencing flat to declining enrollment for several years.

Lastly they are facing increasing regulation which should make the sector much more competitive and limits medical loss ratios and restricts how much they can increase premiums.


The company is an absolute cash cow. They currently sell for 8 times earnings and just over 7 times free cashflow.

Since 2005 the company has reduced the shares outstanding from 660 million to roughly 310 million at the end of October 2012. You don’t need a calculator to figure out that these share buybacks have been huge. It is interesting to note that revenue and earnings have gone up 200% and 100% since then but the stock price has declined.  P/E ratio has fallen from 17 times to 8 times.

Now if your math is any good you would have also notice that this is not a very good operating performance. Earnings per share (EPS) should naturally double when you buy back half your shares.  What this really tells you is that their net profit margin has declined by 50%, not good.

While many would use this to criticize the company I see it as an opportunity. At the current pace of share buybacks, EPS should grow at 10% and if they improve the operating performance of the company they could grow earnings at a much faster clip.

Now this is not some pie in the sky estimate. If their expenses were comparable to say Unitedhealth (NYSE:UNH), earnings would rise by 50%. That is huge opportunity and no revenue growth is required.

Next some of the headwinds facing the company should shortly become tailwinds. First enrollment should begin to rise as the economy improves and companies add to their payrolls. The high unemployment rate over the past several years has hurt the company.

Lastly, the recent regulatory changes (due to Obamacare) has increased costs as company sorts out the changes. Some of these costs are here to stay but some should taper off over time.

If you add it all up you a have a company that is selling well below book value and can earn decent returns on equity. Recent headwinds should shortly turn into tailwinds and they have huge opportunities cut expenses. If the company can find a decent CEO who can get costs under control and the economy picks up a little, watch out, this stock is going to double in very short order.

POSCO (NYSE - PKX (ADR), $82.15)

I’m getting tired so this one is going to be short and sweet.   POSCO is the third largest steel producer in the world. So what is so great about POSCO? Well to start with, they are selling for about 60% of book value.  Why is that so important? It means you’re paying about the same valuation that Warren Buffett paid for his POSCO shares back in 2005.

Why would you want to own POSCO?  As I've said before, in any commodity business you want to own the low cost producer.  POSCO is likely among the lowest cost steel producers in the world and are much more efficient than US competitors.   Their operating margins are double that of American steel companies.  Lastly, the company has been constantly profitable for the past decade unlike many other steel producers. 

POSCO will also benefit as the world’s economy improves.  I would expect ROE and net profits to improve by a couple percentage points.  You’re definitely not buying the company at a time when they are generating peak returns.  At 6.5 times normal earnings, your getting over a 15% earnings yield.

Good luck and may 2013 be as profitable as 2012.

Best Regards,

Kevin Graham

Disclosure:  I own BAC class A warrants & BRK.b.

Tuesday, January 1, 2013

Top Investments for 2013

2012 Year in Review

Well 2012 was a fairly strong year for negative news yet surprisingly the markets were strong.  If this year taught me anything it was to avoid the headline news and just buy cheap stocks.  There was negative news regarding Europe most of the year and China has been a major drag on commodities. Interestingly enough, despite the negativity, the S&P 500 was up just over 13% and the Dow Jones Industrial Average was up just over 7% for the year. Here in Canada the TSX Composite index was up 2% for the year.  

So how did this compare to the stock recommended for 2012?  On average, they strongly outperformed the broader markets.  Due to my overweight in financials (stated at the beginning of 2012) contributed to very strong returns in my personal portfolio. 

Company  Ticker Return Return (w/Div)
Bank of America BAC 109% 110%
Goldman Sachs GS 41% 43%
First Niagara Financial Group FNFG -8% -4%
Sears Canada SCC -4% 6%
Speedway Motorsports TRK 16% 20%
Average Gain 31% 35%

Here is the graphical performance (click on image to see it better).

Now these five stocks soundly trounced the market as a whole.  It doesn't surprise me that the financials led the way with BAC powering ahead.  It was so cheap at the beginning of 2012 it was like shooting fish in a barrel.  Goldman Sachs performed much as expected but surprisingly it is still very cheap on a Net working capital basis (current assets less all liabilities including long term debt and preferred stock). 

I found the First Niagara results quite interesting but not overly surprising.  I find it amazing how many stocks sell on a price to earnings (P/E) basis while the underlying earnings capability is much higher.  For First Niagara, it's earnings are masked by large integration costs due to acquisition of the HSBC assets earlier in the year.  This reduced HSBC's profitability by 135 million in 2012.  I still consider FNFG to be cheap. 

Sears Canada's result was also interesting.  It was up strongly early in the year but ended flat.  They did pay a special $1/share dividend from it's cash hoard, so the return was still satisfactory. 

Speedway Motorsports benefited from the improvement in the economy.  This trend should benefit the company in 2013 as well.

Top Investments for 2013

Bank of America (NYSE – BAC, $11.61)

Berkshire Hathaway (NYSE - BRK.b, $89.70)

Sony Corporation (NYSE - SNE (ADR), $11.20)

Wellpoint (NYSE - WLP, $60.92)

POSCO (NYSE - PKX (ADR), $82.15)

Click Here for Investment Commentary 

Safe and Very Cheap (New Category)

Wells Fargo (NYSE –WFC, $34.18) & Microsoft (NYSE - MSFT, $26.71)

Wells Fargo was in the Safe and Cheap last year and it stays there again for this year.  I also decided to add MSFT this year because of the recent price decline.  To me the recent price decline make the investment even more safer.  As a shareholder I am very thankful that the shares are low and I hope they stay there.  Why you might ask?  So they can repurchase more shares at a cheaper price. 

Warren Buffett explained this well in his 2011 letter to shareholders.  While discussing his investment in IBM & share buybacks this is what he had to say. 

"...Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%.  Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us.  Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares.  Our quiz for the day: What should a long-term shareholder (in IBM stock), such as Berkshire, cheer for during that period? 

I won’t keep you in suspense. We should wish for IBM’s stock price to languish throughout the five years...

The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon.  Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply. 

Charlie and I don’t expect to win many of you over to our way of thinking – we’ve observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus. And here a confession is in order: In my early days I, too, rejoiced when the market rose. Then I read Chapter Eight of Ben Graham’s The Intelligent Investor, the chapter dealing with how investors should view fluctuations in stock prices. Immediately the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life."

I couldn't agree more.   

Some Honorable Mentions – Research in Motion (TSE - RIM, $11.80), Hewlett Packard (NYSE - HPQ, $14.25), Teva Pharmaceuticals (NYSE - TEVA (ADR), $37.34), Prudential Financial (NYSE - PRU, $53.33), Arkansas Best (NASDAQ - ABFS, $9.55) & a small Canadian energy company which I cannot disclose at this time (but perhaps in the near future)

Again 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,


Disclosure – I own BAC Class A warrants, WFC, GS, BRK.b,  and MSFT.