Saturday, January 4, 2014

2014 Investment Commentary


Ezcorp is a short term financier, putting a positive spin on it. To put it bluntly they are a pawn broker and payday loan lender. Here is a breakdown of the operations of Ezcorp:
  • 495 U.S. pawn stores (operating primarily as EZPAWN or Value Pawn & Jewelry);
  • 7 U.S. buy/sell stores (operating as Cash Converters);
  • 239 pawn stores in Mexico (operating as Empeño Fácil);
  • 489 U.S. financial services stores (operating primarily as EZMONEY);
  • 15 buy/sell and financial services stores in Canada (operating as Cash Converters);
  • 24 financial services stores in Canada (operating as CASHMAX);
  • 19 buy/sell stores in Mexico (operating as TUYO); and
  • 54 financial services branches in Mexico (operating as Crediamigo or Adex).
  • Offer consumer loans online in the U.S. and the U.K. operating primarily as and, respectively.
  • Own approximately 30% of Albemarle & Bond Holdings, PLC, one of the United Kingdom's largest pawn broking businesses with approximately 230 stores.
  • Own approximately 33% of Cash Converters International Limited, which is based in Australia and franchises and operates a worldwide network of approximately 700 locations that provide financial services and buy and sell second-hand goods. O
  • Own the Cash Converters master franchise rights in Canada and are the franchisor of eight stores there.
Ezcorp had an unusually bad year in fiscal 2013 for a couple of reasons. The biggest reason for this was the huge drop in the price of gold. Gold started 2013 at around $1700 per ounce and ended around $1200 per ounce. That 30% decline contributed to some really tough business conditions. In the pawn business, gold and jewelry are the two most common forms of collateral. Moreover, unless you’ve been living under a rock in recent years, the gold scrapping business has been big business. 
Conditions in Mexico were extremely tough for the company in the gold pawn business. On the latest conference call they discussed how competitive it has gotten down there. The industry got so competitive that everyone was posting the price of gold they were willing to pay for scrapping. That squeezed margins. This also led to the closure of 57 gold only stores in Mexico. 
Now to add more insult to injury, the company recorded a $43 million ($29 million after tax) impairment charge on its investment in Albemarle & Bond. The UK pawn lender had a very tough year and was delayed in releasing their financials. This wrote off the majority of their investment in the company. Albemarle is now for sale. 
Lastly, the company’s operating expenses have gotten way out of line. In 2011 operating expenses were 33% of revenue and in 2012 they were 34%. In 2013, operating expenses rose to 41% of revenue. This is obviously not very good performance but leaves lots of room for improvement. 
So what does all this mean for you? Basically EZPW was still profitable in 2013, albeit marginally. Earnings have risen every year since 2002. The company sells for 70% of book value.  Book value has grow at 17.5% over the past 10 years.  Debt is only 19% of total capital so they are not heavily financed.  Interest is well covered.  There are a few weird quirks with this small cap but I won't bother you with them here (read the 10-k and listen to the conference call for details).
If you exclude the one-time expenses that occurred in 2013 the company would have earned around $1.70 per share. That works out to a current P/E ratio of 6.5. Now if you, like me, assume that the gold scrapping hay-days are over (no recovery of this business) but they can reduce operating expenses by 3%, then EPS will rise to $2.35 per share (P/E = 4.7). If operating expenses can get back down to historical levels of 34% of revenue, EPS will rise to $2.95 per share (P/E = 3.7). 
It doesn't take an advanced degree in math to see that EZPW is worth at least double the current quote (at a minimum) and up to four times the current quote (at a maximum).  Let's call fair value roughly $30/share. 

"It is better to be roughly right than precisely wrong." - John Maynard Keynes
Lightstream Resources (TSE - LTS, $5.88)
This is the former PetroBakken and Petrobank, if you're familiar with those companies.  They put some lipstick on this pig by giving it a new name back in May 2013.
If you don't remember I wrote about both Petrobank and Petrobakken quite a few times back in 2010.  I even had a spirited debate with a fellow blogger called Devon Shire over the valuations of the companies.
The original article can be found here:
The back and forth can be found here:
Here is what I said about the company back then:

Lets start with Petrobakken (TSE - PBN). First, the PBN's reserves have a net present value, discounted at 10%, before tax value (NPV10-BT) of $2.46 billion for proved reserves (1P) and a NPV10-BT value of $3.65 billion for proved plus probable reserves (2P). I tend to be conservative and use proven reserves but for this analysis it won't matter much so we'll use the more optimistic value of $3.7 billion, which includes reserves that are not yet on production. The company has a convoluted debt structure of bank debt, net working capital deficiency and convertible debentures. The convertible debentures are convertible into common shares at prescribed prices so for the sake of analysis I will add them to the fully diluted shares and only consider the debt to be the sum of the bank debt and working capital deficiency. For PBN the total debt is $698 million. The fully diluted shares outstanding if you include all options and convertible debentures is 207.7 million shares. Petrobank owns 58% of PBN.

NAV10-BT 1P = ($2460 million – 698 million) / 207.7 million shares = $8.48/share

NAV10-BT 2P = ($3650 million – 698 million) / 207.7 million shares = $14.21/share

The PBN shares closed today at $22.84, a sizeable premium to the reserves. This is a 61% premium to the 2P reserve value.

Needless to say Devon Shire was wrong.  If you read the comments over at gurufocus you'll see that I struck a nerve with a number of individuals who didn't want to be shown they were wrong.

 "You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right." - Benjamin Graham

Anyway, fast forward to today and the picture is quite different.  The biggest change is the major drop in price.  It now sells for a fraction (1/4) of the price compared to when it was being promoted by Devon Shire.  Those who bought at those inflated prices got what they deserved. 

I am a value investor, price is of paramount importance.  I could care less about what the market values the company at.  I want to see my own analysis make sense and have a significant margin of safety.

So today if you read the reserve report in conjunction with the financial statements you can calculate that:

NAV10-BT 1P = $9.26/share

This is the net asset value of the proven reserves using a discount rate of 10% before taxes (debt adjusted per share).  As you can see not much has happened since the 2009 reserve report.

In layman's terms this means that if you bought the entire company, stopped drilling (except remaining proven undeveloped reserves, PUDs), and put the company into blow down mode the net present value company's production stream would be worth $9.26/share discounted at 10%. 

Now this figure is strongly influenced by the commodity price forecast so if you believe oil will rise it is worth more than this, and if you believe oil will fall it would be worth less than this. 

Just for fun lets apply a 15% and 20% discount rate to the proven reserves. 

NAV15-BT 1P = $6.74/share.
NAV20-BT 1P = $4.99/share.

So when the share price got down to it's 52 week low on December 12th, 2013, you could have purchased the entire company, net of all liabilities, and made 20% on your investment (assuming oil prices match the forecast). 

The above information might explain why the CEO purchased $2.8 million in stock on December 12th, 2013 and has purchased $5.8 million of stock in the past 12 months.

I would also note the analysis above gives no value to the probable reserves.  For a company like LTS this is a reasonable assumption because they are a terrible explorer for oil and gas. 

The only other positives are that the company slashed the dividend and canceled the DRIP program because it is highly dilutive at these prices.  The good news is that even at the new dividend rate of $0.04/month or $0.48/year, the dividend rate is 8.1%.  Whether that dividend rate is affordable or not is a discussion for another day. 

Now I am not planning on purchasing this company for a couple reasons but it should double this year barring a major collapse in oil prices.  Buying today you are getting a 15% return on your money. 

The biggest reason I wouldn't invest in this company is that it is very poorly run.  I could put some information on this blog that comes from reliable industry sources (but hasn't been confirmed as fact) but it would likely earn me a lawsuit.  The other reason I wouldn't buy this stock is because I have no idea where oil prices will be a year from now and if you think you do, I have news for you... you're self deceived. 

So for those long LTS, I applaud you.  You should make a buck here but don't stick around much past $10-12/share.  The current quote is cheap enough to offer a decent margin of safety and a decent dividend.  Management is a key criteria when I decide to make an investment and on this point they fail the test.  

Oh and one last thing... those who subscribe to the investment newsletter from Devon Shire (aka, I hope you getting your money's worth.
Bank of America (NYSE – BAC, $15.57)
I have written extensively about Bank of America over the past few years.  It is still cheap, analysts are starting to get all excited about this bank, that happens to be the largest bank by deposits.  BAC will eventually earn 1% on assets and that works out to more than $2 per share.  Beyond that they will realize significantly higher cash earnings because they have $33 billion in deferred tax assets to utilize.  This means if they report $2 per share and didn't pay taxes, actual earnings would be closer to $3/share.  Now their actual cash earnings will not be this high because the net operating losses have occurred in different businesses and in different jurisdictions.  In order to utilize these tax assets they need to realize a profit in those specific divisions. 

Furthermore, deferred tax assets are being phased out for capital requirements over the next 4 years.  Starting in 2014 they are reduced by 20% for capital requirements.  Not to worry though, BAC has already met Basil 3 capital requirements on a fully phased in basis. 

What will BAC do with the profits over the next few years?  I would bet the dividend gets increased this year and they buy back a large chunk of the outstanding shares.  This will create tremendous shareholder value over the next several years.

For the upcoming year, according to First Call, analysts estimate they will earn $1.32/share.  Factoring in the deferred tax assets, cash earnings could be up to $2/share this year. 

Look for a dividend increase in March after the capital plan/stress test results are announced (CCAR). 

Book value is just shy of $22/share.  That means the market is still discounting their capitalization by $68 billion.  Is this discount reasonable?  You can argue that they are under reserved but by $68 billion??? (Note: last year it was a $99 billion discount). 

Citigroup (NYSE – C, $52.11)

I added Citigroup simple because I wanted to have another financial stock selection for this year.  The nice thing about Citigroup is that they are a little cheaper than Bank of America on a tangible book basis.  Citigroup sells for just under tangible book value, while Bank of America sells for 1.2x tangible book.

First Call calculates the average analyst estimate to be $5.32/share for this year.  That puts them at slightly below 10 times earnings. 

Again if they earn 1% on assets that would work out to $6.10/share. 

Now if you thought BAC had significant deferred tax assets (DTAs) you were right, but Citi has $53 billion.  The kicker is that $47.5 billion of that is US Federal, $4.5 billion is US State and the rest is foreign. 

So actual Citi cash earnings could be in the $8-9/share range going forward.  They did utilize 1.8 billion in their DTAs in 2013 YTD. 

Look for the dividend to rise substantially in March when the capital plan/stress test (CCAR) results are announced. 

Citigroup could easily double and still be fairly valued.  Look for it to gain 30-50% this year. 
POSCO (NYSE - PKX (ADR), $78.00)

POSCO was a selection from last year and was carried over.  Here is what I said a year ago:

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.

Nothing has changed except book value grew to around $135/ADR last year.  While that is lower than their 15% annual increase in book value over the last ten years, look for it to continue to grow.

Now earnings will likely come in at around $7.25/ADR in 2013, so you might be asking what's so fantastic about that.  Well, PKX did earn much more than that amount over the past decade.  Typically net profit margins have been in 10-12% range, and up to 15% at times.  Last year they were 7.3%.  That means if they return to past profitability levels earnings will rise to around $11-13/ADR or up 40-80%. 

PKX is a solid long term holding. 

Good luck in 2014!

Best Regards,

Kevin Graham

Disclosure - Long EZPW & BAC class A warrants. 


  1. Hey Kevin,

    Nice picks for 2014. I think you will do well. I just had one question for you. Do you think that the BAC.A warrants are still a buy today or is it better to go with the common?



  2. Thanks for the detailed post.

    In the case of C and BAC, obviously the DTA's won't last forever, they'll bump up earnings for a few years and then revert back to the 1% return on assets that you suggested. if C were to earn $6 a share, for it to double from the current price, it would have to trade at a p/e of 17! Some how I don't see that happening.

    Both BAC and C are cheap, but I see as much upside in WFC with a lot more safety.

  3. 1) Greg - I like the warrants better but it can depend on the account and what you want to do. I had a post a while back explaining the relative benefit from the warrants if held to maturity. I plan on holding them for at least another 2 years and the math says they can return about 40% annually over that time period. Even if I'm off by 50% that will be a 20% annual return.

    2) Regarding the question regarding the DTAs, yes you are correct they won't last forever but they do represent significant present value not being taken into account at the current quote. In the case of Citigroup, they could buy back 1/3 of the outstanding shares with the DTAs. That would permanently increase the EPS by a large amount. You can do the math yourself.

    All I showed is that at normalized EPS and a 12x P/E, the stock would rise 40%.

    If you add in the value from the DTAs, normal earnings growth and a normalize earnings... you will realize 30% for many years.

    Best Regards,

  4. Saw your idea on COBF. What do you think of the issues related to this being non-voting stock, and the Corporate governance concerns?

    Interesting idea!


  5. What do I think? I don't like it just like I don't like how much Jamie Dimon gets paid. If I didn't like the concerns I would vote with my feet and sell the stock. That said, I don't think that management is incompetent. They will get this business back on track.

    I think the concerns for this company are heightened because of the nature of the business. Google has a similar structure and I don't seem as much discussion about their governance. Same can be said for Fairfax.

    I don't plan on holding forever, however I do believe the share price is so low right now you do have a significant margin of safety.

  6. Hey Kevin,

    Just wondering what your thoughts are on Citigroup's earnings the other today?



  7. Hi Rob, not sure what you are referring to specifically. Citi's earnings were disappointing, revenue was down and costs were up from Q3. Earnings have nowhere to go but up. Citi holdings are about a half billion dollar drag every quarter and those assets are fading in the past.


  8. Hello Kevin,

    Are you buying any C or PKX today? PKX has been getting crushed here. Amost selling for half of book!!!!



  9. Hi Tom,

    No I am not buying any although I am interested in PKX at slightly lower prices.

  10. Kevin, we're you able to get EZPW at below $10?

    1. Hi Bill, No I did not buy any below $10 but I know some who did. Were you a buyer today?

      Perhaps you want to make a donation to my paypal account?

  11. Hello Kevin. Long time reader, first time commenter. I would agree that your assessment of EZPW is rock solid as usual. But I'm going to commit a value investors immortal sin and look past the numbers and suggest that the 'news' on this company will ultimately influence its long term value. The Department of Justice is looking to cripple payday operators with legislation into the practice (and not to mention that EZPW’s Executive Chairman of the Board is deciding to step down). True, the pending legislation could create an even better buying opportunity once it passes, but its long term growth would be affected if a large percentage of it’s business is cut-off at the knees by very real legislative restrictions. Cheers. Adam.

  12. Hi Kevin, just wondering what your thoughts are on EZPW now with the change at the heads and the stock price near its lows. Are you adding to your position? Cheers

  13. Yes, I just bought some more. They have already preannounced higher earnings for Q3 and Q4. The latest drama is interesting but the stock remains undervalued.