Stocks

A Stroll Thru The Junkyard ($LKQ)

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This report is offered as an example of the analysis performed during a stock study that you might experience with investment club partners.  The champion and grandfather of the modern investment club movement, George Nicholson Jr. CFA focused attention on the overall quality of companies and suggested laser type emphasis on sales growth, profitability and valuation trends while building a return forecast for companies that we study or own.  At Manifest Investing (www.manifestinvesting.com) we feature several companies each week — generally triggered by (1) positive or negative shifts in fundamentals or (2) stocks that are widely followed by our community of long-term investors.  If you’d like to explore the resources for long-term investors at Manifest Investing, send a request for a test drive to manifest@manifestinvesting.com and we’d be glad to give you some time to kick the tires.

LKQ (LKQ) provides replacement systems, components and parts needed to repair cars and light trucks, primarily in North America and Europe.

Think fender bender. That’s LKQ’s cue to spring into action.

LKQ buys wrecked cars at auction and distributes the reusable parts to collision repair shops. It also provides aftermarket parts services. Customers include repair facilities and insurance companies.

The industry is hugely fragmented. LKQ deploys an aggressive acquisition strategy.

Equity Analysis (Business Model)

It’s easy to see why this company captures the attention of many investors in our community. The up, straight and parallel images suggest a great deal of consistency in an industry that is fairly challenging and very competitive.

The Value Line low total return forecast is 14%.

Focusing on recent history and expectations for our 5-year time horizon, a sales growth forecast of 12% seems feasible. This could be vulnerable to an industry shift from repair to replace. We’ll probably take a closer look at the Retail Automotive industry — and its massive recent performance — and check that against some longer term history from trade/industry data to condition and build growth and profitability forecasts.

The projected net margin is more likely at 6% but Value Line is using 8.1% for their 3-5 year forecast. Shareholders hope that the Value Line analyst (Iason Dalavagas) is right.

A projected average P/E ratio of approximately 20x seems to be in order for this consistent performer that is still a medium-sized workhorse slogging away quite well in an extremely fragmented industry. But they’re becoming the 800-lb gorilla or at least they’re on the way to the jungle.

The Morningstar price-to-fair value (P/FV) ratio is 98% making them a little less optimistic. The S&P P/FV is 78%. The analyst consensus estimate (ACE) for 52-week total return is 33.9%. It’d be interesting to see how that would be impacted by any shift in industry repair/replace trends.

LKQ has a 40% debt-to-capital ratio and the effective interest rate is 6.39% (lowest quartile) so it’s not a leisurely walk through the junkyard. There are some junkyard dogs lurking that bite. Morningstar reduced the financial health to “B” and this will lower our financial strength composite to 72%. The overall quality ranking will still be 95 (Excellent).

Our projected annual return (PAR) is 15% based on 12.2% growth, 6.3% net margins and a projected P/E of 20×.

When Irish Cows Are Smiling

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This Week at MANIFEST (3/20/2015)

“There is little value in the single cow.” — Irish Proverb

“Any man who owns a cow can always find a woman to milk her.” — Irish Saying

Happy St. Patrick’s Day, Daniella!

After spending last weekend in Chicago with some Badgers, Spartans, Buckeyes and various other varmints, I was reminded that Chicago starts St. Patrick’s Day early with a parade on Saturday. The streets were packed with throngs of green-clad celebrants and we watched as the Chicago River was dyed green in compliance. I’m not sure I understand the difference between an Irish proverb and an Irish saying … or what is the meaning behind the bovine suggestions here. But given a choice, I think every portfolio needs more than one cow to avoid the adverse effects of cow tipping.

Chicago also honors a famous cow with a play every March, “When Irish Cows Are Smiling.” Set in March 1872, five months since the Great Chicago Fire, the MOO-morial service, held at the Diggum, Deepe & Dye Funeral Parlour, pays tribute to Mrs. O’Leary’s cow, Daniella Joy, the infamous firebug.

Companies of Interest: Value Line

The average Value Line low total return forecast for the companies in this week’s update batch is 3.9% — slightly higher than the 3.7% for the Value Line 1700.

Materially Stronger: Gentex (GNTX), Synaptics (SYNA), Drew Industries (DW)

Materially Weaker: Avon Products (AVP), Windstream (WIN), Titan International (TWI), Cincinnati Bell (CBB)

Standard Coverage Initiated: Balchem (BCPC)

Discontinued:

Market Barometer

Value Line Low Total Return (VLLTR) Forecast. The long-term low total return forecast for the 1700 companies featured in the Value Line Investment Survey is 3.7%, up slightly from 3.6% last week. For context, this indicator has ranged from low single digits (when stocks are generally overvalued) to approximately 20% when stocks are in the teeth of bear markets like 2008-2009.

Stocks to Study (3/20/2015)

  • LKQ Corp (LKQ) – Highest MANIFEST Rank (100)
  • Neustar (NSR) – Highest Low Return Forecast (VL)
  • Express Scripts (ESRX) – Lowest P/FV (Morningstar)
  • Neustar (NSR) – Lowest P/FV (S&P)
  • Bioscrip (BIOS) – Best 1-Yr Outlook (ACE)
  • Neustar (NSR) – Best 1-Yr Outlook (S&P)

Breaking News: Rite-Aid (RAD) actually has a financial strength rating (2%). While Value Line maintains its “C” (0%) rating on Rite-Aid, Morningstar checks in with a “C” … and the effective interest rate is still steep at 6.8% but it is better than it was!

Stocks to Study (3/9/2015)

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The most “green lights” are on Chart Industries (GTLS) with a nod to Precision Castparts (PCP) a long-time community favorite.

We also note that — despite a solid 2014 (+26.6%) — Berkshire Hathaway (BRK-B) is still a pretty good idea. And a far, far better idea than reading what Berkshire Hathaway has bought and chasing those purchases. It’s a recipe for disaster … or at least erosion of several percentage points of total return.

Stocks to study 20150313

Railroading Profitability: A Quest

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Baron Buffett: What Did He Know & When Did He Know It?

Investors have joked that Warren Buffett’s purchase of the Burlington Northern Santa Fe railroad was simply the fulfillment of a child’s unfulfilled Christmas wish. And on a grand scale.

On November 3, 2009, Warren Buffett’s Berkshire Hathaway announced it would acquire the remaining 77.4 percent of BNSF it did not already own for $100 per share in cash and stock – a deal valued at $44 billion. The company is investing an estimated $34 billion in BNSF and acquiring $10 billion in debt. On February 12, 2010, shareholders of Burlington Northern Santa Fe Corporation voted in favor of the acquisition.

I haven’t dug in to attempt to determine the rate of return on Burlington Northern (yet) but the average annualized return for the average railroad since the time of the transaction is 29.8%. (Berkshire’s return on BNSF is probably in the annual letter to shareholders.)

The Heritage & Industry Profitability

Everything I’ve seen and remember suggest that the profitability levels of 2004-2009 were fairly typical, representative of general net margin levels going back for quite some time.

Note the inflection and the increased profitability that’s been a powerful work-in-progress for the last 5-6 years.

How might he have known that this was going to happen?

Are there any documented instances or evidence of why this is something that could have been anticipated back then?

Is there any place or industry today that has a similar profitability enhancement potential?

Investors, start your locomotive engines.

Southwestern Energy (SWN)

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Four years ago (3/11/2011) Southwestern appeared — as it often has — among our stocks to study during our weekly update. The stock price at the time was 36.12. And although the price reached 49.2 during 2014, the persistent backslide over the last year to 24.54 means that SWN has delivered an annualized return of -9.2%. The Wilshire 5000 has gained 14.8% during the Southwestern swoon.

Business Description

Southwestern Energy is primarily engaged in the exploration & production (E&P) of natural gas and oil.

2011 Outlook

Our forecast at the time featured 10% sales growth, 26% net margins and a projected average P/E ratio of 19x for a projected annual return of approximately 9%.

Equity Analysis

What’s gone wrong? Overall, the sales growth forecast has remained intact. It seems reasonable to expect 7-10% from this relatively small and well-managed company.

The profitability is what has waned. Value Line’s 3-5 year forecast was 31% four years ago and we took some “shots” at that optimism at the time with some duct tape. Optimism is a good thing — in moderation.

The P/E of 20x or so is still OK. This is a good company.

Yes, Virginia, stock prices follow earnings. .

If it’s reasonable to expect the conditions shown in the accompanying analysis, the Southwestern stock price is going to ultimately follow the blue arrow. But it might gurgle for a while.

Why? Because the economic environment and the prices on gas pumps matter. When they tumble, like from $4.29 to $2.19 rather rapidly, companies like SWN get hammered — some more than others. Check out this side-by-side of the SWN stock price swoon versus the price of oil ($BRENT) as a proxy for “energy prices in general.” Believe it or not, Southwestern is less impacted than most and generally recovers faster than most. The natural gas and oil portfolio diversification of their operations probably helps here.

Q: Does the price of energy fluctuate?

A: Yes.

brent 20150306

Conclusion

Many of us, including Hugh, have been talking about the accumulation opportunity that we’re currently experiencing with companies like BP (BP), Schlumberger (SLB) and others.

Looking at the preceding graph, unless you expect that long-term moving average (blue line) to invert and start heading “south”, energy prices will be higher at some point in the future. Companies like Southwestern will persist and ultimately do better.

Personally, I look at the long-term characteristic of that trend (+6.3% annualized over the last 6 years) and see $130-$150 price levels in 3-5 years. It’s possible. Virginia would like to remind all of us that stock prices follow earnings … eventually.

Exxon Mobil (XOM)

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Much has been made of Berkshire Hathaway’s recent sale of Exxon Mobil ($XOM) in recent days — with Buffett himself stepping up to defend the company as a high-quality industry leader.  From a long term investing perspective, some of the integrated oil companies look compelling but may admittedly have some tough sledding for the next 18-24 months if current EPS forecasts are credible and materialize.

Because yes, Virginia, stock prices do ultimately follow earnings.

Here’s a look at current Equity Analysis Guide worksheet for Exxon Mobil (XOM) showing the turbulence. It’s not small.

That long-term growth trend is approximately 2%.

Xom eagle 20150304

Exxon Mobil (XOM) can also be an example of using a different valuation method (P/CF) for building a return forecast.

In this case, do a regression-based sales forecast for 5 years from now (~460,000).

The cash flow margin (cash flow/sales) is quite consistent at 13%.

The price-to-cash flow (P/CF) is also very consistent at 8.0×.

Xom pcf 20150304

This supports an average long-term price forecast of $115 — and a return forecast of 8-9%.
Xom pcf forecast 20150304

Round Table (February 2015)

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You’re invited to join us as the colleagues of the Round Table present their favorite stock study ideas at the February session.

It’s our annual black tie over suit-of-armor extravaganza as we’ll also honor the best moments and decisions of 2014 and since inception of the Round Table five years ago.

Awards to be Presented

  • Best Stock Selection (2014)
  • Best Stock Selection (All-Time)
  • Best Picture/Story
  • Best Accuracy (2014 & All-Time)
  • Best Return Performance (2014 & All-Time)

Registration: https://www.manifestinvesting.com/events/166-round-table-february-2015

This Is How We Do (2014 Results)

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For those of you who watched the Super Bowl (and those of you who watch the commercials and halftime show), recall that Katy Perry rode into the stadium for the halftime extravaganza on a huge lion, singing about roaring like a champion?

One of her hit songs is entitled, This Is How We Do.

This is how we do… yeah, chilling, laid back
Straight stuntin’ ya we do it like that

I didn’t know what “stuntin” actually referred to but based on this urban dictionary rendition, we think it applies to all things Groundhog. Hugh McManus of Pasadena and the Serious Investment Club of Pittsburgh are the latest in a long line of stuntin legacy — taking home top honors for Groundhog Challenge VIII in the individual and group categories.

Collectively, we “chill, lay back” and select a basket of 5-20 stocks that will go unchanged over the course of the Groundhog Calendar. Over the years, we’ve noticed very little swinging for the fences. A few participants will try to isolate a promising deep value situation with a potential catalyst that could deliver over the course of a year. But for the most part, the participants select high-quality stocks that would be suitable for the long term, a time horizon measured in years, if not decades.

Gh returns 20150202r
We kick off this performance results summary with a look at the collective performance over eight years where the average annualized return is 10.0% during a period when the Wilshire 5000 delivered 6.6% annualized returns.

Straight stuntin’ indeed.

The following table presents the leader board at the conclusion of the 2014 stock picking contest.  $1,000,000 invested on Groundhog Day (2/2/2014) became what is displayed here.

All-Time Results: Honor Roll

Tesla Motors (TSLA): Speed Bump?

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Some people think Tesla Motors (TSLA) got “crushed” on a weak earnings report.

Tsla crushed

Here’s the aforementioned MarketWatch article:

http://www.marketwatch.com/story/tesla-four-takeaways-from-earnings-2015-02-11

From a short term/trading perspective that first chart is a whack.

But on this chart, it’s a speed bump.

Tsla chart 20150212

This is what a crushing looks like.

Crushed car

I have no idea what the future holds for Tesla, I expect it to be “consumed” by one of the large car companies, but who knows?

But from a long-term perspective, this feels more like a speed bump …

Speed bump poster

Heavy Hogs (2015): Invest With Your Friends

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Here are the consensus favorites from the entries in Groundhog Challenge IX (2015).

It was a dead heat between QUALCOMM (QCOM) and Cognizant Technology (CTSH). The figures in parentheses are the number of times a stock appeared among the 2015 entries.

It’s a solid list across the board with an overall PAR of 15.1% and an average quality rating of 91. Collectively, these selections rank in the top 7th percentile of all stocks based on return forecast and quality ranking. The average Value Line low total return forecast is 11.1% (vs. 3-4% for the Value Line 1700). The price-to-fair value ratios according to Morningstar and S&P are also quite favorable … as well as the 1-year total return forecast (+20.3%) based on consensus 1-year price targets (and current yields).

Heavy hogs 2015 20150206

The tracking dashboard for the 2015 consensus selections (Heavy Hogs) is available at:

https://www.manifestinvesting.com/dashboards/public/heavy-hogs-2015